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EX-31.1 - EXHIBIT 31.1 - COMMUNITY FINANCIAL SHARES INCv392994_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY FINANCIAL SHARES INCv392994_ex31-2.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended September 30, 2014
   
  OR
   
o 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)

 

Maryland   36-4387843
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   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)

 

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

 

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

 

 

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

 

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

 

 

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

 

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

 

Class   Outstanding at November 8, 2014
Common Stock, $0.01 par value per share   10,781,988 shares

  

1
 

 

Form 10-Q Quarterly Report

 

Table of Contents

 

PART I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements 3
Item 2. Management’s Discussion and Analysis of  
  Financial Condition and Results of Operations 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
Item 4 Controls and Procedures 40
     
     
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 41
Item 1A. Risk Factors 41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
Item 3. Defaults Upon Senior Securities 41
Item 4. Mine Safety Disclosures 41
Item 5. Other Information 41
Item 6. Exhibits 41
  Signatures 42

 

2
 

 

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

   September 30,   December 31, 
   2014   2013 
   (Unaudited)     
ASSETS          
Cash and due from banks  $7,570   $4,485 
Interest-bearing deposits   3,512    25,068 
Cash and cash equivalents   11,082    29,553 
           
Interest-bearing time deposits   198    945 
Securities available for sale   102,606    95,829 
Loans held for sale   522    804 
Loans, less allowance for loan losses of $2,682 and $2,500          
at September 30, 2014 and December 31, 2013, respectively   189,171    193,451 
Foreclosed assets, net   2,433    2,269 
Federal Home Loan Bank stock   1,119    926 
Premises and equipment, net   14,605    14,862 
Cash value of life insurance   6,804    6,644 
Interest receivable and other assets   6,644    3,688 
           
Total assets  $335,184   $348,971 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Deposits  $298,495   $315,709 
Federal Home Loan Bank advances   2,000    4,500 
Subordinated debentures   3,609    3,609 
Interest payable and other liabilities   3,206    3,526 
Total liabilities   307,310    327,344 
           
Commitments and contingent liabilities   -    - 
           
Shareholders' equity          
Common stock - $0.01 par value, 75,000,000 shares authorized;          
10,781,988 shares issued and outstanding   -    - 
Preferred stock - $1.00 par value, $100 liquidation preference 1,000,000          
shares authorized; 191,246 shares issued and outstanding   191    191 
Paid-in capital   30,393    30,386 
Accumulated deficit   (1,977)   (7,133)
Accumulated other comprehensive loss   (733)   (1,817)
Total shareholders' equity   27,874    21,627 
           
Total liabilities and shareholders' equity  $335,184   $348,971 

 

See Notes to Condensed Consolidated Financial Statements

 

3
 

 

 

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three and Nine Months Ended September 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

 

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2014   2013   2014   2013 
Interest and dividend income                    
Interest and fees on loans  $2,470   $2,697   $7,571   $7,972 
Securities:                    
             Taxable   343    276    1,019    790 
             Exempt from federal income tax   107    77    296    191 
     Other interest income   10    25    43    104 
Total interest and dividend income   2,930    3,075    8,929    9,057 
Interest expense                    
Deposits   295    351    908    1,120 
        Federal Home Loan Bank advances and other                    
           borrowed funds   15    28    68    92 
Subordinated debentures   17    18    51    52 
Total interest expense   327    397    1,027    1,264 
Net interest income   2,603    2,678    7,902    7,793 
Provision for loan losses   (75)   120    111    1,420 
Net interest income after provision for loan losses   2,678    2,558    7,791    6,373 
Non-interest income                    
       Service charges on deposit accounts   95    89    276    260 
       Gain on sale of loans   133    222    389    993 
       Gain on sale of securities   -    -    -    55 
       Gain/(Loss) on sale of foreclosed assets   -    7    (21)   (331)
       Other non-interest income   279    231    778    713 
                  Total non-interest income   507    549    1,422    1,690 
Non-interest expense                    
       Salaries and employee benefits   1,469    1,468    4,326    4,584 
       Net occupancy and equipment expense   301    299    969    954 
       Data processing expense   252    341    751    1,009 
       Advertising and promotions   45    47    120    137 
       Professional fees   200    343    616    1,058 
       FDIC insurance premiums   128    205    400    617 
       Write-down on other real estate owned   25    386    115    1,251 
       Other real estate owned expenses   36    187    126    507 
       Other operating expenses   206    282    591    1,039 
                 Total non-interest expense   2,662    3,558    8,014    11,156 
Income (Loss) before income taxes   523    (451)   1,199    (3,093)
Income taxes/(benefit)   (3,956)   -    (3,956)   146 
Net income (loss)  $4,479   $(451)  $5,155   $(3,239)
Earnings (loss) per share                    
        Basic  $0.15   $(0.07)  $0.17   $(0.53)
        Diluted  $0.15   $(0.07)  $0.17   $(0.53)
 
Average shares outstanding basic
   10,781,988    6,590,610    10,781,988    6,098,213 
Average shares outstanding diluted   10,782,014    6,590,610    10,782,032    6,098,213 
Dividends per share  $0.00   $0.00   $0.00   $0.00 

 

See Notes to Condensed Consolidated Financial Statements

 

4
 

  

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and Nine Months Ended September 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2014   2013   2014   2013 
                 
Net income (loss)  $4,479   $(451)  $5,155   $(3,239)
  Other comprehensive income/(loss):                    
    Unrealized holding gains/(losses) arising during the period:                    
      Unrealized net gains/(losses)   (27)   (357)   1,769    (2,461)
       Related income tax benefit/(expense)   11    138    (685)   954 
         Net unrealized gains/(losses)   (16)   (219)   1,084    (1,507)
Less:  reclassification adjustment for net gains realized during the period                     
  Realized net gains   -    -    -    55 
  Related income tax expense   -    -    -    (20)
    Net realized gains   -    -    -    35 
      Other comprehensive income/(loss)   (16)   (219)   1,084    (1,542)
         Comprehensive income/(loss)  $4,463   $(670)  $6,239   $(4,781)

 

See Notes to Condensed Consolidated Financial Statements

 

5
 

  

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Nine Months Ended September 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

 

 

   Number               Accumulated     
   of               Other   Total 
   Common   Preferred   Paid-In   Accumulated   Comprehensive   Shareholders' 
   Shares   Stock   Capital   Deficit   Income (loss)   Equity 
                         
Balance at January 1, 2014   10,781,988   $191   $30,386   $(7,132)  $(1,817)  $21,628 
Net income   -    -    -    5,155    -    5,155 
Other comprehensive income   -    -    -    -    1,084    1,084 
Amortization of stock option expense   -    -    7    -    -   7 
Balance at September 30, 2014   10,781,988   $191   $30,393   $(1,977)  $(733)  $27,874 
                               
                               
Balance at January 1, 2013   5,560,567   $197   $26,270   $(4,346)  $231   $22,352 
Net loss   -    -    -    (3,239)   -    (3,239)
Other comprehensive loss   -    -    -    -    (1,542)   (1,542)
Net proceeds of rights offering   3,670,221    -    4,090    -    -    4,090 
Preferred stock conversion to common   1,551,200    (16)   16    -    -    - 
Preferred stock issued   -    10    -    -    -    10 
Amortization of stock option expense   -    -    9    -    -    9 
Balance at September 30, 2013   10,781,988   $191   $30,385   $(7,585)  $(1,311)  $21,680 

  

 

See Notes to Condensed Consolidated Financial Statements

 

6
 

  

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2014 and 2013

(In thousands)

(Unaudited)

 

 

   Nine Months 
   Ended September 30, 
   2014   2013 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income (loss)  $5,155   $(3,239)
Adjustments to reconcile net loss to net cash          
from (used in) operating activities          
Amortization on securities, net   769    505 
Depreciation   452    460 
Provision for loan losses   111    1,420 
Gain on sale of securities   -    (55)
Write-down on other real estate owned   115    1,251 
Loss on sale of foreclosed assets   21    331 
Gain on sale of loans   (389)   (993)
Originations of loans for sale   (15,474)   (39,696)
Proceeds from sales of loans   16,145    47,438 
Compensation cost of stock options   7    9 
Change in cash value of life insurance   (160)   (169)
Change in interest receivable and other assets   (4,109)   (323)
Change in interest payable and other liabilities   (320)   (491)
Net cash from operating activities   2,323    6,448 
CASH FLOWS FROM INVESTING ACTIVITIES          
Net change in interest-bearing time deposits   747    498 
Purchases of securities available for sale   (17,759)   (62,550)
Proceeds from maturities and calls of securities available for sale   11,711    11,664 
Proceeds from sales of securities available for sale   271    8,063 
Proceeds from sale of other real estate owned   167    3,990 
Net change in loans   4,170    (5,791)
Purchase of Federal Home Loan Bank stock   (193)   - 
Property and equipment expenditures, net   (195)   (699)
Net cash (used in) investing activities   (1,081)   (44,825)
CASH FLOWS FROM FINANCING ACTIVITIES          
Change in:          
Non-interest bearing and interest-bearing demand          
deposits and savings   (7,694)   4,004 
Certificates and other time deposits   (9,519)   (2,089)
Proceeds of capital raises   -    4,100 
Repayments of borrowings   (2,500)   (4,500)
Net cash from (used in) financing activities   (19,713)   1,515 
           
Change in cash and cash equivalents   (18,471)   (36,862)
Cash and cash equivalents at beginning of period   29,553    71,021 
CASH AND CASH EQUIVALENTS AT END OF PERIOD  $11,082   $34,159 
           
Supplemental disclosures          
 Interest paid  $996   $1,251 
 Income taxes paid   -    - 
 Transfers from loans to foreclosed assets   -      1,594 

 

See Notes to Condensed Consolidated Financial Statements

7
 

 

 

 

COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2014 and 2013

 

NOTE 1 – BASIS OF PRESENTATION

 

The accounting policies followed in the preparation of the interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q are consistent with those used in the preparation of annual consolidated financial statements. The interim condensed consolidated financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management of Community Financial Shares, Inc. (the “Company”), for a fair statement of results of operations and cash flows for the interim periods presented. Results of operations and cash flows for the nine months ended September 30, 2014 are not necessarily indicative of the results of operations and cash flows that may be expected for the year ending December 31, 2014 or any other period.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for the interim financial period and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the U.S. Securities and Exchange Commission on March 28, 2014. The condensed consolidated balance sheet of the Company as of December 31, 2013 has been derived from the audited consolidated balance sheet as of that date.

