ITEM
2.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING
STATEMENTS
This
report contains forward-looking statements within the meaning of the federal
securities laws. These statements are not historical facts, rather they are
statements based on the Company's current expectations regarding its business
strategies and their intended results and its future performance.
Forward-looking statements are preceded by terms such as "expects," "believes,"
"anticipates," "intends," and similar expressions. Forward-looking statements
are not guarantees of future performance. Numerous risks and uncertainties
could
cause the Company's actual results, performance, and achievements to be
materially different from those expressed or implied by the forward-looking
statements. Factors that may cause or contribute to these differences include,
without limitation, general economic conditions, including changes in market
interest rates and changes in monetary and fiscal policies of the federal
government; legislative and regulatory changes; and other factors disclosed
periodically in the Company's filings with the Securities and Exchange
Commission. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them, whether
included in this report or made elsewhere from time to time by the Company
or on
its behalf. The Company assumes no obligation to update any forward-looking
statements.
GENERAL
Management's
discussion and analysis of financial condition and results of operations is
intended to assist in understanding the financial condition and results of
operations of the Company. The information contained in this section should
be
read in conjunction with the unaudited condensed consolidated financial
statements and accompanying notes thereto.
COMPARISON
OF FINANCIAL CONDITION AT SEPTEMBER 30, 2007, AND JUNE 30, 2007
Total
consolidated assets of the Company increased $957,000, or 0.3%, to $363.9
million at September 30, 2007, from $363.0 million at June 30, 2007. Loan
activity accounted for the majority of the increase.
Cash
and
cash equivalents, which consist mainly of funds on deposit at the Federal Home
Loan Bank of Indianapolis (FHLB) or the Federal Reserve Bank, increased $250,000
to $15.1 million during the three months ended September 30, 2007. Certificates
of deposit (CDs) with other financial institutions, which are all fully insured
by the FDIC, totaled $1.3 million at September 30, 2007, compared to $1.6
million at June 30, 2007.
Investment
securities decreased 0.9% during the quarter to $79.4 million due mainly to
maturing federal agency debentures and principal receipts from mortgage-backed
securities. The portfolio is composed entirely of mortgage-related securities,
federal agency notes, municipal bonds, and investment grade asset-backed paper.
Recent economic conditions have not adversely affected the ratings of any
securities in the portfolio.
Net
loans
totaled $235.2 million at September 30, 2007, a 0.9% increase from the $233.2
million balance at June 30, 2007, with consumer and commercial real estate
loans
accounting for most of the growth. In particular, permanent loans secured by
nonresidential or multi-family real estate grew $705,000 or 2.8% during the
first fiscal quarter. During the same period, the consumer loan portfolio,
including loans secured by savings accounts, increased 1.8% as indirect
automobile loan production totaled $10.5 million. Also, $1.6 million of newly
originated permanent single family residential mortgage loans, or 49.0% of
total
production, were sold during the most recent quarter. For the foreseeable
future, management intends to continue building the mortgage loan servicing
portfolio through the origination and sale of loans. Consumer loan retention
is
subject to First Federal's liquidity needs, as well as internal and regulatory
asset diversification limitations to which First Federal is in full
compliance.
The
allowance for loan losses totaled $1.1 million at September 30, 2007, a $9,000
increase from three months earlier. The change was composed of $80,000 in
provisions for losses and $71,000 in net charge-offs. The Company’s allowance
for loan losses represented 0.45% of total loans at September 30, 2007,
unchanged from the level at June 30, 2007. The allowance for loan losses
increased to 667.1% of nonperforming loans at September 30, 2007, from 326.7%
at
June 30, 2007.
