UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended MARCH 31, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
----------------- ---------------
Commission file number 0-51243
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 85-0453611
(State or other jurisdiction (I.R.S. Employer ID No.)
of incorporation or organization
300 NORTH PENNSYLVANIA AVENUE, ROSWELL, NEW MEXICO 88201
(Address of principal executive offices)
(505) 622-6201
(Issuer's telephone number including area code)
N/A
(Former name, address, and fiscal year, if changed since last report)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
(1) [ X ] Yes [ ] No
(2) [ X ] Yes [ ] No
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [ X ] No
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
3,979,453 shares of common stock, par value $0.01 per share, as of May 9, 2006
Transitional Small Business Disclosure Format (check one), [ ] Yes [ X ] No
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE
Item 1 Financial Statements.
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Stockholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial Condition 11
and Results of Operations.
Item 3 Controls and Procedures. 23
PART II OTHER INFORMATION
Item 1 Legal Proceedings. 23
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds. 23
Item 3 Defaults Upon Senior Securities. 24
Item 4 Submission of Matters to Vote of Security Holders. 24
Item 5 Other Information. 24
Item 6 Exhibits. 24
Signatures 25
Exhibit 31.1 Certification of Chief Executive Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002
Exhibit 32 Certification Pursuant to Section 906 of Sarbanes-Oxley Act
of 2002
1
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
Consolidated Statements Of Financial Condition
- ----------------------------------------------------------------------------------------------------------
March 31, 2006 Compared to September 30, 2005
ASSETS MARCH 31, September 30,
2006 2005
--------- ---------
(UNAUDITED)
($ IN THOUSANDS)
Cash and due from banks $ 12,877 $ 11,777
Interest-bearing deposits with banks 37,522 26,185
Held-to-maturity investments securities 391 2,132
Available-for-sale investment securities 57,021 64,902
Loans held for sale 1,398 2,892
Loans receivable, net 414,209 412,073
Accrued interest receivable 2,054 2,036
Federal Home Loan Bank stock, at cost, restricted 5,708 6,373
Property, equipment, and construction in progress, net 13,946 13,726
Identifiable Intangibles 3,435 3,645
Goodwill 2,286 2,286
Investment in non-bank subsidiaries 310 310
Other assets 1,575 1,605
--------- ---------
TOTAL ASSETS $ 552,732 $ 549,942
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 61,640 $ 62,106
Interest bearing 322,553 315,609
Advances from the Federal Home Loan Bank 102,105 107,991
Escrows from borrowers for taxes and insurance 1,382 1,561
Accrued and other liabilities 3,292 3,156
Long term subordinated debt 10,310 10,310
--------- ---------
TOTAL LIABILITIES 501,282 500,733
--------- ---------
Commitments and contingencies -- --
Stockholders' Equity
Preferred stock, $0.01 par value; 500,000 shares
authorized; no shares issued and outstanding -- --
Common stock, $0.01 par value; 6,000,000 shares authorized; 4,300,045
shares issued and 3,979,453 shares outstanding at March 31, 2006;
4,289,445 shares issued and 3,968,853 shares
outstanding at September 30, 2005 43 43
Additional paid-in capital 18,011 17,916
Retained earnings 36,647 34,345
Accumulated other comprehensive income (530) (374)
Treasury stock, at cost, 320,592 shares at March 31, 2006 and
September 30, 2005 respectively (2,721) (2,721)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 51,450 49,209
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 552,732 $ 549,942
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------------------------------------------------------
Three and Six Months Ended March 31, 2006 and 2005 (unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
--------------------- ---------------------
2006 2005 2006 2005
---------- --------- --------- ----------
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest Income
Interest and fees on loans $ 7,813 $ 4,323 $ 15,584 $ 8,611
Interest on investment securities 593 255 1,208 510
Interest and dividends on other investments 374 211 665 348
-------- -------- --------- -------
Total interest income 8,780 4,789 17,457 9,469
-------- -------- --------- -------
Interest Expense
Deposits 1,867 684 3,371 1,375
Borrowed funds 1,228 735 2,482 1,350
-------- -------- --------- -------
Total interest expense 3,095 1,419 5,853 2,725
-------- -------- --------- -------
Net interest income before provision for loan losses 5,685 3,370 11,604 6,744
Provision for loan losses 287 - 428 -
-------- -------- --------- -------
Net interest income after provision
for loan losses 5,972 3,370 12,032 6,744
-------- -------- --------- -------
Other Income
Fees for services to customers 305 188 632 403
Gain on sale of loans 105 142 265 271
Gain on sale of available-for-sale investment securities - - - -
Other 184 137 336 253
-------- -------- --------- -------
Total other income 594 467 1,233 927
-------- -------- --------- -------
Other Expenses
Compensation and related benefits 2,545 1,573 4,963 3,103
Occupancy 335 229 603 439
Data processing 299 103 572 231
Advertising 60 40 109 58
Telephone 57 40 130 104
Postage 48 38 95 82
Printing & supplies 85 46 158 94
Employee expenses 103 51 201 108
Depreciation and amortization 316 144 632 291
Professional fees 140 56 272 99
Other 392 273 757 540
-------- -------- --------- -------
Total other expenses 4,380 2,593 8,492 5,149
-------- -------- --------- -------
Income before income taxes 2,186 1,244 4,773 2,522
Income tax expense 881 507 1,914 1,019
-------- -------- --------- -------
Net income $ 1,305 $ 737 $ 2,859 $ 1,503
======== ======= ========= ========
Net income per average common share
Basic 0.33 0.23 0.72 0.47
Diluted 0.32 0.22 0.71 0.46
Average common shares - basic 3,979,453 3,201,528 3,976,824 3,197,112
Average common shares - diluted 4,033,660 3,298,856 4,031,031 3,294,440
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
For the Six Months Ended March 31, 2006 (unaudited) and the Year Ended September 30, 2005
($ in thousands, except share data)
Common Treasury
Stock Additional Stock Accumulated
--------------------- Paid-in ------------------- Retained Other Comp.
