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 JUNE 30, 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:
3,992,453 shares of common stock, par value $0.01 per share, as of August 9,
2006
Transitional Small Business Disclosure Format (check one),
[ ] Yes [ X ] No
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE
- ---------------------------------- ----
Item 1 Financial Statements.
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Stockholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial Condition 12
and Results of Operations.
Item 3 Controls and Procedures. 24
PART II OTHER INFORMATION
- ------- -----------------
Item 1 Legal Proceedings. 25
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds. 25
Item 3 Defaults Upon Senior Securities. 25
Item 4 Submission of Matters to Vote of Security Holders. 25
Item 5 Other Information. 25
Item 6 Exhibits. 25
Signatures 26
Exhibit 31.1 Certification of Chief Executive Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002
Exhibit 32 Certification Pursuant to Section 906 of Sarbanes-Oxley Act
of 2002
1
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
Consolidated Statements Of Financial Condition
- --------------------------------------------------------------------------------
June 30, 2006 Compared to September 30, 2005
ASSETS JUNE 30, September 30,
2006 2005
-------------- -------------
(UNAUDITED)
($ IN THOUSANDS)
Cash and due from banks $ 16,589 $ 11,777
Interest-bearing deposits with banks 47,440 26,185
Held-to-maturity investment securities 9 2,132
Available-for-sale investment securities 53,145 64,902
Loans held for sale 4,221 2,892
Loans receivable, net 412,523 412,073
Accrued interest receivable 2,035 2,036
Federal Home Loan Bank stock, at cost, restricted 5,335 6,373
Property, equipment, and construction in progress, net 13,752 13,726
Identifiable intangibles 3,329 3,645
Goodwill 2,286 2,286
Investment in non-bank subsidiaries 310 310
Other assets 1,312 1,605
-------------- -------------
TOTAL ASSETS $ 562,286 $ 549,942
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 73,326 $ 62,106
Interest bearing 318,835 315,609
Advances from the Federal Home Loan Bank 102,697 107,991
Escrows from borrowers for taxes and insurance 981 1,561
Accrued and other liabilities 3,605 3,156
Long term subordinated debt 10,310 10,310
-------------- -------------
TOTAL LIABILITIES 509,754 500,733
-------------- -------------
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; 4,313,045 shares issued and
3,992,453 shares outstanding at June 30, 2006;
4,289,445 shares issued and 3,968,853 shares
outstanding at September 30, 2005 43 43
Additional paid-in capital 18,185 17,916
Retained earnings 37,646 34,345
Accumulated other comprehensive loss (621) (374)
Treasury stock, at cost, 320,592 shares at June 30, 2006 and
September 30, 2005 respectively (2,721) (2,721)
-------------- -------------
TOTAL STOCKHOLDERS' EQUITY 52,532 49,209
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 562,286 $ 549,942
============== =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
Three and Nine Months Ended June 30, 2006 and 2005 (unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -----------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest Income
Interest and fees on loans $ 8,030 $ 5,379 $ 23,614 $ 13,990
Interest on investment securities 588 365 1,796 874
Interest and dividends on other investments 565 193 1,221 541
----------- ----------- ------------ ------------
Total interest income 9,183 5,937 26,631 15,405
----------- ----------- ------------ ------------
Interest Expense
Deposits 2,077 929 5,448 2,303
Borrowed funds 1,209 949 3,682 2,299
----------- ----------- ------------ ------------
Total interest expense 3,286 1,878 9,130 4,602
----------- ----------- ------------ ------------
Net interest income before provision for 5,897 4,059 17,501 10,803
loan losses
Benefit (provision) for loan losses (5) - 422 -
----------- ----------- ------------ ------------
Net interest income after provision
for loan losses 5,892 4,059 17,923 10,803
----------- ----------- ------------ ------------
Other Income
Fees for services to customers 342 253 974 656
Gain on sale of loans 106 127 371 398
Gain on sale of available-for-sale investment
securities - - - -
Other 219 137 555 390
----------- ----------- ------------ ------------
Total other income 667 517 1,900 1,444
----------- ----------- ------------ ------------
Other Expenses
Compensation and related benefits 2,594 1,964 7,557 5,067
Occupancy 286 241 889 680
Data processing 285 148 857 379
Advertising 39 41 148 98
Telephone 68 38 198 142
Postage 47 30 141 113
Printing and supplies 81 72 240 166
Employee expenses 63 73 264 180
Depreciation and amortization 332 168 964 459
Loss on sale of available-for-sale investment
securities 59 - 59 -
Professional fees 117 80 389 179
Other 386 282 1,142 823
----------- ----------- ------------ ------------
Total other expenses 4,357 3,137 12,848 8,286
----------- ----------- ------------ ------------
Income before income taxes 2,202 1,439 6,975 3,961
Income tax expense 924 580 2,838 1,599
----------- ----------- ------------ ------------
