UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
T | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year endedDecember 31, 2011
OR
£ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission file number: 0-54124
FEDFIRST FINANCIAL CORPORATION | ||
(Exact name of registrant as specified in its charter) |
Maryland | 80-0578993 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
565 Donner Avenue, Monessen, Pennsylvania | 15062 | |
(Address of principal executive offices) | (Zip Code) |
Issuer’s telephone number: (724) 684-6800
Securities registered under Section 12(b) of the Exchange Act:
Common Stock, par value $0.01 per share | Nasdaq Stock Market LLC | |
Title of each class | Name of each exchange on which registered |
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes£ NoT
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£ NoT
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. YesT No£
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YesT No0
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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.T
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 the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | £ | Accelerated filer | £ | ||
Non-accelerated filer | £ (Do not check if a smaller reporting company) | Smaller reporting company | T |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes£ NoT
The aggregate market value of the voting and non-voting common equity held by nonaffiliates as of June 30, 2011 was approximately $41,202,000.
The number of shares outstanding of the registrant’s common stock as of March 21, 2012 was 2,912,302.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 2012 Annual Meeting of Stockholders are incorporated by reference in Part III of this 10-K.
INDEX
Page | |||
PART I | |||
Item 1. | Business | K-1 | |
Item 1A. | Risk Factors | K-15 | |
Item 1B. | Unresolved Staff Comments | K-20 | |
Item 2. | Properties | K-21 | |
Item 3. | Legal Proceedings | K-21 | |
Item 4. | Mine Safety Disclosures | K-21 | |
PART II | |||
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities | K-21 | |
Item 6. | Selected Financial Data | K-22 | |
Item 7. | Management’s Discussion and Analysis of Financial Condition and | ||
Results of Operation | K-22 | ||
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | K-50 | |
Item 8. | Financial Statements and Supplementary Data | K-50 | |
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | K-50 | |
Item 9A. | Controls and Procedures | K-50 | |
Item 9B. | Other Information | K-51 | |
PART III | |||
Item 10. | Directors, Executive Officers, and Corporate Governance | K-51 | |
Item 11. | Executive Compensation | K-51 | |
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | K-51 | |
Item 13. | Certain Relationships and Related Transactions, and Director Independence | K-52 | |
Item 14. | Principal Accounting Fees and Services | K-52 | |
Item 15. | Exhibits and Financial Statement Schedules | K-53 | |
SIGNATURES |
i |
This report contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on FedFirst Financial Corporation’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.
Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include the following: interest rate trends; the general economic climate in the market area in which FedFirst Financial Corporation operates, as well as nationwide; FedFirst Financial Corporation’s ability to control costs and expenses; competitive products and pricing; loan delinquency rates; and changes in federal and state legislation and regulation. Additional factors that may affect our results are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. FedFirst Financial Corporation assumes no obligation to update any forward-looking statements.
PART I
ITEM 1. | BUSINESS |
General
FedFirst Financial Corporation (“FedFirst Financial” or the “Company”) is a stock holding company established in 2010, whose wholly owned subsidiary is First Federal Savings Bank (“First Federal” or the “Bank”), a federally chartered stock savings bank. Through its wholly-owned subsidiary FedFirst Exchange Corporation (“FFEC”), the Bank has an 80% controlling interest in Exchange Underwriters, Inc. (“Exchange Underwriters”). Exchange Underwriters is a full-service, independent insurance agency that offers property and casualty, commercial liability, surety and other insurance products.
The Company completed its conversion from the mutual holding company form of organization to the stock holding company form on September 21, 2010. As a result of the conversion, FedFirst Financial Corporation, a newly formed state-chartered corporation, became the holding company for First Federal Savings Bank, and FedFirst Financial Mutual Holding Company and the former FedFirst Financial Corporation ceased to exist. As part of the conversion, all outstanding shares of the former FedFirst Financial Corporation common stock (other than those owned by FedFirst Financial Mutual Holding Company) were converted into the right to receive 0.4735 of a share of the new FedFirst Financial common stock resulting in 1,270,484 shares issued in the exchange. In addition, a total of 1,722,185 shares of common stock were sold in the subscription, community and syndicated community offerings at the price of $10.00 per share or $17.2 million in the aggregate. The completion of the Company’s public offering raised $15.4 million in proceeds, net of $1.9 million in offering expenses.
The Bank operates as a community-oriented financial institution offering residential, multi-family and commercial mortgages, consumer loans and commercial business loans as well as a variety of deposit products for individuals and businesses from eight locations in southwestern Pennsylvania. The Bank conducts insurance brokerage activities through Exchange Underwriters. The Bank is subject to competition from other financial institutions and to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), on July 21, 2011 the Office of the Comptroller of the Currency (“OCC”) assumed responsibility from the Office of Thrift Supervision (“OTS”) for the ongoing examination, supervision, and regulation of federal savings associations and rulemaking for all savings associations. In addition, the Dodd-Frank Act transferred OTS functions related to the supervision of savings and loan holding companies to the Board of Governors of the Federal Reserve System.
K-1 |
Our website address is www.firstfederal-savings.com. Information on our website should not be considered a part of this Annual Report on Form 10-K.
Market Area
Our eight banking offices are located in Fayette, Washington and Westmoreland counties, which are located in the southern suburban area of metropolitan Pittsburgh. Generally, our offices are located in small industrial communities that, in the past, relied extensively on the steel industry. Until the mid-1970s, these communities flourished. However, in the past 30 years, the economy of our market area has diminished in direct correlation with the decline in the United States steel industry. With the decline of the steel industry, Fayette, Washington and Westmoreland counties now have smaller and more diversified economies, with employment in services constituting the primary source of employment in all three counties. The largest private-sector employers in our market area are providers of health care services.
In the past, the communities in which our offices are located provided a stable customer base for traditional thrift products, such as statement savings, certificates of deposit and residential mortgages. Following the closing of the area’s steel mills, population and employment trends declined. The population in many of the smaller communities in our market area continues to shrink as the younger population leaves to seek better and more reliable employment. As a result, the median age of our customers has been increasing. With an aging customer base and little new real estate development, the lending opportunities in our primary market area are limited. To counter these trends, we expanded into communities that are experiencing population growth and economic expansion. In July 2006, we opened an office in Peters Township in Washington County. In June 2007, we opened an office in the downtown area of Washington, Pennsylvania.
Competition
We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the several financial institutions operating in our market area and from other financial service companies, such as brokerage firms, credit unions and insurance companies. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2011, which is the most recent date for which data is available from the FDIC, we held approximately 0.29% of the deposits in the Pittsburgh metropolitan area. Banks owned by The PNC Financial Services Group, Inc., Citizens Financial Group, Inc. and BNY Mellon also operate in our market area. These institutions, as well as many other banking institutions operating in our market area, are significantly larger than us and, therefore, have significantly greater resources.
Our competition for loans comes primarily from financial institutions in our market area and, to a lesser extent, from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.
We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Competition for deposits and the origination of loans could limit our growth in the future.
Lending Activities
Residential Mortgage Loans.Our primary lending activity is the origination of mortgage loans to enable borrowers to purchase or refinance existing homes located in the greater Pittsburgh metropolitan area. We offer fixed and adjustable rate mortgage loans with terms up to 30 years.
K-2 |
Interest rates and payments on our adjustable rate mortgage loans generally adjust annually after an initial fixed period that ranges from one to ten years. Interest rates and payments on our adjustable rate loans generally are adjusted to a rate typically equal to 2.75% or 3.00% above the applicable index. We use the one year constant maturity Treasury index for loans that adjust annually and the three year constant maturity Treasury index for loans that adjust every three years. The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan. Borrower demand for adjustable versus fixed rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed rate mortgage loans and the initial period interest rates and loan fees for adjustable rate loans. The relative amount of fixed and adjustable rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. We currently have a low demand for our adjustable rate mortgage loans. The loan fees charged, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.
Prior to 2006, we purchased newly originated, single family, fixed rate mortgage loans to supplement our origination activities. The properties securing the loans are located in 13 states around the country. We underwrote all of the purchased loans to the same standards as loans originated by us. We may purchase additional loans in the future to supplement our origination activities. At December 31, 2011, we had 103 purchased residential loans that totaled $16.3 million. Of these, 40 loans totaling $5.1 million were secured by homes in Michigan and 25 loans totaling $5.1 million were secured by homes in Ohio.
While residential real estate loans are normally originated with up to 30 year terms, such loans may remain outstanding for shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
We generally do not make conventional loans with loan-to-value ratios exceeding 97%. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral. We require all properties securing mortgage loans to be appraised by a board-approved, independent appraiser. We generally require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance for loans on property located in a flood zone, before closing the loan.
In an effort to provide financing for low and moderate income and first-time buyers, we offer a special home buyers program. We offer residential mortgage loans through this program to qualified individuals and originate the loans using modified underwriting guidelines, including reduced fees and loan conditions. We do not engage in subprime or Alt-A lending.
Commercial and Multi-Family Real Estate Loans.We offer a variety of fixed and adjustable rate mortgage loans secured by commercial property and multi-family real estate. These loans generally have terms of ten years with a 20 year amortization and are typically secured by apartment buildings, office buildings, or manufacturing facilities. Loans are secured by first mortgages, and amounts generally do not exceed 80% of the property’s appraised value. In addition to originating these loans, we also purchase and sell participation loans originated with other financial institutions in the region.
Prior to 2006, we purchased newly originated multi-family real estate loans as part of our efforts to increase our loan portfolio. The properties securing the loans are located in six states throughout the country. We sought geographic diversification among the purchased loans so that we would not concentrate exposure to changes in any particular local or regional economy. We underwrote all of the purchased loans to the same standards as loans originated by us. At December 31, 2011, purchased multi-family real estate loans totaled $5.1 million.
K-3 |
At December 31, 2011, our largest multi-family real estate loan was $3.6 million and was secured by a 10 building apartment complex. Our largest commercial real estate loan was a $2.4 million line of credit secured by a commercial property with $1.6 million outstanding. These loans were performing in accordance with their original terms at December 31, 2011.
At December 31, 2011, loan participations at other financial institutions totaled $9.3 million. All of the properties securing these loans are located in the Pittsburgh metropolitan area. Our largest participation loan was $1.3 million.
Construction Loans.We originate loans to individuals to finance the construction of residential dwellings. We also make loans for the construction of commercial properties, including apartment buildings and owner-occupied properties used for businesses. Our construction loans generally provide for the payment of interest only during the construction phase, which is usually 12 months. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Loans generally can be made with a maximum loan-to-value ratio of 97% on residential construction and 80% on commercial construction. Loans with loan-to-value ratios in excess of 80% on residential construction generally require private mortgage insurance or additional collateral. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also will require an inspection of the property before disbursement of funds during the term of the construction loan.
At December 31, 2011, our largest outstanding residential construction loan commitment was for $1.3 million, of which $123,000 had been disbursed. At December 31, 2011, our largest outstanding commercial construction commitment was a $7.3 million participation loan that was originated internally. The Bank has retained a $2.1 million interest in the loan, of which $1.7 million had been disbursed. These loans were performing in accordance with their original terms at December 31, 2011.
Commercial Business Loans.We originate commercial business loans to professionals and small businesses in our market area. We offer installment loans for a variety of business needs including capital improvements and equipment acquisition. Other commercial loans are secured by business assets such as accounts receivable, inventory, and equipment, and are typically backed by the personal guarantee of the borrower. We originate working capital lines of credit to finance the short-term needs of businesses. These credit lines are repaid by seasonal cash flows from operations and are also typically backed by the personal guarantee of the borrower.
We also originate commercial leases through a Pittsburgh area machinery and equipment leasing company. These leases are secured by machinery and equipment. At December 31, 2011, we had 15 equipment leases totaling $3.6 million.
When evaluating commercial business loans, we perform a detailed financial analysis of the borrower and/or guarantor which includes but is not limited to: cash flow and balance sheet analysis, debt service capabilities, review of industry (geographic and economic conditions) and collateral analysis. We independently underwrite in accordance with our commercial loan policy all of the equipment leases that we originate through the third-party leasing company.
At December 31, 2011, our largest commercial business loan relationship was a $2.0 million warehouse line of credit, of which $1.7 million was outstanding. This loan was performing in accordance with its original terms at December 31, 2011.
Consumer Loans.Our consumer loans include home equity lines of credit, home equity installment loans, loans on savings accounts, and personal lines of credit and installment loans.
The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
K-4 |
We offer home equity installment loans and home equity lines of credit. In 2007, we discontinued offering home equity loans with a maximum loan-to-value ratio greater than 100%. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate. Home equity installment loans have fixed interest rates and terms that range up to 30 years. We also offer secured and unsecured consumer loans that have fixed interest rates and terms that can range from one to 10 years.
Loan Underwriting Risks
Adjustable Rate Loans.While we anticipate that adjustable rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed rate mortgages, the increased mortgage payments required of adjustable rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. In addition, although adjustable rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.
Commercial and Multi-Family Real Estate Loans.Loans secured by commercial and multi-family real estate generally have larger balances and involve a greater degree of risk than residential mortgage loans. Of primary concern in commercial and multi-family real estate lending is the borrower’s creditworthiness and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor cash flow on income properties, we require borrowers and/or guarantors to provide annual financial statements regarding the commercial and multi-family real estate. In reaching a decision on whether to grant a commercial or multi-family real estate loan, we consider the cash flow of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property. We also may look to the financial strength of any related entities in approving the request.
We have generally required that the properties securing these real estate loans have a debt service coverage ratio (cash flow available to service debt/debt service) of at least 1.25x and a leverage ratio (debt-to-worth) of less than 3.0x. Environmental surveys are obtained for requests greater than $1.0 million or when circumstances suggest the possibility of the presence of hazardous materials.
We underwrite all commercial loan participations to the same standards as loans originated by us. In addition, we also consider the financial strength and reputation of the lead lender. We require the lead lender to provide a full closing package as well as annual financial statements for the borrower and related entities so that we can conduct an annual loan review for all loan participations.
Construction Loans.Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Commercial Business Loans. Commercial business loans are higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. A debt service coverage ratio of at least 1.25x and a leverage ratio of less than 3.0x are also applicable to commercial business loans. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We also maintain allowable advance rates for each collateral type to ensure coverage.
K-5 |
Consumer Loans.Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations are telephone marketing efforts, existing customers, walk-in traffic, loan brokers, advertising and referrals from customers. We have a relationship with a mortgage broker through which we originate a substantial portion of our residential mortgage loans, and we have a relationship with a commercial leasing company through which we originate commercial equipment leases. We generally originate loans for our portfolio and have not sold any loans in recent years. Prior to 2006, we had purchased loans to supplement our own loan originations.
Loan Approval Procedures and Authority.Our lending activities follow written, nondiscriminatory, underwriting standards and loan origination procedures established by our board of directors and management. The board of directors has granted certain loan approval authority to a committee of officers. The loan committee approves all residential mortgages, construction loans and consumer loans. All commercial and multi-family loans over $500,000 and loans or extensions of credit to insiders require the approval of the board of directors. All commercial loans up to $500,000 require approval from a committee that includes two executive officers.
Loans to One Borrower.The maximum amount that we may lend to one borrower and the borrower’s related entities is limited, by regulation, to generally 15.0% of our unimpaired capital and surplus. At December 31, 2011, our regulatory limit on loans to one borrower was $6.8 million. At that date, our largest lending relationship was a $3.6 million multi-family loan. This loan was performing in accordance with its original terms at December 31, 2011.
Loan Commitments.We issue commitments for fixed and adjustable rate mortgage and commercial loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 45 days.
Investment Activities
We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, Government-sponsored enterprise securities and securities of various federal agencies and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions. Within certain regulatory limits, we also may invest a portion of our assets in corporate securities and mutual funds. We also are required to maintain an investment in Federal Home Loan Bank (“FHLB”) of Pittsburgh stock. While we have the authority under applicable law and our investment policies to invest in derivative securities, we have never invested in such investments.
At December 31, 2011, our investment portfolio consisted of Government-sponsored enterprise securities, municipal bonds, mortgage-backed securities issued primarily by Fannie Mae and Freddie Mac, guaranteed REMIC pass-through certificates, and corporate debt securities.
Our investment objectives are to provide and maintain liquidity, to provide collateral for pledging requirements, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of investment when demand for loans is weak and to generate a favorable return. Our board of directors has the overall responsibility for the investment portfolio, including approval of the investment policy and appointment of the Investment Committee. The Investment Committee consists of four of our executive officers. The Investment Committee is responsible for implementation of the investment policy and monitoring our investment performance. Individual investment transactions are reviewed and ratified by the board of directors on a monthly basis.
K-6 |
Insurance Activities
We conduct insurance brokerage activities through our 80%-owned subsidiary, Exchange Underwriters. Exchange Underwriters is a full-service, independent insurance agency that offers a variety of property and casualty, liability, and other insurance products for small businesses and individuals through over 25 insurance carriers. Exchange Underwriters is licensed in more than 35 states. In addition to serving businesses and individuals in the Pittsburgh metropolitan areas, Exchange Underwriters has developed specialty programs that are sold nationwide.
Exchange Underwriters generates revenues primarily from commissions paid by insurance companies with respect to the placement of insurance products. Commission revenue includes contingent commissions, which are commissions paid by an insurance carrier that are based on the overall profit and/or volume of the business placed with that insurance carrier during a particular calendar year.
In March 2009, Exchange Underwriters expanded its operation through the acquisition of the Allsurance Insurance Agency, which is a full-service, independent insurance agency that offers insurance for individuals and small businesses.
Deposit Activities and Other Sources of Funds
General.Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and economic conditions.
Deposit Accounts.Substantially all of our depositors are residents of Pennsylvania. Deposits are attracted from within our market area through the offering of a broad selection of deposit products such as noninterest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), statement savings accounts and certificates of deposit (including individual retirement accounts). Deposit products are supported by services including internet banking, bill pay and telephone banking. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, liquidity needs, profitability, matching deposit and loan products and customer preferences and concerns. We generally review our deposit mix and pricing weekly. Our current strategy is to offer competitive rates on all types of deposit products.
In addition to accounts for individuals, we also offer deposit accounts designed for the businesses operating in our market area. Our business banking deposit products include commercial checking accounts, money market accounts, sweep services and remote electronic deposit.
At December 31, 2011, we did not have any brokered deposits.
Borrowings.We utilize advances from the FHLB and, to a limited extent, repurchase agreements to supplement our supply of investable funds. The Bank also has the ability to borrow from the Federal Reserve based upon eligible collateral. The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States or Government-sponsored enterprises), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the FHLB’s assessment of the institution’s creditworthiness.
Personnel
At December 31, 2011, we had 86 full-time equivalent employees, including 17 employees of our insurance agency subsidiary, none of whom is represented by a collective bargaining unit. We believe that our relationship with our employees is good.
K-7 |
Subsidiaries
FedFirst Financial’s only direct subsidiary is First Federal Savings Bank. First Federal Savings Bank’s only direct subsidiary is FedFirst Exchange Corporation. FedFirst Exchange Corporation owns an 80% interest in Exchange Underwriters.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are elected annually by the board of directors and serve at the board’s discretion. The following individuals currently serve as executive officers of FedFirst Financial and First Federal Savings Bank.
Name | Position |
Patrick G. O’Brien | President and Chief Executive Officer of FedFirst Financial and First Federal Savings Bank |
Jamie L. Prah | Senior Vice President—Chief Financial Officer of FedFirst Financial and First Federal Savings Bank and Assistant Corporate Secretary of First Federal Savings. |
Richard B. Boyer | Vice President—Insurance Operations of First Federal Savings Bank and President of Exchange Underwriters, Inc. |
Henry B. Brown III | Senior Vice President—Chief Lending Officer of First Federal Savings Bank |
Geraldine A. Ferrara | Vice President—Manager Branch Service and Sales of First Federal Savings Bank |
Jennifer L. George | Senior Vice President—Chief Risk Officer of First Federal Savings Bank and Corporate Secretary of FedFirst Financial and First Federal Savings Bank. |
DaCosta Smith, III | Vice President—Manager Human Resources of First Federal Savings Bank and Vice President of FedFirst Financial |
Below is information regarding our executive officers who are not also directors. Each executive officer has held his or her current position for at least the last five years unless stated otherwise. Ages presented are as of December 31, 2011.
Jamie L. Prahwas appointed as Senior Vice President – Chief Financial Officer of FedFirst Financial and First Federal in September 2011 after previously serving as Vice President—Controller and Treasurer of First Federal since February 2005. In 2010, Mr. Prah was also appointed Assistant Corporate Secretary of First Federal. Age 41.
Henry B. Brown IIIwas appointed as Senior Vice President – Chief Lending Officer in September 2011 after previously serving as Vice President—Manager Production & Credit of First Federal since August 2007. Prior to joining First Federal, Mr. Brown served as Senior Vice President—Treasury Management at WesBanco Bank, Inc. from May 2005 to August 2007. Age 60.
Geraldine A. Ferrarawas appointed as Vice President – Manager Branch Services and Sales in August 2006 after previously serving as Vice President—Consumer Sales Manager since October 2005. Prior to working with First Federal, Ms. Ferrara served as Vice President—Market Manager at PNC Bank from June 2004 to October 2005. Age 60.
Jennifer L. Georgewas appointed as Senior Vice President – Chief Risk Officer in September 2011 after previously serving as Vice President—Bank Operations since July 2007. Ms. George joined First Federal in January 2006 as Assistant Controller. In 2010, Ms. George was also appointed Corporate Secretary of FedFirst Financial and First Federal. Prior to working with First Federal, Ms. George served as Accounts Payable Manager with Del Monte Foods from April 2005 to December 2005. Age 40.
DaCosta Smith, IIIhas served as the Vice President—Manager Human Resources for First Federal since 1992. Age 56.
K-8 |
REGULATION AND SUPERVISION
General
As a savings and loan holding company, FedFirst Financial is required by federal law to report to, and otherwise comply with the rules and regulations of, the Federal Reserve Board (“FRB”). The Bank, as an insured federal savings association, is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”), as the insurer of its deposits.
The Bank is a member of the FHLB System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the FDIC. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition and obtain regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings associations. The OCC and/or the FDIC conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OCC, the FRB, the FDIC or Congress, could have a material adverse impact on FedFirst Financial, the Bank and their operations.
The Dodd-Frank Act, enacted in 2010, makes extensive changes in the regulation and supervision of federal savings institutions like the Bank. Under the Dodd-Frank Act, the OTS was eliminated, and responsibility for the supervision and regulation of federal savings banks was transferred to the OCC, the agency that regulates national banks. The OCC assumed primary responsibility for examining the Bank and implementing and enforcing many of the laws and regulations applicable to federal savings institutions. At the same time, the responsibility for supervising and regulating savings and loan holding companies, such as FedFirst Financial, was transferred to the FRB. In addition, the Dodd-Frank Act created a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the FRB, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the enforcement authority of, their primary federal regulator rather than the Consumer Financial Protection Bureau.
Certain regulatory requirements applicable to the Bank and to FedFirst Financial are referred to below or elsewhere herein. The summary of statutory provisions and regulations applicable to savings associations and their holding companies set forth below and elsewhere in this document does not purport to be a complete description of such statutes and regulations and their effects on the Bank and FedFirst Financial and is qualified in its entirety by reference to the actual laws and regulations.
K-9 |
Holding Company Regulation
Activities Restrictions.FedFirst Financial is a unitary savings and loan holding company within the meaning of federal law. As a unitary savings and loan holding company that was in existence prior to May 4, 1999, FedFirst Financial is generally not restricted as to the types of business activities in which it may engage, provided that the Bank continues to be a qualified thrift lender. See “Federal Savings Association Regulation - QTL Test.” No company may acquire control of a savings association unless that company engages only in the financial activities permitted for financial holding companies under the law (which includes those permitted for bank holding companies) or for multiple savings and loan holding companies as described below. Upon any non-supervisory acquisition by FedFirst Financial of another savings association or savings bank that meets the qualified thrift lender test and is deemed to be a savings association by the OCC, FedFirst Financial would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies, subject to the prior approval of the FRB, and certain activities authorized by FRB regulation. In addition, FedFirst Financial may also engage in activities permitted for financial holding companies under certain conditions, including the filing of an election to be treated as a financial holding company with the FRB.
A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company, without prior written approval of the FRB and from acquiring or retaining control of a depository institution that is not insured by the FDIC.
The FRB may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings associations 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 association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. There is a five-year transition period before the capital requirements will apply to savings and loan holding companies. Instruments such as cumulative preferred stock and trust preferred securities will not be includable as Tier 1 capital, except that instruments issued before May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions, which will require holding companies to provide capital and other support to their subsidiary institutions in times of financial distress.
Source of Strength.The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
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Acquisition of FedFirst Financial.Under the Federal Change in Control Act, a notice must be submitted to the FRB if any person (including a company or savings association), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company or savings association. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of FedFirst Financial’s outstanding voting stock, unless the FRB has found that the acquisition will not result in control of FedFirst Financial. A change in control definitively occurs upon the acquisition of 25% or more of FedFirst Financial’s outstanding voting stock. Under the Change in Control Act, the FRB 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. Any company that acquires control would then be subject to regulation as a savings and loan holding company.
Federal Savings Association Regulation
Business Activities.The activities of federal savings associations are governed by federal laws and regulations. Those laws and regulations delineate the nature and extent of the business activities in which federal savings associations may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.
The Dodd-Frank Act authorized the payment of interest on commercial checking accounts, effective July 21, 2011.
Capital Requirements.Federal savings associations must meet three minimum capital standards: a 1.5% tangible capital to total assets ratio; a 4% tier 1 capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) 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 activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OCC capital regulation based on the risks believed inherent in the type of asset. The OCC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular circumstances. At December 31, 2011, the Bank met each of its capital requirements.
Prompt Corrective Regulatory Action.The OCC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OCC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.
Insurance of Deposit Accounts.The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.
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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 factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations. Assessment rates currently range from seven to 77.5 basis points. As required by the Dodd-Frank Act, the FDIC has revised its procedures to base its assessments upon total assets less tangible equity instead of deposits. The FDIC may adjust the scale uniformly, except that no adjustment can deviate more than three basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.
The FDIC required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012. The estimated assessments, which included an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 31, 2009. As of December 31, 2009, and each quarter thereafter, a charge to earnings is recorded for each regular assessment with an offsetting credit to the prepaid asset.
Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000. That coverage was made permanent by the Dodd-Frank Act. In addition, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012. The Bank opted to participate in the unlimited noninterest-bearing transaction account coverage and the Bank and FedFirst Financial opted not to participate in the unsecured debt guarantee program. The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transaction accounts from January 1, 2011 until December 31, 2012 without the opportunity for opt out.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Loans to One Borrower.Federal law provides that savings associations are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.
QTL Test.Federal law requires savings associations to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; 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 securities but also including education, credit card and small business loans) in at least 9 months out of each 12 month period.
A savings association that fails the qualified thrift lender test is subject to certain operating restrictions, including dividend limitations. The Dodd-Frank Act made noncompliance with the qualified thrift lender test subject to agency enforcement action as a violation of law. As of December 31, 2011, the Bank maintained 84.3% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.
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Limitation on Capital Distributions.FRB and OCC regulations impose limitations upon all capital distributions by a savings association, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, a notice must be filed with the FRB 30 days prior to declaring a dividend, with a notice to the OCC. The FRB may disapprove a dividend notice if the proposed dividend raises safety and soundness concerns, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. In the event the Bank’s capital fell below its regulatory requirements or the OCC notified it that it was in need of increased supervision, the Bank’s ability to make capital distributions could be restricted. In addition, the FRB could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the FRB determines that such distribution would constitute an unsafe or unsound practice.
Transactions with Related Parties. The Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with the Bank, including FedFirst Financial and its other subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings association may purchase the securities of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by FedFirst Financial to its executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control is limited. The laws limit both the individual and aggregate amount of loans that the Bank may make to insiders based, in part, on the Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.
Enforcement.The OCC has primary enforcement responsibility over savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OCC that enforcement action be taken with respect to a particular savings association. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
FHLB System
The Bank is a member of the FHLB System, which consists of twelve (12) regional Federal Home Loan Banks. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Pittsburgh, is required to acquire and hold shares of capital stock in that FHLB. The Bank was in compliance with this requirement with an investment in FHLB of Pittsburgh stock at December 31, 2011 of $5.3 million.
K-13 |
The Federal Home Loan Banks have been required to provide funds for the resolution of insolvent thrifts in the late 1980s and contribute funds for affordable housing programs. These and similar requirements, or general economic conditions, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, the Bank’s net interest income would likely also be reduced.
Federal Reserve System
The FRB regulations require savings associations to maintain non-interest earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts). For 2011, the regulations provided that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio was assessed on net transaction accounts up to and including $58.8 million; a 10% reserve ratio was applied above $58.8 million. The first $10.7 million of otherwise reservable balances were exempted from the reserve requirements. These amounts are adjusted annually and, for 2012, require a 3% ratio for up to $71.0 million and an exemption of $11.5 million. The Bank complies with the foregoing requirements.
FEDERAL AND STATE TAXATION
Federal Income Taxation
General.We report our income on a fiscal year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly, our reserve for bad debts, discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. Our federal income tax returns have been either audited or closed under the statute of limitations through tax year 2007. For its 2011 fiscal year, FedFirst Financial’s maximum federal income tax rate was 34%.
FedFirst Financial and the Bank have entered into a tax allocation agreement. Because FedFirst Financial owns 100% of the issued and outstanding capital stock of the Bank, FedFirst Financial and the Bank are members of an affiliated group within the meaning of Section 1504(a) of the Internal Revenue Code, of which group FedFirst Financial is the common parent corporation. As a result of this affiliation, The Bank may be included in the filing of a consolidated federal income tax return with FedFirst Financial and, if a decision to file a consolidated tax return is made, the parties agree to compensate each other for their individual share of the consolidated tax liability and/or any tax benefits provided by them in the filing of the consolidated federal income tax return.
Bad Debt Reserves.For fiscal years beginning before 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for nonqualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and require savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $2.5 million of FedFirst Financial’s accumulated bad debt reserves would not be recaptured into taxable income unless the Bank makes a “non-dividend distribution” to FedFirst Financial as described below.
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Distributions.If the Bank makes “non-dividend distributions” to FedFirst Financial, the distributions will be considered to have been made from the Bank’s unrecaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from the Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in the Bank’s taxable income. Non-dividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank’s current or accumulated earnings and profits will not be so included in the Bank’s taxable income.
The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if the Bank makes a non-dividend distribution to FedFirst Financial, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
State Taxation
FedFirst Financial and its non-thrift Pennsylvania subsidiaries are subject to the Pennsylvania Corporation Net Income Tax and Capital Stock and Franchise Tax. The state Corporate Net Income Tax rate for fiscal years ended 2011, 2010 and 2009 was 9.99% and was imposed on FedFirst Financial’s and its non-thrift subsidiaries’ unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed at the rate of 0.289% of a corporation’s capital stock value, which is determined in accordance with a fixed formula. In addition, the Pennsylvania mutual thrifts institutions tax is imposed at the rate of 11.5% on savings institutions, savings banks, and savings and loan associations conducting business in Pennsylvania. The mutual thrift institutions tax applies to the net earnings or income received or accrued from all sources during the tax year. In 2011 and 2010, no mutual thrift institutions tax was paid due to the utilization of state net operating loss carryforwards. There are no remaining state net operating loss carryforwards as of December 31, 2011.
