ANNUAL REPORT
TO SHAREHOLDERS
TABLE OF CONTENTS
Page
Message to Our Shareholders ............................................... 1
Selected Consolidated Financial Data ........................................ 3
Management's Discussion and Analysis .........................................4
Report of Independent Registered Public Accounting Firm .....................20
Consolidated Balance Sheets .................................................21
Consolidated Statements of Income ...........................................22
Consolidated Statements of Shareholders' Equity .............................23
Consolidated Statements of Cash Flows ...................................... 24
Notes to Consolidated Financial Statements ..................................26
Directors and Executive Officers ............................................58
Shareholder Information .....................................................59
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 and main office
located in Mishawaka, Indiana and the Bank's eleven financial centers in
St. Joseph, Elkhart, and Hamilton Counties of Indiana, and also has a
mortgage loan office located in New Buffalo in Berrien County, Michigan. The
Bank offers a variety of lending, deposit, trust, investment, 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.
The Bank's wholly-owned subsidiary, Community Wealth Management Group, Inc.,
is based out of Hamilton and Montgomery counties in Indiana, and attracts
high net-worth clients and offers trust, investment, insurance,
broker advisory, retirement plan and private banking services in the Bank's
market area. MFBC Statutory Trust I is MFB Corp's wholly-owned trust
preferred security subsidiary.
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, 2007.
First and foremost, it is my pleasure to report to you that in the Company's
118 years of history, the fiscal year ended September 30, 2007 was our most
profitable year ever with earnings in excess of $3.2 million. The Company
easily surpassed the previous most profitable fiscal year- ended
September 30, 2000- with earnings of $2.8 million. This year's excellent
performance is attributable to the outstanding effort of a dedicated,
hard-working team which, among other things, helped us recover $1.6 million
of a previously reserved loan. Remarkably, this success was achieved
during a turbulent time that finds many of our competitors recording
significant additional provisions or losses related to the sub-prime mortgage
business.
The turmoil in the subprime mortgage loan market was well documented and
well publicized this past year and has created a ripple effect of uncertainty
and anxiety for homeowners, investors and our economy in general. It is
important to note that our company remains largely unaffected by these events.
Our commitment to asset quality means an unwavering commitment to lending
standards that have stood the test of time. We continue to operate and
underwrite to those standards. As a result, our asset quality remains
strong and has, in fact, improved significantly in the past year.
Non-performing assets as a percent of total loans decreased from
2.18% at September 30, 2006 to 1.28% at September 30, 2007.
On September 28, 2007, we completed a strategic acquisition that is
intended to create critical mass in our wealth management business
immediately. The acquisition involved over $270 million of trust and
asset management client relationships in the Indianapolis and
Crawfordsville markets. The revenue stream and operating profit potential of
this book of business is strong and management will work diligently to
integrate this business and maximize its contribution to future earnings of
the Company. In addition, we entered the retirement plan services
business to complement and support our efforts to create new sources of
non-interest revenue in the future.
Reduced consumer confidence and a slowing economy prompted an easing of
monetary policy in the last half of the year. Although lower short-term
interest rates may put pressure on near-term earnings, the long-term
prospects are good. The Company expects reduced funding costs in the next
12 to 18 months should the current rate environment remain steady.
Our earnings success this past year is attributable in large measure to a
negative provision for loan losses of $1.3 million. During the year we
collected over $1.6 million of a fully reserved credit facility and over
$400,000 in settlement proceeds from an investment security that had been
written down during 2002. We continue to pursue the collection of additional
amounts related to these assets.
The Company experienced strong balance sheet growth during the year. Total
assets at September 30, 2007 were $510.4 million, an increase of
$14.3 million from the prior year. The increase reflects loan portfolio
growth of $28.6 million funded in part through repayments and maturities of
investment securities during the year. These funds were supplemented by
additional borrowings that replaced high rate certificates of deposits that
were not retained. As a result, borrowed funds increased $27.2 million while
total deposits decreased $12.4 million during the year. Our book value per
common share outstanding increased to $31.25 at year-end, up from $29.48 a
year ago. In October of 2007, the Company approved an increase in the
quarterly dividend to $0.190 per share, a 15.2% 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
<page>
MFB CORP. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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.
<table>
<caption>
At September 30,
(Dollars in thousands, except for supplemental data)
<s> <c> <c> <c> <c> <c>
2007 2006 2005 2004 2003
Summary of Financial Condition:
Total assets $ 510,448 $ 496,072 $ 554,877 $ 541,222 $ 428,624
Loans receivable 407,756 379,222 390,695 399,925 318,155
Allowance for loan losses 5,298 7,230 6,388 6,074 5,198
Loans held for sale, net 612 - 407 1,034 6,626
Cash and cash equivalents 23,470 16,289 54,209 28,595 40,357
Securities available for sale, including FHLB stock 41,126 66,545 72,563 74,820 46,499
Goodwill and other intangible assets 3,892 3,669 4,557 5,056 -
Deposits 333,803 346,243 374,364 357,893 292,106
FHLB advances 124,258 97,053 125,854 133,443 98,790
Shareholders' equity 41,057 38,939 38,673 35,906 34,251
</table>
<table>
<caption>
Years Ended September 30,
(Dollars in thousands, except for supplemental data)
2007 2006 2005 2004 2003
Summary of Operating Results:
<s> <c> <c> <c> <c> <c>
Interest income $ 29,299 $ 28,607 $ 27,947 $ 22,792 $ 23,326
Interest expense 15,930 15,145 13,277 11,089 12,244
Net interest income 13,369 13,462 14,670 11,703 11,082
Provision for loan losses (1,257) 1,032 723 800 1,110
Net interest income after provision 14,626 12,430 13,947 10,903 9,972
for loan losses
Noninterest income 5,863 6,273 4,989 5,680 4,981
Noninterest expense 16,278 16,327 15,829 14,558 11,882
Income before income taxes 4,211 2,376 3,107 2,025 3,071
Income tax expense 979 210 611 235 671
Net income $ 3,232 $ 2,166 $ 2,496 $ 1,790 $ 2,400
Supplemental Data:
Basic earnings per common share $ 2.45 $ 1.61 $ 1.85 $ 1.36 $ 1.87
Diluted earnings per common share 2.37 1.56 1.81 1.30 1.80
Dividends declared per common share 0.660 0.530 0.495 0.470 0.435
Book value per common share 31.25 29.48 28.52 27.02 26.60
Return on assets 0.64% 0.42% 0.47% 0.40% 0.56%
Return on equity 8.08 5.69 6.82 5.05 7.14
Interest rate spread 2.63 2.51 2.79 2.53 2.41
Net yield on average interest-earning assets 2.94 2.79 2.97 2.81 2.73
Dividend pay-out ratio 26.94 32.92 26.73 34.56 23.26
Equity-to-assets 8.04 7.85 6.97 6.63 7.99
Non-performing assets to total loans 1.28 2.18 0.80 1.07 1.43
Allowance for loan losses to total loans 1.30 1.91 1.63 1.52 1.63
</table>
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 Bank's Wealth Management Group attracts high
net 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 $33,000, ($30,000) and
$481,000 for 2007, 2006, and 2005, 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, 2007 and 2006, mortgage servicing rights had a carrying value
of $2.3 million and $2.4 million, respectively.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 2007 AND 2006
RESULTS OF OPERATIONS
Consolidated net income for the Company for the year ended September 30, 2007
was $3.2 million or $2.37 diluted net income per common share compared to $2.2
million or $1.56 diluted net income per common share for the same period in
2006. The increase in net income was primarily attributable to a negative
provision for loan loss.
Net interest income totaled $13.4 million for the year ended
September 30, 2007 compared to $13.5 million for the same period one year ago.
Interest income increased $700,000 and interest expense increased $800,000
during the year ended September 30, 2007, compared to the same period in 2006.
Interest rates continued to increase during fiscal year 2007, reflected in
the Company's yield earned on interest-earning assets, which increased 52
basis points, rising from 5.93% in fiscal year 2006 to 6.45% in 2007. The
average interest rate paid on interest-bearing liabilities increased 40 basis
points, from 3.42% to 3.82% during the same period, due largely to increases in
the cost of deposits, as rates on various savings accounts continued to rise
from record lows. As a result, the interest rate spread increased 12 basis
points from 2.51% in 2006 to 2.63% in 2007.
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. The provision for loan losses decreased from
$1.0 million of provision expense for the year ended September 30, 2006 to
$1.3 million of income (negative provision for loan losses) for the year
ended September 30, 2007. The negative provision for loan losses for the
year ending September 30, 2007 was primarily related to one impaired
commercial loan discussed further in Note 4 to the consolidated financial
statements. Specific reserves on commercial loans decreased $2.2 million
from 2006 to 2007 and were offset by an increase in general reserves on
commercial loans of $227,000 due to an increase in overall commercial loan
balances. Net charge-offs totaled $190,000 and $675,000 for the years ended
September 30, 2006 and 2007 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 $3.7 million of commercial loans classified as impaired at the end of this
year. Impaired loans decreased to $3.7 million from $6.9 million last year
predominantly due to the payments received on an outstanding loan referred to
above and discussed in Note 4 to the consolidated financial statements and the
improved financial condition of another commercial loan customer. Management
of the Bank is continually monitoring these impaired loans for any changes
necessary in the provision for loan losses.
Noninterest income decreased from $6.3 million for fiscal year 2006 to $5.9
million for the same period ended September 30, 2007. Included in noninterest
income for fiscal year 2006 were two nonrecurring items, 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. In fiscal
year 2007, noninterest income included a $402,000 gain on securities from a
settlement of an investment written down in fiscal year 2002.