Net income $ 1,278 $ 859 $ 4,137 $ 2,362
=========== =========== ============ ============
Net income per average common share
Basic $ 0.32 $ 0.25 $ 1.04 $ 0.72
Diluted $ 0.32 $ 0.24 $ 1.03 $ 0.68
Average common shares - basic 3,983,203 3,387,719 3,979,113 3,272,913
Average common shares - diluted 4,035,577 3,587,413 4,030,057 3,472,607
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the Nine Months Ended June 30, 2006 (unaudited)
($ 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 23,600 242 242
Compensation expense - stock
Compensation plan 27 27
Dividends - $0.21 per share (836) (836)
Comprehensive income:
Change in unrealized
(loss) on investment
securities,
net of taxes (247)
Net income 4,137
TOTAL 3,890
------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2006 4,313,045 $ 43 $ 18,185 320,592 $ (2,721) $ 37,646 $ (621) $52,532
================================================================================================
Reconciliation of Other Comprehensive Income (Loss) FOR THE NINE MONTHS
ENDED JUNE 30,
------------ -----------
2006 2005
------------ -----------
Unrealized losses on securities:
Unrealized holding losses arising during period $ (471) $ (442)
Related taxes 189 177
Reclassification adjustments for net losses in
net income 59 -
Related taxes (24) -
------------ -----------
TOTAL OTHER COMPREHENSIVE (LOSS) $ (247) $ (265)
============ ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Nine Months Ended June 30, 2006 and 2005 (unaudited)
NINE MONTHS ENDED
JUNE 30,
------------------------------------
2006 2005
------------- ------------
(IN THOUSANDS)
Cash Flows from Operating Activities
Net income $ 4,137 $ 2,362
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation & amortization of intangibles 964 451
Net loss (gain) on sale of REO (6) -
Net loss on sale of available-
for-sale investments 59 -
Accretion of deferred loan fees (244) -
Proceeds from sales of loans held for sale 27,938 23,287
Origination of loans held for sale (28,896) (22,833)
Gain on sale of sold loans (370) (398)
Provision (benefit) for loan losses (422) -
Amortization of investments, net 47 298
FHLB stock dividend (192) (99)
Non-cash compensation expense for stock option grants 27 -
Change in accrued interest & dividend receivable - 33
Change in prepaid/other assets 118 (1,000)
Change in accounts payable & accrued liabilities 450 2,010
Accretion of market-to-market, net (171) -
Other, net (152) 177
------------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,287 4,288
------------- ------------
Cash Flows from Investing Activities
Change in deposits in banks (21,255) 2,524
Proceeds from maturity and principal paydowns
of held-to-maturity securities 2,105 17,551
Purchases of investment securities held-to-maturity - (225)
Principal payments on mortgage backed securities
held-to-maturity 17 -
Proceeds from sales, maturities and principal paydowns
of available-for-sale securities 6,791 2,000
Purchases of available-for-sale investment securities - (8,910)
Principal payments on mortgage backed securities
available-for-sale 4,766 1,762
Loan origination and principal repayment on loans, net 106 (22,135)
Net cash paid for acquisition of GFSB - (4,355)
Proceeds from sale of foreclosed properties 285 -
Proceeds from redemption of FHLB stock 1,231 -
Proceeds from sale of property and equipment - 128
Purchases of trust preferred common securities - (310)
Purchases of building and equipment (663) (1,060)
------------- ------------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (6,617) (13,030)
------------- ------------
Cash Flows from Financing Activities
Net increase in transaction accounts, savings
and now deposits 14,368 4,271
Net increase (decrease) in mortgage escrow funds (580) (74)
Proceeds from FHLB advances 10,449 15,490
Repayments on FHLB advances (15,500) (13,798)
Dividends paid or to be paid in cash (837) (280)
Proceeds from exercise of stock options 242 184
Proceeds from sale of subordinated debentures - 10,310
Purchase of treasury stock, net - -
------------- ------------
NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES 8,142 16,103
------------- ------------
INCREASE IN CASH AND DUE FROM BANKS $ 4,812 $ 7,361
============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
- --------------------------------------------------------------------------------
Nine Months Ended June 30, 2006 and 2005 (unaudited)
NINE MONTHS ENDED
JUNE 30,
-------------------------------------------
2006 2005
---------------- -----------------
(IN THOUSANDS)
Increase in cash and due from banks $ 4,812 $ 7,361
Cash and due from banks at beginning of year 11,777 9,529
---------------- -----------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 16,589 $ 16,890
================ ================
SUPPLEMENTAL DISCLOSURES
Cash paid during the period for
Interest on deposits and advances $ 8,541 $ 3,931
Income taxes 2,608 1,183
(Increase) in unrealized loss, net of deferred taxes
on available-for-sale securities (other comprehensive income) (247) (265)
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 June
30, 2006, and the results of operations for all interim periods presented.
