ITEM 1. BUSINESS
Forward Looking Statements
This Annual Report on Form 10-K contains, and other periodic and current reports and press releases of BankFinancial Corporation may contain, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that involve significant risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for the purpose of invoking these safe harbor provisions. Forward-looking statements are based on certain assumptions or describe our future plans, strategies and expectations, and are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “plan,” or similar expressions. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain, and actual results or effects may differ from those predicted. Factors that could have a material adverse effect on operations and could affect management’s outlook or our future prospects include, but are not limited to: higher than expected overhead, infrastructure and compliance costs, changes in market interest rates, changes in the yield curve, balance sheet shrinkage or less than anticipated balance sheet growth, lack of demand for loan products, illiquidity and changes in financial markets, including the market for mortgage backed securities and other debt obligations, declining demand for real estate and real estate valuations, increasing unemployment levels, deposit flows, pricing, underwriting and other forms of competition, adverse federal or state legislative or regulatory developments, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board, adverse economic conditions that could result in increased delinquencies in our loan portfolio or a decline in the value of our investment securities and the collateral for our loans, the quality or composition of our loan or investment portfolios, demand for financial services and multi-family, commercial and residential real estate loans in our market areas, the possible dilutive effect of potential acquisitions or de novo branches, if any, changes in accounting principles, policies and guidelines, increased costs of federal deposit insurance, our failure to integrate an acquired institution successfully or achieve expected synergies and cost savings, and future adverse developments concerning the Federal Home Loan Bank of Chicago. These risks and uncertainties, as well as the Risk Factors set forth in Item 1A
ITEM 1A. RISK FACTORS
The risks set forth below may adversely affect our business, financial condition and operating results. In addition to the risks set forth below and the other risks described in Item 1, “Business, Forward Looking Statements,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” there may also be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operating results. As a result, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
Current Economic Conditions Present Higher Risks to Our Loan Portfolio
At December 31, 2010, our loan portfolio included $296.9 million in multi-family mortgage loans, or 27.7% of total loans; $282.0 million in nonresidential real estate loans, or 26.3% of total loans; $151.1 million in commercial leases, or 14.1% of total loans; $64.7 million in commercial loans, or 6.0% of total loans; and $76.0 million in non owner occupied residential real estate loans, or 7.1% of total loans; $103.3 million in residential real estate loans, or 16.7% of total loans; and $18.4 million in construction and land loans, or 1.7% of total loans. Current economic conditions, including high unemployment rates, weakened consumer and business spending and materially declining real estate values, all present risks to our loan portfolio. Our historical loan underwriting standards presumed a reasonable range of economic and operating conditions for our borrowers and their underlying business or personal circumstances. The depth and speed of the decline in economic activity exceeded, and will continue to exceed, the financial and management capabilities of certain borrowers to meet their credit obligations. Furthermore, the decline in real estate values in all market segments not only diminishes an important source of repayment, but also diminishes the economic interest of borrowers in investing additional financial resources into their businesses or residences. Though the risk of a sudden and catastrophic event in financial markets appears to have receded, persistently weak economic growth in the U.S. and certain of its trading partners will continue to depress the operating results of certain commercial lessees. These factors and conditions and prudent loan portfolio management have also combined to reduce the overall level of acceptable credit exposures available in the market, resulting in lower loan portfolio balances and reduced interest income from the loan portfolio.
If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease
In the event that our loan customers do not repay their loans according to their terms, and the collateral securing the repayment of these loans is insufficient to cover any remaining loan balance, we could experience significant loan losses or increase our provision for loan losses or both, which could have a material adverse effect on our operating results. At December 31, 2010, our allowance for loan losses was $22.2 million, representing 2.07% of total loans and 48.5% of nonperforming loans as of that date. In determining the amount of our allowance for loan losses, we rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors. In addition, we make various estimates and assumptions about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets, if any, serving as collateral for the repayment of our loans. We also make judgments concerning our legal positions and the priority of our interests in contested legal or bankruptcy proceedings, and at times, we may lack sufficient information to establish specific reserves for loans involved in such proceedings. We base these estimates, assumptions and judgments on information that we consider reliable, but if an estimate, assumption or judgment that we make ultimately proves to be incorrect, additional provisions to our allowance for loan losses may become necessary.
We Have a Goodwill Asset that Could Be Classified as Impaired in the Future. If the Goodwill Asset Is Considered to Be Partially or Fully Impaired in the Future, Our Earnings and the Book Values of This Asset Would Decrease
As of December 31, 2010, we maintained goodwill as an asset in the amount of $22.6 million. We assess our goodwill asset for impairment at least annually. In fourth quarter, 2010, we engaged an independent third-party valuation firm to assist us in our most recent goodwill impairment testing as of December 31, 2010. In its valuation analysis, the third-party valuation firm determined that the fair value of BankFinancial, F.S.B., the reporting unit pursuant to ASC 350-20-35-36, was sufficient to support the carrying value of our goodwill asset. However, if our market capitalization remains below its tangible book value or if the fair value of the reporting unit were to decline, future goodwill impairment testing could result in a partial or full impairment of the value of the Bank’s goodwill asset. If we determine that an impairment of our goodwill asset exists at a given point in time, our earnings and the book value of our goodwill asset will be reduced by the amount of the impairment. An impairment of our goodwill asset would have little or no impact on our tangible book value or regulatory capital levels.
If the Company’s Deferred Tax Assets Require a Valuation Allowance in the Future, Earnings Will Be Negatively Impacted
We periodically evaluate our deferred tax assets to determine whether a valuation allowance is needed for some portion or all of our deferred tax assets. A valuation allowance must be recognized for a deferred tax asset if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. We concluded from our most recent evaluation of our deferred tax assets that it is more likely than not that we will realize the $17.6 million in gross deferred tax assets that were recorded at December 31, 2010. However, if we record net losses in 2011 or in future years, this could call into question our ability to realize some portion or all of the deferred tax assets that we have recorded and require us to recognize a valuation allowance. The recognition of a valuation allowance would have a corresponding impact on our earnings in the period it is recognized.
Changes in Market Interest Rates Could Adversely Affect Our Financial Condition and Results of Operations
Our financial condition and results of operations are significantly affected by changes in market interest rates because our assets, primarily loans, and our liabilities, primarily deposits, are monetary in nature. Our results of operations depend substantially on our net interest income, which is the difference between the interest income that we earn on our interest-earning assets and the interest expense that we pay on our interest-bearing liabilities. We are unable to predict changes in market interest rates that are affected by many factors beyond our control, including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets. Our net interest income is affected not only by the level and direction of interest rates, but also by the shape of the yield curve and relationships between interest sensitive instruments and key driver rates, including credit risk spreads, and by balance sheet growth, customer loan and deposit preferences and the timing of changes in these variables which themselves are impacted by changes in market interest rates. As a result, changes in market interest rates can significantly impact our net interest income as well as the fair market valuation of our assets and liabilities.
The Risks Presented by the Acquisition of Other Institutions Could Adversely Affect Our Financial Condition and Results of Operations
If we acquire other institutions, we will be presented with many risks that could have a material adverse effect on our financial condition and results of operations. An institution that we acquire may have unknown asset quality issues or unknown or contingent liabilities that we did not discover or fully recognize in the due diligence process, thereby resulting in unanticipated losses, particularly in the case of FDIC-assisted transactions due to the highly restrictive due diligence available to potential bidders. The acquisition of other institutions typically requires the integration of different corporate cultures, loan and deposit products, pricing strategies, data processing systems and other technologies, accounting, internal audit and financial reporting systems, operational processes, policies, procedures and internal controls, marketing programs and personnel of the acquired institution in order to make the transaction economically advantageous. The integration process is complicated and time consuming, and could divert our attention from other business concerns and be disruptive to our customers and the customers of the acquired institution. Our failure to integrate an acquired institution successfully could result in the loss of key customers and employees, and prevent us from achieving expected synergies and cost savings. Acquisitions also result in professional fees, purchase price adjustments, the amortization of core deposit intangibles and other expenses that could adversely affect our earnings, and in goodwill that could become impaired, requiring us to recognize further charges. We may finance acquisitions with borrowed funds, thereby increasing our leverage and reducing our liquidity, or with potentially dilutive issuances of equity securities.
Since Our Business is Concentrated in the Chicago Metropolitan Area, Local Economic Conditions May Adversely Affect Our Business
Although we make certain types of loans and leases to borrowers located in other states, our lending and deposit gathering activities are concentrated primarily in the Chicago metropolitan area. Our success can be affected by the general economic conditions of this area and surrounding areas. In addition, many of the loans in our loan portfolio are secured by real estate located in the Chicago metropolitan area. Negative conditions in the real estate markets where collateral for a mortgage loan is located could adversely affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors beyond our control, including real estate supply and demand, the impact of mortgage foreclosures and short sales, changes in general or regional economic conditions and unemployment rates, interest rates, governmental rules or policies and natural disasters. The value of real estate located in many segments of the Chicago metropolitan area has been and continues to be adversely impacted by many of these factors, and this has had, and may continue to have, a negative impact on our loan growth, our ability to collect certain loans according to their terms, and our results of operations.
Difficult Economic Conditions Have Adversely Affected the Banking Industry
National and local economic conditions have been difficult in recent years, and this has resulted in declining real estate values, a tightening of the availability of credit, illiquidity in certain securities markets, increasing loan delinquencies, mortgage foreclosures, personal and business bankruptcies, rising unemployment rates, declining consumer confidence and spending, significant write-downs of asset values by financial institutions and government-sponsored entities, and a reduction of manufacturing and service business activity and international trade. These conditions have contributed to significant declines in the trading prices of certain financial institution stocks, many of which have not fully recovered. We do not expect that the national and local economies will fully recover over the short term, and a continuation or worsening of these conditions could exacerbate their adverse effects. The adverse effects of these conditions could include increases in loan delinquencies and charge-offs, increases to the portion of our loan loss reserve that we base on national or local economic factors, increases to our specific loan loss reserves due to the impact of these conditions on specific borrowers or the collateral for their loans, declines in the value of our investment securities, increases in regulatory and compliance costs, and declines in the trading price of our common stock.
If Our Investment in the Federal Home Loan Bank of Chicago is Classified as Other-Than-Temporarily Impaired, Our Earnings Could Decrease
We own FHLBC common stock to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBC’s advance program. The aggregate cost of our FHLBC common stock as of December 31, 2010 was $15.6 million based on its par value. There is no market for our FHLBC common stock. Due to our receipt of stock dividends and a reduction of our outstanding FHLBC advances, we owned shares of FHLBC common stock at December 31, 2010 with a par value that was $9.0 million more than we were required to own to maintain our membership, in the Federal Home Loan Bank System and to be eligible to obtain advances (“excess” or “voluntary” capital stock).
The FHLBC is subject to a cease and desist order issued by the Federal Housing Finance Board, now known as the Federal Housing Finance Agency (“FHFA”), in 2007. Among other things, the cease and desist order requires the FHLBC to submit a capital plan to the FHFA, prohibits certain capital stock repurchases and stock redemptions, including certain redemptions upon membership withdrawal, without the prior approval of the Director of the Office of Supervision of the FHFA ( “Director”), and prohibits the payments of dividends without the prior approval of the Director. The FHLBC has reported that it has submitted a capital plan to the Director but that it has not yet been approved. The FHLBC did not pay any dividends from the third quarter of 2007 through 2010, but in the first quarter of 2011, paid a nominal cash dividend at an annualized rate of 10 basis points per share. The FHLBC reported in February 2011 that it had earnings of net income of $366 million for 2010, compared to a net loss of $65 million in 2009, and that it is in compliance with its regulatory capital requirements.
Current accounting guidance requires us to evaluate our FHLBC common stock for impairment based on the “ultimate recoverability” of the par value of the security without regard to temporary declines in value. We concluded from our most recent impairment testing that it is probable that the par value of our FHLBC common stock is ultimately recoverable based on the FHLBC’s current compliance with its regulatory capital requirements, the net income that it reported for 2010, its receipt of regulatory approval to pay a dividend in the first quarter of 2011 and published reports indicating that it is continuing to work with its regulator to finalize a capital plan. However, if events were to occur that give rise to substantial doubt about the ultimate recoverability of the par value of our FHLBC common stock, this investment could become other-than-temporarily impaired, and the impairment loss that we would be required to record would cause our earnings to decrease by the after-tax amount of the impairment loss.
Our Future Success is Dependent on Our Ability to Compete Effectively in the Highly Competitive Banking Industry
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. To date, we have grown our business successfully by focusing on our geographic markets and emphasizing the high level of service and responsiveness desired by our customers. We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, brokerage houses, mutual funds, insurance companies, real estate conduits, and specialized finance companies. Many of our competitors offer products and services that we do not offer, and many have substantially greater resources and lending limits, name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, and smaller newer competitors may be more aggressive in pricing loans and deposits in order to increase their market share. Some of the financial institutions and financial services organizations with which we compete are not subject to the extensive regulations imposed on federal savings banks and their holding companies. As a result, these nonbank competitors have certain advantages over us in accessing funding and in providing various financial services.
Our Business May Be Adversely Affected by the Highly Regulated Environment in Which We Operate
We are subject to extensive federal and state legislation, regulation, examination and supervision. The Dodd-Frank Act and other recently enacted legislation, the regulations promulgated there, and future legislation and regulations that may be enacted or promulgated, could have an adverse effect on our business and operations. In addition, the OTS will cease to be the primary federal regulator of the Company and the Bank on July 21, 2011, and we may need to make adjustments in our policies and procedures to ensure compliance with the rules and regulations of the OCC and the FRB. Our success will be impacted by our continued ability to comply with applicable laws and regulations. Some of these laws and regulations may increase our costs. While we cannot predict what effect any future changes in these laws or regulations or their interpretations would have on us, these changes or interpretations may adversely affect our future operations.
Trading Activity in the Company’s Common Stock Could Result in Material Price Fluctuations
It is possible that trading activity in the Company’s common stock, including short-selling or significant sales by current stockholders, could result in material price fluctuations of the price per share of the Company’s common stock. In addition, such trading activity and the resultant volatility could make it more difficult for the Company to sell equity or equity-related securities in the future at a time and price it deems appropriate, or to use its stock as consideration for an acquisition. See “Our Ability to Successfully Conduct Acquisitions Will Affect Our Ability to Grow Our Franchise and Compete Effectively in Our Marketplace”.
Our Return on Stockholders’ Equity Will Continue to Be Low Due to Our High Capital Level
Net income divided by average stockholders’ equity, known as return on equity, is a ratio that many investors use to compare the performance of a financial institution to its peers. Our capital remains relatively high by industry standards pending a more optimal deployment of the additional capital raised in our 2005 mutual-to-stock conversion. Until we can increase our net interest income and noninterest income, we expect our return on equity to continue to be below the historical industry average, which may negatively affect the value of our shares of common stock
The Company’s Ability to Pay Dividends is Affected by Regulatory Limitations on the Bank’s Ability to Pay Dividends and Other Regulatory Limitations
The Company is a separate legal entity from its subsidiaries and does not have significant operations of its own. Dividends from the Bank provide a significant source of cash for the Company. The availability of dividends from the Bank is limited by various statutes and regulations. Under these statutes and regulations, the Bank is not permitted to pay dividends on its capital stock to the Company, its sole stockholder, if the dividend would reduce the stockholders’ equity of the Bank below the amount of the liquidation account established in connection with the mutual-to-stock conversion. The Bank may pay dividends without the approval of its primary federal regulator only if the Bank meets its applicable regulatory capital requirements before and after the payment of the dividends and its total dividends do not exceed its net income to date over the calendar year plus its retained net income over the preceding two years. Although the Bank’s capital exceeded applicable regulatory requirements at December 31, 2010, the Bank did not have sufficient net income over the preceding two years to pay a dividend to the Company without the prior approval of its primary federal regulator. If the Bank were to seek the approval of its primary federal regulator to pay a dividend, there can be no assurance that such approval would be granted. If at some point in the future the Company utilizes its available cash for other purposes Bank is unable to pay dividends to the Company, the Company may not have sufficient funds to continue to pay dividends on its common stock. In addition, the Company’s ability to pay dividends on its common stock could be further limited by the application of the “source of strength doctrine,” which requires holding companies to provide financial support to their subsidiary depository institutions if the subsidiary is in financial distress, or by regulatory order.
We Continually Encounter Technological Change, and May Have Fewer Resources than Many of Our Competitors to Continue to Invest in Technological Improvements
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We also may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
Our Ability to Successfully Conduct Acquisitions Will Affect Our Ability to Grow Our Franchise and Compete Effectively in Our Marketplace
We consider the possible acquisition of other banks, thrifts and other financial services companies in private or FDIC-assisted transactions to supplement internal growth. Although we entered into a definitive agreement to acquire DG Bancorp, Inc. and its subsidiary, Downers Grove National Bank in the third quarter of 2010, our efforts to acquire other financial institutions and financial service companies in the future may not be successful. Other potential acquirors exist for most acquisition candidates, creating competition that can affect the purchase price for which the institution can be acquired. In many cases, our competitors have significantly greater resources than we have, and greater flexibility to structure the consideration for the transaction. We may not participate in specific acquisition opportunities if we consider the proposed transaction unacceptable, including the current or potential future terms, conditions and limitations imposed by an FDIC-assisted transaction. We also may not be the successful bidder in acquisition opportunities that we pursue due to the willingness or ability of other potential acquirors to propose a higher purchase price or more attractive terms and conditions than we are willing or able to propose. The results of a merger or acquisition could change materially based on future changes in applicable accounting principles and regulatory requirements related to acquired assets and liabilities. If we are unable to or do not conduct acquisitions to supplement internal growth, our ability to deploy effectively the capital we raised in the 2005 offering, expand our geographic presence and improve our results of operations could be adversely affected.
FDIC Deposit Insurance Premiums Have Increased and May Increase Further in the Future
The Federal Deposit Insurance Act, as amended, requires the FDIC to maintain a reserve ratio between 1.15% and 1.50%. The FDIC’s Board of Directors is required to establish a designated reserve ratio within that range and set assessment rates to meet that target within a time frame that the FDIC’s Board of Directors deems appropriate. If the reserve ratio falls below 1.15%, the FDIC’s Board of Directors is required to establish a restoration plan to bring the reserve ratio back to 1.15% within five years. The FDIC’s reserve ratio declined over the past several years due to costs associated with bank failures, and it is possible that the reserve ratio could be placed under stress due to future bank failures. As part of its plan to restore the reserve ratio to 1.15%, the FDIC’s Board of Directors imposed a special assessment equal to five basis points of assets less Tier 1 capital as of June 30, 2009, which was payable on September 30, 2009. In addition, the FDIC increased its quarterly assessment rates and amended the method by which rates are calculated. On November 12, 2009, the FDIC approved a final rule requiring insured depository institutions to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future. Any unused prepayments will be returned on June 30, 2013. See “Supervision and Regulation - Insurance of Deposit Accounts.” On December 30, 2009, the Bank paid the estimated assessment fees for the fourth quarter of 2009 and prepaid $6.8 million in estimated assessment fees through 2012. These increased assessments have had an adverse impact on our results of operations in 2009 and will continue to have an adverse impact in future years. If circumstances require the FDIC to impose additional special assessments or further increase its quarterly assessment rates, the adverse impact will be exacerbated.