Shares Value Capital Shares Cost Earnings Loss Total
BALANCE AT SEPTEMBER 30, 2005 4,289,445 $ 43 $ 17,916 320,592 $ (2,721) $ 34,345 $ (374) $ 49,209
Stock issued for stock options 10,600 -- 95 95
Dividends - $0.14 per share (557) (557)
Comprehensive income:
Change in unrealized loss
on investment securities,
net of taxes (156)
Net income -- -- -- -- -- 2,859 -- --
TOTAL 2,703
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT MARCH 31, 2006 4,300,045 $ 43 $ 18,011 320,592 $ (2,721) $ 36,647 $ (530) $ 51,450
========== ========== ========== ========== ========== ========== ========== ==========
Reconciliation of Other Comprehensive Income (Loss) FOR THE SIX MONTHS
ENDED MARCH 31,
---------------------
2006 2005
---------------------
Unrealized losses on securities:
Unrealized holding losses arising during period $(260) $(300)
Related taxes 104 120
Reclassification adjustments for net losses in net income -- --
Related taxes -- --
---------------------
TOTAL OTHER COMPREHENSIVE LOSS $(156) $(180)
=====================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ----------------------------------------------------------------------------------------
Six Months Ended March 31, 2006 and 2005 (unaudited)
SIX MONTHS ENDED
MARCH 31,
2006 2005
-------- --------
(IN THOUSANDS)
Cash Flows from Operating Activities
Net income $ 2,859 $ 1,503
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation & amortization of intangibles 632 291
Net loss (gain) on sale of REO 3 --
Accretion of deferred loan fees (202) (52)
Proceeds from sales of loans held for sale 18,209 15,882
Origination of loans held for sale (16,451) (15,811)
Gain on sale of sold loans (265) (271)
Provision (benefit) for loan losses (427) --
Amortization of investments, net 7 93
FHLB Stock dividend (126) (44)
Change in accrued interest & dividend receivable (19) (15)
Change in prepaid/other assets (119) (621)
Change in accounts payable & accrued liabilities 137 67
Accretion of market-to-market, net (114) --
Other, net (98) 180
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,026 1,202
-------- --------
Cash Flows from Investing Activities
Change in deposits in banks (11,336) (3,784)
Proceeds from maturity and principal paydowns
of held-to-maturity securities 1,725 12,250
Principal payments on mortgage backed securities
held-to-maturity 15 15
Proceeds from sales, maturities and principal paydowns
of available-for-sale securities 4,496 500
Purchases of available-for-sale securities -- (7,468)
Principal payments on mortgage backed securities
available-for-sale 3,320 411
Loan origination and principal repayment on loans, net (1,583) (10,567)
Proceeds from sale of loans -- --
Proceeds from sale of foreclosed properties 223 --
Proceeds from redemption of FHLB stock 791 --
Proceeds from sale of property and equipment -- 105
Purchases of FHLB stock -- --
Purchases of building and equipment (637) (387)
-------- --------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (2,986) (8,925)
-------- --------
Cash Flows from Financing Activities
Net increase (decrease) in transaction accounts, savings
and now deposits 6,425 (3,331)
Net increase (decrease) in mortgage escrow funds (179) (26)
Proceeds from FHLB advances 5,294 10,352
Repayments on FHLB advances (11,018) (5,889)
Dividends paid or to be paid in cash (557) (280)
Proceeds from exercise of stock options 95 148
Proceeds from sale of subordinated debentures -- 7,217
Purchase of treasury stock, net -- --
-------- --------
NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES 60 8,191
-------- --------
NET CASH AND DUE FROM BANKS $ 1,100 $ 468
======== ========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
- --------------------------------------------------------------------------------
Six Months Ended March 31, 2006 and 2005 (unaudited)
SIX MONTHS ENDED
MARCH 31,
2006 2005
-------- --------
(IN THOUSANDS)
Increase in cash and due from banks $ 1,100 $ 468
Cash and due from banks at beginning of year 11,777 9,528
-------- --------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 12,877 $ 9,996
======== ========
SUPPLEMENTAL DISCLOSURES
Cash paid during the period for
Interest on deposits and advances $ 4,365 $ 2,613
Income taxes 1,873 850
(Increase) in unrealized loss, net of deferred taxes
on available-for-sale securities (other comprehensive income) (156) (180)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
FIRST FEDERAL BANC OF THE SOUTHWEST, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The financial statements include the accounts of First Federal Banc of
the Southwest, Inc. (the "Company") and its wholly owned subsidiary, First
Federal Bank (the "Bank"). All significant intercompany balances and
transactions have been eliminated in consolidation. First Federal NM Trust I and
First Federal NM Trust II ("Trust I" and "Trust II") are wholly owned
subsidiaries of the Company and are not consolidated in these financial
statements (see Note 3 below for additional information).
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-QSB. Accordingly, they do not include all the
information and disclosures required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, the financial statements contain all adjustments
(consisting only of normal reoccurring adjustments) necessary to present fairly
the financial condition of First Federal Banc of the Southwest, Inc. as of March
31, 2006, and the results of operations for all interim periods presented.
Operating results for the three and six months ended March 31, 2006, are not
necessarily indicative of the results that may be expected for the entire fiscal
year. The unaudited consolidated financial statements presented herein should be
read in conjunction with the annual consolidated financial statements and
related notes of the Company for the fiscal year ended September 30, 2005 filed
on Form 10-KSB.
Certain 2005 amounts have been reclassified to conform to the 2006
presentation. Such reclassifications had no effect on net income.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS AND REGULATORY DEVELOPMENTS
In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1
and 124-1, THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO
CERTAIN INVESTMENTS. The FASB addresses the determination of when an investment
is considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss. The FSP also includes accounting
considerations subsequent to the recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized losses that have
not been recognized as other-than-temporary impairments. The FSP amends FASB
Statement No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY
SECURITIES, FASB Statement No. 124, ACCOUNTING FOR CERTAIN INVESTMENTS HELD BY
NOT-FOR-PROFIT ORGANIZATIONS and APB Opinion No. 18, THE EQUITY METHOD OF
ACCOUNTING FOR INVESTMENTS IN COMMON STOCK. The FSP nullifies certain
requirements of
7
EITF Issue No. 03-1, THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS
APPLICATION TO CERTAIN INVESTMENTS and supersedes EITF Abstracts, Topics D-44,
RECOGNITION OF OTHER-THAN-TEMPORARY IMPAIRMENT UPON THE PLANNED SALE OF A
SECURITY WHOSE COST EXCEEDS FAIR VALUE. The FSP is required to be applied to
annual financial statements for reporting periods beginning after December 15,
2005. The Company does not expect adoption to have a material impact on the
consolidated annual financial statements.
On April 14, 2005, the Securities and Exchange Commission (SEC)
announced the adoption of a new rule that amends the compliance dates for SFAS
No. 123R. Under SFAS No. 123R, the Company (as a small business issuer) would
have been required to implement the standard as of the beginning of the first
interim period that begins after December 15, 2005. The SEC's new rule allows
small business issuers to implement SFAS No. 123R at the beginning of their next
fiscal year, or the next reporting period, that begins after December 15, 2005.