Operating results for the three and nine months ended June 30, 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 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.
7
During this reporting period the 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.
In June 2006, the FASB issued FASB Interpretation No. 48, ACCOUNTING FOR
UNCERTAINTY IN INCOME TAXES - an interpretation of FASB Statement No. 109 ("FIN
48"). This interpretation clarifies the accounting for uncertainity in income
taxes recognized in an enterprise's financial statements in accordance with FASB
Statement No. 109, ACCOUNTING FOR INCOME TAXES. This interpretation prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. This interpretation is effective for years beginning
after December 15, 2006. The adoption of this interpretation is not expected to
have a material impact on the Company's financial condition or operations.
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 June 30 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. 46R, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51, as revised. Prior to FIN 46R, 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 46R, 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
The Company adopted Statement of Financial Accounting Standards No.
123R, SHARE BASED PAYMENT, ("SFAS No. 123R") to account for stock-based
compensation granted through the existing stock option plans. Beginning January
1, 2006, compensation expense is calculated based on the grant date fair value.
The Company elected to use the modified prospective transition method as
permitted by SFAS No. 123R and, therefore, has not restated the financial
results for prior periods. Under this method, the provisions of SFAS No. 123R
are applied to new awards and to awards modified, repurchased, or cancelled
after January 1, 2006. In addition, the Company recognizes compensation expense
for unvested awards outstanding at December 31, 2005.
9
Stock options are subject to various vesting schedules and terms,
subject to accelerated vesting upon death and disability or a change in control.
Compensation expense for the issuance of stock options is recognized over the
required service period based on the estimated fair value of the options on the
date of grant using a Black-Scholes valuation model. Included in the
determination of net income as reported for the nine months ending June 30, 2006
is compensation expense related to options of $27,000 (representing the expense
from January 1 to June 30, 2006). Prior to the adoption of SFAS No. 123R, the
Company accounted for stock-based compensation in accordance with Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. As a
result, no compensation expense was recognized during 2005 related to stock
options. Had compensation cost for the stock options been determined as if the
Company accounted for its stock-based compensation plans consistent with the
fair value method of SFAS No. 123R, the Company's same period 2005 results would
have been reduced by a similar immaterial amount as reported in the 2006 period.
A summary of the Company's stock option activity related information for
the nine months ended June 30, 2006 follows:
OPTIONS
--------
Outstanding at the beginning of the period 166,400
Granted 69,950
Exercised (23,600)
Forfeited (5,900)
--------
Outstanding at June 30, 2006 206,850
Exercisable at June 30, 2006 126,850
Exercise prices for options outstanding as of June 30, 2006 ranged from
$8.50 to $16.56 per share.
As of June 30, 2006, the total unrecognized compensation expense related
to non-vested stock options was approximately $312,000 and is expected to be
recorded, on a straight-line method, over the estimated average period of 5.75
years.
The Black-Scholes valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
10
The following table outlines the weighted average assumptions input into
the Black-Scholes valuation model to calculate fair value for unvested stock
options granted in 2003 under the 2002 STOCK OPTION AND INCENTIVE PLAN for the
period ending June 30, 2006:
Total number of unvested options during the period 80,000
Risk-free interest rate (at grant date) 2.78%
Expected life, in years 7.7
Expected volatility 33.98%
Expected dividend yield 2.4%
Estimated fair value per option $4.23
The risk-free interest rate is based on the market price for a U.S.
