ITEM 1. DESCRIPTION OF BUSINESS
General
The Company. First Robinson Financial Corporation (the “Company”) was incorporated under the laws of the State of Delaware in March 1997, at the direction of the Board of Directors of First Robinson Savings and Loan Association (the “Association”), the predecessor institution to First Robinson Savings Bank, National Association (the “Bank”) for the purpose of serving as a holding company of the Bank. The Company has no significant assets other than the outstanding capital stock of the Bank. Unless otherwise indicated, all activities discussed below are of the Bank.
The Bank. The Bank is a national bank, the deposits of which are federally insured and backed by the full faith and credit of the U.S. Government up to $250,000 through December 31, 2013 and in the case of certain non-interest-bearing accounts completely insured regardless of the dollar amount through December 31, 2009. The Bank is a community-oriented financial institution that seeks to serve the financial needs of the residents and businesses in its market area. The Bank primarily serves Crawford County and surrounding counties in Illinois and Knox County and surrounding counties in Indiana. The principal business of the Bank has historically consisted of attracting retail deposits from the general public and primarily investing those funds in one- to four-family residential real estate loans and, to a lesser extent, consumer loans, commercial and agricultural real estate loans and commercial business and agricultural finance loans. At March 31, 2009, substantially all of the Bank’s real estate mortgage loans, were secured by properties located in the Bank’s market area. The Bank also invests in investment and equity securities and mortgage-backed securities, and other permissible investments.
The Bank currently offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank’s deposits include statement savings, NOW accounts, certificate accounts, IRA accounts, limited accounts and non-interest bearing accounts. The Bank generally solicits deposits in its primary market area. The Bank does not accept any brokered deposits.
The Bank’s revenues are derived principally from interest income, including interest on loans, deposits in other banks and mortgage-backed securities and other investments.
Market Area
The Bank currently has four offices in Crawford County, Illinois, consisting of three full service offices and one drive-up, located in Robinson, Palestine and Oblong, Illinois. On December 29, 2008, the Bank entered the Knox County, Indiana market by opening a new office in Vincennes, Indiana.
Robinson, Palestine and Oblong, Illinois are located in Crawford County, Illinois, approximately 150 miles east of St. Louis, Missouri and 35 miles northwest of Vincennes, Indiana. Vincennes is located in southwestern Indiana and is the county seat of Knox County. The major employers in the Crawford County, Illinois area include Marathon Petroleum Company LLC, The Hershey Company, Robinson Correctional Facility, Dana Corporation, Crawford Memorial Hospital and E.H. Baare Corporation. The major employers in the Knox County, Indiana area include Good Samaritan Hospital, Vincennes University, Vincennes Community School Corporation, Gemtron Corporation and Packaging Corporation of America.
The Bank, and therefore the Company, is dependent upon the economy of its market area for continued success, since the vast majority of its loans are located in the Bank’s market area. See Note 4 of Notes to Consolidated Financial Statements.
Lending Activities
General. The Bank’s loan portfolio consists primarily of conventional, first mortgage loans secured by one- to four-family residences and, to a lesser extent, consumer loans, commercial and agricultural real estate loans, commercial business and agricultural finance loans and multi-family real estate and construction loans. At March 31, 2009, the Bank’s gross loans outstanding totaled $90.4 million, of which $43.9 million, or 48.6%, were one- to four-family residential mortgage loans. This amount also includes one- to four-family loans held for sale of $392,000 and home equity loans totaling $3.0 million. Of the one- to four-family mortgage loans outstanding at that date, 27.0% were fixed-rate loans, and 73.0% were adjustable-rate loans. At that same date, construction and development property loans totaled $2.6 million, or 2.9%, of the Bank’s total loan portfolio. Also at that date, the Bank’s multi-family real estate, commercial and agricultural real estate loans totaled $16.1 million, or 17.8%, of the Bank’s total loan portfolio of which 76.0% were adjustable-rate loans and 24.0% were fixed-rate loans. Loans to State and Municipal Governments totaled $2.2 million, or 2.4%, of the Bank’s total loan portfolio as of March 31, 2009. At that same date, consumer and other loans totaled $7.8 million, or 8.6%, of the Bank’s total loan portfolio. At March 31, 2009, commercial business and agricultural finance loans totaled $17.8 million, or 19.7%, of the Bank’s total loan portfolio, of which 49.7% were fixed-rate loans and 50.3% adjustable-rate loans. See Note 4 of Notes to Consolidated Financial Statements.
The Bank’s loans to one borrower limit is generally limited to the greater of 15% of unimpaired capital and surplus or, if a bank’s lending limit under this calculation would be less than $500,000, a bank may make loans and extensions of credit to one borrower at one time in an amount not to exceed $500,000. See “Regulation - Federal Regulation of National Banks.” Pursuant to certain lending provisions in the regulations of the Office of the Comptroller of the Currency (“OCC”) for defined eligible banks, however, the Bank may lend up to 25% of its unimpaired capital and surplus to one borrower for loans secured by one-to-four family residential real estate, loans secured by small businesses or small farm loans. The total outstanding amount of the Bank’s loans or extensions of credit made to all of its borrowers under the special limits in these regulations may not exceed 100% of the Bank’s unimpaired capital and surplus. Loans to affiliates and their related interests are not eligible for this program. See Note 14 of Notes to Consolidated Financial Statements for information regarding loans to affiliates. At March 31, 2009, the maximum amount which the bank could have lent under this program to any one borrower and the borrowers related interests was approximately $3.2 million. At March 31, 2009, the Bank had three borrowers with outstanding balances and available lines of credit that exceeded the 15% legal lending limit but was within the 25% legal lending limit for eligible banks. At March 31, 2009, the Bank had no loans or groups of loans to related borrowers with outstanding balances in excess of $3.2 million.
The Bank’s five largest lending relationships at March 31, 2009 were as follows: (i) $5.1 million in loans and available lines of credit to a heavy equipment operator of which $3.3 million was participated with other lenders and which is secured by real estate, equipment, inventory, accounts receivable and personal guarantees; (ii) $4.4 million in loans and available lines of credit to an individual and his closely held entities of which $1.5 million was participated with other lenders and which is secured by real estate, oil production and leaseholds, inventory, equipment, and personal guarantees; (iii) $3.0 million in loans and available lines of credit to a commercial business secured by inventory and accounts receivable; (iv) $2.5 million in loans and available lines of credit to a farmer secured by crops and farm machinery; and (v) $1.6 million in loans and available lines of credit to a commercial business secured by a blanket security agreement on all business assets and personal guarantees. At March 31, 2009, all of these loans, which totaled $16.6 million in the aggregate, of which $4.8 million was participated to other lenders, were performing in accordance with their terms.
Loan Portfolio Composition. The following information concerning the composition of the Bank’s loan portfolios in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowances for losses) as of the dates indicated.
The following schedule illustrates the interest rate sensitivity of the Bank’s loan portfolio at March 31, 2009. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract reprices; however, $21.9 million in adjustable rate loans have reached their contractual floor rate. These loans then report at their maturity date. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
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(1)
Includes demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after March 31, 2010 which have predetermined interest rates is $30.8 million, while the total amount of loans due after such dates which have floating or adjustable interest rates is $49.2 million, a portion of which have reached their contractual floor rate and are shown in the above table at their contractual maturity.
Underwriting Standards. All of the Bank’s lending is subject to its written underwriting standards and loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and, if applicable, property valuations. Properties securing real estate loans made by the Bank are generally appraised by Board-approved independent appraisers. In the loan approval process, the Bank assesses the borrower’s ability to repay the loan, the adequacy of the proposed security, the employment stability of the borrower and the credit-worthiness of the borrower.
The Bank requires evidence of marketable title and lien position or appropriate title insurance on all loans secured by real property. The Bank also requires fire and extended coverage casualty insurance in amounts at least equal to the lesser of the principal amount of the loan or the value of improvements on the property, depending on the type of loan. As required by federal regulations, the Bank also requires flood insurance to protect the property securing its interest if such property is located in a designated flood area.
Management reserves the right to change the amount or type of lending in which it engages to adjust to market or other factors.
One- To- Four-Family Residential Mortgage Lending. Residential loan originations are generated by the Bank’s marketing efforts, its present customers, walk-in customers, and referrals from real estate brokers. Historically, the Bank has focused its lending efforts primarily on the origination of loans secured by one- to four-family residential mortgages in its market area. At March 31, 2009, the Bank’s one- to four-family residential mortgage loans totaled $43.9 million, or 48.6%, of the Bank’s gross loan portfolio, of which $192,000 was non-performing at that date.
The Bank offers both adjustable and fixed rate mortgage loans. For the year ended March 31, 2009, the Bank originated $44.5 million of real estate loans, of which $34.8 million were secured by one- to four-family residential real estate, $2.9 million was secured by one- to four-family or commercial constructions and land loans, $5.4 million was secured by commercial or agricultural real estate, and $1.4 million was secured by multi-family residential real estate. Substantially all of the Bank’s one- to four-family residential mortgage originations are secured by properties located in its market area.
