UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2008
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _________________
Commission File Number: 000-50810
Monadnock Bancorp, Inc.
(Exact name of Registrant as specified in its charter)
Maryland 20-4649880
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Jaffrey Road, Peterborough, NH 03458
(Address of principal executive offices) (Zip Code)
(603) 924-9654
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definition of "large accelerated filer," "accelerated filer"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer ( ) Accelerated filer ( )
Non-accelerated filer ( ) Smaller reporting company (X)
Indicate by check mark whether the registrant is a Shell Company (as
defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
As of November 1, 2008, there were 1,293,608 shares issued and 1,163,958
shares outstanding of the issuer's common stock.
INDEX
Monadnock Bancorp, Inc. and Subsidiary
Part I. Financial Information Page
--------------------- ----
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2008
(unaudited) and December 31, 2007 3
Condensed Consolidated Statements of Income for the Three and
Nine Months Ended September 30, 2008 and 2007 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2008 and 2007 (unaudited) 5
Condensed Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 21
Part II. Other Information
-----------------
Item 1. Legal Proceedings 22
Item 1A. Risk Factors 22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits 22
SIGNATURES 23
2
MONADNOCK BANCORP, INC. AND SUBSIDIARY
--------------------------------------
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
September 30, December 31,
ASSETS 2008 2007
- ------ ------------- ------------
(Unaudited)
Cash and due from banks $ 1,045,751 $ 1,181,206
Interest-bearing demand deposits with other banks 232
Federal Home Loan Bank overnight deposit 230,000
------------ ------------
Total cash and cash equivalents 1,275,983 1,181,206
Interest-bearing time deposits in other bank 200,000 100,000
Investments in available-for-sale securities (at fair value) 35,202,691 36,595,813
Federal Home Loan Bank stock, at cost 2,221,400 1,607,700
Loans, net of allowance for loan losses of $401,838 as of
September 30, 2008 and $389,770 as of December 31, 2007 69,737,469 64,030,781
Premises and equipment 743,302 809,493
Other real estate owned 474,349
Goodwill 132,293 132,293
Core deposit intangible 47,750 61,250
Accrued interest receivable 492,336 442,749
Other assets 229,121 214,674
------------ ------------
Total assets $110,756,694 $105,175,959
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing $ 5,094,953 $ 5,286,039
Interest-bearing 53,508,943 59,531,823
------------ ------------
Total deposits 58,603,896 64,817,862
Federal Home Loan Bank advances 42,265,158 30,537,976
Other borrowings - ESOP loan 400,000
Other liabilities 429,788 383,533
------------ ------------
Total liabilities 101,698,842 95,739,371
------------ ------------
Stockholders' equity:
Preferred stock, par value $.01 per share; authorized 2,000,000 shares;
issued and outstanding none
Common stock, par value $.01 per share; authorized 10,000,000 shares;
1,293,608 shares issued at September 30, 2008 and December 31, 2007;
1,163,958 and 1,228,958 outstanding at September 30, 2008 and
December 31, 2007, respectively 12,936 12,936
Paid-in capital 7,791,138 7,755,439
Retained earnings 2,778,481 2,710,788
Unearned compensation - ESOP (402,683) (402,683)
Unearned compensation - Recognition and Retention Plan (281,684) (298,799)
Treasury stock, at cost (129,650 shares at September 30, 2008
and 64,650 shares at December 31, 2007) (842,238) (431,687)
Accumulated other comprehensive income 1,902 90,594
------------ ------------
Total stockholders' equity 9,057,852 9,436,588
------------ ------------
Total liabilities and stockholders' equity $110,756,694 $105,175,959
============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
MONADNOCK BANCORP, INC. AND SUBSIDIARY
--------------------------------------
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
-------------------------------------------
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2008 2007 2008 2007
---------- ---------- ---------- ----------
Interest and dividend income:
Interest and fees on loans $1,109,302 $1,032,659 $3,236,221 $2,932,864
Interest on investments-taxable 454,346 491,450 1,476,327 1,372,627
Other interest income 20,438 53,709 76,210 141,070
---------- ---------- ---------- ----------
Total interest and dividend income 1,584,086 1,577,818 4,788,758 4,446,561
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits 396,958 624,185 1,403,514 1,709,200
Interest on FHLB advances and other borrowings 439,695 290,971 1,247,877 841,190
---------- ---------- ---------- ----------
Total interest expense 836,653 915,156 2,651,391 2,550,390
---------- ---------- ---------- ----------
Net interest and dividend income 747,433 662,662 2,137,367 1,896,171
Provision for loan losses 44,630 13,830 128,485 58,753
---------- ---------- ---------- ----------
Net interest and dividend income
after provision for loan losses 702,803 648,832 2,008,882 1,837,418
---------- ---------- ---------- ----------
Noninterest income:
Service charges on deposits 50,295 42,597 156,236 146,169
Net (loss) gain on sales of available-for-sale securities (835) 95,617 16,081
Loan commissions 2,246
Other income 28,036 20,828 77,148 54,359
---------- ---------- ---------- ----------
Total noninterest income 77,496 63,425 329,001 218,855
---------- ---------- ---------- ----------
Noninterest expense:
Salaries and employee benefits 383,830 349,149 1,119,845 1,000,144
Occupancy expense 41,866 38,053 122,247 114,585
Equipment expense 21,960 21,647 67,630 65,173
Data processing 67,284 55,245 202,645 159,210
Blanket bond insurance 4,727 4,727 11,108 11,523
Professional fees 36,715 47,586 135,883 133,211
Supplies and printing 10,491 6,376 27,739 26,715
Telephone expense 13,670 12,609 39,220 38,403
Marketing expense 21,078 22,589 102,072 58,982
Postage expense 9,057 9,691 28,666 29,200
Other expense 131,501 81,475 357,506 257,831
---------- ---------- ---------- ----------
Total noninterest expense 742,179 649,147 2,214,561 1,894,977
---------- ---------- ---------- ----------
Income before income tax expense 38,120 63,110 123,322 161,296
Income tax expense 13,127 28,439 55,629 72,169
---------- ---------- ---------- ----------
Net income $ 24,993 $ 34,671 $ 67,693 $ 89,127
========== ========== ========== ==========
Shares used in computing net income per share:
Basic 1,072,034 1,164,567 1,101,107 1,193,040
Diluted 1,113,860 1,214,929 1,144,671 1,231,564
Net income per share - basic $ 0.02 $ 0.03 $ 0.06 $ 0.07
Net income per share - diluted $ 0.02 $ 0.03 $ 0.06 $ 0.07
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
MONADNOCK BANCORP, INC. AND SUBSIDIARY
--------------------------------------
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(UNAUDITED)
Nine Months Ended
September 30,
-----------------------------
2008 2007
------------ ------------
Cash flows from operating activities:
Net income $ 67,693 $ 89,127
Adjustments to reconcile net income to net cash provided by
operating activities:
Net gains on sales of available-for-sale securities (95,617) (16,081)
Net amortization of securities 143,926 57,196
Change in deferred loan origination costs, net 4,338 (30,310)
Provision for loan losses 128,485 58,753
Amortization of unearned compensation - restricted stock award plans 17,115
Recognition of stock option expense 35,699 25,487
Depreciation and amortization 82,647 79,898
Increase in accrued interest receivable (49,586) (45,157)
Amortization of core deposit intangible 13,500 15,750
Decrease in other assets 25,817 1,638
Decrease in loan servicing rights and interest-only strips, net 1,126 13,298
Increase in prepaid expenses (13,406) (53,709)
(Increase) decrease in taxes receivable (27,984) 7,299
Increase in taxes payable 45,772
Deferred income tax benefit (4,348) (3,124)
Increase in accrued ESOP and restricted stock award plans expense 33,075 37,658
Increase in accrued expenses 25,325 24,244
Increase in accrued interest payable 46,945 17,212
Increase in other liabilities 3,432 26,235
------------ ------------
Net cash provided by operating activities 438,182 351,186
------------ -------------
Cash flows from investing activities:
Purchase of interest-bearing time deposits in other bank (100,000)
Purchases of available-for-sale securities (25,953,550) (15,276,190)
Proceeds from sales of available-for-sale securities 17,592,883 2,645,150
Principal payments received on available-for-sale securities 9,558,614 10,265,775
Purchase of Federal Home Loan Bank stock (613,700) (160,100)
Loan originations and principal collections, net (5,417,574) (5,916,735)
Loans purchased (900,010) (821,813)
Recoveries of previously charged off loans 3,724 3,325
Capital expenditures - premises and equipment (16,457) (115,415)
------------ ------------
Net cash used in investing activities (5,846,070) (9,376,003)
------------ ------------
Cash flows from financing activities:
Net increase in demand deposits, savings and NOW deposits 4,338,929 1,500,239
Net (decrease) increase in time deposits (10,552,895) 4,358,253