ITEM 1A. | RISK FACTORS |
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
Following a national home price peak in mid-2006, falling home prices and sharply reduced sales volumes, along with the collapse of the United States’ subprime mortgage industry in early 2007, significantly contributed to a recession that officially lasted until June 2009, although the effects continued thereafter. Dramatic declines in real estate values and high levels of foreclosures resulted in significant asset write-downs by financial institutions, which have caused many financial institutions to seek additional capital, to merge with other institutions and, in some cases, to fail. Concerns over the United States’ credit rating (which was downgraded by Standard & Poor’s), the European sovereign debt crisis, and continued high unemployment in the United States, among other economic indicators, have contributed to increased volatility in the capital markets and diminished expectations for the economy.
A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
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Our emphasis on residential mortgage loans exposes us to a risk of loss due to a decline in property values.
At December 31, 2011, $133.9 million, or 52.4%, of our loan portfolio consisted of residential mortgage loans, and $38.4 million, or 15.1%, of our loan portfolio consisted of home equity loans. We currently originate home equity lines of credit with maximum combined loan-to-value ratios of up to 100%. Until 2007, such loans were offered with combined loan-to-value ratios of up to 125%. Recent declines in the housing market have resulted in declines in real estate values in our market areas. These declines in real estate values could cause some of our mortgage and home equity loans to be inadequately collateralized—particularly those home equity loans that were originated with combined loan-to-value ratios in excess of 100% – which would expose us to a greater risk of loss in the event that we seek to recover on defaulted loans by selling the real estate collateral.
Commercial lending may expose us to increased lending risks.
At December 31, 2011, $77.3 million, or 30.3%, of our loan portfolio consisted of commercial and multi-family real estate loans, commercial construction loans and commercial business loans. Commercial lending is an important part of our business strategy, and we expect this portion of our loan portfolio to continue to grow. Commercial loans generally expose a lender to greater risk of non-payment and loss than residential mortgage loans because repayment of the loans often depends on the successful operation of the borrower’s business. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential mortgage loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan.
Changes in interest rates could reduce our net interest income and earnings.
Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest spread is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates – up or down – could adversely affect our net interest spread and, as a result, our net interest income and net interest margin. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract. This contraction could be more severe following a prolonged period of lower interest rates, as a larger proportion of our fixed rate residential loan portfolio will have been originated at those lower rates and borrowers may be more reluctant or unable to sell their homes in a higher interest rate environment. Changes in the slope of the “yield curve” – or the spread between short-term and long-term interest rates – could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.
The unseasoned nature of our commercial loan portfolio may expose us to increased lending risks.
Many of our commercial real estate and commercial business loans are unseasoned, meaning that they were originated recently. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our future performance.
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If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.
As of December 31, 2011, our investment portfolio included 5 securities with unrealized losses of $2.6 million that we considered for other-than-temporary impairment. We evaluate our securities portfolio for other-than-temporary impairment throughout the year. Each investment that has a fair value less than book value is reviewed on a quarterly basis. An impairment charge is recorded against individual securities if management concludes that the decline in value is other than temporary. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.
Included in securities with unrealized losses are three trust preferred securities with an amortized cost of $4.0 million and a fair value of $1.5 million at December 31, 2011. The trust preferred securities were issued by two issuer pools consisting of insurance companies. A number of factors or combinations of factors could cause us to conclude in future reporting periods that these securities have experienced other-than-temporary impairment. These factors include, but are not limited to, failure to make scheduled interest payments, an increase in the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions, and industry or issuer-specific factors that would render us unable to forecast a full recovery of the amortized cost basis.
Higher loan losses could require us to increase our allowance for loan losses through a charge to earnings.
When we loan money we incur the risk that our borrowers will not repay their loans. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. In addition, our determination as to the amount of our allowance for loan losses is subject to review by our primary regulator, the OCC, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the OCC after a review of the information available at the time of its examination. Our allowance for loan losses amounted to 1.21% of total loans outstanding and 144% of nonperforming loans at December 31, 2011. Our allowance for loan losses at December 31, 2011, may not be sufficient to cover future loan losses. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.
Our inability to retain deposits as they become due may cause us to rely more heavily on wholesale funding strategies, which could increase our expenses and adversely affect our operating margins and profitability.
A large percentage of our certificates of deposit have maturities of less than one year. The Bank has marketing and pricing initiatives to retain these certificates of deposit when they mature, however, there can be no guarantee that we will retain the deposits necessary to continue to fund asset growth at reasonable prices. If we are not able to maintain sufficient deposits, we will have to rely more heavily on wholesale strategies to fund our asset growth, which historically are more expensive than retail sources of funding. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
K-17 |
We do not control the premiums on which our insurance commissions are based, and volatility or declines in premiums may negatively impact the revenues of our insurance agency.
Exchange Underwriters derives most of its revenues from commissions for brokerage services. We do not determine insurance premiums on which our commissions are generally based. Fluctuations in premiums charged by the insurance carriers have a direct and potentially material impact on Exchange Underwriters’ results of operations. Commission levels generally follow the same trend as premium levels, as commissions are derived from a percentage of the premiums paid by the insureds. Due to their cyclical nature, insurance premiums may vary widely between periods. Such variations can have a potentially material impact on our commission revenues.
Contingent commissions paid by insurance companies are less predictable than standard commissions, and any decrease in the amount of contingent commissions received by Exchange Underwriters could adversely affect its results of operations.
Exchange Underwriters derives a portion of its revenues from contingent commissions paid by insurance companies. Contingent commissions are special revenue-sharing commissions paid by insurance companies based upon the profitability, volume and/or growth of the business placed with such companies during the prior year. If, due to the current economic environment or for any other reason, Exchange Underwriters is unable to meet insurance companies’ profitability, volume and/or growth thresholds, and/or insurance companies increase their estimate of loss reserves, over which Exchange Underwriters has no control, actual contingent commissions received by Exchange Underwriters could be less than anticipated, which could negatively affect Exchange Underwriters’ revenues.
Our market area limits our growth potential.
Our offices are located primarily in small industrial communities in the southern suburban area of metropolitan Pittsburgh. Most of these communities have experienced population and economic decline as a result of the decline of the United States steel industry. Because we have an aging customer base and there is little new real estate development in several of the communities where our offices are located, the opportunities for originating loans and growing deposits in our primary market area are limited. If we are unable to grow our business it will be difficult for us to increase our earnings.
Our branching strategy may not be successful.
A key component of our strategy to grow and improve profitability is to expand into communities that are experiencing population growth and economic expansion. In July 2006, we opened a new branch in Peters Township in Washington County, Pennsylvania. In June 2007, we opened a new branch located in the downtown area of Washington, Pennsylvania. We can provide no assurance that we will be successful in increasing the volume of our loans and deposits by expanding our branch network. Building and/or staffing new branch offices will increase our operating expenses. We can provide no assurance that we will be able to manage the costs and implementation risks associated with this strategy so that expansion of our branch network will be profitable.
We own stock in the FHLB of Pittsburgh, which is experiencing financial difficulties.
Our agreement with the FHLB of Pittsburgh requires us to purchase capital stock in the FHLB commensurate with the amount of our advances and unused borrowing capacity. This stock is carried at cost and was $5.3 million at December 31, 2011. If the FHLB of Pittsburgh is unable to meet minimum regulatory capital requirements or is required to aid the remaining Federal Home Loan Banks, our holding of FHLB stock may be determined to be other than temporarily impaired and may require a charge to our earnings, which could have a material impact on our financial condition, results of operations and cash flows.
K-18 |
Additionally, in December 2008, the FHLB of Pittsburgh suspended payment of dividends until further notice. In February 2012, the FHLB resumed payments of dividends and future declarations will be determined on a quarterly basis going forward. Repurchases of excess capital stock have also been limited to the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding and are determined on a quarterly basis. The absence of a dividend, limitations on the redemption of our FHLB stock, and the obligation to increase our investment in the FHLB would hurt our interest income.
Our purchase of out-of-state loans may expose us to increased lending risks.
Prior to 2006, we purchased newly originated residential and multi-family real estate loans secured by properties throughout the United States in order to supplement our own loan originations. At December 31, 2011, we had $16.3 million of purchased residential mortgage loans, of which $1.4 million were non-performing, and $5.1 million of purchased multi-family real estate loans, of which all were performing. It is difficult to assess the future performance of this part of our loan portfolio because the properties securing these loans are located outside of our market area, which makes them more difficult to monitor. We can give no assurance that these loans will not have delinquency or charge-off levels above our historical experience, which would adversely affect our future performance.
We are dependent upon the services of key executives.
We rely heavily on our President and Chief Executive Officer, Patrick G. O’Brien. We also rely heavily on the President of Exchange Underwriters, Richard B. Boyer, to manage our insurance operations. The loss of Mr. O’Brien or Mr. Boyer could have a material adverse impact on our operations because, as a small company, we have fewer management-level personnel that have the experience and expertise to readily replace these individuals. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition, and results of operations. We have employment agreements with Messrs. O’Brien and Boyer. We maintain life insurance covering Mr. Boyer under a bank-owned life insurance program.
Increased and/or special FDIC assessments will hurt our earnings.
The recent economic recession has caused a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $155,000. In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012. Additional increases in the base assessment rate or special assessments would negatively impact our earnings.
Strong competition within our market area could reduce our profits and slow growth.
We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and at times has forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. As of June 30, 2011, which is the most recent date for which information is available, we held 0.29% of the deposits in the Pittsburgh metropolitan area and 1.8% of the deposits in the counties in which our offices are located. Several of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.
K-19 |
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the FRB, which regulates savings and loan holding companies, the OCC, which regulates all national banks and federal savings associations, and by the FDIC, as our insurer of our deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.
Recently enacted regulatory reform may have a material impact on our operations.
The Dodd-Frank Act, enacted in 2010, restructures the regulation of depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision, which previously regulated the Bank, was merged into the OCC, which until then only regulated national banks. As a result of the Dodd-Frank Act, savings and loan holding companies, including FedFirst Financial, are now regulated by the Board of Governors of the Federal Reserve System. The Dodd-Frank Act also creates a new federal agency to administer consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. The federal preemption of state laws previously accorded federally chartered depository institutions has been reduced, and State Attorneys General now have greater authority to bring a suit against a federally chartered institution, such as the Bank, for violations of certain state and federal consumer protection laws. The Dodd-Frank Act also will impose consolidated capital requirements on savings and loan holding companies effective in five years, which will limit our ability to borrow at the holding company level and invest the proceeds from such borrowings as capital in the Bank that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.
In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies have taken stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the recent economic crisis. The actions include the entering into of written agreements and cease and desist orders that place certain limitations on their operations. Federal bank regulators recently have also been using with more frequency their ability to impose individual minimal capital requirements on banks, which requirements may be higher than those imposed under the Dodd-Frank Act or which would otherwise qualify the bank as being “well capitalized” under the FDIC’s prompt corrective action regulations. If we were to become subject to a supervisory agreement or higher individual capital requirements, such action may have a negative impact on our ability to execute our business plans, as well as our ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in our operations.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
Not applicable.
K-20 |
ITEM 2. | PROPERTIES |
We currently conduct our banking business through eight full-service offices in Monessen, Monongahela, Belle Vernon, Uniontown, Donora, Perryopolis, McMurray and Washington, Pennsylvania. Our administrative offices are located in Monessen, Pennsylvania. We own all of our banking offices except for those in McMurray and Washington. The lease for our McMurray office expires in 2014 and has an option for an additional five year period. The lease for our Washington office expires in 2017 and has an option for two additional five year periods. The Uniontown office is subject to a ground lease that expires in 2014 and has an option to extend for two separate five year periods.
Exchange Underwriters’ office is located in two buildings in Canonsburg, Pennsylvania, one of which is leased and the other which is owned. The lease for our Exchange Underwriters’ office expires in 2012 and has an option for an additional five year period.
The net book value of the land, buildings, furniture, fixtures and equipment owned by us was $2.2 million at December 31, 2011.
ITEM 3. | LEGAL PROCEEDINGS |
Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse affect on our financial condition, results of operations or cash flows.
ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
PART II
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES |
Market, Holder and Dividend Information
Our common stock is listed on the NASDAQ Capital Market under the trading symbol “FFCO.” The following table sets forth the high and low sales prices of the common stock as reported on the NASDAQ Capital Market and the dividend paid per share of common stock for the four quarters of 2011 and 2010.
2011 | 2010(1) | |||||||||||||||||||||||
Quarter | High | Low | Dividend | High | Low | Dividend | ||||||||||||||||||
First Quarter | $ | 14.30 | $ | 13.10 | $ | 0.03 | $ | 14.68 | $ | 7.29 | N/A | |||||||||||||
Second Quarter | 16.50 | 13.85 | 0.03 | 14.07 | 10.56 | N/A | ||||||||||||||||||
Third Quarter | 15.51 | 13.05 | 0.03 | 11.83 | 7.84 | N/A | ||||||||||||||||||
Fourth Quarter | 13.80 | 12.66 | 0.03 | 14.04 | 11.00 | $ | 0.03 |
(1) | The sales prices are presented as adjusted to reflect the conversion completed September 21, 2010. |
K-21 |
FedFirst Financial declared and paid a common stock dividend of $0.03 in each quarter of 2011 and the fourth quarter of 2010. There were no other dividends declared or paid for any other period in 2010. FedFirst can provide no assurance that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends, once declared, will continue. FedFirst Financial’s ability to pay dividends is dependent on available cash and profitability of the Bank as a source of additional funds. For a discussion of restrictions on the payment of cash dividends by the Bank, see “Business – Regulation and Supervision – Federal Savings Bank Regulation – Limitation on Capital Distributions” in this Annual Report on Form 10-K.
As of March 21, 2012, there were approximately 217 holders of record of our common stock, excluding the number of persons or entities holding stock in street name through various brokerage firms.
Purchases of Equity Securities
The Company made the following purchases of its common stock during the three months ended December 31, 2011.
Total Number of | Maximum | |||||||||||||||
Shares | Number of | |||||||||||||||
Purchased as | Shares that May | |||||||||||||||
Total | Part of the | Yet Be | ||||||||||||||
Number of | Average | Publicly | Purchased | |||||||||||||
Shares | Price Paid | Announced | Under the | |||||||||||||
Period | Purchased | per Share | Programs(1) | Programs(1) | ||||||||||||
October 1-31, 2011 | — | $ | — | — | 150,000 | |||||||||||
November 1-30, 2011 | 17,500 | 13.72 | 17,500 | 132,500 | ||||||||||||
December 1-31, 2011 | 15,000 | 13.39 | 15,000 | 117,500 | ||||||||||||
Total | 32,500 | 13.57 | 32,500 |
(1) | On September 28, 2011, the Company announced that the board of directors had approved a program allowing the Company to repurchase up to 150,000 shares of the Company’s outstanding common stock, which was approximately 5% of outstanding shares. This repurchase program was scheduled to expire on November 2, 2012. As of December 31, 2011 and March 21, 2012, 32,500 and 77,500 shares, respectively, of the Company’s common stock had been repurchased under this program. |
ITEM 6. | SELECTED FINANCIAL DATA |
Not applicable as we are a smaller reporting company.
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION |
The objective of this section is to help stockholders and potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in this Annual Report on Form 10-K.
K-22 |
Overview
We conduct community banking activities by accepting deposits and making loans in our market area. Our lending products include residential mortgage loans, commercial real estate and business loans, and home equity and other consumer loans. We also maintain an investment portfolio consisting primarily of mortgage-backed securities. Our loan and investment portfolios are funded with deposits as well as collateralized borrowings from the FHLB of Pittsburgh.
Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. A secondary source of income is noninterest income, which is revenue that we receive from providing products and services. The majority of our noninterest income generally comes from commissions from the sale of insurance products, service charges (mostly from service charges on deposit accounts) and bank-owned life insurance. In some years we may also recognize income from the sale of securities.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the 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.
Expenses.The noninterest expenses we incur in operating our business consist primarily of compensation and employee benefits expenses and occupancy expenses, which include depreciation. We also incur expenses for FDIC insurance premiums, data processing and other miscellaneous items.
Compensation and employee benefits consist primarily of: salaries and wages paid to our employees; payroll taxes; and expenses for health insurance, retirement plans, equity compensation plans and other employee benefits.
Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, lease expense, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities.
Federal insurance premiums are payments we make to the FDIC for insurance of our deposit accounts.
Data processing expenses are the fees we pay to third parties for processing customer information, deposits, loans and general ledger activity.
Other expenses include advertising, professional services, stationary, printing, and supplies, telephone, postage, correspondent bank fees, real estate owned expenses, amortization of intangibles and other miscellaneous operating expenses.
Our Business Strategy
The following are the key elements of our business strategy:
• | Improve earnings through asset diversification. Historically, we have emphasized the origination of residential mortgage loans secured by homes in our market area. We intend to continue this emphasis going forward. However, loan diversification improves our earnings because commercial real estate and commercial business loans generally have higher interest rates than residential mortgage loans. Another benefit of commercial lending is that it improves the sensitivity of our interest-earning assets because commercial loans typically have shorter terms than residential mortgage loans and frequently have variable interest rates. |
K-23 |
• | Use conservative underwriting practices to maintain asset quality.We have sought to maintain a high level of asset quality and moderate credit risk by using underwriting standards that we believe are conservative. While the delinquencies in our loan portfolio have increased during the recent economic downturn, non-performing loans were 0.84% of our total loan portfolio at December 31, 2011. Although we intend to continue our efforts to originate commercial real estate and business loans, we intend to continue our philosophy of managing loan exposures through our conservative approach to lending. | |
• | Improve our funding mix by marketing core deposits. Core deposits (demand, money market and savings accounts) comprised 53.2% of our total deposits at December 31, 2011. We value core deposits because they represent longer-term customer relationships and a lower cost of funding compared to certificates of deposit. We have succeeded in growing core deposits by promoting a sales culture in our branch offices that is supported by the use of technology and by offering a variety of products for our business customers, such as treasury management products, internet banking, and remote deposit capture. | |
• | Supplement fee income through our insurance operations. Fee income earned through our insurance agency, Exchange Underwriters, supplements our income from banking operations. We expanded our insurance operations in 2009 through the acquisition of another insurance agency. We intend to pursue opportunities to grow this line of business, including hiring insurance producers with established books of business and through further acquisitions. | |
• | Grow through expansion of our branch network. Since our initial public offering in 2005, we have opened two branches in Washington County in communities that are experiencing population growth and economic expansion. We will continue to consider pursuing expansion in our market area through de novo branching in strategic locations that maximize growth opportunities. We also may expand in our market area or in areas contiguous to our market area through the acquisition of branches of other financial institutions or through whole bank acquisitions. |
Critical Accounting Policies
In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in the notes to our consolidated financial statements.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that in management’s judgment should be charged-off. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, peer group information, 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, prevailing economic conditions and other factors related to the collectability of the loan portfolio. This evaluation is inherently subjective as it involves a high degree of judgment and requires estimates that are susceptible to significant revision as more information becomes available.
K-24 |
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 or interest according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, 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 performs individual assessments of larger impaired loans to determine the existence of loss exposure and, where applicable, the extent of loss exposure based upon the present value of expected future cash flows available to pay the loan, or based upon the estimated realizable collateral where a loan is collateral dependent. Generally, individual residential mortgage and consumer loans are not separately identified for impairment disclosures unless such loans are the subject of a troubled debt restructuring (“TDR”) agreement or are related to a commercial relationship that is collectively evaluated for impairment. Loans excluded from the individual impairment analysis are collectively evaluated by management to estimate losses inherent in those loans. Management determines historical loss experience for each group of loans with similar risk characteristics within the portfolio based on loss experience for loans in each group. Loan categories will represent groups of loans with similar risk characteristics and may include types of loans by product, large credit exposures, concentrations, loan grade, or any other characteristic that causes a loan’s risk profile to be similar to another. We also consider qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience including changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; changes in experience, ability and depth of loan management; changes in the volume and severity of past due loans, non-accrual loans and adversely graded or classified loans; changes in the quality of the loan review system; changes in the value of underlying collateral for collateral dependent loans; existence of or changes in concentrations of credit; changes in economic or business conditions; and the effect of competition, legal and regulatory requirements on estimated credit losses.
A loan whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties is considered a TDR. TDRs typically result from our loss mitigation activities and could include rate reductions, principal forgiveness, forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. A restructuring for a borrower that is experiencing financial difficulties, but results in only a delay in payment that is insignificant is not considered a concession. Loans classified as TDRs are designated as impaired. Once a loan is classified as a TDR, the determination of income recognition is based on the status of the loan prior to classification. If a loan is in non-accrual status, then it will remain in that classification for a minimum of six consecutive months until uncertainty with respect to collectability no longer exists. Loans that are current at the time of classification will remain on an accrual basis and are monitored. If restructured contractual terms of a loan are not met, then the loan will be placed on nonaccrual status.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized as special mention have potential weaknesses that may result in deterioration if uncorrected and not monitored. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified as substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. To determine the appropriate risk rating category, the borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans.
K-25 |
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. The OCC may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings. See Notes 1 and 3 of the Notes to Consolidated Financial Statements included in this report.
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 statements’ 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. The realization of deferred tax assets is assessed and a valuation allowance provided, when necessary, for that portion of the asset which is not likely to be realized.
We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period, which would negatively affect earnings.
Goodwill.In connection with our acquisition of Exchange Underwriters, we recorded $1.1 million of goodwill. Goodwill is not amortized but is tested for impairment annually or more frequently if impairment indicators arise. The goodwill impairment model is a two-step process. First, it requires a comparison of the book value of net assets to the fair value of the related operations that have goodwill assigned to them. If the fair value is determined to be less than book value, a second step is performed to compute the amount of the impairment. We estimate the fair values of the related operations using discounted cash flows. The forecasts of future cash flows are based on our best estimate of future revenues and operating costs, based primarily on contracts in effect, new accounts and cancellations and operating budgets. The impairment analysis requires management to make subjective judgments concerning how the acquired assets will perform in the future. Events and factors that may significantly affect the estimates include competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and industry and market trends. Changes in these forecasts could cause a reporting unit to either pass or fail the first step in the goodwill impairment model, which could significantly change the amount of impairment recorded. Our annual assessment of potential goodwill impairment was completed in the fourth quarter of 2011. Based on the results of this assessment, no goodwill impairment was recognized.
Other-Than-Temporary Impairment (“OTTI”). We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events that may influence the operations of the issuer, and the intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market.
We recognize credit-related OTTI on debt securities in earnings while noncredit-related OTTI on debt securities not expected to be sold is recognized in accumulated other comprehensive income (“OCI”). We assess whether the credit loss existed by considering whether (a) we have the intent to sell the security, (b) it is more likely than not that we will be required to sell the security before recovery, or (c) we do not expect to recover the entire amortized cost basis of the security. We can bifurcate the OTTI on securities not expected to be sold or where the entire amortized cost of the security is not expected to be recovered into the components representing credit loss and the component representing loss related to other factors. The portion of the fair value decline attributable to credit loss is recognized through earnings.
K-26 |
Corporate debt securities are evaluated for OTTI by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows involves the calculation of the present value of remaining cash flows compared to previously projected cash flows. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit-related OTTI exists on corporate debt securities.
Revenue Recognition of Insurance Commissions and Contingency Fees. Exchange Underwriters records insurance commission based on the method in which the policy is billed. For policies that Exchange Underwriters directly bills to policyholders, income is recorded when billed. For policies that a third-party insurance company directly bills to policyholders on behalf of Exchange Underwriters, income is recorded as payments are received. Commissions are recorded net of cancellations.
Exchange Underwriters also receives guaranteed supplemental payments and contingency fees that may be significant to its financial results. Guaranteed supplemental payments and contingency fees are dependent on several factors, which include, but are not limited to, eligible written premiums, earned premiums, incurred losses, and stop loss charges. Guaranteed supplemental payments are only accrued when insurance companies offer a lock-in provision and Exchange Underwriters agrees to a stipulated amount that typically includes a predetermined percentage adjusting the final payout calculations. Otherwise, contingency fees are recorded on a cash basis when received based on final calculations. Contingency fees are typically received in the first quarter of the year. Since insurance companies are not required to provide any estimates, we are not able to accrue contingency fees in the period earned as we do with guaranteed supplemental payments.
Balance Sheet Analysis
General. Total assets decreased $7.8 million, or 2.3%, to $335.3 million at December 31, 2011 compared to $343.1 million at December 31, 2010. During 2011, securities available-for-sale decreased $26.3 million to $52.4 million which was partially offset by a net increase of $15.2 million in loans to $245.3 million. Loan declines were primarily from payoffs of one-to-four family residential loans, which were partially offset by growth in multi-family, home equity and commercial business loans. We improved our funding mix in 2011, as deposits increased $18.0 million and borrowings decreased $27.6 million. Funds from deposit growth were used to pay down borrowings.
Loans. Our primary lending activity is the origination of loans secured by real estate. We originate residential loans, commercial and multi-family real estate loans and construction loans. We also originate commercial business and consumer loans. In order to improve the mix and profitability of our loan portfolio, we have recently emphasized the origination of commercial real estate and business loans and home equity loans.
Total loans increased $18.7 million, or 7.9%, to $255.4 million at December 31, 2011, compared to $236.8 million at December 31, 2010.
Residential mortgage loans decreased $8.0 million, or 5.7%, to $133.9 million and represented 52.4% of total loans at December 31, 2011, compared to $142.0 million, or 60.0% of total loans, at December 31, 2010. The decrease was the result of loan payoffs primarily driven by economic and market conditions.
Multi-family real estate loans increased $8.9 million to $18.2 million and represented 7.1% of total loans at December 31, 2011, compared to $9.3 million, or 3.9% of total loans, at December 31, 2010. The increase was primarily the result of new loans for apartment buildings and student housing.
Commercial real estate loans increased $1.6 million, or 4.7%, to $35.3 million and represented 13.8% of total loans at December 31, 2011, compared to $33.7 million, or 14.2% of total loans, at December 31, 2010. The increase was the result of our focus on diversifying our loan portfolio by growing our commercial loans and becoming a greater presence in the business community.
Construction loans increased $4.7 million, or 61.9%, to $12.2 million and represented 4.8% of total loans at December 31, 2011, compared to $7.5 million, or 3.2% of total loans, at December 31, 2010.
K-27 |
Consumer loans increased $7.0 million, or 21.0%, to $40.3 million, or 15.8% of total loans, at December 31, 2011, compared to $33.3 million, or 14.1% of total loans, at December 31, 2010. Home equity loans, which increased $7.2 million, or 23.0%, to $38.4 million, accounted for the majority of the increase in consumer loans.
Commercial business loans increased $4.6 million, or 42.0%, to $15.4 million and represented 6.1% of total loans at December 31, 2011, compared to $10.9 million, or 4.6% of total loans, at December 31, 2010. The increase from the prior year reflects our continued focus on developing business relationships and improving the mix and profitability of our loan portfolio.
K-28 |
The following table sets forth the composition of our loan portfolio at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||||||
Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||||||||||||||||||||||
One-to-four family residential | ||||||||||||||||||||||||||||||||||||||||
Originated | $ | 117,622 | 46.0 | % | $ | 121,376 | 51.3 | % | $ | 134,201 | 54.8 | % | $ | 126,031 | 53.2 | $ | 99,017 | 51.5 | ||||||||||||||||||||||
Purchased | 16,304 | 6.4 | 20,591 | 8.7 | 23,872 | 9.8 | 29,840 | 12.5 | 36,436 | 18.9 | ||||||||||||||||||||||||||||||
Total one-to-four family residential | 133,926 | 52.4 | 141,967 | 60.0 | 158,073 | 64.6 | 155,871 | 65.7 | % | 135,453 | 70.4 | % | ||||||||||||||||||||||||||||
Multi-family | ||||||||||||||||||||||||||||||||||||||||
Originated | 13,122 | 5.1 | 4,082 | 1.7 | 3,970 | 1.6 | 3,846 | 1.6 | 1,119 | 0.6 | ||||||||||||||||||||||||||||||
Purchased | 5,121 | 2.0 | 5,261 | 2.2 | 6,021 | 2.5 | 7,100 | 3.0 | 10,866 | 5.6 | ||||||||||||||||||||||||||||||
Total multi-family | 18,243 | 7.1 | 9,343 | 3.9 | 9,991 | 4.1 | 10,946 | 4.6 | 11,985 | 6.2 | ||||||||||||||||||||||||||||||
Commercial | 35,307 | 13.8 | 33,732 | 14.2 | 31,405 | 12.8 | 24,301 | 10.3 | 14,483 | 7.5 | ||||||||||||||||||||||||||||||
Total real estate - mortgage | 187,476 | 73.3 | 185,042 | 78.1 | 199,469 | 81.5 | 191,118 | 80.6 | 161,921 | 84.1 | ||||||||||||||||||||||||||||||
Real estate - construction: | ||||||||||||||||||||||||||||||||||||||||
Residential | 3,874 | 1.5 | 6,787 | 2.9 | 3,028 | 1.2 | 9,833 | 4.2 | 6,671 | 3.5 | ||||||||||||||||||||||||||||||
Commercial | 8,308 | 3.3 | 736 | 0.3 | 2,576 | 1.1 | 3,443 | 1.5 | — | — | ||||||||||||||||||||||||||||||
Total real estate - construction | 12,182 | 4.8 | 7,523 | 3.2 | 5,604 | 2.3 | 13,276 | 5.7 | 6,671 | 3.5 | ||||||||||||||||||||||||||||||
Consumer: | ||||||||||||||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||||||||||||||
Loan-to-value ratio of 80% or less | 30,679 | 12.0 | 22,628 | 9.6 | 17,802 | 7.3 | 12,625 | 5.3 | 9,694 | 5.0 | ||||||||||||||||||||||||||||||
Loan-to-value ratio of greater than 80% | 7,758 | 3.1 | 8,624 | 3.6 | 9,288 | 3.8 | 9,719 | 4.1 | 8,168 | 4.3 | ||||||||||||||||||||||||||||||
Total home equity | 38,437 | 15.1 | 31,252 | 13.2 | 27,090 | 11.1 | 22,344 | 9.4 | 17,862 | 9.3 | ||||||||||||||||||||||||||||||
Other | 1,892 | 0.7 | 2,090 | 0.9 | 2,243 | 0.9 | 1,707 | 0.7 | 1,548 | 0.8 | ||||||||||||||||||||||||||||||
Total consumer | 40,329 | 15.8 | 33,342 | 14.1 | 29,333 | 12.0 | 24,051 | 10.1 | 19,410 | 10.1 | ||||||||||||||||||||||||||||||
Commercial business | 15,445 | 6.1 | 10,875 | 4.6 | 10,327 | 4.2 | 8,474 | 3.6 | 4,341 | 2.3 | ||||||||||||||||||||||||||||||
Total loans | 255,432 | 100.0 | % | 236,782 | 100.0 | % | 244,733 | 100.0 | % | 236,919 | 100.0 | % | 192,343 | 100.0 | % | |||||||||||||||||||||||||
Net premium on loans purchased | 127 | 116 | 108 | 120 | 191 | |||||||||||||||||||||||||||||||||||
Net deferred loan costs | 606 | 697 | 829 | 850 | 491 | |||||||||||||||||||||||||||||||||||
Loans in process | (7,790 | ) | (4,716 | ) | (2,774 | ) | (5,899 | ) | (3,614 | ) | ||||||||||||||||||||||||||||||
Allowance for losses | (3,098 | ) | (2,824 | ) | (2,509 | ) | (1,806 | ) | (1,457 | ) | ||||||||||||||||||||||||||||||
Loans, net | $ | 245,277 | $ | 230,055 | $ | 240,387 | $ | 230,184 | $ | 187,954 |
K-29 |
The following table sets forth certain information at December 31, 2011 regarding the dollar amount of loans maturing during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Real estate – construction loans will be converted to a real estate – mortgage loan at the end of the construction period and are reported based on the maturity date of the real estate – mortgage loan (dollars in thousands).