The SEC's new rule does not change the accounting required by SFAS No. 123R; it
changes only the dates for compliance with the standard. As a result of the SEC
rule change, the Company began complying with the Statement on January 1, 2006.
During this reporting period FASB issued SFAS 155 and 156. SFAS 155,
ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS, AN AMENDMENT OF FASB
STATEMENTS NO. 133 AND 140 was issued in February 2006. This Statement is
effective for all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. SFAS 156,
ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS, AN AMENDMENT OF FASB STATEMENT NO.
140 was issued in March 2006. The effective date for this Statement is the
beginning of the first fiscal year that begins after September 15, 2006. For the
Company, the effective date for both of these Statements is the fiscal year
beginning October 1, 2006. At this time management does not believe either of
these Statements will have a material effect on the Company's results.
NOTE 3. JUNIOR SUBORDINATED DEBT OWED TO UNCONSOLIDATED TRUSTS
The following table presents details on the junior subordinated debt
owed to the unconsolidated trusts listed below as of March 31, 2006:
FIRST FEDERAL NM FIRST FEDERAL NM
TRUST I TRUST II
----------------------- ---------------------
Date of Issue JANUARY 19, 2005 MAY 23, 2005
Amount of trust preferred securities issued $ 7,000,000 $ 3,000,000
Rate on trust preferred securities 5.7% 6.145%
Maturity March 15, 2035 June 15, 2035
Date of first redemption March 15, 2010 June 15, 2010
Common equity securities issued $ 217,000 $ 93,000
Junior subordinated deferrable interest
debentures owed $ 7,217,000 $ 3,093,000
Rate on junior subordinated deferrable interest
debentures 5.7% 6.145%
8
In 2005, the Trusts, each being a Delaware statutory business trust,
issued trust preferred securities in the amounts and at the rates indicated
above. These securities represent preferred beneficial interests in the assets
of the Trusts. The trust preferred securities will mature on the dates
indicated, and are redeemable in whole or in part at the option of the Company
at any time after the date of first redemption indicated above, and in whole at
any time upon the occurrence of certain events affecting their tax or regulatory
capital treatment. The Trusts also issued common equity securities to the
Company in the amounts indicated above. The rates on the trust preferred
securities are fixed through the respective first redemption dates. Subsequent
to those dates, the interest rate will be equal to LIBOR plus 1.85%. The Trusts
used the proceeds of the offering of the trust preferred securities to purchase
junior subordinated deferrable interest debentures (the debentures) issued by
the Company, which have terms substantially similar to the trust preferred
securities. The Company has the right to defer payments of interest on the
debentures at any time or from time to time for a period of up to 20 consecutive
quarterly periods with respect to each interest payment deferred. Under the
terms of the debentures, in the event that under certain circumstances there is
an event of default under the debentures, or the Company has elected to defer
interest on the debentures, the Company may not, with certain exceptions,
declare or pay any dividends or distributions on its capital stock or purchase
or acquire any of its capital stock. The Company used the proceeds from the sale
of the debentures, in part, to fund the cash portion of the acquisition of GFSB
Bancorp, Inc.
The Company owns all of the outstanding common securities of the Trusts.
Each Trust is considered a variable interest entity (VIE) under Financial
Accounting Standards Board Interpretation (FIN) No. 46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51, as revised. Prior to FIN 46, VIEs were generally consolidated by an
enterprise when the enterprise had a controlling financial interest through
ownership of a majority of voting interest in the entity. Under FIN 46, a VIE
should be consolidated by its primary beneficiary. Because the Company is not
the primary beneficiary of the Trusts, the financial statements of the Trusts
are not included in the consolidated financial statements of the Company.
Payments of distributions on the trust preferred securities and payments
on redemption of the trust preferred securities are guaranteed by the Company on
a limited basis. The obligations of the Company under the junior subordinated
debentures, the related indentures, the trust agreements establishing the
Trusts, the guarantees and the agreements as to expenses and liabilities, in the
aggregate, constitute a full and unconditional guarantee by the Company of the
Trusts' obligations under the trust preferred securities.
NOTE 4. STOCK OPTION PLANS
In December 2004, the FASB issued SFAS No. 123R, SHARE-BASED PAYMENT,
which is an Amendment of FASB Statement Nos. 123 and 95. SFAS No. 123R changes,
among other things, the manner in which share-based compensation, such as stock
options, will be accounted for by both public and non-public companies. For
public companies, the cost of employee services received in exchange for equity
instruments, including options and restricted stock awards, generally will be
measured at fair value at the grant date. The grant date fair value will be
estimated using option-pricing models adjusted for the unique characteristics of
those options
9
and instruments, unless observable market prices for the same or similar options
are available. The cost will be recognized over the requisite service period,
often the vesting period, and will be remeasured at each reporting date through
the settlement date. The changes in accounting will replace existing
requirements under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, and
will eliminate the ability to account for share-based compensation transactions
using APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, which does
not require companies to expense options if the exercise price is equal to the
trading price at the date of grant. The accounting for similar transactions
involving parties other than employees or the accounting for employee stock
ownership plans that are subject to AICPA Statement of Position 93-6, EMPLOYERS'
ACCOUNTING FOR EMPLOYEE STOCK OWNERSHIP PLANS, would remain unchanged. As a
result of actions by the SEC, SFAS 123R was effective for the Company on January
1, 2006.
Prior to January 1, 2006, the Company granted 69,950 stock options to
directors and officers of the Company and its subsidiary bank. The exercise
price was equal to or greater than the closing price on the grant date;
therefore, no stock-based compensation costs are reflected in net income. There
have been no awards of stock options since the January 1, 2006 effective date of
implementation.
NOTE 5. EARNINGS PER SHARE
Earnings per share are presented pursuant to the provisions of SFAS No.
128, EARNINGS PER SHARE. Basic earnings per share are calculated based on the
weighted average number of common shares outstanding during the respective
periods.
Diluted earnings per share are computed taking into consideration common
shares outstanding and dilutive potential common shares to be issued under the
Company's stock option plans and recognition and retention plan.
All earnings per share computations are presented on a split-adjusted
basis to reflect the 8 for 1 stock split that was completed on May 20, 2005.
10
NOTE 6. ACQUISITION
After the close of business on May 31, 2005, the Company completed its
acquisition of GFSB Bancorp, Inc (GFSB). The results of GFSB's operations have
been included in the consolidated financial statements since June 1, 2005. The
following table depicts select balances of GFSB as of May 31, 2005. All amounts
are presented at book value.
