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| CWLZ > SEC Filings for CWLZ > Form 10-Q on 14-Aug-2008 | All Recent SEC Filings |
14-Aug-2008
Quarterly Report
Critical Accounting Estimates
The Company's most critical accounting estimate is related to the allowance for credit losses. The Company utilizes both quantitative and qualitative considerations in establishing an allowance for credit losses believed to be appropriate as of each reporting date.
Quantitative factors include:
· the volume and severity of non-performing loans and adversely classified credits,
· the level of net charge-offs experienced on previously classified loans,
· the nature and value of collateral securing the loans,
· the trend in loan growth and the percentage of change,
· the level of geographic and/or industry concentration,
· the relationship and trend over the past several years of recoveries in relation to charge-offs, and
· other known factors regarding specific loans.
Qualitative factors include:
· the effectiveness of credit administration,
· the adequacy of loan review,
· the adequacy of loan operations personnel and processes,
· the effect of competitive issues that impact loan underwriting and structure,
· the impact of economic conditions, including interest rate trends,
· the introduction of new loan products or specific marketing efforts,
· large credit exposure and trends, and
· industry segments that are exhibiting stress.
Changes in the above factors could significantly affect the determination of the adequacy of the allowance for credit losses. Management performs a full analysis, no less often than quarterly, to ensure that changes in estimated loan loss levels are adjusted on a timely basis. For further discussion of this significant management estimate, see "Allowance for Credit Losses."
Another critical accounting estimate of the Company is that related to the carrying value of goodwill. Impairment analysis of the fair value of goodwill involves a substantial amount of judgment. Under Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142), the Company ceased amortization of goodwill on January 1, 2002 and periodically tests goodwill for impairment.
Results of Operations for the Three and Six Months Ended June 30, 2008 and 2007
Overview
The Company's net loss for the quarter ended June 30, 2008 was $8.1 million, or ($1.60) per share, compared with net income of $673,000, or $0.13 per diluted share during the same period of 2007. For the first six months of 2008, the Company's net loss was $7.2 million, compared with net income of $2.0 million in the first half of 2007.
Net interest income was $0.2 million higher in the second quarter of 2008, compared with the same period in 2007. For the first six months of 2008, net interest income was down $0.2 million from the same period in 2007. Average earning assets were $485.4 million in the second quarter of 2008, compared with $442.8 million in the second quarter of 2007. The increase related primarily to higher loan balances. Average interest-bearing liabilities in the second quarter of 2008 were $382.4 million, compared with $327.7 million in the second quarter of 2007, as these deposits were primarily used to fund loan growth.
The provision for credit losses was $13.0 million in the second quarter of 2008. There was no provision in the second quarter of 2007. For the six months period ended June 30, 2008, the provision for credit losses was $13.6 million compared with $275,000 in the same period of 2007. The higher provision in 2008 reflected primarily unfavorable conditions in the residential real estate market that affected home builders and developers and an increase in loans charged-off during the process. A slowdown in home buying has resulted in slower sales and declining real estate valuations, which have significantly affected these borrowers' liquidity and ability to repay loans.
At June 30, 2008, total assets were $530.3 million, an increase of $16.1 million, or 3.1%, from December 31, 2007. Total loans increased 8% to $428.2 million, from $397.3 million at December 31, 2007. Loans grew at an annualized rate of 16% in the first six months of 2008. Total deposits increased 5% to $465.4 million at June 30, 2008 from $441.2 million at December 31, 2007. The Company continues to maintain capital ratios in excess of regulatory levels required to be well-capitalized. In addition, management believes the Company has significant amounts of liquidity readily available.
Analysis of Net Interest Income
The primary component of the Company's earnings is net interest income. Net interest income is the difference between interest income, principally from loans and the investment securities portfolio, and interest expense, principally on customer deposits and borrowings. Changes in net interest income, net interest spread, and net interest margin result from changes in asset and liability volume and mix, and to rates earned or paid. Net interest spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest margin is the ratio of net interest income to total interest-earning assets and is influenced by the volume and relative mix of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities.