Net change on short-term advances from Federal Home Loan Bank 476,000 (237,000)
Long-term advances from Federal Home Loan Bank 15,629,884 9,769,105
Payments on long-term advances from Federal Home Loan Bank (4,378,702) (6,192,000)
Refinance ESOP loan with another financial institution 400,000
Purchase of common stock for treasury (410,551) (336,928)
Purchase of 25,931 shares for MRP (176,330)
Net cash provided by financing activities 5,502,665 8,685,339
------------ ------------
5
MONADNOCK BANCORP, INC. AND SUBSIDIARY
--------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(UNAUDITED)
(continued)
Nine Months Ended
September 30,
-----------------------------
2008 2007
------------ ------------
Net increase (decrease) in cash and cash equivalents 94,777 (339,478)
Cash and cash equivalents at beginning of period 1,181,206 1,098,189
------------ ------------
Cash and cash equivalents at end of period $ 1,275,983 $ 758,711
============ ============
Supplemental disclosures:
Interest paid $ 2,604,446 $ 2,533,178
Income taxes paid 79,500 40,051
Transfer of loans to other real estate owned 474,349
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
MONADNOCK BANCORP, INC. AND SUBSIDIARY
--------------------------------------
Part I - Financial Information
Item 1. - Financial Statements
Condensed Notes to Unaudited Consolidated Financial Statements
--------------------------------------------------------------
September 30, 2008
Note 1. Nature of Business and Significant Accounting Policies
Nature of Operations: Monadnock Community Bank (the "Bank") provides a
variety of financial services to corporations and individuals from its offices
in Peterborough, New Hampshire and Winchendon, Massachusetts. The Bank is
engaged principally in the business of attracting deposits from the general
public and investing those deposits in residential and commercial real estate
loans, and in consumer and small business loans. On June 28, 2004, in
accordance with a Plan of Mutual Holding Company Reorganization and Stock
Issuance, the Bank became a federally chartered stock bank and wholly-owned
subsidiary of Monadnock Community Bancorp, Inc., a federally chartered stock
holding company. Monadnock Community Bancorp, Inc. became a majority owned
subsidiary of Monadnock Mutual Holding Company, a federally chartered mutual
holding company. On June 28, 2006, in accordance with a Plan of Conversion and
Reorganization, the Bank became the wholly-owned subsidiary of Monadnock
Bancorp, Inc. (the "Company"), a Maryland chartered stock holding company.
Further, Monadnock Mutual Holding Company sold its ownership interest in
Monadnock Community Bancorp, Inc. to the public in a "second step" offering and
ceased to exist. The Company sold 707,681 shares, par value of $.01 per share
or the maximum of the offering range, to the public raising $4.8 million in net
proceeds. As part of the conversion, existing public stockholders of Monadnock
Community Bancorp, Inc. received 1.3699 shares of Company common stock in
exchange for each of their existing shares of Monadnock Community Bancorp, Inc.
common stock.
Basis of Presentation: The consolidated financial statements presented in
this quarterly report include the accounts of the Bank and the Company. The
consolidated financial statements of the Company have been prepared in
conformity with accounting principles generally accepted in the United States
of America ("GAAP") for interim financial information and predominant practices
followed by the financial services industry, and are unaudited. Interim
statements are subject to possible adjustment in connection with the annual
audit of the Company for the year ending December 31, 2008. In the opinion of
the Company's management, all adjustments consisting of normal recurring
accruals necessary 1) for a fair presentation of the financial condition and
results of operations for the interim periods included herein have been made
and 2) in order to make the financial statements not misleading have been made.
The results of operations for the three and nine month periods ended
September 30, 2008 are not necessarily indicative of the results of operations
that may be expected for any other interim period or for the year ending
December 31, 2008. Certain information and note disclosures normally included
in the Company's annual financial statements have been condensed or omitted.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-KSB for
the year ended December 31, 2007.
Use of Estimates: The preparation of the consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect amounts reported in the consolidated financial
statements. Changes in these estimates and assumptions are considered
reasonably possible and may have a material impact on the financial statements
and thus actual results could differ from the amounts reported and disclosed
herein. The Company considers the allowance for loan losses, the amortization
of loan purchase premiums and amortization of mortgage-backed purchase premiums
on investment securities to be critical accounting estimates.
At September 30, 2008, there were no material changes in the Company's
significant accounting policies or critical accounting estimates from those
disclosed in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2007.
Note 2. Earnings Per Share
Basic earnings per share is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance. Weighted average options to purchase 73,102 shares, 73,102 shares and
128,437 shares of common stock were outstanding during the first, second and
third quarters of 2008, respectively, compared with weighted average options to
purchase 2,602 shares of common stock were outstanding for the first, second
and third quarters of 2007, but were not included in the computation of
weighted average common shares outstanding for purposes of computing diluted
earnings per share, because the effect would have been antidilutive.
7
Note 3. Investments
The Company classifies its investments in debt securities as securities
held-to-maturity, securities available-for-sale or trading securities.
Securities held-to-maturity are carried at amortized cost, securities
available-for-sale are carried at fair value with unrealized gains and losses
shown in accumulated other comprehensive income (loss) as a separate component
of stockholders' equity, net of related tax effects, and trading securities are
carried at fair value with unrealized gains and losses reflected in earnings.
The Company had no securities classified as held-to-maturity or trading
securities during 2008 or 2007.
The amortized cost and estimated fair value of securities at September
30, 2008 and December 31, 2007 are as follows:
Amortized Estimated
Cost Basis Fair Value
----------- -----------
September 30, 2008:
Mortgage-backed securities:
Fannie Mae $13,018,352 $13,035,823
Freddie Mac 14,499,225 14,469,838
Ginnie Mae 7,681,964 7,697,030
----------- -----------
Total mortgage-backed securities 35,199,541 35,202,691
----------- -----------
Total investments in available-for-sale securities $35,199,541 $35,202,691
=========== ===========
December 31, 2007:
Mortgage-backed securities:
Fannie Mae $13,639,059 $13,752,814
Freddie Mac 8,370,811 8,397,971
Ginnie Mae 14,435,927 14,445,028
----------- -----------
Total mortgage-backed securities 36,445,797 36,595,813
----------- -----------
Total investments in available-for-sale securities $36,445,797 $36,595,813
=========== ===========
Note 4. Loans
Loans consist of the following at:
September 30, December 31,
2008 2007
------------- ------------
One- to four-family residential $32,691,079 $31,526,555
Home equity 5,715,974 5,350,078
Commercial real estate 15,926,461 14,693,410
Multifamily 1,197,412 1,704,787
Construction and land development loans 549,361 1,141,352
Commercial loans 10,319,717 7,065,867
Consumer loans 3,412,288 2,607,149
----------- -----------
69,812,292 64,089,198
Allowance for loan losses (401,838) (389,770)
Deferred costs, net 327,015 331,353
----------- -----------
Net loans $69,737,469 $64,030,781
=========== ===========
Interest on loans is accrued and credited to operations based upon the
principal amount outstanding. When management determines that significant doubt
exists as to the collectibility of principal or interest on a loan, the loan is
placed on nonaccrual status. In addition, loans past due 90 days or more as to
principal or interest are placed on nonaccrual status, except for those loans
which, in management's judgment, are fully secured and in the process of
collection. Interest accrued but not received on loans placed on nonaccrual
status is reversed and charged against current operations. Interest
subsequently received on nonaccrual loans is either applied against principal
or recorded as income according to management's judgment as to the
collectibility of principal.
Loans considered to be uncollectible are charged against the allowance
for loan losses. The allowance is increased by charges to current operations in
amounts sufficient to maintain the adequacy of the allowance. The adequacy of
the allowance is determined by management's evaluation of the extent of losses
inherent in the loan portfolio and prevailing economic conditions.
