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| MFSF > SEC Filings for MFSF > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
General
MutualFirst Financial, Inc., a Maryland corporation (the "Company"), was organized in September 1999. On December 29, 1999, it acquired the common stock of MutualBank ("Mutual") upon the conversion of Mutual from a federal mutual savings bank to a federal stock savings bank.
Mutual was originally organized in 1889 and currently conducts its business from thirty-three full service financial centers located in Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties, Indiana, with its main office located in Muncie. Mutual also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. Mutual's principal business consists of attracting deposits from the general public and originating fixed and variable rate loans secured primarily by first mortgage liens on residential and commercial real estate, consumer goods, and business assets. Mutual's deposit accounts are insured by the Federal Deposit Insurance Corporation up to applicable limits.
Mutual subsidiaries include, First MFSB Corporation, Mutual Federal Investment Company ("MFIC"), MFB Investments I, Inc., and Mishawaka Financial Services. The assets of First MFSB Corporation consist of an investment in Family Financial Holdings Incorporated. Family Financial is an ordinary Indiana corporation that provides debt cancellation products to financial institutions. MFIC is a Nevada corporation holding approximately $46 million in investments. MFIC currently owns one subsidiary, Mutual Federal REIT. The assets of Mutual Federal REIT consist of approximately $119 million in one-to four-family mortgage loans. MFB Investments I, Inc., MFB Investments II, Inc. and MFB Investments, LP are Nevada corporations and a Nevada limited partnership that manage a portion of the Bank's investment portfolio. The corporations and limited partnership holds approximately $22 million in investments. Mishawaka Financial Services was acquired with MFB Corp. and is engaged in the sale of life and health insurance to customers of the bank.
The following should be read in conjunction with the Management's Discussion and Analysis in the Company's December 31, 2007 Annual Report on Form 10-K.
Critical Accounting Policies
The notes to the consolidated financial statements contain a summary of the Company's significant accounting policies presented on pages 65 to 69 of the Annual Report on Form 10-K for the year ended December 31, 2007. Certain of these policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights and intangible assets.
Allowance for Loan Losses
The allowance for loan losses is a significant estimate that can and does change based on management's assumptions about specific borrowers and current general economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. A worsening or protracted economic decline would increase the likelihood of additional losses due to credit and market risk and could create the need for additional loss reserves.
Foreclosed Assets
Foreclosed assets are carried at the lower of cost or fair value less estimated selling costs. Management estimates the fair value of the properties based on current appraisal information. Fair value estimates are particularly susceptible to significant changes in the economic environment, market conditions, and real estate market. A worsening or protracted economic decline would increase the likelihood of a decline in property values and could create the need to write down the properties through current operations.
Mortgage Servicing Rights
Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.
Intangible Assets
The Company periodically assesses the potential impairment of its goodwill and the recoverability of its core deposit intangible. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. If actual external conditions and future operating results differ from the Company's judgments, impairment and/or increased amortization charges may be necessary to reduce the carrying value of these assets to the appropriate value.
Securities
Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not effect earnings until realized.
The fair values of the Company's securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of the Company's fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment in necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.
The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in Financial Accounting Standards Board (FASB) Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. The Company may also evaluate securities for OTTI more frequently when economic or market concerns warrant additional evaluations. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in stockholders' equity) and not recognized in income until the security is ultimately sold.
The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.
Forward Looking Statements
This quarterly report on Form 10-Q contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may appear in a number of places in this Form 10-Q and include statements regarding the intent, belief, outlook, estimate or expectations of the company, its directors or its officers primarily with respect to future events and the future financial performance of the company. Readers of this Form 10-Q are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risk and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors. The accompanying information contained in this Form 10-Q identifies important factors that could cause such differences. These factors include changes in interest rates; the loss of deposits and loan demand to competitors; substantial changes in financial markets; changes in real estate values and the real estate market; or regulatory changes.
