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ANNUAL REPORT
TO SHAREHOLDERS
TABLE OF CONTENTS
Page
Letter to Shareholders .................................................... 1
Selected Consolidated Financial Data ...................................... 2
Management's Discussion and Analysis ...................................... 3
Report of Independent Registered Public Accounting Firm.................... 18
Consolidated Balance Sheets ............................................... 19
Consolidated Statements of Income ......................................... 20
Consolidated Statements of Shareholders' Equity ........................... 21
Consolidated Statements of Cash Flows ..................................... 23
Notes to Consolidated Financial Statements ................................ 25
Directors and Executive Officers .......................................... 59
Shareholder Information ................................................... 60
DESCRIPTION OF BUSINESS
MFB Corp. is an Indiana unitary savings and loan holding company organized in
1993, and parent company of its wholly-owned savings bank subsidiary, MFB
Financial (the "Bank"). MFB Corp. and the Bank (collectively referred to as the
"Company") conduct business from their corporate office located in Mishawaka,
Indiana and the Bank's twelve branch locations in St. Joseph, Elkhart, and
Hamilton Counties of Indiana. The Bank offers a variety of lending, deposit,
trust, investment, insurance, broker advisory, private banking, retirement plan
and other financial services to its retail and business customers. The Bank's
wholly-owned subsidiary, Mishawaka Financial Services, Inc., is engaged in the
sale of life and health 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 a portion of the Bank's investment portfolio. MFBC
Statutory Trust I is MFB Corp's wholly-owned trust preferred security
subsidiary.
1
MESSAGE TO OUR SHAREHOLDERS
On behalf of the Board of Directors, our management team and all the employees
of MFB Corp. (the "Company") and its subsidiary, MFB Financial, it is my
pleasure to provide you with our Annual Report for the fiscal year ended
September 30, 2006.
The changing interest rate environment and related economic slowdown that began
earlier this year certainly impacted our organization as it did much of our
industry. The aggressive tightening of monetary policy by the federal government
resulted in a dramatic rise in short term interest rates over a short period of
time. Although the Company benefited from increased rates of return on certain
assets, the increases in the cost of funding outweighed such benefits and
interest margins suffered. Our overall interest rate spread declined by 28 basis
points.
However, the slowing economy did offer some opportunity as well. Reduced loan
demand allowed us to utilize available cash to reduce high cost borrowings
during the year. As of September 30, 2006 our reliance on Federal Home Loan Bank
borrowings had been reduced to levels not seen since 1998.
During the first quarter of this fiscal year we made a substantial addition to
our loan loss reserve for one large credit facility. This decision created a
total reserve for this credit in an amount equal to the entire outstanding debt
to the Company. Nonetheless, we are diligently pursuing recovery through work
out activities and as of September 30, 2006 over $600,000 of such recoveries
have occurred. The ratio of non-performing loans to total loans at year end was
1.85%. When you segregate this single credit from total non-performing loans,
the ratio of non-performing loans to total loans at September 30, 2006 was 1.02%
compared to 0.36% one year earlier. Our commitment to improving asset quality
has never been greater.
We also took advantage of the opportunity to reduce future operating overhead
this past year by selling a 10,000 square foot branch bank facility and
constructing a more efficient facility on adjacent property. Although we
recorded a loss on the sale, the reduced operating expense of the new facility
is expected to result in a payback of less than three years.
We conducted a thorough review of our property and casualty insurance business
this past year as well. This evaluation resulted in the sale of this book of
business to a respected local insurance agency. Concurrently, we negotiated a
long term working relationship with that agency that will allow us to create a
new revenue stream without incurring the expenses associated with agency
operations.
Total assets at September 30, 2006 were $496.1 million, reflecting the reduction
of borrowed money and higher cost deposits. Our book value per common share
outstanding increased to $29.48 at year-end, up from $28.52 a year ago. In
October, 2006, the Company approved an increase in the quarterly dividend to
$0.165 per share, a 22% increase over the dividend paid in the prior quarter.
This increase reflects the Company's continued commitment to improve long term
value for our shareholders.
Charles J. Viater
President and Chief Executive Officer
MFB CORP. AND SUBSIDIARY
- -------------------------------------------------------------------------------
2
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of MFB Corp. and its
subsidiary is qualified in its entirety by, and should be read in conjunction
with the consolidated financial statements, including notes thereto, included
elsewhere in this Annual Report.
At September 30,
(In Thousands)
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Summary of Financial Condition:
Total assets $ 496,072 $ 554,877 $ 541,222 $ 428,624 $ 421,200
Loans receivable 379,222 390,695 399,925 318,155 316,391
Allowance for loan losses 7,230 6,388 6,074 5,198 5,143
Loans held for sale, net - 407 1,034 6,626 6,404
Cash and cash equivalents 16,289 54,209 28,595 40,357 27,582
Securities available for sale, including FHLB stock 67,371 72,563 74,820 46,499 59,892
Goodwill and other intangible assets 3,669 4,557 5,056 - -
Deposits 346,243 374,364 357,893 292,106 264,377
FHLB advances 97,053 125,854 133,443 98,790 119,215
Shareholders' equity 38,939 38,673 35,906 34,251 33,952
Years Ended September 30,
(In Thousands)
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Summary of Operating Results:
Interest income $ 28,607 $ 27,947 $ 22,792 $ 23,326 $ 26,188
Interest expense 15,145 13,277 11,089 12,244 13,829
----------- ----------- ----------- ----------- -----------
Net interest income 13,462 14,670 11,703 11,082 12,359
Provision for loan losses 1,032 723 800 1,110 3,369
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 12,430 13,947 10,903 9,972 8,990
Noninterest income
Service charges on deposit accounts 3,259 3,291 3,030 1,624 1,049
Trust fee income 414 385 495 464 298
Insurance commissions 151 211 208 187 158
Net realized gains from sales of loans 261 835 1,032 3,395 1,578
Mortgage servicing right recovery (impairment) 161 180 217 (576) -
Net gain (loss) on securities available for sale - (948) (109) 40 (934)
Gain on call of FHLB advance 238 - - - -
Gain on sale of property/casualty insurance 200 - - - -
Other income 1,650 1,034 807 (153) 20
----------- ----------- ----------- ------------ -----------
Total noninterest income 6,334 4,988 5,680 4,981 2,169
Noninterest expense
Salaries and employee benefits 7,923 7,519 7,021 6,803 5,922
Occupancy and equipment expense 3,377 3,063 2,743 1,558 1,483
Professional and consulting fees 432 712 1,226 364 297
Data processing expense 838 754 632 596 669
Loss on sales of fixed assets 229 9 46 3 -
Other expense 3,589 3,771 2,890 2,558 2,121
----------- ----------- ----------- ----------- -----------
Total noninterest expense 16,388 15,828 14,558 11,882 10,492
----------- ----------- ----------- ----------- -----------
Income before income taxes 2,376 3,107 2,025 3,071 667
Income tax expense 210 611 235 671 18
----------- ----------- ----------- ----------- -----------
Net income $ 2,166 $ 2,496 $ 1,790 $ 2,400 $ 649
=========== =========== =========== =========== ===========
Supplemental Data:
Basic earnings per common share $ 1.61 $ 1.85 $ 1.36 $ 1.87 $ 0.49
Diluted earnings per common share 1.56 1.81 1.30 1.80 0.47
Dividends declared per common share 0.530 0.495 0.470 0.435 0.415
Book value per common share 29.48 28.52 27.02 26.60 25.53
Return on assets 0.42% 0.47% 0.40% 0.56% 0.16%
Return on equity 5.69 6.82 5.05 7.14 1.84
Interest rate spread 2.51 2.79 2.53 2.41 2.73
Net yield on average interest-earning assets 2.79 2.97 2.81 2.73 3.08
Dividend pay-out ratio 32.92 26.73 34.56 23.26 84.69
Equity-to-assets 7.85 6.97 6.63 7.99 8.06
Non-performing assets to total loans 2.18 0.80 1.07 1.43 1.88
Allowance for loan losses to total loans 1.91 1.63 1.52 1.63 1.63
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The principal business of the Bank has historically consisted of attracting
deposits from the general public and the business community and making loans
secured by various types of collateral, including real estate and general
business assets. The Wealth Management Group of MFB attracts high new worth
clients and offers trust, investment, insurance, broker advisory, retirement
plan and private banking services. 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, sale of loans and income
provided from operations. The Company's earnings 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 are also affected by the Bank's
provisions for loan losses, mortgage servicing rights valuation adjustments,
service charges, fee income, gains from sales of loans, mortgage loan servicing
fees, income from subsidiary activities, operating expenses and income taxes.
The Company's operations are managed and financial performance is evaluated on a
company-wide basis and, accordingly, considered a single operating segment.
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 that could affect these judgments
include, but are not limited to; changes in interest rates, performance of the
economy or 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 available for sale and the valuation of
mortgage servicing rights.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan losses and decreased by charge-offs, less recoveries. Management estimates
the allowance for loan losses balance required by evaluating current economic
conditions, changes in character and size of the loan portfolio, delinquencies
and adequacy of loan collateral securing loan delinquencies, historical and
estimated charge offs and other pertinent information derived from a review of
the loan portfolio. Allocations to the allowance for loan losses may be made for
specific loans, but the entire allowance for loan losses is available for any
loan that, in management's judgment, should be charged-off. Loan losses are
charged against the allowance for loan losses when management believes the loan
balance is uncollectible.
A loan is impaired when the full payment of principal and interest is not
expected to be paid in accordance with the original terms of the loan.
Impairment is evaluated in total for small-balance loans of similar nature such
as residential mortgage and consumer loans, and on an individual loan basis for
commercial loans. If a loan is impaired, a portion of the allowance for loan
losses is allocated so that the loan is reported on a net basis at the present
value of estimated future cash flows using the loan's existing rate or at the
fair value of collateral if repayment is expected solely from the collateral.
Thus, changes in estimates of future cash flows or collateral values for
individual loans could significantly impact the allowance for loan losses and
provision expense.
Fair Value of Securities Available for Sale: Securities available for sale are
carried at fair value, with unrealized holding gains and losses reported
separately in accumulated other comprehensive income (loss), net of tax. The
Company obtains market values from a third party on a monthly basis in order to
adjust the securities to fair value. As a result of changes in the fair market
value of the Company's available for sale securities portfolio, other
comprehensive income (loss), net of tax, totaled ($31,000), $481,000 and
($326,000) for 2006, 2005, and 2004, respectively. Additionally, securities
available for sale are required to be written down to fair value when a decline
in fair value is not temporary; therefore, future changes in the fair value of
securities could have a significant impact on the Company's operating results.
In determining whether a market value decline is other than temporary,
management considers the reason for the decline, the extent of the decline and
the duration of the decline as well as the intent and ability of the company to
retain its investment for a period of time sufficient to allow for the
anticipated recovery in fair value.
Mortgage Servicing Rights: Servicing rights represent both purchased rights and
the allocated value of servicing rights retained on loans sold. Servicing rights
are expensed in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights,
determined using prices for similar assets with similar characteristics or
discounted cash flows using market based assumptions. Any impairment of a
grouping is reported as a valuation allowance. Changes in interest rates and the
level of refinance activity can have volatile effects on the carrying value of
servicing rights. The Company obtains an outside appraisal on a quarterly basis
from a national firm that specializes in mortgage servicing valuation. This
valuation is used to evaluate the Company's mortgage servicing rights asset for
impairment. At September 30, 2006 and 2005, mortgage servicing rights had a
carrying value of $2.4 million and $2.3 million.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 2006 AND 2005
RESULTS OF OPERATIONS
Consolidated net income for the Company for the year ended September 30, 2006
was $2.2 million or $1.56 diluted net income per common share compared to $2.5
million or $1.81 diluted net income per common share for the same period in
2005. The decrease in net income was primarily attributable to a decrease in net
interest income and an increase in noninterest expense offset by an increase in
noninterest income.
Net interest income totaled $13.5 million for the year ended September 30, 2006
compared to $14.7 million for the same period one year ago. Interest income
increased $660,000 and interest expense increased $1.9 million during the year
ended September 30, 2006 compared to the same period in 2005. Interest rates
continued to increase during fiscal year 2006 and this was reflected in the
Company's yield earned on interest-bearing assets which increased 26 basis
points from the prior year of 5.67% to 5.93% in 2006. The average interest rate
paid on interest-bearing liabilities, however, increased 54 basis points from
2.88% to 3.42% during the same period, due largely to increases in the cost of
deposits, as rates on various savings accounts increased from record lows. As a
result, the interest rate spread decreased 28 basis points from 2.79% in 2005 to
2.51% in 2006.
The provision for loan losses is determined in conjunction with management's
review and evaluation of current economic conditions, changes in the character
and size of the loan portfolio, loan delinquencies (current status as well as
past trends), adequacy of collateral securing impaired and delinquent loans,
historical and estimated net charge-offs and other pertinent information. Based
on the factors above, the provision for loan losses increased from $723,000 for
the year ended September 30, 2005 to $1.0 million for the year ended September
30, 2006. The provision for loan losses for the year ending September 30, 2006
was primarily related to one impaired commercial loan discussed further in Note
4 to the consolidated financial statements. Specific reserves on commercial
loans increased $1.5 million from 2005 to 2006 and were offset by a decrease in
general reserves on commercial loans of $690,000 due to a reduction in overall
commercial loan balances. Net charge-offs totaled $409,000 and $190,000 for the
years ended September 30, 2005 and 2006 respectively. The Bank continues to
enhance its loan review and risk assessment procedures giving particular
attention to the risks related to the commercial loan portfolio and the risk of
loss for the $6.9 million of commercial loans classified as impaired at the end
of this year. Impaired loans decreased from $8.7 million last year predominantly
due to the payments received on an outstanding debt from one loan relationship
referred to above and discussed in Note 4 to the consolidated financial
statements and the improved financial condition of another commercial customer.
Management of the Bank is continually monitoring these impaired loans for any
changes necessary in the provision for loan losses.
Noninterest income increased from $5.0 million for the twelve months ended
September 30, 2005 to $6.3 million for the same period ended September 30, 2006.
A large part of the increase was the result of a write down of equity securities
held by MFB Corp of $948,000 ($626,000 net of tax) in fiscal year 2005,
discussed further in Note 3 of the consolidated financial statements. The
Company had no losses on securities in fiscal year 2006. In addition, lease
rental income from space in the Company's corporate headquarters increased by
$443,000 over fiscal 2005 as additional tenants occupied the building during
2006 as discussed further during discussion of premises and equipment in the
balance sheet composition section. Two nonrecurring items affected noninterest
income during 2006, a gain of $238,000 related to a called FHLB advance and a
gain of $200,000 from a sale of the Company's Insurance subsidiary property and
casualty line.
Noninterest expense increased from $15.8 million for the twelve months ended
September 30, 2005 to $16.4 million for the same period ending September 30,
2006. The largest increase was for salaries and employee benefits, which
increased $404,000. Occupancy and equipment expenses increased $313,000; loss on
sale of fixed assets increased $221,000 primarily due to a $189,000 loss on the
sale of a branch building as discussed further in Note 5 of the consolidated
financial statements; and other expenses decreased $182,000 from 2005 to 2006.
