ITEM 1 - BUSINESS
Business
Consumers Bancorp, Inc. (Corporation), is a bank holding company under the Bank Holding Company Act of 1956, as amended and is a registered bank holding company, incorporated under the laws of the State of Ohio. The Corporation owns all of the issued and outstanding capital stock of Consumers National Bank (Bank), a bank chartered under the laws of the United States of America. On February 28, 1995, the Corporation acquired all of the common stock issued by the Bank. The Corporation’s activities have been limited primarily to holding the common stock of the Bank.
Since 1965, the Bank’s main office has been serving the Minerva, Ohio area from its location at 614 East Lincoln Way, Minerva, Ohio. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its market area, consisting primarily of Stark, Columbiana, Carroll and contiguous counties in Ohio. The Bank also invests in securities consisting primarily of obligations of U.S. government sponsored entities, municipal obligations and mortgage-backed securities.
Supervision and Regulation
The following discussion of supervision and regulation is qualified in its entirety by reference to the statutory and regulatory provisions discussed. Changes in applicable law or in the policies of various regulatory authorities could affect materially the business and prospects of the Corporation and the Bank.
Regulation of the Corporation:
The Bank Holding Company Act: As a bank holding company, the Corporation is subject to regulation under the Bank Holding Company Act of 1956, as amended (BHCA) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (Federal Reserve Board). Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve Board and required to file periodic reports regarding its operations and any additional information that the Federal Reserve Board may require.
The BHCA generally limits the activities of a bank holding company to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries and engaging in any other activities that the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident to those activities. In addition, the BHCA requires every bank holding company to obtain the approval of the Federal Reserve Board prior to acquiring substantially all the assets of any bank, acquiring direct or indirect ownership or control of more than 5% of the voting shares of a bank or merging or consolidating with another bank holding company.
Privacy Provisions of Gramm-Leach-Bliley Act: The Gramm-Leach-Bliley Act of 2000 contains extensive provisions on a customer’s right to privacy of non-public personal information. Under these provisions, a financial institution must provide to its customers the institution’s policies and procedures regarding the handling of customers’ non-public personal information. Except in certain cases, an institution may not provide personal information to unaffiliated third parties unless the institution discloses that such information may be disclosed and the customer is given the opportunity to opt out of such disclosure. The Corporation and the Bank are also subject to certain state laws that deal with the use and distribution of non-public personal information.
Interstate Banking and Branching: Prior to enactment of the Interstate Banking and Branch Efficiency Act of 1995, the Corporation would have been prohibited from acquiring banks outside Ohio, unless the laws of the state in which the target bank was located specifically authorized the transaction. The Interstate Banking and Branch Efficiency Act has eased restrictions on interstate expansion and consolidation of banking operations by, among other things: (i) permitting interstate bank acquisitions regardless of host state laws, (ii) permitting interstate merger of banks unless specific states have opted out of this provision and (iii) permitting banks to establish new branches outside the state provided the law of the host state specifically allows interstate bank branching.
Sarbanes-Oxley Act: The Sarbanes-Oxley Act of 2002 contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with section 302(a) of the Sarbanes-Oxley Act, written certifications by the Corporation’s Chief Executive Officer and Chief Financial Officer are required. These certifications attest that the Corporation’s quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact or omit to state a material fact. See Item 9A(T) “Controls and Procedures” for the Corporation’s evaluation of its disclosure controls and procedures.
Regulation of the Bank:
Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation Regulation: As a national bank, Consumers National Bank is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). It is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (FDIC).
Under regulations promulgated by the OCC, the Bank may not declare a dividend in excess of its undivided profits. Additionally, the Bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by the Bank in any calendar year exceeds the total of its retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the OCC. The Bank may not declare or pay any dividend if, after making the dividend, the Bank would be “undercapitalized,” as defined in the federal regulations.
The FDIC is an independent federal agency, which insures the deposits of federally insured banks and savings associations up to certain prescribed limits and safeguards the safety and soundness of financial institutions. The deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund of the FDIC. Under the FDIC’s deposit insurance assessment system, the assessment rate for any insured institutions varies according to regulatory capital levels of the institution and other factors such as supervisory evaluations.
The FDIC is authorized to prohibit any insured institution from engaging in any activity that poses a serious threat to the insurance fund and may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may also terminate the deposit insurance of any institution that has engaged in or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, order or condition imposed by the FDIC.
In addition to the supervision and regulation matters listed above, the Bank is also a member of the Federal Home Loan Bank of Cincinnati (FHLB), which is a privately capitalized, government sponsored enterprise that expands housing and economic development opportunities throughout the nation by providing loans and other banking services to community-based financial institutions.
Risk-Based Capital Requirements: The Federal Reserve Board and the OCC employ similar risk-based capital guidelines in their examination and regulation of bank holding companies and national banks. If capital falls below the minimum levels established by the guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities. Failure to satisfy capital guidelines could subject a banking institution to a variety of enforcement actions by federal bank regulatory authorities, including the termination of deposit insurance by the FDIC and a prohibition on the acceptance of “brokered deposits.”
In the calculation of risk-based capital, assets and off-balance sheet items are assigned to broad risk categories, each with an assigned weighting (0%, 20%, 50% and 100%). Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property, which carry a 50% rating. Direct obligations of or obligations guaranteed by the United States Treasury or United States Government agencies have a 0% risk-weight. Off-balance sheet items are also taken into account in the calculation of risk-based capital, with each class of off-balance sheet item being converted to a balance sheet equivalent according to established “conversion factors.” From these computations, the total of risk-weighted assets is derived. Risk-based capital ratios therefore state capital as a percentage of total risk-weighted assets and off-balance sheet items. The ratios established by guideline are minimums only.
Current risk-based capital guidelines require bank holding companies and banks to maintain a minimum risk-based total capital ratio equal to 8% and a Tier 1 capital ratio of 4%. Intangibles other than readily marketable mortgage servicing rights are generally deducted from capital. Tier 1 capital includes stockholders’ equity, qualifying perpetual preferred stock (within limits and subject to conditions, particularly if the preferred stock is cumulative preferred stock), and minority interests in equity accounts of consolidated subsidiaries, less intangibles, identified losses, investments in securities subsidiaries, and certain other assets. Tier 2 capital includes the allowance for loan losses, up to a maximum of 1.25% of risk-weighted assets, any qualifying perpetual preferred stock exceeding the amount includable in Tier 1 capital, mandatory convertible securities, and subordinated debt and intermediate term preferred stock, up to 50% of Tier 1 capital. The OCC’s evaluation of an institution’s capital adequacy takes into account a variety of other factors as well, including interest rate risks to which the institution is subject, the level and quality of an institution’s earnings, loan and investment portfolio characteristics and risks, risks arising from the conduct of nontraditional activities, and a variety of other factors.
Accordingly, the OCC’s final supervisory judgment concerning an institution’s capital adequacy could differ significantly from the conclusions that might be derived from the absolute level of an institution’s risk-based capital ratios. Therefore, institutions generally are expected to maintain risk-based capital ratios that exceed the minimum ratios discussed above.
The banking agencies have also established a minimum leverage ratio of 3%, which represents Tier 1 capital as a percentage of total assets, less intangibles. However, for all but the most highly rated banks and bank holding companies, the banking agencies expect an additional margin of at least 100 to 200 basis points. At June 30, 2008, the Bank was in compliance with all regulatory capital requirements. Actual and required capital amounts and ratios are presented elsewhere, specifically in Note 11 of the Corporation’s audited financial statements for the year ended June 30, 2008.
Prompt Corrective Action. To resolve the problems of undercapitalized institutions and to prevent a recurrence of the banking crisis of the 1980s and early 1990s, the Federal Deposit Insurance Corporation Improvement Act of 1991 established a system known as “prompt corrective action.” Under the prompt corrective action provisions and implementing regulations, every institution is classified into one of five categories, depending on its total risk-based capital ratio, its Tier 1 risk-based capital ratio, its leverage ratio, and subjective factors. The categories are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A financial institution’s operations can be significantly affected by its capital classification. For example, an institution that is not “well capitalized” generally is prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market, and the holding company of any undercapitalized institution must guarantee, in part, aspects of the institution’s capital plan. Financial institution regulatory agencies generally are required to appoint a receiver or conservator shortly after an institution enters the category of weakest capitalization. The Federal Deposit Insurance Corporation Improvement Act of 1991 also authorizes the regulatory agencies to reclassify an institution from one category into a lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. Undercapitalized institutions are required to take specified actions to increase their capital or otherwise decrease the risks to the federal deposit insurance funds.
