ITEM 1. DESCRIPTION OF BUSINESS
Forward Looking Statements
This Annual Report contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services.
General
AJS Bancorp, Inc.
AJS Bancorp, Inc. is a mid-tier stock holding company for A. J. Smith Federal Savings Bank (the “Bank” or “A. J. Smith Federal”). The business of AJS Bancorp, Inc. consists of holding all of the outstanding common stock of A. J. Smith Federal Savings Bank. AJS Bancorp, Inc. is chartered under federal law. AJS Bancorp, Inc. has 1,227,544 issued and outstanding shares of common stock to our mutual holding company parent, AJS Bancorp, MHC (“MHC”), and 798,089 issued and outstanding shares to the public at December 31, 2008. Under federal regulations, so long as AJS Bancorp, MHC exists, it will own at least 50.1% of the voting stock of AJS Bancorp, Inc. At December 31, 2008, AJS Bancorp, Inc. had total consolidated assets of $244.0 million, total deposits of $180.3 million, and stockholders’ equity of $27.1 million. Our executive offices are located at 14757 South Cicero Avenue, Midlothian, Illinois 60445, and our telephone number is (708) 687-7400.
A. J. Smith Federal Savings Bank
A. J. Smith Federal Savings Bank was founded in 1892 by Arthur J. Smith as a building and loan cooperative organization. In 1924 we were chartered as an Illinois savings and loan association, and in 1934 we converted to a federal charter. In 1984 we amended our charter to become a federally chartered savings bank. We are a customer-oriented institution, operating from a main office in Midlothian, Illinois, and two branch offices in Orland Park, Illinois. Our primary business activity is the origination of one- to four-family real estate loans. To a lesser extent, we originate home equity and consumer loans. We also invest in securities, primarily United States Government Agency securities and mortgage-backed securities. In addition, we offer insurance and investment products and services. During the past year as short term interest rates declined to near record lows, we reduced our cash and cash equivalents and purchased short term investment securities to allow for greater yields while preserving our liquidity. At December 31, 2008, investment securities have become a larger percentage of our assets, while loans have become a smaller portion of our assets than has historically been the case. We believe that the repositioning of our assets in this manner will position A. J. Smith Federal to take advantage of the changes in long-term interest rates while reducing our interest rate and credit risk profile.
Recent Market Developments
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Under the EESA, the U.S. Department of the Treasury was given the authority to, among other things, purchase up to $700 billion of securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
On October 14, 2008, the Treasury Department announced a Capital Purchase Program under which it would acquire equity investments, usually preferred stock, in banks and thrifts and their holding companies. In conjunction with the purchase of preferred stock, the Treasury Department also received warrants to purchase common stock from participating financial institutions. Participating financial institutions also were required to adopt the Treasury Department’s standards for executive compensation and corporate governance for the period during which the department holds equity issued under the Capital Purchase Program. We have determined that we would not participate in the Capital Purchase Program.
On November 21, 2008, the FDIC adopted a final rule relating to a Temporary Liquidity Guarantee Program, which the FDIC had previously announced as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the Temporary Liquidity Guarantee Program the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 (“Debt Guarantee Program”) and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and certain other accounts held at participating FDIC-insured institutions through December 31, 2009 (“Transaction Account Guarantee Program”). Coverage under the Temporary Liquidity Guarantee Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. We have elected to participate in the Transaction Account Guarantee Program.
The American Recovery and Reinvestment Act of 2009 (“ARRA”), more commonly known as the economic stimulus or economic recovery package, was signed into law on February 17, 2009, by President Obama. ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future Troubled Asset Relief Program (“TARP”) recipients until the recipient has repaid the Treasury, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the Treasury’s consultation with the recipient’s appropriate regulatory agency.
Market Area
A. J. Smith Federal has been, and continues to be, a community-oriented savings bank offering a variety of financial products and services to meet the needs of the communities we serve. Our lending and deposit-generating area is concentrated in the neighborhoods surrounding our three offices; our main office in Midlothian, Illinois, and two branch offices in Orland Park, Illinois. Our offices are located in Cook County. However, we consider our market area to be the counties of Will and Cook. Midlothian is primarily a residential community, and its largest employers are state and local governments and automobile dealerships. Orland Park has more retail businesses, as well as light industrial companies.
Our market area economy consists primarily of the services industry, wholesalers and retailers and manufacturing. Major employers in our market area include the Orland Park School District, the Village of Orland Park, and various retailers including J. C. Penney, Macy’s and Sears. The economy in our market area is not dependent on any single employer or type of business.
Competition
We face significant competition in both originating loans and attracting deposits. The Chicago metropolitan area has a high concentration of financial institutions, most of which are significantly larger institutions with greater financial resources than A. J. Smith Federal, and all of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, credit unions, and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from non-depository competitors such as mutual funds, securities and brokerage firms, and insurance companies. The Gramm-Leach-Bliley Act, which permits affiliation among banks, securities firms and insurance companies, continues to increase competition among financial services companies.
Lending Activities
General. Our loan portfolio is comprised mainly of one- to four-family residential real estate loans. The majority of these loans have fixed rates of interest. In addition to one- to four-family residential real estate loans, our loan portfolio consists of multi-family loans and home equity lines of credit. At December 31, 2008, our gross loans totaled $129.1 million, of which $84.4 million, or 65.4%, were secured by one- to four-family residential real estate, $32.1 million, or 24.8%, were secured by multi-family residential and commercial real estate, $12.3 million, or 9.5%, were home equity loans, and $323,000, or 0.3%, were consumer loans. Our lending area is the Chicago metropolitan area, with an emphasis on lending in the south and southwest suburbs.
We try to reduce our interest rate risk by making our loan portfolio more interest rate sensitive. Accordingly, we offer adjustable rate mortgage loans, short-and medium-term mortgage loans, and three- and five-year balloon mortgages. In addition, we offer shorter-term consumer loans and home equity lines of credit with adjustable interest rates.
Loan Portfolio Composition. The following table shows the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated.
Maturity of Loan Portfolio. The following table sets forth certain information regarding the dollar amounts maturing and the interest rate sensitivity of our loan portfolio at December 31, 2008. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
The total amount of loans due after December 31, 2009 which have predetermined interest rates is $83.3 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $27.1 million.
One- to Four-Family Residential Real Estate Loans. Our primary lending activity consists of originating one- to four-family, owner-occupied, first and second residential mortgage loans, virtually all of which are secured by properties located in our market area. At December 31, 2008, these loans totaled $84.4 million, or 65.4% of our total loan portfolio.
We currently offer one- to four-family residential real estate loans with terms up to 40 years, although we emphasize the origination of one- to four-family residential loans with terms of 15 years or less. We offer our one- to four-family residential loans with adjustable or fixed interest rates. At December 31, 2008, $67.2 million, or 79.6% of our one- to four-family residential real estate loans had fixed rates of interest, and $17.2 million, or 20.4% of our one- to four-family residential real estate loans, had adjustable rates of interest. Our fixed rate loans include loans that generally amortize on a monthly basis over periods between 7 to 40 years. We also offer loans which generally have balloon payment features after 3 or 5 years. Our balloon loans generally amortize over periods of 15 years or more. One- to four-family residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers have the right to refinance or prepay their loans.
We currently offer adjustable rate mortgage loans with an initial interest rate fixed for one, three, five or seven years, and annual adjustments thereafter based on changes in a designated market index. Our adjustable rate mortgage loans generally have an interest rate adjustment limit of 200 basis points per adjustment, with a maximum lifetime interest rate adjustment limit of 800 basis points and a floor of 500 basis points. Our adjustable rate mortgages are priced at a level tied to the one-year United States Treasury bill rate. We may offer discounted or teaser rates on our adjustable rate mortgages. These loans carry initial rates that are lower than the rate would be if it were to adjust according to the adjustable rate note and rider. We do not offer adjustable rate mortgages that offer the possibility of negative amortization.
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 of the property at the time the loan is originated. For all first lien position mortgage loans we utilize outside independent appraisers. For second position mortgage loans, we utilize outside independent appraisers to perform a drive-by appraisal. For borrowers who do not obtain private mortgage insurance, our lending policies limit the maximum loan to value ratio on both fixed rate and adjustable rate mortgage loans to 80% of the appraised value of the property that is collateral for the loan. For one- to four-family residential real estate loans with loan to value ratios of between 80% and 97%, we require the borrower to obtain private mortgage insurance. For loans in excess of $75,000, we require the borrower to obtain title insurance. For first mortgage loan products under $75,000, we conduct a title search. For second mortgage type products in excess of $200,000, title insurance is required. For second mortgage type products under $200,000, we conduct a title search. We also require homeowners’ insurance, fire and casualty, and flood insurance, if necessary, on properties securing real estate loans.
Multi-Family Loans and Commercial Lending. At December 31, 2008, $32.1 million, or 24.8% of our total loan portfolio, consisted of loans secured by multi-family and commercial real estate properties, virtually all of which are located in the state of Illinois. Our multi-family loans are secured by multi-family and mixed use properties. Our commercial real estate loans are secured by improved property such as offices, small business facilities, unimproved land, warehouses and other non-residential buildings. Due to the current economic conditions and their adverse effect on commercial real estate, we stopped offering multi-family and commercial real estate loans in mid-2008, however, we do refinance or renew existing multi-family and commercial loans. At December 31, 2008, the average balance of our multi-family and commercial real estate loans was $305,000. In the past, we generally made multi-family and commercial real estate loans for up to 80% of the lesser of cost or the appraised value of the property securing the loan.
In the past, prior to funding a loan secured by multi-family, mixed use or commercial property, we generally obtained an environmental assessment from an independent, licensed environmental engineer to ascertain the existence of any environmental risks that may be associated with the property. The level of the environmental consultant’s evaluation of a property will depend on the facts and circumstances relating to the specific loan, but generally the environmental consultant’s actions will range from a Phase I Environmental Site Assessment to a Phase II environmental report. The underwriting process for multi-family and commercial real estate loans includes an analysis of the debt service coverage of the collateral property. We typically required a debt service coverage ratio of 120% or higher. We also required personal guarantees by the principals of the borrower and a cash flow analysis when applicable. However, we no longer originate multi-family or commercial loans.
Loans secured by multi-family residential or commercial real estate generally have larger loan balances and more credit risk than one- to four-family residential mortgage loans. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the impact of local and general economic conditions on the borrower’s ability to repay the loan, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family properties typically depends upon the successful operation of the real property securing the loan. If the cash flow from the property is reduced, the borrower’s ability to repay the loan may be impaired. However, multi-family and commercial real estate loans generally have higher interest rates than loans secured by one- to four-family residential real estate.
In the past, our underwriting standards for commercial business loans included a review of the applicant’s tax returns, financial statements, credit history and an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan based on cash flows generated by the applicant’s business.
Commercial business loans generally have higher interest rates and shorter terms than one- to four-family residential loans, but they also may involve higher average balances, increased difficulty of loan monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business.