 

 

NOTE 2 – EARNINGS (LOSS) PER SHARE

The following is an analysis of the Company’s basic and diluted earnings (loss) per common share, reflecting the application of the two-class method for the three and nine months ended September 30, 2014 and 2013:

 

 

 

  

Three Months

Ended

September 30, 2014

  

Three Months

Ended

September 30, 2013

 
         
Net income (loss) available for distribution  $4,479   $(451)
Dividends and undistributed earnings allocated to participating securities   (2,864)   - 
Income (loss) attributable to common shareholders  $1,615   $(451)
           
Average common shares outstanding for basic earnings per share   10,781,988    6,590,610 
Effect of dilutive stock options   26    - 
Average common and common-equivalent shares for dilutive earnings per share   10,782,014    6,590,610 
           
Basic  $0.15   $(0.07)
Diluted  $0.15   $(0.07)

 

8
 

 

 

 

 

  

Nine Months

Ended

September 30, 2014

  

Nine Months

Ended

September 30, 2013

 
         
Net income (loss) available for distribution  $5,155   $(3,239)
Dividends and undistributed earnings allocated to participating securities   (3,297)   - 
Income (loss) attributable to common shareholders  $1,858   $(3,239)
           
Average common shares outstanding for basic earnings per share   10,781,988    6,098,213 
Effect of dilutive stock options   44    - 
Average common and common-equivalent shares for dilutive earnings per share   10,782,032    6,098,213 
           
Basic  $0.17   $(0.53)
Diluted  $0.17   $(0.53)

 

 

The Company’s preferred stockholders are entitled to participate in all common stock dividends on an as-converted basis, and no dividends may be paid on shares of the Company’s common stock unless an identical dividend is payable to preferred stockholders on an as-converted basis.

 

There were 21,480 and 24,480 anti-dilutive shares at September 30, 2014 and 2013, respectively.

 

 

NOTE 3 – CAPITAL ADEQUACY AND REGULATORY AND SUPERVISORY MATTERS

 

At the dates indicated, the capital ratios of Community Bank-Wheaton/Glen Ellyn (the “Bank”), the wholly owned subsidiary of the Company, were as follows:

   September 30, 2014   December 31, 2013 
   Amount   Ratio   Amount   Ratio 
                 
Total capital (to risk-weighted assets)  $27,814    12.9%  $25,990    11.9%
Tier I capital (to risk-weighted assets)   25,132    11.7%   23,490    10.8%
Tier I capital (to average assets)   25,132    7.7%   23,490    6.8%

 

At September 30, 2014, regulatory approval is required for all dividend declarations by both the Bank and the Company.

 

On January 10, 2014, the Bank received notification from the Federal Deposit Insurance Corporation (the “FDIC”) and the Division of Banking of the Illinois Department of Financial and Professional Regulation (the “IDFPR”) that the Consent Order (the “Order”) issued to the Bank by the FDIC and IDFPR on January 21, 2011 was terminated effective January 10, 2014. The material terms and conditions of the Order were previously disclosed in the Company’s Current Report on Form 8-K filed on January 26, 2011. In connection with the termination of the Order, the Bank agreed 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. At September 30, 2014, these capital ratios were 7.7% and 12.9%, respectively.

 

Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If undercapitalized, capital distributions are limited, as are asset growth and expansion, and plans for capital restoration are required.

 

9
 

 

 

NOTE 4 - SECURITIES AVAILABLE FOR SALE

 

The fair value of securities available for sale at September 30, 2014 and December 31, 2013 are as follows:

 

   September 30, 2014 
  
Fair
Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
 
U.S. government agency debt securities  $11,792   $-   $(682)
State and political subdivisions   19,110    234    (87)
U.S. government agency mortgage-backed securities   63,312    212    (844)
Preferred stock   40    36    - 
SBA securities   8,352    2    (68)
   $102,606   $484   $(1,681)

 

 

   December 31, 2013 
  
Fair
Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
 
U.S. government agency debt securities  $11,059   $-   $(1,414)
State and political subdivisions   16,367    50    (419)
U.S. government agency mortgage-backed securities   60,065    124    (1,235)
Preferred stock   35    31    - 
SBA securities   8,303    1    (104)
   $95,829   $206   $(3,172)

 

 

Securities classified as U. S. government agency debt securities 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 securities are pools of loans guaranteed by the Small Business Administration.

 

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 September 30, 2014 and December 31, 2013:

 

 

10
 

 

 

   September 30, 2014 
   Less than 12 Months   12 Months or More    
Description of
Securities
  Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Total
Fair Value
   Unrealized
Losses
 
U.S. government agency debt securities  $-   $-   $11,792   $(682)  $11,792   $(682)
State and political subdivisions   3,585    (21)   4,569    (66)   8,154    (87)
U.S. government agency mortgage-backed securities   20,100    (148)   26,415    (696)   46,515    (844)
SBA securities   3,825    (19)   3,974    (49)   7,799    (68)
    Total temporarily impaired
             securities
  $27,510   $(188)  $46,750   $(1,493)  $74,260   $(1,681)

 

   December 31, 2013 
   Less than 12 Months   12 Months or More    
Description of
Securities
  Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Total
Fair Value
   Unrealized
Losses
 
U.S. Government agency debt securities  $6,694   $(797)  $4,365   $(617)  $11,059   $(1,414)
State and political subdivisions   10,027    (419)   -    -    10,027    (419)
U.S. government agency mortgage-backed securities   48,023    (1,234)   16    (1)   48,039    (1,235)
SBA securities   7,987    (104)   -    -    7,987    (104)
   Total temporarily impaired
             securities
  $72,731   $(2,554)  $4,381   $(618)  $77,112   $(3,172)

 

 

Unrealized gains and losses within the investment portfolio are determined to be temporary. The Company performed an evaluation of its investments for other than temporary impairment and there was no impairment identified during the nine months ended September 30, 2014. The entire portfolio is classified as available for sale, however, management has no specific intent to sell any securities, and it is more likely than not that the Company will not have to sell any security before recovery of its amortized cost basis.

 

The fair values of securities available for sale at September 30, 2014, 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  $1,506   $1,506 
Due after one year through five years   2,617    2,597 
Due after five years through ten years   11,541    11,565 
Due after ten years   15,773    15,234 
           
U.S. government agency mortgage-backed securities   63,944    63,312 
SBA securities   8,418    8,352 
Preferred stock   4    40 
   $103,803   $102,606 

 

 

11
 

 

 

Securities with a carrying value of approximately $8.0 million at September 30, 2014 were pledged to secure public deposits as well as for other purposes as required or permitted by law.

 

Sales activities for securities for the three and nine months ended September 30, 2014 are shown in the following table:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
Sales proceeds  $-   $-   $271   $8,063 
Gross gains on sales   -    -    -    55 

 

 

NOTE 5 – LOANS

 

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 as 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 is 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, the 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.

 

12
 

 

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.

 

The Company has a geographic concentration of loan and deposit customers within the Chicago metropolitan area. Most of the Company’s 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 September 30, 2014 and December 31, 2013, respectively:

 

   September 30,   December 31, 
   2014   2013 
Real estate          
    Commercial  $95,255   $97,813 
    Construction   1,408    1,856 
    Residential   27,054    26,240 
    Home equity   46,447    47,050 
        Total real estate loans   170,164    172,959 
Commercial   20,229    21,379 
Consumer   1,198    1,384 
    Total loans   191,591    195,722 
Deferred loan costs, net   262    229 
Allowance for loan losses   (2,682)   (2,500)
       Loans, net  $189,171   $193,451 

 

 

The risk characteristics of each loan portfolio segment are as follows:

 

Commercial

 

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

 

13
 

  

Commercial Real Estate

 

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

 

Construction

 

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Residential and Consumer, including Home Equity Lines of Credit (HELOC)

 

With respect to residential loans that are secured by one-to-four family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and may require private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one-to-four family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

 

Policy for charging off loans:

 

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

 

Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

 

For all loan portfolio segments except one-to-four family residential loans and consumer loans, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

 

The Company charges-off one-to-four family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of one-to-four family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

 

14
 

 

Policy for determining delinquency:

 

The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

 

Period utilized for determining historical loss factors:

 

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years. Management believes the three year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

 

Policy for recognizing interest income on impaired loans:

 

Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

 

Policy for recognizing interest income on non-accrual loans:

 

Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

 

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 not related to the Company or the Bank. 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, 2014  $1,006 
New loans including renewals   - 
Payments including renewals   (225)
Balances, September 30, 2014  $781 

 

 

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three months ended September 30, 2014 and 2013:

 

 

   Three Months Ended September 30, 2014 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                                    
Balance at beginning of period  $510   $1,392   $11   $16   $273   $532   $2,734 
Provision for loan losses   (47)   (102)   10    (1)   53    12    (75)
Charge-offs   -    -    -    -    -    -    - 
Recoveries   9    2    -    -    12    -    23 
Balance at end of period  $472   $1,292   $21   $15   $338   $544   $2,682 

 

 

15
 

 

 

