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 March 31, 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 July 6, 2012
Common Stock, no par value per share		1,245,267 shares

 

 

 

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Form 10-Q Quarterly Report

Table of Contents

 

		PART I – FINANCIAL INFORMATION
Item 1.		Financial Statements			3
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			35
Item 4		Controls and Procedures			35
		PART II – OTHER INFORMATION
Item 1.		Legal Proceedings			36
Item 1A.		Risk Factors			36
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			36
Item 3.		Defaults Upon Senior Securities			36
Item 4.		Mine Safety Disclosures			36
Item 5.		Other Information			36
Item 6.		Exhibits			36
		Signatures			37

 

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

		March 31, 2012				December 31, 2011
		(Unaudited)
ASSETS
Cash and due from banks		$	4,541			$	4,486
Interest-bearing deposits			45,854				39,772
Cash and cash equivalents			50,395				44,258
Interest-bearing time deposits			3,186				3,435
Securities available for sale			50,490				43,931
Loans held for sale			680				633
Loans, less allowance for loan losses of $5,695 and $8,854 at March 31, 2012 and December 31, 2011, respectively			195,348				198,110
Foreclosed assets, net			10,133				9,265
Prepaid FDIC assessment			381				490
Federal Home Loan Bank stock			3,164				5,398
Premises and equipment, net			15,030				15,121
Cash value of life insurance			6,242				6,182
Interest receivable and other assets			2,500				2,163
Total assets		$	337,549			$	328,986
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits		$	309,418			$	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			3,460				2,726
Total liabilities			330,787				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			12,053				12,033
Accumulated deficit			(5,857	)			(5,407	)
Accumulated other comprehensive income			559				617
Total shareholders’ equity			6,762				7,250
Total liabilities and shareholders’ equity		$	337,549			$	328,986

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended March 31, 2012 and 2011

(In thousands, except share and per share data)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
Interest and dividend income
Interest and fees on loans		$	2,812			$	2,954
Securities:
Taxable			225				241
Exempt from federal income tax			107				112
Other interest income			37				31
Total interest and dividend income			3,181				3,338
Interest expense
Deposits			466				555
Federal Home Loan Bank advances and other borrowed funds			100				100
Subordinated debentures			20				17
Total interest expense			586				672
Net interest income			2,595				2,666
Provision for loan losses			180				173
Net interest income after provision for loan losses			2,415				2,493
Non-interest income
Service charges on deposit accounts			97				100
Gain on sale of loans			196				226
Gain on sale of securities			—				104
Writedown on other real estate owned			(192	)			—
Gain on sale of foreclosed assets			—				18
Other non-interest income			261				261
Total non-interest income			362				709
Non-interest expense
Salaries and employee benefits			1,404				1,493
Net occupancy and equipment expense			331				350
Data processing expense			300				289
Advertising and promotions			59				51
Professional fees			254				261
FDIC insurance premiums			296				266
Other real estate owned expenses			107				86
Other operating expenses			327				300
Total non-interest expense			3,078				3,096
Income (loss) before income taxes			(301	)			106
Income tax (benefit)			37				(23	)
Net income (loss)			(338	)			129
Preferred stock dividend and accretion			(112	)			(111	)
Net income (loss) available to common shareholders		$	(450	)		$	18
Earnings (loss) per share
Basic		$	(0.36	)		$	0.02
Diluted		$	(0.36	)		$	0.02
Average shares outstanding basic			1,245,267				1,245,267
Average shares outstanding diluted			1,245,267				1,245,267
Dividends per share		$	0.00			$	0.00

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three Months Ended March 31, 2012 and 2011

(In thousands, except share and per share data)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
Net income (loss)		$	(338	)		$	129
Other comprehensive income (loss):
Unrealized holding gains (losses) arising during the period:
Unrealized net gains (loss)			(94	)			50
Related income tax (expense) benefit			36				(17	)
Net unrealized gains (losses)			(58	)			33
Less: reclassification adjustment for net gains realized during the period
Realized net gains			—				104
Related income tax expense			—				(38	)
Net realized gains			—				66
Other comprehensive loss			(58	)			(33	)
Comprehensive income (loss)		$	(396	)		$	96