Treasury security issued near the date of grant with a maturity date
approximately equal to the expected life of the option at the grant date. The
expected life of the option is based on the term of the options since these
options relate only to one grantee. Volatility is based on the historical
volatility of other similar companies since our Company has only been in the
public market for one year and insufficient history is available. The dividend
yield is calculated by applying the Company's historical dividend growth rate to
the current quarterly dividend over the expected life of the stock option.
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.
11
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 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.
12
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
JUNE 30, 2006 COMPARED TO SEPTEMBER 30, 2005.
Total assets increased to $562.3 million as of June 30, 2006, up
approximately $12.4 million or 2.2%, from the September 30, 2005 balance of
$549.9 million.
Total net loans, excluding loans held for sale, remained nearly
unchanged at $412.5 million as of June 30, 2006, compared to $412.1 million as
of September 30, 2005. While the total balance in the net loan portfolio shows
little change, the composition of the portfolio has changed between the
respective dates. Residential mortgage loans have declined from $192 million to
$179.4 million at June 30, 2006. This represents a decrease of about 6.6%. The
decline is primarily attributable to the institution's policy regarding not
holding 30-year fixed rate mortgage loans. The rising short-term interest rates
have forced up the rates on adjustable-rate mortgage products to the point that
most customers will select the 30-year fixed rate loan which is relatively close
to the same rate as the adjustable products and shorter term mortgage loans.
Consequently, the demand for adjustable rate loans and 15-year fixed rate loans
is very low. While we continue to offer long-term fixed rate mortgages, we sell
them into the secondary market. This policy decision coupled with the overall
slowing of the mortgage business on a national scale represents the reason for
this decline. The decline in the residential mortgage portfolio has been
primarily offset by an increase in the commercial and construction loan segment
of our business. These categories of loans increased from $195.6 million at
September 30, 2005 to $209.8 million or $14.2 million, representing a 7.3%
increase. 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 unsold homes as they move into subdivisions so they
have opportunities to sell construction-in-progress homes. The bank limits the
number of unsold homes in relation to the number of pre-sold homes through the
use of loan covenants. 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. The demand for housing also requires additional loans
for development of subdivisions which ultimately produce the building lots
necessary for home construction. Nearly all the growth in the commercial loan
portfolio has been associated with real estate based collateral. We also attempt
to manage interest rate risk in our commercial real estate loans by embedding an
interest adjustment in three or five years even though the amortization of the
loan may be 15 or 20 years. Consumer loans declined approximately $400,000 as of
June 30, 2006 compared to September 30, 2005.
13
The total investment securities owned by the Company declined from
approximately $67.0 million at September 30, 2005 to $53.2 million at June 30,
2006. The $13.8 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. The funds from 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 June 30, 2006 balance of $45.7 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 adjusts daily. While the yield curve
remains in this flat position, management anticipates keeping any excess funds
in very short-term investments and seeks high-quality loans with adjustable-rate
terms.
Total deposits increased approximately $14.4 million from the September
30, 2005 level of $377.7 million to $392.2 million at June 30, 2006.
Non-interest bearing deposits increased approximately $11.2 million during this
period, while interest bearing deposits increased $3.2 million. Non-interest
bearing deposits consist of demand deposit accounts and can fluctuate
significantly on a day-to-day basis driven by the activities of our customers.
The most notable increase in demand deposits is in the area of corporate
accounts which increased from $50.4 million at September 30, 2005 to $60.4
million at June 30, 2006. The increase is the result of attempting to cross-sell
our electronic banking services to commercial customers and placing more
emphasis on requiring our commercial loan customers to maintain deposit
relationships with the bank. Within interest bearing deposits, numerous changes
between types of accounts have taken place. Savings accounts declined
approximately $19.8 million while money market accounts increased $36.9 million
and NOW accounts remained nearly unchanged. Time deposits decreased a net of
approximately $14.4 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 $4.5 million and non-public time deposits over
$100,000 decreased $7.2 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.
14
Federal Home Loan Bank of Dallas ("FHLB") borrowings decreased $5.3
million or 4.9% from $108 million at September 30, 2005 to $102.7 million at
June 30, 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 $3.3 million, or 6.7%, to $52.5 million
as of June 30, 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 $4.1 million, less the cash dividends declared of approximately $836,000 and
the net increase in comprehensive loss of $247,000 associated with the net
decrease in the value of the investment securities. Additional paid in capital
increased approximately $269,000 due to the exercise of stock options and
accounting for stock option expense.