Amounts Due in | ||||||||||||||||
One Year or | One to | After Five | ||||||||||||||
Less | Five Years | Years | Total | |||||||||||||
Real estate - mortgage | $ | 807 | $ | 13,702 | $ | 172,967 | $ | 187,476 | ||||||||
Real estate - construction | 123 | — | 12,059 | 12,182 | ||||||||||||
Consumer | 1,942 | 1,023 | 37,364 | 40,329 | ||||||||||||
Commercial business | 6,101 | 5,893 | 3,451 | 15,445 | ||||||||||||
Total | $ | 8,973 | $ | 20,618 | $ | 225,841 | $ | 255,432 |
The following table sets forth the dollar amount of all loans at December 31, 2011 that are due after December 31, 2012 and have either fixed or adjustable interest rates (dollars in thousands).
Fixed | Adjustable | Total | ||||||||||
Real estate - mortgage | $ | 166,366 | $ | 20,303 | $ | 186,669 | ||||||
Real estate - construction | 8,223 | 3,836 | 12,059 | |||||||||
Consumer | 37,367 | 1,020 | 38,387 | |||||||||
Commercial business | 9,331 | 13 | 9,344 | |||||||||
Total | $ | 221,287 | $ | 25,172 | $ | 246,459 |
Our adjustable rate mortgage loans generally do not provide for downward adjustments below the initial contract rate. This feature has prevented some loans from adjusting downward in a declining interest rate environment. When market interest rates rise, the interest rates on these loans will not increase until the contract rate (the index plus the margin) exceeds the interest rate floor.
Securities.Our securities portfolio consists primarily of Government-sponsored enterprise securities, municipal bonds, mortgage-backed securities, guaranteed REMIC pass-through certificates, and corporate debt securities.
REMICs (real estate mortgage investment conduits) represent a participation interest in a pool of mortgages. REMICs are created by redirecting the cash flows from the pool of mortgages underlying those securities to create two or more classes (or tranches) with different maturity or risk characteristics designed to meet a variety of investor needs and preferences. REMICs may be sponsored by U.S. Government agencies and Government-sponsored enterprises. We believe that these securities represent attractive alternatives relative to other investments due to the wide variety of maturity, repayment and interest rate options available.
We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer including any specific events that may influence the operations of the issuer, and the intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market.
K-30 |
We also invest in corporate debt and are subject to credit risk related to pooled trust preferred insurance company term obligations. Corporate debt securities generally have greater credit risk than Government-sponsored enterprises securities and generally have higher yields than government securities of similar duration. Therefore, we limit the amount of the portfolio based on these concerns. At December 31, 2011, we held corporate debt securities with a carrying value of $1.5 million.
At December 31, 2011, we had three corporate debt securities that were in an unrealized loss position for 12 months or greater at an amount of $2.5 million. These securities consist of two pools of insurance company-issued preferred trust obligations. These securities were downgraded from their original rating issuance to below investment grade. The lack of liquidity in the market for this type of security, credit rating downgrades and market uncertainties are factors contributing to the unrealized losses on these securities. These securities are evaluated for OTTI by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows involves the calculation of the present value of remaining cash flows compared to previously projected cash flows. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit-related OTTI exists. Additionally, reports are reviewed that provide information for the amount of deferral/defaults that would have to occur to prevent the tranche from collecting contractual cash flows (principal and interest). None of these securities are projecting a cash flow disruption, nor have any of these securities experienced a cash flow disruption. The Company also reviewed each of the issues’ collateral participants, including their financial condition, ratings provided by A. M. Best (for insurance companies), and adverse conditions specifically related to industry or geographic area. This information did not suggest additional deferrals and defaults in the future that would result in the securities not receiving all of their contractual cash flows. Based on the analysis performed and the fact that the Company does not expect to sell these securities and it is not more likely than not that the Company will be required to sell the securities before recovery of their amortized cost basis, the Company concluded that there is no OTTI on these securities at December 31, 2011.
Securities at amortized cost decreased $26.2 million, or 33.2%, to $52.7 million at December 31, 2011.The majority of the activity account for change was paydowns and calls of $21.3 million and security sales of $10.2 million which included a realized gain of $304,000, partially offset by purchases of $5.4 million of Government-sponsored enterprises and municipal bonds. In addition, the securities portfolio reflects an unrealized loss of $274,000 at December 31, 2011 compared to $210,000 at December 31, 2010.
The following table sets forth the amortized cost and fair value of the securities portfolio at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | 2009 | |||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||
Government-sponsored enterprises | $ | 2,000 | $ | 2,003 | $ | 7,580 | $ | 7,614 | $ | 5,954 | $ | 5,745 | ||||||||||||
Municipal bonds | 6,738 | 7,125 | 4,012 | 4,296 | 4,014 | 4,271 | ||||||||||||||||||
Mortgage-backed | 16,572 | 17,544 | 32,747 | 33,989 | 35,467 | 36,936 | ||||||||||||||||||
REMICs | 23,413 | 24,318 | 30,580 | 31,565 | 30,144 | 30,465 | ||||||||||||||||||
Corporate debt | 3,995 | 1,454 | 3,995 | 1,240 | 3,995 | 2,093 | ||||||||||||||||||
Equities | 4 | 4 | 4 | 4 | 4 | 4 | ||||||||||||||||||
Total securities available-for-sale | $ | 52,722 | $ | 52,448 | $ | 78,918 | $ | 78,708 | $ | 79,578 | $ | 79,514 |
At December 31, 2011, we had no investments in a single company or entity that had an aggregate book value in excess of 10% of our equity.
K-31 |
The following table sets forth the stated maturities and weighted average yields of our mortgage-backed and debt securities at December 31, 2011. Certain mortgage-backed securities have adjustable interest rates and will reprice periodically within the various maturity ranges. These repricing schedules are not reflected in the table below. At December 31, 2011, mortgage-backed securities and REMICs with adjustable rates totaled $2.3 million (dollars in thousands).
Amounts due in | ||||||||||||||||||||||||||||||||||||||||
One Year or Less | One Year to Five Years | Five Years to Ten Years | After Ten Years | Total | ||||||||||||||||||||||||||||||||||||
Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | |||||||||||||||||||||||||||||||
Government-sponsored enterprises | $ | — | — | % | $ | — | — | % | $ | 2,003 | 3.00 | % | $ | — | — | % | $ | 2,003 | 3.00 | % | ||||||||||||||||||||
Municipal bonds | — | — | 3,718 | 5.58 | — | — | 3,407 | 2.72 | 7,125 | 4.15 | ||||||||||||||||||||||||||||||
Mortgage-backed | — | — | 14 | 2.99 | 7,556 | 2.55 | 9,974 | 5.57 | 17,544 | 4.22 | ||||||||||||||||||||||||||||||
REMICs | — | — | — | — | — | — | 24,318 | 3.75 | 24,318 | 3.75 | ||||||||||||||||||||||||||||||
Corporate debt | — | — | — | — | — | — | 1,454 | 2.53 | 1,454 | 2.53 | ||||||||||||||||||||||||||||||
Total available-for-sale debt securities | $ | — | — | % | $ | 3,732 | 5.57 | % | $ | 9,559 | 2.65 | % | $ | 39,153 | 3.96 | % | $ | 52,444 | 3.83 | % | ||||||||||||||||||||
Equity securities | 4 | |||||||||||||||||||||||||||||||||||||||
Total securities available-for-sale | $ | 52,448 |
K-32 |
Deposits. Our deposit base is comprised of demand deposits, savings accounts, money market accounts and certificates of deposits. We consider demand deposits, savings accounts and money market accounts to be core deposits. Total deposits increased $18.0 million, or 8.8%, for the year ended December 31, 2011, as certificates of deposit increased $9.8 million, primarily due to a 13 month CD special, noninterest-bearing deposits increased $4.9 million, primarily due to relationships developed with commercial customers, savings accounts increased $1.5 million, interest-bearing demand deposits increased $971,000, and money market deposit accounts increased $760,000.
The following table sets forth the balances of our deposit products at the dates indicated (dollars in thousands).
2011 | 2010 | 2009 | ||||||||||||||||||||||
Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||
Noninterest-bearing demand deposits | $ | 20,536 | 9.3 | % | $ | 15,612 | 7.7 | % | $ | 15,963 | 8.2 | % | ||||||||||||
Interest-bearing demand deposits | 14,555 | 6.6 | 13,584 | 6.7 | 15,214 | 7.9 | ||||||||||||||||||
Savings accounts | 22,827 | 10.3 | 21,320 | 10.5 | 21,560 | 11.1 | ||||||||||||||||||
Money market accounts | 59,709 | 27.0 | 58,949 | 29.0 | 53,282 | 27.5 | ||||||||||||||||||
Certificates of deposit | 103,913 | 46.8 | 94,097 | 46.1 | 87,562 | 45.3 | ||||||||||||||||||
Total deposits | $ | 221,540 | 100.0 | % | $ | 203,562 | 100.0 | % | $ | 193,581 | 100.0 | % |
The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity at December 31, 2011. Jumbo certificates of deposit require minimum deposits of $100,000 (dollars in thousands).
Certificates | ||||
Maturity Period | of Deposit | |||
Three months or less | $ | 2,050 | ||
Over three through six months | 16,604 | |||
Over six through twelve months | 3,829 | |||
Over twelve months | 12,889 | |||
Total jumbo certificates | $ | 35,372 |
The following table sets forth certificates of deposit classified by rates at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | 2009 | |||||||||
Less than 1.00% | $ | 17,459 | $ | 6,774 | $ | — | ||||||
1.01 - 2.00% | 36,142 | 28,318 | 22,052 | |||||||||
2.01 - 3.00% | 32,923 | 36,270 | 19,367 | |||||||||
3.01 - 4.00% | 8,098 | 10,045 | 26,167 | |||||||||
4.01 - 5.00% | 8,597 | 10,103 | 15,118 | |||||||||
5.01 - 6.00% | 694 | 1,746 | 2,284 | |||||||||
6.01 - 7.00% | — | 841 | 2,574 | |||||||||
Total certificates of deposits | $ | 103,913 | $ | 94,097 | $ | 87,562 |
K-33 |
The following table sets forth the amount and maturities of certificates of deposit at December 31, 2011 (dollars in thousands).
Amounts Due in | ||||||||||||||||||||||||||||||||
One Year | One to | Two to | Three to | Four to | Five Years | Percent | ||||||||||||||||||||||||||
or Less | Two Years | Three Years | Four Years | Five Years | and Thereafter | Total | of Total | |||||||||||||||||||||||||
Less than 1.00% | $ | 13,068 | $ | 4,085 | $ | 306 | $ | — | $ | — | $ | — | $ | 17,459 | 16.8 | % | ||||||||||||||||
1.01 - 2.00% | 29,542 | 2,942 | 1,939 | 709 | 604 | 406 | 36,142 | 34.8 | ||||||||||||||||||||||||
2.01 - 3.00% | 11,964 | 4,436 | 1,453 | 2,901 | 1,147 | 11,022 | 32,923 | 31.6 | ||||||||||||||||||||||||
3.01 - 4.00% | 2,130 | 614 | 3,131 | 1,294 | — | 929 | 8,098 | 7.8 | ||||||||||||||||||||||||
4.01 - 5.00% | 3,094 | 1,466 | 639 | 1,798 | 953 | 647 | 8,597 | 8.3 | ||||||||||||||||||||||||
5.01 - 6.00% | 510 | — | — | — | 127 | 57 | 694 | 0.7 | ||||||||||||||||||||||||
Total | $ | 60,308 | $ | 13,543 | $ | 7,468 | $ | 6,702 | $ | 2,831 | $ | 13,061 | $ | 103,913 | 100.0 | % |
The following table sets forth deposit activity for the periods indicated (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | 2009 | |||||||||
Beginning balance | $ | 203,562 | $ | 193,581 | $ | 172,804 | ||||||
Increase before interest credited | 15,117 | 6,541 | 16,335 | |||||||||
Interest credited | 2,861 | 3,440 | 4,442 | |||||||||
Net increase in deposits | 17,978 | 9,981 | 20,777 | |||||||||
Deposits at end of year | $ | 221,540 | $ | 203,562 | $ | 193,581 |
Borrowings. We utilize borrowings from the FHLB of Pittsburgh and, to a limited extent, repurchase agreements to supplement our funding for loans and securities (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | 2009 | |||||||||
Maximum amount outstanding at any month end during the year | $ | 72,864 | $ | 110,456 | $ | 127,559 | ||||||
Average amounts outstanding during the year | 58,150 | 90,455 | 118,987 | |||||||||
Weighted average rate during the year | 3.69 | % | 3.75 | % | 3.86 | % | ||||||
Balance outstanding at end of year | $ | 49,289 | $ | 76,893 | $ | 112,511 | ||||||
Weighted average rate at end of year | 3.69 | % | 3.52 | % | 3.67 | % |
Borrowings decreased $27.6 million, or 35.9%, to $49.3 million at December 31, 2011 compared to $76.9 million at December 31, 2010. The decrease in borrowings was funded primarily through deposit growth. Outstanding advances mature in 2011 through 2015.
Stockholders’ Equity. Stockholders’ equity increased $214,000, or 0.4%, to $58.8 million at December 31, 2011 compared to $58.6 million at December 31, 2010. The increase was primarily due to $859,000 in net income for the year ended December 31, 2011, partially offset by $464,000 of stock repurchases and $349,000 of dividends paid to stockholders.
K-34 |
Results of Operations for the Years Ended December 31, 2011 and 2010
Overview.
(Dollars in thousands) | 2011 | 2010 | ||||||
Net income | $ | 859 | $ | 608 | ||||
Return on average assets | 0.25 | % | 0.17 | % | ||||
Return on average equity | 1.43 | 1.26 | ||||||
Average equity to average assets | 17.54 | 13.85 |
Net income was $859,000 for the year ended December 31, 2011 compared to $608,000 for the year ended December 31, 2010.
Net Interest Income.Net interest income for the year ended December 31, 2011 increased $551,000 to $10.6 million compared to $10.1 million for the year ended December 31, 2010. Net interest margin was 3.35% for the year ended December 31, 2011 compared to 3.14% for the year ended December 31, 2010. The improvement in net interest margin is primarily attributable to a funding shift on the Company’s balance sheet whereby a reduction in borrowings resulted in a $1.2 million decrease in borrowings expense and, despite an increase in overall deposits, interest rate reductions on deposits resulted in a $567,000 decrease in deposits expense that together more than offset the decline in interest income from securities and loans.
Total interest income decreased $1.3 million, or 7.5%, to $15.5 million for the year ended December 31, 2011 as compared to $16.8 million for the year ended December 31, 2010. Interest income on securities decreased $931,000 due to a decrease of 97 basis points in yield and $6.0 million in the average balance, primarily due to paydowns and sales of higher yielding mortgage-backed and REMIC securities, which were reinvested in lower yielding securities with shorter durations. Interest income on loans decreased $317,000 due to a decrease of 29 basis points in yield, primarily from loan payoffs on higher rate residential real estate loans partially offset by a $6.7 million increase in the average balance, primarily in home equity, multi-family, and commercial real estate loans.
Total interest expense decreased $1.8 million, or 26.9%, to $4.9 million for the year ended December 31, 2011 compared to $6.7 million for the year ended December 31, 2010. Interest expense on borrowings decreased $1.2 million, or 36.8%, to $2.1 million primarily due to a decrease of $32.3 million in the average balance as deposit growth and funds from the completion of the stock offering were used to reduce borrowings. Interest expense on deposits decreased $567,000 due to a decrease of 38 basis points in cost, primarily related to the repricing of maturing certificates of deposit and money market accounts at lower rates, partially offset by an increase of $11.5 million in the average balance, primarily in certificates of deposit and money market accounts.
K-35 |
Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented (dollars in thousands). Interest income has not been calculated on a tax-equivalent basis because the impact would be insignificant.
Years Ended December 31, | 2011 | 2010 | ||||||||||||||||||||||
Interest | Average | Interest | Average | |||||||||||||||||||||
Average | and | Yield/ | Average | and | Yield/ | |||||||||||||||||||
Balance | Dividends | Cost | Balance | Dividends | Cost | |||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans, net(1)(2) | $ | 239,972 | $ | 13,049 | 5.44 | % | $ | 233,257 | $ | 13,366 | 5.73 | % | ||||||||||||
Securities(3) | 67,205 | 2,473 | 3.68 | 73,161 | 3,404 | 4.65 | ||||||||||||||||||
Other interest-earning assets | 9,677 | 10 | 0.10 | 13,490 | 25 | 0.19 | ||||||||||||||||||
Total interest-earning assets | 316,854 | $ | 15,532 | 4.90 | 319,908 | $ | 16,795 | 5.25 | ||||||||||||||||
Noninterest-earning assets | 26,250 | 28,509 | ||||||||||||||||||||||
Total assets | $ | 343,104 | $ | 348,417 | ||||||||||||||||||||
Liabilities and Stockholders’ equity: | ||||||||||||||||||||||||
Interest-bearing liablities: | ||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 13,934 | $ | 33 | 0.24 | % | $ | 13,768 | $ | 39 | 0.28 | % | ||||||||||||
Savings accounts | 22,463 | 99 | 0.44 | 22,074 | 110 | 0.50 | ||||||||||||||||||
Money market accounts | 61,321 | 472 | 0.77 | 58,994 | 666 | 1.13 | ||||||||||||||||||
Certificates of deposit | 102,721 | 2,173 | 2.12 | 94,094 | 2,529 | 2.69 | ||||||||||||||||||
Total interest-bearing deposits | 200,439 | 2,777 | 1.39 | 188,930 | 3,344 | 1.77 | ||||||||||||||||||
Borrowings | 58,150 | 2,143 | 3.69 | 90,455 | 3,390 | 3.75 | ||||||||||||||||||
Total interest-bearing liabilities | 258,589 | 4,920 | 1.90 | 279,385 | 6,734 | 2.41 | ||||||||||||||||||
Noninterest-bearing liabilities | 24,324 | 20,791 | ||||||||||||||||||||||
Total liabilities | 282,913 | 300,176 | ||||||||||||||||||||||
Stockholders’ equity | 60,191 | 48,241 | ||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 343,104 | $ | 348,417 | ||||||||||||||||||||
Net interest income | $ | 10,612 | $ | 10,061 | ||||||||||||||||||||
Interest rate spread | 3.00 | % | 2.84 | % | ||||||||||||||||||||
Net interest margin | 3.35 | 3.14 | ||||||||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities | 122.53 | % | 114.50 | % |
(1) | Amount is net of deferred loan costs, loans in process, and estimated allowance for loan losses. |
(2) | Amount includes nonaccrual loans in average balances only. |
(3) | Amount does not include effect of unrealized (loss) gain on securities available-for-sale. |
K-36 |
Rate/Volume Analysis.The following table sets forth the effects of changing rates and volumes on our net interest income (dollars in thousands). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The total column represents the sum of change. Changes related to volume/rate are prorated into volume and rate components.
2011 Compared to 2010 | ||||||||||||
Increase (Decrease) Due to | ||||||||||||
Volume | Rate | Total | ||||||||||
Interest and dividend income: | ||||||||||||
Loans, net | $ | 371 | $ | (688 | ) | $ | (317 | ) | ||||
Securities | (263 | ) | (668 | ) | (931 | ) | ||||||
Other interest-earning assets | (5 | ) | (10 | ) | (15 | ) | ||||||
Total interest-earning assets | 103 | (1,366 | ) | (1,263 | ) | |||||||
Interest expense: | ||||||||||||
Deposits | 194 | (761 | ) | (567 | ) | |||||||
Borrowings | (1,194 | ) | (53 | ) | (1,247 | ) | ||||||
Total interest-bearing liablities | (1,000 | ) | (814 | ) | (1,814 | ) | ||||||
Change in net interest income | $ | 1,103 | $ | (552 | ) | $ | 551 |
Provision for Loan Losses.The following table summarizes the activity in the allowance for loan losses for the years ended December 31, 2011 and 2010 (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | ||||||
Allowance at beginning of year | $ | 2,824 | $ | 2,509 | ||||
Provision for loan losses | 850 | 850 | ||||||
Charge-offs | (578 | ) | (535 | ) | ||||
Recoveries | 2 | — | ||||||
Net charge-offs | (576 | ) | (535 | ) | ||||
Allowance at end of year | $ | 3,098 | $ | 2,824 |
Provisions for loan losses were $850,000 for the years ended December 31, 2011 and 2010. Net charge-offs increased $41,000 to $576,000 for the year ended December 31, 2011 compared to $535,000 for the year ended December 31, 2010. The allowance for loan losses to total loans ratio increased to 1.21% at December 31, 2011 compared to 1.19% at December 31, 2010.
An analysis of the changes in the allowance for loan losses is presented under “Risk Management—Analysis and Determination of the Allowance for Loan Losses.”
K-37 |
Noninterest Income.The following table summarizes noninterest (loss) income for the years ended December 31, 2011 and 2010 (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | ||||||
Fees and service charges | $ | 602 | $ | 518 | ||||
Insurance commissions | 2,119 | 2,324 | ||||||
Income from bank-owned life insurance | 269 | 284 | ||||||
Net gain (loss) on sales of securities | 304 | (658 | ) | |||||
Net loss on sale of real estate owned | (29 | ) | (42 | ) | ||||
Other | 41 | 26 | ||||||
Total noninterest income | $ | 3,306 | $ | 2,452 |
Noninterest income increased $854,000, or 34.8%, to $3.3 million for the year ended December 31, 2011 compared to $2.5 million for the year ended December 31, 2010. In the current year, the Company recognized a gain on the sale of available-for-sale securities of $304,000 compared to a $658,000 loss in the prior year. In 2010, the Company restructured a portion of its investment portfolio as described above. In addition, fees and service charges increased $84,000 primarily due to increased income from a new fee structure and a prepayment penalty received on a commercial real estate loan in the current period. This was partially offset by a $205,000 decrease in insurance commissions primarily due to a decrease in contingency fee income as a result of incurred losses, stop loss charges, and a decline in eligible written and earned premiums on insurance policies.
Noninterest Expense.The following table summarizes noninterest expense for the years ended December 31, 2011 and 2010 (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | ||||||
Compensation and employee benefits | $ | 7,183 | $ | 6,051 | ||||
Occupancy | 1,476 | 1,425 | ||||||
FDIC insurance premiums | 255 | 353 | ||||||
Data processing | 530 | 486 | ||||||
Professional services | 752 | 624 | ||||||
Advertising | 135 | 131 | ||||||
Stationary, printing and supplies | 98 | 119 | ||||||
Telephone | 52 | 48 | ||||||
Postage | 148 | 146 | ||||||
Correspondent bank fees | 146 | 172 | ||||||
Real estate owned expense | 113 | 234 | ||||||
Amortization of intangibles | 109 | 110 | ||||||
All other | 768 | 714 | ||||||
Total noninterest expense | $ | 11,765 | $ | 10,613 |
Noninterest expense increased $1.2 million, or 10.9%, to $11.8 million for the year ended December 31, 2011 compared to $10.6 million for the year ended December 31, 2010. The increase was primarily due to an increase of $1.1 million in compensation expense related to the termination of executive supplemental retirement agreements with current and former executive officers. In addition, professional services increased $128,000 primarily due to costs associated with a branch facilities assessment, higher shareholder-related expenses, and the implementation of XBRL reporting requirements. This was partially offset by a $121,000 decrease in real estate owned expenses as a result of property writedowns in the prior year and a $98,000 decrease in insurance premiums due to the Federal Deposit Insurance Corporation’s revised assessment methodology implemented in the current year.
K-38 |
Income Taxes. For the year ended December 31, 2011, income tax expense was $432,000 compared to $386,000 for the year ended December 31, 2010. We determined that we were not required to establish a valuation allowance for deferred tax assets since it is more likely than not that the deferred tax assets will be realized through future taxable income and future reversals of existing taxable temporary differences. For more information, see Note 9 of the Notes to Consolidated Financial Statements.
Results of Operations of Exchange Underwriters
Exchange Underwriters’ net income decreased $219,000 to $61,000 for the year ended December 31, 2011 compared to $280,000 for the year ended December 31, 2010.
Overall, insurance revenue decreased $205,000 to $2.1 million for the year ended December 31, 2011 compared to $2.3 million for the year ended December 31, 2010. The decrease is primarily due to revenue from guaranteed supplemental payments and contingency fees, which decreased $245,000 to $108,000 for the year ended December 31, 2011 compared to $354,000 for the year December 31, 2010 as a result of incurred losses, stop loss charges, and a decline in eligible written and earned premiums on insurance policies. Substantially all of the revenue of Exchange Underwriters comes from commissions received for the sale of insurance. The decrease in contingency fees was partially offset by a $40,000 increase in commissions.
Total expenses increased $155,000 to $2.0 million for the year ended December 31, 2011 compared to $1.8 million for the year ended December 31, 2010. The increase is primarily from compensation due to addition of personnel and higher commissions based on volume.
Risk Management
Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.
Credit Risk Management.Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans.
When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a past due notice is generated and sent to the borrower. If the payment is not received within five days, a second past due notice is sent. If payment is not then received by the 30th day of delinquency, additional letters and phone calls generally are made. Generally, when a mortgage loan becomes 60 days past due, we send a letter notifying the borrower that he or she may apply for assistance under a state mortgage assistance program. If the borrower does not apply for assistance within the allotted time period or applies for assistance and is rejected, we will commence foreclosure proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Generally, when a consumer loan becomes 60 days past due, we institute collection proceedings and attempt to repossess any personal property that secures the loan. We may consider loan workout arrangements with certain borrowers under certain circumstances.
Management informs the board of directors monthly of the amount of loans delinquent more than 30 days, all loans in foreclosure and all foreclosed and repossessed property that we own.
K-39 |
Market Risk Management.The process by which we manage our interest rate risk is called asset/liability management. The goal of our asset/liability management is to increase net interest income without taking undue interest rate risk while maintaining adequate liquidity. The Asset Liability Committee is responsible for the identification and management of interest rate risk exposure and continuously evaluates strategies to manage our exposure to interest rate fluctuations.
Analysis of Nonperforming and Classified Assets. We consider repossessed assets and loans that are 90 days or more past due to be nonperforming assets. Loans are generally placed on nonaccrual status when they become 90 days delinquent, at which time the accrual of interest ceases and all previously accrued and unpaid interest is reversed against earnings.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired it is recorded at the lower of its cost, which is the unpaid balance of the loan, plus foreclosure costs, or fair market value at the date of foreclosure. Holding costs and declines in fair value after acquisition of the property result in charges against income.
K-40 |
The following table provides information with respect to our nonperforming assets at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Nonaccrual loans: | ||||||||||||||||||||
Real estate - mortgage | ||||||||||||||||||||
One-to-four family residential | ||||||||||||||||||||
Originated | $ | 128 | $ | 332 | $ | 137 | $ | 210 | $ | 492 | ||||||||||
Purchased | 1,416 | 394 | 227 | 235 | 772 | |||||||||||||||
Total one-to-four family residential | 1,544 | 726 | 364 | 445 | 1,264 | |||||||||||||||
Multi-family | ||||||||||||||||||||
Originated | — | — | — | — | — | |||||||||||||||
Purchased | — | — | 634 | — | — | |||||||||||||||
Total multi-family | — | — | 634 | — | — | |||||||||||||||
Commercial | 568 | 493 | 98 | 187 | — | |||||||||||||||
Total real estate - mortgage | 2,112 | 1,219 | 1,096 | 632 | 1,264 | |||||||||||||||
Real estate - construction | ||||||||||||||||||||
Residential | — | — | — | — | — | |||||||||||||||
Commercial | — | — | — | — | — | |||||||||||||||
Total real estate - construction | — | — | — | — | — | |||||||||||||||
Consumer | ||||||||||||||||||||
Home equity | ||||||||||||||||||||
Loan-to-value ratio of 80% or less | — | — | 79 | — | — | |||||||||||||||
Loan-to-value ratio of greater than 80% | 33 | — | 45 | — | — | |||||||||||||||
Total home equity | 33 | — | 124 | — | — | |||||||||||||||
Other | — | — | 11 | 4 | 17 | |||||||||||||||
Total consumer | 33 | — | 135 | 4 | 17 | |||||||||||||||
Commercial business | — | — | — | — | — | |||||||||||||||
Total nonaccrual loans | 2,145 | 1,219 | 1,231 | 636 | 1,281 | |||||||||||||||
Accruing loans past due 90 days or more | — | — | — | — | — | |||||||||||||||
Total nonaccrual loans and accruing loans past due 90 days or more | 2,145 | 1,219 | 1,231 | 636 | 1,281 | |||||||||||||||
Real estate owned | 544 | 426 | 419 | 295 | 1,119 | |||||||||||||||
Total nonperforming assets | $ | 2,689 | $ | 1,645 | $ | 1,650 | $ | 931 | $ | 2,400 | ||||||||||
Troubled debt restructurings: | ||||||||||||||||||||
In nonaccrual status | $ | 465 | $ | 493 | $ | — | $ | — | $ | — | ||||||||||
Performing under modifed terms | 1,565 | 672 | — | — | — | |||||||||||||||
Total troubled debt restructurings | $ | 2,030 | $ | 1,165 | $ | — | $ | — | $ | — | ||||||||||
Total nonperforming loans to total loans | 0.84 | % | 0.51 | % | 0.50 | % | 0.27 | % | 0.67 | % | ||||||||||
Total nonperforming assets to total assets | 0.80 | 0.48 | 0.47 | 0.27 | 0.79 |
Interest income that would have been recorded for the years ended December 31, 2011 and December 31, 2010 had nonaccruing loans been current according to their original terms amounted to $324,000 and $190,000, respectively. No interest related to nonaccrual loans was included in interest income for the years ended December 31, 2011 and 2010.
K-41 |
At December 31, 2011 nonaccrual loans consisted primarily of nine residential mortgage loans that total $1.5 million, of which one was originated internally in the amount of $128,000 and eight were purchased in the amount of $1.4 million. Of these loans, the eight purchased residential properties were in process of foreclosure at December 31, 2011. The nonaccrual purchased residential loans included one relationship comprised of six loans totaling $1.3 million. Additionally, nonaccrual loans included two commercial real estate relationships, which consisted of three loans in the amount of $568,000, and one home equity loan in the amount of $33,000.