   Nine Months Ended September 30, 2014 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                                    
Balance at beginning of period  $483   $1,336   $44   $41   $266   $330   $2,500 
Provision for loan losses   (87)   (18)   (23)   (24)   49    214    111 
Charge-offs   -    (28)   -    (2)   -    -    (30)
Recoveries   76    2    -    -    23    -    101 
Balance at end of period  $472   $1,292   $21   $15   $338   $544   $2,682 
                                    
Ending balance: individually evaluated for impairment  $-   $6   $-   $-   $38   $144   $188 
Ending balance: collectively evaluated for impairment  $472   $1,286   $21   $15   $300   $400   $2,494 
                                    
Total Loans:                                   
Ending balance  $20,229   $95,255   $1,408   $1,198   $27,054   $46,447   $191,591 
Ending balance: individually evaluated for impairment  $-   $1,293   $-   $-   $539   $1,025   $2,857 
Ending balance: collectively evaluated for impairment  $20,229   $94,797   $1,408   $1,198   $26,524   $45,935   $190,091 

 

 

   Three Months Ended September 30, 2013 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                                    
Balance at beginning of period  $454   $1,453   $63   $19   $168   $277   $2,434 
Provision for loan losses   110    (38)   (28)   6    24    46    120 
Charge-offs   (80)   -    -    -    -    (12)   (92)
Recoveries   -    74    -    -    7    1    82 
Balance at end of period  $484   $1,489   $35   $25   $199   $312   $2,544 

 

 

   Nine Months Ended September 30, 2013 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                                    
Balance at beginning of period  $621   $1,386   $53   $21   $305   $646   $3,032 
Provision for loan losses   129    374    (18)   17    714    204    1,420 
Charge-offs   (266)   (357)   -    (14)   (835)   (542)   (2,014)
Recoveries   -    86    -    1    15    4    106 
Balance at end of period  $484   $1,489   $35   $25   $199   $312   $2,544 
                                    
Ending balance: individually evaluated for impairment  $-   $249   $-   $-   $-   $46   $295 
Ending balance: collectively evaluated for impairment  $484   $1,240   $35   $25   $199   $266   $2,249 

 

 

16
 

  

The following table presents the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2013:

 

   December 31, 2013 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                             
Balance at beginning of period  $621   $1,386   $53   $21   $305   $646   $3,032 
Provision for loan losses   129    221    (9)   34    773    279    1,427 
Charge-offs   (267)   (357)   -    (15)   (835)   (600)   (2,074)
Recoveries   -    86    -    1    23    5    115 
Balance at end of period  $483   $1,336   $44   $41   $266   $330   $2,500 
                                    
Ending balance: individually evaluated for impairment  $-   $126   $-   $-   $-   $46   $72 
Ending balance: collectively evaluated for impairment  $483   $1,310   $44   $41   $266   $284   $2,428 
Total Loans:                                   
Ending balance  $21,379   $97,813   $1,856   $1,384   $26,240   $47,050   $195,722 
Ending balance: individually evaluated for impairment  $1,566   $437   $-   $-   $398   $505   $2,906 
Ending balance: collectively evaluated for impairment  $19,813   $97,376   $1,856   $1,384   $25,842   $46,545   $192,816 

 

 

The following table summarizes the Company’s nonaccrual loans by class at September 30, 2014 and December 31, 2013.

 

  

September 30,
2014

    December 31,
2013
 
Real estate loans:        
        Commercial  $1,293   $437 
        Residential   539    - 
        Home equity   1,025    505 
            Total  $2,857   $942 

 

 

The following tables present information regarding impaired loans as of September 30, 2014:

 

   Recorded
Balance
   Unpaid Principal Balance   Specific Allowance 
With no related allowance recorded:               
Commercial real estate  $835   $835   $- 
Residential   9    9    - 
HELOC   513    513    - 
   Subtotal  $1,357   $1,357   $- 
With an allowance recorded:               
Commercial real estate  $458   $458   $6 
Residential   530    530    38 
HELOC   572    512    144 
    Subtotal   1,560    1,500    188 
Total Impaired Loans  $2,917   $2,857   $188 

 

 

 

17
 

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2014   2013   2014   2013 
   Average Investment in Impaired
Loans
   Interest Income Recognized   Average Investment in Impaired
Loans
   Interest Income Recognized   Average Investment in Impaired
Loans
   Interest Income Recognized   Average Investment in Impaired
Loans
   Interest Income Recognized 
With no related allowance recorded:                                        
Commercial  $-   $-   $1,700   $25   $-   $-   $729   $25 
Commercial real estate   835    -    445    -    837    30    457    - 
Residential   9    -    401    5    10    -    531    14 
HELOC   569    -    165    -    591    8    166    - 
   Subtotal   1,413    -    2,711    30    1,438    38    1,883    39 
With an allowance recorded:                                        
Commercial real estate   458    -    918    -    870    12    993    - 
Residential   531    -    -    -    532    24    -    - 
HELOC   633    20    340    -    650    22    342    - 
    Subtotal   1,622    20    1,258    -    2,052    58    1,275    - 
Total Impaired Loans  $3,035   $20   $3,969   $30   $3,490   $96   $3,158   $39 

 

 

The following table presents information regarding impaired loans as of December 31, 2013:

 

   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
   Average
Investment in
Impaired
Loans
   Interest Income
Recognized
 
With no related allowance recorded:                         
Commercial real estate  $1,566   $1,566   $-   $1,549   $62 
Residential   398    398    -    402    21 
HELOC   166    166    -    165    - 
   Subtotal   2,130    2,130    -    2,116    83 
With an allowance recorded:                         
Commercial real estate   437    812    26    834    - 
HELOC   339    396    46    396    - 
    Subtotal   776    1,208    72    1,230    - 
Total Impaired Loans  $2,906   $3,338   $72   $3,346   $83 

  

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed during the loan approval process and is updated as circumstances warrant. The Company uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Bank’s credit position at some future date.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well- defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

 

18
 

 

The following tables summarize the credit quality of the Company at September 30, 2014 and December 31, 2013:

 

   September 30, 2014 
   Pass   Special
Mention
   Substandard   Doubtful   Loss   Total 
                               
Commercial  $20,164   $   $65   $   $   $20,229 
Real estate loans:                              
Construction   1,408                    1,408 
Commercial   91,745    231    3,279            95,255 
Residential   26,516        538            27,054 
Home equity   45,394    28    1,025            46,447 
Consumer   1,198                    1,198 
Total  $186,425   $259   $4,907   $   $   $191,591 

 

 

   December 31, 2013 
   Pass   Special
Mention
   Substandard   Doubtful   Loss   Total 
                               
Commercial  $19,536   $209   $1,634   $   $   $21,379 
Real estate loans:                              
Construction   1,856                    1,856 
Commercial   93,679    3,235    899            97,813 
Residential mortgage   24,763    1,477                26,240 
Home equity   46,515    29    506            47,050 
Consumer   1,384                    1,384 
Total  $187,733   $4,950   $3,039   $   $   $195,722 

 

 

The following tables summarize past due aging of the Company’s loan portfolio at September 30, 2014 and December 31, 2013:

 

   September 30, 2014 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater
Than
90 Days
   Total
Past Due
   Current   Total Loans   Loans >
90 Days and
Accruing
 
                                    
Commercial  $213   $   $39   $252   $19,977   $20,229   $39 
Real estate loans:                                   
Construction   142            142    1,266    1,408     
Commercial   604    271    1,293    2,168    93,087    95,255     
Residential   121    1,245    539    1,905    25,149    27,054     
Home equity   544    80    978    1,602    44,845    46,447     
Consumer           1    1    1,197    1,198    1 
Total  $1,624   $1,596   $2,850   $6,070   $185,521   $191,591   $40 

 

19
 

 

 

   December 31, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater
Than
90 Days
   Total
Past Due
   Current   Total Loans   Loans >
90 Days and
Accruing
 
                                    
Commercial  $100   $   $   $100   $21,279   $21,379   $ 
Real estate loans:                                   
Construction                   1,856    1,856     
Commercial real estate       569    169    738    97,075    97,813    168 
Residential mortgage   687    1,342    11    2,040    24,200    26,240    11 
Home equity   445    328    555    1,328    45,722    47,050    50 
Consumer       1    1    2    1,382    1,384    1 
Total  $1,232   $2,240   $736   $4,208   $191,514   $195,722   $230 

 

 

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition that it would not otherwise consider resulting in a modified loan which is then identified as a troubled debt restructuring (“TDR”). The Company may modify loans through interest rate reductions, short-term extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations. Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses.

 

The Company identifies loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future.

 

For one-to-four family residential and home equity lines of credit, a restructure often occurs with past due loans and may be offered as an alternative to foreclosure. There are other situations where borrowers, who are not past due, experience a sudden job loss, become overextended with credit obligations, or other problems, have indicated that they will be unable to make the required monthly payment and request payment relief.

 

When considering a loan restructure, management will determine if: (i) the financial distress is short or long term; (ii) loan concessions are necessary; and (iii) the restructure is a viable solution.

 

When a loan is restructured, the new terms often require a reduced monthly debt service payment. No TDRs that were on non-accrual status at the time the concessions were granted have been returned to accrual status.

 

For commercial loans, management completes an analysis of the operating entity’s ability to repay the debt. If the operating entity is capable of servicing the new debt service requirements and the underlying collateral value is believed to be sufficient to repay the debt in the event of a default, the new loan is generally placed on accrual status.

 

For retail loans, an analysis of the individual’s ability to service the new required payments is performed. If the borrower complies with the terms of the newly restructured debt for at least six consecutive months and the underlying collateral value is believed to be sufficient to repay the debt in the event of a future default, the new loan is generally placed on accrual status. The reason for the TDR is also considered, such as paying past due real estate taxes or payments caused by a temporary job loss, when determining whether a retail TDR loan could be returned to accrual status. Retail TDRs remain on non-accrual status until sufficient payments have been made to bring the past due principal and interest current at which point the loan would be transferred to accrual status.

