10-Q 1 d398209d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2012

OR

 

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

For the transition period from              to             

Commission file number: 0-51296

 

 

COMMUNITY FINANCIAL SHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   36-4387843

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

357 Roosevelt Road

Glen Ellyn, Illinois

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

(630) 545-0900

(Registrant’s telephone number, including area code)

None

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

 

 

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   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   x

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

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

 

Class

 

Outstanding at November 6, 2012

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

 

 

 


Table of Contents

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

     28   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     41   

Item 4

  

Controls and Procedures

     41   
  

PART II – OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     42   

Item 1A.

  

Risk Factors

     42   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     42   

Item 3.

  

Defaults Upon Senior Securities

     42   

Item 4.

  

Mine Safety Disclosures

     42   

Item 5.

  

Other Information

     42   

Item 6.

  

Exhibits

     42   
  

Signatures

     43   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

     September 30,
2012
    December 31,
2011
 
     (Unaudited)        

ASSETS

    

Cash and due from banks

   $ 4,498      $ 4,486   

Interest-bearing deposits

     41,949        39,772   
  

 

 

   

 

 

 

Cash and cash equivalents

     46,447        44,258   

Interest-bearing time deposits

     1,941        3,435   

Securities available for sale

     50,857        43,931   

Loans held for sale

     3,651        633   

Loans, less allowance for loan losses of $5,309 and $8,854 at September 30, 2012 and December 31, 2011, respectively

     194,217        198,110   

Foreclosed assets, net

     11,078        9,265   

Prepaid FDIC assessment

     —          490   

Federal Home Loan Bank stock

     1,895        5,398   

Premises and equipment, net

     14,871        15,121   

Cash value of life insurance

     6,362        6,182   

Interest receivable and other assets

     2,859        2,163   
  

 

 

   

 

 

 

Total assets

   $ 334,178      $ 328,986   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits

   $ 307,430      $ 301,101   

Federal Home Loan Bank advances

     13,000        13,000   

Other borrowings

     1,300        1,300   

Subordinated debentures

     3,609        3,609   

Interest payable and other liabilities

     3,354        2,726   
  

 

 

   

 

 

 

Total liabilities

     328,693        321,736   

Commitments and contingent liabilities

    

Shareholders’ equity

    

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

     —          —     

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

     7        7   

Paid-in capital

     12,097        12,033   

Accumulated deficit

     (7,326     (5,407

Accumulated other comprehensive income

     707        617   
  

 

 

   

 

 

 

Total shareholders’ equity

     5,485        7,250   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 334,178      $ 328,986   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three and Nine Months Ended September 30, 2012 and 2011

(In thousands, except share and per share data)

(Unaudited)

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2012     2011     2012     2011  

Interest and dividend income

        

Interest and fees on loans

   $ 2,719      $ 2,930      $ 8,289      $ 8,855   

Securities:

        

Taxable

     241        254        710        774   

Exempt from federal income tax

     82        110        283        332   

Other interest income

     38        27        117        87   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and dividend income

     3,080        3,321        9,399        10,048   

Interest expense

        

Deposits

     426        487        1,343        1,560   

Federal Home Loan Bank advances and other borrowed funds

     89        101        286        301   

Subordinated debentures

     19        17        58        53   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     534        605        1,687        1,914   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     2,546        2,716        7,712        8,134   

Provision for loan losses

     180        173        1,137        2,867   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest after provision for loan losses

     2,366        2,543        6,575        5,267   

Non-interest income

        

Service charges on deposit accounts

     98        108        289        323   

Gain on sale of loans

     229        126        609        467   

Gain on sale of securities

     —          —          141        104   

Write-down on other real estate owned

     —          —          (424     (255

Loss on sale of foreclosed assets

     (25     (33     (20     (28

Other non-interest income

     256        272        800        809   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     558        473        1,395        1,420   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense

        

Salaries and employee benefits

     1,548        1,402        4,361        4,264   

Net occupancy and equipment expense

     313        345        962        1,037   

Data processing expense

     317        300        930        889   

Advertising and promotions

     81        72        218        188   

Professional fees

     254        255        778        770   

FDIC insurance premiums

     319        296        912        829   

Other real estate owned expenses

     141        134        412        394   

Other operating expenses

     335        325        1,033        939   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

     3,308        3,129        9,606        9,310   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (384     (113     (1,636     (2,623

Benefit for income taxes

     (30     (112     (56     (482
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (354     (1     (1,580     (2,141
  

 

 

   

 

 

   

 

 

   

 

 

 

Preferred stock dividend and accretion

     (114     (113     (339     (335
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss available to common shareholders

   $ (468   $ (114   $ (1,919   $ (2,476
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per share

        

Basic

   $ (0.38   $ (0.09   $ (1.54   $ (1.99

Diluted

   $ (0.38   $ (0.09   $ (1.54   $ (1.99

Average shares outstanding basic

     1,245,267        1,245,267        1,245,267        1,245,267   

Average shares outstanding diluted

     1,245,267        1,245,267        1,245,267        1,245,267   

Dividends per share

   $ 0.00      $ 0.00      $ 0.00      $ 0.00   

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

Three and Nine Months Ended September 30, 2012 and 2011

(In thousands, except share and per share data)

(Unaudited)

 

     Three Months
Ended September 30,
   

Nine Months

Ended September 30,

 
     2012     2011     2012     2011  

Net loss

   $ (354   $ (1   $ (1,580   $ (2,141

Other comprehensive income (loss):

        

Unrealized holding gains arising during the period:

        

Unrealized net gains

     77        546        287        1,648   

Related income tax expense

     (30     (211     (107     (635
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains

     47        335        180        1,013   

Less: reclassification adjustment for net gains realized during the period

        

Realized net gains

     —          —          141        104   

Related income tax expense

     —          —          (51     (38
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gains

     —          —          90        67   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     47        335        90        946   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (307   $ (334   $ (1,490   $ (1,195
  

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Nine Months Ended September 30, 2012 and 2011

(In thousands, except share and per share data)

(Unaudited)

 

     Number
of
Common
Shares
     Preferred
Stock
     Paid-In
Capital
     Accumulated
Deficit
    Accumulated
Other

Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

Balance at January 1, 2012

     1,245,267       $ 7       $ 12,033       $ (5,407   $ 617      $ 7,250   

Net loss

     —           —           —           (1,580     —          (1,580

Change in unrealized net gain on securities available for sale, net of reclassification adjustment of $141 and tax effects $51

     —           —           —           —          90        90   
               

 

 

 

Total comprehensive loss

                  (1,490

Preferred stock dividends (5%)

     —           —           —           (285     —          (285

Discount on preferred stock

     —           —           54         (54     —          —     

Stock option expense

     —           —           10         —          —          10   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

