10-K 1 a09-35744_110k.htm 10-K

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2009

 

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 No.:  0-28312

 

First Federal Bancshares of Arkansas, Inc.

(Exact name of registrant as specified in its charter)

 

Texas

 

71-0785261

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification Number)

 

1401 Highway 62-65 North

 

 

Harrison, Arkansas

 

72601

(Address)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (870) 741-7641

 

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

 

Common Stock (par value $.01 per share)

 

The Nasdaq Stock Market LLC

(Title of Class)

 

(Exchange on which registered)

 

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

None

 

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

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required 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 o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ( § 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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

 

Large Accelerated Filer o

 

Accelerated Filer o

Non-accelerated Filer o

 

Smaller reporting company x

 

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

 

As of June 30, 2009, the aggregate value of the 4,037,386 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 809,399 shares held by directors and officers of the Registrant as a group, was approximately $15.9 million.  This figure is based on the last sales price of $3.93 per share of the Registrant’s Common Stock on June 30, 2009.

 

Number of shares of Common Stock outstanding as of April 7, 2010:  4,846,785

 

DOCUMENTS INCORPORATED BY REFERENCE

 

List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated.

 

Portions of the definitive proxy statement for the 2010 Annual Meeting of Stockholders are incorporated into Part III, Items 10 through 14 of this Form 10-K.

 

 

 



Table of Contents

 

First Federal Bancshares of Arkansas, Inc.

Form 10-K

For the Year Ended December 31, 2009

 

PART I.

 

 

Item 1.

Business

1

Item 1A.

Risk Factors

32

Item 1B.

Unresolved Staff Comments

38

Item 2.

Properties

38

Item 3.

Legal Proceedings

38

Item 4.

Removed and Reserved

 

 

 

 

PART II.

 

 

Item 5.

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

39

Item 6.

Selected Financial Data

40

Item 7.

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

42

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

56

Item 8.

Financial Statements and Supplementary Data

59

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

92

Item 9A.

Controls and Procedures

92

Item 9B.

Other Information

94

 

 

 

PART III.

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

94

Item 11.

Executive Compensation

94

Item 12.

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

94

Item 13.

Certain Relationships and Related Transactions, and Director Independence

94

Item 14.

Principal Accountant Fees and Services

94

 

 

 

PART IV.

 

 

Item 15.

Exhibits and Financial Statement Schedules

95

 



Table of Contents

 

PART I.

 

Item 1.  Business

 

GENERAL

 

First Federal Bancshares of Arkansas, Inc.  First Federal Bancshares of Arkansas, Inc. (the “Company”) is a Texas corporation organized in January 1996 by First Federal Bank (“First Federal” or the “Bank”) for the purpose of becoming a unitary holding company of the Bank.  The significant asset of the Company is the capital stock of the Bank.  The business and management of the Company consists of the business and management of the Bank.  The Company does not presently own or lease any property, but instead uses the premises, equipment and furniture of the Bank.  At the present time, the Company does not employ any persons other than officers of the Bank, and the Company utilizes the support staff of the Bank from time to time.  Additional employees will be hired as appropriate to the extent the Company expands or changes its business in the future.  At December 31, 2009, the Company had $731.1 million in total assets, $687.8 million in total liabilities and $43.3 million in stockholders’ equity.

 

The Company’s executive office is located at the home office of the Bank at 1401 Highway 62-65 North, Harrison, Arkansas 72601, and its telephone number is (870) 741-7641.

 

First Federal Bank.  The Bank is a federally chartered stock savings and loan association formed in 1934.  First Federal conducts business from its main office and nineteen full service branch offices, all of which are located in a six county area in Northcentral and Northwest Arkansas comprised of Benton, Marion, Washington, Carroll, Baxter and Boone counties.  First Federal’s deposits are insured by the Deposit Insurance Fund (“DIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”), to the maximum extent permitted by law.

 

The Bank is a community-oriented financial institution offering a wide range of retail and business deposit accounts, including noninterest bearing and interest bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts.  Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial non-real estate.  However, the Bank’s lending activities are currently restricted by recent regulatory orders.  See “Regulation — Regulatory Enforcement Actions.”  Other financial services include investment products offered through First Federal Investment Services, Inc.; automated teller machines; 24-hour telephone banking; internet banking, including account access, bill payment, e-statements and online loan applications; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.

 

The Bank is subject to examination and comprehensive regulation by the Office of Thrift Supervision (“OTS”), which is the Bank’s chartering authority and primary regulator.  The Bank is also regulated by the FDIC, the administrator of the DIF.  The Bank is also subject to certain reserve requirements established by the Board of Governors of the Federal Reserve System (“FRB”) and is a member of the Federal Home Loan Bank (“FHLB”) of Dallas, which is one of the 12 regional banks comprising the FHLB System.

 

This Form 10-K contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management.  In addition, in those and other portions of this document, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “should” and similar expressions, or the negative thereof, as they relate to the Company or the Company’s management, are intended to identify forward-looking statements.  Such statements reflect the current views of the Company with respect to future looking events and are subject to certain risks, uncertainties and assumptions.  Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended.  We caution readers not to place undue reliance on any forward-looking statements.  We do not undertake and specifically disclaim any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.  These risks could cause our actual results for the remainder of 2010 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us and could negatively affect the Company’s operating and stock performance.

 

Employees

 

The Bank had 236 full-time employees and 38 part-time employees at December 31, 2009, compared to 268 full-time employees and 44 part-time employees at December 31, 2008.   None of these employees is represented by a collective bargaining agent, and the Bank believes that it enjoys good relations with its personnel.

 

Available Information

 

The Company makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable on or through its website located at www.ffbh.com after filing with the United States Securities and Exchange Commission (“SEC”).

 

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Competition

 

The Bank faces strong competition both in attracting deposits and making loans.  Its most direct competition for deposits has historically come from other savings associations, community banks, credit unions and commercial banks, including many large financial institutions that have greater financial and marketing resources available to them.  In addition, the Bank has faced additional significant competition for investors’ funds from short-term money market securities, mutual funds and other corporate and government securities.  The ability of the Bank to attract and retain savings and certificates of deposit depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.  The Bank’s ability to increase checking deposits depends on offering competitive checking accounts and promoting these products through effective channels.  Additionally, the Bank offers convenient hours, locations and online services to maintain and attract customers.

 

The Bank experiences strong competition for loans principally from savings associations, community banks, commercial banks and mortgage companies.  The Bank competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers.

 

The Bank has twenty offices located in twelve cities and towns in Northwest and Northcentral Arkansas. In our combined market area of Washington, Marion, Carroll, Boone, Benton, and Baxter Counties, we had 6.53% of the deposit market share at June 30, 2009 compared to 6.87% at June 30, 2008. Of the thirteen banks in this market area, we are the third largest in our combined market area.

 

Corporate Overview and Strategic Initiatives

 

Overview.  As a community-oriented financial institution serving the borrowing and deposit needs of its primary market area of Northcentral and Northwest Arkansas, the Bank’s loan portfolio grew as a reflection of the economic strength and expansion of its primary market area.  Between December 31, 2002 and December 31, 2005, the Bank’s loan portfolio grew from $507.0 million to $790.6 million, primarily as a result of increased construction, commercial real estate, and land lending. However, beginning in late 2005, the Bank began to note an oversupply of homes and lots in the Northwest Arkansas market and limited its construction loan activity.  Construction loan originations dropped from $195.8 million in 2005 to $93.6 million in 2006, $39.0 million in 2007, $15.1 million in 2008, and $12.5 million in 2009.  This oversupply and, beginning in 2007, the current recession, resulted in an increase in nonperforming assets, which amounted to $78.0 million or 10.67% of total assets at December 31, 2009.  The costs associated with the Bank’s nonperforming assets, including the provision for loan losses and real estate owned expenses, were the primary factors in the Company’s net loss of $45.5 million for 2009.  As discussed further below, management has taken various actions to address its operational issues and will continue to devote substantial resources toward the resolution of all delinquent and nonperforming assets.