The Bank offers adjustable-rate mortgage loans at rates and on terms determined in accordance with market and competitive factors. The Bank currently originates adjustable-rate mortgage loans with a term of up to 30 years. The Bank offers six-month and one-year adjustable-rate mortgage loans and loans that are fixed for three years, then adjustable annually after that with a stated interest rate margin generally over the one-year Treasury Bill Index. Increases or decreases in the interest rate of the Bank’s adjustable-rate loans is generally limited to 200 basis points at any adjustment date and 600 basis points over the life of the loan. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as the Bank’s liabilities. The Bank qualifies borrowers for adjustable-rate loans based on the initial interest rate of the loan. As a result, the risk of default on these loans may increase as interest rates increase. See “Asset Quality - Non-Performing Assets.” At March 31, 2009, the total balance of one-to four-family adjustable-rate loans was $31.7 million, or 35.1%, of the Bank’s gross loan portfolio. See “- Originations, Purchases and Sales of Loans.”
The Bank offers fixed-rate mortgage loans with a term of up to 30 years. At March 31, 2009, the total balance of one- to four-family fixed-rate loans was $12.2 million, or 13.5%, of the Bank’s gross loan portfolio. The Bank also offers U.S. Department of Agriculture (“USDA”) Guaranteed Rural Housing Loans to borrowers that meet certain income limitations with minimal to no down payment. These loans are 30-year fixed rate loans with a 90% guarantee from USDA. At March 31, 2009, the total balance of USDA Guaranteed Rural Housing Loans was $139,000, or 0.1%, of the Bank’s gross loan portfolio. During the fiscal year ended March 31, 2009, the Bank sold $1.9 million in USDA Guaranteed Rural Housing Loans. The Bank provides servicing on $2.8 million of these Rural Housing Loans. In April 2007, the Bank began offering USDA Rural Housing Loans where servicing is retained with a 44 basis point fee. See “- Originations, Purchases and Sales of Loans.” The Bank will generally lend up to 80% of the lesser of the appraised value or purchase price of the security property on owner occupied one- to four-family loans. Residential loans do not include prepayment penalties, are non-assumable (other than government-insured or guaranteed loans), and do not produce negative amortization. Real estate loans originated by the Bank contain a “due on sale” clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the security property. The Bank utilizes private mortgage insurance.
The majority of the fixed rate loans currently originated by the Bank are underwritten and documented pursuant to the guidelines of the Federal Home Loan Bank of Chicago’s (the “FHLB”) Mortgage Partnership Finance (“MPF”) program. Effective January 1, 1999, the Bank joined the MPF program offered by the FHLB. This program is a secondary mortgage market structure under which the FHLB purchased and funded eligible mortgage loans from or through participating banks and, in certain instances, the FHLB purchased participations in pools of eligible mortgage loans from other Federal Home Loan Banks. The FHLB announced, however, that it would no longer enter into new master commitments except for immaterial amounts of MPF loans that primarily support affordable housing and are guaranteed by a federal government entity. MPF loans purchased after November 1, 2008 are now concurrently sold to Fannie Mae as a third-party investor pursuant to a program announced in September 2008, whereby Fannie Mae will purchase 30- 20- and 15-year fixed rate mortgage loans from the FHLB. Fannie Mae will purchase loans channeled through the MPF Program. Participating banks generally retain the right to service these loans.
At March 31, 2009, the Company's home equity loans amounted to $3.0 million, or 3.3%, of the total loan portfolio. These loans are secured by the underlying equity in the borrower's residence, and accordingly, are reported with the one-to-four family real estate loans. As a result, the Company generally requires loan-to-value ratios of 90% or less after taking into consideration the first mortgage held by the Company. These loans typically have fifteen-year terms with an interest rate adjustment monthly.
Multi-Family Lending. The Bank offers one-year adjustable-rate multi-family loans for terms of up to 20 years. The Bank will generally lend up to 80% of the value of the collateral securing the loan. At March 31, 2009, the Bank had $1.2 million of multi-family real estate loans, or 1.4% of the Bank’s gross loan portfolio. All of these loans were performing in accordance with their terms at that date.
Multi-family lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending. This greater risk in multi-family lending is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.
Commercial and Agricultural Real Estate Lending. The Bank also originates commercial and agricultural real estate loans. At March 31, 2009 approximately $14.8 million, or 16.4% of the Bank’s gross loan portfolio, was comprised of commercial and agricultural real estate loans. Of this amount, approximately $3.7 million, or 24.8%, of these loans were fixed-rate commercial and agricultural real estate loans and approximately $11.1 million, or 75.2%, were adjustable-rate loans. At March 31, 2009, all of these loans were performing. The largest commercial or agricultural real estate loan was a $3.5 million line of credit of which $1.5 million was participated to another institution.
The Bank will generally lend up to 80% of the value of the collateral securing the loan with varying maturities up to 20 years with re-pricing periods ranging from daily to one year. In underwriting these loans, the Bank currently analyzes the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the business. The Bank generally requires personal guaranties on corporate borrowers. Appraisals on properties securing commercial and agricultural real estate loans originated by the Bank are primarily performed by independent appraisers. The Bank also offers small business loans, which are generally guaranteed up to 90% by various governmental agencies.
Commercial and agricultural real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and agricultural real estate is typically dependent upon the successful operation of the business. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
Construction Lending. The Bank had $2.6 million in construction loans for one- to four- family residences, commercial property and land loans, or 2.9%, of the total loan portfolio at March 31, 2009. The Bank offers construction loans to individuals for the construction of one- to four-family residences or commercial buildings. Such loans are offered with fixed and adjustable-rates of interest. Following the construction period, these loans may become permanent loans.
Construction lending is generally considered to involve a higher level of credit risk since the risk of loss on construction loans is dependent largely upon the accuracy of the initial estimate of the individual property’s value upon completion of the project and the estimated cost (including interest) of the project. If the cost estimate proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. The Bank conducts periodic inspections of the construction project to help mitigate this risk.
State and Municipal Government Loans. The Bank originates both fixed and adjustable loans for state and municipal governments. At March 31, 2009, the Bank’s loans to state and municipal governments totaled $2.2 million, or 2.4% of the total loan portfolio, of which 70.1% were fixed and 29.9% were adjustable. Loans to state and municipal governments are generally at a lower rate than consumer or commercial loans due to the tax-free nature of municipal loans.
For underwriting purposes, the Bank does not require financial documentation as long as the loan is to the general obligation of the local entity. However, proper documentation in the entity’s minutes, from a board meeting when a quorum was present, that indicate the approval to seek a loan and the authorized individuals to sign for the loan are required.
Consumer and Other Lending. The Bank offers secured and unsecured consumer and other loans. Secured loans may be collateralized by a variety of asset types, including automobiles, mobile homes, equity securities, and deposits. The Bank currently originates substantially all of its consumer and other loans in its primary market area. At March 31, 2009, the Bank’s consumer and other loan portfolio totaled $7.8 million, or 8.6%, of its gross loan portfolio, of which 85.4% were fixed-rate loans.
A significant component of the Bank’s consumer loan portfolio consists of new and used automobile loans. These loans generally have terms that do not exceed five years. Generally, loans on vehicles are made in amounts up to 80% of the sales price or the National Automobile Dealers Association value, whichever is least. At March 31, 2009, the Bank’s automobile loans totaled $4.9 million, or 5.5%, of the Bank’s gross loan portfolio. These loans were originated predominately on a direct lending basis.
Consumer and other loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Consumer and other loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At March 31, 2009, $14,000 of the Bank’s consumer and other loans were non-performing. There can be no assurances that additional delinquencies will not occur in the future.
Commercial Business and Agricultural Finance Lending. The Bank also originates commercial and agricultural business loans. At March 31, 2009, approximately $17.8 million, or 19.7% of the Bank’s gross loan portfolio, was comprised of commercial and agricultural business loans. Of the $17.8 million, approximately $8.8 million, or 49.7%, were fixed-rate loans and approximately $9.0 million, or 50.3%, were adjustable-rate loans. At March 31, 2009, $29,000 of the Bank’s commercial and agricultural business loans were non-performing. The largest commercial business loan was a $3.0 million line of credit.
Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business and agricultural finance loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business and agricultural finance loans may be substantially dependent on the success of the business itself (which, in turn, is likely to be dependent upon the general economic environment). The Bank’s commercial business and agricultural finance loans are usually secured by business or personal assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At March 31, 2009, $142,000 of the Bank’s commercial business and agricultural finance loans were unsecured.
The Bank’s commercial business and agricultural finance lending policy includes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of the Bank’s current credit analysis. Nonetheless, such loans are believed to carry higher credit risk than more traditional investments.
Originations, Purchases and Sales of Loans
Loan originations are developed from continuing business with (i) depositors and borrowers, (ii) soliciting realtors, (iii) builders, and (iv) walk-in customers.