Home Equity Lines of Credit. We offer home equity lines of credit, the total of which amounted to $12.3 million, or 9.5% of our total loan portfolio, as of December 31, 2008. Home equity lines of credit are generally made for owner-occupied homes, and are secured by first or second mortgages on residences. During 2008, we generally offered these loans with a maximum loan to appraised value ratio of 90% (including senior liens on the collateral property), however due to the decline in real estate values, during the third quarter of 2008 we revised the maximum loan to appraised value ratio that we will originate to 80% when combined with the first lien loan amount. We currently offer these lines of credit
for a period of 5 years, and generally at rates tied to the prevailing prime interest rate. Our home equity lines of credit are generally underwritten in the same manner as our one- to four-family residential loans.
Consumer Loans. We are authorized to make loans for a variety of personal and consumer purposes. As of December 31, 2008, consumer loans totaled $323,000, and consisted primarily of automobile loans and loans secured by deposit accounts. Automobile loans accounted for $258,000 of our consumer loans and loans secured by deposit accounts were $65,000 at December 31, 2008. Our procedure for underwriting consumer loans includes an assessment of the applicant’s credit history and ability to meet existing obligations and payments of the proposed loan, as well as an evaluation of the value of the collateral security, if any. Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of loans that are unsecured or are secured by assets that tend to depreciate in value, such as automobiles. In these cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan, and the remaining value often does not warrant further substantial collection efforts against the borrower.
Loan Originations, Purchases, Sales and Servicing. Although we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon borrower demand, market interest rates, borrower preference for fixed- versus adjustable-rate loans, and the interest rates offered on each type of loan by other lenders in our market area. These lenders include commercial banks, savings institutions, credit unions, and mortgage banking companies, as well as Wall Street conduits that also actively compete for local real estate loans. Our loan originations come from a number of sources, including real estate broker referrals, existing customers, borrowers, builders, attorneys, and “walk-in” customers.
Our loan origination activity may be affected adversely by a rising interest rate environment that typically results in decreased loan demand. Historically, a declining interest rate environment generally would result in increased loan demand, however, in the case of declining real estate values, our loan origination activity may also decline as fewer home purchases occur. Accordingly, the volume of loan originations and the profitability of this activity may vary from period to period. Historically, we have originated mortgage loans for sale in the secondary market, and we may do so in the future, although this is not a significant part of our business at this time.
The following table shows our loan origination and repayment activities for the periods indicated. We did not purchase any loans during the periods indicated.
Loan Approval Procedures and Authority. Our lending activities are subject to written, non-discriminatory underwriting standards and loan origination procedures adopted by management and the Board of Directors. A loan officer initially reviews all loans, regardless of size or type. Loans up to the Fannie Mae single family loan limit, currently $417,000, must be reviewed and approved by a loan
underwriter or a Vice President of the loan department. All loans of $417,000 or less that do not meet our standard underwriting ratios and credit criteria must be reviewed by the Vice President or in their absence, the President or the Officers’ Loan Committee. The Officers’ Loan Committee, which consists of Raymond Blake, Edward Milen, Lyn G. Rupich, and Donna Manuel, has the authority to approve all loans up to $750,000. The Chief Executive Officer and the Board of Directors must approve loans in excess of $750,000.
Loans-to-One-Borrower. Federal savings banks are subject to the same loans-to-one-borrower limits as those applicable to national banks, which 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 December 31, 2008, our lending limit was $4.3 million. At December 31, 2008, our largest lending relationship to one borrower totaled $4.0 million. At December 31, 2008, we had 22 lending relationships in which the total amount outstanding exceeded $500,000. Six of these lending relationships totaling $10.1 million are impaired, while two lending relationship totaling $1.1 million are on the Company’s watch list as of December 31, 2008. The Company’s watch list includes any commercial loan that has for the past twelve months been late paying three times or more.
Asset Quality
Loan Delinquencies and Collection Procedures. When a borrower fails to make required payments on a loan, we take a number of steps to induce the borrower to cure the delinquency and restore the loan to a current status. In the case of mortgage loans, a reminder notice is sent 15 days after an account becomes delinquent. After 15 days, we attempt to establish telephone contact with the borrower. If the borrower does not remit the entire payment due by the end of the month, then a letter that includes information regarding home-ownership counseling organizations is sent to the borrower. During the first 15 days of the following month, a second letter is sent, and we also attempt to establish telephone contact with the borrower. At this time, and after reviewing the cause of the delinquency and the borrower’s previous loan payment history, we may agree to accept repayment over a period of time, which will generally not exceed 60 days. However, should a loan become delinquent by two or more payments, and the borrower is either unwilling or unable to repay the delinquency over a period of time acceptable to us, we send a notice of default by both regular and certified mail. This notice will provide the borrower with the terms which must be met to cure the default, and will again include information regarding home-ownership counseling. In the case of commercial mortgage loans, attempts will be made to work out a repayment plan that will preserve the current ownership of the property while allowing the Company to retain a performing lending relationship. Loan modifications that meet the definition of troubled debt restructurings are accounted for accordingly.
In the event the borrower does not cure the default within 30 days of the postmark of the notice of default, we may instruct our attorneys to institute foreclosure proceedings depending on the loan-to-value ratio or our relationship with the borrower. We hold property foreclosed upon as real estate owned. We carry foreclosed real estate at its fair value less estimated selling costs or carrying value, whichever is less. If a foreclosure action begins and the loan is not brought current or paid in full before the foreclosure sale, we will either sell the real property securing the loan at the foreclosure sale or sell the property as soon thereafter as practical.
In the case of consumer loans, customers are mailed delinquency notices when the loan is 15 days past due. We also attempt to establish telephone contact with the borrower. If collection efforts are unsuccessful, we may instruct our attorneys to take further action.
Our policies require that management continuously monitor the status of the loan portfolio and report to the Board of Directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate and our actions and plans to cure the delinquent status of the loans and to dispose of any real estate acquired through foreclosure.
Non-Performing Loans. Non-performing loans and impaired loans are defined differently. A loan is 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. A loan is non-performing when it is greater than ninety days past due. Some loans may be included in both categories, whereas other loans may only be included in one category. Specific allocations are made for loans that are determined to be impaired. Company policy requires that all non-homogeneous loans past due greater than ninety days be classified as impaired and non-performing. However, loans past due less than 90 days may also be classified as impaired when management does not expect to collect all amounts due according to the contractual terms of the loan agreement. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses as compared to the loan carrying value.
The Company has not originated, nor has it invested in, interest-only, negative amortization or payment option ARM loans. Further, the Company has not originated or invested in sub-prime or Alt-A loans.
As of December 31, 2008, our total non-accrual loans were $3.7 million, compared to $934,000 at December 31, 2007.
The following table sets forth our loan delinquencies by type, amount and percentage at December 31, 2008.
The table below sets forth the amounts and categories of non-performing assets in our loan portfolio. During 2008 we restructured three loans totaling $3.5 million, which are classified as impaired loans at December 31, 2008. For the previous years presented of 2004, 2005, 2006 and 2007, we had no troubled debt restructurings within the meaning of Statement of Financial Accounting Standards No. 15. For the periods presented, we had no accruing loans delinquent more than 90 days. Foreclosed assets include assets acquired in settlement of loans.
For the year ended December 31, 2008, gross interest income which would have been recorded had the non-performing loans been current in accordance with their original terms amounted to $541,000. The amount that was included in interest income totaled $190,000 for the year ended December 31, 2008.
The Company has six single-family loans on non-accrual status, one of which is also impaired, as of December 31, 2008. The Company has two commercial lending relationships with principal balances in excess of $500,000 that are impaired and on non-accrual as of December 31, 2008. Additionally, the Company has five commercial lending relationships that are impaired, but are not more than 90 days delinquent at December 31, 2008, two of which have principal balances in excess of $500,000. The following paragraphs detail further information on the large commercial loans. The Company has no other large single family or other loans that are impaired or more than 90 days delinquent as of December 31, 2008.
The Company has a $4.0 million participation interest in a $26.2 million loan secured by vacant land that the borrower intended to develop into a residential/commercial site. The borrower defaulted on the loan and the property is now in foreclosure proceedings. The lead lender conducted an appraisal of the property in the fourth quarter of 2008 that reflects a range of fair values based upon city zoning and the retention of the property’s tax incentive (“TIF”) status. Based on the appraisal and consideration of all known facts, the Company has charged off $2.3 million of the outstanding loan balance at December 31, 2008.
The Company has three mortgage loans to one borrower totaling $2.7 million secured by two retail office space commercial buildings. The borrower defaulted on these mortgage loans, therefore the properties are currently in foreclosure proceedings. During the fourth quarter, management obtained updated appraisals on these properties. Based on deterioration in fair values, as detailed in the appraisal, the Company charged off $957,000 of the outstanding loan balance as of December 31, 2008.
The Company has a $3.0 million or 3.3% participation in a $91.5 million loan secured by an indoor water park. Though the borrower continued to pay interest through December 2008, they previously indicated that they were in financial difficulty and wanted to restructure the interest-only loan. Several troubled debt restructuring options have been presented; however, the most recent plans have not
been accepted. Due to negative cash flows and identified concerns with the borrower, the Company has recorded a $600,000 impairment reserve on this property as of December 31, 2008.
The Company has a $2.9 million mortgage loan on a 46 unit apartment building in Chicago that is deemed to be impaired, but in which the borrower is current in its payments as of December 31, 2008. The borrower had experienced financial difficulty and requested the loan be restructured in the fourth quarter of 2008. The Company restructured the interest rate on the loan and obtained an appraisal on the property in December of 2008. Accordingly, the Company has recorded a $600,000 impairment reserve on this property as of December 31, 2008.
While these properties are in the midst of foreclosure or possible restructuring there is no guarantee that the fair value of the properties will not decline further. Therefore, although the Company recorded its best estimate of probable losses expected at December 31, 2008, there may be additional losses on these properties in the future.
Real Estate Owned. Real estate owned consists of property acquired through formal foreclosure or by deed in lieu of foreclosure, and is recorded at the lower of recorded investment or fair value less estimated costs to sell. Write-downs from recorded investment to fair value, which are required at the time of foreclosure, are charged to the allowance for loan losses. After transfer, the property is carried at the lower of recorded investment or fair value, less estimated selling expenses. Adjustments to the carrying value of the properties that result from subsequent declines in value are charged to operations in the period in which the declines occur. During 2008, one residential real estate property was transferred into other real estate and was subsequently sold at an immaterial loss. At December 31, 2008, we did not have any real estate owned.
Classification of Assets. Consistent with regulatory guidelines, we provide for the classification of loans and other assets, such as securities, that are considered to be of lesser credit quality as substandard, special mention, 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 loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Doubtful assets are those that are past maturity and therefore require additional steps to protect our collateral. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated as special mention by management.
When we classify assets as substandard, we allocate for analytical purposes a portion of our general valuation allowances or loss reserves to these assets as we consider prudent. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which have not been allocated to particular problem assets. When we classify problem assets as loss, we establish a specific allowance for losses equal to 100% of the amount of the assets so classified, or we charge-off the amount. Our determination as to the classification of assets and the amount of valuation allowances is subject to review by regulatory agencies, which can order the establishment of additional loss allowances. Management regularly reviews our assets to determine whether any require reclassification.
On the basis of management’s review of our assets at December 31, 2008, we had classified assets of $10.6 million as substandard.
Allowance for Loan Losses. The following table sets forth information regarding our allowance for loan losses and other ratios at or for the dates indicated.