Community Reinvestment Act: The Community Reinvestment Act requires depository institutions to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practices. Under this Act, each institution is required to adopt a statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance and assigned ratings. Banking regulators consider these ratings when considering approval of a proposed transaction by an institution.
USA Patriot Act: In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA Patriot Act) Act of 2001 (Patriot Act). The Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to implement additional policies and procedures with respect to additional measures designed to address any or all of the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.
Employees
As of June 30, 2008, the Bank employed 84 full-time and 26 part-time employees. None of the employees are represented by a collective bargaining group. Management considers its relations with employees to be good.
Statistical Disclosure
The following statistical information is included on the indicated pages of this Report:
Average Consolidated Balance Sheet And Net Interest Margin
Interest Rates and Interest Differential
Carrying Values Of Securities
Maturities And Weighted-Average Yield Of Securities
Loan Types
Selected Loan Maturities And Interest Sensitivity
Non-accrual, Past Due And Restructured Loans And Other Nonperforming Assets
Potential Problem Loans
Summary Of Loan Loss Experience
Allocation Of Allowance For Loan Losses
Average Amount And Average Rate Paid On Deposits
Time Deposits Of $100,000 Or More
Short-Term Borrowings
21 and 41
Selected Consolidated Financial Data
Available Information
The Corporation files annual, quarterly, and current reports, proxy statements, and other information with the SEC. These filings are available to the public over the Internet at the SEC’s web site at www.sec.gov. Shareholders may also read and copy any document that the Corporation files at the SEC’s public reference room located at 450 Fifth Street, NW, Washington, DC 20549. Shareholders may call the SEC at 1-800-SEC-0330 for further information on the public reference room.
Shareholders may request a copy of any of the Corporation’s filings at no cost by writing or e-mailing the Corporation at the following address or e-mail address: Consumers Bancorp, Inc., Attn: Theresa J. Linder, 614 East Lincoln Way, Minerva, Ohio 44657 or e-mail to shareholderrelations@consumersbank.com.
The Corporation’s Code of Ethics Policy, which is applicable to all directors, officers and employees of the corporation, and its Code of Ethics for Principal Financial Officers, which is applicable to the principal executive officer and the principal financial officer, are each available on the Investor Relations section under Required Disclosures of the Corporation’s website (www.consumersbancorp.com). Copies of either of the Code of Ethics Policies are also available in print to shareholders upon request, addressed to the Corporate Secretary at Consumers Bancorp, Inc., 614 East Lincoln Way, Minerva, Ohio 44657. The Corporation intends to post amendments to or waivers from its Code of Ethics on its website.
ITEM 1A
ITEM 1A - RISK FACTORS
Our business may be adversely affected if we fail to effectively manage our lending risks. There are many risks in the business of lending, including risks associated with the duration over which loans may be repaid, risks resulting from changes in economic conditions, risks inherent in dealing with individual borrowers, and risks resulting from changes in the value of loan collateral. Our credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. A large percentage of our loan portfolio is secured by real estate collateral. In addition, commercial loans to small and medium-sized businesses represent a significant portion of our loan portfolio. Accordingly, the asset quality of our loan portfolio is largely dependent upon the area’s economy and real estate markets. A downturn in the local economy would adversely affect our operations and limit our future growth potential.
Our allowance for loan losses might not be sufficient to absorb future charge-offs. An allowance for loan losses recorded under generally accepted accounting principles is an institution’s best estimate within a range of the probable amount of loans that, based on current information and events, the institution will be unable to collect. The amount of the allowance is a product of management’s judgment and it is inevitably imprecise. Estimating the allowance requires significant judgment and the use of estimates related to many factors, including the amount and timing of future cash flows on problem loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which are susceptible to significant change. Our judgment about the adequacy of the loan loss allowance is based on assumptions that we believe are reasonable but that might nevertheless prove to be incorrect. We can give you no assurance that the allowance is sufficient to absorb future charge-offs.
Changing interest rates have a direct and immediate impact on financial institutions. Fluctuating rates of interest prevailing in the market affect a bank’s net interest income, which is the difference between interest earned from loans and investments, on one hand, and interest paid on deposits and borrowings, on the other. Banks manage interest rate risk exposure by closely monitoring assets and liabilities, altering from time to time the mix and maturity of loans, investments, and funding sources. Changes in interest rates affect the volume of loans originated, as well as the value of loans and other interest-earning assets, including investment securities. Changes in interest rates could also result in an increase in higher-cost deposit liabilities as well as movement of funds from deposit accounts into direct investments (such as U.S. Government and corporate securities, and other investment instruments such as mutual funds) if the Bank does not pay competitive interest rates. The percentage of household financial assets held in the form of deposits has declined over the years, with banking customers investing a greater portion of their financial assets in stocks, bonds, and mutual funds. Federal Reserve Board monetary policies have had a significant effect on the interest income and interest expense of commercial banks, including the Bank, and are expected to continue to do so in the future.
Consumers National Bank has significant competition in both attracting and retaining deposits and in originating loans. Competition is intense in the markets the Bank serves. It is anticipated that the competition will remain intense. The Bank competes on price and service with other banks and financial services companies such as savings and loans, credit unions, finance companies, mortgage companies, and brokerage firms. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from non-banks, greater technological developments in the industry and banking reform.
Concentration of service area could negatively affect our financial performance. A concentration of credit risk can arise with respect to loans and deposits. As of June 30, 2008, the Bank’s deposit and lending market area is concentrated in Stark, Columbiana and Carroll Counties in northeastern Ohio. Because of the concentration of deposits and loans in these three counties, in the event of adverse economic conditions, the Bank could experience more difficulty in attracting deposits and experience higher rates of loss and delinquency on its loans than if the loans were more geographically diversified. Adverse economic conditions in this region of Ohio may reduce demand for credit of fee-based products and could negatively affect real estate and other collateral values, interest rate levels, and the availability of credit to refinance loans at or prior to maturity.
Our common stock is thinly traded and therefore susceptible to wide price swings. Our common stock is traded on the over-the-counter (OTC) Bulletin Board® under the ticker symbol “CBKM,” but trading volume is low. Thinly traded, illiquid stocks are more susceptible to significant and sudden price changes than stocks that are widely followed by the investment community and actively traded on an exchange or NASDAQ. The liquidity of the common stock depends upon the presence in the marketplace of willing buyers and sellers. We do not intend at the current time to seek listing of our common stock on a securities exchange and we do not intend to seek authorization for trading of our shares on NASDAQ.
The banking industry is heavily regulated; the compliance burden to the industry is considerable; the principal beneficiary of federal and state regulation is the public at large and depositors, not shareholders. We are and will remain subject to extensive federal government supervision and regulation. Affecting many aspects of the banking business, including permissible activities, lending, investments, payment of dividends, the geographic locations in which banking services can be offered, and numerous other matters, federal supervision and regulation are intended principally to protect depositors, the public, and the deposit insurance funds administered by the FDIC. Protection of shareholders is not a goal of banking regulation.
Applicable statutes, regulations, agency and court interpretations, and agency enforcement policies have undergone significant changes, some retroactively applied, and they could change significantly again. Changes in applicable laws and regulatory policies could adversely affect the banking industry generally or us in particular. The burdens of banking regulation could place banks in general at a competitive disadvantage compared to less regulated competitors. We cannot predict whether any potential legislation will be enacted, and if enacted, the effect that it, or any implemented regulations, would have on our financial condition or results of operations. We are not aware of any current recommendations by regulatory authorities that, if they were to be implemented, would have a material effect on our business.
Government regulation could restrict our ability to pay cash dividends. Dividends from the Bank are our most significant source of cash for payment of dividends to our shareholders. Statutory and regulatory limits could prevent the Bank from paying dividends. We believe that we will be able to continue paying our regular quarterly cash dividend. However, we cannot assure you that the Bank’s profitability will continue to provide sufficient cash to allow us to continue paying our regular quarterly cash dividends.
