Summary of LSB CORP - Yahoo! Finance

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
FORWARD-LOOKING STATEMENTS AND FACTORS WHICH MAY AFFECT FUTURE RESULTS Certain statements in this Management's Discussion and Analysis are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are made based upon, among other things, the Company's current assumptions, expectations and beliefs concerning future developments and their potential effect on the Company. Additional information regarding the treatment of forward-looking statements is included at the beginning of Part 1 above.
OVERVIEW
The Company's financial results are dependent on the following areas of the income statement: net interest income, provision for loan losses, non-interest income, non-interest expense and provision for income taxes. Net interest income is the primary earnings of the Company and the main focus of management. Net interest income is the difference between interest earned on loans and investment securities and interest paid on deposits and borrowings. Deposits and borrowings have short durations and the cost of these funds do not rise and fall in tandem with earnings on loans and investment securities. There are many risks involved in managing net interest income including but not limited to credit risk, interest rate risk and duration risk. These risks have a direct impact on the level of net interest income. The Company manages these risks through credit review by an outside firm and regular meetings of its Asset and Liability Management Committee ("ALCO"). The credit review process reviews loans for underwriting and grading of loan quality while ALCO reviews liquidity, interest rate risk and capital resources. Loan quality has a direct impact on the amount of provisions for loan losses the Company reports.
Non-interest income includes net gains or losses on sales of investment securities and various fees. Customers' loan and deposit accounts generate various amounts of fee income depending on the product selected. The Company receives fee income from servicing loans that were sold in previous periods. Non-interest income is primarily impacted by the volume of customers' transactions, which could change in response to changes in interest rates, pricing and competition.
Non-interest expenses include salaries and employee benefits, occupancy and equipment, professional, data processing and other expenses of the Company, which generally are directly related to business volume and are managed by a budget process.
Provisions for income taxes are directly related to earnings of the Company. Changes in the statutory tax rates and the earnings of the Company, the Bank and its subsidiaries, as well as the mix of earnings among the different entities would affect the amount of income tax expense reported and the overall effective income tax rate recorded.
For the past several years, short-term market interest rates (which are used as a general guide in pricing deposits) have increased while longer-term market interest rates (which are used to benchmark the pricing on loans) have not changed by similar amounts. While the Bank has had success in changing the mix of the asset structure into higher yielding commercial real estate and construction loans and away from lower yielding investments, it is still challenged in generating deposit balances, and in particular, lower costing core deposit accounts. This compression is felt throughout the banking industry, but the Company is particularly vulnerable since a relatively large portion of its earning assets are funded by wholesale borrowings. The Company is committed to maintaining its current strategy of improving the overall yield of the assets while carefully managing its cost of funds to the best of its abilities. Lastly, there are areas of the consolidated financial statements where significant estimates or assumptions are used and include the provision and allowance for loan losses, the provision for income taxes, and the impairment of investment securities. These areas are considered as the Company's Critical Accounting Policies. Management regularly monitors the application of the Company's Critical Accounting Policies in relation to the nature and impact of these estimates and assumptions on earnings. The Critical Accounting Policies are discussed below.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those policies that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to the allowance for loan losses, income taxes and impairment of securities. Actual results could differ from the amount derived from managements' estimates and assumptions using different conditions. The Company's critical accounting policies are as follows:
ALLOWANCE FOR LOAN LOSSES
The allowance balance reflects management's assessment of losses and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a