     1,245,267       $ 7       $ 12,097       $ (7,326   $ 707      $ 5,485   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at January 1, 2011

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

Net loss

     —           —           —           (2,141     —          (2,141

Change in unrealized net gain on securities available for sale, net of reclassification adjustment of $104 and tax effects $38

     —           —           —           —          946        946   
               

 

 

 

Total comprehensive loss

                  (1,195

Preferred stock dividends (5%)

     —              —           (285     —          (285

Discount on preferred stock

     —           —           50         (50     —          —     

Stock option expense

     —           —           10         —          —          10   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

     1,245,267       $ 7       $ 12,014       $ 3,570      $ 694      $ 16,285   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2012 and 2011

(In thousands)

(Unaudited)

 

     Nine Months
Ended September 30,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net loss

   $ (1,580   $ (2,141

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

    

Amortization on securities, net

     174        107   

Depreciation

     490        487   

Provision for loan losses

     1,137        2,867   

Gain on sale of securities

     (141     (104

Write-down on other real estate owned

     424        255   

Loss on sale of foreclosed assets

     20        28   

Gain on sale of loans

     (609     (467

Originations of loans for sale

     (28,693     (24,721

Proceeds from sales of loans

     29,302        25,188   

Compensation cost of stock options

     10        10   

Change in cash value of life insurance

     (180     (182

Change in interest receivable and other assets

     (2,500     1,004   

Change in interest payable and other liabilities

     343        33   
  

 

 

   

 

 

 

Net cash from (used in) operating activities

     (1,803     2,364   

CASH FLOWS FROM INVESTING ACTIVITIES

    

Net change in interest-bearing time deposits

     1,494        1,194   

Purchases of securities available for sale

     (29,752     (13,029

Proceeds from maturities and calls of securities available for sale

     18,547        13,429   

Proceeds from sales of securities available for sale

     4,392        2,526   

Proceeds from Federal Home Loan Bank stock redemption

     3,503        —     

Proceeds from sale of other real estate owned

     1,053        7,889   

Net change in loans

     (1,334     131   

Property and equipment expenditures, net

     (240     (201
  

 

 

   

 

 

 

Net cash from (used in) investing activities

     (2,337     11,939   

CASH FLOWS FROM FINANCING ACTIVITIES

    

Change in:

    

Non-interest bearing and interest-bearing demand deposits and savings

     3,996        (2,488

Certificates and other time deposits

     2,333        (15,180

Proceeds of borrowings

     —          2,000   

Repayments of borrowings

     —          (2,200
  

 

 

   

 

 

 

Net cash from (used in) financing activities

     6,329        (17,868
  

 

 

   

 

 

 

Change in cash and cash equivalents

     2,189        (3,565

Cash and cash equivalents at beginning of period

     44,258        32,487   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 46,447      $ 28,922   
  

 

 

   

 

 

 

Supplemental disclosures

    

Interest paid

   $ 1,601      $ 1,932   

Income taxes paid

     —          —     

Transfers from loans to foreclosed assets and real estate held for investment

     2,237        4,053   

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINACIAL STATEMENTS

(Table dollars in thousands)

September 30, 2012 and 2011

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 for the interim periods presented. Results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 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, 2011, which was filed with the U.S. Securities and Exchange Commission on June 22, 2012. The condensed consolidated balance sheet of the Company as of December 31, 2011 has been derived from the audited consolidated balance sheet as of that date.

NOTE 2 – FINANCIAL CONDITION AND MANAGEMENT’S PLAN

The report of the Company’s independent registered public accounting firm for the year ended December 31, 2011 contains an explanatory paragraph as to the Company’s ability to continue as a going concern primarily because (i) the Company reported significant losses during 2011 and 2010 and (ii) the Company has not sufficiently demonstrated its ability to meet the capital requirements set forth in the Consent Order (the “Order”) issued by the Federal Deposit Insurance Corporation the (the “FDIC”) and the Illinois Department of Financial and Professional Regulation (the “IDFPR”) to Community Bank-Wheaton/Glen Ellyn (the “Bank”) in January 2011 or its ability to meet its obligations under a loan agreement that it has entered into with an unaffiliated third party lender.

The losses reported by the Company during 2011 and 2010 were primarily due to large provisions for loan losses and the establishment of valuation allowances against the Company’s deferred tax asset. Prior to sustaining these losses, the Company had a history of profitable operations. The Company’s return to profitable operations is contingent in part on the economic recovery in its market area and the stability of collateral values of the real estate that secures many of its loans. It is difficult to predict when the local economy will fully recover and the impact of that recovery on the Company’s operations. Therefore, the Company cannot predict the timing of its return to profitable operations.

In addition, the Company remains subject to the provisions of the Order and a loan agreement that it has entered into with an unaffiliated third party lender. The Order requires the Bank to achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets. The Company’s loan with the unaffiliated third party, which had a fixed rate of 6.0% and an outstanding balance of $1.3 million at December 31, 2011, is secured by all of the outstanding capital stock of the Bank. As of September 30, 2012, the Company has made all required interest payments on the outstanding principal amounts on a timely basis. As a condition of the Company’s loan agreement, the Bank must maintain a nonperforming assets-to-tangible-capital ratio of not more than 65% measured quarterly and not incur a net loss of more than $250,000 for the calendar year ended December 31, 2010. As of September 30, 2012, the Company was not in compliance with the debt covenants set forth in the loan agreement. On May 3, 2012, the Company and the lender entered into a letter agreement pursuant to which the lender agreed to accept $900,000, as full satisfaction of the indebtedness provided that such payment are made by the Company to the lender on or before July 30, 2012. The payment date has been extended to November 15, 2012.

 

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In addition, upon receipt of the payment, all of the liens on and security interests in favor of the lender under the loan documents shall be automatically terminated and released and all indebtedness shall be deemed fully satisfied.

The Company has evaluated all options to increase its capital levels and is currently engaged in preliminary negotiations with various third parties regarding the raising of additional capital. If the Company cannot raise additional capital, it may not be able to sustain further deterioration in its financial condition and other regulatory actions may be taken. As of the date of this Quarterly Report on Form 10-Q, the Company has not entered into a definitive agreement regarding the raising of additional capital and no assurances can be made that the Company will ultimately enter into such an agreement.