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Three Months Ended March 31, 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			—				—				—				(338	)			—				(338	)
Change in unrealized net gain on securities available for sale			—				—				—				—				(58	)			(58	)
Total comprehensive loss																							(396	)
Preferred stock dividends (5%)			—				—				—				(95	)			—				(95	)
Discount on preferred stock			—				—				17				(17	)			—				—
Stock option expense			—				—				3				—				—				3
Balance at March 31, 2012			1,245,267			$	7			$	12,053			$	(5,857	)		$	559			$	6,762
Balance at January 1, 2011			1,245,267			$	7			$	11,954			$	6,046			$	(252	)		$	17,755
Net income			—				—				—				129				—				129
Change in unrealized net gain on securities available for sale, net of reclassification adjustment of $104 and tax effects $21			—				—				—				—				(33	)			(33	)
Total comprehensive income																							96
Preferred stock dividends (5%)			—								—				(95	)			—				(95	)
Discount on preferred stock			—				—				16				(16	)			—				—
Stock option expense			—				—				3				—				—				3
Balance at March 31, 2011			1,245,267			$	7			$	11,973			$	6,064			$	(285	)		$	17,759

See Notes to Condensed Consolidated Financial Statements

 

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COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended March 31, 2012 and 2011

(In thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(338	)		$	129
Adjustments to reconcile net loss to net cash from (used in) operating activities
Amortization on securities, net			49				45
Depreciation			164				159
Provision for loan losses			180				173
Gain on sale of securities			—				(104	)
Gain on sale of foreclosed assets			—				(18	)
Gain on sale of loans			(196	)			(226	)
Originations of loans for sale			(9,574	)			(11,530	)
Proceeds from sales of loans			9,770				11,756
Compensation cost of stock options			3				3
Change in cash value of life insurance			(60	)			(59	)
Change in interest receivable and other assets			(1,252	)			(2,429	)
Change in interest payable and other liabilities			638				149
Net cash used in operating activities			(616	)			(1,952	)
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing time deposits			249				—
Purchases of securities available for sale			(9,538	)			(9,722	)
Proceeds from maturities and calls of securities available for sale			2,836				2,066
Proceeds from sales of securities available for sale			—				2,526
Proceeds from Federal Home Loan Bank stock redemption			2,234				—
Net change in loans			2,728				9,976
Property and equipment expenditures, net			(73	)			(21	)
Net cash from (used in) investing activities			(1,564	)			4,825
CASH FLOWS FROM FINANCING ACTIVITIES
Change in:
Non-interest bearing and interest bearing demand deposits and savings			6,419				(5,793	)
Certificates and other time deposits			1,898				(5,802	)
Repayments of borrowings			—				(200	)
Net cash from (used in) financing activities			8,317				(11,795	)
Change in cash and cash equivalents			6,137				(8,922	)
Cash and cash equivalents at beginning of period			44,258				32,487
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	50,395			$	23,565
Supplemental disclosures
Interest paid		$	562			$	774
Income taxes paid			—				—
Transfers from loans to foreclosed assets and real estate held for investment			1,030				2,649

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)

March 31, 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 months ended March 31, 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 Order 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 March 31, 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 March 31, 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. 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.

 

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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 the report of the Company’s independent registered public accounting firm, 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 – EARNINGS (LOSS) PER SHARE

 

		Three Months Ended March 31,
		2012				2011
(in thousands)
Net income (loss)		$	(338	)		$	129
Less: Accretion of discount on preferred stock			(17	)			(16	)
Dividends on preferred stock			(95	)			(95	)
Income (loss) available to common shareholders		$	(450	)		$	18
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
Effect of dilutive securities:
Stock options			—				—
Shares used to compute diluted earnings (loss) per share			1,245,267				1,245,267
Earnings (loss) per share:
Basic		$	(0.36	)		$	0.02
Diluted		$	(0.36	)		$	0.02

There were 32,330 and 32,730 anti-dilutive shares at March 31, 2012 and 2011, respectively.

 

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NOTE 4 – CAPITAL ADEQUACY AND REGULATORY AND SUPERVISORY MATTERS

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

 

		March 31, 2012								December 31, 2011
		Amount				Ratio				Amount				Ratio
Total capital (to risk-weighted assets)		$	13,623				6.0	%		$	13,756				6.1	%
Tier I capital (to risk-weighted assets)			10,796				4.7	%			10,860				4.8	%
Tier I capital (to average assets)			10,796				3.2	%			10,860				3.3	%

At March 31, 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 a Consent Order (the “Order”) by the FDIC and IDFPR, without admitting or denying that grounds exist for the FDIC and IDFPR to initiate an administrative proceeding against the Bank.

The Order requires the Bank to 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 March 31, 2012, these capital ratios were 3.2% and 6.0%, respectively. As a result, the Bank is currently deemed to be “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, acquisitions, new activities, new branches, payment of dividends, declaration of capital distributions and management fees.

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.

