ITEM 1. Business - -----------------
General
Wayne Savings Bancshares, Inc.
Wayne Savings Bancshares, Inc. (the "Company"), is a unitary holding company for Wayne Savings Community Bank (the "Bank"). The only significant asset of the Company is its investment in the Bank. A plan of conversion and reorganization was approved by the stockholders of the Company, the depositors of Wayne Savings Community Bank and the Office of Thrift Supervision ("OTS") in fiscal 2003, and the related stock offering was completed on January 8, 2003. As of that date 1,350,699 shares of common stock of the Company owned by the M.H.C. were retired and the Company sold 2,040,816 shares of common stock for $10.00 per share. After consideration of funding the employee stock ownership plan ("ESOP") with $1.6 million and related expenses of $1.9 million, net proceeds from the stock offering amounted to $17.1 million. An additional 1,847,820 shares were issued to existing shareholders based on an exchange rate of 1.5109 new shares of common stock for each existing share, resulting in 3,888,795 total new shares outstanding. At March 31, 2006, the Company had total assets of $403.7 million, total deposits of $332.6 million, and stockholders' equity of $35.5 million. On June 1, 2004, the Company acquired Stebbins Bancshares, Inc., and its national bank subsidiary, Stebbins National Bank of Creston, Ohio. The acquisition of Stebbins National Bank increased the Bank's branches to eleven full-service locations. The Company's principal office is located at 151 North Market Street, Wooster, Ohio, and its telephone number at that address is (330) 264-5767.
Wayne Savings Community Bank
The Bank is an Ohio-chartered stock savings and loan association headquartered in Wooster, Ohio. The Bank's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since 1937.
The Bank is a community-oriented savings institution offering traditional financial services to its local community. The Bank's primary lending and deposit gathering area includes Wayne, Holmes, Ashland, Medina and Stark counties, where it operates eleven full-service offices. This contiguous five-county area is located in northeast Ohio, and is an active manufacturing and agricultural market. The Bank's principal business activities consist of originating one- to four-family residential real estate loans, multi-family residential, commercial and non-residential real estate loans. The Bank also originates consumer loans, and to a lesser extent, construction loans. The Bank also invests in mortgage-backed securities and currently maintains a significant portion of its assets in liquid investments, such as United States Government securities, federal funds, and deposits in other financial institutions.
During the most recent five fiscal years, the Company has rebalanced the loan portfolio by placing an increased emphasis on nonresidential real estate and commercial business loans. Nonresidential real estate loans and commercial loans have increased from $12.4 million, or 4.82% of the loan portfolio and $3.1 million, or 1.22% of the total loan portfolio at March 31, 2002 to $50.8 million, or 21.25%, and $21.6 million, or 9.02%, at March 31, 2006. Correspondingly, one- to four-family residential loans have decreased from $220.1 million, or 85.36% of the total loan portfolio at March 31, 2002 to $149.1 million, or 62.4%, at March 31, 2006. Nonresidential real estate loans and commercial loans generally carry higher yields and shorter terms than one- to four-family loans. The increased emphasis on nonresidential real estate and commercial business loans have diversified the loan portfolio, expanded the Company's product offerings and broadened the Company's customer base.
The Bank's principal executive office is located at 151 North Market Street, Wooster, Ohio, and its telephone number at that address is (330) 264-5767.
Market Area/Local Economy
The Bank, headquartered in Wooster, Ohio, operates in Wayne, Ashland, Medina, Holmes and Stark Counties in northeast Ohio. Wooster, Ohio is located in Wayne County and is approximately midway between Cleveland and Columbus, Ohio.
Wayne County is characterized by a diverse economic base, which is not dependent on any particular industry. It is one of the leading agricultural counties in the state. Since 1892, Wooster has been the headquarters of the Ohio Agricultural Research and Development Center, the agricultural research arm of The Ohio State University. In addition, Wayne County is also the home base of such nationally known companies like J.M. Smucker Company, Worthington Industries/The Gertsenslager Company, and the Wooster Brush Company. It is also the home of many industrial plants, including Packaging Corporation of America, International Paper Company, Morton Salt, and FritoLay, Inc. The City of Wooster has benefited from the commitment of the world renowned Cleveland Clinic as they have established new state of the art medical facilities. Wayne County is also known for its excellence in education. The College of Wooster was founded in 1866 and serves 1,800 students during the school season. Other quality educational opportunities are offered by the Agricultural Technical Institute of Ohio State University, and Wayne College, a branch of The University of Akron. Wayne Savings operates four full-service offices in Wooster, one stand-alone drive-thru facility and one full-service office in both Rittman and Creston.
Ashland County, which is located due west of Wayne County, also has a diverse economic base. In addition to its agricultural segment, Ashland County has manufacturing plants producing rubber and plastics, machinery, transportation equipment, chemicals, apparel, and other items. Ashland is also the home of Ashland University. The City of Ashland is the county seat and the location of two of the Bank's branch offices.
Medina County, located just north of Wayne County, is the center of a fertile agricultural region. Farming remains the largest industry in the county in terms of dollar value of goods produced. However, over 100 small manufacturing firms also operate in the county. The City of Medina is located in the center of the Cleveland-Akron-Lorain Standard Consolidated Statistical Marketing Area. Medina is located approximately 30 miles south of Cleveland and 15 miles west of Akron. Due to its proximity to Akron and Cleveland, a majority of Medina County's labor force is employed in these two cities. The Bank operates one full-service office in Medina County, which is located in the Village of Lodi.
Holmes County, located directly south of Wayne County, has a mostly rural economy. The local economy depends mostly upon agriculture, light manufacturing, fabrics, and wood products. Because of the scenic beauty and a large Amish settlement, revenues from tourism are becoming increasingly significant. The county is also noted for its many fine cheese-making operations. A large number of Holmes County residents are employed in Wayne County. The City of Millersburg is the county seat and the location of one of the Bank's branch offices.
Stark County, located directly east of Wayne County, is characterized by a diverse economy and over 1,500 different products are manufactured in the county. Stark County also has a strong agricultural base, and ranks fourth in Ohio in the production of dairy products. The major employers in North Canton are the Hoover Company, Diebold Incorporated (a major manufacturer of bank security products and automated teller machines) and the Timken Company (a world-wide manufacturer of tapered roller bearings and specialty steels). Maytag Corp., the parent of the Hoover Company, was acquired by Whirlpool Corp. The future of the Hoover Company in North Canton is uncertain. Timken has also had plants close, resulting in
job losses in the North Canton region of approximately 30%. The Bank does not have a material concentration of loans in the North Canton market area. Jackson Township is the home to the Belden Village Shopping Center, while Plain Township is a residential and agricultural area with a few widely scattered light industries. North Canton is the location of one of the Bank's branches.
Lending Activities
General. Historically, the principal lending activity of the Company has been the origination of fixed and adjustable rate mortgage ("ARM") loans collateralized by one- to four-family residential properties located in its market area. The Company originates ARM loans for retention in its portfolio, and fixed rate loans that are eligible for resale in the secondary mortgage market. The Company also originates loans collateralized by non-residential and multi-family residential real estate, as well as commercial business loans. The Company also originates consumer loans to broaden services offered to customers.
The Company has sought to make its interest-earning assets more interest rate sensitive by originating adjustable rate loans, such as ARM loans, home equity loans, and medium-term consumer loans. The Company also purchases mortgage-backed securities generally with estimated remaining average lives of 5 years or less. At March 31, 2006, approximately $70.9 million, or 24.4%, of the Company's total loans and mortgage-backed securities consisted of loans or securities with adjustable interest rates.
The Company continues to actively originate fixed rate mortgage loans, generally with 15 to 30 year terms to maturity, collateralized by one- to our-family residential properties. One- to four-family fixed rate residential mortgage loans generally are originated and underwritten according to standards that allow the Company to resell such loans in the secondary mortgage market for purposes of managing interest rate risk and liquidity. Since November 2005, the Company has decided to retain all one- to four-family, fixed rate residential mortgage loan originations with terms of 15 and 30 years in an attempt to stabilize this sector of the loan portfolio. The Company retains servicing on its sold mortgage loans and realizes monthly service fee income. The Company also originates interim construction loans on one- to four-family residential properties.
The Company has continued developing the commercial business loan program. The purpose of this program is to increase the Company's interest rate sensitive assets, increase interest income and diversify both the loan portfolio and the Company's customer base. The Company has three experienced commercial lenders to help in this effort. The Company targets small local businesses with loan amounts in the $50,000 - $1.0 million range with a majority of loans under $500,000. Commercial loans increased to $21.6 million at March 31, 2006 as compared to $14.1 million at March 31, 2005 and $3.1 million at March 31, 2002. Further, the Company has placed an increased emphasis on nonresidential real estate loan products over the last five years. Nonresidential real estate and land loans increased from $12.4 million, or 4.8%, of the total loan portfolio at March 31, 2002 to $50.8 million, or 21.2%, of the total loan portfolio at March 31, 2006.
Analysis of Loan Portfolio. Set forth below are selected data relating to the composition of the Company's loan portfolio, including loans held for sale, by type of loan as of the dates indicated.
(1) Includes equity loans collateralized by second mortgages in the aggregate amount of $20.9 million, $20.3 million, $20.3 million, $21.2 million, and $18.9 million as of March 31, 2006, 2005, 2004, 2003 and 2002, respectively. Such loans have been underwritten on substantially the same basis as the Company's first mortgage loans. (2) Includes land loans of $674,000, $1.4 million, $575,000, $813,000 and $736,000 as of March 31, 2006, 2005, 2004, 2003 and 2002, respectively. (3) Includes second mortgage loans of $783,000, $1.4 million, $535,000, $859,000 and $1.2 million as of March 31, 2006, 2005, 2004, 2003 and 2002, respectively. (4) Includes mortgage-backed securities designated as available for sale.
Loan and Mortgage-Backed Securities Maturity and Repricing Schedule. The following table sets forth certain information as of March 31, 2006, regarding the dollar amount of loans and mortgage-backed securities maturing in the Company's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Adjustable and floating rate loans and mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust rather than in which they mature, and fixed rate loans and mortgage-backed securities are included in the period in which the final contractual repayment is due. Fixed rate mortgage-backed securities are assumed to mature in the period in which the final contractual payment is due on the underlying mortgage.
- ----------------------------- (1) Amounts shown are net of loans in process of $1.7 million in construction loans. (2) Includes mortgage-backed securities available for sale. Does not include premiums of $514,000, discounts of $287,000 and unrealized losses of $728,000.
The following table sets forth at March 31, 2006, the dollar amount of all fixed rate and adjustable rate loans and mortgage-backed securities maturing or repricing after March 31, 2007.
Fixed Adjustable (In Thousands) Mortgage loans: One- to four-family residential ...................... $103,781 $ 11,789 Construction (1) ..................................... 2,473 -- Multi-family residential, non-residential and land (1) 24,385 28,200 Consumer ............................................. 3,630 -- Commercial business .................................. 2,436 1,231 -------- -------- Total loans ................................... $136,705 $ 41,220 ======== ========
Mortgage-backed securities(2) .......................... $ 45,164 $ 2,050 ======== ========
- ----------------- (1) Net of loans in process of $1.7 million in residential construction loans. (2) Includes mortgage-backed securities available for sale, which totaled $53.9 million as of March 31, 2006. Does not include premiums of $514,000, discounts of $287,000 and unrealized losses of $728,000.
One- to Four-Family Residential Real Estate Loans. The Company's primary lending activity consists of the origination of one- to four-family, owner-occupied, residential mortgage loans on properties located in the Company's market area. The Company generally does not originate one- to four-family residential loans secured by properties outside of its market area. At March 31, 2006, the Company had $149.1 million, or 62.4%, of its total loan portfolio invested in one- to four-family residential mortgage loans.
The Company's fixed rate loans generally are originated and underwritten according to standards that permit resale in the secondary mortgage market. Whether the Company can or will sell fixed rate loans into the secondary market, however, depends on a number of factors including the Company's portfolio mix, gap and liquidity positions, and market conditions. Moreover, the Company is more likely to retain fixed rate loans if its one-year gap is positive. The Company's fixed rate mortgage loans are amortized on a monthly basis with principal and interest due each month. One- to four-family residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option. The Company's one- to four-family residential portfolio has declined $8.5 million, or 5.4%, from March 31, 2005 to March 31, 2006. This reduction was due mainly to the low interest rate environment which prompted many mortgage customers to refinance their loans, coupled with management's intent to increase the commercial loan portfolio. The Company's secondary market activities have been limited to sales of $6.1 million, $6.0 million, $6.2 million, $4.0 million and $27.4 million, for the fiscal years ended March 31, 2006, 2005, 2004, 2003 and 2002, respectively. Such sales generally constituted current period originations. In the third quarter of fiscal 2006, the Company's management temporarily halted sales of loans to stabilize balances in this segment of the loan portfolio. There were no loans identified as available for sale as of March 31, 2006, 2005, 2004, 2003, or 2002.
The Company currently offers one- to four-family residential mortgage loans with terms typically ranging from 15 to 30 years, and with adjustable or fixed interest rates. Originations of fixed rate mortgage loans versus ARM loans are monitored on an ongoing basis and are affected significantly by the level of market interest rates, customer preference, the Company's interest rate gap position, and loan products offered by the Company's competitors. Despite the Company's emphasis on ARM loans, the low interest rate environment over the last few years has resulted in customer preference for fixed rate mortgage loans. As a result, during the year ended March 31, 2006, the Company's ARM portfolio decreased by $3.5 million, or 7.6%.
The Company offers one ARM loan product. The Treasury ARM loan adjusts annually with interest rate adjustment limitations of 2% per year and with a cap of 3% or 5% on total rate increases or decreases over the life of the loan. The index on the Treasury ARM loan is the weekly average yield on U.S. Treasury securities, adjusted to a constant maturity of one year plus a margin. However, these loans are underwritten at the fully-indexed interest rate. One- to four-family residential ARM loans totaled $42.6 million, or 17.8%, of the Company's total loan portfolio at March 31, 2006.
The primary purpose of offering ARM loans is to make the Company's loan portfolio more interest rate sensitive. However, as the interest income earned on ARM loans varies with prevailing interest rates, such loans do not offer the Company predictable cash flows as would long-term, fixed rate loans. ARM loans carry increased credit risk associated with potentially higher monthly payments by borrowers as general market interest rates increase. It is possible, therefore, that during periods of rising interest rates, the risk of default on ARM loans may increase due to the upward adjustment of interest costs to the borrower. Management believes that the Company's credit risk associated with its ARM loans is reduced because the Company has either a 3% or 5% cap on interest rate increases during the life of its ARM loans.
The Company also offers home equity loans and equity lines of credit collateralized by a second mortgage on the borrower's principal residence. In underwriting these home equity loans, the Company requires that the maximum loan-to-value ratios, including the principal balances of both the first and second mortgage loans, not exceed 85%. The home equity loan portfolio consists of adjustable rate loans which use the prime rate as published in The Wall Street Journal as interest rate indices. Home equity loans include fixed term adjustable rate loans, as well as lines of credit. As of March 31, 2006, the Company's equity loan portfolio totaled $20.9 million, or 13.6%, of its one- to four-family mortgage loan portfolio.
The Company's one- to four-family residential first mortgage loans customarily include due-on-sale clauses, which are provisions giving the Company the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan. Due-on-sale clauses are an important means of adjusting the rates on the Company's fixed rate mortgage loan portfolio.
Regulations limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. The Company's lending policies limit the maximum loan-to-value ratio on both fixed rate and ARM loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the property to serve as collateral for the loan. However, the Company makes one- to four-family real estate loans with loan-to-value ratios in excess of 80%. For 15 year fixed rate ARM loans with loan-to-value ratios of 80.01% to 85%, 85.01% to 90%, 90.01% to 95%, and 95.01% to 97%, the Company requires the first 6%, 12%, 25% and 30%, respectively, of the loan to be covered by private mortgage insurance. For 30 year fixed rate loans with loan-to-value ratios of 80.01% to 85%, 85.01% to 90%, and 90.01% to 97%, the Company requires the first 12%, 25%, and 30%, respectively, of the loan to be covered by private mortgage insurance. The Company requires fire and casualty insurance, as well as title insurance regarding good title, on all properties securing real estate loans made by the Company and flood insurance, where applicable.
Multi-Family Residential Real Estate Loans. Loans secured by multi-family real estate constituted approximately $7.9 million, or 3.3%, of the Company's total loan portfolio at March 31, 2006. The Company's multi-family real estate loans are secured by multi-family residences, such as apartment buildings. At March 31, 2006, most of the Company's multi-family loans were secured by properties located within the Company's market area. At March 31, 2006, the Company's multi-family real estate loans had an average balance of $496,000, and the largest multi-family real estate loan had a principal balance of $3.2 million. Multi-family real estate loans currently are offered with adjustable interest rates or short term balloon maturities, although in the past the Company originated fixed rate long-term multi-family real estate loans. The terms of each multi-family loan are negotiated on a case by case basis, although such loans typically have
adjustable interest rates tied to a market index, and amortize over 15 to 25 years. The Company currently does not emphasize multi-family real estate construction loans.
