8 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2003 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: 0-23374 MFB CORP. (Exact name of registrant as specified in its charter) Indiana 35-1907258 ------- ---------- State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification Number) 121 South Church Street P.O. Box 528 Mishawaka, Indiana 46546 (Address of principal executive offices, including Zip Code) (574) 255-3146 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes X No ----- ----- (2) Yes X No ----- ----- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes ___ No X ------- The number of shares of the registrant's common stock, without par value, outstanding as of July 31, 2003 was 1,271,710. MFB CORP. AND SUBSIDIARIES FORM 10-Q INDEX Page No. Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets June 30 2003 (Unaudited) and September 30, 2002 3 Consolidated Statements of Income (Unaudited) Three and nine months ended June 30, 2003 and 2002 4 Condensed Consolidated Statements of Changes in Shareholders' Equity (Unaudited) Three and nine months ended June 30, 2003 and 2002 5 Consolidated Statements of Cash Flows (Unaudited) Nine months ended June 30, 2003 and 2002 6 Notes to (Unaudited) Consolidated Financial Statements June 30, 2003 7 Item 2. Management's Discussion and Analysis of Financial Condition And Results of Operations 13 Results of Operations 13 Balance Sheet Composition 15 Liquidity and Capital Resources 16 Critical Accounting Policies 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Item 4. Controls and Procedures 20 Part II. Other Information Items 1-6. 21 Signatures 22 Certifications 23 MFB CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, 2003 and September 30, 2002 (In thousands, except share information) (Unaudited) June 30, September 30, 2003 2002 ASSETS Cash and due from financial institutions $ 11,374 $ 13,647 Interest - bearing deposits in other financial institutions - short term 20,947 13,935 ----------------- ----------------- Total cash and cash equivalents 32,321 27,582 Securities available for sale 50,711 53,585 Interest-bearing time deposits in other financial institutions 1,000 500 Federal Home Loan Bank (FHLB) stock, at cost 6,391 6,308 Investment in limited partnership 2,603 2,713 Loans held for sale 1,586 6,404 Loans receivable 319,973 316,391 Less: allowance for loan losses (5,713) (5,143) ----------------- ----------------- Loan receivable, net 314,260 311,248 Accrued interest receivable 1,649 1,766 Premises and equipment, net 6,070 5,054 Mortgage servicing rights 907 1,617 Cash surrender value of life insurance 5,149 - Other assets 3,697 4,423 ----------------- ----------------- Total assets $ 426,344 $ 421,200 ================= ================= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Noninterest-bearing demand deposits $ 26,227 $ 20,270 Savings, NOW and MMDA deposits 101,841 86,559 Time deposits 156,569 157,548 ----------------- ----------------- Total deposits 284,637 264,377 FHLB advances 119,215 103,790 Loans from Correspondent Banks 300 - Advances from borrowers for taxes and insurance 661 1,414 Accrued expenses and other liabilities 4,211 2,242 ----------------- ----------------- Total liabilities 393,599 387,248 Shareholders' equity Common stock, no par value, 5,000,000 shares authorized; shares issued: 1,689,417-06/30/03 and 09/30/02; shares outstanding: 1,267,610-06/30/03 and 1,330,049-09/30/02 12,766 12,880 Retained earnings - substantially restricted 30,055 29,183 Accumulated other comprehensive income (loss), net of tax of $(133) -06/30/03 and $57 - 09/30/02 (764) (194) Treasury stock, 421,807common shares - 06/30/03; 359,368 common shares - 09/30/02, at cost (9,312) (7,917) ----------------- ----------------- Total shareholders' equity 32,745 33,952 ----------------- ----------------- Total Liabilities and Shareholders' equity $ 426,344 $ 421,200 ================= ================= MFB CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three and nine months ended June 30, 2003 and 2002 (in thousands except per share information) Three Months Ended Nine Months Ended June 30 June 30 2003 2002 2003 2002 Interest income Loans receivable, including fees Mortgage loans $ 2,212 $ 2,773 $ 7,045 $ 8,679 Consumer and other loans 434 481 1,378 1,511 Commercial loans 2,332 2,235 6,871 6,595 Securities - taxable 482 811 1,621 2,285 Other interest-bearing assets 127 65 278 354 Total interest income 5,587 6,365 17,193 19,424 Interest expense Deposits 1,442 1,607 4,444 5,292 FHLB advances 1,623 1,689 4,992 5,069 Securities sold under agreements to repurchase - 36 - 129 Total interest expense 3,065 3,332 9,436 10,490 Net interest income 2,522 3,033 7,757 8,934 Provision for loan losses 110 2,235 1,010 2,919 Net interest income after provision for loan losses 2,412 798 6,747 6,015 Noninterest income Service charges on deposit accounts 371 262 973 759 Trust fee income 132 53 358 168 Insurance commissions 46 47 130 116 Net realized gains from sales of loans 737 151 2,645 1,072 Loan servicing fees, net of amortization (320) 28 (697) (21) Mortgage Servicing impairment charge (704) - (704) - Gain (loss) on securities 0 (831) 40 (831) Other income 149 37 422 104 Total noninterest income 411 (253) 3,167 1,367 Noninterest expense Salaries and employee benefits 1,759 1,494 5,066 4,414 Occupancy and equipment 424 372 1,156 1,107 Data processing expense 127 172 488 500 Other expense 665 564 1,726 1,505 Total noninterest expense 2,975 2,602 8,436 7,526 Income (loss) before income taxes (152) (2,057) 1,478 (144) Income tax expense (benefit) (213) (860) 186 (217) Net income (loss) $ 61 $ (1,197) $ 1,292 $ 73 Basic earnings (loss) per common share $ .05 $ (0.90) $ 1.00 $ 0.05 Diluted earnings (loss) per common share $ .05 $ ( 0.90) $ .97 $ 0.05 See accompanying notes to (unaudited) consolidated financial statements MFB CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) Three and nine months ended June 30, 2003 and 2002 (In thousands) Three Months Ended Nine Months Ended June 30, June 30, 2003 2002 2003 2002 ---- ---- ---- ---- Balance at beginning of period $ 33,139 $ 34,618 $ 33,952 $ 34,380 Purchase of treasury stock - (250) (1,676) (431) Stock option exercise 10 - 167 115 Cash dividends declared (139) (140) (420) (415) Comprehensive income (loss): Net income (loss) 61 (1,197) 1,292 73 Net change in net unrealized gains and losses on securities available for sale, net of tax (326) 277 (570) (414) effects ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total comprehensive income (loss) (265) (920) 722 (341) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Balance at end of period $ 32,745 $ 33,308 $ 32,745 $ 33,308 =========== =========== =========== =========== See accompanying notes to (unaudited) consolidated financial statement MFB CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine months ended June 30, 2003 and 2002 (In Thousands) Nine Months Ended June 30, 2003 2002 ---- ---- Cash flows from operating activities Net income $ 1,292 $ 73 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization, net of accretion 937 857 Provision for loan losses 1,010 2,919 Net (gains) losses from sales or valuation of securities available for sale (40) 831 Net realized gains from sales of loans (2,645) (1,072) Amortization of mortgage servicing rights 999 225 Impairment of mortgage servicing rights 704 - Origination of loans held for sale (71,651) (47,680) Proceeds from sales of loans held for sale 87,778 49,845 Equity in loss of investment in limited partnership 111 129 Appreciation in cash surrender value of life insurance (149) - Net change in: Accrued interest receivable 117 (73) Other assets 946 (1,132) Accrued expenses and other liabilities 1,969 (76) ----------- ------------- Net cash from operating activities 21,378 4,846 Cash flows from investing activities Net change in interest-bearing time deposits in other financial institutions - 500 Net change in loans receivable (13,679) (8,681) Proceeds from: Principal payments of mortgage-backed and related securities 24,549 17,205 Sales, Maturities and calls of securities available for sale 4,160 22,309 Purchase of: Securities available for sale (27,152) (54,211) Life insurance (5,000) - FHLB stock (83) - Interest-bearing time deposits in other financial institutions (500) - Premises and equipment, net (1,356) (168) ----------- ------------- Net cash used in investing activities (19,061) (23,046) Cash flows from financing activities Purchase of MFB Corp common stock (1,676) (431) Net change in deposits 20,260 10,484 Net change in securities sold under agreement to repurchase - (2,241) Repayment of FHLB borrowings (15,425) (470) Proceeds from other borrowings 300 - Proceeds from exercise of stock options 136 90 Net change in advances from borrowers for taxes and insurance (753) (794) Cash dividends paid (420) (415) ----------- ------------- Net cash from financing activities 2,422 6,223 ----------- ------------- Net change in cash and cash equivalents 4,739 (11,977) Cash and cash equivalents at beginning of period 27,582 34,223 ----------- ------------- Cash and cash equivalents at end of period 32,321 $ 22,246 =========== ============= Supplemental disclosures of cash flow information Cash paid during the period for: Interest $7,639 $ 10,594 Income taxes 100 812 Supplemental schedule of noncash investing activities: Transfer from Loans receivable to loans held for sale $9,657 $ - MFB CORP. AND SUBSIDIARIES NOTES TO (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS June 30, 2003 NOTE 1 - BASIS OF PRESENTATION AND ACCOUNTING POLICIES Nature of Operations: MFB Corp. is an Indiana unitary savings and loan holding company organized in 1993, and parent company of its wholly owned federal savings bank subsidiary, MFB Financial (the "Bank"). MFB Corp. and the Bank (collectively referred to as the "Company") conduct business from their main office in Mishawaka, Indiana, and six branch locations in St. Joseph and Elkhart Counties of Indiana. The Bank offers a variety of lending, deposit, trust and other financial services to its retail and commercial customers. The Bank's wholly-owned subsidiary, Mishawaka Financial Services, Inc., offers general property, casualty and life insurance to customers in the Bank's market area. The Bank's wholly-owned subsidiaries, MFB Investments I, Inc., MFB Investments II, Inc. and MFB Investments, LP are Nevada corporations and a Nevada limited partnership that manage the Bank's investment portfolio. Basis of Presentation: The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of the financial statements. In the opinion of management, the consolidated financial statements contain all normal recurring adjustments necessary to present fairly the consolidated balance sheets of MFB Corp. and its subsidiary MFB Financial as of June 30, 2003 and September 30, 2002, the consolidated statements of income and the condensed consolidated statements of changes in shareholders' equity for the three and nine months ended June 30, 2003 and 2002 and the consolidated statements of cash flows for the nine months ended June 30, 2003 and 2002. All significant intercompany transactions and balances are eliminated in consolidation. Reclassifications: Some items in the prior consolidated financial statements have been reclassified to conform with the current presentation. (Continued) NOTE 2 - EARNINGS (LOSS) PER COMMON SHARE Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share