 

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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 5 – SECURITIES AVAILABLE FOR SALE

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

 

		March 31, 2012
		Fair Value				Gross Unrealized Gains				Gross Unrealized Losses
U. S. government agencies		$	13,961			$	6			$	(39	)
State and political subdivisions			12,479				471				(4	)
Mortgage-backed securities – Government sponsored entities (GSE) residential			23,755				476				(9	)
Preferred stock			27				12				—
SBA guaranteed			268				1				(1	)
		$	50,490			$	966			$	(53	)

 

		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 March 31, 2012 and December 31, 2011:

 

		March 31, 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		$	4,961			$	(39	)		$	—			$	—			$	4,961			$	(39	)
State and political subdivisions			136				(4	)			—				—				136				(4	)
Mortgage-backed securities – GSE residential			1,162				(9	)			8				—				1,162				(9	)
SBA guaranteed			—				—				101				(1	)			101				(1	)
Total temporarily impaired securities		$	6,259			$	(52	)		$	109			$	(1	)		$	6,360			$	(53	)

 

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		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	)

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

The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies, state and political subdivisions and mortgage-backed securities were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.

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 first quarter of 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 March 31, 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			$	63
Due after one year through five years			950				979
Due after five years through ten years			1,864				1,872
Due after ten years			23,131				23,526
Mortgage-backed securities			23,287				23,755
Preferred stock			15				27
SBA guaranteed			268				268
		$	49,577			$	50,490

Securities with a carrying value of approximately $25.6 million at March 31, 2012 were pledged to secure public deposits, Federal Home Loan Bank advances and for other purposes as required or permitted by law.

 

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Sales activities for securities for the three months ended March 31, 2012 and 2011 is shown in the following table:

 

		Three Months Ended March 31,
		2012				2011
Sales proceeds		$	—			$	2,526
Gross gains on sales			—				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 adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

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

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

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

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

Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

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

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

 

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

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

The Company has a geographic concentration of loan and deposit customers within the Chicago metropolitan area. Most of the 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 March 31, 2012 and December 31, 2011, respectively:

 

		March 31, 2012				December 31, 2011
Real estate
Commercial		$	93,547			$	94,513
Construction			2,441				4,361
Residential			20,421				21,054
Home equity			57,487				59,176
Total real estate loans			173,896				179,104
Commercial			25,480				26,203
Consumer			1,419				1,392
Total loans			200,795				206,699
Deferred loan costs, net			248				265
Allowance for loan losses			(5,695	)			(8,854	)
Loans, net		$	195,348			$	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

 

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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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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			—
Payments, etc., including renewals			(162	)
Balances, March 31, 2012		$	3,119

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 for the three months ended March 31, 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			(1	)			180				6				2				(50	)			43				180
Charge-offs			—				(1,212	)			(1,740	)			—				(401	)			—				(3,353	)
Recoveries			—				—				—				—				14				—				14
Balance at end of period		$	694			$	3,139			$	34			$	20			$	367			$	1,441			$	5,695
Ending balance: individually evaluated for impairment		$	39			$	1,869			$	—			$	—			$	71			$	1,114			$	3,093
Ending balance: collectively evaluated for impairment		$	655			$	1,270			$	34			$	20			$	296			$	327			$	2,602
Total Loans:
Ending balance		$	25,480			$	93,547			$	2,441			$	1,419			$	20,421			$	57,487			$	200,795
Ending balance: individually evaluated for impairment		$	39			$	3,928			$	34			$	—			$	2,592			$	3,096			$	9,689
Ending balance: collectively evaluated for impairment		$	25,441			$	89,619			$	2,407			$	1,419			$	17,829			$	54,391			$	191,106

 

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The following table presents the changes in the allowance for loan losses for the three months ended March 31, 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			(31	)			689				(428	)			(2	)			(51	)			273				(277	)			173
Charge-offs			(109	)			—				(2,342	)			—				(128	)			(87	)			—				(2,666	)
Recoveries			2				—				—				2				—				—				—				4
Balance at end of period		$	653			$	1,889			$	1,107			$	19			$	482			$	1,024			$	16			$	5,190

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 March 31, 2012 and December 31, 2011.

 

		March 31, 2012				December 31, 2011
Commercial and industrial		$	39			$	39
Real estate loans:
Construction			34				2,175
Commercial and farm land			1,979				4,721
Residential mortgage			2,592				4,187
Home equity			3,096				2,677
Total		$	7,740			$	13,799

 

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The following table presents impaired loans as of March 31, 2012:

 

