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EX-32.1 - EXHIBIT 32.1 - COMMUNITY FINANCIAL SHARES INCv384744_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - COMMUNITY FINANCIAL SHARES INCv384744_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY FINANCIAL SHARES INCv384744_ex31-2.htm
EX-32.2 - EXHIBIT 32.2 - COMMUNITY FINANCIAL SHARES INCv384744_ex32-2.htm

 

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 June 30, 2014    
         
    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)

 

Maryland   36-4387843
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     

357 Roosevelt Road

Glen Ellyn, Illinois

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

(630) 545-0900

(Registrant’s telephone number, including area code)

None

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                       No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x                       No ¨

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨                             No x

 

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

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

 

 
 

  

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 39
Item 4 Controls and Procedures 39
     
PART II – OTHER INFORMATION
     
Item 1. Legal Proceedings 40
Item 1A. Risk Factors 40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 40
Item 3. Defaults Upon Senior Securities 40
Item 4. Mine Safety Disclosures 40
Item 5. Other Information 40
Item 6. Exhibits 40
  Signatures 41

 

2
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

   June 30,   December 31, 
   2014   2013 
   (Unaudited)     
ASSETS          
Cash and due from banks  $4,871   $4,485 
Interest-bearing deposits   17,245    25,068 
Cash and cash equivalents   22,116    29,553 
           
Interest-bearing time deposits   198    945 
Securities available for sale   103,489    95,829 
Loans held for sale   1,047    804 
Loans, less allowance for loan losses of $2,734 and $2,500 at June 30, 2014 and December 31, 2013, respectively   190,435    193,451 
Foreclosed assets, net   2,458    2,269 
Federal Home Loan Bank stock   1,119    926 
Premises and equipment, net   14,714    14,862 
Cash value of life insurance   6,751    6,644 
Interest receivable and other assets   2,721    3,688 
           
Total assets  $345,048   $348,971 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Deposits  $310,072   $315,709 
Federal Home Loan Bank advances   4,500    4,500 
Subordinated debentures   3,609    3,609 
Interest payable and other liabilities   3,458    3,526 
Total liabilities   321,639    327,344 
           
Commitments and contingent liabilities          
           
Shareholders' equity          
Common stock - $0.01 par value, 75,000,000 shares authorized; 10,781,988 shares issued and outstanding   -    - 
Preferred stock - $1.00 par value, $100 liquidation preference 1,000,000 shares authorized; 191,246 shares issued and outstanding   191    191 
Paid-in capital   30,391    30,386 
Accumulated deficit   (6,456)   (7,133)
Accumulated other comprehensive loss   (717)   (1,817)
Total shareholders' equity   23,409    21,627 
           
Total liabilities and shareholders' equity  $345,048   $348,971 

 

See Notes to Condensed Consolidated Financial Statements

 

3
 

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three and Six Months Ended June 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2014   2013   2014   2013 
Interest and dividend income                    
Interest and fees on loans  $2,553   $2,671   $5,101   $5,275 
Securities:                    
Taxable   344    278    676    513 
Exempt from federal income tax   99    73    189    115 
Other interest income   17    36    33    79 
Total interest and dividend income   3,013    3,058    5,999    5,982 
Interest expense                    
Deposits   302    367    613    769 
Federal Home Loan Bank advances and other borrowed funds   27    26    53    64 
Subordinated debentures   17    17    34    35 
Total interest expense   346    410    700    868 
Net interest income   2,667    2,648    5,299    5,114 
Provision for loan losses   50    270    186    1,300 
Net interest income after provision for loan losses   2,617    2,378    5,113    3,814 
Non-interest income                    
Service charges on deposit accounts   99    85    182    171 
Gain on sale of loans   144    289    256    771 
Gain on sale of securities   -    48    -    55 
Loss on sale of foreclosed assets   -    (18)   (21)   (338)
Other non-interest income   269    253    498    482 
Total non-interest income   512    657    915    1,141 
Non-interest expense                    
Salaries and employee benefits   1,407    1,520    2,857    3,116 
Net occupancy and equipment expense   311    328    667    655 
Data processing expense   254    338    499    669 
Advertising and promotions   38    36    75    90 
Professional fees   218    397    417    714 
FDIC insurance premiums   137    206    272    412 
Write-down on other real estate owned   90    23    90    865 
Other real estate owned expenses   41    158    90    320 
Other operating expenses   191    408    384    757 
Total non-interest expense   2,687    3,414    5,351    7,598 
Income (Loss) before income taxes   442    (379)   677    (2,643)
Income taxes   -    101    -    146 
Net income (loss)  $442   $(480)  $677   $(2,789)
Earnings (loss) per share                    
Basic  $0.01   $(0.08)  $0.02   $(0.48)
Diluted  $0.01   $(0.08)  $0.02   $(0.48)
                     
Average shares outstanding basic   10,781,988    6,116,215    10,781,988    5,847,934 
Average shares outstanding diluted   10,782,039    6,116,215    10,782,041    5,847,934 
Dividends per share  $0.00   $0.00   $0.00   $0.00 

 

See Notes to Condensed Consolidated Financial Statements

 

4
 

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and Six Months Ended June 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2014   2013   2014   2013 
                 
Net income (loss)  $442   $(480)  $677   $(2,789)
Other comprehensive income/(loss):                    
Unrealized holding gains/(losses) arising during the period:                    
Unrealized net gains/(losses)   1,022    (1,995)   1,796    (2,104)
Related income tax benefit/(expense)   (397)   774    (696)   816 
Net unrealized gains/(losses)   625    (1,221)   1,100    (1,288)
Less:  reclassification adjustment for net gains realized during the period                    
Realized net gains   -    48    -    55 
Related income tax expense   -    (17)   -    (20)
Net realized gains   -    31    -    35 
Other comprehensive income/(loss)   625    (1,252)   1,100    (1,323)
Comprehensive income/(loss)  $1,067   $(1,732)  $1,776   $(4,112)

 

See Notes to Condensed Consolidated Financial Statements

 

5
 

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Six Months Ended June 30, 2014 and 2013

(In thousands, except share and per share data)

(Unaudited)

 

   Number               Accumulated     
   of               Other   Total 
   Common   Preferred   Paid-In   Accumulated   Comprehensive   Shareholders' 
   Shares   Stock   Capital   Deficit   Income (loss)   Equity 
                         
Balance at January 1, 2014   10,781,988   $191   $30,386   $(7,133)  $(1,817)  $21,627 
Net income   -    -    -    677    -    677 
Other comprehensive income   -    -    -    -    1,100    1,100 
Amortization of stock option expense   -    -    5    -    -    5 
Balance at June 30, 2014   10,781,988   $191   $30,391   $(6,456)  $(717)  $23,409 
                               