Loans secured by multi-family real estate generally involve a greater degree of credit risk than one-to- four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired.
Non-Residential Real Estate and Land Loans. Loans secured by non-residential real estate constituted approximately $50.1 million, or 21.0%, of the Company's total loan portfolio at March 31, 2006. The Company's non-residential real estate loans are secured by improved property such as offices, small business facilities, and other non-residential buildings. At March 31, 2006, most of the Company's non-residential real estate loans were secured by properties located within the Company's market area. At March 31, 2006, the Company's non-residential loans had an average balance of $241,000 and the largest non-residential real estate loan had a principal balance of $2.3 million. The terms of each non-residential real estate loan are negotiated on a case by case basis. Non-residential real estate loans are currently offered with adjustable interest rates or short term balloon maturities, although in the past the Company has originated fixed rate long term non-residential real estate loans. Non-residential real estate loans originated by the Company generally amortize over 15 to 25 years. The Company currently does not emphasize non-residential real estate construction loans.
Nonresidential real estate loans have significantly increased from $12.4 million or 4.82% of the total loan portfolio at March 31, 2002 to $50.8 million or 21.25% of the total loan portfolio at March 31, 2006. The Company intends to further diversify its loan portfolio and its increased emphasis on nonresidential real estate lending.
Loans secured by non-residential real estate generally involve a greater degree of risk than one-to- four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by non-residential real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired.
The Company also originates a limited number of land loans secured by individual improved and unimproved lots for future residential construction. Land loans are generally offered with a fixed rate and with terms of up to 5 years. Land loans totaled $674,000 at March 31, 2006.
Residential Construction Loans. To a lesser extent, the Company originates loans to finance the construction of one- to four-family residential property. At March 31, 2006, the Company had $4.7 million, or 2.0%, of its total loan portfolio invested in interim construction loans. The Company makes construction loans to private individuals and to builders. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction loans are typically structured as permanent one- to four-family loans originated by the Company with a 12-month construction phase. Accordingly, upon completion of the construction phase, there is no change in interest rate or term to maturity of the original construction loan, nor is a new permanent loan originated.
Commercial Business Loans. Commercial business loans totaled $21.6 million, or 9.0% of the Company's total loan portfolio at March 31, 2006. This represents net growth of $7.5 million which equates
to a 53.1% increase as percentage of total loans compared to $14.1 million at March 31, 2005. The Company has three experienced commercial lenders and is developing an additional commercial lender internally. The Company has plans to continue commercial lending growth as market conditions permit.
Commercial loans carry a higher degree of risk than one-to-four-residential loans. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers for rental or business properties. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the success of the operation of the related project and thus is typically affected by adverse conditions in the real estate market and in the economy. The Company makes loans generally in the $100,000 to $1,000,000 range with the majority of them being under $500,000. Commercial loans are generally underwritten based on the borrower's ability to pay and assets such as buildings, land and equipment are taken as additional loan collateral. Each loan is evaluated for a level of risk and assigned a rating from "1" (the highest rating) to "7" (the lowest rating). All loans originated to date have been rated 4 or higher.
Consumer Loans. Ohio savings associations are authorized to invest in secured and unsecured consumer loans in an aggregate amount which, when combined with investments in commercial paper and corporate debt securities, does not exceed 20% of an association's assets. In addition, an Ohio association is permitted to invest up to 5% of its assets in loans for educational purposes.
As of March 31, 2006, consumer loans totaled $4.9 million, or 2.1%, of the Company's total loan portfolio. The principal types of consumer loans offered by the Company are second mortgage loans, fixed rate auto and truck loans, education loans, credit card loans, unsecured personal loans, and loans secured by deposit accounts. Consumer loans are offered primarily on a fixed rate basis with maturities generally of less than ten years.
The Company's second mortgage consumer loans are secured by the borrower's principal residence with a maximum loan-to-value ratio, including the principal balances of both the first and second mortgage loans, of 80% or less. Such loans are offered on a fixed rate basis with terms of up to ten years. At March 31, 2006, second mortgage loans totaled $783,000, or .5%, of one- to four-family mortgages.
The underwriting standards employed by the Company for consumer loans include a determination of the applicant's credit history and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan. The quality and stability of the applicant's monthly income are determined by analyzing the gross monthly income from primary employment, and additionally from any verifiable secondary income. Creditworthiness of the applicant is of primary consideration. However, where applicable, the underwriting process also includes a comparison of the value of the collateral in relation to the proposed loan amount.
Consumer loans entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, and recreational vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the lack of demand for used automobiles. The Company adds a general provision on a regular basis to its consumer loan loss allowance, based on, among other factors, general economic conditions and prior loss experience. See "--Delinquencies and Classified Assets--Non-Performing and Impaired Assets," and "--Classification of Assets" for information regarding the Company's loan loss experience and reserve policy.
Mortgage-Backed Securities. The Company also invests in mortgage-backed securities generally issued or guaranteed by the United States Government or agencies thereof. Investments in mortgage-backed securities are made either directly or by exchanging mortgage loans in the Company's portfolio for such securities. These securities consist primarily of adjustable rate mortgage-backed securities issued or guaranteed by the Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), and the Government National Mortgage Association ("GNMA"). Total mortgage-backed securities, including those designated as available for sale, decreased from $60.4 million at March 31, 2005 to $55.7 million at March 31, 2006 primarily due to repayments.
The Company's objectives in investing in mortgage-backed securities vary from time to time depending upon market interest rates, local mortgage loan demand, and the Company's level of liquidity. Mortgage-backed securities are more liquid than whole loans and can be readily sold in response to market conditions and changes in interest rates. Mortgage-backed securities purchased by the Company also have lower credit risk because principal and interest are either insured or guaranteed by the United States Government or agencies thereof.
Loan Originations, Solicitation, Processing, and Commitments. Loan originations are derived from a number of sources such as real estate broker referrals, existing customers, borrowers, builders, attorneys and walk-in customers. The Company has also entered into a number of participation loans with high quality lead lenders. The participations are outside the Company's normal lending area and diversify the loan portfolio. Upon receiving a loan application, the Company obtains a credit report and employment verification to verify specific information relating to the applicant's employment, income, and credit standing. In the case of a real estate loan, an appraiser approved by the Company appraises the real estate intended to secure the proposed loan. An underwriter in the Company's loan department checks the loan application file for accuracy and completeness, and verifies the information provided. One- to four-family and multi-family residential, and commercial real estate loans, for up to $150,000, may be approved by the manager of the mortgage loan department, loans between $150,000 and $300,000 must be approved by the Chief Executive Officer and loans in excess of $300,000 must be approved by the Board of Directors. The Loan Committee meets once a week to review and verify that loan officer approvals of loans are made within the scope of management's authority. All approvals subsequently are ratified monthly by the full Board of Directors. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan. After the loan is approved, a loan commitment letter is promptly issued to the borrower. At March 31, 2006, the Company had commitments to originate $1.6 million of loans.
If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. The borrower must provide proof of fire and casualty insurance on the property serving as collateral, which insurance must be maintained during the full term of the loan. A title search of the property is required on all loans secured by real property.
Origination, Purchase and Sale of Loans and Mortgage-Backed Securities. The table below shows the Company's loan origination, purchase and sales activity for the periods indicated.
- ------------------- (1) Includes loans to finance the construction of one- to four-family residential properties, and loans originated for sale in the secondary market. (2) Includes loans to finance the sale of real estate acquired through foreclosure. (3) For fiscal 2005, includes other activity related to the Stebbins acquisition.
Loan Origination Fees and Other Income. In addition to interest earned on loans, the Company generally receives loan origination fees. The Company accounts for loan origination fees in accordance with Statement of Financial Accounting Standards ("SFAS") No. 91 "Accounting for Non-refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." To the extent that loans are originated or acquired for the Company's portfolio, SFAS No. 91 requires that the Company defer loan origination fees and costs and amortize such amounts as an adjustment of yield over the life of the loan by use of the level yield method. SFAS No. 91 reduces the amount of revenue recognized by many financial institutions at the time such loans are originated or acquired. Fees deferred under SFAS No. 91 are recognized into income immediately upon prepayment or the sale of the related loan. At March 31, 2006, the Company had $443,000 of deferred loan origination fees. Loan origination fees are volatile sources of income. Such fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand for and availability of money.
The Company receives other fees, service charges, and other income that consist primarily of deposit transaction account service charges, late charges, credit card fees, and income from REO operations. The Company recognized fees and service charges of $1.3 million, $1.3 million and $1.5 million, for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
Loans to One Borrower. Savings associations are subject to the same limits as those applicable to national banks, which under current regulations restrict loans to one borrower to an amount equal to 15% of unimpaired capital and unimpaired surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured by readily marketable collateral (generally, financial instruments and bullion, but not real estate). At March 31, 2006, the Company's largest concentration of loans to one borrower totaled $3.2 million. All of the loans in this concentration were current at March 31, 2006. The Company had no loans at March 31, 2006, which exceeded the loans to one borrower regulations.
Delinquencies and Classified Assets
Delinquencies. The Company's collection procedures provide that when a loan is 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment, plus a late charge. This notice is followed with a letter again requesting payment when the payment becomes 20 days past due. If delinquency continues, at 30 days another collection letter is sent and personal contact efforts are attempted, either in person or by telephone, to strengthen the collection process and obtain reasons for the delinquency. Also, plans to arrange a repayment plan are made. If a loan becomes 60 days past due, the loan becomes subject to possible legal action if suitable arrangements to repay have not been made. In addition, the borrower is given information which provides access to consumer counseling services, to the extent required by HUD regulations. When a loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been made or kept by the borrower, a notice of intent to foreclose is sent to the borrower, giving 30 days to cure the delinquency. If not cured, foreclosure proceedings are initiated.
Non-Performing and Impaired Assets. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Mortgage loans are placed on non-accrual status generally when either principal or interest is 90 days or more past due and management considers the interest uncollectible. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income.
Under the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," a loan is defined as impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due under the contractual terms of the loan agreement. In applying the provisions of SFAS No. 114, the Bank considers investment in one- to four-family residential loans and consumer installment loans to be homogeneous and therefore excluded from separate identification for impairment. With respect to the Bank's investment in multi-family commercial and nonresidential loans, and the evaluation of impairment thereof, such loans are collateral dependent and, as a result, are carried as a practical expedient at the lower of cost or fair value.
At March 31, 2006, the Company had non-performing loans of $772,000 and a ratio of non-performing and impaired loans to loans receivable of .33%. At March 31, 2005, the Company had non-performing loans of $906,000 and a ratio of non-performing and impaired loans to loans receivable of 0.42%. For both fiscal 2006 and 2005, the nonperforming loans consisted mainly of one- to four-family residential mortgage loans. The Company generally does not recognize losses on one- to four-family residential mortgage loans primarily because the loan will generally be a maximum 85% LTV ratio on these mortgages without further insurance. In the opinion of management, all non-performing loans are adequately collateralized as of March 31, 2006 and no significant unreserved loss is anticipated.
Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure ("REO") is deemed REO until such time as it is sold. When REO is acquired, it is recorded at the lower of the unpaid principal balance of the related loan or its fair value, less estimated selling expenses. Valuations are periodically performed by management, and any subsequent decline in fair value is charged to operations.
The following table sets forth information regarding our non-accrual and impaired loans and real estate acquired by foreclosure at the dates indicated. For all the dates indicated, we did not have any material loans which had been restructured pursuant to SFAS No. 15.
- -------------------------------- (1) Includes loans deemed impaired that are currently performing. (2) Represents the net book value of property acquired by the Company through foreclosure or deed in lieu of foreclosure. These properties are recorded at the lower of the loan's unpaid principal balance or fair value less estimated selling expenses.
During the year ended March 31, 2006, 2005 and 2004, gross interest income of $44,000, $40,000 and $37,000 would have been recorded on loans currently accounted for on a non-accrual basis if the loans had been current throughout the period. Interest income recognized on non-accrual loans totaled $44,000, $45,000 and $23,000 for the years ended March 31, 2006, 2005 and 2004, respectively. The Company did not record interest income on impaired loans for fiscal 2006 or 2005. The Company recognized interest income on impaired loans using the cash method of accounting of approximately $249,000 for the year ended March 31, 2004.
The following table sets forth information with respect to loans past due 60-89 days and 90 days or more in our portfolio at the dates indicated.
At March 31, ------------------------------------------ 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ (In Thousands)
Loans past due 60-89 days .......... $ 626 $1,084 $ 669 $ 723 $ 431 Loans past due 90 days or more ..... 772 906 747 2,495 3,165 ------ ------ ------ ------ ------ Total past due 60 days or more .. $1,398 $1,990 $1,416 $3,218 $3,596 ====== ====== ====== ====== ======
Classification of Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their
Classification of Assets. (continued)
continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management.
When a savings institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a savings institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the assets so classified, or to charge off such amount. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which can order the establishment of additional general or specific loss allowances. The Company regularly reviews the problem loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations.
The following table sets forth the aggregate amount of the Company's classified assets at the dates indicated. At March 31, ------------------------------------------ 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ (Dollars in Thousands) Substandard assets(1) ........ $1,119 $2,767 $ 839 $2,481 $3,303 Doubtful assets .............. -- -- -- -- -- Loss assets .................. -- -- -- -- 105 ------ ------ ------ ------ ------ Total classified assets ... $1,119 $2,767 $ 839 $2,481 $3,408 ====== ====== ====== ====== ====== - ---------------- (1) Includes REO.
Allowance for Loan Losses. In determining the amount of the allowance for loan losses at any point in time, management and the Board of Directors apply a systematic process focusing on the risk of loss in the loan portfolio. First, delinquent non-residential, multi-family and commercial loans are evaluated individually for potential impairment in their carrying value. Second, management applies historic loss experience to the individual loan types in the portfolio. In addition to the historic loss percentage, management employs an additional risk percentage tailored to the perception of overall risk in the economy. However, the analysis of the allowance for loan losses requires an element of judgment and is subject to the possibility that the allowance may need to be increased, with the corresponding reduction in earnings.
During the fiscal years ended March 31, 2006, 2005 and 2004, the Company added $211,000, $430,000 and $173,000, respectively, to the provision for loan losses. The Company's allowance for loan losses totaled $1.5 million, $1.4 million and $815,000 at March 31, 2006, 2005 and 2004, respectively. Management decreased the provision for loan losses by $219,000 in fiscal 2006 mainly due to the Company's decrease in non-accrual loans and classified assets, coupled with the absence of the additional provisioning related to the Stebbin's acquisition in fiscal 2005. These positive factors were partially offset by provisioning related to the Company's portfolio growth in fiscal 2006. While management believes that the Company's current allowance for loan losses is adequate, there can be no assurance that the allowance for loan losses will be adequate to cover losses that may in fact be realized in the future or that additional provisions for loan losses will not be required. To the best of management's knowledge, all known losses as of March 31, 2006 have been recorded.
Analysis of the Allowance For Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
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(1) At March 31, 2002, a specific allowance of $105,000 was reserved for a nonresidential loan that met the definition of impaired pursuant to SFAS No. 114.
Allocation of Allowance for Loan Losses. The following table sets forth the allocation of allowance for loan losses by loan category for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
Investment Activities
The Company's investment portfolio is comprised of investment securities, corporate bonds and notes and state and local obligations. The carrying value of the Company's investment securities totaled $73.3 million at March 31, 2006, compared to $72.9 million at March 31, 2005. The Company's cash and cash equivalents, consisting of cash and due from banks, federal funds sold and interest bearing deposits due from other financial institutions with original maturities of three months or less, totaled $14.1 million at March 31, 2006 compared to $29.9 million at March 31, 2005, a decrease of $15.8 million, or 52.8% as the Company was able to repay $7.3 million of short term FHLB advances with excess federal funds sold.
Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in the Company's loan origination and other activities.
Investment Portfolio. The following table sets forth the carrying value of the Company's investment securities portfolio, short-term investments and FHLB stock, at the dates indicated.
Investment Portfolio Maturities. The following table sets forth the scheduled maturities, carrying values, market values and average yields for the Company's investment securities at March 31, 2006. The Company does not hold any investment securities with maturities in excess of 30 years.
At March 31, 2006 ----------------------------------- Total Investment Securities ----------------------------------- Average Weighted Life Carrying Market Average In Years Value Value Yield -------- ------- ------- ------- (Dollars in Thousands)
Investment Securities: Corporate bonds and notes ............... .72 $ 6,016 $ 5,999 6.60% U.S. Government and agency obligations .. 2.55 55,802 55,803 3.82 Municipal obligations ................... 13.16 11,489 11,499 6.25 ------- ------- ------- ------- Total investment securities ............. 4.03 $73,307 $73,301 4.42% ======= ======= ======= =======
Sources of Funds
General. Deposits are the major source of the Company's funds for lending and other investment purposes. In addition to deposits, the Company derives funds from the amortization, prepayment or sale of loans and mortgage-backed securities, the sale or maturity of investment securities, operations and, if needed, advances from the Federal Home Loan Bank ("FHLB"). Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. The Company had $32.8 million of advances from the FHLB at March 31, 2006.