Noninterest expense remained constant at $16.3 million for the twelve
months ended September 30, 2006 and September 30, 2007. The largest increase
was for salaries and employee benefits, which increased $438,000. Occupancy
and equipment expenses decreased $212,000; loss on sale of fixed assets
decreased $162,000 primarily due to a $189,000 loss on the sale of a branch
building in 2006.
Income tax expense increased from $210,000 last year to $979,000 this year
primarily due to increased income before tax. Federal income tax expense
increased from $264,000 to $876,000 and state income tax expense (benefit)
increased from ($54,000) to $103,000. The overall effective income tax
expense rate increased from 8.8% last year to 23.3% this year 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.
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 rose from record lows. As a result, the interest
rate spread decreased 28 basis points from 2.79% 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. The increase was predominantly 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. The Company had no losses on securities in fiscal
year 2006. In addition, rental income from lease of space in the Company's
corporate headquarters increased by $443,000 over fiscal 2005 as additional
tenants occupied the building during 2006. Also, 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 $16.3 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; 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% in 2005 to 8.8% in 2006 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.
BALANCE SHEET COMPOSITION
The Company's cash and cash equivalents increased $7.2 million, from $16.3
million as of September 30, 2006 to $23.5 million as of September 30, 2007.
Net cash from operating activities was $6.0 million in 2007 compared to $2.5
million net cash provided in 2006. The net cash provided from investing
activities was $19.5 million in 2006 to a use of funds of $9.6 million in
2007. The net cash from financing activities provided a source of funds of
$10.8 million in 2007 compared to an outflow of $60.0 million in 2006.
Primary sources of cash came from net borrowings from the
Federal Home Loan Bank (FHLB) of $27.5 million and from payments and
maturities of investments of $25.0 million. Outlays of cash funded an increase
in the Company's loan portfolio of $31.1 million, and a decrease in deposits
of $12.4 million.
As of September 30, 2007, the securities available for sale portfolio was
$33.4 million, a decline of $25.0 million from $58.4 million at
September 30, 2006. Securities portfolio activity included maturities
of $17.0 million and principal payments on mortgage-backed and related
securities of $8.0 million. The Company made no purchases of investments in
fiscal year 2007.
As of September 30, 2007, loans receivable were $407.8 million, an increase
of $28.6 million from $379.2 million as of September 30, 2006. Residential
mortgage loans increased $2.0 million from $199.2 million at September 30, 2006
to $201.2 million at September 30, 2007. Commercial loans outstanding
increased by $19.5 million from $134.4 million at September 30, 2006 to
$153.9 million at September 30, 2007. Consumer loan receivables, which
include home equity term loans and lines of credit, increased $7.0 million to
$52.6 million. Diversification of the asset mix in the balance sheet will
continue to be a focus to improve profit margins, to 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, 2007, the Company completed secondary
market mortgage loan sales totaling $14.4 million, and the net gains realized
on these loan sales were $306,000, including $179,000 related to recording
mortgage loan servicing rights. Loan sales in 2006 were $12.1 million, and
the net gains realized on these loans sales were $261,000, including
$150,000 related to recording mortgage loan servicing rights. The loans sold
during the year ended September 30, 2007 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 $11.9 million of fixed rate mortgage loans originated
during 2007, with a weighted average interest rate of 6.72%. At
September 30, 2006, no loans were classified as loans held for sale compared
to $612,000 at September 30, 2007. Mortgage loans serviced for others by the
Company declined from $196.0 million last fiscal year to $186.6
million at the end of this fiscal year.
The Company's allowance for loan losses at September 30, 2007 was $5.3
million or 1.30% of loans, comparable to the $7.2 million or 1.91% of loans at
the end of last year. The ratio of non-performing loans to loans was 1.85% at
September 30, 2006 compared to 1.25% at September 30, 2007. A negative
provision of $1.3 million was recorded to the allowance for loan losses
during the year ended September 30, 2007 compared to a provision of $1.0
million recorded to the allowance for loan losses during the prior year
ended September 30, 2006. The change in the allowance for loan losses was due
predominantly to payments received on impaired loans during the year ended
September 30, 2007, which were previously reserved for in the allowance for
loan losses. 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. Net charge offs
deducted from the allowance for loan losses was $675,000 for the year ended
September 30, 2007 compared to $190,000 for the prior year. In management's
opinion, the Company's allowance for loan losses at September 30, 2007
and loan loss provision for the year is appropriate for the loan portfolio.
The decrease in premises and equipment from $19.5 million at
September 30, 2006 to $18.5 million at September 30, 2007 was primarily
due to annual depreciation expense. The corporate headquarters consists of
approximately 114,300 square feet with approximately 44.00% of the space
utilized by the Company. At September 30, 2007, tenants occupied
approximately 56,000 square feet of rentable space under leases with various
terms that extend 15 years. At September 30, 2007 the Company had leased
approximately 87.00% of available lease space.
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. Trust customer relationship
intangible assets totaling $610,000 were recorded at the acquisition date as
a result of the purchase of Community Trust and Investment Company, Inc.
in September 2007 (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, 2007 the balance of goodwill was $2.0 million and the
balance of the other intangible assets was $1.9 million. The Company
assesses goodwill for impairment at least annually and determined there
was no impairment as of September 30, 2007. The other intangible assets
included the identified value of the core deposits acquired and the value of
customer relationships and trust customer relationships obtained in the
acquisitions. The two intangible assets relating to the Sobieski Bank
acquisition are amortized to expense over a ten year period with approximately
seven years remaining, and the one intangible asset relating to the Community
Trust and Investment Company, Inc. acquisition is amortized to expense over a
ten year period with approximately ten years remaining.
Total deposits decreased by $12.4 million to $333.8 million as of
September 30, 2007 from $346.2 million as of September 30, 2006 in part due to
the reduction of high cost deposit products. Deposits consisting of demand,
NOW, savings, repurchase agreements and MMDA accounts increased from $159.3
million to $163.3 million from September 30, 2006 to September 30, 2007.
Federal Home Loan Bank ("FHLB") advances increased from $97.1 million as of
September 30, 2006 to $124.3 million as of September 30, 2007.
Total shareholders' equity increased from $38.9 million as of
September 30, 2006 to $41.1 million as of September 30, 2007. The
increases to equity resulted from net income of $3.2 million and $216,000
generated from the exercise of stock options, partially offset by cash
dividend payments of $870,000 and purchases of treasury stock of $576,000.
The book value of MFB Corp. common stock, based on the actual number of shares
outstanding, increased from $29.48 as of September 30, 2006 to $31.25 at
September 30, 2007.
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 utilized by the
Office of Thrift Supervision (OTS). 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 10.88% as of September 30, 2007, a decrease from 11.16% at September
30, 2006. The decrease is primarily the result of the change in investment
securities and FHLB advances. As referenced above in the Balance Sheet
Composition section, an increase in cash, commercial loans, and mortgage
loans, was offset in part with a decrease in investment securities, and
corresponds to an increase in FHLB advances and a decrease in 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, 2007 and 2006, 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 points.
As illustrated in the September 30, 2007 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, 2007
(Dollars in thousands)
<table>
<caption>
Change in
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)
<s> <c> <c> <c> <c> <c>
+300 $ 42,694 $ (14,466) (25)% 8.50% (238) bp
+200 48,537 (8,623) (15) 9.51 (137) bp
+100 53,335 (3,825) (7) 10.29 (59) bp
0 57,160 - - 10.88 - bp
(100) 57,366 206 - 10.84 (4) bp
(200) 56,923 (237) - 10.69 (19) bp
(1) Expressed in basis points ("bp")
</Table>
Specifically, the September 30, 2007 table indicates that the Company's
NPV was $57.2 million or 10.88% 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 $8.6 million or 15% decrease in the
Company's NPV and would result in a 137 basis point decrease in the Company's
NPV ratio to 9.51%. Also, an immediate 200 basis point decrease in market
interest rates would result in a $237,000 or 0% decrease in the Company's
NPV, and a 19 basis point decrease in the Company's NPV ratio to 10.69%.
As illustrated in the September 30, 2006 table below, the Company's interest
rate risk was sensitive to rising rates and positively impacted by declining
rates. 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, 2006
(Dollars in thousands)
<table>
<caption>
Change in
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)
<s> <c> <c> <c> <c> <c>
+300 $ 39,710 $ (16,488) (29)% 8.24% (290) 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 ("bp")
</table>
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%.
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 $612,000 in loans classified as held for sale as
of September 30, 2007 that were to be sold in October 2007. The Company
retains the servicing on loans sold in the secondary market and, at
September 30, 2007, $186.6 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 3.42% for the
year ended September 30, 2006 to 3.82% for the year ended
September 30, 2007. The Company has also experienced an increase in the
percentage of low interest cost demand and savings deposits to total
interest-bearing liabilities as well as an increase in other borrowings and
FHLB advances which increases its sensitivity to a decrease in rates.
AVERAGE BALANCE SHEETS
The following are the average balance sheets for the years ended September 30:
<table>
<caption>
2007 2006 2005
Average Average Average
Outstanding Outstanding Outstanding
Balance Balance Balance
(Dollars in thousands)
Assets:
Interest earning assets:
<s> <c> <c> <c>
Interest-earning deposits $ 6,132 $ 26,337 $ 22,157
Mortgage-backed securities (1) 29,032 37,554 39,021
Other securities available for sale (1) 21,126 28,436 22,429
FHLB stock 7,796 8,809 8,952
Loans held for sale 254 802 1,105
Loans receivable (2) 389,758 379,568 399,469
Total interest-earning assets 454,098 481,506 493,133
Noninterest-earning assets, net
of allowance for loan losses 43,924 38,734 39,057
Total assets $ 498,022 $ 520,240 $ 532,190
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Savings accounts $ 52,966 $ 58,887 $ 47,071
NOW and money market accounts 74,098 77,428 89,443
Certificates of deposit 179,219 186,109 185,268
Securities sold under agreements to repurchase 74 - -
Federal Home Loan Bank advances 104,197 108,815 131,101
Other borrowings 1,849 6,330 6,500
Subordinated debentures 5,000 5,000 875
Total interest-bearing liabilities 417,403 442,569 460,258
Other liabilities 40,632 39,634 35,345
Total liabilities 458,035 482,203 495,603
Shareholders' equity:
Common stock 12,256 11,731 12,413
Retained earnings 36,650 34,629 32,222
Net unrealized gain (loss) on
securities available for sale (110) (506) (418)
Treasury stock (8,809) (7,817) (7,630)
Total shareholders' equity 39,987 38,037 36,587
Total liabilities and
shareholders' equity $ 498,022 $ 520,240 $ 532,190
(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.