 

Regulatory Enforcement Actions. The OTS is the primary federal regulator of the Bank.  As a result of the loss in 2009 and the increase in nonperforming assets and based on a regulatory examination of the Company and the Bank in the fall of 2009, on April 12, 2010, the Company and the Bank each consented to the terms of Cease and Desist Orders issued by the OTS (the “Bank Order” and the “Company Order” and, together, the “Orders”).  The Orders impose certain operations restrictions on the Company and, to a greater extent, the Bank, including lending and dividend restrictions.  The Orders also require the Company and the Bank to take certain actions, including the submission to the OTS of capital plans and business plans to, among other things, preserve and enhance the capital of the Company and the Bank and strengthen and improve the consolidated Company’s operations, earnings and profitability.  The Bank Order specifically requires the Bank to achieve and maintain, by December 31, 2010, a tier 1 (core) capital ratio of at least 8% and a total risk-based capital ratio of at least 12%.  The Orders are described in greater detail herein under “Regulation — Regulatory Enforcement Matters.”  In addition, copies of the stipulations and the Orders are included as Exhibits 10.7 to 10.10 and are incorporated herein by reference.  The descriptions of the Orders set forth herein do not purport to be complete, and are qualified by reference to the full text of the Orders.

 

Any material failure by the Company and the Bank to comply with the provisions of the Orders could result in further enforcement actions by the OTS. While the Company and the Bank intend to take such actions as may be necessary to comply with the requirements of the Orders, there can be no assurance that the Company or the Bank will be able to comply fully with the Orders, or that efforts to comply with the Orders will not have adverse effects on the operations and financial condition of the Company or the Bank.  See “Risk Factors.”

 

Report of Independent Registered Public Accounting Firm. The report of the Company’s independent registered public accounting firm for the year ended December 31, 2009 contained an explanatory paragraph as to the Company’s ability to continue as a going concern primarily due to the Company’s loss of $45.5 million in 2009, the Bank’s significant level of criticized assets and the decline in the Bank’s capital position.  See Note 2 of the Notes to the Consolidated Financial Statements included in Item 8 herein.

 

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Table of Contents

 

Strategic Initiatives.  In response to the operational issues which have arisen as a result of the level of the Bank’s nonperforming assets and the difficult economic and banking environment, management has taken a number of cost saving actions, implemented various strategic initiatives and aggressively addressed the nature and level of its nonperforming assets.

 

During 2009, the Company reviewed all aspects of its cost structure and implemented the following cost saving measures:

 

·                  Reductions in compensation and benefits through

·                  decreased executive and senior management salaries,

·                  reduced director fees,

·                  reduced staffing levels,

·                  eliminated Company’s 401(k) match,

·                  suspended pay increases and bonuses;

·                  Reductions in discretionary expenses such as travel and entertainment, professional education and contributions;

·                  Reductions in advertising and public relations costs; and

·                  Reductions in third-party contract provider costs.

 

In order to complement the cost saving of the actions described above and to provide the Company with greater operational flexibility, the Company took the following actions:

 

·                  Significantly reduced lending, particularly construction and land loans;

·                  Increased liquidity;

·                  Suspended cash dividends on common and preferred stock;

·                  Maintained the level of its interest rate spread and net interest margin; and

·                  Recently hired an experienced former bank regulator as the Bank’s Credit Risk and Loan Review Manager.

 

The Company continues to work through the credit problems presented by the oversupply of homes and lots in the Company’s Northwest Arkansas market area, the housing market downturn and current market conditions.  In order to address the Company’s nonperforming assets, the Company has taken the following steps:

 

·                  Provided $44.4 million to its allowance for loan losses;

·                  Charged off $18.8 million of loans;

·                  Transferred over $24 million of loans to real estate owned;

·                  Recently hired an independent third party contractor to conduct a thorough review and analysis of its loan portfolio, including a review of collateral valuations; and

·                  Obtained updated appraisals or valuations on approximately 90% of the Company’s nonperforming assets.

 

During 2010, the Company intends to continue to proactively address the challenges presented by the economy.  The Company will focus on the following primary objectives during 2010:

 

·                  Addressing and resolving problem assets;

·                  Further reducing costs to achieve greater efficiency;

·                  Addressing and complying with all terms and conditions of the Orders; and

·                  Raising capital.

 

The Orders require the Company and the Bank to, among other things, submit a capital plan to the OTS to preserve and enhance the capital of the Company and the Bank.  In addition, the Bank Order requires the Bank to achieve and maintain a tier one core capital ratio and a total risk-based capital ratio of at least 8% and 12%, respectively, by December 31, 2010.  While the Company will consider all strategic alternatives available to it, including the reduction of assets, the Company currently intends to raise capital in the third or fourth quarter of 2010.

 

Lending Activities

 

General.  At December 31, 2009, the Bank’s portfolio of net loans receivable amounted to $481.5 million or 65.9% of the Company’s total assets.  The Bank has traditionally concentrated its lending activities on loans collateralized by real estate.  Consistent with such approach, $486.3 million or 93.8% of the Bank’s total portfolio of loans receivable (“total loan portfolio”) consisted of loans collateralized by real estate at December 31, 2009.  The Bank is currently subject to various lending restrictions as a result of the provisions of the Bank Order.  See “Regulation-Regulatory Enforcement Actions.”

 

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Table of Contents

 

Loan Composition.  The following table sets forth certain data relating to the composition of the Bank’s loan portfolio by type of loan at the dates indicated.

 

 

 

December 31,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

 

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

 

 

(Dollars in Thousands)

 

Mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One-to four-family residences

 

$

235,990

 

45.49

%

$

241,735

 

41.38

%

$

227,173

 

35.49

%

$

256,768

 

34.96

%

$

278,259

 

35.31

%

Home equity and second mortgage

 

27,022

 

5.21

 

31,712

 

5.43

 

34,315

 

5.36

 

35,192

 

4.79

 

29,210

 

3.71

 

Multifamily residential

 

27,987

 

5.40

 

24,147

 

4.13

 

15,616

 

2.44

 

12,203

 

1.66

 

12,900

 

1.64

 

Commercial real estate

 

104,618

 

20.17

 

115,935

 

19.85

 

117,548

 

18.36

 

134,647

 

18.33

 

131,181

 

16.65

 

Land loans

 

41,405

 

7.98

 

50,510

 

8.65

 

42,843

 

6.69

 

47,590

 

6.48

 

47,585

 

6.04

 

Total permanent loans

 

437,022

 

84.25

 

464,039

 

79.44

 

437,495

 

68.34

 

486,400

 

66.22

 

499,135

 

63.35

 

Construction loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residences

 

7,102

 

1.37

 

8,450

 

1.45

 

20,815

 

3.25

 

32,146

 

4.38

 

51,579

 

6.55

 

Speculative one- to four-family residences

 

8,849

 

1.71

 

17,096

 

2.93

 

40,893

 

6.39

 

80,311

 

10.93

 

104,001

 

13.20

 

Multifamily residential

 

14,178

 

2.73

 

15,016

 

2.56

 

18,632

 

2.91

 

14,120

 

1.92

 

20,919

 

2.65

 

Commercial real estate

 

9,717

 

1.87

 

18,297

 

3.13

 

31,239

 

4.88

 

21,896

 

2.98

 

22,331

 

2.83

 

Land development

 

9,449

 

1.82

 

18,457

 

3.16

 

42,145

 

6.58

 

47,439

 

6.46

 

40,232

 

5.11

 