Balance at January 1, 2013   5,560,567   $197   $26,270   $(4,346)  $231   $22,352 
Net loss   -    -    -    (2,789)   -    (2,789)
Other comprehensive loss   -    -    -    -    (1,323)   (1,323)
Net proceeds of rights offering   483,121    -    483    -    -    483 
Preferred stock conversion to common   200,000    (2)   2    -    -    - 
Amortization of stock option expense   -    -    6    -    -    6 
Balance at June 30, 2013   6,243,688   $195   $26,761   $(7,135)  $(1,092)  $18,729 

 

See Notes to Condensed Consolidated Financial Statements

 

6
 

 

COMMUNITY FINANCIAL SHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended June 30, 2014 and 2013

(In thousands)

(Unaudited)

 

   Six Months 
   Ended June 30, 
   2014   2013 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income (loss)  $677   $(2,789)
Adjustments to reconcile net loss to net cash from (used in) operating activities          
Amortization on securities, net   472    273 
Depreciation   304    310 
Provision for loan losses   186    1,300 
Gain on sale of securities   -    (55)
Write-down on other real estate owned   90    865 
Loss on sale of foreclosed assets   21    338 
Gain on sale of loans   (256)   (771)
Originations of loans for sale   (9,981)   (29,805)
Proceeds from sales of loans   9,995    34,029 
Compensation cost of stock options   5    6 
Change in cash value of life insurance   (108)   (115)
Change in interest receivable and other assets   (196)   (939)
Change in interest payable and other liabilities   (70)   (283)
Net cash from operating activities   1,139    2,364 
CASH FLOWS FROM INVESTING ACTIVITIES          
Net change in interest-bearing time deposits   747    - 
Purchases of securities available for sale   (13,537)   (57,868)
Proceeds from maturities and calls of securities available for sale   6,931    7,192 
Proceeds from sales of securities available for sale   271    8,063 
Proceeds from sale of other real estate owned   167    3,057 
Net change in loans   2,831    (3,810)
Purchase of Federal Home Loan Bank stock   (193)   - 
Property and equipment expenditures, net   (156)   (40)
Net cash provided by investing activities   (2,939)   (43,406)
CASH FLOWS FROM FINANCING ACTIVITIES          
Change in:          
Non-interest bearing and interest-bearing demand deposits and savings   364    9,303 
Certificates and other time deposits   (6,001)   534 
Proceeds of capital raises   -    483 
Repayments of borrowings   -    (4,500)
Net cash from (used in) financing activities   (5,637)   5,820 
           
Change in cash and cash equivalents   (7,437)   (35,222)
Cash and cash equivalents at beginning of period   29,553    71,021 
CASH AND CASH EQUIVALENTS AT END OF PERIOD  $22,116   $35,799 
           
Supplemental disclosures          
Interest paid  $678   $868 
Income taxes paid   -    - 
Transfers from loans to foreclosed assets   -    1,941 

 

See Notes to Condensed Consolidated Financial Statements

 

7
 

 

COMMUNITY FINANCIAL SHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

June 30, 2014 and 2013

 

NOTE 1 – BASIS OF PRESENTATION

 

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

 

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

 

NOTE 2 – EARNINGS (LOSS) PER SHARE

 

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

 

   Three Months
Ended 
June 30, 2014
   Three Months
Ended 
 June 30, 2013
 
         
Net income (loss) available for distribution  $442   $(480)
Dividends and undistributed earnings allocated to participating securities   (283)   - 
Income (loss) attributable to common shareholders  $159   $(480)
           
Average common shares outstanding for basic earnings per share   10,781,988    6,116,215 
Effect of dilutive convertible preferred stock   -    - 
Effect of dilutive stock options   51    - 
Average common and common-equivalent shares for dilutive earnings per share   10,782,039    6,116,215 
           
Basic  $0.01   $(0.08)
Diluted  $0.01   $(0.08)

  

8
 

  

   Six Months
Ended 
June 30, 2014
   Six Months
Ended 
 June 30, 2013
 
         
Net income (loss) available for distribution  $677   $(2,789)
Dividends and undistributed earnings allocated to participating securities   (433)   - 
Income (loss) attributable to common shareholders  $244   $(2,789)
           
Average common shares outstanding for basic earnings per share   10,781,988    5,847,934 
Effect of dilutive convertible preferred stock   -    - 
Effect of dilutive stock options   53    - 
Average common and common-equivalent shares for dilutive earnings per share   10,782,041    5,847,934 
           
Basic  $0.02   $(0.48)
Diluted  $0.02   $(0.48)

 

 

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

 

There were 22,180 and 25,280 anti-dilutive shares at June 30, 2014 and 2013, respectively.

 

NOTE 3 – CAPITAL ADEQUACY AND REGULATORY AND SUPERVISORY MATTERS

 

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

   June 30, 2014   December 31, 2013 
   Amount   Ratio   Amount   Ratio 
                     
Total capital (to risk-weighted assets)  $27,032    12.5%  $25,990    11.9%
Tier I capital (to risk-weighted assets)   24,326    11.2%   23,490    10.8%
Tier I capital (to average assets)   24,326    7.2%   23,490    6.8%

 

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

 

On January 10, 2014, the Bank received notification from the Federal Deposit Insurance Corporation (the “FDIC”) and the Division of Banking of the Illinois Department of Financial and Professional Regulation (the “IDFPR”) that the Consent Order (the “Order”) issued to the Bank by the FDIC and IDFPR on January 21, 2011 was terminated effective January 10, 2014. The material terms and conditions of the Order were previously disclosed in the Company’s Current Report on Form 8-K filed on January 26, 2011. In connection with the termination of the Order, the Bank agreed to achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets. At June 30, 2014, these capital ratios were 7.2% and 12.5%, respectively.

 

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

 

9
 

 

NOTE 4 - SECURITIES AVAILABLE FOR SALE

 

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

 

   June 30, 2014 
   Fair
Value
  

Gross

Unrealized
Gains

   Gross
Unrealized
Losses
 
U.S. government agency debt securities  $11,698   $-   $(775)
State and political subdivisions   19,766    196    (127)
U.S. government agency mortgage-backed securities   63,739    263    (696)
Preferred stock   47    43    - 
SBA securities   8,239    3    (76)
   $103,489   $505   $(1,674)

 

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

  

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

 

The following tables show gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013: 

 

10
 

  

   June 30, 2014 
   Less than 12 Months   12 Months or More        
Description of
Securities
  Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Total
Fair Value
   Unrealized
Losses
 
U.S. government agency debt securities  $-   $-   $11,698   $(775)  $11,698   $(775)
State and political subdivisions   2,910    (23)   6,237    (104)   9,147    (127)
U.S. government agency mortgage-backed securities   10,312    (137)   27,606    (559)   37,918    (696)
SBA securities   3,153    (24)   4,134    (52)   7,287    (76)
Total temporarily impaired securities  $16,375   $(184)  $49,675   $(1,490)  $66,050   $(1,674)

 

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

 

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

 

The fair values of securities available for sale at June 30, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity are shown separately.