</table>
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.
<table>
<caption>
Year ended September 30,
2007 2006 2005
Average interest rate earned on:
<s> <c> <c> <c>
Interest-earning deposits 5.01% 3.31% 1.82%
Mortgage-backed securities (1) 4.42 4.28 3.89
Other securities available for sale (1) 4.66 4.21 3.26
FHLB stock 4.56 4.79 4.30
Loans held for Sale 6.76 6.43 6.22
Loans receivable (2) 6.76 6.43 6.22
Total interest-earning assets 6.45 5.93 5.67
Average interest rate of:
Savings accounts 1.96% 1.79% 0.89%
NOW and money market accounts 2.00 1.65 1.01
Certificates of deposit 4.25 3.60 2.87
Securities sold under agreements to repurchase 3.33 - -
Federal Home Loan Bank advances 5.13 4.98 4.81
Other borrowings 7.07 6.31 4.38
Subordinated debentures 6.22 6.22 6.02
Total interest-bearing liabilities 3.82 3.42 2.88
Interest rate spread (3) 2.63 2.51 2.79
Net yield on interest-earning assets (4) 2.94 2.79 2.97
</table>
(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 new 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.
<table>
<caption>
Year ending September 30, 2007
compared to year ended Total Net Due to Due to
September 30, 2006 Change Rate Volume
(Dollars in thousands)
Interest-earning assets:
<s> <c> <c> <c>
Interest-earning deposits $ (563) $ 449 $ (1,012)
Securities (334) 56 (390)
Mortgage-backed securities (231) 129 (360)
FHLB stock (67) (21) (46)
Loans held for sale (34) 3 (37)
Loans receivable 1,921 1,232 689
Total 692 1,848 (1,156)
Interest-bearing liabilities:
Savings accounts (14) 102 (116)
NOW and money market accounts 208 275 (67)
Certificates of deposit 930 1,223 (293)
Securities sold under agreements
to repurchase 2 - 2
Federal Home Loan Bank advances (72) 164 (236)
Other borrowings (269) 48 (317)
Subordinated debentures - - -
Total 785 1,812 (1,027)
Change in net interest income $ (93) $ 36 $ (129)
Year ending September 30, 2006
compared to year ended Total Net Due to Due to
September 30, 2005 Change Rate Volume
(Dollars in thousands)
Interest-earning assets:
Interest-earning 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
Federal Home Loan advances (894) 215 (1,109)
Other borrowings 114 125 (11)
Subordinated debentures 258 2 256
Total 1,868 2,689 (821)
Change in net interest income $ (1,208) $ (1,082) $ (126)
</table>
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-earning deposits in other
financial institutions, and securities available for sale. These assets are
commonly referred to as liquid assets.
Liquid assets were $57.4 million as of September 30, 2007 compared to $75.6
million as of September 30, 2006. The decrease is primarily the result of
the continued liquidation of the Company's lower interest-earning
investment portfolio to fund higher interest-earning loan growth. Long and
short term borrowings from the FHLB have provided adequate additional
liquidity as needed for the fluctuations in deposit balances. Management
believes the Company's liquidity level as of September 30, 2007 is sufficient
to meet future 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, 2007, 2006 and 2005 follows.
During the year ended September 30, 2007, net cash and cash equivalents
increased by $7.2 million, from $16.3 million at September 30, 2006 to $23.5
million at year end.
The Company experienced a net increase in cash from operating activities of
$6.0 million during the year, primarily from net income of $3.2 million, net
proceeds from the sale of mortgage loans of $2.2 million, adjustments for
depreciation and amortization of $1.3 million, and an increase in accrued
interest and other liabilities of $579,000. 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. As of September 30, 2007, the Company had $612,000 in
loans held for sale, which are subject to market price fluctuations until sold.
Investing activities decreased cash by $9.6 million during fiscal year 2007.
Funds were used to increase loans receivable by $31.2 million and to purchase
additional bank owned life insurance of $4.0 million. These were partially
offset by maturities, calls and payments from the Company's
available-for-sale investment portfolio of $25.0 million. Proceeds from
other investments provided $947,000.
Financing activities provided net cash of $10.8 million for the year ended
September 30, 2007. The source of cash came principally from net borrowings
from the FHLB in the amount of $27.5 million. In part, those funds were used
to fund a $12.4 million reduction in deposits and the repayment of the
Company's loan with a correspondent bank of $4.5 million.
The following table reflects, as of September 30, 2007, the company's
estimated significant fixed and determinable contractual obligations by
payment date:
<table>
<caption>
Contractual Obligations Payments due by period
(Dollars in thousands)
Less than More than
1 Year 1-3 Years 3-5 Years 5 Years Total
<s> <c> <c> <c> <c> <c>
Deposits without a stated maturity $ 162,761 $ - $ - $ - $ 162,761
Certificates of deposit 97,733 48,731 22,142 2,436 171,042
Long-term debt obligations 69,134 36,238 18,250 - 123,622
Subordinated debentures - - - 5,000 5,000
Purchase obligations 851 1,249 - - 2,100
Securities sold under agreement to repurchase 540 - - - 540
</table>
OFF-BALANCE SHEET ARRANGEMENTS
As of the date of this Annual Report, the Company does not have any off-balance
sheet arrangements that have or are reasonably likely to have a current or
future effect on the Company's financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that are material to investors. The term
"off-balance sheet arrangement" generally means any transaction, agreement,
or other contractual arrangement to which any entity unconsolidated
with the Company is a party and under which the Company has (i) any
obligation arising under a guarantee contract, derivative instrument or
variable interest; or (ii) a retained or contingent interest in assets
transferred to such entity or similar arrangement that serves as credit,
liquidity or market risk support for such assets.
See Note 14 to the consolidated financial statements regarding off-balance sheet
commitments and contingencies.
NEW ACCOUNTING PRONOUNCEMENTS
The "Effect of Newly Issued But Not Yet Effective Accounting Standards"
is discussed 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.
QUARTERLY RESULTS OF OPERATION
Selected unaudited quarterly financial data for fiscal years 2007 and 2006
appear in Note 20 to the consolidated financial statements.
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.
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, 2007 and 2006, and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended September 30, 2007. These consolidated
financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall consolidated
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, 2007 and 2006, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2007, in conformity with U.S. generally accepted accounting
principles.