The allowance for loan losses is a valuation account that reflects our evaluation of the losses known and inherent in our loan portfolio that are both probable and reasonable to estimate. We maintain the allowance through provisions for loan losses that we charge to income. We charge losses on loans against the allowance for loan losses when we believe the collection of loan principal is unlikely.
Our evaluation of risk in maintaining the allowance for loan losses includes the review of all loans on which the collectibility of principal may not be reasonably assured. We consider the following factors as part of this evaluation: our historical loan loss experience, known and inherent risks in the loan portfolio, the estimated value of the underlying collateral and current economic and market trends. There may be other factors that may warrant our consideration in maintaining an allowance at a level sufficient to provide for probable losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available or as future events change. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, future additions may be necessary if economic and other conditions in the future differ substantially from the current operating environment.
In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The Office of Thrift Supervision may require us to increase the allowance for loan losses or the valuation allowance for foreclosed real estate based on its review of information available at the time of the examination, thereby adversely affecting our results of operations.
Allocation of the Allowance for Loan Losses. The following table presents our allocation of the allowance for loan losses by loan category and the percentage of loans in each category to total loans at the periods indicated.
Management evaluates the total balance of the allowance for loan losses based on several factors that are not loan specific but are reflective of the probable, incurred losses inherent in the loan portfolio. This includes management’s periodic review of loan collectibility in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions such as housing trends, inflation rates and unemployment rates, geographic concentrations of loans within our immediate market area, and levels of allowance for loan losses. Generally, small balance, homogenous type loans, such as consumer and home equity loans are evaluated for impairment in total. The allowance related to these loans is established primarily by using loss experience data by general loan type. Nonperforming loans are evaluated individually, based primarily on the value of the underlying collateral securing the loan. Larger loans, such as multi-family mortgages, are also generally evaluated for impairment individually. The allowance is allocated to each loan type based on the results of the evaluation described above. Inherent credit risks that cannot be allocated to specific loan groups are presented as “unallocated” in the table.
Investment Activities
We are permitted under federal law to invest in various types of liquid assets, including United States Government obligations, securities of various federal agencies and of state and municipal governments, deposits at the Federal Home Loan Bank of Chicago (FHLB), certificates of deposit of federally insured institutions, certain bankers’ acceptances and federal funds. Within certain regulatory limits, we may also invest a portion of our assets in commercial paper and corporate debt securities. We are also required to maintain an investment in FHLB stock.
SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that securities be categorized as “held to maturity,” “trading securities” or “available for sale,” based on management’s intent as to the ultimate disposition of each security. SFAS No. 115 allows debt securities to be classified as “held to maturity” and reported in financial statements at amortized cost only if the reporting entity has the positive intent and ability to hold these securities to maturity. Securities that might be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, or other similar factors cannot be classified as “held to maturity.”
Trading securities at December 31, 2008 consist of securities classified as trading upon adoption of FAS 159. These trading securities are carried at fair value with unrealized gains and losses recorded through earnings. We typically do not use a trading account with the intent to purchase and sell securities. Debt and equity securities not classified as “held to maturity” are classified as “available for sale.” These securities are reported at fair value, and unrealized gains and losses on the securities are excluded from earnings and reported, net of deferred taxes, as a separate component of equity. Our trading securities are not a material portion of our investment portfolio.
All of our securities carry market risk insofar as increases in market rates of interest may cause a decrease in their fair value. Investments in securities are made based on certain considerations, which include the interest rate, tax considerations, yield, settlement date and maturity of the security, our liquidity position, and anticipated cash needs and sources. The effect that the proposed security would have on our credit and interest rate risk and risk-based capital is also considered. We purchase securities to provide necessary liquidity for day-to-day operations, and when investable funds exceed loan demand.
Generally, our investment policy is to invest funds in various categories of securities and maturities based upon our liquidity needs, asset/liability management policies, investment quality, marketability and performance objectives. The Board of Directors reviews our securities portfolio on a monthly basis.
Securities classified as held to maturity, excluding mortgage-backed securities, totaled $320,000 at December 31, 2008. Our securities classified as available-for-sale, other than mortgage-backed securities, totaled $20.2 million at December 31, 2008, and consisted of Federal agency obligations, primarily Federal Farm Credit Bank (FFCB) notes, Federal Home Loan Bank (FHLB), Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) obligations with maturities of one to twenty years.
We also have a $2.5 million investment in FHLB stock at December 31, 2008, which is classified separately for securities due to the restrictions on sale or transfer. For further information regarding our securities portfolio, see Note 2 to Consolidated Financial Statements.
The following table sets forth the composition of our securities portfolio (excluding mortgage-backed securities) and other interest earning assets at the dates indicated.
Mortgage-Backed Securities
Mortgage-backed securities represent a participation interest in a pool of one- to four-family or multi-family mortgages. The mortgage originators use intermediaries (generally United States Government agencies and government-sponsored enterprises) to pool and repackage the participation interests in the form of securities, with investors such as A. J. Smith Federal receiving the principal and interest payments on the mortgages. Such United States Government agencies guarantee the payment of principal and interest to investors.
Mortgage-backed securities are typically issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a specific range and have varying maturities. The characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security thus approximates the life of the underlying mortgages. Our mortgage-backed securities consist of Fannie Mae, Freddie Mac and Ginnie Mae securities.
At December 31, 2008, our mortgage-backed securities totaled $69.3 million, which represented 28.4% of our total assets at that date. At December 31, 2008, a majority of our mortgage-backed securities were classified as available-for-sale. At that date, 96.5% of our mortgage-backed securities had fixed rates of interest. We purchased $36.2 million of mortgage-backed securities during the year ended December 31, 2008, and $16.9 million during the year ended December 31, 2007.
Mortgage-backed securities generally yield less than the mortgage loans underlying such securities because of their payment guarantees or credit enhancements, which offer nominal credit risk to the security holder. In addition, mortgage-backed securities are more liquid than individual mortgage loans and we may use them to collateralize borrowings or other obligations of A. J. Smith Federal.
The following table sets forth the composition of our mortgage-backed securities at the dates indicated.
Carrying Values, Yields and Maturities. The composition and maturities of our debt securities portfolio and of our mortgage-backed securities are indicated in the following table. Cost represents the amortized cost of the securities and mortgage-backed securities at December 31, 2008.
Sources of Funds
General. Deposits have been our primary source of funds for lending and other investment purposes. In addition to deposits, we derive funds primarily from principal and interest payments on loans. These loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources, and may be used on a longer-term basis for general business purposes.
Deposits. Our deposits are generated primarily from residents within our primary market area. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. We are not currently using, nor have we used in the past, brokers to obtain deposits. Our deposit products include demand, NOW, money market, savings, and term certificate accounts. We establish interest rates, maturity terms, service fees and withdrawal penalties on a periodic basis. Management determines the rates and terms based on rates paid by competitors, our need for funds or liquidity, growth goals and federal and state regulations.
Deposit Activity. The following table sets forth our deposit flows during the periods indicated.
Deposit Accounts. The following table sets forth the dollar amount of savings deposits in the various types of deposit programs we offered as of the dates indicated.
Deposit Maturity Schedule. The following table presents, by rate category, the remaining period to maturity of time deposit accounts outstanding as of December 31, 2008.
Large Certificates. The following table indicates the amount of our certificates of deposit and other deposits by time remaining until maturity as of December 31, 2008.
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Deposits from governmental and other public entities. The amounts shown under public funds include deposits of $100,000 or more totaling $5.6 million.
Borrowings. We may obtain advances from the FHLB of Chicago upon the security of the common stock we own in the FHLB and our qualifying residential mortgage loans and mortgage-backed securities, provided certain standards related to creditworthiness are met. These advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. FHLB advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending.
The following table sets forth the maximum month-end balance and average balance of FHLB advances for the periods indicated.
The following table sets forth the balances of, and weighted average interest rate on, certain borrowings at the dates indicated.
Employees
At December 31, 2008, we had a total of 49 full-time and 18 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relationships with our employees.
Regulation
Loans-to-One-Borrower. Federal savings banks generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and unimpaired surplus on an unsecured basis. An additional amount may be lent, equal to 10% of unimpaired capital and unimpaired surplus, if the loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. As of December 31, 2008, we were in compliance with our loans-to-one-borrower limitations.
Qualified Thrift Lender Test. As a federal savings bank, we are required to satisfy a qualified thrift lender test whereby we must maintain at least 65% of our “portfolio assets” in “qualified thrift investments”. These consist primarily of residential mortgages and related investments, including mortgage-backed and related securities. “Portfolio assets” generally means total assets less specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used to conduct business. A savings bank that fails the qualified thrift lender test must either convert to a bank charter or operate under specified restrictions. As of December 31, 2008, we maintained 87.92% of our portfolio assets in qualified thrift investments and, therefore, we met the qualified thrift lender test.
Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by savings institutions, which include cash dividends, stock repurchases and other transactions charged to the capital account of a savings institution. A savings institution must file an application for Office of Thrift Supervision approval of the capital distribution if either (1) the total capital distributions for the applicable calendar year exceed the sum of the institution’s net income for that year to date plus the institution’s retained net income for the preceding two years that is still available for distribution, (2) the institution would not be at least adequately capitalized following the distribution, (3) the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition, or (4) the institution is not eligible for expedited review of its filings. If an application is not required to be filed, savings institutions, which are a subsidiary of a holding company, as well as certain other institutions, must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution.
Any additional capital distributions would require prior regulatory approval. In the event our capital falls below the adequately capitalized requirement or the Office of Thrift Supervision notifies us that we are in need of more than normal supervision, our ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if it determines that the distribution would constitute an unsafe or unsound practice.
Community Reinvestment Act and Fair Lending Laws. Federal savings banks have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities, and failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. We received a Satisfactory Community Reinvestment Act rating in our most recent examination by the Office of Thrift Supervision.
Transactions with Related Parties. Our authority to engage in transactions with related parties or “affiliates” or to make loans to specified insiders is limited by Sections 23A and 23B of the Federal Reserve Act and its implementing regulations. The term “affiliate” for these purposes generally means any company that controls or is under common control with an institution, including AJS Bancorp, Inc. and its non-savings institution subsidiaries, if any. The regulation limits the aggregate amount of certain “covered” transactions with any individual affiliate to 10% of the capital and surplus of the savings institution and also limits the aggregate amount of covered transactions with all affiliates to 20% of the savings institution’s capital and surplus. Covered transactions with affiliates are required to be secured by collateral in an amount and of a type described in the regulation, and purchasing low quality assets from affiliates is generally prohibited. The regulation also provides that covered 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.
Our authority to extend credit to executive officers, directors and 10% stockholders, as well as entities controlled by these persons, is currently governed by Sections 22(g) and 22(h) of the Federal Reserve Act, and its implementing regulation, Regulation O. Among other things, this regulation generally requires these loans to be made on terms substantially the same as those offered to unaffiliated individuals and do not involve more than the normal risk of repayment. However, the regulation permits executive officers and directors to receive the same terms through benefit or compensation plans 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. Regulation O also places individual and aggregate limits on the amount of loans we may make to these persons based, in part, on our capital position, and requires approval procedures to be followed. At December 31, 2008, we were in compliance with these regulations.