Income tax expense decreased from $611,000 last year to $210,000 this year
primarily due to decreased income before tax. Federal income tax expense
decreased from $511,000 to $264,000 and state income tax expense (benefit)
decreased from $100,000 to ($54,000). The overall effective income tax expense
rate decreased from 19.7% last year to 8.8% this year primarily due to
maintaining a comparable level of low income housing income tax credits and
non-taxable income on a decreased amount of taxable income.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 2005 AND 2004
RESULTS OF OPERATIONS
Consolidated net income for the Company for the year ended September 30, 2005
was $2.5 million or $1.81 diluted net income per common share compared to $1.8
million or $1.30 diluted net income per common share for the same period in
2004. The increase in net income was primarily attributable to an increase in
net interest income partially offset by a decrease in noninterest income and an
increase in noninterest expense.
Net interest income totaled $14.7 million for the year ended September 30, 2005
compared to $11.7 million for fiscal year 2004. Interest income increased $5.2
million and interest expense increased $2.2 million during the year ended
September 30, 2005 compared to the prior fiscal year. Record low interest rates
began to increase during mid-2004, and this was reflected in the Company's yield
earned on interest-bearing assets compared to the prior year due to upward
repricing of these instruments. The yield on interest-earning assets increased
20 basis points from 5.47% in 2004 to 5.67% in 2005. The average interest rate
paid on interest-bearing liabilities, however, decreased six basis points from
2.94% to 2.88% during the same period, due mostly to a significant decrease in
the cost of the Company's borrowings from the FHLB. As a result, the interest
rate spread increased 26 basis points from 2.53% to 2.79% in 2005.
The provision for loan losses is determined in conjunction with management's
review and evaluation of current economic conditions, changes in the character
and size of the loan portfolio, loan delinquencies (current status as well as
past trends), adequacy of collateral securing impaired and delinquent loans,
historical and estimated net charge-offs and other pertinent information. Based
on the factors above, the provision for loan losses decreased from $800,000 for
the year ended September 30, 2004 to $723,000 for the year ended September 30,
2005. Net charge-offs totaled $526,000 and $409,000 for the years ended
September 30, 2004 and 2005 respectively. The Bank continues to enhance its loan
review and risk assessment procedures giving particular attention to the risks
related to the increasing commercial loan portfolio and the risk of loss for the
$8.7 million of commercial loans classified as impaired at the end of 2005.
Impaired loans increased from $2.2 million at September 30, 2004 in part due to
the inclusion of two commercial loans with a deterioration of credit quality
which is discussed further in the Balance Sheet comparison. Management of the
Bank is continually monitoring these impaired loans for any changes necessary in
the provision for loan losses.
Noninterest income decreased from $5.7 million for the twelve months ended
September 30, 2004 to $5.0 million for the same period ended September 30, 2005.
The decrease was predominantly the result of a write down of equity securities
held by MFB Corp of $948,000 ($626,000 net of tax) discussed further in Note 3
of the consolidated financial statements. The Company had losses on securities
of $109,000 in fiscal year 2004. Most other categories of noninterest income did
not change significantly; deposit account fees increased $261,000 and net gain
on loan sales decreased $197,000 during 2005.
Noninterest expense increased from $14.6 million for the twelve months ended
September 30, 2005 to $15.8 million for the twelve month period ending September
30, 2004. The largest increase was for salaries and employee benefits, which
increased $498,000. Occupancy and equipment expenses increased $321,000, of
which $276,000 was related to the full year of operation of three branches
acquired late in fiscal year 2004. Other expenses increased $438,000 primarily
due to $462,000 increase in amortization of intangible assets recorded in the
acquisition of Sobieski Bank in late 2004. Consulting fees, which we had
expected to rise with the implementation of Sarbanes/Oxley Section 404
regulations, actually decreased $198,000 as the Securities and Exchange
Commission delayed the implementation of 404 regulations for non-accelerated
filers.
Income tax expense increased from $235,000 last year to $611,000 this year
primarily due to increased income before tax. Federal income tax expense
increased from $229,000 to $511,000 and state income tax expense increased from
$6,000 to $100,000. The overall effective income tax expense rate increased from
11.6% in 2004 to 19.7% in 2005 primarily due to maintaining a comparable level
of low income housing income tax credits and non-taxable income on an increased
amount of taxable income.
BALANCE SHEET COMPOSITION
Cash and cash equivalents decreased $37.9 million from $54.2 million as of
September 30, 2005 to $16.3 million as of September 30, 2006. Net cash from
operating activities was $2.5 million in 2006 compared to $9.6 million net cash
provided in 2005. The net cash provided from investing activities increased from
$2.2 million in 2005 to $19.5 million in 2006. The net cash from financing
activities decreased from a source of funds of $13.8 million in 2005 to a use of
$59.9 million in 2006. Cash decreased primarily from the net repayment of FHLB
borrowings of $28.1 million, and a decline in deposits, predominantly high cost
deposits, of $28.0 million offset by a decrease in the loans receivable of $13.4
million.
As of September 30, 2006, the securities available for sale portfolio was $58.4
million, a decline of $5.2 million from $63.6 million at September 30, 2005.
Securities portfolio activity included purchases of $15.0 million, maturities of
$8.5 million and principal payments on mortgage-backed and related securities of
$11.5 million.
As of September 30, 2006, loans receivable were $379.2 million, a decrease of
$11.5 million from $390.7 million as of September 30, 2005. Residential mortgage
loans increased $7.2 million from $192.0 million at September 30, 2005 to $199.2
million at September 30, 2006, offset by commercial loans outstanding decreasing
by $23.4 million from $157.8 million at September 30, 2005 to $134.4 million at
September 30, 2006. Consumer loan receivables, which include home equity term
loans and lines of credit, increased $4.7 million to $45.6 million.
Diversification of the asset mix in the balance sheet will continue to be a
focus to improve profit margins, control margin volatility and to appeal to a
broader range of customers and potential customers. The Company continues to
build on its reputation as a quality local lender satisfying the market's desire
for local service and local decision making.
During the year ended September 30, 2006, the Company completed secondary market
mortgage loan sales totaling $12.1 million, and the net gains realized on these
loan sales were $261,000, including $150,000 related to recording mortgage loan
servicing rights. Loan sales in 2005 were $38.5 million, and the net gains
realized on these loans sales were $835,000, including $464,000 related to
recording mortgage loan servicing rights. The loans sold during the year ended
September 30, 2006 were primarily fixed rate mortgage loans with maturities of
fifteen years or longer. The sale of mortgage loans 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.
Adjustable rate loans often provide rates of return that are generally superior
to other investments that carry similar terms to repricing. The Company
anticipates these loans will continue to be originated and retained in the
Bank's portfolio. Also, as part of its efforts to manage the Company's current
interest rate risk position, the Company originated and held in its portfolio
$15.3 million of fixed rate mortgage loans originated during 2006, with a
weighted average interest rate of 6.70%. At September 30, 2006, no loans were
classified as loans held for sale compared to $407,000 at September 30, 2005.
Mortgage loans serviced for others by the Company declined from $208.9 million
last fiscal year to $196.0 million at the end of this fiscal year.
The Company's allowance for loan losses at September 30, 2006 was $7.2 million
or 1.91% of loans, comparable to the $6.4 million or 1.63% of loans at the end
of last year. The ratio of non-performing loans to loans was 0.36% at September
30, 2005 compared to 1.85% at September 30, 2006. Based on the evaluation of
many factors including current economic conditions, changes in the character and
size of the loan portfolio, current and past delinquency trends and historical
and estimated net charge-offs, the Company provided $1.0 million to its
allowance for loan losses during the year ended September 30, 2006 compared to
$723,000 for the prior year ended September 30, 2005. As discussed further in
Note 4, management's increased attention to and the Company's subsequent
increase in non-performing loans was offset by a decrease in commercial impaired
loans. During the year ended September 30, 2006 management noted several
commercial loans with improved credit performance which was offset by two
commercial loans with a deterioration of credit quality. Net charge offs
deducted from the allowance for loan losses was $190,000 for the year ended
September 30, 2006 compared to $409,000 for the prior year. In management's
opinion, the Company's allowance for loan losses at September 30, 2006 and loan
loss provision for the year is appropriate for the loan portfolio.
Premises and equipment decreased from $20.3 million at September 30, 2005 to
$19.5 million at September 30, 2006 due to the sale of a branch building sold in
June 2006, offset by the remodeling of the corporate headquarters for new
tenants. The corporate headquarters consists of approximately 114,300 square
feet with approximately 44% of the space utilized by the Company. At September
30, 2006, tenants occupied approximately 47,000 square feet of rentable space
under leases with various terms that extend 15 years. Another tenant has
executed a lease to occupy approximately 4,100 square feet which will commence
in January 2007. At September 30, 2006 the Company had leased (including the
4,100 square feet) approximately 81% of available lease space. In June 2006, a
new branch building was constructed to create a more efficient and cost
effective financial center as discussed further in Note 5 to the consolidated
financial statements.
Goodwill and other intangible assets totaling $5.2 million were recorded at the
acquisition date as a result of the purchase of certain assets and liabilities
of Sobieski Bank in August 2004 (discussed further in Note 16). These
intangibles represent the difference between the purchase price and the value of
the tangible assets purchased and the value of the liabilities assumed. At
September 30, 2006 the balance of goodwill was $2.0 million and the balance of
the other intangible assets was $1.7 million. The Company assesses goodwill for
impairment at least annually and determined there was no impairment as of
September 30, 2006. The other intangible assets included the identified value of
the core deposits acquired and the value of customer relationships obtained in
the acquisition. These two intangible assets are amortized to expense over a ten
year period with approximately eight years remaining.
Total deposits decreased by $28.0 million to $346.2 million as of September 30,
2006 from $374.4 million as of September 30, 2005 in part due to the reduction
of high cost deposit products. Deposits consisting of demand, NOW, savings and
MMDA accounts decreased from $190.7 million to $159.3 million from September 30,
2005 to September 30, 2006. Federal Home Loan Bank ("FHLB") advances decreased
from $125.9 million as of September 30, 2005 to $97.1 million as of September
30, 2006.
Total shareholders' equity increased from $38.7 million as of September 30, 2005
to $38.9 million as of September 30, 2006. The increases to equity resulted from
net income of $2.2 million and $218,000 generated from the exercise of stock
options, offset by $1.5 million in purchases of treasury stock and cash dividend
payments of $713,000. The book value of MFB Corp. common stock, based on the
actual number of shares outstanding, increased from $28.52 at September 30, 2005
to $29.48 at September 30, 2006.
ASSET/LIABILITY MANAGEMENT
The Company is subject to interest rate risk to the extent 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. Historically, the Company has sought to
reduce exposure to its earnings through the use of adjustable rate loans and
through the sale of fixed rate loans in the secondary market, and by extending
funding maturities through the use of FHLB advances.
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 is the NPV which was
11.14% as of September 30, 2006, an increase from 10.60% at September 30, 2005.
The increase is primarily the result of the change in the mix of mortgage loans,
cash, deposits, and FHLB advances. As referenced above in the Balance Sheet
Composition section, a decrease in cash, investment securities, and commercial
loans was offset in part with an increase in mortgage loans and corresponds to a
decrease in both FHLB advances and savings, NOW and MMDA deposits. 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 tables
presented here, as of September 30, 2006 and 2005, are 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 200 basis.
As illustrated in the September 30, 2006 table below, the Company's interest
rate risk is sensitive to rising rates and positively impacted by declining
rates. The decline in NPV with a rate increase is due to the relative volume of
mortgage assets with fixed rate characteristics over the volume of liabilities
with fixed rate characteristics.
September 30, 2006
Change in (Dollars in Thousands)
Interest Rates NPV as % of Portfolio
In Basis Net Portfolio Value Value of Assets
--------------------------------------------------------------
Points NPV
(Rate Shock) (1) $ Amount $ Change % Change Ratio Change (1)
- ----------- --- -------- -------- -------- ----- ---------
+300 $ 39,710 $(16,488) (29%) 8.24% (291) bp
+200 45,865 (10,333) (18) 9.36 (178) bp
+100 51,391 (4,807) (9) 10.33 (81) bp
0 56,198 11.14 -
(100) 58,682 2,484 4 11.51 37 bp
(200) 59,723 3,524 6 11.62 48 bp
(1) Expressed in basis points
Specifically, the September 30, 2006 table indicates that the Company's NPV was
$56.2 million or 11.14% of the market value of portfolio assets. Based upon the
assumptions utilized, an immediate 200 basis point increase in market interest
rates would result in a $10.3 million or 18% decrease in the Company's NPV and
would result in a 178 basis point decrease in the Company's NPV ratio to 9.36%.
Also, an immediate 200 basis point decrease in market interest rates would
result in a $3.5 million or 6% increase in the Company's NPV, and a 48 basis
point increase in the Company's NPV ratio to 11.62%.
As illustrated in the September 30, 2005 table below, the Company's interest
rate risk was sensitive to both rising and declining rates. The decline in NPV
with a rate reduction was due to the change in value of fixed rate Federal Home
Loan Bank borrowings that would occur. The decline in NPV with a rate increase
was due to the relative volume of mortgage assets with fixed rate
characteristics over the volume of liabilities with fixed rate characteristics.
September 30, 2005
Change in (Dollars in Thousands)
Interest Rates NPV as % of Portfolio
In Basis Net Portfolio Value Value of Assets
------------------------------------ --------------------
Points NPV
(Rate Shock) (1) $ Amount $ Change % Change Ratio Change (1)
- ----------- --- -------- -------- -------- ----- ---------
+300 $ 46,693 $(13,763) (23)% 8.56% (204) bp
+200 52,340 (8,115) (13) 9.44 (116) bp
+100 57,091 (3,365) (6) 10.15 (45) bp
0 60,456 - - 10.60 -
(100) 60,147 (309) (1) 10.45 (14) bp
(200) 57,553 (2,902) (5) 9.95 (65) bp
(1) Expressed in basis points
Specifically, the September 30, 2005 table indicates that the Company's NPV was
$60.5 million or 10.60% of the market value of portfolio assets. Based upon the
assumptions utilized, an immediate 200 basis point increase in market interest
rates would result in a $8.1 million or 13% decrease in the Company's NPV and
would result in a 116 basis point decrease in the Company's NPV ratio to 9.44%.
Also, an immediate 200 basis point decrease in market interest rates would
result in a $2.9 million or 5% decrease in the Company's NPV, and a 65 basis
point decrease in the Company's NPV ratio to 9.95%.
In addition to monitoring selected measures of 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, during periods
of declining or stable interest rates, 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.
In evaluating the Company's exposure to interest rate movements, certain
shortcomings inherent in the method of analysis presented in the foregoing
tables must be considered. For example, although certain assets and liabilities
may have similar maturities or repricing periods, 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.