NOTE 3 – LOSS PER SHARE

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2012     2011     2012     2011  
(in thousands)                         

Net loss

   $ (354   $ (1   $ (1,580   $ (2,141

Less: Accretion of discount on preferred stock

     (18     (17     (54     (50

Dividends on preferred stock

     (96     (96     (285     (285
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss available to common shareholders

   $ (468   $ (114   $ (1,919   $ (2,476
  

 

 

   

 

 

   

 

 

   

 

 

 

The number of shares used to compute basic and diluted loss per share were as follows:

 

Weighted Average Shares outstanding

     1,245,267        1,245,267        1,245,267        1,245,267   

Effect of dilutive securities:

        

Stock options

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used to compute diluted loss per share

     1,245,267        1,245,267        1,245,267        1,245,267   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per share:

        

Basic

   $ (0.38   $ (0.09   $ (1.54   $ (1.99

Diluted

     (0.38     (0.09   $ (1.54   $ (1.99

There were 31,830 anti-dilutive shares at both September 30, 2012 and 2011.

 

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NOTE 4 – CAPITAL ADEQUACY AND REGULATORY AND SUPERVISORY MATTERS

At the dates indicated, the capital ratios of the Bank were as follows:

 

     September 30, 2012     December 31, 2011  
     Amount      Ratio     Amount      Ratio  

Total capital (to risk-weighted assets)

   $ 12,326         5.5   $ 13,756         6.1

Tier I capital (to risk-weighted assets)

     9,489         4.2     10,860         4.8

Tier I capital (to average assets)

     9,489         2.9     10,860         3.3

At September 30, 2012, regulatory approval is required for all dividend declarations by both the Bank and the Company.

On January 21, 2011, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the FDIC and IDFPR, whereby the Bank consented to the issuance of the Order by the FDIC and IDFPR, without admitting or denying that grounds exist for the FDIC and IDFPR to initiate an administrative proceeding against the Bank.

The Order requires the Bank to achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets within 120 days. At September 30, 2012, these capital ratios were 2.9% and 5.5%, respectively. As a result, the Bank is currently deemed to be “significantly undercapitalized” pursuant to the regulatory framework for prompt corrective action and is subject to the mandatory provisions of 12 U.S.C. § 1831o and 12 C.F.R § 325(subpart B). These provisions include, among other things, a requirement that the Bank submit a capital restoration plan to the FDIC and restrictions on the Bank’s asset growth, payment of interest rates on deposits, acquisitions, new activities, new branches, payment of dividends, declaration of capital distributions and management fees and ability to accept deposits from correspondent banks. In addition, the Bank may not pay a bonus or give a raise to a senior executive officer without prior regulatory agency approval, and may also be required, among other things, to raise additional capital, reduce total assets, terminate certain activities, replace officers or directors, or seek to be acquired.

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

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

The Company has evaluated all options to increase its capital levels and is currently engaged in preliminary negotiations with various third parties regarding the raising of additional capital. If the Company cannot raise additional capital, it may not be able to sustain further deterioration in its financial condition and other regulatory actions may be taken. As of the date of this Quarterly Report on Form 10-Q, the Company has not entered into a definitive agreement regarding the raising of additional capital and no assurances can be made that the Company will ultimately enter into such an agreement.

 

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NOTE 5 - SECURITIES AVAILABLE FOR SALE

The fair value of securities available for sale at September 30, 2012 and December 31, 2011 are as follows:

 

     September 30, 2012  
     Fair
Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 

U. S. government agencies

   $ 15,358       $ 52       $ (74

State and political subdivisions

     11,053         771         (16

Mortgage-backed securities – Government sponsored entities (GSE) residential

     24,190         443         (24

Preferred stock

     13         —           (2

SBA guaranteed

     243         3         —     
  

 

 

    

 

 

    

 

 

 
   $ 50,857       $ 1,269       $ (116
  

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Fair
Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 

U. S. government agencies

   $ 9,041       $ 42       $ —     

State and political subdivisions

     12,926         482         (3

Mortgage-backed securities – GSE residential

     21,665         477         (1

Preferred stock

     25         10         —     

SBA guaranteed

     274         1         (1
  

 

 

    

 

 

    

 

 

 
   $ 43,931       $ 1,012       $ (5
  

 

 

    

 

 

    

 

 

 

Securities classified as U. S. government agencies include notes issued by government-sponsored enterprises such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Federal Home Loan Bank. The SBA-guaranteed securities are pools of 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, 2012 and December 31, 2011:

 

     September 30, 2012  
     Less than 12 Months     12 Months or More     Total  

Description of Securities

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

U. S. government agencies

   $ 6,311       $ (74   $ —         $ —        $ 6,311       $ (74

State and political subdivisions

     547         (16     —           —          547         (16

Mortgage-backed securities – GSE residential

     3,658         (23     23         —          3,681         (24

Preferred stock

     13         (2          13         (2

SBA guaranteed

     —           —          26         (1     26         —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities

   $ 10,529       $ (115   $ 49       $ (1   $ 10,578       $ (116
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2011  
     Less than 12 Months     12 Months or More     Total  

Description of Securities

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

State and political subdivisions

   $ —         $ —        $ 476       $ (3   $ 476       $ (3

Mortgage-backed securities – GSE residential

     109         (1     —           —          109         (1

Preferred stock

     —           —          229         (1     229         (1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities

   $ 109       $ (1   $ 705       $ (4   $ 814       $ (5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Unrealized gains and losses within the investment portfolio are determined to be temporary. The Company has performed an evaluation of its investments for other than temporary impairment and there was no impairment identified during the nine months ended September 30, 2012. 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, 2012, 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

   $ 62       $ 62   

Due after one year through five years

     951         980   

Due after five years through ten years

     2,658         2,679   

Due after ten years

     22,007         22,690   

Mortgage-backed securities

     23,771         24,190   

Preferred stock

     15         13   

SBA guaranteed

     240         243   
  

 

 

    

 

 

 
   $ 49,704       $ 50,857   
  

 

 

    

 

 

 

Securities with a carrying value of approximately $29.8 million at September 30, 2012 were pledged to secure public deposits and Federal Home Loan Bank advances as well as for other purposes as required or permitted by law.

 

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Sales activities for securities for the three and nine months ended September 30, 2012 and 2011 is shown in the following table:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Sales proceeds

   $ —         $ —         $ 4,392       $ 2,526   

Gross gains on sales

     —           —           141         104   

NOTE 6 – 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.

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

 

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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 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, 2012 and December 31, 2011, respectively:

 

     September 30,     December 31,  
     2012     2011  

Real estate

    

Commercial

   $ 96,116      $ 94,513   

Construction

     2,486        4,361   

Residential

     19,460        21,054   

Home equity

     53,749        59,176   
  

 

 

   

 

 

 

Total real estate loans

     171,811        179,104   

Commercial

     26,205        26,203   

Consumer

     1,299        1,392   
  

 

 

   

 

 

 

Total loans

     199,315        206,699   

Deferred loan costs, net

     211        265   

Allowance for loan losses

     (5,309     (8,854
  

 

 

   

 

 

 

Loans, net

   $ 194,217      $ 198,110   
  

 

 

   

 

 

 

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.