 

   Amortized
Cost
   Fair
Value
 
Due in one year or less  $1,707   $1,708 
Due after one year through five years   2,627    2,604 
Due after five years through ten years   11,367    11,344 
Due after ten years   16,469    15,808 
           
U.S. government agency mortgage-backed securities   64,172    63,739 
SBA securities   8,312    8,239 
Preferred stock   4    47 
   $104,658   $103,489 

 

Securities with a carrying value of approximately $13.0 million at June 30, 2014 were pledged to secure public deposits and Federal Home Loan Bank advances as well as for other purposes as required or permitted by law.

 

11
 

 

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

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
Sales proceeds  $-   $59   $271   $8,063 
Gross gains on sales   -    48    -    55 

 

NOTE 5 – LOANS

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

12
 

 

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

 

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

 

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

 

Loans consisted of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
Real estate          
Commercial  $96,813   $97,813 
Construction   898    1,856 
Residential   24,562    26,240 
Home equity   48,333    47,050 
Total real estate loans   170,606    172,959 
Commercial   21,075    21,379 
Consumer   1,225    1,384 
Total loans   192,906    195,722 
Deferred loan costs, net   263    229 
Allowance for loan losses   (2,734)   (2,500)
Loans, net  $190,435   $193,451 

 

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

 

Commercial

 

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

 

Commercial Real Estate

 

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

 

13
 

 

Construction

 

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

 

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

 

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

 

Policy for charging off loans:

 

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

 

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

 

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

 

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

 

14
 

  

Policy for determining delinquency:

 

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

 

Period utilized for determining historical loss factors:

 

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

 

Policy for recognizing interest income on impaired loans:

 

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

 

Policy for recognizing interest income on non-accrual loans:

 

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

 

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

 

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

 

Balances, January 1, 2014  $1,006 
New loans including renewals   - 
Payments including renewals   (201)
Balances, June 30, 2014  $805 

  

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

 

   Three Months Ended June 30, 2014 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                             
Balance at beginning of period  $533   $1,432   $13   $16   $254   $459   $2,707 
Provision for loan losses   (23)   (13)   (2)   -    15    73    50 
Charge-offs   -    (425)   -    -    -    -    (425)
Recoveries   -    398    -    -    4    -    402 
Balance at end of period  $510   $1,392   $11   $16   $273   $532   $2,734 

  

15
 

 

   Six Months Ended June 30, 2014 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                             
Balance at beginning of period  $483   $1,336   $44   $41   $266   $330   $2,500 
                                    
Provision for loan losses   (40)   84    (33)   (23)   (4)   202    186 
Charge-offs   -    (425)   -    (2)   -    -    (427)
Recoveries   67    397    -    -    11    -    475 
Balance at end of period  $510   $1,392   $11   $16   $273   $532   $2,734 
                                    
Ending balance: individually evaluated for impairment  $-   $-   $-   $-   $-   $118   $118 
Ending balance: collectively evaluated for impairment  $510   $1,392   $11   $16   $273   $414   $2,616 
                                    
Total Loans:                                   
Ending balance  $21,075   $96,813   $898   $1,225   $24,562   $48,333   $192,906 
Ending balance: individually evaluated for impairment  $-   $-   $-   $-   $-   $653   $653 
Ending balance: collectively evaluated for impairment  $21,075   $96,813   $898   $1,225   $24,562   $47,680   $192,253 

 

   Three Months Ended June 30, 2013 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                             
Balance at beginning of period  $577   $1,560   $48   $23   $808   $692   $3,708 
                                    
Provision for loan losses   63    122    15    8    15    47    270 
Charge-offs   (186)   (235)   -    (12)   (661)   (462)   (1,556)
Recoveries   -    6    -    -    6    -    12 
Balance at end of period  $454   $1,453   $63   $19   $168   $277   $2,434 

  

   Six Months Ended June 30, 2013 
   Commercial   Commercial
Real Estate
   Construction   Consumer   Residential   HELOC   Total 
                             
Balance at beginning of period  $621   $1,386   $53   $21   $305   $646   $3,032 
Provision for loan losses   19    412    10    11    690    158    1,300 
Charge-offs   (186)   (357)   -    (14)   (835)   (530)   (1,922)
Recoveries   -    12    -    1    8    3    24 
Balance at end of period  $454   $1,453   $63   $19   $168   $277   $2,434 
                                    
Ending balance: individually evaluated for impairment  $-   $223   $-   $-   $-   $18   $241 
Ending balance: collectively evaluated for impairment  $454   $1,230   $63   $19   $168   $259   $2,193 
                                    
Total Loans:                                   
Ending balance  $21,934   $101,200   $3,801   $1,335   $22,041   $46,888   $197,199 
Ending balance: individually evaluated for impairment  $1,603   $2,250   $-   $-   $402   $505   $4,760 
Ending balance: collectively evaluated for impairment  $20,331   $98,950   $3,801   $1,335   $21,639   $46,383   $192,439 

 

16
 

 

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

 

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

 

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

 

  

June 30,

2014

   December 31,
2013
 
Real estate loans:          
Commercial  $-   $437 
Home equity   653    505 
Total  $653   $942 

 

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

 

   Recorded
Balance
   Unpaid
Principal
Balance
   Specific
Allowance
 
With no related allowance recorded:               
HELOC  $100   $100   $- 
Subtotal   100    100    - 
With an allowance recorded:               
HELOC   553    553    118 
Subtotal   553    553    118 
Total Impaired Loans  $653   $653   $118 

 

17
 

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2014   2013   2014   2013 
   Average
Investment in
Impaired
Loans
   Interest
Income
Recognized
   Average
Investment in
Impaired
Loans
   Interest
Income
Recognized
   Average
Investment in
Impaired
Loans
   Interest
Income
Recognized
   Average
Investment in
Impaired
Loans
   Interest
Income
Recognized
 
With no related allowance recorded:                                        
Commercial  $-   $-   $247   $3   $-   $-   $1,724   $23 
Commercial real estate   -    -    1,789    8    -    -    1,843    17 
Residential   -    -    403    5    -    -    403    9 
HELOC   100    -    165    -    100    -    165    - 
Subtotal   100    -    2,604    16    100    -    4,135    49 
With an allowance recorded:                                        
Commercial real estate   544    -    462    -    677    -    446    - 
Residential   -    -    -    -    -    -    -    - 
HELOC   555    -    342    -    555    -    344    - 
Subtotal   1,099    -    804    -    1,232    -    790    - 
Total Impaired Loans  $1,199   $-   $3,408   $16   $1,332   $-   $4,925   $49 