Total construction loans

 

49,295

 

9.50

 

77,316

 

13.23

 

153,724

 

24.01

 

195,912

 

26.67

 

239,062

 

30.34

 

Total mortgage loans

 

486,317

 

93.75

 

541,355

 

92.67

 

591,219

 

92.35

 

682,312

 

92.89

 

738,197

 

93.69

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans

 

14,575

 

2.81

 

21,922

 

3.75

 

24,846

 

3.88

 

26,281

 

3.58

 

20,835

 

2.64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Automobile

 

6,810

 

1.31

 

8,631

 

1.48

 

9,531

 

1.49

 

12,086

 

1.65

 

15,748

 

2.00

 

Other consumer

 

11,052

 

2.13

 

12,291

 

2.10

 

14,537

 

2.28

 

13,815

 

1.88

 

13,149

 

1.67

 

Total consumer loans

 

17,862

 

3.44

 

20,922

 

3.58

 

24,068

 

3.77

 

25,901

 

3.53

 

28,897

 

3.67

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable

 

518,754

 

100.00

%

584,199

 

100.00

%

640,133

 

100.00

%

734,494

 

100.00

%

787,929

 

100.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Undisbursed loan funds

 

(4,327

)

 

 

(11,750

)

 

 

(36,868

)

 

 

(40,069

)

 

 

(69,086

)

 

 

Unearned discounts and net deferred loan costs (fees)

 

23

 

 

 

529

 

 

 

321

 

 

 

143

 

 

 

(156

)

 

 

Allowance for losses

 

(32,908

)

 

 

(6,441

)

 

 

(5,162

)

 

 

(2,572

)

 

 

(2,114

)

 

 

Total loans receivable, net

 

$

481,542

 

 

 

$

566,537

 

 

 

$

598,424

 

 

 

$

691,996

 

 

 

$

716,573

 

 

 

 

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Table of Contents

 

Loan Maturity and Interest Rates.  The following table sets forth certain information at December 31, 2009, regarding the dollar amount of loans maturing in the Bank’s loan portfolio based on their contractual terms to maturity.  Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. All other loans are included in the period in which the final contractual repayment is due.

 

 

 

Within
One Year

 

One Year
Through
Five Years

 

After Five
Years

 

Total

 

 

 

(In Thousands)

 

Mortgage loans:

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

10,970

 

$

20,483

 

$

204,537

 

$

235,990

 

Home equity and second mortgage

 

12,109

 

12,835

 

2,078

 

27,022

 

Multifamily residential

 

7,929

 

18,978

 

1,080

 

27,987

 

Commercial real estate

 

31,449

 

65,504

 

7,665

 

104,618

 

Land loans

 

23,068

 

16,820

 

1,517

 

41,405

 

Construction

 

42,197

 

7,098

 

 

49,295

 

Commercial loans

 

6,584

 

6,364

 

1,627

 

14,575

 

Consumer loans

 

3,855

 

12,924

 

1,083

 

17,862

 

Total(1)

 

$

138,161

 

$

161,006

 

$

219,587

 

$

518,754

 

 


(1)     Gross of undisbursed loan funds, unearned discounts and net deferred loan fees, and the allowance for loan losses.

 

The following table sets forth the dollar amount of the Bank’s loans at December 31, 2009, due after one year from such date which have fixed interest rates or which have floating or adjustable interest rates.

 

 

 

Fixed Rates

 

Floating or
Adjustable Rates

 

Total

 

 

 

(In Thousands)

 

Mortgage loans:

 

 

 

 

 

 

 

One- to four-family residential

 

$

48,959

 

$

176,061

 

$

225,020

 

Home equity and second mortgage

 

9,330

 

5,583

 

14,913

 

Multifamily residential

 

18,836

 

1,222

 

20,058

 

Commercial real estate

 

69,034

 

4,135

 

73,169

 

Land loans

 

16,782

 

1,555

 

18,337

 

Construction

 

1,600

 

5,498

 

7,098

 

Commercial loans

 

7,259

 

732

 

7,991

 

Consumer loans

 

11,690

 

2,317

 

14,007

 

Total

 

$

183,490

 

$

197,103

 

$

380,593

 

 

Scheduled contractual maturities of loans do not necessarily reflect the actual term of the Bank’s loan portfolio. The average life of mortgage loans is substantially less than their average contractual terms because of loan prepayments and refinancing.  The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans substantially exceed current mortgage loan rates.

 

Origination, Purchase and Sale of Loans.  The lending activities of the Bank are subject to the written, non-discriminatory underwriting standards and policies established by the Bank’s board of directors and management.  Loan originations are obtained from a variety of sources, including realtor referrals, walk-in customers to the Bank’s branch locations, solicitation by loan officers, radio, television and newspaper advertising and the Bank’s Internet website.  The Bank continually emphasizes its community ties and its practice of quick and efficient underwriting and loan approval processes, made possible in part through the use of automation and through residential automated underwriting software provided by Freddie Mac and Fannie Mae.  The Bank believes it provides exceptional personalized service to its customers.  The Bank requires hazard insurance, title insurance, and, to the extent applicable, flood insurance on all secured real property.

 

Applications are initially received by loan officers or from the Bank’s secure website.   Applications received over the Bank’s website are forwarded to loan officers.  All loans exceeding an individual officer’s approval authority are subject to review by members of the appropriate loan committee. The Bank has three loan committees (Senior Loan Committee, Executive Loan Committee, and Director Loan Committee) that review and make a decision based upon type, size, and classification of the credit.

 

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Table of Contents

 

During 2009, the Bank purchased a participation in one single family residential loan totaling $100,000.  During 2008, the Bank purchased a participation in one commercial mortgage loan totaling $2.3 million.  During 2007, the Bank purchased participations in four commercial construction loans with a total commitment amount of $18.7 million as well as a $1.6 million participation in a commercial loan.

 

To minimize interest rate risk, fixed rate loans with terms of fifteen years or greater are typically sold to specific investors in the secondary mortgage market.  The rights to service such loans are typically sold with the loans. This allows the Bank to provide its customers competitive long-term fixed rate mortgage products, which have been the predominant mortgage financial product for residential home buyers recently due to the low rate environment, while not exposing the Bank to undue interest rate risk.  These loans are originated subject to Fannie Mae, Freddie Mac and the specific investor’s underwriting guidelines.  The Secondary Market Department of the Bank typically locks and confirms the purchase price of the loan on the day of the loan application, which protects the Bank from market price movements and ensures that the Bank will receive a fair and reasonable price on the sale of the respective loan.  In 2009, the Bank used third party contract underwriting services with the Bank assuming all risk associated with underwriting loans including material error(s), fraud, early payoff, and early payment default.  No loans were required to be repurchased during 2009.  However, the Bank was unable to sell six loans during 2009, five due to the collapse of Taylor Bean and Whitaker.  The Bank had loans in process of being funded when this firm collapsed but the Bank was able to recover its credits and did not experience any loss associated with these loans.  In 2009, 2008, and 2007, the Bank’s secondary market loan sales amounted to $44.5 million, $25.0 million, and $58.1 million, respectively.  The Bank is not involved in loan hedging or other speculative mortgage loan origination activities.

 

In addition to sales of loans on the secondary market, the Bank periodically sells larger commercial loans or participations in such loans in order to comply with the Bank’s loans to one borrower limit or for credit concentration purposes.  In such situations, the loans are typically sold with servicing retained.  During 2009, no such loans were sold.  During the years ended December 31, 2008 and 2007, such loans sold amounted to approximately $4.0 million and $7.2 million, respectively.  At December 31, 2009, 2008, and 2007, the balances of loans sold with servicing retained were approximately $11.8 million, $28.5 million, and $27.8 million, respectively.   Loan servicing fee income for the years ended December 31, 2009, 2008, and 2007, was approximately $91,000, $117,000, and $110,000, respectively.