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

 

14


Table of Contents

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.

 

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Table of Contents

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. 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, 2012

   $ 3,281   

New loans including renewals

     2,164   

Payments, etc., including renewals

     (3,099
  

 

 

 

Balances, September 30, 2012

   $ 2,346   
  

 

 

 

 

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Table of Contents

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 nine months ended September 30, 2012 and 2011:

 

     September 30, 2012  
     Commercial     Commercial
Real Estate
    Construction     Consumer     Residential     HELOC     Total  

Balance at beginning of period

   $ 695      $ 4,171      $ 1,768      $ 18      $ 804      $ 1,398      $ 8,854   

Provision for loan losses

     254        950        9        5        71        (152     1,137   

Charge-offs

     (295     (1,877     (1,740     (5     (456     (358     (4,731

Recoveries

     9        10        —          —          30        —          49   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 663      $ 3,254      $ 37      $ 18      $ 449      $ 888      $ 5,309   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ —        $ 2,034      $ —        $ —        $ 240      $ 571      $ 2,845   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 663      $ 1,220      $ 37      $ 18      $ 209      $ 317      $ 2,464   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Loans:

              

Ending balance

   $ 26,205      $ 96,116      $ 2,486      $ 1,299      $ 19,460      $ 53,749      $ 199,315   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ —        $ 6,771      $ —        $ —        $ 1,686      $ 2,651      $ 11,108   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 26,205      $ 89,345      $ 2,486      $ 1,299      $ 17,774      $ 51,098      $ 188,207   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     September 30, 2011  
     Commercial     Commercial
Real Estate
    Construction     Consumer     Residential     HELOC     Unallocated     Total  

Balance at beginning of period

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

Provision for loan losses

     6        1,849        410        3        345        533        (279     2,867   

Charge-offs

     (109     (194     (2,801     (8     (139     (530     —          (3,781

Recoveries

     1        —          —          3        —          4        —          8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 689      $ 2,855      $ 1,486      $ 17      $ 867      $ 845      $ 14      $ 6,773   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ —        $ 1,683      $ 1,450      $ —        $ 566      $ 447      $ —        $ 4,146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 689      $ 1,172      $ 36      $ 17      $ 301      $ 398      $ 14      $ 2,627   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Loans:

                

Ending balance

   $ 28,279      $ 94,782      $ 5,699      $ 1,448      $ 25,701      $ 61,329      $ —        $ 217,238   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ —        $ 6,606      $ 2,722      $ —        $ 7,946      $ 1,796      $ —        $ 19,070   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 28,279      $ 88,176      $ 2,977      $ 1,448      $ 17,755      $ 59,533      $ —        $ 198,168   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following tables present the changes in the allowance for loan losses for the three months ended September 30, 2012 and 2011:

 

     September 30, 2012  
     Commercial      Commercial
Real Estate
    Construction      Consumer      Residential      HELOC     Unallocated      Total  

Balance at beginning of period

   $ 652       $ 3,051      $ 28       $ 18       $ 274       $ 1,144      $ —         $ 5,168   

Provision for loan losses

     11         217        9         —           165         (222     —           180   

Charge-offs

     —           (20     —           —           —           (34     —           (54

Recoveries

     —           6        —           —           10         —          —           16   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance at end of period

   $ 663       $ 3,254      $ 37       $ 18       $ 449       $ 888      $ —         $ 5,309   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     September 30, 2011  
     Commercial      Commercial
Real Estate
     Construction     Consumer     Residential      HELOC      Unallocated      Total  

Balance at beginning of period

   $ 658       $ 2,780       $ 1,543      $ 19      $ 789       $ 815       $ —         $ 6,604   

Provision for loan losses

     31         75         (57     2        78         30         14         173   

Charge-offs

     —           —           —          (8     —           —           —           (8

Recoveries

     —           —           —          4        —           —           —           4   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 689       $ 2,855       $ 1,486      $ 17      $ 867       $ 845       $ 14       $ 6,773   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

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, 2011:

 

     Commercial      Commercial
Real Estate
     Construction      Consumer      Residential      HELOC      Unallocated      Total  

Ending balance: individually evaluated for impairment

   $ 39       $ 3,002       $ 1,740       $ —         $ 451       $ 977       $ —         $ 6,209   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: collectively evaluated for impairment

   $ 656       $ 1,214       $ 28       $ 19       $ 352       $ 376       $ —         $ 2,645   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans:

                       

Ending balance

   $ 26,203       $ 94,513       $ 4,361       $ 1,392       $ 21,054       $ 59,176       $ —         $ 206,699   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ 39       $ 6,671       $ 2,175       $ —         $ 3,709       $ 2,659       $ —         $ 15,253   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: collectively evaluated for impairment

   $ 26,164       $ 87,842       $ 2,186       $ 1,392       $ 17,345       $ 56,517       $ —         $ 191,446   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the Company’s nonaccrual loans by class at September 30, 2012 and December 31, 2011.

 

     September 30,
2012
     December 31,
2011
 

Commercial

   $ —         $ 39   

Consumer

     —           —     

Real estate loans:

     

Construction

     —           2,175   

Commercial

     4,886         4,721   

Residential

     1,280         4,187   

Home equity

     2,652         2,677   
  

 

 

    

 

 

 

Total

   $ 8,818       $ 13,799   
  

 

 

    

 

 

 

 

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Table of Contents

The following table presents impaired loans as of September 30, 2012:

 

     Recorded
Balance
     Unpaid
Principal
Balance
     Specific
Allowance
 

With no related allowance recorded:

        

Commercial real estate

   $ 1,884       $ 1,884       $ —     

Construction

     —           —           —     

Residential

     786         786         —     

HELOC

     181         181         —     
  

 

 

    

 

 

    

 

 

 

Subtotal

     2,851         2,851         —     
  

 

 

    

 

 

    

 

 

 

With an allowance recorded:

        

Commercial

     —           —           —     

Commercial real estate

     4,886         4,886         2,034   

Construction

     —           —           —     

Residential

     901         901         240   

HELOC

     2,470         2,470         571   
  

 

 

    

 

 

    

 

 

 

Subtotal

     8,257         8,257         2,845   
  

 

 

    

 

 

    

 

 

 

Total Impaired Loans

   $ 11,108       $ 11,108       $ 2,845   
  

 

 

    

 

 

    

 

 

 

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2012      2011      2012      2011  
     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 real estate

   $ 1,889       $ 21       $ —         $ —         $ 1,466       $ 58       $ 760       $ —     

Construction

     —           —           572         —           —           —           572         —     

Residential

     786         4         2,358         —           1,836         9         2,360         —     