While the Bank currently originates adjustable-rate and fixed-rate loans, its ability to originate loans to a certain extent is dependent upon the relative customer demand for loans in its market, which is affected by the interest rate environment, among other factors. For the year ended March 31, 2009, the Bank had total originations of $41.5 million in fixed-rate loans and $23.6 million in adjustable-rate loans.
The Bank sold $19.6 million in one- to four-family loans through market programs during the year ended March 31, 2009. Sales of these loans generally are beneficial to the Bank since these sales may produce future servicing income, provide funds for additional lending and other investments and increase liquidity. The Bank sells loans pursuant to forward sales commitments and, therefore, an increase in interest rates after loan origination and prior to sale should not adversely affect the Bank’s income at the time of sale.
The following table shows the loan origination, purchase, sale and repayment activities of the Bank for the periods indicated.
Asset Quality
Delinquencies. When a borrower fails to make a required payment on a loan, the Bank attempts to cause the delinquency to be cured by contacting the borrower. In the case of loans secured by real estate, reminder notices are sent to borrowers. If payment is late, appropriate late charges are assessed and a notice of late charges is sent to the borrower. If the loan is between 60-90 days delinquent, the loan will generally be referred to the Bank’s legal counsel for collection.
When a loan becomes more than 90 days delinquent and collection of principal and interest is considered doubtful, or is otherwise impaired, the Bank will generally place the loan on non-accrual status and previously accrued interest income on the loan is charged against current income.
Delinquent consumer loans are handled in a manner similar to that described above. The Bank’s procedures for repossession and sale of consumer collateral are subject to various requirements under applicable consumer protection laws.
The following table sets forth the Bank’s loan delinquencies by type, by amount and by percentage of type at March 31, 2009.
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(1) Loans are still accruing.
Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets in the Bank’s loan portfolio. Loans are placed on non-accrual status when the collection of principal and/or interest become doubtful. Foreclosed assets include assets acquired in settlement of loans.
For the year ended March 31, 2009, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to approximately $16,000. This represents $16,000 that would have been included in interest income on such loans for the year ended March 31, 2009.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities, considered by the OCC to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, who may order the establishment of additional general or specific loss allowances.
In connection with the filing of its periodic reports with the OCC and in accordance with its classification of assets policy, the Bank regularly reviews loans in its portfolio to determine whether such assets require classification in accordance with applicable regulations. On the basis of management’s review of its assets, at March 31, 2009, the Bank had classified a total of $411,000 of its assets as substandard and $78,000 as doubtful. At March 31, 2009, total classified assets comprised $489,000, or 3.9%, of the Bank’s capital, and 0.3% of the Bank’s total assets.
Other Loans of Concern. As of March 31, 2009, there were $6.1 million in loans identified, but not classified, by the Bank with respect to which known information about the possible credit problems of the borrowers or the cash flows of the business have caused management to have some doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories.
At March 31, 2009, the Company had a commercial loan in the amount of $1.0 million, secured by the common stock of a financial institution. The borrower has been under increased regulatory pressure with respect to its capital position in recent months due to the borrower’s deteriorating investment portfolio. The borrower is in the process of securing additional capital to address the regulatory concerns. The allowance for loan losses reflects management’s best estimate of the anticipated losses in this loan. Due to the nature of the collateral, the Company could incur additional losses.
Allowance For Loan Losses. The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions. Allowances for impaired loans are generally determined based on collateral values. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries.
Real estate properties acquired through foreclosure are recorded at the fair value minus 20% of the fair value if the property is appraised at $50,000 or less. If the property is appraised at greater than $50,000, then the property is recorded at the fair value less 10% of the fair value. If fair value at the date of foreclosure is lower than the balance of the related loan, the difference will be charged-off to the allowance for loan losses at the time of transfer. Valuations are periodically updated by management and if the value declines, a specific provision for losses on such property is established by a charge to operations. At March 31, 2009, the Bank had one real estate property acquired through foreclosure. Although management believes that it uses the best information available to determine the allowance, unforeseen market conditions could result in adjustments and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Future additions to the Bank’s allowance for loan losses will be the result of periodic loan, property and collateral reviews and thus cannot be predicted in advance. In addition, federal regulatory agencies, as an integral part of the examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to increase the allowance, or change the classification that the Bank has assigned to various assets, based upon its judgment of the information available to it at the time of its examination. At March 31, 2009, the Bank had a total allowance for loan losses of $780,000, representing 0.9% of the Bank’s loans, net. See Note 4 of Notes to Consolidated Financial Statements.
The distribution of the Bank’s allowance for losses on loans at the dates indicated is summarized as follows:
The following table sets forth an analysis of the Bank’s allowance for loan losses.
Investment Activities
General. The Bank also invests in mortgage-backed securities, government securities, obligations of states or political subdivisions and other debt securities. At March 31, 2009, mortgage-backed securities totaled $40.9 million, or 73.1%, of the Bank’s total investment and mortgage-backed securities portfolio. Government securities, obligations of state and political subdivisions and other debt securities totaled $15.0 million, or 26.9% of the Bank’s total investment and mortgage-backed securities portfolio.
Historically, the Bank has generally maintained liquid assets at levels believed adequate to meet the requirements of normal operations, including repayments of maturing debt and potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. A national bank is not subject to prescribed requirements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resource.”
National banking associations have the authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, national banks may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a national banking association is otherwise authorized to make directly.
Generally, the investment policy of the Bank, as established by the Board of Directors, is to invest funds among various categories of investments and maturities based upon the Bank’s liquidity needs, asset/liability management policies, investment quality, marketability and performance objectives.
Investment Securities. At March 31, 2009, the Bank’s investment securities, excluding mortgage-backed securities, totaled $15.0 million, or 9.1% of its total assets. It has been the Bank’s general policy to invest in obligations of state and political subdivisions, federal agency obligations and other investment securities.
National banks are restricted in investments in corporate debt and equity securities. These restrictions include prohibitions against investments in the debt securities of any one issuer in excess of 15% of the Bank’s unimpaired capital and unimpaired surplus as defined by federal regulations, which totaled $11.9 million as of March 31, 2009, plus an additional 10% if the investments are fully secured by readily marketable collateral. At March 31, 2009, the Bank was in compliance with this regulation. See “Regulation - Federal Regulation of National Banks” for a discussion of additional restrictions on the Bank’s investment activities. See Note 3 of Notes to Consolidated Financial Statements.
The following table sets forth the composition of the Bank’s securities, all of which are classified as available for sale.
The Bank’s investment securities portfolio at March 31, 2009, contained no securities of any issuer with an aggregate book value in excess of 10% of the Bank’s retained earnings, excluding those issued by the U.S. government, or its agencies.
First Robinson’s investments, including the mortgage-backed securities portfolio, are managed in accordance with a written investment policy adopted by the Board of Directors.
OCC guidelines, as well as those of the other federal banking regulators, regarding investment portfolio policy and accounting require banks to categorize securities and certain other assets as held for “investment,” “sale,” or “trading.” In addition, the Bank has adopted SFAS 115 which states that securities available for sale are accounted for at fair value and securities which management has the intent and the Bank has the ability to hold to maturity are accounted for on an amortized cost basis. The Bank’s investment policy has strategies for each type of security. At March 31, 2009, the Bank classified $55.9 million of its investments as available for sale.
Mortgage-Backed Securities. The Bank invests primarily in federal agency obligations. At March 31, 2009, the Bank’s investment in mortgage-backed securities totaled $40.9 million or 24.9% of its total assets. All of the mortgage-backed securities are classified as available for sale. At March 31, 2009, the Bank did not have a trading portfolio.
The following table sets forth the maturities of the Bank’s mortgage-backed securities at March 31, 2009.
Trust Services
A trust officer was hired by the Bank in July 2008, and shortly thereafter the Bank began offering wealth management and trust services to its higher net worth customers to assist them in investment, tax and estate planning. The Bank offers these services in a manner consistent with the principles of prudent and safe banking and in compliance with applicable laws, rules, regulations and regulatory guidelines. The Bank earns fees for managing client’s assets and providing trust services. Revenues from wealth management and trust services comprised less than 0.02% of the Banks revenue for the period during which such services have been offered.
Sources of Funds
General. The Bank’s primary sources of funds are deposits, receipt of principal and interest on loans and securities, interest earned on deposits with other banks, and other funds provided from operations.
The Bank has used FHLB advances to support lending activities and to assist in the Bank’s asset/liability management strategy. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management.” At March 31, 2009, the Bank had no FHLB advances and no FHLB Letters of Credit pledged to secure public unit deposits. The Bank had a credit enhancement reserve of $1.2 million established with the FHLB for participation in the Mortgage Partnership Finance (“MPF”) program. The MPF credit enhancement reserve reduced the amount available to borrow from the FHLB of Chicago to $25.7 million. The Company and Bank could also borrow up to $5.6 million from a correspondent bank located in Springfield, Illinois. The Bank has also established borrowing capabilities with the Federal Reserve Bank of St. Louis. See Notes 9 and 10 of Notes to Consolidated Financial Statements.