8
Changes in the allowance for loan losses are as follows:
Nine months ended
September 30,
-----------------------
2008 2007
-------- --------
Balance at beginning of period $389,770 $334,917
Recoveries of loans previously charged off 3,724 3,325
Provision for loan losses 128,485 58,753
Charge offs (120,141) (14,332)
-------- --------
Balance at end of period $401,838 $382,663
======== ========
Information with respect to impaired loans consisted of the following at:
September 30, December 31,
2008 2007
------------- ------------
Recorded investment in impaired loans $510,732 $269,725
======== ========
Impaired loans with specific loss allowances
$130,958 $242,804
======== ========
Loss allowances reserved on impaired loans $ 57,824 $ 37,448
======== ========
The Company's policy for interest income recognition on impaired loans is
to recognize income on impaired loans on the cash basis when the loans are both
current and the collateral on the loan is sufficient to cover the outstanding
obligation to the Company; if these factors do not exist, the Company will not
recognize income. The average recorded investment in impaired loans was
$498,000 and $205,000 for the nine months ended September 30, 2008 and 2007,
respectively. During the three and nine months ended September 30, 2008 and
2007, the Company recognized no income on impaired loans.
Note 5. Deposits
Interest-bearing deposits consisted of the following at:
September 30, December 31,
2008 2007
------------- ------------
NOW accounts $12,257,155 $ 7,613,526
Savings accounts 2,615,908 2,448,071
Money market deposit accounts 8,063,147 8,344,598
Time certificates 30,572,733 41,125,628
----------- -----------
$53,508,943 $59,531,823
=========== ===========
Note 6. Fair Value Measurement Disclosures
As of January 1, 2008, we adopted SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and enhances
disclosures about fair value measurements for financial assets and financial
liabilities. In accordance with Financial Accounting Standards Board ("FASB")
Staff Position No. 157-2, "Effective Date of FAS Statement No. 157," we have
delayed the application of SFAS No. 157 for nonfinancial assets, such as
goodwill and real property held for sale, and nonfinancial liabilities until
January 1, 2009.
The fair value hierarchy established by SFAS No. 157 is based on
observable and unobservable inputs participants use to price an asset or
liability. SFAS No. 157 has prioritized these inputs into the following fair
value hierarchy:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical
assets or liabilities that are available at the measurement date.
Level 2 Inputs - Inputs other than quoted prices included within Level 1
that are observable for the asset or liability, either directly or indirectly.
These might include quoted prices for similar assets or liabilities in active
markets, quoted prices for identical or similar assets or liabilities in
markets that are not active, inputs other than quoted prices that are
observable for the asset or liability (such as interest rates, volatilities,
prepayment speeds, credit risks, etc.) or inputs that are derived principally
from or corroborated by market data by correlation or other means.
9
Level 3 Inputs - Unobservable inputs for determining the fair value of
the asset or liability and are based on the entity's own assumptions about the
assumptions that market participants would use to price the asset or liability.
A description of the valuation methodologies used for instruments
measured at fair value, as well as the general classification of such
instruments pursuant to the valuation hierarchy is set forth below. These
valuation methodologies were applied to all of the Company's financial assets
and liabilities carried at fair value effective January 1, 2008.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Securities available-for-sale. The fair value of our securities
available-for-sale portfolio was estimated using Level 2 inputs. We obtain fair
value measurements from an independent pricing service. The fair value
measurements consider observable data that may include dealer quotes, market
spreads, cash flows, market consensus prepayment speeds, credit information,
and the bond's term and conditions, among other factors. At September 30, 2008,
the carrying value and estimated fair value, using Level 2 inputs, of our
securities available-for-sale was $35.2 million.
10
Monadnock Bancorp, Inc. and Subsidiary
Part I - Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
September 30, 2008
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements,
which are based on assumptions and describe future plans, strategies and
expectations of Monadnock Bancorp, Inc. (or the "Company") and its wholly owned
subsidiary, Monadnock Community Bank (or the "Bank"). These forward-looking
statements are generally identified by use of the words "believe," "expect,"
"intend," "anticipate," "estimate," "project," or similar words. Our ability to
predict results or the actual effect of future plans or strategies is
uncertain. Factors which could have a material adverse effect on our operations
include, but are not limited to, changes in interest rates, general economic
conditions, economic conditions in the states of New Hampshire or
Massachusetts, legislative and regulatory changes, monetary and fiscal policies
of the U.S. Government, including policies of the U.S. Treasury and the Federal
Reserve Board, fiscal policies of the New Hampshire or Massachusetts State
Government, the quality or composition of our loan or investment portfolios,
demand for loan products, competition for and the availability of loans that we
purchase for our portfolio, deposit flows, competition, demand for financial
services in our market areas and accounting principles and guidelines,
acquisitions and the integration of acquired businesses, asset-liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity.
We wish to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. We wish to
advise readers that the factors listed above could affect our financial
performance and could cause our actual results for future periods to differ
materially from any opinions or statements expressed with respect to future
periods in any current statements. We do not undertake and specifically decline
any obligation to publicly release the result of any revisions which may be
made to any forward-looking statements to reflect events or circumstances after
the date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
General
The following discussion is intended to assist in understanding the
financial condition and results of operations of Monadnock Bancorp, Inc. and
Monadnock Community Bank. On June 28, 2006, Monadnock Bancorp, Inc. succeeded
Monadnock Community Bancorp, Inc. as the holding company of Monadnock Community
Bank. The information contained in this section should be read in conjunction
with other sections of management discussion and analysis, including these
consolidated financial statements.
As a community based financial institution, our principal business has
historically consisted of attracting deposits from the general public and the
business community and making loans secured by various types of collateral,
including residential and commercial real estate and general business assets.
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, interest rate levels, the number and quality of lenders, and
regional economic cycles. Our sources of funds for lending activities include
deposits, borrowings, payments on loans, maturities and principal payments on
securities and income provided from operations.
Our earnings are primarily dependent upon our net interest income, which
is the difference between interest and dividend income on interest-earning
assets, which principally consist of loans and investment securities, and
interest expense on interest-bearing liabilities, which principally consist of
deposits and borrowings. Our results of operations also are affected by the
level of our provision for loan losses, non-interest income and non-interest
expense. Non-interest income consists primarily of service charges on deposit
accounts, point of sale income from debit and credit transactions, ATM fees and
any gain on sale of loans and investments. Non-interest expense consists
primarily of salaries and employee benefits, occupancy, equipment, data
processing and ATM expense. Our results of operations may also be affected
significantly by general and local economic and competitive conditions, changes
in market interest rates, governmental policies, Federal Home Loan Bank
("FHLB") dividend policies, Federal Deposit Insurance Corporation ("FDIC")
assessment rates and actions of regulatory authorities.
Management Strategy
Our strategy is to operate as an independent financial institution
dedicated to serving the needs of customers in our market area, which consists
of western Hillsborough, eastern Cheshire counties in New Hampshire and
northern Worcester county in Massachusetts. We intend to continue to increase
our loan portfolio and to attract retail deposits, with the goal of
11
expanding our deposit base. This growth may include the establishment of a new
office, either by acquisition or by exploring opportunities in our market area
although we currently have no arrangements or understandings regarding any
specific transaction. On June 28, 2006, we completed our conversion to full
stock ownership in order to raise additional capital to continue our growth.
Our commitment is to provide a reasonable range of products and services
to meet the needs of our customers. Our goal is to grow Monadnock Bancorp, Inc.
while providing cost effective services to our market area and leveraging our
infrastructure.
Financial highlights of our strategy include:
Operating as a Community Savings Bank and Offering Personalized Customer
Service. We are committed to meeting the financial needs of the communities in
which we operate. We provide a broad range of individualized consumer and
business financial services. We believe that we can be more effective in
servicing our customers than many of our non-local competitors because our
employees and senior management are able to respond promptly to customer needs
and inquiries. Our ability to provide these services is enhanced by the
experience of our senior management, which has an average of nearly 30 years'
experience in the financial services industry.
Increasing Loan Production. Our strategy of increasing net income
includes increasing our loan production. Our business plan anticipates that we
may emphasize originating commercial real estate, both permanent and
construction, commercial business loans and one- to four-family residential
real estate loans. Commercial real estate and commercial business loans provide
higher returns but involve a greater degree of credit risk than one- to
four-family residential mortgage loans. Because payments on these loans are
often dependent on the successful operation or management of the properties or
business, repayment of such loans may be subject to adverse conditions in the
real estate market or the economy. Our net loan portfolio increased $9.3
million, or 15.4%, from $60.4 million at September 30, 2007 to $69.7 million at
September 30, 2008. We plan to continue to grow our loan portfolio with the net
proceeds raised in the 2006 stock offering.