We could incur liabilities under federal and state environmental laws if we foreclose on commercial properties. A high percentage of the Bank’s loans are secured by real estate. Although many of these loans are residential mortgage loans with little associated environmental risk, some are commercial loans secured by property on which manufacturing and other commercial enterprises are conducted. The Bank has in the past and could again acquire property by foreclosing on loans in default. Under federal and state environmental laws, the Bank could face liability for some or all of the costs of removing hazardous substances, contaminants, or pollutants from properties acquired in this fashion. Although other persons might be primarily responsible for these costs, they might not be financially solvent or they might be unable to bear the full cost of clean up.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
None
ITEM 2
ITEM 2 - PROPERTIES
The Bank owns and maintains the premises in which seven of the ten banking facilities are located, and leases offices in Carrollton, Alliance and Malvern. The location of each of the currently operating offices is as follows:
Minerva Office:
614 E. Lincoln Way, P.O. Box 256, Minerva, Ohio, 44657
Salem Office:
141 S. Ellsworth Ave., P.O. Box 798, Salem, Ohio, 44460
Waynesburg Office:
8607 Waynesburg Dr. SE, P.O. Box 746, Waynesburg, Ohio, 44423
Hanoverton Office:
30034 Canal St., P.O. Box 178, Hanoverton, Ohio, 44423
Carrollton Office:
1017 Canton Rd. NW, P.O. Box 8, Carrollton, Ohio, 44615
Alliance Office:
610 West State St., Alliance, Ohio, 44601
Lisbon Office:
7985 Dickey Dr., Lisbon, Ohio 44432
Louisville Office:
East Canton Office:
1111 N. Chapel St., Louisville, Ohio 44641
440 W. Noble, East Canton, Ohio, 44730
Malvern Office:
4070 Alliance Rd., Malvern, Ohio 44644
In the opinion of management, the properties listed above are adequate for their present uses and the Bank’s business requirements and are adequately covered by insurance.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
The Corporation is not a party to any pending material legal or administrative proceedings, other than ordinary routine litigation incidental to the business of the Corporation. Further, there are no material legal proceedings in which any director, executive officer, principal shareholder or affiliate of the Corporation is a party or has a material interest that is adverse to the Corporation. No routine litigation in which the Corporation is involved is expected to have a material adverse impact on the financial position or results of operations of the Corporation.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Nothing to be reported.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Corporation had 2,029,558 common shares outstanding on June 30, 2008 with 654 shareholders of record and an estimated 270 additional beneficial holders whose stock was held in nominee name.
The common shares of Consumers Bancorp, Inc. are traded on the over-the-counter bulletin board. The following quoted market prices reflect inter-dealer prices, without adjustments for retail markups, markdowns, or commissions and may not represent actual transactions. The market prices represent highs and lows reported during the quarterly period.
Management does not have knowledge of the prices paid in all transactions and has not verified the accuracy of those prices that have been reported. Because of the lack of an established market for the Corporation’s common shares, these prices may not reflect the prices at which the common shares would trade in an active market.
The Corporation’s principal source of funds for dividend payment is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. See Note 1 and Note 11 to the Consolidated Financial Statements for dividend restrictions.
The Corporation has no compensation plans under which equity securities are authorized for issuance. There were no repurchases of the Corporation’s securities during the fourth quarter of fiscal year 2008. The share repurchase plan that was approved by the Board of Directors in June 2007 ended with 35,876 shares purchased of the 75,000 shares that were authorized for repurchase.
Performance Graph
Set forth below is a line graph comparing the yearly change in the cumulative total shareholder return on Consumers Bancorp’s Common Stock against the cumulative return of the NASDAQ Bank Index and the S&P 500 Index for the five-year period ended June 30, 2008. The total shareholder return assumes a $100 investment in Consumers Bancorp’s Common Stock, the NASDAQ Bank Index and the S&P 500 Index on June 30, 2003 and that all dividends were reinvested.
Historical stock price performance shown on the graph is not necessarily indicative of the future price performance.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
Five-Year Selected Data
(Dollar amounts in thousands, except per share data)
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
General
The following is management’s analysis of the Corporation’s financial condition and results of operations as of and for the year ended June 30, 2008, compared to prior years. This discussion is designed to provide a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report.
Overview
Consumers Bancorp, Inc., a bank holding company incorporated under the laws of the State of Ohio, owns all of the issued and outstanding capital stock of Consumers National Bank, a bank chartered under the laws of the United States of America. The Corporation’s activities have been limited primarily to holding the common stock of the Bank. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its market area, consisting primarily of Stark, Columbiana, Carroll and contiguous counties in Ohio. The Bank also invests in securities consisting primarily of U.S. government sponsored entities, municipal obligations and mortgage-backed securities.
Forward-Looking Statements
All statements set forth in this discussion or future filings by the Corporation with the Securities and Exchange Commission, or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, that are not historical in nature, including statements as to the Corporation’s expectations, beliefs and strategies regarding the future, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may involve risks and uncertainties that are difficult to predict, may be beyond the Corporation’s control and could cause actual results to differ materially from those described in such statements. Although the Corporation believes that the expectations reflected in such forward-looking statements are reasonable, the Corporation can give no assurance that such expectations will prove to be correct. The forward-looking statements included in this discussion speak only as of the date of this Form 10-K, and, except as required by law, the Corporation undertakes no obligation to update these forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from those suggested by these forward-looking statements and that could adversely affect the Corporation’s performance are set forth under Item 1A - Risk Factors in this Report on Form 10-K.
Comparison of Results of Operations for the Years Ended June 30, 2008, June 30, 2007 and June 30, 2006
Net Income. Net income increased by $540, or 42.8%, from 2007 to 2008 mainly as a result of an increase in the net interest income, other income and as a result of a reduction in provision for loan losses. Net income increased by $85, or 7.2%, from 2006 to 2007 mainly as a result of an increase in the net interest margin from 4.65% to 4.67% and as a result of a reduction in other expenses.
Net Interest Income. Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the largest component of the Corporation’s earnings. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. Net interest margin is calculated by dividing net interest income on a fully tax equivalent basis (FTE) by total interest-earning assets. FTE income includes tax-exempt income, restated to a pre-tax equivalent, based on the statutory federal income tax rate. All average balances are daily average balances. Non-accruing loans are included in average loan balances.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Net interest income for the year of 2008 was $8,850, an increase of $424, or 5.0%, from $8,426 in the year of 2007. The Corporation’s net interest margin for the year ended June 30, 2008 was 4.48%, a decrease of 19 basis points from 2007. Interest income for the year of 2008 was $13,478, an increase of $1,140, or 9.2%, from $12,338 in the year of 2007. This increase was mainly the result of an $18,328, or 9.8% increase in average interest earning assets. Interest expense for the year of 2008 was $4,628, an increase of $716, or 18.3%, from $3,912 in the year of 2007. This increase was mainly due to a $15,465, or 11.1%, increase in average interest bearing liabilities.
Net interest income for the year of 2007 was $8,426, an increase of $68, or 0.8%, from $8,358 in the year of 2006. The Corporation’s net interest margin for the year ended June 30, 2007 was 4.67%, an increase of 2 basis points from 2006. Interest income for the year of 2007 was $12,338, an increase of $951, or 8.4%, from $11,387 in the year of 2006. This increase was mainly due to an increase in the yield on loans of 61 basis points from 2006 to 2007. The yield on loans was positively impacted as variable rate loans within the portfolio repriced upward to higher market rates. Interest expense for the year of 2007 was $3,912, an increase of $883, or 29.2%, from $3,029 in the year of 2006. This increase was mainly caused by higher market rates affecting the rates paid on time deposits and borrowings. The Corporation’s net interest margin remains higher than most other banks in Ohio due to a higher than average commercial mortgage portfolio and our low cost of funds.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Three-Year Average Balance Sheet and Net Interest Margin
(1) Calculated on a fully taxable equivalent basis
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
The following table presents the changes in the Corporation’s interest income and interest expense resulting from changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities. Changes attributable to both rate and volume that cannot be segregated have been allocated in proportion to the changes due to rate and volume.
INTEREST RATES AND INTEREST DIFFERENTIAL
(1) Nontaxable income is adjusted to a fully tax equivalent basis utilizing a 34% tax rate.
(2) Non-accrual loan balances are included for purposes of computing the rate and volume effects although interest on these balances has been excluded.
Provision for Loan Losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents management’s assessment of the estimated probable credit losses inherent in the Corporation’s loan portfolio that have been incurred at each balance sheet date. The provision for loan losses was $430 in fiscal year 2008 compared to $728 in fiscal year 2007 and $730 in fiscal year 2006. The lower provision for loan losses in 2008 mainly resulted from net charge-offs declining to their lowest level in five years. Net charge-offs and the net charge-off ratio were $102 and 0.07%, respectively, for 2008 compared with $904 and 0.64%, respectively, for the same period last year. In 2007, the $728 provision for loan losses mainly resulted from net charge-offs that were taken during the same period. A portion of the 2007 net charge-offs were related to a loan that had been specifically allocated for within the allowance for loan loss in a prior period when the probable loss had been identified. The provision for loan losses for the twelve month period ended June 30, 2006 resulted from an increase in net charge-offs and an increase in non-performing loans.
