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EX-32.1 - SECTION 906 CEO CERTIFICATION - COMMUNITY FINANCIAL SHARES INCdex321.htm
EX-21.0 - SUBSIDIARIES OF THE COMPANY - COMMUNITY FINANCIAL SHARES INCdex210.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - COMMUNITY FINANCIAL SHARES INCdex312.htm
EX-23.0 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - COMMUNITY FINANCIAL SHARES INCdex230.htm
EX-99.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - COMMUNITY FINANCIAL SHARES INCdex992.htm
EX-99.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - COMMUNITY FINANCIAL SHARES INCdex991.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - COMMUNITY FINANCIAL SHARES INCdex311.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - COMMUNITY FINANCIAL SHARES INCdex322.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

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

For the fiscal year 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: 0-51296

 

 

COMMUNITY FINANCIAL SHARES, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   36-4387843

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

357 Roosevelt Road

Glen Ellyn, Illinois

  60137
(Address of principal executive offices)   (Zip Code)

(630) 545-0900

(Registrant’s telephone number, including area code)

None

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

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

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 (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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   x

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $8,506,000 based upon the average bid and asked price of such common equity as of the last business day of the registrant’s most recently completed second fiscal quarter.

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

 

Class

 

Outstanding at March 21, 2011

Common Stock, no par value per share   1,245,267 shares

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement to be delivered to stockholders in connection with the Annual Meeting of Stockholders to be held on May 25, 2011 are incorporated by reference into Part III of this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  

PART I

     3   

Item 1.

  Business      3   

Item 1A.

  Risk Factors      18   

Item 1B.

  Unresolved Staff Comments      26   

Item 2.

  Properties      27   

Item 3.

  Legal Proceedings      27   

Item 4.

  [Removed and Reserved]      27   

PART II

     28   

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      28   

Item 6.

  Selected Financial Data      28   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      29   

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk      41   

Item 8.

  Financial Statements and Supplementary Data      42   

Item 9.

  Changes In and Disagreements with Accountants on Accounting and Financial Disclosure      76   

Item 9A.

  Controls and Procedures      76   

Item 9B.

  Other Information      76   

PART III

     77   

Item 10.

  Directors, Executive Officers and Corporate Governance      77   

Item 11.

  Executive Compensation      77   

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      77   

Item 13.

  Certain Relationships, Related Transactions and Director Independence      78   

Item 14.

  Principal Accountant Fees and Services      78   

PART IV

     78   

Item 15.

  Exhibits and Financial Statement Schedules      78   

Signatures

     79   

Exhibits

     80   


Table of Contents

Forward-Looking Statements

Community Financial Shares, Inc. (“the Company”) from time to time includes forward-looking statements in its oral and written communications. The Company may include forward-looking statements in filings with the Securities and Exchange Commission, such as this Form 10-K and Form 10-Q, in other written materials and in oral statements made by senior management to analysts, investors, representatives of the media and others. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and the Company is including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like “estimate,” “project,” “intend,” “anticipate,” “expect” and similar expressions. These forward-looking statements include:

 

   

statements of the Company’s goals, intentions and expectations;

 

   

statements regarding the Company’s business plan and growth strategies;

 

   

statements regarding the asset quality of the Company’s loan and investment portfolios; and

 

   

estimates of the Company’s risks and future costs and benefits.

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

 

   

The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, an escalation in problem assets and foreclosures, a deterioration in the credit quality and value of the Company’s assets, especially real estate, which, in turn would likely reduce our customers’ borrowing power and the value of assets and collateral associated with our existing loans;

 

   

The potential impact of the Company’s participation in the U.S. Department of Treasury’s Troubled Asset Relief Program’s Capital Purchase Program;

 

   

The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters;

 

   

The failure of assumptions underlying the establishment of our allowance for loan losses, that may prove to be materially incorrect or may not be borne out by subsequent events;

 

   

The success and timing of our business strategies and our ability to effectively carry out our business plan;

 

   

An inability to meet our liquidity needs;

 

   

The effect of changes in accounting policies and practices, as may be adopted from time-to-time by bank regulatory agencies, the Securities and Exchange Commission, the Public Company Accounting Oversight Board, the Financial Accounting Standards Board or other accounting standards setters;

 

   

The effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rate, market and monetary fluctuations;

 

   

The risks of changes in interest rates on the level and composition of deposits, loan demand and the values of loan collateral, securities and interest sensitive assets and liabilities;

 

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The effect of changes to our regulatory ratings or the imposition of enforcement action by bank regulatory authorities upon the Bank or the Company as a result of our inability to comply with regulatory agreements;

 

   

Our ability to effectively manage market risk, credit risk and operational risk;

 

   

The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector;

 

   

The inability of the Company to obtain new customers and to retain existing customers;

 

   

The timely development and acceptance of products and services including services, products and services offered through alternative delivery channels such as the Internet;

 

   

Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers;

 

   

The ability of the Company to develop and maintain secure and reliable electronic systems;

 

   

The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner;

 

   

Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected;

 

   

The costs, effects and outcomes of existing or future litigation; and

 

   

The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

Because of these and other uncertainties, the Company’s actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Company’s past results of operations do not necessarily indicate its future results. The Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date such forward-looking statement is made.

PART I

Item 1. Business

General

Community Financial Shares, Inc. (the “Company”) is a registered bank holding company. The operations of the Company and its banking subsidiary consist primarily of those financial activities common to the commercial banking industry and are explained more fully below under the heading “Lending Activities”. Unless the context otherwise requires, the term “Company” as used herein includes the Company and its banking subsidiary on a consolidated basis. All of the operating income of the Company is attributable to its wholly-owned banking subsidiary, Community Bank-Wheaton/Glen Ellyn (the “Bank”).

The Company was incorporated in the State of Delaware in July 2000 as part of an internal reorganization whereby the stockholders of the Bank exchanged all of their Bank stock for all of the issued and outstanding stock of the Company. The reorganization was completed in December 2000. As a result of the reorganization the former stockholders of the Bank acquired 100% of the Company’s stock and the Company acquired (and still holds) 100% of the Bank’s stock. The former Bank stockholders received two shares of the Company’s common stock for each share of Bank common stock exchanged in the reorganization. The Company was formed for the purpose of providing financial flexibility as a holding company for the Bank. At the present time, the Company has no specific plans of engaging in any activities other than operating the Bank as a subsidiary.

 

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The Bank was established as a state chartered federally insured commercial bank on March 1, 1994 and opened for business November 21, 1994 on Roosevelt Road in Glen Ellyn. The Bank opened a second location in downtown Wheaton on November 21, 1998. A third location was opened in northwest Wheaton on March 24, 2005. A fourth full service branch was opened on November 21, 2007 in north Wheaton. The Bank provides banking services common to the industry, including but not limited to, demand, savings and time deposits, loans, mortgage loan origination for investors, cash management, electronic banking services, Internet banking services including bill payment, Community Investment Center services, and debit cards. The Bank serves a diverse customer base including individuals, businesses, governmental units, and institutional customers located primarily in Wheaton and Glen Ellyn and surrounding communities in DuPage County, Illinois. The Bank has banking offices in Glen Ellyn, and Wheaton, Illinois.

Market Area

The Company is located in the village of Glen Ellyn in DuPage County in Illinois. Glen Ellyn is a suburb of Chicago and is located approximately 20 miles directly west of the city. The combined population of Wheaton and Glen Ellyn is approximately 84,000 while the county of DuPage currently has approximately 930,000 residents. The median household income within the Bank’s market area is above $88,000 which is higher than the area average. The economic base of both communities is comprised primarily of professionals and service related industry. There are no dominant employers in the area. However, the DuPage County offices as well as the College of DuPage, both of whom are nearby, are likely the largest. The local economy remains stable however, real estate values have been negatively impacted which is reflected in the local real estate market.

Regulatory Actions

As previously disclosed in a Current Report on Form 8-K dated January 26, 2011, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the Federal Deposit Insurance Corporation (the “FDIC”) and the Illinois Department of Financial and Professional Regulation (the “IDFPR”) on January 21, 2011, whereby the Bank consented to the issuance of a Consent Order (the “Order”) by the FDIC and IDFPR, without admitting or denying that grounds exist for the FDIC and IDFPR to initiate an administrative proceeding against the Bank.

The Order requires the Bank to take the following actions: ensure that the Bank has competent management in place in all executive officer positions; increase the participation of the Bank’s Board of Directors in the affairs of the Bank and in the approval of sound policies and objectives for the supervision of the Bank’s activities; establish a compliance program to monitor the Bank’s compliance with the Order; achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets within 120 days; increase its allowance for loan losses to $4,728,000 after application of the funds necessary to effect the charge-off of certain adversely classified loans identified in the related Report of Examination of the FDIC and IDFPR (the “ROE”); implement a program for the maintenance of an adequate allowance for loan and lease losses; adopt a written profit plan and a realistic, comprehensive budget for all categories of income and expense for calendar year 2011; charge off from its books and records any loan classified as “loss” in the ROE; adopt a written plan to reduce the Bank’s risk position in each asset in excess of $500,000 which has been classified as “substandard” or “doubtful” in the ROE; cease extending additional credit to any borrower who is already obligated in any manner to the Bank on any extension of credit that has been charged off the books of the Bank or classified as “loss” in the ROE without the prior non-objection of the FDIC; not pay any dividends to the Company without prior regulatory approval; implement procedures for managing the Bank’s sensitivity to interest rate risk; provide the Company with a copy of the Order; and submit quarterly progress reports to the FDIC and IDFPR regarding the Bank’s compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and IDFPR. Any material failure to comply with the provisions of the Order could result in enforcement actions by the FDIC and IDFPR. While the Company intends to take such actions as may be necessary to enable the Bank to comply with the requirements of the Order, there can be no assurance that the Bank will be able to comply fully with the

 

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provisions of the Order, or to do so within the timeframes required, that compliance with the Order will not be more time consuming or more expensive than anticipated, or that compliance with the Order will enable the Company and the Bank to resume profitable operations, or that efforts to comply with the Order will not have adverse effects on the operations and financial condition of the Company and the Bank.

In addition, on January 14, 2011, the Company was notified by the Federal Reserve Bank of Chicago (the “FRB”) that the overall condition of the Company and the Bank is less than satisfactory. As a result, the Company must now obtain prior written approval from the FRB prior to, among other things, (i) the payment of any capital distribution, including stockholder dividends on the shares of Company preferred stock issued to the U.S. Department of Treasury (the “Treasury”) pursuant to the Trouble Asset Relief Program (“TARP”) Capital Purchase Program or (ii) making any payments related to any outstanding trust preferred securities. The Company is also required, within thirty days of January 14, 2011, to downstream all remaining funds to the Bank with the exception of the Company’s non-discretionary payments required to be made over the next twelve months. Additionally, the Company will be required to comply with (i) the provisions of Section 32 of the Federal Deposit Insurance Act and Section 225.71 of the Rules and Regulations of the Board of Governors of the Federal Reserve System with respect to the appointment of any new Company directors or the hiring or change in position of any Company senior executive officer and (ii) the restrictions on making “golden parachute” payments set forth in Section 18(k) of the Federal Deposit Insurance Act.

Competition

Active competition exists in all principal areas where the Bank operates, not only with other commercial banks, finance companies and mortgage bankers, but also with savings and loan associations, credit unions, and other financial service companies serving the Company’s market area. The principal methods of competition between the Company and its competitors are price and service. Price competition, primarily in the form of interest rate competition, is a standard practice within the Company’s market place as well as the financial services industry. Service, expansive banking hours, and product quality are also significant factors in competing and allow for differentiation from competitors.

Deposits in the Bank are well balanced, with a large customer base and no dominant segment of accounts. The Bank’s loan portfolio is also characterized by a large customer base, including loans to commercial, not-for-profit and consumer customers, with no dominant relationships. There is no readily available source of information that delineates the market for financial services offered by non-bank competitors in the Company’s market.

Lending Activities

General. The Bank’s loan portfolio is comprised primarily of real-estate mortgage loans, which include loans secured by residential, multi-family and nonresidential properties. The Bank originates loans on real estate generally located in the Bank’s primary lending area in central DuPage County, Illinois. In addition to portfolio mortgages, the Bank routinely originates and sells residential mortgage loans and servicing rights for other investors in the secondary market. The Bank services all of its portfolio loans and the Bank has not purchased mortgage servicing rights.

Loans represent the principal source of revenue for the Company. Risk is controlled through loan portfolio diversification and the avoidance of credit concentrations. Loans are made primarily within the Company’s geographic market area. The loan portfolio is distributed among general business loans, commercial real estate, residential real estate, and consumer installment loans. The Company has no foreign loans, no highly leveraged transactions, and no syndicated purchase participations.

 

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The Company’s loan portfolio by major category as of December 31 for each of the past five years is shown below.

 

     2010     2009     2008     2007     2006  
     (In thousands)  

Real estate

          

Commercial

   $ 94,356      $ 99,416      $ 84,103      $ 87,746      $ 85,598   

Construction

     15,435        21,341        31,243        39,016        27,903   

Residential

     25,964        25,424        18,790        21,279        21,526   

Home Equity

     66,243        63,758        59,727        51,498        38,132   
                                        

Total real estate

     201,998        209,939        193,863        199,539        173,159   

Commercial

     25,572        25,907        27,175        28,228        26,318   

Consumer

     1,399        1,662        1,762        1,895        1,876   
                                        

Total loans

     228,969        237,508        222,800        229,662        201,353   

Deferred loan costs, net

     317        276        115        44        16   

Allowance for loan losses

     (7,679     (4,812     (3,300     (1,970     (1,549
                                        

Loans, net

   $ 221,607      $ 232,972      $ 219,615      $ 227,736      $ 199,820   
                                        

Loan Maturities and Sensitivities of Loans to Changes in Interest Rates

The following table shows the amount of total loans outstanding as of December 31, 2010 which, based on remaining scheduled repayments of principal, are due in the periods indicated.

 

     Maturing  
     Within
One Year
     After One
But Within
Five Years
     After Five
Years
     Total  
     (Dollars in thousands)  

Commercial

   $ 20,208       $ 5,121       $ 243       $ 25,572   

Real Estate

     46,270         90,009         65,719         201,998   

Consumer

     1,219         180         —           1,399   
                                   

Totals

   $ 67,697       $ 95,310       $ 65,962       $ 228,969   
                                   

Below is a schedule of loan amounts maturing or re-pricing, classified according to sensitivity to changes in interest rates, as of December 31, 2010.

