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| RIVR > SEC Filings for RIVR > Form 10-Q on 14-Nov-2008 | All Recent SEC Filings |
14-Nov-2008
Quarterly Report
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q ("Form 10-Q") contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief, outlook, estimate or expectations of the Corporation (as defined in the notes to the consolidated condensed financial statements), its directors or its officers primarily with respect to future events and the future financial performance of the Corporation. Readers of this Form 10-Q are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risks 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; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; regulatory changes; or turmoil and governmental intervention in the financial services industry.
EFFECT OF CURRENT EVENTS
Although the Company's fundamental banking practices and policies have protected it from the significant write-downs, impairments and disruption being experienced in the industry, management continues to assess the impact on the Corporation of the uncertain economic and regulatory environment affecting the country at large and the financial services industry in particular. The Corporation has decided to file an application under the Troubled Asset Relief Program ("TARP") Capital Purchase Program ("CPP") seeking approval to sell $8,100,000 in preferred stock to the Treasury. See Note 7, Subsequent Event, to the Corporation's Unaudited Consolidated Condensed Financial Statements, included in this Form 10-Q and incorporated herein, for further information related to this decision.
Both the level of turmoil in the financial services industry and the Corporation's participation in the TARP's CPP will present unusual risks and challenges for the Corporation, as described below:
The Current Economic Environment Poses Challenges For Us and Could Adversely Affect Our Financial Condition and Results of Operations. We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. The capital and credit markets have been experiencing volatility and disruption for more than 12 months. In recent weeks, the volatility and disruption has reached unprecedented levels. The risks associated with our business become more acute in periods of a slowing economy or slow growth. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we are taking steps to decrease and limit our exposure to problem loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.
Our loan portfolio includes commercial real estate loans, residential mortgage
loans, and construction and land development loans. Continued declines in real
estate values, home sales volumes and financial stress on borrowers as a result
of the uncertain economic environment, including job losses, could have an
adverse effect on our borrowers or their customers, which could adversely affect
our financial condition and results of operations. In addition, a possible
national economic recession or further deterioration in local economic
conditions in our markets could drive losses beyond that which is provided for
in our allowance for loan losses and result in the following other consequences:
increases in loan delinquencies, problem assets and foreclosures may increase;
demand for our products and services may decline; deposits may decrease, which
would adversely impact our liquidity position; and collateral for our loans,
especially real estate, may decline in value, in turn reducing customers'
borrowing power, and reducing the value of assets and collateral associated with
our existing loans.
Impact of Recent and Future Legislation. Congress and the Treasury Department have recently adopted legislation and taken actions to address the disruptions in the financial system and declines in the housing market. See Note 7, Subsequent Event, to the Corporation's Unaudited Consolidated Condensed Financial Statements, included in this Form 10-Q and incorporated herein. It is not clear at this time what impact the Emergency Economic Stabilization Act ("EESA"), TARP, other liquidity and funding initiatives of the Treasury and other bank regulatory agencies that have been previously announced, and any additional programs that may be initiated in the future, will have on the financial markets and the financial services industry. The extreme levels of volatility and limited credit availability currently being experienced could continue to affect the U.S. banking industry and the broader U.S. and global economies, which will have an effect on all financial institutions, including the Corporation.
In addition to the legislation mentioned above, federal and state governments could pass additional legislation responsive to current credit conditions. As an example, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank's borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
Possible Increases in Insurance Premiums. The Federal Deposit Insurance Corporation ("FDIC") insures the Bank's deposits up to certain limits. The FDIC charges us premiums to maintain the Deposit Insurance Fund. The Bank is considering participating in the FDIC's Temporary Liquidity Guarantee Program, which could increase its insurance premiums up to 85 basis points per annum with respect to the Bank's deposits.
Current economic conditions have increased expectations for bank failures. The FDIC takes control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC has designated the Deposit Insurance Fund long-term target reserve ratio at 1.25 percent of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15 percent, the statutory minimum. The FDIC has developed a proposed restoration plan that will uniformly increase insurance assessments by 7 basis points (annualized). The plan also proposes changes to the deposit insurance assessment system requiring riskier institutions to pay a larger share. Further increases in premium assessments would increase the Corporation's expenses.
Our Participation in the TARP Capital Purchase Program May Adversely Affect the Value of Our Common Stock and the Rights of Our Common Stockholders. The terms of the preferred stock the Corporation will issue under the TARP CPP if its application is accepted and the transaction closes could reduce investment returns to the Corporation's common stockholders by restricting dividends, diluting existing shareholders' ownership interests, and restricting capital management practices. Without the prior consent of the Treasury, the Corporation will be prohibited from increasing its common stock dividends or repurchasing shares of its common stock for the first three years while the Treasury holds the preferred stock.
Also, the preferred stock requires quarterly dividends to be paid at the rate of 5% per annum for the first five years and 9% per annum thereafter until the stock is redeemed by the Corporation. The payments of these dividends will decrease the excess cash the Corporation otherwise has available to pay dividends on its common stock and to use for general corporate purposes, including working capital.