HELOC

     166         —           525         —           165         —           523         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     2,841         25         3,455         —           3,467         67         4,215         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                       

Commercial

     —           —           —           —           —           —           —           —     

Commercial real estate

     4,854         —           6,607         36         3,940         53         5,534         199   

Construction

     —           —           2,150         —           —           —           2,150         —     

Residential

     902         4         5,596         13         435         8         5,609         47   

HELOC

     2,491         7         1,261         3         2,505         7         1,258         7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     8,247         11         15,614         52         6,880         68         14,551         253   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Impaired Loans

   $ 11,088       $ 36       $ 19,069       $ 52       $ 10,347       $ 135       $ 18,766       $ 254   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table presents impaired loans as of December 31, 2011:

 

     Recorded
Balance
     Unpaid
Principal
Balance
     Specific
Allowance
 

With no related allowance recorded:

        

Construction

   $ 25       $ 776       $ —     

Residential

     2,353         2,353         —     

HELOC

     510         510         —     
  

 

 

    

 

 

    

 

 

 

Subtotal

     2,888         3,639         —     
  

 

 

    

 

 

    

 

 

 

With an allowance recorded:

        

Commercial

     39         39         39   

Commercial real estate

     6,671         6,671         3,002   

Construction

     2,150         2,150         1,740   

Residential

     1,356         1,355         451   

HELOC

     2,149         2,149         977   
  

 

 

    

 

 

    

 

 

 

Subtotal

     12,365         12,364         6,209   
  

 

 

    

 

 

    

 

 

 

Total Impaired Loans

   $ 15,253       $ 16,003       $ 6,209   
  

 

 

    

 

 

    

 

 

 

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.

The following tables summarize credit quality of the Company at September 30, 2012 and December 31, 2011:

 

     September 30, 2012  
     Pass      Special
Mention
     Substandard      Doubtful      Loss      Total  

Commercial

   $ 25,682       $ 255       $ 268       $ —         $ —         $ 26,205   

Real estate loans:

                 

Construction

     2,486         —           —           —           —           2,486   

Commercial real estate

     86,866         3,373         5,877         —           —           96,116   

Residential

     14,644         2,665         2,151         —           —           19,460   

Home equity

     50,522         30         3,197         —           —           53,749   

Individuals loans for household and other personal expenditures

     1,299         —           —           —           —           1,299   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 181,499       $ 6,323       $ 11,493       $ —         $ —         $ 199,315   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2011  
     Pass      Special
Mention
     Substandard      Doubtful      Loss      Total  

Commercial

   $ 24,582       $ 910       $ 711       $ —         $ —         $ 26,203   

Real estate loans:

                 

Construction

     1,144         —           3,217         —           —           4,361   

Commercial real estate

     84,492         3,351         6,670         —           —           94,513   

Residential

     12,042         3,804         5,208         —           —           21,054   

Home equity

     54,665         530         3,981         —           —           59,176   

Individuals loans for household and other personal expenditures

     1,392         —           —           —           —           1,392   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 178,317       $ 8,595       $ 19,787       $ —         $ —         $ 206,699   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following tables summarize past due aging of the Company’s loan portfolio at September 30, 2012 and December 31, 2011:

 

     September 30, 2012  
     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

   $ 200       $ —         $ —         $ 200       $ 26,005       $ 26,205       $ —     

Real estate loans:

                    

Construction

     —           —           —           —           2,486         2,486         —     

Commercial real estate

     1,801         239         4,886         6,926         89,190         96,116         20   

Residential

     1,875         870         1,299         4,044         15,416         19,460         —     

Home equity

     335         500         2,652         3,487         50,262         53,749         —     

Individuals loans for household and other personal expenditures

     —           —           —           —           1,299         1,299         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,211       $ 1,609       $ 8,837       $ 14,657       $ 184,658       $ 199,315       $ 20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     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

   $ —         $ —         $ 39       $ 39       $ 26,164       $ 26,203       $ —     

Real estate loans:

                    

Construction

     —           —           2,175         2,175         2,186         4,361         —     

Commercial real estate

     674         —           4,721         5,395         89,118         94,513         —     

Residential

     204         43         4,187         4,434         16,620         21,054         —     

Home equity

     60         463         2,677         3,200         55,976         59,176         —     

Individuals loans for household and other personal expenditures

     —           —           —           —           1,392         1,392         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 938       $ 506       $ 13,799       $ 15,243       $ 191,456       $ 206,699       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

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Table of Contents

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.

The following table summarizes the loans that have been restructured as TDRs during the three and nine months ended September 30, 2012:

 

     Three months  ended
September 30, 2012
     Nine months ended
September 30, 2012
 
     Count      Balance  Prior
to

TDR
     Balance
after
TDR
     Count      Balance  Prior
to

TDR
     Balance
after
TDR
 

Real estate loans:

                 

Commercial real estate

     —         $ —         $ —           2       $ 997       $ 997   

Residential

     —           —           —           2         636         636   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     —         $ —         $ —           4       $ 1,633       $ 1,633   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Three months ended
September 30, 2011
     Nine months ended
September 30, 2011
 
     Count      Balance Prior
to

TDR
     Balance
after
TDR
     Count      Balance Prior
to

TDR
     Balance
after
TDR
 

Real estate loans:

                 

Commercial real estate

     —         $ —         $ —           1       $ 1,100       $ 1,128   

Construction

     3         533         533         3         533         533   

Residential

     1         371         371         1         371         371   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4       $ 904       $ 904         5       $ 2,004       $ 2,032   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

The following table sets forth the Company’s TDRs that had payment defaults during the nine months ended September 30, 2012. 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.

 

     Count      Default
Balance
 

Real estate loans:

     

Commercial real estate

     3       $ 4,457   

Residential

     2         579   
  

 

 

    

 

 

 

Total

     5       $ 5,036   
  

 

 

    

 

 

 

NOTE 7 – 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 1    Quoted prices in active markets for identical assets or liabilities.
Level 2    Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3    Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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 security includes 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 such techniques 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, 2012 and December 31, 2011, respectively:

 

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Table of Contents

 

            At September 30, 2012  
            Fair Value Measurements Using  
     Fair
Value
     Level 1      Level 2      Level 3  

Available-for-sale securities:

           

U.S. government agencies

   $ 15,358       $ —         $ 15,358       $ —     

State and political subdivisions

     11,053         —           11,053         —     

Mortgage-backed securities – GSE residential

     24,190         —           24,190         —     

Preferred stock

     13         13         —           —     

SBA guaranteed

     243         —           243         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 50,857       $ 13       $ 50,844       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
            At December 31, 2011  
            Fair Value Measurements Using  
     Fair
Value
     Level 1      Level 2      Level 3  

Available-for-sale securities:

           

U.S. government agencies

   $ 9,041       $ —         $ 9,041       $ —     

State and political subdivisions

     12,926         —           12,926         —     

Mortgage-backed securities – GSE residential

     21,665         —           21,665         —     

Preferred stock

     25         25         —           —     

SBA guaranteed

     274         —           274         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 43,931       $ 25       $ 43,906       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

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, 2012 and December 31, 2011 balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

            At September 30, 2012  
            Fair Value Measurements Using  
     Fair
Value
     Level 1      Level 2      Level 3  

Impaired loans

   $ 5,413         —           —         $ 5,413   

Other real estate owned

     3,914         —           —           3,914   
            At December 31, 2011  
            Fair Value Measurements Using  
     Fair
Value
     Level 1      Level 2      Level 3  

Impaired loans

   $ 7,008         —           —         $ 7,008   

Other real estate owned

     4,722         —           —           4,722   

 

24


Table of Contents

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.