Various Factors May Make Takeover Attempts That You Want to Succeed More Difficult to Achieve, Which May Affect the Value of Shares of Our Common Stock
Provisions of our articles of incorporation and bylaws, federal regulations, Maryland law and various other factors may make it more difficult for companies or persons to acquire control of the Company without the consent of our board of directors. You may want a takeover attempt to succeed because, for example, a potential acquiror could offer a premium over the then prevailing price of our shares of common stock. The OTS regulations prohibit the direct or indirect acquisition of more than 10% of any class of equity security of a converted savings institution without the prior approval of the OTS. Provisions of our articles of incorporation and bylaws also may make it difficult to remove our current board of directors or management if our board of directors opposes the removal. We have elected to be subject to the Maryland Business Combination Act, which places restrictions on mergers and other business combinations with large stockholders. In addition, our articles of incorporation provide that certain mergers and other similar transactions, as well as amendments to our articles of incorporation, must be approved by stockholders owning at least two-thirds of our shares of common stock entitled to vote on the matter unless first approved by at least two-thirds of the number of our authorized directors, assuming no vacancies. If approved by at least two-thirds of the number of our authorized directors, assuming no vacancies, the action must still be approved by a majority of our shares entitled to vote on the matter. In addition, a director can be removed from office, but only for cause, if such removal is approved by stockholders owning at least two-thirds of our shares of common stock entitled to vote on the matter. However, if at least two-thirds of the number of our authorized directors, assuming no vacancies, approves the removal of a director, the removal may be with or without cause, but must still be approved by a majority of our voting shares entitled to vote on the matter. Additional provisions include limitations on the voting rights of any beneficial owners of more than 10% of our common stock. Our bylaws, which can only be amended by the board of directors, also contain provisions regarding the timing, content and procedural requirements for stockholder proposals and nominations.
Non-Compliance with USA PATRIOT Act, Bank Secrecy Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act or Other Laws and Regulations Could Result in Fines or Sanctions, and Curtail Expansion Opportunities
Financial institutions are required under the USA PATRIOT and Bank Secrecy Acts to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, curtailment of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the U.S. Government imposed and will continue to expand laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. We have developed policies and continue to augment procedures and systems designed to assist in compliance with these laws and regulations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2010 the net book value of our properties was $28.5 million. The following is a list of our offices:
Except for our Chicago-Lincoln Park, Northbrook, and Hyde Park East offices, which are leased, all of our offices are owned. In addition to the above listed properties, we also operate three Express Branch facilities, two satellite national commercial leasing offices and two remote ATMs on sites where we do not have a full-service banking office.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.
ITEM 4.
ITEM 4. [RESERVED]
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our shares of common stock are traded on the Nasdaq Global Select Market under the symbol “BFIN.” The approximate number of holders of record of the Company’s common stock as of December 31, 2010 was 1,820. Certain shares of the Company’s common stock are held in “nominee” or “street” name, and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number.
The following table presents quarterly market information provided by the Nasdaq Stock Market for the Company’s common stock and cash dividends paid for the periods ended December 31, 2010 and 2009.
The Company is subject to state law limitations on the payment of dividends. Maryland law generally limits dividends to an amount equal to the excess of our capital surplus over payments that would be owed upon dissolution to stockholders whose preferential rights upon dissolution are superior to those receiving the dividend, and to an amount that would not make us insolvent provided, however, that even if the Company’s assets are less than the amount necessary to satisfy the requirement set forth above, the Company may make a distribution from: (A) the Company’s net earnings for the fiscal year in which the distribution is made; (B) the Company’s net earnings for the preceding fiscal year; or (C) the sum of the Company’s net earnings for the preceding eight fiscal quarters. Dividends from the Bank provide a significant source of cash for the Company. The availability of dividends from the Bank is limited by various statutes and regulations. For a discussion of the Bank’s ability to pay dividends, see Part I, Item 1, Business -“Supervision and Regulation-Federal Banking Regulation-Capital Distributions.”
Recent Sales of Unregistered Securities
The Company had no sales of unregistered stock during the quarter ended December 31, 2010.
Repurchases of Equity Securities
Our Board of Directors has authorized the repurchase of up to 5,047,423 shares of our common stock. In accordance with this authorization, we had repurchased 4,239,134 shares of our common stock as of December 31, 2010. There were no share repurchases conducted in the fourth quarter of 2010. The current share repurchase authorization will expire on May 16, 2011, unless extended by our Board of Directors.
Stock Performance Graph
The following Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
We completed our mutual-to-stock conversion on June 23, 2005, in connection with which the Company sold an aggregate of 24,466,250 shares of common stock at a price of $10.00 per share. The Company’s common stock began trading on the Nasdaq Stock Market under the symbol “BFIN” on June 24, 2005, and the per share closing price of one share of the Company’s common stock on that date was $13.60. The following graph represents $100 invested in our common stock at the $13.60 per share closing price on June 24, 2005. The graph illustrates the comparison of the cumulative total returns for the common stock of the Company, the Russell 2000 Index, the NASDAQ Bank Index and the America’s Community Bankers NASDAQ Index for the periods indicated.
There can be no assurance that our stock performance will continue in the future with the same or similar trend depicted in the graph below. We will not make or endorse any predictions as to future stock performance.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following information is derived from the audited consolidated financial statements of the Company. For additional information, reference is made to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company and related notes included elsewhere in this Annual Report.
(footnotes on following page)
(1) Noninterest expense for the years ended December 31, 2009 and 2008 includes $401,000 and $35.9 million, respectively, of impairment loss on securities.
(2) The net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities for the period.
(3) The net interest margin represents net interest income divided by average total interest-earning assets for the period.
(4) The efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
(5) Nonperforming assets include nonperforming loans and other real estate owned and in process.
N.M. Not Meaningful
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis that follows focuses on the factors affecting our consolidated financial condition at December 31, 2010 and 2009, and our consolidated results of operations for the three years ended December 31, 2010. The consolidated financial statements, the related notes and the discussion of our critical accounting policies appearing elsewhere in this Annual Report should be read in conjunction with this discussion and analysis.
Overview
Loans. Our loan portfolio consists primarily of investment and business loans (multifamily, nonresidential real estate, commercial, construction and land loans, and commercial leases), which together make up 75.9% of gross loans at December 31, 2010. Net loans receivable decreased $167.8 million, or 13.8%, to $1.051 billion at December 31, 2010, from $1.219 billion at December 31, 2009. Multi-family mortgage loans decreased by $32.3 million, or 9.8%, due in substantial part to a HUD refinancing that was completed by a related group of borrowers. Commercial loans decreased by $23.4 million, or 26.6%, due to the combined impact of loan pay downs and reduced originations. Commercial leases decreased by $25.7 million, or 14.5%, as scheduled lease payments outpaced originations. Nonresidential real estate loans decreased $34.6 million, or 10.9%, primarily due to principal payments of $56.6 million, which were partially offset by $15.3 million in draws on existing credit commitments. Construction and land loans decreased $14.2 million, or 43.5%, primarily due to project sales and conversions to permanent amortizing loans. One-to-four family residential mortgage loans decreased $33.3 million, or 11.5%, primarily due to refinancings that were not replaced with new originations. Future loan growth could be adversely affected by our unwillingness to compete for loans by relaxing our historical underwriting standards.
Securities. Securities increased $18.6 million, or 18.2%, to $120.7 million at December 31, 2010, from $102.1 million at December 31, 2009. The primary reason for the increase was $50.5 million in purchases, offset by $31.8 million of principal repayments and maturities of securities. During 2010 we utilized FDIC insured certificates of deposit as an investment option.
Deposits. Deposits increased $2.0 million, or 0.2%, to $1.235 billion at December 31, 2010, from $1.233 billion at December 31, 2009. We increased our core deposits (savings, money market, noninterest-bearing demand and NOW accounts) by $25.5 million and reduced our balances of wholesale deposits by $14.7 million during the year. Core deposits increased as a percentage of total deposits, representing 69.2% of total deposits at December 31, 2010, compared to 67.3% of total deposits at December 31, 2009.
Borrowings. Borrowings decreased $27.0 million, or 53.2%, to $23.7 million at December 31, 2010, from $50.8 million at December 31, 2009, due to our repayments of maturing FHLBC advances.
Stockholders’ Equity. Total stockholders’ equity was $253.3 million at December 31, 2010, compared to $263.6 million at December 31, 2009. The decrease in total stockholders’ equity was primarily due to the combined impact of our repurchase of 356,411 shares of our common stock during 2010 at a total cost of $3.1 million, our declaration and payment of cash dividends totaling $5.9 million, the $4.3 million net loss that we recorded for 2010 and a $50,000 decrease in accumulated other comprehensive income. These items were partially offset by a $3.1 million increase in total stockholders’ equity that resulted from the vesting of stock-based compensation and ESOP shares earned. The unallocated shares of common stock that our ESOP owns were reflected as a $14.2 million reduction to stockholders’ equity at December 31, 2010, compared to a $15.2 million reduction to stockholders’ equity at December 31, 2009.
Net Loss. We recorded a net loss of $4.3 million for the year ended December 31, 2010, compared to net losses of $738,000 and $19.4 million for 2009 and 2008, respectively. The net loss in 2010 was due in substantial part to our recording a $12.1 million provision for loan losses, $7.3 million for nonperforming asset management expense and operations of other real estate owned combined with a $1.8 million decrease in net interest income. The net loss in 2009 was due primarily to the recording of an $8.8 million provision for loan losses, a $2.1 million increase in FDIC expense and $1.4 million in combined pre-tax losses that we recorded in connection with the impairment and subsequent sale of our Freddie Mac preferred stocks. The impact of these items was partially offset by a $1.3 million gain that we recognized on the sale of our merchant processing operations in 2009. The net loss in 2008 was due in substantial part to a $35.9 million pre-tax impairment loss that we recorded on our Freddie Mac preferred stocks after Freddie Mac was placed into conservatorship. Our basic loss per common share was $0.22, $0.04 and $0.98 for the years ended December 31, 2010, 2009 and 2008, respectively.
Net Interest Income. We recorded net interest income of $51.8 million for the year ended December 31, 2010, compared to $53.6 million for 2009 and $52.3 million for 2008. The decrease in net interest income for 2010 reflected a $9.2 million decrease in interest income, which was partially offset, by a $7.4 million decrease in interest expense. Our net interest rate spread was 3.36% for the years ended December 31, 2010 and 2009.
Provision for Loan Losses. We recorded a provision for loan losses of $12.1 million for the year ended December 31, 2010, compared to $8.8 million for 2009 and $5.1 million for 2008. The provision for loan losses that we recorded in 2010 reflects the combined impact of a $4.4 million increase in the portion of the specific allowance for loan losses that we allocate to impaired loans and $8.5 million in net charge-offs, which were partially offset by a $794,000 decrease in the general component of the allowance for loan losses.
Noninterest Income. Noninterest income for the year ended December 31, 2010 was $7.1 million, compared to $7.2 million for 2009 and $10.4 million for 2008. Our noninterest income for 2010 included service charges and fees of $3.0 million, compared to $3.4 million for 2009 and $3.6 million for 2008. Earnings on bank-owned life insurance were $430,000 for the year ended December 31, 2010, compared to a $20,000 loss for 2009 and earnings of $586,000 for 2008. Our noninterest income for 2009 included a $988,000 loss on the sale of our Freddie Mac preferred stocks and a $1.3 million gain on the sale of our merchant processing operations. Our noninterest income for 2008 included a $1.4 million pre-tax gain on the sale of shares of Visa, Inc. Class B common stock that we received in connection with Visa, Inc.’s initial public offering, and a $1.2 million pre-tax gain on additional shares of Visa, Inc. Class B common stock that were allocated to us in the initial public offering and are currently held in a litigation escrow under Visa, Inc.’s retrospective responsibility plan. The gain that we recorded on the escrowed shares of the Visa, Inc. Class B common stock reduced our obligation to indemnify Visa USA under Visa, Inc.’s retrospective responsibility plan.
Noninterest Expense. Noninterest expense for the year ended December 31, 2010 was $53.9 million, compared to $52.7 million for 2009 and $89.1 million for 2008. Noninterest expense for 2010 included $3.3 million in nonperforming asset management expenses, compared to $770,000 in 2009. Operations of other real estate owned totaled $4.0 million in 2010, compared to $1.3 million in 2009. Noninterest expense for 2009 included a $401,000 pre-tax impairment loss that we recorded on our holdings of Freddie Mac preferred stocks. Expense for FDIC deposit insurance totaled $2.1 million during the year ended December 31, 2010, compared to $2.2 million for 2009 and $162,000 for 2008. The increase in our 2009 expense for FDIC deposit insurance was due to the combined effect of the FDIC’s increase in its quarterly assessment rate, the FDIC’s imposition of a special assessment against all insured institutions and the full utilization of the FDIC assessment credits that we previously had available to offset or reduce FDIC quarterly assessments. Noninterest expense for 2008 included a $35.9 million pre-tax impairment loss that we recorded on our holdings of Freddie Mac preferred stocks and a $2.0 million pre-tax loss on the early extinguishment of borrowings that we recorded in connection with the prepayment of a $25 million FHLBC term advance.
Income Taxes. We recorded an income tax benefit of $2.7 million for the year ended December 31, 2010, compared to $13,000 and $12.0 million for 2009 and 2008. The effective tax rates were 38.94%, 1.73% and 38.32% for the years ended December 31, 2010, 2009 and 2008, respectively. For 2009, the difference between the GAAP basis (fair market value at the date of grant) and the tax basis (fair market value at the date of vesting) of equity-based compensation granted in prior years reduced our income tax benefit. The income tax benefit for 2008 was due in substantial part to the recording of an impairment loss on our Freddie Mac preferred stocks.
Key Strategic Initiatives and Events
Stock Repurchase Program. Our Board of Directors has authorized the repurchase of up to 5,047,423 shares of our common stock. The authorization permits shares to be repurchased in open market or negotiated transactions, and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission. The authorization may be utilized at management's discretion, subject to the limitations set forth in Rule 10b-18 of the Securities and Exchange Commission and other applicable legal requirements, and to price and other internal limitations established by the Board of Directors. The repurchase authorization will expire on May 16, 2011, unless extended by the Board of Directors. As of December 31, 2010, the Company had repurchased 4,239,134 shares of its common stock pursuant to the repurchase authorization.
Quarterly Cash Dividends. Our Board of Directors declared four quarterly cash dividends of $0.07 per share during 2010. Cash dividends totaling $5.9 million were paid in 2010. On January 27, 2011, the Board of Directors declared a quarterly cash dividend of $0.07 per share that is payable on March 4, 2011.
Pending Acquisition. On September 13, 2010, we entered into a definitive agreement to acquire DG Bancorp, Inc., the bank holding company for Downers Grove National Bank, a privately held community bank with approximately $219 million in assets and $213 million in deposits as of December 31, 2010. Downers Grove National Bank has two banking offices located in Downers Grove and Westmont, Illinois. We have received all regulatory approvals that are required to consummate the transaction and the closing is expected to occur during the first quarter of 2011, subject to customary closing conditions. Downers Grove National Bank will be merged into the Bank as part of the consummation of the transaction.
We are in the process of negotiating the acquisition of a portfolio of performing loans from Citibank N.A. with an aggregate unpaid principal balance of approximately $155.8 million. The purchase is scheduled to close in March 2011, subject to customary closing conditions. This loan portfolio consists of multifamily loans originated by Citibank N.A. or the former Citibank, F.S.B. and the loans are secured by real estate collateral located in the Chicago metropolitan market area. The portfolio consists of 470 loans with an overall weighted average effective yield of 5.87%. All loans in the portfolio were current on all payments due as of the month prior to the month in which the purchase is scheduled to close. Upon the closing of the purchase, we expect to file a Current Report on Form 8-K further describing the portfolio acquisition transaction and the portfolio characteristics.
Economic and Competitive Conditions
General U.S. financial market conditions further stabilized during 2010. The national economy began a very modest expansion but local economic conditions remained largely unchanged from 2009. Pricing and underwriting for multi-family and commercial real estate loans were generally favorable, but we experienced relatively low demand for these loan types throughout 2010. Pricing for commercial leases became less favorable during 2010 amid weak supply as lessors deployed excess cash and several competitors re-entered the market during the year. Demand for the Bank’s traditional adjustable-rate residential mortgage loans remained low due to an overwhelming market preference for fixed-rate residential mortgage loans given low market interest rates and our underwriting standards.
We experienced net declines in all loan portfolio component balances during 2010 due to several factors, including overall weak loan demand, loan payoffs, our decisions to exit certain credit relationships and transfers of certain loans to OREO upon the conclusion of formal collection proceedings. We expect a return to modest growth in most loan portfolio segments if real estate market valuations stabilize and the supply of commercial lease opportunities improves based on global macroeconomic conditions.
Our loan portfolio quality metrics reflected the overall economic environment in 2010. The net increase in nonaccrual loans and a related increase in our loan loss reserves resulted primarily from a corresponding material decline in the valuations of the underlying collateral and a decline in effective rents and occupancies in certain income-producing properties; however, effective rents and occupancies in multifamily properties began to stabilize late in 2010. We also noted a continued influx of personal and business bankruptcy cases; of these, the majority of borrowers sought to avoid their obligations while a minority sought to restructure their debt to continue ownership of their assets. General market conditions and efforts by various governmental entities and local courts to further slow the pace of foreclosures continued to affect the pace of our progress in resolving classified assets, but we expect the pace of resolutions to increase in 2011. We continue to believe that unemployment, consumer spending and borrower perceptions of residential and commercial real estate valuations will be the primary factors affecting loan portfolio quality in 2011.
As we expected, our general loan loss reserves continued to increase. As part of our computation of the required level for our general loan loss reserve, our model incorporates the changes in national and local economic risk factors, the changes in the levels of classified loans by loan type, and the impact of the additional specific valuation allowances or charge-offs recorded on classified loans. Our underwriting standards remain consistent with our historical standards, although our credit analyses incorporate somewhat more conservative assumptions with respect to effective rents, expenses and occupancies given the current economic environment.
Deposits increased slightly in 2010. Pricing conditions for local deposits, whether low-balance core deposits, certificates of deposits or high-balance, high-yield transaction accounts, remained favorable during the year due to very low market yields and continued weak industry-wide loan demand. We continued to moderate our competitive position given the weak lending environment and our excess liquidity position. We expect a similar competitive environment for the first half of 2011, and we will continue our marketing efforts to further enhance the depth and quality of our deposit portfolio.
Our net interest spread declined in 2010 as the decline in loan portfolio balances and, to a lesser extent, the impact of loans placed on non-accrual status offset the benefits of a favorable yield curve and improved credit spreads. Given the quantity and volatility of the variables affecting our net interest margin and net interest spread, we are unable to confidently predict our net interest margin and net interest spread in 2011.
Non-interest income decreased in 2010 due to a materially lower net gain on the sale of securities and reduced deposit-related fee income, which was partially offset by higher income from insurance and annuities and other fee income. Wealth management performed slightly better than our expectations for 2010.
Non-interest expense increased slightly in 2010 as a significant increase in expenses related to non-performing assets and write-downs on OREO offset the favorable impact of our focus on improving efficiency through operational reviews and technology deployments. We expect that the expenses related to non-performing loans and classified asset management will decline in the latter part of 2011 in conjunction with the anticipated gradual decline of the levels of non-performing assets.
Critical Accounting Policies
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the most critical accounting policies upon which our financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are as follows:
Allowance for Loan Losses. Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. Our allowance for loan losses provides for probable incurred losses based upon evaluations of known and inherent risks in the loan portfolio. We review the level of the allowance on a quarterly basis and establish the provision for loan losses based upon historical loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors to assess the adequacy of the allowance for loan losses. Among the material estimates that we must make to establish the allowance are loss exposure at default; the amount and timing of future cash flows on affected loans; the value of collateral; and a determination of loss factors to be applied to the various elements of the loan portfolio. All of these estimates are susceptible to significant change. Although we believe that we use the best information available to us to establish the allowance for loan losses, future adjustments to the allowance may be necessary if borrower financial, collateral valuation or economic conditions differ substantially from the information and assumptions used in making the evaluation. In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses. These agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.
Intangible Assets. Acquisitions accounted for under purchase accounting require us to record as assets on our financial statements both goodwill, an intangible asset that is equal to the excess of the purchase price which we pay for another company over the estimated fair value of the net assets acquired, and identifiable intangible assets such as core deposit intangibles and non-compete agreements. We evaluate our goodwill asset at least annually, or when other indicators suggest that an impairment may have occurred. We are required to reduce the carrying value of our goodwill asset through a charge to earnings if an impairment exists. Core deposit and other identifiable intangible assets are amortized to expense over their estimated useful lives and are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be fully recoverable. The valuation techniques that we use to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates that we used to determine the carrying value of our goodwill and identifiable intangible assets or which otherwise adversely affect their value or estimated lives could have a material adverse impact on our results of operations. As of December 31, 2010, our intangible assets consisted of a goodwill asset of $22.6 million and core deposit intangibles of $2.7 million.