 

 

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There were no loans restructured as TDRs during the three and nine months ended September 30, 2014 or June 30, 2013.

 

The following table sets forth the Company’s TDRs that had payment defaults during the three and nine months ended September 30, 2014 and 2013. A default occurs when a TDR is 90 days or more past due, transferred to non-accrual status, or transferred to other real estate owned within twelve months of restructuring.

 

   Three months ended
September 30, 2014
   Three months ended
September 30, 2013
 
       Default       Default 
   Count   Balance   Count   Balance 
Real estate loans:                    
    Commercial   -   $-    1   $444 
    Residential   -    -    1    339 
        Total   -   $-    2   $783 

 

 

   Nine months ended
September 30, 2014
   Nine months ended
September 30, 2013
 
       Default       Default 
   Count   Balance   Count   Balance 
Real estate loans:                    
    Commercial   -   $-    1   $444 
    Residential   -    -    1    339 
        Total   -   $-    2   $783 

 

 

NOTE 6 – DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

 

The Company measures fair value according to the Financial Accounting Standards Board Accounting Standards Codification (ASC) Fair Value Measurements and Disclosures (ASC 820-10). ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs used in valuation techniques, but not the valuation techniques themselves. The fair value hierarchy is designed to indicate the relative reliability of the fair value measure. The highest priority given to quoted prices in active markets and the lowest to unobservable data such as the Company’s internal information. ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs into the fair value hierarchy (Level 1 being the highest priority and Level 3 being the lowest priority):

 

Level 1Quoted prices in active markets for identical assets or liabilities.
Level 2Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

Available-for-sale Securities

 

If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 1 securities include preferred stock. Level 2 securities include certain collateralized mortgage and debt obligations, municipal securities, U.S. government agencies and SBA securities. Third party vendors compile prices from various sources and may apply techniques such as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather on the investment securities’ relationship to other benchmark quoted investment securities. The following tables are as of September 30, 2014 and December 31, 2013, respectively:

 

 

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       At September 30, 2014 
       Fair Value Measurements Using 
   Fair             
Available-for-sale securities:  Value   Level 1   Level 2   Level 3 
U.S. government agency debt securities  $11,792   $-   $11,792   $- 
State and political subdivisions   19,110    -    19,110    - 
U.S. government agency mortgage-backed securities   63,312    -    63,312    - 
Preferred stock   40    -    40    - 
SBA securities   8,352    -    8,352    - 
  Total available-for-sale securities  $102,606   $-   $102,606   $- 

  

       At December 31, 2013 
       Fair Value Measurements Using 
   Fair             
Available-for-sale securities:  Value   Level 1   Level 2   Level 3 
U.S. government agency debt securities  $11,059   $-   $11,059   $- 
State and political subdivisions   16,367    -    16,367    - 
U.S. government agency mortgage-backed securities   60,065    -    60,065    - 
Preferred stock   35    35    -    - 
SBA securities   8,303    -    8,303    - 
  Total available-for-sale securities  $95,829   $35   $95,794   $- 

 

 

The following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying September 30, 2014 and December 31, 2013 balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

  

       At September 30, 2014 
       Fair Value Measurements Using 
   Fair             
  Value   Level 1   Level 2   Level 3 
Impaired loans (collateral dependent)  $2,857    -    -   $2,857 
Other real estate owned   2,433    -    -    2,433 

 

       At December 31, 2013 
       Fair Value Measurements Using 
   Fair             
  Value   Level 1   Level 2   Level 3 
Impaired loans (collateral dependent)  $2,906    -    -   $2,906 
Other real estate owned   2,269    -    -    2,269 

 

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The following table presents quantitative information about unobservable inputs in recurring and nonrecurring Level 3 fair value measurements:

 

  As of September 30, 2014
   Fair   Valuation  Unobservable   
   Value   Technique  Inputs  Range
Impaired loans (collateral dependent)  $2,857   Market comparable properties  Marketability discount  5% - 30%
               
Other real estate owned
  $2,433   Fair value appraisals      
               

 

 

   As of December 31, 2013
   Fair   Valuation  Unobservable   
   Value   Technique  Inputs  Range
Impaired loans (collateral dependent)  $2,906   Market comparable properties  Marketability discount   5% - 30.7%
               
Other real estate owned
  $2,269   Fair value appraisals      
               

  

Impaired Loans (Collateral Dependent)

 

Loans for which it is probable that the Bank will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans, based on current appraisals. If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

 

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect fair value. The Company’s practice is to obtain new or updated appraisals on the loans subject to initial impairment review and then to generally update on an annual basis thereafter. The Company discounts the appraisal amount as necessary for selling costs and past due real estate taxes. If a new or updated appraisal is not available at the time of a loan’s impairment review, the Company typically applies a discount to the value of an old appraisal to reflect the property’s current estimated value if there is believed to be deterioration in either (i) the physical or economic aspects of the subject property or (ii) any market conditions. These discounts are developed by the Company’s Chief Credit Officer. The results of the impairment review results in an increase in the allowance for loan loss or in a partial charge-off of the loan, if warranted. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method based on current appraisals.

 

Other Real Estate Owned

 

Other real estate owned (“OREO”) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired. Estimated fair value of OREO is based on appraisals or evaluations. OREO is classified within Level 3 of the fair value hierarchy. Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed by the Company’s Chief Credit Officer. Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer. Appraisers are selected from the list of approved appraisers maintained by management.

 

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The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2014:

 

       At September 30, 2014 
       Fair Value Measurements Using 
   Carrying             
   Amount   Level 1   Level 2   Level 3 
Financial assets                    
    Cash and cash equivalents  $11,082   $11,082   $-   $- 
   Interest-bearing time deposits   198    198    -    - 
   Securities available for sale   102,606    40    102,566    - 
   Loans held for sale   522    -    522    - 
   Loans receivable, net   189,171    -    -    189,474 
   Federal Home Loan Bank stock   1,119    -    1,119    - 
   Interest receivable   960    -    960    - 
 
Financial liabilities
                    
   Deposits   298,495    -    284,792    - 
   Federal Home Loan Bank advances   2,000    -    2,031    - 
   Subordinated debentures   3,609    -    -    1,284 
   Interest payable   200    -    200    - 

 

 

The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2013:

 

       At December 31, 2013 
       Fair Value Measurements Using 
   Carrying             
   Amount   Level 1   Level 2   Level 3 
Financial assets                    
    Cash and cash equivalents  $29,553   $29,553   $-    - 
   Interest-bearing time deposits   945    945    -    - 
   Securities available for sale   95,829    35    95,794    - 
   Loans held for sale   804    -    804    - 
   Loans receivable, net   193,451    -    -    193,864 
   Federal Home Loan Bank stock   926    -    926    - 
   Interest receivable   884    -    884    - 
 
Financial liabilities
                    
   Deposits   315,709    -    303,199    - 
   Federal Home Loan Bank advances   4,500    -    4,478    - 
   Subordinated debentures   3,609    -    -    1,259 
   Interest payable   169    -    169    - 

  

The methods and assumptions used to estimate fair value are described as follows:

 

Carrying amount is the estimated fair value for cash and cash equivalents, interest-bearing time deposits, loans held for sale, Federal Home Loan Bank stock, interest receivable and payable, deposits due on demand, variable rate loans and other borrowings. Security fair values are based on market prices or dealer quotes and, if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans and time deposits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using a discounted cash flow analysis or underlying collateral values. The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW and money market accounts, is equal to the carrying amount. There is however, additional value to the deposits of the Company, a significant portion of which has not been recognized in the consolidated financial statements. This value results from the cost savings of these core-funding sources versus obtaining higher-rate funding in the market. The fair values of fixed rate Federal Home Loan Bank advances, other borrowings and subordinated debentures are based on current rates for similar financing. The fair value of off-balance-sheet items, which is based on the current fees or cost that would be charged to enter into or terminate such arrangements, is immaterial.

 

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While the above estimates are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of these items on the respective dates, the fair values would have been achieved, because the market value may differ depending on the circumstances. The estimated fair values at year end should not necessarily be considered to apply at subsequent dates.

 

Other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the above disclosures. Also, nonfinancial instruments typically not recognized on the balance sheets may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposits, the trained workforce, customer goodwill, and similar items.

 

NOTE 7 – RECENT ACCOUNTING PRONOUNCEMENTS

 

Accounting Standards Update No. 2014-08- Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity – In April 2014, FASB issued ASU 2014-08. This update seeks to better define the groups of assets which qualify for discontinued operations, in order to ease the burden and cost for prepares and stakeholders. This issue changed “the criteria for reporting discontinued operations” and related reporting requirements, including the provision for disclosures about the “disposal of and individually significant component of an entity that does not qualify for discontinued operations presentation.”

 

The amendments in this Update are effective for fiscal years beginning after December 15, 2014. Early adoption is permitted only for disposals or classifications as held for sale. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

Accounting Standards Update No. 2014-09- Revenue from Contracts with Customers – In May 2014, FASB, in joint cooperation with IASB, issued ASU 2014-09. The topic of Revenue Recognition had become broad, with several other regulatory agencies issuing standards which lacked cohesion. The new guidance establishes a “common framework” and “reduces the number of requirements to which an entity must consider in recognizing revenue” and yet provides improved disclosures to assist stakeholders reviewing financial statements.

 

The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

Accounting Standards Update No. 2014-11- Transfers and Servicing – In June 2014, FASB, issued ASU 2014-11. This update addresses the concerns of stakeholders’ by changing the accounting practices surrounding repurchase agreements. The new guidance changes the “accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements.”