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over savings institutions and has the authority to bring enforcement action against all “institution-related parties,” including stockholders, 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 institution, 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 $1.0 million per day. The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under the federal law. 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 guidelines address internal controls and information systems, internal audit systems, credit underwriting,
loan documentation, interest rate risk exposure, asset growth, and compensation, fees and benefits. 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. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.
Capital Requirements
Office of Thrift Supervision capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. Office of Thrift Supervision regulations also require that in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. At December 31, 2008, A.J. Smith Federal met each of its capital requirements.
Prompt Corrective Regulatory Action
Under its Prompt Corrective Action regulations, the Office of Thrift Supervision is required to take supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s level of capital. 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 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.” A savings institution that has a tangible capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized”. Generally, 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 Office of Thrift Supervision 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 Office of Thrift Supervision may also take
any one of a number of discretionary supervisory actions against undercapitalized institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts
Deposit accounts in A.J. Smith Federal are insured by the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. However, pursuant to its statutory authority, the Board of the Federal Deposit Insurance Corporation recently increased the deposit insurance available on deposit accounts to $250,000 effective until December 31, 2009. Congress has recently proposed legislation to make the $250,000 deposit insurance amount permanent. A.J. Smith Federal’s deposits are subject to Federal Deposit Insurance Corporation deposit insurance assessments. The Federal Deposit Insurance Corporation has adopted a risk-based system for determining deposit insurance assessments.
The Federal Deposit Insurance Corporation imposes an assessment against institutions for deposit insurance. This assessment is based on the risk category of the institution and ranges from 5 to 43 basis points of the institution’s deposits. On December 22, 2008, the Federal Deposit Insurance Corporation published a final rule raising the current deposit insurance assessment rates uniformly for all institutions by 7 basis points (to a range from 12 to 50 basis points) for the first quarter of 2009 and thereafter. However, the FDIC approved an extension of the comment period on the parts of the proposed rulemaking that would become effective on April 1, 2009. The FDIC expects to issue a second final rule early in 2009, to be effective April 1, 2009, to change the way that the FDIC’s assessment system differentiates for risk and to set new assessment rates beginning with the second quarter of 2009.
On March 2, 2009 the FDIC announced an interim rule approving a special assessment of 20 basis points for the June 30, 2009 quarter to be paid September 30, 2009. Comments on this interim rule are due by April 2, 2009. If the rule stands as currently published, assuming the Company’s risk category does not change and the deposit base remains relatively stable, we estimate the total FDIC premium expense incurred during 2009 to be approximately $650,000. The FDIC has indicated that it would reduce the special assessment to 10 basis points in the event congress provided the FDIC with greater borrowing authority. There can be no assurances that the risk category will remain the same or that the deposit base will remain stable. If the risk category increases or the deposit base increases, the FDIC premium will also increase.
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the year ended December 31, 2008, the annualized FICO assessment was equal to 1.75 basis points for each $100 in domestic deposits maintained at an institution.
In October 2008, the FDIC announced the Temporary Liquidity Guarantee Program, under which any participating depository institution would be able to provide full deposit insurance coverage for non-interest bearing transaction accounts, regardless of the dollar amount. Under the program, effective November 14, 2008, insured depository institutions that have not opted out of the FDIC Temporary Liquidity Guarantee Program will be subject to a 0.10% surcharge applied to non-interest bearing transaction deposit account balances in excess of $250,000, which surcharge will be added to the institution’s existing risk-based deposit insurance assessments. A.J. Smith Federal chose to participate in the Transaction Account Guarantee Program portion of the FDIC Temporary Liquidity Guaranty Program.
Federal Home Loan Bank System
We are a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Chicago (FHLB), we are required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount equal to at least 1% of the aggregate principal amount of our unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of our borrowings from the FHLB, whichever is greater. As of December 31, 2008, we were in compliance with this requirement. The Federal Home Loan Banks 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 Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. On October 18, 2005 the Federal Home Loan Bank of Chicago announced a policy to discontinue excess capital stock redemptions or “voluntary” stock redemptions. Voluntary stock is stock held by members beyond the amount required as a condition of membership or to support advance borrowings. The FHLB has not paid a dividend on the FHLB stock since the third quarter of 2007 and there are no plans to do so in the near future. The Company holds $2.5 million of FHLB stock as of December 31, 2008.
Federal Reserve System
Federal Reserve Board regulations require savings institutions to maintain noninterest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At December 31, 2008, we were in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision.
Holding Company Regulation
General. AJS Bancorp, MHC and AJS Bancorp, Inc. are non-diversified savings and loan holding companies within the meaning of the Home Owners’ Loan Act. As such, AJS Bancorp, MHC and AJS Bancorp, Inc. are registered with the Office of Thrift Supervision and are subject to Office of Thrift Supervision regulations, examinations, supervision and reporting requirements. In addition, the Office of Thrift Supervision has enforcement authority over AJS Bancorp, Inc. and AJS Bancorp, MHC and their subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. As federal corporations, AJS Bancorp, Inc. and AJS Bancorp, MHC are generally not subject to state business organization laws.
Permitted Activities. Pursuant to Section 10(o) of the Home Owners’ Loan Act and Office of Thrift Supervision regulations and policy, a mutual holding company, such as AJS Bancorp, MHC, and a federally chartered mid-tier holding company such as AJS Bancorp, Inc. may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of
such company; (viii) acting as trustee under deeds of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987; (x) any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act, including securities and insurance underwriting; and (xi) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Director. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of two years to cease any nonconforming activities and divest of any nonconforming investments.
The Home Owners’ Loan Act prohibits a savings and loan holding company, including AJS Bancorp, Inc. and AJS Bancorp, MHC, directly or indirectly, or through one or more subsidiaries, from acquiring another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a non-subsidiary savings institution, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the Home Owners’ Loan Act; or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Waivers of Dividends by AJS Bancorp, MHC. Office of Thrift Supervision regulations require AJS Bancorp, MHC to notify the Office of Thrift Supervision of any proposed waiver of its receipt of dividends from AJS Bancorp, Inc. The Office of Thrift Supervision reviews dividend waiver notices on a case-by-case basis, and, in general, does not object to any such waiver if: (i) the mutual holding company’s board of directors determines that such waiver is consistent with such directors’ fiduciary duties to the mutual holding company’s members; (ii) for as long as the savings association subsidiary is controlled by the mutual holding company, the dollar amount of dividends waived by the mutual holding company are considered as a restriction on the retained earnings of the savings association, which restriction, if material, is disclosed in the public financial statements of the savings association as a note to the financial statements; (iii) the amount of any dividend waived by the mutual holding company is available for declaration as a dividend solely to the mutual holding company, and, in accordance with SFAS 5, where the savings association determines that the payment of such dividend to the mutual holding company is probable, an appropriate dollar amount is recorded as a liability; and (iv) the amount of any waived dividend is considered as having been paid by the savings association in evaluating any proposed dividend under Office of Thrift Supervision capital distribution regulations. AJS Bancorp, MHC may waive dividends paid by AJS Bancorp, Inc. Under Office of Thrift Supervision regulations, our public stockholders would not be diluted because of any dividends waived by AJS Bancorp, MHC (and waived dividends would not be considered in determining an appropriate exchange ratio) in the
event AJS Bancorp, MHC converts to stock form. During the twelve months ended 2008 the Company paid four regular quarterly dividends of $0.11 per share, and one special dividend of $0.50 per share to stockholders of record. In conjunction with the Office of Thrift Supervision approval, AJS Bancorp, MHC waived 100% of the dividends due on its 1,227,544 shares. The Company anticipates that AJS Bancorp, MHC will waive 100% of dividends in the foreseeable future.
Conversion of AJS Bancorp, MHC to Stock Form. Office of Thrift Supervision regulations permit AJS Bancorp, MHC to convert from the mutual form of organization to the capital stock form of organization (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new holding company would be formed as the successor to AJS Bancorp, Inc. (the “New Holding Company”), AJS Bancorp, MHC’s corporate existence would end, and certain depositors of A. J. Smith Federal would receive the right to subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by stockholders other than AJS Bancorp, MHC (“Minority Stockholders”) would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant to an exchange ratio that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in AJS Bancorp, Inc. immediately prior to the Conversion Transaction. Under Office of Thrift Supervision regulations, Minority Stockholders would not be diluted because of any dividends waived by AJS Bancorp, MHC (and waived dividends would not be considered in determining an appropriate exchange ratio), in the event AJS Bancorp, MHC converts to stock form. The total number of shares held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.
The USA PATRIOT Act
In response to the events of September 11, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, was signed into law on October 26, 2001. The USA PATRIOT Act gave the Federal Government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA PATRIOT Act has no material impact on the Bank’s operations.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Securities Exchange Act of 1934.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules requiring the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Recently, the SEC created a committee to evaluate Sarbanes-Oxley issues that may
affect small public companies. Specifically being reviewed are the requirements under Sarbanes-Oxley section 404, which require significant oversight of a public company’s internal control over the financial statements. The Company will be subject to Section 404 compliance for the year ending December 31, 2009, therefore, costs for compliance with the Sarbanes-Oxley Act will increase. At this time the Company cannot accurately predict what additional expenses may be incurred in complying with all of the provisions of the Sarbanes-Oxley Act.
Taxation
Federal Taxation For federal income tax purposes, AJS Bancorp, Inc. and A. J. Smith Federal file separate federal income tax returns on a calendar year basis using the accrual method of accounting.
As a result of the enactment of the Small Business Job Protection Act of 1996, all savings banks and savings associations may convert to a commercial bank charter, diversify their lending, or merge into a commercial bank without having to recapture any of their pre-1988 tax bad debt reserve accumulations. However, transactions which would require recapture of the pre-1988 tax bad debt reserve include redemption of A. J. Smith Federal’s stock, payment of dividends or distributions in excess of earnings and profits, or failure by the institution to qualify as a bank for federal income tax purposes. At December 31, 2008, A. J. Smith Federal had approximately $2.4 million of pre-1988 tax bad debt reserves. A deferred tax liability has not been provided on this amount, as management does not intend to make distributions, redeem stock or fail certain bank tests that would result in recapture of the reserve.
Deferred income taxes arise from the recognition of items of income and expense for tax purposes in years different from those in which they are recognized in the consolidated financial statements. AJS Bancorp, Inc. will account for deferred income taxes by the asset and liability method, applying the enacted statutory rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. The resulting deferred tax liabilities and assets will be adjusted to reflect changes in the tax laws.
AJS Bancorp, Inc. is subject to the corporate alternative minimum tax to the extent it exceeds AJS Bancorp, Inc.’s regular income tax for the year. The alternative minimum tax will be imposed at the rate of 20% of a specially computed tax base. Included in this base are a number of preference items, including interest on certain tax-exempt bonds issued after August 7, 1986, and an “adjusted current earnings” computation which is similar to a tax earnings and profits computation. In addition, for purposes of the alternative minimum tax, the amount of alternative minimum taxable income that may be offset by net operating losses is limited to 90% of alternative minimum taxable income.
A. J. Smith Federal’s income tax returns have not been audited by the Internal Revenue Service within the past five years.