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 nine month periods ended June 30, 2006 and
2005 will all have significant variances due to the acquisition. Both the three
and nine month periods ending in June 2006 contain results "with" the acquired
entity while the respective periods ended in June 2005 are "without" the
acquired entity except for the month of June 2005.
15
NET INCOME. Net income for the three months ended June 30, 2006
increased by approximately $419,000 from $859,000 for the three months ended
June 30, 2005, to $1.3 million, or an approximate increase of 48.8%. The
increase was primarily due to an increase in net interest income of $1.8
million, or approximately 43.9%. Non-interest income increased $150,000 or 29%
while non-interest expenses increased $1.2 million, or 38.7% for the three-month
period ending June 30, 2006 as compared to the same period in 2005. This
resulted in pre-tax income increasing $763,000 or 53%, less the increase of tax
expense of $344,000. Similar types of percentage increases are noted for the
nine month period ending June 30, 2006 compared to the same period in 2005. Net
income increased by $1.7 million to $4.1 million as compared to $2.4 million for
the nine months ended in June 2005. This increase represents a 70.8% improvement
over the prior period. Net interest income grew by 62%, or $6.7 million, and
non-interest income increased $456,000, or 31.5% over the nine month period in
2005. Total non-interest expenses increased 54.2% or $4.5 million over the prior
year. As a result of these changes, pre-tax income increased by $3 million or
76.8%, which was partially offset by the $1.2 million increase in income tax
expense.
NET INTEREST INCOME. For the three months ending June 30, 2006, net
interest income before loan loss provision increased $1.8 million or 43.9% from
approximately $4.1 million for the three months ending June 30, 2005, to $5.9
million for the three months ending June 30, 2006. Total interest income
increased $3.3 million or 55.9% from $5.9 million for the quarter ending June
30, 2005 to $9.2 million for the quarter ending June 30, 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 June 30,
2006 increased $1.4 million, or 73.6%, to $3.3 million 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 nine month period ending June 30, 2006 exhibits the same types of
trends discussed above regarding the most recent quarter end results. Total
interest income in the nine month period ending June 30, 2006 increased $11.2
million or 72.7% over the same period ending in June 2005. The Yield and Cost
Data Section that follows in this document, indicates that average
interest-earning assets (for the respective nine month periods) increased from
$351.1 million to $512.2 million in the period ending in June 2006. In addition
to the 45.9% increase in volume of interest-earning assets, the average yield on
those assets increased from 5.4% to 6.5%. Interest expense for the nine month
period ending in June 2006 increased to $9.1 million from $4.6 million for the
same period in 2005, an increase of 97.8%. 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
5.7%. As reflected in the Yield and Cost Section, the annualized cost of
interest-bearing liabilities increased from 2% for the period in 2005 to 2.8%
for the same nine month period ending in June 2006. The average cost of deposits
increased from 1.3% in 2005 to 2.3% in 2006. The cost of borrowed funds declined
from 4.4% 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 nine months ending in 2006, a
number of long-term, high cost advances matured, thus reducing the average cost
associated with the FHLB advances. As a result of the changes identified above,
the net interest spread for the Company has increased from 3.4% for the nine
month period ending June 30, 2005 to 3.7% for the same period in 2006. 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.
16
PROVISION FOR LOAN LOSSES. The Company provisioned approximately $5,000
for the Allowance for Loan Losses during the quarter ended June 30, 2006. For
the nine month period ending in June 2006, the Company has reversed $422,000
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 June 30, 2006, total
other income increased approximately $150,000, or 29%, 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 $21,000 or
16.5%. The trend for the nine month period ending June 30, 2006 indicates
similar results. Total other income increased $456,000 or 31.6%, to $1.9
million. Again the majority of the increase is related to fees and service
charges which increased 48.5% to $974,000 in 2006, compared to $656,000 in the
same period of 2005. For the nine month period, income from the sale of mortgage
loans decreased $27,000 to $371,000 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.
17
OTHER EXPENSE. Total non-interest expense increased approximately $1.3
million, or 41.9%, to $4.4 million for the quarter ending June 30, 2006 in
comparison to $3.1 million for the same quarter in 2005. Similar results are
reported for the nine month period ending in June 2006. Overall, non-interest
expense for the nine months ended June 30, 2006 was $12.8 million, an increase
of $4.5 million, or 54.2% from the same period in 2005.