														2012								2011
														Three Months Ended								Three Months Ended
		Recorded Balance				Unpaid Principal Balance				Specific Allowance				Average Investment in Impaired Loans				Interest Income Recognized				Average Investment in Impaired Loans				Interest Income Recognized
With no related allowance recorded:
Commercial real estate		$	—			$	—			$	—			$	—			$	—			$	464			$	—
Construction			34				785				—				29				—				572				—
Residential			2,351				2,351				—				2,351				—				2,362				—
HELOC			478				478				—				497				—				389				—
Subtotal			2,863				3,614				—				2,877				—				3,787				—
With an allowance recorded:
Commercial and industrial			39				39				39				39				—				—				—
Commercial real estate			3,928				3,928				1,869				3,933				4				5,243				47
Construction			—				—				—				—				—				3,550				—
Residential			205				205				71				241				—				4,438				—
HELOC			2,653				2,653				1,114				2,604				—				1,668				—
Subtotal			6,825				6,825				3,093				6,816				4				14,899				47
Total Impaired Loans		$	9,689			$	10,439			$	3,093			$	9,693			$	4			$	18,686			$	47

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.

 

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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 March 31, 2012 and December 31, 2011:

 

		March 31, 2012
		Pass				Special Mention				Substandard				Doubtful				Loss				Total
Commercial and industrial		$	23,997			$	781			$	702			$	—			$	—			$	25,480
Real estate loans:
Construction			2,114				—				327				—				—				2,441
Commercial real estate			86,186				3,433				3,928				—				—				93,547
Residential mortgage			13,227				3,643				3,551				—				—				20,421
Home equity			53,280				1,111				3,096				—				—				57,487
Individuals loans for household and other personal expenditures			1,419				—				—				—				—				1,419
Total		$	180,223			$	8,968			$	11,604			$	—			$	—			$	200,795

 

		December 31, 2011
		Pass				Special Mention				Substandard				Doubtful				Loss				Total
Commercial and industrial		$	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 mortgage			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 March 31, 2012 and December 31, 2011:

 

		March 31, 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 and industrial		$	—			$	—			$	39			$	39			$	25,441			$	25,480			$	—
Real estate loans:
Construction			—				—				34				34				2,407				2,441				—
Commercial real estate			640				—				1,980				2,620				90,927				93,547				—
Residential mortgage			556				41				2,591				3,188				17,233				20,421				—
Home equity			231				—				3,096				3,327				54,160				57,487				—
Individuals loans for household and other personal expenditures			2				—				—				2				1,417				1,419				—
Total		$	1,429			$	41			$	7,740			$	9,210			$	191,585			$	200,795			$	—

 

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		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 and industrial		$	—			$	—			$	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 mortgage			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.

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 is capable of servicing the newly restructured debt and the underlying collateral value is believed to be sufficient to repay the debt in the event of a future default, the new loan is generally placed on accrual status. The reason for the TDR is also considered, such as paying past due real estate taxes or payments caused by a temporary job loss, when determining whether a retail TDR loan could be returned to accrual status. Retail TDRs remain on non-accrual status until sufficient payments have been made to bring the past due principal and interest current at which point the loan would be transferred to accrual status.

 

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The following table summarizes the loans that have been restructured as TDRs during the three months ended March 31, 2011 and year ended December 31, 2011:

 

		Three months ended March 31, 2012
		Count				Balance Prior  to TDR				Balance after TDR
Real estate loans:
Commercial and industrial			1			$	458			$	458
Commercial real estate			4				4,827				4,827
Construction			2				343				343
Residential mortgage			3				3,118				3,118
Total			10			$	8,746			$	8,746

The following table sets forth the Company’s TDRs that had payment defaults during the three months ended March 31, 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.

 

						Default
		Count				Balance
Real estate loans:
Commercial real estate			1			$	1,979
Residential			1				2,351
Total			2			$	4,330

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

 

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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 March 31, 2012 and December 31, 2011, respectively:

 

						At March 31, 2012
						Fair Value Measurements Using
		Fair Value				Level 1				Level 2				Level 3
Available for sale securities:
U.S. government agencies		$	13,961			$	—			$	13,961			$	—
State and political subdivisions			12,479				—				12,479				—
Mortgage-backed securities – GSE residential			23,755				—				23,755				—
Preferred stock			27				27				—				—
SBA guaranteed			268				—				268				—
Total available for sale securities		$	50,490			$	27			$	50,463			$	—

 

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

 

						At March 31, 2012
						Fair Value Measurements Using
		Fair Value				Level 1				Level 2				Level 3
Impaired loans		$	3,734				—				—			$	3,734
Other real estate owned			2,585				—				—				2,585

 

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						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

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 March 31, 2012:

 

						At March 31, 2012
						Fair Value Measurements Using
		Carrying Amount				Level 1				Level 2				Level 3
Financial assets
Cash and cash equivalents		$	50,395			$	50,395			$	—				—
Interest-bearing time deposits			3,186				3,186				—				—
Securities available for sale			50,490				27				50,463				—
Loans held for sale			680				—				680				—
Loans receivable, net			195,348				—				—				198,203
Federal Home Loan Bank stock			3,164				—				3,164				—
Interest receivable			1,056				—				1,056				—
Financial liabilities
Deposits			309,418				—				311,355				—
Federal Home Loan Bank advances			13,000				—				13,311				—
Other borrowings			1,300				—				1,300				—
Subordinated debentures			3,609				—				—				1,196
Interest payable			271				—				271				—

 

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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.