In performing its analysis, the third-party valuation firm considered three general approaches to valuation: the asset-based approach, the market approach, and the income approach. In its valuation, the third-party valuation firm used two methods within the market approach and one method within the income approach. The method utilized within the income approach was the discounted cash flow method, which relies upon the perception of a future stream of benefits, the present value of which represents the indication of value of BankFinancial FSB, the reporting unit pursuant to applicable ASC 350 guidance. The methods utilized within the market approach were the guideline public company method and guideline transaction method. The guideline public company method utilizes the pricing of guideline public companies, which in our case were publicly-traded banks and bank holding companies bearing certain similarities to the reporting unit, including asset size, geographic region, and profitability. The third-party valuation firm concluded that the fair value of the reporting unit, exceeded its carrying value as of the valuation date, and therefore, there was no impairment of our goodwill asset pursuant to the first step of the goodwill impairment test prescribed by ASC 350, Intangibles - Goodwill and Other. We concurred with the methodology and the conclusion of the third-party valuation firm.
Income Taxes. We consider accounting for income taxes a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation. We use the asset/liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. We must assess the realization of the deferred tax asset and, to the extent that we believe that recovery is not likely, a valuation allowance is established. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. No valuation allowance was required at December 31, 2010. Although we have determined a valuation allowance is not required for any deferred tax assets at December 31, 2010, there is no guarantee that a valuation allowance will not be required in the future.
Statement of Financial Condition at December 31, 2010 and December 31, 2009
Total assets decreased $36.3 million, or 2.3%, to $1.531 billion at December 31, 2010, from $1.567 billion at December 31, 2009, primarily due to a $167.8 million decrease in net loans, to $1.051 billion at December 31, 2010, from $1.219 billion at December 31, 2009, partially offset by a $112.6 million increase in net cash and cash equivalents to $220.8 million at December 31, 2010, from $108.2 million at December 31, 2009.
Our loan portfolio consists primarily of investment and business loans (multi-family, nonresidential real estate, commercial, construction and land loans, and commercial leases), which together make up 75.9% of gross loans. Net loans receivable decreased $167.8 million, or 13.8%, to $1.051 billion at December 31, 2010, from $1.219 billion at December 31, 2009. Nonresidential real estate loans decreased $34.6 million, or 10.9%, primarily due to principal payments of $56.6 million, which were partially offset by $15.3 million in draws on existing credit commitments. Multi-family mortgage loans decreased by $32.3 million, or 9.8%, due in substantial part to a HUD refinancing that was completed by a related group of borrowers. Commercial loans decreased by $23.4 million, or 26.6%, due the combined impact of loan pay downs and reduced originations. Commercial leases decreased by $25.7 million, or 14.5%, as scheduled lease payments outpaced originations. Construction and land loans decreased $14.2 million, or 43.5%, primarily due to project sales and conversions to permanent amortizing loans. One-to-four family residential mortgage loans decreased $33.3 million, or 11.5%, primarily due to refinancings that were not replaced with new originations.
Our allowance for loan losses increased by $3.6 million, to $22.2 million at December 31, 2010, from $18.6 million at December 31, 2009. The increase reflects the combined impact of a $4.4 million increase in the portion of the specific allowance for loan losses that we allocate to impaired loans and $8.5 million in net charge-offs, which were partially offset by a $794,000 decrease in the general component of the allowance for loan losses. Increases in the specific portion of the allowance for loan losses occurred principally in the following areas: multi-family mortgage loans ($2.6 million); non-residential real estate loans ($131,000); commercial loans ($1.1 million); construction and land loans ($729,000); and commercial leases ($72,000). Net decreases in the specific portion of the allowance for loan losses that we allocate to impaired loans occurred for investor-owned one-to-four family residential loans ($283,000), due to the transfer of properties to other real estate owned during 2010.
Securities increased by $18.6 million, or 18.2%, to $120.7 million at December 31, 2010, from $102.1 million at December 31, 2009. The primary reason for the increase was $50.5 million in security purchases, which were partially offset by $31.8 million in principal repayments, sales and maturities of securities. In 2010, we utilized investments in FDIC insured certificates of deposit as an investment option.
We owned common stock of the FHLBC with a stated par value of $15.6 million at December 31, 2010 and 2009. The FHLBC did not declare or pay any dividends from the third quarter of 2007 through 2010. In the first quarter of 2011, the FHLBC declared and paid a cash dividend at an annualized rate of 10 basis points per share.
In late 2009, we prepaid our estimated quarterly risk-based assessments for the remainder of 2009, and for all of 2010, 2011, and 2012, pursuant to the FDIC final rule requiring the prepayment of deposit insurance assessments by insured depository institutions. At December 31, 2010, the remaining prepaid FDIC assessment was $4.8 million.
In conjunction with the sale of our Freddie Mac preferred stocks in 2009, we recorded an income tax receivable of $11.7 million at December 31, 2009. We received $11.3 million in tax refunds during 2010. Other assets increased $2.9 million to $15.1 million at December 31, 2010, from $12.2 million at December 31, 2009, primarily due to a $2.7 million increase in deferred tax assets.
Deposits increased $2.0 million, or 0.2%, to $1.235 billion at December 31, 2010, from $1.233 billion at December 31, 2009, primarily due to increased money market account, savings and noninterest-bearing demand balances. Money market accounts increased $18.9 million, or 5.9%, to $341.0 million at December 31, 2010, from $322.1 million at December 31, 2009. Savings accounts increased $2.8 million, or 2.9%, to $98.9 million at December 31, 2010, from $96.1 million at December 31, 2009, and noninterest-bearing demand accounts increased $4.2 million to $112.5 million at December 31, 2010, from $108.3 million at December 31, 2009. Total core deposits (savings, money market, noninterest-bearing demand and interest-bearing NOW accounts) increased as a percentage of total deposits, representing 69.2% of total deposits at December 31, 2010, compared to 67.3% of total deposits at December 31, 2009.
Borrowings decreased $27.0 million, or 53.2%, to $23.7 million at December 31, 2010, from $50.8 million at December 31, 2009, due to our repayments of maturing FHLBC advances.
Total stockholders’ equity was $253.3 million at December 31, 2010, compared to $263.6 million at December 31, 2009. The decrease in total stockholders’ equity was primarily due to the combined impact of our repurchase of 356,411 shares of our common stock during 2010 at a total cost of $3.1 million, and our declaration and payment of cash dividends totaling $5.9 million, the $4.3 million net loss that we recorded for 2010 and a $50,000 decrease accumulated other comprehensive income. These items were partially offset by a $3.1 million increase in total stockholders’ equity that resulted from the vesting of stock-based compensation and ESOP shares earned. The unallocated shares of common stock that our ESOP owns were reflected as a $14.2 million reduction to stockholders’ equity at December 31, 2010, compared to a $15.2 million reduction to stockholders’ equity at December 31, 2009.
Loans
We originate multi-family mortgage loans, nonresidential real estate loans, commercial loans, commercial leases, and construction and land loans. In addition, we originate one-to-four family residential mortgage loans and consumer loans, and purchase and sell loan participations from time-to-time. The following briefly describes our principal loan products.
Multi-family Mortgage Loans. Loans secured by multi-family mortgage loans totaled $296.9 million, or 27.7%, of our total loan portfolio, at December 31, 2010. At December 31, 2010, $73.0 million of our multi-family mortgage loan portfolio consisted of loans originated in carefully selected metropolitan markets outside the Bank’s primary lending area, and these loans represented 24.6% of our multi-family mortgage loan portfolio and 6.8% of our total loan portfolio. Multi-family mortgage loans generally are secured by multi-family rental properties such as apartment buildings, including subsidized apartment units. The majority of our multi-family mortgage loans have adjustable interest rates following an initial fixed-rate period, typically between three and five years.
Nonresidential Real Estate Loans. Loans secured by nonresidential real estate totaled $282.0 million, or 26.3%, of our total loan portfolio, at December 31, 2010. We emphasize nonresidential real estate loans with initial principal balances between $1.0 million and $5.0 million. The nonresidential real estate properties securing these loans are predominantly office buildings, light industrial buildings, shopping centers and mixed-use developments, and to a lesser extent, more specialized properties such as nursing homes and other healthcare facilities. Substantially all of our nonresidential real estate loans are secured by properties located in our primary market area. Our nonresidential real estate loans are typically written as three- or five-year adjustable-rate mortgage loans or mortgage loans with balloon maturities of three or five years. Amortization of these loans is typically based on 20- to 25-year payout schedules. We also originate some 15-year fixed-rate, fully amortizing loans.
Commercial Loans. Commercial loans totaled $64.7 million, or 6.0%, of our total loan portfolio, at December 31, 2010. This total includes unsecured commercial loans with an aggregate outstanding balance of $7.8 million. We generally make commercial loans to customers in our primary market area to finance equipment acquisition, expansion, working capital and other general business purposes. The terms of these loans generally range from less than one year to five years. The loans either carry a fixed-rate or adjustable interest rates indexed to a lending rate that is either determined internally or based on a short-term market rate index.
Commercial Leases. Commercial leases totaled $151.1 million, or 14.1%, of our total loan portfolio, at December 31, 2010. Our commercial leases primarily involve technology equipment, material handling equipment, medical equipment and other capital equipment. The transactions are generally structured as a non-recourse assignment by the leasing company of the payment stream on the lease supplemented by the grant of a security interest in the lease and the leased equipment. Consequently, we underwrite leases by examining the creditworthiness of the lessee rather than the lessor. The lessee generally agrees to send the lease payments directly to us. As of December 31, 2010, 57.7% of our commercial lease portfolio involved lessees with investment-grade rated public debt, 39.9% involved publicly-traded lessees with no public debt and thus no public debt rating, and 2.4% involved privately-held lessees or lessees with a below investment-grade public debt rating. Debt ratings are determined by Moody’s, Standard & Poors, Fitch, A.M. Best or an equivalent rating firm. Commercial leases typically have a maximum maturity of seven years and we limit our maximum outstanding credit exposure to $10.0 million to any single lessee. Leases to companies with no public debt ratings generally involve companies with a net worth in excess of $25.0 million and typically have a maximum maturity of five years.
Construction and Land Loans. Construction and land loans totaled $18.4 million, or 1.7%, of our total loan portfolio at December 31, 2010. These loans generally consist of land acquisition loans to help finance the purchase of land intended for further development, including single-family homes, multi-family housing and commercial income property, development loans to builders in our market area to finance improvements to real estate, consisting mostly of single-family subdivisions, typically to finance the cost of utilities, roads, sewers and other development costs. These builders generally rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder, often in conjunction with development loans. In general, the maximum loan-to-value ratio for raw land acquisition loan is 65% of the appraised value of the property, and the maximum term of these loans is two years. The maximum amount loaned on a development loan is generally limited to the cost of the land and public improvements, and advances are made in accordance with a schedule reflecting the cost of the improvements. Advances are generally limited to 90% of actual construction costs and, as required by applicable regulations, a 75% loan to completed appraised value ratio. We have discouraged new construction lending for the past several years and have had only limited interest in site acquisition loans for future construction.
One-to-Four Family Residential Mortgage Lending. Conforming and non-conforming fixed-rate and adjustable-rate residential mortgage loans totaled $256.3 million, or 23.9%, of our total loan portfolio at December 31, 2010. Our residential mortgage loan portfolio includes traditional one-to-four family residential mortgage loans, home equity loans and home equity lines of credit that are secured by the borrower’s primary residence, and loans to investors in non-owner-occupied single-family homes. At December 31, 2010, home equity loans totaled $9.8 million, or 0.9%, of total loans, home equity lines of credit totaled $79.7 million, or 7.4%, of total loans, and loans to investors in non-owner-occupied single-family homes totaled $76.0 million, or 7.1% of total loans. We generally originate both fixed- and adjustable-rate loans in amounts up to the maximum conforming loan limits as established by Fannie Mae, which currently is $417,000 for single-family homes in our market area. Private mortgage insurance is required for first mortgage loans with loan-to-value ratios in excess of 80%. At December 31, 2010, our adjustable-rate residential first mortgage loan portfolio totaled $129.6 million, and included $18.6 million in loans that re-price once a year and $111.0 million in loans that re-price periodically after an initial fixed-rate period of three years or more.
We also originate loans above conforming limits, referred to as “jumbo loans,” that are underwritten to the credit standards of Fannie Mae given the demand for these loans in the Chicago metropolitan area. We also originate loans that do not fully meet the credit standards of Fannie Mae if they are considered acceptable risks given their favorable compensating risk factors. In general, we do not originate or purchase loans with underwriting characteristics that, taken together, are materially lower than the credit standards of Fannie Mae, and as part of the underwriting process, we consider the availability of purchasers for jumbo and other nonconforming loans.
Loan Portfolio Composition
The following table sets forth the composition of our loan portfolio, excluding loans held-for-sale, by type of loan at the dates indicated.
Loan Portfolio Maturities
The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2010. Demand loans, loans having no stated repayment schedule or maturity and overdraft loans are reported as being due in one year or less.
Past Due Loans
The following table reflects investment and business loans past due less than 90 days:
At December 31, 2010, multifamily, non-residential real estate, construction and development and commercial loans past due loans totaled $50.1 million. Of the $50.1 million, $29.5 million or 58.9% were “Pass” rated matured loans in the process of renewal and $8.4 million or 16.8% were on non-accrual status. The remaining $13.0 million or 24.5% were subject to informal collection activity to bring the loan current.
Nonperforming Loans and Assets
We review loans on a regular basis, and generally place loans on nonaccrual status when either principal or interest is 90 days or more past due. In addition, we place loans on nonaccrual status when we do not expect to receive full payment of interest or principal. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Interest payments received on nonaccrual loans are recognized in accordance with our significant accounting policies. Once a loan is placed on nonaccrual status, the borrower must generally demonstrate at least six months of payment performance before the loan is eligible to return to accrual status. We may have loans classified as 90 days or more delinquent and still accruing. Generally, we do not utilize this category of loan classification unless: (1) the loan is repaid in full shortly after the period end date; (2) the loan is well secured and there are no asserted or pending legal barriers to its collection; or (3) the borrower has remitted all scheduled payments and is otherwise in substantial compliance with the terms of the loan, but the processing of loan payments actually received or the renewal of the loan has not occurred for administrative reasons. At December 31, 2010, we had four loans totaling $818,000 in this category.
We typically obtain new third-party appraisals or collateral valuations when we place a loan on nonaccrual status or when we commence formal collection action, unless the existing valuation information for the collateral is sufficiently current to comply with the requirements of our Appraisal and Collateral Valuation Policy ( “ACV Policy”). We also obtain new third-party appraisals or collateral valuations when the judicial foreclosure process concludes with respect to real estate collateral, and when we otherwise acquire actual or constructive title to real estate collateral. We use updated valuation information based on Multiple Listing Service data, broker opinions of value, actual sales prices of similar assets sold by us, and approved sales prices in response to offers to purchase similar assets owned by us to provide interim valuation information for financial statement and management purposes. Our ACV Policy establishes the maximum useful life of a real estate appraisal at 18 months. As of December 31, 2010, the average life of the third-party appraisals on collateral supporting the computation of ASC 310-10-35 specific valuation allowances was 12 months and the average life of the appraisals supporting the net realizable value of OREO was nine months. Because appraisals and updated valuations utilize historical or “ask-side” data in reaching valuation conclusions, the appraised or updated valuation may or may not reflect the actual sales price that we will receive at the time of sale.
Real estate appraisals may include up to three approaches to value: the sales comparison approach, the income approach (for income-producing property) and the cost approach. Not all appraisals utilize all three approaches. Depending on the nature of the collateral and market conditions, we may emphasize one approach over another in determining the fair value of real estate collateral. Appraisals may also contain different estimates of value based on the level of occupancy or planned future improvements. “As-is” valuations represent an estimate of value based on current market conditions with no changes to the use or condition of the real estate collateral. “As-stabilized” or “as-completed” valuations assume the real estate collateral will be improved to a stated standard or achieve its highest and best use in terms of occupancy. “As-stabilized” or “as-completed” valuations may be subject to a present value adjustment for market conditions or the schedule of improvements.
As part of the asset classification process, we develop an exit strategy for real estate collateral or OREO by assessing overall market conditions, the current use and condition of the asset, and its highest and best use. For most income-producing real estate, investors value most highly a stable income stream from the asset; consequently, we conduct a comparative evaluation to determine whether conducting a sale on an “as-is,” “as-stabilized” or “as-improved” basis is most likely to produce the highest net realizable value. If we determine that the “as-stabilized” or “as-improved” basis is appropriate, we then complete the necessary improvements or tenant stabilization tasks, with the applicable time value discount and improvement expenses incorporated into our estimates of the expected costs to sell. As of December 31, 2010, impaired real estate loans and OREO valued on an “as-is” basis was $27.3 million, or 74.0% of the total principal balance of impaired real estate loans, and $10.3 million, or 70.7% of the net book value of OREO.
Our estimates of the net realizable value of real estate collateral also include a deduction for the expected costs to sell the collateral or such other deductions from the cash flows resulting from the operation and liquidation of the asset as are appropriate. For most real estate collateral subject to the judicial foreclosure process, we apply a 10.0% deduction to the value of the asset to determine the expected costs to sell the asset. This estimate includes one year of real estate taxes, sales commissions and miscellaneous repair and closing costs. If we receive a purchase offer that requires unbudgeted repairs, or if the expected resolution period for the asset exceeds one year, we then include, on a case-by-case basis, the costs of the additional real estate taxes and repairs and any other material holding costs in the expected costs to sell the collateral. For OREO, we only apply a 5.0% deduction to determine the expected costs to sell, as expenses for real estate taxes and repairs are expensed when incurred.
Nonperforming Assets Summary
The following table below sets forth the amounts and categories of our nonperforming loans and nonperforming assets at the dates indicated.
Loans on Nonaccrual Status
At December 31, 2010, nonaccrual loans declined slightly due principally to transfers of loans to OREO and resolutions of pending cases. The decline was partially offset by isolated increases in nonaccrual loans in the commercial real estate and commercial lease categories. Nonaccrual loans decreased by $3.8 million to $45.7 million at December 31, 2010, from $49.5 million at December 31, 2009. For the year ended December 31, 2010, no accrued interest on nonaccrual loans had been recognized.
At December 31, 2010, our total non-performing loans involved 105 borrower relationships, or an average of $435,000 loan per borrower relationship. Therefore, there are no specific concentrations of credit risk such that a majority of loans involves only a few borrower relationships. Our three largest non-performing borrower relationships represent 31.9% of total non-performing loans. These loans are briefly described as follows:
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We have a $5.8 million nonperforming loan that is secured by a retail shopping center located in our primary Chicago metropolitan market. As of December 31, 2010, this loan was on nonaccrual status and had a $787,000 specific valuation allowance that was based on an updated “as improved” third party appraisal. The shopping center is 92% occupied by businesses that are affiliated with investors in the entity that owns the shopping center. The loan is further secured by additional collateral pledged by the investors, and is supported by the personal guarantees of the investors. The business operations of the existing tenants of the shopping center, together with the supplementary personal resources of the guarantors, were not sufficient to comply with the planned payment schedule of principal and interest. Accordingly, pursuant to applicable regulatory guidance, future renewals of the loan will be classified as a troubled debt restructuring (“TDR”), and the loan will remain on nonaccrual status until the borrower’s business operations demonstrate the capability to sustain at least six months of debt service on a fully amortizing basis.