 

The following table shows the Bank’s originations, sales, purchases, and repayments of loans during the periods indicated.

 

 

 

Year Ended December 31,

 

 

 

2009

 

2008

 

2007

 

 

 

(In Thousands)

 

 

 

 

 

 

 

 

 

Loans receivable at beginning of period

 

$

584,199

 

$

640,133

 

$

734,494

 

Loan originations:

 

 

 

 

 

 

 

Mortgage loans:

 

 

 

 

 

 

 

One- to four-family residential

 

37,508

 

68,121

 

27,001

 

Home equity and second mortgage loans

 

7,464

 

15,214

 

20,914

 

Multifamily residential

 

584

 

6,769

 

6,427

 

Commercial real estate

 

16,297

 

23,869

 

18,356

 

Land loans

 

5,510

 

23,264

 

5,880

 

Construction

 

12,541

 

15,060

 

39,016

 

Commercial loans

 

4,803

 

14,277

 

12,395

 

Consumer:

 

 

 

 

 

 

 

Automobile

 

3,531

 

5,589

 

5,916

 

Other

 

6,866

 

9,060

 

13,347

 

Total loan originations(2)

 

95,104

 

181,223

 

149,252

 

Loan purchases

 

100

 

2,333

 

20,365

 

Repayments

 

(119,418

)

(206,781

)

(242,230

)

Loan sales

 

 

(4,045

)

(7,207

)

Transfers to real estate owned

 

(41,231

)

(28,664

)

(13,037

)

Other

 

 

 

(1,504

)

Net loan activity

 

(65,445

)

(55,934

)

(94,361

)

Loans receivable at end of period(1)

 

$

518,754

 

$

584,199

 

$

640,133

 

 


(1)     Gross of undisbursed loan funds, unearned discounts and net loan fees and the allowance for loan losses.

(2)     Includes loans with the Bank which were refinanced with the Bank of $18.9 million, $38.0 million, and $18.4 million for each of the years ended December 31, 2009, 2008, and 2007, respectively.

 

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Table of Contents

 

Loans to One Borrower.  A savings institution generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities.  At December 31, 2009, the Bank’s limit on loans to one borrower was approximately $7.3 million compared to $11.1 million at December 31, 2008.  At December 31, 2009, the Bank’s largest loan or group of loans to one borrower, including persons or entities related to the borrower, amounted to $10.8 million, including undisbursed loan funds.  Since these loans were within the Bank’s regulatory limit at the time the loans were made, they are not considered a violation of the loans to one borrower regulation.  However, they are considered non-conforming loans.  The Bank is in the process of reducing its exposure on borrower relationships that exceeded the loans to one borrower limit at December 31, 2009.   The Bank’s ten largest loans or groups of loans to one borrower, including persons or entities related to the borrower, including unfunded commitments, totaled $77.2 million at December 31, 2009.  Of the $77.2 million, twelve loans totaling $16.1 million related to three borrowers are on nonaccrual status at December 31, 2009.  See “Asset Quality.”

 

One- to Four-Family Residential Real Estate Loans.  At December 31, 2009, $236.0 million or 45.5% of the Bank’s total loan portfolio consisted of one- to four-family residential real estate loans.   Of the $236.0 million of such loans at December 31, 2009, $176.1 million or 74.6% had adjustable rates of interest (including $23.1 million of seven-year adjustable rate loans) and $59.9 million or 25.4% had fixed rates of interest. At December 31, 2009, the Bank had $11.9 million of nonaccrual one- to four-family residential loans and $2.8 million of one- to four-family residential loans 30-89 days delinquent.  See “Asset Quality.”

 

The Bank currently originates both fixed rate and adjustable rate one- to four-family residential mortgage loans.  The Bank’s fixed rate loans to be held in portfolio are typically originated with maximum terms of fifteen years and are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term.  The Bank generally does offer fixed rate loans with terms exceeding fifteen years and such loans are typically sold in the secondary market.  From time to time, the Bank does offer special 30 year fixed rate financing program for its portfolio.  These are approved by the Bank’s Executive Committee, follow traditional underwriting guidelines, and are limited in nature due to the interest rate risk involved.  The Bank’s one- to four-family loans are typically originated under terms, conditions and documentation that permit them to be sold to U.S. Government-sponsored agencies such as Fannie Mae or Freddie Mac. However, as stated above, such loans with terms of less than fifteen years are generally originated for retention in the Bank’s portfolio while substantially all of such loans with terms of fifteen years or longer are sold in the secondary market.  The Bank’s residential loans typically include “due on sale” clauses.

 

The Bank’s adjustable rate mortgage loans that are held in the portfolio typically provide for an interest rate which adjusts every one, three, five or seven years in accordance with a designated index plus a margin.  Such loans are typically based on a 15-, 20-, 25- or 30-year amortization schedule.  The Bank generally does not offer below market rates, and the amount of any increase or decrease in the interest rate per one- or three-year period is generally limited to 2%, with a limit of 6% over the life of the loan.  The Bank’s five-year adjustable rate loans provide that any increase or decrease in the interest rate per period is limited to 3%, with a limit of 6% over the life of the loan.  The Bank’s seven-year adjustable rate loans provide that any increase or decrease in the interest rate per period is limited to 5%, with a limit of 5% over the life of the loan.  The Bank’s adjustable rate loans are assumable (generally without release of the initial borrower), do not contain prepayment penalties and do not provide for negative amortization and typically contain “due on sale” clauses. The Bank generally underwrites its one- and three-year adjustable rate loans on the basis of the borrowers’ ability to pay at the rate after the first interest rate adjustment.  Adjustable rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.

 

The Bank’s residential mortgage loans generally do not exceed 80% of the lesser of purchase price or appraised value of the secured property. However, pursuant to the underwriting guidelines adopted by the board of directors, the Bank may lend up to 100% of the value of the property securing a one- to four-family residential loan with private mortgage insurance to protect the portion of the loan that exceeds 80% of the value.  The Bank may, on occasion, extend a loan up to 90% of the value of the secured property without private mortgage insurance coverage.  However, these exceptions are minimal and are only approved on loans with exceptional credit scores, sizeable asset reserves, or other compensating factors.

 

Home Equity and Second Mortgage Loans.   At December 31, 2009, $27.0 million or 5.2% of the Bank’s total loan portfolio consisted of home equity and second mortgage loans.  At December 31, 2009, the unused portion of home equity lines of credit was $8.7 million.  At December 31, 2009, the Bank had nonaccrual home equity and second mortgage loans totaling $1.2 million.  See “Asset Quality.”

 

The Bank’s home equity and second mortgage loans are fixed rate loans with fully amortized terms of up to fifteen years, variable rate interest-only loans with terms up to three years, or home equity lines of credit.  The variable rate loans are typically tied to Wall Street Journal Prime, plus a margin commensurate with the risk as determined by the borrower’s

 

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Table of Contents

 

credit score.  Longer-term amortizing loans typically have a balloon feature in five, seven, or ten years.  The home equity lines of credit are typically either fixed rate for a term of no longer than one year or variable rate with terms typically up to three years.  The Bank generally limits the total loan-to-value on these mortgages to 90% of the value of the secured property.

 

Multifamily Residential Real Estate Loans.    The Bank Order currently prohibits the Bank from making, purchasing or committing to purchase commercial real estate loans, including multifamily loans, except with the prior written non-objection of the OTS.  At December 31, 2009, $28.0 million or 5.4% of the Bank’s total loan portfolio consisted of loans collateralized by existing multifamily residential real estate properties.  At December 31, 2009, the Bank had $1.4 million of nonaccrual multifamily real estate loans.  See “Asset Quality.”