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.

 

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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

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. ASU 2011-02 clarifies the guidance in ASC 310-40 Receivables: Troubled Debt Restructurings by Creditors. Creditors are required to identify a restructuring as a troubled debt restructuring if the restructuring constitutes a concession and the debtor is experiencing financial difficulties. ASU 2011-02 clarifies guidance on whether a creditor has granted a concession and clarifies the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulties. In addition, ASU 2011-02 also precludes the creditor from using the effective interest rate test in the debtor’s guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring. The effective date of ASU 2011-2 for public entities is effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. If, as a result of adoption, an entity identifies newly impaired receivables, an entity should apply the amendments for purposes of measuring impairment prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company adopted the methodologies prescribed by this ASU on July 1, 2011 with no material impact on its financial condition, results of operation, and cash flows or on the total TDRs identified by the Company.

ASU No. 2011-05; Amendments to Topic 220, Comprehensive Income. In June, 2011 FASB issued ASU No. 2011-05. Under the amendments in this ASU, an entity has the option to present the total comprehensive income, the components of net income, and the components of other comprehensive income either in a continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this ASU should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted, because compliance with the amendments is already permitted. The amendments do not require any transition disclosures.

 

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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 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.

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 March 31, 2012 and December 31, 2011

Total assets at March 31, 2012 were $337.6 million, which represented an increase of $8.6 million, or 2.6%, 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 $6.6 million, or 14.9%, to $50.5 million at March 31, 2012 from $43.9 million at December 31, 2011. This increase is primarily due to investing excess liquidity and the weak loan demand in the first quarter of 2012. Cash and cash equivalents increased $6.1 million, or 13.8%, to $50.4 million at March 31, 2012 from $44.3 million at December 31, 2011. In addition, foreclosed assets increased $800,000, or 9.4%, to $10.1 million at March 31, 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 $2.8 million, or 1.4%, to $195.3 million at March 31, 2012 from $198.1 million at December 31, 2011 and federal home loan bank stock decreased $2.2 million, or 41.4%, to $3.2 million at March 31, 2012 from $5.4 million at December 31, 2011. The decrease in loans during the three months ended March 31, 2012 is primarily due to charge-offs totaling $3.4 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 March 31, 2012 are 12 one-to-four family residences, a mixed-use commercial/residential property, six commercial properties and two parcels of land.

Total liabilities at March 31, 2012 were $330.8 million, which represented an increase of $9.1 million, or 2.8%, compared to $321.7 million at December 31, 2011. Deposits increased $8.3 million, or 2.8%, to $309.4 million at March 31, 2012 from $301.1 million at December 31, 2011. This increase in deposits primarily consists of increases in: (1) regular savings accounts of $4.5 million, or 8.1%, to $59.5 million at March 31, 2012 from $55.0 million at December 31, 2011; (2) certificates of deposit of $1.9 million, or 2.1%, to $94.2 million at March 31, 2012 from $92.3 million at December 31, 2011; and (3) money market accounts of $1.8 million, or 4.4%, to $43.7 million at March 31, 2012 from $41.9 million at December 31, 2011. Interest-bearing demand deposit accounts remained unchanged at March 31, 2012 from December 31, 2011 totaling $75.5 million. The percentage of regular savings accounts to total deposits increased to 19.2% at March 31, 2012 from 18.3% at December 31, 2011 and the percentage of certificates of deposit to total deposits decreased slightly to 30.5% at March 31, 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 March 31, 2012 as compared to December 31, 2011.

Stockholders’ equity decreased $487,000, or 6.7%, to $6.8 million at March 31, 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 three months ended March 31, 2012. In addition, the Company’s accumulated other comprehensive income relating to the change in fair value of its available-for-sale investment portfolio decreased $58,000 for the three months ended March 31, 2012. As of March 31, 2012 there were 1,245,267 shares of Company common stock outstanding, resulting in a tangible book value of ($0.14) 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 GAAP. Management believes the presentation of tangible book value per share provides useful supplemental

 

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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:

 

		March 31, 2012				December 31, 2011
Tangible book value per share:
Total capital		$	6,792			$	7,250
Less: Preferred equity			6,970				6,970
Tangible common equity		$	(178	)		$	280
Outstanding common shares			1,245,267				1,245,267
Tangible book value per share		$	(0.14	)		$	0.22