The Company does not undertake - and specifically disclaims any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Overview
The Company's results of operations depend primarily on the level of net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and costs incurred with respect to interest-bearing liabilities, primarily deposits and borrowings. The structure of our interest-earning assets versus the structure of interest-bearing liabilities along with the shape of the yield curve has a direct impact on our net interest income.
Historically, our interest-earning assets have been longer term in nature (i.e., fixed-rate mortgage loans) and interest-bearing liabilities have been shorter term (i.e., certificates of deposit, regular savings accounts, etc). This structure would impact net interest income favorably in a decreasing rate environment, assuming a normally shaped yield curve, as the rates on interest-bearing liabilities would decrease more rapidly than rates on the interest-earning assets. Conversely, in an increasing rate environment, assuming a normally shaped yield curve, net interest income would be impacted unfavorably as rates on interest-earning assets would increase at a slower rate than rates on interest-bearing liabilities. The acquisition of MFB Corp. helped reduce the interest rate risk exposure of the Bank primarily due to changes in the loan composition. This decline in the Bank's liability sensitive exposure should provide for less net portfolio value volatility with future rate movements.
Since 2000 it has been the Company's strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities and therefore reduce the impact interest rate changes have on our net interest income. Strategies employed to accomplish this objective have been to increase the originations of variable rate commercial loans and shorter term consumer loans and to sell longer term mortgage loans. The percentage of consumer and commercial loans to total loans has increased from 35% at the end of 2000 to 52% currently. As we continue to increase our investment in business-related loans, which are considered to entail greater risks than one-to four- family residential loans, in order to help offset the pressure on our net interest margin, our provision for loan losses may increase to reflect this increased risk. On the liability side of the balance sheet, the Company is employing strategies to increase the balance of core deposit accounts such as low cost checking and money market accounts. The percentage of core deposits to total deposits has increased from 33% to 39% over this time period. These are ongoing strategies that are dependent on current market conditions and competition.
During the first nine months of 2008, in keeping with its strategic objective to reduce interest rate risk exposure, the Company also sold $86.6 million of long term fixed rate loans that had been held for sale, which reduced potential earning assets and therefore had a negative impact on net interest income. This was offset, in the short term, by recognizing a gain on the sale of these loans of $1.4 million.
The Company converted to a public company at the end of 1999, and at the end of 2000 bought a $200 million thrift for stock. Since that time the Company has been buying back the Company's stock to manage capital levels and enhance earnings per share. During the first nine months of 2008, the Company used $1.7 million for this purpose, thereby reducing earning assets from where they otherwise would have been and correspondingly reducing net interest income.
On March 22, 2007 the Bank completed the acquisition of Wagley Investment Advisors, Inc. Wagley Investment Advisors, Inc. is now known as Mutual Financial Advisors, providing new and expanded investment management services not previously offered by the Bank. Mutual Financial Advisors offers a full range of non-bank investment options and money management.
On July 18, 2008, the Company completed the purchase of MFB Corp. The assets purchased primarily included residential mortgage loans of $167.9 million, consumer loans of $48.5 million, commercial real estate loans of $91.6 million and commercial business loans of $75.5 million. The liabilities assumed included $331.1 million in deposits and $96.4 million in borrowings.
Results of operations also depend upon the level of the Company's non-interest income, including fee income and service charges, and the level of its non-interest expense, including general and administrative expenses. The acquisition of MFB Corp. added trust services to the Bank, which will be leveraged through the Bank's existing footprint. The Company has also opened two new branches in Elkhart County in 2008. The intent of these initiatives is to increase income over the long term. However, on a short term basis, expenses relating to expanding trust services and new branches will have the affect of increasing non-interest expense with limited immediate offsetting income.