At December 31, 2010 nonaccrual loans consisted primarily of seven residential mortgage loans that total $726,000, of which four were originated internally in the amount of $332,000 and three were purchased in the amount of $394,000. Of these loans, one originated and one purchased residential property in the amounts of $160,000 and $231,000 were in process of foreclosure at December 31, 2010. Additionally, nonaccrual loans included one commercial real estate relationship which consisted of two loans in the amount of $493,000.
The Bank had three relationships classified as TDRs at the dates indicated summarized as follows:
• | One relationship composed of two commercial real estate loans with a total balance of $465,000 and $493,000 at December 31, 2011 and December 31, 2010, respectively. The borrower was experiencing financial difficulties and was given a six month interest-only payment concession in 2010. After conclusion of the interest-only period in 2011, the borrower was unable to consistently make regular loan payments and defaulted on the loans, which resulted in the Bank beginning the foreclosure process on the collateral securing the loans. To halt foreclosure, the borrower signed a forbearance agreement and, in 2012, paid off one of the loans and began making monthly payments. If a payment is missed the foreclosure process will restart. This relationship was evaluated for impairment and it was determined based on an appraisal of the underlying loan collateral that a specific allowance was not necessary because there was sufficient collateral to cover the outstanding loan balance. These loans are included in total nonaccrual loans in the previous table. | |
• | One commercial real estate participation loan with a balance of $654,000 and $672,000 at December 31, 2011 and December 31, 2010, respectively. Because the borrower believed it would be unable to obtain financing to pay the loan in full upon original maturity in 2010, the loan was modified through a forbearance agreement in 2010 by extending the maturity date by three years to 2013. This loan has demonstrated performance under the modified terms and therefore was in a performing (accrual) status. This relationship was evaluated for impairment and it was determined that a $170,000 specific allowance was necessary due to a decline in the underlying collateral as determined by an appraisal on the property. |
• | One relationship that totaled $911,000 at December 31, 2011 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000 that has been deemed impaired based on the current financial standing of the borrower. In the fourth quarter of 2011, three commercial business loans were consolidated into one commercial real estate loan and additional collateral was obtained. The Bank previously determined a $75,000 specific allowance was necessary based on the current information that was available. However, after enhancing the collateral position and reviewing the updated property appraisals of the underlying | |
loan collateral and the updated valuation of the other business assets securing the loan, it was determined that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was no longer necessary at December 31, 2011. |
The following table shows the aggregate amounts of our classified assets at the dates indicated (dollars in thousands). Real estate owned properties are considered substandard based on internal policy
December 31, | 2011 | 2010 | 2009 | |||||||||
Special mention assets | $ | 2,338 | $ | 3,156 | $ | 3,562 | ||||||
Substandard assets | 4,477 | 3,047 | 2,339 | |||||||||
Doubtful assets | — | — | — | |||||||||
Loss assets | — | — | — | |||||||||
Total classified assets | $ | 6,815 | $ | 6,203 | $ | 5,901 |
At December 31, 2011, special mention assets were $2.3 million and included three relationships that consisted of four commercial real estate loans and one mortgage loan totaling $2.1 million and $262,000, respectively. Substandard assets were $4.5 million and consisted of real estate owned properties, $2.1 million of non-accrual loans, two commercial real estate loans in the amount of $877,000 and one relationship that totaled $911,000 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000. Nonaccrual loans consisted of $1.5 million of residential mortgage loans, $568,000 of commercial real estate loans, and a $33,000 home equity loan. The nonaccrual residential loans included one purchased relationship comprised of six loans totaling $1.3 million.
K-42 |
Analysis and Determination of the Allowance for Loan Losses. Our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a valuation allowance on impaired loans; and (2) a 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.
Allowance on Impaired Loans. We establish an allowance for loans that are individually evaluated and determined to be impaired. The allowance is determined by utilizing one of the three impairment measurement methods. At December 31, 2011, there were five loan relationships that were individually evaluated for impairment, of which three are considered TDRs. The three relationships that are considered TDRs are summarized as follows:
• | One relationship composed of two commercial real estate loans with a total balance of $465,000. The borrower was experiencing financial difficulties and was given a six month interest-only payment concession in 2010. After conclusion of the interest-only period in 2011, the borrower was unable to consistently make regular loan payments and defaulted on the loans, which resulted in the Bank beginning the foreclosure process on the collateral securing the loans. To halt foreclosure, the borrower signed a forbearance agreement and, in 2012, paid off one of the loans and began making monthly payments. If a payment is missed the foreclosure process will restart. This relationship was evaluated for impairment and it was determined based on an appraisal of the underlying loan collateral that a specific allowance was not necessary because there was sufficient collateral to cover the outstanding loan balance. These loans are included in total nonaccrual loans. | |
• | One commercial real estate participation loan with a balance of $654,000. Because the borrower believed they would be unable to obtain financing to pay the loan in full upon original maturity in 2010, the loan was modified through a forbearance agreement in 2010 by extending the maturity date by three years to 2013. This loan has demonstrated performance under the modified terms and therefore was in a performing (accrual) status. This relationship was evaluated for impairment and it was determined that a $170,000 specific allowance was necessary due to a decline in the underlying collateral as determined by an appraisal on the property. |
• | One relationship that totaled $911,000 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000 that has been deemed impaired based on the current financial standing of the borrower. In the fourth quarter of 2011, three commercial business loans were consolidated into one commercial real estate loan and additional collateral was obtained. The Bank previously determined a $75,000 specific allowance was necessary based on the current information that was available. However, after enhancing the collateral position and reviewing the updated property appraisals of the underlying loan collateral and the updated valuation of the other business assets securing the loan, it was determined that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was no longer necessary at December 31, 2011. | |
The two relationships that are not considered TDRs are summarized as follows: | ||
• | One purchased residential mortgage relationship consisting of six loans totaling $1.3 million that has been deemed impaired due to the borrower no longer making payments. One loan with a balance of $116,000 was paid off in 2012 and the remaining five loans were in process of foreclosure. It was determined based on an appraisal of the underlying loan collateral that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was not established. | |
• | One commercial real estate relationship totaling $223,000 that has been deemed impaired based on the current financial standing of the borrower. It was determined based on an appraisal of the underlying loan collateral that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was not established. |
K-43 |
Allowance on the Remainder of the Loan Portfolio. We establish another allowance for loans that are not determined to be impaired. Management determines historical loss experience for each group of loans with similar risk characteristics within the portfolio based on loss experience for loans in each group. Loan categories will represent groups of loans with similar risk characteristics and may include types of loans categorized by product, large credit exposures, concentrations, loan grade, or any other characteristic that causes a loan’s risk profile to be similar to another. We currently utilize previous years’ net charge-off experience by loan category as a basis in determining loss projections. In addition, there are two categories of loans considered to be higher risk concentrations that are evaluated separately when calculating the allowance for loan losses:
• | Loans purchased in the secondary market. Prior to 2006, pools of multi-family and one-to-four family residential mortgage loans located in areas outside of our primary geographic lending area in southwestern Pennsylvania were acquired in the secondary market. Although these loans were underwritten to our lending standards, they are considered higher risk given our unfamiliarity with the geographic areas where the properties are located. | |
• | Home equity loans with a loan-to-value ratio greater than 80%. These loans are considered higher risk given the pressure on property values and reduced credit alternatives available to leveraged borrowers. |
We also consider qualitative or environmental factors that are likely to cause estimated credit losses associated with our existing portfolio to differ from historical loss experience. Our historical loss experience and qualitative and environmental factors are reviewed on a quarterly basis to ensure they are reflective of current conditions in our loan portfolio and economy. In 2011, the qualitative factor related to changes in adversely graded loans was adjusted to include a factor for special mention loans. The factors related to changes in the volume and severity of past due loans, nonaccrual loans and adversely graded or classified loans and changes in the value of underlying collateral for collateral dependent loans were also adjusted specifically for the purchased residential loans due to severity of the number of past due loans in this portfolio segment and the continued deterioration of property values, primarily on Michigan properties. The qualitative factor related to changes in underlying collateral on collateral dependent loans was previously adjusted in 2010 due to the current real estate conditions outside the Bank’s footprint, specifically in the Michigan area where the majority of our delinquent purchased loans are located. In addition, in 2011 and 2010, certain historical loss factors were adjusted to place more emphasis on recent and expected loss experience while generally excluding periods where we did not experience any losses.
At December 31, 2011, our allowance for loan losses represented 1.21% of total loans compared to 1.19% at December 31, 2010. The increase is primarily due to loan growth and the qualitative factor changes previously noted.
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 or a shortfall in collateral value would result in our charging off the loan or the portion of the loan that was impaired.
The OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. The OCC may require us to make additional provisions for loan losses based on judgments different from ours.
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 our 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 GAAP, there can be no assurance that regulators, in reviewing our loan portfolio, will not request us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans 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.
K-44 |
The following table sets forth the allowance for loan losses by loan category at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent of | Percent of | Percent of | ||||||||||||||||||||||||||||||||||||
Total | Total | Total | Total | Total | ||||||||||||||||||||||||||||||||||||
Amount | Loans(1) | Amount | Loans(1) | Amount | Loans(1) | Amount | Loans(1) | Amount | Loans(1) | |||||||||||||||||||||||||||||||
Real estate - mortgage | ||||||||||||||||||||||||||||||||||||||||
One-to-four family residential | ||||||||||||||||||||||||||||||||||||||||
Originated | $ | 534 | 46.0 | % | $ | 558 | 51.3 | % | $ | 641 | 54.8 | % | $ | 513 | 53.2 | % | $ | 330 | 51.5 | % | ||||||||||||||||||||
Purchased | 465 | 6.4 | 433 | 8.7 | 323 | 9.8 | 203 | 12.5 | 184 | 18.9 | ||||||||||||||||||||||||||||||
Total one-to-four family | 999 | 52.4 | 991 | 60.0 | 964 | 64.6 | 716 | 65.7 | 514 | 70.4 | ||||||||||||||||||||||||||||||
Multi-family | ||||||||||||||||||||||||||||||||||||||||
Originated | 39 | 5.1 | 12 | 1.7 | 12 | 1.6 | 11 | 1.6 | 1 | 0.6 | ||||||||||||||||||||||||||||||
Purchased | 124 | 2.0 | 127 | 2.2 | 117 | 2.5 | 81 | 3.0 | 163 | 5.6 | ||||||||||||||||||||||||||||||
Total multi-family | 163 | 7.1 | 139 | 3.9 | 129 | 4.1 | 92 | 4.6 | 164 | 6.2 | ||||||||||||||||||||||||||||||
Commercial | 858 | 13.8 | 804 | 14.2 | 647 | 12.8 | 387 | 10.3 | 190 | 7.5 | ||||||||||||||||||||||||||||||
Total real estate - mortgage | 2,020 | 73.3 | 1,934 | 78.1 | 1,740 | 81.5 | 1,195 | 80.6 | 868 | 84.1 | ||||||||||||||||||||||||||||||
Real estate - construction | ||||||||||||||||||||||||||||||||||||||||
Residential | 6 | 1.5 | 10 | 2.9 | 4 | 1.2 | 15 | 4.2 | 16 | 3.5 | ||||||||||||||||||||||||||||||
Commercial | 12 | 3.3 | 1 | 0.3 | 4 | 1.1 | 5 | 1.5 | — | — | ||||||||||||||||||||||||||||||
Total real estate - construction | 18 | 4.8 | 11 | 3.2 | 8 | 2.3 | 20 | 5.7 | 16 | 3.5 | ||||||||||||||||||||||||||||||
Consumer | ||||||||||||||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||||||||||||||
Loan-to-value ratio of 80% or less | 379 | 12.0 | 294 | 9.6 | 168 | 7.3 | 99 | 5.3 | 29 | 5.0 | ||||||||||||||||||||||||||||||
Loan-to-value ratio of greater than 80% | 267 | 3.1 | 292 | 3.6 | 321 | 3.8 | 306 | 4.1 | 117 | 4.3 | ||||||||||||||||||||||||||||||
Home equity | 646 | 15.1 | 586 | 13.2 | 489 | 11.1 | 405 | 9.4 | 146 | 9.3 | ||||||||||||||||||||||||||||||
Other | 24 | 0.7 | 26 | 0.9 | 31 | 0.9 | 19 | 0.7 | 24 | 0.8 | ||||||||||||||||||||||||||||||
Total consumer | 670 | 15.8 | 612 | 14.1 | 520 | 12.0 | 424 | 10.1 | 170 | 10.1 | ||||||||||||||||||||||||||||||
Commercial business | 242 | 6.1 | 171 | 4.6 | 160 | 4.2 | 121 | 3.6 | 95 | 2.3 | ||||||||||||||||||||||||||||||
Unallocated | 148 | — | 96 | — | 81 | — | 46 | — | 308 | — | ||||||||||||||||||||||||||||||
Total allowance for loan losses | $ | 3,098 | 100.0 | % | $ | 2,824 | 100.0 | % | $ | 2,509 | 100.0 | % | $ | 1,806 | 100.0 | % | $ | 1,457 | 100.0 | % |
(1) Represents percentage of loans in each category to total loans.
K-45 |
Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Allowance at beginning of year | $ | 2,824 | $ | 2,509 | $ | 1,806 | $ | 1,457 | $ | 866 | ||||||||||
Provision for loan losses | 850 | 850 | 1,090 | 878 | 1,119 | |||||||||||||||
Charge-offs: | ||||||||||||||||||||
Real estate - mortgage | ||||||||||||||||||||
One-to-four family residential (originated) | — | (82 | ) | (32 | ) | (307 | ) | — | ||||||||||||
One-to-four family residential (purchased) | (489 | ) | (181 | ) | (105 | ) | (135 | ) | — | |||||||||||
Multi-family (originated) | — | — | — | — | — | |||||||||||||||
Multi-family (purchased) | — | (46 | ) | (130 | ) | — | (355 | ) | ||||||||||||
Commercial | — | — | (63 | ) | (40 | ) | — | |||||||||||||
Total real estate - mortgage | (489 | ) | (309 | ) | (330 | ) | (482 | ) | (355 | ) | ||||||||||
Real estate - construction | ||||||||||||||||||||
Residential | — | — | — | — | — | |||||||||||||||
Commercial | — | — | — | — | — | |||||||||||||||
Total real estate - construction | — | — | — | — | — | |||||||||||||||
Consumer | ||||||||||||||||||||
Home equity (loan-to-value ratio of 80% or less) | (14 | ) | (87 | ) | — | — | — | |||||||||||||
Home equity (loan-to-value ratio of greater than 80%) | (64 | ) | (119 | ) | (46 | ) | (27 | ) | (158 | ) | ||||||||||
Other | (11 | ) | (18 | ) | (14 | ) | (20 | ) | (15 | ) | ||||||||||
Total consumer | (89 | ) | (224 | ) | (60 | ) | (47 | ) | (173 | ) | ||||||||||
Commercial business | — | (2 | ) | — | — | — | ||||||||||||||
Total charge-offs | (578 | ) | (535 | ) | (390 | ) | (529 | ) | (528 | ) | ||||||||||
Recoveries | 2 | — | 3 | — | — | |||||||||||||||
Net charge-offs | (576 | ) | (535 | ) | (387 | ) | (529 | ) | (528 | ) | ||||||||||
Allowance at end of year | $ | 3,098 | $ | 2,824 | $ | 2,509 | $ | 1,806 | $ | 1,457 | ||||||||||
Allowance to nonperforming loans | 144.43 | % | 231.67 | % | 203.82 | % | 283.96 | % | 113.74 | % | ||||||||||
Allowance to total loans | 1.21 | 1.19 | 1.03 | 0.76 | 0.76 | |||||||||||||||
Net charge-offs to average loans | 0.24 | 0.23 | 0.16 | 0.25 | 0.29 |
Interest Rate Risk Management. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments.
K-46 |
We have an Asset/Liability Committee, which includes members of executive management, to communicate, coordinate and control all aspects of our business involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.
We use an interest rate sensitivity analysis prepared by the OCC to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 50 to 300 basis point increase or 50 to 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement. Because of the low level of market interest rates, this analysis is not performed for decreases of more than 100 basis points. We measure interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios. The following table, which is based on information that we provide to the OCC, presents the change in our net portfolio value at December 31, 2011 that would occur in the event of an immediate change in interest rates based on OCC assumptions, with no effect given to any steps that we might take to counteract that change (dollars in thousands).
NPV as a Percent of | ||||||||||||||||||||
December 31, 2011 | Net Portfolio Value (“NPV”) | Portfolio Value of Assets | ||||||||||||||||||
Basis Point (“bp”) | Dollar | Dollar | Percent | |||||||||||||||||
Change in Rates | Amount | Change | Change | NPV Ratio | Change | |||||||||||||||
300 bp | $ | 45,320 | $ | (10,198 | ) | (18.4 | )% | 13.63 | % | (217) | bp | |||||||||
200 | 52,194 | (3,324 | ) | (6.0 | ) | 15.26 | (54 | ) | ||||||||||||
100 | 56,042 | 524 | 0.9 | 16.07 | 27 | |||||||||||||||
50 | 55,591 | 73 | 0.1 | 15.89 | 9 | |||||||||||||||
Static | 55,518 | — | — | 15.80 | — | |||||||||||||||
(50) | 54,213 | (1,305 | ) | (2.4 | ) | 15.42 | (38 | ) | ||||||||||||
(100) | 53,759 | (1,759 | ) | (3.2 | ) | 15.26 | (54 | ) |
The OCC uses certain assumptions in assessing the interest rate risk of savings associations. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.
Beginning in 2012, the OCC will no longer prepare an interest rate sensitivity analysis and we will internally prepare an interest rate sensitivity analysis utilizing a simulation model to determine the effect of immediate incremental increases and decreases in interest rates on net income and the market value of our equity. Similar to the OCC analysis, certain assumptions will be made regarding interest rates, loan prepayments and decay rates of deposit accounts in order to generate the results.
K-47 |
Liquidity Management.Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of available-for-sale securities and borrowings from the FHLB of Pittsburgh. 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.
We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.
Our most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At December 31, 2011, cash and cash equivalents totaled $14.6 million. Securities classified as available-for-sale that are not pledged as collateral, and which provide additional sources of liquidity, totaled $42.5 million at December 31, 2011. In addition, at December 31, 2011, we had a maximum remaining borrowing capacity at the FHLB of approximately $124.3 million. We also have the ability to borrow from the Federal Reserve based upon eligible collateral and have an $8.0 million unsecured discretionary line of credit. At December 31, 2011 and 2010, the Bank had no borrowings with the Federal Reserve and had not taken any advances on the line of credit..
At December 31, 2011, we had $24.3 million of commitments to lend, which was comprised of $7.8 million of loans in process, $6.0 million of unused commercial lines of credit, $4.6 million of commercial commitments, $3.7 million of unused consumer lines of credit, $1.3 million of residential commitments, and $817,000 of consumer commitments. Certificates of deposit due within one year of December 31, 2011 totaled $60.3 million, or 58.0% of certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customers’ hesitancy to invest their funds for long periods in the recent interest rate environment. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. We believe, however, based on past experience that a significant portion of our maturing certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
The following table presents certain of our contractual obligations as of December 31, 2011 (dollars in thousands).
Amounts Due in | ||||||||||||||||||||
One Year | One to | Three to | After | |||||||||||||||||
Total | or Less | Three Years | Five Years | Five Years | ||||||||||||||||
Borrowings | $ | 49,903 | $ | 8,406 | $ | 29,497 | $ | 12,000 | $ | — | ||||||||||
Operating lease obligations(1) | 635 | 166 | 263 | 177 | 29 | |||||||||||||||
Total | $ | 50,538 | $ | 8,572 | $ | 29,760 | $ | 12,177 | $ | 29 |
(1)Payments are for lease of real property.
Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts and FHLB advances. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposit relationships. Occasionally, we offer promotional rates on certain deposit products to attract deposits. No further changes in our funding mix are currently planned or expected, other than changes in the ordinary course of business resulting from deposit flows. For information about our costs of funds, see “Results of Operations for the Years Ended December 31, 2011 and 2010—Net Interest Income.”
K-48 |
The following table presents our primary investing and financing activities during the periods indicated (dollars in thousands).
Years Ended December 31, | 2011 | 2010 | ||||||
Investing activities: | ||||||||
Loans disbursed or closed | $ | (68,163 | ) | $ | (40,555 | ) | ||
Loan principal repayments | 51,602 | 48,743 | ||||||
Proceeds from maturities and principal repayments of securities | 21,282 | 19,884 | ||||||
Proceeds from sales of securities available-for-sale | 10,162 | 14,449 | ||||||
Purchases of securities | (5,366 | ) | (34,352 | ) | ||||
Financing activities: | ||||||||
Increase in deposits | 17,978 | 9,981 | ||||||
Decrease in borrowings | (27,604 | ) | (35,618 | ) |
FedFirst Financial Corporation is a separate legal entity from the Bank and must provide for its own liquidity. FedFirst Financial’s financial obligations consist primarily of its operating expenses and payments of dividends to stockholders, when declared. FedFirst Financial has no outstanding indebtedness. FedFirst Financial’s available sources of income are interest and dividends on its investments and dividends from the Bank. The amount of dividends that the Bank can pay to FedFirst Financial in any calendar year without the prior approval of the OCC cannot exceed retained net income for the year plus retained net income for the two prior calendar years.
Capital Management.We are subject to various regulatory capital requirements administered by the OCC, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2011, we exceeded all of our regulatory capital requirements. We are considered “well capitalized” under regulatory guidelines.
The following table sets forth the Bank’s regulatory capital amounts and ratios, as well as the minimum amounts and ratios required to be well capitalized (dollars in thousands).
To Be Well | ||||||||||||||||||||||||
For Capital | Capitalized | |||||||||||||||||||||||
Adequacy | Under Prompt | |||||||||||||||||||||||
Actual | Purposes | Corrective Action | ||||||||||||||||||||||
December 31, 2011 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 47,771 | 25.30 | % | $ | 15,107 | 8.00 | % | $ | 18,884 | 10.00 | % | ||||||||||||
Tier 1 capital (to risk-weighted assets) | 45,401 | 24.04 | 7,553 | 4.00 | 11,330 | 6.00 | ||||||||||||||||||
Tier 1 capital (to adjusted total assets) | 45,401 | 13.59 | 13,360 | 4.00 | 16,700 | 5.00 | ||||||||||||||||||
Tangible capital (to tangible assets) | 45,401 | 13.59 | 5,010 | 1.50 | N/A | N/A |
December 31, 2010 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 46,565 | 25.44 | % | $ | 14,641 | 8.00 | % | $ | 18,302 | 10.00 | % | ||||||||||||
Tier 1 capital (to risk-weighted assets) | 44,277 | 24.19 | 7,321 | 4.00 | 10,981 | 6.00 | ||||||||||||||||||
Tier 1 capital (to adjusted total assets) | 44,277 | 12.95 | 13,681 | 4.00 | 17,102 | 5.00 | ||||||||||||||||||
Tangible capital (to tangible assets) | 44,277 | 12.95 | 5,130 | 1.50 | N/A | N/A |
K-49 |
Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, 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 and lines of credit. For information about our loan commitments and unused lines of credit, see Note 13 of the Notes to Consolidated Financial Statements.
For the year ended December 31, 2011, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Effect of Inflation and Changing Prices
The Consolidated Financial Statements and related financial data presented in this Annual Report on Form 10-K have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change 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 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 do general levels of 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 |
The information required by this item is incorporated herein by reference to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Information required by this item is included herein beginning on page F-1.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
FedFirst Financial’s management, including FedFirst Financial’s principal executive officer and principal financial officer, have evaluated the effectiveness of FedFirst Financial’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, FedFirst Financial’s disclosure controls and procedures were effective.
K-50 |
There have been no changes in FedFirst Financial’s internal control over financial reporting during the quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, FedFirst Financial’s internal control over financial reporting.
See Item 8 for management’s report on internal control over financial reporting.
ITEM 9B. | OTHER INFORMATION |
None.
PART III
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE |
The information regarding the directors and officers of FedFirst Financial and compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders and to Part I, Item 1 “Business – Executive Officers of the Registrant” to this Annual Report on Form 10-K. FedFirst Financial has adopted a Code of Ethics and Business Conduct which is available on our website at www.firstfederal-savings.com.
ITEM 11. | EXECUTIVE COMPENSATION |
The information regarding executive compensation is incorporated herein by reference to FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
(a) | Security Ownership of Certain Beneficial Owners |
The information relating to certain relationships and related transactions is incorporated herein by reference to the section captioned “Stock Ownership” in FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders. | ||
(b) | Security Ownership of Management | |
The information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders. | ||
(c) | Changes in Control | |
Management of FedFirst Financial knows of no arrangements, including any pledge by any person or securities of FedFirst Financial’s, the operation of which may at a subsequent date result in a change in control of the registrant. |
K-51 |
(d) | Equity Compensation Plan Information | |
The following table provides information at December 31, 2011 for compensation plans under which equity securities may be issued. |
Number of securities | ||||||||||||
remaining available for | ||||||||||||
Number of securities | future issuance under | |||||||||||
to be issued upon | Weighted-average | equity compensation | ||||||||||
exercise of | exercise price of | plans (excluding | ||||||||||
outstanding options | outstanding options | securities reflected | ||||||||||
Plan Category | warrants and rights | warrants and rights | in column (A)) | |||||||||
(A) | (B) | (C) | ||||||||||
Equity compensation plans: | ||||||||||||
Approved by stockholders | 140,119 | $ | 16.86 | 159,170 | ||||||||
Not approved by stockholders | — | — | — | |||||||||
Total | 140,119 | $ | 16.86 | 159,170 |
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
The information relating to certain relationships and related transactions is incorporated herein by reference to FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders.
ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES |
The information relating to principal accounting fees and expenses is incorporated herein by reference to FedFirst Financial’s Proxy Statement for the 2012 Annual Meeting of Stockholders.
K-52 |
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
3.1 | Articles of Incorporation of FedFirst Financial Corporation (incorporated herein by reference to Exhibit 3.1 to the Registration Statement on Form S-1 (Registration No. 333-165437) initially filed on March 12, 2010) | |
3.2 | Bylaws of FedFirst Financial Corporation (incorporated herein by reference to Exhibit 3.2 to the Registration Statement on Form S-1 (Registration No. 333-165437) initially filed on March 12, 2010) | |
10.1 | Form of First Federal Savings Bank Employee Severance Compensation Plan (incorporated herein by reference to Exhibit 10.5 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004) (1) | |
10.2 | Director Fee Continuation Agreements dated as of June 30, 1999 by and between First Federal Savings Bank and certain Directors (incorporated herein by reference to Exhibit 10.6 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004) (1) | |
10.3 | Agreement dated as of November 30, 2011 by and between First Federal Savings Bank and Richard B. Boyer (incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on December 2, 2011)(1) | |
10.4 | Split Dollar Life Insurance Agreements dated as of June 30, 1999 by and between First Federal Savings Bank and certain Directors (incorporated herein by reference to Exhibit 10.9 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004) (1) | |
10.5 | Split Dollar Life Insurance Agreement dated as of June 1, 2002 by and between First Federal Savings Bank and Richard B. Boyer (incorporated herein by reference to Exhibit 10.11 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004)(1) | |
10.6 | Employment Agreement dated as of May 29, 2002 by and between First Federal Savings Bank and Richard B. Boyer (incorporated herein by reference to Exhibit 10.15 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004)(1) | |
10.7 | Lease Agreement dated as of June 1, 2002 by and between Exchange Underwriters, Inc. and Richard B. and Wendy A. Boyer (incorporated herein by reference to Exhibit 10.17 to the Registration Statement on Form SB-2, as amended (File No. 333-121405), initially filed on December 17, 2004) | |
10.8 | FedFirst Financial Corporation 2011 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Proxy Statement filed on April 15, 2011)(1) | |
10.9 | FedFirst Financial Corporation 2006 Equity Incentive Plan dated as of March 28, 2006 (incorporated herein by reference to Appendix C to the Proxy Statement filed on April 13, 2006)(1) | |
10.10 | Amendment dated as of April 28, 2008 to the Director Fee Continuation Agreements Between First Federal Savings Bank and certain directors (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, filed on May 9, 2008)(1) | |
10.11 | Amendment dated as of July 19, 2002 to the Life Insurance Endorsement Method Split Dollar Plan Agreement by and between First Federal Savings Bank and Richard B. Boyer (incorporated herein by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, filed on May 9, 2008)(1) |
K-53 |
10.12 | Amendment dated as of September 13, 2005 to the Life Insurance Endorsement Method Split Dollar Plan Agreement by and between First Federal Savings Bank and Richard B. Boyer (incorporated herein by reference to Exhibit 10.4 to the Form 10-Q for the quarter ended March 31, 2008, filed on May 9, 2008)(1) | |
10.13 | Employment Agreement dated as of June 1, 2008 by and between Exchange Underwriters, Inc. and Richard B. Boyer (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed on August 8, 2008)(1) | |
10.14 | Employment Agreement dated as of May 21, 2009 by and between First Federal Savings Bank, FedFirst Financial Corporation and Patrick G. O’Brien (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 2009, filed on August 13, 2009)(1) | |
10.15 | Consulting Agreement dated as of May 21, 2009 by and between FedFirst Financial Corporation, First Federal Savings Bank and John G. Robinson (incorporated herein by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 2009, filed on August 13, 2009)(1) | |
10.16 | Amendment dated as of October 15, 2009 to the Employment Agreement by and between Exchange Underwriters, Inc. and Richard B. Boyer (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2009, filed on November 13, 2009)(1) | |
10.17 | Amendment dated as of April 1, 2010 to the Employment Agreement by and between First Federal Savings Bank, FedFirst Financial Corporation and Patrick G. O’Brien (incorporated herein by reference to Exhibit 10.22 to the Registration Statement on Form S-1/A (Registration No. 333-165437) initially filed on May 6, 2010)(1) | |
10.18 | Amendment dated as of April 1, 2010 to the Employment Agreement by and between Exchange Underwriters, Inc. and Richard B. Boyer (incorporated herein by reference to Exhibit 10.23 to the Registration Statement on Form S-1/A (Registration No. 333-165437) initially filed on May 6, 2010)(1) | |
10.19 | Change in Control Agreement dated as of October 14, 2011 by and between First Federal Savings Bank, FedFirst Financial Corporation and Jamie L. Prah (incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on October 17, 2011) (1) | |
21.0 | Subsidiaries of the Registrant (incorporated herein by reference to Exhibit 21.0 to the Registration Statement on Form S-1 (Registration No. 333-165437) initially filed on March 12, 2010) | |
23.1 | Consent of ParenteBeard LLC | |
31.1 | Rule 13(a)-14(a)/15d-14(a) Certification of Chief Executive Officer | |
31.2 | Rule 13(a)-14(a)/15d-14(a) Certification of Principal Financial Officer | |
32.0 | Section 1350 Certification of Chief Executive Officer and Principal Financial Officer | |
101.0 | The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Audited Consolidated Financial Statements, tagged as blocks of text(2) |
___________________
(1) Management contract or compensation plan or arrangement
(2)Furnished, not filed.