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loan-by-loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company's regular review of individual loans, and economic conditions are primary factors in establishing the allowance. The allowance for loan losses reflects all information available at the end of the year. The allowance is increased by provisions for loan losses, which are a charge to the income statement, and by recoveries on loans previously charged-off. The allowance is reduced by loans charged-off and by negative (credit) provisions to the allowance. For a further discussion of the Company's methodology of assessing the adequacy of the allowance for loan losses, see Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1 to the Consolidated Financial Statements for more details on establishing the allowance for loan losses.
INCOME TAXES
Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax valuation allowances are established and based on management's judgment as to whether it is more likely than not that all or some portion of the future tax benefits of prior operating losses will be realized. For example, a deferred tax valuation allowance is required to reduce the potential deferred tax asset when it is more likely than not that all or some portion of the potential deferred tax asset will not be realized due to the lack of sufficient taxable income in the carry-forward period. Factors beyond management's control, such as the general state of the economy and real estate values, can affect future levels of taxable income and no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences.
For a further discussion on income taxes, see Results of Operations - Income Taxes, below and Notes 1 & 8 to the Consolidated Financial Statements.
INVESTMENT SECURITIES
The measurement of the impairment of the securities portfolio requires an evaluation process that considers both the historical and current financial performance and environment of the security, credit worthiness of the issuer, and potential recovery measures of each impaired investment. Management periodically reviews all securities to identify those that show signs of impairment. Once identified, these securities are monitored and evaluated based upon the above considerations and if the decline in fair value is below the cost basis of an investment and is judged to be other-than-temporary, the cost basis is written down to the current fair value and the amount of the write-down is included in the results of operations. For a further discussion on investment securities, see Financial Condition of Investment Securities, below and Notes 1 & 2 to the Consolidated Financial Statements.
FINANCIAL CONDITION
OVERVIEW
Total assets increased to $621.7 million at December 31, 2007 up from $543.0 million at December 31, 2006. The increase in asset size is mainly attributable to strong loan growth since year end 2006 of $70.0 million, an increase of $11.9 million in investment securities available for sale portfolio and the purchase of Bank-owned life insurance ("BOLI") amounting to $10.2 million, partially offset by a decrease of $11.8 million federal funds sold. The funding of the loan growth was derived from an increase of $50.6 million in total borrowed funds coupled with an increase in deposits by $26.4 million from 2006.
INTEREST EARNING ASSETS
The Company manages its earning assets by utilizing available capital resources in a manner consistent with the Company's credit, investment and leverage policies. Loans, U.S. Treasury and government-sponsored enterprise obligations, mortgage-backed securities, other investment securities, and short-term investments comprise the Company's earning assets. Total earning assets averaged $562.5 million in 2007, an increase of $47.9 million or 9.3% from 2006. One of the Company's primary objectives continues to be the origination of loans that are soundly underwritten and collateralized. The Company's average loan portfolios increased $72.6 million in 2007 to $326.1 million.
The Company increases the investment portfolio through funds obtained from depositors, the FHLBB, repurchase agreements and other borrowings when it is profitable to do so. The average balance of investment securities, including U.S. Treasury and government-sponsored enterprise obligations, mortgage-backed securities, other bonds and equity securities, and short-term investments amounted to $236.4 million in 2007 as compared to $261.1 million in 2006. These securities represent 40.8% of the Company's total average assets at December 31, 2007 versus 49.3% of total average assets at December 31, 2006.
INVESTMENT SECURITIES
The investment portfolio totaled $230.6 million and $218.7 million, respectively, at December 31, 2007 and 2006, reflecting an increase of $11.9 million or 5.4% in 2007. During 2007, the largest increase of $39.0 million was in mortgage-backed securities.

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Also experiencing an increase was equity securities of $5.1 million. Partially offsetting these increases were decreases in government-sponsored enterprises, collateralized mortgage obligations, and corporate obligations, decreasing $18.5 million, $11.4 million, and $1.5 million, respectively. The change in mix in the investment securities portfolio for 2006 was primarily due to the second quarter 2006 balance sheet restructuring, with most of the sales coming from government-sponsored enterprise and collateralized mortgage obligations
("CMOs"), partially offset by purchases of mortgage-backed securities ("MBSs")
and, to a lesser extent, corporate bonds. The balance sheet restructuring resulted in the sale of $78.5 million of low-yielding investments were sold at a pre-tax loss of $2.4 million and $50 million of the proceeds were reinvested in higher yielding securities. For more information on investment securities, see Note 2 of the Consolidated Financial Statements.
The fair value and percentage distribution of investment securities available for sale at December 31, follow:

                                     2007                             2006                             2005
(Dollars in
Thousands)                  Amount          Percent          Amount          Percent          Amount         Percent
U. S. Treasury bonds       $   5,541             2.4 %      $   5,214             2.4 %      $  4,769            10.3 %
Government-sponsored
enterprise
obligations                   15,810             6.9 %         35,190            16.1 %         9,667            20.9 %
Mortgage-backed
securities                   136,703            59.3 %         97,898            44.8 %         3,364             7.3 %
Collateralized
mortgage obligations          60,147            26.1 %         71,555            32.7 %        24,329            52.3 %
Corporate obligations          5,820             2.5 %          7,364             3.4 %         3,046             6.6 %
Mutual funds                     959             0.4 %            947             0.4 %           955             2.1 %
Equity securities              5,616             2.4 %            514             0.2 %           233             0.5 %

Total                      $ 230,596           100.0 %      $ 218,682           100.0 %      $ 46,363           100.0 %

The amortized cost and percentage distribution of investment securities held to maturity at December 31, 2005 follow:

         (Dollars in Thousands)                         Amount       Percent
         Government-sponsored enterprise obligations   $  87,017         40.7 %
         Mortgage-backed securities                       43,701         20.5 %
         Collateralized mortgage obligations              70,415         32.9 %
         Corporate obligations                            11,024          5.2 %
         Municipal obligations                             1,526          0.7 %