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. 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.

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 Chief Credit Officer (CCO). Appraisals are reviewed for accuracy and consistency by the CCO. Appraisers are selected from the list of approved appraisers maintained by management.

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, 2012:

 

            At September 30, 2012  
            Fair Value Measurements Using  
     Carrying
Amount
     Level 1      Level 2      Level 3  

Financial assets

           

Cash and cash equivalents

   $ 46,447       $ 46,447       $ —           —     

Interest-bearing time deposits

     1,941         1,941         —           —     

Securities available for sale

     50,857         13         50,844         —     

Loans held for sale

     3,651         —           3,651         —     

Loans receivable, net

     194,217         —           —           196,479   

Federal Home Loan Bank stock

     1,895         —           1,895         —     

Interest receivable

     1,094         —           1,094         —     

Financial liabilities

           

Deposits

     307,430         —           308,767         —     

Federal Home Loan Bank advances

     13,000         —           13,239         —     

Other borrowings

     1,300         —           1,300         —     

Subordinated debentures

     3,609         —           —           1,210   

Interest payable

     334         —           334         —     

 

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The carrying amount and estimated fair value of financial instruments at December 31, 2011 year end are as follows:

 

     Carrying
Value
     Fair
Value
 

Financial assets

     

Cash and cash equivalents

   $ 44,258       $ 44,258   

Interest-bearing time deposits

     3,435         3,435   

Securities available for sale

     43,931         43,931   

Loans held for sale

     633         633   

Loans receivable, net

     198,110         200,526   

Federal Home Loan Bank stock

     5,398         5,398   

Interest receivable

     1,047         1,047   

Financial liabilities

     

Deposits

     301,101         303,213   

Federal Home Loan Bank advances

     13,000         13,356   

Other borrowings

     1,300         1,300   

Subordinated debentures

     3,609         1,189   

Interest payable

     248         248   

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. 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. The fair value of fixed rate Federal Home Loan Bank advances 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.

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 sheet 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.

 

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NOTE 8 – TARP CAPITAL PURCHASE PROGRAM

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

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

As part of the transaction, the Department of Treasury exercised the Warrant and received 349 shares of Series B preferred stock. The Series B preferred stock will pay cumulative dividends at a rate of 9% per annum. The Series B preferred stock may also be redeemed, in whole or in part, at any time from time to time, at the option of the Company, subject to consultation with the Company’s primary federal regulator, provided that any partial redemption must be for at least 25% of the liquidation value of the Series B preferred stock. The Series B preferred stock cannot be redeemed until all of the outstanding shares of Series A preferred stock have been redeemed.

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

On January 14, 2011, the Company was notified by the Federal Reserve Bank of Chicago (the “FRB”) that the overall condition of the Company and the Bank is less than satisfactory. As a result, the Company must now obtain prior written approval from the FRB prior to, among other things, the payment of any capital distribution, including stockholder dividends on the shares of Company preferred stock issued to the Department of Treasury pursuant to the TARP Capital Purchase Program. The Company has notified the Department of Treasury that, beginning with the February 15, 2011 dividend payment, the Company will defer all payments of dividends on its Series A preferred stock for an indefinite period of time.

NOTE 9 – RECENT ACCOUNTING PRONOUNCEMENTS

Accounting Standards Update No. 2011-11 – Balance Sheet (Topic 210). In December 2011, FASB issued ASU 2011-11. The objective of this Update is to provide enhanced disclosures that will enable users of financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this Update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45.

An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. 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 potential impact of the Company’s participation in the U.S. Department of Treasury’s Troubled Asset Relief Program’s Capital Purchase Program;

 

   

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

 

   

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

 

   

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

 

   

An inability to meet our liquidity needs;

 

   

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

 

   

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

 

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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 comply with the requirements of the Order and the mandatory provisions of 12 U.S.C. § 1831o and 12 C.F.R. § 325 (subpart B), as well as the effect of further changes to our regulatory ratings or capital levels under the regulatory framework for prompt corrective action or the imposition of additional enforcement action by regulatory authorities upon the Bank or the Company as a result of our inability to comply with applicable laws, regulations, regulatory orders and agreements;

 

   

Our ability to continue to operate as a going concern;

 

   

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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the U.S. Securities and Exchange Commission on June 22, 2012.

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

 

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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.

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.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

Total assets at September 30, 2012 were $334.2 million, which represented an increase of $5.2 million, or 1.6%, compared to $329.0 million at December 31, 2011. The increase in total assets was primarily due to increases in investment securities, cash and cash equivalents and foreclosed assets. Investment securities increased $7.0 million, or 15.9%, to $50.9 million at September 30, 2012 from $43.9 million at December 31, 2011. This increase is primarily due to investing excess liquidity and weak loan demand for the nine months ended September 30, 2012. Cash and cash equivalents increased $2.1 million, or 4.7%, to $46.4 million at September 30, 2012 from $44.3 million at December 31, 2011. In addition, foreclosed assets increased $1.8 million, or 19.4%, to $11.1 million at September 30, 2012 from $9.3 million at December 31, 2011. Partially offsetting these increases were decreases in loans receivable and Federal Home Loan Bank stock. Loans receivable decreased $3.9 million, or 2.0%, to $194.2 million at September 30, 2012 from $198.1 million at December 31, 2011 and Federal Home Loan Bank stock decreased $3.5 million, or 64.8%, to $1.9 million at September 30, 2012 from $5.4 million at December 31, 2011. The decrease in loans during the nine months ended September 30, 2012 is primarily due to charge-offs totaling $4.7 million. These write-downs were primarily due to the recognition of decreases in valuations on a portion of the Bank’s nonperforming commercial real estate loans. Included in foreclosed assets at September 30, 2012 are 12 one-to-four family residences, a mixed-use commercial/residential property, five commercial properties, two multi-family properties and three parcels of land.