Crowe Chizek and Company LLC
South Bend, Indiana
December 7, 2007
<page>
MFB CORP. AND SUBSIDIARY
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
September 30, 2007 and 2006
- -------------------------------------------------------------------------------
<table>
<caption>
2007 2006
(Dollars in thousands)
ASSETS
<s> <c> <c>
Cash and due from financial institutions $ 7,546 $ 6,726
Interest-earning deposits in other financial
institutions - short-term 15,924 9,563
Total cash and cash equivalents 23,470 16,289
Securities available for sale 33,409 58,383
FHLB Stock and other investments 9,718 10,939
Loans held for sale 612 -
Mortgage loans 201,233 199,196
Commercial loans 153,945 134,412
Consumer loans 52,578 45,614
Loans receivable 407,756 379,222
Less: allowance for loan losses (5,298) (7,230)
Loans receivable, net 402,458 371,992
Premises and equipment, net 18,506 19,477
Mortgage servicing rights, net 2,253 2,366
Cash surrender value of life insurance 10,565 6,237
Goodwill 1,970 1,970
Other intangible assets 1,922 1,699
Other assets 5,565 6,720
Total assets $ 510,448 $ 496,072
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand deposits $ 39,043 $ 30,031
Savings, NOW and MMDA deposits 123,718 129,233
Time deposits 171,042 186,979
Total deposits 333,803 346,243
Securities sold under agreements to repurchase 540 -
Federal Home Loan Bank advances 124,258 97,053
Other borrowings - 4,500
Subordinated debentures 5,000 5,000
Accrued expenses and other liabilities 5,790 4,337
Total liabilities 469,391 457,133
Shareholders' equity
Common stock, 5,000,000 shares authorized;
shares issued: 1,689,417 - 2007 and 2006, shares
outstanding: 1,313,671 - 2007; 1,320,844 - 2006 12,500 12,421
Retained earnings - substantially restricted 37,841 35,479
Accumulated other comprehensive loss,
net of tax of $(159) in 2007 and $(176) in 2006 (308) (341)
Treasury stock, 375,746 common shares - 2007;
368,573 common shares - 2006, at cost (8,976) (8,620)
Total shareholders' equity 41,057 38,939
Total liabilities and shareholders' equity $ 510,448 $ 496,072
</table>
<page>
<table>
<caption>
CONSOLIDATED STATEMENTS OF INCOME
Years ended September 30, 2007, 2006 and 2005
- -------------------------------------------------------------------------------
2007 2006 2005
(Dollars in thousands, except per share data)
Interest income
<s> <c> <c> <c>
Loans receivable, including fees $ 26,361 $ 24,474 $ 24,904
Securities - taxable 2,599 3,214 2,594
Other interest-earning assets 339 919 449
Total interest income 29,299 28,607 27,947
Interest expense
Deposits 10,144 9,020 6,631
Securities sold under agreements
to repurchase 2 - -
FHLB advances and other borrowings 5,784 6,125 6,646
Total interest expense 15,930 15,145 13,277
Net interest income 13,369 13,462 14,670
Provision for loan losses (1,257) 1,032 723
Net interest income after provision
for loan losses 14,626 12,430 13,947
Noninterest income
Service charges on deposit accounts 3,265 3,318 3,363
Trust and brokerage fee income 562 414 385
Insurance commissions 29 151 211
Net realized gains from sales of loans 306 261 835
Mortgage servicing right recovery (8) 178 181
Net gain (loss) on securities available for sale 402 - (948)
Gain on call of FHLB advance - 238 -
Gain on sale of property and casualty insurance - 200 -
Earnings on life insurance 296 237 220
Other income 1,011 1,276 742
Total noninterest income 5,863 6,273 4,989
Noninterest expense
Salaries and employee benefits 8,361 7,923 7,519
Occupancy and equipment expense 3,104 3,316 3,064
Professional and consulting fees 797 803 1,067
Data processing expense 793 838 754
Loss on sales of premises and equipment 68 230 9
Business development and marketing 591 466 500
Supplies and communications 563 669 692
Amortization of intangibles 387 435 559
Other expense 1,614 1,647 1,665
Total noninterest expense 16,278 16,327 15,829
Income before income taxes 4,211 2,376 3,107
Income tax expense 979 210 611
Net income $ 3,232 $ 2,166 $ 2,496
Basic earnings per common share $ 2.45 $ 1.61 $ 1.85
Diluted earnings per common share 2.37 1.56 1.81
</table>
<page>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
<table>
<caption>
- -------------------------------------------------------------------------- ----
Accumulated
Other
Comprehensive Total
Common Retained Income (Loss), Treasury Shareholders'
Stock Earnings Net of Tax Stock Equity
(Dollars in thousands, except per share data)
<s> <c> <c> <c> <c> <c>
Balance at September 30, 2004 $ 12,486 $ 32,195 $ (792) $ (7,983) $ 35,906
Stock option exercise-issuance of 26,800 shares of treasury stock (124) 563 439
Tax benefit related to employee stock plan 15 15
Cash dividends declared - $0.495 per share (664) (664)
Comprehensive income:
Net income for the year ended September 30, 2005 2,496 2,496
Other comprehensive income (loss), net of tax 481 481
Total comprehensive income 2,977
Balance at September 30, 2005 $ 12,377 $ 34,027 $ (311) $ (7,420) $ 38,673
Balance at September 30, 2005 $ 12,377 $ 34,027 $ (311) $ (7,420) $ 38,673
Stock-based compensation 103 - - - 103
Purchase of 48,206 shares of treasury stock - - - (1,486) (1,486)
Stock option exercise-issuance of 13,190 shares of treasury stock (68) - - 286 218
Tax benefit related to employee stock plan 9 - - - 9
Cash dividends declared - $0.530 per share - (714) - - (714)
Comprehensive income:
Net income for the year ended September 30, 2006 - 2,166 - - 2,166
Other comprehensive income (loss), net of tax - - (30) - (30)
Total comprehensive income - - - - 2,136
Balance at September 30, 2006 $ 12,421 $ 35,479 $ (341) $ (8,620) $ 38,939
</table>
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2007, 2006 and 2005
- -------------------------------------------------------------------------------
<table>
<caption>
- -------------------------------------------------------------------------------
Accumulated
Other
Comprehensive Total
Retained Income (Loss) Treasury Shareholders'
Common Stock Earnings Net of Tax Stock Equity
(Dollars in thousands, except per share data)
<s> <c> <c> <c> <c> <c>
Balance at September 30, 2006 $ 12,421 $ 35,479 $ (341) $ (8,620) $ 38,939
Stock-based compensation 35 - - - 35
Purchase of 17,073 shares of treasury stock - - - (576) (576)
Stock option exercise-issuance of 9,900 shares of treasury stock (4) - - 220 216
Tax benefit related to employee stock plan 48 - - - 48
Cash dividends declared - $0.660 per share - (870) - - (870)
Comprehensive income:
Net income for the year ended September 30, 2007 - 3,232 - - 3,232
Other comprehensive income (loss), net of tax - - 33 - 33
Total comprehensive income - - - - 3,265
Balance at September 30, 2007 $ 12,500 $ 37,841 $ (308) $ (8,976) $ 41,057
</table>
<page>
- -------------------------------------------------------------------------------
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2007, 2006 and 2005
<table>
<caption>
- -------------------------------------------------------------------------------
2007 2006 2005
(Dollars in thousands)
Cash flows from operating activities
<s> <c> <c> <c>
Net income $ 3,232 $ 2,166 $ 2,496
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization, net of
accretion 1,325 1,442 1,445
Provision for loan losses (1,257) 1,032 723
Net losses on securities available for sale - - 948
Net realized gains from sales of loans (306) (261) (835)
Amortization of mortgage servicing rights 284 304 395
Amortization/(accretion) of intangible assets
and purchase adjustments 361 448 (344)
Gain on call of FHLB advance - (238) -
Origination of loans held for sale (12,180) (14,256) (32,259)
Expense (Recovery) of mortgage servicing rights 8 (178) (181)
Proceeds from sales of loans held for sale 14,416 12,096 38,486
(Gain) loss sale of premises and equipment 33 227 (40)
Equity in loss of investment in limited
Partnership 274 249 303
Stock dividend paid by FHLB - - (188)
Stock-based compensation 35 103 -
Appreciation in cash surrender value of
life insurance (296) (237) (220)
Net change in:
Accrued interest receivable 119 (196) (106)
Other assets 20 152 620
Accrued expenses and other liabilities (31) (313) (1,651)
Net cash provided in operating activities 6,037 2,540 9,592
Cash flows from investing activities
Net change in interest-earning time
deposits in other financial institutions 501 500 -
Net change in loans receivable (31,174) 13,372 2,900
Net cash received (paid) in acquisition/settlement - 453 (60)
Stock repurchase by FHLB 446 825 -
Proceeds from:
Principal payments of mortgage-backed
and related securities 7,971 11,503 12,979
Maturities and calls of securities available
for sale 17,011 8,500 4,945
Sales of fixed assets 35 1,211 42
Purchase of:
Securities available for sale - (14,958) (16,352)
Life Insurance (4,032) (37) (37)
Premises and equipment, net (395) (1,917) (2,217)
Net cash provided (used) in investing activities (9,637) 19,452 2,200
</table>
<page>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2007, 2006 and 2005
- -------------------------------------------------------------------------------
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
Cash flows from financing activities
<s> <c> <c> <c>
Purchase of treasury stock $ (576) $ (1,486) $ -
Net change in deposits (12,440) (28,004) 17,176
Net change in securities sold under
agreements to repurchase 540 - -
Proceeds from FHLB borrowings 138,143 15,268 74,100
Repayment of FHLB borrowings (110,606) (43,358) (80,885)
Proceeds from subordinated debentures - - 5,000
Repayment of other borrowings (4,500) (2,000) -
Proceeds from exercise of stock options, including
tax benefit 216 218 439
Net change in advances from
borrowers for taxes and insurance 874 164 (1,343)
Cash dividends paid (870) (714) (664)
Net cash from (used in) financing activities 10,781 (59,912) 13,823
Net change in cash and cash equivalents 7,181 (37,920) 25,614
Cash and cash equivalents at beginning of year 16,289 54,209 28,595
Cash and cash equivalents at end of year $ 23,470 $ 16,289 $ 54,209
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 16,210 $ 15,794 $ 13,326
Income taxes 569 738 199
Supplemental schedule of noncash investing
activities:
Transfer from:
Loans receivable to loans held for sale $ 2,721 $ 2,678 $ 5,228
Loans receivable to real estate owned 65 - 99
Loan made to facilitate sale of real estate owned 900 - -
</table>
<page>
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------- ------
(continued)
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., MFB Investments, LP, and
Community Wealth Management Group, Inc. (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. Community Wealth Management Group, Inc., is based out of Hamilton
and Montgomery counties in Indiana, and attracts high net worth clients and
offers trust, investment, insurance, broker advisory, retirement plan and
private banking services in the Bank's market area. 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)
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.
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, 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
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.
- -------------------------------------------------------------------------------
(continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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,
and 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.
Servicing Rights: Servicing rights are recognized separately when they are
acquired through sales of loans. For sales of mortgage loans prior to
January 1, 2007, a portion of the cost of the loan was allocated to the
servicing right based on relative fair values. The Company adopted SFAS
No. 156 on January 1, 2007, and for sales of mortgage loans beginning in 2007,
servicing rights are initially recorded at fair value with the income
statement effect recorded in gains on sales of loans. Fair value is based on
market prices for comparable mortgage servicing contracts, when available,
or alternatively, is based on a valuation model that calculates the present
value of estimated future net servicing income. The valuation model
incorporates assumptions that market participants would use in estimating
future let servicing income, such as the cost to service, the discount rate,
the custodial earnings rate, an inflation rate, ancillary income,
prepayment speeds and default rates and losses. The valuation model is
provided by a third party that specializes in providing estimated fair values
of mortgage servicing rights, and the Company believes the utilization of
this third party provides assurance that the valuation model provides valid
results. Additionally, the Company compares the valuation model inputs and
results to published industry data in order to validate the model results
and assumptions. All classes of servicing assets are subsequently measured
using the amortization method which requires servicing rights to be
amortized into non-interest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying loans.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to carrying amount. Impairment is determined by
stratifying rights into groupings based on predominant risk
characteristics, such as interest rate, loan type and investor type.
Impairment is recognized through a valuation allowance for an individual
grouping, to the extent that fair value is less than the carrying amount.