May 31, 2005
(In thousands)
Cash and due from banks $ 7,404
Available for sale investment securities 24,516
Available for sale mortgage-backed securities 23,285
Loans receivable, net 139,604
Other assets 7,677
--------
Total assets $202,486
========
Demand deposits and NOW accounts $ 32,727
Savings and money market accounts 22,834
Time deposits 73,915
Advances from Federal Home Loan Bank 48,154
Other liabilities 5,250
--------
Total liabilities 182,880
Total stockholders' equity 19,606
--------
Total liabilities and stockholders' equity $202,486
========
The acquisition of GFSB increased the geographic footprint of the
Company and allowed shareholders an interest in a larger entity with access to
the public markets. The Company hopes to realize cost savings and efficiencies
by combining the respective operations. The value of the long-term nature of the
customer base contributed to a purchase price in excess of GFSB's book values.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
The information in this report may contain forward-looking statements
about the Company's growth and acquisition strategies, new products and
services, and future financial performance, including earnings and dividends per
share, return on average assets, return on average equity, efficiency ratio and
capital ratio. These and other statements in this report constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation
11
Reform Act of 1995. Such forward-looking information is based upon certain
underlying assumptions, risks and uncertainties. Because of the possibility of
change in the underlying assumptions, actual results could differ materially
from these forward-looking statements. Risks and uncertainties that may affect
future results include: interest rate risk, competitive pressures, pricing
pressures on loans and deposits, actions of bank and non-bank competitors,
changes in local and national economic conditions, changes in regulatory
requirements, actions of the SEC and/or the Office of Thrift Supervision, and
customer acceptance of the Company's products and services. The Company
undertakes no obligation to revise or update such forward-looking statements to
reflect current events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in the Notes
to Consolidated Financial Statements set forth in the consolidated financial
statements as of September 30, 2005, which were filed with the SEC on Form
10-KSB (File No. 000-51243). Based on its consideration of accounting policies
that involve the most complex and subjective estimates and judgments, management
has identified its most critical accounting policy to be that related to the
allowance for loan losses. The allowance for loan losses is established through
a provision for loan losses charged to expense. Loans are charged against the
allowance for loan losses when management believes that collectibility of the
principal is unlikely. The Company has policies and procedures for evaluating
the overall credit quality of its loan portfolio including timely identification
of potential problem credits. On a quarterly basis, management reviews the
appropriate level for the allowance for loan losses incorporating a variety of
risk considerations, both quantitative and qualitative. Quantitative factors
include the Company's historical loss experience, delinquency and charge-off
trends, collateral values, known information about individual loans and other
factors. Qualitative factors include the general economic environment in the
Company's market areas and the expected trend of those economic conditions. To
the extent actual results differ from forecasts and management's judgment, the
allowance for loan losses may be greater or less than future charge-offs.
FINANCIAL CONDITION
MARCH 31, 2006 COMPARED TO SEPTEMBER 30, 2005.
Total assets remained nearly unchanged at $552.7 million as of March 31,
2006, up approximately $2.8 million (or 0.5%) from the September 30, 2005
balance of $549.9 million.
Total net loans, excluding loans held for sale, increased $2.2 million,
or 0.5%, from $412.0 million as of September 30, 2005, to $414.2 million as of
March 31, 2006. The majority of the net increase in loans was attributable to an
increase of approximately $7.8 million in one-to four- family residential
construction loans. This category increased from $30.8 million to $38.6 million
at March 31, 2006. The majority of this increase is from the Las Cruces and
Albuquerque markets where the demand for housing is very strong and the housing
construction industry is experiencing record breaking growth. The majority of
these loans are made to the homebuilders after the home is pre-sold. The
homebuilders generally will construct model and
12
unsold homes as they move into subdivisions so they have opportunities to sell
construction-in-progress homes. The bank will limit the number of unsold homes
in relation to the number of pre-sold homes through the use of loan covenants.
The mortgage loan portfolio declined approximately $6 million during the period.
The bank continues to sell all 30 year mortgages into the secondary market and
only retains adjustable rate loans and 15-year fixed rate loans. Consumer loans
declined approximately $1.2 million which was offset by an increase in
commercial loans of approximately $1.0 million.
The total investment securities owned by the Company declined from
approximately $67.0 million at September 30, 2005 to $57.4 million at March 31,
2006. The $9.6 million decrease was attributed to investment securities maturing
and principal payments on asset backed securities. The Company made no
significant purchases of investments during this period and instead allowed the
portfolio to decline to fund the loan growth mentioned above. The excess funds
contributed by the investment maturities have been retained in the overnight
account with the Federal Home Loan Bank. This has contributed to the increase in
this account from $23.9 million at September 30, 2005 to the March 31, 2006
balance of $35.6 million. In the opinion of management, the flat yield curve is
not affording the return necessary to warrant the interest rate risk from
placing fixed rate investments in the portfolio with very little yield
improvement compared to liquid assets. Generally, the rate paid on the overnight
account tracks closely with the rates paid in the Federal Funds market and
adjust daily. Construction loans for one-to four- family residential units
generally are six to nine months in duration and are floating with Wall Street
Journal prime rate. While the yield curve remains in this flat position,
management anticipates keeping any excess funds in very short-term investments.
Total deposits increased approximately $6.5 million from the September
30, 2005 level of $377.7 million to $384.2 million at March 31, 2006.
Non-interest bearing deposits decreased approximately $466,000 during this
period, while interest bearing deposits increased $6.9 million. Within interest
bearing deposits, numerous changes between types of accounts have taken place.
Savings accounts declined approximately $17.0 million while money market
accounts increased $28.1 million and NOW accounts decreased approximately $1.2
million. Time deposits decreased a net of approximately $7.6 million during the
reporting period. However, within time deposits, public funds over $100,000
decreased $11.7 million while retail time certificates under $100,000 grew $8.2
million and non-public time deposits over $100,000 decreased $4.1 million. As
discussed in previous Securities and Exchange Commission filings, the goal of
the Company is to replace the jumbo time deposits owned by public entities that
were acquired with the GFSB Bancorp Inc. acquisition in June 2005 with a more
retail deposit base structure. Pricing on these jumbo public deposits is
generally established by the State of New Mexico and provides no opportunity to
cross-sell any other types of bank services. In an effort to change the deposit
structure, we have been offering different types of deposit products with
different rates and terms to attract new customers and retain existing retail
customers. The growth in money market accounts is attributed to a promotional
program that offered an attractive interest rate guaranteed through August 1,
2006. While this strategy does not necessarily translate to lower cost deposits,
we believe developing relationships with customers is in the best interest of
the Company rather than using wholesale funding sources. We will continue to use
a variety of sources to meet our funding needs in an effort to maximize our
earnings opportunities and increase the value of our franchise.
