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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 00-50347

 

 

JEFFERSON BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Tennessee   45-0508261

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

120 Evans Avenue, Morristown, Tennessee   37814
(Address of principal executive offices)   (Zip code)

(423) 586-8421

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

At February 11, 2011, the registrant had 6,635,125 shares of common stock, $0.01 par value per share, outstanding.

 

 

 


Table of Contents

INDEX

 

         Page
    PART I. FINANCIAL INFORMATION     
Item 1.   Financial Statements     
  Consolidated Statements of Condition - Unaudited Six months ended December 31, 2010 and year ended June 30, 2010    3
  Consolidated Statements of Earnings - Unaudited Three and six months ended December 31, 2010 and 2009    4
  Consolidated Statements of Changes in Stockholders’ Equity - Unaudited Six months ended December 31, 2010 and 2009    5
  Consolidated Statements of Cash Flows - Unaudited Six months ended December 31, 2010 and 2009    6
  Notes to Consolidated Financial Statements - Unaudited    7
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    20
Item 3.   Quantitative and Qualitative Disclosures About Market Risk    38
Item 4.   Controls and Procedures    38
PART II. OTHER INFORMATION
Item 1.   Legal Proceedings    39
Item 1A.   Risk Factors    39
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    39
Item 3.   Defaults Upon Senior Securities    40
Item 4.   [Removed and Reserved]    40
Item 5.   Other Information    40
Item 6.   Exhibits    40
SIGNATURES

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(Dollars in Thousands)

 

     December 31,
2010
    June 30,
2010
 
     (Unaudited)        

Assets

    

Cash and cash equivalents

   $ 3,904      $ 5,071   

Interest-earning deposits

     87,712        59,232   

Fed funds sold

     3,800        5,000   

Investment securities classified as available for sale, net

     46,191        62,989   

Federal Home Loan Bank stock

     4,735        4,735   

Bank owned life insurance

     6,509        6,390   

Loans receivable, net of allowance for loan losses of $8,748 and $9,649

     405,820        434,378   

Loans held-for-sale

     208        1,153   

Premises and equipment, net

     27,080        27,555   

Foreclosed real estate, net

     9,937        6,851   

Accrued interest receivable:

    

Investments

     205        256   

Loans receivable

     1,552        1,744   

Deferred tax asset

     8,638        8,524   

Core deposit intangible

     2,217        2,475   

Other assets

     5,193        4,417   
                

Total Assets

   $ 613,701      $ 630,770   
                

Liabilities and Stockholders’ Equity

    

Deposits

    

Noninterest-bearing

   $ 52,859      $ 41,653   

Interest-bearing

     435,260        437,530   

Repurchase agreements

     294        944   

Federal Home Loan Bank advances

     58,287        84,834   

Subordinated debentures

     7,077        7,021   

Other liabilities

     3,470        2,265   

Accrued income taxes

     —          —     
                

Total liabilities

     557,247        574,247   
                

Commitments and contingent liabilities

     —          —     

Stockholders’ equity:

    

Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding

    

Common stock, $.01 par value; 30,000,000 shares authorized; 9,182,372 shares issued and 6,636,494 shares outstanding at December 31, 2010 and 6,659,212 shares outstanding at June 30, 2010

     92        92   

Additional paid-in capital

     79,033        79,175   

Unearned ESOP shares

     (3,457     (3,673

Unearned compensation

     (1,020     (1,053

Accumulated other comprehensive income

     478        1,206   

Retained earnings

     12,654        12,023   

Treasury stock, at cost (2,545,878 and 2,523,160 shares)

     (31,326     (31,247
                

Total stockholders’ equity

     56,454        56,523   
                

Total liabilities and stockholders’ equity

   $ 613,701      $ 630,770   
                

See accompanying notes to financial statements.

 

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Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Earnings (Unaudited)

(Dollars in Thousands, Except Net Earnings Per Share)

 

     Three Months Ended
December 31,
    Six Months Ended
December 31,
 
     2010     2009     2010     2009  

Interest income:

        

Interest on loans receivable

   $ 6,112      $ 6,819      $ 12,394      $ 13,948   

Interest on investment securities

     409        670        891        1,415   

Other interest

     109        66        201        137   
                                

Total interest income

     6,630        7,555        13,486        15,500   
                                

Interest expense:

        

Deposits

     1,534        2,203        3,197        4,544   

Repurchase agreements

     2        3        4        5   

Advances from FHLB

     582        820        1,343        1,639   

Subordinated debentures

     80        79        162        167   
                                

Total interest expense

     2,198        3,105        4,706        6,355   
                                

Net interest income

     4,432        4,450        8,780        9,145   

Provision for loan losses

     950        1,509        950        1,809   
                                

Net interest income after provision for loan losses

     3,482        2,941        7,830        7,336   
                                

Noninterest income:

        

Mortgage origination fee income

     224        96        364        240   

Service charges and fees

     315        418        671        864   

Gain on investments

     743        13        752        20   

Gain (loss) on sale of foreclosed real estate, net

     (58     —          (405     (9

BOLI increase in cash value

     59        59        119        117   

Other

     161        218        333        470   
                                

Total noninterest income

     1,444        804        1,834        1,702   
                                

Noninterest expense:

        

Compensation and benefits

     1,703        1,729        3,444        3,717   

Occupancy expense

     358        555        722        1,103   

Equipment and data processing expense

     610        617        1,262        1,233   

DIF premiums

     163        192        325        352   

Advertising

     59        92        105        158   

Valuation adjustment and expenses on OREO

     573        241        1,104        326   

Loss on early extinguishment of debt

     190        —          190        —     

Other

     731        919        1,588        2,057   
                                

Total noninterest expense

     4,387        4,345        8,740        8,946   
                                

Earnings before income taxes

     539        (600     924        92   
                                

Income taxes:

        

Current

     3        23        3        175   

Deferred

     177        (208     303        (152
                                

Total income taxes

     180        (185     306        23   
                                

Net earnings

   $ 359      ($ 415   $ 618      $ 69   
                                

Net earnings per share, basic

   $ 0.06      ($ 0.07   $ 0.10      $ 0.01   
                                

Net earnings per share, diluted

   $ 0.06      ($ 0.07   $ 0.10      $ 0.01   
                                

See accompanying notes to financial statements.

 

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Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

Six Months Ended December 31, 2010 and 2009

(Dollars in Thousands)

 

     Common
Stock
     Additional
Paid-in
Capital
    Unallocated
Common
Stock in
ESOP
    Unearned
Compensation
    Accumulated
Other
Comprehensive
Income
    Retained
Earnings
     Treasury
Stock
    Total
Stockholders’
Equity
 

Balance at June 30, 2010

   $ 92       $ 79,175      ($ 3,673   ($ 1,053   $ 1,206      $ 12,023       ($ 31,247   $ 56,523   
                        

Comprehensive income:

                  

Net earnings

     —           —          —          —          —          618         —          618   

Change in net unrealized gain (loss) on securities available for sale, net of taxes of ($452)

     —           —          —          —          (728     —           —          (728
                        

Total comprehensive income

     —           —          —          —          —          —           —          (110

Dividends used for ESOP payment

     —           —          —          —          —          13           13   

Shares committed to be released by the ESOP

     —           (142     216        —          —          —           —          74   

Earned portion of stock grants

     —           —          —          33        —          —           —          33   

Purchase of common stock (22,718 shares)

     —           —          —          —          —          —           (79     (79
                                                                  

Balance at December 31, 2010

   $ 92       $ 79,033      ($ 3,457   ($ 1,020   $ 478      $ 12,654       ($ 31,326   $ 56,454   
                                                                  

 

     Common
Stock
     Additional
Paid-in
Capital
    Unallocated
Common
Stock in
ESOP
    Unearned
Compensation
    Accumulated
Other
Comprehensive
Income
     Retained
Earnings
    Treasury
Stock
    Total
Stockholders’
Equity
 

Balance at June 30, 2009

   $ 92       $ 79,394      ($ 4,105   ($ 1,121   $ 150       $ 36,140      ($ 31,045   $ 79,505   
                        

Comprehensive income:

                  

Net earnings

     —           —          —          —          —           69        —          69   

Change in net unrealized gain (loss) on securities available for sale, net of taxes of $448

     —           —          —          —          723         —          —          723   
                        

Total comprehensive income

     —           —          —          —          —           —          —          792   

Dividends

     —           —          —          —          —           (201     —          (201

Dividends used for ESOP payment

     —           —          —          —          —           76        —          76   

Shares committed to be released by the ESOP

     —           (100     216        —          —           —          —          116   

Earned portion of stock grants

     —           —          —          34        —           —          —          34   

Purchase of common stock (2,578 shares)

     —           —          —          —          —           —          (14     (14
                                                                  

Balance at December 31, 2009

   $ 92       $ 79,294      ($ 3,889   ($ 1,087   $ 873       $ 36,084      ($ 31,059   $ 80,308   
                                                                  

 

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Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

 

     Six Months Ended
December 31,
 
     2010     2009  

Cash flows from operating activities:

    

Net earnings

   $ 618      $ 69   

Adjustments to reconcile net earnings to net cash provided by (used for) operating activities:

    

Allocated ESOP shares

     74        115   

Depreciation and amortization expense

     678        744   

Amortization of premiums (discounts), net on investment securities

     218        (564

Provision for loan losses

     950        1,809   

Amortization of deferred loan fees, net

     (146     (144

(Gain) loss on sale of investment securities

     5        (20

(Gain) loss on sale of foreclosed real estate, net

     405        9   

Deferred tax benefit

     303        (151

Originations of mortgage loans held for sale

     (13,487     (10,114

Proceeds from sale of mortgage loans

     14,432        10,778   

Increase in cash value of life insurance

     (119     (117

Earned portion of MRP

     34        34   

Decrease (increase) in:

    

Accrued interest receivable

     243        100   

Other assets

     (776     (1,682

Increase (decrease) in other liabilities and accrued income taxes

     1,205        (1,378
                

Net cash provided by (used for) operating activities

     4,637        (512
                

Cash flows used for investing activities:

    

Loan originations, net of principal collections

     21,551        34,672   

Investment securities classified as available-for-sale:

    

Proceeds from maturities, calls and prepayments

     38,536        14,718   

Proceeds from sale

     756        1,313   

Purchase of securities

     (23,127     (35,127

Proceeds from sale of premises and equipment, construction overpayments

     —          122   

Purchase of premises and equipment

     (80     (50

Proceeds from sale of (additions to) foreclosed real estate, net

     1,915        1,188   
                

Net cash provided by (used for) investing activities

     39,551        16,836   
                

Cash flows from financing activities:

    

Net increase (decrease) in deposits

     8,964        8,661   

Net increase in repurchase agreements

     (650     747   

Proceeds from advances from FHLB

     309        —     

Repayment of FHLB advances

     (26,619     (42

Purchase of treasury stock

     (79     (14

Dividends paid

     —          (603
                

Net cash provided by (used for) financing activities

     (18,075     8,749   
                

Net increase (decrease) in cash, cash equivalents and interest-earning deposits

     26,113        25,073   

Cash, cash equivalents and interest-earning deposits at beginning of period

     69,303        44,108   
                

Cash, cash equivalents and interest-earning deposits at end of period

   $ 95,416      $ 69,181   
                

Supplemental disclosures of cash flow information:

    

Cash paid during period for:

    

Interest on deposits

   $ 3,205      $ 4,663   

Interest on FHLB advances

   $ 1,543      $ 1,639   

Interest on other borrowings

   $ 106      $ 172   

Income taxes

     —        $ 350   

Real estate acquired in settlement of loans

   $ 8,635      $ 2,211   

See accompanying notes to financial statements.

 

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Notes To Consolidated Financial Statements

 

(1) Basis of Presentation

The condensed consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the “Company” or “Jefferson Bancshares”) and its wholly-owned subsidiary, Jefferson Federal Bank (the “Bank” or “Jefferson Federal”). The accompanying interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. The results of operations for the period ended December 31, 2010 are not necessarily indicative of the results which may be expected for the entire fiscal year. These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2010, which was filed with the Securities and Exchange Commission on September 24, 2010. All dollar amounts, other than per-share amounts, are in thousands unless otherwise noted. The Company has adopted FASB ASC Topic 855 for Subsequent Events which did not significantly change the subsequent events the Company reports either through recognition or disclosure.

 

(2) Principles of Consolidation

The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank. All significant intercompany balances and transactions have been eliminated in consolidation.

 

(3) Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown. Actual results could differ from the estimates and assumptions used in the consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.

 

(4) Limitation on Capital Distributions

Jefferson Federal may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of Jefferson Federal at the time of its conversion to stock form.

Under applicable regulations, Jefferson Federal is prohibited from making any capital distributions if, after making the distribution, the Bank would have: (i) total risk-based capital ratio of less than 8.0%; (ii) Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.

Under the banking laws of the State of Tennessee, a Tennessee chartered savings bank may not declare dividends in any calendar year in which the dividend would exceed the total of its net income for that year, combined with its retained net income for the preceding two years, without the prior approval of the Commissioner of the Tennessee Department of Financial Institutions.

 

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(5) Earnings Per Common Share

Earnings per common share and diluted earnings per common share have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unallocated employee stock ownership plan (“ESOP”) shares. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. For the period ended December 31, 2010, stock options to purchase 525,287 shares were not included in the computation of diluted net income per share as their effect would have been anti-dilutive. The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:

 

     Weighted-Average Shares
Outstanding for the

Three Months Ended
December 31,
     Weighted-Average Shares
Outstanding for the

Six Months Ended
December 31,
 
     2010      2009      2010      2009  

Weighted average number of common shares used in computing basic earnings per common share

     6,197,757         6,215,304         6,201,670         6,215,909   

Effect of dilutive stock options

     —           —           —           —     
                                   

Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming dilution

     6,197,757         6,215,304         6,201,670         6,215,909   
                                   

 

(6) Accounting by Creditors for Allowance for Loan Losses and Impairment of a Loan

The allowance for loan and lease losses is an estimate of the losses that are inherent in the loan and lease portfolio. The allowance is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Bank’s charge-off policy is consistent with bank regulatory standards. Generally, loans are charged off when the loan becomes over 120 days delinquent. Real estate acquired as a result of foreclosure is initially recorded at the lower of the amount of the loan or the fair value, less estimated selling costs. Any writedown to fair value is charged to the allowance for loan and lease losses. Any subsequent writedown of foreclosed real estate is charged against earnings.

The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses. Loans are grouped into pools based on loan type and further segregated by loan grade. Loans pools include residential mortgage loans, multi-family loans, construction and land development loans, non-residential real estate loans (owner occupied and non-owner occupied), commercial loans and consumer loans. Commercial business loans and loans secured by commercial real estate are generally larger and involve a greater degree of risk than residential mortgage loans. In addition, loans secured by commercial real estate are more

 

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likely to be negatively impacted by adverse conditions in the real estate market or the economy. Management utilizes a loan grading system and assigns a loan grade of “Pass”, “Watch”, “Special Mention”, “Substandard”, “Doubtful” or “Loss” based on risk characteristics of loans. Lending staff reviews the loan grades of customers on a regular basis and makes changes as needed given that the creditworthiness of customers may change over time.

Descriptions of loan grades are as follows:

Pass - loans in this category represent an acceptable risk and do not require heightened levels of monitoring by lending staff.

Watch - loans in this category represent an acceptable risk; however, require monitoring by lending staff due to potential weakness for any number of reasons.

Special Mention - loans in this category have potential weaknesses that may result in deteriorating prospects for the asset or in the Bank’s credit position at some future date.

Substandard - loans in this category are inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Borrowers in this category have a well-defined weakness(es) that jeopardize the proper liquidation of the debt.

Doubtful - loans classified as doubtful have a clear and defined weakness making the ultimate repayment of the loan, or portions thereof, highly improbable.

Loss - loans classified as “loss” are those of such little value that their continuance as bank assets is not warranted, even though partial recovery may be affected in the future. Charge off is required in the month this grade is assigned.

Specific valuation allowances are established for impaired loans. The Company considers a loan to be impaired when, based on current information and events, it is probable that the company will be unable to collect all amounts due according to the contractual terms of the loan agreement on a timely basis. A specific reserve represents the difference between the recorded value of the loan and either its estimated fair value less estimated disposition costs, or the net present value as determined by a discounted cash flow analysis. On a quarterly basis, Management evaluates individual loans which have an outstanding principal balance of $500,000 or more and which are classified as either substandard, doubtful or loss according to the loan grading policy for impairment. Troubled debt restructurings (“TDRs”) are also considered to be impaired, except for those that have been performing under the new terms for at least six consecutive months. A TDR occurs when the Bank grants a concession to a borrower with financial difficulties that it would not otherwise consider. The majority of the Bank’s TDRs involve a modification in loan terms such as a temporary period of interest only or extension of the maturity date. A TDR may be non-accruing or it may accrue interest. A nonaccrual TDR will be returned to accruing status at such time when the borrower successfully performs under the new terms for six consecutive months.

The accrual of interest on all loans is discontinued at the time the loan is 90 days delinquent. All interest accrued but not collected for loans considered impaired, placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost-recovery method until the loan is returned to accrual status. Loans are returned to accrual status when future payments are reasonably assured. Payments received on non-accrual loans are applied to the remaining principal balance of the loans.

 

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The evaluation of the allowance for loan and lease losses is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The Company is subject to periodic examination by regulatory agencies, which may require the Company to record increases in the allowances based on the regulator’s evaluation of available information. There can be no assurance that the Company’s regulators will not require further increases to the allowances.