Deposits. Consumer and commercial deposits are attracted principally from within the Company's market area through the offering of a broad selection of deposit instruments including NOW accounts, passbook savings, money market deposit, term certificate accounts, commercial repurchase agreements, and individual retirement accounts. The Company accepts deposits of $100,000 or more and offers negotiated interest rates on such deposits. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The Company regularly evaluates its internal cost of funds, surveys rates offered by competing institutions, reviews the Company's cash flow requirements for lending and liquidity, and executes rate changes when deemed appropriate. The Company does not obtain funds through brokers, nor does it solicit funds outside its market area.
Deposit Portfolio. Savings and other deposits in the Company as of March 31, 2006, were comprised of the following:
The following table sets forth the change in dollar amount of savings deposits in the various types of savings accounts offered by the Company between the dates indicated.
- ------------------------------ (1) Certain Individual Retirement Accounts ("IRAs") are included in the respective certificate balances. IRAs totaled $34.7 million, $34.1 million and $32.8 million, as of March 31, 2006, 2005 and 2004, respectively.
The following table sets forth the average dollar amount and weighted average rate of savings deposits in the various types of savings accounts offered by the Company.
The following table sets forth the certificates of deposit in the Company classified by rates as of the dates indicated:
At March 31, ------------------------------ 2006 2005 2004 -------- -------- -------- (Dollars in Thousands)
1.05- 2.00% ....................... $ 9,256 $ 39,272 $ 59,687 2.01- 4.00% ....................... 66,103 82,548 48,536 4.01- 6.00% ....................... 112,721 45,294 46,565 6.01- 6.75% ....................... -- 131 377 -------- -------- -------- Total ........................ $188,080 $167,245 $155,165 ======== ======== ========
The following table sets forth the amount and maturities of certificates of deposit at March 31, 2006.
Amount Due ---------------------------------------------------- Less Than 1-2 2-3 After One Year Years Years 3 Years Total -------- -------- -------- -------- -------- Rate (In Thousands) - ----
1.05- 2.00% ............. $ 9,256 $ -- $ -- $ -- $ 9,256 2.01- 4.00% ............. 38,763 19,655 6,368 1,317 66,103 4.01- 6.00% ............. 81,947 14,799 5,071 10,904 112,721 -------- -------- -------- -------- -------- Total .............. $129,966 $ 34,454 $ 11,439 $ 12,221 $188,080 ======== ======== ======== ======== ========
The following table indicates the amount of the Company's certificates of deposit of $100,000 or more by time remaining until maturity as of March 31, 2006.
Maturity Period Certificates of Deposit --------------- ----------------------- (In Thousands)
Three months or less.................................. $ 9,814 Over three months through six months.................. 9,902 Over six months through twelve months................. 18,525 Over twelve months.................................... 12,175 ------- Total............................................ $50,416 =======
Borrowings
Savings deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes. The Bank may rely upon advances from the FHLB and the Federal Reserve Bank discount window to supplement their supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB typically are collateralized by stock in the FHLB and a portion of first mortgage loans held by the Bank. At March 31, 2006, the Company had $32.8 million in advances outstanding.
The FHLB functions as a central reserve bank providing credit for member savings associations and financial institutions. As members, the Banks are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain home mortgages and other assets (principally, securities that are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of a member institution's net worth or on the FHLB's assessment of the institution's creditworthiness. Although advances may be used on a short-term basis for cash management needs, FHLB advances have not been, nor are they expected to be, a significant long-term funding source for the Company.
Year Ended March 31, -------------------------------- 2006 2005 2004 -------- -------- -------- (Dollars in thousands)
Federal Home Loan Bank advances: Maximum month-end balance ..... $ 39,000 $ 40,000 $ 30,000 Balance at end of period ...... 32,750 40,000 30,000 Average balance ............... 28,424 26,076 30,000
Weighted average interest rate on: Balance at end of period ...... 4.19% 3.59% 4.15% Average balance for period .... 3.81 3.96 4.16
Competition
The Company encounters strong competition both in attracting deposits and in originating real estate and other loans. Its most direct competition for deposits has come historically from commercial banks, brokerage houses, other savings associations, and credit unions in its market area, and the Company expects continued strong competition from such financial institutions in the foreseeable future. The Company's market area includes branches of several commercial banks that are substantially larger than the Company in terms of state-wide deposits. The Company competes for savings by offering depositors a high level of personal service and expertise together with a wide range of financial services.
The competition for real estate and other loans comes principally from commercial banks, mortgage banking companies, and other savings associations. This competition for loans has increased substantially in recent years as a result of the large number of institutions competing in the Company's market area as well as the increased efforts by commercial banks to expand mortgage loan originations.
The Company competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers, real estate brokers, and builders. Factors that affect competition include general and local economic conditions, current interest rate levels, and volatility of the mortgage markets.
Subsidiaries
At March 31, 2006, the Company did not have any direct unconsolidated subsidiaries.
Total Employees
The Company had 102 full-time employees and 38 part-time employees at March 31, 2006. None of these employees are represented by a collective bargaining agent, and the Company believes that it enjoys good relations with its personnel.
Regulation
As a state-chartered, FDIC insured institution, the Bank is subject to examination, supervision and extensive regulation by the OTS, the Ohio Department of Commerce, Division of Financial Institutions ("ODFI") , and the FDIC. The Bank is a member of, and owns stock in, the FHLB of Cincinnati, which is one of the twelve regional banks in the Federal Home Loan Bank System. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The OTS and ODFI regularly examine the Bank and prepare reports for the consideration of the Company's Board of Directors on any deficiencies that they may find in the Company's operations. The FDIC also examines the Bank in its role as the administrator of the SAIF. The Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws especially in such matters as the ownership of savings accounts and the form and content of the Bank's mortgage documents. Any change in such regulation, whether by the FDIC, OTS, ODFI, or Congress, could have a material adverse impact on the Company, the Bank and their operations.
Federal Regulation of Savings Institutions
Business Activities. The activities of savings associations are governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit Insurance Act (the "FDI Act"). These federal statutes, among other things, (1) limit the types of loans a savings association may make, (2) prohibit the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, and (3) restrict the aggregate amount of loans secured by non-residential real estate property to 400% of capital. The description of statutory provisions and regulations applicable to savings associations set forth herein does not purport to be a complete description of such statutes and regulations and their effect on the Company or the Bank.
Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the national bank limits on loans to one borrower. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the institution's unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. See "--Lending Activities--Loans to One Borrower."
Qualified Thrift Lender Test. The HOLA requires savings associations to meet a qualified thrift lender ("QTL") test. Under the QTL test, a savings association is required to maintain at least 65% of its "portfolio assets" (total assets less (i) specified liquid assets up to 20% of total assets, (ii) intangibles, including goodwill, and (iii) the value of property used to conduct business) in certain "qualified thrift investments," primarily residential mortgages and related investments, including certain mortgage-backed and related securities on a monthly basis in 9 out of every 12 months.
A savings association that fails the QTL test must either convert to a bank charter or operate under certain restrictions. As of March 31, 2006, the Company maintained 91.7% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger and other distributions charged against capital. A "well-capitalized" institution can, after prior notice but without the approval of the OTS, make capital distributions during a calendar year in an amount up to 100% of its net income during the calendar year, plus its retained net income for the preceding two years. As of March 31, 2006 the Bank was a "well-capitalized" institution.
Community Reinvestment. Under the Community Reinvestment Act (the "CRA"), as implemented by OTS regulations, a savings institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Company received a "satisfactory" CRA rating under the current CRA regulations in its most recent federal examination by the OTS.
Transactions with Related Parties. The Company's authority to engage in transactions with related parties or "affiliates" (i.e., any company that controls or is under common control with an institution, including the Bank and any non-savings institution subsidiaries) or to make loans to certain insiders, is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings institution and also limits the aggregate amount of transactions with all affiliates to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring enforcement action against all "institution-related parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institutions, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. Criminal penalties for most financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances.
Standards for Safety and Soundness. The federal banking agencies have adopted a final regulation and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to implement the safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and compensation, fees and benefits. The agencies also adopted a proposed rule which proposes asset quality and earnings standards which, if adopted, would be added to the Guidelines. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings institutions to meet three capital standards: a 1.5% tangible capital standard, a 4.0% leverage ratio (or core capital ratio) and an 8.0% risk-based capital standard. Core capital is defined as common stockholders' equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus, minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain qualifying supervisory goodwill and certain mortgage servicing rights. The OTS regulations also require that, in meeting the tangible ratio, leverage and risk-based capital standards, institutions must deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 2 (core) and total capital (which is defined as core capital and supplementary capital) to risk weighted assets of 4.0% and 8.0%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital regulation based on the risks the OTS believes are inherent in the type of asset. The components of Tier 1 (core) capital are equivalent to those discussed earlier under the 4.0% leverage ratio standard. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and allowance for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25%. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
Prompt Corrective Regulatory Action
Under the OTS Prompt Corrective Action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. Generally, a savings institution that has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1 core capital ratio that is less than 4.0% is considered to be undercapitalized. A savings institution that has the total risk-based capital less than 6.0%, a Tier 1 core risk-based capital ratio of less than 3.0% or a leverage ratio that is less than 3.0% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2.0% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date an institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the institution, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Accounts and Regulation by the FDIC
The Bank is a member of the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the U.S. Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings and loan associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. Currently, FDIC deposit insurance rates generally range from zero basis points to 27 basis points, depending on the assessment risk classification assigned to the depository institution.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the deposit insurance of the Bank.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in that FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. The Bank was in compliance with this requirement with an investment in FHLB-Cincinnati stock, at March 31, 2006, of $4.6 million.
The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. FHLB dividends were 5.0% for the fiscal year ended March 31, 2006. In the likely event that dividends are reduced, or interest on future FHLB-Cincinnati advances is increased, the Company's net interest income will decline.
Ohio Regulation
As a savings and loan association organized under the laws of the State of Ohio, the Bank is subject to regulation by the Ohio Department of Commerce, Division of Financial Institutions ("ODFI"). Regulation by the ODFI affects the Bank's internal organization as well as its savings, mortgage lending, and other investment activities. Periodic examinations by the ODFI are usually conducted on a joint basis with the OTS. Ohio law requires that the Bank maintain federal deposit insurance as a condition of doing business.
Under Ohio law, an Ohio association may buy any obligation representing a loan that would be a legal loan if originated by the Bank, subject to various requirements including: loans secured by liens on income-producing real estate may not exceed 20% of an association's assets; consumer loans, commercial paper, and corporate debt securities may not exceed 20% of an association's assets; loans for commercial, corporate, business, or agricultural purposes may not exceed 30% of an association's assets, provided that an association's required reserve must increase proportionately; certain other types of loans may be made for lesser percentages of the association's assets; and, with certain limitations and exceptions, certain additional loans may be made if not in excess of 3% of the association's total assets. In addition, no association may make real estate acquisition and development loans for primarily residential use to one borrower in excess of 2% of assets. The total investments in commercial paper or corporate debt of any issuer cannot exceed 1% of an association's assets, with certain exceptions.
Ohio law authorizes Ohio-chartered associations to, among other things: (i) invest up to 15% of assets in the capital stock, obligations, and other securities of service corporations organized under the laws of Ohio, and an additional 20% of net worth may be invested in loans to majority owned service corporations; (ii) invest up to 10% of assets in corporate equity securities, bonds, debentures, notes, or other evidence of indebtedness; (iii) exceed limits otherwise applicable to certain types of investments (other than investments in service corporations) by and between 3% and 10% of assets, depending upon the level of the institution's permanent stock, general reserves, surplus, and undivided profits; and (iv) invest up to 15% of assets in any loans or investments not otherwise specifically authorized or prohibited, subject to authorization by the institution's board of directors.
An Ohio association may invest in such real property or interests therein as its board of directors deems necessary or convenient for the conduct of the business of the association, but the amount so invested may not exceed the net worth of the association at the time the investment is made. Additionally, an association may invest an amount equal to 10% of its assets in any other real estate. This limitation does not apply, however, to real estate acquired by foreclosure, conveyance in lieu of foreclosure, or other legal proceedings in relation to loan security interests.
Notwithstanding the above powers authorized under Ohio law and regulation, a state-chartered savings association, such as the Bank, is subject to certain limitations on its permitted activities and investments under federal law, which may restrict the ability of an Ohio-chartered association to engage in activities and make investments otherwise authorized under Ohio law.
Ohio has adopted statutory limitations on the acquisition of control of an Ohio savings and loan association by requiring the written approval of the ODFI prior to the acquisition by any person or company, as defined under the Ohio Revised Code, of a controlling interest in an Ohio association. Control exists, for purposes of Ohio law, when any person or company, either directly, indirectly, or acting in concert with one or more other persons or companies (a) acquires 15% of any class of voting stock, irrevocable proxies, or any combination thereof, (b) directs the election of a majority of directors, (c) becomes the general partner of the savings and loan association, (d) has influence over the management and policies of the savings and loan association, (e) has the ability to direct shareholder votes, or (f) anything else deemed to be control by the ODFI. The ODFI's written permission is required when the total amount of control held by the acquiror was less than or equal to 25% control before the acquisition and more than 25% control after the acquisition, or when the total amount of control held by the acquiror was less than 50% before the acquisition and more than 50% after the acquisition. Ohio law also prescribes other situations in which the ODFI must be notified of the acquisition even though prior approval is not required. Any person or company, which would include a director, will not be deemed to be in control by virtue of an annual solicitation of proxies voted as directed by a majority of the board of directors.
Under certain circumstances, interstate mergers and acquisitions involving associations incorporated under Ohio law are permitted by Ohio law. A savings and loan association or savings and loan holding company with its principal place of business in another state may acquire a savings and loan association or savings and loan holding company incorporated under Ohio law if the laws of such other state permit an Ohio savings and loan association or an Ohio holding company reciprocal rights. Additionally, recently enacted legislation permits interstate branching by savings and loan associations incorporated under Ohio law.
Ohio law requires prior written approval of the Ohio Superintendent of Savings and Loans of a merger of an Ohio association with another savings and loan association or a holding company affiliate.
Holding Company Regulation
Holding Company Acquisitions. The Company is a registered savings and loan holding company within the meaning of Section 10 of the HOLA, and is subject to OTS examination and supervision as well as certain reporting requirements. Federal law generally prohibits a savings and loan holding company, without prior OTS approval, from acquiring the ownership or control of any other savings institution or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares thereof. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings institution not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS.
Holding Company Activities. The Company operates as a unitary savings and loan holding company. The activities of the Company and its non-savings institution subsidiaries are restricted to activities traditionally permitted to multiple savings and loan holding companies and to financial holding companies under newly added provisions of the Bank Holding Company Act. Multiple savings and loan holding companies may:
o furnish or perform management services for a savings association subsidiary of a savings and loan holding company;
o hold, manage or liquidate assets owned or acquired from a savings association subsidiary of a savings and loan holding company;
o hold or manage properties used or occupied by a savings association subsidiary of a savings and loan holding company;
o engage in activities determined by the Federal Reserve to be closely related to banking and a proper incident thereto; and
o engage in services and activities previously determined by the Federal Home Loan Bank Board by regulation to be permissible for a multiple savings and loan holding company as of March 5, 1987.
The activities financial holding companies may engage in include:
o lending, exchanging, transferring or investing for others, or safeguarding money or securities;
o insuring, guaranteeing or indemnifying others, issuing annuities, and acting as principal, agent or broker for purposes of the foregoing;
o providing financial, investment or economic advisory services, including advising an investment company;
o issuing or selling interests in pooled assets that a bank could hold directly;
o underwriting, dealing in or making a market in securities; and
o merchant banking activities.
If the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the OTS may impose such restrictions as deemed necessary to address such risk. These restrictions include limiting the following:
o the payment of dividends by the savings institution; o transactions between the savings institution and its affiliates; and o any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution.
Federal Securities Laws. The Company registered its common stock with the Securities and Exchange Commission under Section 12(g) of the Securities Exchange Act of 1934. The Company is subject to the proxy and tender offer rules, insider trading reporting requirements and restrictions, and certain other requirements under the Exchange Act.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") implemented legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of an accounting oversight board which enforces auditing, quality control and independence standards, the Sarbanes-Oxley Act restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client requires pre-approval by the company's audit committee members. In addition, the audit partners must be rotated. The Sarbanes-Oxley Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Sarbanes-Oxley Act, counsel are required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.
Longer prison terms now apply to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Sarbanes-Oxley Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution ("FAIR") provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change.
The Sarbanes-Oxley Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company's "registered public accounting firm." Audit Committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a "financial expert," as such term is defined by the SEC, and if not, why not. Under the Sarbanes-Oxley Act, a registered public accounting firm is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Sarbanes-Oxley Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statement's materially misleading. The Sarbanes-Oxley Act also required the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders. The Sarbanes-Oxley Act requires the registered public accounting firm that issues the audit report to attest to and report on management's assessment of the company's internal controls. In addition, the Sarbanes-Oxley Act requires that each financial report required to be prepared in accordance with, or reconciled to, generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a registered public accounting firm in accordance with generally accepted accounting principles and the rules and regulations of the SEC.