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We have a $4.4 million nonperforming loan that is secured by a 242-unit multifamily residential building located outside of our primary Chicago metropolitan market. This loan is included in our Wholesale Commercial Lending category of loans. As of December 31, 2010, this loan was on nonaccrual status and had a $1.5 million specific valuation allowance that was based on an updated “as improved” third-party appraisal. The borrower initially filed a Chapter 11 bankruptcy petition, but the bankruptcy case was recently dismissed. A court-appointed receiver is now in place. We recently received two separate offers to purchase this property for prices in excess of our net book value, and tentatively expect this matter to be fully resolved in 2011.
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We have a $4.4 million credit exposure to a single borrower, that is secured by a completed single-family residence that the borrower constructed for the purposes of sale, a parcel of vacant land, and the borrower’s personal residence. All of the real estate collateral is located in our primary Chicago metropolitan market. As of December 31, 2010, the loans were on nonaccrual status and had a $1.2 million specific valuation allowance based on updated “as is” third-party appraisals. The Bank has been appointed mortgagee-in-possession of the completed single family residence, and the pending foreclosure action is expected to conclude in 2011.
Other Real Estate Owned or In Process
Real estate that is acquired through foreclosure or a deed in lieu of foreclosure is classified as OREO or OREO in process until it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value, less the estimated costs of disposal as discussed above. If the fair value of the property is less than the loan balance, the difference is charged against the allowance for loan losses.
As discussed above, the appraised value of real estate assets may or may not reflect the actual sales price that will be received. We market real estate for sale based on our estimate of its net realizable value. Depending on the levels of market interest received during the initial period of market exposure, we may reduce the offering price in subsequent periods; if we do so, the new offering price becomes the new net realizable value. We may also accept an offer to purchase a given real estate asset at a price below the net realizable value if there has been limited interest at the original offering price and we conclude that further market exposure time (even at a price lower than the current offering price but higher than the proposed actual sales price) will not produce materially better results given the holding costs and management risks incurred over time.
Loan Extensions and Modifications
Maturing loans are subject to our standard loan underwriting policies and practices. Due to the need to obtain updated borrower and guarantor financial information, collateral information or to prepare revised loan documentations, loans in the process of renewal may appear as past due because the information needed to underwrite a renewal of the loan is not available to us prior to the maturity date of the loan. At times, short-term administrative extensions, which are typically 90 days in duration, are granted to facilitate proper underwriting. In general, loan modifications are subject to a risk-adjusted pricing analysis. We do not grant loan modification requests that involve below-market interest rates. Other than split-note restructurings conducted in conformance with applicable Federal Financial Institutions Examination Council (“FFIEC”) workout guidance, we do not grant loan modifications that involve principal concessions. We also do not grant loan modifications that suspend all loan payments for any period; however, we may grant loan modifications that involve the short-term suspension of principal amortization payments. Typically, we grant loan modifications for three to six month periods, at the conclusion of which the loan will either mature or return in all material respects to its original terms and conditions. During 2010, the Bank conducted thirteen commercial loan modifications to eight borrowers totaling $7.1 million (or 0.66% of total loans as of December 31, 2010) that did not qualify as troubled debt restructurings due to the fact that no concessions were made to the borrowers other than those which we would grant in the ordinary course of business. The modifications involved actions such as reducing an above-market interest rate to a market interest rate or extending a shorter-duration amortization period to a longer amortization period that remained in compliance with our normal underwriting standards. We also conducted loan modifications to four residential borrowers with a total exposure of $410,296. These modifications generally involved the repayment of past due principal and/or interest loan payments over a three- to six-month period of time, in exchange for a forbearance of our legal remedies.
When appropriate, we evaluate loan extensions or modifications in accordance with ASC 310-40 and related federal regulatory guidance concerning TDRs and the FFIEC workout guidance to determine the required treatment for nonaccrual status and risk classification purposes. In general, if we grant a loan modification or extension that involves either the absence of principal amortization (other than for revolving lines of credit which are customarily granted on interest-only terms), or if we grant a material extension of an existing loan amortization period in excess of our underwriting standards, the loan will be placed on nonaccrual status and impairment testing conducted to determine whether a specific valuation allowance or loss classification / charge-off is required. If the loan is well secured by an abundance of collateral and the collectability of both interest and principal is probable, the loan may remain on accrual status, but it will be classified as a TDR due to the concession made in the loan principal amortization payment component. A loan in full compliance with the payment requirements specified in a loan modification will not be considered as past due, but may nonetheless be placed on nonaccrual status or be classified as a TDR, as appropriate under the circumstances.
In accordance with the FFIEC workout guidance, the resulting “A” promissory note in a split-note restructuring will be considered a TDR at the time of the restructuring and will remain so classified for at least 12 months. The resulting “B” note will be either placed on nonaccrual status or charged-off and any payments on the “B” promissory note will be treated as a recovery of principal unless the note is fully collateralized pursuant to our underwriting standards and we believe that the collection of both the principal and interest of the “B” note is probable.
Troubled Debt Restructurings
The following table sets forth the troubled debt restructurings by loan category as of December 31,
TDR loans decreased $3.0 million in 2010. Total loans classified as TDRs represented 0.61% of the total loans at December 31, 2010.
Of the $6.5 million in loans that were classified as TDRs at December 31, 2010, 52% were on accrual status and continued to perform according to the terms of the applicable loan agreements. Of the $9.6 million in loans that were classified as TDRs at December 31, 2009, $7.4 million, or 77%, remained on accrual status as of that date. Subsequently, approximately 50% of the TDRs that were on accrual status at December 31, 2009 were placed on nonaccrual status during 2010 due principally to an inability of the borrowers to continue debt service on a fully-amortizing basis.
Risk Classification of Assets
Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets, or designated as special mention.
An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral for the loan, if any. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in assets classified as substandard with the added characteristic that the weaknesses present also 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 is not warranted; such balances are promptly charged-off as required by applicable federal regulations. An asset designated as special mention has potential weaknesses that deserve close attention and, if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position with respect to the asset at some future date. Assets designated special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Based on a review of our assets at December 31, 2010, classified assets consisted of substandard assets of $60.4 million, doubtful assets of $477,000, and no loans classified as loss assets. As of December 31, 2010, we had $25.9 million of assets designated as special mention.
Allowance for Loan Losses
We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb probable incurred credit losses in the loan portfolio. In determining the level of the allowance for loan losses, we consider past and current loss experience, trends in nonaccrual loans, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from the estimates as more information becomes available or events change.
We provide for loan losses based on the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors that, in our judgment, deserve current recognition in estimating probable incurred credit losses. We review the loan portfolio on an ongoing basis and make provisions for loan losses on a quarterly basis to maintain the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America. The allowance for loan losses consists of two components:
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specific allowances established for any impaired residential owner or non-owner occupied mortgage, multi-family mortgage, nonresidential real estate, construction and land, commercial, and commercial lease loans for which the recorded investment in the loan exceeds the measured value of the loan; and
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general allowances for loan losses for each loan class based on historical loan loss experience; and adjustments to historical loss experience (general allowances), maintained to cover uncertainties that affect our estimate of probable incurred credit losses for each loan class.
The adjustments to historical loss experience are based on our evaluation of several factors, including levels of, and trends in, past due and classified loans; levels of, and trends in, charge-offs and recoveries; trends in volume and terms of loans, including any credit concentrations in the loan portfolio; experience, ability, and depth of lending management and other relevant staff; and national and local economic trends and conditions.
We evaluate the allowance for loan losses based upon the combined total of the specific and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable incurred credit losses than would be the case without the increase. Conversely, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology generally results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
We review our loan portfolio on an ongoing basis to determine whether any loans require classification and impairment testing in accordance with applicable regulations and accounting principles. When we classify loans as either substandard or doubtful and in certain other cases, we review the collateral and future cash flow projections to determine if a specific reserve is necessary. The allowance for loan losses represents amounts that have been established to recognize incurred credit losses in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements. When we classify problem loans as loss, we charge-off such amounts.
We refined the calculation of the general component of the allowance for loan losses during the fourth quarter of 2010 in response to the new FASB disclosure requirement to segment each loan portfolio category into specific loan classes (FASB Standards Update 2010-20 (ASU 210-20), “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”). Loan class segmentation tables are presented in Note 4 - Loans Receivable of the Consolidated Financial Statements. As a matter of consistency, the loan class segmentation was also applied within the 12-quarter loss history used to calculate the general component of the allowance for loan losses, an adjustment of the inherent risk factor weightings based on our evaluation of their relevance to the new loan classes, and the elimination of duplicative historical loss factors as a result of the segmentation of the portfolio by class. These refinements were applied to the loan balances, net of impaired loans, to calculate a $12.8 million general component of our allowance for loan losses at December 31, 2010. The refinements resulted in a net reduction of $1.7 million to the general component of our allowance for loan losses at December 31, 2010, principally due to the establishment of loan class segments that had lower historical loss ratios than the general loan categories to which they belong. Specifically, the refinements reduced the portion of the general component of the allowance for loan losses attributable to commercial leases by $908,000, the portion attributable to commercial loans by $788,000, the portion attributable to non-residential real estate loans by $195,000, and the portion attributable to multi-family mortgage loans by $144,000. These reductions were partially offset by a $384,000 increase in the portion of the general component of the allowance for loan losses that is attributable to one-to-four family mortgage loans.
While we use the best information available to make evaluations, future adjustments to the allowance may become necessary if conditions differ substantially from the information that we used in making the evaluations. Our determinations as to the risk classification of our loans and the amount of our allowance for loan losses are subject to review by our regulatory agencies, which can require that we establish additional loss allowances.
Net Charge-offs and Recoveries
The following table sets forth activity in our allowance for loan losses for the years indicated.
Net charge-offs and total charge-offs were $8.5 million and $9.3 million, respectively, for the year ended December 31, 2010, compared to $4.9 million in net charge-offs and $5.1 million in total charge-offs for the year ended December 31, 2009, and $1.4 million in net charge-offs and total charge-offs for the year ended December 31, 2008. Total recoveries were $764,000 in 2010, compared to $130,000 in 2009 and $16,000 in 2008.
We recorded a provision for loan losses of $12.1 million in 2010, compared to $8.8 million in 2009 and $5.1 million in 2008. Of the $12.1 million provision for loan losses that we recorded in 2010, $4.4 million is attributable to the specific portion of the allowance for loan losses that we allocate to impaired loans and $8.5 million in charge-offs, which were partially offset by a $794,000 decrease in the general portion of the allowance for loan losses.
A loan balance is classified as a loss and charged-off when it is confirmed that there is no readily apparent source of repayment for the amount of the loan that is classified as loss. Confirmation can occur upon the receipt of updated third-party appraisal valuation information indicating that there is a low probability of repayment upon sale of the collateral, the final disposition of collateral where the net proceeds are insufficient to pay the loan balance in full, our failure to obtain possession of certain consumer-loan collateral within certain time limits specified by applicable federal regulations, the conclusion of legal proceedings where the borrower’s obligation to repay is legally discharged (such as a federal Chapter 7 bankruptcy proceeding), or when it appears that further formal collection procedures are not likely to result in net proceeds in excess of the costs to collect.
Included in 2010 charge-offs of $9.3 million were $3.3 million in charge-offs related to final disposition of collateral or other loan resolutions, of which $1.7 million occurred in the fourth quarter 2010. $6.0 million of charge-offs recorded at the time real estate transferred to other real estate owned, of which $3.8 million occurred in the fourth quarter 2010.
Allocation of Allowance for Loan Losses
The following table sets forth our allowance for loan losses allocated by loan category. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
Securities
Our investment policy is established by our Board of Directors. The policy emphasizes safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy.
At December 31, 2010, our mortgage-backed securities and collateralized mortgage obligations (“CMOs”) reflected in the following table were issued by U.S. government-sponsored enterprises and agencies, Freddie Mac, Fannie Mae and Ginnie Mae, and are obligations which the federal government has affirmed its commitment to support. The equity securities reflected in the 2008 columns in the table consist of Freddie Mac preferred stocks. All securities reflected in the table were classified as available-for-sale at December 31, 2010, 2009 and 2008.
We hold the FHLBC common stock to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBC’s advance program. The aggregate cost of our FHLBC common stock as of December 31, 2010 was $15.6 million based on its par value. There is no market for FHLBC common stock. Due to our receipt of stock dividends in prior years and the amount of our outstanding FHLBC advances, we owned shares of FHLBC common stock at December 31, 2010 with a par value that was $9.0 million more than we were required to own to maintain our membership in the Federal Home Loan Bank System and to be eligible to obtain advances (“excess” or “voluntary” capital stock).
The following table sets forth the composition, amortized cost and fair value of our securities at the dates indicated.
The fair values of marketable equity securities are generally determined by quoted prices, in active markets, for each specific security. If quoted market prices are not available for a marketable equity security, we determine its fair value based on the quoted price of a similar security traded in an active market. The fair values of debt securities are generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value of a security is used to determine the amount of any unrealized losses that must be reflected in our other comprehensive income and the net book value of our securities.
We evaluate marketable investment securities with significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under current accounting guidance, which generally provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the impairment is other-than-temporary.
We also periodically evaluate our FHLBC common stock, which is not a marketable investment security, for impairment in accordance with Statement of Position (SOP) 01-6 (ASC 942-325-35), Accounting by Certain Entities (Including Entities with Trade Receivables) that lend to or Finance the Activities of Others. SOP 01-6 provides that when evaluating FHLB stock for impairment, its value should be determined based on the ultimate recovery of its par value rather than by recognizing temporary declines in value.
The FHLBC is subject to a cease and desist order issued by the FHFA, in 2007. Among other things, the cease and desist order requires the FHLBC to submit a capital plan to the FHFA, prohibits certain capital stock repurchases and stock redemptions, including certain redemptions upon membership withdrawal, without the prior approval of the Director, and prohibits the payments of dividends without the prior approval of the Director. The FHLBC has reported that it has submitted a capital plan to the Director but that it has not yet been approved. The FHLBC did not pay any dividends from the third quarter of 2007 through 2010, but in the first quarter of 2011, paid a nominal cash dividend at an annualized rate of 10 basis points per share. The FHLBC reported in February 2011 that it had earnings of net income of $366 million for 2010, compared to a net loss of $65 million in 2009, and that it is compliance with its regulatory capital requirements.
We considered the above evidence in accordance with SOP 01-6 and concluded that it is probable that its par value is ultimately recoverable based on the FHLBC’s current compliance with its regulatory capital requirements, the net income that it reported for 2010, its receipt of approval from the Director to pay a dividend in the first quarter of 2011 and published reports indicating that it is continuing to work with the FHFA to finalize a capital plan.
Portfolio Maturities and Yields
The composition and maturities of the securities portfolio and the mortgage-backed securities portfolio at December 31, 2010 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. Municipal securities yields have not been adjusted to a tax-equivalent basis, as the amount is immaterial.
Sources of Funds
Deposits. At December 31, 2010, our deposits totaled $1.235 billion. Interest-bearing deposits totaled $1.123 billion and noninterest-bearing demand deposits totaled $112.5 million. NOW, savings and money market accounts totaled $742.8 million. Noninterest-bearing demand deposits at December 31, 2010 included $6.0 million in internal checking accounts, such as accounts for Bank cashier’s checks and money orders. At December 31, 2010, we had $380.1 million of certificates of deposit outstanding, of which $271.2 million had maturities of one year or less. Although we have a significant portion of our deposits in shorter-term certificates of deposit, we believe, based on historical experience and our current pricing strategy, that we will retain a significant portion of these accounts upon maturity.
We originate deposits predominantly from the areas where our branch offices are located. We rely on our favorable locations, customer service, competitive pricing, our Internet Branch and related deposit services such as cash management to attract and retain these deposits. While we accept certificates of deposit in excess of the FDIC’s deposit insurance limits, we generally do not solicit such deposits because they are more difficult to retain than core deposits and at times are more costly than brokered deposits.
The following table sets forth the distribution of total deposit accounts, by account type, for the periods indicated.
The following table sets forth certificates of deposit by time remaining until maturity at December 31, 2010.
Borrowings. Our borrowings consist primarily of Federal Home Loan Bank advances and repurchase agreements. The following table sets forth information concerning balances and interest rates on our borrowings at the dates and for the periods indicated.
At December 31, 2010, we had the capacity to borrow an additional $240.5 million under our credit facilities with the FHLBC. Furthermore, we had unpledged securities that could be used to support in excess of $71.4 million of additional FHLBC borrowings.
At December 31, 2010, we had a pre-approved overnight federal funds borrowing capacity of $28.0 million and a line of credit with the Federal Reserve Bank of Chicago for $425,000. At December 31, 2010, there were no outstanding federal funds borrowings and there was no outstanding balance on the line of credit.
Statement of Operating Results for the Years Ended December 31, 2010, 2009 and 2008
Net Income
Comparison of Year 2010 to 2009. We recorded a net loss of $4.3 million for the year ended December 31, 2010, compared to net loss of $738,000 for the year ended December 31, 2009. The net loss for 2010 was attributable in substantial part to the combined impact of a $12.1 million provision for loan losses and $7.3 million for nonperforming asset management expense and operations of other real estate owned. The 2009 results included an $8.8 million provision for loan losses and a $401,000 loss on impairment of securities. The impact of these items in 2009 was partially offset by a $1.3 million gain that we recognized on the sale of our merchant processing operations. Our loss per share of common stock for year ended December 31, 2010 was $0.22 per share, compared to $0.04 per share for the year ended December 31, 2009.
Comparison of Year 2009 to 2008. We recorded a net loss of $738,000 for the year ended December 31, 2009, compared to net loss of $19.4 million for the year ended December 31, 2008. The net loss for 2009 was attributable in substantial part to the combined impact of an $8.8 million provision for loan losses, a $401,000 pre-tax impairment loss on our Freddie Mac preferred stocks, and a $998,000 pre-tax loss that we recognized upon the subsequent sale of these securities. In addition, we recorded a $2.2 million expense, compared to $162,000 in 2008, for FDIC quarterly and special assessments in 2009 due to the combined effect of the FDIC’s increase in its quarterly assessment rate, the FDIC’s imposition of a special assessment against all insured depository institutions and the full utilization of the FDIC assessment credits that we previously had available to offset or reduce FDIC quarterly assessments. The impact of these items was partially offset by a $1.3 million gain that we recognized on the sale of our merchant processing operations in 2009. The net loss for 2008 was primarily due to a $35.9 million pre-tax impairment loss that we recorded on our Freddie Mac preferred stocks. Our loss per share of common stock for year ended December 31, 2009 was $0.04 per share, compared to a loss of $0.98 per share for the year ended December 31, 2008.
Net Interest Income
Comparison of Year 2010 to 2009. Net interest income decreased by $1.8 million, or 3.4%, to $51.8 million for the year ended December 31, 2010, from $53.6 million for the year ended December 31, 2009. Our net interest rate spread remained at 3.36% for the years ended December 31, 2010 and 2009. Our net interest margin decreased by 12 basis points to 3.57% for the year ended December 31, 2010, from 3.69% for the year ended December 31, 2009. Our average interest-earning assets remained at $1.451 billion for the year ended 2010 and 2009, and our average interest-bearing liabilities increased $8.4 million to $1.184 billion in 2010, from $1.176 billion in 2009.
Interest income decreased by $9.2 million, or 12.4%, to $64.9 million for the year ended December 31, 2010, from $74.1 million for the year ended December 31, 2009. The decrease in interest income resulted primarily from a 64 basis point decrease in the average yield on interest earning assets to 4.47% for the year ended December 31, 2010, from 5.11% for the year ended December 31, 2009, and a decrease in average loans receivable.
Interest income on loans, the most significant portion of interest income, decreased by $8.2 million, or 11.9%, to $60.9 million for the year ended December 31, 2010, from $69.2 million for the year ended December 31, 2009. The average yield on loans decreased 10 basis points to 5.34% for the year ended December 31, 2010, from 5.44% for the year ended December 31, 2009. Interest income on loans and the average yield on loans were impacted by a $130.2 million, or 10.2%, decrease in average loans receivable to $1.141 billion for the year ended December 31, 2010, from $1.271 billion for the year ended December 31, 2009, and a net increase of $381,000 in the reserve for uncollected interest relating to loans that were placed on nonaccrual status during the year ended December 31, 2010.