 

     Interest Sensitivity  
     Fixed Rate      Variable Rate      Total  
     (Dollars in thousands)  

Due within three months

   $ 17,182       $ 14,571       $ 31,753   

Due after three months but within one year

     17,579         16,638         34,217   

Due after one but within five years

     87,467         8,062         95,529   

Due after five years

     4,457         63,013         67,470   
                          

Total

   $ 126,685       $ 102,284       $ 228,969   
                          

Residential – One-to-Four Family. In 1999 the Bank established a dedicated secondary mortgage department to assist local residents in obtaining mortgages with reasonable terms, conditions, and rates. The Bank offers various fixed and adjustable rate one-to-four family residential loan products the majority of which are sold, along with servicing rights, to a variety of investors in the secondary market. Interest rates are essentially dictated by the Bank’s investors and origination fees on secondary mortgage loans are priced to provide a reasonable profit margin and are dictated to a degree by regional competition.

 

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The Bank, for secondary market residential loans, generally makes one-to-four family residential mortgage loans in amounts not to exceed 80% of the appraised value or sale price, whichever is less, of the property securing the loan, or up to 95% if the amount in excess of 80% of the appraised value is secured by private mortgage insurance. Loans for amounts between 80% and 85% of appraised value or sale price may also be granted with an increased interest rate. The Bank usually receives a service release fee of 1.0% to 1.5 % on one-to-four family residential mortgage loans.

In addition to loans originated for the secondary market, the Bank has portfolio loans secured by one-to-four family residential real estate that totaled approximately $26.0 million, or 11.3% of the Bank’s total loan portfolio, as of December 31, 2010.

Commercial Real Estate Lending. Loans secured by commercial real estate totaled approximately $94.4 million, or 41.2% of the Bank’s total loan portfolio, at December 31, 2010. Commercial real estate loans are generally originated in amounts up to 80% of the appraised value of the property. Such appraised value is generally determined by independent appraisers previously approved by the Board of Directors of the Bank.

The Bank’s commercial real estate loans are permanent portfolio loans secured by improved property such as office buildings, retail stores, warehouses, churches, and other non-residential buildings. Of the commercial real estate loans outstanding at December 31, 2010, most are secured by properties located within 10 miles of the Bank’s offices in Wheaton and Glen Ellyn and were made to local customers of the Bank. In addition, borrowers generally must personally guarantee loans secured by commercial real estate. Commercial real estate loans generally have a 10 to 25 year amortization period and are made at rates based upon competitive local market rates, specific loan risk, and structure usage and type. Such loans generally have a five-year maturity.

Commercial real estate loans are both adjustable and fixed, with fixed rates generally limited to no more than five years. Loans secured by commercial real estate properties are generally larger and involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks by lending to established customers and generally restricting such loans to its primary market area.

Construction Lending. The Bank is actively engaged in construction lending. Such activity is generally limited to individual new residential home construction, residential home additions, and new commercial buildings. Currently, the majority of the Bank’s new construction activity is in new commercial construction.

At December 31, 2010, the Bank had $15.4 million in construction loans outstanding, which represented 6.7% of the Bank’s loan portfolio at such date. The Bank presently charges both fixed and variable interest rates on construction and end loans. Loans, with proper credit, may be made for up to 80% of the anticipated value of the property upon completion. Funds are usually disbursed based upon percentage of completion generally verified by an on-site inspection by Bank personnel and generally through a local title company construction escrow account.

Consumer Lending. As a community-oriented lender, the Bank offers consumer loans for any worthwhile purpose. Although the Bank offers signature unsecured loans, consumer loans are generally secured by automobiles, boats, mobile homes, stocks, bonds, and other personal property. Consumer loans totaled $1.4 million, or 0.6% of the Bank’s total loan portfolio, at December 31, 2010. Consumer loans generally have higher yields than residential mortgage loans since they involve a higher credit risk and smaller volumes with which to cover basic costs.

Home Equity Lending. Home equity loans are generally made not to exceed 80% of the first and second combined mortgage loan to value. These loans generally made for five-year terms and are generally revolving credit lines with minimum payment structures of interest only. The interest rate on these lines of credit adjusts at a rate based on the prime rate of interest. Additionally, the Bank offers five-year amortizing fixed rate home equity balloon loans for those who desire to limit interest rate risk. At December 31, 2010, the outstanding home equity loan balance was $66.2 million, or 28.9% of the Bank’s total loan portfolio.

 

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Commercial Lending. The Bank actively engages in general commercial lending within its market area. These loans are primarily revolving working capital lines, inventory loans, and equipment loans. The commercial loans are generally based on serving the needs of small businesses in the Bank’s market area while limiting the Bank’s business risks to reasonable lending standards. Commercial loans are made with both fixed and adjustable rates and are generally secured by equipment, accounts receivable, inventory, and other assets of the business. Personal guarantees generally support these credit facilities. The Bank also provides commercial and standby letters of credit to assist small businesses in their financing of special purchasing or bonding needs. Standby letters of credit outstanding at December 31, 2010 totaled $224,000. Commercial loans totaled approximately $25.6 million or 11.2% of the Bank’s total loan portfolio at December 31, 2010.

Loan Concentration

At December 31, 2010, the Company did not have any concentration of loans exceeding 10% of total loans which are otherwise not disclosed. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions.

Provision for Loan Losses

The provision for loan losses is determined by management through a quarterly evaluation of the adequacy of the allowance for loan losses. This evaluation takes various factors into consideration. The provision is based on management’s judgment of the amount necessary to maintain the allowance for loan losses at an adequate level for probable incurred credit losses. In determining the provision for loan losses, management considers the Company’s consistent loan growth and the amount of net charge-offs each year. Other factors, such as changes in the loan portfolio mix, delinquency trends, current economic conditions and trends, reviews of larger loans and known problem credits and the results of independent loan review and regulatory examinations are also considered by management in assessing the adequacy of the allowance for loan losses.

The allowance for loan losses is particularly subject to change as it is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other environmental factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, may be collectively evaluated for impairment.

Assets acquired through or instead of loan foreclosure such as other real estate are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

The allowance for loan losses was $7.7 million, representing 3.4% of total loans, as of December 31, 2010, compared to an allowance of $4.8 million or 2.03% of total loans at year-end 2009 and $3.3 million or 1.48% of total loans at year-end 2008. The increase in the provision was the result of management’s quarterly analysis of the allowance for loan losses. Management believes that, based on information available at December 31, 2010, the Bank’s allowance for loan losses was adequate to cover probable incurred losses

 

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inherent in its loan portfolio at that time. However, no assurances can be given that the Bank’s level of allowance for loan losses will be sufficient to cover loan losses incurred by the Bank or that future adjustments to the allowance for loan losses will not be necessary if economic or other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance. In addition, the FDIC and IDFPR, as an integral part of their examination processes, periodically review the Bank’s allowance for loan losses and may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. Any material increase in the allowance for loan losses may adversely affect our financial condition, results of operations and our ability to comply with the Order.

The following table details the component changes in the Company’s allowance for loan losses for each of the past five years:

 

     Amount as of December 31,
(Dollars in thousands)
 
     2010     2009     2008     2007     2006  

Net Total Loans at Year-end

   $ 221,607      $ 232,972      $ 219,615      $ 227,736      $ 199,820   

Average daily balances for loans for the year

     232,467        228,676        225,245        205,326        197,410   

Allowance for loan losses at beginning of period

   $ 4,812      $ 3,300      $ 1,970      $ 1,549      $ 1,381   

Loan charge-offs during the period

          

Commercial

     (1,281     (5     (771     (14     (20

Commercial real estate

     (3,647     (774     0        0        0   

Residential

     (141     (36     0        0        0   

Real Estate

     0        0        (125     0        0   

Home equity line of credit

     (428     0        0        0        0   

Consumer

     (15     (22     (9     0        0   
                                        

Total Charge-offs

     (5,512     (837     (905     (14     (20

Loan recoveries during the period

          

Commercial

     22        4        20        15        23   

Residential

     15        0        0        0        0   

Consumer

     2        1        0        0        0   
                                        

Total recoveries

     39        5        20        15        23   
                                        

Net recoveries (charge-offs)

     (5,473     (832     (885     1        3   

Provision charged to expense

     8,340        2,344        2,215        420        165   
                                        

Allowance for loan losses at end of period

   $ 7,679      $ 4,812      $ 3,300      $ 1,970      $ 1,549   
                                        

Ratio of net recoveries/(charge-offs) during the period to average loans outstanding

     (2.35 %)      (0.36 %)      (0.39 %)      0.00     0.00

Allowance for loan losses to loans outstanding at year-end

     3.35     2.03     1.48     0.86     0.77

 

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Allocation of the Allowance for Loan Losses

Presented below is an analysis of the composition of the allowance for loan losses and percent of loans in each category to total loans as of the dates indicated:

 

     2010     2009     2008  
     (Dollars in thousands)  
     Amount      Percent     Amount      Percent     Amount      Percent  

Balance at December 31:

               

Commercial and industrial (1)

   $ 791         10.2   $ 762         15.8   $ 349         10.6

Real estate mortgage (2)

     5,075         56.5        2,863         59.5        2,920         88.5   

HELOC

     838         12.3        389         8.1        —           —     

Residential

     661         8.0        770         16.0        —           —     

Individuals’ loans for household and other personal expenditures, including other loans

     19         0.3        24         0.5        31         0.9   

Unallocated

     295         12.7        4         0.1        —        
                                             

Totals

   $ 7,679         100.0   $ 4,812         100.0   $ 3,300         100.0
                                 

 

(1) Category also includes lease financing, loans to financial institutions, tax-exempt loans, agricultural production financing and other loans to farmers and construction real estate loans.
(2) Category includes commercial, farmland and residential real estate loans.

One measurement used by management in assessing the risk inherent in the loan portfolio is the level of nonperforming loans. Nonperforming loans are comprised of non-accrual loans and other loans 90 days or more past due. Nonperforming loans and other assets were as follows at the dates indicated.

 

     At December 31,  
     (Dollars in thousands)  
     2010     2009     2008     2007     2006  

Non-accrual loans

   $ 11,595      $ 14,555      $ 2,725      $ 62      $ 25   

Non-accrual restructured loans

     8,699        —          —          —          —     

Other loans 90 days past due

     —          480        32        635        645   
                                        

Total nonperforming loans

     20,294        15,035        2,757        697        670   

Other real estate owned

     3,008        2,396        198        —          —     
                                        

Total nonperforming assets

   $ 23,302      $ 17,431      $ 2,955      $ 697      $ 670   
                                        

Accruing restructured loans

   $ 6,090      $ 12,358        —          —          —     

Nonperforming loans to total loans

     8.86     6.33     1.24     0.30     0.34

Allowance for loan losses

          

To nonperforming loans

     37.84     32.00     119.70     282.64     231.19

Total nonperforming assets

          

To total stockholders’ equity

     131.2     69.92     17.79     3.77     3.25

Total nonperforming

          

To total assets

     6.71     5.11     1.01     0.23     0.25

At December 31, 2010, nonperforming assets consisted of $20.3 million of nonaccrual loans and other real estate owned of $3.0 million. In addition, at December 31, 2010 nonaccrual loans included $11.9 million of participating interests with other area community banks all of which are secured by commercial real estate. The largest component of nonperforming assets was residential real estate. This sector represented $9.8 million, or 42.0%, of total nonperforming assets at December 31, 2010. At December 31, 2010, construction loans totaled $5.6 million, or 24.0%, of nonperforming assets, loans secured by commercial real estate totaled $2.5 million, or 10.7%, of total nonperforming assets, loans secured by land totaled $2.2 million, or 9.4%, of total nonperforming assets and commercial loans totaled $242,000, or 1.0%, of nonperforming assets. The ratio of the allowance for loan losses to nonperforming loans was 37.8% as of December 31, 2010 as compared to 32.0% for December 31, 2009.

 

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The Bank would have recorded interest income of $1.2 million for the year ended December 31, 2010 had non-accrual loans and troubled debt restructurings been current in accordance with their original terms.

Other real estate owned (“OREO”) increased $612,000 to $3.0 million at December 31, 2010 from $2.4 million at December 31, 2009. OREO consists of eight properties that were acquired through foreclosure or deed in lieu of foreclosure. Included in the total are six residential properties, a commercial real estate property and a parcel of land.

The provision for loan losses in 2010 totaled $8.3 million, which represents a $6.0 million increase from the amount provided for in 2009. This increase is the result of management’s quarterly analysis of the allowance for loan losses. Levels of nonperforming loans are considered manageable at year end 2010. Total nonperforming loans as a percentage of total loans totaled 8.86% at December 31, 2010 compared to 6.33% for the prior year. Based on its analysis of the loan portfolio risks discussed above, including historical loss experience and levels of nonperforming loans, management believes that the allowance for loan losses is adequate at December 31, 2010 to cover any potential losses.

Net (charge-offs) recoveries for the years ended December 31, 2010 and 2009 totaled ($5.5 million) and ($832,000), respectively. The current year’s charge-offs are in part due to deteriorating economic conditions and the effect that has upon smaller businesses within the marketplace. In 2005 management formed a credit quality committee that was charged with monitoring problem credits and directing their resolution. The committee has been successful in identifying existing problem credits and meets on a monthly basis to monitor troubled credits. The management of the Company is confident that any past problems which resulted from weaknesses in processes have been identified and addressed.

Investment Securities

The Board of Directors sets the investment policy and procedures of the Bank. This policy generally provides that investment decisions will be made based on the safety of the investment, liquidity requirements of the Bank and, to a lesser extent, potential return on the investments. In pursuing these objectives, the Bank considers the ability of an investment to provide earnings consistent with factors of quality, maturity, marketability and risk diversification. The Bank does not participate in hedging programs or other activities involving the use of derivative financial instruments. Similarly, the Bank does not invest in mortgage-related securities which are deemed to be “high risk,” or purchase bonds which are not rated investment grade.

The Company’s securities portfolio can be divided into five categories, as shown below. The securities portfolio is managed to provide liquidity and earnings in various interest rate cycles. The carrying value of these securities for the past three years is detailed below.

 

     2010      2009      2008  

U.S. Government Agencies

   $ 11,801       $ 17,691       $ 10,110   

Mortgage-backed Securities

     18,198         11,131         4,724   

States and Political Subdivisions

     12,868         15,339         10,745   

Agency Preferred Stock

SBA Guaranteed Pool

    

 

11

297

  

  

    

 

20

363

  

  

    

 

6

387

  

  

                          

Total Investment Securities

   $ 43,175       $ 44,544       $ 25,972   
                          

 

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The following table shows the weighted average yield for each security group by term to final maturity as of December 31, 2010.