Illinois State Taxation. AJS Bancorp, Inc. is required to file Illinois income tax returns and pay tax at an effective tax rate of 7.3% of Illinois taxable income. For these purposes, Illinois taxable income generally means federal taxable income subject to certain modifications, primarily the exclusion of interest income on United States obligations.
MANAGEMENT
Executive Officers of AJS Bancorp, Inc. The following individuals hold the following executive officer positions of AJS Bancorp, Inc.
Availability of Annual Report on Form 10-K
Our Annual Report on Form 10-K may be accessed on our website at www.ajsmithbank.com.
ITEM 1A.
ITEM 1A. RISK FACTORS
Not applicable.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTIES
Properties
At December 31, 2008, we conducted our business from our main office at 14757 South Cicero, Midlothian, Illinois, a branch office located at 8000 West 159th Street, Orland Park, Illinois and a branch office located at 11275 W. 143rd Street, Orland Park, Illinois. We own all of our branch locations. At December 31, 2008, the net book value of our office locations was $4.0 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of our business. At December 31, 2008, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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 is quoted on the electronic bulletin board under the symbol “AJSB”.
The following table sets forth the range of the high and low bid prices of the Company’s Common Stock for the prior eight calendar quarters and is based upon information set forth on the over the counter electronic bulletin board. During the twelve months ended December 31, 2008 the Company paid four regular quarterly dividends of $0.11 cents per share, and one special dividend on August 19, 2009 of $0.50 per share, to stockholders of record. In conjunction with Office of Thrift Supervision approval, AJS Bancorp, MHC (the “MHC”) waived 100% of the quarterly dividends due on its 1,227,544 shares.
As of December 31, 2008, the Company had 337 stockholders of record.
The Company's second repurchase plan was announced on May 18, 2004 and allowed for the repurchase of 117,000 shares of the Company's stock, which represented approximately 5% of the Company's outstanding shares. Subsequently, the Company announced increases in the repurchase plan of 100,000, 50,000, 50,000 and 50,000 shares on March 22, 2005, October 18, 2005, August 21, 2007, and February 26, 2008, respectively. As of December 31, 2008 there are 53,302 shares remaining to be purchased under the current repurchase plan.
The following table sets forth the issuer purchases of equity securities during the prior three months.
Set forth below is certain information as of December 31, 2008 regarding equity compensation to directors and executive officers of the Company approved by stockholders. Other than the employee stock ownership plan, the Company did not have any equity plans in place that were not approved by stockholders.
(1) Represents the exercise price of options awarded under the stock option plan.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
Not applicable.
ITEM 7
ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
This Annual Report contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, commercial and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services.
General
Our results of operations typically depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities and interest-earnings deposits with other financial institutions, and the interest we pay on our interest-bearing liabilities, consisting primarily of savings accounts, time deposits and borrowings. Our results of operations are also affected by our provisions for loans losses, other income and other expense. Other income consists primarily of insurance commissions and service charges on deposit accounts. Other expense consists primarily of noninterest expense, including salaries and employee benefits, occupancy, equipment, data processing and deposit insurance premiums. Our results of operations may also be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. The Company’s exposure to credit risk is significantly affected by changes in the economy of Chicago and its suburban areas.
Business Strategy
Our business strategy is to operate as a well-capitalized, profitable, community-oriented savings bank dedicated to providing quality customer service. In the past, we implemented our business strategy by emphasizing the origination of one- to four-family loans and other loans secured by real estate. We will continue to be primarily a one- to four-family lender with the ability to originate FHA loans. In the past, we broadened the scope of our loan products and services to include commercial real estate based loans, however, in light of the recent economic conditions and their impact on commercial real estate in particular, we have discontinued our commercial lending services.. There can be no assurances that we will successfully implement our strategy.
Highlights of our business strategy are as follows:
•
Continuing One- to four-family Residential Real Estate Lending. Historically, we have emphasized one- to four-family residential lending within our market area. As of December 31, 2008, $84.4 million, or 65.4%, of our total loan portfolio consisted of one- to four-family residential real estate loans. During the year ended December 31, 2008, we originated $16.5 million of one- to four-family residential real estate loans. We intend to continue to originate one- to four-family loans because of our expertise with this type of lending.
•
Providing an outlet for Federal Housing Authority (“FHA”) loans. We are committed to meeting the financial needs of the communities in which we operate. In particular, we have begun accepting applications for FHA loans. The Company compiles all the necessary underwriting documents for FHA loans and then forwards those documents to an unaffiliated third party for underwriting and funding. We do not carry any FHA loans in our loan portfolio. Our objective is to actively market our FHA loan services to our existing customers, as well as new customers within our market area.
Comparison of Financial Condition at December 31, 2008 and December 31, 2007
Total consolidated assets as of December 31, 2008 were $244.0 million, a decrease of $4.4 million or 1.8% from $248.3 million at December 31, 2007. The decrease was primarily due to a decrease in cash and cash equivalents and loans receivable, partially offset by an increase in certificates of deposits at other financial institutions and securities. Loans receivable decreased $6.6 million or 4.9% to $126.4 million at December 31, 2008 from $133.0 million at December 31, 2007. The decrease in loans was primarily due to increases in the allowance for loan losses, payoffs and more stringent underwriting and credit standards in the commercial and home equity loan categories, reflecting management’s decision to be more conservative in its loan originations during the severe economic downturn. Certificates of deposit increased $3.8 million or 126.8% to $6.8 million at December 31, 2008 from $3.0 million at December 31, 2007. The Company invested $4.0 million during the first quarter of 2008 in certificates of deposit at other financial institutions. The certificates were invested in maximum increments of $100,000 with yields ranging from 3.25% to 3.40% and maturities ranging from nine months to three years. Securities increased $8.4 million or 10.4% to $89.9 million at December 31, 2008 from $81.4 million at December 31, 2007. The increase in securities primarily reflects purchases of $13.0 million of fixed-rate government-backed notes and bonds, of which $10.0 million had call features, and $36.2 million in mortgage-backed securities. The average term to maturity of the fixed-rate note and bond securities was 90 months; the average term to maturity of the mortgage-backed securities was 114 months.
Total deposits decreased $10.2 million to $180.3 million at December 31, 2008 from $190.5 million at December 31, 2007. The decrease in deposits occurred in the certificates of deposit category, while the balances of passbook and money market accounts both increased. Certificates of deposit decreased $15.4 million to $107.3 million at December 31, 2008 from $122.8 million at December 31, 2007. Passbook savings accounts increased $849,000 to $39.0 million at December 31, 2008 compared to $38.1 million at December 31, 2007. Money market accounts increased to $13.0 million at December 31, 2008 from $7.3 million at December 31, 2007.
FHLB advances increased $6.8 million or 29.2% to $30.2 million at December 31, 2008 from $23.4 million at December 31, 2007. The Bank borrowed $13.8 million in fixed-rate advances from the FHLB during 2008. The advances had maturities of two to five years with a weighted average cost of 3.3%.
The Company had non-performing assets of $3.7 million as of December 31, 2008 and $934,000 as of December 31, 2007. The increase in non-performing assets resulted mainly from an increase in non-performing commercial real estate loans. The allowance for loan losses totaled $2.7 million at December 31, 2008 and $1.5 million at December 31, 2007. This represents a ratio of the allowance for loan losses to gross loans receivable of 2.12% at December 31, 2008 and 1.15% at December 31, 2007. The allowance for loan losses to non-performing loans was 73.2% at December 31, 2008 and 164.8% at December 31, 2007.
The Company has six single-family loans on non-accrual status, one of which is also impaired, as of December 31, 2008. The Company has two commercial lending relationships with principal balances in excess of $500,000 that are impaired and on non-accrual as of December 31, 2008. Additionally, the Company has five commercial lending relationships that are impaired, but are not more than 90 days delinquent at December 31, 2008, two of which have principal balances in excess of $500,000. The following paragraphs detail further information on the large commercial loans. The Company has no large single family or other loans that are impaired or more than 90 days delinquent as of December 31, 2008.
The Company has a $4.0 million participation interest in a $26.2 million loan secured by vacant land that the borrower intended to develop into a residential/commercial site. The borrower defaulted on the loan and the property is now in foreclosure proceedings. The lead lender conducted an appraisal of the property in the fourth quarter of 2008 that reflects a range of fair values based upon city zoning and the retention of the property’s tax incentive (“TIF”) status. Based on the appraisal and consideration of all known facts, the Company has charged off $2.3 million of the outstanding loan balance at December 31, 2008.
The Company has three mortgage loans to one borrower totaling $2.7 million secured by two retail office space commercial buildings. The borrower defaulted on these mortgage loans, therefore the properties are currently in foreclosure proceedings. During the fourth quarter, management obtained updated appraisals on these properties. Based on deterioration in fair values, as detailed in the appraisal, the Company charged off $957,000 of the outstanding loan balance as of December 31, 2008.
The Company has a $3.0 million or 3.3% participation in a $91.5 million loan secured by an indoor water park. Though the borrower continued to pay interest through December 2008, they previously indicated that they were in financial difficulty and wanted to restructure the interest-only loan. Several troubled debt restructuring options have been presented; however, the borrower has not agreed to restructure the loan. Due to negative cash flows and identified concerns with the borrower, the Company has recorded a $600,000 impairment reserve on this property as of December 31, 2008.
The Company has a $2.9 million mortgage loan on a 46 unit apartment building in Chicago that is deemed to be impaired, but in which the borrower is current in its payments as of December 31, 2008. The borrower had experienced financial difficulty and requested the loan be restructured in the fourth quarter of 2008. The Company restructured the interest rate on the loan and obtained an appraisal on the property in December of 2008. Accordingly, the Company has recorded a $600,000 impairment reserve on this property as of December 31, 2008.
While these properties are in the midst of foreclosure or possible restructuring there is no guarantee that the fair value of the properties will not decline further. Therefore, although the Company recorded its best estimate of probable losses expected at December 31, 2008, there may be additional losses on these properties in the future.
Total stockholders’ equity decreased $831,000 to $27.1 million at December 31, 2008 from $27.9 million at December 31, 2007. The decrease in stockholders’ equity primarily resulted from the net loss of $2.1 million during the twelve months ended December 31, 2008 and the repurchase of shares of the Company’s stock during the twelve months ended December 31, 2008, offset by an increase in other comprehensive income due to the increased fair value of the available for sale securities portfolio. The Company repurchased 11,239 shares of its common stock at a cost of $197,000 during the twelve months ended December 31, 2008. In addition, during the year the Company declared and paid four quarterly dividends of $0.11 cents per share, and one special dividend of $0.50 per share. With the non-objection of the Office of Thrift Supervision (“OTS”) AJS Bancorp, MHC (the “MHC”) waived 100% of the dividends due on its 1,227,544 shares. The fair value, net of taxes, of the available for sale securities portfolio increased $1.5 million at December 31, 2008 compared to a tax effective increase in fair value of $695,000 at December 31, 2007.