 

The Bank has originated both fixed rate and adjustable rate multifamily loans.  Fixed rate loans are generally originated with amortization periods not to exceed 30 years, and typically have balloon periods of three, five or seven years.  Adjustable rate loans are typically amortized over terms up to 30 years, with interest rate adjustments every three to seven years.  Loan-to-value ratios on the Bank’s multifamily real estate loans are currently limited to 80%.  It is also the Bank’s general policy to obtain corporate or personal guarantees, as applicable, on its multifamily residential real estate loans from the principals of the borrower.

 

Multifamily real estate lending entails significant additional risks as compared with one- to four-family residential property lending.  Such loans typically involve large loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans is typically dependent on the successful operation of the real estate project.  The success of such projects is sensitive to changes in supply and demand conditions in the market for multifamily real estate as well as regional and economic conditions generally.

 

Commercial Real Estate Loans.  The Bank Order currently prohibits the Bank from making, purchasing or committing to purchase commercial real estate loans, except with the prior written non-objection of the OTS.  At December 31, 2009, $104.6 million or 20.2% of the Bank’s total loan portfolio consisted of loans collateralized by existing commercial real estate properties.  At December 31, 2009, the Bank had $6.8 million of nonaccrual commercial real estate loans. See “Asset Quality.”

 

Many of the Bank’s commercial real estate loans are collateralized by properties such as office buildings, convenience stores, service stations, mini-storage facilities, motels, churches, small shopping malls, and strip centers.  The Bank  underwrites commercial real estate loans specifically in relation to the type of property being collateralized.  Cash flows and occupancy rates are primary considerations when underwriting loans collateralized by office buildings, mini-storage facilities and motels.  Loans with borrowers that are corporations, limited liability companies, trusts, or other such legal entities are also typically personally guaranteed by the principals of the respective entity.  The financial strength of the individuals who are personally guaranteeing the loan is also a primary underwriting factor.

 

The Bank’s policy requires real estate appraisals of properties securing commercial real estate loans by licensed real estate appraisers pursuant to state licensing requirements and federal regulations.  The Bank considers the quality and location of the real estate, the creditworthiness of the borrower, the cash flow of the project, and the quality of management involved with the property.  The Bank’s commercial real estate loans are generally originated with amortization periods not to exceed 25 years.  Generally, the Bank has structured these on three-, five-, or seven-year balloon terms. Recently and to the extent possible, the Bank is restructuring any loan renewal on these credits to variable rate loans priced with a margin tied to Wall Street Journal Prime, minimum floor rate and pricing commensurate with the risk of the credit.  The Bank is generally keeping maturities of these credits shorter in order to enable the Bank to better manage its interest rate sensitivity during this low rate environment.  As part of the criteria for underwriting multifamily and commercial real estate loans, the Bank prepares a cash flow analysis that includes a vacancy rate projection, expenses for taxes, insurance, maintenance and repair reserves as well as debt coverage ratios.  This information is also included in commercial real estate appraisals.

 

Commercial real estate lending entails additional risks as compared to the Bank’s one- to four-family residential property loans. Commercial real estate loans generally involve larger loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans is typically dependent on the successful operation of the real estate project. The success of such projects is sensitive to changes in supply and demand conditions in the market for commercial real estate, and largely on regional and economic conditions.  Within the last several years, reports have ranked the Northwest Arkansas as one of the top performing economic areas in the country.   During these periods of economic expansion the Bank focused on commercial real estate activities within the market in order to take advantage of growth. More recently, this economic expansion resulted in an oversupply of residential lots and residential housing and recently all market areas of the Bank have been affected by the downturn in the national economy.  The Northwest Arkansas market region is currently in a correction mode but the Bank believes this region is still an economically viable area for the future.  This region is the home of the world’s largest retailer, Wal-Mart; as well as the nation’s largest meat company, Tyson Foods; the trucking firm J. B. Hunt; and the University of Arkansas.

 

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Table of Contents

 

Land Loans.  Land loans include loans for the acquisition or refinancing of land for consumer or commercial purposes.  This segment of the portfolio totaled $41.4 million, or 8.0% of the Bank’s total loan portfolio, as of December 31, 2009, and included $24.8 million of raw land, $14.6 million of developed residential lots, and $2.0 million of developed commercial property.  Generally, these loans are collateralized by properties in the Bank’s market areas.  The Bank Order currently prohibits the Bank from extending credit for the purpose of land acquisition, except with the prior written non-objection of the OTS.  At December 31, 2009, the Bank had nonaccrual land loans totaling $13.7 million.  See “Asset Quality.”

 

Land Development Loans.  The Bank has also offered loans for the acquisition and development of land into residential subdivisions. At December 31, 2009, $9.4 million or 1.8% of the Bank’s total loan portfolio consisted of land development loans.  However, no new land development loans have been originated since the fourth quarter of 2006 due to local real estate market conditions.  In addition, the Bank Order currently prohibits the Bank from extending credit for the purpose of land acquisition and development, except with the prior written non-objection of the OTS.  This segment of the market in Northwest Arkansas has been heavily impacted by the housing market slowdown.  As a result of slowing lot sales, borrowers have been unable to rely on lot sales to repay their loans and have had to rely on secondary sources of repayment.  At December 31, 2009, the Bank had nonaccrual land development loans totaling $6.1 million.  See “Asset Quality.”

 

Construction Loans.  The Bank Order currently prohibits the Bank from extending credit for construction lending without the prior non-objection of the OTS, except for construction of an owner occupied one- to four-family dwelling with at least 20 percent down payment or that is subject to a firm pre-sold commitment.  At December 31, 2009, construction loans, including land development loans, amounted to $49.3 million or 9.5% of the Bank’s total loan portfolio. Our market areas of Benton and Washington counties previously experienced tremendous growth and provided the Bank with increased lending opportunities.  However, beginning in late 2005, the Bank began to note an oversupply of homes and lots in the Northwest Arkansas market and limited its construction loan origination activity accordingly.  Construction loan originations dropped from $93.6 million in 2006 to $39.0 million in 2007, $15.1 million in 2008 and $12.5 million in 2009.

 

The Bank’s construction loans generally have fixed interest rates or variable rates that float with Wall Street Journal Prime and have typically been issued for terms of six to eighteen months. However, the Bank has originated construction loans with terms up to two years.  This practice has generally been limited to larger projects that could not be completed in the typical six- to eighteen-month period.  Construction loans were typically made with a maximum loan-to-value ratio of 80% on an as-completed basis.

 

The Bank originated construction loans to individual homeowners and local builders and developers for the purpose of constructing one- to four-family residences.  The Bank typically required that permanent financing with the Bank or some other lender be in place prior to closing any non-speculative construction loan.  Interest on construction/permanent loans is due upon completion of the construction phase of the loan.  At such time, the loan will convert to a permanent loan at the interest rate established at the initial closing of the construction/permanent loan.

 

The Bank has made construction loans to local builders for the purpose of construction of speculative (or unsold) residential properties, and for the construction of pre-sold one- to four-family homes.  These loans were subject to credit review, analysis of personal and, if applicable, corporate financial statements, and an appraisal of the property to be constructed. The Bank also reviewed and inspected the project prior to the disbursement of funds (draws) during the construction term.  Loan proceeds were disbursed after a satisfactory inspection of the project has been made based upon percentage of completion.  Interest on these construction loans is due upon maturity.  The Bank may extend the term of a construction loan upon payment of interest accrued if the property has not been sold by the maturity date.  During 2006, the Bank began to experience an increase in the incidence of builders who were unable to pay their interest at maturity due to a softening of the housing market in Northwest Arkansas.  Market data indicates an overall decrease in the number of home sales in Benton and Washington counties in 2009 compared to 2008, 2007 and 2006.