Net charge-offs were $102 during fiscal year 2008 and were mainly within the installment loan portfolio. Net charges-offs were $904 and $696 for 2007 and 2006, respectively, and were mainly within the commercial, financial and agricultural portfolio. Net charge-offs for 2007 included a total of $669 related to one loan relationship that was secured by two multi-family rental unit properties.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Non-performing loans as a percentage of total loans increased from 0.68% as of June 30, 2007 to 0.94% as of June 30, 2008. The increase in non-performing loans from June 30, 2007 to June 30, 2008 was primarily related to an increase in non-accrual loans within the residential real estate portfolio. Non-performing loans have been considered in management’s analysis of the appropriateness of the allowance for loan losses. Management and the Board of Directors are closely monitoring these loans and believe that the prospects for recovery of principal, less identified specific reserves, are good.
Given the recent uncertainty in the housing market, management completed a review of the Bank’s residential real estate mortgage portfolio to determine its exposure to subprime loans. A detailed analysis of the Bank’s home equity portfolio was completed since this portfolio would be the most affected by a decline in home values. A majority of the Bank’s home equity loans were originated at 85% or less of the home value with a small number of loans originated at 90% of the home value with the additional requirements of a higher minimum credit score and a lower debt-to-income ratio. Delinquency within the real estate portfolio remains below our peer group.
Other Income. Total other income primarily includes service charges on deposit accounts, debit card interchange income and other miscellaneous income. Service charges on deposit accounts increased by $187, or 12.5%, in 2008 to $1,679 from $1,492 mainly from an increase in overdrawn account fee income due to higher volume. In 2007, service charges on deposit accounts declined slightly to $1,492 from $1,540 due to a decline in overdrawn account fee income. Debit card interchange income increased in 2008 to $407 from $317 and $269 for fiscal years ended 2007 and 2006, respectively due to increased volume. Alternative investment income, which is income from investment banking, advisory, brokerage, and underwriting, declined to $22 in 2008 from $179 in 2007. Alternative investment income declined in 2008 due to the program being without a full-time Financial Consultant for much of the year. This program had an impact on other income in 2007, and we believe it will be an important component of earnings in the future.
Gains recognized on the sale of securities totaled $26 during 2008 and $24 during 2007. There were no security gains recognized in 2006. During 2008 and 2006, gains of $13 and $6, respectively were recognized on the sale of other real estate owned, which represents property acquired by the Corporation as a result of loan foreclosure, or by deed in lieu of foreclosure. A loss of $181 was recognized in 2007 from the sale of other real estate owned.
Other Expenses. Total other expenses were $8,592 for the year ended June 30, 2008; an increase of $276, or 3.3% from $8,316 for the year ended June 30, 2007, which had declined $37, or 0.4%, from $8,353 for the year ended June 30, 2006.
Salary and employee benefit expenses increased $65, or 1.5%, during the fiscal year ended June 30, 2008 and decreased $26, or 0.6%, during the fiscal year ended June 30, 2007.
The amortization of the intangible is directly related to the purchase premium of the Lisbon, Ohio branch that was purchased in January 2000.
Debit card processing expenses increased $124 during the 2008 fiscal year. Approximately $89 of this increase was associated with one-time expenses due to the migration to a new regional electronic funds transfer processor that was completed during the third quarter of fiscal year 2008. The remaining portion of the increase was due to increased volume.
Other expense totaled $1,634 for the year ended June 30, 2008, an increase of $94, or 6.1%, from $1,540 for the year ended June 30, 2007. Other expense increased by $51, or 3.4%, from 2006 to 2007. A data system upgrade of the main core processing system was completed during the third quarter of fiscal year 2008. As part of this upgrade, $102 of expenses were incurred and included within other expenses for the 2008 fiscal year. As a result of these changes, long-term cost savings are projected through reduced personnel expense, lower future capital expenditures and reduced expenses related to electronic funds transfer processing.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Income Tax Expense. The provision for income taxes totaled $493, $273 and $268 for the years ended June 30, 2008, 2007 and 2006, respectively. The effective tax rates were 21.5%, 17.8% and 18.5%, respectively. The effective tax rate differed from the federal statutory rate principally as a result of tax-exempt income from obligations of states and political subdivisions, loans and earnings on bank owned life insurance.
Financial Condition
Total assets at June 30, 2008 were $233,077 compared to $201,958 at June 30, 2007, an increase of $31,119, or 15.4%. The increase in total assets is mainly attributed to an increase in loans of $10,903, or 7.7%, and available-for-sale securities of $17,079, or 40.5%.
Securities. Available-for-sale securities increased by $17,079 from $42,133 at June 30, 2007 to $59,212 at June 30, 2008 mainly due to two specific strategies that were implemented in the second quarter of fiscal year 2008. First, the Bank implemented a leveraged transaction in order to take advantage of low cost funding available through the FHLB to purchase $4,000 of mortgage-backed securities and $1,300 of municipal securities. The FHLB funding is at a cost of 3.24% and is callable two years from the date of issue. The securities purchased have a projected average tax equivalent yield of 5.30%.
The second strategy the Bank implemented was the purchase of securities in November 2007, at a time management believed rates were at their peak, in anticipation of cash flow that will be received from the securities portfolio in calendar year 2008 and 2009. As part of this strategy, a $1,500 U.S. Government sponsored entity security, $4,700 of mortgage-backed securities and $800 of municipal securities were purchased at a projected average tax equivalent yield of 5.60%.
The following table sets forth certain information regarding the amortized cost and fair value of the Corporation’s securities at the dates indicated.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
The following tables summarize the amounts and distribution of the Corporation’s securities held and the weighted average yields as of June 30, 2008:
The weighted average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. The weighted average yield on tax-exempt obligations has been calculated on a tax equivalent basis. Average yields are based on amortized cost balances.
At June 30, 2008, trust preferred securities, which represent pooled trust preferred securities, had an amortized cost of $985 and a market value of $741. Based on management’s evaluation of the trust preferred securities, it is believed the decline in market value is temporary due to current market conditions. The Corporation has the intent and ability to hold these securities until the fair value is recovered, which may be maturity, and therefore, does not consider them to be other-than-temporarily impaired at June 30, 2008. Management will continue to monitor this security for any impairment.
At June 30, 2008, available for sale securities included municipal securities issued by Farmersville Texas school district that are insured by Permanent School Fund Guarantee with an aggregate book value of $2,126, or 10.9%, of shareholders’ equity. Other than this issuance, there were no other holdings of securities of any one issuer, other than the U.S. government and its agencies and corporations, with an aggregate book value which exceeds 10% of shareholders’ equity.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Loans. Loan receivables increased by $10,903 to $152,350 at June 30, 2008 compared to $141,447 at June 30, 2007, with the commercial, financial and agriculture loan portfolio increasing by $7,155. As of June 30, 2008, real estate construction loans included $4,896 of owner-occupied commercial loans, $1,092 of nonowner-occupied commercial loans and $416 of owner-occupied residential real estate loans. The increase in loan receivables is mainly attributable to a more favorable rate environment and more aggressive calling efforts by the lending officers.
Major classifications of loans were as follows as of June 30:
The following is a schedule of contractual maturities and repayments of real estate construction, commercial, financial and agricultural loans, as of June 30, 2008:
The following is a schedule of fixed and variable rate real estate construction, commercial, financial and agricultural loans due after one year (variable rate loans are those loans with floating or adjustable interest rates) as of June 30, 2008:
Foreign Outstandings-there were no foreign outstandings during the periods presented. There are no concentrations of loans greater than 10% of total loans, which are not otherwise disclosed as a category of loans.
Allowance for Loan Losses. The allowance for loan losses balance and the provision charged to expense are judgmentally determined by management based upon the periodic review of the loan portfolio, an analysis of impaired loans, past loan loss experience, economic conditions, anticipated loan portfolio growth, and various other circumstances which are subject to change over time. In making this judgment, management reviews selected large loans as well as delinquent loans, non-accrual loans, problem loans, and loans to industries experiencing economic difficulties. The collectability of these loans is evaluated after considering the current financial position of the borrower, the estimated market value of the collateral, guarantees and the Corporation’s collateral position versus other creditors. Judgments, which are necessarily subjective, as to the probability of loss and the amount of such loss, are formed on these loans, as well as other loans in the aggregate.
Failure to receive principal and interest payments when due on any loan results in efforts to restore such loan to a current status. Loans are classified as non-accrual when, in the opinion of management, full collection of principal and accrued interest is in doubt. The loans must be brought and kept current for six sustained payments before being considered for removal from non-accrual status. Continued unsuccessful collection efforts generally lead to initiation of foreclosure or other legal proceedings.
Properties acquired by the Corporation as a result of foreclosure, or by deed in lieu of foreclosure, are classified as “other real estate owned” until such time as they are or otherwise disposed. As of June 30, 2008, there were no properties classified as other real estate owned. Non-performing loans are either in the process of foreclosure or efforts are being made to work with the borrower to bring the loan current.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
The following schedule summarizes non-accrual, past due, and impaired loans for the years ended June 30:
There were no restructured loans for the periods presented. For June 30, 2008, all of the impaired loans were also included in non-accrual loans.