 

Security Type

   Less
than 1
year
     Yield     1 to 5
years
     Yield     5 to 10
years
     Yield     Over 10
years
     Yield  

U.S. Government Agencies

   $ 0         0.00   $ 0         0.00   $ 4,948         2.00   $ 6,853         2.25

Mortgage-Backed Securities

     0         0.00     526         1.37     950         1.80     16,722         2.79

States and Political Subdivisions(1)

     69         2.81     635         5.73     1,822         7.03     10,342         5.94

Agency Preferred Stock

     0         0.00     0         0.00     0         0.00     11         0.00

SBA Guaranteed Pool

     0         0.00     0         0.00     65         2.30     232         2.57
                                                                    

Total Investment Securities

   $ 69         2.81   $ 1,161         3.76   $ 7,785         3.16   $ 34,160         3.63
                                            

 

1

Fully taxable equivalent

At December 31, 2010, the Company did not own any security of any one issuer where the aggregate carrying value of such securities exceeded 10 percent of the Company’s stockholder’s equity, except for certain debt securities of the U.S. Government agencies and corporations.

Deposits

The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Bank’s deposit accounts consist of regular savings accounts, retail checking/NOW accounts, commercial checking accounts, money market accounts and certificate of deposit accounts. The Bank offers certificate of deposit accounts with balances in excess of $100,000 at preferential rates (jumbo certificates) and also offers Individual Retirement Accounts (“IRAs”) and other qualified plan accounts.

At December 31, 2010, the Bank’s deposits totaled $309.1 million, or 93.8% of interest-bearing liabilities. This represents an increase from December 31, 2009 when the Bank’s deposits of $298.3 million represented 93.6% of interest-bearing liabilities. For the year ended December 31, 2010, the average balance of core deposits (savings, NOW, money market and non-interest bearing accounts) totaled $186.0 million, or 62.5% of total average deposits compared to $162.1 million or 59.2% of total average deposits for the prior year. Although the Bank has a significant portion of its deposits in core deposits, management monitors activity on the Bank’s core deposits and, based on historical experience and the Bank’s current pricing strategy, believes it will continue to retain a large portion of such accounts.

The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and local competition. The Bank’s deposits are obtained predominantly from the areas in which its facilities are located. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions affect the Bank’s ability to attract and retain deposits. The Bank uses traditional means of advertising its deposit products and generally does not solicit deposits from outside its market area. While certificates of deposit in excess of $100,000 are accepted by the Bank, and may be subject to preferential rates, the Bank does not actively solicit such deposits as such deposits are more difficult to retain than core deposits.

 

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The following table sets forth the distribution of the Bank’s deposit accounts for the periods indicated and the weighted average rates on each category presented.

 

     At December 31, 2010     At December 31, 2009  
     (Dollars in thousands)  
     Balance      Weighted
Average
Rate
    Balance      Weighted
Average
Rate
 

Non interest-bearing accounts

   $ 34,047         —     $ 29,962         —  

NOW accounts

     80,282         0.58     77,525         1.04

Regular savings accounts

     50,793         0.51     26,140         0.16

Money market accounts

     34,560         0.65     42,894         1.47

Certificates of deposit

     109,398         1.76     121,790         2.84
                      

Total deposits

   $ 309,080         0.96   $ 298,311         1.84
                      

The following table shows the maturity schedule for the Company’s time deposits of $100,000 or more as of December 31, 2010 and December 31, 2009.

 

     2010      2009  
     (In thousands)  

Three months or less

   $ 15,483       $ 18,189   

Three months through six months

     9,759         13,763   

Six months through twelve months

     15,876         15,757   

Over twelve months

     10,188         4,466   
                 
   $ 51,306       $ 52,175   
                 

Personnel

As of December 31, 2010, the Company and its subsidiaries had a total of 77 full-time employees and 17 part-time employees. This compares to 74 full-time and 21 part-time employees as of December 31, 2009. None of these employees are subject to a collective bargaining agreement. We believe our relationship with our employees is good.

REGULATION AND SUPERVISION

The Company and the Bank are subject to an extensive system of banking laws and regulations that are intended primarily for the protection of the customers and depositors of the Company’s bank subsidiary rather than holders of the Company’s securities. These laws and regulations govern such areas as permissible activities, reserves, loans and investments, and rates of interest that can be charged on loans.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted on July 21, 2010, restructures the regulation of depository institutions. The Dodd-Frank Act contains several provisions that will have a direct impact on the operations of the Company and the Bank. The legislation contains changes to the laws governing, among other things, FDIC assessments, mortgage originations, holding company capital requirements and risk retention requirements for securitized loans. The Dodd-Frank Act also provides for the creation of a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by,

 

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and subject to the primary enforcement authority of, the prudential regulator rather than the Consumer Financial Protection Bureau. Much of the legislation requires implementation through regulations and, accordingly, a complete assessment of its impact on the Company and the Bank are not yet possible since such regulations have not yet been issued. However, the enactment of the legislation is likely to increase regulatory burdens and costs for us and have a material impact on our operations.

Certain of the regulatory requirements that are or will be applicable to the Company and the Bank are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on the Company and the Bank and is qualified in its entirety by reference to the actual statutes and regulations.

Regulation of the Company

The Company is regulated as a bank holding company under the Bank Holding Company Act of 1956, as amended by the 1999 financial modernization legislation known as the Gramm-Leach-Bliley Act (the “BHC Act”). As such, it is subject to the supervision and enforcement authority of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks, performing certain servicing activities for subsidiaries, and activities that the Federal Reserve Board has determined, by order of regulation in effect prior to the enactment of the BHC Act, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. As a result of the Gramm-Leach-Bliley Act amendments to the BHC Act, a bank holding company that meets certain requirements and opts to become a “financial holding company” may engage in any activity, or acquire and retain the shares of any company engaged in any activity, that is either (1) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the U.S. Secretary of the Treasury) or (2) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board). Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments in commercial and financial companies.

Further, under the BHC Act, the Company is required to file annual reports and such additional information as the Federal Reserve Board may require and is subject to examination by the Federal Reserve Board. The Federal Reserve Board has jurisdiction to regulate virtually all aspects of the Company’s business. See “The Company’s Banking Subsidiary” below for discussion of regulators of the Bank.

The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before merging with or consolidating into another bank holding company, acquiring substantially all the assets of any bank or acquiring directly or indirectly any ownership or control of more than 5% of the voting shares of any bank.

The BHC Act also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks, or furnishing services to banks and their subsidiaries. The Company, however, may engage in certain businesses determined by the Federal Reserve Board to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. See “Financial Modernization Legislation” below for a discussion of expanded activities permissible to bank holding companies that become financial holding companies.

Banking regulations restrict the amount of dividends that a bank may pay to its stockholders. Thus, the Company’s ability to pay dividends to its shareholders will be limited by statutory and regulatory restrictions. Illinois’ banking laws restrict the payment of cash dividends by a state bank by providing, subject to certain exceptions, that dividends may be paid only out of net profits then on hand after deducting its losses and bad debts. Federal law generally prohibits a bank from making any capital distribution (including payment of a dividend) or paying any management fee to its parent company if the depository institution would thereafter be undercapitalized. The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies which provides that dividends should only be paid out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the

 

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organization’s capital needs, asset quality, and overall financial condition. The Federal Reserve Board’s policies also provide that a bank holding company should serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. These policies could also impact the Company’s ability to pay dividends.

The FDIC may prevent an insured bank from paying dividends if the Bank is in default of payment of any assessment due to the FDIC. In addition, the FDIC may prohibit the payment of dividends by a bank, if such payment is determined, by reason of the financial conditions of the bank, to be an unsafe and unsound banking practice.

For additional information on the lender covenants that potentially restrict the declaration of dividends, see the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Dividends”.

The Regulation of the Bank

The Bank is regulated by the Federal Deposit Insurance Corporation (the “FDIC”), as its primary federal regulator. The Bank is subject to the provisions of the Federal Deposit Insurance Act and examination by the FDIC. As an Illinois state–chartered bank, the Bank is also subject to examination by the Illinois Department of Financial and Professional Regulation. The examinations by the various regulatory authorities are designed for the protection of bank depositors and the solvency of the FDIC Deposit Insurance Fund.

The federal and state laws and regulations generally applicable to the Bank regulate, among other things, the scope of business, its investments, reserves against deposits, the nature and amount of and collateral for loans, and the location of banking offices and types of activities which may be performed at such offices. Both the Illinois Department of Financial and Professional Regulation and the FDIC have enforcement authority over the Bank, including the authority to appoint a conservator or receiver under certain circumstances.

Subsidiaries of a bank holding company are subject to certain restrictions under the Federal Reserve Act and the Federal Deposit Insurance Act on loans and extensions of credit to the bank holding company or to its other subsidiaries, investments in the stock or other securities of the bank holding company or its other subsidiaries, or advances to any borrower collateralized by such stock or other securities.

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation.

Under the Federal Deposit Insurance Corporation’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by Federal Deposit Insurance Corporation regulations. Assessment rates currently range from seven to 77.5 basis points of assessable deposits. The Federal Deposit Insurance Corporation may adjust the scale uniformly, except that no adjustment can deviate more than three basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.

On February 7, 2011, the Federal Deposit Insurance Corporation approved a final rule that implemented changes to the deposit insurance assessment system mandated by the Dodd-Frank Act. The final rule, which will take effect for the quarter beginning April 1, 2011, requires that the base on which deposit insurance assessments are charged be revised from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. Under the final rule, insured depository institutions are required to report their average consolidated total assets on a daily basis, using the regulatory accounting methodology established for reporting total assets. For purposes of the final rule, tangible equity is defined as Tier 1 capital. Prior to the April 1, 2011 effective date of the final rule, the Federal Deposit Insurance Corporation will continue to calculate the assessment base from adjusted domestic deposits.

 

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The Federal Deposit Insurance Corporation imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital (as of June 30, 2009), capped at ten basis points of an institution’s deposit assessment base, in order to cover losses to the Deposit Insurance Fund. That special assessment was collected on September 30, 2009. The Federal Deposit Insurance Corporation provided for similar assessments during the final two quarters of 2009, if deemed necessary.

In lieu of further special assessments, however, the Federal Deposit Insurance Corporation required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012. The estimated assessments, which included an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009. As of December 31, 2009, and each quarter thereafter, a charge to earnings is recorded for each regular assessment with an offsetting credit to the prepaid asset.

Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000. That coverage was made permanent by the Dodd-Frank Act. In addition, the Federal Deposit Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the Federal Deposit Insurance Corporation through June 30, 2012, or in some cases, December 31, 2012. The Bank participates in the unlimited noninterest-bearing transaction account coverage and the Bank and the Company opted not to participate in the unsecured debt guarantee program. The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transaction accounts from January 1, 2011 until December 31, 2012 without the opportunity for opt out.

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the calendar year ending December 31, 2010 averaged 1.05 basis points of assessable deposits.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The Federal Deposit Insurance Corporation must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the Federal Deposit Insurance Corporation and the Federal Deposit Insurance Corporation has recently exercised that discretion by establishing a long range fund ratio of 2%.

The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

Capital Requirements

The Federal Reserve Board and the FDIC have established guidelines for risk-based capital of bank holding companies and banks. These guidelines establish a risk adjusted ratio relating total capital to risk-weighted assets and off-balance-sheet exposures. These capital guidelines primarily define the components of capital, categorize assets into different risk classes, and include certain off-balance-sheet items in the calculation

 

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of capital requirements. Generally, Tier 1 capital consists of shareholders’ equity less intangible assets and unrealized gain or loss on securities available for sale, and Tier 2 capital consists of Tier 1 capital plus qualifying loan loss reserves. The agencies also apply leverage requirements which establish a required ratio of Tier 1 capital to total adjusted assets. On January 21, 2011, the Bank entered into a Stipulation and Consent Order with the Federal Deposit Insurance Corporation and the Illinois Department of Financial and Professional Regulation. The Order requires the Bank to achieve Tier 1 capital at least equal to 8.0% of total assets and total capital at least equal to 12.0% of risk-weighted assets within 120 days of the order. As of December 31, 2010 these ratios totaled 5.4% and 8.6%, respectively.

The FDIC Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized depository institutions. Under this system, federal banking regulators have established five capital categories, well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The federal banking agencies have also specified by regulation the relevant capital levels for each of the categories. Each depository institution is placed within one of these categories and is subject to differential regulation corresponding to the capital category within which it falls.

Federal banking regulators are required to take specified mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. An institution in any of the undercapitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency and such capital plan must be guaranteed by any parent holding company in an amount of the lesser of 5% of the institution’s assets or the amount of the capital deficiency. An undercapitalized institution is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

Failure to meet capital guidelines could subject a bank or a bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, such a bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless the bank could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.

Monetary Policy and Economic Conditions

The earnings of commercial banks and bank holding companies are affected not only by general economic conditions, but also by the policies of various governmental regulatory authorities. In particular, the Federal Reserve Board influences conditions in the money and capital markets, which affect interest rates and growth in bank credit and deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and this is expected to continue in the future. The general effect, if any, of such policies on future business and earnings of the Company and its Bank cannot be predicted.

Consumer Protection Laws

The Company’s business includes making a variety of types of loans to individuals. In making these loans, we are subject to State usury and regulatory laws and to various federal statutes, including the privacy of consumer information provisions of the Graham-Leach-Bliley Act and regulations promulgated thereunder, the Equal Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act, and the regulations promulgated thereunder, which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage servicing activities of the Company, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, the Company is subject to extensive regulation under state and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, the USA Patriot Act of 2001, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Company and its directors and officers.

 

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Federal Taxation

The Company files a consolidated federal income tax return. To the extent a member incurs a net loss that is utilized to reduce the consolidated federal tax liability, that member will be reimbursed for the tax benefit utilized from the member incurring federal tax liabilities.

Amounts provided for income tax expense are based upon income reported for financial statement purposes and do not necessarily represent amounts currently payable to federal and state tax authorities. Deferred income taxes, which principally arise from the temporary difference related to the recognition of certain income and expense items for financial reporting purposes and the period in which they affect federal and state tax income, are included in the amounts provided for income taxes.

State Taxation

The Bank is required to file Illinois income tax returns and pay tax at an effective tax rate of 7.30% of Illinois taxable income. For these purposes, Illinois taxable income generally means federal taxable income subject to certain modifications the primary one of which is the exclusion of interest income on United States obligations.

As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware Corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.

Regulatory Restructuring Legislation

On July 21, 2010, President Obama signed the Dodd-Frank Act, which is legislation that restructures the regulation of depository institutions. In addition to creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, requires changes in the way that institutions are assessed for deposit insurance, requires that originators of securitized loans retain a percentage of the risk for the transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contains a number of reforms related to mortgage originations. Many of the provisions of the Dodd-Frank Act contain delayed effective dates and/or require the issuance of regulations. As a result, it will be some time before their impact on operations can be assessed by management. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and higher compliance, operating, and possibly, interest costs for the Company and the Bank.