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. Typically, the Company manages its interest rate
risk by originating and retaining adjustable rate residential mortgage loans for
its portfolio and selling currently originated fixed rate loans. There were no
loans classified as held for sale as of September 30, 2006 due to the Company's
strategy to portfolio fixed rate loans under the current rate environment. The
Company retains the servicing on loans sold in the secondary market and, at
September 30, 2006, $196.0 million of such loans were being serviced for others.
To further manage this risk, the Company's commercial loan portfolio consists
predominantly of adjustable rate loans and fixed rate loans that reprice in five
years or less.
The Company's investment strategy is to maintain a diversified portfolio of high
quality investments that balances the goals of minimizing interest rate and
credit risks while striving to maximize investment return and provide liquidity
necessary to meet funding needs.
The Company offers a range of maturities on its deposit products at competitive
rates and monitors the maturities on an ongoing basis. The Company's cost of
interest-bearing funds has increased from 2.88% for the year ended September 30,
2005 to 3.42% for the year ended September 30, 2006. The Company has also
experienced an increase in the percentage of low interest cost demand and
savings deposits to total interest-bearing liabilities and a reduction of other
borrowings and FHLB advances which reduces its sensitivity to an increase in
rates.
AVERAGE BALANCE SHEETS
The following are the average balance sheets for the years ended September 30:
2006 2005 2004
Average Average Average
Outstanding Outstanding Outstanding
Balance Balance Balance
(In Thousands)
Assets:
Interest earning assets:
Interest-bearing deposits $ 26,337 $ 22,157 $ 21,210
Mortgage-backed securities (1) 37,554 39,021 18,741
Other securities available for sale (1) 28,436 22,429 24,235
FHLB stock 8,809 8,952 6,932
Loans held for sale 802 1,105 1,287
Loans receivable (2) 379,568 399,469 343,545
------------ ------------ ------------
Total interest-earning assets 481,506 493,133 415,950
Noninterest-earning assets, net
of allowance for loan losses 38,734 39,057 29,116
------------ ------------ ------------
Total assets $ 520,240 $ 532,190 $ 445,066
============ ============ ============
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Savings accounts $ 58,887 $ 47,071 $ 35,309
NOW and money market accounts 77,428 89,443 79,500
Certificates of deposit 186,109 185,268 156,961
Subordinated debentures 5,000 875 -
Other borrowings 6,330 6,500 1,078
FHLB advances 108,815 131,101 104,801
------------ ------------ ------------
Total interest-bearing liabilities 442,569 460,258 377,649
Other liabilities 39,634 35,345 31,974
------------ ------------ ------------
Total liabilities 482,203 495,603 409,623
Shareholders' equity:
Common stock 11,731 12,413 12,393
Retained earnings 34,629 32,222 32,120
Net unrealized gain (loss) on
securities available for sale (506) (418) (812)
Treasury stock (7,817) (7,630) (8,258)
------------- ------------ ------------
Total shareholders' equity 38,037 36,587 35,443
------------ ------------ ------------
Total liabilities and
shareholders' equity $ 520,240 $ 532,190 $ 445,066
============ ============ ============
(1) Average outstanding balances reflect unrealized gain (loss) on securities
available for sale. (2) Total loans less deferred net loan fees and loans in
process and including non accrual loans.
INTEREST RATE SPREAD
The following table sets forth the average effective interest rate earned by the
Company on its consolidated loan and investment portfolios, the average
effective cost of the Company's consolidated deposits and FHLB borrowings, the
interest rate spread of the Company, and the net yield on average
interest-earning assets for the periods presented. Average balances are based on
daily average balances.
Year ended September 30,
2006 2005 2004
---- ---- ----
Average interest rate earned on:
Interest-bearing deposits 3.31% 1.82% 0.82%
Mortgage-backed securities (1) 4.28 3.89 3.21
Other securities available for sale (1) 4.21 3.26 3.08
FHLB stock 4.79 4.30 4.63
Loans held for sale 6.43 6.22 6.07
Loans receivable (2) 6.43 6.22 6.07
Total interest-earning assets 5.93 5.67 5.47
Average interest rate of:
Savings accounts 1.79 0.89 0.62
NOW and money market accounts 1.65 1.01 0.72
Certificates of deposit 3.60 2.87 2.94
Subordinated debentures 6.22 6.02 -
FHLB advances 4.98 4.81 5.38
Other borrowings 6.31 4.38 3.52
Total interest-bearing liabilities 3.42 2.88 2.94
Interest rate spread (3) 2.51 2.79 2.53
Net yield on interest-earning assets (4) 2.79 2.97 2.81
(1) Yield is based on amortized cost without adjustment for unrealized gain
(loss) on securities available for sale.
(2) Including non accrual loans.
(3) Interest rate spread is calculated by subtracting the average interest rate
cost from the average interest rate earned for the period indicated.
(4) The net yield on average interest-earning assets is calculated by dividing
net interest income by the average interest-earning assets for the period
indicated.
The following table describes the extent to which changes in interest rates and
changes in volume of interest-related assets and liabilities have affected the
Company's consolidated interest income and expense during the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (i.e.,
changes in rate multiplied by old volume) and (2) changes in volume (i.e.,
changes in volume multiplied by old rate). Changes not solely attributable to
rate or volume have been allocated proportionately to the change due to volume
and the change due to rate.
Year ending September 30, 2006
compared to year ended Total Net Due to Due to
September 30, 2005 Change Rate Volume
------ ---- ------
(In Thousands)
Interest-earning assets:
Interest-bearing deposits $ 468 $ 330 $ 138
Securities 117 152 (35)
Mortgage-backed securities 468 212 256
FHLB stock 37 44 (7)
Loans held for sale (17) 2 (19)
Loans receivable (413) 867 (1,280)
------------- ------------ -------------
Total 660 1,607 (947)
Interest-bearing liabilities:
Savings accounts 632 421 211
NOW and money market accounts 373 571 (198)
Certificates of deposit 1,385 1,355 30
Subordinated debentures 258 2 256
FHLB advances (894) 215 (1,109)
Other borrowings 114 125 (11)
------------ ------------ -------------
Total 1,868 2,689 (821)
------------ ------------ -------------
Change in net interest income $ (1,208) $ (1,082) $ (126)
============= ============= =============
Year ending September 30, 2005
compared to year ended Total Net Due to Due to
September 30, 2004 Change Rate Volume
------ ---- ------
(In Thousands)
Interest-earning assets:
Interest-bearing deposits $ 229 $ 221 $ 8
Securities (39) 52 (91)
Mortgage-backed securities 919 150 769
FHLB stock 64 (21) 85
Loans held for sale (9) 2 (11)
Loans receivable 3,991 525 3,466
------------ ------------ ------------
Total 5,155 929 4,226
Interest-bearing liabilities:
Savings accounts 201 114 87
NOW and money market accounts 327 249 78
Certificates of deposit 694 (114) 808
Subordinated debentures 53 - 53
FHLB advances 666 (489) 1,155
Other borrowings 247 11 236
------------ ------------ ------------
Total 2,188 (229) 2,417
------------ ------------- ------------
Change in net interest income $ 2,967 $ 1,158 $ 1,809
============ ============ ============
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, over night interest-bearing deposits in other financial
institutions, and securities available for sale. These assets are commonly
referred to as liquid assets.
Liquid assets were $75.7 million as of September 30, 2006 compared to $119.3
million as of September 30, 2005. The decrease in liquid assets is primarily the
result of repayment of FHLB advances and the reduction of high cost deposit
products. The sale of fixed rate loans throughout the year and the maturity of
securities available for sale has provided sources of liquidity. Management
believes the Company's liquidity level as of September 30, 2006 is sufficient to
meet anticipated liquidity needs.
The cash flow statements provide an indication of the Company's sources and uses
of cash as well as an indication of the ability of the Company to maintain an
adequate level of liquidity. A discussion of the changes in the cash flow
statements for the years ended September 30, 2006, 2005 and 2004 follows.
During the year ended September 30, 2006, net cash and cash equivalents
decreased $37.9 million, from $54.2 million at September 30, 2005 to $16.3
million at year end.
The Company experienced a net increase in cash from operating activities of $2.5
million during the year primarily attributable to proceeds of $12.1 million
realized from the sale of mortgage loans, net income of $2.2 million,
adjustments for depreciation and amortization of $1.4 million, adjustments for
the provision for loan losses of $1.0 million, offset by the origination of
$14.3 million of loans held for sale. The Bank originates, sells and delivers
its fixed rate, owner-occupied residential mortgage loans on either FHLMC "Best
Efforts" delivery basis or with "Mandatory Delivery" programs. The "Best
Efforts" program allows the Bank to commit loans for delivery to investors at
prices that are determined prior to loan approval. In the event that loans are
not closed and therefore not delivered, the Bank incurs no penalty. This
strategy reduces interest rate risk exposure by minimizing the amount of loans
held for sale in the loan portfolio. Under mandatory delivery programs, loans
are committed to be delivered at predetermined prices and penalties could be
assessed if delivery commitments are not met. Loans determined to be held for
sale at the time they are originated are not committed for delivery. These loans
are subject to market price fluctuations at time of sale. The Company has no
loans held for sale at September 30, 2006.
The $19.5 million increase in cash from investing activities for the year ended
September 30, 2006 was primarily due to loan payments exceeding loan
originations by $13.4 million, and principal payments and maturities of
securities of $20.0 million, offset by security purchases of $15.0 million.
Financing activities used net cash of $59.9 million for the year ended September
30, 2006. The net cash was expended to pay down borrowings from FHLB by a net
amount of $28.1 million, and $28.0 million was used by a reduction in deposits.
The Company's loan with a correspondent bank was also paid down by $2.0 million.
The following table reflects, as of September 30, 2006, the company's estimated
significant fixed and determinable contractual obligations by payment date:
Contractual Obligations Payments due by period
Less than More than
1 Year 1-3 Years 3-5 Years 5 Years Total
------ --------- --------- ------- -----
Deposits without a stated maturity 159,264,000 - - - 159,264,000
Certificates of deposit 138,057,000 44,358,000 4,261,000 303,000 186,979,000
Long-term debt obligations 13,500,000 65,885,000 19,000,000 3,168,000 101,553,000
Subordinated notes - - - 5,000,000 5,000,000
Purchase obligations 914,000 420,000 - - 1,334,000
Various outstanding commitments and contingent liabilities are not reflected in
the financial statements. Commitments to make loans at September 30 are as
follows:
------------------2 0 0 6---------------- ------------------2 0 0 5----------------
------- -------
Fixed Variable Fixed Variable
Rate Loans Rate Loans Total Rate Loans Rate Loans Total
Mortgage loans $ 728,650 $ 3,112,700 $ 3,841,350 $ 8,013,396 $ 3,268,236 $ 11,281,632
Commercial loans 146,000 - 146,000 775,000 2,545,500 3,320,500
Unused equity lines of credit 21,107,443 16,896,127 38,003,570 13,738,412 21,219,482 34,957,894
Unused commercial lines
and letters of credit - 31,048,089 31,048,089 - 34,508,652 34,508,652
Unused construction loan
lines of credit 2,392,342 1,849,563 4,241,905 1,571,757 - 1,571,757
------------ ------------- ------------ ------------ ------------ ------------
$ 24,374,435 $ 52,906,479 $ 77,280,914 $ 24,098,565 $ 61,541,870 $ 85,640,435
============ ============= ============ ============ ============ ============
Fixed rate mortgage loan commitments at September 30, 2006 are at an average
rate of 6.84% with terms primarily ranging from 15 to 30 years. Commercial loan
fixed rate commitments are primarily for five year terms with an average rate of
8.94%. The average rate on variable mortgage loan commitments is 5.57% and is
tied to the one year treasury bill rate. Rates on variable commercial loan
commitments are tied to the national prime rate.
Since commitments to make loans and to fund unused lines of credit and loans in
process may expire without being used, the amounts do not necessarily represent
future cash commitments. In addition, commitments are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. The maximum exposure to credit loss in the event of nonperformance by
the other party is the contractual amount of these instruments. The same credit
policy is used to make such commitments as is used for loans receivable.
NEW ACCOUNTING PRONOUNCEMENTS
Effective October 1, 2005, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), Share-based Payment.
See "Stock Based Compensation" in Note 1 to the consolidated financial
statements for further discussion of the impact of adopting
this standard.
We also discuss the "Effect of Newly Issued But Not Yet Effective Accounting
Standards" in Note 1 to the consolidated financial statements.
IMPACT OF INFLATION
The audited consolidated financial statements presented herein have been
prepared in accordance with U.S generally accepted accounting principles. These
principles require measurement of financial position and operating results in
terms of historical dollars (except for securities available for sale which are
reported at fair market value and loans held for sale which are reported at the
lower of cost or estimated market value in the aggregate), without considering
changes in the relative purchasing power of money over time due to inflation.
The primary assets and liabilities of the Bank are monetary in nature. As a
result, interest rates have a more significant impact on the Company's
performance than the effects of general levels of inflation. Interest rates can
be affected by inflation. However, they do not necessarily move in the same
direction or with the same magnitude as the indexes that measure inflation.
In periods of rapidly changing interest rates, the liquidity and maturity
structures of the Company's assets and liabilities are critical to the
maintenance of acceptable performance levels. For a discussion of the Company's
continuing efforts to reduce its vulnerability to changes in interest rates, see
"Asset/Liability Management."
The principal effect of inflation, as distinct from levels of interest rates, on
earnings is in the area of noninterest expense. Such expense items as employee
compensation, employee benefits, and occupancy and equipment costs may be
subject to increases as a result of inflation. Although difficult to measure, an
additional effect of inflation is the possible increase in the dollar value of
the collateral securing loans made by the Bank.
FORWARD LOOKING STATEMENTS
When used in this filing and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases, "anticipate,"
"would be," "will allow," "intends to," "will likely result," "are expected to,"
will continue," "is anticipated," "estimated," "project," or similar expressions
are intended to identify "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject to
risks and uncertainties, including but 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, changes in the fair value of securities available
for sale, changes in the value of the Company's mortgage servicing rights, and
competition, all or some of which could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and advise
readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investing activities, and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
MFB Corp.
Mishawaka, Indiana
We have audited the accompanying consolidated balance sheets of MFB Corp. and
Subsidiary as of September 30, 2006 and 2005 and the related consolidated
statements of income, shareholders' equity and cash flows for each of the three
years in the period ended September 30, 2006. These consolidated 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. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MFB Corp. and
Subsidiary as of September 30, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2006 in conformity with U.S. generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its accounting for stock-based compensation in the year ended September
30, 2006.
Crowe Chizek and Company LLC
South Bend, Indiana
November 28, 2006
The accompanying notes are an integral part of these consolidated financial
statements.