 

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

 

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

 

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

 

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

 

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

 

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

 

18
 

 

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

 

   June 30, 2014 
   Pass   Special
Mention
   Substandard   Doubtful   Loss   Total 
                         
Commercial  $21,009   $   $66   $   $   $21,075 
Real estate loans:                              
Construction   898                    898 
Commercial real estate   94,128    2,227    458            96,813 
Residential   24,562                    24,562 
Home equity   47,651    28    654            48,333 
Consumer   1,225                    1,225 
Total  $189,473   $2,255   $1,178   $   $   $192,906 

 

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

 

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

 

   June 30, 2014 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater
Than
90 Days
   Total
Past Due
   Current   Total Loans   Loans >
90 Days and
Accruing
 
                             
Commercial  $50   $221   $   $271   $20,804   $21,075   $ 
Real estate loans:                                   
Construction                   898    898     
Commercial real estate   788    1,067    212    2,067    94,746    96,813    212 
Residential   531            531    24,031    24,562     
Home equity   590        763    1,353    46,980    48,333    109 
Consumer   1            1    1,224    1,225     
Total  $1,960   $1,288   $975   $4,223   $188,683   $192,906   $321 

 

19
 

 

   December 31, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater
Than
90 Days
   Total
Past Due
   Current   Total Loans   Loans >
90 Days and
Accruing
 
                             
Commercial  $100   $   $   $100   $21,279   $21,379   $ 
Real estate loans:                                   
Construction                   1,856    1,856     
Commercial real estate       569    169    737    97,076    97,813    168 
Residential mortgage   687    1,342    11    2,040    24,200    26,240    11 
Home equity   445    328    555    1,328    45,722    47,050    50 
Consumer       1    1    2    1,382    1,384    1 
Total  $1,232   $2,240   $735   $4,207   $191,515   $195,722   $230 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

20
 

 

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

 

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

 

   Six months ended
June 30, 2014
   Six months ended
June 30, 2013
 
       Default       Default 
   Count   Balance   Count   Balance 
Real estate loans:                    
Residential   -    -    2    742 
Total   -   $-    2   $742 

 

NOTE 6 – DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

 

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

 

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

 

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

 

Available-for-sale Securities

 

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

 

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       At June 30, 2014 
   Fair   Fair Value Measurements Using 
  Value   Level 1   Level 2   Level 3 
Available-for-sale securities:                    
U.S. government agency debt securities  $11,698   $-   $11,698   $- 
State and political subdivisions   19,766    -    19,766    - 
U.S. government agency mortgage-backed securities   63,739    -    63,739    - 
Preferred stock   47    47    -    - 
SBA securities   8,239    -    8,239    - 
Total available-for-sale securities  $103,489   $47   $103,442   $- 

 

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

 

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

 

       At June 30, 2014 
   Fair   Fair Value Measurements Using 
   Value   Level 1   Level 2   Level 3 
                 
Impaired loans (collateral dependent)  $653    -    -   $653 
Other real estate owned   2,458    -    -    2,458 

 

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

 

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

 

    As of June 30, 2014
    Fair     Valuation   Unobservable    
    Value     Technique   Inputs   Range
Impaired loans (collateral dependent)   $ 653     Market comparable properties   Marketability discount   5% - 30%
                     
Other real estate owned   $ 2,458     Fair value appraisals        

  

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

  

Impaired Loans (Collateral Dependent)

 

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

 

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

 

Other Real Estate Owned

 

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

 

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

 

       At June 30, 2014 
   Carrying   Fair Value Measurements Using 
   Amount   Level 1   Level 2   Level 3 
Financial assets                    
Cash and cash equivalents  $22,116   $22,116   $-   $- 
Interest-bearing time deposits   198    198    -    - 
Securities available for sale   103,489    47    103,442    - 
Loans held for sale   1,047    -    1,047    - 
Loans receivable, net   190,435    -    -    191,276 
Federal Home Loan Bank stock   1,119    -    1,119    - 
Interest receivable   912    -    912    - 
                     
Financial liabilities                    
Deposits   310,072    -    295,772    - 
Federal Home Loan Bank advances   4,500    -    4,539    - 
Subordinated debentures   3,609    -    -    1,275 
Interest payable   192    -    192    - 

 

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

 

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

 

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

 

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

 

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

 

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

 

NOTE 7 – RECENT ACCOUNTING PRONOUNCEMENTS

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Safe Harbor Statement

 

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

 

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

 

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

 

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

 

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

 

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

 

·An inability to meet our liquidity needs;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Overview

 

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

 

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

 

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

 

Regulatory Matters

 

As previously disclosed, on January 10, 2014, the Bank received notification from the Federal Deposit Insurance Corporation (the “FDIC”) and the Division of Banking of the Illinois Department of Financial and Professional Regulation (the “IDFPR”) that the Consent Order (the “Order”) issued to the Bank by the FDIC and IDFPR on January 21, 2011 was terminated effective January 10, 2014. The material terms and conditions of the Order were previously disclosed in the Company’s Current Report on Form 8-K filed on January 26, 2011. In connection with the termination of the Order, the Bank agreed to achieve Tier 1 capital at least equal to 8% of total assets and total capital at least equal to 12% of risk-weighted assets. At June 30, 2014 our Tier 1 and total capital ratios were 7.2% and 12.5%, respectively, compared to 7.0% and 12.0% at March 31, 2014, 6.8% and 11.9%, at December 31, 2013, 6.8% and 11.4% at September 30, 2013, 6.7% and 11.4% at June 30, 2013, 6.8% and 11.8% at March 31, 2013 and 7.7% and 12.6% at December 31, 2012, respectively.

 

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

 

Total assets at June 30, 2014 were $345.0 million, which represented a decrease of $4.0 million, or 1.1%, compared to $349.0 million at December 31, 2013. The decrease in total assets was primarily due to a decrease in cash and cash equivalents and loans. Cash and cash equivalents decreased $7.5 million, or 25.2%, to $22.1 million at June 30, 2014 from $29.6 million at December 31, 2013. Loans decreased $3.1 million, or 1.6%, to $190.4 million at June 30, 2014 from $193.5 million at December 31, 2013 primarily as a result of the net effect of a $1.0 million decrease in commercial real estate loans, a $1.7 million decrease in residential real estate loans, a $1.0 million decrease in construction loans and a $1.3 million increase in home equity lines of credit. The decrease in cash and cash equivalents and loans was partially offset by an increase in investment securities. Investment securities increased $7.7 million, or 8.0%, to $103.5 million at June 30, 2014 from $95.8 million at December 31, 2013 primarily as a result of the net effect of a $3.4 million increase in municipal securities and a $3.7 million increase in mortgage-backed securities. In addition, foreclosed assets increased $189,000 to $2.5 million as of June 30, 2014 from $2.3 million as of December 31, 2013. Included in foreclosed assets at June 30, 2014 are nine one-to-four family residences, two parcels of land and one commercial real estate property.