At March 31, 2009, the Bank had $9.9 million in repurchase agreements. See Note 8 of Notes to Consolidated Financial Statements.
Deposits. The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank’s deposits consist of statement savings accounts, money market deposit accounts, NOW accounts, IRA accounts, and certificate accounts. The certificate accounts currently range in terms from 90 days to 54 months. The Bank also offers a variable rate certificate for children. The certificate matures on the child’s 18th birthday. The Bank has a significant amount of deposits that will mature within one year. However, management expects that virtually all of the deposits will be renewed.
The Bank relies primarily on advertising, competitive pricing policies and customer service to attract and retain these deposits. Currently, the Bank solicits deposits from its market area only, and does not use brokers to obtain deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.
The Bank remains susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. The Bank endeavors to manage the pricing of its deposits in keeping with its profitability objectives giving consideration to its asset/liability management. The ability of the Bank to attract and maintain deposit accounts and certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.
The following table sets forth the deposit flows at the Bank during the periods indicated.
The following table sets forth the dollar amount of deposits in the various types of deposit programs offered by the Bank for the periods indicated.
The following table shows rate and maturity information for the Bank’s certificates of deposit as of March 31, 2009.
The following table indicates the amount of the Bank’s certificates of deposit and other deposits by time remaining until maturity as of March 31, 2009.
(1)
Deposits from governmental and other public entities.
Subsidiary Activities
As a national bank, the Bank is able to invest unlimited amounts in subsidiaries that are engaged in activities in which the parent bank may engage. In addition, a national bank may invest limited amounts in subsidiaries that provide banking services, such as data processing, to other financial institutions. At March 31, 2009, the Bank had no subsidiaries.
Code of Ethics
A copy of the Company’s Code of Ethics may be obtained in print, without charge, by any stockholder upon written request to Secretary, c/o First Robinson Financial Corporation, 501 East Main Street, Robinson, Illinois 62454.
Competition
The Bank faces strong competition, both in originating real estate, commercial and consumer loans and in attracting deposits. Competition in originating loans comes primarily from commercial banks and credit unions located in the Bank’s market area. Commercial banks provide vigorous competition in consumer lending. The Bank competes for real estate and other loans principally on the basis of the quality of services it provides to borrowers, the interest rates and loan processing fees it charges, and the types of loans it originates. See “- Lending Activities.”
The Bank attracts all of its deposits through its retail banking offices. Therefore, competition for those deposits is principally from retail brokerage offices, commercial banks and a credit union located in the community. The Bank competes for these deposits by offering a variety of account alternatives at competitive rates and by providing convenient business hours.
The Bank primarily serves Crawford County and surrounding counties in Illinois. There are six commercial banks and one credit union, other than the Bank, which compete for deposits and loans in Crawford County. The Bank opened a branch in Vincennes, Indiana on December 29, 2008 and has added Knox County and surrounding counties in Indiana to its primary market area. In Vincennes, there are eight commercial banks and one credit union, other than the Bank, competing for deposits and loans.
Regulation
General. The Company is a registered bank holding company, subject to broad federal regulation and oversight by the Board of Governors of the Federal Reserve Bank (“FRB”). The Bank is a national bank, the deposits of which are federally insured and backed by the full faith and credit of the U.S. Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations by the OCC, the Federal Deposit Insurance Corporation (“FDIC”) and the FRB. The Bank is also a member of the FHLB of Chicago. The Bank is a member of the Deposit Insurance Fund (the “DIF”) and the deposits of the Bank are insured by the FDIC.
Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document. See Note 13 of Notes to Consolidated Financial Statements.
Federal Regulation of National Banks. The OCC has extensive authority over the operations of national banks. As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. All national banks are subject to a semi-annual assessment, based upon the bank’s total assets, to fund the operations of the OCC.
The OCC also has extensive enforcement authority over all national banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations as well as unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required.
The Bank’s loans to one borrower limit is generally limited to the greater of 15% of unimpaired capital and surplus or, if a bank’s lending limit under this calculation would be less than $500,000, a bank may make loans and extensions of credit to one borrower at one time in an amount not to exceed $500,000. However, the Bank is allowed to utilize a program offered by the OCC that permits it to exceed the 15% lending limit under certain circumstances. The Bank may lend up to 25% of its unimpaired capital and surplus to one borrower for loans secured by one-to-four family residential real estate, loans secured by small businesses or small farm loans. The total outstanding amount of the Bank’s loans or extensions of credit made to all of its borrowers under the special limits of this program may not exceed 100% of the Bank’s unimpaired capital and surplus. Loans to affiliates and their related interests are not eligible for this program. See “Lending Activities - General.”
The OCC, as well as the other federal banking agencies, have adopted regulations and guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, internal controls and audit systems, interest rate risk exposure, asset quality and earnings, and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan. A failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action.
Recent Legislation.
Federal Economic Stabilization Programs. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”), giving the US Treasury authority to take certain actions to restore liquidity and stability to the U.S. banking markets. Based upon its authority in the EESA, a number of programs to implement the EESA have been announced. Those programs include the following:
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Capital Purchase Program (“CPP”). Pursuant to this program, the US Treasury, on behalf of the US government, will purchase up to $250 billion of preferred stock, along with warrants to purchase common stock, from certain financial institutions, including bank holding companies, savings and loan holding companies and banks or savings associations not controlled by a holding company. The investment will have a dividend rate of 5% per year, until the fifth anniversary of the US Treasury’s investment and a dividend of 9% thereafter.
During the time the US Treasury holds securities issued pursuant to this program, participating financial institutions will be required to comply with certain provisions regarding executive compensation and corporate governance. Participation in this program also imposes certain restrictions upon an institution’s dividends to common shareholders and stock repurchase activities. As of the date of this report, the Bank did not elect to participate in the CPP.
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Temporary Liquidity Guarantee Program (“TLGP”). That program contains both a debt guarantee component, whereby the FDIC will guarantee until June 30, 2012, the senior unsecured debt issued by eligible financial institutions between October 14, 2008 and June 30, 2009, and a transaction account guarantee component, whereby the FDIC will insure 100% of non-interest bearing deposit transaction accounts held at eligible financial institutions, such as payment processing accounts, payroll accounts and working capital accounts through December 31, 2009. The Bank opted out of the debt guarantee component of the TLGP and thus will not have to pay any participation fees associated therewith. The Bank is, however, participating in the transaction account guarantee program and will be required to pay to the FDIC fees in connection with such participation.
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Temporary increase in deposit insurance coverage. Pursuant to the EESA, the FDIC temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The EESA provides that the basic deposit insurance limit will return to $100,000 after December 31, 2013.
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Another recently implemented program intended to stabilize the nation’s banking system is the Term Asset-Backed Securities Loan Facility (the “TALF”) promulgated by the Board of Governors of the Federal Reserve System. The program, which became operational in March 2009, is intended to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business asset-backed securities (“ABS”) and commercial mortgage-backed securities (“CMBS”). Under TALF, the Federal Reserve Bank of New York will finance the purchase of eligible ABS and CMBS by investors that own eligible collateral so long as such investor maintains an account relationship with a primary dealer. Generally, eligible ABS must be newly issued, highly rated ABS collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. Eligible CMBS must also meet certain requirements, including: (i) it must entitle its holders to payments of principal and interest throughout its remaining term, (ii) it must bear interest at a fixed pass-through rate or at a rate based on the weighted average of the underlying fixed mortgage rates, and (iii) it not be junior to other securities with claims on the same pool of loans. Minimum loan sizes under the TALF will be $10 million and TALF loans will generally have a three year maturity. Starting in June 2009, however, TALF loans secured by SBA Pool Certificates, SBA Development Company Participation Certificates, or ABS secured by student loans or commercial mortgages will have a five-year maturity if the borrower so elects.
Given the current international, national and regional economic climate, it is unclear what effect the provisions of the EESA, the American Recovery and Reinvestment Act of 2009 (signed into law on February 17, 2009), and the programs listed above will have with respect to the profitability and operations of both the Company and the Bank. In addition, the US government, either through the US Treasury or some other federal agency, may also advance additional programs that could materially impact the profitability and operations of both the Company and the Bank. The failure of these governmental efforts to stabilize national and international markets could have a material effect on the Company’s business, financial condition, results of operations or access to the credit markets.
US Treasury Department Plan. On June 17, 2009, the U.S. Treasury Department (“UST”) released a white paper (the “Treasury Plan”) outlining the Obama administration’s blueprint for financial regulatory reform. The Treasury Plan covers a range of topics, including reform of regulations regarding banks and non-bank financial firms.
The Treasury Plan would require all financial firms that are found to pose a systemic threat to the economy’s financial stability, whether or not they own banks, to be subject to consolidated supervision and regulation by the Federal Reserve Board, including higher standards on capital, liquidity and risk management. A new regime to resolve nonbank financial institutions whose failure could have serious systemic effects would be developed, and the Federal Reserve’s emergency lending authority would be revised to improve accountability.