Potential Problem Loans. There were no loans, not otherwise identified above, included on management’s watch or troubled loan lists that management has serious doubts as to the ability of such borrowers to comply with the loan repayment terms. Management’s watch and troubled loan lists includes loans which management has some doubt as to the borrowers’ ability to comply with the present repayment terms, loans which management is actively monitoring due to changes in the borrowers financial condition and other loans which management wants to more closely monitor due to special circumstances. These loans and their potential loss exposure have been considered in management’s analysis of the adequacy of the allowance for loan losses.
The following table summarizes the Corporation’s loan loss experience, and provides a breakdown of the charge-off, recovery and other activity for the years ended June 30:
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and related ratios:
While management’s periodic analysis of the adequacy of the allowance for loan loss may allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge-off that may occur. During 2006, the 2005 unallocated portion of the allowance for loan losses was allocated within the allowance for loan losses to the various loan types.
Funding Sources. Total deposits increased $19,253, or 11.4%, from $169,591 at June 30, 2007 to $188,844 at June 30, 2008. Non-interest bearing deposits increased $2,310, or 5.5%, and interest-bearing checking balances increased $3,212, or 31.8%, from June 30, 2007 to June 30, 2008. Time deposits increased $10,247, or 15.0%, and savings deposits increased $3,484, or 7.1%, from June 30, 2007 to June 30, 2008. We believe commercial and retail customers are turning to community banking in these uncertain times and this trend is reflected in the increase in the deposit balances.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
The following is a schedule of average deposit amounts and average rates paid on each category for the periods included:
The following table summarizes time deposits issued in amounts of $100 or more as of June 30, 2008 by time remaining until maturity:
See Note 7-Short-Term Borrowings to the Consolidated Financial Statements, for information concerning short-term borrowings.
Shareholders’ equity. Total shareholders’ equity increased by $789 from $18,782 at June 30, 2007 to $19,571 at June 30, 2008. The increase was primarily due to net income of $1,803 for the current fiscal year. This increase was partially offset by cash dividends paid and an increase in treasury stock of $424.
The share repurchase plan that was approved by the Board of Directors in June 2007 ended with 35,876 shares purchased of the 75,000 shares that were authorized for repurchase.
Liquidity
Management considers the asset position of the Bank to be sufficiently liquid to meet normal operating needs and conditions. The Bank’s earning assets are divided primarily between loans and available-for-sale securities, with any excess funds placed in federal funds sold on a daily basis.
Net cash from operating activities for the 2008 fiscal year were $3,347, net cash from investing activities was $(30,941) and net cash from financing activities was $28,673. The major sources of cash were $19,253 net increase in deposits, $7,976 net increase in FHLB advances and $10,344 from sales, maturities or principal pay downs on available-for-sale securities. The major uses of cash were the $27,171 purchase of securities and a $10,785 net increase in loans. Total cash and cash equivalents was $6,637 as of June 30, 2008 compared to $5,558 at June 30, 2007.
The Bank groups its loan portfolio into three major categories: real estate loans; commercial, financial and agricultural loans; and consumer loans. The Bank’s real estate loan portfolio consists of three basic segments: conventional mortgage loans having fixed rates for terms not longer than fifteen years, variable rate home equity line of credit loans and fixed rate loans having maturity or renewal dates that are less than the scheduled amortization period. Commercial, financial and agricultural loans are comprised of both variable rate notes subject to interest rate changes based on the prime rate and fixed rate notes having maturities of generally not greater than five years. Personal loans offered by the Bank are generally written for periods of up to five years, based on the nature of the collateral. These may be either installment loans having regular monthly payments or demand type loans for short periods of time.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Funds not allocated to the Bank’s loan portfolio are invested in various securities having diverse maturity schedules. The majority of the Bank’s securities are held in obligations of U.S. Government sponsored entities, mortgage-backed securities, and investments in tax free municipal bonds.
The Bank offers several forms of deposit products to its customers. The rates offered by the Bank and the fees charged for them are competitive with others available currently in the market area. While the Bank continues to be under competitive pressures in the Bank’s market area as financial institutions attempt to attract and keep new deposits, many commercial and retail customers have been turning to community banking in these uncertain times. Time deposit interest rates began to decline in the later half of the second quarter of the 2008 fiscal year. Compared to our peers, the Corporation’s cost of funds still remains at a relatively low level at 2.98%.
Jumbo time deposits (those with balances of $100 and over) increased from $19,972 at June 30, 2007 to $23,715 at June 30, 2008. These deposits are monitored closely by the Bank and typically priced on an individual basis. When these deposits are from a municipality, certain bank-owned securities are pledged to guarantee the safety of these public fund deposits as required by Ohio law. The Corporation has the option to use a fee paid broker to obtain deposits from outside its normal service area as an additional source of funding. However, these deposits are not relied upon as a primary source of funding and the Bank can foresee no dependence on these types of deposits in the near term.
The net interest margin is monitored monthly. It is the Bank’s goal to maintain the net interest margin at 4.0% or greater. The net interest margin on a tax equivalent basis for 2008 was 4.48% as compared to 4.67% for 2007 and 4.65% in 2006.
Capital Resources
At June 30, 2008, management believes the Bank complied with all regulatory capital requirements. Based on the Bank’s computed regulatory capital ratios, the Office of the Comptroller of the Currency has determined the Bank to be well capitalized under the Federal Deposit Insurance Act as of its latest exam date. The Bank’s actual and required capital amounts are disclosed in Note 11 of the consolidated financial statements. Management is not aware of any matters occurring subsequent to that exam that would cause the Bank’s capital category to change.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and results of operations primarily in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of the Corporation are monetary in nature. Therefore, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. The liquidity, maturity structure and quality of the Corporation’s assets and liabilities are critical to the maintenance of acceptable performance levels.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Critical Accounting Policies
The financial condition and results of operations for Consumers Bancorp, Inc. presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the Corporation’s accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
Presented below is a discussion of the accounting policy that management believes is the most important to the portrayal and understanding of the Corporation’s financial condition and result of operations. This policy requires management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. Also, see Note 1 of the Notes to Consolidated Financial Statements for additional information related to significant accounting policies.
Allowance for Loan Losses. Management periodically reviews the loan portfolio in order to establish an estimated allowance for loan losses (allowance) that are probable as of the respective reporting date. Additions to the allowance are charged against earnings for the period as a provision for loan losses. Actual loan losses are charged against the allowance when management believes that the collection of principal will not occur. Unpaid interest for loans that are placed on non-accrual status is reversed against current interest income.
The allowance is regularly reviewed by management to determine whether or not the amount is considered adequate to absorb probable losses. If not, an additional provision is made to increase the allowance. This evaluation includes specific loss estimates on certain individually reviewed loans, loss estimates for loan groups or pools that are based on historical loss experience and general loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and current economic and industry conditions, among other things. The allowance is also subject to periodic examination by regulators whose review includes a determination as to its adequacy to absorb potential losses.
Those judgments and assumptions that are most critical to the application of this accounting policy are the initial and on-going credit-worthiness of the borrower, the amount and timing of future cash flows of the borrower that are available for repayment of the loan, the sufficiency of underlying collateral, the enforceability of third-party guarantees, the frequency and subjectivity of loan reviews and risk grading, emerging or changing trends that might not be fully captured in the historical loss experience, and charges against the allowance for actual losses that are greater than previously estimated. These judgments and assumptions are dependent upon or can be influenced by a variety of factors including the breadth and depth of experience of lending officers, credit administration and the loan review staff that periodically review the status of the loan, changing economic and industry conditions, changes in the financial condition of the borrower, and changes in the value and availability of the underlying collateral and guarantees.
While the Corporation strives to reflect all known risk factors in its evaluations, judgment errors may occur. If different assumptions or conditions were to prevail, the amount and timing of interest income and loan losses could be materially different. These factors are most pronounced during economic downturns. Since, as described above, so many factors can affect the amount and timing of losses on loans it is difficult to predict, with any degree of certainty, the affect on income if different conditions or assumptions were to prevail.