Finally, the Corporation will be prohibited from continuing to pay dividends on its common stock unless it has fully paid all required dividends on the preferred stock issued to the Treasury. Although the Corporation fully expects to be able to pay all required dividends on the preferred stock (and to continue to pay dividends on its common stock at current levels), there is no guarantee that it will be able to do so in the future.
The Soundness of Other Financial Institutions Could Adversely Affect Us. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.
Future Reduction in Liquidity in the Banking System. The Federal Reserve Bank has been providing vast amounts of liquidity in to the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve's activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations.
CRITICAL ACCOUNTING POLICIES
The notes to the consolidated financial statements contain a summary of the Company's significant accounting policies presented on pages 56 through 58 of the Annual Report to Shareholders 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 and the valuation of mortgage servicing rights.
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 allowance for loan losses represents management's estimate of probable losses inherent in the Corporation's loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.
The Corporation's strategy for credit risk management includes conservative, centralized credit policies, and uniform underwriting criteria for all loans as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.
The Corporation's allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.
Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Corporation. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or fair value of the underlying collateral. The Corporation evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans are not individually risk graded. Rather, standard credit scoring systems are used to assess credit risks. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and non-accrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Corporation's internal loan review.
An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.
The Corporation's primary market area for lending is Clark, Floyd and Jefferson counties in southeastern Indiana and portions of northeastern Kentucky. When evaluating the adequacy of allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Corporation's customers.
The Corporation has not substantively changed any aspect to its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance.
VALUATION OF MORTGAGE SERVICING RIGHTS
The Company recognizes the rights to service mortgage loans as separate assets in the consolidated balance sheet. The total cost of loans when sold is allocated between loans and mortgage servicing rights based on the relative fair values of each. Mortgage servicing rights are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Factors included in the calculation of fair value of the mortgage servicing rights include, estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the mortgage servicing rights, resulting in different valuations of the mortgage servicing rights. The differing valuations will affect the carrying value of the mortgage servicing rights on the consolidated balance sheet as well as the income recorded from loan servicing in the income statement. As of September 30, 2008 and December 31, 2007, mortgage servicing rights had carrying values of $264,000 and $284,000 respectively.
FINANCIAL CONDITION
At September 30, 2008, the Corporation's consolidated assets totaled $364.9 million, an increase of $14.8 million, or 4.2% from December 31, 2007. An increase in the Bank's loan portfolio of $20.8 million year-to-date was comprised primarily of consumer loans for 1-4 family residential owner-occupied property ($7.8 million), 1-4 family investment property ($7.8), commercial real estate loans ($3.0 million) and commercial purpose loans, most specifically agricultural crop loans and small business loans, ($3.0 million). Loans for multi-family housing and consumer installment loans dropped over the period. Loan growth was funded partially by called and matured investments and by increases in deposits for the period. Over the same, period interest receivable on interest earning assets decreased by $303,000, or 12.7%, reflecting the drop in interest rates resulting from the January, March, and May reductions of the Prime rate by the Federal Reserve (Fed). Most radically affected by the drops in the Prime interest rate were commercial loans and home equity lines of credit which change directly with the rate. The average yield on loans at September 30, 2008 was 6.35%, a decrease of .71% from the rate of 7.06% at the same period in 2007. Other increases for the period included a 2.0% increase in premises and equipment, reflecting the opening of the new branch in Floyds Knobs, Indiana and a 23.9% increase in non-earning "Other Assets," primarily prepaid expenses and deferred tax assets.
The Corporation's consolidated allowance for loan losses totaled $2.2 million at both September 30, 2008 and December 31, 2007, compared to the total at September 30, 2007of $2.0 million. These levels represented .78%, .85%, and .78 % of total loans, respectively. Non-performing loans (defined as loans delinquent greater than 90 days and loans on non-accrual status) totaled $1.0 million, $1.8 million, and $1.9 million for the same periods. From December 31, 2007 to September 30, 2008 the allowance for loan losses was funded at a level in line with current and estimated charge offs. With the exception of a few loans delinquent due to administrative delays in refinancing, the Bank's non-performing loans represent loans in the lengthy process of foreclosure, for which appropriate specific loss reserves have been established. The provision for loan losses increased to $245,000 for the quarter ended September 30, 2008, as compared to $196,000 for the same period in 2007 and $645,000 for the nine months ended September 30, 2008 as compared to $292,000 for the same period in 2007.
Although management believes that its allowance for loan losses at September 30, 2008, was adequate based upon the available facts and circumstances, there can be no assurance that additions to such allowance will not be necessary in future periods, which could negatively affect the Corporation's results of operations. Management is diligent in the monitoring of delinquent loans and in the analysis of the factors affecting the allowance. At September 30, 2008 the Bank held one piece of repossessed real estate valued at $173,000 as compared to two pieces with a combined value of $184,000 at December 31, 2007.