Federal and State Taxation
Federal Taxation. Income taxes are accounted for under the asset and liability method which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
The Federal tax bad debt reserve method available to thrift institutions was repealed in 1996 for tax years beginning after 1995. As a result, the Company was required to change from the reserve method to the specific charge-off method to compute its bad debt deduction. The recapture amount resulting from the change in a thrift's method of accounting for its bad debt reserves was taken into taxable income ratably (on a straight-line basis) over a six-year period.
Retained earnings as of March 31, 2006 include approximately $2.7 million for which no provision for Federal income tax has been made. This reserve (base year and supplemental) is frozen/not forgiven as certain events could trigger a recapture such as stock redemption or distributions to shareholders in excess of current or accumulated earnings and profits.
The Company's federal income tax returns through March 31, 2003 have been closed by statute or examination.
Ohio Taxation. The Bank files Ohio franchise tax returns. For Ohio franchise tax purposes, savings institutions are currently taxed at a rate equal to 1.3% of taxable net worth. The Bank is not currently under audit with respect to its Ohio franchise tax returns.
Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. The tax is imposed as a percentage of the capital base of the Company with an annual maximum of $165,000. The Company paid Delaware franchise taxes of $33,000 in fiscal 2006.
ITEM 1A.
ITEM 1A. Risk Factors - ------------------------
Except for the historical information contained herein, the matters discussed in this Form 10-K include certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, all statements regarding the intent, belief and expectations of the Company and its management, such as statements concerning the Company's future profitability. Investors are cautioned that all forward-looking statements involve risks and uncertainties including, without limitation, factors detailed from time to time in the Company's filings with the SEC. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in this Form 10-K will prove to be accurate, and in light of the significant uncertainties inherent in the forward-looking Statements included herein, the inclusion of such information should not be regarded as a presentation by the Company or any other person that the objectives and plans of the Company will be achieved. The Company encounters a number of risks in the conduct of its business. A discussion of such risks follows.
The Company's results of operations are significantly dependent on economic conditions and related uncertainties. Commercial banking is affected, directly and indirectly, by domestic and international economic and political conditions and by governmental monetary and fiscal policies. Conditions such as inflation, recession, unemployment, volatile interest rates, real estate values, government monetary policy, international conflicts, the actions of terrorists and other factors beyond our control may adversely affect our results of operations. Changes in interest rates, in particular, could adversely affect our net interest income and have a number of other adverse effects on our operations, as discussed in the immediately succeeding risk factor. Adverse economic conditions also could result in an increase in loan delinquencies, foreclosures and nonperforming assets and a decrease in the value of the property or other collateral which secures our loans, all of which could adversely affect our results of operations. We are particularly sensitive to changes in economic conditions and related uncertainties in Northeast Ohio because we derive substantially all of our loans, deposits and other business from this area. Accordingly, we remain subject to the risks associated with prolonged declines in national or local economies.
Changes in interest rates could have a material adverse effect on our operations. The operations of financial institutions such as the Bank are dependent to a large extent on net interest income, which is the difference between the interest income earned on interest earning assets such as loans and investment securities and the interest expense paid on interest bearing liabilities such as deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted average yield earned on our interest earning assets and the weighted average rate paid on our interest bearing liabilities, or interest rate spread, and the average life of our interest earning assets and interest bearing liabilities. Changes in interest rates also can affect our ability to originate loans; the value of our interest earning assets; our ability to obtain and retain deposits in competition with other available investment alternatives; and the ability of our borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we believe that the estimated maturities of our interest earning assets currently are well balanced in relation to the estimated maturities of our interest bearing liabilities (which involves various estimates as to how changes in the general level of interest rates will impact these assets and liabilities), there can be no assurance that our profitability would not be adversely affected during any period of changes in interest rates.
There are increased risks involved with commercial real estate, construction, commercial business and consumer lending activities. Our lending activities include loans secured by existing commercial real estate. Commercial real estate lending generally is considered to involve a higher degree of risk than single-family residential lending due to a variety of factors, including generally larger loan balances,
the dependency on successful completion or operation of the project for repayment, the difficulties in estimating loan terms which often do not require full amortization of the loan over its term and, instead, provide for a balloon payment at stated maturity. Our lending activities also include commercial business loans to small- to medium-sized businesses, which generally are secured by various equipment, machinery and other corporate assets, and a wide variety of consumer loans, including home equity and second mortgage loans, automobile loans, deposit account secured loans and unsecured loans. Although commercial business loans and consumer loans generally have shorter terms and higher interest rates than mortgage loans, they generally involve more risk than mortgage loans because of the nature of, or in certain cases the absence of, the collateral which secures such loans.
Our allowance for losses on loans may not be adequate to cover probable losses. We have established an allowance for loan losses which we believe is adequate to offset probable losses on our existing loans. There can be no assurance that any future declines in real estate market conditions, general economic conditions or changes in regulatory policies will not require us to increase our allowance for loan losses, which would adversely affect our results of operations.
Growth Strategy. The Company has pursued and continues to pursue a strategy of growth. The success of the Company's growth strategy will depend largely upon its ability to manage its credit risk and control its costs while providing competitive products and services. This growth strategy may present special risks, such as the risk that the Company will not efficiently handle growth with its present operations, the risk of dilution of book value and earnings per share as a result of an acquisition, the risk that earnings will be adversely affected by the start-up costs associated with establishing new products and services, the risk that the Company will not be able to attract and retain qualified personnel needed for expanded operations, and the risk that its internal monitoring and control systems may prove inadequate.
Control by Management; Anti-Takeover Provisions. The Board of directors beneficially own in the aggregate approximately 6.0% of the outstanding shares of Common Stock of the Company at March 31, 2006. In addition to Ohio and federal laws and regulations governing changes in control of insured depository institutions, the Company's Articles of Incorporation and Code of Regulations contain certain provisions that may delay or make more difficult an acquisition of control of the Company. For example, the Company's Articles of Incorporation do not exempt the Company from the provisions of Ohio's "control share acquisition" and "merger moratorium" statutes. Assuming that the principal stockholders continue to retain the number of the outstanding voting shares of the Company that they presently own and the law of Delaware requires, as it presently does, at least two-thirds majority vote of the outstanding shares to approve a merger or other consolidation, unless the articles of incorporation of the constituent companies provide for a lower approval percentage for the transaction, which the Company's articles do not provide, such ownership position could be expected to deter any prospective acquirer from seeking to acquire ownership or control of the Company, and the principal stockholders would be able to defeat any acquisition proposal that requires approval of the Company's stockholders, if the principal stockholders chose to do so. In addition, the principal stockholders may make a private sale of shares of common stock of the Company that they own, including to a person seeking to acquire ownership or control of the Company. The Company has 500,000 shares of authorized but unissued preferred stock, par value $ .10 per share, which may be issued in the future with such rights, privileges and preferences as are determined by the Board of Directors of the Company.
Limited Trading Market; Shares Eligible for Future Sale; Possible Volatility of Stock Price. The Common Stock is traded on the Nasdaq Market under the symbol "WAYN." During the 12 months ended May 15, 2006, the average weekly trading volume in the Common Stock has been approximately 498 shares per week. There can be no assurance given as to the liquidity of the market for the Common Stock or the price at which any sales may occur, which price will depend upon, among other things, the number of holders thereof, the interest of securities dealers in maintaining a market in the Common Stock and other
factors beyond the control of the Company. The market price of the Common Stock could be adversely affected by the sale of additional shares of Common Stock owned by the Company's current shareholders. The principal shareholders are permitted to sell certain limited amounts of Common Stock without registration, pursuant to Rule 144 under the Securities Act. The market price for the Common Stock could be subject to significant fluctuations in response to variations in quarterly and yearly operating results, general trends in the banking industry and other factors. In addition, the stock market can experience price and volume fluctuations that may be unrelated or disproportionate to the operating performance of affected companies. These broad fluctuations may adversely affect the market price of the Common Stock.
Dependence on Management. The Company's success depends to a great extent on its senior management, including its Chairman, Russell L. Harpster; President, Phillip E. Becker and Chief Financial Officer, H. Stewart Fitz Gibbon III and Operations Officer, Bryan C. Fehr. The loss of their individual services could have a material adverse impact on the Company's financial stability and its operations. In addition, the Company's future performance depends on its ability to attract and retain key personnel and skilled employees, particularly at the senior management level. The Company's financial stability and its operations could be adversely affected if, for any reason, one or more key executive officers ceased to be active in the Company's management.
Competition. Banking institutions operate in a highly competitive environment. The Company competes with other commercial banks, credit unions, savings institutions, finance companies, mortgage companies, mutual funds, and other financial institutions, many of which have substantially greater financial resources than the Company. Certain of these competitors offer products and services that are not offered by the Company and certain competitors are not subject to the same extensive laws and regulations as the Company. Additionally, consolidation of the financial services industry in Ohio and in the Midwest in recent years has increased the level of competition. Recent and proposed regulatory changes may further intensify competition in the Company's market area.
Holding Company Structure; Government Regulations and Policies. The Company is a financial holding company, which is substantially dependent on the profitability of its subsidiaries and the upstream payment of dividends from Wayne Savings Community Bank to the Company. Under state and federal banking law, the payment of dividends by the Company are subject to capital adequacy requirements. The inability of the Company to generate profits and pay such dividends to the Company, or regulator restrictions on the payment of such dividends to the Company even if earned, would have an adverse effect on the financial condition and results of operations of the Company and the Company's ability to pay dividends to the shareholders.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments - -------------------------------------
Not applicable.
ITEM 2.
ITEM 2. Properties - ----------------------
The Company conducts its business through its main banking office located in Wooster, Ohio, and its ten additional full service branch offices located in its market area. The following table sets forth information about its offices as of March 31, 2006.
Original Year Leased or Leased or Year of Lease Location Owned Acquired Expiration - -------------------------------- -------- ------------- -------------
North Market Street Office 151 N. Market Street Wooster, Ohio Owned 1902 N/A
Cleveland Point Financial Center 1908 Cleveland Road Owned 1978 N/A Wooster, Ohio
Madison South Office 2024 Millersburg Road Owned 1999 N/A Wooster, Ohio
Northside Office 543 Riffel Road Leased 1999 2019 Wooster, Ohio
Millersburg Office 90 N. Clay Street Owned 1964 N/A Millersburg, Ohio
Claremont Avenue Office 233 Claremont Avenue Owned 1968 N/A Ashland, Ohio
Buehlers-Sugarbush Office 1055 Sugarbush Drive Leased 2001 2021 Ashland, Ohio
Rittman Office 237 North Main Street Owned 1972 N/A Rittman, Ohio
Lodi Office 303 Highland Drive Owned 1980 N/A Lodi, Ohio
Village Office 1265 S. Main Street Owned 1998 N/A North Canton, Ohio
Stebbins Office 121 N. Main Street Creston, Ohio Owned 2005 N/A
The Company's accounting and recordkeeping activities are maintained through an in-house data processing system.
ITEM 3.
ITEM 3. Legal Proceedings - -----------------------------
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts which are believed by management to be immaterial to the financial condition and operations of the Company.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders - ---------------------------------------------------------------
During the fourth quarter of the fiscal year covered by this report, the Registrant did not submit any matters to the vote of security holders.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters - -------------------------------------------------------------------------------- and Issuer Purchases of Equity Securities -----------------------------------------
The Company's common stock trades on the Nasdaq National Market using the symbol "WAYN." The following table sets forth the high and low trading prices of the Company's common stock during the two most recent fiscal years, together with the cash dividends declared.
Cash Fiscal Year Ended dividend March 31, 2006 High Low declared
First quarter $16.43 $13.91 $.120 Second quarter $16.50 $14.75 $.120 Third quarter $16.00 $13.83 $.120 Fourth quarter $16.50 $15.01 $.120
Cash Fiscal Year Ended dividend March 31, 2005 High Low declared
First quarter $21.00 $14.82 $.120 Second quarter $16.79 $15.36 $.120 Third quarter $16.88 $15.92 $.120 Fourth quarter $16.40 $15.35 $.120
As of April 5, 2006, the Company had 1,522 shareholders of record and 3,339,552 shares of common stock outstanding. This does not reflect the number of persons whose stock is in nominee or "street name" accounts through brokers.
Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and depends upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, the Company's results of operations and financial condition, tax considerations, and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends, once declared, will continue.
The Company's primary source of funds with which to pay dividends is cash and cash equivalents held at the holding company level and dividends from the Bank. The Bank's ability to pay dividends to the Company is limited by OTS regulations, and the Bank is required to obtain OTS nonobjection to the payment of dividends to the Company. In determining whether to object to such dividends, the OTS considers whether (i) the Bank would be undercapitalized following the dividend, (ii) the dividend raises safety and soundness concerns, or (iii) the dividend violates any regulatory prohibition or policy.
In addition to the foregoing, earnings of the Company appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of cash dividends or other distributions to stockholders without payment of taxes at the then-current tax rate by the Company on the amount of earnings removed from the reserves for such distributions. The Company intends to make full use of this favorable tax treatment and does not contemplate any distribution that would create federal tax liability.
The following table sets forth information with respect to purchases made by or on behalf of the Company of shares of common stock of the Company during the indicated periods.
- ------------ (1) A repurchase program for 185,491 shares, or 5% of the Company's outstanding shares, was publicly announced on September 2, 2004 and expired on August 26, 2005. As of March 31, 2005, 84,761 shares had been repurchased under that program. On June 6, 2005, the Company announced the completion of the repurchase program and the authorization by the Board of Directors of a new program for the repurchase of 352,433 shares, or 10% of the Company's outstanding shares over any period.
Equity Compensation Plan Information
The following table sets forth information as of March 31, 2006 with respect to compensation plans under which equity securities of the Company are authorized for issuance.
ITEM 6.
ITEM 6. Selected Financial Data - -----------------------------------
The following table set forth certain consolidated financial and other data of Wayne Savings Bancshares, Inc., at the dates and for the years indicated. The consolidated financial statements as of and for the years ended March 31, 2003 and March 31, 2002, inclusive, are those of Wayne Savings Bancshares, Inc. prior to the reorganization and change in corporate form discussed in the Notes to the Consolidated Financial Statements and elsewhere herein. For additional information about the Company, reference is made to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company.
- -------------------------------- (1) Includes loans held for sale. (2) Includes mortgage-backed securities available for sale. (3) Includes cash and due from banks, interest-bearing deposits in other financial institutions, and federal funds sold.
- ------------------ (1) In 2005, general, administrative and other expense includes $1.4 million of costs related to accelerating the Company's Management Recognition and Stock Option Plans. (2) All per share amounts have been restated to give effect to the 1.5109 to 1.00 share exchange ratio provided for in the Company's conversion offering. (3) During the fiscal year ended March 31, 2003, the M.H.C. waived its right to receive all dividends. During fiscal 2002 the M.H.C. waived approximately $.44 of the $.45 per share dividends paid on common stock.
- ---------------- (1) In calculating this ratio, general, administrative and other expense does not include provisions for losses or gains on the sale of real estate acquired through foreclosure. For fiscal 2005, this ratio does not include expense relating to acceleration of the Company's Management Recognition Plan and Stock Option Plan.
ITEM 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and - --------------------------------------------------------------------------- Results of Operations ---------------------
General
The consolidated financial statements include Wayne Savings Bancshares, Inc. and its wholly-owned subsidiary, Wayne Savings Community Bank. Intercompany transactions and balances are eliminated in the consolidated financial statements.
The Company's net earnings are primarily dependent on its net interest income, which is the difference between interest income earned on its loan, mortgage-backed securities and investment portfolios, and its cost of funds consisting of interest paid on deposits and borrowings. The Company's net earnings also are affected by its provision for losses on loans, as well as the amount of other income, including trust fees and service charges, and general, administrative and other expense, such as salaries and employee benefits, deposit insurance premiums, occupancy and equipment costs, and income taxes. Earnings of the Company also are affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.
Business Strategy
The Company's current business strategy is to operate a well-capitalized, profitable and community-oriented bank dedicated to providing quality service and products to its customers. The Company has sought to implement this strategy in recent years by: (1) closely monitoring the needs of customers and providing personal, quality customer service; (2) continuing the origination of a wide array of loan products in the Company's market area; (3) managing interest rate risk exposure by better matching asset and liability maturities and rates; (4) increasing fee income, including the establishment of a trust department; (5) managing asset quality; (6) maintaining a strong retail deposit base; (7) maintaining capital in excess of regulatory requirements; and (8) emphasizing the commercial loan program to add high quality, higher yielding assets to the Company's loan portfolio.
Discussion of Financial Condition Changes from March 31, 2005 to March 31, 2006
In addition to the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. Economic circumstances, the Company's operations, and actual results could differ significantly from those discussed in forward-looking statements. Some of the factors that could cause or contribute to such differences are discussed herein but also include changes in the economy and interest rates in the nation and the Company's general market area. The forward-looking statements contained herein include, but are not limited to, those with respect to the following matters: (1) management's determination of the amount and adequacy of the allowance for loan losses; (2) the effect of changes in interest rates; (3) management's opinion as to the effects of recent accounting pronouncements on the Company's consolidated financial statements; and (4) management's opinion as to the Bank's ability to maintain regulatory capital at current levels. The Company considers the allowance for loan losses and related loss provision to be a critical accounting policy. A detailed discussion as to the application of such policy is set forth on the following pages.