A new Financial Services Oversight Council, to be chaired by the UST, would be created to facilitate coordination of policy and identify emerging risks in firms and market activities among financial regulatory agencies. The Council would have broad authority to collect information about financial firms and activities in financial markets that may pose a threat to financial stability.
The Treasury Plan would also create a new Consumer Financial Protection Agency, which would be an independent entity dedicated to consumer protection in credit, savings, and payments markets, and a new National Bank Supervisor, which would be a single agency with separate status in UST with responsibility for federally chartered depository institutions. This would entail a merger of the OCC with the Office of Thrift Supervision. To promote national coordination in the insurance sector, the Treasury Plan also would create an Office of National Insurance within UST. However, the Treasury Plan would maintain the respective roles of the Federal Reserve and the FDIC in the supervision and regulation of state chartered banks, and would maintain the authority of the National Credit Union Administration (NCUA) with regard to credit unions.
It is unclear whether and to what extent the Treasury Plan will be implemented in the future and the impact it will have upon the operations of both the Company and the Bank.
The Sarbanes-Oxley Act. While not a banking law per se, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America. The Sarbanes-Oxley Act’s principal provisions, many of which have been interpreted through regulations, provide for and include, among other things: (i) the creation of an independent accounting oversight board; (ii) auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements; (iv) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (v) an increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the Company’s independent auditors; (vi) requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer; (vii) requirements that companies disclose whether at least one member of the audit committee is a ‘financial expert’ (as such term is defined by the SEC) and if not discussed, why the audit committee does not have a financial expert; (viii) expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; (ix) a general prohibition on personal loans to directors and officers, except for certain loans made by subsidiary insured financial institutions such as the Bank on non-preferential terms and in compliance with other bank regulatory requirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (xi) requirements that management assess the effectiveness of internal control over financial reporting and that the Company’s Independent Registered Public Accounting Firm attest to the assessment; and (xii) a range of enhanced penalties for fraud and other violations.
Pursuant to Section 302 of the Sarbanes-Oxley Act, the Company’s Chief Executive Officer and the Chief Financial Officer are required to certify that the Company’s quarterly and annual reports filed with the SEC fairly present, in all material respects, the operations and conditions of the Company. In addition, as required by Section 404 of the Sarbanes-Oxley Act, management must make an assessment regarding the effect of internal controls on financial reporting and the Company’s external auditors must attest to such management assessment and reports. The Company is considered a non-accelerated filer based on criteria established by the SEC, and accordingly, beginning with its annual report for the fiscal year ending March 31, 2008, the Company has been required to provide management’s assessment of the effectiveness of its internal control over financial reporting. Management’s assessment for the fiscal year ending March 31, 2009 is included in Item 9A(T) below. Because the Company is a smaller reporting company, its independent registered public accounting firm is not yet required to issue its attestation regarding the Company’s internal controls over financial reporting.
The Company’s management has developed policies, procedures and internal processes to ensure compliance with all applicable provisions of the Sarbanes-Oxley Act. It is anticipated that these and other requirements of the Sarbanes-Oxley Act will increase the Company’s cost of doing business both in terms of the time and energy that its board, committees and executives will have to expend, as well as in hard dollars, although no prediction can be made at this time of how extensive the increased costs will be.
Department of Defense Credit Regulations. As of October 1, 2007, US Department of Defense (“DOD”) regulations regulating certain credit terms for members of the US military became effective. Specifically, these regulations impose certain restrictions on certain terms that may be found in consumer credit products provided to “covered borrowers,” a term that is generally defined in the regulations to include all active duty service members and their dependents. The regulations apply to all “creditors,” a term which includes the Bank. Most importantly, the regulations provide for a Military Annual Percentage Rate, which caps the applicable annual percentage rate on covered transactions at 36%.
The regulations were implemented by the DOD to protect service members from predatory loan practices and are an attempt to balance service member protections with access to credit.
Privacy. The Bank is required by statute and regulation to disclose privacy policies to the individuals requesting information about the Bank’s products and services (the Bank’s consumers) and, on an annual basis, to their customers. The privacy notices provided with respect to this requirement provide Bank customers with the ability to opt out of the sharing of their nonpublic personal information with non-affiliated third parties. Information safeguards are also required with respect to the Bank’s protection of non-public personal information.
Other Regulations. The Bank is also subject to numerous other regulations with respect to its operation, including, but not limited to, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Electronic Funds Transfer Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair Debt Collection Practices Act, and the Fair Credit Reporting Act. Changes in any regulation applicable to the operation of the Bank are not predictable and could affect the Bank’s operations and profitability.
Insurance of Accounts and Regulation by the FDIC.
The Bank is a member of the DIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the U.S. Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against banks after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC based upon a risk classification system established by the agency comprised of four categories that are distinguished by capital ratios and supervisory ratings. Each bank’s risk-based assessment category will be determined, and assessments will be collected, on a quarterly basis.
During the year ended December 31, 2008, DIF assessments ranged from 5 basis points to 10 basis points for every $100 of qualified deposits. The Bank qualified for the 5 basis point deposit insurance rate in 2008. Beginning on April 1, 2009, the FDIC imposed increased deposit insurance assessments on insured depositing institutions like the Bank. Initial base assessment rates for banks in the best risk category now range from 12 cents per $100 to 16 cents per $100 on an annual basis. Under this new rate structure, the Bank will qualify for the 12 cents deposit insurance rate per $100 of assessable deposits. On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The amount of the special assessment for any institution will not exceed 10 basis points times the institution’s assessment base for the second quarter 2009. The special assessment will be collected on September 30, 2009. An additional special assessment of up to 5 basis points later in 2009 is probable, but the amount is uncertain. The additional amount that would be imposed on the Company, as a result of the June 30, 2009 final rule, would be approximately $81,300.
The FDIC has indicated that the Bank’s annual assessment rate for 2009 will be 12 basis points per $100 of deposits. The FDIC has allowed eligible insured institutions to share in a one-time assessment credit for institutions that were in existence at December 31, 1996 and paid deposit insurance assessments prior to that date. The Bank’s one-time assessment credit was originally $83,139. However, it was exhausted with the assessment paid on March 31, 2009. The Bank cannot, however, predict insurance assessment rates for the future.
FICO Assessments. DIF-insured institutions are required to pay a quarterly Financing Corporation (FICO) assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the calendar year ended December 31, 2008, the FICO assessment rate for DIF members ranged between 1.10 basis points and 1.14 basis points. The Bank’s FICO assessment expense for 2009 was $12,300. Management believes this expense will be comparable in 2010.
National Banks. The Bank is subject to, and in compliance with, the capital regulations of the OCC. The OCC’s regulations establish two capital standards for national banks: a leverage requirement and a risk-based capital requirement. In addition, the OCC may, on a case-by-case basis, establish individual minimum capital requirements for a national bank that vary from the requirements which would otherwise apply under OCC regulations. A national bank that fails to satisfy the capital requirements established under the OCC’s regulations will be subject to such administrative action or sanctions as the OCC deems appropriate.
The leverage ratio adopted by the OCC requires a minimum ratio of “Tier 1 capital” to adjusted total assets of 3% for national banks rated composite 1 under the CAMELS rating system for banks. National banks not rated composite 1 under the CAMELS rating system for banks are required to maintain a minimum ratio of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the level and nature of risks of their operations. For purposes of the OCC’s leverage requirement, Tier 1 capital generally consists of common stockholders’ equity and retained income and certain non-cumulative perpetual preferred stock and related income, except that no intangibles and certain purchased mortgage servicing rights and purchased credit card relationships may be included in capital.
The risk-based capital requirements established by the OCC’s regulations require national banks to maintain “total capital” equal to at least 8% of total risk-weighted assets. For purposes of the risk-based capital requirement, “total capital” means Tier 1 capital (as described above) plus “Tier 2 capital,” provided that the amount of Tier 2 capital may not exceed the amount of Tier 1 capital, less certain assets. The components of Tier 2 capital include certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets.
Under this current regulatory scheme, Bank management believes that it will meet the capital requirements set forth above. Economic downturns in the Bank’s market, and other local and national events, however, could adversely affect the Bank’s earnings, thereby affecting its ability to meet its capital requirements.
Prompt Corrective Action. The OCC is authorized and, under certain circumstances required, to take certain actions against national banks that fail to meet their capital requirements. The OCC is generally required to take action to restrict the activities of an “undercapitalized institution” (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such institution must submit a capital restoration plan and, until such plan is approved by the OCC, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OCC is authorized to impose the additional restrictions that are applicable to significantly undercapitalized institutions.
Any national bank that fails to comply with its capital plan or is “significantly undercapitalized” (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions which may cover all aspects of its operations and include a forced merger or acquisition of the bank. A national bank that becomes “critically undercapitalized” (i.e., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized institutions. In addition, the OCC must appoint a receiver (or conservator with the concurrence of the FDIC) for an institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized institution is also subject to the general enforcement authority of the OCC, including the appointment of a conservator or a receiver.
The OCC is also generally authorized to reclassify a bank into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. At March 31, 2009, the Bank was categorized as well capitalized under the OCC’s prompt corrective action regulations.