Item 1A. Risk Factors

An investment in the Company’s common stock involves a number of risks. We urge you to read all of the information contained in this annual report on Form 10-K. In addition, we urge you to consider carefully the following factors before you invest in shares of the registrant’s common stock.

The current economic recession could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.

Our business activities and earnings are affected by general business conditions in the United States and in our primary market area. These conditions include short-term and long-term interest rates, inflation, unemployment levels, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets and the strength of the economy in the United States generally and in our primary market area in particular. In the current recession, the national economy has experienced general economic downturns, with rising unemployment levels, declines in real estate values and an erosion in consumer confidence. The current economic recession has also had a negative impact on our primary market area, which has experienced a softening of the local real estate market and reductions in local property values. A prolonged or more severe economic downturn, continued elevated levels of unemployment, further declines in the values of real estate, or other events that affect household and/or corporate incomes could impair the ability of our borrowers to repay their loans in accordance with their terms. The economic downturn could also result in reduced demand for credit or fee-based products and services, which also would decrease our revenues.

 

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Our provision for loan losses increased substantially during the past fiscal year and we may be required to make further additions to our allowance for loan losses and to charge-off additional loans in the future, especially due to our level of nonperforming assets. Further, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

For fiscal 2010, we recorded a provision for loan losses of $8.3 million, which represents a $6.0 million increase from the amount provided for in 2009. In addition, our net charge-offs increased from $832,000 for the year ended December 31, 2009 to $5.5 million for the year ended December 31, 2010. Our nonperforming assets also increased to $23.3 million, or 6.7% of total assets, at December 31, 2010 from $17.4 million, or 5.1% of total assets at December 31, 2009 and $2.9 million, or 1.0% of total assets, at December 31, 2008. The increase in nonperforming assets was primarily due to the weakened economy and the softening real estate market and the impact of such on our borrowers and the properties securing our loans. If the economy and/or the real estate market remains unchanged or further weakens, we may be required to add further provisions to our allowance for loan losses as nonperforming assets could continue to increase or the value of the collateral securing loans may be insufficient to cover any remaining net loan balance, which could have a negative effect on our results of operations.

Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In evaluating the adequacy of our allowance for loan losses, we consider such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, personal guarantees, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, amount and timing of expected future cash flows on affected loans, value of collateral, personal guarantees, estimated losses on specific loans, as well as consideration of general loss experience. All of these estimates may be susceptible to significant change. While management uses the best information available at the time to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. Our estimates of the risk of loss and the amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, the competitive challenges they face, and the effect of current and future economic conditions on collateral values and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary materially from our current estimates.

The FDIC and IDFPR, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.

A continued deterioration in national and local economic conditions may negatively impact our financial condition and results of operations.

We currently are operating in a challenging and uncertain economic environment, both nationally and in the local markets that we serve. Financial institutions continue to be affected by sharp declines in financial and real estate values. Continued declines in real estate values and home sales, and an increase in the financial stress on borrowers stemming from an uncertain economic environment, including rising unemployment, could have an adverse effect on our borrowers or their customers, which could adversely impact the repayment of the loans we have made. The overall deterioration in economic conditions also could subject us to increased regulatory scrutiny. In addition, a prolonged recession, or further deterioration in local economic conditions,

 

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could result in an increase in loan delinquencies; an increase in problem assets and foreclosures; and a decline in the value of the collateral for our loans. Furthermore, a prolonged recession or further deterioration in local economic conditions could drive the level of loan losses beyond the level we have provided for in our loan loss allowance, which could necessitate increasing our provision for loan losses, which would reduce our earnings. Additionally, the demand for our products and services could be reduced, which would adversely impact our liquidity and the level of revenues we generate.

We are required to comply with the terms of a cease and desist order recently issued by the FDIC and the IDFPR and lack of compliance could result in monetary penalties and/or additional regulatory actions.

We have entered into a Stipulation and Consent to the Issuance of a Consent Order with the FDIC and IDFPR on January 21, 2011, whereby the Bank consented to the issuance of a Consent Order (the “Order”) by the FDIC and IDFPR, without admitting or denying that grounds exist for the FDIC and IDFPR to initiate an administrative proceeding against the Bank. The Order is a formal corrective action pursuant to which we have agreed to address specific areas through the adoption and implementation of procedures, plans and policies designed to enhance the safety and soundness of the Bank. These affirmative actions include, but are not limited to, increased Board participation and the implementation of plans to address capital, sensitivity to interest rate risk, charge-offs and the disposition of assets. The Order specifies certain timeframes for meeting these requirements, and we must furnish periodic progress reports to the FDIC and IDFPR regarding our compliance with the provisions of the Order. The Order will remain in effect until modified or terminated by the FDIC and IDFPR. If we fail to comply with the Order, the FDIC and/or IDFPR may pursue the assessment of civil money penalties against us and our officers and directors and may seek to enforce the terms of the Order through court proceedings.

We are required to raise our regulatory capital ratios; and if we need to raise capital to increase these capital levels and capital is not available, we may be subject to additional regulatory action.

Under the terms of the Order, we are required to develop and adopt a plan that requires the Bank to achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets within 120 days of the date of the Order. This may require that we raise additional capital. At December 31, 2010, these capital ratios were 5.4% and 8.6%, respectively. Our ability to raise any additional capital is contingent on the current capital markets and on our financial performance. Available capital markets are not currently favorable and we do not anticipate any material improvement in these markets in the near term. Accordingly, we cannot be certain of our ability to raise additional capital on any terms. If we cannot raise additional capital and/or continue to down-size operations, we may experience further deterioration in our financial condition and other regulatory actions may be taken by the FDIC and IDFPR.

The Company’s ability to service our debt and otherwise pay our obligations as they come due is substantially dependent on capital distributions from the Bank, and these distributions are subject to regulatory limits and other restrictions.

A substantial source of the Company’s income from which we service our debt and pay our obligations is the receipt of dividends from the Bank. Pursuant to the Order, the Bank is required to obtain prior regulatory approval of the FDIC and IDFPR before making dividend payments to the Company. In the event that the Bank is unable to obtain regulatory approval to pay dividends to us, we may not be able to service our debt or pay our obligations. The inability to receive dividends from the Bank may adversely affect our business, financial condition, results of operations, and prospects.

We may not be able to maintain and manage our growth, which may adversely affect our results of operations and financial conditions and the value of our common stock.

Our strategy has been to increase the size of our company by opening new offices and by pursuing business development opportunities. We have grown rapidly since we commenced operations. We can provide no assurance that we will continue to be successful in increasing the volume of loans and deposits at acceptable risk levels and upon acceptable terms while managing the costs and implementation risks associated with our growth strategy. There can be no assurance that our further expansion will be profitable or that we will continue to be able to sustain our historical rate of growth, either through internal growth or through successful

 

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expansion of our markets, or that we will be able to maintain capital sufficient to support our continued growth. If we grow too quickly, however, and are not able to control costs and maintain asset quality, rapid growth also could adversely affect our financial performance.

We are subject to credit risks in connection with the concentration of adjustable rate loans in our portfolio.

A majority of our loans held for investment are adjustable rate loans. Borrowers with adjustable rate mortgage loans are exposed to increased monthly payments when the related mortgage interest rate adjusts upward under the terms of the loan from the initial fixed rate or low introductory rate, as applicable, to the rate computed in accordance with the applicable index and margin. Any rise in prevailing market interest rates may result in increased payments for borrowers who have adjustable rate mortgage loans, increasing the possibility of default. Borrowers seeking to avoid these increased monthly payments by refinancing their mortgage loans may no longer be able to find available replacement loans at comparably low interest rates. In addition, a decline in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance. Borrowers who intend to sell their homes on or before the expiration of the fixed rate periods on their mortgage loans may also find that they cannot sell their properties for an amount equal to or greater than the unpaid principal balance of their loans. These events, along or in combination, may contribute to higher delinquency rates and negatively impact earnings.

Fluctuations in interest rates could reduce our profitability and affect the value of our assets.

Short-term market interest rates (which we use as a guide to price our deposits) have until recently risen from historically low levels, while longer-term market interest rates (which we use as a guide to price our longer-term loans) have not. This “flattening” of the market yield curve has had a negative impact on our interest rate spread and net interest margin. For the years ended December 31, 2010 and 2009 our net interest margin was 3.42% and 3.13%, respectively. If short-term interest rates rise, and if rates on our deposits re-price upwards faster than the rates on our long-term loans and investments, we would experience compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability. During 2008, however, the U.S. Federal Reserve decreased its target for the federal funds rate to a range of zero to 0.25%. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such loan or securities proceeds into lower-yielding assets, which might also negatively impact our income. For further discussion of how changes in interest rates could impact us, see “Interest Rate Risk” under Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”

Our emphasis on commercial and construction lending may expose us to increased lending risks.

At December 31, 2010, our loan portfolio included $94.4 million, or 41.2% of commercial real estate loans, $15.4 million, or 6.7% of construction loans and $25.6 million, or 11.2% of commercial loans. We intend to continue to increase our emphasis on the origination of commercial type lending. However, this type of loan generally exposes a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Commercial loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than one- to four-family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for the likely increase in probable incurred credit losses associated with the growth of such loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.

 

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Increased and/or special FDIC assessments will hurt our earnings.

The recent economic recession has caused a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $536,000. In lieu of imposing an additional special assessment, the Federal Deposit Insurance Corporation required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $2.3 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.

Recently enacted regulatory reform may have a material impact on our operations.

On July 21, 2010, the President signed into law the Dodd-Frank Act. The Dodd-Frank Act restructures the regulation of depository institutions. The Dodd-Frank Act contains several provisions that will have a direct impact on the operations of the Company and the Bank. The legislation contains changes to the laws governing, among other things, FDIC assessments, mortgage originations, holding company capital requirements and risk retention requirements for securitized loans. The Dodd-Frank Act also provides for the creation of a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the primary enforcement authority of, the prudential regulator rather than the Consumer Financial Protection Bureau. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008 and 2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. However, the Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.

We need to generate liquidity to fund our lending activities.

We must have adequate cash or borrowing capacity to meet our customers’ needs for loans and demand for their deposits. We generate liquidity primarily through the origination of new deposits. We also have access to secured borrowings, Federal Home Loan Bank borrowings and various other lines of credit. The inability to increase deposits or to access other sources of funds would have a negative effect on our ability to meet customer needs, could slow loan growth and could adversely affect our results of operations.

Our profitability depends significantly on economic conditions in our market.

Our success depends to a large degree on the general economic conditions in our market areas. The local economic conditions in these areas have a significant impact on the amount of loans that we make to our borrowers, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and could negatively affect our financial condition and performance.

If we experience greater loan losses than anticipated, it will have an adverse effect on our net income.

While the risk of nonpayment of loans is inherent in banking, if we experience greater nonpayment levels than we anticipate, our earnings and overall financial condition, as well as the value of our common stock, could be adversely affected.

 

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We cannot assure you that our monitoring procedures and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses. In addition, as a result of the growth in our loan portfolio, loan losses may be greater than management’s estimates. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our shareholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect our profitability. Any loan losses will reduce the loan loss allowance. A reduction in the loan loss allowance will be restored by an increase in our provision for loan losses. This would reduce our earnings which could have an adverse effect on our stock price.

The limitations on executive compensation imposed through our participation in the TARP Capital Purchase Program may restrict our ability to attract, retain and motivate key employees, which could adversely affect our operations.

As part of our participation in the TARP Capital Purchase Program, we agreed to be bound by certain executive compensation restrictions, including limitations on severance payments and the clawback of any bonus and incentive compensation that were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria. To the extent that any of these compensation restrictions do not permit us to provide a comprehensive compensation package to our key employees that is competitive in our market area, we have difficulty in attracting, retaining and motivating our key employees, which could have an adverse effect on our results of operations.

Future dividend payments and common stock repurchases are restricted by the terms of the U.S. Treasury’s equity investment in us.

Under the terms of the TARP Capital Purchase Program, until the earlier of the third anniversary of the date of issuance of the Company’s Series A preferred stock (the “Series A Preferred Stock”) and the date on which the Series A Preferred Stock has been redeemed in whole or the U.S. Treasury has transferred all of the Series A Preferred Stock to third parties, we are prohibited from increasing dividends on our common stock from the last quarterly cash dividend per share declared on the common stock prior to May 15, 2009, as adjusted for subsequent stock dividends and other similar actions, and from making certain repurchases of equity securities, including our common stock, without the consent of the U.S. Treasury. Furthermore, as long as the Series A Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.

The terms governing the issuance of the preferred stock to the U.S. Treasury may be changed, the effect of which may have an adverse effect on our operations.

The terms of the Securities Purchase Agreement in which we entered into with U.S. Treasury pursuant to the TARP Capital Purchase Program provides that the U.S. Treasury may unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes in applicable federal law that may occur in the future. We have no assurances that changes in the terms of the transaction will not occur in the future. Such changes may place restrictions on our business or results of operation, which may adversely affect the market price of our common stock.

If we lose key employees with significant business contacts in our market area, our business may suffer.

Our success is largely dependent on the personal contacts of our officers and employees in our market area. If we lose key employees temporarily or permanently, our business could be hurt. We could be particularly hurt if our key employees went to work for our competitors. Our future success depends on the continued contributions of our existing senior management personnel.

In order to be profitable, we must compete successfully with other financial institutions which have greater resources than we do.

The banking business in the Chicago metropolitan area, in general, is extremely competitive. Several of our competitors are larger and have greater resources than we do and have been in existence a longer period of time. We must overcome historical bank-customer relationships to attract customers away from our competition. We compete with the following types of institutions:

 

• other commercial banks

  • securities brokerage firms    

• savings banks

  • mortgage brokers    

• thrifts

  • insurance companies    

• credit unions

  • mutual funds    

• consumer finance companies

  • trust companies    

 

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Some of our competitors are not regulated as extensively as we are and, therefore, may have greater flexibility in competing for business. Some of these competitors are subject to similar regulation but have the advantage of larger established customer bases, higher lending limits, extensive branch networks, numerous automated teller machines, greater advertising-marketing budgets or other factors.

Our legal lending limit is determined by law. The size of the loans which we offer to our customers may be less than the size of the loans than larger competitors are able to offer. This limit may affect to some degree our success in establishing relationships with the larger businesses in our market.

New or acquired branch facilities and other facilities may not be profitable.

We may not be able to correctly identify profitable locations for new branches and the costs to start up new branch facilities or to acquire existing branches, and the additional costs to operate these facilities, may increase our non-interest expense and decrease earnings in the short term. It may be difficult to adequately and profitably manage our growth through the establishment of these branches. In addition, we can provide no assurance that these branch sites will successfully attract enough deposits to offset the expenses of operating these branch sites. Any new branches will be subject to regulatory approval, and there can be no assurance that we will succeed in securing such approvals.