The following table summarizes the activity in the allowance for loan losses for the six months ended December 31, 2010:

 

     Residential
Mortgage
    Multi-
family
     Construction
and land
development
    Non-
residential
real estate
    Owner
occupied
    Commercial     Consumer     Total  

Allowance for Credit Losses:

                 

Balance at June 30, 2010

   $ 1,812      $ 468       $ 1,162      $ 2,408      $ 2,000      $ 1,733      $ 66      $ 9,649   

Charge Offs

     (292     —           (837     (90     (696     (821     (20     (2,756

Recoveries

     2        —           —          —          —          91        9        102   

Provision

     476        156         390        (354     (463     760        (15     950   
                                                                 

Balance at December 31, 2010

   $ 1,998      $ 624       $ 715      $ 1,964      $ 841      $ 1,763      $ 40      $ 7,945   
                                                                 

Ending balance, Individually Evaluated

   $ 1,313      $ 583       $ 557      $ 1,610      $ 229      $ 1,428      $ 2      $ 5,722   

Ending balance, Collectively Evaluated

   $ 685      $ 41       $ 158      $ 354      $ 612      $ 335      $ 38      $ 2,223   

Loans:

                 

Balance at December 31, 2010

   $ 146,034      $ 17,235       $ 31,796      $ 59,994      $ 92,250      $ 60,344      $ 6,333      $ 413,986   

Ending balance, Individually Evaluated

   $ 8,294      $ 5,900       $ 6,263      $ 5,928      $ 1,683      $ 5,015      $ 2      $ 33,085   

Ending balance, Collectively Evaluated

   $ 137,740      $ 11,335       $ 25,533      $ 54,066      $ 90,567      $ 55,329      $ 6,331      $ 380,901   

The following table is an aging analysis of the loan portfolio:

 

     30-59
days past
due
     60-89
days past
due
     Greater
than 90
days
     Total
past due
     Total
Current
     Total loans
receivable
 

Residential Mortgage

   $ 2,947       $ 156       $ 6,476       $ 9,579       $ 136,455       $ 146,034   

Multi-family

     —           —           —           —           17,235         17,235   

Construction/land development

     97         10         2,564         2,671         29,125         31,796   

Non-residential real estate

     328         104         930         1,362         58,632         59,994   

Owner occupied

     1,231         69         2,103         3,403         88,847         92,250   

Commercial

     74         402         1,015         1,491         58,853         60,344   

Consumer

     44         —           67         111         6,222         6,333   
                                                     

Total

   $ 4,721       $ 741       $ 13,155       $ 18,617       $ 395,369       $ 413,986   
                                                     

 

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Table of Contents

The following table summarizes the credit risk profile by internally assigned grade:

 

     Residential
Mortgage
     Multi-
family
     Construction
and land
development
     Non-
residential
realestate
     Owner
occupied
     Commercial      Consumer      Total  

Grade:

                       

Pass

   $ 127,143       $ 6,386       $ 25,030       $ 50,636       $ 88,562       $ 50,862       $ 6,333       $ 354,952   

Special mention

     4,848         2,467         2,259         3,338         677         4,381         —         $ 17,970   

Substandard

     14,043         8,382         4,507         6,020         3,011         5,101         —         $ 41,064   

Doubtful

     —           —           —           —              —           —         $ 0   

Loss

     —           —           —           —           —           —           —         $ 0   
                                                                       

Total:

   $ 146,034       $ 17,235       $ 31,796       $ 59,994       $ 92,250       $ 60,344       $ 6,333       $ 413,986   
                                                                       

 

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The following table summarizes the composition of impaired loans, the associated specific reserves, and interest income recognized on impaired loans:

 

     Recorded
investment
     Unpaid
principal
balance
     Specific
allowance
     Interest income
recognized
 

With no related allowance:

           

Residential Mortgage

   $ 2,851       $ 2,851       $ —         $ 81   

Multi-family

     —           —           —           —     

Construction and land development

     3,482         3,482         —           32   

Non-residential real estate

     1,868         1,868         —           55   

Owner occupied

     1,172         1,172         —           21   

Commercial

     1,540         1,540         —           31   

Consumer

     —           —           —           —     
                                   

Total

   $ 10,913       $ 10,913       $ —         $ 220   

With an allowance recorded:

           

Residential Mortgage

   $ 5,443       $ 5,443       $ 1,313       $ 43   

Multi-family

     5,900         5,900         583         138   

Construction and land development

     2,781         2,781         557         32   

Non-residential real estate

     4,060         4,060         1,610         98   

Owner occupied

     511         511         229         7   

Commercial

     3,475         3,475         1,428         63   

Consumer

     2         2         2         —     
                                   

Total

   $ 22,172       $ 22,172       $ 5,722       $ 381   

Total:

           

Residential Mortgage

   $ 8,294       $ 8,294       $ 1,313       $ 124   

Multi-family

     5,900         5,900         583         138   

Construction and land development

     6,263         6,263         557         64   

Non-residential real estate

     5,928         5,928         1,610         153   

Owner occupied

     1,683         1,683         229         28   

Commercial

     5,015         5,015         1,428         94   

Consumer

     2         2         2         —     
                                   

Total

   $ 33,085       $ 33,085       $ 5,722       $ 601   
                                   

Average impaired loans for the six months ended December 31, 2010

   $ 36,644            

 

(7) Financial Instruments With Off-Balance Sheet Risk

Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The

 

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Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrower’s creditworthiness on a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrower’s property. The amount of collateral obtained is based upon an appraisal of the property.

At December 31, 2010, we had approximately $12.6 million in commitments to extend credit, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $6.3 million in unused letters of credit and approximately $33.9 million in unused lines of credit.

 

(8) Dividend Declaration

On February 2, 2010, the Company announced that the Board of Directors had voted to suspend the payment of the quarterly cash dividend on the Company’s common stock in an effort to conserve capital.

 

(9) Stock Incentive Plans

The Company maintains stock-based benefit plans under which certain employees and directors are eligible to receive stock grants or options. Under the 2004 Stock-Based Benefit Plan, a maximum of 279,500 shares may be granted as restricted stock and a maximum of 698,750 shares may be issued through the exercise of nonstatutory or incentive stock options. The exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is ten years.

Restricted stock grants aggregating 45,000 shares and having a fair value of $597,000 were awarded in 2006. Restrictions on the grants lapse in annual increments over five years. The market value as of the grant date of the restricted stock grants is charged to expense as the restrictions lapse.

In connection with the Company’s previously announced acquisition of State of Franklin Bancshares, Inc. (“State of Franklin”) on October 31, 2008, each outstanding State of Franklin non-qualified option with an exercise price of $13.50 or less was converted into an option to purchase shares of Jefferson Bancshares common stock with an expiration date of October 31, 2011.

The table below summarizes the status of the Company’s stock option plans as of December 31, 2010.

 

     Three Months Ended
December 31, 2010
 
     Shares     Weighted-
average
exercise price
 

Outstanding at beginning of period

     551,490      $ 12.74   

Granted during the three-month period

     —       

Options forfeited

     (26,203   $ 13.69   

Options exercised

     —       

Outstanding at December 31, 2010

     525,287      $ 12.69   

Options exercisable at December 31, 2010

     525,287      $ 12.69   

 

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The following information applies to options outstanding at December 31, 2010:

 

Number outstanding

     525,287   

Range of exercise prices

   $ 10.00 - $13.69   

Weighted-average exercise price

   $ 12.69   

Weighted-average remaining contractual life

     2.29   

Number of options remaining for future issuance

     358,112   

The estimated fair value of stock options at grant date was determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004. An expected dividend yield of 1.17% and expected volatility of 7.01% were used to model the value. The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of the options equaled ten years.

 

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Table of Contents
(10) Investment Securities

Investment securities are summarized as follows:

At December 31, 2010

 

     Amortized
Cost
    Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available-for-sale

         

Debt securities:

         

Federal agency

   $ 15,757      $ 50       $ (138   $ 15,669   

Mortgage-backed

     22,027        2,139         (158     24,008   

Municipals

     6,199        74         (137     6,136   

Other Securities

     1,434        —           (1,056     378   
                                 

Total securities available- for-sale

   $ 45,417      $ 2,263       $ (1,489   $ 46,191   
                                 

Weighted-average rate

     3.66       
               

Pledged at December 31, 2010

   $ 21,731          
               

At June 30, 2010

 

     Amortized
Cost
    Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available-for-sale

         

Debt securities:

         

Federal agency

   $ 31,975      $ 132       $ —        $ 32,107   

Mortgage-backed

     21,812        2,643         (142     24,313   

Municipals

     5,650        126         (12     5,764   

Other Securities

     1,597        183         (975     805   
                                 

Total securities available- for-sale

   $ 61,034      $ 3,084       $ (1,129   $ 62,989   
                                 

Weighted-average rate

     3.73       
               

Pledged at June 30, 2010

   $ 9,574          
               

Securities with unrealized losses not recognized in income are as follows:

 

     Less than 12 months     12 months or more     Total  
     Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

December 31, 2010

               

Federal agency securities

   $ 11,009       $ (138   $ —         $ —        $ 11,009       $ (138

Mortgage-backed securities

     2,743         (68     1,123         (90     3,866         (158

Municipal securities

     3,241         (137     —           —          3,241         (137

Other securities

     5         (49     370         (1,007     375         (1,056
                                                   
   $ 16,998       $ (392   $ 1,493       $ (1,097   $ 18,491       $ (1,489
                                                   

The Company evaluates its securities with significant declines in fair value on a quarterly basis to determine whether they should be considered temporarily or other than temporarily impaired. The company has recognized all of the foregoing unrealized losses in other comprehensive income. The company neither has the intent to sell nor is forecasting the need or requirement to sell the securities before their anticipated recovery.