Valuation of Securities. The portfolio of available-for-sale securities is reported at fair value. The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual security, such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer, and the Corporation’s ability to hold the security to maturity. A decline in value that is considered to be other-than-temporary would be recorded as a loss within other income in the consolidated statements of income.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Quantitative and Qualitative Disclosures about Market Risk
The Bank measures interest-rate risk from the perspectives of earnings at risk and value at risk. The primary purpose of both the loan and securities portfolios is the generation of income. Credit risk is the principal focus of risk analysis in the loan portfolio, while interest-rate risk is the principal focus in the securities portfolio. The securities portfolio is the vehicle used to manage both interest-rate and liquidity risk. The Bank monitors interest rate risk position using simulation analysis of net interest income and net income over a two-year period. The Bank also calculates the effect of an instantaneous change in market interest rates on the economic value of equity or net portfolio value. Once these analyses are complete, management reviews the results, with an emphasis on the income-simulation results for purposes of managing interest-rate risk. The rate sensitivity position is managed to avoid wide swings in net interest margins. Measurement and identification of current and potential interest rate risk exposures is conducted quarterly, with reporting and monitoring also occurring quarterly. The Bank applies interest rate shocks to its financial instruments up and down 50, 100, 200, and 300 basis points. In 2008, the guidelines for the one year change in net interest income and the change in net present value of equity were updated to be more reflective of industry standards for the peer group management uses for comparison purposes.
The projected volatility of net interest income to a +200 and -100 basis points change for all quarterly models during 2008 and 2007 fell within the Board of Directors guidelines for net interest income change. The projected volatility of the net present value of equity to a +200 basis points change in market interest rates is slightly outside of the policy guidelines in 2008. This was mainly caused by widening spreads on government sponsored entity securities. The widening spreads caused more depreciation within the portfolio as rates rise.
The following table presents an analysis of the potential sensitivity of the Bank’s annual net interest income and present value of the Bank’s financial instruments to sudden and sustained increase or decrease of 100 and 200 basis points change in market interest rates:
The preceding analysis is based on numerous assumptions, including relative levels of market interest rates, loan prepayments and reactions of depositors to changes in interest rates, and should not be relied upon as being indicative of actual results. Further, the analysis does not necessarily contemplate all actions the Bank may undertake in response to changes in interest rates.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS-(continued)
(Dollars in thousands, except per share data)
Contractual Obligations, Commitments and Contingent Liabilities
The following table presents, as of June 30, 2008, the Corporation’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.
Note 12 to the Consolidated Financial Statements discusses in greater detail other commitments and contingencies and the various obligations that exist under those agreements. These commitments and contingencies consist primarily of commitments to extend credit to borrowers under lines of credit.
Off-Balance Sheet Arrangements
At June 30, 2008, the Corporation had no unconsolidated, related special purpose entities, nor did the Corporation engage in derivatives and hedging contracts, such as interest rate swaps, which may expose the Corporation to liabilities greater than the amounts recorded on the consolidated balance sheet. The Corporation’s investment policy prohibits engaging in derivative contracts for speculative trading purposes; however, in the future, the Corporation may pursue certain contracts, such as interest rate swaps, in an effort to execute a sound and defensive interest rate risk management policy.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this section appears under the caption “Quantitative and Qualitative Disclosures about Market Risk” located in Item 7 on page 24 of this Report.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Consumers Bancorp, Inc.
Minerva, Ohio
We have audited the accompanying consolidated balance sheets of Consumers Bancorp, Inc. as of June 30, 2008 and 2007 and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended June 30, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumers Bancorp, Inc. as of June 30, 2008 and 2007 and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2008, in conformity with U. S. generally accepted accounting principles.
As discussed in Note 1, the Company adopted Staff Accounting Bulletin 108, “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements” and accordingly adjusted assets and liabilities at the beginning of fiscal 2007 with an offsetting adjustment to the opening balance of retained earnings.
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Columbus, Ohio
August 29, 2008
CONSUMERS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
As of June 30, 2008 and 2007
(Dollar amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSUMERS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSUMERS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSUMERS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2008, 2007 and
(Dollar amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unless otherwise indicated, dollar amounts are in thousands, except per share data.
Principles of Consolidation: The consolidated financial statements include the accounts of Consumers Bancorp, Inc. (Corporation) and its wholly owned subsidiary, Consumers National Bank (Bank). All significant intercompany transactions have been eliminated in the consolidation.
Business Segment Information: Consumers Bancorp, Inc. is a bank holding company engaged in the business of commercial and retail banking, which accounts for substantially all of its revenues, operating income, and assets. Accordingly, all of its operations are reported in one segment, banking.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments, and determination of other-than-temporary impairment of securities are particularly subject to change.
Cash Reserves: The Bank is required by the Federal Reserve to maintain reserves consisting of cash on hand and non-interest bearing balances on deposit with the Federal Reserve Bank. The required reserve balance at June 30, 2008 and 2007 was $1,923 and $1,724, respectively.
Securities: Securities are generally classified into either held-to-maturity or available-for-sale categories. Held-to-maturity securities are those that the Corporation has the positive intent and ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those that the Corporation may decide to sell if needed for liquidity, asset-liability management, or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains or losses included in other comprehensive income as a separate component of equity, net of tax. Other securities, such as Federal Home Loan Bank stock, are carried at cost. Securities are written down to fair value when a decline in fair value is other-than-temporary.
Realized gains or losses on sales are determined based on the amortized cost of the specific security sold. Amortization of premiums and accretion of discounts are computed under a system materially consistent with the level yield method and are recognized as adjustments to interest income. Prepayment activity on mortgage-backed securities is affected primarily by changes in interest rates. Yields on mortgage-backed securities are adjusted as prepayments occur through changes to premium amortization or discount accretion.
Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating, other-than-temporary losses, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, and the Corporation’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Federal Home Loan Bank (FHLB) stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security and periodically evaluated for impairment based on ultimate recovery of par value. Since this stock is viewed as a long-term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Loans: Loans are reported at the principal balance outstanding, net of unearned income, deferred loan fees and costs, and an allowance for loan losses. Interest income is reported on the interest method and includes
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 120 days delinquent unless the loan is well-secured and in the process of collection. Consumer loans are typically charged off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received on loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when the customer has exhibited the ability to repay and demonstrated this ability over a six month period and future payments are reasonably assured.
Concentrations of Credit Risk: The Bank grants consumer, real estate and commercial loans primarily to borrowers in Stark, Columbiana and Carroll counties. Automobiles and other consumer assets, business assets and residential and commercial real estate secure most loans.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and decreased by charge-offs, less recoveries. Management estimates the allowance balance required based on past loan loss experience, known and probable losses in the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
Loan impairment is reported when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer loans and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected from the collateral. Loans are evaluated for impairment when payments are delayed, typically 90 days or more, or when it is probable that not all principal and interest amounts will be collected according to the original terms of the loan.
Cash Surrender Value of Life Insurance: The Bank has purchased single-premium life insurance policies to insure the lives of current and former participants in the salary continuation plan. As of June 30, 2008, the Bank had policies with total death benefits of $10,120 and total cash surrender values of $4,452. As of June 30, 2007, the Bank had policies with total death benefits of $9,972 and total cash surrender values of $4,290. The amount included in income (net of policy commissions and mortality costs) was $162, $151 and $145 for the years ended June 30, 2008, 2007 and 2006, respectively.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). This issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the Issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. This Issue is effective for fiscal years beginning after December 15, 2006. The adoption of EITF 06-5 had no impact on the Corporation’s financial condition or results of operation.
Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful life of the owned asset and, for leasehold improvements, generally over the lesser of the remaining term of the lease facility or the estimated economic life of the improvement. Useful lives range from three years for software to thirty-nine and one-half years for buildings.
Intangible Assets: Core deposit intangible is recorded at cost and is amortized over an estimated life of 12 years on a straight line method. Intangibles are assessed annually for impairment and written down as necessary.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Long-term Assets: Premises and equipment, core deposit and other intangible assets and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Other Real Estate Owned: Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value less costs to sell at the date of acquisition. Any reduction to fair value from the carrying value of the related loan at the time of acquisition is accounted for as a loan loss. After acquisition, a valuation allowance reduces the reported amount to the lower of the initial amount or fair value less costs to sell. Expenses, gains and losses on disposition, and changes in the valuation allowance are reported as a charge to income.
Repurchase Agreements: Substantially all repurchase agreement liabilities, which are classified as short-term borrowings, represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Profit Sharing Plan: The Bank maintains a 401(k) profit sharing plan covering all eligible employees. Contributions are made and expensed annually.
Income Taxes: The Corporation files a consolidated federal income tax return. Income tax expense is the sum of the current-year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of July 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no effect on the Company’s financial statements.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.
Earnings and Dividends Declared per Share: Earnings per common share are computed based on the weighted average common shares outstanding. The weighted average number of common shares outstanding was 2,043,489; 2,105,656 and 2,142,479 for the years ended June 30, 2008, 2007 and 2006, respectively. The Corporation’s capital structure contains no dilutive securities.