shows the dilutive effect of additional potential common shares issuable under stock options. The computations of basic earnings (loss) per common share and diluted earnings (loss) per common share for the periods ended June 30, 2003 and 2002 are presented below. Three Months Ended Nine Months Ended June 30, June 30, 2003 2002 2003 2002 ---- ---- ---- ---- (in thousands except per share information) Basic Earnings (Loss) Per Common Share Numerator Net income (loss) $ 61 $(1,197) $ 1,292 $ 73 =========== =========== ========== ============ Denominator Weighted average common shares outstanding for basic earnings (loss) per common share 1,267 1,330 1,288 1,336 =========== =========== ========== ============ Basic Earnings (Loss) Per Common Share $ 0.05 $(0.90) $ 1.00 $ 0.05 =========== =========== ========== ============ Diluted Earnings (Loss) Per Common Share Numerator Net income (loss) $ 61 $(1,197) $ 1,292 $ 73 =========== =========== ========== ============ Denominator Weighted average common shares outstanding for basic earnings (loss) per common share 1,267 1,330 1,288 1,336 Add: Dilutive effects of assumed exercises of stock options 36 - 42 39 ----------- ----------- ---------- ------------ Weighed average common and dilutive potential common shares 1,303 1,330 1,330 1,375 outstanding =========== =========== ========== ============ Diluted Earnings (Loss) Per Common Share $ 0.05 $(0.90) $ 0.97 $ 0.05 =========== =========== ========== ============ Stock options for 42,500 and 51,750 common shares for the three and nine months ended June 30, 2003, respectively, and stock options for 193,650 and 64,667 common shares for the three and nine months ended June 30, 2002, respectively, were not considered in computing diluted earnings per common share because they were anti-dilutive. NOTE 3 - SECURITIES The amortized cost and fair value of securities available for sale are as follows: ............................June 30, 2003............................ ------------- (in thousands) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Debt securities U.S. Government and federal agencies $ 10,389 $ 258 $ - $ 10,647 Municipal bonds 347 23 - 370 Mortgage-backed 26,866 68 (257) 26,677 Corporate notes 9,768 245 (672) 9,341 ------------ -------------- ------------- -------------- 47,370 594 (929) 47,035 Marketable equity securities 4,237 - (561) 3,676 ------------ -------------- ------------- -------------- $ 51,607 $ 594 $ (1,490) $ 50,711 ============ ============== ============= ============== ..........................September 30, 2002......................... ------------------ (in thousands) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Debt securities U.S. Government and federal agencies $ 12,485 $ 329 $ - $ 12,814 Municipal bonds 349 19 - 368 Mortgage-backed 26,771 272 (6) 27,037 Corporate notes 9,880 138 (609) 9,409 ------------ -------------- ------------- -------------- 49,485 758 (615) 49,628 Marketable equity securities 4,237 - (280) 3,957 ------------ -------------- ------------- -------------- $ 53,722 $ 758 $ (895) $ 53,585 ============ ============== ============= ============== NOTE 4 - LOANS RECEIVABLE, NET Loans receivable at June 30, 2003 and September 30, 2002 are summarized as follows: June 30, September 30, 2003 2002 ----------------- ---------------- First mortgage loans (principally conventional) (in thousands) Principal balances Secured by one to four family residences $ 134,450 $ 146,942 Construction loans 20,654 15,863 Others 7,073 6,027 ----------------- ---------------- 162,177 168,832 Less un-disbursed portion of construction and other mortgage loans (18) (103) ----------------- ---------------- Total first mortgage loans 162,159 168,729 Commercial loans: Principal balances Commercial $ 51,592 $ 48,438 Commercial real estate 79,151 72,703 ----------------- ---------------- ----------------- ---------------- Total commercial loans 130,743 121,141 Consumer loans: Home equity and second mortgage $ 22,387 $ 21,150 Other 5,508 6,165 ----------------- ---------------- Total consumer loans 27,895 27,315 Net deferred loan origination fees (824) (794) ----------------- ---------------- Total loans receivable $ 319,973 $ 316,391 ================= ================ Activity in the allowance for loan losses is summarized as follows for the nine months ended June 30, 2003 and for the year ended September 30, 2002. June 30, September 30, 2003 2002 ---------------- ----------------- (in thousands) Balance at beginning of period $ 5,143 $ 4,632 Provision for loan losses 1,010 3,370 Charge-offs (442) (2,873) Recoveries 2 14 ---------------- ----------------- Balance at end of period $ 5,713 $ 5,143 ================ ================= NOTE 4 - LOANS RECEIVABLE, NET (continued) Quarter Ended Year Ended June 30, September 30, Impaired loans were as follows: 2003 2002 ------------------ ------------------ (in thousands) Quarter-ended and year-end balances with no allocated allowance for loan losses $ - $ - Quarter-ended and year-end loans with allocated allowances for loan losses 5,045 6,567 ------------------ ------------------ Total $ 5,045 $ 6,567 ================== ================== Amount of the allowance for loan losses allocated $ 1,907 $ 1,773 Average of impaired loans 4,904 8,070 Interest income recognized during impairment 22 227 Cash-basis interest income recognized during impairment 12 226 Non-performing loans were as follows: June 30, September 30, 2003 2002 ------------------ ------------------ (in thousands) Loans past due over 90 days still on accrual status $ - $ - Non-accrual loans 3,704 5,464 ------------------ ------------------ Total Non-performing loans $ 3,704 $ 5,464 ================== ================== NOTE 5 - STOCK BASED COMPENSATION