If the Company later determines that all or a portion of the impairment
no longer exists for a particular grouping, a reduction of the allowance
may be recorded as an increase to income. Changes in valuation allowances are
reported separately as mortgage servicing rights recovery on the income
statement. The fair values of servicing rights are subject to significant
fluctuations as a result of changes in estimated and actual prepayment
speeds and default rates and losses.
Servicing fee income is included with other income on the income statement for
fees earned for servicing loans. The fees are based on a contractual
percentage of the outstanding principal; or a fixed amount per loan and are
recorded as income when earned. The amortization of mortgage servicing rights
is netted against loan servicing fee income. Servicing fees totaled $193,000,
$213,000 and $126,000 for the years ended September 30, 2007, 2006 and 2005,
respectively. Late fees and ancillary fees related to loan servicing were not
material.
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 $1.2 million at September 30, 2006 and $144,000 at
September 30, 2007. No valuation allowances were deemed necessary at
September 30, 2006 and 2007, respectively. 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. During the first quarter of fiscal year 2007, the
respective property was sold. The cash proceeds and a loan financed by the
Bank resulted in a loss after sales costs of $9,700.
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.
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.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Federal Home Loan Bank (FHLB) stock: The Bank is a member of the FHLB system.
Members are required to own a certain amount of stock based on the level of
borrowings and other factors, and may invest in additional amounts. FHLB
stock is carried at cost, classified as a restricted security, and
periodically evaluated for impairment based on ultimate recovery of par
value. Both cash and stock dividends are reported as income.
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 annually 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 employees. Company owned life insurance is
recorded at its cash surrender value, or the amount that can be realized.
Securities Sold Under Agreements to Repurchase: Securities sold under
agreements to repurchase consist of obligations of the Company to other
parties. These arrangements are all one-day retail repurchase agreements
and are secured by investment securities. Such collateral is held by
safekeeping agents of the Company.
During the year ended September 30, 2007, the average daily balance was $74,000,
the average interest rate was 3.33%, and the maximum month end balance was
$594,000. The balance was $540,000 at September 30, 2007 and the fair value
of securities underlying these agreements was $758,000 at September 30, 2007.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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. 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 year ending
September 30, 2005, 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 year ending September 30, 2005.
<table>
<caption>
2005
(Dollars in thousands,
except per share date)
<s> <c>
Net income as reported $ 2,496
Deduct: Stock-based compensation expense
determined under the fair value based method 627
Pro forma net income $ 1,869
Basic earnings per share as reported $ 1.85
Pro forma basic earnings per share 1.39
Diluted earnings per share as reported $ 1.81
Pro forma diluted earnings per share 1.36
</table>
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.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
Restriction on Cash: Cash on hand or on deposit with correspondent banks
of $5.3 million and $3.9 million, respectively, was required to meet
regulatory reserve and clearing requirements at year end 2007 and 2006.
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 adoption of this pronouncement
did not have a material impact on the Company's consolidated financial
statements.
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.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
This standard is effective as of the beginning of an entity's first fiscal
year that begins after September 15, 2006. Management does not intend to
carry servicing rights at fair value and the adoption of this statement
did not have a material impact on its consolidated financial position or
results of operations as the Company intends to continue using the
amortization method under FASB No. 156.
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 adoption of this issue.
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 does not
believe the adoption of this issue will have a material impact on our financial
statements.
In September 2006, the FASB Emerging Issues Task Force ("EITF") finalized
Issue No. 06-4, Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.
This issue requires that a liability be recorded during the service period
when a split-dollar life insurance agreement continues after
participants' employment or retirement. The required accrued liability
will be based on either the post-employment benefit cost for the
continuing life insurance or based on the future death benefit depending
on the contractual terms of the underlying agreement. This issue is
effective for fiscal years beginning after December 15, 2007. The Company
does not believe the adoption of EITF No. 06-4 will have a material effect on
the financial statements.
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
does not believe the adoption of this issue will have a material impact on our
financial statements.
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:
<table>
<caption>
Year ended September 30,
2007 2006 2005
(In thousands, except per share data)
Basic Earnings Per Common Share
Numerator
<s> <c> <c> <c>
Net income $ 3,232 $ 2,166 $ 2,496
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,317 1,344 1,346
Basic earnings per common share $ 2.45 $ 1.61 $ 1.85
Year ended September 30,
2007 2006 2005
(In thousands, except per share data)
Diluted Earnings Per Common Share
Numerator
Net income $ 3,232 $ 2,166 $ 2,496
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,317 1,344 1,346
Add: Dilutive effects of assumed
exercises of stock options 49 46 32
Weighted average common shares
and dilutive potential common
shares outstanding 1,366 1,390 1,377
Diluted earnings per common share $ 2.37 $ 1.56 $ 1.81
</table>
Stock options for 17,000, 22,000, and 24,000 shares of common stock were not
considered in computing diluted earnings per common share for the years ended
September 30, 2007, 2006 and 2005 because they were antidilutive.
NOTE 3 - SECURITIES
The fair value of securities available for sale and the related gross
unrealized gains and losses recognized in accumulated other
comprehensive income (loss) are as follows:
<table>
<caption>
September 30, 2007
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
(Dollars in thousands)
Debt securities
U.S. Government
<s> <c> <c> <c>
and federal agencies $ 1,506 $ 6 $ -
Mortgage-backed 25,027 59 (382)
Corporate notes 3,506 - (468)
30,039 65 (850)
Marketable equity securities 3,370 318 -
$ 33,409 $ 383 $ (850)
September 30, 2006
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
(Dollars in thousands)
Debt securities
U.S. Government
and federal agencies $ 14,322 $ 2 $ (72)
Municipal bonds 338 - -
Mortgage-backed 33,195 18 (662)
Corporate notes 7,115 2 (133)
54,970 22 (867)
Marketable equity securities 3,413 328 -
$ 58,383 $ 350 $ (867)
</table>
Marketable equity securities are comprised of government sponsored agency
preferred stocks of $3.1 million for both September 30, 2007 and 2006.
NOTE 3 - SECURITIES (Continued)
Securities with unrealized losses at year-end 2007 and 2006, aggregated by
investment category and length of time that individual securities have been in
a continuous unrealized loss position, are as follows:
<table>
<caption>
September 30, 2007
(Dollars in thousands)
Less than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
<s> <c> <c> <c> <c> <c> <c>
Debt securities
Mortgage-backed $ 610 $ (1) $ 19,335 $ (381) $ 19,945 $ (382)
Corporate notes 458 (39) 3,048 (429) 3,506 (468)
Total $ 1,068 $ (40) $ 22,383 $ (810) $ 23,451 $ (850)
September 30, 2006
(Dollars in thousands)
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 $ (34) $ 3,461 $ (38) $ 12,820 $ (72)
Mortgage-backed 6,991 (40) 24,334 (622) 31,325 (662)
Corporate notes 989 (11) 4,848 (122) 5,837 (133)
Total $ 17,339 $ (85) $ 32,643 $ (782) $ 49,982 $ (867)
</table>
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
gains on these marketable equity securities was $328,000 at
September 30, 2006, and fell slightly to gains of $318,000 at
September 30, 2007, based upon the fair values subsequent to the write-down.
NOTE 3 - SECURITIES (Continued)
Related to the unrealized losses for debt securities classified as corporate
notes, $388,000 and $96,000 of unrealized losses at September 30, 2007 and
2006 were attributable to a trust preferred bond issued by a regional banking
organization. Credit issues are not a factor relative to the current
unrealized losses, but rather the current interest rate structure of the
market for trust preferred instruments. The Bank has the ability to hold this
bond for the foreseeable future and as market interest rate changes and
the issuance approaches its maturity, the fair value is expected to recover.
Unrealized losses on other debt and equity securities as of September 30, 2007
and 2006 have not been recognized into income because the issuer's securities
are of high credit quality (rated AA or higher), 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 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, 2007
(Dollars in thousands)
Fair
Value
Due in one year or less $ 1,003
Due after one year through five years 503
Due after five years through ten years -
Due after ten years 3,506
5,012
Mortgage-backed securities 25,027
$ 30,039
There were no sales of securities available for sale during the years ended
September 30, 2007, 2006 or 2005. During the years ended September 30, 2007,
2006, and 2005 the Company recorded security impairment charges of $-0-,
$-0-, and $948,000, respectively. During the fiscal year ended
September 30, 2002, the Company recorded an $895,000 write down on a $1.0
million WorldCom, Inc. corporate debt security. That security was sold
in October 2002 for $160,000. In total, the Company received $402,000
in distribution payments during fiscal year 2007 as a result of distributions
of funds recovered by the U.S. Securities and Exchange Commission in its
action against WorldCom, Inc. The Company may receive an additional
distribution depending upon the resolution of disputed claims, appeals from
court determinations and additional administrative expenses, interest and
taxes incurred by the settlement funds; however, any further distribution would
likely be relatively small.