At March 31, 2006, total assets of $403.7 million remained virtually unchanged from the $403.6 million total at March 31, 2005.
Liquid assets, consisting of cash, interest-bearing deposits and investment securities, decreased by $15.4 million, or 14.9%, to $87.4 million at March 31, 2006 mainly due to a reduction in federal funds sold of $19.4 million. Mortgage-backed securities decreased by $4.6 million, or 7.7%, to $55.7 million as these adjustable rate securities continued to experience significant principal repayments due to borrowers refinancing to fixed-rate loans in the current rising interest rate environment. Principal repayments were partially offset by purchases of mortgage-backed securities totaling $22.4 million.
During the fiscal year ended March 31, 2006, loans receivable increased $21.7 million, or 10.2%, as the Bank originated and retained $63.1 million of loans and received payments of $35.0 million. Rather than reinvest funds from sales of and repayments on loans in long-term, fixed rate and lower yielding residential loans during this period of rising interest rates, the lending division has been able to originate shorter-term adjustable rate commercial loans. The Company believes that investing in shorter-term and adjustable-rate commercial loans positions the Company favorably in the current interest rate environment. The composition of the loan portfolio continued to evolve during the fiscal year ending March 31, 2006, as exemplified by a net decrease of $7.9 million in residential and construction mortgage loans, which were more than offset by increases in nonresidential real estate loans of $21.6 million and a net increase in commercial loans of $7.5 million.
At March 31, 2006, the allowance for loan losses totaled $1.5 million, or .63% of loans, compared to $1.4 million, or .64% of loans at March 31, 2005. In determining the amount of loan loss analysis at any point of time, management and the board apply a systematic process of focusing on the risk of loss in the portfolio. First, delinquent nonresidential, multi-family and commercial loans are evaluated for potential impairment in carrying value. At March 31, 2006, all delinquent nonresidential, multi-family and commercial loans were viewed as well-secured, with no material loss anticipated. The second step in determining the allowance for loan loss entails the application of historic loss experience to individual loan types in the portfolio. In addition to the historic loss percentage, management employs an additional risk percentage tailored to the Board's and management's perception of the overall risk in the economy. Finally, to provide additional assurance regarding the validity of the commercial loan risk rating system, management engages a third party loan reviewer who provides independent validation of the Bank's loan grading process. Due primarily to the growth of the nonresidential real estate and the commercial loan portfolio, management charged $211,000 to the provision during fiscal 2006.
Discussion of Financial Condition Changes from March 31, 2005 to March 31, 2006 (continued)
Deposits at March 31, 2006, totaled $332.6 million, an increase of $12.0 million from $320.6 million at March 31, 2005, generally reflecting the Bank's competitive deposit pricing in all market areas. Certificates of deposit increased by $20.8 million, newly implemented commercial repurchase agreements increased by $5.7 million, NOW accounts increased by $3.7 million and money market investor accounts increased by $2.6 million. These increases were partially offset by a reduction of $20.8 million in savings deposits.
Borrowings totaled $32.8 million at March 31, 2006 as compared with $40.0 million at March 31, 2005. The Company was able to repay short-term Federal Home Loan Bank advances during the fiscal year by utilizing the increase in deposits and cash flows from the loan and securities portfolios.
Stockholders' equity totaled $35.5 million, a decrease of $4.7 million, or 11.6%, during the year ending March 31, 2006, due primarily to purchases of treasury stock totaling $5.0 million, dividends totaling $1.6 million and an increase in the unrealized loss on available for sale securities of $219,000. These amounts were partially offset by $1.6 million in net earnings for the fiscal year ended March 31, 2006 and from stock option exercises totaling $365,000.
Comparison of Operating Results for the Years Ended March 31, 2006 and 2005
General - -------
The Company has continued to maintain its strategy to aggressively manage interest rate risk. This strategy negatively affected earnings for fiscal 2005 and 2004, with earnings benefits beginning to appear the last half of fiscal 2006. Management believes that the investment of excess funds primarily in shorter term assets will continue to help the Company in the current rising interest rate environment.
Net earnings totaled $1.6 million for fiscal year ended March 31, 2006, an increase of $1.3 million when compared to the net earnings of $381,000 for the fiscal year ended March 31, 2005. The increase in net earnings was primarily attributable to an increase net interest income of $492,000, a decrease in provision for loan losses of $219,000 and a decrease in general, administrative and other expense of $975,000, or 8.2%. The growth in pretax earnings was partially offset by an increase in federal income taxes of $520,000.
Interest Income - ---------------
Interest income increased $2.1 million or 11.7%, to $19.7 million for the fiscal year ended March 31, 2006, compared to the same period in 2005. This increase was mainly due to an increase in the weighted-average yield on interest-earning assets to 5.36% from 4.87% for the fiscal year ended March 31, 2005, coupled with an increase in the weighted average balance of $5.9 million, or 1.6%. The yield increase is primarily due to the Federal Reserve raising the federal funds rate 2.0% over the past year. These rate increases have beneficially affected the yields earned on the Company's investment securities and interest-bearing deposits. The Company has purposefully invested excess funds in shorter-term securities and adjustable rate loans rather than long-term fixed rate loans. Although such strategy can sacrifice short-term income, it strengthens the Company's interest rate position and allows the Company to profitably redeploy such assets in a rising rate environment.
Interest income on loans increased $1.2 million, or 9.3%, for the year ended March 31, 2006, compared to the same period in 2005, due primarily to a $10.2 million, or 4.8%, increase in the weighted-average balance of loans year over year, coupled with a 26 basis point increase in the weighted average yield on loans outstanding. The increase in the weighted-average balance of loans was primarily due to the emphasis on nonresidential and commercial loans.
Comparison of Operating Results for the Years Ended March 31, 2006 and 2005 (continued)
Interest Income (continued) - ---------------------------
Interest income on mortgage-backed securities decreased $159,000, or 7.1%, during fiscal 2006, compared to the same period in 2005, due primarily to a decrease of $18.3 million, or 25.1%, in the weighted-average balance caused mainly by continued principal prepayments. The decrease in the weighted average balance was offset by an increase of 74 basis points to a weighted average yield of 3.83% as compared to 3.09%, from the comparable 2005 period, generally reflecting upward interest rate adjustments in the current rising rate environment.
Interest income on investment securities increased by $1.0 million, or 49.4% during the 2006 period compared to the same period in 2005, reflecting an increase in the weighted average balance of $24.1 million, or 46.1%, to $76.2 million from $52.2 million during the comparable 2005 period, coupled with an increase in the average yield of 8 basis points to 4.01%. The increase in the weighted-average volume reflects the Company's strategy of investing in short-term investment securities in the current increasing interest rate environment. This strategy provides the Company with flexibility to use funds from securities sales and repayments to originate loans such as nonresidential and commercial loans with higher yields and in some instances shorter terms.
Interest income on interest-bearing deposits increased by $6,000, or 1.4%, for the fiscal year ended March 31, 2006, due primarily to an increase in the average yield of 137 basis points to 3.20%, partially offset by a reduction in the weighted average balance during fiscal 2006 of $10.1 million, or 42.2%.
Interest Expense - ----------------
Interest expense for the fiscal year ended March 31, 2006 totaled $8.3 million, an increase of $1.6 million , or 23.3%, from interest expense for fiscal year ended March 31, 2005. The increase in interest expense resulted from an increase in the average cost of funds of 36 basis points to 2.34% for fiscal 2006, coupled with an increase of $13.5 million, or 4.0%, in the weighted average balance of deposits and borrowings outstanding in fiscal 2006.
Interest expense on deposits totaled $7.2 million for fiscal 2006, an increase of $1.5 million, or 26.6%, compared to fiscal 2005. The increase in deposit costs resulted from an increase of 41 basis points in the average cost of deposits to 2.22% for fiscal 2006, coupled with a 2006 increase in the average balance outstanding of $11.2 million, or 3.6%. As noted earlier, a shift in the composition of deposits from lower cost savings deposits to higher cost certificates of deposits contributed to the increase in the cost of deposits.
Interest expense on borrowings totaled $1.1 million for the year ended March 31, 2006, an increase of $51,000, or 4.9%, from the 2005 period, due primarily to an increase in the weighted average balance of $2.3 million, or 9.0%, which was partially offset by rate reduction of 15 basis points to 3.81% for the fiscal year ended March 31, 2006 as a result of the repayment of higher rate advances.
Net Interest Income - -------------------
Net interest income totaled $11.4 million for the fiscal year ended March 31, 2006, an increase of $492,000, or 4.5%, from the amount for fiscal 2005. The average interest rate spread increased to 3.02% for fiscal 2006 from 2.89% for fiscal 2005. The net interest margin increased to 3.10% for fiscal 2006 from 3.02% for the fiscal year ended March 31, 2005.
Comparison of Operating Results for the Years Ended March 31, 2006 and 2005 (continued)
Provision for Losses on Loans - -----------------------------
The Company recorded a provision for losses on loans totaling $211,000 and $430,000 for the fiscal years ended March 31, 2006 and 2005, respectively. To the best of management's knowledge, all known and inherent losses that are probable and which can be reasonably estimated have been recorded as of March 31, 2006.
Other Income - ------------
Other income, consisting primarily of an increase in cash surrender value of life insurance, gains on sale of loans, service fees, and charges on deposit accounts increased by $93,000, or 5.5%, to $1.8 million for fiscal 2006, from $1.7 million for the year ended March 31, 2005. The increase resulted primarily from an increase in cash surrender value of life insurance of $123,000 and $74,000 in other service fees, charges and other operating income, partially offset by a reduction of $104,000 in gain on sale of loans. The decline in gain on sale of loans is primarily due to a significant reduction in origination volume, amplified by management's decision during fiscal 2006 to retain certain fixed rate mortgage loans to facilitate growth in the portfolio.
General, Administrative and Other Expense - -----------------------------------------
General, administrative and other expense decreased by $975,000, or 8.2%, to $10.9 million for the fiscal year ended March 31, 2006, compared to fiscal 2005. The decrease in general, administrative and other expense is primarily due to the absence of the $1.4 million in accelerated expense related to the management recognition and stock option plan recognized in 2005. Employee compensation and benefits decreased by $848,000, or 11.7%. Net of the aforementioned accelerated expense of the management recognition and stock option plan, employee compensation and benefits increased $554,000 due primarily to $421,000 in retirement expense recognized due to the death of the former Chief Executive Officer and retirement of the Chief Operations Officer and normal merit salary increases. An increase of $68,000, or 3.7%, in occupancy and equipment expense was primarily due to increased data line costs related to the online banking program, coupled with an increase of depreciation expense. A decrease of $48,000, or 8.3%, in franchise taxes was due to the reduction in equity from the repurchase of treasury stock. The increase in other operating expense was primarily attributable to increased professional costs related to routine compliance matters, the new online banking program, and additional service charges related to the trust department.
Federal Income Taxes - --------------------
The federal income tax expense was $435,000 for the year ended March 31, 2006, reflecting an increase of $520,000 in federal income tax expense from fiscal 2005. The increase resulted primarily from a $1.8 million increase in pre-tax earnings. The difference in the effective tax rate or rate of benefits from the 34% statutory rate is mainly due to the beneficial effects of income from cash surrender value of life insurance and other tax-exempt obligations.
Comparison of Operating Results for the Years Ended March 31, 2005 and 2004
General - -------
Fiscal 2005 was a year of strategic transition for the Company. The Company's primary competitor was acquired by a major regional bank holding company, positioning Wayne Savings as the largest independent community bank in the five county market areas.
Comparison of Operating Results for the Years Ended March 31, 2005 and 2004 (continued)
General (continued) - -------
Management had long perceived the market area preference for local ownership and decision-making. In recognition of this fact, management believed that the Company had a unique opportunity to expand its product lines, particularly in the areas of commercial lending and trust services. Management also recognized that expansion of such product lines would initially place pressures on the Company's operating costs. As a result, management undertook a review of the Company's ability to expand its product lines in view of its current cost structure.
Such review culminated in the conclusion that several of its benefit plans, specifically the previous grants under the Management Recognition Plan and the Stock Ownership Plan reflected compensation awards which were more closely aligned with past versus future managerial performance. Moreover, in view of the mandatory expensing of stock options pursuant to SFAS No. 123(R), management concluded that the approximate $300,000 in annual pre-tax savings resulting from accelerating the expense of the Stock Option Plan was a prudent method of expanding the Company's product lines without placing undue pressure on the Company's future cost structure.
Due in large part to these decisions, net earnings totaled $381,000 for the fiscal year ended March 31, 2005, a decrease of $2.3 million, or 85.9%, below the net earnings of $2.7 million for the fiscal year ended March 31, 2004. The decline in net earnings was primarily attributable to an increase in general, administrative and other expense of $2.9 million, or 32.4%, an increase in the provision for losses on loans of $257,000, or 148.6%, a decrease in other income of $249,000, or 12.9%, and a decrease in net interest income of $153,000, or 1.4%. These earnings reductions were partially offset by a decrease in federal income tax expense of $1.2 million.
Interest Income - ---------------
Interest income for the fiscal year ended March 31, 2005, decreased $584,000, or 3.2%, to $17.6 million. This decrease was the result of a 29 basis point reduction in the yield earned on interest earning assets to 4.87%, partially offset by an increase in the weighted-average balance of interest-earning assets totaling $9.0 million, or 2.6%, to $361.7 million for the year ended March 31, 2005.
Interest income on loans declined $1.1 million, or 7.8%, for the fiscal year ended March 31, 2005, due primarily to a decrease in the weighted-average balance of loans outstanding of $1.4 million, or 0.6%, compared to the fiscal 2004, coupled with a 47 basis point decrease in the weighted-average yield on loans to 6.06% for fiscal 2005.
Interest income on mortgage-backed securities decreased $235,000 during fiscal 2005, due primarily to a $13.5 million, or 15.7%, decrease in the weighted-average balance outstanding from the 2004 period, which was partially offset by an increase in the average yield of 22 basis points to 3.09%.
Interest income on investments increased by $553,000, or 37.0%, reflecting an increase in the weighted-average balance of $17.5 million, or 50.6%, partially offset by a decrease in the weighted-average yield of 39 basis points to 3.93% from 4.32% during fiscal 2004.
Interest income on interest-bearing deposits and other increased by $182,000, or 71.7%, reflecting an increase in the weighted-average balance of $6.4 million, or 36.6%, coupled with an increase in the weighted-average yield of 38 basis points to 1.83% from 1.45% during fiscal 2004.
Comparison of Operating Results for the Years Ended March 31, 2005 and 2004 (continued)
Interest Income (continued) - ---------------
The decrease in the average balance of loans and mortgage-backed securities as well as the increase in the average balance of investments and interest-bearing deposits is consistent with the Company's aforementioned strategy to shorten the average maturity of the Company's interest-earning assets. The Company has invested a significant portion of the funds from payments on loans and mortgage-backed securities in short term investment securities and other short term investment vehicles.
Interest Expense - ----------------
Interest expense for fiscal 2005 totaled $6.7 million, a decrease of $431,000, or 6.0%, from interest expense of $7.1 million for the fiscal year ended March 31, 2004. The decrease resulted from a 21 basis point decrease in the average cost of funds to 1.98% for fiscal 2005, offset by an increase in the average balance of deposits and borrowings outstanding of $13.4 million, or 4.1%, to $339.7 million for fiscal 2005.
Interest expense on deposits totaled $5.7 million for fiscal 2005, a decrease of $215,000, or 3.6%, from fiscal 2004, as a result of an 18 basis point decrease in the average cost of deposits to 1.81% for the 2005 period offset by an increase in the average balance outstanding of $17.4 million, or 5.9%, to $313.6 million for fiscal 2005.
Interest expense on borrowings totaled $1.0 million for the fiscal year ended March 31, 2005, a decrease of $216,000 from fiscal 2004, primarily due to a reduction in the average balance of borrowings of $3.9 million to an average balance of $26.1 million for fiscal 2005 from $30.0 million for the year ended March 31, 2004, coupled with a decrease in the average cost of borrowings to 3.96% from an average cost of 4.16% for fiscal 2004.
Net Interest Income - -------------------
Net interest income totaled $10.9 million for the fiscal year ended March 31, 2005, a decrease of $153,000, or 1.4%, from fiscal 2004. The average interest rate spread decreased to 2.89% for the year ended March 31, 2005 from 2.97% for fiscal 2004. The net interest margin decreased to 3.02% for fiscal 2005 from 3.14% for fiscal 2004.
Provision for Losses on Loans - -----------------------------
The Company recorded a provision for losses on loans totaling $430,000 and $173,000 for the fiscal years ended March 31, 2005 and 2004, respectively. As a result of the increased commercial loan volume, the acquisition of Stebbins' loan portfolio and an enhancement of the Company's loan rating standards, management increased the provision for loan losses by $257,000 in fiscal 2005. To the best of management's knowledge, all known and inherent losses that are probable and which can be reasonably estimated were recorded at March 31, 2005.