 

The amendments in this Update are effective for annual reporting periods beginning after December 15, 2015. Early adoption is prohibited. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

Accounting Standards Update No. 2014-12- Compensation – Stock Compensation – In June 2014, FASB, issued ASU 2014-12. This update defines the accounting treatment for share-based payments and “resolves the diverse accounting treatment of those awards in practice.” The new requirement mandates that “a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.” Compensation cost will now be recognized in the period in which it becomes likely that the performance target will be met.

 

The amendments in this Update are effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company for the periods indicated. The discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes included in this Form 10-Q. In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed elsewhere in this report.

 

Safe Harbor Statement

 

This report (including information incorporated herein by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

 

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 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 and capital restoration plan;

 

·An inability to meet our liquidity needs or the capital directives issued by our regulators;

 

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·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;

 

·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.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission, including in the Section entitled “Risk Factors” in this form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the U.S. Securities and Exchange Commission on March 28, 2014.

 

Overview

 

Community Financial Shares, Inc. (the “Company”) is the holding company for Community Bank- Wheaton/Glen Ellyn (the “Bank”). The Company is headquartered in Glen Ellyn, Illinois and operates four offices in its primary market area, which is comprised of Glen Ellyn, Illinois and Wheaton, Illinois. One location is in Glen Ellyn and three are located in Wheaton.

 

The Company’s principal business is conducted by the Bank and consists of offering a full range of community-based financial services, including commercial and retail banking services.  The profitability of the Company’s operations depends primarily on its net interest income, provision for loan losses, other income, and other expenses.  Net interest income is the difference between the income the Company receives on its loan and securities portfolios and its cost of funds, which consists of interest paid on deposits and borrowings.  The provision for loan losses reflects the cost of credit risk in the Company’s loan portfolio.  Other income consists of service charges on deposit accounts, gains on loan sales, securities gains (losses), and other income.  Other expenses include salaries and employee benefits expenses, as well as occupancy and equipment expenses and other noninterest expenses.

27
 

 

 

Net interest income is dependent on the amounts and yields of interest-earning assets as compared to the amounts and rates of interest-bearing liabilities.  Net interest income is sensitive to changes in market rates of interest and the Company’s asset/liability management procedures in coping with such changes.  The provision for loan losses is dependent upon management’s assessment of the collectibility of the loan portfolio under current economic conditions.

 

Regulatory Matters

 

As previously disclosed, on January 10, 2014, the Bank received notification from the Federal Deposit Insurance Corporation (the “FDIC”) and the Division of Banking of the Illinois Department of Financial and Professional Regulation (the “IDFPR”) that the Consent Order (the “Order”) issued to the Bank by the FDIC and IDFPR on January 21, 2011 was terminated effective January 10, 2014. The material terms and conditions of the Order were previously disclosed in the Company’s Current Report on Form 8-K filed on January 26, 2011. In connection with the termination of the Order, the Bank agreed 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. At September 30, 2014 our Tier 1 and total capital ratios were 7.7% and 12.9%, respectively, compared to 7.2% and 12.5% at June 30, 2014, 7.0% and 12.0% at March 31, 2014, 6.8% and 11.9% at December 31, 2013, 6.8% and 11.4% at September 30, 2013, 6.7% and 11.4% at June 30, 2013, 6.8% and 11.8% at March 31, 2013 and 7.7% and 12.6% at December 31, 2012, respectively.

 

Comparison of Financial Condition at September 30, 2014 and December 31, 2013

 

Total assets at September 30, 2014 were $335.2 million, which represented a decrease of $13.8 million, or 4.0%, compared to $349.0 million at December 31, 2013. The decrease in total assets was primarily due to a decrease in cash and cash equivalents and loans. Cash and cash equivalents decreased $18.5 million, or 62.5%, to $11.1 million at September 30, 2014 from $29.6 million at December 31, 2013. Loans decreased $4.3 million, or 2.2%, to $189.2 million at September 30, 2014 from $193.5 million at December 31, 2013 primarily as a result of the net effect of a $2.6 million decrease in commercial real estate loans, a $603,000 decrease in home equity lines of credit, a $1.2 million decrease in commercial loans and an $814,000 increase in residential real estate loans. The decrease in cash and cash equivalents and loans was partially offset by an increase in investment securities. Investment securities increased $6.8 million, or 7.1%, to $102.6 million at September 30, 2014 from $95.8 million at December 31, 2013 primarily as a result of a $2.7 million increase in municipal securities and a $3.2 million increase in mortgage-backed securities. In addition, foreclosed assets increased $164,000 to $2.4 million as of September 30, 2014 from $2.3 million as of December 31, 2013. Included in foreclosed assets at September 30, 2014 are nine one-to-four family residences, two parcels of land and one commercial real estate property.

 

Total liabilities at September 30, 2014 were $307.3 million, which represented a decrease of $20.0 million, compared to $327.3 million at December 31, 2013. Federal Home Loan Bank advances decreased $2.5 million to $2.0 million at September 30, 2014 from $4.5 million at December 31, 2013. Deposits decreased $17.2 million to $298.5 million at September 30, 2014 from $315.7 million at December 31, 2013. This decrease in deposits primarily consisted of decreases in certificates of deposits of $9.5 million, or 11.0%, to $77.2 million at September 30, 2014 from $86.7 million at December 31, 2013 and interest-bearing demand deposit accounts of $6.7 million, or 9.3%, to $65.8 million at September 30, 2014 from $72.5 million at December 31, 2013. These decreases were partially offset by an increase in money market accounts of $3.5 million, or 8.1%, to $45.9 million at September 30, 2014 from $42.4 million at December 31, 2013. The percentage of regular savings accounts to total deposits totaled 23.7% at September 30, 2014 and the percentage of certificates of deposit to total deposits decreased to 25.9% at September 30, 2014 from 27.5% at December 31, 2013.

 

Stockholders’ equity increased $6.3 million, or 28.9%, to $27.9 million at September 30, 2014 from $21.6 million at December 31, 2013. The increase in stockholders’ equity was due to the Company’s $5.2 million net income for the nine months ended September 30, 2014 and the increase in the Company’s accumulated other comprehensive income of $1.1 million to a loss of $733,000 for the nine months ended September 30, 2014 due to changes in the fair value of the Company’s available-for-sale investment portfolio.

 

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Deferred Tax Assets. The Company’s $5.2 million net income for the nine months ended September 30, 2014 was primarily due to the reversal of the valuation allowance on a portion of the Company’s net deferred tax assets. The Company experienced loan loss provisions totaling $8.3 million, $6.2 million, $1.5 million and $1.4 million for the fiscal years ended December 31, 2010, 2011, 2012 and 2013, respectively. A significant portion of these losses were related to participation loans in construction and development projects which the Company is no longer involved. The Company recorded income tax expense totaling $4.7 million in 2011 as it established a valuation allowance on substantially all of its net deferred tax assets. In 2012 and 2013, management determined that the realization of the deferred tax asset was not likely and maintained a valuation allowance on substantially all of its net deferred tax assets. In an effort to increase its capital levels, the Company entered into a series of capital raising transactions in 2012 and 2013. These capital transactions raised net proceeds of $25.8 million and allowed the Company to make significant progress in resolving problem credits and reducing expenses associated with credit-related issues.

 

The determination of being able to realize the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future taxable income, available tax planning strategies and assessments of the current and future economic and business conditions. Management considered both positive and negative evidence regarding the Company’s ability to ultimately realize the deferred tax assets, which is largely dependent upon the ability to derive benefits based upon future taxable income. Tax planning strategies available to the Company include investing in taxable instruments rather than tax-exempt securities. In 2014, management reevaluated the income forecasts and other tax strategies and determined that there was support for a change in the valuation allowance against its deferred tax assets. Management concluded in the third quarter of 2014 that, after a comprehensive review of both positive and negative considerations, it was now more likely than not that a portion of the deferred tax assets could be realized. The current five year projection utilized in this analysis includes no net loan growth for 2014 with positive net growth for the forward looking years. In addition, the Company has continued to surpass budgetary projections on a monthly basis for the nine months ended September 30, 2014. As a result of this review a portion of the valuation allowance against deferred tax assets was reversed.

 

The positive evidence considered included the following: 1) the current quarter reflects the fourth consecutive quarter of pre-tax earnings; 2) nonperforming assets have been reduced from $23.1 million at December 31, 2011 to $5.3 million as of September 30, 2014; and 3) the termination of the Order on January 10, 2014. The current trend of pre-tax earnings has not been driven by one-time extraordinary items but by core banking activities. The reduction in nonperforming assets has had a positive effect due to the reduction in legal fees, loan provision expense and other credit related expenses. The improvement in the Bank’s risk profile led to the removal of the Order which also led to a $23,000 monthly reduction in the premiums on FDIC insurance and the lifting of growth restrictions imposed on the Bank, which is an important consideration in the projections used in the analysis. The Bank gained efficiencies and monthly cost savings of approximately $30,000 per month as we converted our core processor in the fourth quarter of 2013. The efficiencies afforded by the new system, along with a general focus on efficiency and accountability, has allowed us to reduce headcount through attrition. Negative evidence included the decrease in the Company’s loan portfolio which was driven by the Order which has now been lifted and reduced noninterest income, primarily from decreased mortgage banking revenue. In future accounting periods, the Company’s management will reevaluate whether the current conditions in addition to the positive and negative evidence support a change in the valuation allowance against the Company’s deferred tax assets. Any such reduction in the estimated valuation allowance would lower the amount of income tax expense recognized by the Company in future periods.

 

Comparison of Operating Results for the Three Months Ended September 30, 2014 and 2013

 

General. The Company’s net income for the three months ended September 30, 2014 totaled $4.5 million compared to a net loss of $451,000 for the three months ended September 30, 2013. This represents basic and diluted earnings per share of $0.15 for the three months ended September 30, 2014 compared to a basic and diluted loss per share of $0.07 for the three months ended September 30, 2013. The improvement in operating results for the three months ended September 30, 2014 is primarily due to the reversal of the valuation allowance on the Company’s deferred tax assets as discussed above, and the combined effect of a $195,000 decrease in provision for loan losses, an $896,000 decrease in noninterest expense and a $42,000 decrease in noninterest income.