Interest income on securities decreased $1.3 million, or 27.6%, to $3.5 million for the year ended December 31, 2010, from $4.8 million for the year ended December 31, 2009. The decrease in interest income on securities was due in substantial part to a $26.6 million, or 23.6%, decrease in the average balance of securities to $86.0 million for the year ended December 31, 2010, from $112.7 million for the year ended December 31, 2009. The average yield on securities decreased by 23 basis points to 4.05% for the year ended December 31, 2010, from 4.28% for the year ended December 31, 2009.
The FHLBC did not pay dividends on its common stock in 2010 or 2009.
Interest income on interest-bearing deposits in other financial institutions increased $399,000 to $522,000 for the year ended December 31, 2010, from $123,000 for the year ended December 31, 2009. The increase was primarily due to a $156.7 million increase in the average balance of our interest bearing deposits in other financial institutions to $208.7 million for the year ended December 31, 2010, from $52.0 million for the year ended December 31, 2009. The average yield on our interest-bearing deposits in other financial institutions increased one basis point to 0.25% for the year ended December 31, 2010, from 0.24% for the year ended December 31, 2009.
Interest expense decreased by $7.4 million, or 35.9%, to $13.2 million for the year ended December 31, 2010, from $20.6 million for the year ended December 31, 2009, representing a decrease in both interest expense on deposits and interest expense on borrowings.
Interest expense on deposits decreased by $6.2 million, or 33.3%, to $12.3 million for the year ended December 31, 2010, from $18.5 million for the year ended December 31, 2009. The decrease in interest expense on deposits was primarily due to a 64 basis point decrease in the average rates paid on deposits, which was partially offset by a $72.5 million, or 6.8%, net increase in the average balance of deposits. The average cost of deposits was 1.08% for the year ended December 31, 2010, compared to 1.72% for the year ended December 31, 2009. The average rate paid on savings accounts decreased eight basis points to 0.43% from 0.51%. On a year over year basis, the average cost of money market accounts decreased 72 basis points to 0.94%, from 1.66%, the average cost of NOW accounts decreased 28 basis points to 0.49%, from 0.77%, and the average cost of certificates of deposit decreased 91 basis points to 1.78% from 2.69%. The average balances of money market accounts increased $76.7 million, or 28.3%, the average balance of NOW accounts increased $11.1 million, or 3.9%, and the average balance of savings accounts increased $1.2 million, or 1.2% for the year ended December 31, 2010. These increases were partially offset by a decrease in the average balances of certificates of deposit of $16.5 million, or 3.9% for the year ended December 31, 2010.
Interest expense on borrowings decreased by $1.2 million, or 58.5%, to $853,000 for the year ended December 31, 2010, from $2.1 million for the year ended December 31, 2009. This decrease was due in substantial part to a decrease in the average balance of borrowings of $64.1 million, or 63.0%, to $37.7 million at December 31, 2010, from $101.8 million at December 31, 2009. The decrease was partially offset by a 25 basis point increase in the average cost of borrowings to 2.27% for the year ended December 31, 2010, from 2.02% for the year ended December 31, 2009.
Comparison of Year 2009 to 2008. Net interest income increased by $1.3 million, or 2.4%, to $53.6 million for the year ended December 31, 2009, from $52.3 million for the year ended December 31, 2008. Our net interest rate spread improved by one basis point to 3.36% for the year ended December 31, 2009, from 3.35% for the year ended December 31, 2008. Our net interest margin decreased by 19 basis points to 3.69% for the year ended December 31, 2009, from 3.88% for the year ended December 31, 2008. Our average interest-earning assets increased $102.2 million to $1.451 billion in 2009, from $1.349 billion in 2008, and our average interest-bearing liabilities increased $120.6 million to $1.176 billion in 2009, from $1.055 billion in 2008.
Interest income decreased by $3.9 million, or 5.0%, to $74.0 million for the year ended December 31, 2009, from $78.0 million for the year ended December 31, 2008. The decrease in interest income resulted primarily from a 68 basis point decrease in the average yield on interest earning assets to 5.10% for the year ended December 31, 2009, from 5.78% for the year ended December 31, 2008. This decrease was partially offset by a $102.2 million increase in total average interest-earning assets to $1.451 billion for the year ended December 31, 2009, from $1.349 billion for the year ended December 31, 2008.
Interest income on loans, the most significant portion of interest income, decreased by $4.8 million, or 6.5%, to $69.2 million for the year ended December 31, 2009, from $74.0 million for the year ended December 31, 2008. Interest income on loans and the average yield on loans were reduced by a net increase of $1.7 million in the reserve for uncollected interest that we established for loans that were placed on nonaccrual status during the year ended December 31, 2009. This increase accounts for 34.4% of the decrease in interest income from loans. In addition, the average yield on loans decreased 52 basis points to 5.44% for the year ended December 31, 2009, from 5.96% for the year ended December 31, 2008. These decreases were partially offset by a $29.5 million, or 2.4%, increase in the average balance of loans outstanding to $1.271 billion for the year ended December 31, 2009, from $1.242 billion for the year ended December 31, 2008.
Interest income on securities increased $955,000, or 24.7%, to $4.8 million for the year ended December 31, 2009, from $3.9 million for the year ended December 31, 2008. The increase in interest income on securities resulted primarily from a $29.5 million, or 35.0%, increase in the average balance of securities to $112.7 million for the year ended December 31, 2009, from $83.5 million for the year ended December 31, 2008. This increase was partially offset by a 35 basis point decrease in the average yield on securities to 4.28% for the year ended December 31, 2009, from 4.63% for the year ended December 31, 2008.
The FHLBC did not pay dividends on its common stock in 2009 or 2008.
Interest income on interest-bearing deposits in other financial institutions increased $7,000, or 6.0%, to $123,000 for the year ended December 31, 2009, from $116,000 for the year ended December 31, 2008. The increase was primarily due to a $43.5 million increase in the average balance of our interest bearing deposits to $52.0 million for the year ended December 31, 2009, from $8.5 million for 2008. This increase was partially offset by a decrease of 113 basis points in the average yield on our interest-bearing deposits to 0.24% for the year ended December 31, 2009, from 1.37% for the year ended December 31, 2008.
Interest expense decreased by $5.1 million, or 19.9%, to $20.6 million for the year ended December 31, 2009, from $25.7 million for the year ended December 31, 2008. The decrease was due to decreased interest expense on deposits and borrowings.
Interest expense on deposits decreased by $3.5 million, or 16.0%, to $18.5 million for the year ended December 31, 2009, from $22.0 million for the year ended December 31, 2008. The decrease in interest expense on deposits was primarily due to a 61 basis point decrease in the average rates paid on deposits, partially offset by a $128.8 million, or 13.6%, net increase in the average balance of deposits. The average cost of deposits was 1.72% for the year ended December 31, 2009, compared to 2.33% for the year ended December 31, 2008. The average rate on savings accounts decreased 22 basis points to 0.51% from 0.73%. On a year over year basis, the average cost of money market accounts decreased 90 basis points to 1.66%, from 2.56%, the average cost of NOW accounts decreased 78 basis points to 0.77%, from 1.55%, and the average cost of certificates of deposit decreased 73 basis points to 2.69% from 3.42%. The average balances of money market accounts increased $59.7 million, or 28.3%, and the average balance of certificates of deposit increased $97.4 million, or 30.0%, for the year ended December 31, 2009. These increases were partially offset by a decrease in the average balances of NOW accounts of $27.3 million, or 8.8%, and a decrease in the average balances of savings accounts of $984,000, or 1.0% for the year ended December 31, 2009.
Interest expense on borrowings decreased by $1.6 million, or 43.4%, to $2.1 million for the year ended December 31, 2009, from $3.6 million for the year ended December 31, 2008. This decrease was due in substantial part to a 128 basis point decrease in the average cost of such borrowings to 2.02% for the year ended December 31, 2009, from 3.30% for the year ended December 31, 2008, and a decrease in the average balance of borrowings of $8.3 million, or 7.5%, to $101.8 million at December 31, 2009, from $110.0 million at December 31, 2008.
Average Balance Sheets
The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect of these adjustments would not be material. Average balances are daily average balances. Nonaccrual loans are included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees and expenses, discounts and premiums, purchase accounting adjustments that are amortized or accreted to interest income or expense.
(1) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(3) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate), and changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.
Provision for Loan Losses
We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb probable incurred credit losses in the loan portfolio. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or events change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance.
Comparison of Year 2010 to 2009. We recorded a provision for loan losses of $12.1 million for the year ended December 31, 2010, compared to a provision for loan losses of $8.8 million for the year ended December 31, 2009. The 2010 provision for loan losses reflects the combined impact of a $4.4 million increase in the specific portion of the allowance for loan losses that we allocate to impaired loans and $8.5 million in net charge-offs, which were partially offset by a $794,000 decrease in the general portion of the allowance for loan losses.
Net loan charge-offs for 2010 were $8.5 million, or 0.75% of average loans, compared to $4.9 million, or 0.39% of average loans, in 2009. Our allowance for loan losses was $22.2 million, or 2.07% of total loans, at December 31, 2010, compared to $18.6 million, or 1.51% of total loans, at December 31, 2009. The allowance for loan losses represented 48.5% of nonperforming loans at December 31, 2010. To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate for each reporting period.
Comparison of Year 2009 to 2008. We recorded a provision for loan losses of $8.8 million for the year ended December 31, 2009, compared to a provision for loan losses of $5.1 million for the year ended December 31, 2008. The 2009 provision for loan losses reflects a $2.4 million increase in the specific portion of the allowance for loan losses that we allocate to impaired loans, a $1.5 million increase in the general portion of the allowance for loan losses, and $4.9 million in net charge-offs. We increased the general portion of the allowance by $1.5 million based on the continued deterioration in national and local economic risk factors included in our model for determining the proper level of general reserves.
Net loan charge-offs for 2009 were $4.9 million, or 0.39% of average loans, compared to $1.4 million, or 0.11% of average loans, in 2008. Our allowance for loan losses was $18.6 million, or 1.51% of total loans, at December 31, 2009, compared to $14.7 million, or 1.15% of total loans, at December 31, 2008. The allowance for loan losses represented 37.6% of nonperforming loans at December 31, 2009. To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate for each reporting period.
Noninterest Income
Comparison of Year 2010 to 2009. Our noninterest income decreased by $111,000 to $7.1 million for the year ended December 31, 2010, from $7.2 million for the year ended December 31, 2009. Our noninterest income for 2010 included $31,000 gain on the sale of securities, compared a $988,000 pre-tax loss relating to the sale of our Freddie Mac preferred stocks in 2009. Additional factors affecting the change in noninterest income from year-to-year included a $343,000, or 10.2%, decrease in deposit service charges and fees to $3.0 million, from $3.4 million for 2009. Income from insurance commissions and annuities increased by $60,000, or 8.4%, to $775,000 for the year ended December 31, 2010, compared to $715,000 for 2009. Gains on the sale of loans decreased by $198,000, or 28.3%, to $501,000, compared to $699,000 for 2009. We recognized a net loss of $19,000 on the disposition of premises and equipment during 2010, compared to a net loss of $40,000 in 2009. Loan servicing fees decreased $49,000, or 7.5%, to $604,000 for the year ended December 31, 2010, from $653,000 for the year ended December 31, 2009. Mortgage servicing rights amortization expense increased $67,000 or 13.9%, to $549,000 for the year ended December 31, 2010, compared to $482,000 for 2009. We recorded a reserve recovery of $74,000 on our mortgage servicing rights in 2010, compared to a reserve recovery of $36,000 on our mortgage servicing rights in 2009. Bank-owned life insurance produced earnings of $430,000 for 2010, compared to a loss of $20,000 for 2009. Other income for 2009 included a $1.3 million gain on the sale of our merchant processing operations.
Comparison of Year 2009 to 2008. Our noninterest income decreased by $3.2 million to $7.2 million for the year ended December 31, 2009, from $10.4 million for the year ended December 31, 2008. Our noninterest income for 2009 included a $988,000 pre-tax loss relating to the sale of our Freddie Mac preferred stocks, compared to $2.6 million in pre-tax gains relating to the redeemed and unredeemed shares of Visa, Inc. Class B common stock that were allocated to us in the initial public offering that Visa, Inc. conducted in March of 2008. Additional factors affecting the change in noninterest income from year-to-year included a $208,000, or 5.8%, decrease in deposit service charges and fees to $3.3 million, from $3.6 million for 2008. Other fee income decreased $128,000, or 6.6%, to $1.8 million, compared to $1.9 million for 2008. Income from insurance commissions and annuities decreased by $79,000, or 10.0%, to $715,000 for the year ended December 31, 2009, compared to $794,000 for 2008, due to decreased sales activity. Gains on the sale of loans increased by $581,000 to $699,000, compared to $118,000 for 2008. We recognized a net loss of $40,000 on the disposition of premises and equipment during 2009, compared to a net loss of $302,000 in 2008. Loan servicing fees decreased $118,000, or 15.3%, to $653,000 for the year ended December 31, 2009, from $771,000 for 2008. Mortgage servicing rights amortization expense increased $68,000 or 16.4%, to $482,000 for the year ended December 31, 2009, compared to $414,000 for 2008. We recorded a reserve recovery of $36,000 on our mortgage servicing rights in 2009, compared to a $110,000 reserve that we recorded for 2008. Bank-owned life insurance produced a loss of $20,000 for 2009, compared to income of $586,000 for 2008, due to our decision to temporarily move investable policy funds into a low-yielding money market sub-account at the end of 2008 as a means of protecting the underlying value of the policy. Other income totaled $1.5 million for the year ended December 31, 2009, compared to $835,000 for 2008, due primarily to the recording of a $1.3 million gain on the sale of our merchant processing operations in the fourth quarter of 2009.
Noninterest Expense
Comparison of Year 2010 to 2009. For the year ended December 31, 2010, noninterest expense increased by $1.1 million, or 2.1%, to $53.8 million, from $52.7 million for the year ended December 31, 2009. Noninterest expense for 2010 included $7.3 million in expenses for nonperforming asset management and operations of other real estate owned. Noninterest expense for 2009 included a $401,000 pre-tax impairment loss that we recorded on our holdings of Freddie Mac preferred stocks. Additional factors affecting the change in noninterest expense from year-to-year included a $2.7 million, or 9.3%, decrease in compensation expense to $26.3 million for the year ended December 31, 2010, from $29.0 million for the year ended December 31, 2009. The decrease was due in part to a decrease of 44 full-time equivalent employees from 372 in 2009 to 328 in 2010. Supplies, telephone and postage expenses decreased $223,000, or 12.3%, to $1.6 million, and intangible amortization expense decreased by $95,000. Net expenses for nonperforming asset management for 2010 included legal expenses of $876,000, receiver fees of $372,000, and real estate taxes and insurance of $1.9 million. Net expenses for operations of other real estate owned totaled $4.0 million for 2010, compared to $1.3 million for the same period in 2009. Net expenses for operations of other real estate owned included $2.4 million in write-downs on OREO and $415,000 of losses upon sale of OREO.
Comparison of Year 2009 to 2008. For the year ended December 31, 2009, noninterest expense decreased by $36.3 million, or 40.8%, to $52.7 million, from $89.1 million for the year ended December 31, 2008. Noninterest expense for 2008 included a $35.9 million pre-tax impairment loss that we recorded on our holdings of Freddie Mac preferred stocks and a $2.0 million pre-tax expense that we recorded in connection with the prepayment of a $25 million FHLBC term advance. Additional factors affecting the change in noninterest expense from year-to-year included a $1.5 million, or 4.9%, decrease in compensation expense to $29.0 million for the year ended December 31, 2009, from $30.5 million for the year ended December 31, 2008. The decrease was due in part to a decrease of 21 full-time equivalent employees from 393 in 2008 to 372 in 2009, resulting from the implementation of functional staffing reviews. Expense relating to equity-based compensation and benefits totaled $3.0 million in 2009, compared to $4.6 million during 2008. Supplies, telephone and postage expenses decreased $251,000, or 12.1%, to $1.8 million, and intangible amortization expense decreased by $94,000. These expense reductions were partially offset by an increase in our net expense from other real estate owned operations to $1.3 million for the year ended December 31, 2009, compared to $434,000 for 2008. Net operations from other real estate owned for the current year included $973,000 in write-downs or losses on other real estate owned, compared to $289,000 in write-downs or losses in 2008. Our expense for FDIC deposit insurance increased to $2.2 million during the year ended December 31, 2009, compared to $162,000 during the same period of 2008. The increase in our expense for FDIC deposit insurance was due to the combined effect of the FDIC’s increase in its quarterly assessment rate, the FDIC’s imposition of a special assessment against all insured depository institutions and the full utilization of the FDIC assessment credits that we previously had available to offset or reduce FDIC quarterly assessments. Other expenses increased by $194,000, or 4.5%, to $4.5 million in 2009.
Income Tax Benefit
Comparison of Year 2010 to 2009. For the year ended December 31, 2010, we recorded an income tax benefit of $2.7 million, compared to an income tax benefit of $13,000 for the year ended December 31, 2009. The effective tax rates were 38.94% and 1.73% for the years ended December 31, 2010 and 2009, respectively. For 2009, the difference between the GAAP basis (fair market value at the date of grant) and the tax basis (fair market value at the date of vesting) of equity-based compensation granted in prior years reduced our income tax benefit.
Comparison of Year 2009 to 2008. For the year ended December 31, 2009, we recorded an income tax benefit of $13,000, compared to an income tax benefit of $12.0 million for the year ended December 31, 2008. For 2009, the difference between the GAAP basis (fair market value at the date of grant) and the tax basis (fair market value at the date of vesting) of equity-based compensation granted in prior years reduced our income tax benefit. The income tax benefit for 2008 was primarily due to the impairment loss that we recorded on our Freddie Mac preferred stocks.
Impact of Inflation and Changing Prices
The Company’s financial statements and the related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The impact of inflation, if any, is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Management of Interest Rate Risk
Qualitative Analysis. A significant form of market risk is interest rate risk. Interest rate risk results from timing differences in the maturity or repricing of our assets, liabilities and off balance sheet contracts (i.e., forward loan commitments), the effect of loan prepayments and deposit withdrawals, the difference in the behavior of lending and funding rates arising from the use of different indices and “yield curve risk” arising from changing rate relationships across the spectrum of maturities for constant or variable credit risk investments. In addition to directly affecting net interest income, changes in market interest rates can also affect the amount of new loan originations, the ability of borrowers to repay variable rate loans, the volume of loan prepayments and refinancings, the carrying value of investment securities classified as available-for-sale and the flow and mix of deposits.
The general objective of our interest rate risk management is to determine the appropriate level of risk given our business strategy and then manage that risk in a manner that is consistent with our policy to reduce, to the extent possible, the exposure of our net interest income to changes in market interest rates. Our Asset/Liability Management Committee (“ALCO”), which consists of certain members of senior management, evaluates the interest rate risk inherent in certain assets and liabilities, our operating environment and capital and liquidity requirements, and modifies our lending, investing and deposit gathering strategies accordingly. The Board of Directors’ Asset/Liability Management Committee then reviews the ALCO’s activities and strategies, the effect of those strategies on our net interest margin, and the effect that changes in market interest rates would have on the economic value of our loan and securities portfolios as well as the intrinsic value of our deposits and borrowings, and reports to the full Board of Directors.
We actively evaluate interest rate risk in connection with our lending, investing and deposit activities. In an effort to better manage interest-rate risk, we have de-emphasized the origination of residential mortgage loans, and have increased our emphasis on the origination of nonresidential real estate loans, multi-family mortgage loans, commercial loans and commercial leases. In addition, depending on market interest rates and our capital and liquidity position, we generally sell all or a portion of our longer-term, fixed-rate residential loans, usually on a servicing-retained basis. Further, we primarily invest in shorter-duration securities, which generally have lower yields compared to longer-term investments. Shortening the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and securities, as well as loans with variable rates of interest, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates. Finally, we have classified all of our investment portfolio as available-for-sale so as to provide flexibility in liquidity management.