The
table
below highlights changes in the Company’s nonperforming assets since the most
recent fiscal year end.
|
|
|
September 30,
2007
|
|
June 30,
2007
|
|
|
|
|
|
|
|
|
|
Loans
accounted for on a nonaccrual basis
|
|
$
|
145,000
|
|
$
|
311,000
|
|
|
Accruing
loans past due 90 days or more
|
|
|
16,000
|
|
|
14,000
|
|
|
Nonperforming
loans
|
|
|
161,000
|
|
|
325,000
|
|
|
Real
estate owned (net)
|
|
|
97,000
|
|
|
10,000
|
|
|
Other
repossessed assets
|
|
|
8,000
|
|
|
33,000
|
|
|
Total
nonperforming assets
|
|
$
|
266,000
|
|
$
|
368,000
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans delinquent 90 days or more to total loans
|
|
|
0.07
|
%
|
|
0.14
|
%
|
|
Total
loans delinquent 90 days or more to total assets
|
|
|
0.04
|
%
|
|
0.09
|
%
|
|
Total
nonperforming assets to total assets
|
|
|
0.07
|
%
|
|
0.10
|
%
|
Total
deposits decreased $11.8 million to $239.4 million at September 30, 2007, from
$251.2 million at June 30, 2007. The decrease was attributed primarily to a
$11.2 million reduction in brokered funds. Borrowings, which consisted mainly
of
FHLB products, totaled $84.7 million at September 30, 2007, a $12.2 million
increase that included $5.2 million of junior subordinated debt associated
with
trust preferred securities issued through a statutory trust. Advances from
the
Federal Home Loan Bank of Indianapolis accounted for the balance of the
increase. First Federal believes that it has substantial resources to increase
its borrowing capacity with the FHLB.
At
$866,000, escrow balances at September 30, 2007, were 24.6% above the levels
three months earlier due mainly to seasonal variances. During the first three
months of fiscal 2008, other liabilities, which include accrued expenses and
miscellaneous short-term payables, increased $588,000, or 13.5%. The change
was
attributed primarily to accrued interest on time deposits and accrued income
taxes.
Total
stockholders’ equity decreased $167,000 to $34.1 million at September 30, 2007,
from $34.2 million at June 30, 2007. In addition to the $189,000 of net income,
the most significant components of the change included 12,738 shares of First
Bancorp common stock repurchased at a total cost of $200,000 and semiannual
cash
dividends totaling $553,000. Also affecting stockholders’ equity were $58,000 in
allocations of ESOP shares, and $40,000 from the exercise of stock options.
Finally, an unrealized gain, adjusted for deferred taxes, of $299,000 was
recognized on the portfolio of available-for-sale securities.
COMPARISON
OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007, AND
2006
GENERAL.
Net income for the quarter ended September 30, 2007, improved 8.6% to $189,000
from $174,000 for the quarter ended September 30, 2006, despite upward pressure
on funding costs that further compressed the net interest margin. The annualized
return on average assets decreased to 0.21% for the quarter ended September
30,
2007, from 0.23% for the same quarter last year. The return on average equity
also fell to 2.24% from 2.47% for the comparative quarters. The significant
increase in noninterest expenses between the comparative periods was largely
due
to the Company’s October 1, 2006, acquisition of Home Building Bancorp,
Inc.
NET
INTEREST INCOME. At $1.9 million, net interest income for the quarter ended
September 30, 2007, was 13.4% higher than in the same quarter a year ago. Total
interest income increased 29.2% between the comparative quarters as a result
of
a $59.4 million increase in average interest-earning assets attributed mainly
to
the merger and a 36 basis point improvement in the average yield on these
assets. Total interest expenses increased 40.0% between the same periods.
Consequently, the net interest margin declined to 2.25% for the first quarter
of
fiscal 2008 from 2.42% for the same period the preceding year.
PROVISION
FOR LOAN LOSSES. The provision for loan losses is intended to establish an
allowance adequate to cover losses inherent in the loan portfolio as of the
balance sheet date based upon management's periodic analysis of information
available at that time. At $80,000, the provision for loan losses for the
quarter ended September 30, 2007, was $15,000 less than the same quarter last
fiscal year. While management believes the allowance for loan losses to be
sufficient given current information, future events, conditions, or regulatory
directives could necessitate additions to the allowance for loan losses that
may
adversely affect net income.
NONINTEREST
INCOME. Noninterest income totaled $490,000 for the quarter ended September
30,
2007, compared to $501,000 for the same quarter last year. Last year’s quarterly
total included a $42,000 gain from the sale of approximately $5.0 million of
consumer loans. The introduction of a new overdraft protection program accounted
for the 68.5% increase in service charges on deposit accounts. Reduced income
from the servicing of sold consumer loans was responsible for the decrease
in
other noninterest income.