 

Construction lending is generally considered to involve a higher level of risk as compared to one- to four-family residential loans.  This is due, in part, to the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on developers and builders.  In addition, construction loans to a builder for construction of homes that are not pre-sold possess a greater potential risk to the Bank than construction loans to individuals on their personal residences or on houses that are pre-sold prior to the inception of the loan.  The Bank analyzed each borrower involved in speculative building and limited the principal amount and number of unsold speculative homes at any one time with such borrower.  At December 31, 2009, the Bank’s portfolio of speculative single-family loans consisted of 41 loans with an average balance of approximately $223,000.  Seventy-four percent of the Bank’s $8.8 million in speculative single-family loans was concentrated with five borrowers who had 25 loans totaling $6.7 million.  One of these borrowers had four loans totaling $830,000 on nonaccrual status at December 31, 2009.  At December 31, 2009, the Bank had nonaccrual speculative one- to four-family construction loans totaling $1.1 million.  See “Asset Quality.”

 

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Table of Contents

 

Commercial Loans.  The Bank also offers commercial loans, which primarily consist of equipment and inventory loans that are typically cross-collateralized by commercial real estate.  At December 31, 2009, such loans amounted to $14.6 million or 2.8% of the total loan portfolio.  At December 31, 2009, the Bank had nonaccrual commercial loans totaling $463,000.  See “Asset Quality.”

 

The Bank’s commercial loans are typically originated with fixed interest rates and call provisions between one and five years.  These loans are typically based on a maximum fifteen-year amortization schedule.  The Bank also originates interest-only commercial loans and variable rate commercial loans.  The Bank’s commercial loans do not provide for negative amortization.

 

Consumer Loans.  The Bank offers consumer loans in order to provide a full range of financial services to its customers while increasing the yield on its overall loan portfolio and decreasing its interest rate risk due to the relatively shorter-term nature of consumer loans. The consumer loans offered by the Bank primarily include automobile loans, deposit account secured loans, and unsecured loans.  Consumer loans amounted to $17.9 million or 3.4% of the total loan portfolio at December 31, 2009, of which $6.8 million and $11.1 million consisted of automobile loans and other consumer loans, respectively.  The Bank intends to continue its emphasis on consumer loans in furtherance of its role as a community-oriented financial institution.  At December 31, 2009, the Bank had $129,000 of nonaccrual consumer loans.  See “Asset Quality.”

 

The Bank’s automobile loans are typically originated for the purchase of new and used cars and trucks.  Such loans are generally originated with a maximum term of five years.  The Bank does offer extended terms on automobile loans to some customers based upon their creditworthiness.

 

Other consumer loans consist primarily of deposit account loans and unsecured loans.  Loans secured by deposit accounts are originated for up to 95% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the deposit account balance.

 

Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Asset Quality

 

Generally, when a borrower fails to make a loan payment before the expiration of the loan’s assigned grace period, a late charge is assessed and a late charge notice is mailed. Collection personnel review all delinquent accounts and attempt to cure the delinquency by contacting the borrower.  The Bank’s policies and procedures provide for frequent contact with the borrower until the delinquency is cured or until an acceptable repayment plan has been agreed upon.  Contact, by phone and mail, with delinquent borrowers begins immediately after the expiration of the loan’s assigned grace days.  The Bank’s collectors also have weekly phone conferences with loan officers to review the respective officer’s delinquent lists. Generally, when a consumer loan is 60 days past due and the borrower has not indicated a willingness to work with the Bank to bring the account current within a reasonable period of time, the collector will mail a letter giving the borrower 10 days to bring the account current or make acceptable arrangements.  If they fail to cure the default, the collateral will be foreclosed or repossessed, as applicable.  We attempt to work with troubled borrowers to return their loans to performing status where possible.  The decision on when to proceed with foreclosure/repossession is made on a case-by- case basis.  The Bank recognizes that this will cause the delinquency rate on the mortgage portfolio to be elevated for an extended period of time.

 

Loans are placed on nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual.  When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income.  The Bank generally does not accrue interest on loans past due 90 days or more.  Loans may be reinstated to accrual status when payments are made to bring the loan less than 90 days past due and, in the opinion of management, collection of the remaining balance can be reasonably expected.  The Bank may continue to accrue interest on certain loans that are 90 days past due or more if such loans are in the process of collection and collection is reasonably assured.

 

Real estate properties acquired through foreclosure are initially recorded at fair value less estimated selling costs.   Fair value is typically determined based on the lower of appraised value or the anticipated listing price of the property. Valuations of real estate owned are performed at least semi-annually.  Real estate is carried at the lower of carrying amount or fair value less cost to sell.

 

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Table of Contents

 

Delinquent Loans.  The following table sets forth information concerning loans past due 30-89 days not on nonaccrual status at December 31, 2009 and 2008, in dollar amounts and as a percentage of the Bank’s total loan portfolio.  The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts that are past due.  Past due loans not on nonaccrual status are up since December 31, 2008 in categories of land, commercial real estate and commercial loans.  We believe the negative trend in these categories is due to economic conditions and we have increased our General Valuation Allowances (“GVA”) in these categories accordingly.

 

 

 

December 31, 2009

 

December 31, 2008

 

One- to four-family residential

 

$

2,759

 

$

4,003

 

Home equity and second mortgage

 

201

 

558

 

Speculative one- to four-family construction

 

 

649

 

Land

 

1,156

 

326

 

Commercial real estate

 

974

 

465

 

Commercial loans

 

1,668

 

114

 

Consumer loans

 

118

 

194

 

 

 

$

6,876

 

$

6,309

 

 

 

 

 

 

 

Percentage of Portfolio

 

1.33

%

1.08

%

 

11


 


Table of Contents

 

The following table sets forth the amounts and categories of the Bank’s nonperforming assets, net of specific valuation allowance, at the dates indicated.

 

 

 

December 31, 2009

 

December 31, 2008

 

December 31, 2007

 

December 31, 2006

 

December 31, 2005

 

 

 

Net

 

% Assets

 

Net

 

% Assets

 

Net

 

% Assets

 

Net

 

% Assets

 

Net

 

% Assets

 

Nonaccrual Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

 11,941

 

1.63

%

$

 8,322

 

1.05

%

$

 6,778

 

0.86

%

$

 3,634

 

0.43

%

$

 2,617

 

0.31

%

Home equity and second mortgage

 

1,174

 

0.16

%

897

 

0.11

%

1,176

 

0.15

%

891

 

0.10

%

267

 

0.03

%

Speculative one- to four-family construction

 

1,081

 

0.15

%

1,461

 

0.18

%

4,902

 

0.62

%

5,287

 

0.62

%

1,140

 

0.13

%

Multifamily residential

 

1,431

 

0.20

%

441

 

0.06

%

 

 

 

 

 

 

Land development

 

6,144

 

0.84

%

1,520

 

0.19

%

9,092

 

1.15

%

5,324

 

0.62

%

 

 

Land

 

13,709

 

1.88

%

2,117

 

0.27

%

1,310

 

0.16

%

1,352

 

0.16

%

 

 

Commercial real estate

 

6,795

 

0.93

%

6,542

 

0.82

%

6,135

 

0.77

%

738

 

0.09

%

707

 

0.08

%

Commercial loans

 

463

 

0.06

%

1,164

 

0.15

%

895

 

0.11

%

1,049

 

0.12

%

181

 

0.02

%

Consumer loans

 

129

 

0.01

%

39

 

0.00

%

146

 

0.02

%

134

 

0.02

%

211

 

0.03

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonaccrual loans

 

42,867

 

5.86

%

22,503

 

2.83

%

30,434

 

3.84

%

18,409

 

2.16

%

5,123

 

0.60

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing loans 90 days or more past due

 

 

 

8,961

 