13
Federal Home Loan Bank of Dallas ("FHLB") borrowings decreased $5.9
million or 5.4% from $108 million at September 30, 2005 to $102.1 million at
March 31, 2006. Through the use of long-term borrowings to fund long-term,
fixed-rate loans, the Company is able to fix a spread to minimize the interest
rate risk associated with long-term loans. Prepayment penalties are required on
these loans to compensate the Company in the event the borrower wants to prepay
the loan. As interest rates have increased during the last quarter, loan demand
in general has slowed and the customer requests for the long-term, fixed-rate
type products have also diminished.
Stockholders' equity increased $2.2 million, or 4.5%, to $51.4 million
as of March 31, 2006, compared to $49.2 million as of September 30, 2005. This
increase is primarily attributable to the year-to-date earnings of the Company
of $2.9 million, less the cash dividends declared of approximately $557,000 and
the comprehensive loss of $156,000 associated with the net decrease in the value
of the investment securities. Additional paid in capital increased approximately
$100,000 due to the exercise of stock options.
RESULT OF OPERATIONS
The Company's results of operations depend primarily upon the level of
net interest income, which is the difference between the interest income earned
on its interest-earning assets such as loans and investments, and the costs of
interest-bearing liabilities, primarily deposits and borrowings. Results of
operations are also dependent upon the level of non-interest income, including
fee income and service charges, and are also affected by the level of its
non-interest expense, including its general and administrative expenses. Net
interest income depends upon the volume of interest-earning assets and
interest-bearing liabilities and the interest rate earned or paid on them,
respectively.
Due to the fact that the Company grew by approximately 60% in size with
the acquisition of GFSB Bancorp Inc on June 1, 2005, all the results of
operations are materially impacted by this change. It is important to note that
the application of purchase accounting requires that the acquiring entity not
recognize any of the income or expenses of the acquired entity prior to the
merger date. Consequently, the following discussions regarding results of
operations for the three month and six month periods ended March 31, 2006 and
2005 will all have significant variances due to the acquisition. Both the three
and six month periods ending in March 2006 contain results "with" the acquired
entity while the respective periods ended in March 2005 are "without" the
acquired entity.
NET INCOME. Net income for the three months ending March 31, 2006
increased by approximately $568,000 from $737,000 for the three months ending
March 31, 2005, to $1.3 million, or approximately 77%. The increase was
primarily due to an increase in net interest income of $2.4 million, or
approximately 70.6%. Non-interest income increased $127,000 or 27.2% while
non-interest expenses increased $1.8 million, or 71% for the three-month period
ending March 31, 2006 as compared to the
14
same period in 2005. This resulted in pre-tax income increasing $942,000 or
75.8%, less the increase of tax expense of $374,000. Similar types of percentage
increase are noted for the six month period ending March 31, 2006 compared to
the same period in 2005. Net income increased by $1.4 million to $2.9 million as
compared to $1.5 million for the six months ended in March 2005. This increase
represents a 90.2% improvement over the prior period. Net interest income grew
by 72.1%, or $4.9 million, and non-interest income increased $306,000, or 33%
over the six month period in 2005. Total non-interest expenses increased 64.9%
or $3.3 million over the prior year. As a result of these changes, pre-tax
income increased by $2.2 million or 89.2%, which was partially offset by the
$895,000 increase in income taxes.
NET INTEREST INCOME. For the three months ending March 31, 2006, net
interest income before loan loss provision increased $2.3 million from
approximately $3.4 million for the three months ending March 31, 2005, to $5.7
million for the three months ending March 31, 2006. Total interest income
increased $4 million or 83.3% from $4.8 million for the quarter ending March 31,
2005 to $8.8 million for the quarter ending March 31, 2006. As discussed below,
the increase in earning assets associated with the GFSB merger and increasing
interest rates helped to push interest income to significantly higher levels.
Likewise, interest expense for the three-month period ending March 31, 2006
increased $1.7 million, or 121.4%, over the same period in 2005. The increase in
interest expense correlates to the increase in the amount of interest bearing
liabilities and the increasing interest rates paid on those liabilities.
The six month period ending March 31, 2006 exhibits the same types of
trends discussed above regarding the most recent quarter end results. Total
interest income in the six month period ending March 31, 2006 increased $8
million or 84.4% over the same period ending in March 2005. The Yield and Cost
Data Section that follows in this document, indicates that average
interest-earning assets (for the respective six month periods) increased from
$328.5 million to $509.1 million in the period ending in March 2006. In addition
to the 55% increase in volume of interest-earning assets, the average yield on
those assets increased from 5.3% to 6.4%. Interest expense for the six month
period ending in March 2006 increased to $5.9 million from $2.7 million for the
same period in 2005, an increase of 114.8%. Generally, GFSB's cost of funds was
higher than the Company's cost of funds. Additionally, the Company's issuance of
the Trust Preferred Securities adversely affected the cost of borrowings since
these debentures have fixed costs for the first five years of approximately
5.8%. As reflected in the Yield and Cost Section, the annualized cost of
interest-bearing liabilities increased from 1.9% for the period in 2005 to 2.7%
for the same six month period ending in March 2006. The average cost of deposits
increased from 1.2% in 2005 to 2.2% in 2006. The cost of borrowed funds declined
from 4.5% in 2005 to 4.2% in 2006. The significant increase in cost of deposits
is attributable to the amount of deposits that are immediately repriceable
(i.e., savings, money market, and NOW accounts) and the overall short life of
the term deposits in comparison to the longer term borrowed funds. Most of the
borrowed funds are FHLB advances. During the six months ending in 2006, a number
of long-term, high cost advances matured, thus reducing the average cost
associated with the FHLB advances. The action of the Federal Reserve Bank to
increase short-term interest rates has caused more pressure on financial
institutions to increase deposit rates to maintain the customer deposit base.
Currently, we compete for customer funds against other financial institutions,
mutual funds, brokerage firms, insurance companies and the equities markets.
Management of the Company believes that deposit rates will continue to increase
as consumers seek the highest available returns.