NONINTEREST
EXPENSE. At $2.0 million for the quarter ended September 30, 2007, total
noninterest expense increased significantly from the same quarter in fiscal
2007
due in large part to the personnel and facilities gained in the merger along
with other merger-related items. The amortization of intangible assets nearly
doubled to $37,000 for the most recent quarter. The change is attributed
primarily to the amortization of the core deposit intangible that resulted
from
the merger. Similarly, the 30.1% increase in data processing expenses was due
mainly to accounts added in the merger. Despite these items, noninterest
expenses relative to average assets declined 22 basis points to an annualized
2.23% for the most recent quarter.
INCOME
TAXES. Effective tax rates for the quarters ended September 30, 2007 and 2006
approximated 18.1% and 20.2%, respectively. The effective tax rates are below
the statutory rates due in large part to the tax benefits generated by
bank-qualified municipal securities relative to the levels of income before
taxes.
LIQUIDITY
AND CAPITAL RESOURCES
Federal
regulations require First Federal to maintain liquidity commensurate with safe
and sound operations. Such liquidity may include both existing assets and access
to reliable funding sources. To this end, First Federal maintains an adequate
level of liquidity to ensure the availability of sufficient funds to fund loan
originations and deposit withdrawals, to satisfy other financial commitments,
and to take advantage of investment opportunities. First Federal invests excess
funds in overnight deposits and other short-term interest-bearing assets to
provide liquidity to meet these needs. At September 30, 2007, bank-only cash
and
cash equivalents totaled $11.4 million, or 3.2% of total assets. First Federal
also had marketable securities, excluding a small inventory of negotiable CDs,
totaling $79.4 million, of which, 81.9% were classified “available for sale.” At
the same time, First Federal had net commitments to fund loans, including loans
in process, of $942,000.
Retail
certificates of deposit scheduled to mature in one year or less totaled $73.1
million at September 30, 2007. Based upon historical experience, management
believes the majority of maturing certificates of deposit will remain with
First
Federal. Management of First Federal believes it can adjust the offering rates
of certificates of deposit to retain deposits in changing interest rate
environments. If a significant portion of these deposits are not retained by
First Federal, First Federal would be able to utilize FHLB advances and other
wholesale sources to fund deposit withdrawals. This could result in an increase
in interest expense to the extent that the average rate paid on wholesale funds
generally exceeds the average rate paid on retail deposits of similar
duration.
Management
believes its ability to generate funds internally will satisfy its liquidity
needs. However, should First Federal require funds beyond its ability to
generate them internally, it has the ability to borrow funds from the Federal
Home Loan Bank. Based on currently pledged collateral, First Federal had
approximately $16.6 million remaining available to borrow under its credit
arrangement with the FHLB as of September 30, 2007. In addition, First Federal
had unpledged collateral sufficient to add another $19.7 million of borrowing
capacity with the FHLB.
Office
of
Thrift Supervision regulations require First Federal to maintain specific
amounts of capital. As of September 30, 2007, First Federal exceeded its minimum
capital requirements as the following table illustrates.
|
|
|
|
|
Regulatory Minimum
|
|
Well Capitalized per
|
|
|
|
|
Actual
|
|
Required Capital
|
|
12 CFR Part 565
|
|
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
|
|
|
(Dollars
in Thousands)
|
|
|
As
of September 30, 2007 (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital (to risk weighted assets)
|
|
$
|
27,066
|
|
|
11.43
|
%
|
$
|
18,940
|
|
|
8.00
|
%
|
$
|
23,675
|
|
|
10.00
|
%
|
|
Tier
I capital (to risk weighted assets)
|
|
|
27,009
|
|
|
11.04
|
|
|
9,470
|
|
|
4.00
|
|
|
14,205
|
|
|
6.00
|
|
|
Tier
I capital (to adjusted total assets)
|
|
|
27,009
|
|
|
7.67
|
|
|
14,088
|
|
|
4.00
|
|
|
17,610
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of June 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital (to risk weighted assets)
|
|
$
|
25,680
|
|
|
10.81
|
%
|
$
|
19,010
|
|
|
8.00
|
%
|
$
|
23,763
|
|
|
10.00
|
%
|
|
Tier
I capital (to risk weighted assets)
|
|
|
25,675
|
|
|
10.40
|
|
|
9,505
|
|
|
4.00
|
|
|
14,258
|
|
|
6.00
|
|
|
Tier
I capital (to adjusted total assets)
|
|
|
25,675
|
|
|
7.23
|
|
|
14,200
|
|
|
4.00
|
|
|
17,750
|
|
|
5.00
|
|
The
Company’s fourth stock repurchase program was announced on August 24, 2006, to
acquire up to 77,000 shares, or 5%, of the outstanding shares. This repurchase
program, as with the previous programs, has been undertaken to enhance
shareholder value and to provide liquidity for the otherwise thinly traded
shares. The repurchase programs generally have been conducted through open
market purchases, although unsolicited negotiated transactions or other types
of
repurchases have also taken place. As of September 30, 2007, 30,379 shares
had
been repurchased under the fourth stock repurchase program leaving 46,621 shares
to be purchased.