Interest income from certain of the Company's earning assets is non-taxable. The following tables present interest income and expense, including adjustments for non-taxable interest income, and the resulting tax-adjusted yields earned, rates paid, interest rate spread, and net interest margin for the periods indicated on an annualized basis.
For Three Months Ended June 30,
2008 2007
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(dollars in thousands) Balance Paid Rate Balance Paid Rate
Assets
Interest-earning assets:
Loans (1) (2) (3) $ 425,731 $ 8,282 7.82 % $ 382,440 $ 8,300 8.70 %
Taxable securities 25,228 341 5.44 % 33,936 458 5.41 %
Non-taxable securities (2) 24,496 397 6.52 % 21,356 293 5.50 %
Temporary investments 9,934 58 2.35 % 5,113 56 4.39 %
Total interest-earning
assets (2) 485,389 $ 9,078 7.52 % 442,845 $ 9,107 8.25 %
Allowance for loan losses (8,283 ) (4,951 )
Other assets 57,304 47,907
Total assets $ 534,410 $ 485,801
Liabilities and
shareholders' equity
Interest-bearing
liabilities:
Savings, money market
and interest-bearing
demand deposits $ 115,641 $ 450 1.57 % $ 95,220 $ 493 2.08 %
Certificates of deposit 250,724 2,583 4.14 % 217,613 2,737 5.04 %
Federal funds purchased 3,536 24 2.73 % 2,337 32 5.49 %
Junior subordinated
debentures 12,372 138 4.49 % 12,372 218 7.07 %
FHLB and other borrowings 94 2 8.56 % 186 4 8.63 %
Total interest-bearing
liabilities 382,367 $ 3,197 3.36 % 327,728 $ 3,484 4.26 %
Non-interest-bearing
deposits 91,002 99,740
Other liabilities 3,889 5,132
Total liabilities 477,258 432,600
Shareholders' equity 57,152 53,201
Total liabilities
and shareholders' equity $ 534,410 $ 485,801
Net interest income (2) $ 5,881 $ 5,623
Net interest spread 4.16 % 3.99 %
Yield on average
interest-earning assets 7.52 % 8.25 %
Interest expense to
average interest-earning
assets 2.65 % 3.16 %
Net interest income to
average interest-earning
assets (net interest
margin) 4.87 % 5.09 %
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(1) Loans include loans on which the accrual of interest has been discontinued.
(2) Interest earned on non-taxable securities and loans has been computed on a 34 percent tax-equivalent basis.
(3) Loan interest income includes net loan fee income of $401,900 and $443,900 for 2008 and 2007, respectively.
For Six Months Ended June 30,
2008 2007
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(dollars in thousands) Balance Paid Rate Balance Paid Rate
Assets
Interest-earning assets:
Loans (1) (2) (3) $ 419,319 $ 16,709 8.01 % $ 369,672 $ 16,306 8.89 %
Taxable securities 26,208 705 5.41 % 34,773 943 5.47 %
Non-taxable securities (2) 24,409 792 6.53 % 21,413 589 5.55 %
Temporary investments 12,513 163 2.62 % 5,596 120 4.32 %
Total interest-earning
assets (2) 482,449 $ 18,369 7.66 % 431,454 $ 17,958 8.39 %
Allowance for loan losses (7,135 ) (4,839 )
Other assets 55,239 46,494
Total assets $ 530,553 $ 473,109
Liabilities and
shareholders' equity
Interest-bearing
liabilities:
Savings, money market and
interest-bearing demand
deposits $ 118,557 $ 1,049 1.78 % $ 91,477 $ 800 1.76 %
Certificates of deposit 245,050 5,523 4.53 % 209,107 5,206 5.02 %
Federal funds purchased 2,438 35 2.89 % 2,028 55 5.47 %
Junior subordinated
debentures 12,372 331 5.38 % 12,372 431 7.03 %
FHLB and other borrowings 104 4 7.73 % 201 8 8.03 %
Total interest-bearing
liabilities 378,521 $ 6,942 3.69 % 315,185 $ 6,500 4.16 %
Non-interest-bearing
deposits 91,369 100,599
Other liabilities 3,961 5,098
Total liabilities 473,851 420,882
Shareholders' equity 56,702 52,227
Total liabilities
and shareholders' equity $ 530,553 $ 473,109
Net interest income (2) $ 11,427 $ 11,458
Net interest spread 3.97 % 4.23 %
Yield on average
interest-earning assets 7.66 % 8.39 %
Interest expense to
average interest-earning
assets 2.89 % 3.04 %
Net interest income to
average interest-earning
assets (net interest
margin) 4.76 % 5.36 %
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(1) Loans include loans on which the accrual of interest has been discontinued.