20
MFB CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, 2006 and 2005
2006 2005
---- ----
ASSETS
Cash and due from financial institutions $ 6,726,145 $ 7,612,979
Interest-bearing deposits in other financial
institutions - short-term 9,563,014 46,596,449
----------------- -----------------
Total cash and cash equivalents 16,289,159 54,209,428
Securities available for sale 58,382,745 63,574,757
FHLB Stock and other investments 10,938,986 12,513,549
Loans held for sale - 407,300
Mortgage loans 199,196,112 191,970,211
Commercial loans 134,412,266 157,803,878
Consumer loans 45,613,641 40,921,196
----------------- --------------
Loans receivable 379,222,019 390,695,285
Less: allowance for loan losses (7,230,092) (6,387,867)
------------------ -----------------
Loans receivable, net 371,991,927 384,307,418
Premises and equipment, net 19,476,731 20,336,172
Mortgage servicing rights, net 2,365,915 2,341,461
Cash surrender value of life insurance 6,237,329 5,963,568
Goodwill 1,970,279 2,423,271
Other intangible assets 1,698,604 2,133,700
Other assets 6,719,909 6,666,917
------------------ -------------
Total assets $ 496,071,584 $ 554,877,541
================== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand deposits $ 30,030,521 $ 36,875,993
Savings, NOW and MMDA deposits 129,233,464 153,864,063
Time deposits 186,978,736 183,623,904
----------------- -----------------
Total deposits 346,242,721 374,363,960
----------------- -----------------
Federal Home Loan Bank advances 97,052,965 125,853,984
Loans from correspondent bank 4,500,000 6,500,000
Subordinated debentures 5,000,000 5,000,000
Accrued expenses and other liabilities 4,337,315 4,486,382
----------------- -----------------
Total liabilities 457,133,001 516,204,326
----------------- -----------------
Shareholders' equity
Common stock, 5,000,000 shares authorized;
shares issued: 1,689,417 - 2006 and 2005,
shares outstanding: 1,320,844 - 2006; 1,355,860 - 2005 12,421,032 12,376,858
Retained earnings - substantially restricted 35,479,131 34,026,839
Accumulated other comprehensive loss,
net of tax of $(175,641) in 2006 and ($174,415) in 2005 (340,949) (310,419)
Treasury stock, 368,573 common shares - 2006;
333,557 common shares - 2005, at cost (8,620,631) (7,420,063)
------------------ -----------------
Total shareholders' equity 38,938,583 38,673,215
----------------- -----------------
Total liabilities and shareholders' equity $ 496,071,584 $ 554,877,541
================= =================
CONSOLIDATED STATEMENTS OF INCOME
Years ended September 30, 2006, 2005 and 2004
2006 2005 2004
---- ---- ----
Interest income
Loans receivable, including fees $ 24,473,700 $ 24,903,930 $ 20,921,584
Securities - taxable 3,213,780 2,594,143 1,696,947
Other interest-earning assets 919,585 449,020 173,736
--------------- --------------- ----------------
Total interest income 28,607,065 27,947,093 22,792,267
Interest expense
Deposits 9,020,234 6,968,931 5,447,584
FHLB advances and other borrowings 6,124,730 6,308,179 5,641,984
--------------- --------------- ----------------
Total interest expense 15,144,964 13,277,110 11,089,568
--------------- --------------- ----------------
Net interest income 13,462,101 14,669,983 11,702,699
Provision for loan losses 1,031,781 723,141 800,000
--------------- --------------- ----------------
Net interest income after provision
for loan losses 12,430,320 13,946,842 10,902,699
Noninterest income
Service charges on deposit accounts 3,258,871 3,291,113 3,030,459
Trust fee income 413,446 385,151 494,922
Insurance commissions 151,012 211,022 208,036
Net realized gains from sales of loans 261,338 835,425 1,032,362
Mortgage servicing right recovery 161,758 180,434 216,905
Net gain (loss) on securities available for sale - (948,000) (109,253)
Gain on call of FHLB advance 238,417 - -
Gain on sale of property and casualty insurance 200,000 - -
Other income 1,649,188 1,033,676 806,957
--------------- --------------- ----------------
Total noninterest income 6,334,030 4,988,821 5,680,388
Noninterest expense
Salaries and employee benefits 7,922,940 7,519,073 7,020,737
Occupancy and equipment expense 3,377,125 3,063,869 2,742,768
Professional and consulting fees 431,908 712,337 821,308
Data processing expense 838,034 753,905 632,329
Loss on sales of premises and equipment 229,524 8,914 46,165
Other expense 3,588,831 3,770,871 3,295,208
--------------- --------------- ----------------
Total noninterest expense 16,388,362 15,828,969 14,558,515
--------------- --------------- ----------------
Income before income taxes 2,375,988 3,106,694 2,024,572
Income tax expense 210,267 610,626 234,923
--------------- --------------- ----------------
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
=============== =============== ================
Basic earnings per common share $ 1.61 $ 1.85 $ 1.36
Diluted earnings per common share 1.56 1.81 1.30
The accompanying notes are an integral part of these
consolidated financial statements.
21
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2006, 2005 and 2004
Accumulated
Other
Comprehensive Total
Retained Income (Loss), Treasury Shareholders'
Common Stock Earnings Net of Tax Stock Equity
Balance at October 1, 2003 12,560,058 31,022,460 (466,113) (8,865,199) 34,251,206
Stock option exercise-issuance of 41,350 shares
of treasury stock (359,104) - - 881,793 522,689
Tax benefit related to employee stock plan 285,360 - - - 285,360
Cash dividends declared - $0.470 per share - (617,430) - - (617,430)
Comprehensive income:
Net income for the year ended September 30, 2004 - 1,789,649 - - 1,789,649
Other comprehensive income (loss), net of tax - - (325,604) - (325,604)
-------------
Total comprehensive income - - - - 1,464,045
------------- ------------- -------------- ---------- -------------
Balance at September 30, 2004 $ 12,486,314 $ 32,194,679 $ (791,717) $ (7,983,406) $ 35,905,870
============= ============= =========== ============== =============
Stock option exercise-issuance of 26,800
shares of treasury stock (124,311) 563,343 439,032
Tax benefit related to employee stock plan 14,855 14,855
Cash dividends declared - $0.495 per share (663,908) (663,908)
Comprehensive income:
Net income for the year ended September 30, 2005 2,496,068 2,496,068
Other comprehensive income (loss), net of tax 481,298 481,298
-------------
Total comprehensive income 2,977,366
------------- ------------- -------------- ------------- ----------
Balance at September 30, 2005 $ 12,376,858 $ 34,026,839 $ (310,419) $ (7,420,063) $ 38,673,215
============= ============= =========== =============== =============
The accompanying notes are an integral part of these
consolidated financial statements.
22
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2006, 2005 and 2004
Accumulated
Other
Comprehensive Total
Retained Income (Loss) Treasury Shareholders'
Common Stock Earnings Net of Tax Stock Equity
Balance at September 30, 2005 $ 12,376,858 $ 34,026,839 $ (310,419) $(7,420,063) $ 38,673,215
Stock-based compensation 103,575 - - - 103,575
Purchase of 48,206 shares of treasury stock - - - (1,486,480) (1,486,480)
Stock option exercise-issuance of 13,190 shares
of treasury stock (68,185) - - 285,912 217,727
Tax benefit related to employee stock plan 8,784 - - - 8,784
Cash dividends declared - $0.530 per share - (713,429) - - (713,429)
Comprehensive income:
Net income for the year ended September 30, 2006 - 2,165,721 - - 2,165,721
Other comprehensive income (loss), net of tax - - (30,530) - (30,530)
--------------
Total comprehensive income - - - - 2,135,191
------------- ------------- ----------- ------------ -------------
Balance at September 30, 2006 $ 12,421,032 $ 35,479,131 $ (340,949) $(8,620,631) $ 38,938,583
============= ============= =========== ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
23
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2006, 2005 and 2004
2006 2005 2004
---- ---- ----
Cash flows from operating activities
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization, net of
accretion 1,441,787 1,445,387 1,278,662
Provision for loan losses 1,031,781 723,141 800,000
Net losses on securities available for sale - 948,000 109,253
Net realized gains from sales of loans (261,338) (835,425) (1,032,362)
Amortization of mortgage servicing rights 287,558 394,593 388,580
Amortization/(accretion) of intangible assets
and purchase adjustments 447,815 (343,772) (133,391)
Gain on call of FHLB advance (238,417) - -
Origination of loans held for sale (14,256,095) (32,259,544) (40,741,232)
Recovery of mortgage servicing rights (161,758) (180,434) (216,905)
Proceeds from sales of loans held for sale 12,095,989 38,485,947 46,784,299
(Gain) loss sale of premises and equipment 226,599 (40,509) 46,165
Equity in loss of investment in limited
Partnership 249,463 303,180 220,253
Stock dividend paid by FHLB - (188,400) (312,300)
Stock-based compensation 103,575 - -
Appreciation in cash surrender value of
life insurance (236,820) (219,871) (230,080)
Net change in:
Accrued interest receivable (195,496) (105,782) 87,453
Other assets 152,514 620,058 1,074,707
Accrued expenses and other liabilities (312,831) (1,650,707) 2,392,077
---------------- --------------- ----------------
Net cash provided in operating activities 2,540,047 9,591,930 12,304,828
Cash flows from investing activities
Net change in interest-bearing time
deposits in other financial institutions 500,000 - (500,000)
Net change in loans receivable 13,371,975 2,900,325 (29,469,712)
Net cash received (paid) in acquisition/settlement 452,991 (60,435) 6,873,938
Stock repurchase by FHLB 825,100 - -
Proceeds from:
Principal payments of mortgage-backed
and related securities 11,502,733 12,979,039 9,212,720
Maturities and calls of securities available
for sale 8,500,000 4,945,000 8,944,482
Sales of fixed assets 1,210,937 42,122 318,039
Purchase of:
Securities available for sale (14,957,410) (16,351,731) (11,049,719)
Life Insurance (36,941) (36,941) (170,545)
Premises and equipment, net (1,916,972) (2,217,502) (11,180,184)
---------------- --------------- ----------------
Net cash provided (used) in investing activities 19,452,413 2,199,877 (27,020,981)
The accompanying notes are an integral part of these
consolidated financial statements.
24
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2006, 2005 and 2004
2006 2005 2004
---- ---- ----
Cash flows from financing activities
Purchase of treasury stock $ (1,486,480) $ - $ -
Net change in deposits (28,003,907) 17,176,344 (3,292,653)
Proceeds from FHLB borrowings 15,268,000 74,100,000 38,000,000
Repayment of FHLB borrowings (43,358,403) (80,885,408) (38,929,859)
Proceeds from other borrowings - - 6,500,000
Proceeds from subordinated debentures - 5,000,000 -
Repayment of other borrowings (2,000,000) - (300,000)
Proceeds from exercise of stock options 217,727 439,032 522,689
Net change in advances from
borrowers for taxes and insurance 163,763 (1,343,469) 1,071,457
Cash dividends paid (713,429) (663,908) (617,430)
---------------- --------------- ----------------
Net cash from (used in) financing activities (59,912,729) 13,822,591 2,954,204
---------------- --------------- ----------------
Net change in cash and cash equivalents (37,920,269) 25,614,398 (11,761,949)
Cash and cash equivalents at beginning of year 54,209,428 28,595,030 40,356,979
--------------- --------------- ----------------
Cash and cash equivalents at end of year $ 16,289,159 $ 54,209,428 $ 28,595,030
=============== =============== ================
Supplemental disclosures of cash flow information Cash paid during the year for:
Interest $ 15,793,740 $ 13,326,157 $ 10,834,701
Income taxes 738,000 199,000 670,000
Supplemental schedule of noncash investing activities:
Transfer from:
Loans receivable to loans held for sale $ 2,678,490 $ 5,227,962 $ -
Loans receivable to real estate owned $ - $ 99,286 $ 1,346,757
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006, 2005 and 2004
(Continued)
25
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of MFB Corp., and its wholly-owned subsidiary MFB Financial
(the "Bank"), a federal stock savings bank, and the wholly-owned subsidiaries of
the Bank, Mishawaka Financial Services, Inc., MFB Investments I, Inc., MFB
Investments II, Inc. and MFB Investments, LP (together referred to as "the
Company"). Mishawaka Financial Services, Inc. is engaged in the sale of life and
health insurance to customers in the Bank's market area. The Company sold the
property and casualty book of business owned by Mishawaka Financial Services,
Inc during the 2006 fiscal year. MFB Investments I, Inc., MFB Investments II,
Inc. and MFB Investments, LP are Nevada corporations and a Nevada limited
partnership that manage a portion of the Bank's investment portfolio. All
significant intercompany transactions and balances are eliminated in
consolidation.
Nature of Business and Concentrations of Credit Risk: The primary source of
income for the Company results from granting commercial, consumer and
residential real estate loans in St. Joseph and Elkhart counties and the
surrounding area. The Company operates primarily in the banking industry which
accounts for more than 95% of its revenues, operating income and assets.
Use of Estimates In Preparing Financial Statements: The preparation of
consolidated financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period, as well as the
disclosures provided. Areas involving the use of estimates and assumptions in
the accompanying financial statements include the allowance for loan losses,
fair values of securities and other financial instruments, determination and
carrying value of loans held for sale, determination and carrying value of
impaired loans and other real estate owned, the value of mortgage servicing
rights, the value of investments in limited partnerships, the value of stock
options, the realization of deferred tax assets, the purchase accounting
valuations for assets and liabilities acquired and the determination of
depreciation of premises and equipment recognized in the Company's financial
statements. Actual results could differ from those estimates. Estimates
associated with the allowance for loan losses, and the fair values of securities
and other financial instruments and mortgage servicing rights are particularly
susceptible to material change in the near term.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash
equivalents is defined to include the Company's cash on hand, due from financial
institutions and short-term interest-bearing deposits in other financial
institutions. The Company reports net cash flows for customer loan transactions,
deposit transactions, short term borrowings having an original maturity of 90
days or less, advances from borrowers for taxes and insurance, and
interest-bearing time deposits in other financial institutions.
(Continued)
31
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities: Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported separately in accumulated
other comprehensive income (loss), net of tax. Declines in the fair value of
securities below their cost that are other than temporary are reflected as
realized losses. In estimating other-than-temporary losses, management
considers: (1) the length of time and extent that fair value has been less than
cost, (2) the financial condition and near term prospects of the issuer, and (3)
the Company's ability and intent to hold the security for a period sufficient to
allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are determined using the specific
identification method based on amortized cost and are reflected in the results
of operations at the time of sale. Interest and dividend income, adjusted by
amortization of purchase premium or discount over the estimated life of the
security using the level yield method, is included in earnings.
Mortgage Banking Activities: Mortgage loans originated and intended for sale in
the secondary market are reported as loans held for sale and are carried at the
lower of cost or estimated market value in the aggregate. Net unrealized losses
are recognized in a valuation allowance by charges to income.
Servicing rights are recognized as assets for purchased rights and for the
allocated value of retained servicing rights on loans sold. Servicing rights are
expensed in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights,
determined using prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using market-based assumptions.
Any impairment charge or recovery is reported in a valuation allowance by
charges or credits to income.
Loans Receivable: Loans receivable that management has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are reported at
their outstanding principal balances adjusted for any charge-offs, the allowance
for loan losses, and any deferred fees or costs on originated loans, and
unamortized premiums or discounts on purchased loans. Loan fees and certain
direct loan origination costs are deferred, and the net fee or cost is
recognized as an adjustment to interest income using the interest method.