Building Core Deposits. We offer checking accounts, NOW accounts and
savings accounts, which generally are lower cost sources of funds than
certificates of deposit and are less sensitive to withdrawal when interest
rates fluctuate. In order to build our core deposit base, we intend to continue
to offer a broad range of deposit products and to increase our core deposits
through possible branch acquisitions, or the establishment of a new office
although we currently have no arrangements or understandings regarding any
specific transaction. In an effort to increase core deposits and become more
competitive, the Bank implemented a Reward Checking account product in October
2007. At September 30, 2008, this product totaled $9.2 million.
Maintaining Asset Quality. Our asset quality is reflected in our ratio of
non-performing assets to total assets, which was 0.89% at September 30, 2008
and 0.26% at December 31, 2007, respectively. The increase in nonperforming
assets was primarily attributable to the following: 1) a commercial loan
relationship secured by an inn for $474,000 which was transferred to other real
estate owned at the end of the second quarter of 2008 and 2) a commercial loan
relationship secured by a convenience store and gas station being placed on
nonperforming status at the end of the third quarter of 2008. Management is
striving to continue to maintain good asset quality. We have introduced new
loan products only when we were confident that our staff had the necessary
expertise and sound underwriting and collection procedures were in place. In
addition to these lending practices, we invest in high grade securities.
Improving Non-Interest Income. Non-interest income consists primarily of
service charges on deposit accounts, point of sale income from debit and credit
transactions, ATM fees and any gain on sale of loans and investments. We plan
to target programs to increase non-interest income such as the overdraft
checking program we instituted in December 2005.
Improving Our Efficiency Ratio. Our infrastructure and fixed operating
costs can support a larger asset base. We believe the conversion and offering
described above has slowly allowed us to increase our asset base through
greater loan production which should help improve our efficiency ratio
(non-interest expense divided by net-interest income and non-interest income)
by generating additional income. Our efficiency ratio was 89.97% and 89.79% for
the three and nine months ended September 30, 2008, respectively, compared with
89.40% and 89.60% for the three and nine months ended September 30, 2007,
respectively.
All of these initiatives are designed to improve our profitability in
future years.
12
Changes in Financial Condition from December 31, 2007 to September 30, 2008
General. Total assets increased $5.6 million, or 5.3%, to $110.8 million
at September 30, 2008 compared with $105.2 million at December 31, 2007. We
increased our assets by $12.0 million during the first quarter of 2008, by
leveraging with $12.4 million in Federal Home Loan Bank advances and purchasing
net investment securities of $10.5 million during the first quarter of 2008 to
take advantage of positive interest rate spreads. During the second and third
quarters of 2008, we reduced our total assets by $6.4 million, thereby
increasing our Tier1 leverage capital ratio to 7.87% at September 30, 2008.
Investments. Monadnock Bancorp, Inc. classifies its investments in debt
securities as securities held-to-maturity, securities available-for-sale or
trading securities. Securities held-to-maturity are carried at amortized cost,
securities available-for-sale are carried at fair value with unrealized gains
and losses shown in accumulated other comprehensive income (loss) as a separate
component of stockholders' equity, net of related tax effects, and trading
securities are carried at fair value with unrealized gains and losses reflected
in earnings. Monadnock Bancorp, Inc. had no securities classified as
held-to-maturity or trading securities at September 30, 2008 or at December 31,
2007.
Our investment portfolio decreased $1.4 million, or 3.8%, to $35.2
million at September 30, 2008 from $36.6 million at December 31, 2007. The
decrease was due to $17.6 million in sales of mortgage-backed securities and
$9.6 million in principal paydowns of mortgage-backed securities, partially
offset by the purchase of $26.0 million in mortgage-backed securities. The
decrease in investment securities was used to partially fund net loan growth
for the nine months of 2008.
At September 30, 2008, the weighted average maturity of mortgage-backed
securities available-for-sale was 313 months, based upon their final
maturities. However, normal principal repayments and prepayments of
mortgage-backed securities are received regularly, substantially reducing their
weighted average maturities. All of our mortgage-backed securities are
adjustable with a weighted average term to next repricing adjustment of 28
months on average.
Loans. Our net loan portfolio grew by $5.7 million, or 8.9%, to $69.7
million at September 30, 2008 from $64.0 million at December 31, 2007. Loan
growth during the nine months ended September 30, 2008 was primarily
concentrated in commercial, commercial real estate and one- to four-family
residential loans which grew $3.3 million, $1.2 million and $1.2 million,
respectively. Other significant loan increases for the nine months ended
September 30, 2008 were in consumer loans of $805,000 and home equity loans of
$366,000 which was partially offset by a decrease in construction and land
development loans of $592,000 and multifamily real estate loans of $507,000.
Deposits. Our total deposits decreased $6.2 million, or 9.6%, to $58.6
million at September 30, 2008 from $64.8 million at December 31, 2007.
Interest-bearing deposits decreased $6.0 million to $53.5 million at September
30, 2008 from $59.5 million at December 31, 2007, while noninterest-bearing
deposits decreased $191,000 during the nine months ended September 30, 2008.
The decrease in interest-bearing deposits was primarily due to a decrease in
time certificates of $10.6 million, partially offset by an increase in NOW
accounts of $4.6 million. The decrease in time certificates was due to a $3.9
million decrease in time certificates over $100,000 as well as customers
transferring these deposits to other deposit products at the Bank and interest
rate sensitive customers leaving due to competitive rates being offered
elsewhere. Overall, deposit accounts $100,000 or greater decreased $5.9 million
during the nine months of 2008 to $12.7 million as customers transferred
deposits to other financial institutions to ensure their deposits were FDIC
insured as a result of the recent financial crisis. The increase in NOW
accounts during the first nine months of 2008 was due to the implementation of
our Rewards Checking account product in the fourth quarter of 2007. Rewards
Checking accounts increased $5.8 million during the first nine months of 2008
and totaled $9.2 million at September 30, 2008.
Borrowings. FHLB advances increased $11.8 million, or 38.7%, to $42.3
million at September 30, 2008 from $30.5 million at December 31, 2007. The
increase in FHLB advances was used to fund the purchase of net investment
securities, and to a lesser extent, net loan growth during the first quarter of
2008.
Principal payments due on other borrowings after September 30, 2008 are
$589,000 in 2008, $5.4 million in 2009, $7.3 million in 2010, $5.7 million in
2011, $7.3 million in 2012 and $16.0 million in years thereafter. The FHLB will
require the repayment of $4.0 million of borrowings during 2008 if the
three-month LIBOR exceeds specified rates; $3.0 million of which is at a
weighted average interest rate of 3.04% maturing in 2009 if the three-month
LIBOR exceeds 6.50%. Additionally, the FHLB will require the repayment of $1.0
million of borrowings during 2008 if the three-month LIBOR exceeds 6.50% of
which borrowings is at an interest rate of 3.99% maturing in 2014. As of
September 30, 2008, the three month LIBOR was at 4.05%. During the first nine
months of 2008, the Bank borrowed an additional $6.0 million in callable
advances from the FHLB. These advances are callable at the discretion of the
FHLB on the call date noted and most are
13
callable continuously on a quarterly basis thereafter. The FHLB has the right
to call $7.0 million in borrowings during 2008, of which borrowings have a
weighted average interest rate of 4.08% and a weighted average maturity of 88
months. The FHLB has the right to call $2.0 million in borrowings during 2009,
of which borrowings have a weighted average interest rate of 3.08% and a
weighted average maturity of 51 months. The FHLB has the right to call $3.0
million in borrowings during 2010, of which borrowings have a weighted average
interest rate of 2.90% and a weighted average maturity of 52 months. In
addition, the FHLB has the right to call $2.0 million in borrowings during
2011, of which borrowings are at a weighted average interest rate of 3.17% and
maturity of 85 months. Should the FHLB require repayment of the putable and
callable borrowings on the put and call dates, the interest cost to replace
such borrowings would likely increase.
Stockholders' Equity. Total stockholders' equity decreased $379,000 to
$9.06 million at September 30, 2008 from $9.44 million at December 31, 2007.