15
PROVISION FOR LOAN LOSSES. The Company reversed approximately $287,000
from the allowance for loan losses during the quarter ended March 31, 2006. For
the six month period ending in March 2006, the Company has reversed $427,000
from the Allowance for Loan Losses. These reversals are attributed to the
improvement of certain assets that were acquired with the GFSB merger. This
action is necessitated to comply with the methodology the Company uses to
estimate the level of allowance required to cover potential losses in the loan
portfolio. This methodology is more fully described in the Notes to Consolidated
Financial Statements set forth in the consolidated financial statements as of
September 30, 2005, which were filed with the SEC on Form 10-KSB (File No.
000-51243). Under current accounting and regulatory requirements, management
must consistently apply a methodology that estimates an allowance sufficient to
cover probable losses based on historical experience and certain qualitative
factors. The Company then must increase or decrease the allowance through a
provision for loan losses that is reported in the income statement. Although the
institution maintains its allowance for loan losses at a level it considers
adequate to provide for probable losses as discussed earlier, there can be no
assurance that such losses will not exceed the estimated amounts or that
additional substantial provisions for loan losses will not be required in future
periods.
OTHER INCOME. For the three-month period ending March 31, 2006, total
other income increased approximately $127,000, or 27.2%, as compared to the same
period in 2005. The majority of this increase was attributed to additional fees
and service charges. Much of this increase is related to the merger. Fees
associated with the sale of mortgage loans decreased approximately $37,000 or
26%. The trend for the six month period ending March 31, 2006 indicates similar
results. Total other income increased $306,000 or 33%, to $1.2 million. Again
the majority of the increase is related to fees and service charges which
increased 56.8% to $632,000 in 2006, compared to $403,000 in the same period of
2005. For the six month period, income from the sale of mortgage loans decreased
$6,000 to $265,000 in 2006. This trend is consistent with declining mortgage
originations on a national scale and has been occurring over the past few years.
Higher interest rates and the saturation of re-financings in 2003 and 2004 have
left a much smaller population of consumers seeking mortgage loans. The Company
continues to seek other markets and types of products to supplement the loss of
volume in this line of business. As other competitors face the same challenges
of dwindling mortgage originations, the profit potential associated with each
transaction is also reduced. Recently we have added mortgage lenders in our
high-growth markets, such as Las Cruces and Albuquerque where record sales of
homes and construction activity have continued even though other geographic
areas are experiencing slowdowns in the housing and mortgage business.
OTHER EXPENSE. Total non-interest expense increased approximately $1.8
million, or 71%, to $4.4 million for the quarter ending March 31, 2006 in
comparison to $2.6 million for the same quarter in 2005. Similar results are
reported for the six month period ending in March 2006. Overall, non-interest
expense for the six months ended March 31, 2006 was $8.5 million, an increase of
$3.3 million, or 64.9% from the same period in 2005.
As would be expected, compensation expense increased during both the
three and six month reporting periods. For the most recent six month period
compensation expense was $5.0 million compared to $3.1 million for the six
months ending in March 2005, an increase of
16
approximately 60%. The Company added approximately 55 full-time equivalent
employees with the merger. During the current six month period the Company has
added several positions in the area of credit administration and credit
analysis. These positions were necessary to effectively manage the loan
portfolio and provide timely responses to customer loan requests.
The mortgage function is being reorganized and centralized to a location
in Albuquerque. Previously the function has been dispersed in various branches.
On May 1, 2006 activity from the various locations was transferred to the
Albuquerque location. During the past six months we have incurred additional
expenses in the training and overlap of employees performing similar functions.
We anticipate a more profitable mortgage operation once activities are centrally
located.
We have also incurred additional employee costs while we were hiring and
preparing for the opening of our second location in Albuquerque. At the end of
February 2006, we opened another banking facility in Albuquerque, located at
1301 Wyoming Blvd. This is a bank owned property that houses a full-service
banking operation in one half and contains the mortgage department in the other
half. While we initially incur costs to add services and expand in the growing
markets, we believe it is in the best interest of the Company and our
shareholders to maximize opportunities for our long-term success. In addition,
the tight labor market for certain types of highly-skilled employees has
generally forced the cost of labor up in most of the markets the Company
operates in. Management is working diligently to identify, hire and retain
quality employees that will allow expansion of our business.
Generally, the other areas of non-interest expense reflect increases
consistent with the size of the new entity.
During the most recent six month period, data processing increased
$341,000 or 147.6% between the reporting periods. A significant portion of the
increase is attributable simply to the volume of processing associated with the
larger size of the new entity. In addition, in May 2005 the Company began the
process to implement electronic check clearing, commonly referred to as Check
21. The Company completed a study in 2005 and determined that given the delays
and costs in processing paper checks and getting them delivered to a Federal
Reserve check processing center it was beneficial on a long-term basis to move
to an imaging platform to clear checks electronically. While certain costs
associated with this conversion are offset by earnings on accelerated clearings,
the full economic value does involve a payback period of approximately five
years. As a result, certain personnel expenses associated with check processing
have declined, due to outsourcing, while other areas have increased, like data
processing and to a lesser extent depreciation. Some of these expenses are
offset by earnings on collected funds and reductions in courier expenses.
Management believes that as the Federal Reserve moves to completely implement
Check 21 nationally over the next several years, the benefits will continue to
grow for the Company.
Another anticipated increase was in the area of depreciation and
amortization. During the six month period ended March 31, 2006, depreciation and
amortization expense increased $341,000 to $632,000 from $291,000 during the
same period in 2005. The increase includes
17
$210,000 of intangible amortization associated with the GFSB merger. The balance
of the increase relates to depreciation of fixed assets acquired in the merger.
Another category of non-interest expense that increased significantly
in the comparison of the six month period ending March 2006 to the same period
in 2005 was professional fees. This expense for the six months in 2005 was
$99,000 and increased by $173,000, or 174.8% to $272,000. Most of the increase
relates to the costs associated with being a public company. Our cost for legal,
consulting and audit services continues to increase. In addition, professional
recruiters have been used to identify qualified candidates for certain highly
skilled positions that we have needed.
INCOME TAX EXPENSE. During the three month and six month periods,
income taxes have increased proportionately to the increase in pre-tax income.
For the six month period ending March 31, 2006, pre-tax income increased by
89.2% and income tax expense increased 87.8% from the 2005 levels. The combined
effective income tax rate for the Company (approximately 40%) has not changed
between the periods in 2006 and 2005.