Government regulations may prevent or impair our ability to pay dividends, engage in additional acquisitions or operate in other ways.

Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to supervision and periodic examination by the Federal Deposit Insurance Corporation as well as the Illinois Department of Financial and Professional Regulation (the “IDFPR”). Our principal subsidiary, Community Bank-Wheaton/ Glen Ellyn, as a state chartered commercial bank, is also subject to regulation and examination by the FDIC and the IDFPR. Banking regulations are designed primarily for the protection of depositors rather than stockholders, and they may limit our growth and the return to you as an investor by restricting its activities, such as:

 

   

the payment of dividends to stockholders;

 

   

possible transactions with or acquisitions by other institutions;

 

   

desired investments;

 

   

loans and interest rates;

 

   

interest rates paid on deposits;

 

   

the possible expansion of branch offices; and

 

   

the ability to provide securities or trust services.

We are registered with the Federal Reserve Board as a bank holding company. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our business. The cost of compliance with regulatory requirements may adversely affect our ability to operate profitably.

Our stock trading volume has been low compared to larger bank holding companies. Accordingly, the value of your common stock may be subject to sudden decreases due to the volatility of the price of our common stock.

 

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Although our common stock trades on the OTC Electronic Bulletin Board, it is not traded as regularly as the common stock of larger bank holding companies listed on other stock exchanges, such as the New York Stock Exchange, the Nasdaq Stock Market or the American Stock Exchange. We cannot predict the extent to which investor interest in us will lead to a more active trading market in our common stock or how liquid that market might become. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control.

The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

 

   

actual or anticipated fluctuations in our operating results;

 

   

changes in interest rates;

 

   

changes in the legal or regulatory environment in which we operate;

 

   

press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;

 

   

changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;

 

   

future sales of our common stock;

 

   

changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and

 

   

other developments affecting our competitors or us.

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance.

We rely on technology to conduct many transactions with our customers and are therefore subject to risks associated with systems failures, interruptions or breaches of security.

Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger, our deposits, and our loans. While we have established policies and procedures to prevent or limit the impact of systems failures, interruptions, and security breaches, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, any compromise of our security systems could deter customers from using our website and our online banking services, both of which involve the transmission of confidential information. Although we rely on commonly used security and processing systems to provide the security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from compromises or breaches of security.

In addition, we outsource certain of our data processing to certain third-party providers. If our third-party providers encounter difficulties, or if we have difficulty in communicating with them, our ability to adequately process and account for customer transactions could be affected, and our business operations could be adversely impacted. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

 

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The occurrence of any systems failure, interruption, or breach of security could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to civil litigation and possible financial liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.

Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition, results of operations, and cash flows.

The legislation that established U.S. Treasury’s Troubled Assets Relief Program (“TARP”), was signed into law on October 3, 2008. As part of TARP, the U.S. Treasury established the TARP Capital Purchase Program (“CPP”) to provide up to $700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Then, on February 17, 2009, further legislation was signed into law as a sweeping economic recovery package intended to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact any of this legislation will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

There have been numerous actions undertaken in connection with or following the recent legislation by the Federal Reserve, Congress, U.S. Treasury, the SEC and the federal bank regulatory agencies in efforts to address the current liquidity and credit crisis in the financial industry that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the temporary increase in FDIC deposit insurance from $100,000 to $250,000, the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The current administration has also proposed comprehensive legislation intended to modernize regulation of the United States financial system. The proposed legislation contains several provisions that would have a direct impact on the Company and the Bank. Among other things, the proposed legislation would create a new federal agency, the Consumer Financial Protection Agency, that would be dedicated to administering and enforcing fair lending and consumer compliance laws with respect to financial products and services, which could result in new regulatory requirements and increased regulatory costs for us. If enacted, the legislation may have a substantial impact on our operations. However, because any final legislation may differ significantly from the current administration’s proposal, the specific effects of the legislation cannot be evaluated at this time.

The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system. The recent legislation and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.

Item 1B. Unresolved Staff Comments

Not applicable.

 

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Item 2. Properties

The following table sets forth information related to the offices from which the Company conducts its business at December 31, 2010. These properties are suitable and adequate for the Company’s business needs.

 

Entity

   Description    Address    City/State    Approximate
Square Feet
   Owned/
Leased
Community Bank-Wheaton/Glen Ellyn    Main office    357 Roosevelt
Road
   Glen Ellyn, IL    10,000    Owned
Community Bank-Wheaton/Glen Ellyn    Wheaton office    100 N. Wheaton
Ave.
   Wheaton, IL    12,500    Owned
Community Bank-Wheaton/Glen Ellyn    County Farm
office
   370 S.

County Farm Rd.

   Wheaton, IL    7,000    Owned
Community Bank-Wheaton/Glen Ellyn    North Wheaton

office

   1901 Gary Ave.    Wheaton, IL    4,700    Owned

Item  3. Legal Proceedings

Neither the Company nor the Bank is a party to, and none of their property is subject to, any material legal proceedings at this time.

Item 4. [Removed and Reserved]

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

As of March 1, 2011, the Company’s stock was held by approximately 521 shareholders of record. The Company’s stock is quoted on the Over-the-Counter Electronic Bulletin Board (“OTCBB”) under the symbol “CFIS”. The following table sets forth quarterly high and low sales information reported on the OTCBB for the Company’s common stock for the years ended December 31, 2010 and 2009. These quotes reflect inter-dealer prices without mark-ups, mark-downs or commissions and may not necessarily reflect actual transactions.

Common Stock Price and Dividend History

 

     High      Low      Dividend
(per share)
 

2010

        

First Quarter

   $ 10.05       $ 7.75       $ 0.00   

Second Quarter

     10.00         8.25         0.00   

Third Quarter

     9.25         7.05         0.00   

Fourth Quarter

     7.40         6.00         0.00   

2009

        

First Quarter

   $ 17.50       $ 11.50       $ 0.00   

Second Quarter

     20.00         11.50         0.00   

Third Quarter

     15.25         12.00         0.00   

Fourth Quarter

     14.50         7.55         0.00   

Historically, it has been a policy of the Company to pay only small to moderate dividends so as to retain earnings to support growth. However, on October 15, 2008 the board of directors voted to suspend the payment of the quarterly cash dividend on the Company’s common stock in an effort to conserve capital. As a result there were no dividends paid on the common stock of the Company in 2010 or 2009.

Item 6. Selected Financial Data

Not Applicable.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(All table dollar amounts in Item 7 are in thousands, except share data)

The following presents management’s discussion and analysis of the results of operations and financial condition of Community Financial Shares, Inc. (the “Company”) as of the dates and for the periods indicated. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto and other financial data appearing elsewhere in this document.

The statements contained in this management’s discussion and analysis that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiary bank include, but are not limited to, changes in: interest rates; general economic conditions; legislation; regulations; monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury and the Federal Reserve Board; the quality or composition of the loan or securities portfolios; demand for loan products; deposit flows; competition; demand for financial services in the Company’s market area; and accounting principles, policies, and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

Because of these and other uncertainties, the Company’s actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Company’s past results of operations do not necessarily indicate its future results. The Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date such forward-looking statement is made.

Overview

The Company is a bank holding company. Through its wholly-owned subsidiary bank, Community Bank–Wheaton/Glen Ellyn, (the “Bank”) the Company provides financial and other banking services to customers located primarily in Wheaton and Glen Ellyn and surrounding communities in DuPage County, Illinois. The Company was formed in July 2000 for the purpose of providing financial flexibility as a holding company for the Bank.

The Company’s principal source of revenue is loans made within the Company’s geographic market area. The Company has experienced consistent loan growth, balancing increased competition from other lending sources with the Company’s desire to remain “well capitalized” under bank regulatory guidelines.

The Bank was established as a state-chartered federally insured commercial bank on March 1, 1994 and opened for business November 21, 1994 on Roosevelt Road in Glen Ellyn. The Bank opened a second location in downtown Wheaton on November 21, 1998. A third location was opened on County Farm Road in Wheaton on March 24, 2005 and a fourth full-service facility was opened in north Wheaton on November 21, 2007.

Regulatory Actions

As previously disclosed in a Current Report on Form 8-K dated January 26, 2011, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the Federal Deposit Insurance Corporation (the “FDIC”) and the Illinois Department of Financial and Professional Regulation (the “IDFPR”) on January 21, 2011, whereby the Bank consented to the issuance of a Consent Order (the “Order”) by the FDIC and IDFPR, without admitting or denying that grounds exist for the FDIC and IDFPR to initiate an administrative proceeding against the Bank.

The Order requires the Bank to take the following actions: ensure that the Bank has competent management in place in all executive officer positions; increase the participation of the Bank’s Board of

 

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Directors in the affairs of the Bank and in the approval of sound policies and objectives for the supervision of the Bank’s activities; establish a compliance program to monitor the Bank’s compliance with the Order; achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets within 120 days; increase its allowance for loan losses to $4,728,000 after application of the funds necessary to effect the charge-off of certain adversely classified loans identified in the related Report of Examination of the FDIC and IDFPR (the “ROE”); implement a program for the maintenance of an adequate allowance for loan and lease losses; adopt a written profit plan and a realistic, comprehensive budget for all categories of income and expense for calendar year 2011; charge off from its books and records any loan classified as “loss” in the ROE; adopt a written plan to reduce the Bank’s risk position in each asset in excess of $500,000 which has been classified as “substandard” or “doubtful” in the ROE; cease extending additional credit to any borrower who is already obligated in any manner to the Bank on any extension of credit that has been charged off the books of the Bank or classified as “loss” in the ROE without the prior non-objection of the FDIC; not pay any dividends to the Company without prior regulatory approval; implement procedures for managing the Bank’s sensitivity to interest rate risk; provide the Company with a copy of the Order; and submit quarterly progress reports to the FDIC and IDFPR regarding the Bank’s compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and IDFPR. Any material failure to comply with the provisions of the Order could result in enforcement actions by the FDIC and IDFPR. While the Company intends to take such actions as may be necessary to enable the Bank to comply with the requirements of the Order, there can be no assurance that the Bank will be able to comply fully with the provisions of the Order, or to do so within the timeframes required, that compliance with the Order will not be more time consuming or more expensive than anticipated, or that compliance with the Order will enable the Company and the Bank to resume profitable operations, or that efforts to comply with the Order will not have adverse effects on the operations and financial condition of the Company and the Bank.

In addition, on January 14, 2011, the Company was notified by the Federal Reserve Bank of Chicago (the “FRB”) that the overall condition of the Company and the Bank is less than satisfactory. As a result, the Company must now obtain prior written approval from the FRB prior to, among other things, (i) the payment of any capital distribution, including stockholder dividends on the shares of Company preferred stock issued to the U.S. Department of Treasury (the “Treasury”) pursuant to the Trouble Asset Relief Program (“TARP”) Capital Purchase Program or (ii) making any payments related to any outstanding trust preferred securities. The Company is also required, within thirty days of January 14, 2011, to downstream all remaining funds to the Bank with the exception of the Company’s non-discretionary payments required to be made over the next twelve months. Additionally, the Company will be required to comply with (i) the provisions of Section 32 of the Federal Deposit Insurance Act and Section 225.71 of the Rules and Regulations of the Board of Governors of the Federal Reserve System with respect to the appointment of any new Company directors or the hiring or change in position of any Company senior executive officer and (ii) the restrictions on making “golden parachute” payments set forth in Section 18(k) of the Federal Deposit Insurance Act.

TARP Capital Purchase Program

On May 15, 2009, the Company entered into a Letter Agreement and related Securities Purchase Agreement with the United States Department of the Treasury (the “Department of Treasury”) in accordance with the terms of the Department of Treasury’s TARP Capital Purchase Program. Pursuant to the Letter Agreement and Securities Purchase Agreement, the Company issued 6,970 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, and a warrant for the purchase of 349 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “warrant”) to the Department of Treasury for an aggregate purchase price of $6,970,000 in cash.

The Series A preferred stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum until February 15, 2014. Beginning February 16, 2014, the dividend rate will increase to 9% per annum. The Series A preferred stock may be redeemed, in whole or in part, at any time from time to time, at the option of the Company, subject to consultation with the Company’s primary federal banking regulator, provided that any partial redemption must be for at least 25% of the issue price of the Series A preferred stock.

As part of the transaction, the Department of Treasury exercised the Warrant and received 349 shares of Series B preferred stock. The Series B preferred stock will pay cumulative dividends at a rate of 9% per

 

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annum. The Series B preferred stock may also be redeemed, in whole or in part, at any time from time to time, at the option of the Company, subject to consultation with the Company’s primary federal regulator, provided that any partial redemption must be for at least 25% of the liquidation value of the Series B preferred stock. The Series B preferred stock cannot be redeemed until all of the outstanding shares of Series A preferred stock have been redeemed.

The Purchase Agreement also subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the “EESA”), as modified by the American Recovery and Reinvestment Act of 2009. The Company will take all necessary action to ensure that its benefit plans with respect to senior executive officers continue to comply with Section 111(b) of the EESA and has agreed to not adopt any benefit plans with respect to, or which cover, its senior executive officers that do not comply with the EESA, and the applicable executives have consented to the foregoing.

On January 14, 2011, the Company was notified by the Federal Reserve Bank of Chicago that the overall condition of the Company and the Bank is less than satisfactory. As a result, the Company notified the Treasury that beginning with the February 15, 2011 dividend payment, the Company will defer all payments of dividends on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A for an indefinite period of time.

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.

 

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Average Balance Sheet. The following table sets forth certain information relating to the Company’s average balance sheets and reflects the yield on average earning assets and cost of average interest-bearing liabilities for the years indicated. Such yields and costs are derived by dividing interest income or expense by the average balance of assets or liabilities. The average balance sheet amounts for loans include balances for nonperforming loans. The yields and costs include fees that are considered adjustments to yields.