The decrease in stockholders' equity was primarily attributable to the
repurchase of 65,000 shares of common stock for treasury for approximately
$411,000 and a decrease in accumulated other comprehensive income of $89,000,
partially offset by net income of $68,000 for the nine months ended September
30, 2008 and a $53,000 increase related to the recognition of stock option
expense as well as restricted stock award amortization. Our equity to assets
ratio was 8.18% at September 30, 2008 compared to 8.97% at December 31, 2007.
Comparison of Results of Operations for the Three Months Ended
September 30, 2008 and 2007
General. We recorded net income of $25,000 for the quarter ended
September 30, 2008 compared with net income of $35,000 for the quarter ended
September 30, 2007. The decrease in earnings for the three months ended
September 30, 2008 compared with the same period a year earlier was primarily
attributable to an increase in noninterest expense of $93,000, an increase in
the provision for loan losses of $31,000, partially offset by an increase in
net interest and dividend income of $84,000, an increase in noninterest income
of $14,000 and a decrease in income tax expense of $15,000.
Our profitability has been marginal during the last few years primarily
due to our high fixed operating costs in relation to the amount of net interest
and dividend income and non-interest income we generated and our comparatively
low net interest margin (net interest and dividend income divided by average
interest earning assets). Our efficiency ratio was 89.97% for the three months
ended September 30, 2008 compared to 89.40% for the three months ended
September 30, 2007. The existing operating platform we have in place relative
to the size of our customer base and asset base has tended to negatively impact
our profitability. Our interest rate spread was 2.32% for the three months
ended September 30, 2008 compared to 2.05% for the three months ended September
30, 2007 and 2.18% for the three months ended June 30, 2008. The increase in
the interest rate spread for the three months ended September 30, 2008 compared
with the same period a year ago was primarily due to a decrease in the average
cost of our interest-bearing liabilities by 73 basis points to 3.42% for the
three months ended September 30, 2008 compared to 4.15% for the three months
ended September 30, 2007, partially offset by a decrease of 46 basis points in
the average yield of our interest-earning assets to 5.74% for the three months
ended September 30, 2008 from 6.20% for the three months ended September 30,
2007. The decrease in our average yields on interest-earning assets as well as
the decrease in our average costs on interest-bearing liabilities was primarily
due to the Federal Reserve's decision to lower the Federal funds rate by 325
basis points since September 2007. The net interest margin for the three months
ended September 30, 2008 was 2.71% compared to 2.61% for the three months ended
September 30, 2007 and 2.58% for the three months ended June 30, 2008. During
the third quarter of 2008, we were able to improve our net interest margin and
interest rate spread compared with the second quarter of 2008 and the third
quarter of 2007 primarily due to the favorable repricing of our time
certificates to lower rates during the third quarter of 2008. In the event we
are unable to generate continued commercial and residential loan volume for the
remainder of 2008, or become reliant on investments in securities, certificates
of deposit or FHLB borrowings, our net interest margin may be negatively
impacted along with our net earnings potential.
Net Interest and Dividend Income. Net interest and dividend income
increased $84,000, or 12.7%, to $747,000 for the three months ended September
30, 2008 compared to $663,000 for the three months ended September 30, 2007.
This increase reflected a $6,000 increase in interest and dividend income, and
a $78,000, or 8.5%, decrease in interest expense. The increase in net interest
and dividend income of $84,000 was primarily due to a decrease in the average
cost of our interest-bearing liabilities by 73 basis points to 3.42% for the
three months ended September 30, 2008 compared to 4.15% for the three months
ended September 30, 2007.
Interest and Dividend Income. Total interest and dividend income was
stable at $1.6 million for both the three months ended September 30, 2008 and
the three months ended September 30, 2007. Interest income on loans increased
$76,000, or 7.4%, to $1.1 million for the three months ended September 30, 2008
from $1.0 million for the same period in 2007, primarily due to a $9.5 million
increase in the average balance of loans from $60.1 million for the three
months ended September 30, 2007 to $69.6 million for the same period in 2008.
This increase in interest income on loans was partially offset by a decrease in
loan yields from 6.82% for the three months ended September 30, 2007 to 6.34%
for the same period
14
in 2008. The increase in the average balance of loans was primarily
attributable to an increase in the average balance of $5.5 million in
commercial real estate and commercial loans, a $2.9 million increase in the
average balance of one- to four-family residential loans as well as a $806,000
increase in the average balance of consumer loans which was primarily related
to mobile home loan financing. The decrease in average loan yields was due to
the repricing of some adjustable rate loans downward due to a decrease in the
prime rate of 3.25% since September 2007. Interest income on investment
securities, FHLB stock and interest-bearing deposits with other financial
institutions decreased $70,000 for the three months ended September 30, 2008 to
$475,000 from $545,000 for the three months ended September 30, 2007. The
decrease was primarily due to a decrease in the overall yield on total
investments from 5.30% for the three months ended September 30, 2007 to 4.69%
for the same period in 2008.
Interest Expense. Total interest expense decreased by $78,000, or 8.5%,
to $837,000 for the three months ended September 30, 2008 from $915,000 for the
three months ended September 30, 2007. The decrease of $78,000 was primarily
due to a decrease in the average cost of our interest-bearing liabilities by 73
basis points to 3.42% for the three months ended September 30, 2008 compared to
4.15% for the three months ended September 30, 2007. Interest expense on
deposits decreased $227,000 to $397,000 for the three months ended September
30, 2008 from $624,000 for the same period in 2007. Interest expense on time
certificates decreased $293,000 to $260,000 for the three months ended
September 30, 2008 from $553,000 for the same period in 2007 while interest
expense on savings deposits increased by $66,000 to $137,000 for the three
months ended September 30, 2008 from $71,000 for the same period in 2007. The
decrease in interest expense on time certificates was attributable to a
decrease in the overall average cost of time certificates by 145 basis points
to 3.42% for the three months ended September 30, 2008 from 4.87% for the same
period in 2007, coupled with a decrease in the average balance of time
certificates of $14.9 million to $30.1 million for the three months ended
September 30, 2008 from $45.0 million for the same period in 2007. The decrease
in the cost of time certificates was the direct result of maturing time
certificates repricing at lower rates during the third quarter of 2008 due to
the lower interest rate environment. The decrease in the average balance of
time certificates was due to customers transferring these deposits to other
Bank deposit products and interest rate sensitive customers withdrawing their
deposits due to competitive rates being offered elsewhere. The decrease in the
average balance of time certificates was also attributable to customers
transferring deposits to other financial institutions to ensure their deposits
were FDIC insured as a result of the recent financial crisis. The increase in
interest expense on savings deposits was attributable to an increase in the
average balance of savings deposits of $7.6 million to $23.9 million for the
three months ended September 30, 2008 from $16.3 million for the same period in
2007, and to a lesser extent, an increase of 55 basis points on the average
cost of savings deposits to 2.29% for the three months ended September 30, 2008
from 1.74% for the same period in 2007. The increase in the average balance and
cost on savings deposits for the three months ended September 30, 2008 compared
to the same period in 2007 was primarily attributable to the introduction of a
Rewards Checking product in October 2007.
Interest expense on FHLB advances and other borrowings increased
$149,000, or 51.2%, to $440,000 for the three months ended September 30, 2008
from $291,000 for the three months ended September 30, 2007. The increase in
interest expense was due to an increase in the average balance of FHLB advances
and other borrowings of $17.4 million to $43.4 million for the three months
ended September 30, 2008 from $26.0 million for the same period in 2007,
partially offset by a decrease in borrowing cost to 4.03% for the three months
ended September 30, 2008 from 4.43% for the same period in 2007. We used the
additional funding from the increase in FHLB advances to increase our net loan
portfolio as well as fund deposit outflows. The decrease in borrowing cost was
due to the Bank using a mix of fixed rate and callable borrowings to lower the
overall funding cost for FHLB advances and other borrowings.