Comparison of Financial Condition at December 31, 2007 and December 31, 2006
Total assets as of December 31, 2007 were $248.3 million, a decrease of $18.2 million or 6.8% from $266.5 million at December 31, 2006. The decrease was primarily due to decreases in cash and cash equivalents, certificates of deposit, and loans receivable, offset by increases in securities and other assets. Deposits at other financial institutions consisting of certificates of deposit decreased $2.5 million or 45.4% to $3.0 million at December 31, 2007 from $5.5 million at December 31, 2006. The decrease was due to the certificates maturing and not being replaced. Loans receivable decreased $5.4 million or 3.9% to $133.0 million at December 31, 2007 from $138.4 million at December 31, 2006. The decrease in loans was primarily due to payoffs and tightened underwriting and credit standards in the commercial loan category. Securities increased $12.5 million or 18.1% to $81.4 million at December 31, 2007 from $69.0 million at December 31, 2006. The increase in securities reflects purchases of fixed-rate government-backed notes and bonds and mortgage-backed securities. The average term to maturity of the fixed-rate note and bond securities was 26 months; the average term to maturity of the mortgage-back securities was 120 months. These investments provided slightly higher yields than overnight federal fund investments. Other assets increased $2.8 million or 92.5% to $5.8 million at December 31, 2007 from $3.0 million at December 31, 2006. The increase in other assets is primarily due to the purchase of $3.0 million in bank owned life insurance in August of 2007. The Company is the sole owner and beneficiary of this life insurance, and the asset will be used to offset the costs of existing benefits for the employees. The change in our asset composition reflects management’s decision to be less aggressive in competing for the higher interest rate time deposits. As a result, our deposits reduced and accordingly so did liquid assets.
Total deposits decreased $11.6 million or 5.8% to $190.5 million at December 31, 2007 from $202.2 million at December 31, 2006. The decrease was primarily in certificates of deposit and passbook savings accounts. Certificates of deposit decreased $6.5 million to $122.8 million at December 31, 2007
from $129.3 million at December 31, 2006. Passbook savings accounts decreased $2.4 million to $38.1 million at December 31, 2007 compared to $40.5 million at December 31, 2006.
FHLB advances decreased $5.4 million or 18.8% to $23.4 million at December 31, 2007 from $28.8 million at December 31, 2006. The decrease was due to the advances maturing and not being replaced.
The Company had non-performing assets of $934,000 as of December 31, 2007 and $540,000 as of December 31, 2006. The increase in non-performing assets resulted from an increase in non-performing single-family loans. The allowance for loan losses totaled $1.5 million at December 31, 2007 and $1.6 million at December 31, 2006. This represents a ratio of the allowance for loan losses to gross loans receivable of 1.15% at December 31, 2007 and 1.16% at December 31, 2006. The allowance for loan losses to non-performing loans was 164.8% at December 31, 2007 and 299.8% at December 31, 2006.
Total stockholders’ equity decreased $821,000 to $27.9 million at December 31, 2007 from $28.7 million at December 31, 2006. The decrease in stockholders’ equity primarily resulted from the repurchase of shares of the Company’s stock during the twelve months ended December 31, 2007 offset by net income of $559,000 and an increase in other comprehensive income due to the increased market value of the available for sale securities portfolio. The Company repurchased 99,832 shares of its common stock at a cost of $2.4 million during the twelve months ended December 31, 2007. In addition, during the year the Company declared and paid dividends of $0.41 cents per share. With the non-objection of the Office of Thrift Supervision (“OTS”) AJS Bancorp, MHC (the “MHC”) waived 100% of the quarterly dividend due on its 1,227,554 shares. The Company has requested and received a non-objection letter from the OTS on the waiver of the quarterly dividend payments due on the MHC shares through the quarter ended September 30, 2008.
Comparison of Operating Results for the Years Ended December 31, 2008 and December 31,
General. The Company recorded a net loss of $2.1 million for the year ended December 31, 2008 compared to net income of $559,000 for the year ended December 31, 2007. As discussed in more detail below, the net loss in 2008 compared with net income in 2007 reflects an increase in the provision for loan losses, a decrease in net interest income, and a decrease in non-interest income, offset by a decrease in non-interest expense.
Interest Income. Total interest income decreased to $12.0 million for the twelve months ended December 31, 2008, down $1.9 million or 13.6% from $13.9 million for the same period in 2007. The decrease in our interest income is primarily due to a lower average yield earned on all categories of our interest-earning assets.
Interest income from loans decreased by $755,000 to $7.7 million for the year ended December 31, 2008, from $8.5 million for the year ended December 31, 2007. The decrease in interest income from loans was primarily due to a decrease in the average yield earned on loan balances during the year. The average yield on loans decreased to 5.75% during 2008 from 6.30% during 2007. Average loan balances remained stable at $134.7 million during the year ended December 31, 2008 and 2007.
Interest income from interest-earning deposits decreased $1.0 million, or 69.3%, to $447,000 for the year ended December 31, 2008, from $1.5 million for the year ended December 31, 2007. The decrease resulted from decreases in the average balances and in the interest rate earned on the deposits. Average balances decreased to $17.7 million from $29.0 million, while the average yield decreased to 2.53% from 5.03% for the comparable twelve-month periods. The decrease in the average balance of
interest earning deposits was caused primarily by a decrease in demand account balances at other financial institutions and the FHLB, offset by an increase in our of certificates of deposit balances held at other financial institutions.
Interest income from federal funds sold decreased $96,000, or 64.4%, to $53,000 for the year ended December 31, 2008, from $149,000 for the year ended December 31, 2007. The decrease resulted from reductions in the average balances and in the average yield earned on federal funds sold. Average balances decreased to $1.6 million from $2.9 million, while the average yield decreased to 3.3% from 5.1% for the comparable twelve-month periods. The decrease in average balances was due to a reduction in the Company’s cash balances as interest rates earned on federal funds reached record lows during the fourth quarter of 2008.
Interest Expense. Interest expense on deposits decreased by $1.9 million, or 29.4% to $4.6 million for the year ended December 31, 2008, from $6.6 million for 2007. The decrease in our cost of deposits reflected the lower average market interest rates during 2008, certificates of deposit maturing and renewing at lower rates during 2008, as well as a decrease in average deposit balances during the year. Average deposits decreased to $181.9 million for the year ended December 31, 2008, from $196.3 million for 2007. Our average cost of deposits decreased to 2.55% from 3.34% for the respective periods. Interest expense on borrowings increased to $1.3 million for the twelve months ended December 31, 2008, from $1.1 million for the same period during 2007, which was due to an increase in average FHLB borrowings.
Net interest income decreased by $125,000 or 2.0% to $6.1 million for the year ended December 31, 2008 from $6.2 million for the same period in 2007. Average interest earning assets were $234.7 million and $249.1 million during the comparative 2008 and 2007 twelve-month periods while the average yield was 5.11% and 5.58% respectively. Our net interest rate spread increased 23 basis points to 2.34% from 2.11% while our net interest margin increased 11 basis points to 2.59% from 2.48% reflecting a more pronounced downward repricing of our interest-bearing liabilities as compared with our interest-earning assets. The ratio of average interest-earning assets to average interest-bearing liabilities decreased to 109.88% for the year ended 2008 from 112.24% for the year ended December 31, 2007. The increase in our net interest rate spread and net interest margin reflects the fact that during the year ended December 31, 2008 the cost of average interest-bearing liabilities decreased at a faster pace than the yield earned on average interest-earning assets
Provision for Loan Losses. We established a provision for loan losses, which are charged to operations, at a level management believes is appropriate to absorb probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change. Based upon our evaluation, there was a provision for loan losses of $4.3 million for the twelve months ended December 31, 2008 compared to a loan loss provision of $179,000 for the twelve months ended December 31, 2007. The loan loss provision made for the twelve months ended December 31, 2008 were based, in part, on the continuation of negative economic trends, as well as, charge-offs and impairment reserves recorded on commercial loan properties. The Company recorded charge-offs of $3.2 million and recoveries of $67,000 during the twelve months ended December 31, 2008. These loans and the properties securing these loans are discussed in-depth in the preceding paragraphs. The Company had a 2.12% allowance for loan loss to gross loans receivable at December 21, 2008 compared to 1.15% allowance for loan loss to gross loans receivable at December 31, 2007. At December 31, 2008 the FAS 5 portion of the allowance
was 1.08%, whereas at December 31, 2007 the FAS 5 portion of the allowance was 1.15%. Based on economic and real estate downturns and with consideration to the increase in Company charge offs, the Company has increased its FAS 5 general reserve allocations. The comparative year over year decrease in the FAS 5 general reserve is the result of $10.3 million of primarily commercial loans with the highest FAS 5 allocation that were included in the FAS 5 general reserve at December 31, 2007 that are now specifically evaluated for impairment under FAS 114. Had these loans remained in the FAS 5 general reserve at December 31, 2008, the FAS 5 general reserve to gross loans would have been 0.15% higher, or 1.23%. Any loan loss provisions made are to maintain the allowance at levels that reflect management’s estimate of known and inherent losses in our loan portfolio.
Management assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses as necessary in order to maintain the adequacy of the allowance. While management uses available information to recognize losses on loans, future loan loss provisions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to recognize additional provisions based on their judgment of information available to them at the time of their examination. The allowance for loan losses as of December 31, 2008 is maintained at a level that represents management’s best estimate of inherent losses in the loan portfolio, and such losses were both probable and reasonably estimable.
Non-interest Income. Non-interest income decreased $93,000 or 10.8% to $765,000 for the year ended December 31, 2008 from $858,000 for the year ended 2007. The decrease was primarily due to a $87,000 decrease in service fees, a $89,000 decrease in insurance commissions, and a $28,000 decrease in rental income offset by a $94,000 increase in earnings on bank owned life insurance, and a $17,000 gain on the sale of securities available for sale.
Service fee income decreased $87,000 or $17.5% to $410,000 for the year ended December 31, 2008 from $497,000 for the same period in 2007. The decrease was primarily due to decreases in prepayment penalties and late fees paid during the year ended December 31, 2008 compared to the same period in 2007.
Insurance commission income decreased $89,000 or 62.2% primarily due to a decrease in the sale of fixed and variable rate annuities for the comparable periods as investors avoided most non-insured financial market instruments.
Rental income decreased $28,000 or 23.3% primarily due to one of the Company’s larger rental units remaining vacant throughout 2008, while in 2007 it was occupied for the majority of the year. Had the unit remained occupied for all of 2008 rental income would have increased by approximately $34,000.
Earnings on bank owned life insurance increased $94,000 or 174.1% primarily due to an increase in the cash surrender value of the Company’s bank owned life insurance. The Company purchased $3.0 million of BOLI in August of 2007.
Non-interest Expense. Non-interest expense decreased $55,000 or 0.9% to $6.0 million for both years ended December 31, 2008 and 2007. The decrease primarily reflects decreases in salaries and employee benefits, loss on the sale of other real estate owned, and loss on the impairment of a mutual fund, offset by increases in occupancy expense, loss on the sale of mutual fund, and other non-interest expense items.
Salaries and employee benefits decreased $145,000 or 4.5% to $3.1 million for the year ended December 31, 2008 compared to $3.3 million for the same period last year. Salaries and employee benefits decreased primarily due to a reduction in the cost of the recognition and retention and stock
option plans. The awards under these plans were fully vested as of May 21, 2008, and accordingly, the benefit expense decreased $168,000 for the comparable periods.