K-54 |
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FedFirst Financial Corporation | |||
Date: March 21, 2012 | /s/ PATRICK G. O’BRIEN | ||
By: | Patrick G. O’Brien | ||
President and Chief Executive Officer |
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Name | Title | Date | ||
/s/ PATRICK G. O’BRIEN | President, Chief Executive | March 21, 2012 | ||
Patrick G. O’Brien | Officer and Director | |||
(principal executive officer) | ||||
/s/ JAMIE L. PRAH | Senior Vice President and | March 21, 2012 | ||
Jamie L. Prah | Chief Financial Officer | |||
(principal accounting and financial officer) | ||||
/s/ R. CARLYN BELCZYK | Director | March 21, 2012 | ||
R. Carlyn Belczyk | ||||
/s/ RICHARD B. BOYER | Director | March 21, 2012 | ||
Richard B. Boyer | ||||
/s/ JOHN M. KISH | Director | March 21, 2012 | ||
John M. Kish | ||||
/s/ JOHN J. LACARTE | Director | March 21, 2012 | ||
John J. LaCarte | ||||
/s/ JOHN M SWIATEK | Director | March 21, 2012 | ||
John M Swiatek | ||||
/s/ DAVID L. WOHLEBER | Director | March 21, 2012 | ||
David L. Wohleber |
K-55 |
FINANCIAL STATEMENTS
Contents
Page | ||
Management’s Report on Internal Control Over Financial Reporting | F-2 | |
Report of Independent Registered Public Accounting Firm | F-3 | |
Consolidated Financial Statements: | ||
Statements of Financial Condition | F-4 | |
Statements of Operations | F-5 | |
Statements of Changes in Stockholders’ Equity and Comprehensive Income | F-6 | |
Statements of Cash Flows | F-8 | |
Notes to Consolidated Financial Statements | F-9 |
F-1 |
MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
FedFirst Financial Corporation’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance to management and the board of directors regarding the preparation and fair presentation of financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of its internal control over financial reporting as of December 31, 2011 based upon the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in a report entitledInternal Control — Integrated Framework.Based on our assessment, management has concluded FedFirst Financial Corporation maintained effective internal control over financial reporting as of December 31, 2011.
FedFirst Financial Corporation is neither an accelerated filer nor a large accelerated filer defined by §240.12b-2. Accordingly, the Company and its independent public accounting firm are not required to include in this Annual Report an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting pursuant to §229.308(a)(4) of Regulation S-K and §210.2-02 (f)(1) of regulation S-X, respectively.
F-2 |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
FedFirst Financial Corporation
Monessen, Pennsylvania
We have audited the accompanying consolidated statements of financial condition of FedFirst Financial Corporation and subsidiaries (“Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the two-year period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 audit included consideration of internal control over financial reporting as a basis for designing audit procedures 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 financial position of FedFirst Financial Corporation and subsidiaries as of December 31, 2011 and 2010 and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
/s/ ParenteBeard LLC
Pittsburgh, Pennsylvania
March 21, 2012
F-3 |
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, | 2011 | 2010 | ||||||
(Dollars in thousands except share data) | ||||||||
Assets: | ||||||||
Cash and cash equivalents: | ||||||||
Cash and due from banks | $ | 1,491 | $ | 1,626 | ||||
Interest-earning deposits | 13,080 | 7,694 | ||||||
Total cash and cash equivalents | 14,571 | 9,320 | ||||||
Securities available-for-sale | 52,448 | 78,708 | ||||||
Loans, net | 245,277 | 230,055 | ||||||
Federal Home Loan Bank (“FHLB”) stock, at cost | 5,340 | 6,556 | ||||||
Accrued interest receivable - loans | 1,008 | 1,038 | ||||||
Accrued interest receivable - securities | 236 | 327 | ||||||
Premises and equipment, net | 2,164 | 2,281 | ||||||
Bank-owned life insurance | 8,267 | 7,998 | ||||||
Goodwill | 1,080 | 1,080 | ||||||
Real estate owned | 544 | 426 | ||||||
Deferred tax assets and tax credit carryforwards | 3,096 | 3,017 | ||||||
Other assets | 1,243 | 2,267 | ||||||
Total assets | $ | 335,274 | $ | 343,073 | ||||
Liabilities and Stockholders’ Equity: | ||||||||
Deposits: | ||||||||
Noninterest-bearing | 20,536 | 15,612 | ||||||
Interest-bearing | 201,004 | 187,950 | ||||||
Total deposits | 221,540 | 203,562 | ||||||
Borrowings | 49,289 | 76,893 | ||||||
Advance payments by borrowers for taxes and insurance | 514 | 455 | ||||||
Accrued interest payable - deposits | 228 | 298 | ||||||
Accrued interest payable - borrowings | 202 | 300 | ||||||
Other liabilities | 4,700 | 2,978 | ||||||
Total liabilities | 276,473 | 284,486 | ||||||
Stockholders’ equity: | ||||||||
FedFirst Financial Corporation stockholders’ equity: | ||||||||
Preferred stock $0.01 par value; 10,000,000 shares authorized; none issued | — | — | ||||||
Common stock $0.01 par value; 20,000,000 shares authorized; 2,991,461 shares issued and 2,957,302 and 2,991,461 shares outstanding | 30 | 30 | ||||||
Additional paid-in-capital | 41,630 | 42,016 | ||||||
Retained earnings - substantially restricted | 18,650 | 18,140 | ||||||
Accumulated other comprehensive loss, net of deferred tax benefit of $107 and $82 | (167 | ) | (128 | ) | ||||
Unearned Employee Stock Ownership Plan (“ESOP”) | (1,382 | ) | (1,555 | ) | ||||
Total FedFirst Financial Corporation stockholders’ equity | 58,761 | 58,503 | ||||||
Noncontrolling interest in subsidiary | 40 | 84 | ||||||
Total stockholders’ equity | 58,801 | 58,587 | ||||||
Total liabilities and stockholders’ equity | $ | 335,274 | $ | 343,073 |
See Notes to the Consolidated Financial Statements
F-4 |
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, | 2011 | 2010 | ||||||
(Dollars in thousands, except per share amounts) | ||||||||
Interest income: | ||||||||
Loans | $ | 13,049 | $ | 13,366 | ||||
Securities | 2,473 | 3,404 | ||||||
Other interest-earning assets | 10 | 25 | ||||||
Total interest income | 15,532 | 16,795 | ||||||
Interest expense: | ||||||||
Deposits | 2,777 | 3,344 | ||||||
Borrowings | 2,143 | 3,390 | ||||||
Total interest expense | 4,920 | 6,734 | ||||||
Net interest income | 10,612 | 10,061 | ||||||
Provision for loan losses | 850 | 850 | ||||||
Net interest income after provision for loan losses | 9,762 | 9,211 | ||||||
Noninterest income: | ||||||||
Fees and service charges | 602 | 518 | ||||||
Insurance commissions | 2,119 | 2,324 | ||||||
Income from bank-owned life insurance | 269 | 284 | ||||||
Net gain (loss) on sales of securities | 304 | (658 | ) | |||||
Net loss on sales of real estate owned | (29 | ) | (42 | ) | ||||
Other | 41 | 26 | ||||||
Total noninterest income | 3,306 | 2,452 | ||||||
Noninterest expense: | ||||||||
Compensation and employee benefits | 7,183 | 6,051 | ||||||
Occupancy | 1,476 | 1,425 | ||||||
FDIC insurance premiums | 255 | 353 | ||||||
Data processing | 530 | 486 | ||||||
Professional services | 752 | 624 | ||||||
Other | 1,569 | 1,674 | ||||||
Total noninterest expense | 11,765 | 10,613 | ||||||
Income before income tax expense and noncontrolling interest in net income of consolidated subsidiary | 1,303 | 1,050 | ||||||
Income tax expense | 432 | 386 | ||||||
Net income before noncontrolling interest in net income of consolidated subsidiary | 871 | 664 | ||||||
Noncontrolling interest in net income of consolidated subsidiary | 12 | 56 | ||||||
Net income of FedFirst Financial Corporation | $ | 859 | $ | 608 | ||||
Earnings per share: | ||||||||
Basic and diluted | $ | 0.30 | $ | 0.21 |
See Notes to the Consolidated Financial Statements
F-5 |
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME
Accumulated | Common | Non- | Total | |||||||||||||||||||||||||||||||||
Additional | Other | Stock | controlling | Stock- | Compre- | |||||||||||||||||||||||||||||||
Common | Paid-in- | Retained | Compre- | Unearned | Held in | Interest in | holders’ | hensive | ||||||||||||||||||||||||||||
Stock | Capital | Earnings | hensive Loss | ESOP | Treasury | Subsidiary | Equity | Income | ||||||||||||||||||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||||||||||||||||||||||
Balance at January 1, 2010 | $ | 67 | $ | 29,558 | $ | 17,619 | $ | (39 | ) | $ | (1,728 | ) | $ | (3,113 | ) | $ | 79 | $ | 42,443 | |||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||||||||
Net income | — | — | 608 | — | — | — | 56 | 664 | $ | 664 | ||||||||||||||||||||||||||
Unrealized loss on securities available-for-sale, net of tax of $(247) | — | — | — | (383 | ) | — | — | — | (383 | ) | (383 | ) | ||||||||||||||||||||||||
Reclassification adjustment on sales of securities available-for-sale, net of tax of $190 | — | — | — | 294 | — | — | — | 294 | 294 | |||||||||||||||||||||||||||
Corporate reorganization | ||||||||||||||||||||||||||||||||||||
Exchange of common stock held by FedFirst Financial Mutual Holding Company | (36 | ) | 19 | — | — | — | — | — | (17 | ) | ||||||||||||||||||||||||||
Retirement of common stock held in treasury | (4 | ) | (3,145 | ) | — | — | — | 3,149 | — | — | ||||||||||||||||||||||||||
Exchange of common stock | (14 | ) | 15 | — | — | — | — | — | 1 | |||||||||||||||||||||||||||
Stock offering proceeds, net of offering expenses | 17 | 15,338 | — | — | — | — | — | 15,355 | ||||||||||||||||||||||||||||
Purchase of common stock to be held in treasury (1,625 shares) | — | — | — | — | — | (16 | ) | — | (16 | ) | ||||||||||||||||||||||||||
ESOP shares committed to be released (8,182 shares) | — | (82 | ) | — | — | 173 | — | — | 91 | |||||||||||||||||||||||||||
Stock-based compensation expense | — | 293 | — | — | — | — | — | 293 | ||||||||||||||||||||||||||||
Stock awards forfeited | — | 20 | — | — | — | (20 | ) | — | — | |||||||||||||||||||||||||||
Distribution to noncontrolling shareholder | — | — | — | — | — | — | (51 | ) | (51 | ) | ||||||||||||||||||||||||||
Cash dividends paid ($0.03 per share) | — | — | (87 | ) | — | — | — | — | (87 | ) | ||||||||||||||||||||||||||
Total comprehensive income | 575 | |||||||||||||||||||||||||||||||||||
Less: Comprehensive income attributable to the noncontrolling interest in subsidiary | 56 | |||||||||||||||||||||||||||||||||||
Comprehensive income attributable to FedFirst Financial Corporation | $ | 519 | ||||||||||||||||||||||||||||||||||
Balance at December 31, 2010 | $ | 30 | $ | 42,016 | $ | 18,140 | $ | (128 | ) | $ | (1,555 | ) | $ | — | $ | 84 | $ | 58,587 |
See Notes to the Consolidated Financial Statements
F-6 |
Accumulated | Non | |||||||||||||||||||||||||||||||
Other | controlling | Total | ||||||||||||||||||||||||||||||
Common | Additional Paid-in- | Retained | Compre- hensive | Unearned | Interest in | Stock- holders’ | Compre- hensive | |||||||||||||||||||||||||
Stock | Capital | Earnings | Loss | ESOP | Subsidiary | Equity | Income | |||||||||||||||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||||||||||||||||||
Balance at January 1, 2011 | $ | 30 | $ | 42,016 | $ | 18,140 | $ | (128 | ) | $ | (1,555 | ) | $ | 84 | $ | 58,587 | ||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||||
Net income | — | — | 859 | — | — | 12 | 871 | $ | 871 | |||||||||||||||||||||||
Unrealized gain on securities available-for-sale, net of tax of $103 | — | — | — | 160 | — | — | 160 | 160 | ||||||||||||||||||||||||
Reclassification adjustment on sales of securities available-for-sale, net of tax of $(128) | — | — | — | (199 | ) | — | — | (199 | ) | (199 | ) | |||||||||||||||||||||
Purchase of common stock for retirement (34,159 shares) | — | (464 | ) | — | — | — | — | (464 | ) | |||||||||||||||||||||||
ESOP shares committed to be released (8,182 shares) | — | (57 | ) | — | — | 173 | — | 116 | ||||||||||||||||||||||||
Stock-based compensation expense | — | 214 | — | — | �� | — | 214 | |||||||||||||||||||||||||
Stock awards issued | — | (79 | ) | — | — | — | (79 | ) | ||||||||||||||||||||||||
Distribution to noncontrolling shareholder | — | — | — | — | — | (56 | ) | (56 | ) | |||||||||||||||||||||||
Cash dividends paid ($0.12 per share) | — | — | (349 | ) | — | — | — | (349 | ) | |||||||||||||||||||||||
Total comprehensive income | 832 | |||||||||||||||||||||||||||||||
Less: Comprehensive income attributable to the noncontrolling interest in subsidiary | 12 | |||||||||||||||||||||||||||||||
Comprehensive income attributable to FedFirst Financial Corporation | $ | 820 | ||||||||||||||||||||||||||||||
Balance at December 31, 2011 | $ | 30 | $ | 41,630 | $ | 18,650 | $ | (167 | ) | $ | (1,382 | ) | $ | 40 | $ | 58,801 |
See Notes to the Consolidated Financial Statements
F-7 |
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, | 2011 | 2010 | ||||||
(Dollars in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 859 | $ | 608 | ||||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Noncontrolling interest in net income of consolidated subsidiary | 12 | 56 | ||||||
Provision for loan losses | 850 | 850 | ||||||
Depreciation | 557 | 525 | ||||||
Amortization of intangibles | 109 | 110 | ||||||
Net (gain) loss on sales of available-for-sale securities | (304 | ) | 658 | |||||
Impairment loss on real estate owned | 99 | 206 | ||||||
Net loss on sales of real estate owned | 29 | 42 | ||||||
Deferred income tax (benefit) expense | (3 | ) | 477 | |||||
Net amortization of security premiums and loan costs | 470 | 145 | ||||||
Noncash expense for ESOP | 110 | 90 | ||||||
Noncash expense for stock-based compensation | 214 | 293 | ||||||
Increase in bank-owned life insurance | (269 | ) | (284 | ) | ||||
Decrease in other assets | 900 | 173 | ||||||
Increase (decrease) in other liabilities | 1,554 | (707 | ) | |||||
Net cash provided by operating activities | 5,187 | 3,242 | ||||||
Cash flows from investing activities: | ||||||||
Net loan (originations) repayments | (16,561 | ) | 8,188 | |||||
Proceeds from maturities and principal repayments of securities available-for-sale | 21,282 | 19,884 | ||||||
Proceeds from sales of securities available-for-sale | 10,162 | 14,449 | ||||||
Purchases of securities available-for-sale | (5,366 | ) | (34,352 | ) | ||||
Purchases of premises and equipment | (440 | ) | (395 | ) | ||||
Decrease in FHLB stock, at cost | 1,216 | 345 | ||||||
Proceeds from sales of real estate owned | 286 | 919 | ||||||
Net cash provided by investing activities | 10,579 | 9,038 | ||||||
Cash flows from financing activities: | ||||||||
Net (decrease) increase in short-term borrowings | (4,200 | ) | 2,400 | |||||
Proceeds from long-term borrowings | — | 12,000 | ||||||
Repayments of long-term borrowings | (23,404 | ) | (50,018 | ) | ||||
Net increase in deposits | 17,978 | 9,981 | ||||||
Increase (decrease) in advance payments by borrowers for taxes and insurance | 59 | (20 | ) | |||||
Purchase of common stock for stock award grants | (79 | ) | — | |||||
Purchase of common stock for retirement | (464 | ) | — | |||||
Purchase of common stock to be held in treasury | — | (16 | ) | |||||
Net stock offering proceeds | — | 15,355 | ||||||
Cash dividends paid | (349 | ) | (87 | ) | ||||
Distribution to noncontrolling shareholder | (56 | ) | (51 | ) | ||||
Net cash used in financing activities | (10,515 | ) | (10,456 | ) | ||||
Net increase in cash and cash equivalents | 5,251 | 1,824 | ||||||
Cash and cash equivalents, beginning of year | 9,320 | 7,496 | ||||||
Cash and cash equivalents, end of year | $ | 14,571 | $ | 9,320 | ||||
Supplemental cash flow information: | ||||||||
Cash paid for: | ||||||||
Interest on deposits and borrowings (including interest credited to deposit accounts of $2,847 and $3,422, respectively) | $ | 5,088 | $ | 6,972 | ||||
Income taxes | 73 | 488 | ||||||
Noncash activities: | ||||||||
Real estate acquired in settlement of loans | $ | 569 | $ | 1,170 | ||||
Extinguishment of common stock held in treasury | — | 3,149 |
See Notes to the Consolidated Financial Statements
F-8 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations
The accompanying audited Consolidated Financial Statements include the accounts of FedFirst Financial Corporation (“FedFirst Financial” or the “Company”), a stock holding company established in 2010, whose wholly owned subsidiary is First Federal Savings Bank (“First Federal” or the “Bank”), a federally chartered stock savings bank, which owns FedFirst Exchange Corporation (“FFEC”). FFEC has an 80% controlling interest in Exchange Underwriters, Inc. (“Exchange Underwriters”). Exchange Underwriters is a full-service, independent insurance agency that offers property and casualty, commercial liability, surety and other insurance products. All significant intercompany transactions have been eliminated.
The Company completed its conversion from the mutual holding company form of organization to the stock holding company form on September 21, 2010. As a result of the conversion, FedFirst Financial Corporation, a newly formed state-chartered corporation, became the holding company for First Federal Savings Bank, and FedFirst Financial Mutual Holding Company and the former FedFirst Financial Corporation ceased to exist. As part of the conversion, all outstanding shares of the former FedFirst Financial Corporation common stock (other than those owned by FedFirst Financial Mutual Holding Company) were converted into the right to receive 0.4735 of a share of the newly formed FedFirst Financial Corporation common stock resulting in 1,270,484 shares issued in the exchange. In addition, a total of 1,722,185 shares of common stock were sold in the subscription, community and syndicated community offerings at the price of $10.00 per share or $17.2 million in the aggregate. The completion of the Company’s public offering raised $15.4 million in proceeds, net of $1.9 million in offering expenses.
First Federal operates as a community-oriented financial institution offering residential, multi-family and commercial mortgages, consumer loans and commercial business loans as well as a variety of deposit products for individuals and businesses from eight locations in southwestern Pennsylvania. First Federal conducts insurance brokerage activities through Exchange Underwriters. The Bank is subject to competition from other financial institutions and to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), on July 21, 2011 the Office of the Comptroller of the Currency (“OCC”) assumed responsibility from the Office of Thrift Supervision (“OTS”) for the ongoing examination, supervision, and regulation of federal savings associations and rulemaking for all savings associations. In addition, the Dodd-Frank Act transferred OTS functions related to the supervision of savings association holding companies to the Board of Governors of the Federal Reserve System.
The Company evaluated subsequent events through the date the consolidated financial statements were filed with the Securities and Exchange Commission and incorporated into the consolidated financial statements the effect of all material known events determined by Accounting Standards Codification (“ASC”) Topic 855,Subsequent Events, to be recognizable events.
Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, evaluation of securities for other-than-temporary impairment (“OTTI”), goodwill impairment, amortization of intangible assets, and the valuation of deferred tax assets.
F-9 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company has defined cash and cash equivalents as those amounts included in the statements of financial condition as cash and due from banks and interest-earning deposits.
Securities
The Company classifies securities at the time of purchase as either trading, available-for-sale or held-to-maturity. Securities that the Company has the positive intent and ability to hold to maturity are classified as securities held-to-maturity and are reported at amortized cost. Securities bought and held principally for the purpose of selling them in the near term are classified as securities for trading and reported at fair value with gains and losses included in earnings. The Company had no held-to-maturity or trading securities at December 31, 2011 or 2010. Securities not classified as held-to-maturity or trading securities are classified as securities available-for-sale and are reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (“OCI”). Interest income includes amortization of purchase premium or discount. Premiums and discounts are amortized and accreted using the level yield method. Net gain or loss on the sale of securities is based on the amortized cost of the specific security sold.
Other-Than-Temporary Impairment
The Company reviews its investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events that may influence the operations of the issuer, and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market.
The Company recognizes credit-related OTTI on debt securities in earnings while noncredit-related OTTI on debt securities not expected to be sold is recognized in accumulated OCI. The Company assesses whether the credit loss existed by considering whether (a) the Company has the intent to sell the security, (b) it is more likely than not that the Company will be required to sell the security before recovery, or (c) the Company does not expect to recover the entire amortized cost basis of the security. The Company can bifurcate the OTTI on securities not expected to be sold or where the entire amortized cost of the security is not expected to be recovered into the components representing credit loss and the component representing loss related to other factors. The portion of the fair value decline attributable to credit loss is recognized through earnings.
Corporate debt securities are evaluated for OTTI by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows involves the calculation of the present value of remaining cash flows compared to previously projected cash flows. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit-related OTTI exists on corporate debt securities.
Loans
Loans are stated at the outstanding principal amount of the loans, net of premiums and discounts on loans purchased, deferred loan costs, loans in process, and the allowance for loan losses. Loans are originated with the intent to hold until maturity. Interest income on loans is accrued and credited to interest income as earned. Loans are generally placed on nonaccrual status at the earlier of when they become delinquent 90 days or more as to principal or interest or when it appears that principal or interest is uncollectible. Interest accrued prior to a loan being placed on nonaccrual status is subsequently reversed. Interest income on nonaccrual loans is recognized only in the period in which it is ultimately collected. Loans are returned to an accrual status when factors indicating doubtful collectability no longer exist.
Loan fees and direct costs of originating loans are deferred, and the net fee or cost is accreted or amortized to interest income as a yield adjustment over the contractual lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
F-10 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that in management’s judgment should be charged-off. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, peer group information, 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, prevailing economic conditions and other factors related to the collectability of the loan portfolio. This evaluation is inherently subjective as it involves a high degree of judgment and 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 the Company will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status 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 performs individual assessments of larger impaired loans to determine the existence of loss exposure and, where applicable, the extent of loss exposure based upon the present value of expected future cash flows available to pay the loan, or based upon the estimated realizable collateral where a loan is collateral dependent. Generally, individual residential mortgage and consumer loans are not separately identified for impairment disclosures unless such loans are the subject of a troubled debt restructuring (“TDR”) agreement or are related to a commercial relationship that is collectively evaluated for impairment.
Loans excluded from the individual impairment analysis are collectively evaluated by management to estimate losses inherent in those loans. Management determines historical loss experience for each group of loans with similar risk characteristics within the portfolio based on loss experience for loans in each group. Loan categories represent groups of loans with similar risk characteristics and may include types of loans by product, large credit exposures, concentrations, loan grade, or any other characteristic that causes a loan’s risk profile to be similar to another. We also consider qualitative or environmental factors that are likely to cause estimated credit losses associated with the bank’s existing portfolio to differ from historical loss experience, including changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; changes in experience, ability and depth of loan management; changes in the volume and severity of past due loans, non-accrual loans and adversely graded or classified loans; changes in the quality of the loan review system; changes in the value of underlying collateral for collateral dependent loans; existence of or changes in concentrations of credit; changes in economic or business conditions; and the effect of competition, legal and regulatory requirements on estimated credit losses.
A loan whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties is considered a TDR. TDRs typically result from our loss mitigation activities and could include rate reductions, principal forgiveness, forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. A restructuring for a borrower that is experiencing financial difficulties, but results in only a delay in payment that is insignificant is not considered a concession. Loans classified as TDRs are designated as impaired. Once a loan is classified as a TDR, the determination of income recognition is based on the status of the loan prior to classification. If a loan is in non-accrual status, then it will remain in that classification for a minimum of six consecutive months until uncertainty with respect to collectability no longer exists. Loans that are current at the time of classification will remain on an accrual basis and are monitored. If restructured contractual terms of a loan are not met, then the loan will be placed on nonaccrual status.
F-11 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized as special mention have potential weaknesses that may result in deterioration if uncorrected and not monitored. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified as substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. To determine the appropriate risk rating category, the borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. The OCC may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings. See Note 3 of the Notes to Consolidated Financial Statements included in this report.
Advertising Costs
The Company follows the policy of charging the costs of advertising to expense as incurred. Total advertising expense was approximately $135,000 and $131,000 for the years ended December 31, 2011 and 2010, respectively.
Real Estate Owned
When properties are acquired through foreclosure, they are transferred at estimated fair value less estimated selling costs, and any required write-downs are charged to the allowance for loan losses. Subsequently, such properties are carried at the lower of the adjusted cost or fair value less estimated selling costs. Estimated fair value of the property is generally based on an appraisal.
Premises and Equipment
Land is carried at cost. Office properties and equipment are carried at cost less accumulated depreciation and amortization. Buildings and leasehold improvements are depreciated using the straight-line method using useful lives generally ranging from 10 to 40 years.
Furniture, fixtures, and equipment are depreciated using the straight-line method with useful lives generally ranging from three to 10 years. Charges for maintenance and repairs are expensed as incurred.
Bank-Owned Life Insurance
The Company purchased insurance on the lives of certain executive officers and directors. The policies accumulate asset values to meet future liabilities, including the payment of employee benefits. Increases in the cash surrender value and proceeds upon the death of a key employee are recorded as noninterest income in the Consolidated Statements of Operations. The cash surrender value of bank-owned life insurance is recorded as an asset in the Consolidated Statements of Financial Condition.
F-12 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill
In connection with our acquisition of Exchange Underwriters, we recorded $1.1 million of goodwill. Goodwill is not amortized but is tested for impairment annually or more frequently if impairment indicators arise. The goodwill impairment model is a two-step process. First, it requires a comparison of the book value of net assets to the fair value of the related operations that have goodwill assigned to them. If the fair value is determined to be less than book value, a second step is performed to compute the amount of the impairment. We estimate the fair values of the related operations using discounted cash flows. The forecasts of future cash flows are based on our best estimate of future revenues and operating costs, based primarily on contracts in effect, new accounts and cancellations and operating budgets. The impairment analysis requires management to make subjective judgments concerning how the acquired assets will perform in the future. Events and factors that may significantly affect the estimates include competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and industry and market trends. Changes in these forecasts could cause a reporting unit to either pass or fail the first step in the goodwill impairment model, which could significantly change the amount of impairment recorded. Our annual assessment of potential goodwill impairment was completed in the fourth quarter of 2011. Based on the results of this assessment, no impairment charge was deemed necessary for the years ended December 31, 2011 and 2010.
Intangible Assets
The Company determines the accounting for intangible assets based on their useful life. An intangible asset with a finite useful life is amortized, whereas an intangible asset with an indefinite useful life is not amortized. The useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the Company. The Company evaluates the remaining useful life of its intangible assets that are being amortized annually to determine whether events and circumstances warrant a revision to the remaining period of amortization.
In 2009, Exchange Underwriters expanded its operation through the acquisition of the Allsurance Insurance Agency (“Allsurance”). The total acquisition cost recorded for Allsurance was $525,000, which included $500,000 of intangible assets related to a non-compete agreement and customer list and $25,000 of premises and equipment. The intangible assets are amortized over their estimated useful lives of four to five years. At December 31, 2011 and 2010, there were $150,000 and $259,000 in net intangible assets, respectively. The Company periodically assesses whether events or changes in circumstances indicate that the carrying amounts of intangible assets may be impaired.
Income Taxes
The provision for income taxes is the total of the current year income tax due or refundable and the change in the deferred tax assets and liabilities. Deferred tax assets and liabilities are the estimated future tax consequences attributable to differences between the financial statements’ 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. The realization of deferred tax assets is assessed and a valuation allowance provided, when necessary, for that portion of the asset which is not likely to be realized. Management believes, based upon current facts, that it is more likely than not there will be sufficient taxable income in future years to realize the deferred tax assets. The Company and its subsidiaries file a consolidated federal income tax return. The Company had no uncertain tax positions at December 31, 2011 and 2010.
Investment in Affordable Housing Projects
The Company accounted for its limited partnership interests in affordable housing projects under the cost-recovery method. The Company received tax credits each year over a 10 year period. The investment was completely amortized at December 31, 2005.
F-13 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2011 and 2010, there was approximately $889,000 and $1.0 million of credits, respectively, that have not been utilized. The credits have been reflected as an asset and are available to be used to offset future taxes payable, with the credits expiring in years 2021 through 2025. Management believes, based upon current facts, that it is more likely than not there will be sufficient income in future years to be able to use the tax credits.
Comprehensive Income
The Company is required to present comprehensive income and its components in a full set of general purpose financial statements for all periods presented. Other comprehensive income is comprised of net unrealized holding gains (losses) on its available-for-sale securities. The Company has elected to report the effects of its comprehensive income as part of the Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income.
Federal Home Loan Bank System
The Company is a member of the Federal Home Loan Bank System. As a member, the Bank is required to maintain an investment in the capital stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”). Deficiencies, if any, in the required investment at the end of any reporting period are purchased in the subsequent reporting period. The investment is carried at cost. No ready market exists for the stock, and it has no quoted market value. The Company may receive dividends on its FHLB capital stock, which are included in interest income and are recognized when declared. In 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock. In October 2010, the FHLB initiated a repurchase program based on outstanding excess capital stock. The amount of excess capital stock repurchased from any member was the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding. In February 2012, the FHLB resumed payments of dividends. Future repurchases of excess capital stock and dividend declarations will be determined on a quarterly basis going forward.
Earnings Per Share
Basic earnings per common share is calculated by dividing the net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is computed in a manner similar to basic earnings per common share except that the weighted-average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. Common stock equivalents include restricted stock awards and stock options. Anti-dilutive shares are common stock equivalents with weighted-average exercise prices in excess of the weighted-average market value for the periods presented. Unallocated common shares held by the Employee Stock Ownership Plan (“ESOP”) are not included in the weighted-average number of common shares outstanding for purposes of calculating both basic and diluted earnings per common share until they are committed to be released.
Stock-Based Compensation
In 2006, FedFirst Financial Corporation’s stockholders approved the 2006 Equity Incentive Plan (the “Plan”). The purpose of the Plan is to promote the Company’s success and enhance its value by linking the personal interests of its employees, officers, directors and directors emeritus to those of the Company’s stockholders, and by providing participants with an incentive for outstanding performance. All of the Company’s salaried employees, officers and directors are eligible to participate in the Plan. The Plan authorizes the granting of options to purchase shares of the Company’s stock, which may be non-statutory stock options or incentive stock options, and restricted stock which is subject to restrictions on transferability and subject to forfeiture. The Plan reserved an aggregate number 214,787 shares of which 153,419 may be issued in connection with the exercise of stock options and 61,367 may be issued as restricted stock.