Provision for Loan Losses. We recorded a provision for loan losses of
$45,000 for the three months ended September 30, 2008 compared with $14,000 for
the three months ended September 30, 2007. The increase in the provision for
loan losses was due to an increase in the level of net charge-offs to $24,000
for the three months ended September 30, 2008, compared with $5,000 for the
three months ended September 30, 2007. In addition, the increase in the
provision was necessary due to additional credit weakness in our evaluation of
a commercial loan for a retail sporting goods establishment for the third
quarter of 2008 which was partially offset by the classification of certain
loans into more favorable risk ratings during 2008 due to the seasoning of real
estate owner occupied first mortgage loans. The allowance for loan losses as a
percent of total loans was 0.58% at September 30, 2008 compared with 0.63% at
September 30, 2007. The mix of the loan portfolio continues to be weighted in
one- to four-family residential and home equity loans which accounted for 55.0%
and 59.5% of total loans at September 30, 2008 and 2007, respectively. These
loans generally have a lower credit risk allocation and the portfolio has
reduced levels of criticized and classified loans. Our methodology for
analyzing the allowance for loan losses consists of specific and general
components. The specific components relates to loans that are classified as
doubtful, substandard or special mention. For such loans that are also
classified as impaired, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience and
quantitative and qualitative factors unique to the Bank for consumer,
residential and commercial loans. The allowance for loan losses as of
15
September 30, 2008 was maintained at a level that represents management's best
estimate of losses inherent in the loan portfolio. Although we believe that we
have established the allowance for loan losses at levels to absorb probable and
estimable losses, future additions or deductions may be necessary if economic
or other conditions in the future differ from the current environment.
Total Noninterest Income. Noninterest income increased $14,000, or 22.2%,
to $77,000 for the three months ended September 30, 2008 from $63,000 for the
three months ended September 30, 2007. The increase was primarily attributable
to an increase in service charges on deposits of $7,000 as well as an increase
in income related to debit, credit and ATM transactions.
Total Noninterest Expense. Noninterest expense increased $93,000, or
14.3% to $742,000 for the three months ended September 30, 2008 compared with
$649,000 for the three months ended September 30, 2007. Salaries and employee
benefits expense increased $35,000 from $349,000 for the three months ended
September 30, 2007 to $384,000 for the three months ended September 30, 2008.
The increase in salaries and employee benefits expense related to salary
increases, an increase in benefit costs for medical coverage as well as an
increase in ESOP costs, partially offset by an increase in the deferrals of
loan origination costs. Other increases in noninterest expense related to an
increase of $51,000 in other expenses. The increase in other expenses was
related to higher FDIC assessment premiums in 2008 compared with 2007, $17,000
of additional expense related to the maintenance of the Bank's other real
estate owned property as well as additional ongoing expenses related to the
Rewards Checking product. On October 7, 2008, the Board of Directors of the
FDIC proposed a restoration plan for the Deposit Insurance Fund which would
raise the assessment rate schedule uniformly by seven basis points (annualized)
beginning January 1, 2009. The FDIC will also adjust the base assessment based
on an institution's level of unsecured debt, secured liabilities and brokered
deposits. As a result, the Bank may also be subject to additional assessments
since the Bank's FHLB advances exceed 15% of domestic deposits. There can be no
assurance that the proposed rule will be implemented by the FDIC in its
proposed form. The increase in FDIC assessments may have a negative effect on
the Bank's earnings for 2009.
Income Tax Expense. Income tax expense decreased $15,000 to $13,000 for
the third quarter of 2008 from $28,000 for the third quarter of 2007 due to
lower pre-tax income. The effective tax rate was 34.4% for the third quarter of
2008 compared to 45.1% for the third quarter of 2007.
Comparison of Results of Operations for the Nine Months Ended
September 30, 2008 and 2007
General. We recorded net income of $68,000 for the nine months ended
September 30, 2008 compared with net income of $89,000 for the nine months
ended September 30, 2007. The decrease in earnings for the nine months ended
September 30, 2008 compared with the same period a year earlier was primarily
attributable to an increase in noninterest expense of $320,000, an increase in
the provision for loan losses of $69,000, partially offset by an increase in
net interest and dividend income of $241,000, an increase in noninterest income
of $110,000 and a decrease in income tax expense of $16,000.
Our profitability has been marginal during the last few years primarily
due to our high fixed operating costs in relation to the amount of net interest
and dividend income and non-interest income we generated and our comparatively
low net interest margin (net interest and dividend income divided by average
interest earning assets). Our efficiency ratio was 89.79% and 89.60% for the
nine months ended September 30, 2008 and the nine months ended September 30,
2007, respectively. The existing operating platform we have in place relative
to the size of our customer base and asset base has tended to negatively impact
our profitability. Our interest rate spread was 2.18% for the nine months ended
September 30, 2008 compared to 2.05% for the nine months ended September 30,
2007. The increase in the interest rate spread for the nine months ended
September 30, 2008 compared with the same period a year ago was primarily due
to a decrease in the average cost of our interest-bearing liabilities by 48
basis points to 3.62% for the nine months ended September 30, 2008 compared to
4.10% for the nine months ended September 30, 2007, partially offset by a
decrease of 35 basis points in the average yield of our interest-earning assets
to 5.80% for the nine months ended September 30, 2008 from 6.15% for the nine
months ended September 30, 2007. The decrease in our average yield on
interest-earning assets as well as the decrease in our average cost on
interest-bearing liabilities was primarily due to the Federal Reserve's
decision to lower the Federal Funds rate by 325 basis points since September
2007. The net interest margin for the nine months ended September 30, 2008 was
2.59% compared to 2.62% for the nine months ended September 30, 2007. In the
event we are unable to generate continued commercial and residential loan
volume for the remainder of 2008, or become reliant on investments in
securities, certificates of deposit or FHLB borrowings, our net interest margin
may be negatively impacted along with our net earnings potential.
16
Net Interest and Dividend Income. Net interest and dividend income
increased $241,000, or 12.7%, to $2.1 million for the nine months ended
September 30, 2008 compared to $1.9 million for the nine months ended September
30, 2007. This increase reflected a $342,000, or 7.7%, increase in interest and
dividend income, and a $101,000, or 4.0%, increase in interest expense. The
increase in net interest and dividend income of $342,000 was primarily due to
an increase in the average balance of interest-earning assets by $13.6 million,
or 14.1% from $96.7 million for the nine months ended September 30, 2007 to
$110.3 million for the nine months ended September 30, 2008.
Interest and Dividend Income. Total interest and dividend income
increased by $342,000, or 7.7%, to $4.8 million for the nine months ended
September 30, 2008 compared with $4.4 million for the nine months ended
September 30, 2007. The increase of $342,000 was primarily due to an increase
in the average balance of interest-earning assets of $13.6 million, or 14.1%,
to $110.3 million for the nine months ended September 30, 2008 from $96.7
million for the nine months ended September 30, 2007, partially offset by a
decrease in the average yield on interest-earning assets to 5.80% for the nine
months ended September 30, 2008 from 6.15% for the nine months ended September
30, 2007. Interest income on loans increased $303,000, or 10.3%, to $3.2
million for the nine months ended September 30, 2008 from $2.9 million for the
same period in 2007, primarily due to a $9.9 million increase in the average
balance of loans from $57.2 million for the nine months ended September 30,
2007 to $67.1 million for the same period in 2008. This increase in interest
income on loans was partially offset by a decrease in loan yields from 6.86%
for the nine months ended September 30, 2007 to 6.44% for the same period in
2008. The increase in the average balance of loans was primarily attributable
to an increase in the average balance of $5.3 million in commercial real estate
and commercial loans, a $3.4 million increase in the average balance of one- to
four-family residential loans as well as a $765,000 increase in the average
balance of consumer loans related to mobile home loan financing. The decrease
in average loan yields was due to the repricing of some adjustable rate loans
downward due to a decrease in the prime rate of 3.25% since September 2007.
Interest income on investment securities, FHLB stock and interest-bearing
deposits with other financial institutions increased $39,000, or 2.6%, to $1.6
million for the nine months ended September 30, 2008 from $1.5 million for the
nine months ended September 30, 2007. The increase was due to an increase in
the average balance of the investment portfolio by $3.7 million to $43.2
million for the nine months ended September 30, 2008 from $39.5 million for the
same period in 2007, partially offset by a decrease in the overall yield on
total investments from 5.12% for the nine months ended September 30, 2007 to
4.80% for the same period in 2008. The increase in the average balances in the
investment portfolio was the direct result of our leveraging the balance sheet
with an increase in funding from FHLB advances.
Interest Expense. Total interest expense increased by $101,000, or 4.0%,
to $2.7 million for the nine months ended September 30, 2008 from $2.6 million
for the nine months ended September 30, 2007. The increase of $101,000 was due
to an increase in the average balance of interest-bearing liabilities of $14.6
million to $97.8 million for the nine months ended September 30, 2008 from
$83.2 million for the same period in 2007, partially offset by a decrease in
the average overall cost of interest-bearing liabilities to 3.62% for the nine
months ended September 30, 2008 from 4.10% for the same period in 2007.