Other Income - ------------
Other income, consisting primarily of an increase in cash surrender value of life insurance, gains on sale of loans, service fees, and charges on deposit accounts, decreased by $249,000, or 12.9%, to $1.7 million for fiscal 2005, from $1.9 million for the year ended March 31, 2004. The decrease resulted primarily from a decrease of $256,000 in merchant fee income due to a significant reduction in volume.
Comparison of Operating Results for the Years Ended March 31, 2005 and 2004 (continued)
General, Administrative and Other Expense - -----------------------------------------
General, administrative and other expense increased by $2.9 million, or 32.4%, to $11.9 million for the year ended March 31, 2005 compared to the fiscal year ended March 31, 2004. Approximately $1.4 million of this increase resulted from management's decision to accelerate the vesting and attendant expense of the Management Recognition and Stock Option Plans.
The increase in employee compensation and benefits of $2.0 million, or 39.4%, was primarily attributable to the acceleration of benefit plan costs, normal merit increases and additional staff needed for operating in a heavily regulated industry. An increase of $355,000, or 23.9%, in occupancy and equipment expense was primarily due to a data conversion and operations costs related to the Stebbins acquisition. An increase of $214,000, or 59.0%, in franchise taxes was due to the increase in equity from the fiscal 2003 conversion to stock form. Similarly, the increase in other operating expense was primarily attributable to increased costs related to the Stebbins acquisition.
Federal Income Taxes - --------------------
The federal income tax benefit was $85,000 for the year ended March 31, 2005, reflecting a decrease of $1.2 million in federal income tax expense from fiscal 2004. The reduction resulted primarily from a $3.6 million, or 92.3%, decrease in pre-tax earnings. The difference in the effective tax rate or rate of benefits from the 34% statutory rate is mainly due to the beneficial effects of income from cash surrender value of life insurance and other tax-exempt obligations.
(1) Includes non-accrual loan balances. (2) Includes mortgage-backed securities designated as available for sale. (3) Includes federal funds sold and interest-bearing deposits in other financial institutions. (4) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (5) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.
Rate/Volume Analysis.
The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in average volume (changes in average volume multiplied by old rate); and (ii) changes in rate (change in rate multiplied by old average volume). Changes in rate-volume (changes in rate multiplied by the change in average volume) have been allocated proportionately between changes in rate and changes in volume.
Liquidity and Capital Resources
The Bank's primary sources of funds are deposits, principal and prepayments on loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions and competition. The Bank manages the pricing of deposits to maintain a desired level of deposits and cost of funds. In addition, the Bank invests excess funds in federal funds and other short-term interest-earning assets, which provide liquidity to meet lending requirements. Federal funds sold and other liquid assets outstanding at March 31, 2006, 2005 and 2004, amounted to $143.2 million, $163.2 million and $139.9 million, respectively. For additional information about cash flows from the Company's operating, financing and investing activities, see the Statements of Cash Flows included in the Consolidated Financial Statements.
A major portion of the Bank's liquidity consists of cash and cash equivalents, which are a product of their operating, investing and financing activities. The primary sources of cash are net earnings, principal repayments on loans and mortgage-backed securities, proceeds from advances from the Federal Home Loan Bank ("FHLB"), and sales of mortgage-backed securities. Liquidity management is both a daily and long-term function of business management. If the Bank requires funds beyond its ability to generate funds internally, borrowing agreements exist with the Federal Home Loan Bank, which provide an additional source of funds. At March 31, 2006, the Company had $32.8 million in outstanding advances from the FHLB. At March 31, 2006, management believes the Company has additional borrowing capacity from the FHLB totaling $168.6 million.
Contractual Obligations
The following table summarizes the Company's contractual obligations at March 31, 2006.
Impact of Inflation and Changing Prices
The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary. As a result, interest rates have a greater impact on the Company's performance than do the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk - ----------------------------------------------------------------------
Asset and Liability Management-Interest Rate Sensitivity Analysis
The Bank, like other financial institutions, is subject to interest rate risk to the extent that interest-earning assets reprice at a different time than interest-bearing liabilities. As part of their effort to monitor and manage interest rate risk, the Bank uses the "net portfolio value" ("NPV") methodology adopted by the OTS as part of its interest rate sensitivity regulations. The application of NPV methodology illustrates certain aspects of the Bank's interest rate risk.
Generally, NPV is the discounted present value of the difference between incoming cash flows on interest-earning and other assets and outgoing cash flows on interest-bearing and other liabilities. The application of the methodology attempts to quantify interest rate risk as the change in the NPV, which would result from a theoretical change in market interest rates.
Presented below, as of March 31, 2006 and 2005, is an analysis of the Bank's interest rate risk as measured by changes in NPV for instantaneous and sustained 100, 200 and 300 basis point (1 basis point equals .01%) increases and a 100 and 200 basis point decrease in market interest rates. Due to the current interest rate environment, the changes in NPV are not estimated for a decrease of 300 basis points.
Asset and Liability Management-Interest Rate Sensitivity Analysis (continued)
As with any method of measuring interest rate risk, certain shortcomings are inherent in the NPV approach. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and mortgage-backed securities and early withdrawal levels from certificates of deposit would likely deviate significantly from those assumed in making the risk calculations.
The Company's policy in recent years had been to reduce its exposure to interest rate risk generally by better matching the maturities of its interest rate sensitive assets and liabilities and by originating adjustable rate mortgage ("ARM") loans and other adjustable rate or short-term loans, as well as by purchasing short-term investments and mortgage-backed securities. However, particularly in the rising short-term interest rate environment which currently exists, borrowers typically prefer fixed rate loans to ARM loans. Accordingly, ARM loan originations were very limited during the fiscal year ended March 31, 2006. The Company has sought to lengthen the maturities of its deposits by promoting longer-term certificates; however, the Company was not successful in lengthening the maturities of its deposits in the interest rate environment that existed throughout fiscal 2006.
The Company has an Asset-Liability Management Committee (ALCO), which is responsible for reviewing the Company's asset-liability policies. The Committee meets and reports monthly to the Board of Directors on interest rate risks and trends, as well as liquidity and capital ratios and requirements. The Bank has operated within the framework of its prescribed asset/liability risk ranges for each of the last three years.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data - -------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors Wayne Savings Bancshares, Inc.
We have audited the accompanying consolidated statements of financial condition of Wayne Savings Bancshares, Inc. as of March 31, 2006 and 2005, and the related consolidated statements of earnings, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended March 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Wayne Savings Bancshares, Inc. as of March 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
As more fully explained in Note A-9, the Company changed its method of accounting for stock-based compensation expense in fiscal 2005 pursuant to SFAS No. 123(R), "Share-Based Payment."
/s/ Grant Thornton LLP
Cincinnati, Ohio June 5, 2006
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include Wayne Savings Bancshares, Inc. (the "Company") and its wholly owned subsidiary Wayne Savings Community Bank ("Wayne Savings" or the "Bank"). During fiscal 2004, the Company's Board of Directors approved a business combination, which was completed in fiscal 2005, whereby Stebbins Bancshares, Inc., the parent of Stebbins National Bank, was merged into Wayne Savings Bancshares, Inc. and Stebbins National Bank merged with and into Wayne Savings Community Bank. The business combination was accounted for using the purchase method of accounting. Accordingly, the March 31, 2005 consolidated financial statements herein include the accounts of Stebbins Bancshares from the June 1, 2004 acquisition date through March 31, 2005. Intercompany transactions and balances are eliminated in the consolidated financial statements. In addition to the Bank, the Company owns a 49% ownership interest in Oak Tree Title, Inc., a title insurance agency. The Company accounts for this investment using the equity method.
The Bank conducts a general banking business in north central Ohio, which consists of attracting deposits from the general public and applying those funds to the origination of loans for residential, consumer and nonresidential purposes. The Bank's profitability is significantly dependent on its net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) and the interest expense paid on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amount of interest-earning assets and interest-bearing liabilities and the interest received or paid on these balances. The level of interest rates paid or received by the Bank can be significantly influenced by a number of environmental factors, such as governmental monetary policy, that are outside of management's control.
The financial information presented herein has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and general accounting practices within the financial services industry. In preparing financial statements in accordance with U.S. GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from such estimates.
The following is a summary of the Company's significant accounting policies, which with the exception of the policy described in Note A-9, have been consistently applied in the preparation of the accompanying financial statements.
1. Investment Securities and Mortgage-Backed Securities ----------------------------------------------------
The Company accounts for investment and mortgage-backed securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires that investments be categorized as held-to-maturity, trading, or available for sale. Securities classified as held-to-maturity are carried at cost only if the Company has the positive intent and ability to hold these securities to maturity. Trading securities and securities designated as available for sale are carried at fair value with resulting unrealized gains or losses recorded to operations or stockholders' equity, respectively. Realized gains or losses on sales of securities are recognized using the specific identification method.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Loans Receivable ----------------
Loans held in portfolio are stated at the principal amount outstanding, adjusted for deferred loan origination fees, the allowance for loan losses, and premiums and discounts on loans purchased and sold. Premiums and discounts on loans purchased and sold are amortized and accreted to operations using the interest method over the average life of the underlying loans.
Interest is accrued as earned unless the collectibility of the loan is in doubt. Uncollectible interest on loans that are contractually past due is charged off, or an allowance is established based on management's periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments has returned to normal, in which case the loan is returned to accrual status.
The Bank recognizes rights to service mortgage loans for others pursuant to SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." In accordance with SFAS No. 140, an institution that acquires mortgage servicing rights through either the purchase or origination of mortgage loans and sells those loans with servicing rights retained must allocate some of the cost of the loans to the mortgage servicing rights.
The Bank recognized $54,000, $54,000 and $61,000 of pre-tax gains on sales of loans related to capitalized mortgage servicing rights during the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
SFAS No. 140 requires that capitalized mortgage servicing rights be assessed for impairment. Impairment is measured based on fair value. The mortgage servicing rights recorded by the Bank, calculated in accordance with the provisions of SFAS No. 140, were segregated into pools for valuation purposes, using as pooling criteria the loan term and coupon rate. Once pooled, each grouping of loans was evaluated on a discounted earnings basis to determine the present value of future earnings that a purchaser could expect to realize from each portfolio. Earnings were projected from a variety of sources including loan servicing fees, interest earned on float, net interest earned on escrows, miscellaneous income and costs to service the loans. The present value of future earnings is the "economic" value for the pool, i.e., the net realizable present value to an acquirer of the acquired servicing.
The Bank recorded amortization related to mortgage servicing rights totaling approximately $28,000, $61,000 and $164,000 for the years ended March 31, 2006, 2005 and 2004, respectively. At March 31, 2006 and 2005, the carrying value of the Bank's mortgage servicing rights, which approximated fair value, totaled $311,000 and $285,000, respectively.
Loans held for sale are carried at the lower of cost or market, determined in the aggregate. In computing cost, deferred loan origination fees are deducted from the principal balances of the related loans. There were no loans identified as held for sale at either March 31, 2006 or March 31, 2005.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
3. Loan Origination Fees ---------------------
The Bank accounts for loan origination fees in accordance with SFAS No. 91 "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." Pursuant to the provisions of SFAS No. 91, origination fees received from loans, net of certain direct origination costs, are deferred and amortized to interest income using the level-yield method, giving effect to actual loan prepayments. Additionally, SFAS No. 91 generally limits deferred loan origination costs to the direct costs attributable to the origination of a loan, i.e. principally actual personnel costs. Fees received for loan commitments that are expected to be drawn upon, based on the Bank's experience with similar commitments, are deferred and amortized over the life of the loan using the level-yield method. Fees for other loan commitments are deferred and amortized over the loan commitment period on a straight-line basis.
4. Allowance for Loan Losses -------------------------
It is the Bank's policy to provide valuation allowances for losses inherent within the loan portfolio that are both probable and can be reasonably estimated. When the collection of a loan becomes doubtful, or otherwise troubled, the Bank records a charge-off equal to the difference between the fair value of the property securing the loan and the loan's carrying value. In providing valuation allowances, costs of holding real estate, including the cost of capital, are considered. Major loans (including development projects) and major lending areas are reviewed periodically to determine potential problems at an early date. The allowance for loan losses is increased by charges to earnings and decreased by charge-offs (net of recoveries).
The Bank accounts for impaired loans in accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." This Statement requires that impaired loans be measured based upon the present value of expected future cash flows discounted at the loan's effective interest rate or, as an alternative, at the loan's observable market price or fair value of the collateral.
A loan is defined under SFAS No. 114 as impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. In applying the provisions of SFAS No. 114, the Bank considers investment in one- to four-family residential loans and consumer installment loans to be homogeneous and therefore excluded from separate identification for evaluation of impairment. With respect to the Bank's investment in multi-family, commercial and nonresidential loans, and the evaluation of impairment thereof, such loans are collateral dependent and, as a result, are carried as a practical expedient at the lower of cost or fair value of collateral.
It is the Bank's policy to charge off unsecured credits that are more than ninety days delinquent. Similarly, collateral dependent loans are evaluated for impairment at the time it becomes possible that the Bank will not collect all contractual amounts due. Generally, this analysis is performed before a loan becomes ninety days delinquent.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
4. Allowance for Loan Losses (continued) -------------------------
Information with respect to loans defined as impaired under SFAS No. 114 is summarized below:
March 31, 2006 2005 2004 Investment in impaired loans $ -- $ -- $ -- Impaired loans with no measurement of loss -- -- -- Impaired loans with measurement of loss -- -- -- Allocated allowance for loan losses -- -- -- Average impaired loans -- -- 900 Charge-off of principal related to impaired loans -- -- --
During the time a loan is deemed impaired, the Bank records interest income using the cash method of accounting. There was no interest income recorded on impaired loans in fiscal 2006 or 2005. Interest income recorded on impaired loans using the cash recovery method totaled approximately $249,000 for the fiscal year ended March 31, 2004.
5. Office Premises and Equipment -----------------------------
Office premises and equipment are carried at cost and include expenditures which extend the useful lives of existing assets. Maintenance, repairs and minor renewals are expensed as incurred. For financial reporting, depreciation and amortization are provided on the straight-line method over the shorter of the remaining useful lives of the assets, or the lease term, estimated to be twenty to fifty-five years for buildings and improvements, five to ten years for furniture and equipment, ten to twenty years for leasehold improvements, and forty years for safe deposit boxes. An accelerated method is used for tax reporting purposes.
6. Real Estate Acquired Through Foreclosure ----------------------------------------
Real estate acquired through foreclosure is carried at the lower of the loan's unpaid principal balance (cost) or fair value less estimated selling expenses at the date of acquisition. Real estate loss provisions are recorded if the properties' fair value subsequently declines below the value determined at the recording date. In determining the lower of cost or fair value at acquisition, costs relating to development and improvement of property are capitalized. Costs relating to holding real estate acquired through foreclosure, net of rental income, are charged against earnings as incurred.
7. Federal Income Taxes --------------------
The Company accounts for federal income taxes pursuant to SFAS No. 109 "Accounting for Income Taxes." In accordance with SFAS No. 109, a deferred tax liability or deferred tax asset is computed by applying the current statutory tax rates to net taxable or deductible temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in net taxable or deductible amounts in future periods. Deferred tax assets are recorded only to the extent that the amount of net deductible temporary differences or carryforward attributes may be utilized against current period earnings, carried back against prior years' earnings, offset against taxable temporary
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
7. Federal Income Taxes (continued) --------------------
differences reversing in future periods, or utilized to the extent of management's estimate of future taxable income. A valuation allowance is provided for deferred tax assets to the extent that the value of net deductible temporary differences and carryforward attributes exceeds management's estimates of taxes payable on future taxable income. Deferred tax liabilities are provided on the total amount of net temporary differences taxable in the future.
The Company's principal temporary differences between pretax financial income and taxable income result primarily from the different methods of accounting for deferred loan origination fees, Federal Home Loan Bank stock dividends, certain components of retirement expense, general loan loss allowances, percentage of earnings bad debt deductions and mortgage servicing rights. A temporary difference is also recognized for depreciation expense computed using accelerated methods for federal income tax purposes.