         Total                                         $ 213,683        100.0 %

The maturities and weighted average yields using the fair value of investment securities available for sale at December 31, 2007, follow:

                            Within         Weighted         One to         Weighted          Five          Weighted          Over
                              One          Average           Five          Average          to Ten         Average            Ten           Average         Average
(Dollars in Thousands)       Year           Yield           Years           Yield           Years           Yield            Years           Yield           Total         Yield
U. S. Treasury bonds
and
government-sponsored
enterprise obligations      $ 5,474             5.19 %     $ 10,841             4.20 %     $  5,036             3.26 %     $       -               - %     $  21,351         4.22 %
Mortgage-backed
securities                        -                - %        5,580             4.02 %       13,863             3.77 %       117,260            5.87 %       136,703         5.57 %
Collateralized mortgage
obligations                       -                - %            -                - %       11,157             4.18 %        48,990            4.49 %        60,147         4.43 %
Corporate obligations             -                - %        5,820             5.48 %            -                - %             -               - %         5,820         5.48 %

Total                       $ 5,474             5.19 %     $ 22,241             4.50 %     $ 30,056             3.84 %     $ 166,250            5.46 %     $ 224,021         5.13 %

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LOANS
Total loans at December 31, 2007 and 2006 amounted to $358.1 million and $288.2 million, respectively, reflecting an increase of $70.0 million or 24.3% in 2007. Corporate loans increased $57.3 million or 29.1% during 2007. Commercial real estate loans increased $35.1 million or 24.6% and commercial and construction loans increased $17.6 million or 161.9% and $4.6 million or 10.6%, respectively. Retail loans increased $12.6 million or 13.8%. Residential real estate loans and home equity loans increased $9.9 million or 14.1% and $2.7 million or 13.3%, respectively, while consumer loans increased modestly. The Company believes that the increase in the portfolios was primarily due to customers taking advantage of the low interest rate environment. For more information on loans, see Item 7A Quantitative and Qualitative Disclosures About Market Risk, Interest Rate Sensitivity and Note 4 to the Consolidated Financial Statements.
The components of the loan portfolio at December 31, follow:

                                      2007                           2006                           2005                           2004                          2003
(Dollars in Thousands)       Balance        Percent         Balance        Percent         Balance        Percent         Balance        Percent         Balance        Percent
Residential real estate
loans:
Fixed rate                  $  49,513           13.8 %     $  39,076           13.5 %     $  34,028           14.5 %     $  33,061           14.2 %     $  33,059          15.7 %
Adjustable rate                30,230            8.4          30,800           10.7          28,159           12.0          26,996           11.6          23,958          11.3
Loans held for sale                 -              -               -              -             472            0.2               -              -             338           0.2

                               79,743           22.2          69,876           24.2          62,659           26.7          60,057           25.8          57,355          27.2

Home equity loans:
Fixed rate                     13,821            3.9          11,170            3.9           3,592            1.5           3,535            1.5           5,882           2.7
Adjustable rate                 9,225            2.6           9,169            3.2           6,820            2.9           5,334            2.3           4,354           2.1

                               23,046            6.5          20,339            7.1          10,412            4.4           8,869            3.8          10,236           4.8

Consumer loans                  1,007            0.3             975            0.3             468            0.2             699            0.3             564           0.3

Total retail loans            103,796           29.0          91,190           31.6          73,539           31.3          69,625           29.9          68,155          32.3


Construction loans             47,885           13.4          43,283           15.0          24,137           10.3          15,211            6.5          16,040           7.6
Commercial real estate
loans:
Fixed rate                     33,920            9.5          17,434            6.1          14,793            6.3          18,629            8.0          16,508           7.8
Adjustable rate               144,048           40.2         125,386           43.5         112,824           48.1         112,976           48.5          95,995          45.3

                              177,968           49.7         142,820           49.6         127,617           54.4         131,605           56.5         112,503          53.1

Commercial loans               28,464            7.9          10,870            3.8           9,318            4.0          16,369            7.1          14,805           7.0

Total corporate loans         254,317           71.0         196,973           68.4         161,072           68.7         163,185           70.1         143,348          67.7


Total loans                   358,113          100.0 %       288,163          100.0 %       234,611          100.0 %       232,810          100.0 %       211,503         100.0 %

Allowance for loan
losses                          4,810                          4,309                          4,126                          4,140                          4,220

Loans, net                  $ 353,303                      $ 283,854                      $ 230,485                      $ 228,670                      $ 207,283

The maturity distribution for construction and commercial loans at December 31, 2007, follows:

                                            Due After
                           Due Within      One Through       Due After
         (In Thousands)     One Year        Five Years      Five Years       Total
         Construction     $     22,133     $     17,777     $     7,975     $ 47,885
         Commercial             15,903            6,310           6,251       28,464

         Total            $     38,036     $     24,087     $    14,226     $ 76,349

Of construction loans and commercial loans maturing more than one year after December 31, 2007, $5.0 million have fixed rates and $33.3 million have floating or variable rates.
At December 31, 2007, the Bank had commercial loan balances participated out to various banks amounting to $8.2 million, compared to $2.9 million at December 31, 2006. These balances participated out to other institutions are not carried as assets on the Company's financial statements. Loans originated by other banks in which the Bank is the participating institution are carried at the Bank's pro rata share of ownership and amounted to $14.0 million, respectively, at December 31, 2007 and December 31, 2006. The Bank performs an independent credit analysis of each commitment prior to participation in the loan.

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ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained through the provision for loan losses which is a charge to operations. The allowance balance reflects management's assessment of estimated credit losses inherent in the Bank's loan portfolio and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan-by-loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company's regular review of individual loans, and economic conditions are primary factors in establishing the allowance. The Company believes that the allowance for loan losses reflects all information available at the end of each year. The Company considers the current year end 2007 level of the allowance for loan losses to be appropriate and adequate. The allowance as a percentage of total loans was 1.34% at December 31, 2007 and 1.50% at December 31, 2006. Notwithstanding the increase in non-performing loans at December 31, 2007 and December 31, 2006, which were primarily due to a single borrower with multiple loans with the Bank, the corporate loan portfolio had moderate delinquencies throughout the year. The low levels of delinquent loans and sustained asset quality of the loan portfolio combined with the minimal levels of loan charge-offs contributed to the reasonableness of the allowance coverage to decline to 1.34% as of December 31, 2007. See Note 1 to the Consolidated Financial Statements for the accounting policy related to the allowance for loan losses.
"Impaired loans" are commercial, commercial real estate loans and individually significant residential mortgage loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are not the same as "non-accrual loans," although the two categories overlap. Non-accrual loans include impaired loans and are those on which the accrual of interest is discontinued when principal or interest has become contractually past due 90 days. The Company may choose to place a loan on non-accrual status due to payment delinquency or the uncertainty of collectibility, while not classifying the loan as impaired, if (i) it is probable that the Company will collect all amounts due in accordance with the contractual terms of the loan or (ii) the loan is not a commercial or commercial real estate loan. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment is determined by the difference between the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or, as a practical expedient in the case of collateral dependent loans, the difference between the fair value of the collateral and the recorded amount of the loan. When foreclosure is probable, impairment is based on the fair value of the collateral.
The level of loan growth during 2007 experienced in all corporate loan categories, combined with the increase in the levels of total corporate loans in proportion to total loans as well as an increase in total loan charge-offs resulted in a charge to the provision for loan losses of $645,000 in the year 2007 compared to a charge to the provision in 2006 in the amount of $160,000. The Company had net charge-offs of $144,000 in 2007 and net recoveries of $23,000 in 2006.
The following table summarizes changes in the allowance for loan losses for the years ended December 31:

(Dollars in Thousands)                2007            2006           2005            2004           2003
Balance at beginning of year         $ 4,309         $ 4,126        $ 4,140         $ 4,220        $ 4,167
Charge-offs by loan type:
Residential mortgage                       -               -              -             (25 )            -
Commercial                                 -               -              -               -              -
Commercial real estate                  (121 )             -              -               -              -
Consumer                                 (36 )           (30 )          (25 )           (20 )            -

Total charge-offs                       (157 )           (30 )          (25 )           (45 )            -


Recoveries by loan type:
Residential mortgage                       -               -              -               -             31
Commercial                                 -               -              -               -              -
Commercial real estate                     3              32              2             254             16
Consumer                                  10              21              9              11              6

Total recoveries                          13              53             11             265             53

Net (charge-offs) recoveries            (144 )            23            (14 )           220             53
Provision (credit) for loan
losses                                   645             160              -            (300 )            -

Ending balance                       $ 4,810         $ 4,309        $ 4,126         $ 4,140        $ 4,220

Ratio of net (charge-offs)
recoveries to average loans
outstanding during the period          (0.04 )%         0.01 %        (0.01 )%         0.10 %         0.02 %

Allowance as a % of total loans         1.34 %          1.50 %         1.76 %          1.78 %         2.00 %

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The following table sets forth the breakdown of the allowance for loan losses by loan category for the years ended December 31. The allocation of the allowance to each category is not necessarily indicative of future losses and does not . . .