The imposition by the OCC of any of these measures on the Bank may have a substantial adverse effect on the Bank’s operations and profitability and the value of the Company’s common stock.
Limitations on Dividends and Other Capital Distributions.
The Bank’s ability to pay dividends is governed by the National Bank Act and OCC regulations. Under such statute and regulations, all dividends by a national bank must be paid out of current or retained net profits, after deducting reserves for losses and bad debts. The National Bank Act further restricts the payment of dividends out of net profits by prohibiting a national bank from declaring a cash dividend on its shares of common stock until the surplus fund equals the amount of capital stock or, if the surplus fund does not equal the amount of capital stock, until one-tenth of the bank’s net profits for the preceding half year in the case of quarterly or semi-annual dividends, or the preceding two half-year periods in the case of annual dividends, are transferred to the surplus fund. In addition, the prior approval of the OCC is required for the payment of a dividend if the total of all dividends declared by a national bank in any calendar year would exceed the total of its net profits for the year combined with its net profits for the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock.
The OCC has the authority to prohibit the payment of dividends by a national bank when it determines such payment to be an unsafe and unsound banking practice. In addition, the bank would be prohibited by federal statute and the OCC’s prompt corrective action regulations from making any capital distribution if, after giving effect to the distribution, the bank would be classified as “undercapitalized” under OCC regulations. See “- Prompt Corrective Action.” Finally, the Bank would not be able to pay dividends on its capital stock if its capital would thereby be reduced below the remaining balance of the liquidation account established in connection with the Bank’s conversion from mutual to stock form.
Accounting.
The OCC requires that investment activities of a national bank be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Accordingly, management must support its classification of and accounting for loans and securities (i.e., whether held for investment, sale or trading) with appropriate documentation. The Bank is in compliance with these requirements.
Community Reinvestment Act.
Under the Community Reinvestment Act (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.
The CRA requires the OCC, in connection with the examination of the institution, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the institution. An unsatisfactory rating may be used as the basis for the denial of an application by the OCC. The Bank’s CRA rating is “satisfactory.”
Transactions with Affiliates.
Generally, transactions between a national bank or its subsidiaries and its affiliates are required to be on terms as favorable to the bank as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the bank’s capital. Affiliates of the bank include any company which is under common control with the bank. In addition, the bank may not acquire the securities of most affiliates. Subsidiaries of the bank are not deemed affiliates. However, the Federal Reserve Board (the “FRB”) has the discretion to treat subsidiaries of national banks as affiliates on a case-by-case basis.
Certain transactions with directors, officers or controlling persons (“Insiders”) are also subject to conflict of interest rules enforced by the OCC. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, as a general matter, loans to Insiders must be made on terms substantially the same as for loans to unaffiliated individuals.
Federal Reserve System.
The FRB requires all depository institutions to maintain reserves at specified levels against their transaction accounts (primarily checking and NOW checking accounts). At March 31, 2009, the Bank $1.2 million in reserve and had $169,900 in FRB stock, which was in compliance with these reserve requirements.
Holding Company Regulation.
General. The Company is a bank holding company registered with the FRB. Bank holding companies are subject to comprehensive regulation by the FRB under the Banking Holding Company Act (the “BHCA”), and the regulations of the FRB. As a bank holding company, the Company is required to file reports with the FRB and such additional information as the FRB may require, and will be subject to regular examinations by the FRB. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
Under FRB policy, a bank holding company must serve as a source of financial and managerial strength for its subsidiary banks. Under this policy the FRB may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank. Failure by a bank holding company to act as a “source of strength” to its subsidiary bank could be deemed by the FRB to be an unsafe and unsound banking practice, a violation of FRB regulation, or both.
Under the BHCA, a bank holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.
Dividends. The FRB previously issued a policy statement, with which the Bank is in compliance, on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that the Company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the Company’s capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the FRB, the FRB may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.” See “Regulation - Prompt Corrective Action.”
Importantly, in 2009, the FRB issued a set of specific factors the board of directors of a bank holding company should consider before declaring a dividend. Those factors include the following:
•
Overall asset quality, potential need to increase reserves and write down assets, and concentrations of credit;
•
Potential for unanticipated losses and declines in asset values;
•
Implicit and explicit liquidity and credit commitments, including off-balance sheet and contingent liabilities;
•
Quality and level of current and prospective earnings, including earnings capacity under a number of plausible economic scenarios;
•
Current and prospective cash flow and liquidity;
•
Ability to serve as an ongoing source of financial and managerial strength to depository institution subsidiaries insured by the Federal Deposit Insurance Corporation, including the extent of double leverage and the condition of subsidiary depository institutions;
•
Other risks that affect the bank holding company’s financial condition and are not fully captured in regulatory capital calculations;
•
Level, composition, and quality of capital; and
•
Ability to raise additional equity capital in prevailing market and economic conditions.
Redemption. Bank holding companies are required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. This notification requirement does not apply to any company that meets the well-capitalized standard for commercial banks, is well managed and is not subject to any unresolved supervisory issues.
Capital Requirements. The FRB has established capital requirements for bank holding companies that generally parallel the capital requirements for national banks. For bank holding companies with consolidated assets of less than $500 million, such as the Company, compliance is measured on a case-by-case basis. See “Regulation - National Banks.” The Company’s capital exceeds such requirements.
Federal Home Loan Bank System.
The Bank is a member of the FHLB of Chicago, which is one of 12 regional FHLBs, that administers the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures, established by the board of directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board (“FHFB”), an agency of the United States government. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the FHLB of Chicago. At March 31, 2009, the Bank had $642,000 in FHLB stock. The Bank made a subsequent purchase of an additional $194,200 in FHLB stock on April 7, 2009, which was in compliance with the stock maintenance requirement.
The FHLB of Chicago entered into a cease-and-desist order (“Order”) with the FHFL, its regulator, on October 10, 2007. Dividends were suspended by the FHLB of Chicago at the end of the third quarter in 2007 and have not yet been reinstated as of the date of this filing. Among other things, the Order provides that any proposed divided must first be approved by the Director of the Office of Supervision of the FHFB.
On July 23, 2008, the FHFB amended this cease-and-desist order to permit the FHLB of Chicago to repurchase or redeem newly-issued capital stock to support new advances, subject to certain conditions set forth in the Order. The FHFB permitted this modification because it determined that permitting the FHLB of Chicago to do this would help it to grow its advances business, and thereby, improve its financial condition while preserving the stability of its existing capital stock.
Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions could have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank’s FHLB stock may result in a corresponding reduction in the Bank’s capital.
Federal and State Taxation
Federal Taxation. In addition to the regular income tax, corporations generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income.
The Company and the Bank file a consolidated income tax return on the accrual basis of accounting. Neither the Company nor the Bank have been audited by the IRS with respect to federal income tax returns.
State Taxation. The Company also is subject to various forms of state taxation under the laws of Illinois as a result of the business it conducts in Illinois, and under the laws of Indiana as a result of the business it conducts in Indiana.
Employees
At March 31, 2009, the Company and the Bank had a total of 52 full-time and 12 part-time employees. The Company’s and the Bank’s employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
Recent Accounting Pronouncements
In December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations-A Replacement of FASB Statement No. 141” (“SFAS No. 141(R)”) and Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures certain items in a business combination, as well as disclosures about the nature and financial effects of a business combination. SFAS No. 160 establishes accounting and reporting standards surrounding noncontrolling interest, or minority interests, which are the portions of equity in a subsidiary not attributable, directly or indirectly, to a parent. The pronouncements are effective for fiscal years beginning on or after December 15, 2008 and apply prospectively to business combinations, meaning they are effective for the Company beginning April 1, 2009. Presentation and disclosure requirements related to noncontrolling interests must be retrospectively applied. Management is currently evaluating the impact of SFAS No. 141(R) on its accounting for future acquisitions; management has evaluated the requirements of SFAS No. 141(R) and believes it will not have a material effect on the Company’s consolidated financial statements.
In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities-An Amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 requires enhanced qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 was effective for the Company for the interim period which begins April 1, 2009, and is not expected to have an effect on the Company’s consolidated financial statements.
In April 2009, the FASB issued the FASB Staff Position on FAS 157-4, “Determining Fair Value When the Volume and Level of Activity For the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (FSP 157-4). FSP 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have decreased significantly. FSP 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The provisions of FSP 157-4 will be effective for the Company’s fiscal year ended March 31, 2010. Management is currently evaluating the impact of FSP 157-4, and believes implementation will not have a material effect on the Company’s consolidated financial statements.
In April 2009, the FASB issued the FASB Staff Position on FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (the FSP). The FSP establishes a methodology of determining and recording other-than-temporary impairments of debt securities and expands disclosures about fair value measurements. The provisions of the FSP will be effective for the Company’s fiscal year ended March 31, 2010. Management is currently evaluating the impact of the FSP.