Because some loans may not be repaid in full, an allowance for loan losses is
recorded. An allowance for loan losses is a valuation allowance for probable
incurred credit losses. The allowance for loan losses is increased by a
provision for loan losses charged to expense and decreased by charge-offs (net
of recoveries). Estimating the risk of loss and the amount of loss on any loan
is necessarily subjective. Accordingly, the allowance is maintained by
management at a level considered adequate to cover losses that are currently
anticipated. Management's periodic evaluation of the adequacy of the allowance
is based on the Company's past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
borrower's ability to repay, the estimated value of any underlying collateral,
and current economic conditions. While management may periodically allocate
portions of the allowance for specific problem loan situations, the whole
allowance is available for any loan charge-offs that occur. Loan losses are
charged against the allowance when management believes the uncollectibility of a
loan balance is confirmed.
Smaller-balance homogeneous loans are evaluated for impairment in total. Such
loans include residential first mortgage loans secured by one-to-four family
residences, residential construction loans, automobile, manufactured homes, home
equity and second mortgage loans. Commercial loans and mortgage loans secured by
other properties are evaluated individually for impairment. Loans are considered
impaired if full principal or interest payments are not anticipated in
accordance with the contractual loan terms. Impaired loans are carried at the
present value of expected future cash flows discounted at the loan's effective
interest rate, or at the fair value of the collateral if the loan is collateral
dependent. A portion of the allowance for loan losses is allocated to impaired
loans if the value of such loans is deemed to be less than the unpaid balance.
If these allocations cause the allowance for loan losses to require an increase,
such increase is reported as a component of the provision for loan losses.
Interest income on loans is accrued over the term of the loans based upon the
principal outstanding. The accrual of interest on loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent that
cash payments are received until, in management's judgment, the borrower has the
ability to make contractual interest and principal payments, in which case the
loan is returned to accrual status.
Foreclosed Real Estate: Real estate properties acquired through, or in lieu of,
loan foreclosure are initially recorded at the lower of carrying amount or fair
value at the date of acquisition, establishing a new cost basis. Any reduction
to fair value from the carrying amount of the related loan at the time of
acquisition is accounted for as a loan loss and charged against the allowance
for loan losses. Valuations are periodically performed by management and
valuation allowances are adjusted through a charge to income for changes in fair
value or estimated selling costs. The carrying value of foreclosed real estate,
included in other assets on the consolidated balance sheet, was $1.7 million at
September 30, 2005 and $1.2 million at September 30, 2006. No valuation
allowances have been deemed needed at either date. At September 30, 2006, the
Company re-classified a $1.2 million property as held and used. This property
was previously accounted for as held for sale. This change in classification was
driven by the longer than expected holding period and resulted in the
recognition of depreciation expense of $80,000 during the year ending September
30, 2006.
Income Taxes: Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
through income tax expense. A valuation allowance, if needed, reduces deferred
tax assets to the amount expected to be realized.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Premises and Equipment: Land is carried at cost. Buildings and improvements, and
furniture and equipment are carried at cost, less accumulated depreciation and
amortization computed principally by using the straight-line method over the
estimated useful lives of the assets.
Useful life of buildings and improvements is 39 years and the range for
furniture and equipment is 3 years to 15 years. These assets are reviewed for
impairment when events indicate the carrying amount is significantly less than
the fair value.
Financial Instruments with Off-Balance-Sheet Risk: The Company, in the normal
course of business, makes commitments to make loans which are not reflected in
the consolidated financial statements. A summary of these commitments is
disclosed in Note 14.
Goodwill and Other Intangible Assets: Goodwill results from business
acquisitions and represents the excess of the purchase price over the fair value
of acquired tangible assets and liabilities and identifiable intangible assets.
Goodwill is assessed quarterly for impairment and any such impairment will be
recognized in the period identified.
Other intangible assets consist of core deposit intangible assets and acquired
customer relationship intangible assets arising from the acquisition of certain
assets and assumption of certain liabilities previously discussed. They are
initially measured at fair value and then are amortized on an accelerated method
over their estimated useful lives.
Investments in Limited Partnerships: Investments in limited partnerships
represent the Company's investments in affordable housing projects for the
primary purpose of available tax benefits. The Company is a limited partner in
these investments and as such, the Company is not involved in the management or
operation of such investments. These investments are accounted for using the
equity method of accounting. Under the equity method of accounting, the Company
records its share of the partnership's earnings or losses in its income
statement and adjusts the carrying amount of the investments on the balance
sheet. These investments are reviewed for impairment when events indicate their
carrying amounts may not be recoverable from future undiscounted cash flows. If
impaired, the investments are reported at fair value. Related tax credits are
recognized as allocated to investors.
Cash Surrender Value of Life Insurance: The Company has purchased life insurance
policies on certain key executives. Company owned life insurance is recorded at
its cash surrender value, or the amount that can be realized.
Earnings Per Common Share: Basic earnings per common share is based on the net
income divided 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 option plans.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Based Compensation: Effective October 1, 2005, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-based
Payment, using the modified prospective transition method. Accordingly, the
Company has included stock-based employee compensation cost in the income
statement relative to the stock option plan(s) for the year ended September 30,
2006. Adopting this standard resulted in a reduction of income before income
taxes of $104,000, a reduction in net income of $69,000, a decrease in basic
earnings per common share of $0.05 and a decrease in diluted earnings per common
share of $0.05.
Prior to October 1, 2005, employee compensation expense under stock options was
reported using the intrinsic value method; therefore, no stock-based
compensation cost is reflected in net income for the years ending September 30,
2005 and 2004, 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 and earnings per share if
expense was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, for the prior years
ending September 30.
2005 2004
---- ----
Net income as reported $ 2,496,068 $ 1,789,649
Deduct: Stock-based compensation expense
determined under the fair value based method 627,313 223,176
--------------- --------------
Pro forma net income $ 1,868,755 $ 1,566,473
=============== ==============
Basic earnings per share as reported $ 1.85 $ 1.36
Pro forma basic earnings per share 1.39 1.19
Diluted earnings per share as reported $ 1.81 $ 1.30
Pro forma diluted earnings per share 1.36 1.14
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income (loss). Other comprehensive income (loss) includes the net
change in net unrealized gains and losses on securities available for sale, net
of reclassification adjustments and tax effects, and is also recognized as a
separate component of shareholders' equity.
Segments: MFB Corp. and its subsidiary, MFB Financial and its subsidiary
Mishawaka Financial Services, Inc. provide a broad range of financial services
to individuals and companies in Mishawaka and the surrounding area. These
services include demand, time and savings deposits; lending; insurance; trust
and other financial services. While the Company's management monitors the
revenue streams of the various Company products and services, operations are
managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the Company's banking operations are considered by
management to be aggregated in one reportable operating segment.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Restriction on Cash: Cash on hand or on deposit with correspondent banks of $3.9
million and $5.0 million, respectively, was required to meet regulatory reserve
and clearing requirements at year end 2006 and 2005.
Reclassifications: Some items in the prior consolidated financial statements
have been reclassified to conform with the current presentation.
Effect of Newly Issued But Not Yet Effective Accounting Standards: In September
2006, the Securities and Exchange Commission (SEC) released Staff Accounting
Bulletin No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB
108 provides guidance on how the effects of prior-year uncorrected financial
statement misstatements should be considered in quantifying a current year
misstatement. SAB 108 requires public companies to quantify misstatements using
both an income statement (rollover) and balance sheet ("iron curtain") approach
and evaluate whether either approach results in a misstatement that, when all
relevant quantitative and qualitative factors are considered, is material. If
prior year errors that had been previously considered immaterial now are
considered material based on either approach, no restatement is required so long
as management properly applied its previous approach and all relevant facts and
circumstances were considered. If prior years are not restated, the cumulative
effect adjustment is recorded in opening retained earnings as of the beginning
of the fiscal year of adoption. SAB 108 is effective for fiscal years ending on
or after November 15, 2006. The Company has not completed its evaluation of the
impact of the adoption of SAB 108.
In March 2006, the Financial Accounting Standards Board (FASB) issued Statement
No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB
Statement No. 140. This Statement provides the following: 1) revised guidance on
when a servicing asset and servicing liability should be recognized; 2) requires
all separately recognized servicing assets and servicing liabilities to be
initially measured at fair value, if practicable; 3) permits an entity to elect
to measure servicing assets and servicing liabilities at fair value each
reporting date and report changes in fair value in earnings in the period in
which the changes occur; 4) upon initial adoption, permits a onetime
reclassification of available-for-sale securities to trading securities for
securities which are identified as offsetting the entity's exposure to changes
in the fair value of servicing assets or liabilities that a servicer elects to
subsequently measure at fair value; and 5) requires separate presentation of
servicing assets and servicing liabilities subsequently measured at fair value
in the statement of financial position and additional footnote disclosures. This
standard is effective as of the beginning of an entity's first fiscal year that
begins after September 15, 2006 with the effects of initial adoption being
reported as a cumulative-effect adjustment to retained earnings. Management does
not intend to carry servicing rights at fair value and therefore does not expect
the adoption of this statement to have a material impact on its consolidated
financial position or results of operations.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements.
This Statement defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. This Statement
establishes a fair value hierarchy about the assumptions used to measure fair
value and clarifies assumptions about risk and the effect of a restriction on
the sale or use of an asset. The standard is effective for fiscal years
beginning after November 15, 2007. The Company has not completed its evaluation
of the impact of the adoption of this standard.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN
48), which prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company has not completed its evaluation
of the impact of the adoption of FIN 48.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5,
Accounting for Purchases of Life Insurance - Determining the Amount That Could
Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for
Purchases of Life Insurance). This issue requires that a policyholder consider
contractual terms of a life insurance policy in determining the amount that
could be realized under the insurance contract. It also requires that if the
contract provides for a greater surrender value if all individual policies in a
group are surrendered at the same time, that the surrender value be determined
based on the assumption that policies will be surrendered on an individual
basis. Lastly, the issue discusses whether the cash surrender value should be
discounted when the policyholder is contractually limited in its ability to
surrender a policy. This issue is effective for fiscal years beginning after
December 15, 2006. The Company has not completed its evaluation of the impact of
adoption of this issue.
NOTE 2 - EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators used in the computation of
the basic earnings per common share and diluted earnings per common share is
presented below:
Year ended September 30,
2006 2005 2004
---- ---- ----
Basic Earnings Per Common Share
Numerator
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
============== ============== ===============
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,343,549 1,345,842 1,316,115
============== ============== ===============
Basic earnings per common share $ 1.61 $ 1.85 $ 1.36
============== ============== ==============
(Continued)
35
NOTE 2 - EARNINGS PER COMMON SHARE (Continued)
Year ended September 30,
2006 2005 2004
---- ---- ----
Diluted Earnings Per Common Share
Numerator
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
============== ============== ===============
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,343,549 1,345,842 1,316,115
Add: Dilutive effects of assumed
exercises of stock options 46,179 31,549 59,885
-------------- -------------- ---------------
Weighted average common shares
and dilutive potential common
shares outstanding 1,389,728 1,377,391 1,376,000
============== ============== ===============
Diluted earnings per common share $ 1.56 $ 1.81 $ 1.30
============== ============== ===============
Stock options for 22,000, 24,000, and 5,000 shares of common stock were not
considered in computing diluted earnings per common share for the years ended
September 30, 2006, 2005 and 2004 because they were antidilutive.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities available for sale are as
follows:
-------------------------September 30, 2006--------------------------
------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Debt securities
U.S. Government
and federal agencies $ 14,391,507 $ 2,385 $ (71,577) $ 14,322,315
Municipal bonds 337,438 351 - 337,789
Mortgage-backed 33,839,494 17,602 (662,142) 33,194,954
Corporate notes 7,245,896 2,150 (133,359) 7,114,687
---------------- ------------ -------------- ---------------
55,814,335 22,488 (867,078) 54,969,745
Marketable equity securities 3,085,000 328,000 - 3,413,000
---------------- ------------ ------------- ---------------
$ 58,899,335 $ 350,488 $ (867,078) $ 58,382,745
================ ============ ============== ===============
NOTE 3 - SECURITIES (Continued)
-------------------------September 30, 2005--------------------------
------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Debt securities
U.S. Government
and federal agencies $ 11,219,798 $ 2,063 $ (42,915) $ 11,178,946
Municipal bonds 340,440 3,397 - 343,837
Mortgage-backed 40,574,979 52,292 (352,377) 40,274,894
Corporate notes 8,744,499 36,536 (211,830) 8,569,205
---------------- ------------ -------------- ---------------
60,879,716 94,288 (607,122) 60,366,882
Marketable equity securities 3,179,875 60,000 (32,000) 3,207,875
---------------- ------------ -------------- ---------------
$ 64,059,591 $ 154,288 $ (639,122) $ 63,574,757
================ ============ ============== ===============
Included in marketable equity securities are government sponsored agency
preferred stocks of $3.1 million for both September 30, 2006 and 2005
respectively.
Securities with unrealized losses at year-end 2006 and 2005, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position, are as follows:
September 30, 2006
Less than 12 Months 12 Months or More Total
------------------- ----------------- -----
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
Debt securities
U.S. Government and
federal agencies $ 9,359,295 $ (33,341) $ 3,460,635 $ (38,236) $12,819,930 $ (71,577)
Mortgage-backed 6,991,013 (39,880) 24,333,805 (622,262) 31,324,818 (662,142)
Corporate notes 988,930 (11,070) 4,848,410 (122,289) 5,837,340 (133,359)
----------- ------------ ----------- ------------ ----------- ------------
Total $17,339,238 $ (84,291) $32,642,850 $ (782,787) $49,982,088 $ (867,078)
=========== ============ =========== ============ =========== ============
NOTE 3 - SECURITIES (Continued)
September 30, 2005
Less than 12 Months 12 Months or More Total
------------------- ----------------- -----
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
Debt securities
U.S. Government and
federal agencies $ 4,487,808 $ (24,881) $ 2,707,820 $ (18,034) $ 7,195,628 $ (42,915)
Mortgage-backed 22,870,101 (192,233) 10,437,862 (160,144) 33,307,963 (352,377)
Corporate notes - - 4,756,250 (211,830) 4,756,250 (211,830)
----------- ----------- ----------- ----------- ----------- -----------
27,357,909 (217,113) 17,901,932 (390,008) 45,259,841 (607,122)
Marketable equity
securities 1,580,000 (32,000) - - 1,580,000 (32,000)
----------- ------------ ----------- ----------- ----------- -----------
Total $28,937,909 $ (249,114) $17,901,932 $ (390,008) $46,839,841 $ (639,122)
=========== =========== =========== =========== =========== ===========
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
In the first quarter of fiscal 2005, management recorded a non-cash impairment
charge through earnings of $948,000 for the decline in the value of floating
rate preferred stock securities. During the quarter ending December 31, 2004, a
multi-billion dollar FNMA preferred stock issuance with a substantially
different structure and higher yield than previous offerings had a detrimental
effect on the fair value of the Company's FNMA and FHLMC preferred stock
holdings. Additionally, a downgrade in rating on the FNMA security due to
disclosed accounting issues, the duration of the suppressed market value on both
the FNMA and FHLMC securities and the Company's inability to project when market
value recovery would occur led management to record the write-down as of
December 31, 2004. The unrealized losses on marketable equity securities was
$32,000 at September 30, 2005, and improved to a gain of $328,000 at September
30, 2006, based upon the fair value subsequent to the write-down.