18
YIELD AND COST DATA
The following table sets forth average balance sheets, average yields
and costs, and certain other information for the periods indicated. No
tax-equivalent yield adjustments were made, as the effect thereof was not
material. All average balances are daily average balances. Non-accruing loans
have been included in the table as loans carrying a zero yield. Not included in
interest income on loans are loan fees and other charges on loans totaling
$1,340,000 and $976,000 for the six months ended March 31, 2006 and 2005,
respectively.
SIX MONTHS ENDED MARCH 31,
2006 2005
------------------------------------ --------------------------------------
AVERAGE AVERAGE
OUTSTANDING YIELD/RATE OUTSTANDING YIELD/RATE
BALANCE INTEREST (3) BALANCE INTEREST (3)
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans......................... $ 414,904 $ 14,509 7.0% $ 257,074 $ 7,906 6.2%
Investment securities......... 69,322 1,351 3.9% 43,372 554 2.6%
Interest-earning
deposits,short-term........ 24,878 522 4.2% 28,047 303 2.2%
--------- --------- --------- --------- --------- ---------
Total interest-earning
assets..................... 509,104 16,382 6.4% 328,493 8,763 5.3%
Non-interest-earning assets... 41,518 23,264
--------- ---------
Total assets............... $ 550,622 $ 351,757
========= =========
INTEREST-BEARING LIABILITIES:
Passbook savings.............. $ 74,007 $ 533 1.4% $ 88,074 $ 314 0.7%
NOW/interest bearing checking. 63,343 46 0.1% 47,568 27 0.1%
Money market.................. 33,730 419 2.5% 7,370 13 0.4%
Certificates of deposit....... 140,713 2,373 3.4% 79,241 1,021 2.6%
--------- --------- --------- --------- --------- ---------
Total deposits............. 311,793 3,371 2.2% 222,253 1,375 1.2%
FHLB advances................. 106,468 2,181 4.1% 58,635 1,270 4.3%
Long-term subordinated debt 10,310 301 5.8% 1,381 80 5.8%
--------- --------- --------- --------- --------- ---------
Total borrowings........... 116,778 2,482 4.2% 60,016 1,350 4.5%
Total interest-bearing
liabilities................... 428,571 5,853 2.7% 282,269 2,725 1.9%
Non-interest-bearing
liabilities................... 71,355 38,494
--------- ---------
Total liabilities.......... 499,926 320,763
Stockholders' equity.......... 50,696 30,994
--------- ---------
Total liabilities and
stockholders' equity..... $ 550,622 $ 351,757
========= =========
Net interest income........... $ 10,529 $ 6,038
========= =========
Net interest rate spread (1).. 3.7% 3.4%
Net interest-earning assets... $ 80,533 $ 46,224
========= =========
Net interest margin (2)....... 4.1% 3.7%
Average interest-earning
assets to interest-bearing
liabilities................ 118.8% 116.4%
- ---------------------
(1) The average interest rate spread represents the difference between the
weighted-average yield on interest-earning assets and the weighted-average
cost of interest-bearing liabilities for the period.
(2) The net interest margin represents net interest income as a percent of
average interest-earning assets for the period.
(3) The yield has been annualized for comparable purposes.
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the changes related to
outstanding balances and those related to the changes in interest rates. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume ( i.e.,
changes
19
in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in
rate multiplied by old volume). For purposes of this table, changes attributable
to both rate and volume, which cannot be segregated, have been allocated
proportionately to the change due to volume and the change due to rate.
SIX MONTHS ENDED MARCH 31,
2006 VS. 2005
-------------------------------
INCREASE (DECREASE)
DUE TO TOTAL
------------------ INCREASE
(DECREASE)
VOLUME RATE INTEREST
------- ------- -------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans ....................... $ 4,854 $ 1,749 $ 6,603
Investment securities ....... 331 466 797
Interest-earning deposits ... (34) 253 219
------- ------- -------
Total interest-earning
assets ............... 5,151 2,468 7,619
------- ------- -------
INTEREST-BEARING LIABILITIES:
Passbook savings ............ 50 (269) (219)
NOW/interest-bearing checking (9) (10) (19)
Money market accounts ....... (46) (360) (406)
Certificates of deposit ..... (792) (560) (1,352)
------- ------- -------
Total deposits .......... (797) (1,199) (1,996)
FHLB advances ............... (1,036) 125 (911)
Long-term subordinated debt . (221) -- (221)
------- ------- -------
Total borrowings ........ (1,257) 125 (1,132)
Total interest-bearing
liabilities .......... (2,054) (1,074) (3,128)
------- ------- -------
Change in net interest income ...... $ 3,097 $ 1,394 $ 4,491
======= ======= =======
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
The Company's profitability, like that of many financial institutions,
is dependent to a large extent upon its net interest income. When
interest-bearing liabilities mature or reprice more quickly (liability
sensitive) than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly (asset
sensitive) than interest-bearing liabilities, falling interest rates could
result in a decrease in net interest income. Finally, a flattening of the "yield
curve" (i.e., a decline in the difference between long- and short-term interest
rates) could adversely impact net interest income to the extent that the
Company's assets have a longer average term than its liabilities.
The Company is also subject to interest rate risk to the extent that the
value of its net assets fluctuates with interest rates. In general, the value of
a portion of the Company's assets will decline in the event of an increase in
interest rates. Historically, the Company's lending activity consisted primarily
of one-to four-family mortgages with long terms and fixed rates. These assets
are interest rate sensitive and therefore decline in value during a period of
rising interest rates. Conversely, these assets can increase in value during a
period of decreasing
20
interest rates to the extent they do not prepay. As part of the Company's
business strategy and asset/liability management policy, a primary focus of
lending activity is the acquisition of variable rate and/or shorter term loans
thereby decreasing interest rate risk and fluctuations in the value of the
Company's assets. At March 31, 2006, the Company had approximately $173.0
million, or roughly 41.4% of the total loan portfolio in variable rate loans.
Economic Value of Equity ("EVE") analysis provides a quantitative
measure of interest rate risk. In essence, this approach calculates the
difference between the market value of assets and liabilities under different
interest rate environments. The degree of change between interest rate shock
levels is a measure of the volatility of value risk. The following table sets
forth, as of March 31, 2006, the estimated changes in First Federal Bank's EVE
in the event of the specified instantaneous changes in interest rates.