In April 2009, the FASB issued the FASB Staff Position on FAS 107-1 and APB 28-1, “Interim Disclosures About Fair Value of Financial Instruments” (the FSP). The FSP requires disclosures about fair value of financial instruments in interim reporting periods of publicly-traded companies that were previously only required to be disclosed in annual financial statements. The provisions of the FSP are effective for the Company for the interim period ended June 30, 2009, and, as the FSP amends only the disclosure requirements about fair value of financial instruments in interim periods, adoption is not expected to affect the Company’s consolidated financial statements.
In May 2009, the FASB issued Statement No. 165, “Subsequent Events”. SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. The Statement does not apply to subsequent events or transactions that are within the scope of other generally accepted accounting principles (GAAP) that provide different guidance on the accounting treatment for subsequent events or transactions. The Statement is effective for interim or annual financial periods after June 15, 2009. The Company will apply the Statement for the interim period ended June 30, 2009 and it is not expected to have a material affect to the Company’s consolidated financial statements.
ITEM 1A.
ITEM 1A. RISK FACTORS
The Company’s business could be harmed by any of the risks noted below, or by other risks not noted because they were not apparent to management. Similarly, the trading price of the Company’s common stock could decline, and stockholders may lose all or part of their investment. In assessing these risks, you should also refer to the other information contained in this annual report on Form 10-K, including the Company’s financial statements and related notes.
Risks Related to Recent Developments and the Banking Industry Generally
Recent negative developments in the financial services industry and U.S. and global credit markets may adversely impact the Company’s operations and results.
The national and global economic downturn has recently resulted in extreme levels of market volatility locally, nationally and internationally. Factors such as consumer spending, business investment, government spending and inflation all affect the business and economic environment and, ultimately, the profitability of the Company. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, stock prices of financial institutions, like ours, have been negatively affected, as has our ability, if needed, to raise capital or borrow in the debt markets. Dramatic declines in the housing market over the past two years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for loan losses.
As a result of the current mortgage crisis and the economic slowdown, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations. Negative developments in the financial services industry and the impact of new legislation in response to those developments could adversely impact our operations, including our ability to originate or sell loans, and adversely impact our financial performance.
There can be no assurance that recently enacted legislation will help stabilize the U.S. financial system.
As discussed further above in Part I, Item 1 “Business - Regulation - Recent Legislation - Federal Economic Stabilization Programs”, since October 2008, numerous legislative actions have been taken in response to the financial crisis affecting the banking system and financial markets. These programs were implemented to help stabilize and provide liquidity to the financial system. There can be no assurance, however, as to the actual impact that stabilization programs, or any other governmental programs, will have on the financial markets. The failure of these programs to stabilize the financial markets and the continuation or worsening of current financial market conditions could materially and adversely affect the Company’s business, financial condition, results of operations, access to credit or the trading price of the Company’s common stock.
The soundness of other financial institutions could adversely affect us.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of a counterparty or client. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure. There is no assurance that any such losses would not materially and adversely affect the Company’s results of operations.
Recent negative developments in the financial industry and the credit markets may subject us to additional regulation.
As a result of the recent global financial crisis, the potential exists for new federal or state laws and regulations regarding lending and funding practices and liquidity standards to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and credit markets, and the impact of new legislation in response to those developments, may negatively impact the Company’s operations by restricting our business operations, including our ability to originate or sell loans, and may adversely impact the Company’s financial performance.
Changes in economic and political conditions could adversely affect the Company’s earnings, as the Company’s borrowers’ ability to repay loans and the value of the collateral securing the Company’s loans decline.
The Company’s success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond the Company’s control may adversely affect the Company’s asset quality, deposit levels and loan demand and, therefore, the Company’s earnings. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of the Company’s borrowers to make timely repayments of their loans, which would have an adverse impact on the Company’s earnings. In addition, substantially all of the Company’s loans are to individuals and businesses in the Company’s market area. Consequently, any economic decline in the Company’s market area could have an adverse impact on the Company’s earnings.
Changes in interest rates could adversely affect the Company’s results of operations and financial condition.
The Company’s earnings depend substantially on the Company’s interest rate spread, which is the difference between (i) the rates we earn on loans, securities and other earning assets, and (ii) the interest rates we pay on deposits and other borrowings. These rates are highly sensitive to many factors beyond the Company’s control, including general economic conditions and the policies of various governmental and regulatory authorities. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
We operate in a highly regulated environment, and changes in laws and regulations to which we are subject may adversely affect the Company’s results of operations.
The Company and the Bank operate in a highly regulated environment and are subject to extensive regulation, supervision and examination by the OCC and the Board of Governors of the Federal Reserve System. See “Business - Regulation” herein. Applicable laws and regulations may change, and there is no assurance that such changes will not adversely affect the Company’s business. Such regulation and supervision govern the activities in which an institution may engage, and are intended primarily for the protection of banks and their depositors. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including but not limited to the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of restrictions on activities, regulatory policy, regulations, or legislation, including but not limited to changes in the regulations governing national banks, could have a material impact on the bank and the Company’s operations.
Changes in technology could be costly.
The banking industry is undergoing technological innovation at a fast pace. To keep up with its competition, the Company needs to stay abreast of innovations and evaluate those technologies that will enable it to compete on a cost-effective basis. The cost of such technology, including personnel, can be high in both absolute and relative terms. There can be no assurance, given the fast pace of change and innovation, that the Company’s technology, either purchased or developed internally, will meet or continue to meet the needs of the Company.
Risks Related to the Company’s Business
We operate in an extremely competitive market, and the Company’s business will suffer if we are unable to compete effectively.
In the Company’s market area, the Bank encounters significant competition from other commercial banks, a credit union, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial intermediaries. Many of the Bank’s competitors have substantially greater resources and lending limits than we do and may offer services that we do not or cannot provide. The Company’s profitability depends upon the Company’s continued ability to compete successfully in the Company’s market area.
The loss of key members of the Company’s senior management team could adversely affect the Company’s business.
We believe that the Company’s success depends largely on the efforts and abilities of the Company’s senior management. Their experience and industry contacts significantly benefit us. The competition for qualified personnel in the financial services industry is intense, and the loss of any of the Company’s key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect the Company’s business.
The Company’s loan portfolio includes loans with a higher risk of loss.
The Bank originates commercial loans, consumer loans, agricultural finance loans and residential mortgage loans primarily within the Company’s market areas. Commercial mortgage, commercial, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. These loans also have greater credit risk than residential real estate for the following reasons:
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Commercial Loans. Repayment is dependent upon the successful operation of the borrower’s business
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Consumer Loans. Consumer loans (such as personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss.
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Agricultural Finance Loans. Repayment is dependent upon the successful operation of the business, which are greatly dependent on many things outside the control of either the Bank or the borrowers. These factor include weather, commodity prices, and interest rates, among others.
If the Company’s actual loan losses exceed the Company’s allowance for loan losses, the Company’s net income will decrease.
The Company makes various assumptions and judgments about the collectibility of the Company’s loan portfolio, including the creditworthiness of the Company’s borrowers and the value of the real estate and other assets serving as collateral for the repayment of the Company’s loans. Despite the Company’s underwriting and monitoring practices, the Company’s loan customers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We may experience significant loan losses, which could have a material adverse effect on the Company’s operating results. Because we must use assumptions regarding individual loans and the economy, the Company’s current allowance for loan losses may not be sufficient to cover actual loan losses, and increases in the allowance may be necessary. We may need to significantly increase the Company’s provision for losses on loans if one or more of the Company’s larger loans or credit relationships becomes delinquent or if we continue to expand the Company’s commercial real estate and commercial lending. In addition, federal regulators periodically review the Company’s allowance for loan losses and may require us to increase the Company’s provision for loan losses or recognize loan charge-offs. Material additions to the Company’s allowance would materially decrease the Company’s net income. We cannot assure you that the Company’s monitoring procedures and policies will reduce certain lending risks or that the Company’s allowance for loan losses will be adequate to cover actual losses.
If we foreclose on collateral property and own the underlying real estate, we may be subject to the increased costs associated with the ownership of real property, resulting in reduced revenues.
We may have to foreclose on collateral property to protect the Company’s investment and may thereafter own and operate such property, in which case we will be exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of the Company’s control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) supply of and demand for rental units or properties; (vii) ability to obtain and maintain adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) acts of God. Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating a real property may exceed the rental income earned from such property, and we may have to advance funds in order to protect the Company’s investment, or we may be required to dispose of the real property at a loss. The foregoing expenditures and costs could adversely affect the Company’s ability to generate revenues, resulting in reduced levels of profitability.
Environmental liability associated with commercial lending could have a material adverse effect on the Company’s business, financial condition and results of operations.
In the course of the Company’s business, we may acquire, through foreclosure, commercial properties securing loans that are in default. There is a risk that hazardous substances could be discovered on those properties. In this event, we could be required to remove the substances from and remediate the properties at the Company’s cost and expense. The cost of removal and environmental remediation could be substantial. We may not have adequate remedies against the owners of the properties or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have a material adverse effect on the Company’s business, financial condition and operating results.