 

Total liabilities at June 30, 2014 were $321.6 million, which represented a decrease of $5.7 million, compared to $327.3 million at December 31, 2013. Borrowed money, consisting solely of Federal Home Loan Bank advances, remained unchanged at $4.5 million at both June 30, 2014 and December 31, 2013. Deposits decreased $5.6 million to $310.1 million at June 30, 2014 from $315.7 million at December 31, 2013. This decrease in deposits primarily consisted of decreases in certificates of deposits of $6.0 million, or 6.9%, to $80.7 million at June 30, 2014 from $86.7 million at December 31, 2013 and interest-bearing demand deposit accounts of $2.2 million, or 3.1%, to $70.3 million at June 30, 2014 from $72.5 million at December 31, 2013. These decreases were partially offset by an increase in money market accounts of $3.6 million, or 8.4%, to $46.0 million at June 30, 2014 from $42.4 million at December 31, 2013. The percentage of regular savings accounts to total deposits totaled 23.5% at June 30, 2014 and the percentage of certificates of deposit to total deposits decreased to 26.0% at June 30, 2014 from 27.5% at December 31, 2013.

 

Stockholders’ equity increased $1.8 million, or 8.2%, to $23.4 million at June 30, 2014 from $21.6 million at December 31, 2013. The increase in stockholders’ equity was due to the Company’s $677,000 net income for the six months ended June 30, 2014 and the increase in the Company’s accumulated other comprehensive income of $1.1 million to a loss of $717,000 for the six months ended June 30, 2014 due to changes in the fair value of the Company’s available-for-sale investment portfolio.

 

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

 

General. The Company’s net income for the three months ended June 30, 2014 totaled $442,000 compared to a net loss of $480,000 for the three months ended June 30, 2013. This represents basic and diluted earnings per share of $0.01 for the three months ended June 30, 2014 compared to a basic and diluted loss per share of $0.08 for the three months ended June 30, 2013. The improvement in operating results for the three months ended June 30, 2014 is primarily the result of the combined effect of a $220,000 decrease in provision for loan losses, a $727,000 decrease in noninterest expense and a $145,000 decrease in noninterest income.

 

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

 

   Three Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Interest and dividend income:                    
Interest and fees on loans  $2,553   $2,671   $(118)   (4.42)%
Securities:                    
Taxable   344    278    66    23.74 
Exempt from federal tax   99    73    26    35.62 
Other interest income   17    36    (19)   (52.78)
Total interest and dividend income   3,013    3,058    (45)   (1.47)
                     
Interest expense:                    
Deposits   302    367    (65)   (17.71)
Federal Home Loan Bank advances and other borrowings   27    26    1    3.85 
Subordinated debentures   17    17    -    - 
Total interest expense   346    410    (64)   (15.61)
Net interest income  $2,667   $2,648   $19    0.72 

 

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

 

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

 

   Three Months Ended June 30, 
   2014   2013 
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
   (Dollars in thousands) 
Interest-earning assets:                              
Taxable securities  $83,952   $344    1.65%  $71,800   $278    1.58%
Tax-exempt securities (1)   17,365    150    3.46    8,737    111    5.10 
Loan receivables (2)   196,576    2,553    5.21    199,648    2,671    5.37 
Interest-bearing deposits, FHLB stock and other   22,307    17    0.30    41,131    36    0.30 
Total interest-earning assets  $320,200    3,064    3.84   $321,316    3,096    3.87 
                               
Interest-bearing liabilities:                              
NOW accounts   71,424    32    0.18    74,750    35    0.19 
Regular savings   74,638    49    0.26    69,289    49    0.28 
Money market accounts   43,579    32    0.29    45,357    39    0.35 
Certificates of deposit   82,182    189    0.92    94,693    244    1.03 
FHLB advances and other   5,227    27    2.07    5,269    26    1.96 
Subordinated debentures   3,609    17    1.88    3,609    17    1.93 
Total interest-bearing liabilities  $280,659    346    0.49   $292,967    410    0.56 
                               
Net interest income/interest rate spread (3)        2,718    3.35%        2,686    3.31%
Less: Taxable equivalent adjustment        51              38      
Net interest income as reported       $2,667             $2,648      
Net interest margin (4)             3.35%             3.31%
Tax equivalent effect             0.06%             0.05%
Net interest margin on a fully tax equivalent basis             3.41%             3.36%

 

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

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

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

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

 

Interest Income. Interest income decreased $45,000 to $3.0 million for the three months ended June 30, 2014. The average tax equivalent yield on interest-earning assets decreased three basis points to 3.84% for the three months ended June 30, 2014 from 3.87% for the comparable prior year period. In addition, interest-earning assets decreased $1.1 million to $320.2 million for the three months ended June 30, 2014 from $321.3 million for the comparable prior year period.

 

Interest and fees on loans decreased $118,000, or 4.4%, to $2.6 million for the three months ended June 30, 2014, compared to $2.7 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $3.0 million to $196.6 million for the three months ended June 30, 2014 from $199.6 million for the comparable prior year period. In addition, the average loan yield decreased 16 basis points to 5.21% for the three months ended June 30, 2014 compared to 5.37% for the three months ended June 30, 2013. Interest on taxable securities increased $66,000 for the three months ended June 30, 2014 compared to the comparable prior year period. This increase is primarily due to an increase in the average balance of taxable securities of $12.2 million to $84.0 million for the three months ended June 30, 2014 from $71.8 million for the comparable prior year period. In addition, the average yield on taxable securities increased seven basis points to 1.65% for the three months ended June 30, 2014 from 1.58% for the comparable prior year period.

 

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Interest Expense. Interest expense decreased by $64,000, or 15.6%, to $346,000 for the three months ended June 30, 2014, from $410,000 for the three months ended June 30, 2013. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of seven basis points to 0.49% for the three months ended June 30, 2014 from 0.56% for the comparable prior year period, which is primarily due to a decrease in overall market rates. In addition, the average balance of interest bearing liabilities decreased $12.3 million to $280.7 million for the three months ended June 30, 2014 from $293.0 million for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings decreased $1,000 during the three months ended June 30, 2014. The average balance on these borrowings decreased $42,000 to $8.8 million for the three months ended June 30, 2014 from $8.9 million for the comparable prior year period. In addition, there was an increase in the average cost of these borrowings of four basis points to 1.99% for the three months ended June 30, 2014 from 1.95% for the comparable period in 2013.