F-14 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 2011, the Company’s stockholders approved the 2011 Equity Incentive Plan (the “2011 Plan”). The 2011 Plan’s details related to purpose, eligibility, and granting of shares are the same as noted above for the 2006 Plan. The 2011 Plan reserved an aggregate number of 204,218 shares of which 145,870 may be issued in connection with the exercise of stock options and 58,348 may be issued as restricted stock.
Awards are typically granted with a five year vesting period and a vesting rate of 20% per year. The contractual life of stock options is typically 10 years from the date of grant. The exercise price for options is the closing price on the date of grant. The Company recognizes expense associated with the awards over the vesting period. Unrecognized compensation cost related to nonvested stock-based compensation is recognized ratably over the remaining service period. The per share weighted-average fair value of stock options granted with an exercise price equal to the market value on the date of grant is calculated using the Black-Scholes-Merton option pricing model, using assumptions for expected life, expected dividend rate, risk-free interest rate, and an expected volatility. The Company uses the simplified method to determine the expected term because it does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its shares have been publicly traded.
Fair Value of Financial Instruments
Fair values are determined by a third-party pricing service using both quoted prices for similar assets, when available, and model-based valuation techniques that derive fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates. In some instances, the fair value of certain securities cannot be determined using these techniques due to the lack of relevant market data. As such, these securities are valued using an alternative technique and classified within Level 3 of the fair value hierarchy.
Revenue Recognition of Insurance Commissions and Contingency Fees
Exchange Underwriters records insurance commission based on the method in which the policy is billed. For policies that Exchange Underwriters directly bills to policyholders, income is recorded when billed. For policies an insurance company directly bills to policyholders on behalf of Exchange Underwriters, income is recorded as payments are received. Commissions are recorded net of cancellations.
Exchange Underwriters also receives guaranteed supplemental payments and contingency fees that may be significant to its financial results. Guaranteed supplemental payments and contingency fees are dependent on several factors, which include, but are not limited to, eligible written premiums, earned premiums, incurred losses, and stop loss charges. Guaranteed supplemental payments are only accrued when insurance companies offer a lock-in provision and Exchange Underwriters agrees to a stipulated amount that typically includes a predetermined percentage adjusting the final payout calculations. Otherwise, contingency fees are recorded on a cash basis when received based on final calculations. Contingency fees are typically received in the first quarter of the year. Since insurance companies are not required to provide any estimates, the Company is not able to accrue contingency fees in the period earned as it does with guaranteed supplemental payments.
Reclassifications of Prior Year’s Statements
Certain previously reported items have been reclassified to conform to the current year’s classifications.
F-15 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
ASU 2011-02A Creditor’s Determination of Whether A Restructuring Is a Troubled Debt Restructuring. In April 2011, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Update (“ASU”) No. 2011-02,A Creditor’s Determination of Whether A Restructuring Is a Troubled Debt Restructuring, which clarifies when a loan modification or restructuring is considered a troubled debt restructuring (TDR).In evaluating whether a modification or restructuring constitutesa TDR, a creditor must separately conclude that both the restructuring constitutes a concession and the borrower is experiencing financial difficulties. To provide greater consistency and transparency inreporting TDRs, this ASU clarifies the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. Early application is permitted.The Company has determined that the adoption of this ASU did not have a material impact on its financial condition and results of operations.
ASU 2011-04Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.In May 2011, the FASB issued ASU No. 2011-04,Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU is the result of joint efforts by the FASB and International Accounting Standards Board (“IASB”) to develop a single, converged fair value framework on how (not when) to measure fair value and on what disclosures to provide about fair value measurements. While the ASU is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands existing disclosure requirements for fair value measurements and makes other amendments to ASC 820,Fair Value Measurement. Many of these amendments were made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. However, some could change how the fair value measurement guidance in ASC 820 is applied. The ASU is effective for interim and annual periods beginning after December 15, 2011. The Company has determined the adoption of this ASU will not have a material impact on its financial condition and results of operation.
ASU 2011—05Presentation of Comprehensive Income. In September 2011, the FASBissued ASU No. 2011-05,Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance eliminates the option to present components of other comprehensive income as part of the Statements of Changes to Stockholders’ Equity and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the income statement format used today, and the second statement would include components of other comprehensive income (OCI). The ASU does not change the items that must be reported in OCI. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Guidance must be applied retrospectively for all periods presented in the financial statements. Early adoption is permitted. The Company has determined the adoption of this ASU will not have a material impact on its financial condition and results of operation.
F-16 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ASU 2011—08 Testing for Goodwill for Impairment. In September 2011, the FASBissued ASU No. 2011-08,Testing Goodwill for Impairment, which amends the guidance on testing goodwill impairment. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e. step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The ASU does not changehow goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill annually for impairment. In addition, the ASU does not amend the requirement to test goodwill for impairment between annual tests if events or circumstances warrant; however, it does revise the examples of events and circumstances that an entity should consider. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Company has determined the adoption of this ASU will not have a material impact on its financial condition and results of operation.
ASU 2011-12Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05. In December, 2011, the FASB issued ASU 2011-12,Deferral of the Effective Date to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05. In response to concerns regarding the operational ramifications of the presentation requirements for reclassification of items out of accumulated other comprehensive income for current and previous years, the FASB has deferred the implementation date of this provision in ASU 2011-05,Presentation of Comprehensive Income, to allow time for further consideration. The requirement in ASU 2011-05 for the presentation of a combined statement of comprehensive income or separate, but consecutive, statements of net income and other comprehensive income is still effective for fiscal years and interim periods beginning after December 15, 2011 for public companies. The Company has determined the adoption of this ASU will not have a material impact on its financial condition and results of operation.
2. Securities
The following table sets forth the amortized cost and fair value of securities available-for-sale at the dates indicated (dollars in thousands).
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
December 31, 2011 | Cost | Gains | Losses | Value | ||||||||||||
Government-sponsored enterprises | $ | 2,000 | $ | 3 | $ | — | $ | 2,003 | ||||||||
Municipal bonds | 6,738 | 391 | 4 | 7,125 | ||||||||||||
Mortgage-backed | 16,572 | 972 | — | 17,544 | ||||||||||||
REMICs | 23,413 | 916 | 11 | 24,318 | ||||||||||||
Corporate debt | 3,995 | — | 2,541 | 1,454 | ||||||||||||
Equities | 4 | — | — | 4 | ||||||||||||
Total securities available-for-sale | $ | 52,722 | $ | 2,282 | $ | 2,556 | $ | 52,448 |
F-17 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
December 31, 2010 | Cost | Gains | Losses | Value | ||||||||||||
Government-sponsored enterprises | $ | 7,580 | $ | 36 | $ | 2 | $ | 7,614 | ||||||||
Municipal bonds | 4,012 | 284 | — | 4,296 | ||||||||||||
Mortgage-backed | 32,747 | 1,306 | 64 | 33,989 | ||||||||||||
REMICs | 30,580 | 1,095 | 110 | 31,565 | ||||||||||||
Corporate debt | 3,995 | — | 2,755 | 1,240 | ||||||||||||
Equities | 4 | — | — | 4 | ||||||||||||
Total securities available-for-sale | $ | 78,918 | $ | 2,721 | $ | 2,931 | $ | 78,708 |
The amortized cost and fair value of securities at December 31, 2011 by contractual maturity were as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties (dollars in thousands).
Amortized | Fair | |||||||
Cost | Value | |||||||
Due in less than one year | $ | — | $ | — | ||||
Due from one to five years | 3,386 | 3,732 | ||||||
Due from five to ten years | 9,412 | 9,559 | ||||||
Due after ten years | 39,920 | 39,153 | ||||||
No scheduled maturity | 4 | 4 | ||||||
Total | $ | 52,722 | $ | 52,448 |
Securities with an amortized cost and fair value of $9.4 million and $9.9 million, respectively, at December 31, 2011 and $11.2 and $12.0 million, respectively, at December 31, 2010 were pledged to secure public deposits and repurchase agreements.
Proceeds from the sale of securities available-for-sale for the year ended December 31, 2011 were $10.2 million and with gross realized gains of $305,000 and gross realized losses of $1,000 for a net gain of $304,000. Proceeds from the sales of securities available-for-sale for the year ended December 31, 2010 were $14.4 million with gross realized gains of $190,000 and gross realized losses of $848,000 for a net loss of $658,000.
The following table presents gross unrealized losses and fair value of securities aggregated by category and length of time that individual securities have been in a continuous loss position at the dates indicated (dollars in thousands).
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||||||||||||||
Number | Gross | Number | Gross | Number | Gross | |||||||||||||||||||||||||||||||
of | Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | ||||||||||||||||||||||||||||
December 31, 2011 | Securitie | Value | Losses | Securities | Value | Losses | Securitie | Value | Losses | |||||||||||||||||||||||||||
Municipal Bonds | 1 | $ | 572 | $ | 4 | — | $ | — | $ | — | 1 | $ | 572 | $ | 4 | |||||||||||||||||||||
REMICs - Government-sponsored enterprises | 1 | 1,531 | 11 | — | — | — | 1 | 1,531 | 11 | |||||||||||||||||||||||||||
Corporate debt | — | — | — | 3 | 1,454 | 2,541 | 3 | 1,454 | 2,541 | |||||||||||||||||||||||||||
Total securities temporarily impaired | 2 | $ | 2,103 | $ | 15 | 3 | $ | 1,454 | $ | 2,541 | 5 | $ | 3,557 | $ | 2,556 |
F-18 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||||||||||||||
Number | Gross | Number | Gross | Number | Gross | |||||||||||||||||||||||||||||||
of | Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | ||||||||||||||||||||||||||||
December 31, 2010 | Securitie | Value | Losses | Securities | Value | Losses | Securitie | Value | Losses | |||||||||||||||||||||||||||
Government-sponsored enterprises | 1 | $ | 2,292 | $ | 2 | — | $ | — | $ | — | 1 | $ | 2,292 | $ | 2 | |||||||||||||||||||||
Mortgage-backed | 3 | 8,168 | 64 | — | — | — | 3 | 8,168 | 64 | |||||||||||||||||||||||||||
REMICs - Government-sponsored enterprises | 2 | 4,895 | 110 | — | — | — | 2 | 4,895 | 110 | |||||||||||||||||||||||||||
Corporate debt | — | — | — | 3 | 1,240 | 2,755 | 3 | 1,240 | 2,755 | |||||||||||||||||||||||||||
Total securities temporarily impaired | 6 | $ | 15,355 | $ | 176 | 3 | $ | 1,240 | $ | 2,755 | 9 | $ | 16,595 | $ | 2,931 |
The Company reviews its investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer including any specific events that may influence the operations of the issuer, and the intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market.
Corporate Debt—At December 31, 2011, the Company had three securities that were in an unrealized loss position for 12 months or greater at an amount of $2.5 million. These securities consist of two pools of insurance company-issued preferred trust obligations. These securities were downgraded from their original rating issuance to below investment grade. The lack of liquidity in the market for this type of security, credit rating downgrades and market uncertainties are factors contributing to the unrealized losses on these securities.
The following table provides additional information related to the Company’s pooled preferred trust obligations at December 31, 2011 (dollars in thousands):
Additional | Additional | |||||||||||||||||||||||||||||||||||||||||||||||
Immediate | Immediate | |||||||||||||||||||||||||||||||||||||||||||||||
Deferrals/ | Deferrals/ | |||||||||||||||||||||||||||||||||||||||||||||||
Defaults | Defaults | |||||||||||||||||||||||||||||||||||||||||||||||
Current | Before | Before | ||||||||||||||||||||||||||||||||||||||||||||||
Number | Current | Causing an | Causing a | |||||||||||||||||||||||||||||||||||||||||||||
S&P / | of | Deferrals | Interest | Break in | ||||||||||||||||||||||||||||||||||||||||||||
Pool | Class | Tranche | Amortized Cost | Fair Value | Unrealized Loss | Fitch Rating | Insurance Companies | Total Collateral | and Defaults | Performing Collateral | Shortfall (a) | Yield (b) | ||||||||||||||||||||||||||||||||||||
I-PreTSL I | Mezzanine | B-3 | $ | 1,500 | $ | 548 | $ | (952 | ) | B+/CCC | 17 | $ | 193,500 | $ | 32,500 | $ | 161,000 | $ | 90,900 | $ | 43,000 | |||||||||||||||||||||||||||
I-PreTSL II | Mezzanine | B-3 | 2,495 | 906 | (1,589 | ) | B+/B | 26 | 343,500 | 17,500 | 326,000 | 153,395 | 122,000 | |||||||||||||||||||||||||||||||||||
$ | 3,995 | $ | 1,454 | $ | (2,541 | ) |
(a) | A temporary interest shortfall is caused by an amount of deferrals/defaults high enough such that there is insufficient cash flow available to pay current interest on the given tranche or by breaching the principal coverage test of the tranche immediately senior to the given tranche. Amounts presented represent additional deferrals/defaults beyond those currently existing that must occur before the security would experience an interest shortfall. | |
(b) | A break in yield for a given tranche means that deferrals/defaults have reached such a level that the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (so not just a temporary interest shortfall, but an actual loss in yield on the investment). In other words, the magnitude of the defaults/deferrals has depleted all of the credit enhancement (excess interest and over-collateralization) beneath the given tranche. Amounts presented represent additional deferrals/defaults beyond those currently existing that must occur before the security would experience a break in yield. |
F-19 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These securities are evaluated for OTTI by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows involves the calculation of the present value of remaining cash flows compared to previously projected cash flows. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit-related OTTI exists. Additionally, reports are reviewed that provide information for the amount of deferral/defaults that would have to occur to prevent the tranche from collecting contractual cash flows (principal and interest). None of these securities are projecting a cash flow disruption, nor have any of these securities experienced a cash flow disruption. The Company also reviewed each of the issues’ collateral participants, including their financial condition, ratings provided by A. M. Best (for insurance companies), and adverse conditions specifically related to industry or geographic area. This information did not suggest additional deferrals and defaults in the future that would result in the securities not receiving all of their contractual cash flows. Based on the analysis performed and the fact that the Company does not expect to sell these securities and it is not more likely than not that the Company will be required to sell the securities before recovery of their amortized cost basis, the Company concluded that there is no OTTI on these securities at December 31, 2011.
Other Securities—This category may include Government-Sponsored Enterprises (“GSE”), municipal bonds, mortgage-backed securities, and GSE - REMICS. At December 31, 2011, the Company had a total of two securities with an unrealized loss of $15,000 in these categories, including one GSE-REMIC with an unrealized loss of $11,000 and one municipal bond with an unrealized loss of $4,000. These securities were in an unrealized loss position of less than 12 months. An evaluation of the individual securities was performed whereby we reviewed all credit ratings and noted all remain at investment grade. The GSE-REMIC security is issued and backed by a GSE (“FHLMC”). The Company believes the unrealized loss of these securities is due to changes in market interest rates or changes in market conditions as there was no indication that the issuer was having financial difficulties. The Company does not intend to sell the securities and it is more likely than not be required to sell the securities before their recovery. The Company expects to recover the entire amortized cost basis of these securities and concluded that there is no OTTI on these securities.
FHLB Stock—The Company is a member of the FHLB of Pittsburgh. As a member, the Company is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements in order to obtain low cost products and services offered by the FHLB. Unlike investment securities, FHLB stock does not provide its holders with an opportunity for appreciation because by regulation FHLB stock can only be purchased, redeemed and transferred at par value. At December 31, 2011 and December 31, 2010, the Company’s FHLB stock totaled $5.3 and $6.6 million, respectively.
The Company evaluates impairment in FHLB stock when certain conditions warrant further consideration. In 2008, the FHLB voluntarily suspended dividend payments on its stock as well as the repurchase of excess stock from members. The FHLB stated that this was due to a reduction in core earnings and concern over the FHLB’s capital position. In October 2010, the FHLB initiated a repurchase program based on outstanding excess capital stock. The amount of excess capital stock repurchased from any member was the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding. Based on this evaluation, the FHLB repurchased 5% of our capital stock in the fourth quarter of 2010 and each quarter in 2011. As of December 31, 2011 the Company had $2.4 million of excess capital stock. In February 2012, the FHLB resumed payments of dividends. Future repurchases of excess capital stock and dividend declarations will be determined on a quarterly basis going forward. After evaluating such factors as the capital adequacy of the FHLB, its overall operating performance and the FHLB’s liquidity and funding position, the Company concluded that the par value was ultimately recoverable and no impairment charge was recognized at December 31, 2011.
F-20 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Loans
The following table sets forth the composition of the Company’s loan portfolio at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Real estate - mortgage: | ||||||||
One-to-four family residential | ||||||||
Originated | $ | 117,622 | $ | 121,376 | ||||
Purchased | 16,304 | 20,591 | ||||||
Total one-to-four family residential | 133,926 | 141,967 | ||||||
Multi-family | ||||||||
Originated | 13,122 | 4,082 | ||||||
Purchased | 5,121 | 5,261 | ||||||
Total multi-family | 18,243 | 9,343 | ||||||
Commercial | 35,307 | 33,732 | ||||||
Total real estate - mortgage | 187,476 | 185,042 | ||||||
Real estate - construction: | ||||||||
Residential | 3,874 | 6,787 | ||||||
Commercial | 8,308 | 736 | ||||||
Total real estate - construction | 12,182 | 7,523 | ||||||
Consumer: | ||||||||
Home equity | ||||||||
Loan-to-value ratio of 80% or less | 30,679 | 22,628 | ||||||
Loan-to-value ratio of greater than 80% | 7,758 | 8,624 | ||||||
Total home equity | 38,437 | 31,252 | ||||||
Other | 1,892 | 2,090 | ||||||
Total consumer | 40,329 | 33,342 | ||||||
Commercial business | 15,445 | 10,875 | ||||||
Total loans | $ | 255,432 | $ | 236,782 | ||||
Net premium on loans purchased | 127 | 116 | ||||||
Net deferred loan costs | 606 | 697 | ||||||
Loans in process | (7,790 | ) | (4,716 | ) | ||||
Allowance for loan losses | (3,098 | ) | (2,824 | ) | ||||
Loans, net | $ | 245,277 | $ | 230,055 |
One-to-Four Family Residential Mortgage Loans. We originate mortgage loans to enable borrowers to purchase or refinance existing homes located in the greater Pittsburgh metropolitan area. We offer fixed and adjustable rate mortgage loans with terms up to 30 years.
We generally do not make conventional loans with loan-to-value ratios exceeding 97%. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral. We require all properties securing mortgage loans to be appraised by a board-approved, independent appraiser. We generally require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance for loans on property located in a flood zone, before closing the loan.
F-21 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to 2006, we purchased newly originated single family, fixed-rate mortgage loans to supplement our origination activities. The properties securing the loans are located in 13 states around the country. We underwrote all of the purchased loans to the same standards as loans originated by us.
Commercial and Multi-Family Real Estate Loans. We offer a variety of fixed and adjustable rate mortgage loans secured by commercial property and multi-family real estate. These loans generally have terms of ten years with a 20 year amortization and are typically secured by apartment buildings, office buildings, or manufacturing facilities. Loans are secured by first mortgages, and amounts generally do not exceed 80% of the property’s appraised value. In addition to originating these loans, we also purchase and sell participation loans originated with other financial institutions in the region.
Prior to 2006, we purchased newly originated multi-family real estate loans as part of our efforts to increase our loan portfolio. The properties securing the loans are located in six states throughout the country. We underwrote all of the purchased loans to the same standards as loans originated by us.
We have generally required that the properties securing these real estate loans have a debt service coverage ratio (cash flow available to service debt / debt service) of at least 1.25x and a leverage ratio (debt to worth) of less than 3.0x. Environmental surveys are obtained for requests greater than $1.0 million or when circumstances suggest the possibility of the presence of hazardous materials.
We underwrite all commercial loan participations to the same standards as loans originated by us. In addition, we also consider the financial strength and reputation of the lead lender. We require the lead lender to provide a full closing package as well as annual financial statements for the borrower and related entities so that we can conduct an annual loan review for all loan participations.
Construction Loans. We originate loans to individuals to finance the construction of residential dwellings. We also make loans for the construction of commercial properties, including apartment buildings and owner-occupied properties used for businesses. Our construction loans generally provide for the payment of interest-only during the construction phase, which is usually 12 months. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Loans generally can be made with a maximum loan-to-value ratio of 97% on residential construction and 80% on commercial construction. Loans with loan-to-value ratios in excess of 80% on residential construction generally require private mortgage insurance or additional collateral. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also will require an inspection of the property before disbursement of funds during the term of the construction loan.
Consumer Loans. Our consumer loans include home equity installment loans and lines of credit as well as other consumer loans including loans on savings accounts and personal lines of credit and installment loans.
The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
We offer home equity installment loans and home equity lines of credit. In 2007, we discontinued offering home equity loans with a maximum loan-to-value ratio greater than 100%. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate. Home equity installment loans have fixed interest rates and terms that range up to 30 years. Home equity loans with a loan-to-value ratio greater than 80% are considered higher risk given the pressure on property values and reduced credit alternatives available to leveraged borrowers.
We offer secured consumer loans in amounts up to $20,000. These loans have fixed interest rates and terms that range from one to 10 years. We offer unsecured consumer loans in amounts up to $10,000. These loans have fixed interest rates and terms that range from one to five years.
F-22 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commercial Business Loans. We originate commercial business loans to professionals and small businesses in our market area. We offer installment loans for a variety of business needs including capital improvements and equipment acquisition. Other commercial loans are secured by business assets such as accounts receivable, inventory, and equipment, and are typically backed by the personal guarantee of the borrower. We originate working capital lines of credit to finance the short-term needs of businesses. These credit lines are repaid by seasonal cash flows from operations and are also typically backed by the personal guarantee of the borrower. We also originate commercial leases through a Pittsburgh area machinery and equipment leasing company. These leases are secured by machinery and equipment.
When evaluating commercial business loans, we perform a detailed financial analysis of the borrower and/or guarantor which includes, but is not limited to: cash flow and balance sheet analysis, debt service capabilities, review of industry (geographic and economic conditions) and collateral analysis. We independently underwrite in accordance with our commercial loan policy all of the equipment leases that we originate through the third-party leasing company.
Commercial business loans are higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. A debt service coverage ratio of at least 1.25x and a leverage ratio of less than 3.0x are also applicable to commercial business loans. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We also maintain allowable advance rates for each collateral type to ensure coverage.
The Bank has made loans to executive officers and directors in the ordinary course of business under the same terms and conditions, including interest rates and collateral, as those prevailing for comparable transaction with other customers and did not, in the opinion of management, involve more than normal credit risk. The following table sets forth the changes to loans to executive officers and directors at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Balance, beginning of year | 1,213 | 839 | ||||||
Additions | 2,075 | 513 | ||||||
Repayments | (154 | ) | (139 | ) | ||||
Loans in process | (376 | ) | — | |||||
Balance, end of year | 2,758 | 1,213 |
In 2011, the Bank made a $2.1 million commercial construction loan to an affiliate of a director of the Company of which $1.7 million was disbursed and the remaining $376,000 was included as loans in process as of December 31, 2011. In addition, the Bank signed a $1.2 million commercial real estate loan commitment with another affiliate of the same director. This loan is expected to be funded in the second quarter of 2012. See Note 13 of the Notes to Consolidated Financial Statements for further discussion of the Bank’s off-balance sheet commitments.
F-23 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides information with respect to our nonperforming assets at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Nonaccrual loans: | ||||||||
Real estate - mortgage | ||||||||
One-to-four family residential | ||||||||
Originated | $ | 128 | $ | 332 | ||||
Purchased | 1,416 | 394 | ||||||
Total one-to-four family residential | 1,544 | 726 | ||||||
Multi-family | ||||||||
Originated | — | — | ||||||
Purchased | — | — | ||||||
Total multi-family | — | — | ||||||
Commercial | 568 | 493 | ||||||
Total real estate - mortgage | 2,112 | 1,219 | ||||||
Real estate - construction | ||||||||
Residential | — | — | ||||||
Commercial | — | — | ||||||
Total real estate - construction | — | — | ||||||
Consumer | ||||||||
Home equity | ||||||||
Loan-to-value ratio of 80% or less | — | — | ||||||
Loan-to-value ratio of greater than 80% | 33 | — | ||||||
Total home equity | 33 | — | ||||||
Other | — | — | ||||||
Total consumer | 33 | — | ||||||
Commercial business | — | — | ||||||
Total nonaccrual loans | 2,145 | 1,219 | ||||||
Accruing loans past due 90 days or more | — | — | ||||||
Total nonaccrual loans and accruing loans past due 90 days or more | 2,145 | 1,219 | ||||||
Real estate owned | 544 | 426 | ||||||
Total nonperforming assets | $ | 2,689 | $ | 1,645 | ||||
Troubled debt restructurings: | ||||||||
In nonaccrual status | $ | 465 | $ | 493 | ||||
Performing under modifed terms | 1,565 | 672 | ||||||
Total troubled debt restructurings | $ | 2,030 | $ | 1,165 | ||||
Total nonperforming loans to total loans | 0.84 | % | 0.51 | % | ||||
Total nonperforming assets to total assets | 0.80 | 0.48 |
At December 31, 2011 nonaccrual loans consisted primarily of nine residential mortgage loans that total $1.5 million, of which one was originated internally in the amount of $128,000 and eight were purchased in the amount of $1.4 million. Of these loans, the eight purchased residential properties were in process of foreclosure at December 31, 2011. The nonaccrual purchased residential loans included one relationship comprised of six loans totaling $1.3 million. Additionally, nonaccrual loans included two commercial real estate relationships, which consisted of three loans in the amount of $568,000, and one home equity loan in the amount of $33,000.
F-24 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2010 nonaccrual loans consisted primarily of seven residential mortgage loans that total $726,000, of which four were originated internally in the amount of $332,000 and three were purchased in the amount of $394,000. Of these loans, one originated and one purchased residential property in the amounts of $160,000 and $231,000 were in process of foreclosure at December 31, 2010. Additionally, nonaccrual loans included one commercial real estate relationship which consisted of two loans in the amount of $493,000.
The Bank had three relationships classified as TDRs at the dates indicated summarized as follows:
· One relationship composed of two commercial real estate loans with a total balance of $465,000 and $493,000 at December 31, 2011 and December 31, 2010, respectively. The borrower was experiencing financial difficulties and was given a six month interest-only payment concession in 2010. After conclusion of the interest-only period in 2011, the borrower was unable to consistently make regular loan payments and defaulted on the loans, which resulted in the Bank beginning the foreclosure process on the collateral securing the loans. To halt foreclosure, the borrower signed a forbearance agreement and, in 2012, paid off one of the loans and began making monthly payments. If a payment is missed the foreclosure process will restart. This relationship was evaluated for impairment and it was determined based on an appraisal of the underlying loan collateral that a specific allowance was not necessary because there was sufficient collateral to cover the outstanding loan balance. These loans are included in total nonaccrual loans in the previous table.
· One commercial real estate participation loan with a balance of $654,000 and $672,000 at December 31, 2011 and December 31, 2010, respectively. Because the borrower believed it would be unable to obtain financing to pay the loan in full upon original maturity in 2010, the loan was modified through a forbearance agreement in 2010 by extending the maturity date by three years to 2013. This loan has demonstrated performance under the modified terms and therefore was in a performing (accrual) status. This relationship was evaluated for impairment and it was determined that a $170,000 specific allowance was necessary due to a decline in the underlying collateral as determined by an appraisal on the property.
· One relationship that totaled $911,000 at December 31, 2011 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000 that has been deemed impaired based on the current financial standing of the borrower. In the fourth quarter of 2011, three commercial business loans were consolidated into one commercial real estate loan and additional collateral was obtained. The Bank previously determined a $75,000 specific allowance was necessary based on the current information that was available. However, after enhancing the collateral position and reviewing the updated property appraisals of the underlying loan collateral and the updated valuation of the other business assets securing the loan, it was determined that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was no longer necessary at December 31, 2011.
F-25 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information in regards to impaired loans by loan portfolio class at the dates indicated (dollars in thousands).
Unpaid | Average | Interest | ||||||||||||||||||
Recorded | Principal | Related | Recorded | Income | ||||||||||||||||
December 31, 2011 | Investment | Balance | Allowance | Investment | Recognized | |||||||||||||||
Impaired loans with no related allowance recorded | ||||||||||||||||||||
One-to-four family purchased residential | $ | 1,287 | $ | 1,287 | $ | — | $ | 1,290 | $ | 11 | ||||||||||
Commercial real estate | 1,447 | 1,510 | — | 1,484 | 60 | |||||||||||||||
Home equity (loan-to-value ratio of 80% or less) | 140 | 140 | — | 143 | 9 | |||||||||||||||
Other consumer | 11 | 11 | — | 12 | 1 | |||||||||||||||
Impaired loans with an allowance recorded | ||||||||||||||||||||
Commercial real estate | 654 | 654 | 170 | 663 | 32 | |||||||||||||||
One-to-four family purchased residential | $ | 1,287 | $ | 1,287 | $ | — | $ | 1,290 | $ | 11 | ||||||||||
Commercial real estate | 2,101 | 2,164 | 170 | 2,147 | 92 | |||||||||||||||
Home equity (loan-to-value ratio of 80% or less) | 140 | 140 | — | 143 | 9 | |||||||||||||||
Other consumer | 11 | 11 | — | 12 | 1 | |||||||||||||||
Total impaired loans | $ | 3,539 | $ | 3,602 | $ | 170 | $ | 3,592 | $ | 113 |
Unpaid | Average | Interest | ||||||||||||||||||
Recorded | Principal | Related | Recorded | Income | ||||||||||||||||
December 31, 2010 | Investment | Balance | Allowance | Investment | Recognized | |||||||||||||||
Impaired loans with no related allowance recorded | ||||||||||||||||||||
Commercial real estate | $ | 493 | $ | 537 | $ | — | $ | 547 | $ | 4 | ||||||||||
Impaired loans with an allowance recorded | ||||||||||||||||||||
Commercial real estate | 672 | 672 | 170 | 680 | 32 | |||||||||||||||
Total impaired loans | ||||||||||||||||||||
Commercial real estate | $ | 1,165 | $ | 1,209 | $ | 170 | $ | 1,227 | $ | 36 |
F-26 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Federal regulations require us to review and classify our assets on a regular basis. In addition, the OCC has the authority to identify problem assets and, if appropriate, require them to be classified. There are four classifications for problem assets: special mention, substandard, doubtful and loss. The following table presents the classes of the loan portfolio and shows our credit risk profile by internally assigned risk rating at the dates indicated (dollars in thousands).