 

     2010     2009     2008  
(Dollars in thousands)    Average
Balance
     Interest      Rate     Average
Balance
     Interest      Rate     Average
Balance
     Interest      Rate  

Interest-earning assets:

                        

Federal funds sold

   $ —         $ —           0.00   $ —         $ —           0.00   $ 321       $ 1         0.37

Taxable securities

     29,504         1,034         3.50     25,231         1,144         4.52     17,688         931         5.26

Tax-exempt securities

     12,148         529         4.35     11,834         506         4.28     12,204         520         4.26

Loans

     232,467         12,137         5.22     228,676         12,550         5.49     227,759         13,705         6.02

Interest-bearing deposits

     24,469         100         0.41     18,371         49         0.29     1,102         27         2.46

FHLB stock

     5,398         —           0.00     5,398         —           0.00     5,398         —           0.00
                                                            

Total interest-earning assets

     303,986         13,800         4.54     289,510         14,249         4.92     264,472         15,184         5.74
                                          

Total non-interest-earning assets

     33,753              27,249              28,746         
                                          

Total assets

   $ 337,739            $ 316,759            $ 293,218         
                                          

Interest-bearing liabilities:

                        

Deposits

                        

NOW

   $ 76,068         443         0.58   $ 67,609         704         1.04   $ 46,910         513         1.09

Savings

     43,700         224         0.51     24,880         40         0.16     25,412         72         0.28

Money market

     36,080         233         0.65     41,112         603         1.47     39,917         950         2.38

Time

     111,600         1,965         1.76     111,521         3,168         2.84     108,014         4,304         3.98

FHLB advances and other

     14,648         468         3.19     18,418         583         3.17     18,971         838         4.42

Federal funds purchased and Repurchase agreements

     —           —           0.00     —           —           0.00     1,883         55         2.90

Subordinated debentures

     3,609         72         1.98     3,609         95         2.64     3,609         178         4.93
                                                                              

Total interest-bearing Liabilities

     285,705         3,405         1.19     267,149         5,193         1.94     244,716         6,910         2.82
                                                            

Non-interest-bearing liabilities:

     30,171              28,782              30,268         

Stockholders’ equity

     21,863              20,828              18,234         
                                          

Total liabilities and stockholders’ equity

   $ 337,739            $ 316,759            $ 293,218         
                                          

Net interest income

      $ 10,395            $ 9,056            $ 8,274      
                                          

Net interest spread

           3.35           2.98           2.92

Net interest income to average interest-earning assets

           3.42           3.13           3.13
                                          

 

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Rate/Volume Analysis. The following table allocates changes in interest income and interest expense in 2010 compared to 2009 and in 2009 compared to 2008 between amounts attributable to changes in rate and changes in volume for the various categories of interest-earning assets and interest-bearing liabilities. The changes in interest income and interest expense due to both volume and rate have been allocated proportionally.

 

     2010 Compared to 2009     2009 Compared to 2008  
(Dollars in thousands)    Change
Due to
Rate
    Change
Due to
Volume
    Total
Change
    Change
Due to
Rate
    Change
Due to
Volume
    Total
Change
 

Interest Earning Assets:

            

Federal funds sold

   $ 0      $ 0      $ 0      $ 0      $ (1   $ (1

Taxable securities

     (279     174        (105     (147     360        213   

Tax exempt securities

     10        14        24        2        (16     (14

Loans receivable

     (619     205        (414     (1,210     55        (1,155

FHLB stock and other

     30        16        46        (17     39        22   
                                                

Total interest-earning assets

     (858     409        (449     (1,372     437        (935

Interest-bearing liabilities

            

Deposits

     (2,029     380        (1,649     (1,930     605        (1,325

FHLB advances and other borrowed funds

     6        (121     (115     (214     (96     (310

Subordinated debentures

     (24     0        (24     (82     0        (82
                                                

Total int.-bearing liabilities

     (2,047     259        (1,788     (2,226     509        (1,717
                                                

Change in net interest income

   $ 1,189      $ 150      $ 1,339      $ 854      $ (72   $ 782   
                                                

Comparison of Financial Condition for the Years Ended December 31, 2010 and December 31, 2009

Total assets as of December 31, 2010 were $347.1 million, which represented an increase of $5.6 million, or 1.6%, compared to $341.5 million at December 31, 2009. The increase in total assets was primarily due to increases in cash and cash equivalents, real estate held for investment and interest bearing time deposits. Cash and cash equivalents increased by $6.7 million, or 25.7%, to $32.5 million at December 31, 2010 as compared to $25.8 million at December 31, 2009. This increase is the result of an increase in deposit accounts, a strategic decision to increase the Bank’s liquidity position and low loan demand. Real estate held for investment increased to $4.3 million at December 31, 2010 from zero the previous year. This increase consists of two commercial real estate properties developed as automobile dealerships that were acquired through foreclosure, both of which have been rented at market rates. Interest bearing time deposits increased by $4.2 million, or 679.6%, to $4.8 million at December 31, 2010 from $618,000 at December 31, 2009. Partially offsetting these increases were decreases in loans receivable, net and investment securities. The decrease in loans receivable was attributable to a $5.9 million decrease in construction loans, a $5.1 million decrease in commercial real estate loans and a $540,000 decrease in residential real estate loans. Partially offsetting these decreases was an increase of $2.5 million in home equity lines of credit. Investment securities decreased by $1.4 million, or 3.1%, to $43.2 million at December 31, 2010. This decrease is primarily due to decreases of $5.9 million in government agency securities, and decreases of $2.5 million in securities issued by state and political subdivisions. Partially offsetting these decreases was an increase of $7.1 million in mortgage backed securities. Other real estate owned (“OREO”) increased $612,000 to $3.0 million at December 31, 2010 from $2.4 million at December 31, 2009. The balance of OREO at the end of 2010 consisted of eight properties that were acquired through foreclosure or deed in lieu of foreclosure. Included in the total are six residential properties, a commercial real estate property and a parcel of land.

Deposits increased $10.8 million, or 3.6%, to $309.1 million at December 31, 2010 as compared to $298.3 million at December 31, 2009. This increase primarily consisted of increases in the Bank’s core deposit accounts, including (1) an increase in savings accounts of $24.7 million, or 94.3%, to $50.8 million at December 31, 2010 from $26.1 million at December 31, 2009; (2) an increase in noninterest bearing demand deposit accounts of $4.0 million, or 13.6%, to $34.0 million at December 31, 2010 from $30.0 million at December 31, 2009; (3) an increase in interest bearing demand deposit accounts of $2.8 million, or 3.6%, to $80.3 million at December 31, 2010 from $77.5 million at December 31, 2009. Contributing to the increase in

 

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deposits are the competitively priced products that are offered through our four facilities. Federal Home Loan Bank (“FHLB”) advances and other borrowed money decreased $300,000, or 2.0%, to $14.5 million at December 31, 2010 from $14.8 million at December 31, 2009.

Stockholders’ equity decreased $4.9 million, or 21.7%, to $17.8 million at December 31, 2010 from $22.7 million at December 31, 2009. The decrease in stockholders’ equity was primarily the due to the net loss for the year ended December 31, 2010, a decrease of $11,000 in the Company’s accumulated other comprehensive income relating to the change in fair value of its available-for-sale investment portfolio and $380,000 dividends paid on the preferred stock issued under the TARP Capital Purchase Program.

Comparison of Operating Results for the Years Ended December 31, 2010 and December 31, 2009

General. The Company recorded a net loss of $4.6 million for the year ended December 31, 2010 compared to a net loss of $912,000 for the year ended December 31, 2009. In addition, net loss available to common shareholders totaled $5.0 million and $1.2 million for the years ended December 31, 2010 and 2009, respectively. For the year ended December 31, 2010 basic and diluted loss per share totaled $4.03 compared to basic and diluted loss per share of $0.95 for the year ended December 31, 2009. The increase in net loss for the year ended December 31, 2010 is primarily the net effect of (1) a $6.0 million increase in provision for loan losses; (2) a $428,000 decrease in noninterest income; (3) a $927,000 increase in noninterest expense and (4) a $1.3 million increase in net interest income.

Net interest income. The following table summarizes interest and dividend income and interest expense for the year ended December 31, 2010 and 2009.

 

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

Interest and dividend income:

          

Interest and fees on loans

   $ 12,137       $ 12,550       $ (413     (3.29 %) 

Securities:

          

Taxable

     1,034         1,144         (110     (9.62

Exempt from federal tax

     529         506         23        4.55   

Federal Home Loan Bank dividends and other

     100         49         51        104.08   
                            

Total interest and dividend income

     13,800         14,249         (449     (3.15
                            

Interest expense:

          

Deposits

     2,865         4,515         (1,650     (36.55

Federal Home Loan Bank advances and other borrowings

     468         583         (115     (19.73

Subordinated debentures

     72         95         (23     (24.21
                            

Total interest expense

     3,405         5,193         (1,788     (34.43
                            

Net interest income

   $ 10,395       $ 9,056       $ 1,339        14.79   
                            

Interest Income. Interest income decreased $449,000, or 3.2%, to $13.8 million for the year ended December 31, 2010, compared to $14.2 million for the year ended December 31, 2009. This decrease resulted primarily from a decrease in average yield. The largest component was a decrease of $413,000 in interest income on loans for the year ended December 31, 2010 compared to the comparable prior year.

Loan interest income decreased $413,000 or 3.3%, to $12.1 million for the year ended December 31, 2010, compared to $12.6 million for the prior year. This decrease resulted from a decrease in the average yield of 27 basis points to 5.22% for the year ended December 31, 2010 from 5.49% for the year ended December 31, 2009. This decrease was partially offset by an increase in the average balance of $3.8 million to $232.5 million for the year ended December 31, 2010 from $228.7 million for the comparable prior year period. The decrease in yield is primarily due to a $5.3 million increase in nonaccrual loans from December 31, 2009 to December 31, 2010. In addition, interest on taxable securities decreased $110,000 for the year ended December 31, 2010 compared to the comparable prior year period. This decrease is primarily due to a decrease in the average yield

 

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on taxable securities of 101 basis points to 3.51% for the year ended December 31, 2010 from 4.52% for the comparable prior year period. This decrease was partially offset by an increase in the average balance of $4.3 million to $29.5 million for the year ended December 31, 2010 from $25.2 million for the year ended December 31, 2009.

Interest Expense. Interest expense decreased by $1.8 million, or 34.4%, to $3.4 million for the year ended December 31, 2010, from $5.2 million for the year ended December 31, 2009. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of 75 basis points to 1.19% for the year ended December 31, 2010 from 1.94% for the comparable prior year period. This decrease was partially offset by an increase in the average balance of interest bearing liabilities of $18.6 million, or 6.9%, to $285.7 million for the year ended December 31, 2010 from $267.1 million for the year ended December 31, 2009. Interest expense resulting from FHLB advances and other borrowings decreased $115,000 during the year ended December 31, 2010. The average balance on these borrowings decreased $3.8 million to $14.6 million for the year ended December 31, 2010 from $18.4 million for the comparable prior year period. Partially offsetting this decrease was an increase in average cost of three basis points to 3.20% for the year ended December 31, 2010 from 3.17% for the comparable period in 2009.

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses increased $1.3 million, or 14.8%, to $10.4 million for the year ended December 31, 2010 from $9.1 million for the comparable period in 2009. The Company’s net interest margin expressed as a percentage of average earning assets increased 29 basis points to 3.42% for the year ended December 31, 2010 from 3.13% for the comparable period in 2009. The yield on average earning assets decreased 38 basis points to 4.54% for the year ended December 31, 2010 from 4.92% for the year ended December 31, 2009. This decrease in the yield on average earning assets was primarily due to a decrease in loan yield, which resulted from the $5.3 million increase in nonaccrual loans. The yield on average loans decreased to 5.22% for the year ended December 31, 2010 from 5.49% for the year ended December 31, 2009. In addition, there was a 75 basis point decrease in the cost of interest-bearing liabilities to 1.19% for the year ended December 31, 2010 as compared to 1.94% a year earlier. Increasing net interest margin is dependent on the Bank’s ability to generate higher yielding assets and lower-cost deposits. Management continues to closely monitor the net interest margin.

Provision for Loan Losses. The Bank’s provision for loan losses increased to $8.3 million for the year ended December 31, 2010 from $2.3 million for 2009. The increase in the provision was the result of management’s quarterly analysis of the allowance for loan loss. At December 31, 2010, September 30, 2010 and December 31, 2009, non-performing loans totaled $20.3 million, $20.8 million and $15.0 million, respectively. At December 31, 2010, the ratio of the allowance for loan losses to non-performing loans was 37.8% compared to 21.1% at September 30, 2010 and 32.0% at December 31, 2009. Management believes the allowance coverage is sufficient due to the estimated loss potential. The ratio of the allowance to total loans was 3.35%, 1.93% and 2.03%, at December 31, 2010, September 30, 2010 and December 31, 2009, respectively. Charge-offs, net of recoveries, totaled $5.5 million for the year ended December 31, 2010 compared to $832,000 for the year ended December 31, 2009. As of December 31, 2010, $11.9 million, or 58.6%, of nonperforming loans consist of interests in loan participations with other banks. Management performs an allowance sufficiency analysis, at least quarterly, based on the portfolio composition, asset classifications, loan-to-value ratios, impairments in the current portfolio, and other factors. This analysis is designed to reflect credit losses for specifically identified loans, as well as credit losses in the remainder of the portfolio. The reserve methodology employed by management reflects the difference in degree of risk between the various categories of loans in the Bank’s portfolio. The reserve methodology also critically assesses those loans adversely classified in the portfolio by management. While management estimates loan losses using the best available information, no assurance can be given that future additions to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding problem loans, identification of additional problem loans and other factors, both within and outside of management’s control. The Bank conducts quarterly evaluations on nonperforming assets and obtains independent appraisals when there is a material development such as a transfer to other real estate owned. In addition, the FDIC and IDFPR as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. As a result of their review the FDIC and IDFPR may require the Bank to make additional provisions for estimated losses based upon judgments different from those of management.

 

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

Non-interest income:

        

Service charges on deposit accounts

   $ 500      $ 597      $ (97     (16.25 %) 

Gain on sale of loans

     825        1,005        (180     (17.91

Gain on sale of securities

     139        50        89        178.00   

Writedown on OREO properties

     (468     —          (468     —     

Loss on sale of foreclosed assets

     (3     (62     59        95.16   

Bank owned life insurance

     239        231        8        3.46   

Other non-interest income

     582        421        161        38.24   
                          

Total non-interest income

   $ 1,814      $ 2,242      $ (428     (19.09
                          

Noninterest Income. Noninterest income consists primarily of service charges on customer deposit accounts, gain on sale of loans, and other service charges and fees. Noninterest income decreased $428,000, or 19.1%, to $1.8 million for the year ended December 31, 2010 as compared to the prior year period primarily due to $468,000 in write-downs on other real estate owned property and a decrease in gain on sale of mortgage loans. These items were partially offset by increases of $89,000 in gain on sale of securities and an increase of $161,000 in other interest income, which largely consists of rents received on real estate held for investment and other foreclosed assets. Gain on sale of loans decreased $180,000 to $825,000 for the year ended December 31, 2010 from $1.1 million for the year ended December 31, 2009. Gain on sale of securities increased $89,000 to $139,000 for the year ended December 31, 2010 from $50,000 for the year ended December 31, 2009. In addition, service charges on deposit accounts decreased $97,000 to $500,000 for the year ended December 31, 2010 from $597,000 for the comparable prior year period. This decrease was primarily due to a lower volume of overdraft fees.