Interest expense on deposits decreased $305,000 to $1.4 million for the nine
months ended September 30, 2008 from $1.7 million for the same period in 2007.
Interest expense on time certificates decreased $477,000 to $1.0 million for
the nine months ended September 30, 2008 from $1.5 million for the same period
in 2007 while interest expense on savings deposits increased by $172,000 to
$361,000 for the nine months ended September 30, 2008 from $189,000 for the
same period in 2007. The decrease in interest expense on time certificates was
attributable to a decrease in the overall average cost of time certificates by
80 basis points to 4.02% for the nine months ended September 30, 2008 from
4.82% for the same period in 2007, coupled with a decrease in the average
balance of time certificates of $7.5 million to $34.6 million for the nine
months ended September 30, 2008 from $42.1 million for the same period in 2007.
The decrease in the cost on time certificates was the direct result of maturing
time certificates repricing into lower rates during the nine months ended
September 30, 2008 due to the lower interest rate environment. The decrease in
the average balance of time certificates was due to customers transferring
these deposits to other Bank deposit products and interest rate sensitive
customers withdrawing their deposits due to competitive rates being offered
elsewhere. The decrease in the average balance of time certificates was also
attributable to customers transferring deposits to other financial institutions
to ensure their deposits were FDIC insured as a result of the recent financial
crisis. The increase in interest expense on savings deposits was attributable
to an increase in the average balance of savings deposits of $6.5 million to
$21.9 million for the nine months ended September 30, 2008 from $15.4 million
for the same period in 2007, and to a lesser extent, an increase of 56 basis
points on the average rate cost of savings deposits to 2.20% for the nine
months ended September 30, 2008 from 1.64% for the same period in 2007. The
increase in the average balances and cost on savings deposits for the nine
months ended September 30, 2008 compared to the same period in 2007 was
primarily attributable to the introduction of a Rewards Checking product in
October 2007.
Interest expense on FHLB advances increased $407,000, or 48.4%, to $1.2
million for the nine months ended September 30, 2008 from $841,000 for the nine
months ended September 30, 2007. The increase in interest expense was due to an
increase in the average balance of FHLB advances of $15.5 million to $41.2
million for the nine months ended September 30, 2008 from $25.7 million for the
same period in 2007, partially offset by a decrease in the borrowing cost to
17
4.05% for the nine months ended September 30, 2008 from 4.38% for the same
period in 2007. We used the additional funding from the increase in FHLB
advances to increase our net loan portfolio, and to a lesser extent, our
investment securities portfolio. The decrease in borrowing costs was due to the
Bank using a mix of fixed rate and callable borrowings to lower the overall
funding costs for FHLB advances.
Provision for Loan Losses. We recorded a provision for loan losses of
$128,000 for the nine months ended September 30, 2008 compared with $59,000 for
the nine months ended September 30, 2007. The increase in the provision was
primarily due to an increase in the level of net charge-offs to $116,000 for
the nine months ended September 30, 2008 compared with $11,000 for the nine
months ended September 30, 2007. The increase in the provision was also
necessary due to additional credit weakness in our evaluation of a commercial
loan for a retail sporting goods establishment during 2008 which was partially
offset by the classification of certain loans into more favorable risk ratings
during 2008 due to the seasoning of real estate owner occupied first mortgage
loans. The allowance for loan losses as a percent of total loans was 0.58% at
September 30, 2008 compared with 0.63% at September 30, 2007. The mix of the
loan portfolio continues to be weighted in one- to four-family residential and
home equity loans which accounted for 55.0% and 59.5% of total loans at
September 30, 2008 and 2007, respectively. These loans generally have a lower
credit risk allocation and the portfolio has reduced levels of criticized and
classified loans. Our methodology for analyzing the allowance for loan losses
consists of specific and general components. The specific components relates to
loans that are classified as doubtful, substandard or special mention. For such
loans that are also classified as impaired, an allowance is established when
the discounted cash flows (or collateral value or observable market price) of
the impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss
experience and quantitative and qualitative factors unique to the Bank for
consumer, residential and commercial loans. The allowance for loan losses as of
September 30, 2008 was maintained at a level that represents management's best
estimate of losses inherent in the loan portfolio. Although we believe that we
have established the allowance for loan losses at levels to absorb probable and
estimable losses, future additions or deductions may be necessary if economic
or other conditions in the future differ from the current environment.
Total Noninterest Income. Noninterest income increased $110,000, or
50.2%, to $329,000 for the nine months ended September 30, 2008 from $219,000
for the nine months ended September 30, 2007. The increase was primarily
attributable to net gains on sales of available-for-sale securities of $96,000
for the nine months ended September 30, 2008 compared with $16,000 of such
sales for the nine months ended September 30, 2007, an increase in income
related to debit, credit and ATM transactions as well as an increase in net
servicing income for the nine months ended September 30, 2008 compared with the
nine months ended September 30, 2007.
Total Noninterest Expense. Noninterest expense increased $320,000, or
16.9% to $2.2 million for the nine months ended September 30, 2008 compared
with $1.9 million for the nine months ended September 30, 2007. Salaries and
employee benefits expense increased $120,000 from $1.0 million for the nine
months ended September 30, 2007 to $1.1 million for the nine months ended
September 30, 2008. The increase in salaries and employee benefits expense
related to an increase in staffing for the commercial lending area, salary
increases, an increase in benefit costs for medical coverage, increases related
to stock benefit plans for executives and employees, partially offset by an
increase in the deferrals of loan origination costs. Other increases in
noninterest expense related to an increase of $100,000 in other expenses, a
$44,000 increase in data processing costs and a $43,000 increase in marketing
expense. The increase in other expenses related to higher FDIC assessment
premiums in 2008 compared with 2007, $17,000 of additional expense related to
the maintenance of the Bank's other real estate owned property, additional
ongoing expenses related to the Rewards Checking product as well as increased
expenses for Directors related to fees and stock benefit plans. The increase in
marketing expense related to costs associated with our Rewards Checking product
which was introduced in the fourth quarter of 2007, the promotion of a new
service for our customers known as Identity Theft 911 as well as other
marketing initiatives aimed at increasing our loan portfolio and core deposits.
The increase in data processing costs related to increased service bureau costs
as well as computer related costs due to internal controls compliance under
Sarbanes-Oxley and other technical support costs. On October 7, 2008, the Board
of Directors of the FDIC proposed a restoration plan for the Deposit Insurance
Fund which would raise the assessment rate schedule uniformly by seven basis
points (annualized) beginning January 1, 2009. The FDIC will also adjust the
base assessment based on an institution's level of unsecured debt, secured
liabilities and brokered deposits. As a result, the Bank may also be subject to
additional assessments since the Bank's FHLB advances exceed 15% of domestic
deposits. There can be no assurance that the proposed rule will be implemented
by the FDIC in its proposed form. The increase in FDIC assessments may have a
negative effect on the Bank's earnings for 2009.
Income Tax Expense. Income tax expense decreased $16,000 to $56,000 for
the nine months ended September 30, 2008 from $72,000 for the nine months ended
September 30, 2007 due to lower pre-tax income. The effective tax rate was
45.1% for the nine months ended September 30, 2008 compared to 44.7% for the
nine months ended September 30, 2007.
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Risk Elements
Total nonperforming assets increased $715,000 to $985,000 or 0.89% of
total assets at September 30, 2008 compared with $270,000 or 0.26% of total
assets at December 31, 2007. The increase in nonperforming assets was primarily
attributable to the following: 1) a commercial loan relationship secured by an
inn for $474,000 which was transferred to other real estate owned at the end of
the second quarter of 2008 and 2) a commercial loan relationship secured by a
convenience store and gas station being placed on nonperforming status at the
end of the third quarter of 2008. The nonperforming loans carry a guarantee by
the United States Small Business Administration covering $50,000 and $165,000
of the balance outstanding, respectively, at September 30, 2008 and December
31, 2007.
As shown in the following table, nonperforming assets as a percentage of
total assets were 0.89% and 0.26%, as of September 30, 2008 and December 31,
2007, respectively.