Real estate - mortgage | Real estate- construction | Consumer | ||||||||||||||||||||||||||||||||||||||||||||||
Home | Home | |||||||||||||||||||||||||||||||||||||||||||||||
One-to- | One-to- | equity | equity | |||||||||||||||||||||||||||||||||||||||||||||
four | four | (loan | (loan | |||||||||||||||||||||||||||||||||||||||||||||
family | family | Multi- | Multi- | to value | to value | Com- | ||||||||||||||||||||||||||||||||||||||||||
residential | residential | family | family | Com- | Resi- | Com- | of 80% | of greater | Other | mercial | Loans | |||||||||||||||||||||||||||||||||||||
December 31, 2011 | (originated) | (purchased) | (originated) | (purchased) | mercial | dential | mercial | or less) | than 80%) | Consumer | business | Total | ||||||||||||||||||||||||||||||||||||
Grade: | ||||||||||||||||||||||||||||||||||||||||||||||||
Pass | $ | 117,232 | $ | 14,888 | $ | 13,122 | $ | 5,121 | $ | 31,026 | $ | 3,874 | $ | 8,308 | $ | 30,539 | $ | 7,725 | $ | 1,881 | $ | 15,445 | $ | 249,161 | ||||||||||||||||||||||||
Special Mention | 262 | — | — | — | 2,076 | — | — | — | — | — | — | 2,338 | ||||||||||||||||||||||||||||||||||||
Substandard | 128 | 1,416 | — | — | 2,205 | — | — | 140 | 33 | 11 | — | 3,933 | ||||||||||||||||||||||||||||||||||||
Doubtful | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
Loss | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
Total | $ | 117,622 | $ | 16,304 | $ | 13,122 | $ | 5,121 | $ | 35,307 | $ | 3,874 | $ | 8,308 | $ | 30,679 | $ | 7,758 | $ | 1,892 | $ | 15,445 | $ | 255,432 |
Real estate- | ||||||||||||||||||||||||||||||||||||||||||||||||
Real estate - mortgage | construction | Consumer | ||||||||||||||||||||||||||||||||||||||||||||||
Home | Home | |||||||||||||||||||||||||||||||||||||||||||||||
equity | equity | |||||||||||||||||||||||||||||||||||||||||||||||
One-to- | One-to- | (loan- | (loan- | |||||||||||||||||||||||||||||||||||||||||||||
four family | four family | Multi- | Multi- | ratio to-value | to-value ratio | Com- | ||||||||||||||||||||||||||||||||||||||||||
residential | residential | family | family | Com- | Resi- | Com- | 80% of | of greater | Other | mercial | Loans | |||||||||||||||||||||||||||||||||||||
December 31, 2010 | (originated) | (purchased) | (originated) | (purchased) | mercial | dential | mercial | or less) | than 80%) | Consumer | business | Total | ||||||||||||||||||||||||||||||||||||
Grade: | ||||||||||||||||||||||||||||||||||||||||||||||||
Pass | $ | 121,044 | $ | 20,197 | $ | 4,082 | $ | 5,261 | $ | 29,518 | $ | 6,787 | $ | 736 | $ | 22,483 | $ | 8,624 | $ | 2,077 | $ | 10,196 | $ | 231,005 | ||||||||||||||||||||||||
Special Mention | — | — | — | — | 2,319 | — | — | 145 | — | 13 | 679 | 3,156 | ||||||||||||||||||||||||||||||||||||
Substandard | 332 | 394 | — | — | 1,895 | — | — | — | — | — | — | 2,621 | ||||||||||||||||||||||||||||||||||||
Doubtful | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
Loss | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
Total | $ | 121,376 | $ | 20,591 | $ | 4,082 | $ | 5,261 | $ | 33,732 | $ | 6,787 | $ | 736 | $ | 22,628 | $ | 8,624 | $ | 2,090 | $ | 10,875 | $ | 236,782 |
At December 31, 2011, special mention assets were $2.3 million and included three relationships that consisted of four commercial real estate loans and one mortgage loan totaling $2.1 million and $262,000, respectively. Substandard assets were $3.9 million and consisted of $2.1 million of non-accrual loans, two commercial real estate loans in the amount of $877,000 and one relationship that totaled $911,000 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000. Nonaccrual loans consisted of $1.5 million of residential mortgage loans, $568,000 of commercial real estate loans, and a $33,000 home equity loan. The nonaccrual residential loans included one purchased relationship comprised of six loans totaling $1.3 million.
At December 31, 2010, special mention assets were $3.2 million and consisted of five relationships. One relationship totaled $970,000 and consisted of three commercial real estate loans, three business loans and two consumer loans. The remaining four relationships consist of five commercial real estate loans totaling $2.1 million. Substandard assets were $2.6 million and consisted of $1.2 million of non-accrual loans and two commercial real estate loans in the amount of $1.4 million. Nonaccrual loans consisted of $726,000 of residential mortgage loans and $493,000 of commercial real estate loans.
F-27 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides information about delinquencies in our loan portfolio at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||||||||||||||||||
90 Days | 90 Days | |||||||||||||||||||||||
30-59 | 60-89 | or | 30-59 | 60-89 | or | |||||||||||||||||||
Days | Days | Greater | Days | Days | Greater | |||||||||||||||||||
Past | Past | Past | Past | Past | Past | |||||||||||||||||||
Due | Due | Due | Due | Due | Due | |||||||||||||||||||
Real estate - mortgage | ||||||||||||||||||||||||
One-to-four family residential | ||||||||||||||||||||||||
Originated | $ | 681 | $ | 584 | $ | — | $ | 1,109 | $ | 59 | $ | 332 | ||||||||||||
Purchased | — | 172 | 1,416 | 260 | 168 | 394 | ||||||||||||||||||
Total one-to-four family residential | 681 | 756 | 1,416 | 1,369 | 227 | 726 | ||||||||||||||||||
Multi-family | ||||||||||||||||||||||||
Originated | — | — | — | — | — | — | ||||||||||||||||||
Purchased | — | — | — | — | — | — | ||||||||||||||||||
Total multi-family | — | — | — | — | — | — | ||||||||||||||||||
Commercial | 25 | 504 | 568 | 753 | — | 68 | ||||||||||||||||||
Total real estate - mortgage | 706 | 1,260 | 1,984 | 2,122 | 227 | 794 | ||||||||||||||||||
Real estate - construction | ||||||||||||||||||||||||
Residential | — | — | — | — | — | — | ||||||||||||||||||
Commercial | — | — | — | — | — | — | ||||||||||||||||||
Total real estate - construction | — | — | — | — | — | — | ||||||||||||||||||
Consumer | ||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||
Loan-to-value ratio of 80% or less | 68 | — | — | 89 | 133 | — | ||||||||||||||||||
Loan-to-value ratio of greater than 80% | 48 | — | 33 | — | 32 | — | ||||||||||||||||||
Total home equity | 116 | — | 33 | 89 | 165 | — | ||||||||||||||||||
Other | 1 | 4 | — | 2 | — | — | ||||||||||||||||||
Total consumer | 117 | 4 | 33 | 91 | 165 | — | ||||||||||||||||||
Commercial business | 28 | — | — | — | — | — | ||||||||||||||||||
Total delinquencies | $ | 851 | $ | 1,264 | $ | 2,017 | $ | 2,213 | $ | 392 | $ | 794 |
Our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a valuation allowance on impaired loans; and (2) a 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.
F-28 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance on Impaired Loans.We establish an allowance for loans that are individually evaluated and determined to be impaired. The allowance is determined by utilizing one of the three impairment measurement methods. At December 31, 2011, there were five loan relationships that were individually evaluated for impairment, of which three are considered TDRs. The three relationships that are considered TDRs are summarized as follows:
· One relationship composed of two commercial real estate loans with a total balance of $465,000. The borrower was experiencing financial difficulties and was given a six month interest-only payment concession in 2010. After conclusion of the interest-only period in 2011, the borrower was unable to consistently make regular loan payments and defaulted on the loans, which resulted in the Bank beginning the foreclosure process on the collateral securing the loans. To halt foreclosure, the borrower signed a forbearance agreement and, in 2012, paid off one of the loans and began making monthly payments. If a payment is missed the foreclosure process will restart. This relationship was evaluated for impairment and it was determined based on an appraisal of the underlying loan collateral that a specific allowance was not necessary because there was sufficient collateral to cover the outstanding loan balance. These loans are included in total nonaccrual loans.
· One commercial real estate participation loan with a balance of $654,000. Because the borrower believed it would be unable to obtain financing to pay the loan in full upon original maturity in 2010, the loan was modified through a forbearance agreement in 2010 by extending the maturity date by three years to 2013. This loan has demonstrated performance under the modified terms and therefore was in a performing (accrual) status. This relationship was evaluated for impairment and it was determined that a $170,000 specific allowance was necessary due to a decline in the underlying collateral as determined by an appraisal on the property.
· One relationship that totaled $911,000 and consisted of three commercial real estate loans totaling $760,000 and two consumer loans totaling $151,000 that has been deemed impaired based on the current financial standing of the borrower. In the fourth quarter of 2011, three commercial business loans were consolidated into one commercial real estate loan and additional collateral was obtained. The Bank previously determined a $75,000 specific allowance was necessary based on the current information that was available. However, after enhancing the collateral position and reviewing the updated property appraisals of the underlying loan collateral and the updated valuation of the other business assets securing the loan, it was determined that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was no longer necessary at December 31, 2011.
The two relationships that are not considered TDRs are summarized as follows:
· One purchased residential mortgage relationship consisting of six loans totaling $1.3 million that has been deemed impaired due to the borrower no longer making payments. One loan with a balance of $116,000 was paid off in 2012 and the remaining five loans were in process of foreclosure. It was determined based on an appraisal of the underlying loan collateral that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was not established.
· One commercial real estate relationship totaling $223,000 that has been deemed impaired based on the current financial standing of the borrower. It was determined based on an appraisal of the underlying loan collateral that there was sufficient collateral to cover the outstanding loan balance and, therefore, a specific allowance was not established.
F-29 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance on the Remainder of the Loan Portfolio. We establish another allowance for loans that are not determined to be impaired. Management determines historical loss experience for each group of loans with similar risk characteristics within the portfolio based on loss experience for loans in each group. Loan categories will represent groups of loans with similar risk characteristics and may include types of loans categorized by product, large credit exposures, concentrations, loan grade, or any other characteristic that causes a loan’s risk profile to be similar to another. We utilize previous years’ net charge-off experience by loan category as a basis in determining loss projections. In addition, there are two categories of loans considered to be higher risk concentrations that are evaluated separately when calculating the allowance for loan losses:
· Loans purchased in the secondary market. Prior to 2006, pools of multi-family and one-to-four family residential mortgage loans located in areas outside of our primary geographic lending area in southwestern Pennsylvania were acquired in the secondary market. Although these loans were underwritten to our lending standards, they are considered higher risk given our unfamiliarity with the geographic areas where the properties are located.
· Home equity loans with a loan-to-value ratio greater than 80%. These loans are considered higher risk given the pressure on property values and reduced credit alternatives available to leveraged borrowers.
We also consider qualitative or environmental factors that are likely to cause estimated credit losses associated with the bank’s existing portfolio to differ from historical loss experience. Our historical loss experience and qualitative and environmental factors are reviewed on a quarterly basis to ensure they are reflective of current conditions in our loan portfolio and economy. In 2011, the qualitative factor related to changes in adversely graded loans was adjusted to include a factor for special mention loans. The factors related to changes in the volume and severity of past due loans, nonaccrual loans and adversely graded or classified loans and changes in the value of underlying collateral for collateral dependent loans were also adjusted specifically for the purchased residential loans due to severity of the number of past due loans in this portfolio segment and the continued deterioration of property values, primarily on Michigan properties. The qualitative factor related to changes in underlying collateral on collateral dependent loans was previously adjusted in 2010 due to the current real estate conditions outside the Bank’s footprint, specifically in the Michigan area where the majority of our delinquent purchased loans are located. In addition, in 2011 and 2010, certain historical loss factors were adjusted to place more emphasis on recent and expected loss experience while generally excluding periods where we did not experience any losses.
At December 31, 2011, the allowance for loan losses to total loans ratio was 1.21% compared to 1.19% at December 31, 2010. The increase is primarily due to loan growth and the qualitative factor changes previously noted.
F-30 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Transactions in the allowance for loan losses during 2011 are summarized as follows (dollars in thousands):
Real estate - mortgage | Real estate- construction | Consumer | ||||||||||||||||||||||||||||||||||||||
One-to- four family residential (originated) | One-to- four family residential (purchased) | Multi- family (originated) | Multi- family (purchased) | Com- mercial | Resi- dential | Com- mercial | Home equity (loan- to-value ratio of 80% or less) | Home equity (loan- to-value ratio of greater than 80%) | Other Consumer | Com- mercial business | Unal- located | Total | ||||||||||||||||||||||||||||
Loan Balance | $ | 117,622 | $ | 16,304 | $ | 13,122 | $ | 5,121 | $ | 35,307 | $ | 3,874 | $ | 8,308 | $ | 30,679 | $ | 7,758 | $ | 1,892 | $ | 15,445 | $ | 255,432 | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||||||||||||||||||
December 31, 2010 | $ | 558 | $ | 433 | $ | 12 | $ | 127 | $ | 804 | $ | 10 | $ | 1 | $ | 294 | $ | 292 | $ | 26 | $ | 171 | $ | 96 | $ | 2,824 | ||||||||||||||
Charge-offs | — | (489 | ) | — | — | — | — | — | (14 | ) | (64 | ) | (11 | ) | — | — | (578 | ) | ||||||||||||||||||||||
Recoveries | — | 1 | — | — | — | — | — | — | — | 1 | — | — | 2 | |||||||||||||||||||||||||||
Provision | (24 | ) | 520 | 27 | (3 | ) | 54 | (4 | ) | 11 | 99 | 39 | 8 | 71 | 52 | 850 | ||||||||||||||||||||||||
December 31, 2011 | $ | 534 | $ | 465 | $ | 39 | $ | 124 | $ | 858 | $ | 6 | $ | 12 | $ | 379 | $ | 267 | $ | 24 | $ | 242 | $ | 148 | $ | 3,098 | ||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | — | $ | — | $ | 170 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 170 | ||||||||||||||
Collectively evaluated on historical loss experience | 155 | 235 | — | 78 | 59 | — | — | 104 | 116 | 18 | 3 | — | 768 | |||||||||||||||||||||||||||
Collectively evaluated on qualitative factors | 379 | 230 | 39 | 46 | 629 | 6 | 12 | 275 | 151 | 6 | 239 | — | 2,012 | |||||||||||||||||||||||||||
Unallocated | — | — | — | — | — | — | — | — | — | — | — | 148 | 148 | |||||||||||||||||||||||||||
Total allowance for loan losses | $ | 534 | $ | 465 | $ | 39 | $ | 124 | $ | 858 | $ | 6 | $ | 12 | $ | 379 | $ | 267 | $ | 24 | $ | 242 | $ | 148 | $ | 3,098 | ||||||||||||||
Percent of Allowance | 17.2 | % | 15.0 | % | 1.3 | % | 4.0 | % | 27.7 | % | 0.2 | % | 0.4 | % | 12.2 | % | 8.6 | % | 0.8 | % | 7.8 | % | 4.8 | % | 100.0 | % | ||||||||||||||
Percent of Loans(1) | 46.0 | % | 6.4 | % | 5.1 | % | 2.0 | % | 13.8 | % | 1.5 | % | 3.3 | % | 12.0 | % | 3.1 | % | 0.7 | % | 6.1 | % | 100.0 | % |
(1) Represents percentage of loans in each category to total loans
F-31 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Transactions in the allowance for loan losses during 2010 are summarized as follows (dollars in thousands):
Real estate - mortgage | Real estate-construction | Consumer | ||||||||||||||||||||||||||||||||||||||
One-to- four family residential (originated) | One-to- four family residential (purchased) | Multi- family (originated) | Multi- family (purchased) | Com- mercial | Resi- dential | Com- mercial | Home equity (loan- to-value ratio of 80% or less) | Home equity (loan- to-value ratio of greater than 80%) | Other Consumer | Com- mercial business | Unal- located | Total | ||||||||||||||||||||||||||||
Loan Balance | $ | 121,376 | $ | 20,591 | $ | 4,082 | $ | 5,261 | $ | 33,732 | $ | 6,787 | $ | 736 | $ | 22,628 | $ | 8,624 | $ | 2,090 | $ | 10,875 | $ | 236,782 | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||||||||||||||||||
December 31, 2009 | $ | 641 | $ | 323 | $ | 12 | $ | 117 | $ | 647 | $ | 4 | $ | 4 | $ | 168 | $ | 321 | $ | 31 | $ | 160 | $ | 81 | $ | 2,509 | ||||||||||||||
Charge-offs | (82 | ) | (181 | ) | — | (46 | ) | — | — | — | (87 | ) | (119 | ) | (18 | ) | (2 | ) | — | (535 | ) | |||||||||||||||||||
Recoveries | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
Provision | (1 | ) | 291 | — | 56 | 157 | 6 | (3 | ) | 213 | 90 | 13 | 13 | 15 | 850 | |||||||||||||||||||||||||
December 31, 2010 | $ | 558 | $ | 433 | $ | 12 | $ | 127 | $ | 804 | $ | 10 | $ | 1 | $ | 294 | $ | 292 | $ | 26 | $ | 171 | $ | 96 | $ | 2,824 | ||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | — | $ | — | $ | 170 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 170 | ||||||||||||||
Collectively evaluated on historical loss experience | 160 | 156 | — | 80 | 56 | — | — | 90 | 128 | 20 | 3 | — | 693 | |||||||||||||||||||||||||||
Collectively evaluated on qualitative factors | 398 | 277 | 12 | 47 | 578 | 10 | 1 | 204 | 164 | 6 | 168 | — | 1,865 | |||||||||||||||||||||||||||
Unallocated | — | — | — | — | — | — | — | — | — | — | — | 96 | 96 | |||||||||||||||||||||||||||
Total allowance for loan losses | $ | 558 | $ | 433 | $ | 12 | $ | 127 | $ | 804 | $ | 10 | $ | 1 | $ | 294 | $ | 292 | $ | 26 | $ | 171 | $ | 96 | $ | 2,824 | ||||||||||||||
Percent of Allowance | 19.8 | % | 15.3 | % | 0.4 | % | 4.5 | % | 28.5 | % | 0.4 | % | 0.0 | % | 10.4 | % | 10.3 | % | 0.9 | % | 6.1 | % | 3.4 | % | 100.0 | % | ||||||||||||||
Percent of Loans(1) | 51.3 | % | 8.7 | % | 1.7 | % | 2.2 | % | 14.2 | % | 2.9 | % | 0.3 | % | 9.6 | % | 3.6 | % | 0.9 | % | 4.6 | % | 100.0 | % |
(1) Represents percentage of loans in each category to total loans
.
F-32 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Premises and Equipment
Premises and equipment are summarized by major classifications as follows (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Land and land improvements | $ | 541 | $ | 511 | ||||
Buildings and leasehold improvements | 4,664 | 4,600 | ||||||
Furniture, fixtures and equipment | 4,124 | 3,778 | ||||||
Total, at cost | 9,329 | 8,889 | ||||||
Less: accumulated depreciation | 7,165 | 6,608 | ||||||
Premises and equipment, net | $ | 2,164 | $ | 2,281 |
Depreciation expense was approximately $557,000 and $525,000 for the years ended December 31, 2011 and 2010, respectively.
5. Deposits
Deposits are summarized as follows (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Noninterest-bearing demand deposits | $ | 20,536 | $ | 15,612 | ||||
Interest-bearing demand deposits | 14,555 | 13,584 | ||||||
Savings accounts | 22,827 | 21,320 | ||||||
Money market accounts | 59,709 | 58,949 | ||||||
Certificates of deposit | 103,913 | 94,097 | ||||||
Total deposits | $ | 221,540 | $ | 203,562 |
Interest expense by deposit category was as follows (dollars in thousands).
Years ended December 31, | 2011 | 2010 | ||||||
Interest-bearing demand deposits | $ | 33 | $ | 39 | ||||
Savings accounts | 99 | 110 | ||||||
Money market accounts | 472 | 666 | ||||||
Certificates of deposit | 2,173 | 2,529 | ||||||
Total interest expense | $ | 2,777 | $ | 3,344 |
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 totaled $35.4 million and $25.6 million at December 31, 2011 and 2010, respectively.
Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000. That coverage was made permanent by the Dodd Frank Act. In addition, the Federal Deposit Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010. The Bank opted to participate in the unlimited noninterest-bearing transaction account coverage. The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transaction accounts from January 1, 2011 until December 31, 2012 without the opportunity for opt out.
F-33 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The term noninterest-bearing transaction account includes a traditional checking account or demand deposit account on which the insured depository institution pays no interest. It also includes Interest on Lawyers Trust Accounts (“IOLTAs”). It does not include other accounts, such as traditional checking or demand deposit accounts that may earn interest, NOW accounts and money market deposit accounts.
Scheduled maturities of certificates of deposit were as follows (dollars in thousands):
December 31, | 2011 | 2010 | ||||||||||
2012 | $ | 60,308 | 2011 | $ | 42,690 | |||||||
2013 | 13,543 | 2012 | 25,001 | |||||||||
2014 | 7,468 | 2013 | 7,224 | |||||||||
2015 | 6,702 | 2014 | 5,558 | |||||||||
2016 | 2,831 | 2015 | 6,209 | |||||||||
Thereafter | 13,061 | Thereafter | 7,415 | |||||||||
Total | $ | 103,913 | Total | $ | 94,097 |
6. Borrowings
We utilize borrowings as a supplemental source of funds for loans and securities. The primary sources of borrowings are FHLB advances and, to a limited extent, repurchase agreements. At December 31, 2011 and 2010, we had $49.9 million and $77.7 million of borrowings, respectively, of which $46.9 million and $74.7 million, respectively, were FHLB advances and $3.0 million were repurchase agreements. At December 31, 2011, our FHLB advances consisted of fixed rate advances. At December 31, 2010, our FHLB advances consisted of fixed rate advances and a convertible select advance. A convertible select advance is a long-term borrowing that, upon expiration of the fixed rate term and quarterly thereafter, the FHLB may convert to an adjustable rate advance at its option. If the advance is converted to an adjustable rate advance, the Bank has the option to prepay the advance with no prepayment fee. At December 31, 2010, the Company had a $1.5 million in convertible select advance which matured in March 2011.
In July 2010, the Company modified a $12.0 million convertible select advance that had an interest rate of 4.79% into a new five year fixed rate FHLB advance with an effective interest rate of 3.82%. The debt modification resulted in an $864,000 prepayment penalty which is deferred and amortized in future periods on a straight-line basis over the life of the new borrowing in accordance with ASC 470-50-40/55 (formerly EITF 96-19) Debtor’s Accounting for a Modification or Exchange of Debt Instruments. Based on ASC 470-50-40/55, the Company concluded that the revised terms constituted a debt modification rather than a debt extinguishment because the change in the present value of cash flows of the new borrowing changed by less than 10% compared to the present value of the remaining cash flows of the old borrowing.
F-34 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth borrowings based on their stated maturities and weighted average rates at December 31, 2011 and 2010 (dollars in thousands).
Weighted | ||||||||||||||||
Average Rate | Balance | |||||||||||||||
December 31, | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Due in one year or less | 4.15 | % | 3.02 | % | $ | 8,406 | $ | 22,159 | ||||||||
Due in one to two years | 3.68 | 4.22 | 11,497 | 9,805 | ||||||||||||
Due in two to three years | 3.41 | 3.68 | 18,000 | 15,717 | ||||||||||||
Due in three to four years | 3.82 | 3.41 | 12,000 | 18,000 | ||||||||||||
Due in four to five years | — | 3.82 | — | 12,000 | ||||||||||||
Total advances | 3.69 | % | 3.52 | % | $ | 49,903 | $ | 77,681 | ||||||||
Less: deferred premium on modification | $ | (614 | ) | $ | (788 | ) | ||||||||||
Total advances | $ | 49,289 | $ | 76,893 |
Advances from the FHLB are secured by the Bank’s stock in the FHLB and a blanket lien on the Bank’s qualifying loans. Securities with an amortized cost and fair value of $3.5 million and $3.7 million at December 31, 2011 as compared to $5.5 million and $5.9 million at December 31, 2010, were pledged to adequately secure the repurchase agreements.
The maximum remaining borrowing capacity at the FHLB at December 31, 2011 and 2010 was approximately $124.3 million and $101.6 million, respectively. The advances are subject to restrictions or penalties in the event of prepayment. The Bank also has the ability to borrow from the Federal Reserve based upon eligible collateral and has an $8.0 million unsecured discretionary line of credit. At December 31, 2011 and 2010, the Bank had no borrowings with the Federal Reserve and had not taken any advances on the line of credit.
7. Earnings Per Share
The following table sets forth basic and diluted earnings per common share at December 31, 2011 and 2010.
Years Ended December 31, | 2011 | 2010 | ||||||
(Dollars in thousands, except per share amounts) | ||||||||
Net income | $ | 859 | $ | 608 | ||||
Weighted-average shares outstanding: | ||||||||
Basic | 2,908,639 | 2,897,469 | ||||||
Effect of dilutive stock options and awards | 2,873 | 1,516 | ||||||
Diluted | 2,911,512 | 2,898,985 | ||||||
Earnings per share: | ||||||||
Basic and diluted | $ | 0.30 | $ | 0.21 |
The dilutive effect on average shares outstanding is the result of stock options outstanding. As of December 31, 2011 and 2010, options to purchase 133,017 and 91,834 shares of common stock, respectively, at a weighted average exercise price of $17.41 and $20.10 per share, respectively, were outstanding but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares.
F-35 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Operating Leases
The Company leases certain properties under operating leases expiring in various years through 2017. Lease expense was $204,000 and $203,000 for the years ended December 31, 2011 and 2010, respectively.
Minimum future rental payments under noncancelable operating leases are as follows (dollars in thousands).
December 31, | 2011 | |||
2012 | $ | 166 | ||
2013 | 156 | |||
2014 | 107 | |||
2015 | 90 | |||
2016 | 87 | |||
Thereafter | 29 | |||
Total | $ | 635 |
9. Income Taxes
The difference between actual income tax benefit and the amount computed by applying the federal statutory income tax rate of 34% to income before income tax expenses were reconciled as follows (dollars in thousands).
Years ended December 31, | 2011 | 2010 | ||||||
Computed income tax expense | $ | 439 | $ | 338 | ||||
Increase (decrease) resulting from: | ||||||||
State taxes (net of federal benefit) | 20 | 41 | ||||||
Nontaxable BOLI income | (91 | ) | (97 | ) | ||||
Stock-based compensation (ISOs) | 51 | 74 | ||||||
Other, net | 13 | 30 | ||||||
Actual income tax expense | $ | 432 | $ | 386 | ||||
Effective tax rate | 33.2 | % | 36.8 | % |
F-36 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as follows (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Deferred tax assets: | ||||||||
Allowance for loan losses | $ | 1,053 | $ | 960 | ||||
Investments in affordable housing projects | — | 32 | ||||||
Postretirement benefits | 1,094 | 674 | ||||||
Net operating loss carryforwards - Federal | — | 511 | ||||||
Depreciation and amortization | 93 | — | ||||||
Stock-based compensation (NSOs) | 118 | 101 | ||||||
Net unrealized loss on securities available-for-sale | 108 | 32 | ||||||
Other deferred tax assets | — | 7 | ||||||
Total deferred tax assets | 2,466 | 2,317 | ||||||
Deferred tax liabilities: | ||||||||
Deferred loan costs | (206 | ) | (237 | ) | ||||
Other deferred tax liabilities | (24 | ) | (22 | ) | ||||
Depreciation and amortization | — | (100 | ) | |||||
Investments in affordable housing projects | (63 | ) | — | |||||
Other deferred tax liabilities | (2 | ) | — | |||||
Total deferred tax liabilities | (295 | ) | (359 | ) | ||||
Net deferred tax assets | 2,171 | 1,958 | ||||||
Tax credit carryforwards | 925 | 1,059 | ||||||
Total deferred tax assets and tax credit carryforwards | $ | 3,096 | $ | 3,017 |
The tax credit carryforwards expiring in 2021 through 2025 are available to offset future taxes payable. The Company determined that it was not required to establish a valuation allowance for deferred tax assets since it is more likely than not that the deferred tax assets will be realized through future taxable income and future reversals of existing taxable temporary differences. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.
Income tax expense is summarized as follows (dollars in thousands).
Years ended December 31, | 2011 | 2010 | ||||||
Current | $ | 435 | $ | (91 | ) | |||
Deferred | (3 | ) | 477 | |||||
Total income tax expense | $ | 432 | $ | 386 |
10. 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 possible additional discretionary, actions by regulators that, if undertaken, could have a direct material affect on the Bank’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.
F-37 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Generally, a savings association is considered to be “undercapitalized” if it has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4%. At December 31, 2011 and 2010, the Bank met all capital adequacy requirements to which it is subject and notifications from the 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 Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes would change the Bank’s categorization. In September 2010, the Company made a $7.7 million investment in the Bank upon the closing of the second step conversion, as required by OTS regulations. The following table sets forth the Bank’s regulatory capital amounts and ratios, as well as the minimum amounts and ratios required to be well capitalized (dollars in thousands).
To Be Well | ||||||||||||||||||||||||
For Capital | Capitalized | |||||||||||||||||||||||
Adequacy | Under Prompt | |||||||||||||||||||||||
Actual | Purposes | Corrective Action | ||||||||||||||||||||||
December 31, 2011 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 47,771 | 25.30 | % | $ | 15,107 | 8.00 | % | $ | 18,884 | 10.00 | % | ||||||||||||
Tier 1 capital (to risk-weighted assets) | 45,401 | 24.04 | 7,553 | 4.00 | 11,330 | 6.00 | ||||||||||||||||||
Tier 1 capital (to adjusted total assets) | 45,401 | 13.59 | 13,360 | 4.00 | 16,700 | 5.00 | ||||||||||||||||||
Tangible capital (to tangible assets) | 45,401 | 13.59 | 5,010 | 1.50 | N/A | N/A | ||||||||||||||||||
December 31, 2010 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 46,565 | 25.44 | % | $ | 14,641 | 8.00 | % | $ | 18,302 | 10.00 | % | ||||||||||||
Tier 1 capital (to risk-weighted assets) | 44,277 | 24.19 | 7,321 | 4.00 | 10,981 | 6.00 | ||||||||||||||||||
Tier 1 capital (to adjusted total assets) | 44,277 | 12.95 | 13,681 | 4.00 | 17,102 | 5.00 | ||||||||||||||||||
Tangible capital (to tangible assets) | 44,277 | 12.95 | 5,130 | 1.50 | N/A | N/A |
The following is a reconciliation of the Bank’s equity under GAAP to regulatory capital at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
GAAP equity | $ | 46,464 | $ | 45,488 | ||||
Goodwill and certain other intangible assets | (1,230 | ) | (1,339 | ) | ||||
Accumulated other comprehensive loss | 167 | 128 | ||||||
Tier 1 capital | 45,401 | 44,277 | ||||||
General regulatory allowance for loan losses* | 2,370 | 2,288 | ||||||
Total capital | $ | 47,771 | $ | 46,565 |
* Limited to 1.25% of risk-weighted assets
Federal banking regulations place certain restrictions on dividends paid by the Bank to the Company. The total amount of dividends that may be paid at any date is generally limited to the earnings of the Bank for the year to date plus retained earnings for the prior two fiscal years, net of any prior capital distributions. In addition, dividends paid by the Bank to the Company would be prohibited if the distribution would cause the Bank’s capital to be reduced below the applicable minimum capital requirements.