1.13

%

2,412

 

0.30

%

668

 

0.08

%

1,600

 

0.19

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate owned

 

35,155

 

4.81

%

22,385

 

2.81

%

8,120

 

1.03

%

3,858

 

0.45

%

892

 

0.10

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets

 

78,022

 

10.67

%

53,849

 

6.77

%

40,966

 

5.17

%

22,935

 

2.69

%

7,615

 

0.89

%

Performing restructured loans

 

4,609

 

0.63

%

1,893

 

0.24

%

1,394

 

0.18

%

1,972

 

0.23

%

6,673

 

0.78

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets and performing restructured loans

 

$

 82,631

 

11.30

%

$

 55,742

 

7.01

%

$

 42,360

 

5.35

%

$

 24,907

 

2.92

%

$

 14,288

 

1.67

%

 

12


 


Table of Contents

 

The increase in net nonaccrual loans from $22.5 million at December 31, 2008 to $42.9 million at December 31, 2009 was primarily related to increases in nonaccrual land development loans, nonaccrual land loans and nonaccrual single family loans.  The increase in nonaccrual land and land development loans was primarily due to the nonaccrual loans disclosed in the table below.  All nonaccrual land and land development loans with a loan balance in excess of $1.0 million at December 31, 2009 are listed in the table below (in thousands).

 

 

 

Location

 

Date to
Nonaccrual

 

Comments

 

Loan
Balance

 

Specific
Valuation
Allowance

 

Net of
SVA

 

Valuation
Date

 

Source

 

Land Development

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

42 developed single family lots

 

Cave Springs, AR

 

3Q2007

 

A

 

$

1,040

 

$

 

$

1,040

 

11/10/2009

 

F

 

52 single family lots and 25 acres of undeveloped land

 

Fayetteville, AR

 

1Q2009

 

B

 

3,720

 

 

3,720

 

11/10/2009

 

F, G

 

40 acres, proposed residential subdivision

 

Farmington, AR

 

3Q2009

 

C

 

1,060

 

 

1,060

 

10/27/2009

 

F

 

Other - two loans

 

 

 

 

 

 

 

394

 

70

 

324

 

 

 

 

 

 

 

 

 

 

 

 

 

$

6,214

 

$

70

 

$

6,144

 

 

 

 

 

Land

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

80 acres for future residential development

 

Fayetteville, AR

 

1Q2009

 

D

 

$

2,223

 

$

 

$

2,223

 

10/27/2009

 

G

 

29 acres for future commercial development

 

Springdale, AR

 

1Q2009

 

D

 

2,029

 

 

2,029

 

10/26/2009

 

G

 

24 acres, commercial zoned

 

Lowell, AR

 

1Q2009

 

D

 

1,947

 

 

1,947

 

10/26/2009

 

G

 

96 developed single family lots

 

Fayetteville, AR

 

1Q2009

 

E

 

2,735

 

310

 

2,425

 

1/8/2010

 

F

 

60 acres, residential zoned

 

Fayetteville, AR

 

1Q2009

 

B

 

2,005

 

777

 

1,228

 

1/15/2010

 

G

 

35 acres, proposed residential subdivision

 

Fayetteville, AR

 

3Q2009

 

C

 

3,447

 

2,308

 

1,139

 

1/9/2010

 

G

 

Other - 24 loans under $1 million each

 

 

 

 

 

 

 

3,247

 

529

 

2,718

 

 

 

 

 

 

 

 

 

 

 

 

 

$

17,633

 

$

3,924

 

$

13,709

 

 

 

 

 

 


A —

This loan has been nonperforming for an extended period while the Bank exercised forbearance with the borrowers to allow them to market and maintain the property. The Bank is currently foreclosing on the property.

B —

These two loans are related to the same borrower. The loans matured in January 2010 and are now in foreclosure.

C —

These two loans are related to the same borrower group. These loans have been sent to legal counsel for collection/foreclosure.

D —

These loans are all related to the same borrower and all are in foreclosure.

E —

This loan is in foreclosure. This property is also the subject of litigation related to bonds that were sold without satisfying the first mortgage with the Bank.

F —

This valuation is based on discounted cash flow analysis.

G —

This valuation is based on comparable sales.

 

We expect a significant amount of the nonaccrual real estate loans to eventually migrate to real estate owned as $22.8 million of the nonaccrual real estate loans, net of specific valuation allowances of $436,000, are in bankruptcy or some stage of the foreclosure process as of December 31, 2009.  Therefore, we expect real estate owned and associated expenses to continue to remain at elevated levels in future periods as such loans migrate from loans to real estate owned.

 

The following table sets forth the amounts and categories of the Bank’s real estate owned at the dates indicated.

 

 

 

December 31,
2009

 

December 31,
2008

 

Increase
(Decrease)

 

Percentage
Change

 

 

 

(Dollars in Thousands)

 

 

 

 

 

Real estate owned

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

10,420

 

$

3,436

 

$

6,984

 

203.3

%

Speculative one- to four-family construction(1)

 

2,970

 

4,310

 

(1,340

)

(31.1

)

Multifamily

 

545

 

 

545

 

 

Land(2)

 

13,808

 

13,314

 

494

 

3.7

 

Commercial real estate

 

7,412

 

1,325

 

6,087

 

459.4

 

Total real estate owned

 

$

35,155

 

$

22,385

 

$

12,770

 

57.0

%

 


(1)          At December 31, 2009, $1.8 million of these properties were 100% complete.  The remainder range from 73% to 93% complete.

(2)          At December 31, 2009, $8.4 million of the land balance represented 288 developed subdivision lots and $2.6 million represented four unimproved commercial lots. The remaining $2.8 million consisted of raw land.

 

13



Table of Contents

 

The land component of real estate owned is made up of the following at December 31, 2009 (in thousands):

 

 

 

Location

 

Date to real
estate owned

 

Balance

 

Valuation Date

 

Source

 

 

 

 

 

 

 

 

 

 

 

 

 

Land

 

 

 

 

 

 

 

 

 

 

 

35 developed single family lots

 

Pea Ridge, AR

 

12/30/2008

 

$

385

 

1/14/2010

 

1

 

48 developed single family lots

 

Elm Springs, AR

 

10/21/2008

 

1,260

 

1/27/2010

 

1

 

110 developed single family lots

 

Springdale, AR

 

4/17/2008

 

3,534

 

1/14/2010

 

1

 

61 developed single family lots

 

Lowell, AR

 

5/30/2008

 

1,701

 

1/15/2010

 

1

 

30.7 acres for future residential development

 

Lowell, AR

 

5/30/2008

 

1,257

 

10/26/2009

 

2

 

63.3 acres for future residential development

 

Elm Springs, AR

 

10/21/2008

 

888

 

1/27/2010

 

2

 

10 developed single family lots

 

Farmington, AR

 

7/2/2009

 

564

 

12/30/2009

 

2

 

1 unimproved commercial lot

 

Rogers, AR

 

10/29/2009

 

1,879

 

1/27/2010

 

2

 

3 unimproved commercial lots

 

Springdale, AR

 

11/19/2009

 

734

 

10/27/2009

 

1

 

Other - 30 properties

 

 

 

 

 

1,606

 

 

 

 

 

 

 

 

 

 

 

$

13,808

 

 

 

 

 

 


1 — This valuation is based on discounted cash flow.

2 — This valuation is based on comparable sales.

 

The Bank is diligently working to dispose of its REO and has several team members dedicated to this effort, including an experienced special assets officer who is working full-time to liquidate the Bank’s properties in the Northwest Arkansas market. Each property is evaluated on a case-by-case basis to determine the best course of action with respect to liquidation.  Properties are marketed directly by the Bank or listed with local real estate agents utilizing appraisals, market information from realtors, market research reports, and our own market evaluations to make pricing and selling decisions.  The Bank’s Chief Lending Officer, loan officers, credit manager, special assets officer, and team members in the collections department all work together in this endeavor.  The Bank’s goal is to liquidate these properties in an orderly and efficient manner without incurring extraordinary losses due to quick sale pricing.