Comparison of Operating Results for the Three Months Ended March 31, 2012 and 2011

General. The Company’s net income decreased $467,000 to a net loss of $338,000 for the three months ended March 31, 2012, from net income of $129,000 for the three months ended March 31, 2011. Due to the effect of preferred stock dividends, net loss available to common shareholders totaled $450,000 for the three months ended March 31, 2012. This represents a basic and diluted loss per share of $0.36 for the three months ended March 31, 2012 compared to basic and diluted earnings per share of $0.02 for the three months ended March 31, 2011. The decrease in net income during the first quarter of 2012 is the result of the combined effect of a $70,000 decrease in net interest income, a $347,000 decrease in noninterest income, a $17,000 decrease 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 March 31, 2012 and 2011.

 

		Three Months Ended March 31,
		2012				2011				$Change				%Change
		(Dollars in thousands)
Interest and dividend income:
Interest and fees on loans		$	2,812			$	2,954			$	(142	)			(4.81	%)
Securities:
Taxable			225				241				(16	)			(6.64	)
Exempt from federal tax			107				112				(5	)			(4.46	)
Other interest income			37				31				6				19.36
Total interest and dividend income			3,181				3,338				(157	)			(4.70	)
Interest expense:
Deposits			466				555				(89	)			(16.04	)
Federal Home Loan Bank advances and other borrowings			100				100				—				—
Subordinated debentures			20				17				3				17.65
Total interest expense			586				672				(86	)			(12.80	)
Net interest income		$	2,595			$	2,666			$	(71	)			(2.66	)

 

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The following table summarizes average balances and annualized average yields or costs for the three months ended March 31, 2012 and 2011.

 

		Three Months Ended March 31,
		2012												2011
										Average												Average
		Average								Yield/				Average								Yield/
		Balance				Interest				Cost				Balance				Interest				Cost
		(Dollars in thousands)
Interest-earning assets:
Taxable securities		$	35,070			$	225				2.58	%		$	35,879			$	241				2.73	%
Tax-exempt securities			9,278				107				4.61				10,114				112				4.47
Loan receivables (1)			206,073				2,812				5.47				224,673				2,954				5.33
Interest-bearing deposits			42,935				36				0.33				25,207				30				0.48
FHLB stock			4,269				1				0.13				5,398				1				0.10
Total interest-earning assets			297,625				3,181				4.29				301,271				3,338				4.49
Interest-bearing liabilities:
NOW accounts			75,788				69				0.36				76,154				78				0.42
Regular savings			57,058				56				0.39				52,029				54				0.42
Money market accounts			42,430				73				0.69				34,894				57				0.66
Certificates of deposit			93,329				268				1.15				107,195				366				1.38
FHLB advances and other			14,300				100				2.80				14,432				100				2.80
Subordinated debentures			3,609				20				2.18				3,609				17				1.95
Total interest-bearing liabilities		$	286,514				586				0.82			$	288,313				672				0.95
Net interest income						$	2,595											$	2,666
Net interest spread											3.47	%											3.54	%
Net interest income to average interest-earning assets											3.50	%											3.59	%

 

(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 $157,000 to $3.2 million for the three months ended March 31, 2012 from $3.3 million for the three months ended March 31, 2011. The average yield on interest-earning assets decreased 20 basis points to 4.29% for the three months ended March 31, 2012 from 4.49% for the comparable prior year period. In addition, there was a decrease of $3.7 million in interest-earning assets to $297.6 million for the three months ended March 31, 2012 from $301.3 million for the prior year period.

Interest and fees on loans decreased $142,000, or 4.8%, to $2.8 million for the three months ended March 31, 2012, compared to $3.0 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $18.6 million to $206.1 million for the three months ended March 31, 2012 from $224.7 million for the comparable prior year period. This decrease was partially offset by an increase in the average loan yield of 14 basis points to 5.47% for the three months ended March 31, 2012 from 5.33% for the comparable prior year period. Interest on taxable securities decreased $16,000 for the three months ended March 31, 2012 compared to the comparable prior year period. This decrease is primarily due to a decrease in the average yield on taxable securities of 15 basis points to 2.58% for the three months ended March 31, 2012 from 2.73% for the comparable prior year period.