NOTE 4 - LOANS RECEIVABLE
Loans receivable, at September 30 are summarized as follows:
<table>
<caption>
2007 2006
(Dollars in thousands)
Residential mortgage loans:
<s> <c> <c>
Secured by one-to-four family residences $ 178,056 $ 174,399
Construction loans 18,107 22,232
Other 5,588 3,090
201,751 199,721
Less:
Net deferred loan origination fees (466) (498)
Undisbursed portion of construction and
other mortgage loans (52) (27)
Total residential mortgage loans 201,233 199,196
Commercial
Commercial real estate 95,241 84,651
Commercial 58,890 49,970
154,131 134,621
Less: net deferred loan origination fees (186) (209)
Total commercial loans 153,945 134,412
Consumer loans:
Home equity and second mortgage 42,593 37,779
Other 9,985 7,835
Net deferred loan costs - -
Total consumer loans 52,578 45,614
Total loans receivable $ 407,756 $ 379,222
</table>
Activity in the allowance for loan losses is summarized as follows for the years
ended September 30:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
<s> <c> <c> <c>
Balance at beginning of year $ 7,230 $ 6,388 $ 6,074
(Negative) Provision for loan losses (1,257) 1,032 723
Charge-offs (701) (195) (499)
Recoveries 26 5 90
Balance at end of year $ 5,298 $ 7,230 $ 6,388
</table>
NOTE 4 - LOANS RECEIVABLE (Continued)
<table>
<caption>
Impaired loans were as follows:
2007 2006
(Dollars in thousands)
<s> <c> <c>
Year-end loans with no allocated allowance
for loan losses $ 759 $ 873
Year-end loans with allocated allowance
for loan losses 2,901 6,052
Total $ 3,660 $ 6,925
Amount of the allowance for loan
losses allocated $ 2,433 $ 4,337
Average of impaired loans during the year 4,644 8,270
Interest income recognized during impairment 9 165
Cash-basis interest income recognized during
impairment 7 159
</table>
The largest loan relationship included in impaired loans as of
September 30, 2007 totaled approximately $1.5 million for which $1.5 million
of the allowance for loan losses has been allocated. Principal payments of
approximately $1.6 million were made on this impaired loan during fiscal year
2007. The Bank maintained the $1.5 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's ability to seek alternative financing or pay down the loan.
At September 30, 2006, this relationship totaled approximately $3.1
million, and $3.1 million of the allowance was allocated to it. Impaired loans
have decreased from 2006 due to payments received on this commercial loan and
other commercial loans with improved financial conditions.
<table>
<caption>
Non-performing loans were as follows at year end:
2007 2006
(Dollars in thousands)
<s> <c> <c>
Loans past due over 90 days still on accrual status $ 41 $ 619
Non-accrual loans 4,693 6,390
Restructured loans 361 -
Total non-performing loans $ 5,095 $ 7,009
</table>
A total of $3.7 million and $5.4 million of the impaired loans were non-accrual
loans as of September 30, 2007 and 2006.
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 E*trade. The unpaid principal balances
of mortgage loans serviced for others at September 30, 2007 and 2006 are
summarized as follows:
<table>
<caption>
2007 2006
(Dollars in thousands)
<s> <c> <c>
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation $ 182,722 $ 191,300
Fannie Mae Corporation 912 1,320
Federal Home Loan Bank of Indianapolis 710 740
Merchants Bank 617 726
E*trade (Formerly Telebank) 439 499
Wells Fargo (Formerly Hanover) 406 453
LaSalle Bank, FSB 388 411
Bank Mutual 239 308
Citizens Bank 119 256
Total $ 186,552 $ 196,013
</table>
Custodial escrow balances maintained in connection with the foregoing
serviced loans were $3.7 million and $1.9 million at September 30, 2007 and 2006
respectively.
Activity for capitalized mortgage servicing rights and the related valuation
allowance was as follows:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
Servicing rights, net of valuation
allowance:
<s> <c> <c> <c>
Balance at beginning of year $ 2,366 $ 2,341 $ 2,092
Additions 179 151 463
Change in Valuation allowance (8) 178 181
Amortized to expense (284) (304) (395)
Balance at end of year $ 2,253 $ 2,366 $ 2,341
Valuation allowance:
Balance at beginning of year $ - $ (178) $ (359)
Impairment charge (120) (116) (555)
Impairment recovery 112 294 736
Balance at end of year $ (8) $ - $ (178)
</table>
NOTE 4 - LOANS RECEIVABLE (Continued)
The fair value of capitalized mortgage servicing rights was $2,412,000 and
$2,527,000 at September 30, 2007 and 2006. The serviced loan portfolio was
stratified by interest rate and fair value was determined at period end based
upon the following weighted average assumptions:
2007 2006
Weighted-average constant prepayment rate 12.30% 11.90%
Weighted-average coupon rate 6.00% 5.95%
Weighted-average net servicing fee 0.25% 0.25%
Weighted-average discount rate 9.09% 9.10%
Weighted-average current age (in years) 3.75 3.10
Additions to capitalized servicing rights are included in gains from the
sales of loans on the consolidated statement of income. Service fee income
received for servicing those loans, net of the amortization of capitalized
servicing rights, aggregated to $193,000, $213,000, and $126,000 for 2007,
2006, and 2005 and is included in other income on the consolidated statement of
income.
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:
2007 2006
(Dollars in thousands)
Balance at beginning of year $ 3,223 $ 3,001
New loans 350 687
Repayments (635) (465)
Related party changes 153 -
Balance at end of year $ 3,091 $ 3,223
NOTE 5 - PREMISES AND EQUIPMENT, NET
Premises and equipment at September 30 are summarized as follows:
<table>
<caption>
2007 2006
(Dollars in thousands)
<s> <c> <c>
Land $ 4,409 $ 4,413
Buildings and improvements 14,543 14,292
Furniture and equipment 5,914 7,303
Total cost 24,866 26,008
Accumulated depreciation and amortization (6,360) (6,531)
Total $ 18,506 $ 19,477
</table>
Depreciation of premises and equipment included in occupancy and equipment
expense was approximately $1.3 million for the years ended September 30, 2007
and 2006 respectively. During fiscal year 2007, the Company disposed of almost
fully depreciated assets no longer in use by the Company.
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
Goodwill
Goodwill was $2.0 million at September 30, 2007 and 2006. 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, 2007:
<table>
<caption>
Gross Carrying Accumulated
Amount Amortization
(Dollars in thousands)
Amortized intangible assets:
<s> <c> <c>
Core deposit intangibles $ 1,610 $ 824
Customer relationship intangibles 1,180 654
Trust customer relationship intangibles 610 -
Total $ 3,400 $ 1,478
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS (Continued)
Acquired intangible assets were as follows as of September 30, 2006:
Gross Carrying Accumulated
Amount Amortization
(Dollars in thousands)
Amortized intangible assets:
Core deposit intangibles $ 1,610 $ 595
Customer relationship intangibles 1,180 496
Total $ 2,790 $ 1,091
</table>
Aggregate amortization expense was $387,000, $435,000 and $559,000 for 2007,
2006 and 2005.
Estimated amortization expense for each of the next five years ending
September 30:
2008 $ 397,000
2009 347,000
2010 298,000
2011 248,000
2012 199,000
Refer to Note 16 for more detailed information on the trust customer
relationship intangible recorded at September 30, 2007.
NOTE 7 - DEPOSITS
At September 30, 2007, the scheduled maturities of certificates of deposit
for the years ending September 30, are as follows (in thousands):
2008 $ 97,733
2009 36,020
2010 12,711
2011 1,845
2012 20,297
Thereafter 2,436
$ 171,042
The aggregate amount of jumbo certificates of deposit in denominations of
$100,000 or more was approximately $48.6 million and $50.5 million at
September 30, 2007 and 2006, respectively.
NOTE 8 - BORROWINGS
At September 30, 2007, advances from the Federal Home Loan Bank of Indianapolis
with $109.3 million fixed rates ranging from 4.10% to 6.35% and $15.0 million
variable rates that reset quarterly with rates ranging from 4.76% to 5.60%
are required to be repaid in the year ending September 30 as follows
(in thousands):
2008 $ 69,134
2009 21,738
2010 14,500
2011 8,000
2012 10,886
$ 124,258
At September 30, 2007, $7.7 million of FHLB stock, $118.3 million of eligible
mortgage loan collateral and $34.6 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 $23.5 million at
September 30, 2007. The Company established a $5.0 million line of credit
with the FHLB on August 24, 2007 and there was no balance outstanding as of
September 30, 2007.
In addition, $78.0 million of the advances outstanding at September 30, 2007
contained put options with quarterly put dates ranging from October 2007 to
December 2007, whereby the advance can be called by the FHLB prior to maturity.
At September 30, 2007, the Company had no outstanding borrowings from a
correspondent bank, compared to $4.5 million at September 30, 2006. This
variable rate line of credit, tied to the one month LIBOR rate plus 160 basis
points was paid off on February 28, 2007.
NOTE 9 - SUBORDINATED DEBENTURES
A trust, MFBC Statutory Trust I, formed by the Company, issued $5.0 million 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. 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, 2007, 2006 and 2005 was approximately $386,000, $333,000 and
$320,000 respectively.
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
and ceased adding new participants. As of September 30, 2007 all
participants in the ESOP were 100% vested. Employees monitor ESOP shares as
part of their 401(k) balance. Pursuant to the Pension Protection Act of 2006,
eligible employees have the ability to divest MFB Corp shares at anytime.
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, 2007, 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, 2007, 8,000
options remain available for future grants.
For the year ended September 30, 2007, stock option compensation expense of
$35,000 was recognized in connection with the option plans with related tax
benefits of $12,000. At September 30, 2007, compensation expense related to
non vested stock option grants aggregated to $43,000 and is expected to be
recognized as follows:
Stock Option Compensation
Expense (dollars in thousands)
For the fiscal years ending September 30: 2008 $ 32
2009 11
Total $ 43
NOTE 10 - EMPLOYEE BENEFITS (Continued)
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. There were no stock options granted during 2007.