Loss on sale of other real estate owned decreased $56,000 due to the foreclosure and subsequent sale of one commercial loan property that occurred during the 2007 year. The Company did not take a loss on the sale of other real estate owned during 2008.
The Company recorded a $244,000 loss related to an other than temporary impairment on the Company’s Shay AMF Ultra Short Mortgage fund (“mutual fund”) during 2007. In April of 2008, the Company recorded a $192,000 loss on the sale of 100% of its investment in this mutual fund. The Company sold the mutual fund to avoid expected further declines in fair value, which did occur. The Company has not experienced an other than temporary impairment on any of its securities held as of December 31, 2008.
Occupancy expense increased $70,000 or 9.0% to $849,000 for the year ended December 31, 2008 compared to $779,000 for the same period in 2007. The increase reflects the Company’s successful appeal of the real estate tax assessment and the resulting refund of real estate taxes received during the year ended December 31, 2007, as well as an increase in maintenance expenses on the buildings for the year ended December 31, 2008 when compared to the same period in 2007.
Other non-interest expense items increased $65,000 or 11.1% to $652,000 for the twelve months ended December 31, 2008 compared to $587,000 for the same period last year. Loan fees increased $20,000, depreciation on automobiles increased $15,000, and loss on fair value of securities increased $13,000, respectively, for the comparable periods. The increase in loan fees was primarily due to increased costs associated with obtaining appraisals on distressed properties, fees charged in conjunction with foreclosures on participation loans. Depreciation on automobiles increased due to the purchase of an automobile during the first quarter of 2008.
Provision for Income Taxes. The Company had a federal and state tax benefit of $1.4 million for the year ended December 31, 2008 and a tax expense of $275,000 during the same period of 2007. The $1.7 million change is due to the pre-tax loss recognized during the period.
Comparison of Operating Results for the Years Ended December 31, 2007 and December 31,
General. Net income decreased $352,000, or 38.6%, to $559,000 for the year ended December 31, 2007, from $911,000 for the year ended December 31, 2006. The decrease in net income resulted primarily from decreases in net interest income, and an increase in the provision for loan losses, the impairment of our investment in a mutual fund, offset by a decrease in income tax expense. The 2006 to 2007 changes in non-interest income and non-interest expense were only a net $28,000. However, the Company recorded a $244,000 charge to other non-interest expense due to the other than temporary impairment of a mutual fund as of December 31, 2007. The Company recorded the impairment due to an inability to definitively forecast a recovery within a reasonable time period.
Interest Income. Total interest income increased to $13.9 million for the twelve months ended December 31, 2007, up $301,000 or 2.2% from $13.6 million for the same period in 2006. The increase in our interest income is primarily due to a higher average yield earned on all categories of our interest-earning assets.
Interest income from loans decreased by $758,000 to $8.5 million for the year ended December 31, 2007, from $9.3 million for the year ended December 31, 2006. The decrease in interest income from loans was due to a decrease in the average loan balances during the year. The average yield
on loans increased to 6.3% during 2007 from 6.2% during 2006. Average loan balances were $134.7 million during the year ended December 31, 2007 compared to average loan balances of $149.4 million during the year ended December 31, 2006.
Interest income from securities increased by $917,000 to $3.8 million for the year ended December 31, 2007 compared to $2.9 million for the year ended December 31, 2006. The increase was due to increases in the average balances of securities and in interest rates earned on the securities during the year. Average securities balances were $82.5 million during the year ended December 31, 2007 compared to average securities balances of $70.3 million during the year ended December 31, 2006. The increase in the average securities balances reflects purchases of fixed-rate government-backed notes and bonds and mortgage-backed securities. The average term to maturity of the fixed-rate note and bond securities was 26 months; the average term to maturity of the mortgage-back securities was 120 months. The average yield on securities increased to 4.6% during 2007 from 4.1% during 2006.
Interest income from interest-earning deposits and other increased $231,000, or 18.8%, to $1.5 million for the year ended December 31, 2007, from $1.2 million for the year ended December 31, 2006. The increase resulted from increases in the average balances and an increase in the interest rate earned on the deposits. Average balances increased to $29.0 million from $26.2 million, while the average yield increased to 5.0% from 4.7% for the comparable twelve-month periods. The increase in the average balance of interest earning deposits was caused primarily by an increase in demand account balances at other financial institutions, offset by a decrease in our of certificates of deposit balances held at other financial institutions and a decrease in our investment in FHLB stock.
Interest income from federal funds sold decreased $89,000, or 37.4%, to $149,000 for the year ended December 31, 2007, from $238,000 for the year ended December 31, 2006. The decrease resulted primarily from a decrease in the average balances. Average balances decreased to $2.9 million from $4.9 million, while the average yield increased to 5.1% from 4.9% for the comparable twelve-month periods. The decrease in average balances was due to a reduction in investment in federal funds sold as the Company shifted funds into demand accounts at the Federal Home Loan Bank towards the end of 2007.
Interest Expense. Interest expense on deposits increased by $825,000, or 14.4% to $6.6 million for the year ended December 31, 2007, from $5.7 million for 2006. The increase in our cost of deposits reflected the higher average market interest rates during 2007, certificates of deposit maturing and renewing at higher rates during 2007, as well as an increase in average deposit balances during the year. Average deposits increased to $196.3 million for the year ended December 31, 2007, from $194.0 million for 2006. Our average cost of deposits increased to 3.3% from 3.0% for the respective periods. Interest expense on borrowings decreased to $1.2 million for the twelve months ended December 31, 2007, from $1.3 million for the same period during 2006, which was due to a decrease in the average FHLB borrowings.
Net interest income decreased by $382,000 or 5.8% to $6.2 million for the year ended December 31, 2007 from $6.6 million for the same period in 2006. Average interest earning assets were $249.1 million and $250.7 million during the comparative 2007 and 2006 twelve-month periods while the average yield was 5.58% and 5.42%, respectively. Our net interest rate spread decreased 18 basis points to 2.11% from 2.29% while our net interest margin decreased 14 basis points to 2.48% from 2.62%. The ratio of average interest-earning assets to average interest-bearing liabilities increased to 112.24% for the year ended 2007 from 111.96% for the year ended December 31, 2006. The decrease in our net interest rate spread and net interest margin reflects the fact that during the year ended December 31, 2007 the cost of average interest-bearing liabilities increased at a faster pace than the yield earned on interest-earning assets.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations, at a level management believes is appropriate to absorb probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change. Based on our evaluation of these factors, we made a provision of $179,000 for the year ended December 31, 2007 and a negative $28,000 provision for the same period in 2006. The loan loss provision made for the year ended December 31, 2007 was based, in part, on concerns regarding economic conditions as real estate values trend downwards and increased commercial loan credit risk that may be imbedded in the portfolio, as well as, additional specific reserves allocated for on commercial and single-family properties. The Company recorded a $197,000 specific reserve on two commercial office buildings, with a lending relationship totaling $2.7 million, owned by the same entity that in October 2007 reported increased vacancies and weaknesses in cash flow. The loans secured by the commercial office buildings are currently performing, however the Company felt a $197,000 loss on these properties was necessary. The Company has a commercial lending relationship totaling $294,000 that is impaired and one commercial lending relationship totaling $2.9 million that is on the Company’s watch list as of December 31, 2007. The Company’s watch list includes any commercial loan that has for the past twelve months been late paying three times or more. We used the same methodology while updating credit risk assumptions in assessing the adequacy of the allowance. The allowance for loan losses was $1.5 million or 1.15% of loans outstanding at December 31, 2007 compared to $1.6 million, or 1.16%, of loans outstanding at December 31, 2006. The non-performing assets to total assets at December 31, 2007 was 0.38% as compared to 0.20% at December 31, 2006. The level of the allowance is based on estimates and the ultimate losses may vary from the estimates.
Management assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses as necessary in order to maintain the adequacy of the allowance. While management uses available information to recognize losses on loans, future loan loss provisions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to recognize additional provisions based on their judgment of information available to them at the time of their examination. The allowance for loan losses as of December 31, 2007 is maintained at a level that represents management’s best estimate of inherent losses in the loan portfolio, and such losses were both probable and reasonably estimable.
Non-interest Income. Non-interest income decreased $81,000 or 8.6% to $858,000 for the year ended December 31, 2007 from $939,000 for the year ended 2006. The decrease was primarily due to a $45,000 decrease in insurance commissions, a $54,000 decrease in gain on the sale of loans, and a $19,000 decrease in rental income, offset by a $51,000 increase in other non-interest income.
Insurance commission income decreased $45,000 or 23.9% for the year ended December 31, 2007 when compared to the year ended December 31, 2006. Insurance commissions decreased primarily due to a reduction in the insurance sales staff during the year ended December 31, 2007.
Gain on the sale of loans decreased $54,000 or 100% during the twelve-month period ended December 31, 2007 reflecting management’s decision to portfolio the loans originated during 2007. Management may decide to sell loans in the secondary market in the future. Rental income decreased $19,000 or 13.7% primarily due to several vacant rental units that were occupied during 2006. During the twelve months ended December 31, 2007 four rental units located at our 80th Avenue facility terminated
their leases. The termination of these four leases will result in reduced rental income of approximately $18,000 per quarter. Accordingly, the Company expects the rental income to decline in the future.
Other non-interest income increased $51,000 or 108.5% for the year ended December 31, 2007 when compared to the year ended December 31, 2006. The increase was primarily due to an increase in the cash surrender value of the Company’s bank owned life insurance (“BOLI”).
Non-interest Expense. Non-interest expense decreased $53,000 to $6.0 million for the year ended December 31, 2007 compared to $6.1 million for the same period in 2006. The decrease primarily reflects decreases in salaries and employee benefits, occupancy expense, advertising and promotion costs and postage and supplies, offset by increases in loss on the sale of other real estate owned, loss on impairment of mutual fund and other non-interest expense items.
Salaries and employee benefits decreased $205,000 or 5.9% to $3.3 million for the year ended December 31, 2007 compared to $3.5 million for the same period last year. Salaries and employee benefits decreased primarily due to a reduction in the number of full time equivalent employees for the comparable periods. The Company had 58 full time equivalent employees at December 31, 2007 compared to 64 full time equivalent employees at December 31, 2006.
Occupancy expense decreased $71,000 or 8.4% to $779,000 for the year ended December 31, 2007 compared to $850,000 for the same period in 2006. The decrease reflects the Company’s successful appeal of the real estate tax assessment and the resulting refund of real estate taxes received during the year ended December 31, 2007, as well as a decrease in depreciation expenses for the year ended December 31, 2007 when compared to the same period in 2006.
Advertising and promotion costs decreased $51,000 or 15.8% to $271,000 for the year ended December 31, 2007 compared to $322,000 for the period last year. The decrease was primarily due to a cost reduction program implemented in the beginning of 2007.
Postage and supplies costs decreased $44,000 or 21.7% to $159,000 for the year ended December 31, 2007 compared to $203,000 for the period last year. The decrease was primarily due to the implementation of a cost reduction program during 2007, as well as the printing and mailing of advertisements that was done in-house rather than outsourced during 2006.
Loss on sale of other real estate owned increased $56,000 due to the foreclosure and subsequent sale of one commercial loan property that occurred during the 2007 year. There was no real estate owned during the year ended 2006.