If the Company fails to maintain an effective system of internal control over financial reporting, it may not be able to accurately report the Company’s financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in the Company’s financial reporting, which could adversely affect the Company’s business, the trading price of the Company’s stock and the Company’s ability to attract additional deposits.
In order to comply with the requirements of Section 404 of the Sarbanes-Oxley Act and SEC rules and regulations, beginning with the Company’s annual report on Form 10-K for the fiscal year ended March 31, 2008, we have included in our annual reports filed with the SEC a report of the Company’s management regarding internal control over financial reporting. In anticipation of preparing such reports, we began in 2007 to document and evaluate the Company’s internal control over financial reporting. Management retained outside consultants to assist in (i) assessing and documenting the adequacy of the Company’s internal control over financial reporting, (ii) improving control processes, where appropriate, and (iii) verifying through testing that controls are functioning as documented. If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of the Company’s internal control over financial reporting or fail to prevent fraud, current and potential stockholders and depositors could lose confidence in the Company’s financial reporting, which could adversely affect the Company’s business, financial condition and results of operations, the trading price of the Company’s stock and the Company’s ability to attract additional deposits.
A breach of information security or compliance breach by one of our agents or vendors could negatively affect the Company’s reputation and business.
The Bank depends on data processing, communication and information exchange on a variety of computing platforms and networks and over the internet. We cannot be certain all of the Company’s systems are entirely free from vulnerability to attack, despite safeguards we have installed. Additionally, we rely on and do business with a variety of third-party service providers, agents and vendors with respect to the Company’s business, data and communications needs. If information security is breached, or one of our agents or vendors breaches compliance procedures, information could be lost or misappropriated, resulting in financial loss or costs to us or damages to others. These costs or losses could materially exceed the Company’s amount of insurance coverage, if any, which would adversely affect the Company’s business.
The price of the Company’s common stock may be volatile, which may result in losses for investors.
The market price for shares of the Company’s common stock has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future. These factors include:
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announcements of developments related to the Company’s business,
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fluctuations in the Company’s results of operations,
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sales of substantial amounts of the Company’s securities into the marketplace,
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general conditions in the Company’s banking niche or the worldwide economy,
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a shortfall in revenues or earnings compared to securities analysts’ expectations,
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lack of an active trading market for the common stock,
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commencement of, or changes in analysts’ recommendations or projections, and
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the Company’s announcement of new acquisitions or other projects.
The market price of the Company’s common stock may fluctuate significantly in the future, and these fluctuations may be unrelated to the Company’s performance. General market price declines or market volatility in the future could adversely affect the price of the Company’s common stock, and the current market price may not be indicative of future market prices.
Risks Related to the Company’s Stock
The Company’s common stock is thinly traded, and thus your ability to sell shares or purchase additional shares of the Company’s common stock will be limited, and the market price at any time may not reflect true value.
Your ability to sell shares of the Company’s common stock or purchase additional shares largely depends upon the existence of an active market for the common stock. The Company’s common stock is quoted on the Over the Counter Bulletin Board. The volume of trades on any given day is light, and you may be unable to find a buyer for shares you wish to sell or a seller of additional shares you wish to purchase. In addition, a fair valuation of the purchase or sales price of a share of common stock also depends upon active trading, and thus the price you receive for a thinly traded stock, such as the Company’s common stock, may not reflect its true value.
Federal regulations may inhibit a takeover, prevent a transaction you may favor or limit the Company’s growth opportunities, which could cause the market price of the Company’s common stock to decline.
Certain provisions of the Company’s charter documents and federal regulations could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. In addition, we must obtain approval from regulatory authorities before acquiring control of any other company.
We may not be able to pay dividends in the future in accordance with past practice.
We pay an annual dividend to stockholders. The payment of dividends is subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Bank’s earnings, capital requirements, financial condition and other factors considered relevant by the Company’s Board of Directors.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business through its main office and four branch offices, three of which are located in Crawford County, Illinois, and one of which is located in Knox County, Indiana. The commercial property for the newest branch, located in Vincennes, Indiana, was acquired by the Company in February 2008, and the branch opened on December 29, 2008. The Bank owns its main office and branch offices. The total net book value of the Bank’s premises and equipment (including land, buildings and leasehold improvements and furniture, fixtures and equipment) at March 31, 2009 was approximately $3.9 million. The following table sets forth information relating to the Bank’s offices as of March 31, 2009.
The Company and the Bank believe that current facilities are adequate to meet the present and foreseeable needs and are adequately covered by insurance. See Note 5 of Notes to Consolidated Financial Statements.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company and the Bank are involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of its businesses. While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing the Company and the Bank in the proceedings, that the resolution of these proceedings should not have a material effect on the Company’s results of operations on a consolidated basis.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, for the quarter ended March 31, 2009.
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
Pages 61 and 62 of the attached 2009 Annual Report to Stockholders are incorporated herein by reference.
PURCHASES OF EQUITY SECURITIES BY COMPANY (1) (2)
(1)
On July 24, 2008, the Board of Directors of First Robinson Financial Corporation voted to approve the extension and expansion of the repurchase program of its equity stock approved on September 18, 2007. The Company may repurchase up to 22,000 additional shares of the Company’s outstanding common stock in the open market or in negotiated private transactions from time to time when deemed appropriate by management. The increase represents approximately 5% of the Company’s issued and outstanding shares. As of July 24, 2008, the Company had repurchased 20,108 shares of its common stock out of the 25,000 shares that had been previously authorized for repurchase. As a result of these actions, the Company is currently authorized to repurchase 26,892 shares of common stock. The Program, with an original expiration date of September 17, 2008, has been extended to August 1, 2009 or the completion of the repurchase of the 26,892 shares. As of March 31, 2009, 22,698 shares of the 26,892 have been purchased in the new program leaving 4,194 remaining to be purchased.
(2)
The trustees of the First Robinson Savings and Loan Directors’ Retirement Plan purchased 200 shares of the Company’s common stock. The stock is allocated to the Directors’ accounts and will be distributed upon retirement.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Pages 3 and 4 of the attached 2009 Annual Report to Stockholders are incorporated herein by reference.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pages 5 through 24 of the attached 2009 Annual Report to Stockholders are incorporated herein by reference.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pages 21 through 23 of the attached 2009 Annual Report to Stockholders are incorporated herein by reference.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following information appearing in the Company’s Annual Report to Stockholders for the year ended March 31, 2009, is incorporated by reference in this Annual Report on Form 10-K as Exhibit 13.
With the exception of the aforementioned information, the Company’s Annual Report to Stockholders for the year ended March 31, 2009 is not deemed filed as part of this Annual Report on Form 10-K.
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
Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in timely alerting them to the material information relating to us required to be included in our periodic SEC filings. There were no significant changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Management’s Annual Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2009, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control-Integrated Framework.” Based on the assessment, management determined that, as of March 31, 2009, the Company’s internal control over financial reporting is effective, based on those criteria.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only the management’s report in this annual report.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
Information concerning Directors of the Company is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
Executive Officers
Information concerning Executive Officers of the Company and the Bank is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
Compliance with Section 16(A)
Information concerning compliance with Section 16(a) of the Exchange Act is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information
The Company does not currently maintain any equity compensation plans.
Additional information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accounting fees and services is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on July 23, 2009, a copy of which was filed with the SEC on June 24, 2009.
ITEM 15.
ITEM 15.
EXHIBITS
(a)
Exhibits
Exhibit
Number
Document
Reference to
Prior Filing or
Exhibit Number
Attached Hereto
3(i)
Certificate of Incorporation
*
3(ii)
By-Laws
**
Instruments defining the rights of security holders, including debentures
*
Material Contracts
None
Annual Report to Stockholders
Subsidiaries of Registrant
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.1
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
32.1
Certification of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act of
32.1
*
Incorporated by reference to the Company’s Registration Statement on Form S-1 filed with the SEC on March 19, 1997 (File No. 333-23625).
**
Incorporated by reference to the Company’s Form 10-KSB for the fiscal year ended March 31, 2008 filed with the SEC on June 30, 2008 (File No. 001-12969; Film No. 08924531).
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 the registrant and in the capacities and on the dates indicated.
By:
/s/ Rick L. Catt
By:
/s/ Jamie E. McReynolds
Rick L. Catt,
Director, President and Chief
Executive Officer (Principal Executive
and Operating Officer)
Jamie E. McReynolds,
Vice President, Chief Financial Officer
and Secretary
(Chief Financial and Accounting Officer)
Date:
June 29, 2009
Date:
June 29, 2009
By:
/s/ Scott F. Pulliam
By:
/s/ J. Douglas Goodwine
Scott F. Pulliam,
Director
J. Douglas Goodwine,
Director
Date:
June 29, 2009
Date:
June 29, 2009
By:
/s/ Robin E. Guyer
By:
/s/ Steven E. Neeley
Robin E. Guyer,
Director
Steven E. Neeley,
Director
Date:
June 29, 2009
Date:
June 29, 2009
By:
/s/ William K. Thomas
William K. Thomas,
Director
Date:
June 29, 2009