NOTE 3 - SECURITIES (Continued)
Related to the unrealized losses for debt securities classified as corporate
notes, $96,000 and $157,000 of unrealized losses at September 30, 2006 and 2005
were attributable to a trust preferred bond issued by a regional banking
organization. These unrealized losses are primarily attributable to the low
interest rate environment, and the variable interest rate structure of the bond.
Such interest rate adjustments resulted in coupons being set at a level lower
than current market rates. As interest rates rise and the bonds coupon rate
increases, management anticipates recovery of the unrealized losses. Management
has the ability to hold this bond to maturity, at which time the face value of
the bond would be realized. Credit issues are not considered to be a significant
factor relative to the current unrealized losses.
Relative to unrealized losses on other debt securities as of September 30, 2006
and 2005, management has the intent and ability to hold the investments for the
foreseeable future, and the decline in fair value is largely due to changes in
market interest rates. The fair value is expected to recover as the investments
approach maturity.
The amortized cost and fair value of debt securities by contractual maturity are
shown below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
September 30, 2006
Amortized Fair
Cost Value
Due in one year or less $ 13,504,351 $ 13,416,835
Due after one year through five years 3,499,790 3,494,576
Due after five years through ten years 1,000,000 1,000,310
Due after ten years 3,970,700 3,863,070
---------------- ---------------
21,974,841 21,774,791
Mortgage-backed securities 33,839,494 33,194,954
---------------- ---------------
$ 55,814,335 $ 54,969,745
================ ===============
There were no sales of securities available for sale during the years ended
September 30, 2006, 2005 and 2004. During the years ended September 30, 2006,
2005, and 2004 the Company recorded security impairment charges of $-0-,
$948,000, and $109,253.
NOTE 4 - LOANS RECEIVABLE
Loans receivable, at September 30 are summarized as follows:
2006 2005
---- ----
Residential mortgage loans:
Secured by one-to-four family residences $ 174,399,371 $ 167,658,516
Construction loans 22,231,691 21,756,812
Other 3,089,568 3,249,047
----------------- -----------------
199,720,630 192,664,375
Less:
Net deferred loan origination fees (497,809) (508,920)
Undisbursed portion of construction and
other mortgage loans (26,709) (185,244)
------------------ -----------------
Total residential mortgage loans 199,196,112 191,970,211
Commercial
Commercial real estate 84,651,532 96,223,551
Commercial 49,969,802 61,846,976
----------------- -----------------
134,621,334 158,070,527
Less: net deferred loan origination fees (209,068) (266,649)
------------------ -----------------
Total commercial loans 134,412,266 157,803,878
Consumer loans:
Home equity and second mortgage 37,778,961 33,900,667
Other 7,834,680 7,010,720
Net deferred loan costs - 9,809
----------------- -----------------
Total consumer loans 45,613,641 40,921,196
----------------- -----------------
Total loans receivable $ 379,222,019 $ 390,695,285
================= =================
Activity in the allowance for loan losses is summarized as follows for the years
ended September 30:
2006 2005 2004
---- ---- ----
Balance at beginning of year $ 6,387,867 $ 6,074,134 $ 5,198,137
Provision for loan losses 1,031,781 723,141 800,000
Acquired allowance for loan losses - - 602,467
Charge-offs (194,978) (499,827) (543,734)
Recoveries 5,422 90,419 17,264
-------------- ----------------- -----------------
Balance at end of year $ 7,230,092 $ 6,387,867 $ 6,074,134
============== ================= =================
NOTE 4 - LOANS RECEIVABLE (Continued)
Impaired loans were as follows:
2006 2005
---- ----
Year-end loans with no allocated allowance
for loan losses $ 873,000 $ 603,000
Year-end loans with allocated allowance
for loan losses 6,052,000 8,074,000
--------------- ----------------
Total $ 6,925,000 $ 8,677,000
=============== ================
Amount of the allowance for loan
losses allocated $ 4,337,000 $ 2,714,000
Average of impaired loans during the year 8,270,000 2,505,000
Interest income recognized during impairment 165,000 92,000
Cash-basis interest income recognized during
impairment 159,000 75,000
The largest loan relationship included in impaired loans as of September 30,
2006 totaled approximately $3.1 million for which $3.1 million of the allowance
for loan losses has been allocated. As of September 30, 2006, the customer was
in compliance with a forbearance agreement dated September 8, 2006, and has made
payments of $624,000. The agreement provides for full payment of the outstanding
debt by December 31, 2006. However, the Bank maintained the $3.1 million
allowance for the loan losses allocation based upon the history of unreliable
and inconsistent financial reporting and cash flows of the customer's business.
The actual loss on this loan relationship may vary significantly from the
current estimate contingent upon the borrower remaining in compliance with the
terms of the forbearance agreement. At September 30, 2005, this relationship
totaled approximately $3.8 million, and $1.4 million of the allowance was
allocated to it. This loan was still performing at September 30, 2005; however
it is reported as non-performing at September 30, 2006 and is the primary cause
of the increase in non-performing loans. Impaired loans have decreased from 2005
due to payments received on this commercial loan and other commercial loans with
improved financial conditions.
Non-performing loans were as follows at year end:
2006 2005
---- ----
Loans past due over 90 days still on accrual status $ 619,000 $ 136,000
Non-accrual loans 6,390,000 1,284,000
--------------- ----------------
Total non-performing loans $ 7,009,000 $ 1,420,000
=============== ================
A total of $5,386,000 and $747,000 of the impaired loans were non-accrual loans
as of September 30, 2006 and 2005.
NOTE 4 - LOANS RECEIVABLE (Continued)
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The Company is subject to certain recourse
obligations on the loans serviced for Telebank. The unpaid principal balances of
mortgage loans serviced for others at September 30, 2006 and 2005 are summarized
as follows:
2006 2005
---- ----
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation $ 191,299,590 $ 202,947,491
Fannie Mae Corporation 1,319,739 1,603,859
Hanover Capital Mortgage Holdings, Inc. 739,681 485,449
Merchants Bank 726,159 903,933
Federal Home Loan Bank of Indianapolis 499,062 766,588
Telebank 453,023 664,326
Bank Mutual 411,409 602,567
Citizens Bank 307,827 374,049
LaSalle Bank, FSB 255,864 589,491
--------------- ----------------
Total $ 196,012,354 $ 208,937,753
================= =================
Custodial escrow balances maintained in connection with the foregoing serviced
loans were $1,895,034 and $1,645,326 at September 30, 2006 and 2005
respectively.
Activity for capitalized mortgage servicing rights and the related valuation
allowance was as follows:
2006 2005 2004
---- ---- ----
Servicing rights, net of valuation allowance:
Balance at beginning of year $ 2,341,461 $ 2,092,135 $ 1,373,201
Additions 150,254 463,485 581,035
Change in Valuation allowance 161,758 180,434 216,905
Acquired from Sobieski - - 309,574
Amortized to expense (287,558) (394,593) (388,580)
--------------- ------------- -------------
Balance at end of year $ 2,365,915 $ 2,341,461 $ 2,092,135
============== ============= =============
Valuation allowance:
Balance at beginning of year $ (179,037) $ (359,471) $ (576,376)
Impairment charge (116,306) (554,923) (414,736)
Impairment recovery 278,064 735,357 631,641
-------------- ------------- -------------
Balance at end of year $ (17,279) $ (179,037) $ (359,471)
=============== ============= =============
NOTE 4 - LOANS RECEIVABLE (Continued)
Certain directors and executive officers of the Company and its subsidiary,
including associates of such persons, are loan customers. A summary of the
related party loan activity, for loans aggregating $60,000 or more to any one
related party, is as follows:
2006 2005
---- ----
Balance at beginning of year $ 3,000,634 $ 1,948,015
New loans 686,564 136,921
Repayments (464,542) (165,553)
Related party changes - 1,081,251
---------------- ---------------
Balance at end of year $ 3,222,656 $ 3,000,634
================ ===============
NOTE 5 - PREMISES AND EQUIPMENT, NET
Premises and equipment at September 30 are summarized as follows:
2006 2005
---- ----
Land$ 4,413,363 $ 4,537,708
Buildings and improvements 14,292,199 13,307,581
Furniture and equipment 7,302,490 8,365,080
---------------- ---------------
Total cost 26,008,052 26,210,369
Accumulated depreciation and amortization (6,531,321) (5,874,197)
----------------- ---------------
Total $ 19,476,731 $ 20,336,172
================ ===============
Depreciation of premises and equipment included in occupancy and equipment
expense was approximately $1,339,000 and $1,292,000 for the years ended
September 30, 2006 and 2005 respectively. In June, 2006, the Bank disposed of a
building and real estate which was originally purchased from Sobieski Bancorp in
August 2004 as part of the acquisition of certain assets and liabilities. The
building served as Sobieski's headquarters and contained space beyond the
typical needs of MFB's current financial centers. In order to reduce future
operating expenses, the building was sold at a loss of $189,000 and a new,
smaller facility was constructed on an adjacent parcel of vacant land.
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
Goodwill
Goodwill was $2.0 million and $2.4 million at September 30, 2006 and 2005.
During the year ended September 30, 2006, the company received $453,000 from
Sobieski Bancorp as a result of the successful voluntary mediation relating to a
disputed asset from the August 2004 closing of the acquisition of certain assets
and certain liabilities. The proceeds, net of legal fees, were recorded as a
reduction of goodwill when received.
Acquired Intangible Assets
Acquired intangible assets were as follows as of September 30, 2006:
Gross Carrying Accumulated
Amount Amortization
Amortized intangible assets:
Core deposit intangibles $ 1,610,000 $ 595,196
Other customer relationship intangibles 1,180,000 496,200
--------------- ----------------
Total $ 2,790,000 $ 1,091,396
=============== ================
Acquired intangible assets were as follows as of September 30, 2005:
Gross Carrying Accumulated
Amount Amortization
Amortized intangible assets:
Core deposit intangibles $ 1,610,000 $ 336,596
Other customer relationship intangibles 1,180,000 319,704
--------------- ----------------
Total $ 2,790,000 $ 656,300
=============== ================
Aggregate amortization expense was $435,096, $559,200 and $97,100 for 2006, 2005
and 2004.
Estimated amortization expense for each of the next five years ending September
30:
2007 $ 385,500
2008 335,800
2009 286,300
2010 236,700
2011 187,100
NOTE 7 - DEPOSITS
At September 30, 2006, the scheduled maturities of certificates of deposit for
the years ending September 30, are as follows:
2007 $ 138,057,424
2008 31,744,771
2009 12,613,068
2010 3,347,573
2011 912,914
Thereafter 302,986
-----------------
$ 186,978,736
The aggregate amount of (predominantly short-term) jumbo certificates of deposit
in denominations of $100,000 or more was approximately $50,514,000 and
$46,292,000 at September 30, 2006 and 2005, respectively.
NOTE 8 - BORROWINGS
At September 30, 2006, advances from the Federal Home Loan Bank of Indianapolis
with fixed rates ranging from 4.10% to 6.73% are required to be repaid in the
year ending September 30 as follows:
2007 $ 9,000,000
2008 49,000,000
2009 16,884,581
2010 11,000,000
2011 8,000,000
Thereafter 3,168,384
-----------------
$ 97,052,965
At September 30, 2006, $8.2 million of FHLB stock, $115.3 million of eligible
mortgage loan collateral and $33.2 million of other real estate loan related
collateral are pledged to the FHLB to secure advances outstanding. The Company's
additional borrowing capacity with the FHLB is $51.6 million at September 30,
2006.
In addition, $73.0 million of the advances outstanding at September 30, 2006
contained put options with quarterly put dates ranging from October 2006 to
December 2006, whereby the advance can be called by the FHLB prior to maturity.
During the year ended 2006, the Company recorded a gain of $238,000 on the call
of an FHLB advance.
NOTE 8 - BORROWINGS (Continued)
At September 30, 2006 and 2005, the Company had outstanding borrowings of $4.5
million and $6.5 million, respectively from a correspondent bank. This variable
rate line of credit, tied to the one month LIBOR rate plus 160 basis points
(6.92% as of September 30, 2006), matures on August 31, 2007, at which time it
may be converted to a term loan to be amortized over a five year period. The
borrowing is collateralized by MFB Financial stock and requires the Bank to
remain "well-capitalized" as defined by regulatory capital adequacy guidelines.
NOTE 9 - SUBORDINATED DEBENTURES
A trust, MFBC Statutory Trust I, formed by the Company issued $5,000,000 of
trust preferred securities on July 29, 2005 as part of a private placement of
such securities. The Company issued subordinated debentures to the trust in
exchange for the proceeds of the offering; the debentures and related debt
issuance costs represent the sole assets of the trust. The securities mature 30
years from the date of issuance, require quarterly distributions and bear a
fixed rate of interest of 6.22% per annum for the first five years, resetting
quarterly thereafter at the prevailing three-month LIBOR rate plus 1.7% per
annum. Interest on the securities is payable quarterly in arrears each September
15, December 15, March 15, and June 15 commencing September 15, 2005. The
Company may redeem the trust preferred securities, in whole or in part, without
penalty, on or after September 15, 2010, or earlier upon the occurrence of
certain events with the payment of a premium upon redemption, and the securities
mature on September 15, 2035.
NOTE 10 - EMPLOYEE BENEFITS
401(k) Plan: The Company maintains a retirement savings 401(k) plan which covers
all employees who are 21 years or older and have completed three months of
service. Employees are eligible to receive contributions from the Company after
one year of service. Participants may defer up to 75% of compensation and the
Company will contribute an amount equal to 125% of elective deferrals on 6% of
the participants' compensation elected to be deferred. Expense for the 401(k)
plan for the years ended September 30, 2006, 2005 and 2004 was approximately
$333,000, $320,000 and $315,000 respectively.
42
Employee Stock Ownership Plan (ESOP): On July 1, 2004, the Bank merged the ESOP
into the MFB Financial Employees' Savings and Profit Sharing Plan and Trust. In
doing so, no new participants will enter into the ESOP. Those participants in
the ESOP, as of July 1, 2004, will follow all provisions of the Plan prior to
the merger date. Per the Plan, benefits generally become 100% vested after five
(5) years of credited service. A participant who terminates employment for
reason other than death, normal retirement (or early retirement), or disability
prior to the completion of five (5) years of credited service does not receive
any benefits under the ESOP portion of the combined Plan. Forfeitures are
reallocated among the remaining participating employees.