Financial Condition
With the addition of MFB Corp, assets totaled $1.4 billion at September 30, 2008, an increase from December 31, 2007 of $436.4 million, or 45.3%. Loans, excluding loans held for sale, increased $319.4 million, or 39.8%, due primarily to the acquisition of $383.1 million of net loans from MFB Corp. Consumer loans increased $44.6 million, or 19.8%, residential mortgage loans held in the portfolio increased $91.8 million, or 20.7%, and commercial loans increased $183.0 million, or 128.2%. Mortgage loans held for sale increased $1.1 million and mortgage loans sold during the first nine months of 2008 totaled $86.6 million. The increased loan balances are due primarily to the purchase of MFB Corp in the third quarter of 2008. Total net loans, excluding the amount of acquired loans, declined $63.7 million primarily due to the sale of $58.4 million of fixed rate mortgage loans in the third quarter of 2008. Investment securities available for sale increased $20.1 million, or 45.9%, compared to December 31, 2007 due primarily to $23.9 million of investment securities acquired with MFB Corp. Investment securities held to maturity increased $9.9 million due to the redemption in kind securities received in the previously announced sale of the AMF Ultra Funds.
Allowance for loan losses increased $3.9 million, including $3.0 million acquired with MFB Corp, to $12.2 million at September 30, 2008 when compared to December 31, 2007. Net charge offs for the first nine months of 2008 were $1.3 million, or .20% of average loans on an annualized basis, compared to $1.4 million, or .23% of average loans for the comparable period in 2007. The decrease was primarily due to larger recoveries during the 2008 period. As of September 30, 2008 the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.08% and 66.06%, respectively, compared to 1.00% and 78.62%, respectively, at December 31, 2007. Management continues to review non-performing loans individually to determine the adequacy of the allowance for loan losses.
Total deposits were $978.9 million at September 30, 2008, an increase of $312.5 million at December 31, 2007. This increase was due primarily to the assumption of $331.1 million in deposits from MFB Corp. Total borrowings increased $80.0 million to $276.7 million at September 30, 2008 from $196.6 million at December 31, 2007 due primarily to the assumption of $96.4 million in borrowings from MFB Corp.
Stockholders' equity increased $37.0 million, or 42.5%, from $87.0 million at December 31, 2007, to $124.0 million at September 30, 2008. The increase was due primarily to stock issued to acquire MFB Corp of $39.8 million, net income of $2.7 million, and Employee Stock Ownership Plan (ESOP) and RRP shares earned of $295,000. This increase was partially offset by the repurchase of 144,000 shares of common stock for $1.7 million and dividend payments of $2.4 million. Also, the market value of securities available for sale compared to their book value decreased $1.7 million from a loss of $414,000 at December 31, 2007 to a loss of $2.1 million at September 30, 2008. Securities are evaluated for impairment and the Bank has the ability and intent to hold all of the impaired securities until maturity or recovery.
Comparison of the Operating Results for the Three Months Ended September 30, 2008 and 2007
Net income for the third quarter ended September 30, 2008 was $359,000, or $.06 for basic and diluted earnings per share. This compared to net income for the comparable period in 2007 of $1.2 million, or $.28 for basic and diluted earnings per share. Annualized return on assets was .11% and return on average tangible equity was 1.77% for the third quarter of 2008 compared to .49% and 6.45%, respectively, for the same period last year.
The provision for loan losses for the third quarter of 2008 was $912,000, compared to $532,000 for last year's comparable period. Non-performing loans to total loans at September 30, 2008 were 1.63% compared to 1.27% at September 30, 2007 and 1.29% at December 31, 2007. Non-performing assets to total assets were 1.64% at September 30, 2008 compared to 1.37% at September 30, 2007 and 1.35% at December 31, 2007. The reason for the increase is higher loan balances and more non-performing loans due primarily from the acquisition of MFB Corp.
Non-interest income decreased $900,000 to $1.1 million, or 44.5%, for the three months ended September 30, 2008 compared to the same period in 2007. The decrease was due primarily to losses related to the sale/redemption of the AMF Ultra Funds of $2.6 million and a write-down of a Lehman's corporate bond of $200,000. These decreases were partially offset by a $1.0 million gain from a $51.6 million bulk loan sale. Other increases due primarily to the MFB acquisition included increases in service fee income of $549,000, increases in commission income of $274,000, and increases in cash surrender value of life insurance of $59,000.