The Board of Directors of the Company has adopted the MFB Corp. Stock Option Plans (the "Option Plans"). The number of options authorized under the Option Plans totals 450,000 shares of common stock. Officers, employees and outside directors of the Company and its subsidiary are eligible to participate in the Option Plans. The option exercise price must be no less than 85% of the fair market value of common stock on the date of the grant, and the option term cannot exceed ten years and one day from the date of the grant. As of June 30, 2003, all options granted have an exercise price of at least 100% of the market value of the common stock on the date of grant and no compensation expense was recognized for stock options during the nine months ended June 30, 2003 and 2002. Compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income (loss) and earnings (loss) per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation. Three Months Ending Nine Months Ended June 30, June 30, 2003 2002 2003 2002 ---- ---- ---- ---- Net income (loss) as reported $ 61 $ (1,197) $ 1,292 $ 73 Less: Stock-based compensation expense determined under fair value based method 54 35 161 134 ----------- ----------- ----------- ---------- Pro forma net income (loss) $ 7 $ (1,232) $ 1,131 $ (61) Basic earnings (loss) per share as reported $ .05 $ (.90) $ 1.00 $ .05 Pro forma basic earnings (loss) per share .01 (.92) .88 (.05) Diluted earnings (loss) per share as reported .05 (.90) .97 .05 Pro forma diluted earnings (loss) per share .01 (.92) .85 (.05) The weighted average fair value of stock options granted during the nine months ended June 30, 2003 and 2002 were $5.82 and $4.45. The fair value of options granted during the nine months ended June 30, 2003 and 2002 were estimated using an option pricing model with the following weighted average information as of the grant dates: June 30, 2003 2002 ---- ---- Risk free rate of interest 3.72% 4.83% Expected option life 8 years 8 years Expected dividend yield 1.82% 2.17% Expected volatility 23.23% 14.41% In future years, as additional options are granted, the proforma effect on net income and earnings per share may increase. Stock options are used to reward directors and certain executive officers and provide them with an additional equity interest. Options are issued for ten year periods and have varying vesting schedules. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL The principal business of MFB Financial has historically consisted of attracting deposits from the general public and the small business community and making loans secured by various types of collateral, including real estate and general business assets. The Bank is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions. Deposit flows are influenced by a number of factors, including interest rates paid on competing investments, account maturities, fee structures, and level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles. Sources of funds for lending activities of the Bank include deposits, borrowings, payments on loans and income provided from operations. The Company's earnings (losses) are primarily dependent upon the Bank's net interest income, the difference between interest income and interest expense. Interest income is a function of the balances of loans and investments outstanding during a given period and the yield earned on such loans and investments. Interest expense is a function of the amount of deposits and borrowings outstanding during the same period and interest rates paid on such deposits and borrowings. The Company's earnings (losses) are also affected by the Bank's provisions for loan losses, service charges, fee income, gains from sales of loans, valuation and fees related to mortgage loan servicing operations, income from subsidiaries activities, operating expenses and income taxes. RESULTS OF OPERATION COMPARISON OF THREE AND NINE MONTHS ENDED JUNE 30, 2003 AND 2002 The Company's consolidated net income for the three months ended June 30, 2003 was $61,000 or $0.05 diluted earnings per common share, compared to net loss of ($1,197,000) million or $(0.90) diluted loss per share, for the three months ended June 30, 2002. The Company's consolidated net income for the nine months ended June 30, 2003 was $1.29 million or $0.97 diluted earnings per share, compared to $73,000, or $0.05 diluted earnings per share, for the same period last year. The increase in net income over last year for both the three and nine months periods ending June 30, 2003 was primarily due to a significant reduction in the loan loss provision and increased non-interest income, offset by reduced net interest income and increased non-interest expense. Both the third quarters ending June 30, 2003 and 2002 had significant charges for declines in value of assets held as discussed below. Net interest income before provision for loan losses for the three month period ended June 30, 2003 totaled $2.52 million compared to $3.03 million for the same period one year ago. Total interest income for the third quarter decreased $778,000 while total interest expense decreased $267,000 from the third quarter last year as a result of greater sensitivity to interest rate declines of the Company's interest earning assets over its interest bearing liabilities. For the nine months ended June 30, 2003 net interest income declined from $8.93 million last year to $7.76 million this year. The provision for loan losses for the quarter ended June 30, 2003 was $110,000 compared to $2,235,000 for the same quarter last year. The provision for loan losses for the nine months ended June 30, 2003 was $1,010,000 compared to $2,919,000 for the same period last year. The significantly higher provision last