NOTE 10 - EMPLOYEE BENEFITS (Continued)
The ESOP shares as of September 30 were as follows:
2006 2005 2004
---- ---- ----
Allocated shares 152,750 152,750 152,750
Shares withdrawn from the plan by participants (61,890) (47,246) (29,984)
--------------- ------------- ---------------
Total ESOP shares held in the plan 90,860 105,504 122,766
============== ============= ===============
Stock Option Plans: 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 Plans totals 450,000 shares of common stock. Stock options are used to
reward directors and certain officers and employees of the Company and its
subsidiaries and provide them with an additional equity interest. 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 - the options have varying vesting schedules. As
of September 30, 2006, all options granted have an exercise price of at least
100% of the market value of the common stock on the date of grant. As of
September 30, 2006, 8,000 options remain available for future grants.
For the year ended September 30, 2006, stock option compensation expense of
$103,575 was recognized in connection with the option plans with related tax
benefits of $35,000. At September 30, 2006, compensation expense related to non
vested stock option grants aggregated to $76,300 and is expected to be
recognized as follows:
Stock Option Compensation
Expense (in thousands)
For the fiscal years ending September 30: 2007 35,100
2008 30,600
2009 10,600
-----------
Total $ 76,300
The fair value of each option award is estimated on the date of grant using a
closed form option valuation model that uses the assumptions noted in the table
below. Expected volatilities are based on historical volatilities of the
Company's common stock. The Company uses historical data to estimate option
exercise. Separate groups of employees that have similar historical exercise
behavior are considered separately for valuation purposes. The expected term of
options granted is based on historical data and represents the period of time
that options granted are expected to be outstanding. The risk-free rate of
interest for periods within the contractual life of the option is based on the
U.S. Treasury yield curve in effect at the time of the grant.
2006 2005 2004
---- ---- ----
Risk-free interest rate 4.60% 4.23% 4.11%
Expected dividend rate 1.68 1.96 1.44
Stock price volatility 20.66 28.77 24.53
Estimated Life 8 yrs 8 yrs 8 yrs
Activity in the Option Plans is summarized as follows:
Weighted Weighted Weighted
Number of Average Average
Outstanding Exercise Exercise Fair Value
Options Price Price of Grants
Balance at October 1, 2003 211,450 10.00 - 26.75 $ 19.71
Granted 26,500 30.35 - 34.01 31.90 $ 9.96
Forfeited - - -
Exercised (41,350) 10.00 - 26.75 13.30
-----------
Balance at September 30, 2004 196,600 15.00 - 34.01 22.69
Granted 68,000 25.50 25.50 8.20
Forfeited (12,500) 18.75 - 30.35 23.37
Exercised (26,800) 15.00 - 21.50 16.48
------------
Balance at September 30, 2005 225,300 15.25 - 34.01 24.24
-----------
Granted 5,000 32.30 32.30 9.10
Forfeited - - -
Exercised (13,190) 15.25 - 21.50 16.51
------------
Balance at September 30, 2006 217,110 15.25 - 34.01 24.89
===========
The Company has a policy of using shares held as treasury stock to satisfy share
option exercises. Currently, the Company has a sufficient number of treasury
shares to satisfy expected share option exercises. Options exercisable at
September 30, based on vesting schedules established at the date of grant, are
as follows:
Weighted
Number Average
of Options Exercise Price
September 30, 2004 123,494 22.04
September 30, 2005 196,509 23.95
September 30, 2006 210,310 24.64
At September 30, 2006 options outstanding and options exercisable were as
follows:
Exercisable
Outstanding
Weighted Average
Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise Prices Number Life in years Price Number Price
--------------- ------ ------------- ----- ------ -----
$17.25 - $18.75 3,210 4.42 $ 18.18 3,210 $ 18.18
$20.55 - $26.75 184,900 5.81 23.89 184,900 23.89
$30.35 - $34.01 29,000 7.85 32.00 22,200 31.82
---------- ----------
Outstanding/Exercisable 217,110 6.06 years $ 24.89 210,310 $ 24.64
========== ==========
Aggregate
Intrinsic Value $1,625,153 $ 1,623,521
---------- -----------
The intrinsic value of options exercised was $185,000, $309,000 and $774,000 for
the years ending September 30, 2006, 2005 and 2004. Cash received from option
exercises for the years ended September 30, 2006, 2005 and 2004 was $218,000,
$439,000 and $523,000 respectively. The actual tax benefit realized for the tax
deductions from stock options exercises totaled $9,000, $15,000 and $285,000 for
the years ending September 30, 2006, 2005 and 2004.
NOTE 11 - INCOME TAXES
The Company files consolidated income tax returns. Income tax expense for the
years ended September 30 are summarized as follows:
2006 2005 2004
---- ---- ----
Federal: Current $ 467,131 $ 477,286 $ 402,246
Deferred (202,972) 34,146 (173,499)
--------------- -------------- --------------
264,159 511,432 228,747
State: Current - 89,865 -
Deferred (53,892) 9,329 6,176
--------------- -------------- --------------
(53,892) 99,194 6,176
--------------- -------------- --------------
Total income tax expense $ 210,267 $ 610,626 $ 234,923
============== ============== ==============
Total income tax expense differed from the amounts computed by applying the
federal income tax rate of 34% in all periods presented to income before income
taxes as a result of the following for the years ended September 30:
2006 2005 2004
---- ---- ----
Income taxes at statutory rate $ 807,836 $ 1,056,276 $ 688,354
Tax effect of:
State tax, net of federal income tax effect (35,569) 65,468 4,076
Low income housing credits (402,660) (402,662) (398,208)
Bank owned life insurance income (80,519) (74,756) (78,227)
Other items, net (78,821) (33,700) 18,928
--------------- -------------- --------------
Total income tax expense $ 210,267 $ 610,626 $ 234,923
============== ============== ==============
NOTE 11 - INCOME TAXES (Continued)
The components of the net deferred tax asset (liability) recorded in the
consolidated balance sheets as of September 30 are as follows:
2006 2005
---- ----
Deferred tax assets
Bad debt deduction $ 2,851,292 $ 2,512,344
Low income housing credit carry-forward 475,531 618,782
Net deferred loan fees 278,767 283,102
Impairment on Investment Securities 322,320 322,320
Intangible Assets 271,480 172,608
Net operating loss carryforward 58,292 47,160
Net unrealized depreciation on securities available for sale 175,641 174,415
Other 73,648 18,571
-------------- --------------
Total deferred tax assets 4,506,971 4,149,302
Deferred tax liabilities
Accretion (92,717) (77,856)
Depreciation (304,000) (307,842)
FHLB stock dividend (261,740) (292,730)
Mortgage servicing rights (919,734) (900,229)
Goodwill (124,854) (66,982)
Partnership income (133,547) (88,704)
Other (69,885) (72,555)
--------------- --------------
Total deferred tax liabilities (1,906,477) (1,806,898)
--------------- --------------
Net deferred tax asset (liability) $ 2,600,494 $ 2,342,404
============== ==============
Federal income tax laws provided savings banks with additional bad debt
deductions through the tax year ended September 30, 1987, totaling $4,596,000
for the Bank. Accounting standards do not require a deferred tax liability to be
recorded on this amount, which liability would otherwise total $1,563,000 at
September 30, 2006 and 2005. If the Bank were liquidated or otherwise ceases to
be a bank or if tax laws change, the $1,563,000 would be recorded as expense.
NOTE 12 - REGULATORY MATTERS
The Bank is subject to 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 are presented
below:
Minimum
Requirement
Minimum To Be Well
Requirement Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
As of September 30, 2006
Total capital (to risk
weighted assets) $ 43,221 12.96% $ 26,688 8.00% $ 33,360 10.00%
Tier 1 (core) capital
(to risk weighted assets) 40,859 12.10 13,344 4.00 20,016 6.00
Tier 1 (core) capital (to
adjusted total assets) 40,859 8.34 19,604 4.00 24,506 5.00
As of September 30, 2005
Total capital (to risk
weighted assets) $ 40,588 11.11% $ 29,222 8.00% $ 36,528 10.00%
Tier 1 (core) capital
(to risk weighted assets) 38,015 10.23 14,611 4.00 21,917 6.00
Tier 1 (core) capital (to
adjusted total assets) 38,015 6.93 22,180 4.00 27,422 5.00
Regulations limit the dividends that may be paid by the Bank without prior
approval of the Office of Thrift Supervision. Accordingly, at October 1, 2006,
$6.5 million of the Bank's retained earnings was potentially available for
distribution to the Company, without obtaining prior regulatory approval.
NOTE 13 - OTHER NON-INTEREST INCOME AND EXPENSE
Other noninterest income and expense amounts are summarized as follows for the
years ended September 30:
2006 2005 2004
---- ---- ----
Other noninterest income
Loan servicing fees - net $ 228,769 $ 126,208 $ 51,460
Other service charges and fees 216,826 227,063 159,913
ATM foreign surcharges 47,018 49,089 57,010
Brokerage commissions 132,826 71,870 -
Visa interchange income 123,178 104,972 81,966
Partnership equity loss (221,091) (281,954) (217,510)
Bank owned life insurance 236,820 219,871 230,079
Rental income 624,506 181,697 244,642
Rental income - other real estate 150,000 166,500 102,465
Other 110,336 168,360 96,932
-------------- -------------- --------------
$ 1,649,188 $ 1,033,676 $ 806,957
============== ============== ==============
2006 2005 2004
---- ---- ----
Other noninterest expense
Printing, postage and supplies $ 415,135 $ 437,460 $ 438,481
Advertising and business development 412,571 433,123 409,906
Telephone 204,279 214,611 239,479
Insurance 213,193 238,281 170,130
Directors fees 243,754 215,118 167,537
Intangible amortization 435,096 559,200 97,100
Other 1,664,803 1,673,078 1,772,575
-------------- -------------- --------------
$ 3,588,831 $ 3,770,871 $ 3,295,208
============== ============== ==============
NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONTINGENCIES
Various outstanding commitments and contingent liabilities are not reflected in
the financial statements. Commitments to make loans at September 30 are as
follows:
------------------2 0 0 6---------------- ------------------2 0 0 5----------------
------- -------
Fixed Variable Fixed Variable
Rate Loans Rate Loans Total Rate Loans Rate Loans Total
Mortgage loans $ 728,650 $ 3,112,700 $ 3,841,350 $ 8,013,396 $ 3,268,236 $ 11,281,632
Commercial loans 146,000 - 146,000 775,000 2,545,500 3,320,500
Unused equity lines of credit 21,107,443 16,896,127 38,003,570 13,738,412 21,219,482 34,957,894
Unused commercial lines
and letters of credit - 31,048,089 31,048,089 - 34,508,652 34,508,652
Unused construction loan
lines of credit 2,392,342 1,849,563 4,241,905 1,571,757 - 1,571,757
------------ ------------- ------------ ------------ ------------ ------------
$ 24,374,435 $ 52,906,479 $ 77,280,914 $ 24,098,565 $ 61,541,870 $ 85,640,435
============ ============= ============ ============ ============ ============
Fixed rate mortgage loan commitments at September 30, 2006 are at an average
rate of 6.84% with terms primarily ranging from 15 to 30 years. Commercial loan
fixed rate commitments are primarily for five year terms with an average rate of
8.94%. The average rate on variable mortgage loan commitments is 5.57% and are
tied to the one year treasury bill rate. Rates on variable commercial loan
commitments are tied to the national prime rate.
Since commitments to make loans and to fund unused lines of credit and loans in
process may expire without being used, the amounts do not necessarily represent
future cash commitments. In addition, commitments are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. The maximum exposure to credit loss in the event of nonperformance by
the other party is the contractual amount of these instruments. The same credit
policy is used to make such commitments as is used for loans receivable.
Under employment agreements with certain executive officers, certain events
leading to separation from the Company could result in cash payments totaling
$1.37 million as of September 30, 2006.
The Company and the Bank are subject to certain claims and legal actions arising
in the ordinary course of business. A creditor of the $3.1 million impaired loan
relationship discussed in Note 4 has filed a lawsuit against MFB seeking to
recover approximately $171,000 from MFB. The forbearance agreement discussed in
Note 4 provides for payments to this creditor from the impaired loan
relationship and has resulted in payments of approximately $816,000 during
fiscal year 2006. The Company believes it has valid defenses and will vigorously
contest this lawsuit should the impaired loan relationship not comply with the
terms of the forbearance agreement and no liability for this lawsuit has been
recorded at September 30, 2006. In the opinion of management, after consultation
with legal counsel, the ultimate disposition of all other legal matters is not
expected to have a material adverse effect on the consolidated financial
position or results of operation of the Company.
NOTE 15 - SHAREHOLDER RIGHTS PLAN
The Company has adopted a Shareholder Rights Plan and declared a dividend
distribution at the rate of one Right for each share of common stock held of
record as of the close of business on October 21, 1996, and for each share of
common stock issued thereafter up to the Distribution Date (defined below).
Currently each Right entitles holders of common stock to buy one share of common
stock of the Company at an exercise price of $46. In addition, each Right would
be exercisable, and would detach from the common stock (the "Distribution Date")
only if a person or group (i) were to acquire 12% or more of the outstanding
shares of common stock of the Company; (ii) were to announce a tender or
exchange offer that, if consummated, would result in a person or group
beneficially owning 30% or more of the outstanding shares of common stock of the
Company; or (iii) were declared by the Board to be an Adverse Person (as defined
in the Plan) if such person or group beneficially owns 10% or more of the
outstanding shares of common stock in the Company. In the event of any
occurrence triggering the Distribution Date, each Right may be exercised by the
holder (other than such an acquiring person or group) to purchase shares of
common stock of the Company (or, in certain circumstances, common stock of the
acquiring person) at a 50% discount to market price. The Company is entitled to
redeem the Rights at $.01 per Right at any time. The Rights will expire at the
close of business on October 1, 2006.
The Company has adopted a similar Shareholder Rights Plan on October 21, 2006 to
replace the Plan described above upon expiration. The new plan will expire at
the close of business on October 1, 2016.
NOTE 16 - BUSINESS COMBINATION
On August 6, 2004, the Company acquired certain assets and assumed certain
liabilities of Sobieski Bank, a savings and loan association with three
locations in South Bend, Indiana. The following table presents pro forma
information for the year ended September 30, 2004 as if the acquisition had
occurred at October 1, 2003. The pro forma information includes adjustments for
interest income and loans and securities acquired, amortization of intangibles
arising from the transaction, depreciation expense on property acquired,
interest expense on deposits acquired, and the related income tax effects. The
effects of certain transactions related to various fraudulent and otherwise
unauthorized loan matters impacting Sobieski Bank's historical financial results
were not included in the pro forma information below. However, other factors
negatively impacting the historical financial results of Sobieski Bank have not
been excluded from the pro forma information presented below. Therefore, pro
forma financial information is not necessarily indicative of the results of
operations as they would have been had the acquisition been effected on the
assumed date.
2004
Net interest income $ 14,694,000
Net income 1,328,000
Basic earnings per share $ 1.01
Diluted earnings per share .97
NOTE 17 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are the condensed financial statements for the parent company,
MFB Corp.