 

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

Non-interest expenses:

          

Salaries and employee benefits

   $ 5,575       $ 5,491       $ 84        1.53

Net occupancy

     869         840         29        3.45   

Equipment expense

     507         546         (39     (7.14

Data processing expense

     1,102         937         165        17.61   

Advertising and promotions

     296         295         1        0.34   

Professional fees

     928         681         247        36.27   

FDIC premiums

     746         861         (115     (13.36

Other real estate owned expenses

     546         29         517        1,782.76   

Other operating expenses

     1,239         1,201         38        3.16   
                            

Total non-interest expenses

   $ 11,808       $ 10,881       $ 927        8.52   
                            

Noninterest Expense. Noninterest expense increased by $927,000, to $11.8 million for the year ended December 31, 2010 from $10.9 million for the comparable prior year period. This increase is primarily due to an increase in other real estate owned expenses of $517,000 for the year ended December 31, 2010 as compared to the prior year period. Professional fees, including legal and audit expenses, increased by $247,000 to $928,000 for the year ended December 31, 2010 from $681,000 for the comparable prior year period. This increase is partially due to higher legal fees associated with foreclosure actions. Other operating expenses, including occupancy, equipment, data processing, and marketing and advertising expenses, increased by a combined $156,000, or 5.96%, to $2.8 million for the year ended December 31, 2010. Of this increase, $165,000 is related to data processing expense and $1,000 is related to marketing and advertising expenses. These increases were partially offset by lower equipment expense, which decreased by $39,000 from the prior period. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to a growing market base.

 

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Income Tax Expense. Income tax benefit totaled $3.4 million for the year ended December 31, 2010 compared to $1.0 million for the comparable prior year period. The increase in income tax benefit is primarily the result of an increase in loss before income tax of $6.0 million to $7.9 million for the year ended December 31, 2010 compared to $1.9 million for the comparable prior year period.

With the above tax benefit, the Company’s net deferred tax asset increased to $5.2 million as of December 31, 2010 as compared to $1.9 million as of December 31, 2009. Realization of deferred tax assets is dependent on generating sufficient taxable income to cover net operating losses generated by the reversal of temporary differences. A partial or total valuation allowance is provided by way of a charge to income tax expense if it is determined that it is more likely than not that some of or all of the deferred tax asset will not be realized.

Management considers both positive and negative evidence when considering the ability of the Company to utilize its net deferred tax asset. The Company’s expenses related to the provision for loan losses, other real estate owned and collection efforts have been well above historic levels while the Company’s core earning have remained at or above historic levels. Management believes that once the Company resolves some of the credit issues related to the economic conditions, profitability will improve and based upon projections and available tax strategies, management believes that the deferred tax asset will be utilized. However, if operating losses continue into the future, there can be no guarantee that a valuation allowance against the deferred tax asset will not be necessary in future periods.

Asset/Liability Management

The primary objectives of the Company’s asset/liability management policies are to:

a) Manage and minimize interest rate risk;

b) Manage the investment portfolio to maximize yield;

c) Assess and monitor general risks of operations; and

d) Maintain adequate liquidity to meet the withdrawal requirements of depositors and the financing needs of borrowers.

Liquidity

The Company’s primary source of funds is dividends it receives from the Bank. Without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding net profits for the current year plus those of the previous two years. The Bank normally restricts dividends to a lesser amount because of the need to maintain an adequate capital structure. Total stockholder’s equity of the Bank totaled $21.2 million at December 31, 2010. The Bank’s primary sources of funds are deposits, proceeds from principal and interest payments on loans, maturities of securities, federal funds purchased, and to a lesser extent advances from the Federal Home Loan Bank. While maturities and scheduled amortization of loans and securities are generally predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition.

The Company’s liquidity, represented by cash and cash equivalents, is generally a product of its operating, investing, and financing activities. Liquidity is monitored frequently by management and quarterly by the asset/liability management/investment committee and Board of Directors. This monitoring includes a review of net non-core funding dependency, loans to deposits, and short-term investments to total assets ratios, including trends in these ratios. Cash flows from general banking activities are reviewed for their ability to handle unusual liquidity needs. Management also reviews a liquidity/dependency report covering measurements of liquidity ratio, net potential liabilities, and dependency ratios.

Management expects ongoing operating activities to continue to be a primary source of cash flows for the Company. In addition, the Bank maintains secured borrowing facilities at the Federal Home Loan Bank of Chicago, Marshall & Isley Bank (M&I), and US Bank. Management is confident that the Bank has adequate liquidity for normal banking activities.

 

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A primary investing activity of the Company is the origination of loans. Loans made to customers, net of principal collections, were ($8.5) million in 2010, $16.0 million in 2009 and ($4.3) million in 2008. The Company’s strongest loan growth was in home equity lines of credit with the loans in this category increasing by $2.5 million in 2010. In 2010, construction loans decreased by $5.9 million and commercial real estate loans decreased by $5.1 million.

Deposits grew by $10.8 million, $44.8 million and $4.5 million in 2010, 2009 and 2008, respectively. Despite intense competition for deposits from the many financial institutions in the Company’s market area, the Company has been successful in attracting sufficient deposits to provide for the majority of its funding needs. However, funding through retail deposits continues to grow more challenging as well as more expensive than in past years.

During 2010, the Company reduced the amount owed on a loan with M & I Bank to $1.5 million at December 31, 2010 from $1.8 million at December 31, 2009.

Critical Accounting Policies

Generally accepted accounting principles require management to apply significant judgment to certain accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply those principles where actual measurement is not possible or practical. For a complete discussion of the Company’s significant accounting policies, see the notes to the consolidated financial statements and discussion throughout this Annual Report. Below is a discussion of the Company’s critical accounting policies. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the Company’s financial statements. Management has reviewed the application of these policies with the Company’s Audit Committee.

Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of probable losses inherent in the Company’s loan portfolio. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.

The Company’s strategy for credit risk management includes conservative credit policies and underwriting criteria for all loans, as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit quality reviews and management reviews of large credit exposures and loans experiencing deterioration of credit quality.

Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are impaired as provided in ASC 310-40, Accounting by Creditors for Impairment of a Loan. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.

Homogenous loans, such as consumer installment and residential mortgage loans are not individually risk graded. Rather, credit scoring systems are used to assess credit risks. Reserves are established for each pool of loans using loss rates based on a five year average net charge-off history by loan category.

Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans,) changes in mix, asset quality

 

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trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Company’s internal loan review. An unallocated reserve, primarily based on the factors noted above, is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.

The Company’s primary market area for lending is the county of DuPage in northeastern Illinois. When evaluating the adequacy of allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Company’s customers.

The Company has not substantively changed any aspect of its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance.

Any material increase in the allowance for loan losses may adversely affect our financial condition, results of operations and our ability to comply with the Order.

Valuation of Securities. The Company’s available-for-sale security portfolio is reported at fair value. The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Available-for-sale securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Company’s ability to hold the security to maturity. A decline in value that is considered to be other-than-temporary is recorded as a loss within other operating income in the consolidated statement of income.

Accounting Matters

In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets, which pertains to securitizations. ASU 2009-16 requires more information about transfers of financial assets, including securitization transactions, and where entities have continued exposure to the risks related to transferred assets. The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations.

In June 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity. The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations since the Company does not have any special purpose entities.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It also requires the presentation of purchases, sales, issuances, and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. The Company’s disclosures about fair value measurements are presented in Note 17: Fair Value Measurements. These new disclosure requirements were effective for the period ended March 31, 2010, except for the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010. There was no significant effect to the Company’s financial statement disclosure upon adoption of this ASU.

 

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In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements. Removal of the disclosure requirement did not have an affect on the nature or timing of subsequent events evaluations performed by the Company. ASU 2010-09 became effective upon issuance.

In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans. A company will need to disaggregate new and existing disclosures based on how it develops its allowance for loan losses and how it manages credit exposures. The existing disclosures to be presented on a disaggregated basis include a rollforward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans. Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of past due loans, information about troubled debt restructurings, and significant purchases and sales of loans during the reporting period by class. For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010. Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Company adopted this standard effective December 31, 2010. Since the adoption of this standard was disclosure related, it did not have a material effect on its financial position or results of operations.

In January 2011, the FASB issued ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. ASU 2011-01 temporarily delays the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. That guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

The Company monitors and manages risks associated with changes in interest rates and mismatched asset and deposit maturities. Significant changes in rates can adversely affect net interest income, market value of securities, and the economic value of equity. Based on the Company’s current simulation model, the following schedule indicates the estimated effects of an immediate upward rate shift of 100, 200 and 300 basis points as of December 31, 2010. As of December 31, 2009, these effects totaled -2.0%, -3.7% and 0.8% for net interest income and -6.4%, -13.7% and -20.4% for economic value of equity.

 

     100 Basis Point
Rate Shift Up
    200 Basis Point
Rate Shift Up
    300 Basis Point
Rate Shift Up
 

Net interest income

     -0.4     +0.3     +5.9

Economic value of equity

     -2.5     -5.5     -7.8

Based on the Company’s current simulation model, the following schedule indicates the estimated effects of an immediate downward rate shift of 100, 200, 300 basis points as of December 31, 2010. As of December 31, 2009, these effects totaled -42.3% for net interest income and 17.0% for economic value of equity. Due to the current interest rate environment being at historic lows, a 200 and 300 a basis point decrease is considered unlikely and therefore not presented. All other measures of interest rate risk are within policy guidelines.

 

     100 Basis Point
Rate Shift Down
    200 Basis Point
Rate Shift Down
     300 Basis Point
Rate Shift Down
 

Net interest income

     -1.9     N/A         N/A   

Economic value of equity

     +20.5     N/A         N/A   

 

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Item 8. Financial Statements

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders

Community Financial Shares, Inc.

Glen Ellyn, Illinois

We have audited the accompanying consolidated balance sheets of Community Financial Shares, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing auditing procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits also included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Financial Shares, Inc. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Indianapolis, Indiana

March 31, 2011

 

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COMMUNITY FINANCIAL SHARES, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2010 and 2009

(Dollars in thousands)

 

 

 

   2010     2009  

ASSETS

    

Cash and due from banks

   $ 4,553      $ 7,186   

Interest-bearing deposits

     27,934        18,662   
                

Cash and cash equivalents

     32,487        25,848   

Interest-bearing time deposits

     4,827        618   

Securities available for sale

     43,175        44,544   

Loans held for sale

     1,770        1,698   

Loans, less allowance for loan losses of $7,679 and $4,812

     221,607        232,972   

Foreclosed assets

     3,008        2,396   

Real estate held for investment

     4,318        —     

Prepaid FDIC assessment

     1,506        2,160   

Federal Home Loan Bank stock

     5,398        5,398   

Premises and equipment, net

     15,535        15,864   

Cash value of life insurance

     5,938        5,700   

Interest receivable and other assets

     7,527        4,332   
                

Total assets

   $ 347,096      $ 341,530   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Deposits

   $ 309,080      $ 298,311   

Federal Home Loan Bank advances

     13,000        13,000   

Other borrowings

     1,500        1,800   

Subordinated debentures

     3,609        3,609   

Interest payable and other liabilities

     2,152        2,103   
                

Total liabilities

     329,341        318,823   
                

Commitments and contingencies

    

Stockholders’ equity

    

Common stock - no par value, 5,000,000 shares authorized; 1,245,267 shares issued and outstanding

     —          —     

Preferred stock - $1.00 par value, 1,000,000 shares authorized; 7,319 shares issued and outstanding

     7        7   

Paid-in capital

     11,954        11,877   

Retained earnings

     6,046        11,064   

Accumulated other comprehensive loss

     (252     (241
                

Total stockholders’ equity

     17,755        22,707   
                

Total liabilities and stockholders’ equity

   $ 347,096      $ 341,530   
                

 

 

See accompanying notes to consolidated financial statements.

 

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COMMUNITY FINANCIAL SHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years ended December 31, 2010 and 2009

(Dollars in thousands, except per share data)

 

 

 

     2010     2009  

Interest and dividend income

    

Interest and fees on loans

   $ 12,137      $ 12,550   

Securities

    

Taxable

     1,034        1,144   

Exempt from federal income tax

     529        506   

Federal Home Loan Bank dividends and other

     100        49   
                

Total interest income

     13,800        14,249   
                

Interest expense

    

Deposits

     2,865        4,515   

Federal Home Loan Bank advances and other borrowed funds

     468        583   

Subordinated debentures

     72        95   
                

Total interest expense

     3,405        5,193   
                

Net interest income

     10,395        9,056   

Provision for loan losses

     8,340        2,344   
                

Net interest income after provision for loan losses

     2,055        6,712   
                

Noninterest income

    

Service charges on deposit accounts

     500        597   

Gain on sale of loans

     825        1,005   

Write-down on foreclosed assets

     (468     —     

Loss on sale of foreclosed assets

     (3     (62

Gain on sale of securities

     139        50   

Increase in cash surrender value of bank-owned life insurance

     239        231   

Other service charges and fees

     582        421   
                

Total noninterest income

     1,814        2,242   
                

Noninterest expense

    

Salaries and employee benefits

     5,575        5,491   

Net occupancy expense

     869        840   

Equipment expense

     507        546   

Data processing

     1,102        937   

Advertising and marketing

     296        295   

Professional fees

     928        681   

FDIC premiums

     746        861   

Other real estate owned expenses

     546        29   

Other operating expenses

     1,239        1,201   
                

Total noninterest expense

     11,808        10,881   
                

Loss before income taxes

     (7,939     (1,927

Income tax benefit

     (3,365     (1,015
                

Net loss

     (4,574     (912
                

Preferred stock dividend and accretion

     (444     (274
                

Net loss available to common shareholders

   $ (5,018   $ (1,186
                

Loss per share

    

Basic

   $ (4.03   $ (0.95

Diluted

   $ (4.03   $ (0.95

 

 

See accompanying notes to consolidated financial statements.

 

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COMMUNITY FINANCIAL SHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years ended December 31, 2010 and 2009

(Dollars in thousands, except share data)

 

 

 

     Number
of
Common
Shares
     Preferred
Stock
     Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Total
Stockholders’
Equity
 

Balance at January 1, 2009

     1,245,267         —         $ 4,866       $ 12,201      $ (454   $ 16,613   

Comprehensive loss

               

Net loss

     —           —           —           (912     —          (912

Change in unrealized loss on securities available for sale, net of reclassification adjustment and tax of $134

     —           —           —           —          213        213   
                     

Total comprehensive loss

                  (699

Preferred stock dividends (5%)

     —           —           —           (190     —          (190

Preferred stock issued

     —           7         6,963         —          —          6,970   

Discount accretion on preferred stock

     —           —           35         (35     —          —     

Amortization of stock option compensation

     —           —           13         —          —          13   
                                                   

Balance at December 31, 2009

     1,245,267         7         11,877         11,064        (241     22,707   

Comprehensive loss

               

Net loss

     —           —           —           (4,574     —          (4,574

Change in unrealized loss on securities available for sale, net of reclassification adjustment and tax of $7

     —           —           —           —          (11     (11
                     

Total comprehensive loss

                  (4,585

Preferred stock dividends (5%)

     —           —           —           (380     —          (380

Discount accretion on preferred stock

     —           —           64         (64     —          —     

Amortization of stock option compensation

     —           —           13         —          —          13   
                                                   

Balance at December 31, 2010

     1,245,267       $ 7       $ 11,954       $ 6,046      $ (252   $ 17,755   
                                                   

 

 

See accompanying notes to consolidated financial statements.