Statement of Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include the Corporation’s cash on hand and due from banks. The Corporation reports net cash flows for customer loan, deposit, Federal Funds sold or purchased, and repurchase agreement transactions. The Bank paid $4,605, $3,987 and $2,950 in interest and $460, $225, and $300 in income taxes for the years ended June 30, 2008, 2007 and 2006, respectively.
Comprehensive Income (loss): Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Dividend Restrictions: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the holding company or by the holding company to shareholders. As of June 30, 2008 the Bank could, without prior approval, declare a dividend of approximately $684.
Adoption of New Accounting Standards: In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which is effective for fiscal years ending on or after November 15, 2006. SAB No. 108 provides guidance on how the effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. SAB No.108 requires public companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain) approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior years errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under the method previously used, but now considered material under the dual approach required by SAB No. 108, are to be recorded upon initial adoption of SAB No. 108. The amount so recorded is shown as a cumulative effect adjustment in opening retained earnings as of July 1, 2006. Included in this cumulative effect adjustment are the following items and amounts:
Vacation accrual: The Corporation under accrued vacation expense over several prior years. The annual under accrual that occurred in prior periods was insignificant to any given prior period’s earnings. The accumulation of these annual under accruals totaled $129, net of tax, as of July 1, 2006.
Effect of Newly Issued But Not Yet Effective Accounting Standards: In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management has not completed its evaluation of the impact of adoption of this standard.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Assets and Financial Liabilities. This statement allows entities the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities. Subsequent changes in fair value of the financial assets and liabilities would be recognized in earnings when they occur. This pronouncement also establishes certain additional disclosure requirements. It is effective as of the beginning of the first fiscal year beginning after November 15, 2007. The Company did not elect the fair value option for any financial asset or financial liability as of July 1, 2008.
In July 2006, the Emerging Issues Task Force (“EITF”) of FASB issued a draft abstract for EITF Issue No. 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangement.” This draft abstract from EITF reached a consensus that for an endorsement split-dollar life insurance arrangement within the scope of this Issue, an employer should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” The Task Force concluded that a liability for the benefit obligation under SFAS No. 106 has not been settled through the purchase of an endorsement type life insurance policy. In September 2006, FASB agreed to ratify the consensus reached in EITF Issue No. 06-04. This new accounting standard will be effective for fiscal years beginning after December 15, 2007. At June 30, 2008, the Corporation owned $4,452 of bank owned life insurance. However, these life insurance policies are not subject to endorsement split-dollar life insurance arrangements. Therefore, management does not expect the adoption of EITF Issue No. 06-4 to have a material impact on the Corporation’s financial statements.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). Previously, SAB 105, Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The adoption of this standard did not have a material impact of the financial statements.
Reclassifications: Certain reclassifications have been made to the June 30, 2007 and 2006 financial statements to be comparable to the June 30, 2008 presentation.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 2-SECURITIES
The following table sets forth certain information regarding the amortized cost and fair value of the Corporation’s securities at the dates indicated.
Securities with a carrying value of approximately $27,560 and $26,145 were pledged at June 30, 2008 and 2007, respectively, to secure public deposits and commitments as required or permitted by law.
Proceeds from sales of all equity and debt securities during 2008 and 2007 were $4,783 and $1,922, respectively. During 2008, gross gains of $35 and gross losses of $9 were recognized. During 2007, gross gains were $24 with no losses recognized. There were no sales of equity or debt securities during 2006.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Securities with unrealized losses at June 30, 2008 and 2007, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
Unrealized losses on securities have not been recognized into income because the issuer(s) of the securities are of high credit quality and the decline in fair value is primarily due to changes in interest rates and current market conditions. Management has the ability and intent to hold these securities for the foreseeable future. The fair value is expected to recover as the securities approach their maturity dates including the trust preferred securities which represent pooled trust preferred securities with a stated final maturity.
The fair values of debt securities available-for-sale at June 30, 2008 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities and trust preferred securities, are shown separately.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 3-LOANS
Major classifications of loans were as follows as of June 30:
The changes in the allowance for loan losses consists of the following for the years ended June 30:
Impaired loans were as follows as of June 30:
As of June 30, 2008, all impaired loans had a specific allowance for loan loss allocation.
Nonperforming loans were as follows:
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
The Bank has granted loans to certain of its executive officers, directors and their affiliates. A summary of activity during the year ended June 30, 2008 of related party loans were as follows:
NOTE 4-PREMISES AND EQUIPMENT
Major classifications of premises and equipment were as follows as of June 30:
Depreciation was $570, $568 and $580 for the years ended June 30, 2008, 2007 and 2006, respectively.
The Corporation is obligated under non-cancelable operating leases for facilities and equipment. The approximate minimum annual rentals and commitments under these non-cancelable agreements and leases with remaining terms in excess of one year are as follows:
Rent expense incurred during the fiscal years ended June 30, 2008, 2007 and 2006 was $96, $96 and $81, respectively.
During the 2006 fiscal year, Consumers National Bank entered into an operating lease agreement for the Malvern branch location. The lessor of the property is a member of the Corporation’s Board of Directors. The initial term of the lease is a period of ten years. The base rent through the end of the fifth year is one percent of the total Project Cost, as defined in the lease agreement. At the beginning of year six, the rent to be paid shall be increased in accordance with the change in the Consumers Price Index. For years one through five, the estimated annual lease expense is $32 per year.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 5-INTANGIBLE ASSETS
The following summarizes the original balance and accumulated amortization of core deposit intangible assets at June 30, 2008 and 2007:
Amortization expense for the years ended June 30, 2008, 2007 and 2006 was $161 for each year. Amortization expense is estimated to be $161 for each of the next three years and $89 in year four.
NOTE 6-DEPOSITS
The aggregate amount of time deposits, each with a minimum denomination of $100, was $23,715 and $19,972 as of June 30, 2008 and 2007, respectively.
Scheduled maturities of time deposits at June 30, 2008 were as follows:
Related party deposits totaled $3,864 as of June 30, 2008 and $2,610 as of June 30, 2007.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 7-SHORT-TERM BORROWINGS
Short-term borrowings consisted of Federal funds purchased and repurchase agreements. Repurchase agreements are financing arrangements. Physical control is maintained for all securities pledged to secure repurchase agreements. Information concerning all short-term borrowings at June 30, maturing in less than one year is summarized as follows:
Repurchase agreements mature daily. The Bank has pledged obligations of government sponsored entities and mortgage-backed securities with a carrying value of $16,750 at June 30, 2008, as collateral for the repurchase agreements. Total interest expense on short-term borrowings was $386, $186 and $134 for the years ended June 30, 2008, 2007 and 2006, respectively.
NOTE 8-FEDERAL HOME LOAN BANK ADVANCES
A summary of Federal Home Loan Bank (FHLB) advances were as follows:
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Each fixed rate advance has a prepayment penalty equal to the present value of 100% of the lost cash flow based upon the difference between the contract rate on the advance and the current rate on the new advance. The following table is a summary of the scheduled principal payments for all advances:
Pursuant to collateral agreements with the FHLB, advances are secured by all the stock invested in the FHLB and certain qualifying first mortgage loans. As of June 30, 2008, the Bank could borrow a total of $23,596 in advances based on the amount of FHLB stock owned. Qualifying first mortgage loans available to secure FHLB advances totaled approximately $33,180 and $36,835 at June 30, 2008 and 2007, respectively.
NOTE 9-EMPLOYEE BENEFIT PLANS
The Bank has a 401(k) savings and retirement plan available for substantially all eligible employees. Under the plan, the Bank is required to match each participant’s voluntary contribution to the plan but not to exceed four percent of the individual’s compensation. Amounts charged to operations were $103, $101 and $84, for the years ended June 30, 2008, 2007 and 2006, respectively.
The Bank has adopted a Salary Continuation Plan (the “Plan”) to encourage Bank executives to remain employees of the Bank. The Plan provide such executives (and, in the event of the executive’s death, surviving beneficiary) with 180 months of salary continuation payments equal to a certain percentage of an executive’s average compensation, as defined within each agreement, for the three full calendar years prior to Normal Retirement Age. For purposes of the Plan, “Normal Retirement Age” means the executive’s 65th birthday. Vesting under the Plan commences at age 50 and is prorated until age 65. If an executive dies during active service, the executive’s beneficiary is entitled to the Normal Retirement Benefit. The executive can become fully vested in the Accrual Balance upon termination of employment following a disability or a change in control of the Bank. For purposes of the Plan, “Accrual Balance” means the liability that should be accrued by the Company for the Company’s obligation to the executive under the Plan. For purposes of calculating the Accrual Balance, the discount rate in effect at June 30, 2008 was 6.0%. The accrued liability for the salary continuation plan was $874 as of June 30, 2008 and $721 as of June 30, 2007. For the years ended June 30, 2008, 2007 and 2006, approximately $169, $148 and $137, respectively, have been charged to expense in connection with the Plan.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 10-INCOME TAXES
The provision for income taxes consists of the following for the years ended June 30:
The net deferred income tax asset consists of the following components at June 30:
The difference between the provision for income taxes and amounts computed by applying the statutory income tax rate of 34% to statutory income before taxes consists of the following for the years ended June 30:
The adoption of FIN 48 at July 1, 2007 had no impact on the Corporation’s financial statements. At July 1, 2007 and June 30, 2008, the Corporation had no FIN 48 unrecognized tax benefits recorded. The Corporation does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months.