 

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses increased $19,000, or 0.7%, to $2.7 million for the three months ended June 30, 2014 compared to $2.6 million for the comparable period in 2013. The Company’s net interest margin expressed as a percentage of average interest-earning assets increased to 3.35% for the three months ended June 30, 2014 as compared to 3.31% for the three months ended June 30, 2013. The average tax equivalent yield on interest-earning assets decreased three basis points to 3.84% for the three months ended June 30, 2014 from 3.87% for the comparable period ended June 30, 2013. The average balance of interest earning assets decreased $1.1 million to $320.2 million for the three months ended June 30, 2014 from $321.3 million for the three months ended June 30, 2013. The yield on taxable securities increased seven basis points to 1.65% for the three months ended June 30, 2014 from 1.58% for the comparable prior year period. The yield on average loans decreased 16 basis points to 5.21% for the three months ended June 30, 2014 from 5.37% for the three months ended June 30, 2013. In addition, there was a seven basis point decrease in the cost of average interest-bearing liabilities to 0.49% for the three months ended June 30, 2014 as compared to 0.56% for the comparable 2013 period.

 

Provision for Loan Losses. The Bank’s provision for loan losses decreased to $50,000 for the three months ended June 30, 2014 from $270,000 for the comparable period in 2013. The $220,000 decrease in the provision was the result of management’s quarterly analysis of the allowance for loan losses. At June 30, 2014, December 31, 2013 and June 30, 2013, nonperforming loans totaled $653,000, $942,000 and $1.9 million, respectively. At June 30, 2014, the ratio of the allowance for loan losses to nonperforming loans was 280.7% compared to 213.3% at December 31, 2013 and 125.1% at June 30, 2013. The ratio of the allowance to total loans was 1.42%, 1.28% and 1.24%, at June 30, 2014, December 31, 2013 and June 30, 2013, respectively.

 

Nonperforming loans decreased $289,000, or 30.7%, to $653,000 at June 30, 2014 from $942,000 at December 31, 2013. The largest component of nonperforming loans is home equity lines of credit, which increased $148,000, or 29.3%, to $653,000, or 100.0% of total nonperforming loans, at June 30, 2014, from $505,000, or 53.6% of total nonperforming loans at December 31, 2013. Nonperforming commercial real estate loans decreased to zero at June 30, 2014 from $437,000 at December 31, 2013. Charge-offs, net of recoveries, totaled $23,000 for the three months ended June 30, 2014 compared to $1.2 million for the three months ended June 30, 2013. Nonperforming loans are loans that are ninety days past due and placed on nonaccrual status. Management continues to take aggressive actions in identifying and disposing of problem credits.

 

The amounts of the provision and allowance for loan losses are influenced by a number of factors, including current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. Should the local economic climate continue to deteriorate, borrowers may experience increased difficulties paying off loans and the level of non-performing loans, charge-offs, and delinquencies could continue to rise, which would require us to further increase the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions. Management believes that, based on information available at June 30, 2014, the Bank’s allowance for loan losses was adequate to cover probable incurred losses inherent in its loan portfolio at that time. However, no assurances can be given that the Bank’s level of allowance for loan losses will be sufficient to cover loan losses incurred by the Bank or that future adjustments to the allowance will not be necessary if economic or other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance. In addition, the FDIC and IDFPR, as an integral part of their examination processes, periodically reviews the Bank’s allowance for loan losses and may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management.

 

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Noninterest Income

   Three Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Non-interest income:                    
Service charges on deposit accounts  $99   $85   $14    16.47%
Gain on sale of loans   144    289    (145)   (50.17)
Loss on sale of foreclosed assets   -    (18)   18    100.00 
Gain on sale of securities   -    48    (48)   (100.00)
Other non-interest income   269    253    16    6.32 
Total non-interest income  $512   $657   $(145)   (22.07)

 

Noninterest income totaled $512,000 and $657,000 for the three months ended June 30, 2014 and 2013, respectively. Gain on sale of loans decreased $145,000 to $144,000 for the three months ended June 30, 2014 from $289,000 for the comparable prior year period. Loss on sale of foreclosed assets improved $18,000 to zero for the three months ended June 30, 2014 as compared to the prior year period. In addition, gain on sale of securities decreased $48,000 to zero for the three months ended June 30, 2014 as compared to the prior year period.

 

Noninterest Expense

   Three Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Non-interest expenses:                    
Salaries and employee benefits  $1,407   $1,520   $(113)   (7.43)%
Net occupancy and equipment expense   311    328    (17)   (5.18)
Data processing expense   254    338    (84)   (24.85)
Advertising and promotions   38    36    2    5.56 
Professional fees   218    397    (179)   (45.09)
FDIC insurance premiums   137    206    (69)   (33.50)
Write-down on other real estate owned   90    23    67    291.30 
Other real estate owned expenses   41    158    (117)   (74.05)
Other operating expenses   191    408    (217)   (53.19)
Total non-interest expenses  $2,687   $3,414   $(727)   (21.30)

 

Noninterest expense decreased by $727,000 to $2.7 million for the three months ended June 30, 2014 from $3.4 million for the comparable prior year period. Salaries and employee benefits expenses decreased by $113,000, or 7.4%, to $1.4 million for the three months ended June 30, 2014. This decrease is primarily due to a lower level of full-time equivalents as the Bank gained efficiencies as the result of a core processing conversion. Professional fees decreased $179,000, or 45.1%, to $218,000 for the three months ended June 30, 2014 from $397,000 for the comparable prior year period. This decrease is primarily due to lower attorney’s fees related to resolving problem credits. FDIC insurance premiums decreased by $69,000, or 33.5%, to $137,000 for the three months ended June 30, 2014 compared to $206,000 for the prior year period. Other real estate owned expenses decreased to $41,000 for the three months ended June 30, 2014 compared to $158,000 for the comparable prior year period. In addition, write-downs on foreclosed assets increased to $90,000 for the three months ended June 30, 2014 from $23,000 for the comparable prior year period. Data processing expenses decreased $84,000, or 24.9%, to $254,000 for the three months ended June 30, 2014 from $338,000 for the three months ended June 30, 2013. This decrease is primarily due to the savings from the recent core processing conversion the Bank completed. Advertising expenses increased $2,000 to $38,000 for the three months ended June 30, 2014 compared to the prior year period. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to its market.

 

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Income Tax Expense. The Company recorded income tax expense of zero for the three months ended June 30, 2014. As of June 30, 2014 the Company’s deferred tax assets related to net operating losses are fully reserved. Under generally accepted accounting principles, income tax benefits and the related tax assets may only be 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 additional valuation allowances will be necessary. Income tax expense totaled $101,000 for the three months ended June 30, 2013.