ECONOMIC VALUE OF EQUITY
-------------------------------------------------------------------
Change in
Interest Rates Amount of
(Basis Points) Estimated EVE Change Percent Change
-------------------------------------------------------------------
(Dollars in Thousands)
-------------------------------------------------------------------
+300 $ 75,367 $ (6,131) -8%
+200 77,774 (3,724) -5%
+100 79,869 (1,628) -2%
0 81,498 - -
-100 82,159 661 +1%
-200 81,016 (482) -1%
-------------------------------------------------------------------
Certain assumptions were employed in preparing the previous table. These
assumptions relate to interest rates, loan prepayment rates varied by categories
and rate environment, deposit decay rates varied by categories and rate
environment and the market values of certain assets under the various interest
rate scenarios. In addition, an intangible asset is created that approximates
the value of the deposits at $26.4 million as of March 31, 2006. It was also
assumed that delinquency rates will not change as a result of changes in
interest rates although there can be no assurance that this will be the case. In
the event that interest rates do change in the designated amounts, there can be
no assurance that First Federal's assets and liabilities would perform as set
forth above. In addition, a change in Treasury rates in the designated amounts
accompanied by a change in the shape of the Treasury yield curve would cause
significantly different changes to the EVE than indicated above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of funds are deposits and borrowings,
scheduled payments and prepayment of loan principal and mortgage-backed
securities, scheduled payments and maturities of investment securities and
operations. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan repayments are more
influenced by general interest rates, floors and caps on loan rates, general
economic
21
conditions and competition. The Company generally manages the pricing of its
deposits to be competitive and to increase core deposit relationships. From time
to time the Company has decided not to pay deposit rates that are as high as
those of its competitors. In such cases, to meet funding needs the Company can
supplement deposits with less expensive alternative sources of funds, such as
FHLB borrowings.
The primary investing activities of the Company are originating loans
and, to a much lesser extent, purchasing mortgage-backed and investment
securities. For the six months ended March 31, 2006 and 2005, the Company
increased outstanding loans balances by $1.6 million and $10.6 million,
respectively. The net growth was primarily funded by the maturities and
principal payments on investment securities, and FHLB advances were used to fund
a portion of loan originations.
The primary financing activities of the Company are deposits and
borrowings. During the six months ended March 31, 2006, the Company experienced
a net increase in deposits of $6.4 million compared to a net decrease of $3.3
million during the same period ending March 31, 2005. Certificates of deposits
as of March 31, 2006, maturing within one year, totaled $84.8 million.
Management expects most of the non-public deposits to remain with the Bank. The
net decrease in FHLB borrowings for the six-month period ended March 31, 2006,
was $5.9 million. This was primarily related to maturities of advances and no
significant demand for this type of funding source.
The Company's most liquid assets are cash and cash equivalents, which
consist of currency on hand, items in process of clearing and due from banks.
These items are non-interest bearing. The level of these assets is dependent on
the Company's operating, financing and investing activities during any given
period. At September 30, 2005 and March 31, 2006, cash and cash equivalents
totaled $11.8 million and $12.9 million, respectively. Additionally, the Company
maintains overnight funds that are interest-bearing. As of September 30, 2005
the balance was $23.9 million. At March 31, 2006 the overnight fund balance was
$35.6 million. Management has allowed these funds to accumulate rather than put
the funds into investment securities which have interest rate risk and yet no
corresponding yield on the longer term of the investment. As of March 31, 2006,
the ten-year U.S. Treasury Note was yielding approximately ten basis points more
than the overnight Fed Funds rate.
Liquidity management is both a daily and long-term responsibility of
management. The Company adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquidity is invested generally in interest-earning overnight deposits,
short- and intermediate-term U.S. Government and agency obligations and
mortgage-backed securities of short duration. If the Company requires funds
beyond its ability to generate them internally, the Bank has additional
borrowing capacity with the FHLB of Dallas, which is, in the opinion of
management, adequate to provide any funds needed.
22
At September 30, 2005, the Company had outstanding unfunded loan
commitments totaling $52 million and $64.8 million as of March 31, 2006. The
Company anticipates that it will have sufficient funds available to meet current
loan commitments.
First Federal Bank is required to maintain minimum levels of regulatory
capital. At March 31, 2006, First Federal Bank exceeded all of the capital
requirements.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related consolidated financial
data presented herein have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical
dollars without consideration for changes in the relative purchasing power of
money over time due to inflation. The impact of inflation can be found in the
increased cost of the Company's operations. Nearly all the assets and
liabilities of the Company are financial, unlike most industrial companies. As a
result, the Company's performance is directly impacted by changes in interest
rates, which are indirectly influenced by inflationary expectations. Changes in
interest rates do not necessarily move to the same extent as changes in the
price of goods and services.
ITEM 3. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act)
as of the end of the period covered by this quarterly report. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the end of the period covered by this quarterly report, our
disclosure controls and procedures were effective to ensure that information
required to be disclosed in the reports that the Company files or submits under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There have not been any changes in internal control over financial
reporting in the last quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
The annual meeting of Shareholders (the "Meeting") of First
Federal Banc of the Southwest, Inc. was held on February 22, 2006. The
matters approved by the shareholders at the Meeting and the number of
votes cast for, against or withheld (as well as the number of
abstentions) as to each matter are as follows:
PROPOSALS FOR AGAINST WITHHELD ABSTAIN
(1) Election of the following
directors for terms to
expire in 2009:
Edward K. David 2,941,579 - 26,529 --
Aubrey L. Dunn, Jr 2,883,473 - 84,635 --
Kay R. McMillan 2,753,865 - 214,243 --
Michael P. Mataya 2,965,678 - 2,430 --
(2) Ratification of the
appointment of the
independent registered
public accounting firm 2,853,029 99,760 - 15,319
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
31.1 Certification of Aubrey L. Dunn, Jr. pursuant to Rule
13a-14 under the Securities Exchange Act of 1934
31.2 Certification of George A. Rosenbaum, Jr. pursuant
to Rule 13a-14 under the Securities Exchange Act of
1934
32 Certification of Aubrey L. Dunn, Jr. and George A.
Rosenbaum, Jr. pursuant to 18 U.S.C. 1350 as adopted
pursuant to Section 906 of the Sarbanes Oxley Act of
2002
24
SIGNATURES
In accordance with section 13 or 15(d) 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.
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
Registrant
MAY 12, 2006 By: \S\ AUBREY L. DUNN, JR.
- ------------------------------ ---------------------------------------
Date Aubrey L. Dunn, Jr.
President and Chief Executive Officer
Principal Executive Officer)
MAY 12, 2006 By: \S\ GEORGE A. ROSENBAUM, JR.
- ------------------------------ ----------------------------------------
Date George A. Rosenbaum, Jr.
Executive Vice President and Chief
Financial Officer (Principal
Accounting and
Financial Officer)