<table>
<caption>
2007 2006 2005
<s> <c> <c> <c>
Risk-free interest rate - 4.60% 4.23%
Expected dividend rate - 1.68 1.96
Stock price volatility - 20.66 28.77
Estimated Life - 8 yrs 8 yrs
</table>
Activity in the Option Plans is summarized as follows:
<table>
<caption>
Weighted Weighted
Average Average
Exercise Exercise Fair Value
Options Price Price of Grants
<s> <c> <c> <c> <c>
Balance at September 30, 2006 217,110 $17.25 - $34.01 $24.89
Granted - - - $ -
Forfeited - - -
Exercised (9,990) 21.30 - 30.35 21.81
Balance at September 30, 2007 207,210 17.25 - 34.01 25.04
</table>
NOTE 10 - EMPLOYEE BENEFITS (Continued)
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:
<table>
<caption>
Weighted
Number Average
of Options Exercise Price
<s> <c> <c> <c> <c>
September 30, 2005 196,509 $23.95
September 30, 2006 210,310 24.64
September 30, 2007 201,410 24.83
</table>
At September 30, 2007 options outstanding and options exercisable were as
follows:
<table>
<caption>
Exercisable
Outstanding
Weighted Average
Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise Prices Number Life in years Price Number Price
<c> <c> <c> <c> <c> <c>
$17.25 - $18.75 3,210 3.42 18.18 3,210 18.18
$20.55 - $26.75 175,500 4.84 24.03 175,500 24.03
$30.35 - $34.01 28,500 6.87 32.03 22,700 31.95
- -------------------------------------------- -------------------- -------------------------- ------------------- ------------------
Outstanding/Exercisable 207,210 5.10 25.04 201,410 24.83
- -------------------------------------------- -------------------- -------------------------- ------------------- -------------------
- -------------------------------------------- -------------------- -------------------------- ------------------- -------------------
Aggregate
Intrinsic Value $1,100,477 $1,100,477
- -------------------------------------------- -------------------- -------------------------- ------------------- -------------------
</table>
The intrinsic value of options exercised was $124,000, $185,000 and $309,000
for the years ended September 30, 2007, 2006 and 2005. Cash received from
option exercises for the years ended September 30, 2007, 2006 and 2005 was
$216,000, $218,000 and $439,000 respectively. The actual tax benefit
realized for the tax deductions from stock options exercises totaled
$48,000, $9,000 and $15,000 for the years ending September 30, 2007, 2006 and
2005.
Continuation Agreements: On September 18, 2007, the Board of Directors of the
Bank approved a "Salary Continuation Agreement" for the President/CEO and a
"Director Fee Continuation Agreement" to provide retirement benefits to
directors in certain circumstances. Under the Salary Continuation Agreement,
if the President/CEO retires at the age of sixty, he will receive an annual
benefit in the amount of $60,000 in equal monthly installments for a period
of fifteen years. Under the Director Fee Continuation Agreement, a director
who serves the Bank for at least 5 years and who retires after reaching age
72 will receive an annual benefit for 5 years (10 years, if the director has
served for 10 or more years) equal to 50% of the total fees paid to the director
during the last year before ending service. As a result of the two approved
agreements, the Bank charged $95,000 to salaries and employee benefits and
recorded a corresponding liability of $95,000 as of September 30, 2007.
NOTE 11 - INCOME TAXES
The Company files consolidated income tax returns. Income tax expense for the
years ended September 30 are summarized as follows:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
<s> <c> <c> <c> <c>
Federal: Current $ 574 $ 467 $ 478
Deferred 302 (203) 34
876 264 511
State: Current - - 90
Deferred 103 (54) 9
103 (54) 99
Total income tax expense $ 979 $ 210 $ 611
</table>
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:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
<s> <c> <c> <c>
Income taxes at statutory rate $ 1,432 $ 808 $ 1,056
Tax effect of:
State tax, net of federal income tax effect 68 (36) 66
Low income housing credits (403) (403) (402)
Bank owned life insurance income (100) (80) (75)
Other items, net (18) (79) (34)
Total income tax expense $ 979 $ 210 $ 611
</table>
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:
<table>
<caption>
2007 2006
(Dollars in thousands)
<s> <c> <c>
Deferred tax assets
Bad debt deduction $ 2,088 $ 2,851
Low income housing credit carry-forward 619 475
Net deferred loan fees 257 279
Impairment on Investment Securities 322 322
Intangible Assets 342 271
Net operating loss carryforward 90 58
Net unrealized depreciation on securities available for sale 159 176
Other 92 74
Total deferred tax assets 3,969 4,506
Deferred tax liabilities
Accretion (106) (92)
Depreciation (168) (304)
FHLB stock dividend (217) (262)
Mortgage servicing rights (888) (920)
Goodwill (176) (125)
Partnership income (167) (133)
Other (69) (70)
Total deferred tax liabilities (1,791) (1,906)
Net deferred tax asset (liability) $ 2,178 $ 2,600
</table>
Federal income tax laws provided savings banks with additional bad debt
deductions through the tax year ended September 30, 1987, totaling $4.6
million for the Bank. Accounting standards do not require a deferred tax
liability to be recorded on this amount, which liability would otherwise
total $1.6 million at September 30, 2007 and 2006. If the Bank were liquidated
or otherwise ceases to be a bank or if tax laws change, the $1.6 million 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:
<table>
<caption>
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)
<s> <c> <c> <c> <c> <c> <c>
As of September 30, 2007
Total capital (to risk
weighted assets) $ 41,220 10.79% $ 30,550 8.00% $ 38,188 10.00%
Tier 1 (core) capital
(to risk weighted assets) 38,582 9.99 15,275 4.00 22,913 6.00
Tier 1 (core) capital (to
adjusted total assets) 38,582 7.65 20,182 4.00 25,228 5.00
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
</table>
Regulations limit the dividends that may be paid by the Bank without
prior approval of the Office of Thrift Supervision. Accordingly, at
October 1, 2007, $3.0 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:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
<s> <c> <c> <c>
Other noninterest income:
Loan servicing fees - net $ 193 $ 213 $ 126
Other service charges and fees 71 117 191
ATM foreign surcharges 47 47 49
Brokerage commissions 210 133 72
Visa interchange income 136 123 105
Partnership equity loss (245) (221) (282)
Rental income 479 563 182
Rental income - other real estate 25 150 166
Other 95 151 133
$ 1,011 $ 1,276 $ 742
2007 2006 2005
(Dollars in thousands)
Other noninterest expense:
Insurance $ 188 $ 213 $ 238
Miscellaneous Employee 238 319 274
Lending 405 292 282
Deposit 91 83 107
Wealth Management 137 118 102
Collection 146 216 197
Bad Debt and Fraud 116 100 89
Other 293 306 376
$ 1,614 $ 1,647 $ 1,665
</table>
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:
<table>
<caption>
------------------2 0 0 7---------------- ------------------2 0 0 6----------------
(Dollars in thousands)
Fixed Variable Fixed Variable
Rate Loans Rate Loans Total Rate Loans Rate Loans Total
<s> <c> <c> <c> <c> <c> <c>
Mortgage loans $ 1,555 $ 1,343 $ 2,898 $ 728 $ 3,113 $ 3,841
Commercial loans 465 - 465 146 - 146
Unused equity lines of credit 26,605 12,864 39,469 21,107 16,896 38,003
Unused commercial lines
and letters of credit - 31,057 31,057 - 31,048 31,048
Unused construction loan
lines of credit 3,551 1,380 4,931 2,392 1,850 4,242
$ 32,176 $ 46,644 $ 78,820 $ 24,373 $ 52,907 $ 77,280
</table>
Fixed rate mortgage loan commitments at September 30, 2007 are at an average
rate of 7.08% with terms primarily ranging from 15 to 30 years. There were no
commercial loan fixed rate commitments at September 30, 2007. The average
rate on variable mortgage loan commitments is 6.13% 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.
Under employment agreements with certain executive officers, certain events
leading to separation from the Company could result in cash payments totaling
$1.4 million as of September 30, 2007.
In the opinion of management, after consultation with legal counsel, the
ultimate disposition of all 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, 2006, 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 $93. 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, 2016.
NOTE 16 - BUSINESS COMBINATION
On September 28, 2007, the Company acquired certain trust assets, personal
property and contracts (the "Trust Business") of Community Trust & Investment
Company, Inc., an Indiana trust company serving the greater Indianapolis area
and Crawfordsville, Indiana. The Trust Business provides a myriad of trust
services including trust account administration under agreement and wills;
agency accounts, guardianships, estate settlement; custodial and other
standard trust services. The business also offers administration of employee
benefit and employee welfare plans and administrative service through
partnerships with established investment advisors. The Company acquired
approximately $275.0 million in trust assets and will be operating from offices
in Carmel and Crawfordsville, Indiana. The acquisition includes a group of
trust professionals that complement the Company's existing trust department.
The purchase price is based upon the fees earned and received on the trust
assets acquired during the three year period from the date of closing. The
first year's payment is 25%, the second year's payment is 20%, and the third
year payment is 15% of the fees earned and received during those periods. At
closing, the estimated purchase price approximated $660,000 and resulted in a
present value intangible asset of $610,000. This intangible asset will be
amortized on a straight line basis over ten years and will be adjusted, with
offsetting impact to the acquisition payable, as actual payments are determined.
NOTE 17 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are the condensed financial statements for the parent company,
MFB Corp.