8. Earnings Per Share ------------------
Basic earnings per common share is computed based upon the weighted-average number of common shares outstanding during the year, reduced by unallocated shares in the Employee Stock Ownership Plan ("ESOP") totaling 118,717, 129,109 and 145,209 shares for the fiscal years ended March 31, 2006, 2005 and 2004. Diluted earnings per common share include the dilutive effects of additional potential common shares issuable under the Company's Stock Option Plan. For each of the years presented, there were no shares excluded from the diluted earnings per share calculation because the related options were anti-dilutive. The computations are as follows:
9. Stock Option and Benefit Plans ------------------------------
The Company has a 1993 incentive Stock Option Plan that provided for the issuance of 196,390 adjusted shares of common stock. In fiscal 2004, the Company adopted a new Stock Option Plan that provided for the issuance of 204,081 options of authorized common stock.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Stock Option and Benefit Plans (continued) ------------------------------
In the fourth quarter of fiscal 2005, the Company adopted the provisions of SFAS No. 123(R), "Share Based Payment." SFAS No.123(R) requires the recognition of compensation related to stock option awards based on the fair value of the option award on the grant date. Compensation cost is then recognized over the vesting period. Subsequent to adoption of SFAS No. 123(R), the Company modified 163,265 stock option awards under the 2003 Stock Option Plan, eliminating the reload options contained therein and immediately vesting these shares. Pursuant to SFAS No. 123(R), the modification represents a new grant. Accordingly, in accordance with the modified prospective application method under SFAS No. 123(R), the Company recognized compensation costs representing the fair value of the option awards at the date of modification. This change in measuring compensation cost, integrated with the incremental expense of accelerating the Management Recognition Plan resulted in pre-tax charge of $664,000 and an after-tax charge to earnings of $450,000, or $.12 per diluted share in fiscal 2005. During fiscal 2006, the Company recognized tax benefits on exercised options totaling $80,000.
The Company accounted for its stock option plans in fiscal 2004 and prior pursuant to SFAS No. 123 "Accounting for Stock Based Compensation," which also provided for a fair value-based method for measuring compensation cost at the grant date based on the fair value of the award at the grant date. Compensation was then recognized over the service period, generally defined as the vesting period. Alternatively, SFAS No. 123 permitted companies to continue the account for stock options using APB Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that continued to account for stock options using APB Opinion No. 25 were required to make pro forma disclosures of net earnings and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. Wayne Savings had continued to account for stock option expense pursuant to APB Opinion No. 25.
In accordance with APB Opinion No. 25, no compensation cost has been recognized for the plans in fiscal 2004. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards under the plans consistent with the accounting method utilized in SFAS No. 123(R), the Company's net earnings and earnings per share would have been reported in the manner presented below:
Net earnings $ 2,704 Stock-based compensation, net of tax (106) --------- Pro-forma net earnings $ 2,598 =========
Earnings per share Basic $ .72 Stock-based compensation, net of tax (.03) --------- Pro-forma earnings per share $ .69 =========
Diluted $ .72 Stock-based compensation, net of tax (.03) --------- Pro-forma earnings per share $ .69 =========
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Stock Option and Benefit Plans (continued) ------------------------------
The following information applies to options outstanding at March 31, 2006:
Number outstanding 179,148 Range of exercise prices $11.67 - $13.95 Weighted-average exercise price $13.92 Weighted-average remaining contractual life 8.00
At March 31, 2006, all of the stock options are subject to exercise at the discretion of the grantees with 2,567 options expiring in fiscal 2013, and 176,581 options expiring in fiscal 2014.
A summary of the status of the Company's stock option plans as of March 31, 2006, 2005 and 2004, and changes during the years ending on those dates is presented below:
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model. The following assumptions were used for grants in each of the respective years:
2005 2004
Dividend yield 4.5% 3.3% Expected volatility 27.3 28.8 Expected life in years 9 10
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Stock Option and Benefit Plans (continued) ------------------------------
In connection with conversion to stock form, the Company implemented a Management Recognition Plan and an ESOP. The Management Recognition Plan granted share awards to certain members of management and the directorate. The value of such awards totaled $1.1 million at acquisition and was originally scheduled to vest over a five year period. The Company recognized scheduled expense under the plan of $231,000 and $173,000 in fiscal 2005 and 2004, and accelerated the vesting of the remaining awards in fiscal 2005.
Additionally, the Company initiated an ESOP in fiscal 2003 that provided for the purchase of 163,265 shares in the Company's conversion offering. The Company recognized expense under the ESOP of $161,000, $256,000 and $206,000 in fiscal 2006, 2005 and 2004, allocating 11,358, 15,695 and 14,645 shares, respectively. At March 31,2006, 118,717 ESOP shares remain unallocated.
10. Cash and Cash Equivalents -------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold, and interest-bearing deposits due from other financial institutions with original maturities of less than three months.
11. Fair Value of Financial Instruments -----------------------------------
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of the fair value of financial instruments, both assets and liabilities whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. For financial instruments where quoted market prices are not available, fair values are based on estimates using present value and other valuation methods.
The methods used are greatly affected by the assumptions applied, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in an exchange for certain financial instruments.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments at March 31, 2006 and 2005:
Cash and cash equivalents: The carrying amounts presented in the --------------------------- consolidated statements of financial condition for cash and cash equivalents are deemed to approximate fair value.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
11. Fair Value of Financial Instruments (continued) -----------------------------------
Investment and mortgage-backed securities: For investment and ----------------------------------------------- mortgage-backed securities, fair value is deemed to equal the quoted market price.
Loans receivable: The loan portfolio has been segregated into ------------------ categories with similar characteristics, such as one- to four-family residential, multi-family residential and nonresidential real estate, and commercial. These loan categories were further delineated into fixed-rate and adjustable-rate loans. The fair values for the resultant loan categories were computed via discounted cash flow analysis, using current interest rates offered for loans with similar terms to borrowers of similar credit quality. For loans on deposit accounts and consumer and other loans, fair values were deemed to equal the historic carrying values. The historical carrying amount of accrued interest on loans is deemed to approximate fair value.
Federal Home Loan Bank stock: The carrying amount presented in the ----------------------------- consolidated statements of financial condition is deemed to approximate fair value.
Deposits: The fair value of NOW accounts, passbook and club accounts, -------- money market deposits, commercial repurchase accounts and advances by borrowers is deemed to approximate the amount payable on demand. Fair values for fixed-rate certificates of deposit have been estimated using a discounted cash flow calculation using the interest rates currently offered for deposits of similar remaining maturities.
Advances from Federal Home Loan Bank: The fair value of these advances ------------------------------------ is estimated using the rates currently offered for similar advances of similar remaining maturities or, when available, quoted market prices.
Commitments to extend credit: For fixed-rate and adjustable-rate loan ---------------------------- commitments, the fair value estimate considers the difference between current levels of interest rates and committed rates. At March 31, 2006 and 2005, the fair value of loan commitments was not material.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
11. Fair Value of Financial Instruments (continued) -----------------------------------
Based on the foregoing methods and assumptions, the carrying value and fair value of the Company's financial instruments at March 31 are as follows:
2006 2005 Carrying Fair Carrying Fair value value value value (In thousands) Financial assets Cash and cash equivalents $ 14,123 $ 14,123 $ 29,942 $ 29,942 Investment securities 73,307 73,301 72,856 72,945 Mortgage-backed securities 55,731 55,737 60,352 60,371 Loans receivable 235,312 232,733 213,627 214,238 Federal Home Loan Bank stock 4,623 4,623 4,386 4,386 -------- -------- -------- --------
$383,096 $380,517 $381,163 $381,882 ======== ======== ======== ========
Financial liabilities Deposits $332,570 $319,617 $320,586 $318,534 Advances from the Federal Home Loan Bank 32,750 32,225 40,000 39,533 Advances by borrowers for taxes and insurance 521 521 481 481 -------- -------- -------- --------
$365,841 $352,363 $361,067 $358,548 ======== ======== ======== ========
12. Investment in Federal Home Loan Bank Stock ------------------------------------------
The Company is required as a condition of membership in the Federal Home Loan Bank of Cincinnati (FHLB) to maintain an investment in FHLB common stock. The stock is redeemable at par and, therefore, its cost is equivalent to its redemption value. The Company's ability to redeem FHLB shares is dependent on the redemption practices of the FHLB of Cincinnati. At March 31, 2006, the FHLB of Cincinnati placed no restrictions on redemption of shares in excess of a member's required investment in the stock.
13. Advertising -----------
Advertising costs are expensed when incurred. The Company's advertising expense totaled $146,000, $163,000 and $132,000 for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
14. Goodwill and Other Intangible Assets ------------------------------------
In connection with the Stebbins acquisition in fiscal 2005, the Company initially recorded goodwill and other intangible assets totaling $2.7 million. The composition of these assets at March 31, 2006 and 2005 is as follows:
March 31, 2006 2005 (In thousands)
Goodwill $1,719 $1,719 Core deposit intangible, net 789 895 ------ ------
Total $2,508 $2,614 ====== ======
The Company recorded amortization relative to the core deposit intangible totaling $106,000 and $87,000 for the fiscal years ended March 31, 2006 and 2005. Such amortization is derived using the interest method over a twelve year estimated useful life. Pursuant to SFAS No. 142, the Company is required to annually test goodwill and other intangible assets for impairment. The Company's testing of goodwill and other intangible assets in the current fiscal year indicated there was no impairment in the carrying value of these assets.
During fiscal 2006, the Company reclassified goodwill and other intangible assets as a separate financial statement line item, giving effect therein to the tax effects related to the acquisition.
15. Reclassifications -----------------
Certain prior year amounts have been reclassified to conform to the March 31, 2006 consolidated financial statement presentation.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES
Carrying values and estimated fair values of investment securities at March 31 are summarized as follows:
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
The Company has pledged $14.8 million and $7.8 million in investment securities to secure public deposits and commercial repurchase agreements at March 31, 2006 and 2005, respectively.
The amortized cost, gross unrealized gains, gross unrealized losses and estimated fair values of mortgage-backed securities at March 31, 2006 and 2005, including those designated as available for sale, are summarized as follows:
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost of investment and mortgage-backed securities, including those designated as available for sale, at March 31, 2006 and 2005, by contractual terms to maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may generally prepay obligations without prepayment penalties.
March 31, 2006 2005 Estimated Estimated Amortized fair Amortized fair cost value cost value (In thousands)
Held to maturity: Due within one year or less $ 4,992 $ 4,975 $ 6,032 $ 6,121 Due in one to five years -- -- 4,989 4,976 Due in five to ten years 169 179 194 207 Due after ten years 641 642 797 797 ---------- ---------- ---------- ---------- 5,802 5,796 12,012 12,101
Mortgage-backed securities 1,799 1,805 2,628 2,647 ---------- ---------- ---------- ----------
$ 7,601 $ 7,601 $ 14,640 $ 14,748 ========== ========== ========== ==========
Available for sale: Due within one year or less $ 17,643 $ 17,475 $ 3,997 $ 3,974 Due in one to five years 32,537 31,837 45,567 44,890 Due in five to ten years 9,287 9,171 992 980 Due after ten years 8,844 9,022 11,007 11,000 ---------- ---------- ---------- ---------- 68,311 67,505 61,563 60,844
Mortgage-backed securities 54,660 53,932 58,204 57,724 ---------- ---------- ---------- ----------
$ 122,971 $ 121,437 $ 119,767 $ 118,568 ========== ========== ========== ==========
Proceeds from the sale of mortgage-backed securities during the year ended March 31, 2005, totaled $2.9 million resulting in no gross realized gain or loss. Proceeds from the sales of mortgage-backed securities during the year ended March 31, 2004, totaled $4.4 million resulting in gross realized gains of $16,000.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at March 31, 2006 and 2005:
Management has the intent and ability to hold these securities for the foreseeable future and the decline in the fair value is primarily due to an increase in market interest rates. The fair values are expected to recover as securities approach the respective maturity dates.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at March 31 is as follows:
2006 2005 (In thousands)
One- to four-family residential $149,134 $157,658 Multi-family residential 7,930 7,872 Construction 4,675 4,053 Nonresidential real estate and land 50,778 29,187 Commercial 21,550 14,075 Consumer and other 4,901 4,306 -------- -------- 238,968 217,151 Less: Undisbursed portion of loans in process 1,729 1,638 Deferred loan origination fees 443 512 Allowance for loan losses 1,484 1,374 -------- --------
$235,312 $213,627 ======== ========
The Bank's lending efforts have historically focused on one- to four-family residential and multi-family residential real estate loans, which comprise approximately $160.0 million, or 68%, of the total loan portfolio at March 31, 2006, and $167.9 million, or 79%, of the total loan portfolio at March 31, 2005. Generally, such loans have been underwritten on the basis of no more than an 80% loan-to-value ratio, which has historically provided the Company with adequate collateral coverage in the event of default. Nevertheless, the Bank, as with any lending institution, is subject to the risk that real estate values could deteriorate in the primary lending area of north central Ohio, thereby impairing collateral values. However, management is of the belief that residential real estate values in the Company's primary lending area are presently stable.
As discussed previously, Wayne Savings has sold whole loans and participating interests in loans in the secondary market, retaining servicing on the loans sold. Loans sold and serviced for others totaled approximately $34.4 million, $34.0 million and $35.3 million at March 31, 2006, 2005 and 2004, respectively.
In the normal course of business, the Bank has made loans to directors, officers and their related business interests. Related party loans are made on the same terms that are widely available to other employees, as long as the director or executive officer is not given preferential treatment compared to other participating employees. The aggregate dollar amount of loans outstanding to directors, officers and their related business interests totaled approximately $2.8 million, $2.8 million and $2.7 million at March 31, 2006, 2005 and 2004, respectively.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for the years ended March 31:
2006 2005 2004 (In thousands)
Balance at beginning of year $ 1,374 $ 815 $ 678 Provision for losses on loans 211 430 173 Stebbins acquisition -- 230 -- Charge-offs of loans (158) (126) (65) Recovery of loans previously charged off 57 25 29 ------- ------- -------
Balance at end of year $ 1,484 $ 1,374 $ 815 ======= ======= =======
As of March 31, 2006, the Bank's allowance for loan losses was comprised solely of a general loan loss allowance, which is includible as a component of regulatory risk-based capital.
Non-accrual and nonperforming loans totaled approximately $772,000 and $906,000 at March 31, 2006 and 2005, respectively.
During the years ended March 31, 2006, 2005 and 2004, interest income of approximately $44,000, $40,000 and $37,000, respectively, would have been recognized had non-accrual loans been performing in accordance with contractual terms.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment are comprised of the following at March 31:
2006 2005 (In thousands)
Land and improvements $ 1,654 $ 1,654 Office buildings and improvements 7,310 7,294 Furniture, fixtures and equipment 4,038 3,776 Leasehold improvements 356 356 ------- ------- 13,358 13,080 Less accumulated depreciation and amortization 4,801 4,158 ------- -------
$ 8,557 $ 8,922 ======= =======
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE F - DEPOSITS
Deposits consist of the following major classifications at March 31:
Deposit type and weighted-average interest rate 2006 2005 (In thousands)
NOW accounts 2006 - 0.33% $ 56,791 2005 - 0.43% $ 53,060 Savings accounts 2006 - 0.58% 61,339 2005 - 0.74% 82,184 Money market investor 2006 - 2.09% 20,656 2005 - 1.34% 18,097 Commercial repurchase agreements 2006 -3.76% 5,704 -- -------- -------- Total demand, transaction and Savings account deposits 144,490 153,341
Certificates of deposit Original maturities of: Less than 12 months 2006 - 4.05% 61,814 2005 - 1.99% 42,483 12 to 24 months 2006 - 2.38% 19,181 2005 - 1.97% 24,438 25 to 36 months 2006 - 3.41% 18,541 2005 - 3.02% 16,039 More than 36 months 2006 - 4.44% 53,641 2005 - 4.39% 53,183 Jumbo 2006 - 4.34% 34,903 2005 - 3.24% 31,102 -------- --------
Total certificates of deposit 188,080 167,245 -------- --------
Total deposit accounts $332,570 $320,586 ======== ========
At March 31, 2006 and 2005, the Bank had certificates of deposit with balances in excess of $100,000 totaling $37.8 million and $34.4 million, respectively.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE F - DEPOSITS (continued)
Interest expense on deposits for the years ended March 31 is summarized as follows:
2006 2005 2004
Savings accounts $ 464 $ 653 $ 688 NOW and money market deposit accounts 527 383 269 Commercial repurchase agreements 148 -- -- Certificates of deposit 6,058 4,648 4,942 ------ ------ ------
$7,197 $5,684 $5,899 ====== ====== ======
Maturities of outstanding certificates of deposit at March 31 are summarized as follows:
2006 2005 (In thousands) Maturing year ending March 31, 2006 $ -- $ 91,507 2007 129,966 38,083 2008 34,454 18,277 2009 11,439 9,056 2010 10,370 9,333 2011 1,271 289 2012 and thereafter 580 700 ---------- ---------
$ 188,080 $ 167,245 ========== =========
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank were collateralized at March 31, 2006 and 2005 by pledges of certain residential mortgage loans totaling $40.9 million and $50.0 million, respectively, and the Bank's investment in Federal Home Loan Bank stock, are summarized as follows:
Maturing year ending Interest rate range March 31, 2006 2005 (Dollars in thousands) Floating rate - 2.95% 2006 $ -- $15,000 3.13% - 3.36% 2007 15,250 7,500 3.51% - 3.61% 2008 5,000 5,000 4.01% 2009 2,500 2,500 4.34% 2010 2,500 2,500 4.60% 2011 2,500 2,500 4.77% - 4.87% 2012 and thereafter 5,000 5,000 -------- -------
$ 32,750 $40,000 ======== =======
Weighted-average interest rate 4.19% 3.59% ======== =======
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE H - FEDERAL INCOME TAXES
The provision for federal income taxes (benefits) at the 34% statutory composite tax rate is as follows:
2006 2005 2004 (In thousands)
Federal income taxes computed at expected 34% statutory rate $ 706 $ 101 $ 1,312 Cash surrender value of life insurance (130) (88) (88) Tax-exempt obligations, net (159) (129) (80) Other 18 31 10 ------- ------- -------
Federal income tax provision (benefit) per consolidated financial statements $ 435 $ (85) $ 1,154 ======= ======= =======
The composition of the Corporation's net deferred tax liability at March 31 is as follows:
Taxes (payable) refundable on temporary 2006 2005 differences at statutory rate: (In thousands)
Deferred tax assets: Deferred loan origination fees $ 151 $ 174 General loan loss allowance 516 487 Unrealized losses on securities available for sale 522 409 Reserve for uncollected interest 16 59 Benefit plan expense 128 166 Other 10 38 ------- ------- Total deferred tax assets 1,343 1,333
Deferred tax liabilities: Prepaid pension (187) (306) Federal Home Loan Bank stock dividends (1,080) (1,000) Book/tax depreciation differences (312) (257) Financed loan fees (109) (90) Bad debt deduction -- (16) Mortgage servicing rights (106) (97) Purchase price adjustments - net (214) (200) ------- ------- Total deferred tax liabilities (2,008) (1,966) ------- -------
Net deferred tax liability $ (665) $ (633) ======= =======
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE H - FEDERAL INCOME TAXES (continued)
Prior to fiscal 1997, Wayne Savings was allowed a special bad debt deduction based on a percentage of earnings, generally limited to 8% of otherwise taxable income and subject to certain limitations based on aggregate loans and deposit account balances at the end of the year. This cumulative percentage of earnings bad debt deduction totaled approximately $2.7 million as of March 31, 2006. If the amounts that qualified as deductions for federal income taxes are later used for purposes other than bad debt losses, including distributions in liquidation, such distributions will be subject to federal income taxes at the then current corporate income tax rate. The amount of unrecognized deferred tax liability relating to the cumulative bad debt deduction was approximately $918,000 at March 31, 2006.