 

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Table of Contents

Maturities of debt securities at December 31, 2010, are summarized as follows:

 

     Amortized
Cost
     Fair
Value
     Weighted
Average
Yield
 

Within 1 year

   $ 375       $ 376         3.01

Over 1 year through 5 years

     12,573         12,581         1.31

After 5 years through 10 years

     7,257         7,240         1.90

Over 10 years

     25,212         25,994         5.34
                          
   $ 45,417       $ 46,191         3.66
                          

 

(11) Fair Value Disclosures

Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. When measuring fair value, the Company uses valuation techniques that are appropriate and consistently applied. A hierarchy is also established under the standard and is used to prioritize valuation inputs into the following three levels used to measure fair value:

Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts and residential mortgage loans held-for-sale.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques,

 

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Table of Contents

as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly structured or long-term derivative contracts.

The following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available for Sale

Level 2 investment securities classified as “available-for-sale” are recorded at fair value on at least a monthly basis. Fair value measurements are based upon independent pricing models or other model-based valuation techniques with inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds, bonds issued by government agencies, and corporate debt securities. Level 3 investment securities classified as “available-for-sale” are recorded at fair value on at least a semi-annual basis. Fair value measurements are based upon independent pricing models based upon unobservable inputs which require significant management judgment or estimation. Level 3 includes certain mortgage-backed securities and other debt securities.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2010, substantially all of the total impaired loans were evaluated based on either the fair value of the collateral or its liquidation value. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value:

 

     December 31, 2010  

Description

   Level 1      Level 2      Level 3      Total Carrying
Amount in
Statement of
Financial Condition
     Assets/Liabilities
Measured at

Fair Value
 

Securities available for sale

     —         $ 40,060       $ 6,131       $ 46,191       $ 46,191   

 

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Table of Contents

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.

 

     December 31, 2010  

Description

   Level 1      Level 2      Level 3      Total Carrying
Amount in
Statement of
Financial Condition
     Assets/Liabilities
Measured at

Fair Value
 

Impaired Loans

     —           —         $ 27,363       $ 27,363       $ 27,363   

 

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Table of Contents

The carrying value and estimated fair value of the Company’s financial instruments are as follows:

 

     December 31, 2010     June 30, 2010  
     Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 

Financial assets:

        

Cash and due from banks and interest-earning deposits with banks

   $ 95,416      $ 95,416      $ 69,303      $ 69,303   

Available-for-sale securities

     46,191        46,191        62,989        62,989   

Federal Home Loan Bank stock

     4,735        4,735        4,735        4,735   

Loans receivable

     414,207        415,100        444,474        445,655   

Accrued interest receivable

     1,757        1,757        2,000        2,000   

Loans held-for-sale

     208        208        1,153        1,153   

Financial liabilities:

        

Deposits

     (488,119     (475,563     (479,183     (471,821

Repurchase agreements

     (294     (294     (944     (944

Borrowed funds

     (58,287     (59,894     (84,834     (87,028

Subordinated debentures

     (7,077     (6,510     (7,021     (5,630

Off-balance sheet assets (liabilities):

        

Commitments to extend credit

     —          12,553        —          18,023   

Unused letters of credit

     —          6,282        —          5,320   

Unused lines of credit

     —          33,922        —          36,192   

 

(12) Business Combination

On October 31, 2008, the Company completed the acquisition of State of Franklin. State of Franklin was headquartered in Johnson City, Tennessee, which is approximately 70 miles northeast of the Company’s headquarters. State of Franklin operated six offices in Johnson City and Kingsport, Tennessee with a branch under construction in Bristol, Tennessee. The primary reason for the acquisition of State of Franklin was to expand the Company’s presence into upper East Tennessee. Under the terms of the merger agreement, the Company issued a combination of shares of Company common stock and cash for the outstanding common shares of State of Franklin. State of Franklin shareholders were given the option of receiving $10.00 in cash or 1.1287 shares of Company common stock for each share of State of Franklin common stock, or a combination of stock and cash for each share of State of Franklin common stock, provided that 60% of the aggregate shares of State of Franklin common stock would be exchanged for Company common stock and subject to the allocation and proration formula set forth in the merger agreement. However, all State of Franklin common stockholders residing outside of Tennessee were only eligible to receive cash consideration. Based on this structure, the aggregate merger consideration totaled approximately $4.3 million in cash and 736,000 shares of Company common stock. The Company also incurred $557,000 in merger costs that were capitalized into goodwill. The acquisition was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles for business combinations.

 

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Table of Contents
(13) Subordinated Debt

As part of the State of Franklin acquisition, the Company acquired State of Franklin Statutory Trust II (the “Trust”) and assumed the Trust’s obligation with respect to certain capital securities described below. On December 13, 2006, State of Franklin issued $10.3 million of junior subordinated debentures to the Trust, a Delaware business trust wholly owned by State of Franklin. The Trust (a) sold $10.0 million of capital securities through its underwriters to institutional investors and upstreamed the proceeds to State of Franklin and (b) issued $310,000 of common securities to State of Franklin. The sole assets of the Trust are the $10.3 million of junior subordinated debentures issued by State of Franklin. The securities are redeemable at par after January 30, 2012, and have a final maturity of January 30, 2037. The interest is payable quarterly at a floating rate equal to 3-month LIBOR plus 1.7%.

 

(14) Subsequent Events

The company has evaluated subsequent events for potential recognition and disclosure for the three months ended December 31, 2010 through February 9, 2011. No items were identified during this evaluation that required adjustment to or disclosure in the accompanying financial statements.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Jefferson Bancshares. The information contained in this section should be read in conjunction with the financial statements and accompanying notes thereto. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010, which was filed with the Securities and Exchange Commission on September 24, 2010.

General

Jefferson Bancshares, Inc. (also referred to as the “Company” or “Jefferson Bancshares”) is the holding company for Jefferson Federal Bank (the “Bank” or “Jefferson Federal”).

The Company has no significant assets, other than all of the outstanding shares of the Bank, and no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank.

Jefferson Federal is a community oriented financial institution offering traditional financial services to its local communities. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds to originate loans secured by first mortgages on owner-occupied, one-to four- family residential properties, as well as originate commercial real estate and multi-family mortgage loans, construction loans, consumer loans, commercial non-real estate loans and make other investments permitted by applicable laws and regulations.

 

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The Bank’s savings accounts are insured up to the applicable legal limits by the Federal Deposit Insurance Corporation (“FDIC”) through the Deposit Insurance Fund. Jefferson Federal is a member of the Federal Home Loan Bank (“FHLB”) System.

Private Securities Litigation Reform Act Safe Harbor Statement

This Quarterly Report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; but rather, are statements based on Jefferson Bancshares’ current expectations regarding its business strategies and their intended results and the Company’s future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company’s loan or investment portfolios. Additional factors that may affect our results are discussed in the reports we file with the SEC, including our Annual Report on Form 10-K for the year ended June 30, 2010 under “Item 1A. Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Jefferson Bancshares assumes no obligation to update any forward-looking statements.

Results of Operations for the Three Months Ended December 31, 2010 and 2009

Net Income

Net income for the three months ended December 31, 2010 was $359,000, or $0.06 per diluted share, compared to a net loss of $415,000, or ($0.07) per diluted share, for the corresponding period in 2009. Net income for the three months ended December 31, 2010 was favorably impacted by a $743,000 gain on investment securities and a decrease in the provision for loan and lease losses which more than offset an increase in write-downs and losses on other real estate owned (“OREO”).

 

     Three Months Ended
December 31,
 
     2010     2009  
     (Dollars in thousands,
except per share data)
 

Net earnings

   $ 359      ($ 415

Net earnings per share, basic

   $ 0.06      ($ 0.07

Net earnings per share, diluted

   $ 0.06      ($ 0.07

Return on average assets (annualized)

     0.23     (0.25 %) 

Return on average equity (annualized)

     2.51     (2.04 %) 

 

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Net Interest Income

Net interest income before loan loss provision decreased $18,000 to $4.4 million for the three months ended December 31, 2010 compared to $4.5 million for the same period in 2009. The interest rate spread and net interest margin for the quarter ended December 31, 2010 were 3.12% and 3.20%, respectively, compared to 3.11% and 3.21%, respectively, for the same period in 2009.