Interest Expense. Interest expense decreased by $86,000, or 12.8%, to $586,000 for the three months ended March 31, 2012, from $672,000 for the three months ended March 31, 2011. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of 13 basis points to 0.82% for the three months ended March 31, 2012 from 0.95% for the comparable prior year period. This decrease is primarily due to a decrease in overall market rates. In addition, the average balance of interest bearing liabilities decreased $1.8 million to $286.5 million for the three months ended March 31, 2012 from $288.3 million for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings

 

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increased $3,000 during the three months ended March 31, 2012. The average balance on these borrowings decreased $132,000 to $17.9 million for the three months ended March 31, 2012 from $18.0 million for the comparable prior year period. In addition, there was an increase in the average cost on these borrowings of 5 basis points to 2.68% for the three months ended March 31, 2012 from 2.63% for the comparable period in 2011.

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses decreased $71,000, or 2.6%, to $2.6 million for the three months ended March 31, 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 3.50% for the three months ended March 31, 2012 as compared to 3.59% for the three months ended March 31, 2011. The yield on average interest-earning assets decreased 20 basis points to 4.29% for the three months ended March 31, 2012 from 4.49% for the comparable period ended March 31, 2011. The yield on taxable securities decreased 15 basis points to 2.58% for the three months ended March 31, 2012 from 2.73% for the comparable prior year period. The yield on average loans increased to 5.47% for the three months ended March 31, 2012 from 5.33% for the three months ended March 31, 2011. In addition, there was a 13 basis point decrease in the cost of average interest-bearing liabilities to 0.82% for the three months ended March 31, 2012 as compared to 0.95% 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 March 31, 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 loss. At March 31, 2012, December 31, 2011 and March 31, 2011, nonperforming loans totaled $7.7 million, $13.8 million and $14.0 million, respectively. At March 31, 2012, the ratio of the allowance for loan losses to nonperforming loans was 73.6% compared to 64.2% at December 31, 2011 and 37.0% at March 31, 2011. The ratio of the allowance to total loans was 2.83%, 4.28% and 2.38%, at March 31, 2012, December 31, 2011 and March 31, 2011, respectively. The decrease is primarily due to reserves established in prior periods on loans which were charged off during the three months ended March 31, 2012.

Nonperforming loans decreased $6.1 million, or 43.9%, to $7.7 million at March 31, 2012 from $13.8 million at December 31, 2011. The largest component of nonperforming loans is home equity lines of credit, which increased $419,000, or 15.7%, to $3.1 million, or 40.0% of total nonperforming loans, at March 31, 2012, from $2.7 million, or 19.4% of total nonperforming loans at December 31, 2011. Nonperforming residential mortgage loans decreased $1.6 million, or 38.1%, to $2.6 million at March 31, 2012 from $4.2 million at December 31, 2011. Nonperforming commercial real estate loans decreased $2.7 million, or 58.1%, to $2.0 million at March 31, 2012 from $4.7 million at December 31, 2011. Finally, nonperforming construction loans decreased $2.1 million, or 98.4% to $34,000 at March 31, 2012 from $2.2 million at December 31, 2011. Charge-offs, net of recoveries, totaled $3.3 million for the three months ended March 31, 2012 compared to $2.7 million for the three months ended March 31, 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 March 31, 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 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

 

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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 March 31,
		2012				2011				$ Change				% Change
		(Dollars in thousands)
Non-interest income:
Service charges on deposit accounts		$	97			$	100			$	(3	)			(3.00	%)
Gain on sale of loans			196				226				(30	)			(13.27	)
Gain on sale of securities			—				104				(104	)			(100.00	)
Writedown on other real estate owned			(192	)			—				(192	)			—
Gain on sale of foreclosed assets			—				18				(18	)			(100.00	)
Other non-interest income			261				261				—				—
Total non-interest income		$	362			$	709			$	(347	)			(21.86	)

Noninterest income totaled $362,000 and $709,000 for the three months ended March 31, 2012 and 2011, respectively. Gain on sale of loans decreased $30,000 to $196,000 for the three months ended March 31, 2012 from $226,000 for the comparable prior year period. Gain on sale of securities decreased $104,000 to zero for the three months ended March 31, 2012 from $104,000 for the comparable prior year period. Writedown on other real estate owned totaled $192,000 for the three months ended March 31, 2012 compared to zero for the comparable prior year period. In addition, gain on sale of foreclosed assets decreased $18,000 for the three months ended March 31, 2012 as compared to the prior year period.