29
 

 

 

Net interest income. The following table summarizes interest and dividend income and interest expense for the three months ended September 30, 2014 and 2013.

 

   Three Months Ended September 30, 
   2014   2013   $ Change   % Change 
    (Dollars in thousands) 
Interest and dividend income:                    
Interest and fees on loans  $2,470   $2,697   $(227)   (8.42%)
Securities:                    
Taxable   343    276    67    24.28 
Exempt from federal tax   107    77    30    38.96 
Other interest income   10    25    (15)   (60.00)
Total interest and dividend income   2,930    3,075    (145)   (4.72)
                     
Interest expense:                    
Deposits   295    351    (56)   (15.95)
Federal Home Loan Bank advances and                    
other borrowings   15    28    (13)   (46.43)
Subordinated debentures   17    18    (1)   (5.56)
Total interest expense   327    397    (70)   (17.63)
Net interest income  $2,603   $2,678   $(75)   (2.80)

 

 

Average Balance Sheet. The following table sets forth certain information relating to the Company’s average balance sheets and reflects the taxable equivalent yield on average earning assets and cost of average interest-bearing liabilities for the periods 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 non-accrual loans. The yields and costs include fees that are considered adjustments to yields.

 

  

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The following table summarizes average balances and annualized tax equivalent average yields or costs for the three months ended September 30, 2014 and 2013.

 

   Three Months Ended September 30, 
   2014   2013 
   Average
Balance
   Interest   Average
Yield/
Cost
   Average
Balance
   Interest   Average
Yield/
Cost
 
   (Dollars in thousands) 
Interest-earning assets:                              
Taxable securities  $86,765   $343    1.57%  $74,910   $276    1.46%
Tax-exempt securities (1)   18,573    160    3.42    12,365    116    3.72 
Loan receivables (2)   190,505    2,470    5.14    197,392    2,697    5.42 
Interest-bearing deposits,                              
FHLB stock and other   11,586    10    0.32    32,273    25    0.31 
Total interest-earning assets  $307,429    2,983    3.85   $316,940    3,114    3.90 
Interest-bearing liabilities:                              
NOW accounts   68,770    31    0.18    72,301    33    0.18 
Regular savings   72,004    48    0.26    72,018    46    0.26 
Money market accounts   46,152    34    0.30    44,739    35    0.31 
Certificates of deposit   78,955    182    0.91    92,861    237    1.01 
FHLB advances and other   2,724    15    2.12    5,271    28    2.09 
Subordinated debentures   3,609    17    1.88    3,609    18    1.92 
Total interest-bearing liabilities  $272,214    327    0.48   $290,799    397    0.54 
                               
Net interest income/interest rate spread (3)        2,656    3.37%        2,717    3.36%
Less: Taxable equivalent adjustment        53              39      
Net interest income as reported       $2,603             $2,678      
Net interest margin (4)             3.36%             3.35%
Tax equivalent effect             0.07%             0.05%
Net interest margin on a fully tax equivalent basis             3.43%             3.40%

 

(1) Tax-exempt investment income is presented on a fully taxable equivalent basis assuming a 35% tax rate.

(2) Includes fees that are considered adjustments to yield and the average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis.

(3) Interest rate spread represents the difference between the average yield on interest earning assets and average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.

(4) Net interest margin represents net interest income as a percentage of average interest earning assets.

  

Interest Income. Interest income decreased $145,000 to $2.9 million for the three months ended September 30, 2014. The average tax equivalent yield on interest-earning assets decreased five basis points to 3.85% for the three months ended September 30, 2014 from 3.90% for the comparable prior year period. In addition, interest-earning assets decreased $9.5 million to $307.4 million for the three months ended September 30, 2014 from $316.9 million for the comparable prior year period.

 

Interest and fees on loans decreased $227,000, or 8.4%, to $2.5 million for the three months ended September 30, 2014, compared to $2.7 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $6.9 million to $190.5 million for the three months ended September 30, 2014 from $197.4 million for the comparable prior year period. In addition, the average loan yield decreased 28 basis points to 5.14% for the three months ended September 30, 2014 compared to 5.42% for the three months ended September 30, 2013. Interest on taxable securities increased $67,000 for the three months ended September 30, 2014 compared to the comparable prior year period. This increase is primarily due to an increase in the average balance of taxable securities of $11.9 million to $86.8 million for the three months ended September 30, 2014 from $74.9 million for the comparable prior year period. In addition, the average yield on taxable securities increased 11 basis points to 1.57% for the three months ended September 30, 2014 from 1.46% for the comparable prior year period.

 

 

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Interest Expense. Interest expense decreased by $70,000, or 17.6%, to $327,000 for the three months ended September 30, 2014, from $397,000 for the three months ended September 30, 2013. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of six basis points to 0.48% for the three months ended September 30, 2014 from 0.54% for the comparable prior year period, which is primarily due to a decrease in overall market rates. In addition, the average balance of interest bearing liabilities decreased $18.6 million to $272.2 million for the three months ended September 30, 2014 from $290.8 million for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings decreased $14,000 during the three months ended September 30, 2014. The average balance on these borrowings decreased $2.5 million to $6.3 million for the three months ended September 30, 2014 from $8.9 million for the comparable prior year period. In addition, there was a decrease in the average cost of these borrowings of four basis points to 1.98% for the three months ended September 30, 2014 from 2.02% for the comparable period in 2013.

 

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses decreased $75,000, or 2.8%, to $2.6 million for the three months ended September 30, 2014 compared to $2.7 million for the comparable period in 2013. The Company’s net interest margin expressed as a percentage of average interest-earning assets increased to 3.36% for the three months ended September 30, 2014 as compared to 3.35% for the three months ended September 30, 2013. The average tax equivalent yield on interest-earning assets decreased five basis points to 3.85% for the three months ended September 30, 2014 from 3.90% for the comparable period ended September 30, 2013. The average balance of interest earning assets decreased $9.5 million to $307.4 million for the three months ended September 30, 2014 from $316.9 million for the three months ended September 30, 2013. The yield on taxable securities increased 11 basis points to 1.57% for the three months ended September 30, 2014 from 1.46% for the comparable prior year period. The yield on average loans decreased 28 basis points to 5.14% for the three months ended September 30, 2014 from 5.42% for the three months ended September 30, 2013. In addition, there was a six basis point decrease in the cost of average interest-bearing liabilities to 0.48% for the three months ended September 30, 2014 as compared to 0.54% for the comparable 2013 period.

 

Provision for Loan Losses. The Bank’s provision for loan losses decreased $195,000 to a credit of $75,000 for the three months ended September 30, 2014 from $120,000 for the comparable period in 2013. The $195,000 decrease in the provision was the result of management’s quarterly analysis of the allowance for loan losses. At September 30, 2014, December 31, 2013 and September 30, 2013, nonperforming loans totaled $2.9 million, $942,000 and $1.9 million, respectively. At September 30, 2014, the ratio of the allowance for loan losses to nonperforming loans was 93.9% compared to 213.3% at December 31, 2013 and 126.9% at September 30, 2013. The ratio of the allowance to total loans was 1.40%, 1.28% and 1.28%, at September 30, 2014, December 31, 2013 and September 30, 2013, respectively.

 

Nonperforming loans increased $1.9 million, or 203.3%, to $2.9 million at September 30, 2014 from $942,000 at December 31, 2013. The largest component of nonperforming loans is commercial real estate loans, which increased to $1.3 million, or 45.3% of total nonperforming loans, at September 30, 2014, from $437,000 at December 31, 2013. Nonperforming residential real estate loans increased to $539,000 at September 30, 2014 from zero at December 31, 2013 and nonperforming home equity lines of credit increased to $1.0 million at September 30, 2014 from $505,000 at December 31, 2013. Charge-offs, net of recoveries, totaled ($23,000) for the three months ended September 30, 2014 compared to $10,000 for the three months ended September 30, 2013. Nonperforming loans are loans that are ninety days past due and placed on nonaccrual status. Management continues to take aggressive actions in identifying and disposing of problem credits.

 

The amounts of the provision and allowance for loan losses are influenced by a number of factors, including current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. Should the local economic climate continue to deteriorate, borrowers may experience increased difficulties paying off loans and the level of non-performing loans, charge-offs, and delinquencies could continue to rise, which would require us to further increase the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions. Management believes that, based on information available at September 30, 2014, the Bank’s allowance for loan losses was adequate to cover probable incurred losses 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 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.

 

32
 

 

Noninterest Income

 

   Three Months Ended September 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Non-interest income:                    
Service charges on deposit accounts  $95   $89   $6    6.74%
Gain on sale of loans   133    222    (89)   (40.09)
Gain on sale of foreclosed assets   -    7    (7)   100.00 
Other non-interest income   279    231    48    20.78 
Total non-interest income  $507   $549   $(42)   (7.65)

 

 

Noninterest income totaled $507,000 and $549,000 for the three months ended September 30, 2014 and 2013, respectively. Gain on sale of loans decreased $89,000 to $133,000 for the three months ended September 30, 2014 from $222,000 for the comparable prior year period. Gain on sale of foreclosed assets decreased $7,000 to zero for the three months ended September 30, 2014 as compared to the prior year period. Other non-interest income increased $48,000 to $279,000 for the three months ended September 30, 2014 from $231,000 for the comparable prior year period primarily due to increased interchange income related to debit card usage.