The following table summarizes changes in interest income and expense for the three month periods ended December 31, 2010 and 2009:

 

     Three Months
Ended
December 31,
     $     %  
     2010      2009      Change     Change  
     (Dollars in thousands)               

Interest income:

          

Loans

   $ 6,112       $ 6,819       ($ 707     (10.4 %) 

Investment securities

     409         670         (261     (39.0 %) 

Interest-earning deposits

     61         12         49        408.3

FHLB stock

     48         54         (6     (11.1 %) 
                            

Total interest income

     6,630         7,555         (925     (12.2 %) 
                            

Interest expense:

          

Deposits

     1,534         2,203         (669     (30.4 %) 

Repurchase Agreements

     2         3         (1     (33.3 %) 

Borrowings

     582         820         (238     (29.0 %) 

Subordinated Notes & Debentures

     80         79         1        1.3
                            

Total interest expense

     2,198         3,105         (907     (29.2 %) 
                            

Net interest income

   $ 4,432       $ 4,450       ($ 18     (0.4 %) 
                            

The following table summarizes average balances and average yields and costs for the three months ended December 31, 2010 and 2009. For purposes of this table nonaccrual loan balances and related accrued interest income have been excluded.

 

     Three Months Ended December 31,  
     2010     2009  
     Average
Balance
     Yield/
Cost
    Average
Balance
     Yield/
Cost
 
     (Dollars in thousands)  

Loans

   $ 405,308         5.98   $ 455,314         5.94

Investment securities

     43,718         3.90     52,065         5.23

Interest-earning deposits

     97,945         0.25     40,694         0.12

FHLB stock

     4,735         4.02     4,735         4.52

Deposits

     449,999         1.35     432,082         2.02

FHLB advances

     67,067         3.44     90,149         3.61

Repurchase agreements

     1,142         0.69     1,671         0.71

Subordinated debentures

     7,059         4.50     6,947         4.51

 

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The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

 

     Three Months
Ended December 31,
2010 Compared to 2009
 
     Increase (Decrease)
Due To
       
     Volume     Rate     Net  
     (In thousands)  

Interest income:

      

Loans receivable

   ($ 754   $ 47      ($ 707

Investment securities

     (61     (200   ($ 261

Daily interest-earning deposits and other interest-earning assets

     27        16      $ 43   
                        

Total interest-earning assets

     (788     (137     (925
                        

Interest expense:

      

Deposits

     95        (764   ($ 669

Total borrowings

     (208     (30   ($ 238
                        

Total interest-bearing liabilities

     (113     (794     (907
                        

Net change in interest income

   ($ 675   $ 657      ($ 18
                        

Total interest income decreased $925,000, or 12.2%, to $6.6 million for the three months ended December 31, 2010 primarily due to a change in the mix of average earning assets. The average yield on earning assets declined 65 basis points to 4.78% compared to 5.43% for the same period in 2009, due primarily to a shift of average loan balances into lower yielding investment and interest-earning deposits.

Interest on loans decreased $707,000, or 10.4%, to $6.1 million for the three months ended December 31, 2010 primarily due to a lower average balance of loans. The average balance of loans decreased $50.0 million, or 11.0%, to $405.3 million, due to the combination of reduced loan demand, normal paydowns on existing loans, transfers to OREO and charge-offs. Reduced loan demand has resulted from continued economic weakness in the Bank’s market areas. The average yield on loans was 5.98% for the three months ended December 31, 2010 compared to 5.94% for the same period in 2009.

Interest on investment securities decreased $261,000, or 39.0%, to $409,000 for the three months ended December 31, 2010 due to a lower average yield and a lower average balance. The average yield on investment securities decreased to 3.90% for the three months ended December 31, 2010 compared to 5.23% for the same period in 2009 due to lower market interest rates and changes in the composition of the portfolio. A portion of the proceeds from called securities has been reinvested in similar securities but with lower yields.

 

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Total interest expense decreased $907,000 to $2.2 million for the three months ended December 31, 2010 compared to $3.1 million for the corresponding period in 2009 primarily due to lower market interest rates. The rate paid on interest-bearing liabilities declined 66 basis points to 1.66% while the average balance of interest-bearing liabilities decreased $5.6 million, to $525.3 million during the quarter ended December 31, 2010. The average rate paid on deposits was 1.35% for the three months ended December 31, 2010, compared to 2.02% for the same period in 2009. Average FHLB borrowings decreased $23.1 million to $67.1 million for the three months ended December 31, 2010 compared to $90.1 million for the three months ended December 31, 2009, while the average rate paid on borrowings decreased 17 basis points to 3.44%, as excess liquidity was used to repay FHLB advances.

Provision for Loan Losses

The provision for loan losses for the three months ended December 31, 2010 was $950,000, compared to $1.5 million for the comparable period in 2009. Net charge-offs for the three months ended December 31, 2010 were $1.8 million compared to $924,000 for the comparable period in 2009. A significant portion of the loan charge-offs during the three months ended December 31, 2010 were against specific reserves and did not require replenishment of the allowance for loan and lease losses.

Management reviews the level of the allowance for loan losses on a monthly basis and establishes the provision for loan losses based on changes in the nature and volume of the loan portfolio, the amount of impaired and classified loans, historical loan loss experience and other qualitative factors. In addition, the Federal Deposit Insurance Corporation and Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses and may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

Noninterest Income

Noninterest income increased $640,000 to $1.4 million for the three months ended December 31, 2010 compared to $804,000 for the corresponding period in 2009 due primarily to an increase in gain on investment securities. The gain on investment securities was the result of a large unexpected prepayment of principal on a deeply discounted mortgage-backed security. The deep discount on this security originated from the GAAP required write down to fair value in connection with the Company’s acquisition of State of Franklin Bancshares, Inc., which was consummated on October 31, 2008. Service charges and fees declined $103,000, or 24.6%, to $315,000 for the three months ended December 31, 2010 compared to the prior year period. Management believes fee revenue decreased due to heightened customer awareness of fees and a resultant increased management of account balances in the current economic downturn. Mortgage origination fee income increased $128,000 to $224,000 for the three months ended December 31, 2010 due to higher demand for residential mortgage refinancing resulting from the low interest rate environment.

 

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The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the three months ended December 31, 2010 compared to the same period in 2009.

 

     Three Months Ended               
     December 31,      $     %  
     2010     2009      Change     Change  
     (Dollars in thousands)               

Noninterest income:

         

Mortgage origination fee income

   $ 224      $ 96       $ 128        133.3

Service charges and fees

     315        418         (103     (24.6 %) 

(Loss) gain on investment securities

     743        13         730        5615.4

Gain (loss) on sale of foreclosed real estate, net

     (58     —           (58     —     

BOLI increase in cash value

     59        59         —          0.0

Other

     161        218         (57     (26.1 %) 
                           

Total noninterest income

   $ 1,444      $ 804       $ 640        79.6
                           

Noninterest Expense

Noninterest expense decreased $42,000 to $4.4 million for the three months ended December 31, 2010 compared to $4.3 million for the corresponding 2009 period. Noninterest expense for the three months ended December 31, 2010 was negatively impacted by an increase in OREO expense due to valuation adjustments and expenses related to the maintenance and disposition of foreclosed real estate. OREO expense increased $332,000 to $573,000 for the three months ended December 31, 2010 as compared to the corresponding period in 2009. Occupancy expense decreased $197,000 to $358,000 for the three months ended December 31, 2010, due to a decrease in amortization of leasehold improvements. Advertising expense decreased $33,000 to $59,000 during the three months ended December 31, 2010 as compared to $92,000 for the same period in 2009 due to Management’s strategic decision to postpone marketing campaigns to future periods. Prepayment penalties totaling $190,000 were incurred in connection with the repayment of FHLB advances totaling $26.5 million during the three months ending December 31, 2010. Management believes the future savings in interest expense will more than offset the prepayment penalties. Other categories of noninterest expense decreased $188,000 to $731,000 for the three months ended December 31, 2010 due to cost control initiatives, declines in legal and professional fees and lower franchise tax expense.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended December 31, 2010 compared to the same period in 2009.

 

     Three Months Ended               
     December 31,      $     %  
     2010      2009      Change     Change  
     (Dollars in thousands)               

Noninterest expense:

          

Compensation and benefits

   $ 1,703       $ 1,729       ($ 26     (1.5 %) 

Occupancy expense

     358         555         (197     (35.5 %) 

Equipment and data processing expense

     610         617         (7     (1.1 %) 

Deposit insurance premiums

     163         192         (29     (15.1 %) 

Advertising

     59         92         (33     (35.9 %) 

Valuation adjustment and expenses on OREO

     573         241         332        137.8

Loss on early extinguishment of debt

     190         —           190        —     

Other

     731         919         (188     (20.5 %) 
                            

Total noninterest expense

   $ 4,387       $ 4,345       $ 42        1.0
                            

 

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Table of Contents

Income Taxes

Income tax expense for the three months ended December 31, 2010 was $180,000 compared to a tax benefit of $185,000 for the same period in 2009 due to higher taxable income.