NOTE I - COMMITMENTS
The Company is a party to financial instruments with off balance-sheet risk in the normal course of business to meet the financing needs of its customers, including commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of the commitments reflect the extent of the Company 's involvement in such financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as those utilized for on-balance-sheet instruments.
At March 31, 2006, the Company had total outstanding commitments of approximately $1.6 million to originate loans at rates ranging from 5.875% to 6.50%. The Bank also had loans in process of $1.7 million at March 31, 2006, consisting entirely of one- to four-family loans. The Company had unused lines of credit outstanding under home equity loans of $18.4 million at March 31, 2006. The Company also had $306,000 unused lines of credit outstanding under overdraft lines at March 31, 2006. Additionally, the Company had unused lines of credit on commercial loans of $10.6 million at March 31, 2006 and 2005, and outstanding letters of credit of $913,000 at March 31, 2006.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE I - COMMITMENTS (continued)
requirements. Management believes that all disbursements for commitments will be funded via normal cash flow from operations and existing excess liquidity. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral on loans may vary but the preponderance of loans granted generally includes a mortgage interest in real estate as security.
The Company leases certain branch banking facilities under operating leases. The minimum annual lease payments over the initial lease term are as follows:
Fiscal year ended (In thousands)
2007 $ 85 2008 86 2009 86 2010 59 2011 63 ----
Total $379 ====
The Company incurred rental expense under operating leases totaling approximately $71,000, $70,000 and $68,000 for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
There were no other material commitments or contingencies at March 31, 2006.
NOTE J - REGULATORY CAPITAL
The Bank is subject to minimum regulatory capital standards promulgated by the OTS. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. The minimum capital standards of the OTS generally require the maintenance of regulatory capital sufficient to meet each of three tests, hereinafter described as the tangible capital requirement, the core capital requirement and the risk-based capital requirement. The tangible capital requirement provides for minimum tangible capital (defined as stockholders' equity less all intangible assets) equal to 1.5% of adjusted total assets. The core capital requirement provides for minimum core capital (tangible capital plus certain forms of supervisory goodwill and other qualifying intangible assets) generally equal to 4.0% of adjusted total assets except for those associations with the highest examination rating and acceptable levels of risk. The risk-based capital requirement provides for the maintenance of core capital plus general loss allowances equal to 8.0% of risk-weighted assets. In computing risk-weighted assets, the Bank multiplies the value of each asset on their statement of financial condition by a defined risk-weighting factor, e.g. one- to four-family residential loans carry a risk-weighted factor of 50%.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE J - REGULATORY CAPITAL (continued)
As of March 31, 2006, management believes that the Bank met all capital adequacy requirements to which it was subject. As of the most recent examination date, management was advised by the OTS that the Bank met the definition of a "well capitalized" institution.
The Bank's management believes that, under the current regulatory capital regulations, the Bank will continue to maintain its well-capitalized classification in the foreseeable future. However, events beyond the control of the Bank, such as increased interest rates or a downturn in the economy in the Bank's market area, could adversely affect future earnings and, consequently, the ability to meet future minimum regulatory capital requirements.
The Bank is subject to regulations imposed by the OTS regarding the amount of capital distributions payable to the Company. Generally, the Bank's payment of dividends is limited, without prior OTS approval, to net earnings for the current calendar year, plus the two preceding years, less capital distributions paid over the comparable time period. Insured institutions are required to file an application with the OTS for capital distributions in excess of the limitation. In fiscal 2006, the Bank received capital distributions in excess of the last two year's earnings. As a result, the Bank will have to file applications for future capital distributions. Management does not believe future dividend payments will be unreasonably restricted given the Bank's current well-capitalized status.
The following tables sets forth Wayne Savings' tangible, core and risk-based capital rates at March 31, 2006 and 2005.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE K - RETIREMENT PLANS
The Company had a non-contributory insured defined benefit pension plan (the "Plan") covering all eligible employees. The Plan benefits were based on years-of-service and other factors . In fiscal 2004, Wayne Savings froze its defined benefit pension plan. Also in fiscal 2004, management changed the Plan's investment structure from life insurance to stocks and bonds. At March 31, 2006, Plan assets consisted of 2% cash, 61% stocks and 37% bonds. The Company's intent is to terminate the Plan at some point in the future when financial considerations are more favorable. Contributions are intended to provide only for benefits accrued for service to the plan freeze date.
Information with respect to the Plan for the years ended March 31, 2006, 2005 and 2004 is as follows:
The changes in benefit obligations are computed as follows:
The following table sets forth the Plan's funded status at March 31:
2006 2005 (In thousands)
Funded status $249 $ -- Unrecognized net actuarial loss 300 957 ---- ----
Prepaid pension cost $549 $957 ==== ====
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE K - RETIREMENT PLANS (continued)
The weighted-average actuarial assumptions used in the valuations were:
2006 2005 2004
Weighted-average discount rate 6.50% 6.00% 6.50% Weighted-average expected long-term rate of return on plan assets 7.00% 7.00% 7.00%
Net periodic pension costs includes the following components:
2006 2005 2004 (In thousands)
Service cost $ -- $ -- $ 55 Interest cost 136 152 26 Actual return on plan assets, net (159) (155) (145) Amortization of prior net loss 73 28 166 Settlement losses 358 89 -- ----- ----- -----
Net periodic pension cost $ 408 $ 114 $ 102 ===== ===== =====
The following benefit payments are expected to be paid in future years:
iscal Benefits (In thousands)
2007 $ 28 2008 28 2009 28 2010 44 2011 44 Thereafter 189
The Bank has a savings plan covering substantially all employees who meet certain age and service requirements. Under the plan, the Bank matches each participant's contribution - up to 3% of the participant's salary; a 50% match is provided for up to the next 4% of the participant's salary. This contribution is dependent on availability of sufficient net earnings from current or prior years. Additional contributions may be made as approved by the Board of Directors. Expense under the plan totaled approximately $135,000, $121,000 and $78,000 for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE L - CONDENSED FINANCIAL STATEMENTS OF WAYNE SAVINGS BANCSHARES, INC.
The following condensed financial statements summarize the financial position of Wayne Savings Bancshares, Inc. as of March 31, 2006 and 2005, and the results of its operations and its cash flows for the years ended March 31, 2006, 2005 and 2004:
WAYNE SAVINGS BANCSHARES, INC. STATEMENT OF FINANCIAL CONDITION March 31, 2006 and 2005 (In thousands)
ASSETS 2006 2005
Cash and due from banks $ 98 $ 480 Notes receivable from Wayne Savings 1,240 1,304 Investment in Wayne Savings 34,569 38,321 Prepaid expenses and other assets 22 547 -------- --------
Total assets $ 35,929 $ 40,652 ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 413 $ 453
Stockholders' equity Common stock and additional paid-in capital 35,997 35,524 Retained earnings 11,394 11,371 Less required contributions for shares acquired by ESOP (1,239) (1,304) Less 595,322 and 282,261 of treasury stock at March 31, 2006 and 2005, respectively - at cost (9,625) (4,600) Accumulated other comprehensive loss (1,011) (792) -------- -------- Total stockholders' equity 35,516 40,199 -------- --------
Total liabilities and stockholders' equity $ 35,929 $ 40,652 ======== ========
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE L - CONDENSED FINANCIAL STATEMENTS OF WAYNE SAVINGS BANCSHARES, INC. (continued)
WAYNE SAVINGS BANCSHARES, INC. STATEMENT OF EARNINGS Year ended March 31, 2006, 2005 and 2004 (In thousands)
2006 2005 2004
Income Interest income $ 85 $ 103 $ 183 Gain on sale of investment securities -- -- 2 Equity in earnings of subsidiary 1,715 1,610 2,851 ------- ------- ------- Total income 1,800 1,713 3,036
General, administrative and other expense 199 1,966 409 ------- ------- -------
Earnings (loss) before federal income tax benefits 1,601 (253) 2,627
Federal income tax benefits (39) (634) (77) ------- ------- -------
Net earnings $ 1,640 $ 381 $ 2,704 ======= ======= =======
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE L - CONDENSED FINANCIAL STATEMENTS OF WAYNE SAVINGS BANCSHARES, INC. (continued)
WAYNE SAVINGS BANCSHARES, INC. STATEMENT OF CASH FLOWS Year ended March 31, 2006, 2005 and 2004 (In thousands)
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE M - BUSINESS COMBINATION
During 2004, the Company agreed to acquired Stebbins Bancshares, Inc. Stebbins Bancshares, Inc. was merged into the Company in fiscal 2005 and its banking subsidiary Stebbins National Bank, continued operations as a branch of Wayne Savings. Wayne Savings Bancshares, Inc. paid $1.3 million in connection with the acquisition.
Presented below are Wayne Savings Bancshares' pro-forma condensed consolidated statements of earnings and earnings per share which have been prepared as if the acquisition had been consummated as of the beginning of each of the years ended March 31, 2005 and 2004.
2005 2004 (In thousands) (Unaudited)
Total interest income $ 17,805 $ 19,476 Total interest expense 6,740 7,349 -------- -------- Net interest income 11,065 12,127 Provision for losses on loans 430 213 Other income 1,719 2,051 General, administrative and other expense 12,025 10,142 -------- -------- Earnings before income taxes (benefits) 329 3,823 Federal income taxes (benefits) (85) 1,093 -------- --------
NET EARNINGS $ 414 $ 2,730 ======== ========
Earnings per share Basic $ .12 $ .73 ======== ======== Diluted $ .12 $ .73 ======== ========
NOTE N - RELATED PARTIES
The Bank paid legal fees to the law firm to which one of the Directors is a partner. The amount paid totaled approximately $35,000, $24,000 and $22,000 for the years ended March 31, 2006, 2005 and 2004, respectively.
In the normal course of business Wayne Savings received demand and time deposits from directors, officers and their related business interests of approximately $702,000 and $904,000 at March 31, 2006 and 2005, respectively.
WAYNE SAVINGS BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 31, 2006, 2005 and 2004
NOTE O - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table summarizes the Company's quarterly results for the fiscal years ended March 31, 2006 and 2005.
ITEM 9.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and - --------------------------------------------------------------------------- Financial Disclosure --------------------
Not Applicable
ITEM 9A.
ITEM 9A. Controls and Procedures - -----------------------------------
Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and regulations and are operating in an effective manner.
ITEM 9B.
ITEM 9B. Other Information - -----------------------------
Not Applicable
PART III --------
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant - --------------------------------------------------------------
The information required herein is incorporated by reference from the section captioned "Information with Respect to Nominees for Director, Continuing Directors and Executive Officers" in the Company's definitive proxy statement for the annual meeting of shareholders to be held on July 27, 2006, (the "Proxy Statement") expected to be filed with the Securities and Exchange Commission on or about June 29, 2006.
Incorporated by reference to "Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management - Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
The Company has adopted a Code of Conduct and Ethics that applies to its principal executive officer and principal financial officer, as well as other officers and employees of the Company and the Bank. Upon receipt of a written request we will furnish without charge to any stockholder a copy of the Code of Conduct and Ethics. Such written requests should be directed to Mr. H. Stewart Fitz Gibbon III, Secretary, Wayne Savings Bancshares, Inc., 151 North Market Street, Wooster, Ohio 44691.
ITEM 11.
ITEM 11. Executive Compensation - ----------------------------------
The information required herein is incorporated by reference from the sections captioned "Management Compensation," "Report of the Compensation Committee" and "Performance Graph" in the Proxy Statement.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and - -------------------------------------------------------------------------------- Related Stockholder Matters ---------------------------
The information required herein is incorporated herein by reference from the section captioned "Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management" and Item 5 hereof.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions - ----------------------------------------------------------
The information required by this Item 13 of Form 10-K is incorporated by reference from the section captioned "Management Compensation - Indebtedness of Management and Related Party Transactions" in the Proxy Statement.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services - --------------------------------------------------
The information required herein is incorporated by reference from the section captioned "Proposal II - Ratification of Appointment of Independent Registered Public Accounting Firm" in the Proxy Statement.
PART IV -------
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules - ---------------------------------------------------
(a)(1) Financial Statements
The following documents have been filed under "Item 8, Financial Statement and Supplementary Data" of this Form 10.
(i) Report of Independent Registered Certified Public Accountants; (ii) Consolidated Statements of Financial Condition; (iii) Consolidated Statements of Earnings; (iv) Consolidated Statements of Stockholders' Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules -----------------------------
All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements.
(a)(3) Exhibits --------
Exhibit Number Description -------------- ----------------------------------------------------- 3.1(1) Articles of Incorporation 3.2(1) Bylaws 4.0(2) Form of Common Stock Certificate of Wayne Savings Bancshares, Inc. 10.1(3) Employment Agreement between Wayne Savings Community Bank and Bryan C. Fehr dated May 27, 2004 10.2(3) Employment Agreement between Wayne Savings Community Bank and H. Stewart Fitz Gibbon III dated November 14, 2005 10.3(4) Employment Agreement between Wayne Savings Community Bank and Phillip E. Becker dated February 15, 2005 10.4(5) The Wayne Savings and Loan Company 1993 Incentive Stock Option Plan 10.5(6) Wayne Savings Bancshares, Inc. Amended and Restated 2003 Stock Option Plan 11.0(7) Statement re: computation of per share earnings 21.0 Subsidiaries of Registrant-Reference is made to Item 1 - "Business" for the Required Information 23.0 Consent of Grant Thornton LLP
Exhibit Number Description -------------- ----------------------------------------------------- 31.1 Certification pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer
31.2 Certification pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer
32.0 Certification pursuant to 18 U.S.C. Section 1350
------------------------
(1) Filed as exhibits to the Plan of Conversion and Reorganization filed as Exhibit 2 to the Registrant's registration statement on Form SB-2, initially filed on September 18, 2001, as amended (Registration No. 333-69600).
(2) Filed as Exhibit 4, to the Registrant's registration statement on Form SB-2, initially filed on September 18, 2001, as amended (Registration No. 333-69600).
(3) Incorporated by reference to the Exhibits to the Company's Form 10-K for year ended March 31, 2004, filed on June 29, 2004 (File No. 000-23433).
(4) Incorporated by reference to the Exhibits to the Company's Form 10-Q for quarter ended December 31, 2004, filed on February 11, 2005 (File No. 000-23433).
(5) Incorporated by reference from the Company's Registration Statement on Form S-8 filed on December 4, 1997 (File No. 333-41479).
(6) Incorporated by reference from the Company's Registration Statement on Form S-8 filed on October 5, 2004 (File No. 333-119556).
(7) Incorporated by reference to Note A.8. of "Notes to Consolidated Financial Statements" in Item 8 hereof.
(b) The Exhibits listed under (a)(3) of this Item 15 are filed herewith.
(c) Reference is made to (a)(2) of this Item 15.
SIGNATURES ----------
Pursuant to the requirements of Section 13 or 15(d) 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.
WAYNE SAVINGS BANCSHARES, INC.
Date: June 28, 2006 By: /s/Phillip E. Becker ------------------------------------- Phillip E. Becker President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.