The Company has recorded a $244,000 loss related to an other than temporary impairment on the Company’s Shay AMF Ultra Short Mortgage fund (“mutual fund”). The Company’s investment in the mutual fund has exceeded its market value since mid-year 2003, however, the Company has had the intent and ability to hold the fund until its forecasted recovery period. Historically, the fund’s market value has correlated inversely with short-term interest rates, therefore, the projected recovery was expected to occur as short-term interest rates declined. However, as short-term interest rates declined the fund no longer performed as it had historically, most likely due to the unusual market conditions that have occurred in the recent past. The Company continues to believe the fund will recover its previous market value, however, the forecasted recovery period is uncertain. The Company does not believe there is significant credit risk imbedded within the mutual fund’s portfolio, and intends to continue to hold the fund for the foreseeable future. However, since the forecasted recovery period is no longer certain, the Company felt that it was appropriate to record the decline in the market value of the fund into earnings at December 31, 2007. The Company intends to adopt the FASB issued Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities as of January 1, 2008 for the Company’s equity securities, which will include the mutual fund, therefore, further changes in the market value of this fund will flow through earnings.
Other non-interest expense items increased $49,000 or 9.1% to $587,000 for the twelve months ended December 31, 2007 compared to $538,000 for the same period last year. The increase was primarily due to costs associated with the maintenance and repair of the Company’s other real estate owned. The Company had no other real estate owned during 2006.
Provision for Income Taxes. The provision for income taxes decreased to $275,000, or 33.0% of income before income taxes for the year ended December 31, 2007 from $540,000 or 37.2% of income before taxes for the year ended December 31, 2006. The decrease was primarily due to a decrease in pretax earnings, as well as an increase in state-tax exempt securities held during 2007.
Average Balance Sheets
The following tables present for the periods indicated the total dollar amount of interest income on average interest-earning assets and the resultant yields, the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, as well as yields and costs at December 31, 2008. No tax equivalent adjustments were made. All average balances are monthly average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Management of Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. Senior management monitors the level of interest rate risk on a regular basis and the Asset/Liability Management Committee, which consists of senior management operating under a policy adopted by the Board of Directors, meets as needed to review our asset/liability policies and interest rate risk position.
We have sought to manage our interest rate risk by more closely matching the maturities of our interest rate sensitive assets and liabilities. In particular, we offer one, three-, five- and seven-year adjustable rate mortgage loans, and three- and five-year balloon loans. In a low interest rate environment, borrowers typically prefer fixed-rate loans to adjustable-rate mortgages. We may sell our originations of longer-term fixed-rate loans into the secondary market. We do not solicit high-rate jumbo certificates of deposit or brokered funds.
Net Portfolio Value. In past years, many savings associations have measured interest rate sensitivity by computing the “gap” between the assets and liabilities which are expected to mature or reprice within certain time periods based on assumptions regarding loan prepayment and deposit decay rates formerly provided by the Office of Thrift Supervision. However, the Office of Thrift Supervision now requires the computation of amounts by which the net present value of an institution’s cash flow
from assets, liabilities and off-balance-sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. The Office of Thrift Supervision provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report with an interest rate sensitivity report of net portfolio value. The Office of Thrift Supervision simulation model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value. The Office of Thrift Supervision model estimates the economic value of each type of asset, liability and off-balance-sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 50 to 300 basis points. (A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 7% to 8% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below). The Office of Thrift Supervision provides us the results of the interest rate sensitivity model, which is based on information we provide to the Office of Thrift Supervision to estimate the sensitivity of our net portfolio value.
The table below sets forth, as of September 30, 2008 (the latest date for which information is available), the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve.
(1) Expressed in basis points.
The table above indicates that at September 30, 2008, in the event of a 100 basis point decrease in interest rates, we would experience a 1% increase in net portfolio value. In the event of a 200 basis point increase in interest rates, we would experience an 11% decrease in net portfolio value.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve, regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income, and will differ from actual results.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. By their nature, changes in these assumptions and estimates could significantly affect the Company's financial position or results of operations. Actual results could differ from those estimates. Discussed below are selected critical accounting policies that are of particular significance to the Company.
Allowance for Loan Losses. The allowance for loan losses represents management's estimate of probable incurred credit losses inherent in the loan portfolio. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
The allowance for loan losses consists of specific allocations on impaired loans under Statement of Financial Accounting Standards (SFAS) 114 and general allocation for inherent credit risks under SFAS 5. The SFAS 114 component of the allowance for loan losses reflects expected losses resulting from analyses developed through specific credit allocations for individual loans. The SFAS 5 component of the allowance reflects historical loss experience for each loan category adjusted for trends and credit risks. The specific credit allocations are based on analyses involving a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The historical loss analysis is performed quarterly and loss factors are updated regularly based on actual experience and trends and credit risk.
The allowance reflects management's estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the unallocated allowance includes a component that accounts for the inherent imprecision in loan loss models. Uncertainty surrounding the strength and timing of economic cycles also affects estimates of loss. The historical losses used in the migration analysis may not be representative of actual unrealized losses inherent in the portfolio.
There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect earnings or financial position in future periods. Significant influences currently impacting the Company’s allowance for loan losses are rising real estate inventories which is applying downward pressure in real estate values and general economic conditions. Management continues to monitor these credit risk trends during each quarterly allowance for loan loss analysis.
Other Than Temporary Impairment. We review investment securities with significant declines in fair value for potential other-than-temporary impairment pursuant to the guidance set forth in Statement of Financial Accounting Standards 115, “Accounting for Certain Investments in Debt and Equity Securities”
(“SFAS 115”) on a quarterly basis. We have developed a methodology for conducting quarterly impairment evaluation with consideration given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet our liquidity needs. Our liquidity ratio averaged 16.1% and 20.4% for the years ended December 31, 2008 and 2007. We adjust our liquidity levels to fund deposit outflows, pay real estate taxes on mortgage loans, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.
Our primary sources of liquidity are deposits, amortization and prepayment of 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 general interest rates, economic conditions, and competition. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term interest-earning investments and other assets, which provide liquidity to meet lending requirements. Short-term interest-earning deposits with the Federal Home Loan Bank of Chicago amounted to $1.5 million at December 31, 2008 and $3.2 million at December 31, 2007. For additional information about cash flows from our operating, financing, and investing activities, see Consolidated Statements of Cash Flows included in the consolidated financial statements.
A significant portion of our liquidity consists of securities classified as available-for-sale and cash and cash equivalents, which are a product of our operating, investing and financing activities. Our primary sources of cash are net income, principal repayments on loans and mortgage-backed securities, and increases in deposit accounts, along with advances from the Federal Home Loan Bank of Chicago.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Chicago which provide an additional source of funds. At December 31, 2008, we had $30.2 million in advances from the Federal Home Loan Bank of Chicago. Of this amount, $10.9 million is due within one year, $14.3 million is due between one and three years, $5.0 million is due between four and five years.
At December 31, 2008, we had outstanding commitments of $4.6 million to originate loans. This amount does not include the unfunded portion of loans in process. At December 31, 2008, certificates of deposit scheduled to mature in less than one year totaled $81.0 million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In addition, the cost of such deposits may be significantly higher upon renewal in a rising interest rate environment. We intend to utilize our high levels of liquidity to fund our lending activities.
Liquidity. We are required to maintain liquid assets in an amount that would ensure our safe and sound operation. Our liquidity ratio at December 31, 2008 was 11.8%.
The following table sets forth our contractual obligations and commercial commitments at December 31, 2008.
________________________________
(1)
Represents amounts committed to customers.
Not included above is the $1.3 million liability for the Employee Stock Ownership Plan (“ESOP”) put option. This option allows the ESOP participant, following termination of their employment, to ‘put’ their stock back to the Company at the fair value as determined by an independent appraisal. It is unlikely that all of the plan participants will put their stock back to the Company at any one time, however, should they choose to do so the participants could put their stock back to the Company during 2009.
Impact of Inflation and Changing Prices
Accounting principles generally accepted in the United States of America (“GAAP”) generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effect of inflation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements are attached as Exhibit 13 hereto and are incorporated by reference hereunder.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a)
Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer, President and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the fiscal year (the “Evaluation Date”). Based upon that evaluation, the Chief Executive Officer, President and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b)
Management’s annual report on internal control over financial reporting
The management of AJS Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material affect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. However, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2008, the Company’s internal control over financial reporting was effective based on the criteria established in the Internal Control-Integrated Framework.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in the annual report.
(c)
Changes in internal controls.
There were no significant changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.
See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning Directors of the Company is incorporated herein by reference from the Company’s definitive Proxy Statement (the “Proxy Statement”), specifically the section captioned “Proposal I-Election of Directors.” In addition, see “Executive Officers of AJS Bancorp, Inc.” in Item 1 for information concerning the Company’s executive officers.
The Board of Directors has adopted a Code of Ethics, applicable to the Chief Executive Officer, President and Chief Financial Officer. The Code of Ethics may be accessed through our website at www.ajsmithbank.com and is filed as Exhibit 14 hereto.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Executive Compensation”.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain owners and management is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Voting Securities and Principal Holder Thereof”.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning relationships and transactions is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons”.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services is incorporated herein by reference from the Company’s Proxy Statement.
ITEM 15.
ITEM 15. EXHIBITS
3.2
Bylaws of AJS Bancorp, Inc. (1)
10.1
Employment Agreement with Thomas R. Butkus(2)
10.3
AJS Bancorp, Inc. 2003 Stock Option Plan(4)
10.5
Amendments to 2003 Stock Option Plan(5)
Code of Ethics(2)
Consent of Auditors to incorporate financial statements into Form S-8
31.2
Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
___________________
(1)
Incorporated by reference to the Company’s registration statement on Form S-1 (commission file number 333-69482, filed on September 17, 2001, as amended)
(2)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on June 23,
(3)
Incorporated by reference to the Company’s Current Report on Form 8 - K filed on October 24, 2008.
(4)
Incorporated by reference to the Company’s registration statement on Form S-8 (commission file number 333-105598, filed on May 28, 2003)
(5)
Incorporated by reference to the Company’s Annual Report on Form 10 - K for the year ended December 31, 2005
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.
AJS Bancorp, Inc.
Date:
March 16, 2009
By:
/s/ Thomas R. Butkus
Thomas R. Butkus,
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act 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.
By:
/s/ Thomas R. Butkus
By:
/s/ Lyn G. Rupich
Thomas R. Butkus, Chairman of the Board
Lyn G. Rupich, President
and Chief Executive Officer
Principal Operating Officer
(Principal Executive Officer)
Date:
March 16, 2009
Date:
March 16, 2009
By:
/s/ Pamela N. Favero
By:
/s/ Roger L. Aurelio
Pamela N. Favero, Chief Financial Officer
Roger L. Aurelio, Director
Date:
March 16, 2009
Date:
March 16, 2009
By:
/s/ Raymond J. Blake
By:
/s/ Richard J. Nogal
Raymond J. Blake, Director
Richard J. Nogal, Director
Date:
March 16, 2009
Date:
March 16, 2009
By:
/s/ Edward S. Milen
Edward S. Milen, Director
Date:
March 16, 2009