Total liabilities at September 30, 2012 were $328.7 million, which represented an increase of $7.0 million, or 2.2%, compared to $321.7 million at December 31, 2011. Deposits increased $6.3 million, or 2.1%, to $307.4 million at September 30, 2012 from $301.1 million at December 31, 2011. This increase in deposits primarily consists of increases in: (1) regular savings accounts of $5.9 million, or 10.6%, to $60.9 million at September 30, 2012 from $55.0 million at December 31, 2011; (2) certificates of deposit of $2.4 million, or 2.5%, to $94.7 million at September 30, 2012 from $92.3 million at December 31, 2011; and (3) money market accounts of $1.5 million, or 3.6%, to $43.4 million at September 30, 2012 from $41.9 million at December 31, 2011. Interest-bearing demand deposit accounts decreased $4.5 million, or 6.0% to $71.0 million at September 30, 2012 from $75.5 million at December 31, 2011. The percentage of regular savings accounts to total deposits increased to 19.8% at September 30, 2012 from 18.3% at December 31, 2011 and the percentage of certificates of deposit to total deposits decreased slightly to 30.8% at September 30, 2012 from 30.7% at December 31, 2011. Borrowed money, consisting of Federal Home Loan Bank advances and other borrowings remained unchanged at $14.3 million at September 30, 2012 as compared to December 31, 2011.

Stockholders’ equity decreased $1.7 million, or 23.6%, to $5.5 million at September 30, 2012 from $7.2 million at December 31, 2011. The decrease in stockholders’ equity was primarily due to the Company’s net loss for the nine months ended September 30, 2012. In addition, the Company’s accumulated other comprehensive income relating to the change in fair value of its available-for-sale investment portfolio increased $90,000 for the nine months ended September 30, 2012. As of September 30, 2012 there were 1,245,267 shares of Company common stock outstanding, resulting in a tangible book value of ($1.19) per share at that date.

Tangible book value provides a method to assess the level of tangible net assets on a per share basis. Tangible book value is determined by methods other than in accordance with Accounting Principles Generally Accepted in the United States (“GAAP”). The Company’s management uses this non-GAAP measure in its analysis of the Company’s performance. This measure should not be considered a substitute for book value per share value, a GAAP basis measure, nor should it be viewed as a substitute for operating results determined in accordance with

 

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GAAP. Management believes the presentation of tangible book value per share provides useful supplemental information that is essential to a proper understanding of the financial results of the Company. A reconciliation of tangible book value to GAAP book value can be found in the following table:

 

Tangible book value per share:    September 30,
2012
    December 31,
2011
 

Total capital

   $ 5,485      $ 7,250   

Less: Preferred equity

     6,970        6,970   
  

 

 

   

 

 

 

Tangible common equity

   $ (1,485   $ 280   
  

 

 

   

 

 

 

Outstanding common shares

     1,245,267        1,245,267   

Tangible book value per share

   $ (1.19   $ 0.22   

Comparison of Operating Results for the Three Months Ended September 30, 2012 and 2011

General. The Company’s net loss for the three months ended September 30, 2012 totaled $354,000 compared to a net loss of $1,000 for the comparable prior year period. Due to the effect of preferred stock dividends, net loss available to common shareholders totaled $468,000 for the three months ended September 30, 2012. This represents a basic and diluted loss per share of $0.38 for the three months ended September 30, 2012 compared to basic and diluted loss per share of $0.09 for the three months ended September 30, 2012. The increase in net loss during the three months ended September 30, 2012 is the result of the combined effect of a $170,000 decrease in net interest income, an $85,000 increase in noninterest income, a $179,000 increase in noninterest expense and a $7,000 increase in provision for loan losses.

Net interest income. The following table summarizes interest and dividend income and interest expense for the three months ended September 30, 2012 and 2011.

 

     Three Months Ended September 30,  
     2012      2011      $ Change     % Change  
     (Dollars in thousands)  

Interest and dividend income:

          

Interest and fees on loans

   $ 2,719       $ 2,930       $ (211     (7.20 %) 

Securities:

          

Taxable

     241         254         (13     (5.12

Exempt from federal tax

     82         110         (28     (25.46

Other interest income

     38         27         11        40.74   
  

 

 

    

 

 

    

 

 

   

Total interest and dividend income

     3,080         3,321         (241     (7.26
  

 

 

    

 

 

    

 

 

   

Interest expense:

          

Deposits

     426         487         (61     (12.53

Federal Home Loan Bank advances and other borrowings

     89         101         (12     (11.88

Subordinated debentures

     19         17         2        11.76   
  

 

 

    

 

 

    

 

 

   

Total interest expense

     534         605         (71     (11.74
  

 

 

    

 

 

    

 

 

   

Net interest income

   $ 2,546       $ 2,716       $ (170     (6.26
  

 

 

    

 

 

    

 

 

   

 

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The following table summarizes average balances and annualized average yields or costs for the three months ended September 30, 2012 and 2011.

 

     Three Months Ended September 30,  
     2012     2011  
     Average
Balance
     Interest      Average
Yield/
Cost
    Average
Balance
     Interest      Average
Yield/
Cost
 
     (Dollars in thousands)  

Interest-earning assets:

                

Taxable securities

   $ 42,838       $ 241         2.23   $ 36,139       $ 254         2.78

Tax-exempt securities

     7,637         82         4.28        10,102         110         4.32   

Loan receivables (1)

     199,083         2,719         5.42        217,476         2,930         5.35   

Interest-bearing deposits

     47,180         36         0.30        22,672         26         0.47   

FHLB stock

     2,247         2         0.37        5,398         1         0.10   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-earning assets

     298,985         3,080         4.09        291,787         3,321         4.52   

Interest-bearing liabilities:

                

NOW accounts

     72,656         55         0.30        71,897         66         0.36   

Regular savings

     61,671         52         0.33        53,065         52         0.39   

Money market accounts

     44,569         54         0.48        36,760         63         0.68   

Certificates of deposit

     94,826         265         1.11        95,164         306         1.28   

FHLB advances and other

     14,300         89         2.46        14,300         101         2.79   

Subordinated debentures

     3,609         19         2.11        3,609         17         1.91   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing liabilities

   $ 291,631         534         0.73      $ 274,795         605         0.87   
     

 

 

         

 

 

    

Net interest income

      $ 2,546            $ 2,716      
     

 

 

         

 

 

    

Net interest spread

           3.36           3.65
        

 

 

         

 

 

 

Net interest income to average interest-earning assets

           3.38           3.69
        

 

 

         

 

 

 

 

(1) The average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis.