 

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COMMUNITY FINANCIAL SHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2010 and 2009

(Dollars in thousands)

 

 

 

     2010     2009  

Cash flows from operating activities

    

Net loss

   $ (4,574   $ (912

Adjustments to reconcile net loss to net cash provided by (used in) operating activities

    

Amortization on securities, net

     147        106   

Depreciation

     659        661   

Provision for loan losses

     8,340        2,344   

Gain on sale of securities

     (139     (50

Write-down on foreclosed assets

     468        —     

Gain on sale of loans

     (825     (1,005

Originations of loans for sale

     (44,838     (55,961

Proceeds from sales of loans

     45,663        56,966   

Loss on sale of foreclosed assets

     3        62   

Deferred income taxes

     (3,558     (887

Compensation cost of stock options

     13        13   

Change in cash value of life insurance

     (239     (231

Change in interest receivable and other assets

     1,023        (1,967

Change in interest payable and other liabilities

     49        163   
                

Net cash provided by (used in) operating activities

     2,192        (698
                

Cash flows from investing activities

    

Purchases of securities available for sale

     (30,205     (34,778

Proceeds from maturities and calls of securities available for sale

     26,124        13,443   

Proceeds from sales of securities available for sale

     5,424        3,054   

Proceeds from sales of foreclosed assets

     2,778        —     

Net change in interest-bearing time deposits

     (4,209     374   

Net change in loans

     (5,225     (18,335

Premises and equipment expenditures, net

     (329     (413
                

Net cash used in investing activities

     (5,642     (36,655
                

Cash flows from financing activities

    

Change in

    

Non-interest bearing and interest bearing demand deposits and savings

     23,161        31,629   

Certificates and other time deposits

     (12,392     13,167   

Short-term borrowings

     —          (200

Proceeds from borrowings

     13,000        12,500   

Repayment of borrowings

     (13,300     (16,500

Proceeds from issuance of preferred stock

     —          6,970   

Dividends paid on preferred stock

     (380     (190
                

Net cash provided by financing activities

     10,089        47,376   
                

Net change in cash and cash equivalents

     6,639        10,023   

Cash and cash equivalents at beginning of year

     25,848        15,825   
                

Cash and cash equivalents at end of year

   $ 32,487      $ 25,848   
                

Supplemental disclosures

    

Interest paid

   $ 3,596      $ 5,317   

Transfers from loans to foreclosed assets

     3,861        2,346   

Transfers from loans to real estate held for investment

     4,318        —     

 

 

See accompanying notes to consolidated financial statements.

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Principles of Consolidation: The consolidated financial statements include Community Financial Shares, Inc. (the Holding Company) and its wholly owned subsidiary, Community Bank - Wheaton/Glen Ellyn (the Bank) together referred to herein as the Company.

The Bank was chartered by the Illinois Commissioner of Banks and Real Estate in 1994. The Bank provides a range of banking and financial services through its operation as a commercial bank with offices located in Wheaton and Glen Ellyn, Illinois. The Bank’s primary activities include deposit services and commercial and retail lending. Interest income is also earned on investments in debt securities, federal funds sold, and short-term investments.

Significant intercompany transactions and balances have been eliminated in consolidation.

Internal financial information is reported and aggregated as one line of business.

Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided and future results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change.

Securities: Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Effective April 1, 2009, the Company adopted new accounting guidance related to recognition and presentation of other-than-temporary impairment (ASC 320-10). When the Company does not intend to sell a debt security, and it is more likely than not, the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

Prior to the adoption of the recent accounting guidance on April 1, 2009, management considered, in determining whether other-than-temporary impairment exists, (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.

 

 

47

 


Table of Contents

COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Gains and losses on loan sales are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan.

Loans and Loan Income: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off are reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Discounts and premiums on purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. 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 allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

Federal Home Loan Bank Stock: Federal Home Loan Bank (FHLB) stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula.

The Bank owned $5,398,000 of FHLB stock as of December 31, 2010 and 2009. During the third quarter of 2007, the FHLB of Chicago received a Cease and Desist Order from their regulator, the Federal Housing Finance Board. The FHLB will continue to provide liquidity and funding through advances; however, the draft order prohibits capital stock repurchases and redemptions until a time to be determined by the Federal Housing Finance Board. The FHLB of Chicago did not pay a dividend during 2010 or 2009. The FHLB will continue to assess their dividend capacity each quarter, and will obtain the necessary approval if a dividend is to be made. Management performed an analysis and deemed the investment in FHLB stock was not impaired.

Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs incurred after acquisition that do not meet the criteria for capitalization are expensed.

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 10 to 50 years. Furniture, fixtures, and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 10 years.

Long-Term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate that their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Stock Compensation: At December 31, 2010, the Company has a stock-based employee compensation plan, which is described more fully in Note 14.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Income Taxes: The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment.

The Company recognizes interest and penalties on income taxes as a component of income tax expense.

The Company files consolidated income tax returns with its subsidiaries.

With a few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2007.

Off-Balance-Sheet Financial Instruments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Statements of Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and interest-bearing deposits. Most federal funds are sold for one-day periods. Net cash flows are reported for customer loan and deposit transactions.

Earnings Per Share: Basic earnings per share is net income available to common shareholders divided by the weighted average number of shares outstanding during the year. Diluted earnings per share include the dilutive effect of additional potential shares issuable under stock options.

Comprehensive Income or Loss: Comprehensive income or loss consists of net income or loss and other comprehensive income or loss. Other comprehensive income or loss includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of equity.

Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Holding Company or by the Holding Company to the stockholders.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of active markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Recently Issued Accounting Standards: In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets, which pertains to securitizations. ASU 2009-16 requires more information about transfers of financial assets, including securitization transactions, and where entities have continued exposure to the risks related to transferred assets. The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations.

In June 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity. The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations since the Company does not have any special purpose entities.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It also requires the presentation of purchases, sales, issuances, and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. The Company’s disclosures about fair value measurements are presented in Note 15: Fair Value Measurements. These new disclosure requirements were effective for the period ended March 31, 2010, except for the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010. There was no significant effect to the Company’s financial statement disclosure upon adoption of this ASU.

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements. Removal of the disclosure requirement did not have an affect on the nature or timing of subsequent events evaluations performed by the Company. ASU 2010-09 became effective upon issuance.

In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans. A company will need to disaggregate new and existing disclosures based on how it develops its allowance for loan losses and how it manages credit exposures. The existing disclosures to be presented on a disaggregated basis include a rollforward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans. Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of past due loans, information about troubled debt

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

restructurings, and significant purchases and sales of loans during the reporting period by class. For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010. Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Company adopted this standard effective December 31, 2010. Since the adoption of this standard was disclosure related, it did not have a material effect on its financial position or results of operations.

In January 2011, the FASB issued ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. ASU 2011-01 temporarily delays the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. That guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.

Current Economic Conditions: The current protracted economic decline continues to present financial institutions with circumstances and challenges that in many cases have resulted in large and unanticipated declines in the fair values of investments and other assets, constraints on liquidity and capital and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans. The financial statements have been prepared using values and information currently available to the Company.

At December 31, 2010, the Company held $94.4 million in commercial real estate loans. Due to the national, state and local economic conditions, values for commercial real estate have declined significantly and the market for these properties is depressed.

Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 2 – CASH AND CASH EQUIVALENTS

The Company considers all liquid investments with original maturities of three months or less to be cash equivalents.

The financial institutions holding the Company’s cash accounts are participating in the FDIC’s Transaction Account Guarantee Program. Under that program, through December 31, 2010, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Pursuant to legislation enacted in 2010, the FDIC will fully insure all noninterest-bearing transaction accounts beginning December 31, 2010 through December 31, 2012, at all FDIC-insured institutions.

Effective July 21, 2010, the FDIC’s insurance limits were permanently increased to $250,000. At December 31, 2010, the Company had cash balances of $27,686,000 at the FRB and FHLB that did not have FDIC insurance coverage.

Cash on hand or on deposit with the Federal Reserve Bank of $4,791,000 was required to meet regulatory reserve and clearing requirements at year-end 2010.

NOTE 3 – SECURITIES AVAILABLE FOR SALE

The fair value of securities available for sale at year end is as follows:

 

2010

  
Fair
Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 

U. S. government agencies

   $ 11,801       $ 13       $ (216

States and political subdivisions

     12,868         173         (470

Mortgage-backed – Government sponsored enterprises (GSE) residential

     18,198         248         (154

Preferred stock

     11         —           (3

SBA guaranteed

     297         —           (3
                          
   $ 43,175       $ 434       $ (846
                          

2009

   Fair
Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 

U. S. government agencies

   $ 17,691       $ 21       $ (326

States and political subdivisions

     15,339         213         (425

Mortgage-backed – GSE residential

     11,131         136         (17

Preferred stock

     20         5         —     

SBA guaranteed

     363         1         (2
                          
   $ 44,544       $ 376       $ (770
                          

Securities classified as U. S. government agencies include notes issued by government-sponsored enterprises such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Federal Home Loan Bank. The SBA-guaranteed securities are pools of the loans guaranteed by the Small Business Administration.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

 

The fair values of securities available for sale at December 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately.

 

     Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ 68       $ 69   

Due after one year through five years

     603         635   

Due after five years through ten years

     6,819         6,769   

Due after ten years

     17,678         17,196   

Mortgage-backed – GSE residential

     18,105         18,198   

Preferred stock

     14         11   

SBA guaranteed

     300         297   
                 
   $ 43,587       $ 43,175   
                 

Securities with a carrying value of approximately $22,665,000 and $14,180,000 at December 31, 2010 and 2009, respectively, were pledged to secure public deposits, Federal Home Loan Bank advances and for other purposes as required or permitted by law.

Sales of securities were as follows:

 

     2010      2009  

Proceeds

   $ 5,424       $ 3,054   

Gross gains

     139         50   

Gross losses

     —           —     

Tax expense

     54         10   

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2010 and 2009 was $27,029,000 and $25,257,000, respectively, which is approximately 62.6% and 56.7% of the Company’s investment portfolio, respectively. These declines primarily resulted from changes in market interest rates and current depressed market conditions. Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

 

The following tables show gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2010 and 2009:

 

2010    Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

U.S. government agencies

   $ 7,788       $ (216   $ —           —        $ 7,788       $ (216

State and political subdivisions

     8,411         (365     1,568         (105     9,979         (470

Mortgage-backed – GSE residential

     9,002         (154     —           —          9,002         (154

Preferred stock

     11         (3     —           —          11         (3

SBA guaranteed

     136         (1     113         (2     249         (3
                                                   

Total temporarily impaired securities

   $ 25,348       $ (739   $ 1,681       $ (107   $ 27,029       $ (846
                                                   
2009    Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

U.S. government agencies

   $ 12,665       $ (326   $ —           —        $ 12,665       $ (326

State and political subdivisions

     4,456         (85     4,558         (340     9,014         (425

Mortgage-backed – GSE residential

     3,315         (16     99         (1     3,414         (17

SBA guaranteed

     —           —          164         (2     164         (2
                                                   

Total temporarily impaired securities

   $ 20,436       $ (427   $ 4,821       $ (343   $ 25,257       $ (770
                                                   

U.S. Government Agencies, State and Political Subdivisions, and Mortgage-backed securities

The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies, state and political subdivisions and mortgage-backed securities were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2010.

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 4 – LOANS

The Company has a geographic concentration of loan and deposit customers within the Chicago metropolitan area. Most of the loans are secured by specific items of collateral including commercial and residential real estate and other business and consumer assets. Commercial loans are expected to be repaid from cash flow from operations of businesses.

Loans consisted of the following at December 31:

 

     2010     2009  

Real estate

    

Commercial

   $ 94,356      $ 99,416   

Construction

     15,435        21,341   

Residential

     25,964        25,424   

Home equity

     66,243        63,758   
                

Total real estate loans

     201,998        209,939   

Commercial

     25,572        25,907   

Consumer

     1,399        1,662   
                

Total loans

     228,969        237,508   

Deferred loan costs, net

     317        276   

Allowance for loan losses

     (7,679     (4,812
                

Loans, net

   $ 221,607      $ 232,972   
                

The Bank has entered into transactions, including the making of direct and indirect loans, with certain directors and their affiliates (related parties). Such transactions were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management’s opinion, these loans did not involve more than normal risk of collectibility or present other unfavorable features.

The aggregate amount of loans, as defined, to such related parties were as follows:

 

Balances, January 1, 2010

   $ 3,184   

New loans including renewals

     812   

Payments, etc., including renewals

     (643
        

Balances, December 31, 2010

   $ 3,353   
        

Activity in the allowance for loan losses is summarized below:

 

     2010     2009  

Balance at beginning of year

   $ 4,812      $ 3,300   

Provision for loan losses

     8,340        2,344   

Charge-offs

     (5,512     (837

Recoveries

     39        5   
                

Balance at end of year

   $ 7,679      $ 4,812   
                

 

 

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010 and 2009

(Table dollar amounts in thousands, except share data)

 

 

 

NOTE 4 – LOANS (Continued)

 

The following table shows the Company’s allowance for credit losses by loan segment for December 31, 2010:

 

     2010  
     Commercial      Commercial
Real Estate
     Construction      Consumer      Residential      HELOC      Unallocated      Total  

Allowance Balances:

                       

Individually evaluated for impairment

   $ 109       $ 315       $ 3,647       $ —         $ 387       $ 469       $ —         $ 4,927   

Collectively evaluated for impairment

     682         885         230         19         274         369         293         2,752   
                                                                       

Total allowance for loan losses

   $ 791       $ 1,200       $ 3,877       $ 19       $ 661       $ 838       $ 293       $ 7,679   
                                                                       

Loans Balances:

                       

Individually evaluated for impairment

   $ 351       $ 5,707       $ 11,189       $ —         $ 6,928       $ 2,174       $ —         $ 26,349   

Collectively evaluated for impairment

     25,221         88,649         4,246         1,399         19,036         64,069         —           202,620   
                                                                       

Total loans

   $ 25,572       $ 94,356       $ 15,435       $ 1,399       $ 25,964       $ 66,243 &n