The
following chart summarizes stock repurchase activity during the most recent
quarter.
|
Period
|
|
Total
Number of Shares Purchased
|
|
Average
Price Paid per Share
|
|
Total
Number of Shares Purchased as Part of Publicly Announced Plans or
Programs
|
|
Maximum
Number of Shares that May Yet Be Purchased Under the Plans or
Programs
|
|
|
July
1, 2007 through July 31, 2007
|
|
|
0
|
|
|
N/A
|
|
|
N/A
|
|
|
59,359
|
|
|
August
1, 2007 through August 31, 2007
|
|
|
11,238
|
|
$
|
15.69
|
|
|
11,238
|
|
|
48,121
|
|
|
September
1, 2007 through September 30, 2007
|
|
|
1,500
|
|
$
|
15.10
|
|
|
1,500
|
|
|
46,621
|
|
|
Total
|
|
|
12,738
|
|
$
|
15.62
|
|
|
12,738
|
|
|
|
|
CRITICAL
ACCOUNTING POLICIES
ALLOWANCE
FOR LOAN LOSSES. The allowance for loan losses is established through a
provision for loan losses charged to earnings at the time losses are estimated
to have occurred. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.
The
allowance for loan losses is evaluated on a regular basis by management and
is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes
available.
A
loan is
considered impaired when, based on current information and events, it is
probable that the Bank will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as
impaired.
Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record and the amount of the
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.
Large
groups of smaller balance homogenous loans are collectively evaluated for
impairment. Accordingly, the Bank does not separately identify individual
consumer and residential loans for impairment disclosures.
MORTGAGE
SERVICING RIGHTS. Mortgage servicing rights on originated loans that have been
sold are capitalized by allocating the total cost of the mortgage loans between
the mortgage servicing rights and the loans based on their relative fair values.
Capitalized servicing rights are amortized in proportion to and over the period
of estimated servicing revenues. Impairment of mortgage-servicing rights is
assessed based on the fair value of those rights. Fair values are estimated
using discounted cash flows based on a current market interest rate. For
purposes of measuring impairment, the rights are stratified based on the
predominant risk characteristics of the underlying loans. The predominant
characteristic currently used for stratification is type of loan. The amount
of
impairment recognized is the amount by which the capitalized mortgage servicing
rights for a stratum exceed their fair value.
GOODWILL.
Goodwill is tested annually for impairment. If the implied fair value of
goodwill is lower than its carrying amount, goodwill impairment is indicated
and
goodwill is written down to its implied fair value. Subsequent increases in
goodwill value are not recognized in the financial statements.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
September 2006, FASB issued Statement No. 157 (SFAS 157),
Fair
Value Measurements
.
This
Statement defines fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. Although this statement
does not require any new fair value measurements, the application of this
Statement may change current practices. The new standard will be effective
for
the Company beginning July 1, 2008. The Company has not completed its evaluation
of the impact of the adoption of SFAS 157.
In
February 2007, FASB issued Statement No. 159 (SFAS 159),
The
Fair Value Option for Financial Assets and Financial Liabilities - Including
an
amendment of FASB Statement No. 115.
This
Statement permits entities to choose to measure many financial instruments
and
certain other items at fair value.
The
new
standard will be effective for the Company beginning July 1, 2008, although
early adoption is allowed. The Company is currently evaluating the impact of
the
impact of the adoption of SFAS 159 and did not elect to early
adopt.