Noninterest Expense

 

		Three Months Ended March 31,
		2012				2011				$ Change				% Change
		(Dollars in thousands)
Non-interest expenses:
Salaries and employee benefits		$	1,404			$	1,493			$	(89	)			(5.96	%)
Net occupancy and equipment expense			331				350				(19	)			(5.43	)
Data processing expense			300				289				11				3.81
Advertising and promotions			59				51				8				15.69
Professional fees			254				261				(7	)			(2.68	)
FDIC insurance premiums			296				266				30				11.28
Other real estate owned expenses			107				86				21				24.42
Other operating expenses			327				300				27				9.00
Total non-interest expenses		$	3,078			$	3,096			$	(18	)			(0.58	)

Noninterest expense decreased by $18,000 to $3.1 million for the three months ended March 31, 2012 from the comparable prior year period. Salaries and employee benefits expenses decreased by $89,000, or 6.0%, to $1.4 million for the three months ended March 31, 2012. Professional fees, including legal expenses, decreased by $7,000 to $254,000 for the three months ended March 31, 2012. Partially offsetting these decreases were increases in other real estate owned expenses and FDIC insurance premiums. Other real estate owned expenses increased to $107,000 for the three months ended March 31, 2012 compared to $86,000 for the prior year period. This increase is entirely due to expenses related to taking possession of foreclosed real estate. FDIC insurance premiums increased by $30,000, or 11.3%, to $296,000 for the three months ended March 31, 2012 compared to $266,000 for the prior year period. Other operating expenses, including occupancy, data processing, and marketing and advertising expenses, remained unchanged on a net basis. Occupancy expenses decreased $19,000, or 5.4%, to $331,000 for the three months ended March 31, 2012 compared to the prior year period. Offsetting this decrease were increases of $11,000 and $8,000 for data processing and marketing and advertising expenses, respectively. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to a growing market base.

 

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Income Tax Expense (Benefit). The Company recorded income tax expense of $37,000 for the three months ended March 31, 2012, despite a $349,000 pre-tax loss during that period due to the establishment of a valuation allowance against the Company’s deferred tax assets. A valuation allowance totaling $181,000 was established on the Company’s deferred tax asset for the three months ended March 31, 2012. As of March 31, 2012 the Company’s deferred tax assets are fully reserved. Under generally accepted accounting principles, income tax benefits and the related tax assets are only allowed to be recognized if they will more likely than not be fully utilized. In each future accounting period, the Company’s management will consider both positive and negative evidence when considering the ability of the Company to utilize its net deferred tax asset. Any subsequent reduction in the valuation allowance would lower the amount of income tax expense recognized in the Company’s consolidated statements of operations in future periods. However, if operating losses continue into the future, there can be no guarantee that an additional valuation allowance against the deferred tax assets will be necessary. Income tax benefit totaled $23,000 for the three months ended March 31, 2011.

Critical Accounting Policies

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2011, which was filed with the U.S. Securities and Exchange Commission on June 22, 2012. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.

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

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

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

 

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Liquidity and Capital Resources

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

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

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

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company’s primary source of funds is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is generally restricted under applicable law to net profits in the current year plus those for the previous two years. At March 31, 2012, the Company had liquid assets of $862,000.

Contractual Obligations

The following table discloses contractual obligations of the Company as of March 31, 2012:

 

		2012				2013				2014				2015				2016				2017 and after				Total
(Dollars in Thousands)
Federal Home Loan Bank advances		$	4,000			$	4,500			$	2,500			$	2,000			$	—			$	—			$	13,000
Other borrowing Subordinated debentures			1,300 —				—   —				—   —				—   —				—   —				—   3,609				1,300 3,609
Data Processing (1), (2)			450				601				—				—				—				—				1,051
Total		$	5,750			$	5,101			$	2,500			$	2,000			$	—			$	3,609			$	18,960

 

(1)	Estimated contract amount based on transaction volume. Actual expense was $751,000 and $712,000 in 2011 and 2010, respectively.

(2)	Contract expires September 30, 2013.

Off-balance-sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and lines of credit. For information about our loan commitments and unused lines of credit, see Note 17 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on June 22, 2012. We currently have no plans to engage in hedging activities in the future. For the year ended December 31, 2011 and for the three months ended March 31, 2012, we engaged in no off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

 

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Impact of Inflation and Changing Prices

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

 

ITEM 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

For a discussion of the potential impact of interest rate changes upon the market value of the Company’s portfolio equity, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since December 31, 2011.

 

ITEM 4:

CONTROLS AND PROCEDURES

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the three months ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

There are no material changes to the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2011.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

 

31.1

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)

 

31.2

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)

 

32.1

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101.0*

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity; (iv) the Consolidated Statements of Cash Flows; and (v) the Notes to the Consolidated Financial Statements, tagged as blocks of text.

 

*	Furnished, not filed.

 

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SIGNATURES

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

COMMUNITY FINANCIAL SHARES, INC.

(Registrant)

/s/ Scott W. Hamer                

Scott W. Hamer

Dated: July 13, 2012

President and Chief Executive Officer

(Principal Executive Officer)

/s/ Eric J. Wedeen                

Eric J. Wedeen

Dated: July 13, 2012

Chief Financial Officer

(Principal Financial Officer)

 

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