Non-interest expense increased $3.9 million for the three months ended September 30, 2008 compared to the same period in 2007. Increases in current quarter non-interest expense compared to the same period in 2007 include increased salaries and employee benefits of $1.6 million, increased occupancy expense of $357,000, increased data processing expense of $100,000, increased professional fees of $205,000, increased marketing expense of $271,000 and increased other expenses of $1.4 million. These increases were primarily due to the acquisition of MFB Corp.
Income tax expense decreased $422,000 for the three months ended September 30, 2008 compared to the same period in 2007 due primarily to less taxable income. The effective tax rate also decreased from (3.2)% to (462.6)% due to a higher percentage of non-taxable income to total income before income tax and an increased percentage of low income housing tax credits to taxable income when comparing the third quarter of 2008 to the third quarter of 2007, respectively.
Comparison of the Operating Results for the Nine Months Ended September 30, 2008 and 2007
Net income for the nine months ended September 30, 2008 was $2.7 million, or $.58 for both basic and diluted earnings per share. This compared to net income for the comparable period in 2007 of $3.3 million, or $.81 for basic and $.80 for diluted earnings per share. Annualized return on average assets was .34% and return on average tangible equity was 4.91% for the first nine months of 2008 compared to .47% and 6.16% respectively, for the same period last year.
Net interest income before the provision for loan losses increased $5.0 million for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. The reasons for the increase were similar to those stated above. Average interest earning assets increased $111.3 million, or 12.9% and the net interest margin increased by 38 basis points from 2.77% for the nine months ended September 30, 2007 to 3.15% for the same period in 2008.
The provision for loan losses for the nine months ended September 30, 2008 was $2.3 million, compared to $1.4 million for last year's comparable period. Non-performing loans to total loans at September 30, 2008 were 1.63% compared to 1.27% at September 30, 2007 and 1.29% at December 31, 2007. Non-performing assets to total assets were 1.64% at September 30, 2008 compared to 1.37% at September 30, 2007 and 1.35% at December 31, 2007. The reason for the increase is higher loan balances and more non-performing loans due primarily from the acquisition of MFB Corp.
For the nine month period ended September 30, 2008 non-interest income decreased $350,000, or 6.2%, to $5.3 million compared to $5.7 million for the same period in 2007. The decrease was due primarily to losses related to the sale of the AMF Ultra Funds of $2.6 million and a write-down of a Lehman's corporate bond of $200,000. These decreases were partially offset by a $1.0 million gain from a $51.6 million bulk loan sale. The decrease in non-interest income was also partially offset with increases in fees and service charges on deposit accounts of $764,000 and increases in commission income of $432,000. These increases were primarily due to the acquisition of MFB.
Non-interest expense increased $4.9 million to $23.5 million for the nine months ended September 30, 2008 compared to $18.6 million for the same period in 2007. This increase was primarily due to increased salaries and employee benefits of $2.1 million, increased occupancy and equipment expense of $582,000, increased data processing expense of $56,000, increased professional fees of $289,000, increased marketing expense of $381,000, and increased other expenses of $1.5 million primarily due to the acquisition of MFB Corp. in the third quarter of 2008.
For the nine-month period ended September 30, 2008, income tax expense decreased
$476,000 compared to the same period in 2007. The decrease was due primarily to
decreased taxable income. The effective tax rate also decreased from 8.3% to
(6.8)% due to a higher percentage of non-taxable income to total income before
income tax and an increased percentage of low income housing tax credits to
taxable income when comparing the first nine months of 2008 to the first nine
months of 2007, respectively.
Liquidity and Capital Resources
The standard measure of liquidity for savings associations is the ratio of cash and eligible investments to a certain percentage of the net-withdrawable savings accounts and borrowings due within one year. As of September 30, 2008, Mutual had liquid assets of $90.1 million and a liquidity ratio of 7.02%. It is anticipated that this level of liquidity will be adequate for the remainder of 2008.
The Bank continues to maintain capital ratios which exceed "well-capitalized" levels as defined pursuant to all regulatory standards as of September 30, 2008. Mutual's current total risk-based capital ratio is 10.45% and tier 1 risk-based capital ratio is 9.38%.
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