(2) Interest earned on non-taxable securities and loans has been computed on a 34 percent tax-equivalent basis.
(3) Loan interest income includes net loan fee income of $889,500 and $912,400 for 2008 and 2007, respectively.
Net interest margin as a percentage was 4.87% in the second quarter of 2008, compared with 5.09% in the same quarter last year and 4.76% and 5.36% for the six months ended June 30, 2008 and 2007, respectively. Comparing the first six months of 2008 to the first six months of 2007, tax-equivalent interest income was $0.4 million higher, primarily due to an increase of $51.0 million in average interest-earning assets. Interest expense increased $0.4 million, as the volume of average interest-bearing liabilities increased $63.3 million. Net interest margin decreased 22 b.p in the second quarter of 2008 compared to the second quarter of 2007. The first six months of 2008 net interest margin decreased 60 b.p. compared with the first six months of 2007. The net interest margin was affected by several factors, including dramatic rate cuts of 325 basis points over the last 12 months by the Federal Reserve, competitive market pricing on both sides of the balance sheet, the impact of an elevated level of nonperforming loans and a lower level of noninterest-bearing demand deposit accounts year-over-year. The net cash received by the Company for interest payments from counterparties in the three and six-month periods ended June 30, 2008 was $820,100 and $1,251,300, respectively, compared to net payments to counterparties of $57,300 in the same periods of 2007.
The 2008 net interest margins were also affected by the Company's election to redeem $45.1 million in callable certificates of deposit, with $21.5 million settling in March of 2008 and the balance in the second quarter of 2008. The new certificates of deposit have an approximately 150 basis point lower average cost and a slightly longer duration. In connection with the redemptions, the Company wrote off all unamortized premiums associated with those deposits. The deposit premium write-off increased the average cost of interest-bearing liabilities and decreased the net interest margin by approximately 6 basis points in the second quarter of 2008, and increased the average cost of interest-bearing liabilities by 13 basis points and decreased the margin by 10 basis points in the first quarter of 2008. The margin in the second quarter of 2007 was lower by approximately 25 basis points as the result of interest reversals on non-accrual loans in that quarter.
Provision for Credit Losses
The Company recorded a provision for credit losses of $13 million in the second quarter of 2008, compared with no provision in the second quarter 2007 and $13.6 million in the first six months of 2008 compared to $275,000 in the same period in 2007. The amount of the allowance for credit losses is analyzed by management on a regular basis to ensure that it is adequate to absorb losses inherent in the loan portfolio as of the reporting date. When a provision for credit losses is recorded, the amount is based on the current volume of loans and commitments to extend credit, anticipated changes in loan volumes, past charge-off experience, management's assessment of the risk of loss on current loans, the level of non-performing and impaired loans, evaluation of future economic trends in the Company's market area, and other factors relevant to the loan portfolio. An internal loan risk grading system is used to evaluate potential losses of individual loans. The Company does not, as part of its analysis, group loans together by loan type to assign risk. See "Allowance for Credit Losses" below for a more detailed discussion.