As would be expected, compensation expense increased during both the
three and nine month reporting periods. For the most recent nine month period
compensation expense was $7.6 million compared to $5.1 million for the nine
months ending in June 2005, an increase of approximately 49%. The Company added
approximately 55 full-time equivalent employees with the merger. During the
current nine 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 has been reorganized and centralized to a location
in Albuquerque. Previously the function has been dispersed in various branches.
On May 1, 2006 mortgage activities from the various locations were transferred
to the Albuquerque location. During the past nine months we have incurred
additional expenses in the training and overlap of employees performing similar
functions. We anticipate a more profitable mortgage operation as these
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 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.
18
Generally, the other areas of non-interest expense reflect increases
consistent with the size of the new entity.
During the most recent nine month period, data processing increased
$478,000 or 126.1% 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 nine month period ended June 30, 2006, depreciation and
amortization expense increased $505,000 to $964,000 from $459,000 during the
same period in 2005. The increase includes $315,000 of intangible amortization
associated with the GFSB merger. The balance of the increase relates to
depreciation of fixed assets acquired in the merger as well as the addition of
the new facility in Albuquerque.
Another category of non-interest expense that increased significantly in
the comparison of the nine month period ending June 2006 to the same period in
2005 was professional fees. This expense for the nine months in 2005 was
$179,000 and increased by $210,000, or 117.3% to $389,000. 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.
In May 2006, the Company sold an available-for-sale investment in a
closed-end fund that specialized in investing in low income projects. The
uninvested portion of the fund was required to invest in US government or US
agency securities. As a result of the mark-to-market adjustments, the fund was
declining in value and had been losing value for an extended period of time.
Management recommended to the Board that the fund position be liquidated at the
next opportunity. The fund offered a repurchase opportunity and the Company
elected to place the holdings for repurchase. The repurchase price was the net
asset value as of the specified date. As a result of this action the Company
recorded a pre-tax loss of approximately $59,000. This action was taken based
upon consideration of the accounting requirements for investments with
other-than-temporary impairments and the future outlook for this fund.
19
INCOME TAX EXPENSE. During the three month and nine month periods,
income taxes have increased proportionately to the increase in pre-tax income.
For the nine month period ending June 30, 2006, pre-tax income increased by
76.1% and income tax expense increased 75% 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.
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 $2.0
million and $1.4 million for the nine months ended June 30, 2006 and 2005,
respectively.
NINE MONTHS ENDED JUNE 30,
----------------------------------------------------------------------------
2006 2005
-------------------------------------- ------------------------------------
AVERAGE AVERAGE
OUTSTANDING YIELD/RATE OUTSTANDING YIELD/RATE
BALANCE INTEREST (3) BALANCE INTEREST (3)
----------- --------- --------- ------------ --------- ---------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans......................... $ 415,009 $ 22,007 7.1% $ 277,302 $ 12,940 6.2%
Investment securities......... 65,273 1,952 4.0% 45,674 910 2.7%
Interest-earning
deposits,short-term 31,882 1,064 4.4% 28,094 499 2.4%
----------- --------- --------- ------------ --------- ---------
Total interest-earning
assets..................... 512,164 25,023 6.5% 351,070 14,349 5.4%
Non-interest-earning assets... 37,297 24,035
----------- -----------
Total assets............... $ 549,461 $ 375,105
=========== ===========
INTEREST-BEARING LIABILITIES:
Passbook savings.............. $ 71,019 $ 842 1.6% $ 85,023 $ 496 0.8%
NOW/interest bearing checking. 64,176 73 0.2% 49,793 46 0.1%
Money market.................. 41,560 898 2.9% 8,967 31 0.5%
Certificates of deposit....... 138,510 3,635 3.5% 87,422 1,729 2.6%
----------- --------- --------- ------------ --------- ---------
Total deposits............. 315,265 5,448 2.3% 231,205 2,302 1.3%
FHLB advances................. 105,387 3,244 4.1% 65,644 2,094 4.3%
Long-term subordinated debt 10,310 438 5.7% 4,792 206 5.7%
----------- --------- --------- ------------ --------- ---------
Total borrowings........... 115,697 3,682 4.2% 70,436 2,300 4.4%
Total interest-bearing
liabilities................ 430,962 9,130 2.8% 301,641 4,602 2.0%
Non-interest-bearing
liabilities................ 72,277 45,002
----------- -----------
Total liabilities.......... 503,239 346,643
Stockholders' equity.......... 51,203 36,438
----------- -----------
Total liabilities and
stockholders' equity..... $ 554,442 $ 383,081
=========== ===========
Net interest income........... $ 15,893 $ 9,747
========= =========
Net interest rate spread (1).. 3.7% 3.4%
Net interest-earning assets... $ 81,202 $ 49,429
=========== ===========
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.