 

Noninterest Expense

 

   Three Months Ended September 30, 
   2014   2013   $ Change   % Change 
      (Dollars in thousands)     
Non-interest expenses:                    
Salaries and employee benefits  $1,469   $1,468   $1    0.07%
Net occupancy and equipment expense   301    299    2    0.67 
Data processing expense   252    341    (89)   (26.10)
Advertising and promotions   45    47    (2)   (4.26)
Professional fees   200    343    (143)   (41.69)
FDIC insurance premiums   128    205    (77)   (37.56)
Write-down on other real estate owned   25    386    (361)   (93.52)
Other real estate owned expenses   36    187    (151)   (80.75)
Other operating expenses   206    282    (76)   (26.95)
Total non-interest expenses  $2,662   $3,558   $(896)   (25.18)

 

 

Noninterest expense decreased by $896,000 to $2.7 million for the three months ended September 30, 2014 from $3.6 million for the comparable prior year period. Professional fees decreased $143,000, or 41.7%, to $200,000 for the three months ended September 30, 2014 from $343,000 for the comparable prior year period. This decrease is primarily due to lower attorney’s fees related to resolving problem credits. FDIC insurance premiums decreased $77,000, or 37.6%, to $128,000 for the three months ended September 30, 2014 compared to $205,000 for the prior year period. Other real estate owned expenses decreased to $36,000 for the three months ended September 30, 2014 compared to $187,000 for the comparable prior year period. In addition, write-downs on foreclosed assets decreased to $25,000 for the three months ended September 30, 2014 from $386,000 for the comparable prior year period. This decrease is due to lower expenses related to OREO valuation adjustments. Data processing expenses decreased $89,000, or 26.1%, to $252,000 for the three months ended September 30, 2014 from $341,000 for the three months ended September 30, 2013. This decrease is primarily due to the savings from the core processing conversion the Bank completed in the fourth quarter of 2013. Advertising expenses decreased $2,000 to $45,000 for the three months ended September 30, 2014 compared to the prior year period. Other operating expenses decreased $76,000 to $206,000 for the three months ended September 30, 2014 from $282,000 for the comparable prior year period primarily due to decreased directors and officers insurance premiums and mortgage division related expenses. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to its market

 

33
 

 

 

Income Tax Expense. The Company recorded a tax benefit of $4.0 million on $523,000 in pre-tax income for the three months ended September 30, 2014. This tax benefit was due to the reversal of the valuation allowance on a portion of the Company’s net deferred tax assets, made possible by the Company’s return to profitability. The valuation allowance against the Company’s deferred tax assets was established as of December 31, 2011. The determination of being able to realize the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future taxable income and tax planning strategies. Management considered both positive and negative evidence regarding the Company’s ability to realize the deferred tax assets, which is largely dependent upon the ability to derive benefits based upon future taxable income. As of September 30, 2014, management determined that the realization of a portion of the deferred tax asset was more likely than not as required by accounting principles and reversed that amount which was fully supported by the analysis. Income tax expense totaled zero for the three months ended September 30, 2013.

 

Comparison of Operating Results for the Nine Months Ended September 30, 2014 and 2013

 

General. The Company’s net income for the nine months ended September 30, 2014 totaled $5.2 million compared to a net loss of $3.2 million for the nine months ended September 30, 2013. This represents basic and diluted earnings per share of $0.17 for the nine months ended September 30, 2014 compared to a basic and diluted loss per share of $0.53 for the nine months ended September 30, 2013. The improvement in operating results for the nine months ended September 30, 2014 is primarily the result of the $4.0 million reversal of the valuation allowance on the Company’s deferred tax assets discussed earlier and the combined effect of a $1.3 million decrease in provision for loan losses, a $109,000 increase in net interest income, a $3.1 million decrease in noninterest expense and an $268,000 decrease in noninterest income.

 

Net interest income. The following table summarizes interest and dividend income and interest expense for the nine months ended September 30, 2014 and 2013.

 

   Nine Months Ended September 30, 
   2014   2013   $ Change   % Change 
  (Dollars in thousands) 
Interest and dividend income:                    
Interest and fees on loans  $7,571   $7,972   $(401)   (5.03%)
Securities:                    
Taxable   1,019    790    229    28.99 
Exempt from federal tax   296    191    105    54.97 
Other interest income   43    104    (61)   (58.65)
Total interest and dividend income   8,929    9,057    (128)   (1.41)
                     
Interest expense:                    
Deposits   908    1,120    (212)   (18.93)
Federal Home Loan Bank advances and                    
other borrowings   68    92    (24)   (26.09)
Subordinated debentures   51    52    (1)   (1.92)
Total interest expense   1,027    1,264    (237)   (18.75)
Net interest income  $7,902   $7,793   $109    1.40 

  

 

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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 periods 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 non-accrual loans. The yields and costs include fees that are considered adjustments to yields.

 

The following table summarizes average balances and annualized average yields or costs for the nine months ended September 30, 2014 and 2013.

 

   Nine Months Ended September 30, 
   2014    2013  
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
   (Dollars in thousands) 
Interest-earning assets:                              
Taxable securities  $82,710   $1,019    1.65%  $68,158   $790    1.55%
Tax-exempt securities (1)   17,118    446    3.48    8,414    290    4.61 
Loan receivables (2)   194,817    7,571    5.20    198,699    7,972    5.36 
Interest-bearing deposits,                              
FHLB stock and other   19,421    43    0.29    42,739    104    0.33 
Total interest-earning assets  $314,066    9,079    3.86   $318,010    9,156    3.85 
                               
Interest-bearing liabilities:                              
NOW accounts   70,964    95    0.18    74,128    118    0.21 
Regular savings   73,683    144    0.26    69,350    151    0.29 
Money market accounts   44,140    97    0.29    44,729    124    0.37 
Certificates of deposit   82,293    572    0.93    94,051    727    1.03 
FHLB advances and other   4,384    68    2.08    5,921    92    2.08 
Subordinated debentures   3,609    51    1.88    3,609    52    1.93 
Total interest-bearing liabilities  $279,073    1,027    0.49   $291,788    1,264    0.58 
                               
Net interest income/interest rate spread (3)        8,052    3.37%        7,892    3.27%
Less: Taxable equivalent adjustment        150              99      
Net interest income as reported       $7,902             $7,793      
Net interest margin (4)             3.36%             3.28%
Tax equivalent effect             0.06%             0.04%
Net interest margin on a fully tax equivalent basis             3.43%             3.32%

  

(1) Tax-exempt investment income is presented on a fully taxable equivalent basis assuming a 35% tax rate.

(2) Includes fees that are considered adjustments to yield and the average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis.

(3) Interest rate spread represents the difference between the average yield on interest earning assets and average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.

(4) Net interest margin represents net interest income as a percentage of average interest earning assets.

 

 

Interest Income. Interest income decreased $128,000 to $8.9 million for the nine months ended September 30, 2014. The average tax equivalent yield on interest-earning assets increased one basis point to 3.86% for the nine months ended September 30, 2014 from 3.85% for the comparable prior year period. In addition, interest-earning assets decreased $3.9 million to $314.1 million for the nine months ended September 30, 2014 from $318.0 million for the comparable prior year period.

 

Interest and fees on loans decreased $401,000, or 5.0%, to $7.6 million for the nine months ended September 30, 2014, compared to $8.0 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $3.9 million to $194.8 million for the nine months ended September 30, 2014 from $198.7 million for the comparable prior year period. In addition, the average loan yield decreased 16 basis points to 5.20% for the nine months ended September 30, 2014 compared to 5.36% for the nine months ended September 30, 2013. Interest on taxable securities increased $229,000 for the nine months ended September 30, 2014 compared to the comparable prior year period. This increase is primarily due to an increase in the average balance of taxable securities of $14.6 million to $82.7 million for the nine months ended September 30, 2014 from $68.2 million for the comparable prior year period. In addition, the average yield on taxable securities increased 10 basis points to 1.65% for the nine months ended September 30, 2014 from 1.55% for the comparable prior year period.

 

35
 

 

 

Interest Expense. Interest expense decreased $237,000, or 18.8%, to $1.0 million for the nine months ended September 30, 2014, from $1.3 million for the nine months ended September 30, 2013. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of nine basis points to 0.49% for the nine months ended September 30, 2014 from 0.58% for the comparable prior year period, which is primarily due to a decrease in overall market rates. In addition, the average balance of interest bearing liabilities decreased $12.7 million to $279.1 million for the nine months ended September 30, 2014 from $291.2 million for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings decreased $25,000 during the nine months ended September 30, 2014. The average balance on these borrowings decreased $1.5 million to $8.0 million for the nine months ended September 30, 2014 from $9.5 million for the comparable prior year period. In addition, there was a decrease in the average cost of these borrowings of three basis points to 1.99% for the nine months ended September 30, 2014 from 2.02% for the comparable period in 2013.

 

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses increased $109,000, or 1.4%, to $7.9 million for the nine months ended September 30, 2014 compared to $7.8 million for the comparable period in 2013. The Company’s net interest margin expressed as a percentage of average interest-earning assets increased to 3.36% for the nine months ended September 30, 2014 as compared to 3.28% for the nine months ended September 30, 2013. The average tax equivalent yield on interest-earning assets increased one basis point to 3.86% for the nine months ended September 30, 2014 from 3.85% for the comparable period ended September 30, 2013. The average balance of interest earning assets decreased $3.9 million to $314.1 million for the nine months ended September 30, 2014 from $318.0 million for the nine months ended September 30, 2013. The yield on taxable securities increased 10 basis points to 1.65% for the nine months ended September 30, 2014 from 1.55% for the comparable prior year period. The yield on average loans decreased 16 basis points to 5.20% for the nine months ended September 30, 2014 from 5.36% for the nine months ended September 30, 2013. In addition, there was a nine basis point decrease in the cost of average interest-bearing liabilities to 0.49% for the nine months ended September 30, 2014 as compared to 0.58% for the comparable 2013 period.