The Corporation and the Bank are subject to U.S. federal income tax as an income-based tax and a capital-based franchise tax, respectively, in the state of Ohio. The Corporation and the Bank are no longer subject to examination by taxing authorities for years before 2004.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 11-REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.
As of fiscal year-end 2008, the Corporation met the definition of a small bank holding company and, therefore was exempt from consolidated risk-based and leverage capital adequacy guidelines for bank holding companies. At year-end 2008 and 2007, actual Bank capital levels (in millions) and minimum required levels were as follows:
As of the latest regulatory examination, the Bank was categorized as well capitalized. There are no conditions or events since that examination that management believes may have changed the Bank’s category.
The Corporation’s principal source of funds for dividend payment is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. As of June 30, 2008 the Bank could, without prior approval, declare a dividend of approximately $684.
NOTE 12-COMMITMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to commitments to extend credit in the normal course of business to meet the financing needs of its customers. Commitments are agreements to lend to customers providing there are no violations of any condition established in the contract. Commitments to extend credit have a fixed expiration date or other termination clause. These instruments involve elements of credit and interest rate risk more than the amount
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
recognized in the statements of financial position. The Bank uses the same credit policies in making commitments to extend credit as it does for on-balance sheet instruments.
The Bank evaluates each customer’s credit on a case by case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. The amount of commitments to extend credit and the exposure to credit loss for non-performance by the customer was $23,545 and $23,470 as of June 30, 2008 and 2007, respectively. Of the June 30, 2008 commitments, $21,656 carried variable rates of interest ranging from 3.75% to 10.00% and $1,889 carried fixed rates of interest ranging from 4.00% to 7.75%. Of the June 30, 2007 commitments, $17,934 carried variable rates of interest ranging from 4.75% to 11.25% and $5,536 carried fixed rates of interest ranging from 4.37% to 9.25%. Financial standby letters of credit were $1,218 and $2,327 as of June 30, 2008 and 2007, respectively. In addition, commitments to extend credit of $6,288 and $4,762 as of June 30, 2008 and 2007, respectively, were available to checking account customers related to the overdraft protection program. Since some loan commitments expire without being used, the amount does not necessarily represent future cash commitments.
During 2008 the Bank contracted with a new regional electronic funds transfer processor and a data service provider. For the 2009 fiscal year, the total amount of expense associated with these contracts is expected to approximate $765 and is expected to be a comparable amount through the end of the contracts.
NOTE 13-FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The following table shows the estimated fair value at June 30, 2008 and 2007, and the related carrying value of financial instruments:
For purposes of the above disclosures of estimated fair value, the following assumptions were used. Estimated fair value for cash and due from banks and federal funds sold were considered to approximate cost. Estimated fair value of securities was based on quoted market values for the individual securities or equivalent securities. Fair value for loans was estimated for portfolios of loans with similar financial characteristics. For adjustable rate loans that reprice at least annually and for fixed rate commercial loans with maturities of six months or less which possess normal risk characteristics, carrying value was determined to be fair value. Fair value of other types of loans (including adjustable rate loans which reprice less frequently than annually and fixed rate term loans or loans which possess higher risk characteristics) was estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar anticipated maturities. Fair value for non-accrual loans was based on recent appraisals of the collateral or, if appropriate, using estimated discounted cash flows.
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Fair value of core deposits, including demand deposits, savings accounts and certain money market deposits, was the amount payable on demand. Fair value of fixed-maturity certificates of deposit was estimated using the rates offered at June 30, 2008 and 2007, for deposits of similar remaining maturities. Estimated fair value does not include the benefit that result from low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. Fair value of short-term borrowings and accrued interest was determined to be the carrying amounts since these financial instruments generally represent obligations that are due on demand. Fair value of Federal Home Loan Bank advances was estimated using current rates at June 30, 2008 and 2007 for similar financing. The fair value of unrecorded commitments at June 30, 2008 and 2007 was not material.
NOTE 14-PARENT COMPANY FINANCIAL STATEMENTS
Condensed financial information of Consumers Bancorp. Inc. (parent company only) follows:
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 15-OTHER COMPREHENSIVE INCOME
CONSUMERS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
June 30, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 16-QUARTERLY FINANCIAL DATA (Unaudited)
The fourth quarter of 2007 includes a loss on other real estate owned of $156, or $103 after-tax, due to information obtained during the fourth quarter following the pending sale of an OREO property.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T)-
ITEM 9A(T)-CONTROLS AND PROCEDURES
Management of Consumers Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. 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 the degree of compliance with the policies and procedures may deteriorate.
Management of Consumers Bancorp, Inc., including the Chief Executive Officer and the Chief Financial Officer, has assessed the Company’s internal control over financial reporting as of June 30, 2008, based on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of June 30, 2008, based on the specified criteria.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting because 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.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item as to the Corporation’s directors and executive officers is set forth in the Corporation’s Proxy Statement dated September 15, 2008 under the captions “Election of Directors” on page 2, “Directors and Executive Officers” on pages 3 and 4, “The Board of Directors and its Committees” on pages 5 and 6, “Section 16(a) Beneficial Ownership Reporting Compliance” on page 15, and “Certain Transactions and Relationships” on page 15, and is incorporated herein by reference.
The Corporation’s Code of Ethics Policy, which is applicable to all directors, officers and employees of the Corporation, and its Code of Ethics for Principal Financial Officers, which is applicable to the principal executive officer and the principal financial officer, are each available on the Investor Relations section under Required Disclosures of the corporation’s website (www.consumersbancorp.com). Copies of either of the Code of Ethics Policies are also available in print to share owners upon request, addressed to the Corporate Secretary at Consumers Bancorp, Inc., 614 East Lincoln Way, Minerva, Ohio 44657. The Corporation intends to post amendments to or waivers from its Code of Ethics on its website.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item is set forth in the Corporation’s Proxy Statement dated September 15, 2008 under the captions “Compensation of Directors” on page 7, “Executive Compensation” on page 10-12, “Defined Contribution Plan” on page 12, “Salary Continuation Program” on page 13, “Change of Control Agreements” on pages 13-14, “Compensation Committee Report on Compensation” on page 14, and “Compensation Committee Interlock and Insider Participation” on page 14, and is incorporated herein by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is set forth in the Corporation’s Proxy Statement dated September 15, 2008 under the caption “Security Ownership of Certain Beneficial Owners and Management” on pages 8-9, and is incorporated herein by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item is set forth in the Corporation’s Proxy Statement dated September 15, 2008 under the caption “Certain Transactions and Relationships” on page 15, and is incorporated herein by reference.
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth in the Corporation’s Proxy Statement dated September 15, 2008 under the caption “Principal Accountant Fees and Services” on page 16, and is incorporated herein by reference.
PART IV
ITEM 15
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. FINANCIAL STATEMENTS
The consolidated financial statements required in response to this Item are incorporated by reference to Item 8 of this Report.
(a) 2. FINANCIAL STATEMENT SCHEDULES
Not applicable
(a) 3. EXHIBITS
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of registrant and in the capacities indicated on September 15, 2008.
Signatures
Signatures
/S/ LAURIE L. MCCLELLAN
/S/ STEVEN L. MUCKLEY
Laurie L. McClellan
Steven L. Muckley
Chairman of the Board of Directors
Chief Executive Officer and Director
/S/ JOHN P. FUREY
/S/ JAMES V. HANNA
John P. Furey
James V. Hanna
Director
Director
/S/ DAVID W. JOHNSON
/S/ JAMES R. KIKO, SR.
David W. Johnson
James R. Kiko, Sr.
Director
Director
/S/ THOMAS M. KISHMAN
/S/ RALPH J. LOBER, II
Thomas M. Kishman
Ralph J. Lober, II
Director
President, Chief Operating Officer and Director
/S/ HARRY W. SCHMUCK, JR.
/S/ JOHN E. TONTI
Harry W. Schmuck, Jr.
John E. Tonti
Director
Director
EXHIBIT INDEX