CONDENSED BALANCE SHEETS
September 30, 2006 and 2005
2006 2005
---- ----
ASSETS
Cash and cash equivalents $ 1,533,157 $ 5,610,076
Securities available for sale 33,000 127,875
Investment in Bank subsidiary 46,833,949 44,066,693
Other assets 118,054 433,921
--------------- ----------------
Total assets $ 48,518,160 $ 50,238,565
============ ===============
LIABILITIES
Loans from correspondent bank 4,500,000 6,500,000
Subordinated debentures 5,000,000 5,000,000
Accrued expenses and other liabilities 79,577 65,350
--------------- ----------------
Total liabilities 9,579,577 11,565,350
SHAREHOLDERS' EQUITY 38,938,583 38,673,215
----------- --------------
Total liabilities and shareholders' equity $ 48,518,160 $ 50,238,565
============ ===============
CONDENSED STATEMENTS OF INCOME
Years ended September 30, 2006, 2005 and 2004
2006 2005 2004
---- ---- ----
INCOME
Dividends from Bank subsidiary - cash $ - $ - $ 630,000
Interest income 9,641 10,637 39,081
-------------- -------------- ---------------
Total 9,641 10,637 669,081
EXPENSES
Interest expense 719,879 345,080 56,758
Other expenses 323,354 242,389 291,541
-------------- -------------- ---------------
Total 1,043,233 587,469 348,299
Income before income taxes and
equity in undistributed (excess distributed)
net income of Bank subsidiary (1,033,592) (576,832) 320,782
Income tax (benefit) (401,527) (279,605) (40,186)
--------------- -------------- ---------------
Income (loss) before equity in undistributed
(excess distributed) net income
of Bank subsidiary (632,065) (297,227) 360,968
Equity in undistributed
net income of Bank subsidiary 2,797,786 2,793,295 1,428,681
-------------- -------------- ---------------
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
============== ============== ===============
(Continued)
53
NOTE 17 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended September 30, 2006, 2005 and 2004
2006 2005 2004
---- ---- ----
Cash flows from operating activities
Net income $ 2,165,721 $ 2,496,068 $ 1,789,649
Adjustments to reconcile net income to
net cash from operating activities
Equity in undistributed net income
of Bank subsidiary (2,797,786) (2,793,295) (1,428,681)
Stock based compensation expense 103,575 - -
Investment impairment valuation - - 109,253
Net change in other assets 324,651 (306,177) 376,055
Net change in accrued expenses and
other liabilities 14,227 2,375 18,151
--------------- -------------- --------------
Net cash from operating activities (189,612) (601,029) 864,427
Cash flows from investing activities
Investment in banking subsidiary - - (6,500,000)
Maturities and calls of securities 94,875 1,000,000 -
--------------- -------------- -------------
Net cash from investing activities 94,875 1,000,000 (6,500,000)
Cash flows from financing activities
Purchase of MFB Corp. common stock (1,486,480) - -
Proceeds from exercise of stock options 217,727 439,032 522,689
Proceeds from other borrowings - - 6,500,000
Proceeds from subordinated debentures - 5,000,000 -
Repayment of other borrowings (2,000,000) (450,000) (300,000)
Cash dividends paid (713,429) (663,908) (617,430)
---------------- -------------- --------------
Net cash from financing activities (3,982,182) 4,325,124 6,105,259
---------------- -------------- --------------
Net change in cash and cash equivalents (4,076,919) 4,724,095 469,686
Cash and cash equivalents at beginning
of year 5,610,076 885,981 416,295
--------------- -------------- --------------
Cash and cash equivalents at end of year $ 1,533,157 $ 5,610,076 $ 885,981
=============== ============== ==============
NOTE 18 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table shows the estimated fair values and the related carrying
amounts of the Company's financial instruments at September 30, 2006 and 2005.
Items which are not financial instruments are not included.
2006 2005
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Assets
Cash and cash equivalents $ 16,289,159 $ 16,289,000 $ 54,209,428 $ 54,209,000
Other investments 10,938,986 10,939,000 12,513,549 12,514,000
Securities available for sale 58,382,745 58,383,000 63,574,757 63,575,000
Loans held for sale - - 407,300 407,000
Loans receivable, net of
allowance for loan losses 371,991,927 366,561,000 384,307,418 385,801,000
Liabilities
Noninterest-bearing demand
deposits (30,030,521) (30,031,000) (36,875,993) (36,876,000)
Savings, NOW and MMDA
deposits (129,233,464) (129,233,000) (153,864,063) (153,864,000)
Time deposits (186,978,736) (186,232,000) (183,623,904) (182,405,000)
FHLB advances (97,052,965) (96,742,000) (125,853,984) (126,665,000)
Loans from correspondent
banks (4,500,000) (4,500,000) (6,500,000) (6,500,000)
Subordinated Debentures (5,000,000) (5,000,000) (5,000,000) (4,981,000)
For purposes of the above disclosures of estimated fair value, the following
assumptions were used as of September 30, 2006 and 2005. The estimated fair
value for cash and cash equivalents and interest-bearing time deposits in other
financial institutions are considered to approximate cost. The estimated fair
value for securities available for sale is based upon quoted market values for
the individual securities or for equivalent securities. The estimated fair value
for loans held for sale, net, is based on the price offered in the secondary
market on September 30, 2006 and 2005 for loans having similar interest rates
and maturities. The estimated fair value for loans receivable is based upon
estimates of the difference in interest rates the Company would charge the
borrowers for similar such loans with similar maturities made at September 30,
2006 and 2005, applied for an estimated time period until the loan is assumed to
reprice or be paid. In addition, when computing the estimated fair value for
loans receivable, the allowance for loan losses was subtracted from the
calculated fair value for consideration of credit issues. The estimated fair
value for other investments, noninterest-bearing demand deposits and savings,
NOW and MMDA deposits is based upon their carrying value. The estimated fair
value for other time deposits as well as loans from correspondent banks,
subordinated debentures and FHLB advances is based upon estimates of the rate
the Company would pay on such deposits or borrowings at September 30, 2006 and
2005, applied for the time period until maturity. The estimated fair value of
other financial instruments and off-balance-sheet loan commitments approximate
cost and are not considered significant to this presentation.
55
NOTE 18 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that were the Company to have
disposed of such items at September 30, 2006 and 2005, the estimated fair values
would necessarily have been achieved at that date, since market values may
differ depending on various circumstances. The estimated fair values at
September 30, 2006 and 2005 should not necessarily be considered to apply at
subsequent dates.
In addition, other assets and liabilities of the Company that are not defined as
financial instruments are not included in the above disclosures, such as
property and equipment. Also, nonfinancial instruments typically not recognized
in financial statements nevertheless may have value but are not included in the
above disclosures. Excluded, among other items, are the estimated earning power
of core deposit accounts, the trained work force, customer goodwill and similar
items.
NOTE 19 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
2006 2005 2004
---- ---- ----
Net change in net unrealized gains and losses
on securities available for sale
Unrealized gains (losses) arising during
the year $ (31,756) $ (679,048) $ (361,190)
Reclassification adjustment for (gains) losses
included in net income - 948,000 109,253
-------------- -------------- ---------------
Net change in net unrealized gains
(losses) on securities available
for sale (31,756) 268,952 (251,937)
Tax expense (benefit) (1,226) (212,346) 73,667
--------------- -------------- ---------------
Total other comprehensive income (loss) $ (30,530) $ 481,298 $ (325,604)
=============== ============== ===============
NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
--------------Year Ended September 30, 2006--------------
-----------------------------
1st * 2nd 3rd 4th **
(In thousands, except per share data) Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 7,165 $ 7,114 $ 7,184 $ 7,144
Interest expense 3,708 3,700 3,792 3,945
----------- ----------- ----------- -----------
Net interest income 3,457 3,414 3,392 3,199
Provision for (recovery of) loan losses 2,055 (154) (35) (835)
----------- ------------ ------------ ------------
Net interest income after provision for loan
losses 1,402 3,568 3,427 4,034
Non-interest income 1,616 1,461 1,846 1,410
Non-interest expense 3,972 3,956 4,286 4,174
----------- ----------- ----------- -----------
Income (loss) before income taxes (954) 1,073 987 1,270
Income tax expense (benefit) (557) 258 193 316
------------ ----------- ----------- -----------
Net income (loss) $ (397) $ 815 $ 794 $ 954
============ =========== =========== ===========
Basic earnings (loss) per common share $ (0.29) $ 0.60 $ 0.59 $ 0.72
============ =========== =========== ===========
Diluted earnings (loss) per common share $ (0.29) $ 0.58 $ 0.57 $ 0.69
============ =========== =========== ===========
* The significant increase in the provision for loan losses and the resulting
net loss for the 1st quarter of fiscal 2006 is primarily related to the
allowance for loan losses allocation on the impaired commercial loan
relationship previously discussed in Note 4.
** The recovery of loan losses in the 4th quarter is primarily related to
payments from the loan mentioned above in addition to improvement in the
financial condition of other commercial loans.
57
NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (Continued)
--------------Year Ended September 30, 2005--------------
-----------------------------
1st * 2nd 3rd 4th
(In thousands, except per share data) Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 6,831 $ 6,700 $ 6,977 $ 7,440
Interest expense 3,268 3,213 3,225 3,571
----------- ----------- ----------- -----------
Net interest income 3,563 3,487 3,752 3,869
Provision for (recovery of) loan losses 300 (29) 361 91
----------- ------------ ----------- -----------
Net interest income after provision for loan
losses 3,263 3,516 3,391 3,778
Non-interest income 375 1,451 1,276 1,885
Non-interest expense 3,991 3,933 3,885 4,019
----------- ----------- ----------- -----------
Income (loss) before income taxes (353) 1,034 782 1,644
Income tax expense (benefit) (243) 238 168 448
------------ ----------- ----------- -----------
Net income (loss) $ (110) $ 796 $ 614 $ 1,196
============ =========== =========== ===========
Basic earnings (loss) per common share $ (0.08) $ 0.59 $ 0.45 $ 0.88
=========== =========== =========== ===========
Diluted earnings (loss) per common share $ (0.08) $ 0.59 $ 0.44 $ 0.87
=========== =========== =========== ===========
* The significant decrease in non-interest income and the resulting net loss for
the 1st quarter of fiscal 2005 is primarily related to the security impairment
charge of $948,000 as previously discussed.
MFB CORP. AND SUBSIDIARY
58
DIRECTORS AND OFFICERS
September 30, 2006
MFB CORP. AND MFB FINANCIAL DIRECTORS
Robert C. Beutter (age 71) became of counsel to the South Bend law firm May
Oberfell Lorber in November 2005. Before that he was an attorney in private
practice in Mishawaka since 1962 and served as mayor of Mishawaka from 1984 to
2003.
M. Gilbert Eberhart (age 72) has served as Secretary of MFB Financial since 1987
and of MFB Corp. since inception. He is a dentist based in Mishawaka.
Jonathan Housand (age 67) retired with thirty years banking experience most
recently serving as President of Ameritrust National Bank in Elkhart. Since
retiring, he has served as president and General Manager of WNIT, Channel 34,
and as Program Officer of the Elkhart County Community Foundation.
Jonathan E. Kintner (age 63) has a private practice of optometry in Mishawaka.
Christine A. Lauber (age 61) has served as a certified public accountant in
private practice in South Bend, Indiana for more than the last five years. She
also serves as President of Automated Information Management, Inc., South Bend,
Indiana.
Edward Levy (age 58) has served as an officer and owner of Freeman-Spicer
Leasing and Insurance Corp. and its affiliated entities (financial services) for
more than the past five years. In 2005 he became an executive officer of Take
Out Foods International, Inc. based in Indianapolis.
Michael J. Marien (age 58) has served as an Account Manager for IT/Signode Corp.
a division of Illinois Tool Works. He is the
current Chairman of MFB Corp. and MFB Financial.
Charles J. Viater (age 52) has served as President and Chief Executive
Officer of MFB Corp., MFB Financial and Mishawaka Financial
Services, Inc. since September 1995.
Reginald H. Wagle (age 64) has served as Vice President of Memorial Health
Foundation since 1992. Until 1992, he was a free-lance political consultant and
until 1991, he also served as District Director for the Office of United States
Representative John P. Hiler, Third Congressional District of Indiana.
MFB FINANCIAL EXECUTIVE OFFICERS
Charles J. Viater James P. Coleman, III
President and Executive Vice President and
Chief Executive Officer* Director of Wealth Management
Donald R. Kyle Terry L. Clark
Executive Vice President and Vice President, Principal Financial
Chief Operating Officer Officer and Controller
M. Gilbert Eberhart
Secretary*
* Holds same position with MFB Corp.
SHAREHOLDER INFORMATION
September 30, 2006
Market Information
The common stock of MFB Corp. is traded on the NASDAQ Stock Market Global Market
(formerly known as the National Market), under the symbol "MFBC." As of
September 30, 2006, there were approximately 430 shareholders of record. The
following table sets forth market price (based on daily closing prices) and
dividend information for the Company's common stock for the periods indicated.
Dividend
Fiscal Quarters Ended High Trade Low Trade Declared
December 31, 2004 31.00 27.98 0.120
March 31, 2005 30.00 26.62 0.125
June 30, 2005 34.00 24.05 0.125
September 30, 2005 28.55 24.50 0.125
December 31, 2005 28.34 24.50 0.125
March 31, 2006 32.00 27.01 0.135
June 30, 2006 31.50 29.25 0.135
September 30, 2006 33.38 30.28 0.135
Transfer Agent and Registrar
Registrar and Transfer Co.
10 Commerce Drive
Cranford, NJ 07016
Special Counsel
Barnes & Thornburg LLP
1313 Merchants Company Building
11 South Meridian Street
Indianapolis, IN 46204
Independent Auditors
Crowe Chizek and Company LLC
330 East Jefferson Blvd.
South Bend, IN 46624
60
SHAREHOLDER INFORMATION
September 30, 2006
Shareholder and General Inquiries
The Company is required to file an Annual Report on Form 10-K for its fiscal
year ended September 30, 2006 with the Securities and Exchange Commission.
Copies of this annual report may be obtained without charge via our website at
www.mfbbank.com or upon written request to:
Charles J. Viater
President and Chief Executive Officer
MFB Corp.
4100 Edison Lakes Parkway, Suite 300
Mishawaka, IN 46545
Office Locations
Corporate Headquarters Main Office Branch Office
4100 Edison Lakes Parkway 4100 Edison Lakes Parkway 25990 County Road 6
Mishawaka, IN 46545 Mishawaka, IN 46545 Elkhart, IN 46514
Branch Office Branch Office
2427 Mishawaka Ave. 23132 US 33
South Bend, IN 46615 Elkhart, IN 46517
Branch Office Branch Office
100 E. Wayne St. 402 W. Cleveland Rd.
Suite 150 Granger, IN 46530
South Bend, IN 46601
Branch Office Branch Office
2850 W. Cleveland Rd. 411 W. McKinley Ave
South Bend, IN 46628 Mishawaka, IN 46545
Branch Office Branch Office
742 E. Ireland Rd. 23761 Western Ave.
South Bend, IN 46614 South Bend, IN 46619
Branch Office Branch Office
121 S. Church St. 11611 N. Meridian Suite 110
Mishawka, IN 46544 Carmel, IN 46032