year for the three and nine months ended June 30, 2002 was primarily due to a $750,000 charge on one specific commercial loan and a $770,000 charge to the loan loss provision as a result of increasing loss allocations on specific classified loans. The provision is based on the evaluation of many factors including current economic conditions, changes in the character, mix and size of the loan portfolio, current and past delinquency trends, adequacy of collateral on loans, historical and estimated net charge-offs and the current level of impaired loans and nonperforming loans. The Company's commercial loan portfolio has continued to grow as a percentage of total loans. Total non-interest income was $411,000 for the three months ended June 30, 2003 compared to ($253,000) for the three month period ending June 30, 2002. Net income for the third quarter this year was impacted by a $704,000 non-cash impairment charge related to the decline in the market value of servicing rights associated with MFB Financials $161 million mortgage loan servicing portfolio. Record low interest rate levels have significantly reduced the value of mortgage servicing portfolios throughout the mortgage banking industry. During the third quarter of last year, MFB Corp. recorded an $831,000 charge on the decline in value of a $1.0 million WorldCom, Inc. corporate investment. Other non-interest income (excluding gains and losses on securities and the mortgage servicing impairment charge) has nearly doubled from the third quarter last year to the third quarter this year, increasing from $578,000 to $1.12 million, and has increased from $2.20 million for the nine months ended June 30, 2002 to $3.83 million for the nine months ended June 30, 2003. Significant growth occurred in deposit fees, trust fees, gains on sales of mortgage loans and other fee income for both the three and nine month periods. Net gains on loan sales totaling $737,000 for the third quarter ended June 30, 2003 and $2.65 million for the nine month period this year were up significantly over the same periods last year. An increase in fixed rate mortgage origination volume and improved secondary market pricing contributed to the increase over last year. Non-interest expenses increased 14.3% from $2.60 million for the third quarter ended June 30, 2002 to $2.98 million this current quarter. For the nine months ended June 30, 2003 non-interest expense increased 12.1% from $7.53 million last year to $8.44 million this year. These increases were primarily due to increases in salaries and employee benefits and other expense. The significant growth in salaries and benefits is the result of staffing several key positions in the organization designed to position the bank for growth in the coming years. Other expense has increased over last year primarily due to increases in advertising, telephone, postage and real estate foreclosure expenses. Primarily as a result of increased taxable income, income tax expense increased for the three and nine months ended June 30, 2003, compared to the same periods ended June 30, 2002. BALANCE SHEET COMPOSITION COMPARISON OF JUNE 30, 2003 TO SEPTEMBER 30, 2002 The Company's total assets increased $5.1 million from $421.2 million as of September 30, 2002 to $426.3 million as of June 30, 2003. Cash and cash equivalents increased from $27.6 million at September 30, 2002 to $32.3 million at June 30, 2003. Net cash from operating activities amounted to $21.4 million, net cash from financing activities totaled $2.4 million and the net cash used in investing activities amounted to $19.1 during the nine months ended June 30, 2003. As of June 30, 2003, the total securities available for sale portfolio amounted to $50.7 million, a decrease of $2.9 million from $53.6 million at September 30, 2002. The securities portfolio activity during that period included security purchases of $27.2 million, security maturities and sales of $4.2 million, and principal payments on mortgage-backed and related securities of $24.5 million. As of June 30, 2003, loans receivable were $320.0 million, an increase of $3.6 million from $316.4 million at September 30, 2002. Commercial loans outstanding increased by $9.6 million from $121.1 million at September 30, 2002 to $130.7 million at June 30, 2003. Due to increased volume of mortgage loans sold into the secondary market, mortgage loans declined from $168.7 million at September 30, 2002 to $162.2 million at June 30, 2003. Consumer loans, including home equity and second mortgages, increased $580,000 during the nine month period. Loans held for sale at June 30, 2003 decreased to $1.6 million from $6.4 million at September 30, 2002. Diversification of the mix of loans on the balance sheet continues to be a focus to improve profit margins, control margin volatility and to appeal to a broader range of customers and potential customers. During the third quarter ended June 30, 2003, the Company completed secondary market mortgage loan sales totaling $22.6 million and the net gains realized on these loan sales were $737,000 including $283,000 related to recording mortgage loans servicing rights. During the third quarter ended June 30, 2002 mortgage loan sales of $8.6 million yielded net gains on loan sales of $151,000, including $107,000 related to recording mortgage loan servicing rights. The loans sold this year were primarily fixed rate mortgage loans with maturities of fifteen years or longer. The sale of loan production serves as a source of additional liquidity and management anticipates that the Company will continue to deliver fixed rate loans to the secondary market to meet consumer demand, manage interest rate risk, and diversify the asset mix of the Company. On a non-recurring