 

Comparison of Operating Results for the Six Months Ended June 30, 2014 and 2013

 

General. The Company’s net income for the six months ended June 30, 2014 totaled $677,000 compared to a net loss of $2.8 million for the six months ended June 30, 2013. This represents basic and diluted earnings per share of $0.02 for the six months ended June 30, 2014 compared to a basic and diluted loss per share of $0.48 for the six months ended June 30, 2013. The improvement in operating results for the six months ended June 30, 2014 is primarily the result of the combined effect of a $1.1 million decrease in provision for loan losses, a $185,000 increase in net interest income, a $2.2 million decrease in noninterest expense and an $226,000 decrease in noninterest income.

 

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

 

   Six Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Interest and dividend income:                    
Interest and fees on loans Securities:  $5,101   $5,275   $(174)   (3.30)%
Taxable   676    513    163    31.77 
Exempt from federal tax   189    115    74    64.35 
Other interest income   33    79    (46)   (58.23)
Total interest and dividend income   5,999    5,982    17    0.28 
                     
Interest expense:                    
Deposits   613    769    (156)   (20.29)
Federal Home Loan Bank advances and other borrowings   53    64    (11)   (17.19)
Subordinated debentures   34    35    (1)   (2.86)
Total interest expense   700    868    (168)   (19.36)
Net interest income  $5,299   $5,114   $185    3.62 

 

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

 

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

 

   Six Months Ended June 30, 
   2014   2013 
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
   (Dollars in thousands) 
Interest-earning assets:                              
Taxable securities  $80,650   $676    1.70%  $64,082   $513    1.65%
Tax-exempt securities (1)   16,377    286    3.52    6,446    174    5.45 
Loan receivables (2)   197,008    5,101    5.22    200,470    5,276    5.31 
Interest-bearing deposits, FHLB stock and other   23,404    33    0.27    49,282    79    0.28 
Total interest-earning assets  $317,439    6,096    3.87   $320,280    6,042    3.80 
                               
Interest-bearing liabilities:                              
NOW accounts   72,079    64    0.18    75,480    85    0.23 
Regular savings   74,537    96    0.26    68,377    104    0.31 
Money market accounts   43,117    62    0.29    44,974    90    0.40 
Certificates of deposit   83,989    390    0.94    95,176    490    1.04 
FHLB advances and other   5,228    54    2.07    6,280    64    2.06 
Subordinated debentures   3,609    34    1.88    3,609    35    1.94 
Total interest-bearing liabilities  $282,559    700    0.50   $293,896    868    0.60 
                               
Net interest income/interest rate spread (3)        5,396    3.37%        5,174    3.20%
Less: Taxable equivalent adjustment        97              60      
Net interest income as reported       $5,299             $5,114      
Net interest margin (4)             3.37%             3.22%
Tax equivalent effect             0.06%             0.04%
Net interest margin on a fully tax equivalent basis             3.43%             3.26%

 

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

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

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

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

  

Interest Income. Interest income increased $17,000 to $6.0 million for the six months ended June 30, 2014. The average tax equivalent yield on interest-earning assets increased seven basis points to 3.87% for the six months ended June 30, 2014 from 3.80% for the comparable prior year period. In addition, interest-earning assets decreased $2.9 million to $317.4 million for the six months ended June 30, 2014 from $320.3 million for the comparable prior year period.

 

Interest and fees on loans decreased $174,000, or 3.3%, to $5.1 million for the six months ended June 30, 2014, compared to $5.3 million for the comparable prior year period. This decrease resulted from a decrease in the average balance of loans of $3.5 million to $197.0 million for the six months ended June 30, 2014 from $200.5 million for the comparable prior year period. In addition, the average loan yield decreased nine basis points to 5.22% for the six months ended June 30, 2014 compared to 5.31% for the six months ended June 30, 2013. Interest on taxable securities increased $163,000 for the six months ended June 30, 2014 compared to the comparable prior year period. This increase is primarily due to an increase in the average balance of taxable securities of $16.6 million to $80.7 million for the six months ended June 30, 2014 from $64.1 million for the comparable prior year period. In addition, the average yield on taxable securities increased five basis points to 1.70% for the six months ended June 30, 2014 from 1.65% for the comparable prior year period.

 

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Interest Expense. Interest expense decreased by $168,000, or 19.4%, to $700,000 for the six months ended June 30, 2014, from $868,000 for the six months ended June 30, 2013. This decrease resulted from a decrease in the average rate paid on interest bearing liabilities of 10 basis points to 0.50% for the six months ended June 30, 2014 from 0.60% for the comparable prior year period, which is primarily due to a decrease in overall market rates. In addition, the average balance of interest bearing liabilities decreased $11.3 million to $282.6 million for the six months ended June 30, 2014 from $293.9 million for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances, subordinated debentures and other borrowings decreased $12,000 during the six months ended June 30, 2014. The average balance on these borrowings decreased $1.1 million to $8.8 million for the six months ended June 30, 2014 from $9.9 million for the comparable prior year period. In addition, there was a decrease in the average cost of these borrowings of three basis points to 1.99% for the six months ended June 30, 2014 from 2.02% for the comparable period in 2013.

 

Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses increased $185,000, or 3.6%, to $5.3 million for the six months ended June 30, 2014 compared to $5.1 million for the comparable period in 2013. The Company’s net interest margin expressed as a percentage of average interest-earning assets increased to 3.37% for the six months ended June 30, 2014 as compared to 3.22% for the six months ended June 30, 2013. The average tax equivalent yield on interest-earning assets increased seven basis points to 3.87% for the six months ended June 30, 2014 from 3.80% for the comparable period ended June 30, 2013. The average balance of interest earning assets decreased $2.9 million to $317.4 million for the six months ended June 30, 2014 from $320.3 million for the six months ended June 30, 2013. The yield on taxable securities increased five basis points to 1.70% for the six months ended June 30, 2014 from 1.65% for the comparable prior year period. The yield on average loans decreased nine basis points to 5.22% for the six months ended June 30, 2014 from 5.31% for the six months ended June 30, 2013. In addition, there was a 10 basis point decrease in the cost of average interest-bearing liabilities to 0.50% for the six months ended June 30, 2014 as compared to 0.60% for the comparable 2013 period.

 

Provision for Loan Losses. The Bank’s provision for loan losses decreased to $186,000 for the six months ended June 30, 2014 from $1.3 million for the comparable period in 2013. The $1.1 million decrease in the provision was the result of management’s quarterly analysis of the allowance for loan losses. At June 30, 2014, December 31, 2013 and June 30, 2013, nonperforming loans totaled $653,000, $942,000 and $1.9 million, respectively. At June 30, 2014, the ratio of the allowance for loan losses to nonperforming loans was 280.7% compared to 213.3% at December 31, 2013 and 125.1% at June 30, 2013. The ratio of the allowance to total loans was 1.42%, 1.28% and 1.24%, at June 30, 2014, December 31, 2013 and June 30, 2013, respectively.