Non-Interest Income
Non-interest income consists of the following components:
Three Months Ended Six Months Ended
June 30, June 30,
(dollars in thousands) 2008 2007 2008 2007
Service charges on deposit
accounts 179 $ 171 $ 343 $ 337
International trade fees 135 133 335 279
Fiduciary income 163 174 336 364
Increase in cash surrender
value of bank-owned life
insurance 154 137 306 273
Wire fees 84 94 165 175
Mortgage brokerage fees 46 81 108 133
Securities losses (432 ) - (432 ) -
Other income 118 119 248 254
Total non-interest income $ 447 $ 909 $ 1,409 $ 1,815
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Non-interest income decreased $462,000 in the second quarter of 2008 when compared to the second quarter of 2007. Non-interest income in the first six months of 2008 was $1.4 million, a decrease of $406,000 over the same period in 2007. Securities losses in the three and six month periods ending June 30, 2008 were $432,000 compared to no losses in the same periods in 2007 Of this loss, $200,000 was related to the sale of four mortgage-backed securities. The balance of $232,000 was due to the recognition of an other-than-temporary impairment charge on one FNMA investment grade perpetual callable preferred security, reflecting the extraordinarily unsettled equity market for this government-sponsored enterprise (GSE). Continued uncertainties regarding the future outlook for FNMA and other GSE's could lead to additional impairment charges for these securities.
Non-Interest Expense
Non-interest expense consists of the following components:
Three Months Ended Six Months Ended
June 30, June 30,
(dollars in thousands) 2008 2007 2008 2007
Salaries and employee benefits 2,500 2,419 5,007 4,915
Net occupancy and equipment 630 553 1,247 1,092
Professional services 208 384 471 771
Data processing and communications 231 210 446 470
Business taxes 125 117 242 210
Interest rate contracts adjustments 89 506 317 633
FDIC assessment 96 12 187 24
Foreclosed asset expense, net 2,036 422 1,874 422
Other expense 1,009 921 1,743 1,649
Total non-interest expense $ 6,924 $ 5,544 $ 11,534 $ 10,186
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Non-interest expenses in the second quarter of 2008 were $6.9 million, up $1.4 million from the second quarter of 2007. The increase was primarily due to higher foreclosed asset expenses of $1.6 million due to $1.9 million of OREO write-downs in the second quarter of 2008 to reflect recent appraisals and management's assessment of amounts ultimately collectible on disposition of the properties.
Salaries and employee benefits for the three and six-month periods of 2008 were approximately equal to the amounts in the same periods of 2007. In the first quarter of 2008, the Company substantially completed a planned reduction of approximately 7% in its workforce primarily through attrition and better matching of staffing levels to customer traffic flows, as well as job eliminations. The number of full-time equivalent employees was 129 at June 30, 2008, compared with 142 at June 30, 2007.
On a year-to-date basis, net occupancy and equipment expenses in the first half of 2008 were higher than the first half of 2007 primarily due to higher levels of depreciation related to branch remodeling and related asset acquisitions in mid-2007. Professional services were down significantly in the first half of 2008 compared with the first half of 2007, primarily due to costs associated with Sarbanes-Oxley compliance efforts which were down $182,000 in 2008 when compared to the same period in 2007.
Non-cash charges for the ineffective portion of the Company's cash flow hedges in the second quarter of the 2008 was $89,000, compared with $506,000 in the same quarter last year. In June 2008, the Company sold its $25 million notional value swap for a gain of $482,000. The sale was in response to management's assessment of the Bank's interest rate risk profile and favorable market conditions. The swap was sold for $482,000 and the unrealized gain in comprehensive income will be recognized ratably through interest income as the originally hedged forecasted transactions (interest payments on variable-rate loans) affect earnings. The Company expects to accrete $256,000 and $198,000 of the deferred gain through earnings during 2008 and 2009, respectively, and immaterial amounts in 2010 and 2011.