 

Provision for Loan Losses. The Bank’s provision for loan losses decreased to $111,000 for the nine months ended September 30, 2014 from $1.4 million for the comparable period in 2013. The $1.3 million decrease in the provision was the result of management’s quarterly analysis of the allowance for loan losses. Charge-offs, net of recoveries, totaled ($71,000) for the nine months ended September 30, 2014 compared to $1.9 million for the nine months ended September 30, 2013. Nonperforming loans are loans that are ninety days past due and placed on nonaccrual status. Management continues to take aggressive actions in identifying and disposing of problem credits.

Noninterest Income

 

   Nine Months Ended September 30, 
   2014   2013   $ Change   % Change 
  (Dollars in thousands) 
Non-interest income:                
Service charges on deposit accounts  $276   $260   $16    6.15%
Gain on sale of loans   389    993    (604)   (60.83)
Loss on sale of foreclosed assets   (21)   (331)   310    93.66 
Gain on sale of securities   -    55    (55)   (100.00)
Other non-interest income   778    713    65    9.12 
Total non-interest income  $1,422   $1,690   $(268)   (15.86)

 

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Noninterest income totaled $1.4 million and $1.7 million for the nine months ended September 30, 2014 and 2013, respectively. Gain on sale of loans decreased $604,000 to $389,000 for the nine months ended September 30, 2014 from $993,000 for the comparable prior year period. Loss on sale of foreclosed assets improved $310,000 to a loss of $21,000 for the nine months ended September 30, 2014 as compared to the prior year period. Other non-interest income increased $65,000 to $778,000 for the nine months ended September 30, 2014 from $713,000 for the comparable prior year period primarily due to increased interchange income related to debit card usage.

 

Noninterest Expense

 

   Nine Months Ended September 30, 
   2014   2013   $ Change   % Change 
      (Dollars in thousands)     
Non-interest expenses:                
Salaries and employee benefits  $4,326   $4,584   $(258)   (5.63%)
Net occupancy and equipment expense   969    954    15    1.57 
Data processing expense   751    1,009    (258)   (25.57)
Advertising and promotions   120    137    (17)   (12.41)
Professional fees   616    1,058    (442)   (41.78)
FDIC insurance premiums   400    617    (217)   (35.17)
Write-down on other real estate owned   115    1,251    (1,136)   (90.81)
Other real estate owned expenses   126    507    (381)   (75.15)
Other operating expenses   591    1,039    (448)   (43.12)
Total non-interest expenses  $8,014   $11,156   $(3,142)   (28.16)

 

  

Noninterest expense decreased by $3.2 million to $8.0 million for the nine months ended September 30, 2014 from $11.2 million for the comparable prior year period. Salaries and employee benefits expenses decreased by $258,000, or 5.6%, to $4.3 million for the nine months ended September 30, 2014. This decrease is primarily due to a lower level of full-time equivalents as the Bank gained efficiencies as the result of a core processing conversion and lower commissions paid on mortgage loans sales. Professional fees decreased $442,000, or 41.8%, to $616,000 for the nine months ended September 30, 2014 from $1.1 million for the comparable prior year period. This decrease is primarily due to lower attorney’s fees related to resolving problem credits. FDIC insurance premiums decreased by $217,000, or 35.2%, to $400,000 for the nine months ended September 30, 2014 compared to $617,000 for the prior year period. Other real estate owned expenses decreased to $126,000 for the nine months ended September 30, 2014 compared to $507,000 for the comparable prior year period. In addition, write-downs on foreclosed assets decreased to $115,000 for the nine months ended September 30, 2014 from $1.3 million for the comparable prior year period. This decrease is due to lower expenses related to OREO valuation adjustments. Data processing expenses decreased $258,000, or 25.6%, to $751,000 for the nine months ended September 30, 2014 from $1.0 million for the nine months ended September 30, 2013. This decrease is primarily due to the savings from the core processing conversion the Bank completed in the fourth quarter of 2013. Advertising expenses decreased $17,000 to $120,000 for the nine months ended September 30, 2014 compared to the prior year period. Offsetting these decreases was an increase of $15,000 in occupancy expense primarily related to snow removal costs for the nine months ended September 30, 2014. Other operating expenses decreased $448,000 to $591,000 for the nine months ended September 30, 2014 from $1.0 million for the comparable prior year period primarily due to decreased directors and officers insurance premiums, mortgage division related expenses and lower corporate franchise taxes. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to its market.

 

Income Tax Expense. The Company recorded a tax benefit of $4.0 million on $1.2 million pre-tax income for the nine months ended September 30, 2014. This tax benefit was due to the reversal of the valuation allowance on a portion of the Company’s net deferred tax assets, made possible by the Company’s return to profitability. The determination of being able to realize the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future taxable income and tax planning strategies. Management considered both positive and negative evidence regarding the Company’s ability to realize the deferred tax assets, which is largely dependent upon the ability to derive benefits based upon future taxable income. As of September 30, 2014, management determined that the realization of a portion of the deferred tax asset was more likely than not as required by accounting principles and reversed that amount which was fully supported by the analysis. Income tax expense totaled $146,000 for the nine months ended September 30, 2013.

 

 

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Critical Accounting Policies

 

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2013, which was filed with the U.S. Securities and Exchange Commission on March 28, 2014. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.

 

Allowance for Credit Losses. The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

 

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

 

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

 

Deferred Taxes. 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. Under generally accepted accounting principles, income tax benefits and the related tax assets are only allowed to be recognized if they will more likely than not be fully utilized. In each future accounting period, the Company’s management will consider both positive and negative evidence when considering the ability of the Company to utilize its net deferred tax asset. Any subsequent reduction in the valuation allowance would lower the amount of income tax expense recognized in the Company’s consolidated statements of operations in future periods.

 

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.

 

38
 

 

 

Liquidity and Capital Resources

 

The Company's primary sources of funds are deposits, FHLB advances, and proceeds from principal and interest payments on loans and securities. While maturities, and scheduled amortization of loans and securities, and calls of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company generally manages the pricing of its deposits to be competitive and to increase core deposit relationships.

 

Liquidity management is both a daily and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and securities, and (iv) the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits and short- and intermediate-term U.S. government and agency obligations.

 

The Company's most liquid assets are cash and short-term investments. The levels of these assets are dependent on the Company's operating, financing, lending, and investing activities during any given year. The Company has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans. The Company may also utilize the sale of securities available for sale, federal funds lines of credit from correspondent banks, and borrowings from the Federal Home Loan Bank of Chicago.

 

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company’s primary source of funds is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is generally restricted under applicable law to net profits in the current year plus those for the previous two years. At September 30, 2014, the Company had liquid assets of $3.2 million.

 

Contractual Obligations

 

The following table discloses contractual obligations of the Company as of September 30, 2014:

 

   Payments Due By Year 
(Dollars in Thousands)      2014       2015       2016       2017       2018   and after       Total 
Federal Home Loan Bank                                   
      advances  $-   $2,000   $-   $-   $-   $-   $2,000 
Subordinated debentures   -    -    -    -    -    3,609    3,609 
Data Processing (1), (2)   165    660    660    660    660    1,980    4,785 
Total  $165   $2,660   $660   $660   $660   $5,589   $10,394 
                                    
(1)Estimated contract amount based on transaction volume. Actual expense was $750,000 and $737,000 in 2013 and 2012, respectively.
(2)A new contract was signed and is effective until October 14, 2020.

 

Off-balance-sheet Arrangements

 

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and lines of credit. For information about our loan commitments and unused lines of credit, see Note 15 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 28, 2014. We currently have no plans to engage in hedging activities in the future. For the year ended December 31, 2013 and for the nine months ended September 30, 2014, we engaged in no off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

 

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Impact of Inflation and Changing Prices

 

The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

For a discussion of the potential impact of interest rate changes upon the market value of the Company’s portfolio equity, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since December 31, 2013.

 

ITEM 4: CONTROLS AND PROCEDURES

 

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the nine months ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

40
 

 

PART II

 

ITEM 1.  LEGAL PROCEEDINGS
    

There are no material pending legal proceedings to which the Company or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses.

 

ITEM 1A.  RISK FACTORS

 

There are no material changes to the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2013.

    
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
   None
    
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
  None
    
ITEM 4.  MINE SAFETY DISCLOSURES
   Not applicable
    
ITEM 5.  OTHER INFORMATION
  None
    
ITEM 6.  EXHIBITS

 

3.1Articles of Incorporation of Community Financial Shares, Inc. (1)
3.2Bylaws of Community Financial Shares, Inc. (1)
4.1Form of Common Stock Certificate of Community Financial Shares, Inc. (2)
4.2Form of Stock Certificate for Series C Convertible Noncumulative Perpetual Preferred Stock of Community Financial Shares, Inc. (2)
4.3Form of Stock Certificate for Series D Convertible Noncumulative Perpetual Preferred Stock of Community Financial Shares, Inc. (2)
4.4Form of Stock Certificate for Series E Convertible Noncumulative Perpetual Preferred Stock of Community Financial Shares, Inc. (2)
31.1Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
31.2Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
32.1Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.0The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Loss, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to the Consolidated Financial Statements.

 

______________

(1) Incorporated by reference to the appendices to the Company’s Definitive Proxy Statement on Schedule 14A filed on April 29, 2013.

(2) Incorporated by reference to the exhibits to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.

 

 

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SIGNATURES

 

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

 

 

  COMMUNITY FINANCIAL SHARES, INC.
  (Registrant)
   
   
  /s/ Donald H. Wilson
  Donald H. Wilson
  Dated: November 14, 2014
  President and Chief Executive Officer
  (Principal Executive Officer)
   
   
  /s/ Eric J. Wedeen
  Eric J. Wedeen
  Dated: November 14, 2014
  Chief Financial Officer
  (Principal Financial Officer)

 

 

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