We utilize a combination of analyses to monitor the Bank’s exposure to changes in interest rates. The economic value of equity analysis is a model that estimates the change in net portfolio value (“NPV”) over a range of interest rate scenarios. NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. In calculating changes in NPV, we assume estimated loan prepayment rates, reinvestment rates and deposit decay rates that seem most likely based on historical experience during prior interest rate changes.
Our net interest income analysis utilizes the data derived from the dynamic GAP analysis, described below, and applies several additional elements, including actual interest rate indices and margins, contractual limitations such as interest rate floors and caps and the U.S. Treasury yield curve as of the balance sheet date. In addition, we apply consistent parallel yield curve shifts (in both directions) to determine possible changes in net interest income if the theoretical yield curve shifts occurred instantaneously. Net interest income analysis also adjusts the dynamic GAP repricing analysis based on changes in prepayment rates resulting from the parallel yield curve shifts.
Our dynamic GAP analysis determines the relative balance between the repricing of assets and liabilities over multiple periods of time (ranging from overnight to five years). Dynamic GAP analysis includes expected cash flows from loans and mortgage-backed securities, applying prepayment rates based on the differential between the current interest rate and the market interest rate for each loan and security type. This analysis identifies mismatches in the timing of asset and liability repricing but does not necessarily provide an accurate indicator of interest rate risk because it omits the factors incorporated into the net interest income analysis.
Quantitative Analysis. The following table sets forth, as of December 31, 2010, the estimated changes in the Bank’s NPV and net interest income that would result from the designated instantaneous parallel shift in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
The Company has opted not to include an estimate for a decrease in rates at December 31, 2010 as the results are not relevant given the current targeted fed funds rate of the Federal Open Market Committee. The table set forth above indicates that at December 31, 2010, in the event of an immediate 200 basis point increase in interest rates, the Bank would be expected to experience a 6.99% increase in NPV and a $97,000 decrease in net interest income. This data does not reflect any actions that we may undertake in response to changes in interest rates, such as changes in rates paid on certain deposit accounts based on local competitive factors, which could reduce the actual impact on NPV and net interest income, if any.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and net interest income requires that we make certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The NPV and net interest income table presented above assumes that the composition of our interest-rate-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and, accordingly, the data does not reflect any actions that we may undertake in response to changes in interest rates, such as changes in rates paid on certain deposit accounts based on local competitive factors. The table also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the NPV and net interest income table provides an indication of our sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Liquidity Management
Liquidity Management - Bank. The overall objective of our liquidity management is to ensure the availability of sufficient cash funds to meet all financial commitments and to take advantage of investment opportunities. We manage liquidity in order to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.
Our primary sources of funds are deposits, principal and interest payments on loans and securities, and, to a lesser extent, wholesale borrowings, the proceeds from maturing securities and short-term investments, and the proceeds from the sales of loans and securities. The scheduled amortization of loans and securities, as well as proceeds from borrowings, are predictable sources of funds. Other funding sources, however, such as deposit inflows, mortgage prepayments and mortgage loan sales are greatly influenced by market interest rates, economic conditions and competition.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in the Consolidated Statements of Cash Flows in our Consolidated Financial Statements. Our primary investing activities are the origination for investment or sale of one-to-four family residential mortgage loans, the origination for investment of multi-family mortgage, nonresidential real estate, commercial leases, construction and land, and commercial loans and the purchase of investment securities and mortgage-backed securities. During the years ended December 31, 2010, 2009 and 2008 our loans originated for sale totaled $19.7 million, $40.8 million and $23.4 million, respectively. During the years ended December 31, 2010, 2009 and 2008, our loans originated for investment totaled $676.4 million, $796.3 million and $818.7 million, respectively. Purchases of loans totaled $2.7 million, $19.4 million and $12.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. Purchases of securities totaled $50.5 million and $103.0 million for the years ended December 31, 2010 and 2008, respectively. There were no purchases of securities in 2009.
These activities were funded primarily by principal repayments on loans and securities, and the sale of loans and securities. During the years ended December 31, 2010, 2009 and 2008, principal repayments on loans totaled $817.4 million, $852.1 million and $810.6 million, respectively. During the years ended December 31, 2010, 2009 and 2008, principal repayments on securities totaled $30.1 million, $22.7 million and $9.1 million, respectively. During the years ended December 31, 2010, 2009 and 2008, proceeds from maturities and sales of securities totaled $1.8 million, $2.8 million and $17.5 million, respectively. During the years ended December 31, 2010, 2009 and 2008, the proceeds from the sale of loans totaled $17.5 million, $42.4 million and $22.8 million, respectively.
Loan origination commitments totaled $16.7 million at December 31, 2010, and consisted of $14.3 million of fixed-rate loans and $2.4 million of adjustable-rate loans. Unused lines of credit and standby letters of credit granted to customers totaled $138.2 million and $1.7 million, respectively, at December 31, 2010. At December 31, 2010, commitments to sell mortgages totaled $3.2 million.
Deposit flows are generally affected by the level of market interest rates, the interest rates and other terms and conditions on deposit products offered by our banking competitors, and other factors. We had a net deposit increase of $2.0 million for the year ended December 31, 2010, compared to a net increase of $163.5 million for the year ended December 31, 2009 and net outflows of $3.8 million for the year ended December 31, 2008. At times during recent periods, we have not actively competed for higher cost deposit accounts, including certificates of deposit, choosing instead to fund loan growth from the loan and lease repayments. Certificates of deposit that are scheduled to mature in one year or less from December 31, 2010 totaled $271.2 million. Based upon prior experience and our current pricing strategy, we believe that we will retain a significant portion of these deposits upon their maturities.
We anticipate that we will have sufficient funds available to meet current loan commitments and lines of credit and maturing certificates of deposit that are not renewed or extended. We generally remain fully invested and utilize additional sources of funds through FHLBC advances, of which $16.0 million were outstanding at December 31, 2010. At December 31, 2010 we had the ability to borrow an additional $240.5 million under our credit facilities with the FHLBC. Furthermore, we have unpledged securities that could be used to support borrowings in excess of $71.4 million. Finally, at December 31, 2010 we had available pre-approved overnight federal funds borrowing lines of $28.0 million and a line of credit available with the Federal Reserve Bank of Chicago of $425,000. At December 31, 2010, there was no outstanding balance on these credit lines.
We minimize the funds required to originate one-to-four family residential mortgage loans in two ways. We sell in the secondary market virtually all of our eligible fixed-rate one-to-four family residential mortgage loans. From time to time, we also securitize the conforming adjustable-rate one-to-four family residential mortgage loans that we originate and hold the securities we receive in exchange. The resulting mortgage-backed securities that we retain on our balance sheet can be sold more readily to meet our liquidity or interest rate management needs. Because the securities carry a lower risk-weighting than the underlying loans, the securitizations also lower our regulatory capital requirements. We did not securitize any loans during 2010 and 2009.
Liquidity Management - Company. The liquidity needs of the Company on an unconsolidated basis consist primarily of operating expenses, dividends to stockholders and stock repurchases. The primary sources of liquidity for the Company currently are $16.4 million of cash and cash equivalents and periodic cash dividends from the Bank.
Under the rules of the OTS, the Bank is not permitted to pay dividends on its capital stock to the Company, its sole stockholder, if the dividend would reduce the Bank’s stockholder’s equity below the amount of the liquidation account established in connection with the Company’s mutual-to-stock conversion. The Bank may pay dividends without the approval of the OTS only if the Bank meets its applicable regulatory capital requirements before and after the payment of the dividends and its total dividends do not exceed its net income to date over the calendar year in which the dividend is paid plus retained net income over the preceding two years. The OTS has discretion to prohibit permissible capital distributions on general safety and soundness grounds and must be given 30 days advance notice of all capital distributions from the Bank to the Company, including dividends.
During 2010, we used $3.1 million of existing cash and cash equivalents to repurchase shares of our common stock and $6.0 million of existing cash and cash equivalents to pay cash dividends to our stockholders.
As of December 31, 2010, we were not aware of any known trends, events or uncertainties that had or were reasonably likely to have a material impact on our liquidity. As of December 31, 2010, we had no other material commitments for capital expenditures.
Capital Management
Capital Management - Bank. The overall objectives of our capital management are to ensure the availability of sufficient capital to support loan, deposit and other asset and liability growth opportunities and to maintain capital to absorb unforeseen losses or write-downs that are inherent in the business risks associated within the banking industry. We seek to balance the need for higher capital levels to address such unforeseen risks and the goal to achieve an adequate return on the capital invested by our stockholders.
The Bank is subject to regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by the OTS that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. Adequately capitalized institutions require regulatory approval to accept brokered deposits. If undercapitalized, a financial institution’s capital distributions, asset growth and expansion are limited, and for the submission of a capital restoration is required.
At year-end, actual capital ratios and minimum required ratios for the Bank were:
See Note 11 - “Regulatory Matters” in our Consolidated Financial Statements for a reconciliation of the Bank’s equity under GAAP to regulatory capital.
As of December 31, 2010 and 2009, the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since those notifications that management believes have changed the institution’s capitalization category.
Capital Management - Company. On June 23, 2005, the Company completed its mutual-to-stock conversion and sold 24,466,250 shares of common stock in a subscription offering at $10.00 per share and raised $240.3 million in offering proceeds, net of offering expenses. The Company contributed $120.9 million of the net proceeds to the Bank, paid off $30 million of term borrowings, loaned $19.6 million to our ESOP and retained the remaining net proceeds of $72 million. As a result of the offering, the Company has capital levels substantially above those required to support the current size and risk profile of the Company and its subsidiary, the Bank.
Total stockholders’ equity totaled $253.3 million at December 31, 2010, compared to $263.6 million at December 31, 2009. The decrease in total stockholders’ equity was primarily due to the combined impact of our repurchase of 356,411 shares of our common stock during 2010 at a total cost of $3.1 million, and our declaration and payment of cash dividends totaling $5.9 million, the $4.3 million net loss that we recorded for 2010 and a $50,000 decrease accumulated other comprehensive income. These items were partially offset by a $3.1 million increase in total stockholders’ equity that resulted from the vesting of stock-based compensation and ESOP shares earned
The OTS has no specific quantitative capital regulations for savings and loan holding companies on either a consolidated or unconsolidated basis. There are several capital measurements that the OTS uses to evaluate the adequacy of a savings and loan holding company’s capital. One measurement is the tangible capital ratio. The tangible capital ratio (the ratio of tangible capital to tangible total assets (stockholders’ equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets)) for the Company on a consolidated basis measures the percentage of consolidated tangible equity capital supporting our consolidated tangible total assets. The Company’s tangible capital ratio was 14.74% at December 31, 2010, compared to 15.14% at December 31, 2009.
Our strategy for utilizing the capital encompasses several components, including debt reduction, funding our ESOP, financing acquisitions, paying dividends to stockholders, repurchasing shares of our common stock and for other general corporate purposes.
Our Board of Directors has authorized the repurchase of up to 5,047,423 shares of our common stock. The authorization permits shares to be repurchased in open market or negotiated transactions, and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission. The authorization may be utilized at management’s discretion, subject to the limitations set forth in Rule 10b-18 of the Securities and Exchange Commission and other applicable legal requirements, and to price and other internal limitations established by the Board of Directors. The repurchase authorization will expire on May 16, 2011, unless extended by the Board of Directors. As of December 31, 2010, the Company had repurchased 4,239,134 shares of its common stock out of the 5,047,423 shares that have been authorized for repurchase.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit, standby letters of credit, unused lines of credit and commitments to sell loans. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process afforded to loans that we make. Although we consider commitments to extend credit in determining our allowance for loan losses, at December 31, 2010, we had made no provision for losses on commitments to extend credit, and had no specific or general allowance for losses on such commitments, as we have had no historical loss experience with commitments to extend credit and we believed that no probable and reasonably estimable losses were inherent in our portfolio as a result of our commitments to extend credit. For additional information, see Note 14 - “Loan Commitments and Other Off-Balance Sheet Activities” in our Consolidated Financial Statements.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment.
The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at December 31, 2010. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.
Pending Acquisition
On September 13, 2010, the Company signed a definitive Merger Agreement to acquire DG Bancorp, Inc. and its wholly-owned subsidiary, Downers Grove National Bank. Founded in 1955, Downers Grove National Bank is a privately held community bank with $219 million in assets and $213 million in deposits as of December 31, 2010. Downers Grove National Bank has two banking locations in Downers Grove and Westmont, IL communities. The transaction has been approved by the Bank’s primary federal regulator, the Office of Thrift Supervision, and is expected to close in the first quarter of 2011, subject to customary closing conditions.
The following represents financial statements of DG Bancorp as of December 31, 2010 and 2009 and the results of their operations in the two years ended December 31, 2010. These results have been audited in accordance with the auditing standards generally accepted in the United States of America, with an opinion thereon February 23, 2011.
DG Bancorp, Inc and Subsidiary
Consolidated Balance Sheet
December 31,
(In thousands)
DG Bancorp, Inc and Subsidiary
Consolidated Statement of Operations
For the Years Ended December 31,
(In thousands, except per share amounts)
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
For information regarding market risk see Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Management of Interest Rate Risk.”
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of BankFinancial Corporation is responsible for establishing and maintaining effective internal control over financial reporting.
Management evaluates the effectiveness of internal control over financial reporting and tests for reliability of recorded financial information through a program of ongoing internal audits. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
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 accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Management assessed the Company’s internal control over financial reporting as of December 31, 2010, as required by Section 404 of the Sarbanes-Oxley Act of 2002, based on the criteria for effective internal control over financial reporting described in the “Internal Control-Integrated Framework,” adopted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concludes that, as of December 31, 2010, the Company’s internal control over financial reporting is effective.
The Company’s independent registered public accounting firm has issued their report on the effectiveness of the Company’s internal control over financial reporting. That report follows under the heading, Report of Independent Registered Public Accounting Firm.
/s/ F. Morgan Gasior
/s/ Paul A. Cloutier
F. Morgan Gasior
Paul A. Cloutier
Chairman of the Board, Chief Executive
Officer and President
Executive Vice President and
Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying statements of financial condition of BankFinancial Corporation (the “Company”) as of December 31, 2010 and 2009, and the related statements of operations, changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2010. We also have audited the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design, and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) 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.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BankFinancial Corporation as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Crowe Horwath LLP
Oak Brook, Illinois
March 8, 2011
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2010 and 2009
(In thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2010, 2009, and 2008
(In thousands, except per share data)
See accompanying notes to consolidated financial statements.
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2010, 2009, and 2008
(In thousands)
See accompanying notes to consolidated financial statements.
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2010, 2009, and 2008
(In thousands)
See accompanying notes to consolidated financial statements.
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2010, 2009, and 2008
(In thousands)
(Continued)
BANKFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2010, 2009, and 2008
(In thousands)
See accompanying notes to consolidated financial statements.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: BankFinancial Corporation, a Maryland corporation headquartered in Burr Ridge, Illinois (the “Company”), is the owner of all of the issued and outstanding capital stock of BankFinancial, F.S.B. (the “Bank”). On March 15, 2008, Financial Assurance Services, Inc. (“Financial Assurance”), a wholly-owned subsidiary of the Bank, completed the sale of its title insurance agency business to a newly formed, third-party title insurance agency. The transaction had no material impact on the Company’s total assets, stockholders’ equity or net income.
Principles of Consolidation: The consolidated financial statements include the accounts of and transactions of BankFinancial Corporation, the Maryland corporation, the Bank, and the Bank’s wholly-owned subsidiaries, Financial Assurance Services, Inc. and BF Asset Recovery Corporation (collectively, “the Company”). All significant intercompany accounts and transactions have been eliminated.
Nature of Business: The Company’s revenues, operating income, and assets are primarily from the banking industry. All of the Company’s banking operations are considered by management to be aggregated in one reportable operating segment for financial reporting purposes. Loan origination customers are mainly located in the greater Chicago metropolitan area. To supplement loan originations, the Company purchases mortgage loans. The loan portfolio is concentrated in loans that are primarily secured by real estate.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, mortgage servicing rights, deferred tax assets, goodwill, other intangible assets, stock-based compensation, impairment of securities and fair value of financial instruments are particularly subject to change.
Interest-bearing Deposits in Other Financial Institutions: Interest-bearing deposits in other financial institutions maturing in less than 90 days are carried at cost.
Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions maturing in less than 90 days, and daily federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, borrowings, and advance payments by borrowers for taxes and insurance.
Securities: Debt securities are classified as available-for-sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available-for-sale. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are based on the amortized cost of the security sold. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In determining if losses are other-than-temporary, management considers: (1) the length of time and extent that fair value has been less than cost or adjusted cost, as applicable, (2) the financial condition and near term prospects of the issuer, and (3) whether the Company has the intent to sell the debt security or it is more likely than not that the Company will be required to sell the debt security before the anticipated recovery.
Federal Home Loan Bank Stock: The Bank is a member of the Federal Home Loan Bank system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. Federal Home Loan Bank of Chicago (“FHLBC”) stock is carried at cost and classified as a restricted security. Current accounting guidance for FHLBC stock provides that, for impairment testing purposes, the value of long term investments such as our FHLBC common stock is based on the “ultimate recoverability” of the par value of the security without regard to temporary declines in value. Both cash and stock dividends are reported as income.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans Held-for-Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair market value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Mortgage loans held-for-sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the fair value of the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans and Loan Income: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of the allowance for loan losses, premiums and discounts on loans purchased, and net deferred loan costs. Interest income on loans is recognized in income over the term of the loan based on the amount of principal outstanding.
Premiums and discounts associated with loans purchased are amortized over the contractual term of the loan using the level-yield method.
Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the contractual loan term, adjusted for prepayments. Interest income is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received for loans placed on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience; the nature and volume of the portfolio; information about specific borrower situations; and estimated collateral values, economic conditions, and other factors. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available, or as later events occur or circumstances change. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers nonclassified loans and is based on historical loss experience adjusted for current factors.
A loan is impaired when full payment under the loan terms is not expected. Loans that experience insignificant payment delays and payment shortfalls are generally not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, considering the length of the delay, reasons for the delay and prior experience with the borrower. Multi-family, nonresidential, construction and land, and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Trouble debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception or the fair value of the collateral.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Mortgage Servicing Rights: Mortgage servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value and gains on sales of loans are recorded in the statement of operations. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the servicing cost per loan, the discount rate, the escrow float rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The Company compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported with amortization and impairment of servicing assets on the statement of operations. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Servicing fee income that is reported on the statement of operations as loan servicing fees is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. Late fees and ancillary fees related to loan servicing are not material.
Other Real Estate Owned: Real estate properties acquired in collection of a loan are initially recorded at fair value less cost to sell at acquisition, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating expenses, gains and losses on disposition, and changes in the valuation allowance are reported in noninterest expense as operations of other real estate owned.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is included in noninterest expense and is computed on the straight-line method over the estimated useful lives of the assets. Useful lives are estimated to be 25 to 40 years for buildings and improvements that extend the life of the original building, ten to 20 years for routine building improvements, five to 15 years for furniture and equipment, two to five years for computer hardware and software and no greater than four years on automobiles. The cost of maintenance and repairs is charged to expense as incurred and significant repairs are capitalized.
Goodwill and Other Intangible Assets: The goodwill asset resulted from business acquisitions prior to January 1, 2009 and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets.
The goodwill asset is assessed at least annually for impairment and any such impairment will be recognized in the period identified. There was no impairment of the Bank’s goodwill asset for the years ended December 31, 2010, 2009 and 2008. The Company has selected December 31 as the date to perform the annual impairment test.