20
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 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.
NINE MONTHS ENDED JUNE 30,
2006 VS. 2005
----------------------------------------------------
INCREASE (DECREASE)
DUE TO
--------------------------------- TOTAL
INCREASE
VOLUME RATE (DECREASE)
--------------- -------------- ---------------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans................................. $ 6,426 $ 2,641 $ 9,067
Investment securities................. 390 652 1,042
Interest-earning deposits............. 67 498 565
--------------- -------------- ---------------
Total interest-earning
assets......................... 6,883 3,791 10,674
--------------- -------------- ---------------
INTEREST-BEARING LIABILITIES:
Passbook savings...................... 82 (428) (346)
NOW/interest bearing checking......... (13) (14) (27)
Money market accounts................. (113) (754) (867)
Certificates of deposit............... (1,010) (896) (1,906)
--------------- -------------- ---------------
Total deposits.................... (1,054) (2,092) (3,146)
FHLB advances......................... (1,268) 118 (1,150)
Long-term subordinated debt........... (237) 5 (232)
--------------- -------------- ---------------
Total borrowings.................. (1,505) 123 (1,382)
Total interest-bearing
liabilities.................... (2,559) (1,969) (4,528)
--------------- -------------- ---------------
Change in net interest income............... $ 4,324 $ 1,822 $ 6,146
=============== ============== ===============
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.
21
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 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 June 30, 2006, the Company had approximately $172.3
million, or roughly 41.8% 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 June 30, 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 $ 79,297 $ (5,376) -6%
+200 81,519 (3,154) -4%
+100 83,449 (1,224) -1%
0 84,673 - -
-100 84,803 129 -
-200 84,254 (419) -
------------------ --------------- ---------------- ---------------
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 $29.5 million as of June 30, 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.
22
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 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,
purchasing investment securities and holding funds in overnight investments. For
the nine months ended June 30, 2006 the Company increased deposits in banks by
$21.3 million. This is in contrast to the nine month period in June 2005 where
outstanding loans balances increased by $22.1 million. The deposits in bank
growth in 2006 were primarily funded by the maturities and principal payments on
investment securities as well as increases in deposits. Loan balance increases
in 2005 were funded with proceeds from maturities and payments on investment
securities, and FHLB advances.
The primary financing activities of the Company are deposits and
borrowings. During the nine months ended June 30, 2006, the Company experienced
a net increase in deposits of $14.4 million compared to a net increase of $4.3
million during the same period ending June 30, 2005. Certificates of deposits as
of June 30, 2006, maturing within one year, totaled $80.4 million. Management
expects most of the non-public deposits to remain with the Bank. The net
decrease in FHLB borrowings for the nine-month period ended June 30, 2006, was
$5.3 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 June 30, 2006, cash and cash equivalents
totaled $11.8 million and $16.6 million, respectively. Additionally, the Company
maintains overnight funds that are interest-bearing. As of September 30, 2005
the balance was $23.9 million. At June 30, 2006 the overnight fund balance was
$45.7 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 June 30, 2006,
the ten-year U.S. Treasury Note was yielding approximately ten basis points more
than the overnight Fed Funds rate.
23
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.
At September 30, 2005, the Company had outstanding unfunded loan
commitments totaling $52 million and $68.3 million as of June 30, 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 June 30, 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.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
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
25
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
AUGUST 11, 2006 By: \S\ AUBREY L. DUNN, JR.
- ------------------------------- -------------------------------------
Date Aubrey L. Dunn, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
AUGUST 11, 2006 By: \S\ GEORGE A. ROSENBAUM, JR.
- ------------------------------- -------------------------------------
Date George A. Rosenbaum, Jr.
Executive Vice President and Chief
Financial Officer (Principal
Accounting and Financial Officer)
26