Results of Operations for the Six Months Ended December 31, 2010 and 2009

Net Income

Net income for the six months ended December 31, 2010 was $618,000, or $0.10 per diluted share compared to $69,000, or $0.01 per diluted share, for the same period in 2009. Net income for the six months ended December 31, 2010 was favorably impacted by a $752,000 gain on investment securities and a decrease in the provision for loan and lease losses which more than offset an increase in write-downs and losses on OREO.

 

     Six Months Ended  
     December 31,  
     2010     2009  
     (Dollars in thousands,
except per share data)
 

Net earnings

   $ 618      $ 69   

Net earnings per share, basic

   $ 0.10      $ 0.01   

Net earnings per share, diluted

   $ 0.10      $ 0.01   

Return on average assets (annualized)

     0.20     0.02

Return on average equity (annualized)

     2.17     0.17

Net Interest Income

Net interest income before loan loss provision decreased $365,000, or 4.0%, to $8.8 million for the six months ended December 31, 2010 from $9.1 million for the corresponding period in 2009. The interest rate spread and net interest margin for the six months ended December 31, 2010 were 3.06% and 3.14%, respectively, compared to 3.14% and 3.26%, respectively, for the same period in 2009.

 

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The following table summarizes changes in interest income and expense for the six month periods ended December 31, 2010 and 2009:

 

     Six Months Ended
December 31,
     $     %  
     2010      2009      Change     Change  
     (Dollars in thousands)               

Interest income:

          

Loans

   $ 12,394       $ 13,948       ($ 1,554     (11.1 %) 

Investment securities

     891         1,415         (524     (37.0 %) 

Interest-earning deposits

     100         24         76        316.7

FHLB stock

     101         113         (12     (10.6 %) 
                            

Total interest income

     13,486         15,500         (2,014     (13.0 %) 
                            

Interest expense:

          

Deposits

     3,197         4,544         (1,347     (29.6 %) 

Repurchase Agreements

     4         5         (1     (20.0 %) 

FHLB advances

     1,343         1,639         (296     (18.1 %) 

Subordinated Notes & Debentures

     162         167         (5     (3.0 %) 
                            

Total interest expense

     4,706         6,355         (1,649     (25.9 %) 
                            

Net interest income

   $ 8,780       $ 9,145       ($ 365     (4.0 %) 
                            

The following table summarizes average balances and average yields and costs for the six months ended December 31, 2010 and 2009. For purposes of this table nonaccrual loan balances and related accrued interest income have been excluded.

 

     Six Months Ended December 31,  
     2010     2009  
     Average
Balance
     Yield/
Cost
    Average
Balance
     Yield/
Cost
 
     (Dollars in thousands)  

Loans

   $ 411,754         5.97   $ 466,148         5.94

Investment securities

     49,171         3.76     47,445         6.06

Interest-earning deposits

     91,198         0.22     40,289         0.12

FHLB stock

     4,735         4.23     4,735         4.73

Deposits

     446,588         1.42     432,515         2.08

FHLB advances

     76,061         3.50     90,208         3.60

Repurchase agreements

     1,193         0.67     1,391         0.71

Subordinated debentures

     7,045         4.56     6,935         4.78

The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

 

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Table of Contents
     Six Months
Ended December 31,
2010 Compared to 2009
 
     Increase (Decrease)
Due To
       
     Volume     Rate     Net  
     (In thousands)  

Interest income:

      

Loans receivable

   ($ 1,638   $ 84      ($ 1,554

Investment securities

     (34     (490   ($ 524

Daily interest-earning deposits and other interest-earning assets

     46        18      $ 64   
                        

Total interest-earning assets

     (1,626     (388     (2,014
                        

Interest expense:

      

Deposits

     153        (1,500   ($ 1,347

Total borrowings

     (256     (46   ($ 302
                        

Total interest-bearing liabilities

     (103     (1,546     (1,649
                        

Net change in interest income

   ($ 1,523   $ 1,158      ($ 365
                        

Total interest income decreased $2.0 million, or 13.0%, to $13.5 million for the six months ended December 31, 2010 primarily due to a change in the mix of average earning assets. The average yield on earning assets declined 70 basis points to 4.82% compared to 5.52% for the same period in 2009, due primarily to a shift from average loan balances into lower yielding investment and interest-earning deposits.

Interest on loans decreased $1.6 million, or 11.1%, to $12.4 million for the six months ended December 31, 2010 primarily due to a lower average balance of loans. The average balance of loans decreased $54.4 million, or 11.7%, to $411.8 million, due to the combination of reduced loan demand, normal paydowns on existing loans, transfers to OREO and charge-offs. Reduced loan demand has resulted from continued economic weakness in the Bank’s market areas. The average yield on loans was 5.97% for the six months ended December 31, 2010 compared to 5.94% for the same period in 2009.

Interest on investment securities decreased $524,000, or 37.0%, to $891,000 for the six months ended December 31, 2010 due to a lower average yield. The average yield on investment securities decreased to 3.76% for the six months ended December 31, 2010 compared to 6.06% for the same period in 2009 due to lower market interest rates and changes in the composition of the portfolio. A portion of the proceeds from called securities has been reinvested in similar securities but with lower yields.

Total interest expense decreased $1.6 million to $4.7 million for the six months ended December 31, 2010 compared to $6.4 million for the corresponding period in 2009 primarily due to lower market interest rates. The rate paid on interest-bearing liabilities declined 62 basis points to 1.76% while the average balance of interest-bearing liabilities remained stable at $531.0 million for the six months ended December 31, 2010 compared to the same period in 2009. The average rate paid on deposits was 1.42% for the six months ended December 31, 2010, compared to 2.08% for the same period in 2009 due to lower rates paid on deposits. Average FHLB borrowings decreased $14.1 million to $76.1 million for the six months ended December 31, 2010 compared to $90.2 million for the six months ended December 31, 2009, while the average rate paid on borrowings decreased 10 basis points to 3.50%, as excess liquidity was used to repay FHLB advances.

 

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Provision for Loan Losses

The provision for loan losses for the six months ended December 31, 2010 was $950,000, compared to $1.8 million for the comparable period in 2009. Net charge-offs for the six months ended December 31, 2010 were $2.7 million compared to $1.4 million for the comparable period in 2009. A significant portion of the loan charge-offs during the six months ended December 31, 2010 were against specific reserves and did not require replenishment of the allowance for loan and lease losses.

Management reviews the level of the allowance for loan losses on a monthly basis and establishes the provision for loan losses based on changes in the nature and volume of the loan portfolio, the amount of impaired and classified loans, historical loan loss experience and other qualitative factors. In addition, the Federal Deposit Insurance Corporation and Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses and may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

Noninterest Income

Noninterest income increased $132,000 to $1.8 million for the six months ended December 31, 2010 compared to $1.7 million for the corresponding period in 2009 due primarily to an increase in gain on investment securities. The gain on investment securities was the result of a large unexpected prepayment of principal on a deeply discounted mortgage-backed security. The deep discount on this security originated from the GAAP required write down to fair value in connection with the Company’s acquisition of State of Franklin Bancshares, Inc., which was consummated on October 31, 2008. Loss on sale of foreclosed property increased $396,000 to $405,000 for the six months ended December 31, 2010. Service charges and fees declined $193,000, or 22.3%, primarily due to decreases in late fees and overdraft fees. Management believes fee revenue decreased due to heightened customer awareness of fees and a resultant increased management of account balances in the current economic downturn.

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the six months ended December 31, 2010 compared to the same period in 2009.

 

     Six Months Ended
December 31,
    $     %  
     2010     2009     Change     Change  
     (Dollars in thousands)              

Noninterest income:

        

Mortgage origination fee income

   $ 364      $ 240      $ 124        51.7

Service charges and fees

     671        864        (193     (22.3 %) 

Gain on investment securities

     752        20        732        3660.0

Gain (loss) on sale of foreclosed real estate, net

     (405     (9     (396     4400.0

BOLI increase in cash value

     119        117        2        1.7

Other

     333        470        (137     (29.1 %) 
                          

Total noninterest income

   $ 1,834      $ 1,702      $ 132        7.8
                          

 

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Noninterest Expense

Noninterest expense decreased $206,000, or 2.3%, to $8.7 million for the six months ended December 31, 2010 compared to the corresponding 2009 period. Compensation expense decreased $273,000, or 7.3%, to $3.4 million for the six months ended December 31, 2010 compared to the same period in 2009 due to an overall reduction in number of employees. The number of full-time equivalent employees was 140 at December 31, 2010 compared to 149 for the same period in 2009. The number of employees decreased from period to period primarily due to the integration of the State of Franklin acquisition. Expenses related to other real estate owned increased to $1.1 million for the six months ended December 31, 2010 compared to $326,000 for the comparable 2009 period due to valuation adjustments and expenses related to the maintenance and disposition of foreclosed real estate. Occupancy expense decreased $381,000 to $722,000 for the six months ended December 31, 2010, due to a decrease in amortization of leasehold improvements. Advertising expense decreased $53,000 to $105,000 during the six months ended December 31, 2010 as compared to $158,000 for the same period in 2009 due to Management’s strategic decision to postpone marketing campaigns to future periods. Prepayment penalties totaling $190,000 were incurred in connection with the repayment of FHLB advances totaling $26.5 million during the six months ending December 31, 2010. Management believes the future savings in interest expense will more than offset the prepayment penalties. Other categories of noninterest expense decreased $469,000 to $1.6 million for the six months ended December 31, 2010 due to cost control initiatives, declines in legal and professional fees and lower franchise tax expense.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the six months ended December 31, 2010 compared to the same period in 2009.