 

Nonperforming loans decreased $289,000, or 30.7%, to $653,000 at June 30, 2014 from $942,000 at December 31, 2013. The largest component of nonperforming loans is home equity lines of credit, which increased $148,000, or 29.3%, to $653,000, or 100.0% of total nonperforming loans, at June 30, 2014, from $505,000, or 53.6% of total nonperforming loans at December 31, 2013. Nonperforming commercial real estate loans decreased to zero at June 30, 2014 from $437,000 at December 31, 2013. Charge-offs, net of recoveries, totaled ($49,000) for the six months ended June 30, 2014 compared to $1.6 million for the six months ended June 30, 2013. Nonperforming loans are loans that are ninety days past due and placed on nonaccrual status. Management continues to take aggressive actions in identifying and disposing of problem credits.

 

Noninterest Income

   Six Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Non-interest income:                    
Service charges on deposit accounts  $182   $171   $11    6.43%
Gain on sale of loans   256    771    (515)   (66.80)
Loss on sale of foreclosed assets   (21)   (338)   317    93.79 
Gain on sale of securities   -    55    (55)   (100.00)
Other non-interest income   498    482    16    3.32 
Total non-interest income  $915   $1,141   $(226)   (19.81)

 

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Noninterest income totaled $915,000 and $1.1 million for the six months ended June 30, 2014 and 2013, respectively. Gain on sale of loans decreased $515,000 to $256,000 for the six months ended June 30, 2014 from $771,000 for the comparable prior year period. Loss on sale of foreclosed assets improved $317,000 to a loss of $21,000 for the six months ended June 30, 2014 as compared to the prior year period.

 

Noninterest Expense

   Six Months Ended June 30, 
   2014   2013   $ Change   % Change 
   (Dollars in thousands) 
Non-interest expenses:                    
Salaries and employee benefits  $2,857   $3,116   $(259)   (8.31)%
Net occupancy and equipment expense   667    655    12    1.83 
Data processing expense   499    669    (170)   (25.41)
Advertising and promotions   75    90    (15)   (16.67)
Professional fees   417    714    (297)   (41.60)
FDIC insurance premiums   272    412    (140)   (33.98)
Write-down on other real estate owned   90    865    (775)   (89.60)
Other real estate owned expenses   90    320    (230)   (71.88)
Other operating expenses   384    757    (373)   (49.27)
Total non-interest expenses  $5,351   $7,598   $(2,247)   (29.57)

 

Noninterest expense decreased by $2.2 million to $5.4 million for the six months ended June 30, 2014 from $7.6 million for the comparable prior year period. Salaries and employee benefits expenses decreased by $259,000, or 8.3%, to $2.9 million for the six months ended June 30, 2014. This decrease is primarily due to a lower level of full-time equivalents as the Bank gained efficiencies as the result of a core processing conversion. Professional fees decreased $297,000, or 41.6%, to $417,000 for the six months ended June 30, 2014 from $714,000 for the comparable prior year period. This decrease is primarily due to lower attorney’s fees related to resolving problem credits. FDIC insurance premiums decreased by $140,000, or 34.0%, to $272,000 for the six months ended June 30, 2014 compared to $412,000 for the prior year period. Other real estate owned expenses decreased to $90,000 for the six months ended June 30, 2014 compared to $320,000 for the comparable prior year period. In addition, write-downs on foreclosed assets decreased to $90,000 for the six months ended June 30, 2014 from $865,000 for the comparable prior year period. Data processing expenses decreased $170,000, or 25.4%, to $499,000 for the six months ended June 30, 2014 from $669,000 for the six months ended June 30, 2013. This decrease is primarily due to the savings from the recent core processing conversion the Bank completed. Advertising expenses decreased $15,000 to $75,000 for the six months ended June 30, 2014 compared to the prior year period. Offsetting these decreases was an increase of $12,000 in occupancy expense primarily related to snow removal costs for the six months ended June 30, 2014. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to its market.

 

Income Tax Expense. The Company recorded income tax expense of zero for the six months ended June 30, 2014. As of June 30, 2014 the Company’s deferred tax assets related to net operating losses are fully reserved. Under generally accepted accounting principles, income tax benefits and the related tax assets may only be 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 additional valuation allowances will be necessary. Income tax expense totaled $146,000 for the six months ended June 30, 2013.

 

Critical Accounting Policies

 

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

 

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

 

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

 

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

 

Deferred Taxes. Realization of deferred tax assets is dependent on generating sufficient taxable income to cover net operating losses generated by the reversal of temporary differences. A partial or total valuation allowance is provided by way of a charge to income tax expense if it is determined that it is more likely than not that some of or all of the deferred tax asset will not be realized. Under generally accepted accounting principles, income tax benefits and the related tax assets are only allowed to be recognized if they will more likely than not be fully utilized. In each future accounting period, the Company’s management will consider both positive and negative evidence when considering the ability of the Company to utilize its net deferred tax asset. Any subsequent reduction in the valuation allowance would lower the amount of income tax expense recognized in the Company’s consolidated statements of operations in future periods.

 

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

 

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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.

 

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 June 30, 2014, the Company had liquid assets of $3.4 million.

 

Contractual Obligations

 

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

 

       Payments Due By Year         
   2014   2015   2016   2017   2018   2019   Total 
(Dollars in Thousands)                      and after     
                             
Federal Home Loan Bank advances  $2,500   $2,000   $-   $-   $-   $-   $4,500 
Subordinated debentures   -    -    -    -    -    3,609    3,609 
Data Processing (1), (2)   330    660    660    660    660    1,980    4,950 
Total  $2,830   $2,660   $2,660   $660   $660   $5,589   $13,059 

 

(1)Estimated contract amount based on transaction volume. Actual expense was $750,000 and $737,000 in 2013 and 2012, respectively.
(2)A new contract was signed and is effective until October 14, 2020.

 

Off-balance-sheet Arrangements

 

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

 

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Impact of Inflation and Changing Prices

 

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

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

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

 

ITEM 4: CONTROLS AND PROCEDURES

 

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the six months ended June 30, 2014 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, 2013.

 

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

None

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

None

 

ITEM 4.MINE SAFETY DISCLOSURES

Not applicable

 

ITEM 5.OTHER INFORMATION

None

 

ITEM 6.EXHIBITS

 

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

  

 

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

 

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SIGNATURES

 

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

  

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

 

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