Other intangible assets consist of core deposit intangible assets arising from whole bank acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Bank Owned Life Insurance The Company has purchased life insurance policies on certain key executives. The Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Long-Term Assets: Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate that their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Income Taxes: Income tax expense is the sum of the current year income tax due or refundable and the change in the deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, presuming that a tax examination will occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. At December 31, 2010 and 2009 the Company had unrecognized tax benefits of $176,000 and $165,000, respectively. The Company and its subsidiary are subject to U.S. federal income tax as well as income tax of the State of Illinois. The Company is no longer subject to examination by these taxing authorities for years before 2006. Beginning in 2010 and 2009, the Company and the Bank became subject to income taxes in the States of Colorado and New Jersey, respectively, due to the physical presence of regional National Commercial Leasing bankers in these jurisdictions. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense. At December 31, 2010 and 2009, the Company had recorded a cumulative accrual of $30,000 and $27,000, respectively, for potential interest and penalties.
Retirement Plans: Employee 401(k) and profit sharing plan expense is the amount of matching contributions and any annual discretionary contribution made at the discretion of the Company’s Board of Directors. Deferred compensation expense allocates the benefits over years of service.
Employee Stock Ownership Plan (“ESOP”): The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest.
Earnings (Loss) Per Common Share: Basic earnings (loss) per common share is net income (loss) divided by the weighted average number of common shares outstanding during the period. ESOP shares are considered outstanding for this calculation unless unearned. Diluted earnings (loss) per common share is net income (loss) divided by the weighted average number of common shares outstanding during the period plus the dilutive effect of restricted stock shares and the additional potential shares issuable under stock options.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe that there are such matters that will have a material effect on the financial statements as of December 31, 2010.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank which is required to meet regulatory reserve and clearing requirements. These required balances do not earn interest.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market value information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Comprehensive Income (Loss): Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities, which are also recognized as separate components of stockholders’ equity.
Stock-based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. The Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Operating Segments: While management monitors the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating results are not reviewed by senior management to make resource allocation or performance decisions. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications: Certain reclassifications have been made in the prior year’s financial statements to conform to the current year’s presentation.
Recent Accounting Pronouncements
FASB ASU 2010-20, “Receivable (Topic 310), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” - ASU 2010-20 requires new and enhanced disclosures about the credit quality of an entity’s financing receivables and its allowance for credit losses. The new and amended disclosure requirements focus on such areas as nonaccrual and past due financing receivables, allowance for credit losses related to financing receivables, impaired loans, credit quality information and modifications. The ASU requires an entity to disaggregate new and existing disclosures based on how it develops its allowance for credit losses and how it manages credit exposures. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. See Note 3 to these Consolidated Financial Statements for the required disclosures at December 31, 2010.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Newly Issued But Not Yet Effective Accounting Pronouncements:
FASB ASU 2011-01, “Receivables (Topic 310), Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20” - Under the existing effective date in FASB ASU 2010-20, public-entity creditors would have provided disclosures about troubled debt restructuring for periods beginning on or after December 15, 2010. ASU 2011-01 temporarily defers that effective date, enabling public-entity creditors to provide those disclosures (paragraphs 310-10-50-31 through 50-34) after the Financial Accounting Standards Board clarifies the guidance for determining what constitutes a troubled debt restructuring. In the proposed Accounting Standards Update, Receivables (Topic 310), Clarifications to Accounting for Troubled Debt Restructurings by Creditors, the Board proposed that the clarifications would be effective for interim and annual periods ending after June 15, 2011. For the new disclosures about troubled debt restructurings in FASB ASU 2011-01, those clarifications would be applied retrospectively to the beginning of the fiscal year in which the proposal is adopted. We have not yet evaluated the impact on our disclosures in the consolidated financial statements upon the adoption.
FASB ASU 2010-29, “Business Combinations (Topic 805), Disclosure of Supplementary Pro Forma Information for Business Combinations” - ASU 2010-29 specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 affects any public entity as defined by Topic 805 that enters into business combinations that are material on an individual or aggregate basis. This guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period on or after December 15, 2010. We have not yet evaluated the impact of adoption of ASU 2010-29 on our disclosures for periods after adoption.
FASB ASU 2010-28, “Intangibles - Goodwill and Other (Topic 350), When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts” - ASU 2010-28 affects all entities that have recognized a goodwill asset and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. ASU 2010-28 modifies Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, this guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The guidance is effective for a public entity’s first annual period that ends on or after December 15, 2010. Adoption of ASU 2010-28 is not expected to have a significant impact on our consolidated financial statements.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 2 - LOSS PER SHARE
Amounts reported in loss per share reflect loss available to common stockholders for the period divided by the weighted average number of shares of common stock outstanding during the period, exclusive of unearned ESOP shares and unvested restricted stock shares. Stock options and restricted stock are regarded as potential common stock and are considered in the diluted earnings per share calculations to the extent that they would have a dilutive effect if converted to common stock.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 3 - SECURITIES
The fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) at December 31 is as follows:
Mortgage-backed securities and collateralized mortgage obligations reflected in the preceding table were issued by U.S. government-sponsored entities and agencies, Freddie Mac, Fannie Mae and Ginnie Mae, and are obligations which the government has affirmed its commitment to support. All securities reflected in the preceding table were classified as available-for-sale at December 31, 2010 and 2009.
The amortized cost and fair values of securities at December 31, 2010 by contractual maturity are shown below. Securities not due at a single maturity date are shown separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities pledged at December 31, 2010 and 2009 had a carrying amount of $13.0 million and $75.1 million, respectively, and the security interests resulting from the pledges secures certain depository relationships, customer repurchase agreements and a line of credit with the Federal Reserve Bank of Chicago.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 3 - SECURITIES (continued)
Sale of securities were as follows:
Securities with unrealized losses at December 31, 2010 and 2009 not recognized in income are as follows:
The Company evaluates marketable investment securities with significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under current accounting guidance, which generally provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the impairment is other-than-temporary.
The mortgage-backed securities and collateralized mortgage obligations that the Company holds in its investment portfolio remained in an unrealized loss position at December 31, 2010, but the unrealized losses were not considered significant under the Company’s impairment testing methodology. In addition, the Company does not intend to sell these securities, and it is likely that the Company will not be required to sell the securities before their anticipated recovery occurs.
At December 31, 2008, the Company held shares of Freddie Mac preferred stock in its investment portfolio. The securities experienced significant declines in fair value (as measured by quoted market prices for these securities) during the years ended December 31, 2009 and 2008 due to a variety of market conditions and issuer-specific factors, including Freddie Mac’s conservatorship, its issuance of new shares of preferred stock that are senior to all previously issued preferred shares, and its suspension of dividends on all previously issued preferred shares. The Company evaluated these shares of Freddie Mac preferred stock for impairment, and concluded that the unrealized losses that existed at that date with respect to this series of Freddie Mac preferred stock constituted an other-than-temporary impairment under the current accounting guidance. Based on this conclusion, the Company recorded a pre-tax impairment loss of $401,000 and $35.9 million for the years ended December 31, 2009 and 2008, respectively. These securities were sold in the fourth quarter of 2009 and the Company recorded a pre-tax loss of $988,000 on the sale.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE
Loans receivable are as follows:
Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. The Company reviews and approves these policies and procedures on a periodic basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
The majority of the loans the Company originates are investment and business loans (multi-family, nonresidential real estate, commercial, construction and land loans, and commercial leases). In addition, we originate one-to-four family residential mortgage loans and consumer loans, and purchase and sell loan participations from time-to-time. The following briefly describes our principal loan products.
Multi-family mortgage loans generally are secured by multi-family rental properties such as apartment buildings, including subsidized apartment units. In general, loan amounts range between $250,000 and $5.0 million. Approximately 25% of the collateral is located outside of our primary market area; however, we do not have a concentration in any single market outside of our primary market territory. In underwriting multi-family mortgage loans, the Company consider a number of factors, which include the projected net cash flow to the loan’s debt service requirement (generally requiring a minimum ratio of 115% for loans below $400,000 and 120% for loans above $400,000), the age and condition of the collateral, the financial resources and income level of the borrower and the borrower’s experience in owning or managing similar properties. Multi-family mortgage loans are originated in amounts up to 80% of the appraised value of the property securing the loan. Personal guarantees are usually obtained from multi-family mortgage borrowers.
Loans secured by multi-family mortgages generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family mortgages typically depends upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
The Company also originates real estate loans principally secured by first liens on nonresidential real estate. The nonresidential real estate properties are predominantly office buildings, light industrial buildings, shopping centers and mixed-use developments and, to a lesser extent, more specialized properties such as nursing homes and other healthcare facilities. The Company may, from time to time, purchase commercial real estate loan participations.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
The Company emphasizes nonresidential real estate loans with initial principal balances between $250,000 and $5.0 million. Substantially all of our nonresidential real estate loans are secured by properties located in our primary market area. The Company’s nonresidential real estate loans are generally written as three- or five-year adjustable-rate mortgages or mortgages with balloon maturities of three or five years. Amortization on these loans is typically based on 20- to 25-year schedules. The Company also originates some 15-year fixed-rate, fully amortizing loans.
In the underwriting of nonresidential real estate loans, the Company generally lends up to 80% of the property’s appraised value. Decisions to lend are based on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement (generally requiring a minimum ratio of 120%), computed after deduction for a vacancy factor and property expenses we deem appropriate. Personal guarantees are usually obtained from nonresidential real estate borrowers. The Company requires title insurance insuring the priority of our lien, fire and extended coverage casualty insurance, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property.
Nonresidential real estate loans generally carry higher interest rates and have shorter terms than those on one- to four-family residential mortgage loans. Nonresidential real estate loans, however, entail significant additional credit risks compared to one- to four-family residential mortgage loans, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.
The Company makes various types of secured and unsecured commercial loans to customers in our market area for the purpose of financing equipment acquisition, expansion, working capital and other general business purposes. The terms of these loans generally range from less than one year to five years. The loans are either negotiated on a fixed-rate basis or carry adjustable interest rates indexed to (i) a lending rate that is determined internally, or (ii) a short-term market rate index.
Commercial credit decisions are based upon our credit assessment of the loan applicant. The Company determines the applicant’s ability to repay in accordance with the proposed terms of the loans and we assess the risks involved. An evaluation is made of the applicant to determine character and capacity to manage. Personal guarantees of the principals are usually obtained. In addition to evaluating the loan applicant’s financial statements, we consider the adequacy of the primary and secondary sources of repayment for the loan. Credit agency reports of the applicant’s credit history supplement our analysis of the applicant’s creditworthiness and at times are supplemented with inquiries to other banks and trade investigations. Collateral supporting a secured transaction also is analyzed to determine its marketability. Commercial business loans generally have higher interest rates than residential loans of like duration because they have a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business and the sufficiency of any collateral. Pricing of commercial loans is based primarily on the credit risk of the borrower, with due consideration given to borrowers with appropriate deposit relationships.
The Company also lends money to small and mid-size leasing companies for equipment financing leases. Generally, commercial leases are secured by an assignment by the leasing company of the lease payments and by a secured interest in the equipment being leased. The lessee acknowledges our security interest in the leased equipment and agrees to send lease payments directly to us. Consequently, the Company underwrites lease loans by examining the creditworthiness of the lessee rather than the lessor. Lease loans generally are non-recourse to the leasing company.
The Company’s commercial leases are secured primarily by technology equipment, medical equipment, material handling equipment and other capital equipment. Lessees tend to be publicly-traded companies with investment-grade rated debt or companies that have not issued public debt and therefore do not have a public debt rating. The Company requires that a minimum of 50% of our commercial lessees have an investment grade public debt rating by Moody’s or Standard & Poors, or the equivalent. Commercial leases to these entities have a maximum maturity of seven years and a maximum outstanding credit exposure of $5.0 million to any single entity. Lessees without public debt ratings generally have net worth in excess of $25.0 million. If the lessee does not have a public debt rating, they are subject to the same internal credit analysis as any other customer. Commercial leases to these lessees have a maximum maturity of five years and a maximum outstanding credit exposure of $3.0 million to any single entity. In addition, the Company will originate commercial leases to lessees with below-investment grade public debt ratings, but these leases are limited to 10% of our commercial lease portfolio and have a maximum outstanding credit exposure of $2.0 million to any single entity. Lease loans are almost always fully amortizing, with fixed interest rates.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
Although the Company does not actively originate construction and land loans at present, construction and land loans generally consist of land acquisition loans to help finance the purchase of land intended for further development, including single-family homes, multi-family housing and commercial income property, development loans to builders in our market area to finance improvements to real estate, consisting mostly of single-family subdivisions, typically to finance the cost of utilities, roads, sewers and other development costs. These builders generally rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder, often in conjunction with development loans. Construction and land loans typically involve a higher degree of credit risk than financing on improved, owner-occupied real estate. The risk of loss on construction and land loans is largely dependent upon the accuracy of the initial appraisal of the property’s value upon completion of construction or development; the estimated cost of construction, including interest; and the estimated time to complete and/or sell or lease such property. The Company seeks to minimize these risks by maintaining consistent lending policies and rigorous underwriting standards. However, if the estimate of value proves to be inaccurate, the cost of completion is greater than expected, the length of time to complete and/or sell or lease the collateral property is greater than anticipated, or if there is a downturn in the local economy or real estate market, the property could have a value upon completion that is insufficient to assure full repayment of the loan. This could have a material adverse effect on the quality of the construction and land loan portfolio, and could result in significant losses or delinquencies.
The Company offers conforming and non-conforming, fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years and maximum loan amounts generally of up to $2.5 million. The Company currently offers fixed-rate conventional mortgage loans with terms of 10 to 30 years that are fully amortizing with monthly payments, and adjustable-rate conventional mortgage loans with initial terms of between one and three years that amortize up to 30 years. One- to four-family residential mortgage loans are generally underwritten according to Fannie Mae guidelines, and loans that conform to such guidelines are referred to as “conforming loans.” The Company generally originates both fixed- and adjustable-rate loans in amounts up to the maximum conforming loan limits as established by Fannie Mae, which is currently $417,000 for single-family homes. Private mortgage insurance is required for first mortgage loans with loan-to-value ratios in excess of 80%.
The Company also originates loans above conforming limits, sometimes referred to as “jumbo loans,” that have been underwritten to the credit standards of Fannie Mae. These loans are generally eligible for sale to various firms that specialize in the purchase of such non-conforming loans. In the Chicago metropolitan area, larger residential loans are not uncommon. The Company also originates loans at higher rates that do not fully meet the credit standards of Fannie Mae but are deemed to be acceptable risks.
The markets served by the Company have been impacted by widespread economic weakness and high unemployment, which have contributed to a rise in charge-offs and non-performing assets. The ability of the Company’s borrowers to repay their loans, and the value of the collateral securing such loans, could be further adversely impacted by continued or more significant economic weakness in its local markets as a result of increased unemployment, declining real estate values, or increased residential and office vacancies. This not only could result in the Company experiencing a further increase in charge-offs and/or non-performing assets, but also could necessitate an increase in the provision for loan losses. These events, if they were to occur, would have an adverse impact on the Company’s results of operations and its capital.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2010 and 2009:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
Activity in the allowance for loan losses is as follows:
We refined the calculation of the general component of the allowance for loan losses during the fourth quarter of 2010 in response to the new FASB disclosure requirement to segment each loan portfolio category into specific loan classes (FASB Standards Update 2010-20 (ASU 210-20), “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”) As a matter of consistency, the loan class segmentation was also applied within the 12-quarter loss history used to calculate the general component of the allowance for loan losses, an adjustment of the inherent risk factor weightings based on our evaluation of their relevance to the new loan classes, and the elimination of duplicative historical loss factors as a result of the segmentation of the portfolio by class. These refinements were applied to the loan balances, net of impaired loans, to calculate a $12.8 million general component of our allowance for loan losses at December 31, 2010. The refinements resulted in a net reduction of $1.7 million to the general component of our allowance for loan losses at December 31, 2010, principally due to the establishment of loan class segments that had lower historical loss ratios than the general loan categories to which they belong. Specifically, the refinements reduced the portion of the general component of the allowance for loan losses attributable to commercial leases by $908,000, the portion attributable to commercial loans by $788,000, the portion attributable to non-residential real estate loans by $195,000, and the portion attributable to multi-family mortgage loans by $144,000. These reductions were partially offset by a $384,000 increase in the portion of the general component of the allowance for loan losses that is attributable one-to-four family mortgage loans.
Impaired loans were as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
Several of the following disclosures are presented by “recorded investment,” which the FASB defines as “the amount of the investment in a loan, which is not net of a valuation allowance, but which does reflect any direct write-down of the investment.” The following represents the components of recorded investment:
Loan principal balance
Less unapplied payments
Plus negative unapplied balance
Less escrow balance
Plus negative escrow balance
Plus unamortized net deferred loan costs
Less unamortized net deferred loan fees
Plus unamortized premium
Less unamortized discount
Less previous charge-offs
Plus recorded accrued interest
= Recorded investment
The following table presents loans individually evaluated for impairment by class loans as of December 31, 2010:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
Nonaccrual loans and loans past due 90 days still on accrual are as follows:
The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2010:
Nonaccrual loans and impaired loans are defined differently. Some loans may be included in both categories, and some may only be included in one category. Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
Generally, the Bank utilizes the “90 days delinquent, still accruing” category of loan classification when: (1) the loan is repaid in full shortly after the period end date; (2) the loan is well secured and there are no asserted or pending legal barriers to its collection; or (3) the borrower has remitted all scheduled payments and is otherwise in substantial compliance with the terms of the loan, but the processing of payments actually received or the renewal of a loan has not occurred for administrative reasons.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
The following table presents the aging of the recorded investment in past due loans as December 31, 2010 by class of loans:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
Troubled Debt Restructurings:
The Company has $6.5 million of troubled debt restructurings at December 31, 2010, with an allocated $658,000 of specific reserves to those customers. Troubled debt restructurings at December 31, 2009 were $9.6 million, with an allocated $525,000 of specific reserves to those customers. The Company has no outstanding commitments to customers whose loans are classified as troubled debt restructurings.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 4 - LOANS RECEIVABLE (continued)
As of December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 5 - SECONDARY MORTGAGE MARKET ACTIVITIES
First mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of these loans were $220.9 million, $274.2 million, and $303.9 million at December 31, 2010, 2009, and 2008, respectively. Custodial escrow balances maintained in connection with the foregoing loan servicing were $6.9 million, $6.4 million, and $6.3 million at December 31, 2010, 2009, and 2008, respectively.
Capitalized mortgage servicing rights are included in other assets in the accompanying consolidated statements of financial condition. Activity for capitalized mortgage servicing rights and the related valuation allowance was as follows.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 5 - SECONDARY MORTGAGE MARKET ACTIVITIES (continued)
The estimated fair value of mortgage servicing rights is the present value of the expected future cash flows over the projected life of the loan. Assumptions used in the present value calculation are based on actual performance of the underlying servicing along with general market consensus. The expected cash flow is the net amount of all mortgage servicing income and expense items. The expected cash flows are discounted at an interest rate appropriate for the associated risk given the current market conditions. Significant assumptions are as follows:
Key economic assumptions used in measuring the fair value of the Company’s mortgage servicing rights as of December 31, 2010 and the effect on the fair value of our mortgage servicing rights from adverse changes in those assumptions, are as follows:
These sensitivities are hypothetical and should be used with caution. As the above table indicates, changes in fair value based on variations in individual assumptions generally cannot be used to predict changes in fair value based upon further variations of the same assumptions. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated in the above table independently, without changing any other assumption. In reality, changes in one factor may result in changes in another factor, which might magnify or counteract the sensitivities.