 

     Six Months Ended
December 31,
     $     %  
     2010      2009      Change     Change  
     (Dollars in thousands)               

Noninterest expense:

          

Compensation and benefits

   $ 3,444       $ 3,717       ($ 273     (7.3 %) 

Occupancy expense

     722         1,103         (381     (34.5 %) 

Equipment and data processing expense

     1,262         1,233         29        2.4

Deposit insurance premiums

     325         352         (27     (7.7 %) 

Advertising

     105         158         (53     (33.5 %) 

Valuation adjustment and expenses on OREO

     1,104         326         778        238.7

Loss on early extinguishment of debt

     190         —           190        —     

Other

     1,588         2,057         (469     (22.8 %) 
                            

Total noninterest expense

   $ 8,740       $ 8,946       ($ 206     (2.3 %) 
                            

Income Taxes

Income tax expense for the six months ended December 31, 2010 was $306,000 compared to $23,000 for the same period in 2009 due to higher taxable income.

Financial Condition

Cash, Cash Equivalents and Interest-Earning Deposits

Cash, cash equivalents, and interest-earning deposits increased $26.1 million to $95.4 million at December 31, 2010 compared to $69.3 million at June 30, 2010 due to decreases in loan and investment balances combined with an increase in customer deposits. Management has maintained higher than usual levels of liquidity during the current economic downturn.

 

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Investments

The Company’s investment security portfolio primarily consists of U.S. Government agency obligations, mortgage-backed securities issued by government-sponsored entities, and municipal bonds. Investment securities decreased to $46.2 million at December 31, 2010 compared to $63.0 million at June 30, 2010. Investments classified as available-for-sale are carried at fair market value and reflect an unrealized gain of $774,000, or $478,000 net of taxes. The $16.8 million decrease in the investment portfolio is due to calls of U.S. agency securities exceeding new purchases.

Loans

Net loans decreased $28.6 million to $405.8 million at December 31, 2010 compared to $434.4 million at June 30, 2010 due primarily to reduced loan demand combined with normal paydowns on existing loans, transfers to OREO and charge-offs. Reduced loan demand has resulted from continued economic weakness in the Bank’s market areas.

 

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Loans receivable, net, are summarized as follows:

 

     At
December 31,
2010
    At
June 30,
2010
             
     Amount     Percent
of Portfolio
    Amount     Percent
of Portfolio
    $
Change
    %
Change
 
     (Dollars in thousands)              

Real estate loans:

            

Residential one-to four-family

   $ 127,779        30.8   $ 136,430        30.7   $ (8,651     (6.3 %) 

Home equity line of credit

     20,887        5.0     19,768        4.4     1,119        5.7

Commercial

     141,874        34.3     140,024        31.5     1,850        1.3

Multi-family

     17,862        4.3     16,536        3.7     1,326        8.0

Construction

     9,169        2.2     21,073        4.7     (11,904     (56.5 %) 

Land

     30,200        7.3     37,135        8.4     (6,935     (18.7 %) 
                                          

Total real estate loans

     347,771        84.0     370,966        83.5     (23,195     (6.3 %) 
                                          

Commercial business loans

     60,102        14.5     66,699        15.0     (6,597     (9.9 %) 
                                          

Consumer loans:

            

Automobile loans

     1,615        0.4     1,848        0.4     (233     (12.6 %) 

Mobile home loans

     17        0.0     23        0.0     (6     (26.1 %) 

Loans secured by deposits

     1,504        0.4     1,372        0.3     132        9.6

Other consumer loans

     3,198        0.8     3,566        0.8     (368     (10.3 %) 
                                          

Total consumer loans

     6,334        1.5     6,809        1.5     (475     (7.0 %) 
                                          

Total gross loans

     414,207        100.0     444,474        100.0     (30,267     (6.8 %) 
                        

Less:

            

Deferred loan fees, net

     (442       (447       5        (1.1 %) 

Allowance for losses

     (7,945       (9,649       1,704        (17.7 %) 
                              

Loans receivable, net

   $ 405,820        $ 434,378        $ (28,558     (6.6 %) 
                              

Loan Loss Allowance

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish reserves against losses on loans on a monthly basis. When additional reserves are necessary, a provision for loan losses is charged to earnings.

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses. The methodology utilizes a loan grading system which segments loans with similar risk characteristics. Management performs a monthly assessment of the allowance for loan losses based on the nature and volume of the loan portfolio, the amount of impaired and classified loans and historical loan loss experience. In addition, management considers other qualitative factors, including delinquency trends, economic conditions and loan considerations.

 

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The FDIC and the Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses. The FDIC and/or the Tennessee Department of Financial Institutions may require us to make additional provisions for loan losses based on judgments different from ours.

The allowance for loan losses was $7.9 million at December 31, 2010 compared to $9.6 million at June 30, 2010. Our allowance for loan losses represented 1.92% of total loans and 60.40% of nonperforming loans at December 31, 2010 compared to 2.17% of total loans and 51.38% of nonperforming loans at June 30, 2010.

 

     Three Months Ended
December 31,
    Six Months Ended
December 31,
 
     2010     2009     2010     2009  
     (Dollars in thousands)     (Dollars in thousands)  

Balance at beginning of period

   $ 8,748      $ 4,595      $ 9,649      $ 4,722   

Provision for loan losses

     950        1,509        950        1,809   

Recoveries

     94        23        102        48   

Charge-offs

     (1,847     (947     (2,756     (1,399
                                

Net charge-offs

     (1,753     (924     (2,654     (1,351
                                

Allowance at end of period

   $ 7,945      $ 5,180      $ 7,945      $ 5,180   
                                

Net charge-offs to average outstanding loans during the period, annualized

     1.67     0.78     1.24     0.56

Nonperforming Assets

We consider repossessed assets and nonaccrual loans to be nonperforming assets. Loans are reviewed on a monthly basis and are generally placed on nonaccrual status when the loan becomes more than 90 days delinquent. Nonaccrual loans totaled $13.2 million at December 31, 2010 compared to $18.8 million at June 30, 2010. The decrease in nonaccrual loans is primarily due to an increase in both nonaccrual residential and commercial real estate loans. Troubled debt restructuring (“TDR”) loans were $5.2 million at December 31, 2010 compared to $3.1 million at June 30, 2010. In general, a TDR exists when we grant a concession to a borrower experiencing financial difficulty that we normally would not otherwise consider. These concessions can result in avoidance of foreclosure proceedings and can result in the full repayment of the loan principal amount. The majority of the Bank’s TDRs involve a modification in loan terms such as a temporary period of interest only or extension of the maturity date. The majority of loans in this category are in compliance with their modified loan terms as of December 31, 2010. The amount of accruing TDR loans totaled $4.4 million at December 31, 2010. Foreclosed real estate amounted to $9.9 million at December 31, 2010 compared to $6.9 million at June 30, 2010. Foreclosed real estate is initially recorded at the lower of the amount of the loan or the fair value of the foreclosed real estate, less estimated selling costs. Any initial writedown to fair value is charged to the allowance for loan losses. Any subsequent writedown of foreclosed real estate is charged against earnings. Foreclosed real estate at December 31, 2010 consisted of vacant land totaling $1.1 million, residential property totaling $2.1 million and commercial real estate totaling $6.7 million.

 

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     December 31,
2010
    June 30,
2010
 
     (Dollars in thousands)  

Nonaccruing loans:

    

Residential real estate

   $ 9,040      $ 10,750   

Commercial real estate

     3,033        6,617   

Commercial business

     1,015        1,309   

Consumer

     67        103   
                

Total nonaccrual loans

     13,155        18,779   

Nonaccrual investments

     376        731   

Real estate owned

     9,937        6,865   

Other repossessed assets

     —          —     
                

Total nonperforming assets

   $ 23,468      $ 26,375   
                

Total nonperforming assets to total assets

     3.82     4.18

Total nonperforming loans to total loans

     3.18     4.22

Allowance for loan losses to total nonperforming loans

     60.40     51.38

The following table summarizes activity in OREO during the six months ended December 31, 2010:

 

OREO balance at beginning of period

   $ 6,851   

OREO acquired

     8,635   

OREO sold

     (3,609

Initial valuation adjustments

     (1,498

Subsequent valuation adjustments

     (442
        

OREO ending balance

   $ 9,937   
        

Bank Owned Life Insurance

We hold bank owned life insurance (“BOLI”) to help offset the cost of employee benefit plans. BOLI provides earnings from accumulated cash value growth and provides tax advantages inherent in a life insurance contract. The cash surrender value of the BOLI at December 31, 2010 was $6.5 million.