F-38 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company maintains a liquidation account for the benefit of certain depositors of the Bank who remain depositors of the Bank at the time of liquidation. The liquidation account is designed to provide payments to these depositors of their liquidation interests in the event of a liquidation of the Company and the Bank, or the Bank alone. The liquidation account will be reduced annually to the extent that eligible depositors have reduced their qualifying deposits. The Company may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the unlikely event that the Company and the Bank were to liquidate in the future, all claims of creditors, including those of depositors, would be paid first, followed by distribution to eligible depositors of the liquidation account maintained by the Company. Also, in a complete liquidation of both entities, or of just the Bank, when the Company has insufficient assets to fund the liquidation account distribution due to depositors and the Bank has positive net worth, the Bank would immediately pay amounts necessary to fund the Company’s remaining obligations under the liquidation account. If the Company is completely liquidated or sold apart from a sale or liquidation of the Bank, then the rights of such depositors in the liquidation account maintained by the Company would be surrendered and treated as a liquidation account in the Bank - the “bank liquidation account” - and these depositors shall have an equivalent interest in the bank liquidation account and the same rights and terms as the liquidation account.
After two years from the date of conversion and upon the written request of the OCC, the Company will eliminate or transfer the liquidation account and the interests in such account to the Bank and the liquidation account would become the liquidation account of the Bank and not subject in any manner or amount to the Company’s creditors. Also, under the rules and regulations of the OCC, no post-conversion merger, consolidation, or similar combination or transaction with another depository institution in which the Company or the Bank is not the surviving institution would be considered liquidation and, in such a transaction, the liquidation account would be assumed by the surviving institution.
11. Benefit Plans
401(k) Plan
The Company maintains a 401(k) plan for all salaried employees and may make a discretionary contribution to the plan based on a computation in relation to net income and compensation expense. The Company also matches the first 5% of employee deferrals on a graduated scale of 100% of the first 3% and 50% for the next 2% for a maximum match of 4%. Plan expense was approximately $145,000 and $141,000 for the years ended December 31, 2011 and 2010, respectively. A full-time employee is eligible to participate in the plan after three months of employment, the attainment of age 21, and completion of 250 hours of service each Plan year.
Supplemental Executive Retirement Plan
The Company maintains a nonqualified defined benefit supplemental executive retirement plan (“SERP”) for certain directors. The present value of estimated supplemental retirement benefits is charged to operations. A set retirement benefit is provided to the directors.
The agreements for the nonqualified defined contribution SERP between the Bank and certain current and former key executive officers were terminated in November 2011. Substantially all of the liabilities associated with the executive SERP agreements were previously recorded as an expense by the Company in prior years. The Company recorded a one-time, pre-tax expense of $970,000 in the fourth quarter of 2011 in connection with the termination of the outstanding executive SERP agreements. Benefit payments are expected to occur in the fourth quarter of 2012.
The expense for the SERP plans for the years ended December 31, 2011 and 2010 was approximately $1.4 million and $318,000, respectively. The increase in expense is related to the termination of the executive SERP.
F-39 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Employee Stock Ownership Plan
In 2005, the Bank established an ESOP that purchased 122,735 shares of Company common stock from proceeds provided by the Company in the form of a loan. The effective date of the ESOP is January 1, 2005 and it is considered a leveraged plan. A full-time employee is eligible to participate in the plan after three months of employment, the attainment of age 21, and completion of 250 hours of service in a plan year. Each plan year, the Bank may, at its discretion, make additional contributions to the plan; however, at a minimum, the Bank has agreed to provide a contribution in the amount necessary to service the debt incurred to acquire the stock.
Shares are scheduled for release as the loan is repaid based on the interest method. The present amortization schedule calls for 8,182 shares to be released each December 31. The Company utilized current year dividends on allocated and unallocated shares in the payment of current year loan payment in accordance with plan document. The use of allocated dividends reduces compensation expense and participants will receive an equivalent allocation of shares in relation to their respective dividends to compensate for use of dividends in loan payment.
As shares in the ESOP are earned and committed to be released, compensation expense is recorded based on their average fair value. The difference between the average fair value of the shares committed to be released and the cost of those shares to the ESOP is charged or credited to additional paid-in capital. The balance of unearned shares held by the ESOP is shown as a reduction of stockholders’ equity. Only those shares in the ESOP that have been earned and are committed to be released are included in the computation of earnings per share.
ESOP compensation expense was $110,000 for the year ended December 31, 2011 compared to $90,000 for the year ended December 31, 2010. There were 8,182 shares earned and committed to be released and 39,911 allocated shares at December 31, 2011. At December 31, 2010, there were 8,182 shares earned and committed to be released and 35,105 allocated shares. The 65,459 and 73,641 remaining unearned/unallocated shares at December 31, 2011 and 2010 had an approximate fair market value of $897,000 and $1.0 million, respectively.
12. Stock-Based Compensation
In 2006, the Company’s stockholders approved the 2006 Equity Incentive Plan (the “2006 Plan”). The purpose of the 2006 Plan is to promote the Company’s success and enhance its value by linking the personal interests of its employees, officers, directors and directors emeritus to those of the Company’s stockholders, and by providing participants with an incentive for outstanding performance. All of the Company’s salaried employees, officers and directors are eligible to participate in the 2006 Plan. The 2006 Plan authorizes the granting of options to purchase shares of the Company’s stock, which may be non-statutory stock options or incentive stock options, and restricted stock which is subject to restrictions on transferability and subject to forfeiture. The 2006 Plan reserved an aggregate number of 214,787 shares of which 153,419 may be issued in connection with the exercise of stock options and 61,367 may be issued as restricted stock. As of December 31, 2011, there were 1,483 shares available to be issued in connection with the exercise of stock options and 6,769 shares that may be issued as restricted stock.
In 2011, the Company’s stockholders approved the 2011 Equity Incentive Plan (the “2011 Plan”). The 2011 Plan’s details related to purpose, eligibility, and granting of shares are the same as noted above for the 2006 Plan. The 2011 Plan reserved an aggregate number of 204,218 shares of which 145,870 may be issued in connection with the exercise of stock options and 58,348 may be issued as restricted stock.
F-40 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On May 26, 2011, two directors of the Company were awarded an aggregate of 5,000 restricted shares of common stock and 12,500 options to purchase shares of common stock. The awards vest over five years at the rate of 20% per year and the stock options have a 10 year contractual life from the date of grant. The Company’s common stock closed at $15.375 per share on May 26, 2011, which is the exercise price of the options granted on that date. The market value of the restricted stock awards was approximately $77,000, before the impact of income taxes. The estimated value of the stock options was $39,000, before the impact of income taxes. The per share weighted-average fair value of stock options granted with an exercise price equal to the market value on May 26, 2011 was $3.14 using the following Black-Scholes-Merton option pricing model assumptions: expected life of seven years, expected dividend rate of 0.85%, risk-free interest rate of 2.44% and an expected volatility of 16.0%, based on historical results.
On September 27, 2011, five nonemployee directors and five executive officers of the Company were awarded an aggregate of 40,500 options to purchase shares of common stock. The awards vest over five years at the rate of 20% per year and the stock options have a 10 year contractual life from the date of grant. The Company’s common stock closed at $13.10 per share on September 27, 2011, which is the exercise price of the options granted on that date. The estimated value of the stock options was $132,000, before the impact of income taxes. The per share weighted-average fair value of stock options granted with an exercise price equal to the market value on September 27, 2011 was $3.27 using the following Black-Scholes-Merton option pricing model assumptions: expected life of seven years, expected dividend rate of 0.69%, risk-free interest rate of 1.02% and an expected volatility of 24.4%, based on historical results.
The Company recognizes expense associated with the awards over the five-year vesting period. Compensation expense was $214,000 for the year ended December 31, 2011 compared to $293,000 for the year ended December 31, 2010. As of December 31, 2011, there was $316,000 of total unrecognized compensation cost related to nonvested stock-based compensation compared to $282,000 at December 31, 2010. The compensation expense cost at December 31, 2011 is expected to be recognized ratably over the weighted average remaining service period of 3.8 years. The Company realized a tax benefit for stock options (NSOs) of $17,000 for the year ended December 31, 2011 compared to tax expense of $9,000 for the year ended December 31, 2010.
F-41 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options | ||||||||||||
Weighted | Weighted | |||||||||||
Number | Average | Average | ||||||||||
of | Exercise | Remaining | ||||||||||
Stock-Based Compensation | Shares | Price | Term | |||||||||
Outstanding at December 31, 2009 | 102,750 | $ | 19.03 | 7.09 | ||||||||
Granted | — | — | ||||||||||
Exercised or converted | — | — | ||||||||||
Forfeited | 2,557 | 15.76 | ||||||||||
Expired | 1,231 | 17.11 | ||||||||||
Fractional shares(1) | 26 | |||||||||||
Outstanding at December 31, 2010 | 98,936 | $ | 19.13 | 6.06 | ||||||||
Granted | 53,000 | 13.64 | ||||||||||
Exercised or converted | — | — | ||||||||||
Forfeited | — | — | ||||||||||
Expired | 11,817 | 21.35 | ||||||||||
Outstanding at December 31, 2011 | 140,119 | $ | 16.86 | 6.86 | ||||||||
Exercisable at December 31, 2011 | 76,099 | $ | 19.86 | 4.89 |
(1) Represents adjustment for total of fractional shares on a participant level due to second step conversion.
Stock Options | Restricted Stock Awards | |||||||||||||||
Number of | Fair-Value | Number of | Fair-Value | |||||||||||||
Shares | Price | Shares | Price | |||||||||||||
Nonvested at December 31, 2009 | 53,175 | $ | 6.04 | 23,060 | $ | 17.15 | ||||||||||
Granted | — | — | — | — | ||||||||||||
Vested | 19,792 | 6.31 | 8,570 | 19.25 | ||||||||||||
Forfeited | 2,557 | 6.12 | 1,278 | 15.76 | ||||||||||||
Fractional Shares(1) | 14 | — | 11 | — | ||||||||||||
Nonvested at December 31, 2010 | 30,812 | $ | 5.86 | 13,201 | $ | 16.81 | ||||||||||
Granted | 53,000 | 3.24 | 5,000 | 15.38 | ||||||||||||
Vested | 19,792 | 6.31 | 8,569 | 19.24 | ||||||||||||
Forfeited | — | — | — | — | ||||||||||||
Nonvested at December 31, 2011 | 64,020 | $ | 3.55 | 9,632 | $ | 13.90 |
(1) Represents adjustment for total of fractional shares on a participant level due to second step conversion.
13. Concentration of Credit Risk
The risk of loss from lending and investing activities includes the possibility that a loss may occur from the failure of another party to perform according to the terms of the loan or investment agreement. This possibility of loss is known as credit risk. Credit risk can be reduced by diversifying the Company’s assets to prevent imprudent concentrations. The Company has adopted policies designed to prevent imprudent concentrations within its security and loan portfolio.
F-42 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The primary investment vehicles for the Company for the years ended December 31, 2011 and 2010 were mortgage-backed securities, which are comprised of diversified individual residential mortgage notes, and REMICs (real estate mortgage investment conduits), which represent a participation interest in a pool of mortgages. Mortgage-backed securities are guaranteed as to the timely repayment of principal and interest by a Government-sponsored enterprise. REMICs are created by redirecting the cash flows from the pool of mortgages underlying those securities to create two or more classes (or tranches) with different maturity or risk characteristics designed to meet a variety of investor needs and preferences. REMICs may be sponsored by U.S. Government agencies and Government-sponsored enterprises. Investments in other securities consist of Government-sponsored enterprise securities and municipal bonds which are made to provide and maintain liquidity within the guidelines of applicable regulations.
Substantially all of the Company’s loans, excluding those serviced by others, are made to customers located in southwestern Pennsylvania. The Company does not have any other concentration of credit risk representing greater than 10% of loans.
Off-Balance Sheet Risk
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit on consumer and commercial lines of credit, fixed rate residential, and home equity installment commitments, and are summarized as follows at the dates indicated (dollars in thousands).
December 31, | 2011 | 2010 | ||||||
Loans in process | $ | 7,790 | $ | 4,716 | ||||
Unused consumer revolving lines of credit | 3,693 | 3,152 | ||||||
Unused commercial lines of credit | 6,034 | 5,103 | ||||||
One-to-four family residential commitments | 1,345 | 443 | ||||||
Commercial commitments | 4,643 | — | ||||||
Consumer commitments | 817 | 897 | ||||||
Total commitments outstanding | $ | 24,322 | $ | 14,311 |
In 2011, the Bank made a $2.1 million commercial construction loan to an affiliate of a director of the Company of which $1.7 million was disbursed and the remaining $376,000 was included as loans in process as of December 31, 2011. In addition, the Bank signed a $1.2 million commercial real estate loan commitment with another affiliate of the same director. This loan is expected to be funded in the second quarter of 2012.
F-43 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Fair Value Measurements and Fair Values of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of December 31, 2011 and 2010 and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to December 31, 2011 and 2010 may be different than the amounts reported at each period end.
The fair value hierarchy prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
Level 1 | – | Quoted prices for identical instruments in active markets. |
Level 2 | – | Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are active, and model-derived valuations in which significant inputs or significant drivers are observable in active markets. |
Level 3 | – | Valuations derived from valuation techniques in which one or more significant inputs or significant drivers are unobservable. |
The majority of the Company’s securities are included in Level 2 of the fair value hierarchy. Fair values were determined by a third party pricing service using both quoted prices for similar assets, when available, and model-based valuation techniques that derive fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates. In some instances, the fair value of certain securities cannot be determined using these techniques due to the lack of relevant market data. As such, these securities are valued using an alternative technique and classified within Level 3 of the fair value hierarchy.
At December 31, 2011, Level 3 includes 10 securities totaling $1.5 million. This balance is comprised of seven odd-lot mortgage-backed securities at $32,000 and three corporate debt securities at $1.5 million, which are pooled trust preferred insurance company term obligations. The mortgage-backed securities, which were AAA rated at purchase, do not have an active market due to their size and nature and as such the Company has used an alternative method to determine the fair value of these securities. The fair value has been determined using a discounted cash flow model using market assumptions, which generally include cash flow, collateral and other market assumptions. The corporate debt securities, which were rated A at purchase and are currently rated below investment grade, could not be priced using quoted market prices, observable market activity or comparable trades, and the financial market was considered not active. The trust preferred market has been severely impacted by the lack of liquidity in the credit markets and concern over the financial services industry. Fair values for trust preferred securities were obtained from pricing sources with reasonable pricing transparency, taking into account other unobservable inputs related to the risks for each issuer. The pooled trust preferred corporate term obligations owned are collateralized by the trust preferred securities of insurance companies in the United States. There has been little or no active trading in these securities; therefore it was more appropriate to determine fair value using a discounted cash flow analysis. Determining the appropriate discount rate for the discounted cash flow analysis combined current and observable market spreads for comparable structured credit products with specific risks identified within each issue. The observable market spreads incorporated both credit and liquidity premiums.
F-44 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For financial assets measured at fair value on a recurring basis, the following tables set forth the fair value measurements by fair value hierarchy at the dates indicated (dollars in thousands).
December 31, 2011 | December 31, 2010 | |||||||
Significant other observable inputs (Level 2) | ||||||||
Government-sponsored enterprises | $ | 2,003 | $ | 7,614 | ||||
Municipal bonds | 7,125 | 4,296 | ||||||
Mortgage-backed | 17,512 | 33,951 | ||||||
REMICs | 24,318 | 31,565 | ||||||
Equities | 4 | 4 | ||||||
Total significant other observable inputs (Level 2) | 50,962 | 77,430 | ||||||
Significant unobservable inputs (Level 3) | ||||||||
Mortgage-backed | 32 | 38 | ||||||
Corporate debt | 1,454 | 1,240 | ||||||
Total significant unobservable inputs (Level 3) | 1,486 | 1,278 | ||||||
Total securities | $ | 52,448 | $ | 78,708 |
Significant | ||||||||
Unobservable Inputs | ||||||||
(Level 3) | ||||||||
December 31, 2009 | $ | 3,576 | ||||||
Total unrealized losses | (836 | ) | ||||||
Paydowns and maturities | (300 | ) | ||||||
Net transfers out of level 3 | (1,162 | ) | ||||||
December 31, 2010 | $ | 1,278 | ||||||
Total unrealized gains | 214 | |||||||
Paydowns and maturities | (6 | ) | ||||||
December 31, 2011 | $ | 1,486 | ||||||
December 31, 2011 | December 31, 2010 | |||||||
The amount of total unrealized gains (losses) for the year included in earnings (or changes in net assets) attributable to the change in unrealized gains (losses) relating to assets still held at year end | $ | 214 | $ | (836 | ) |
For financial assets measured at fair value on a nonrecurring basis, the following tables set forth the fair value measurements by fair value hierarchy (dollars in thousands):
Level 2 | December 31, 2011 | December 31, 2010 | ||||||
Impaired loans | $ | 3,369 | $ | 995 | ||||
Real estate owned | 544 | 426 |
F-45 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain impaired loans over $250,000 are individually reviewed to determine the amount of each loan that may be at risk of noncollection. When repayment is expected solely from the collateral, the impaired loans are reported at the fair value of the underlying collateral using Level 2 inputs based on property appraisals less any specific allowance. The fair value of real estate owned was estimated using Level 2 inputs based on property appraisals less any projected selling costs.
The following presents the fair value of financial instruments. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be sustained by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. In addition, the following information should not be interpreted as an estimate of the fair value of the Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2011 and 2010:
Cash and Cash Equivalents
The carrying amounts approximate the asset’s fair values.
Securities (Including Mortgage-Backed Securities)
The fair value of securities are determined by a third-party pricing service using both quoted prices for similar assets, when available, and model-based valuation techniques that derive fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates (Level 2). In some instances, the fair value of certain securities cannot be determined using these techniques due to the lack of relevant market data. As such, these securities are valued using an alternative technique and classified within Level 3 of the fair value hierarchy. Alternative techniques include using a discounted cash flow model using market assumptions, which generally include cash flow, collateral and other market assumptions or obtaining fair values from pricing sources with reasonable pricing transparency, taking into account other unobservable inputs related to the risks for each issuer.
Loans
The fair values for residential loans are estimated using discounted cash flow analyses using mortgage commitment rates from either FNMA or FHLMC. The fair values of consumer and commercial loans are estimated using discounted cash flow analyses, using interest rates reported in various government releases. The fair values of multi-family and nonresidential mortgages are estimated using discounted cash flow analysis, using interest rates based on national commitment rates on similar loans.
Federal Home Loan Bank Stock
The carrying amount approximates the asset’s fair value.
Accrued Interest Receivable and Accrued Interest Payable
The fair value of these instruments approximates the carrying value.
Deposits
The fair values disclosed for demand deposits (e.g., savings accounts) are, by definition, equal to the amount payable on demand at the repricing date (i.e., their carrying amounts). Fair values of certificates of deposits are estimated using a discounted cash flow calculation that applies the FHLB of Pittsburgh advance yield curve to the maturity schedule of the Bank’s certificates of deposit.
F-46 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Borrowings
The fair value of the FHLB advances and repurchase agreements are estimated using a discounted cash flow calculation using the current FHLB advance yield curve. This is the method that the FHLB of Pittsburgh used to determine the cost of terminating the borrowing contract. The FHLB of Pittsburgh issues a valuation report for convertible select advances.
Commitments to Extend Credit
These financial instruments are generally not subject to sale and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment, and the fair value determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure purposes. The contractual amounts of unfunded commitments are presented in Note 13 to these financial statements.
The following table sets forth the carrying amount and estimated fair value of financial instruments (dollars in thousands).
December 31, | 2011 | 2010 | ||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Amount | Fair Value | Amount | Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 14,571 | $ | 14,571 | $ | 9,320 | $ | 9,320 | ||||||||
Securities | 52,448 | 52,448 | 78,708 | 78,708 | ||||||||||||
Loans, net | 245,277 | 256,446 | 230,055 | 236,463 | ||||||||||||
FHLB stock | 5,340 | 5,340 | 6,556 | 6,556 | ||||||||||||
Accrued interest receivable | 1,244 | 1,244 | 1,365 | 1,365 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Deposits | 221,540 | 224,371 | 203,562 | 205,204 | ||||||||||||
Borrowings | 49,289 | 52,179 | 76,893 | 79,764 | ||||||||||||
Accrued interest payable | 430 | 430 | 598 | 598 |
F-47 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Condensed Financial Statements of Parent Company
Financial information pertaining only to FedFirst Financial Corporation (dollars in thousands).
Statements of Financial Condition
December 31, | 2011 | 2010 | ||||||
Assets: | ||||||||
Cash and cash equivalents | $ | 10,321 | $ | 10,924 | ||||
Investment in the Bank | 46,464 | 45,404 | ||||||
Loan receivable, ESOP | 1,623 | 1,780 | ||||||
Other assets | 379 | 587 | ||||||
Total assets | $ | 58,787 | $ | 58,695 | ||||
Liabilities and Stockholders’ Equity: | ||||||||
Accrued expenses | 26 | 192 | ||||||
Stockholders’ equity | 58,761 | 58,503 | ||||||
Total liabilities and stockholders’ equity | $ | 58,787 | $ | 58,695 |
Statements of Operations
Years ended December 31, | 2011 | 2010 | ||||||
Interest income | $ | 102 | $ | 111 | ||||
Operating income | 1 | 1 | ||||||
Operating expense | 278 | 200 | ||||||
Loss before undistributed net income of subsidiary and income tax benefit | (175 | ) | (88 | ) | ||||
Undistributed net income of subsidiary | 975 | 666 | ||||||
Income before income tax benefit | 800 | 578 | ||||||
Income tax benefit | (59 | ) | (30 | ) | ||||
Net income | $ | 859 | $ | 608 |
F-48 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Statements of Cash Flows
Years ended December 31, | 2011 | 2010 | ||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 859 | $ | 608 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Undistributed net income in subsidiary | (975 | ) | (666 | ) | ||||
Noncash expense for stock-based compensation | 214 | 293 | ||||||
Decrease (increase) in other assets | 200 | (233 | ) | |||||
(Decrease) increase in other liabilities | (166 | ) | 164 | |||||
Net cash provided by operating activities | 132 | 166 | ||||||
Cash flows from investing activities: | ||||||||
ESOP loan principal payments received | 157 | 148 | ||||||
Investment in First Federal Savings Bank | — | (7,700 | ) | |||||
Net cash provided by (used in) investing activities | 157 | (7,552 | ) | |||||
Cash flows from financing activities: | ||||||||
Purchase of common stock for stock award grants | (79 | ) | — | |||||
Purchase of common stock for retirement | (464 | ) | — | |||||
Purchases of common stock to be held in treasury | — | (16 | ) | |||||
Net stock offering proceeds | — | 15,355 | ||||||
Cash dividends paid | (349 | ) | (87 | ) | ||||
Net cash (used in) provided by financing activities | (892 | ) | 15,252 | |||||
Net (decrease) increase in cash and cash equivalents | (603 | ) | 7,866 | |||||
Cash and cash equivalents at beginning of year | 10,924 | 3,058 | ||||||
Cash and cash equivalents at end of year | $ | 10,321 | $ | 10,924 |
16. Segment and Related Information
The consolidated operating results of FedFirst Financial are presented as a single financial services segment. FedFirst Financial is the parent company of the Bank, which owns FFEC. FFEC has an 80% controlling interest in Exchange Underwriters. Exchange Underwriters is managed separately from the banking and related financial services that the Company offers. Exchange Underwriters is an independent insurance agency that offers property and casualty, commercial liability, surety and other insurance products.
Following is a table of selected financial data for the Company’s subsidiaries and consolidated results for 2011 and 2010 (dollars in thousands).
F-49 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
First Federal | Exchange | FedFirst | ||||||||||||||||||
Savings Bank | Underwriters, Inc. | Financial Corporation | Net Eliminations | Consolidated | ||||||||||||||||
December 31, 2011 | ||||||||||||||||||||
Assets | $ | 335,151 | $ | 1,041 | $ | 58,787 | $ | (59,705 | ) | $ | 335,274 | |||||||||
Liabilities | 288,645 | 506 | 26 | (12,704 | ) | 276,473 | ||||||||||||||
Stockholders’ equity | 46,506 | 535 | 58,761 | (47,001 | ) | 58,801 | ||||||||||||||
December 31, 2010 | ||||||||||||||||||||
Assets | $ | 343,469 | $ | 1,422 | $ | 58,695 | $ | (60,513 | ) | $ | 343,073 | |||||||||
Liabilities | 297,977 | 667 | 192 | (14,350 | ) | 284,486 | ||||||||||||||
Stockholders’ equity | 45,492 | 755 | 58,503 | (46,163 | ) | 58,587 | ||||||||||||||
Year Ended December 31, 2011 | ||||||||||||||||||||
Total interest income | $ | 15,529 | $ | 3 | $ | 102 | $ | (102 | ) | $ | 15,532 | |||||||||
Total interest expense | 5,022 | — | — | (102 | ) | 4,920 | ||||||||||||||
Net interest income | 10,507 | 3 | 102 | — | 10,612 | |||||||||||||||
Provision for loan losses | 850 | — | — | — | 850 | |||||||||||||||
Net interest income after provision for loan losses | 9,657 | 3 | 102 | — | 9,762 | |||||||||||||||
Noninterest income | 1,185 | 2,120 | 1 | — | 3,306 | |||||||||||||||
Noninterest expense | 9,505 | 1,982 | 278 | — | 11,765 | |||||||||||||||
Undistributed net income of subsidiary | 61 | — | 975 | (1,036 | ) | — | ||||||||||||||
Income before income tax expense (benefit) and noncontrolling interest in net income of consolidated subsidiary | 1,398 | 141 | 800 | (1,036 | ) | 1,303 | ||||||||||||||
Income tax expense (benefit) | 411 | 80 | (59 | ) | — | 432 | ||||||||||||||
Net income before noncontrolling interest in net income of consolidated subsidiary | 987 | 61 | 859 | (1,036 | ) | 871 | ||||||||||||||
Noncontrolling interest in net income of consolidated subsidiary | 12 | — | — | — | 12 | |||||||||||||||
Net income | $ | 975 | $ | 61 | 859 | $ | (1,036 | ) | $ | 859 | ||||||||||
Year Ended December 31, 2010 | ||||||||||||||||||||
Total interest income | $ | 16,786 | $ | 9 | $ | 111 | $ | (111 | ) | $ | 16,795 | |||||||||
Total interest expense | 6,845 | — | — | (111 | ) | 6,734 | ||||||||||||||
Net interest income | 9,941 | 9 | 111 | — | 10,061 | |||||||||||||||
Provision for loan losses | 850 | — | — | — | 850 | |||||||||||||||
Net interest income after provision for loan losses | 9,091 | 9 | 111 | — | 9,211 | |||||||||||||||
Noninterest income | 122 | 2,329 | 1 | — | 2,452 | |||||||||||||||
Noninterest expense | 8,586 | 1,827 | 200 | — | 10,613 | |||||||||||||||
Undistributed net income of subsidiary | 280 | — | 666 | (946 | ) | — | ||||||||||||||
Income before income tax expense (benefit) and noncontrolling interest in net income of consolidated subsidiary | 907 | 511 | 578 | (946 | ) | 1,050 | ||||||||||||||
Income tax expense (benefit) | 185 | 231 | (30 | ) | — | 386 | ||||||||||||||
Net income before noncontrolling interest in net income of consolidated subsidiary | 722 | 280 | 608 | (946 | ) | 664 | ||||||||||||||
Noncontrolling interest in net income of consolidated subsidiary | 56 | — | — | — | 56 | |||||||||||||||
Net income | $ | 666 | $ | 280 | 608 | $ | (946 | ) | $ | 608 |
F-50 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. Quarterly Financial Information (Unaudited)
The following table summarizes selected information regarding the Company’s results of operations for the periods indicated (dollars in thousands). Quarterly earnings (loss) per share data may vary from annual loss per share due to rounding.
March 31, | June 30, | September 30, | December 31, | |||||||||||||
Three Months Ended | 2011 | 2011 | 2011 | 2011 | ||||||||||||
Interest income | $ | 3,932 | $ | 3,913 | $ | 3,904 | $ | 3,783 | ||||||||
Interest expense | 1,332 | 1,268 | 1,199 | 1,121 | ||||||||||||
Net interest income | 2,600 | 2,645 | 2,705 | 2,662 | ||||||||||||
Provision for loan losses | 250 | 200 | 325 | 75 | ||||||||||||
Net interest income after provision for loan losses | 2,350 | 2,445 | 2,380 | 2,587 | ||||||||||||
Noninterest income | 834 | 756 | 727 | 989 | ||||||||||||
Noninterest expense | 2,737 | 2,807 | 2,689 | 3,532 | ||||||||||||
Income before income tax expense and noncontolling interest in net income (loss) of consolidated subsidiary | 447 | 394 | 418 | 44 | ||||||||||||
Income tax expense | 161 | 138 | 133 | — | ||||||||||||
Net income before noncontrolling interest in net income (loss) of consolidated subsidiary | 286 | 256 | 285 | 44 | ||||||||||||
Noncontrolling interest in net income (loss) of consolidated subsidiary | 18 | 10 | (5 | ) | (11 | ) | ||||||||||
Net income | $ | 268 | $ | 246 | $ | 290 | $ | 55 | ||||||||
Earnings per share basic and diluted | $ | 0.09 | $ | 0.08 | $ | 0.10 | $ | 0.02 | ||||||||
Dividends per share | 0.03 | 0.03 | 0.03 | 0.03 |
March 31, | June 30, | September 30, | December 31, | |||||||||||||
Three Months Ended | 2010 | 2010 | 2010 | 2010 | ||||||||||||
Interest income | $ | 4,364 | $ | 4,233 | $ | 4,178 | $ | 4,020 | ||||||||
Interest expense | 1,864 | 1,799 | 1,617 | 1,454 | ||||||||||||
Net interest income | 2,500 | 2,434 | 2,561 | 2,566 | ||||||||||||
Provision for loan losses | 200 | 200 | 200 | 250 | ||||||||||||
Net interest income after provision for loan losses | 2,300 | 2,234 | 2,361 | 2,316 | ||||||||||||
Noninterest income (loss) | 926 | 782 | 672 | 72 | ||||||||||||
Noninterest expense | 2,582 | 2,540 | 2,583 | 2,908 | ||||||||||||
Income (loss) before income tax expense (benefit) and noncontolling interest in net income of consolidated subsidiary | 644 | 476 | 450 | (520 | ) | |||||||||||
Income tax expense (benefit) | 237 | 168 | 152 | (171 | ) | |||||||||||
Net income (loss) before noncontrolling interest in net income of consolidated subsidiary | 407 | 308 | 298 | (349 | ) | |||||||||||
Noncontrolling interest in net income of consolidated subsidiary | 33 | 13 | 3 | 7 | ||||||||||||
Net income (loss) | $ | 374 | $ | 295 | $ | 295 | $ | (356 | ) | |||||||
Earnings per share basic and diluted | $ | 0.13 | $ | 0.10 | $ | 0.10 | $ | (0.12 | ) | |||||||
Dividends per share | N/A | N/A | N/A | 0.03 |
F-51