basis, to meet liquidity needs that arise, the Company may sell certain adjustable rate loans from its portfolio. The allowance for loan losses increased from $5.1 million, or 1.63% of loans, at September 30, 2002 to $5.7 million or 1.79% of loans at June 30, 2003. The increasing percentage of commercial loans in the portfolio has contributed to the increase in the Company's allowance for loan losses. The allowance is maintained through the provision for loan losses, which is charged to earnings. During the nine month period ended June 30, 2003, $1,010,000 was added to the loan loss reserve through the loan loss provision and a total of $440,000 of net charge offs were recorded during the same period. The Company's non-performing assets have decreased from $5.95 million at September 30, 2002 to $4.24 million at June 30, 2003. The decrease was attributable to partial liquidations on non-accrual loans and sales of other real estate and non-performing securities. Impaired loans have decreased from $6.6 million at September 30, 2002 to $5.0 million at June 30, 2003. In management's opinion, the allowance for loan losses is adequate to cover probable incurred losses at June 30, 2003. Total liabilities increased from $387.2 million at September 30, 2002 to $393.6 million at June 30, 2003. Total deposits increased $20.2 million from $264.4 million at September 30, 2002 to $284.6 million at June 30, 2003.The increase consisted of a $15.3 million increase in Savings, Now and MMDA deposits, $5.9 million increase in non-interest bearing demand deposits and $1.0 million decrease in time deposits. FHLB advances decreased from $119.2 million at September 30, 2002 to $103.8 million at June 30, 2003. The $103.8 million of Federal Home Loan Bank advances have a weighted average interest rate of 5.46% and mature over the next nine years. One $15.0 million advance carrying a rate of 6.60% matured in June, 2003. A total of $5.8 million of the remaining advances mature in the next twelve months. Total shareholders' equity decreased from $34.0 million as of September 30, 2002 to $32.7 million as of June 30, 2003. Net income of $1.29 million was offset by a reduction in the market value of available for sale securities of $570,000 net of tax, cash dividend payments of $420,000 and the repurchase of 75,339 shares of outstanding common stock during this period at a cost of $1.68 million. MFB Corp's equity to assets ratio was 7.68% at June 30, 2003 compared to 8.06% at September 30, 2002. The book value of MFB Corp. stock increased from $25.53 at September 30, 2002 to $25.83 at June 30, 2003. LIQUIDITY AND CAPITAL RESOURCES Liquidity relates primarily to the Company's ability to fund loan demand, meet deposit customers' withdrawal requirements and provide for operating expenses. Assets used to satisfy these needs consist of cash, deposits with other financial institutions, overnight interest-bearing deposits in other financial institutions and securities available for sale. These assets are commonly referred to as liquid assets. Liquid assets were $84.0 million as of June 30, 2003 compared to $81.7 million as of September 30, 2002. This $2.3 increase was primarily due to an increase in short-term deposits with other financial institutions. The sale of fixed rate loan production has provided a source of additional liquidity. Management believes the liquidity level as of June 30, 2003 is sufficient to meet anticipated cash needs. Short-term borrowings or long-term debt, such as Federal Home Loan Bank advances, are used to compensate for reduction in other sources of funds such as deposits and to assist in asset/liability management. As of June 30, 2003, total FHLB borrowings amounted to $103.8 million and were originally used primarily to fund loan portfolio growth. The Bank had commitments to fund loan originations with borrowers totaling $110.7 million at June 30, 2003, including $75.7 million in available consumer and commercial lines and letters of credit. Certificates of deposit scheduled to mature in one year or less totaled $51.1 million. Based on historical experience, management believes that a significant portion of maturing deposits will remain with the Bank. The Bank anticipates that it will continue to have sufficient cash flow and other cash resources to meet current and anticipated loan funding commitments, deposit customer withdrawal requirements and operating expenses. The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. The prompt corrective action regulations provide five classifications, including well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The Bank's actual capital and required capital amounts and ratios at June 30, 2003 and September 30, 2002 are presented below: Actual Requirement for Capital Requirement to be Well Capitalized Under Prompt Corrective Adequacy Purposes Actual Provisions Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of June 30, 2003 Total capital (to risk weighted $ 35,568 12.24% $ 23,239 8.00% $ 29,048 10.00% assets) Tier 1 (core) capital (to risk weighted 32,263 11.11 11,619 4.00 17,429 6.00 assets) Tier 1 (core) capital (to adjusted total 32,263 7.58 17,029 4.00 21,287 5.00 assets) As of September 30, 2002 Total capital (to risk weighted $ 36,167 12.83% $ 22,553 8.00% $ 28,191 10.00% assets) Tier 1 (core) capital (to risk weighted 32,948 11.69 11,276 4.00 16,914 6.00 assets) Tier 1 (core) capital (to adjusted total 32,948 7.83 16,824 4.00 21,032 5.00 assets) As of June 30, 2003, management is not aware of any current recommendations by regulatory authorities which, if they were to be implemented, would have, or are reasonably likely to have, a material adverse effect on the Company's liquidity, capital resources or operations. The forgoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which involve a number of risks and uncertainties. A number of factors could cause results to differ materially from the objectives and estimates expressed in such forward-looking statements. These factors include, but are not limited to, changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, changes in the position of banking regulators on the adequacy of our allowance for loan losses and competition, changes in the value of the Company's mortgage servicing rights, all or some of which could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These factors should be considered in evaluating any forward-looking statements, and undue reliance should not be placed on such statements. MFB Corp. does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements. CRITICAL ACCOUNTING POLICIES Certain of the Company's accounting policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, determining the fair value of securities and other financial instruments and the valuation of mortgage servicing rights. The Company's critical accounting policies are discussed in detail in the Annual Report for the year ended September 30, 2002 (incorporated by reference as part of the Company's 10K filing) in Note 1 of the Notes to the Consolidated Financial Statements under "Securities," "Mortgage Banking Activities," and "Loans Receivable". If Management were to underestimate the allowance for loan losses, earnings could be reduced in the future as a result of greater than expected net loan losses. Overestimations of the required allowance could result in future increases in income, as loan loss recoveries increase or provisions for loan losses decrease. Fluctuations in the fair value of securities will affect the level of capital in the case of securities held for sale or earnings directly in the case of other securities. Fluctuations in the valuation of mortgage servicing rights as a result of market conditions or the level of interest rates will affect the carrying value of that asset on the balance sheet as well as the income recorded from loan servicing in the income statement. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits and Federal Home Loan Bank (FHLB) advances, reprice more rapidly, or at different rates than its interest-earning assets. A key element of the Company's asset/liability plan is to protect net earnings by managing the maturity or repricing mismatch between its interest-earning assets and rate-sensitive liabilities. The Company has sought to reduce exposure to its earnings by holding adjustable rate loans and selling fixed rate loans into the secondary market, and by extending funding maturities through the use of FHLB advances and longer term certificates of deposit. As part of its efforts to monitor and manage interest rate risk, the Company uses the Net Portfolio Value ("NPV") methodology adopted by the Office of Thrift Supervision (OTS) as part of its capital regulations. In essence, this approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance-sheet contracts. The difference as a percentage of the value of assets is the NPV ratio which was 5.41% as of March 31, 2003 (the most recently available data). Management and the Board of Directors review the OTS measurements on a quarterly basis to determine whether the Company's interest rate exposure is within the limits established by the Board of Directors in the Company's interest rate risk policy. The Company's asset/liability management strategy dictates acceptable limits on the amounts of change in NPV given certain changes in interest rates. The table presented here, as of March 31, 2003 (the most recently available data), is an analysis of the Company's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up 300 basis points and down 300 basis points. Due to the abnormally low interest rate environment prevailing at March 31, 2003, meaningful data was not available from the OTS model for the (-200) and (-300) basis point scenario and therefore is not included in the table below. (Dollars are in thousands) Interest Rate Net Portfolio Value NPV as % of Portfolio ------------------- Changes in Basis Value of Assets ------- --------------- Points NPV (Rate Shock) (1) $ Amount $ Change % Change Ratio Change (1) - ----------------------------- ----------------- ---------------- ------------- ------------- ----------------- +300 25,308 1,431 6% 5.95% 53 +200 26,109 2,232 9% 6.05% 64 +100 25,760 1,883 8% 5.90% 49 0 23,878 - - 5.41% - -100 20,516 (3,362) (14%) 4.61% (80) (1) Expressed in basis points As illustrated in the March 31, 2003 table, the Company's NPV will decline if rates fall, and the NPV would increase if rates were to rise. Specifically, the table indicates that at March 31, 2003, the Company's NPV was $23.9 million or 5.41% of the market value of portfolio assets. Based upon the assumptions utilized, an immediate 100 basis point increase in market interest rates would result in a $1.9 million or 8% increase in the Company's NPV and would result in a 49 basis point or 8% increase in the Company's NPV ratio to 5.90%. Conversely, an immediate 100 basis point decrease in market interest rates would result in a $3.4 million or 14% decrease in the Company's NPV, and a 80 basis point or 14% decrease in the Company's NPV ratio to 4.61%. In evaluating the Company's interest rate risk exposure to interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. 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 interest rates. Additionally, certain assets, such as adjustable rate mortgages (ARM'S), have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed above. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. In addition to monitoring selected measures on NPV, management also monitors effects on net interest income resulting from increases or decreases in rates. This process is used in conjunction with NPV measures to identify excessive interest rate risk. In managing its asset/liability mix, the Company, depending on the relationship between long and short term interest rates, market conditions and consumer preference, may place somewhat greater emphasis on maximizing its net interest margin than on strictly matching the interest rate sensitivity of its assets and liabilities. Management believes that the increased net income which may result from an acceptable mismatch in the actual maturity or repricing of its asset and liability portfolios can provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch. Management believes that the Company's level of interest rate risk is acceptable under this approach as well. The Board of Directors and management of the Company believe that certain factors afford the Company the ability to operate successfully despite its exposure to interest rate risk. The Company manages its interest rate risk by originating and selling the majority of its fixed rate one-to-four family real estate loans. While the Company generally originates adjustable rate mortgage loans for its own portfolio, fixed rate first mortgage loans may be retained in the portfolio from time to time. Loans classified as held for sale as of June 30, 2003 totaled $1.6 million compared to $6.4 million at September 30, 2002. The Company retains the servicing on the majority of loans sold in the secondary market and, at June 30, 2003, $161.3 million in such loans were being serviced for others. The Company's investment strategy is to maintain a diversified portfolio of high quality investments that minimize interest rate and credit risks while striving to maximize investment return and to provide liquidity necessary to meet funding needs. The Company's investment portfolio primarily consists of US government and federal agency obligations, mortgage-backed securities and corporate note obligations. The Company's policy dictates all securities must satisfy the investment grade requirements of the Office of Thrift Supervision at the time of purchase. The Company's cost of funds responds to changes in interest rates due to the relatively short-term nature of its deposit portfolio. The Company offers a range of maturities on its deposit products at competitive rates and monitors the maturities on an ongoing basis. Item 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures. The Company's chief executive officer and chief financial officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended), as of the end of the most recent fiscal quarter covered by this quarterly report (the "Evaluation Date"), have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and are designed to ensure that material information relating to the Company would be made known to such officers by others within the Company on a timely basis. (b) Changes in internal controls. There were no significant changes in the Company's internal control over financial reporting identified in connection with the Company's evaluation of controls that occurred during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION Item 1. Legal Proceedings. None Item 2. Changes in Securities and Use of Proceeds. None Item 3. Defaults Upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 31(1) Certification required by 17 C.F.R. ss. 240.13a-14(a). 31(2) Certification required by 17 C.F.R. ss. 240.13a-14(a). 32 Certification pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) MFB Corp. filed one Form 8-K report during the quarter ended June 30, 2003. Date of report: April 23, 2003 Items reported: News release dated April 23, 2003 regarding the announcement of second quarter earnings and announcement of a cash dividend payable on May 20, 2003 to holders of record on May 6, 2003. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MFB CORP. Date /s/ 08/05/03 By /s/ Charles J Viater --------- -------------------------------------------- Charles J. Viater President and Chief Executive Officer Date /s/ 08/05/03 By /s/ Thomas J Flournoy --------- ------------------------------------------- Thomas J. Flournoy Chief Financial Officer Exhibit 31 CERTIFICATION I, Charles J. Viater, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MFB Corp; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date:__/s/ 08/05/03__ /s/ Charles J Viater ----------------------------------- Charles J. Viater Chief Executive Officer Exhibit 31 CERTIFICATION I, Thomas J. Flournoy, certify that: 6. I have reviewed this quarterly report on Form 10-Q of MFB Corp; 7. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 8. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 9. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 10. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date:___/s/ 08/05/03__ /s/ Thomas J Flournoy ------------------------------------- Thomas J. Flournoy Chief Financial Officer Exhibit 32 CERTIFICATION By signing below, each of the undersigned officers hereby certifies pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his or her knowledge, (i) this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the information contained in this report fairly presents, in all material respects, the financial condition and results of operations of MFB Corp. Signed this 5th day of Auguts, 2003. Thomas J. Flournoy Charles J. Viater Chief Financial Officer Chief Executive Officer A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to MFB Corp. and will be retained by MFB Corp. and furnished to the Securities and Exchange Commission or its staff upon request.