Deposits

Total deposits increased $8.9 million to $488.1 million at December 31, 2010 due primarily to customer preference for higher yielding time deposits during a period of economic uncertainty. Time deposits increased $9.0 million, or 3.7%, to $249.2 million at December 31, 2010. NOW accounts decreased $17.9 million, or 30.8%, to 40.3 million compared to June 30, 2010 due to a planned reduction in public funds.

 

     December 31,
2010
     June 30,
2010
     $
Change
    %
Change
 
     (Dollars in thousands)               

Noninterest-bearing accounts

   $ 52,859       $ 41,653       $ 11,206        26.9

NOW accounts

     40,338         58,257         (17,919     (30.8 %) 

Savings accounts

     88,275         82,830         5,445        6.6

Money market accounts

     57,492         56,247         1,245        2.2

Certificates of deposit

     249,155         240,196         8,959        3.7
                            

Total

   $ 488,119       $ 479,183       $ 8,936        1.9
                            

 

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Advances

Federal Home Loan Bank (“FHLB”) advances decreased $26.5 million to $58.3 million at December 31, 2010 compared to $84.8 million at June 30, 2010 as excess liquidity was used to repay FHLB advances with an average rate of 3.56%. Although prepayment penalties totaling $190,000 were incurred in connection with the repayment of the advances, management believes the future savings in interest expense will more than offset the prepayment penalties.

Stockholders’ Equity

Stockholders’ equity remained relatively stable at $56.5 million at December 31, 2010 compared to June 30, 2010. On November 13, 2008, the Company announced its third stock repurchase program pursuant to which up to 620,770 shares of the Company’s outstanding common stock may be repurchased. At December 31, 2010, 442,257 shares remained eligible for repurchase under the current stock repurchase program. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders’ equity. At December 31, 2010, the adjustment to stockholders’ equity was a net unrealized gain of $478,000 compared to a net unrealized gain of $1.2 million at June 30, 2010.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the FHLB of Cincinnati. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

Investments in liquid assets are regularly adjusted based on our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term U.S. Government agency obligations.

Our most liquid assets are cash and cash equivalents and marketable investment securities that are not pledged as collateral. The levels of these assets are dependent on operating, financing, lending and investing activities during any given period. At December 31, 2010, cash and cash equivalents totaled $95.4 million compared to $69.3 million at June 30, 2010. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $46.2 million at December 31, 2010 compared to $63.0 million at June 30, 2010. At December 31, 2010, approximately $21.7 million of the investment portfolio was pledged as collateral for municipal deposits, FHLB borrowings and repurchase agreements. The Company’s external sources of liquidity include borrowing capacity with the Federal Home Loan Bank of Cincinnati, the Federal Reserve, and other correspondent banks. At December 31, 2010, borrowing capacity with the FHLB totaled $64.3 million based on pledged collateral, of which $6.6 million was unused. In the six-month period ended December 31, 2010, FHLB advances decreased $26.5 million to $58.3 million compared to $84.8 million at June 30, 2010. The Company had approximately $11.5 million of unused borrowing capacity with the Federal Reserve Bank of Atlanta at December 31, 2010. In addition, the Company also maintains a federal funds line with one correspondent bank totaling $10.0 million under which no borrowings were outstanding.

 

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The Company anticipates that it will have sufficient funds available to meet current loan commitments. At December 31, 2010, we had approximately $12.6 million in loan commitments, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $6.3 million in unused letters of credit and approximately $33.9 million in unused lines of credit. At December 31, 2010, we had $223.3 million in certificates of deposit due within one year and $239.0 million in other deposits without specific maturities. We believe, based on past experience, that a significant portion of those deposits will remain with us. Deposit flows are affected by the overall level of interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase deposits. Occasionally, we offer promotional rates on certain deposit products in order to attract deposits. We experienced a net increase in total deposits of $8.9 million during the six-month period ended December 31, 2010.

Jefferson Bancshares is a separate entity and apart from Jefferson Federal and must provide for its own liquidity. In addition to its operating expenses, Jefferson Bancshares is responsible for the payment of dividends declared for its shareholders, and interest and principal on outstanding debt. At times, Jefferson Bancshares has repurchased and retired outstanding shares of its stock pursuant to share repurchase programs adopted by the Board of Directors. Substantially all of Jefferson Bancshares’ revenues are obtained from dividends. Payment of such dividends to Jefferson Bancshares by Jefferson Federal is limited under Tennessee law. The amount that can be paid in any calendar year, without prior approval from the Tennessee Department of Financial Institutions, cannot exceed the total of Jefferson Federal’s net income for the year combined with its retained net income for the preceding two years. Jefferson Bancshares believes that such restriction will not have an impact on its ability to meet its ongoing cash obligations.

Off-Balance Sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.

For the six months ended December 31, 2010, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

 

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Capital Compliance

The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. As of December 31, 2010, Jefferson Federal met each of its capital requirements. The following table presents our capital position relative to our regulatory capital requirements at December 31, 2010 and June 30, 2010:

 

     Actual     For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
     Amount      Ratio     Amount          Ratio     Amount          Ratio  
     (Dollars in thousands)  

At December 31, 2010

                   

Total Risk-Based Capital

                   

(To Risk Weighted Assets)

   $ 52,996         12.48   $ 33,962      >      8.0   $ 42,453      >      10.0
                       

Tier 1 Capital

                   

(To Risk Weighted Assets)

     47,657         11.23     16,981      >      4.0     25,472      >      6.0
                       

Tier 1 Capital

                   

(To Average Assets)

     47,657         7.73     24,675      >      4.0     30,843      >      5.0
                       

At June 30, 2010

                   

Total Risk-Based Capital

                   

(To Risk Weighted Assets)

   $ 52,352         11.61   $ 36,073      >      8.0   $ 45,092      >      10.0
                       

Tier 1 Capital

                   

(To Risk Weighted Assets)

     46,666         10.35     18,037      >      4.0     27,055      >      6.0
                       

Tier 1 Capital

                   

(To Average Assets)

     46,666         7.29     25,609      >      4.0     32,011      >      5.0
                       

Under the capital regulations of the FDIC, Jefferson Federal must satisfy various capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (“Tier I”) capital to average adjusted assets of at least 3.00% if a particular institution has the highest examination rating and at least 4.00% for all others. At December 31, 2010, Jefferson Federal’s leverage capital ratio was 7.73%. The FDIC’s risk-based capital rules require banks supervised by the FDIC to maintain a ratio of risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for Jefferson Federal is defined as Tier 1 capital plus Tier 2 capital. At December 31, 2010, Jefferson Federal had a ratio of total capital to risk-weighted assets of 12.48%. At December 31, 2010, the Bank met the minimum regulatory capital requirements, and the Bank was “well-capitalized” within the meaning of federal regulatory requirements.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

For a discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s portfolio equity, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since June 30, 2010.

 

Item 4. Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

Jefferson Bancshares is not a party to any pending legal proceedings. Periodically, there have been various claims and lawsuits involving Jefferson Federal, such as claims to enforce liens, condemnation proceedings on properties in which Jefferson Federal holds security interests, claims involving the making and servicing of real property loans and other issues incident to Jefferson Federal’s business. Jefferson Federal is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company or the Bank.

 

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Period    (a)
Total Number
of Shares

(or units)
Purchased
     (b)
Average
Price Paid
per Share
(or Unit)
     ( c )
Total Number of
Shares (or Units)
Purchased as
Part of Publicly
Announced Plans
or Progams
     ( d )
Maximum Number
(or Approximate
Dollar Value)

of Shares (or
Units) That May
Yet Be Purchased
Under the Plans

or Programs
 

Month #1

           

October 1, 2010 through October 31, 2010

     —         $ —           —           454,118  (1) 

Month #2

           

November 1, 2010 through November 30, 2010

     3,382       $ 3.41         3,382         450,736  (1) 

Month #3

           

December 1, 2010 through December 31, 2010

     8,479       $ 3.09         8,479         442,257  (1) 

Total

     11,861       $ 3.18         11,861         442,257   

 

(1) On November 13, 2008, the Company announced a stock repurchase program under which the Company may repurchase up to 620,770 shares of the Company’s common stock, from time to time, subject to market conditions. The repurchase program will continue until completed or terminated by the Board of Directors.

 

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Item 3. Defaults Upon Senior Securities

None.

 

Item 4. [Removed and Reserved]

 

Item 5. Other Information

None.

 

Item 6. Exhibits

 

31.1    Rule 13a-14(a)/15d-14(a) certification of the principal executive officer
31.2    Rule 13a-14(a)/15d-14(a) certification of the principal financial officer
32.0    Section 1350 certification

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    JEFFERSON BANCSHARES, INC.
February 14, 2011  

/s/ Anderson L. Smith

  Anderson L. Smith
  President and Chief Executive Officer
February 14, 2011  

/s/ Jane P. Hutton

  Jane P. Hutton
  Chief Financial Officer, Treasurer and Secretary