September 30, December 31,
2008 2007
------------- ------------
($ in Thousands)
Loans 90 days or more past due and still accruing $ 0 $ 0
==== ====
Total nonperforming loans $511 $270
==== ====
Other real estate owned $474 $ 0
==== ====
Total nonperforming loans and nonperforming assets $985 $270
==== ====
Nonperforming loans as a percent of total loans 0.73% 0.42%
Nonperforming assets as a percent of total assets 0.89% 0.26%
The following table is a break down of nonperforming loans by loan type
that have a government guaranty for the periods noted below:
September 30, December 31,
2008 2007
------------- ------------
($ in Thousands)
Commercial business loans with a SBA guarantee $ 50 $184
---- ----
Total nonperforming loans with a SBA guarantee $ 50 $184
==== ====
Guaranteed portion of nonperforming loans $ 42 $165
==== ====
Liquidity and Commitments
Historically, we have maintained liquid assets at levels believed to be
adequate to meet the requirements of normal operations, including potential
deposit outflows. We regularly review cash flow projections and update them to
assure that adequate liquidity is maintained. Liquidity may increase or
decrease depending upon the availability of funds and comparative yields on
investments in relation to the return on loans.
Our liquidity, represented by cash and cash equivalents and
mortgage-backed and related securities, is a product of our operating,
investing and financing activities. Our primary sources of funds are deposits,
amortization, prepayments and maturities of outstanding loans and
mortgage-backed securities, and other short-term investments and funds provided
from operations. While scheduled payments from the amortization of loans and
mortgage-backed related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. In addition, we invest excess funds in
short-term interest-earning assets, which provide liquidity to meet lending
requirements. We also generate cash through borrowings. We utilize FHLB
advances to leverage our capital base and provide funds for our lending and
investment activities, and enhance our interest rate risk management.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer-term basis, we maintain a strategy of
investing in various lending products such as residential, commercial and
consumer loans. We use our sources of funds primarily to meet
19
ongoing commitments, to pay maturing time deposits and savings withdrawals, to
fund loan commitments and to maintain our portfolio of mortgage-backed and
related securities. At September 30, 2008, the total approved loan commitments
unfunded amounted to $8.2 million, which includes the unadvanced portion of
loans of $7.2 million. Certificates of deposit and advances from the FHLB of
Boston scheduled to mature in one year or less at September 30, 2008, totaled
$22.0 million and $5.5 million, respectively. Based on historical experience,
we believe that a significant portion of maturing deposits will remain with the
Bank. We anticipate that we will continue to have sufficient funds, through
deposits and borrowings, to meet our current commitments.
During the first quarter of 2008, the Bank secured a repurchase line of
credit with a brokerage firm for $5.0 million, in the event additional
liquidity was needed.
At September 30, 2008, we had total collateral available to support an
additional $7.4 million in additional advances from the FHLB of Boston.
Stockholders' Equity
Total stockholders' equity decreased $379,000 to $9.06 million at
September 30, 2008 from $9.44 million at December 31, 2007. The decrease in
stockholders' equity was primarily attributable to the repurchase of 65,000
shares of common stock for treasury for approximately $411,000 and a decrease
in accumulated other comprehensive income of $89,000, partially offset by net
income of $68,000 for the nine months ended September 30, 2008 and a $53,000
increase related to the recognition of stock option expense as well as
restricted stock award amortization. Our equity to assets ratio was 8.18% at
September 30, 2008 compared to 8.97% at December 31, 2007.
Consistent with our goal to operate a sound and profitable financial
organization, we actively seek to maintain a "well capitalized" institution in
accordance with regulatory standards. As of September 30, 2008, the most recent
notification from the OTS categorized the Bank as "well-capitalized" under the
regulatory framework for prompt corrective action. To be categorized as
well-capitalized, the subsidiary bank must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios of 10%, 6% and 5%, respectively.
The Bank's regulatory capital ratios at September 30, 2008 were as follows:
total risk-based capital 14.86%, Tier I risk based 14.22% and Tier I leverage
(core capital) 7.87%. There have been no conditions or events since that
notification that management believes would cause a change in the Bank's
categorization.
Impact of Inflation
The financial statements presented in this 10-Q have been prepared in
accordance with accounting principles generally accepted in the United States
of America ("GAAP"). These principles require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Our primary assets and liabilities are monetary in nature. As a result,
interest rates have a more significant impact on our performance than the
effects of general levels of inflation. Interest rates, however, do not
necessarily move in the same direction or with the same magnitude as the price
of goods and services, since such prices are affected by inflation. In a period
of rapidly rising interest rates, the liquidity and maturity structure of our
assets and liabilities are critical to the maintenance of acceptable
performance levels.
The principal effect of inflation, as distinct from levels of interest
rates, on earnings is in the area of non-interest expense. Expense items such
as employee compensation, employee benefits and occupancy and equipment costs
may be subject to increases as a result of inflation. An additional effect of
inflation is the possible increase in the dollar value of the collateral
securing loans that we have made. We are unable to determine the extent, if
any, to which properties securing our loans have appreciated in dollar value
due to inflation.
Our Risk When Interest Rates Change. The rates of interest we earn on
assets and pay on liabilities generally are established contractually for a
period of time. Market interest rates change over time. Our loans generally
have longer maturities than our deposits. Accordingly, our results of
operations, like those of other financial institutions, are impacted by changes
in interest rates and the interest rate sensitivity of our assets and
liabilities. The risk associated with changes in interest rates and our ability
to adapt to these changes is known as interest rate risk and is our most
significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt
to manage our exposure to changes in interest rates and comply with applicable
regulations, we monitor our interest rate risk. In monitoring interest rate
risk we
20
continually analyze and manage assets and liabilities based on their payment
streams and interest rates, the timing of their maturities, and their
sensitivity to actual or potential changes in market interest rates.
In order to minimize the potential for adverse effects of material and
prolonged increases in interest rates on our results of operations, we have
adopted asset/liability and funds management policies to better match the
maturities and repricing terms of our interest-earning assets and
interest-bearing liabilities. The board of directors sets and recommends the
asset and liability and funds management policies of the Bank, which are
implemented by the asset/liability management committee.
The purpose of the asset/liability committee is to communicate,
coordinate and control asset/liability management consistent with our business
plan and board approved policies. The committee establishes and monitors the
volume and mix of assets and funding sources taking into account relative costs
and spreads, interest rate sensitivity and liquidity needs. The objectives are
to manage assets and funding sources to produce results that are consistent
with liquidity, capital adequacy, growth, risk and profitability goals.
The asset/liability management committee generally meets quarterly to
review, among other things, economic conditions and interest rate outlook,
current and projected liquidity needs and capital position, anticipated changes
in the volume and mix of assets and liabilities and interest rate risk exposure
limits versus current projections using a net present value of portfolio equity
analysis and income simulations. The asset/liability management committee
recommends appropriate strategy changes based on this review.
In order to manage our assets and liabilities and achieve the desired
liquidity, credit quality, interest rate risk, profitability and capital
targets, we have focused our strategies on:
o Using FHLB advances and pricing on fixed-term non-core deposits to
align maturities and repricing terms,
o Purchasing adjustable rate securities,
o Originating and purchasing adjustable rate loans,
o Originating and purchasing a reasonable volume of fixed rate
mortgages, and
o Managing our deposits to establish stable deposit relationships.
At times, depending on the level of general interest rates, the
relationship between long- and short-term interest rates, market conditions and
competitive factors, the asset/liability management committee may determine to
increase our interest rate risk position somewhat in order to maintain our net
interest margin.
The asset/liability management committee regularly reviews interest rate
risk by forecasting the impact of alternative interest rate environments on net
interest income and market value of portfolio equity, which is defined as the
net present value of an institution's existing assets, liabilities and
off-balance sheet instruments, and evaluating such impacts against the maximum
potential changes in net interest income and market value of portfolio equity
that are authorized by the board of directors of the Bank.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
This item is not applicable to the Company because we are a smaller
reporting company.
ITEM 4. Controls and Procedures
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based on such evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and regulations and are operating in an effective manner.
21
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934)
occurred during the most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved, from time to time, as plaintiff or defendant in various
legal actions arising in the normal course of business. At September 30, 2008,
we were not involved in any legal proceedings, the outcome of which would be
material to our financial condition, results of operations, or cash flows.
Item 1A. Risk Factors
This item is not applicable to the Company because we are a smaller
reporting company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act
32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act
32.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Monadnock Bancorp, Inc.
Date: November 7, 2008 /s/ William M. Pierce, Jr.
--------------------------
William M. Pierce, Jr.
President and Chief Executive Officer
Date: November 7, 2008 /s/ Karl F. Betz
----------------
Karl F. Betz
Senior Vice President and Chief
Financial Officer
23