 

Classified Assets.  Federal regulations require that each insured savings association classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them.  There are three classifications for problem assets: “substandard,” “doubtful” and “loss.”  Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.  At December 31, 2009, the Bank had $125.5 million of classified assets, all of which were classified as substandard, including $42.9 million of nonaccrual loans and $35.2 million of real estate owned.  Substandard loans include $47.4 million of loans not included in the nonperforming assets table.  Such loans have been reviewed and determined not to be impaired or if impaired, were estimated to have no loss.  As a result, such loans remained on accrual status at December 31, 2009.

 

In addition, at December 31, 2009, the Bank had $41.4 million of assets designated as special mention. Special mention assets have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institution’s credit position at some future date.

 

Potential Problem Loans.   Based on the oversupply of lots in Northwest Arkansas, our land development portfolio poses a higher risk of default.  These loans are typically structured with interest due at maturity and lot sales as the source of repayment.  Since lot sales in the Northwest Arkansas market are significantly slower than when these loans were originated, our borrowers typically must rely on a secondary source of funds to pay the interest as it becomes due.  Due to the relatively large balances of these types of loans, the interest due at maturity is usually significant.  At December 31, 2009, gross land development loans totaled $9.4 million.  Of this total, $6.2 million is on nonaccrual status with $1.4 million in nonaccrual interest, and $3.2 million with $15,000 in accrued interest is classified as substandard and remains on accrual.

 

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 earnings.  Loan losses are charged against the allowance when management believes it is likely that a loan balance is uncollectible.  Subsequent recoveries, if any, are credited to the allowance.

 

14



Table of Contents

 

The allowance for loan losses represents management’s estimate of incurred credit losses inherent in the Company’s loan portfolio as of the balance sheet date.  The estimation of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of the Company’s borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and general economic conditions, including unemployment, bankruptcy trends, vacancy rates and home sales.  Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.

 

A loan is considered impaired when, based on current information and events, it is probable that the Bank 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 short fall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis 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.  Multifamily residential, commercial real estate, land and land development, and commercial loans that are delinquent or where the borrower’s total loan relationship exceeds $1 million are evaluated on a loan-by-loan basis at least annually.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.  Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the allowance for losses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the allowance for losses includes segregating certain specific, poorly performing loans based on their performance characteristics from the pools of loans as to type, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.

 

In estimating the amount of credit losses inherent in our loan portfolio, various judgments and assumptions are made.  For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio.  For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the Bank has to foreclose or repossess the collateral.

 

Although we consider the allowance for loan losses of approximately $32.9 million, which consists of a general valuation allowance of $25.4 million and a specific valuation allowance of $7.5 million, adequate to cover losses inherent in our loan portfolio at December 31, 2009, no assurance can be given that we will not sustain loan losses that are significantly different from the amount recorded, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, would not result in a significant change in the allowance for loan losses.  Either of these occurrences could materially and adversely affect our financial condition and results of operations.

 

15



Table of Contents

 

The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods indicated.

 

 

 

Year Ended December 31,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans outstanding at end of period

 

$

518,754

 

$

584,199

 

$

640,133

 

$

734,494

 

$

787,929

 

Average loans outstanding

 

$

549,215

 

$

583,063

 

$

649,062

 

$

726,642

 

$

687,373

 

Allowance at beginning of period

 

$

6,441

 

$

5,162

 

$

2,572

 

$

2,114

 

$

1,846

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

(1,218

)

(63

)

(75

)

(25

)

(74

)

Home equity and second mortgage

 

(657

)

(392

)

(175

)

(2

)

(49

)

Multifamily residential

 

(601

)

 

 

 

 

Commercial real estate

 

(1,835

)

(316

)

(18

)

 

 

Land

 

(6,312

)

(32

)

(20

)

 

 

Land development

 

(4,453

)

(2,396

)

 

 

 

Construction

 

(630

)

(236

)

(401

)

(239

)

(77

)

Commercial

 

(2,352

)

(827

)

(132

)

(234

)

(41

)

Consumer (1)

 

(706

)

(652

)

(798

)

(695

)

(715

)

Total charge-offs

 

(18,764

)

(4,914

)

(1,619

)

(1,195

)

(956

)

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

7

 

 

5

 

 

 

Home equity and second mortgage

 

5

 

5

 

 

 

2

 

Multifamily residential

 

9

 

 

 

 

 

Commercial real estate

 

14

 

88

 

 

 

1

 

Land

 

2

 

2

 

 

 

 

Land development

 

650

 

 

 

 

 

Construction

 

9

 

231

 

5

 

7

 

 

Commercial

 

2

 

2

 

 

 

 

Consumer (1)

 

168

 

155

 

171

 

164

 

120

 

Total recoveries

 

866

 

483

 

181

 

171

 

123

 

Net charge-offs

 

(17,898

)

(4,431

)

(1,438

)

(1,024

)

(833

)

Total provisions for losses

 

44,365

 

5,710

 

4,028

 

1,482

 

1,101

 

Allowance at end of period

 

$

32,908

 

$

6,441

 

$

5,162

 

$

2,572

 

$

2,114

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of total loans outstanding at end of period

 

6.34

%

1.11

%

0.81

%

0.35

%

0.27

%

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off as a percentage of average loans outstanding

 

3.26

%

0.76

%

0.22

%

0.14

%

0.12

%

 


(1)          Consumer loan charge-offs include overdraft charge-offs of $375,000, $480,000, $575,000, $600,000, and $522,000, for the years ended December 31, 2009, 2008, 2007, 2006, and 2005, respectively.  Consumer loan recoveries include recoveries of overdraft charge-offs of $142,000, $140,000, $162,000, $151,000, and $114,000, for the years ended December 31, 2009, 2008, 2007, 2006, and 2005, respectively.

 

16


 


Table of Contents

 

The following table presents the allocation of the Bank’s allowance for loan losses by the type of loan at each of the dates indicated.

 

 

 

December 31,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

 

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One-to-four family residences

 

$

4,292

 

45.49

%

$

490

 

41.38

%

$

221

 

35.49

%

$

204

 

34.96

 

$

173

 

35.31

%

Home equity and second mortgage

 

1,688

 

5.21

 

350

 

5.43

 

160

 

5.36

 

222

 

4.79

 

136

 

3.71

 

Speculative one- to four-family construction

 

884

 

1.71

 

153

 

2.93

 

405

 

6.39

 

589

 

10.93

 

295

 

13.20

 

Multifamily residential

 

2,671

 

5.40

 

29

 

4.13

 

19

 

2.44

 

15

 

1.66

 

16

 

1.64

 

Commercial real estate

 

8,554

 

20.17

 

448

 

19.85

 

309

 

18.36

 

413

 

18.33

 

372

 

16.65

 

Land

 

8,589

 

7.98

 

869

 

8.65

 

105

 

6.69

 

48

 

6.48

 

 

6.04

 

Land development

 

1,181

 

1.82

 

1,583

 

3.16

 

2,658

 

6.58

 

211

 

6.46

 

101

 

5.11

 

Construction

 

1,911

 

5.97

 

79

 

7.14

 

118

 

11.04

 

92

 

9.28

 

113

 

12.03

 

Commercial

 

2,578

 

2.81

 

2,020

 

3.75

 

628

 

3.88

 

452

 

3.58

 

371

 

2.64

 

Consumer

 

560

 

3.44

 

420

 

3.58

 

539

 

3.77

 

326

 

3.53

 

437

 

3.67