<table>
<caption>
CONDENSED BALANCE SHEETS
September 30, 2007 and 2006
2007 2006
(Dollars in thousands)
ASSETS
<s> <c> <c>
Cash and cash equivalents $ 1,511 $ 1,533
Securities available for sale - 33
Investment in Bank subsidiary 44,593 46,834
Other assets 32 118
Total assets $ 46,136 $ 48,518
LIABILITIES
Other borrowings $ - $ 4,500
Subordinated debentures 5,000 5,000
Accrued expenses and other liabilities 79 79
Total liabilities 5,079 9,579
SHAREHOLDERS' EQUITY 41,057 38,939
Total liabilities and shareholders' equity $ 46,136 $ 48,518
</table>
<table>
<caption>
CONDENSED STATEMENTS OF INCOME
Years ended September 30, 2007, 2006 and 2005
2007 2006 2005
(Dollars in thousands)
INCOME
<s> <c> <c> <c>
Dividends from Bank subsidiary - cash $ 6,000 $ - $ -
Interest and Noninterest income 14 10 11
Total 6,014 10 11
EXPENSES
Interest expense 451 720 345
Other expenses 296 323 243
Total 747 1,043 588
Income before income taxes and
equity in undistributed (excess distributed)
net income of Bank subsidiary 5,267 (1,033) (577)
Income tax (benefit) (239) (401) (280)
Income (loss) before equity in undistributed
(excess distributed) net income
of Bank subsidiary 5,506 (632) (297)
Equity in undistributed
net income of Bank subsidiary (2,274) 2,798 2,793
Net income $ 3,232 $ 2,166 $ 2,496
</table>
(Continued)
NOTE 17 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
<table>
<caption>
CONDENSED STATEMENTS OF CASH FLOWS
Years ended September 30, 2007, 2006 and 2005
2007 2006 2005
(Dollars in thousands)
Cash flows from operating activities
<s> <c> <c> <c>
Net income $ 3,232 $ 2,166 $ 2,496
Adjustments to reconcile net income to
net cash from operating activities
Equity in undistributed net income
of Bank subsidiary 2,274 (2,798) (2,793)
Stock based compensation expense 35 103 -
Net change in other assets 134 325 (306)
Net change in accrued expenses and
other liabilities - 14 2
Net cash from operating activities 5,675 (190) (601)
Cash flows from investing activities
Maturities and calls of securities 33 95 1,000
Net cash from investing activities 33 95 1,000
Cash flows from financing activities
Purchase of MFB Corp. common stock (576) (1,486) -
Proceeds from exercise of stock options 216 218 439
Proceeds from subordinated debentures - - 5,000
Repayment of other borrowings (4,500) (2,000) (450)
Cash dividends paid (870) (714) (664)
Net cash from financing activities (5,730) (3,982) 4,325
Net change in cash and cash equivalents (22) (4,077) 4,724
Cash and cash equivalents at beginning
of year 1,533 5,610 886
Cash and cash equivalents at end of year $ 1,511 $ 1,533 $ 5,610
</table>
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,
2007 and 2006. Items which are not financial instruments are not included.
<table>
<caption>
2007 2006
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
(Dollars in thousands)
Assets
<s> <c> <c> <c> <c>
Cash and cash equivalents $ 23,470 $ 23,470 $ 16,289 $ 16,289
Other investments 9,718 9,718 10,939 10,939
Securities available for sale 33,409 33,409 58,383 58,383
Loans held for sale 612 612 - -
Loans receivable, net of
allowance for loan losses 402,458 402,780 371,992 366,561
Accrued interest receivable 2,246 2,246 2,346 2,346
Liabilities
Noninterest-bearing demand
deposits (39,043) (39,043) (30,031) (30,031)
Savings, NOW and MMDA
deposits (129,719) (129,719) (129,233) (129,233)
Time deposits (171,042) (172,307) (186,979) (186,232)
Securities sold under
agreements to repurchase (540) (540) - -
FHLB advances (124,258) (124,618) (97,053) (96,742)
Other borrowings - - (4,500) (4,500)
Subordinated Debentures (5,000) (5,000) (5,000) (5,000)
Accrued interest payable (419) (419) (855) (855)
</table>
For purposes of the above disclosures of estimated fair value, the
following assumptions were used as of September 30, 2007 and 2006. The
estimated fair value for cash and cash equivalents 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, 2007 and 2006 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, 2007 and 2006, 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
securities sold under agreements to repurchase, other borrowings,
subordinated debentures and FHLB advances is based upon estimates of the rate
the Company would pay on such deposits or borrowings at September 30, 2007 and
2006, 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.
(continued)
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, 2007 and 2006, 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, 2007 and 2006 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:
<table>
<caption>
2007 2006 2005
(Dollars in thousands)
<s> <c> <c> <c>
Net change in net unrealized gains and losses
on securities available for sale
Unrealized gains (losses) arising during
the year $ 50 $ (31) $ (679)
Reclassification adjustment for (gains) losses
included in net income - - 948
Net change in net unrealized gains
(losses) on securities available
for sale 50 (31) 269
Tax expense (benefit) 17 (1) (212)
Total other comprehensive income (loss) $ 33 $ (30) $ 481
</table>
NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<table>
<caption>
--------------Year Ended September 30, 2007--------------
(Dollars in thousands, except per share data)
1st * 2nd 3rd 4th
Quarter Quarter Quarter Quarter
<s> <c> <c> <c> <c>
Interest income $ 7,112 $ 7,337 $ 7,312 $ 7,538
Interest expense 4,052 3,988 3,888 4,002
Net interest income 3,060 3,349 3,424 3,536
Provision for loan losses (1,128) (228) (298) 397
Net interest income after provision for loan
losses 4,188 3,577 3,722 3,139
Non-interest income 1,622 1,424 1,416 1,401
Non-interest expense 4,217 3,985 4,023 4,053
Income before income taxes 1,593 1,016 1,115 487
Income tax expense 442 235 272 30
Net income $ 1,151 $ 781 $ 843 $ 457
Basic earnings (loss) per common share $ 0.87 $ 0.59 $ 0.64 $ 0.35
Diluted earnings (loss) per common share $ 0.84 $ 0.57 $ 0.62 $ 0.34
</table>
* The negative provision for loan losses during the quarter ended
December 31, 2006 was predominantly related to the repayment of two
commercial loans which previously had significant allowance for loan
loss allocations, which is discussed in Note 4 to the consolidated
financial statements.
NOTE 20 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (continued)
<table>
<caption>
--------------Year Ended September 30, 2006--------------
(Dollars in thousands, except per share data)
1st * 2nd 3rd 4th **
Quarter Quarter Quarter Quarter
<s> <c> <c> <c> <c>
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 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
</table>
* 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.
MFB CORP. AND SUBSIDIARY
DIRECTORS AND EXECUTIVE OFFICERS
September 30, 2007
MFB CORP. AND MFB FINANCIAL DIRECTORS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Robert C. Beutter (age 72) 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 73) 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 68) 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 64) has a private practice of optometry in Mishawaka.
Christine A. Lauber (age 62) 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 59) 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 59) 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 Scott A. Taylor
President and Executive Vice President and Vice President
Chief Executive Officer* Director of Wealth Management Chief Deposit Officer
Donald R. Kyle Terry L. Clark M. Gilbert Eberhart
Executive Vice President and Executive Vice President and Secretary*
Chief Operating Officer Chief Financial Officer
* Holds same position with MFB Corp.
SHAREHOLDER INFORMATION
September 30, 2007
Performance Graph
The following graph shows the performance of the Holding Company's Common Stock
since September 30, 2002, in comparison to the NASDAQ Stock market- U.S. Index
and the NASDAQ Bank Index.
-graphic omitted-
<table>
<caption>
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among MFB Corp., The NASDAQ Composite Index
And The NASDAQ Bank Index
- -----------------------------------------------------------------------------------------------------------------------------------
9/02 9/03 9/04 9/05 9/06 9/07
- -----------------------------------------------------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c>
MFB Corp. 100.00 148.89 133.41 122.63 160.22 148.51
NASDAQ Composite 100.00 150.59 162.89 185.48 196.37 236.60
NASDAQ Bank 100.00 121.09 139.12 146.31 158.08 145.74
</table>
*$100 invested on 9/30/02 in stock or index-including reinvestment of dividends.
Fiscal year ending September 30.
- --------------------------------------------------------------------------------
<page>
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
November 30, 2007, there were approximately 396 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.
<table>
<caption>
Dividend
Fiscal Quarters Ended High Trade Low Trade Declared
<s> <c> <c> <c>
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
December 31, 2006 36.19 32.25 0.165
March 31, 2007 35.20 33.00 0.165
June 30, 2007 34.64 33.00 0.165
September 30, 2007 34.58 29.75 0.165
</table>
MFB Corp. is not subject to the regulatory restrictions of the Office of
Thrift Supervision ("OTS") with respect to payment of dividends to its
shareholders, although the source of such dividends will depend in part upon
the receipt of dividends from the Bank. Applicable law restricts the
amount of dividends the Bank may pay to MFB Corp. without obtaining the prior
approval of the OTS. As discussed in Note 12 to the consolidated financial
statements, at Oct 1, 2007, $3.0 million of the Bank's retained earnings
was potentially available for distribution to MFB Corp. without obtaining prior
regulatory approval.
In addition, Indiana law generally limits the payment of dividends to
amounts that will not affect the ability of a corporation, after payment of
the dividend, to pay its debts in the ordinary course of business or exceed the
difference between the corporation's total assets and total liabilities plus
preferential amounts payable to shareholders with rights superior to those of
the holders of common stock. Further, amounts deducted for federal income tax
purposes cannot be used by the Bank to pay cash dividends without the payment
of federal income taxes, and MFB Corp. does not contemplate any distribution
by the Bank that would result in a recapture of the Bank's bad debt reserve or
otherwise create federal tax liabilities.
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
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
62
SHAREHOLDER INFORMATION
September 30, 2007
- -------------------------------------------------------------------------------
Shareholder and General Inquiries
The Company is required to file an Annual Report on Form 10-K for its fiscal
year ended September 30, 2007 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
<table>
<caption>
Office Locations
<s> <c> <c>
Corporate Headquarters Main Office Branch Office
4100 Edison Lakes Parkway 4100 Edison Lakes Parkway 25990 County Road 6
Suite 300 Suite 300 Elkhart, IN 46514
Mishawaka, IN 46545 Mishawaka, IN 46545
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 46545
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 State Road 2
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
Loan Production Office Wealth Management Office
307 West Buffalo St. 119 East Main St.
New Buffalo, MI 49117 Crawfordsville, IN 47933
</table>