The weighted average amortization period is 48 months. The estimated amortization expense for each of the next five years is as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment are as follows:
Depreciation of premises and equipment was $3.2 million, $3.0 million and $2.6 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company leases certain branch facilities under noncancelable operating lease agreements expiring through 2032. Rent expense, net of sublease income, for facilities was $556,000, $519,000, and $452,000 in 2010, 2009, and 2008, respectively, excluding taxes, insurance, and maintenance. The projected minimum rental under existing leases, not including taxes, insurance, and maintenance, as of December 31, 2010 is as follows:
The Company has subleased some of its branch facilities and currently is entitled to receive income as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 7 - CORE DEPOSIT INTANGIBLE
Core deposit intangible assets were as follows:
Aggregate amortization expense was $1.6 million, $1.7 million and $1.8 million for 2010, 2009 and 2008, respectively.
Estimated amortization expense for each of the next five years is as follows:
NOTE 8 - DEPOSITS
Year-end deposits are as follows:
Certificates of deposit of $100,000 or more were $137.0 million and $141.1 million at year-end 2010 and 2009, respectively.
Scheduled maturities of certificates of deposit for the next five years are as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 8 - DEPOSITS (continued)
Interest expense on deposit accounts is summarized as follows for the years indicated:
NOTE 9 - BORROWINGS
Borrowed funds are summarized as follows:
On January 31, 2011 a $6.0 million advance with a rate of 2.14% came due and the Company utilized existing liquidity to repay the advance. In December 2008, the Bank elected to pursue certain balance sheet restructuring strategies as a result of the historically low interest rate environment. The restructuring consisted of retiring a $25.0 million of FHLBC term advance and replacing it with a new FHLBC advance with an adjustable interest rate and a maturity of approximately one month. The Company incurred a net pre-tax prepayment penalty and recognized an immediate loss of $2.0 million on the early extinguishment of borrowings, in accordance with Emerging Issues Task Force 96-19, Debtor’s Accounting for a Modification or Exchange of Debt Instruments. Certain of the Company’s existing borrowings would be subject to prepayment penalties should they be repaid prior to maturity. There were no prepayment penalties recorded in 2010 and 2009.
The Company maintains a collateral pledge agreement covering secured advances whereby the Company has agreed to at all times keep on hand, free of all other pledges, liens, and encumbrances, specifically identified whole first mortgages on improved residential property not more than 90-days delinquent to secure advances from the FHLBC. All of the Bank’s FHLBC common stock is pledged as additional collateral for these advances. At December 31, 2010, $246.2 million and $140.4 million of first mortgage and multi-family mortgage loans, respectively, collateralized the advances. At December 31, 2010, we had the ability to borrow an additional $240.5 million under our credit facilities with the FHLBC. The Company also had available pre-approved overnight federal funds borrowing and repurchase agreement lines. At December 31, 2010 and 2009, there was no outstanding balance on these lines.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 10 - INCOME TAXES
The income tax benefit is as follows:
A reconciliation of the provision for income taxes computed at the statutory federal corporate tax rate of 34% for 2010, 2009 and 2008 to the income tax expense in the consolidated statements of operations follows:
Retained earnings at December 31, 2010 and 2009 include $14.9 million for which no deferred federal income tax liability has been recorded. This amount represents an allocation of income to bad debt deductions for tax purposes alone.
The net deferred tax asset is as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 10 - INCOME TAXES (continued)
At December 31, 2010, the Company had a federal net operating loss carryforward of $5.9 million, which will begin to expire in 2029. At December 31, 2010, the Company had a state net operating loss carryforward for the State of Illinois of $32.0 million, which will begin to expire in 2025. Based upon projections of future taxable income, management believes that it is more likely than not that the deferred tax assets reflected in the above table will be fully realized and thus a valuation allowance is not needed.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
The total amount of interest and penalties recorded in the statement of operations for the year ended December 31, 2010, 2009 and 2008 was $3,000, $2,000, and $5,000, respectively. The amount accrued for interest and penalties at December 31, 2010 and 2009 was $30,000 and $27,000, respectively.
The Company and its subsidiary are subject to U.S. federal income tax as well as income tax of the State of Illinois. The Company is no longer subject to examination by these taxing authorities for years before 2007. Beginning in 2010 and 2009, the Company and the Bank became subject to income taxes in the States of Colorado and New Jersey, respectively, due to the physical presence of regional National Commercial Leasing bankers in these jurisdictions.
NOTE 11 - REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions, asset growth and expansion are limited, and the submission of a capital restoration is required.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 11 - REGULATORY MATTERS
At year-end, actual capital levels and minimum required levels for the Bank were:
A reconciliation of the Bank’s equity under GAAP to regulatory capital is as follows:
As of December 31, 2010 the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 11 - REGULATORY MATTERS (continued)
Federal regulations require the Bank to comply with a Qualified Thrift Lender (“QTL”) test, which generally requires that 65% of assets be maintained in housing-related finance and other specified assets. If the QTL test is not met, limits are placed on growth, branching, new investment, FHLBC advances, and dividends or the institution must convert to a commercial bank charter. Management considers the QTL test to have been met as of December 31, 2010.
The Bank is subject to restrictions on the amount of dividends it may declare and pay to the Company without prior regulatory approval. At December 31, 2010, the Bank does not have pre-approved approval for future dividends.
NOTE 12 - EMPLOYEE BENEFIT PLANS
Employee Stock Ownership Plan. Employees are eligible to participate in the ESOP after attainment of age 21 and completion of one year of service. In connection with the conversion and reorganization, the ESOP borrowed $19.6 million from the Company, and used the proceeds of the loan to purchase 1,957,300 shares of common stock issued in the subscription offering at $10.00 per share. The loan is secured by the shares and will be repaid by the ESOP with funds from the Bank’s discretionary contributions to the ESOP and earnings on ESOP assets. The Bank has committed to make discretionary contributions to the ESOP sufficient to service the loan over a period not to exceed 20 years. When loan payments are made, ESOP shares are allocated to participants based on relative compensation and expense is recorded. Participants receive their earned shares at the end of employment.
Contributions to the ESOP during 2010 and 2009 were $1.5 million and $1.9 million, respectively, including dividends and interest received on unallocated shares of $425,000 and $453,000 in 2010 and 2009, respectively. Expense related to the ESOP, net of dividends and interest received on unallocated ESOP shares, was $529,000, $516,000 and $512,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
Shares held by the ESOP were as follows:
Profit Sharing Plan/401(k) Plan. The Company has a defined contribution plan (“profit sharing plan”) covering all of its eligible employees. Employees are eligible to participate in the profit sharing plan after attainment of age 21 and completion of one year of service. The Company provides a match of $0.50 on each $1.00 of contribution up to 6% of eligible compensation beginning April 1, 2007. The Company may also contribute an additional amount annually at the discretion of the Board of Directors. Contributions totaling $389,000, $376,000, and $442,000 were made for the years ended 2010, 2009, and 2008, respectively.
NOTE 13 - EQUITY INCENTIVE PLANS
On June 27, 2006, the Company’s stockholders approved the BankFinancial Corporation 2006 Equity Incentive Plan, which authorized the Human Resources Committee of the Board of Directors of the Company to grant a variety of cash- and equity-based incentive awards, including stock options, stock appreciation rights, restricted stock, performance shares and other incentive awards, to employees and directors aggregating up to 3,425,275 shares of the Company’s common stock.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 13 - EQUITY INCENTIVE PLANS (continued)
The Human Resources Committee may grant stock options to purchase shares of the Company’s common stock to certain employees and directors of the Company. The exercise price for the stock options is the fair market value of the common stock on the dates of the grants. The stock options generally vest annually over three to five year periods; vesting is subject to acceleration in certain circumstances. The stock options will expire if not exercised within five years from the date of grant.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. The risk-free interest rate was determined using the yield available on the option grant date for a zero-coupon U.S. Treasury security with a term equivalent to the expected life of the option. The expected life for options granted represents the period the option is expected to be outstanding and was determined by applying the simplified method as allowed by SAB 107. The expected volatility for options issued in 2009 was determined using the Company’s historical data. Estimated forfeitures were assumed to be zero due to the lack of historical experience for the Company. There were no options granted in 2010.
The Company recognized $344,000, $406,000 and $594,000 of stock-based compensation expenses relating to the granting of stock options for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, the Company had $12,000 of total unrecognized compensation cost related to unvested stock options that will vest in 2011.
(1) Stock option aggregate intrinsic value represents the number of shares subject to options multiplied by the difference (if positive) in the closing market price of the common stock underlying the options on the date shown and the weighted average exercise price.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 13 - EQUITY INCENTIVE PLANS (continued)
The Human Resources Committee of the Board of Directors may grant shares of restricted stock to certain employees and directors of the Company. The awards generally vest annually over varying periods from three to five years and vesting is subject to acceleration in certain circumstances. The cost of such awards will be accrued ratably as compensation expense over such respective periods based on expected vesting dates. The Company recognized $1.8 million, $2.2 million and $3.5 million of expenses relating to the grant of shares of restricted stock during the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, the total unrecognized compensation cost related to unvested shares of restricted stock was $83,000. The cost is expected to be recognized over an 18 month period.
(1) The end of period balances consist only of unvested shares.
(2) Restricted stock aggregate intrinsic value represents the number of shares of restricted stock multiplied by the market price of the common stock underlying the outstanding shares on the date shown.
NOTE 14 - LOAN COMMITMENTS AND OTHER OFF-BALANCE SHEET ACTIVITIES
The Company is party to various financial instruments with off-balance-sheet risk. The Company uses these financial instruments in the normal course of business to meet the financing needs of customers and to effectively manage exposure to interest rate risk. These financial instruments include commitments to extend credit, standby letters of credit, unused lines of credit, and commitments to sell loans. When viewed in terms of the maximum exposure, those instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Credit risk is the possibility that a counterparty to a financial instrument will be unable to perform its contractual obligations. Interest rate risk is the possibility that, due to changes in economic conditions, the Company’s net interest income will be adversely affected.
The following is a summary of the contractual or notional amount of each significant class of off-balance-sheet financial instruments outstanding. The Company’s exposure to credit loss in the event of nonperformance by the counterparty for commitments to extend credit, standby letters of credit, and unused lines of credit is represented by the contractual notional amount of these instruments.
The contractual or notional amounts are as follows:
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 14 - LOAN COMMITMENTS AND OTHER OFF-BALANCE SHEET ACTIVITIES (continued)
Commitments to extend credit are generally made for periods of 60 days or less. The fixed-rate loans commitment totaled $14.3 million with interest rates ranging from 3.625% to 6.63% and maturities ranging from one to 30 years.
Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customers. The collateral held varies, but primarily consists of single-family residential real estate.
The Bank, as a member of Visa USA, received 51,404 unrestricted shares of Visa, Inc. Class B common stock in connection with Visa, Inc.’s initial public offering in 2007, and 32,398 additional shares of Class B common stock that were deposited into a litigation escrow that Visa, Inc. established under its retrospective responsibility plan. The retroactive responsibility plan obligates all former Visa USA members to indemnify Visa USA, in proportion to their equity interests in Visa USA, for certain litigation losses and expenses, including settlement expenses, for the lawsuits covered by the retrospective responsibility plan. The primary method for discharging the indemnification obligations under the retrospective responsibility plan is a reduction of the ratio at which the Visa, Inc. Class B shares held in the litigation escrow can be converted into publicly traded Class A common shares of Visa, Inc. Due to the restrictions that the retrospective responsibility plan imposes on the Company’s Visa, Inc. Class B shares, the Company has not recorded the Class B shares as an asset.
NOTE 15 - FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
•
Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
•
Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
•
Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
The fair values of marketable equity securities are generally determined by quoted prices, in active markets, for each specific security (Level 1 measurement inputs). If Level 1 measurement inputs are not available for a marketable equity security, we determine its fair value based on the quoted price of a similar security traded in an active market (Level 2 measurement inputs). The fair values of debt securities are generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 measurement inputs).
The fair values of loans held-for-sale are generally determined by quoted prices in active markets that are accessible at the measurement date for similar, unrestricted assets (Level 2 measurement inputs).
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 15 - FAIR VALUE (continued)
Impaired loans and other real estate owned properties are evaluated and valued at the time the loan is identified as impaired or placed into other real estate owned, at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and its fair value is generally determined based on real estate appraisals or other independent evaluations by qualified professionals. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
The fair values of mortgage servicing rights are based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 measurement inputs).
The following table sets forth the Company’s financial assets that were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 15 - FAIR VALUE (continued)
The Company’s assets that were measured at fair value on a non-recurring basis are as follows:
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral-dependent loans, had a carrying amount of $43.7 million, with a valuation allowance of $9.4 million at December 31, 2010, compared to a carrying amount of $50.8 million, with a valuation allowance of $5.1 million at December 31, 2009, resulting in a provision for loan losses of $4.3 million for the year ended December 31, 2010.
OREO and OREO in process, which is carried at lower of cost or fair value less costs to sell, had a carrying value of $14.6 million at December 31, 2010, which included write downs of $2.4 million for the year ended December 31, 2010 compared to $4.1 million at December 31, 2009, which included write downs of $687,000 for the year ended December 31, 2009.
Mortgage servicing rights, which are carried at lower of cost or fair value, had a carrying amount of $1.3 million at December 31, 2010, of which $974,000 related to fixed rate loans and $375,000 related to adjustable rate loans. There was a recovery of $74,000 on mortgage servicing rights for the year ended December 31, 2010, compared to $36,000 recovery for the same period in 2009.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 15 - FAIR VALUE (continued)
The carrying amount and estimated fair value of financial instruments is as follows:
For purposes of the above, the following assumptions were used:
Cash and Cash Equivalents: The estimated fair values for cash and cash equivalents are based on their carrying value due to the short-term nature of these assets.
Loans: The estimated fair value for loans has been determined by calculating the present value of future cash flows based on the current rate the Company would charge for similar loans with similar maturities, applied for an estimated time period until the loan is assumed to be repriced or repaid. The estimated fair values of loans held-for-sale are based on quoted market prices.
FHLBC Stock: It is not practicable to determine the fair value of FHLBC stock due to the restrictions placed on its transferability.
Deposit Liabilities: The estimated fair value for certificates of deposit has been determined by calculating the present value of future cash flows based on estimates of rates the Company would pay on such deposits, applied for the time period until maturity. The estimated fair values of non-interest-bearing demand, NOW, money market, and savings deposits are assumed to approximate their carrying values as management establishes rates on these deposits at a level that approximates the local market area. Additionally, these deposits can be withdrawn on demand.
Borrowings: The estimated fair values of advances from the FHLBC and notes payable are based on current market rates for similar financing. The estimated fair value of securities sold under agreements to repurchase is assumed to equal its carrying value due to the short-term nature of the liability.
Accrued Interest: The estimated fair values of accrued interest receivable and payable are assumed to equal their carrying value.
Off-Balance-Sheet Instruments: Off-balance-sheet items consist principally of unfunded loan commitments, standby letters of credit, and unused lines of credit. The estimated fair values of unfunded loan commitments, standby letters of credit, and unused lines of credit are not material.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 15 - FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
While the above estimates are based on management’s judgment of the most appropriate factors, as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets were disposed of or the liabilities settled at that date, since market values may differ depending on the various circumstances. The estimated fair values would also not apply to subsequent dates.
In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the above disclosures.
NOTE 16 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
NOTE 17 - COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of BankFinancial Corporation as of December 31, 2010 and 2009 and for the three years ended December 31, 2010 follows:
Condensed Statements of Financial Condition
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 17 - COMPANY ONLY CONDENSED FINANCIAL INFORMATION (continued)
Condensed Statements of Operations
Condensed Statements of Cash Flows
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
The Company recorded a net loss of $5.5 million for the fourth quarter of 2010. The Company’s fourth quarter 2010 operating results included an $8.1 million provision for loan losses and $4.7 million recorded in nonperforming asset expense and operations of other real estate owned “OREO” due to fourth quarter 2010 OREO expense accruals, OREO property write-downs to net realizable value, and final resolution of certain classified loans and assets. 2009 fourth quarter results included $4.2 million of provision for loan losses, partially offset by a $1.3 million gain recognized on the sale of our merchant processing operations.
On January 27, 2011, the Company announced that its Board of Directors declared a cash dividend of $0.07 per share of its common stock. The dividend will be payable on March 4, 2011 to stockholders of record on February 9, 2011.
BANKFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table amounts in thousands, except share and per share data)
NOTE 19 - SUBSEQUENT EVENTS (Unaudited)
Pending acquisitions
On September 13, 2010, the Company signed a definitive Merger Agreement to acquire DG Bancorp, Inc. and its wholly-owned subsidiary, Downers Grove National Bank. Founded in 1955, Downers Grove National Bank is a privately held community bank with $219 million in assets and $213 million in deposits as of December 31, 2010. Downers Grove National Bank has two banking locations in Downers Grove and Westmont, IL communities. The transaction has been approved by the Bank’s primary federal regulator, the Office of Thrift Supervision, and is expected to close in the first quarter of 2011, subject to customary closing conditions.
We are in the process of negotiating the acquisition of a portfolio of performing loans from Citibank N.A. with an aggregate unpaid principal balance of approximately $155.8 million. The purchase is scheduled to close in March 2011, subject to customary closing conditions. This loan portfolio consists of multifamily loans originated by Citibank N.A. or the former Citibank, F.S.B. and the loans are secured by real estate collateral located in the Chicago metropolitan market area. The portfolio consists of 470 loans with an overall weighted average effective yield of 5.87%. All loans in the portfolio were current on all payments due as of the month prior to the month in which the purchase is scheduled to close. Upon the closing of the purchase, we expect to file a Current Report on Form 8-K further describing the portfolio acquisition transaction and the portfolio characteristics.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal year ( “Evaluation Date”). Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic Securities and Exchange Commission filings.
(b) Management’s Annual Report on Internal Control Over Financial Reporting.
The annual report of management on the effectiveness of our internal control over financial reporting and the attestation report thereon issued by our independent registered public accounting firm are set forth under “Report of Management on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting” under Item 8 - “Financial Statements and Supplementary Data.”
(c) Changes in internal controls.
There were no changes made in our internal controls during the fourth quarter of 2010 or, to our knowledge, in other factors that have materially affected, or are reasonably likely to materially affect these controls.
See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
The information concerning our directors and executive officers required by this item will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
Section 16(a) Beneficial Ownership Reporting Compliance
The information concerning compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934 by our directors, officers and 10 percent stockholders required by this item will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
Code of Ethics
We have adopted a Code of Ethics for Senior Financial Officers that applies to our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions. A copy of our Code of Ethics was attached as Exhibit 14 to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2006. We have also adopted a Code of Business Conduct, pursuant to Nasdaq requirements, that applies generally to our directors, officers, and employees.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning compensation required by this item will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information concerning security ownership of certain beneficial owners and management required by this item will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
Securities Authorized for Issuance under Equity Compensation Plan
The following table sets forth information regarding the securities that were authorized for issuance under our 2006 Equity Incentive Plan as of December 31, 2010:
Column (A) represents stock options and restricted stock outstanding under the Company’s 2006 Equity Incentive Plan. Future equity awards under the 2006 Equity Incentive Plan may take the form of stock options, stock appreciation rights, performance unit awards, restricted stock, restricted performance stock, restricted stock units, stock awards or cash. Column (B) represents the weighted-average exercise price of the outstanding stock options only; the outstanding restricted stock awards are not included in this calculation. Column (C) represents the maximum aggregate number of future equity awards that can be made under the 2006 Equity Incentive Plan as of December 31, 2010.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related transactions required by this will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information concerning principal accountant fees and services will be filed with the Securities and Exchange Commission by amendment to this Form 10-K, not later than 120 days after the end of our fiscal year.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following consolidated financial statement of the registrant and its subsidiaries are filed as part of this document under Item 8 - “Financial Statements and Supplementary Data.”
(A) Report of Independent Registered Accounting Firm
(B) Consolidated Statements of Financial Condition - at December 31, 2010 and 2009
(C) Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008
(D) Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2010, 2009 and 2008
(E) Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008
(F) Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
The documents set forth below are filed herewith or incorporated herein by reference to the location indicated.
* A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANKFINANCIAL CORPORATION
Date: March 9, 2011
By:
/s/ F. Morgan Gasior
F. Morgan Gasior
Chairman of the Board, Chief Executive Officer and President
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.