Interest Income. Interest income decreased $241,000 to $3.1 million for the three months ended September 30, 2012 from $3.3 million for the three months ended September 30, 2011. The average yield on interest-earning assets decreased 43 basis points to 4.09% for the three months ended September 30, 2012 from 4.52% for the comparable prior year period. In addition, there was an increase of $7.2 million in interest-earning assets to $299.0 million for the three months ended September 30, 2012 from $291.8 million for the prior year period.

Interest and fees on loans decreased $211,000, or 7.2%, to $2.7 million for the three months ended September 30, 2012, compared to $2.9 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $18.4 million to $199.1 million for the three months ended September 30, 2012 from $217.5 million for the comparable prior year period. This decrease was partially offset by an increase in the average loan yield of seven basis points to 5.42% for the three months ended September 30, 2012 from 5.35% for the comparable prior year period. Interest on taxable securities decreased $13,000 for the three months ended September 30, 2012 compared to the comparable prior year period. This decrease is primarily due to a decrease in the average yield on taxable securities of 55 basis points to 2.23% for the three months ended September 30, 2012 from 2.78% for the comparable prior year period.

Interest Expense. Interest expense decreased by $71,000, or 11.7%, to $534,000 for the three months ended September 30, 2012, from $605,000 for the three months ended September 30, 2011. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of 14 basis points to 0.73% for the three months ended September 30, 2012 from 0.87% for the comparable prior year period. This decrease is primarily due to a decrease in overall market rates. The average balance of interest bearing liabilities increased $16.8 million to $291.6 million for the three months ended September 30, 2012 from $274.8 million for the comparable prior year

 

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period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings decreased $10,000 during the three months ended September 30, 2012. The average balance on these borrowings remained unchanged at $17.9 million. In addition, there was a decrease in the average cost of these borrowings of 23 basis points to 2.38% for the three months ended September 30, 2012 from 2.61% for the comparable period in 2011.

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses decreased $170,000, or 6.3%, to $2.5 million for the three months ended September 30, 2012 compared to $2.7 million for the comparable period in 2011. The Company’s net interest margin expressed as a percentage of average interest-earning assets decreased to 3.38% for the three months ended September 30, 2012 as compared to 3.69% for the three months ended September 30, 2011. The yield on average interest-earning assets decreased 43 basis points to 4.09% for the three months ended September 30, 2012 from 4.52% for the comparable period ended September 30, 2011. The yield on taxable securities decreased 55 basis points to 2.23% for the three months ended September 30, 2012 from 2.78% for the comparable prior year period. The yield on average loans increased to 5.42% for the three months ended September 30, 2012 from 5.35% for the three months ended September 30, 2011. In addition, there was a 14 basis point decrease in the cost of average interest-bearing liabilities to 0.73% for the three months ended September 30, 2012 as compared to 0.87% for the comparable 2011 period.

Provision for Loan Losses. The Bank’s provision for loan losses increased to $180,000 for the three months ended September 30, 2012 from $173,000 for the comparable period in 2011. The $7,000 increase in the provision was the result of management’s quarterly analysis of the allowance for loan losses. At September 30, 2012, December 31, 2011 and September 30, 2011, nonperforming loans totaled $8.8 million, $13.8 million and $13.5 million, respectively. At September 30, 2012, the ratio of the allowance for loan losses to nonperforming loans was 60.1% compared to 64.2% at December 31, 2011 and 50.0% at September 30, 2011. The ratio of the allowance to total loans was 2.67%, 4.28% and 3.12%, at September 30, 2012, December 31, 2011 and September 30, 2011, respectively. The decrease is primarily due to reserves established in prior periods on loans which were charged off earlier in 2012.

Nonperforming loans decreased $5.0 million, or 36.2%, to $8.8 million at September 30, 2012 from $13.8 million at December 31, 2011. This decrease is primarily due to charge-offs totaling $4.7 million. The largest component of nonperforming loans is commercial real estate loans, which increased $165,000, or 3.5%, to $4.9 million, or 55.4% of total nonperforming loans, at September 30, 2012, from $4.7 million, or 34.2% of total nonperforming loans at December 31, 2011. Nonperforming residential mortgage loans decreased $2.9 million, or 69.4%, to $1.3 million at September 30, 2012 from $4.2 million at December 31, 2011. Nonperforming home equity lines of credit decreased $25,000, or 0.9%, to $2.7 million at September 30, 2012. Finally, nonperforming construction loans decreased $2.2 million, or 100% to zero at September 30, 2012 from $2.2 million at December 31, 2011. Loans 30-59 days past due increased $3.3 million to $4.2 million at September 30, 2012 from $938,000 at December 31, 2011. This increase is primarily due to loans totaling $3.1 million which matured and did not renew until after the end of the quarter. Charge-offs, net of recoveries, totaled $39,000 for the three months ended September 30, 2012 compared to $4,000 for the three months ended September 30, 2011. 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, 2012, 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

 

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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, as an integral part of its examination processes, periodically reviews 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. The FDIC examines the Bank periodically and, accordingly, as part of this examination the allowance is reviewed utilizing specific guidelines. Based upon its review, the FDIC may accordingly from time to time require reserves in addition to those previously provided.

Noninterest Income

 

     Three Months Ended September 30,  
     2012     2011     $ Change     % Change  
     (Dollars in thousands)  

Non-interest income:

        

Service charges on deposit accounts

   $ 98      $ 108      $ (10     (9.26 %) 

Gain on sale of loans

     229        126        103        81.75   

Loss on sale of foreclosed assets

     (25     (33     8        24.24   

Other non-interest income

     256        272        (16     (5.88
  

 

 

   

 

 

   

 

 

   

Total non-interest income

   $ 558      $ 473      $ 85        11.97   
  

 

 

   

 

 

   

 

 

   

Noninterest income totaled $558,000 and $473,000 for the three months ended September 30, 2012 and 2011, respectively. Gain on sale of loans increased $103,000 to $229,000 for the three months ended September 30, 2012 from $126,000 for the comparable prior year period. In addition, loss on sale of foreclosed assets decreased $8,000 for the three months ended September 30, 2012 as compared to the prior year period.

Noninterest Expense

 

     Three Months Ended September 30,  
     2012      2011      $ Change     % Change  
     (Dollars in thousands)  

Non-interest expenses:

          

Salaries and employee benefits

   $ 1,548       $ 1,402       $ 146        10.41

Net occupancy and equipment expense

     313         345         (32     (9.28

Data processing expense

     317         300         17        5.67   

Advertising and promotions

     81         72         9        12.50   

Professional fees

     254         255         (1     (0.39

FDIC insurance premiums

     319         296         23        7.77   

Other real estate owned expenses

     141         134         7        5.22   

Other operating expenses

     335