The Company's effective tax rate for the first six months of 2008 was 43%, compared with 26% for the first six months of 2007. When the Company incurs a pre-tax loss, its effective tax rate is higher than the Federal statutory rate of 35% primarily due to tax-exempt income related to its municipal securities portfolio and investments in bank-owned life insurance. The Company's effective tax rate for interim periods is based on projections of taxable income or loss for the full year and is affected by the relative amounts of taxable and non-taxable income and the amount of available tax credits.
Financial Condition
Investment Securities
The following table presents the composition and carrying value of the Company's
available for sale investment portfolio:
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June 30, December 31,
(dollars in thousands) 2008 2007
Agency securities $ 1,540 $ 1,514
Mortgage-backed securities 19,545 27,263
Municipal bonds 22,453 22,801
$ 43,538 $ 51,578
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Total investment securities as of June 30, 2008 were $43.5 million, compared with $51.6 million at December 31, 2007. The decrease in total securities from year-end 2007 primarily reflected the sale of four non-agency mortgage-backed securities, as well as scheduled principal payments. The Company's securities, classified as available for sale, are used by management as part of its asset/liability management strategy and may be sold in response to changes in interest rates or significant prepayment risk.
Loans
Total loans outstanding were $428.2 million and $397.3 million at June 30, 2008
and December 31, 2007, respectively. Unfunded loan commitments were $84.4
million at June 30, 2008 and $96.3 million at December 31, 2007.
The following table presents the composition of the Company's loan portfolio, in
accordance with bank regulatory guidelines, at the dates indicated:
June 30, 2008 December 31, 2007
(dollars in thousands) Amount Percent Amount Percent
Commercial $ 94,468 22.0 % $ 92,496 23.2 %
Real estate:
Construction 123,779 28.8 % 109,417 27.5 %
Residential 1-4 family 37,130 8.7 % 33,224 8.3 %
Multifamily 3,937 0.9 % 6,298 1.6 %
Commercial 165,445 38.5 % 153,139 38.4 %
Installment and other consumer 4,547 1.1 % 3,945 1.0 %
Total loans, gross 429,306 100.0 % 398,519 100.0 %
Deferred loan fees (1,119 ) (1,194 )
Loans, net of deferred loan fees $ 428,187 $ 397,325
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Allowance for Credit Losses
The allowance for credit losses represents management's estimate of potential losses as of the date of the financial statements. The loan portfolio is regularly reviewed to evaluate the adequacy of the allowance for credit losses. In determining the level of the allowance, the Company estimates losses inherent in all loans and commitments to make loans, and evaluates non-performing loans to determine the amount, if any, necessary for a specific reserve. An important element in determining the adequacy of the allowance for credit losses is an analysis of loans by loan risk-rating categories. At a loan's inception and periodically throughout the life of the loan, management evaluates the credit risk by using a risk-rating system. This grading system currently includes eleven levels of risk. Risk ratings range from "1" for the strongest credits to "10" for the weakest. A "10" rated loan would normally represent a loss. All loans rated 7-10 collectively comprise the Company's "Watch List". The specific grades from 7-10 are "watch list" (risk-rating 7), "special mention" (risk-rating 7.5), "substandard" (risk-rating 8), "doubtful" (risk-rating 9), and "loss" (risk-rating 10). When indicators such as operating losses, collateral impairment or delinquency problems show that a credit may have weakened, the credit will be downgraded as appropriate. Similarly, as borrowers bring loans current, show improved cash flows or improve the collateral position of a loan, the credits may be upgraded. The result of management's ongoing evaluations and the risk ratings of the portfolio is an allowance with four components: specific; general; special; and an amount available for other factors.
Specific Allowance. Loans on the Bank's Watch List, as described above, are specifically reviewed and analyzed. Management considers in its analysis expected future cash flows, the value of collateral and other factors that may impact the borrower's ability to pay. When significant conditions or circumstances exist on an individual loan indicating greater risk, a specific allowance may be allocated in addition to the general allowance percentage for that particular risk rating, as outlined in Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan."
General Allowance. All loans that do not require a specific allocation are . . .
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