Deposits totaled $234.9 million at September 30, 2008, an increase of $15.2 million, or 6.9%, compared to total deposits at December 31, 2007. During the nine-month period, transactional deposit accounts increased by $2.8 million while interest bearing accounts increased $12.4 million. Deposit increases for the period came primarily from school and governmental accounts as the school year began and tax receipts were received.
Borrowings totaled $101.2 million at September 30, 2008 versus $102.2 million on December 31, 2007. Of total borrowings, $94.0 million and $95.0 million represented Federal Home Loan Bank (FHLB) advances with average rates of 4.62% and 4.64% at the respective dates. The Bank has experienced a slower drop in the overall cost of funds as a result of these longer term borrowing rates, which average slightly less than 1% over the highest paying certificate of deposit rate for the Bank.
Shareholders' equity totaled $25.5 million at September 30, 2008, a slight decrease of $154,000, or .6% from the $25.7 million at December 31, 2007. Of this change, $1.8 million was income from operations, $1.0 million was paid out in dividends to shareholders, and $1.0 million was a decrease in equity resulting from the change from a net gain position on unrealized gains/losses on available for sale securities to a net loss position.
The Bank is required to maintain minimum regulatory capital pursuant to federal regulations. At September 30, 2008, the Bank's regulatory capital exceeded all applicable regulatory capital requirements.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
2007
GENERAL
The Corporation's net income for the nine months ended September 30, 2008, totaled $1.8 million, an increase of $226,000 or 13.9% from the $1,623,000 reported for the period ended September 30, 2007. The increase in income in the 2008 period was primarily attributable to improvements in both the spread on interest bearing items, with net interest income increasing by 15.3% year-to-year, and in non-interest income, most specifically income from the gain on loan sales to the secondary market, which were up by 152% over 2007 levels.
NET INTEREST INCOME
Total interest income for the nine months ended September 30, 2008 increased only slightly by $37,000, or .2%, to $15.3 million from the $15.2 million recorded for the same period in 2007. Despite strong growth in the underlying assets, income increased only slightly as the effect of the rate changes by the Federal Reserve earlier this year were felt.
Total interest expense for the same period exhibited significant declines with a decrease of $894,000, or 9.7%, from $9.2 million at September 30, 2007 to $8.3 million at September 30, 2008. For the nine months ended September 30, 2008 interest expense from deposits totaled $4.6 million while interest expense from borrowings totaled $3.7 million, as compared to $5.7 million and $3.5 million for the same period in 2007. Of the overall decrease in interest expense, $1.1 million, or 18.7%, was attributable to interest expense on deposits as the effect of the Fed rate cuts continued to affect the Bank. Over the same period, the Bank experienced a slight increase of $169,000, or 4.9%, on interest expense for borrowings as the average balance of funds borrowed from the FHLB increased.
Net Interest Income increased to $7.0 million for the nine months ended September 30, 2008 from $6.1 million for the same period in 2007, an increase of $930,000, or 15.3%. This increase reflects both strong loan growth and the effects of the interest rate environment on the spread between interest earning assets and interest bearing liabilities.
PROVISION FOR LOSSES ON LOANS
A provision for losses on loans is charged to income to bring the total allowance for loan losses to a level considered appropriate by management based upon historical experience, the volume and type of lending conducted by the Bank, the status of past due principal and interest payment, general economic conditions, particularly as such conditions relate to the Bank's market area, and other factors related to the collectibility of the Bank's loan portfolio. As a result of such analysis, management recorded a $645,000 provision for losses on loans for the nine months ended September 30, 2008, as compared to $292,000 for the same period in 2007. Non-performing loans as of September 30, 2008 were $1.0 million, a drop of $803,000, or 44%, from the $1.8 million at the same point in 2007, reflecting the charge off of some long standing problem loans and aggressive management of past due accounts. The increase in the provision year-to-year has been predicated primarily on estimated losses with some impact for the current economic environment. While management believes that the allowance for losses on loans is adequate at September 30, 2008, based upon the available facts and circumstances, there can be no assurance that the loan loss allowance will be adequate to cover losses on non-performing assets in the future.
OTHER INCOME
Other income increased slightly by $191,000, during the nine months ended September 30, 2008 to $2.5 million, as compared to the $2.3 million reported for the same period in 2007. This increase was fueled primarily by sales of 1-4 family residential loans to the secondary market and gains on the sale of investments during the period offset by losses on sales of foreclosed property. Unlike interest income, "Other Income" is not always readily predictable and is subject to variations depending on outside influences.
OTHER EXPENSE
Other Expense increased by $510,000, or 8.7%, to $6.4 million during the nine months ended September 30, 2008, as compared to the $5.9 million reported for the same period in 2007. Increases in personnel and occupancy costs relative to the opening of the Floyds Knobs, Indiana branch contributed to this increase, along with data processing costs relative to ATM usage, and loan administration costs, which mirror loan growth and loan sales, and increases in the FDIC assessment. Decreases in professional fees from the higher fees reported in 2007 (which higher 2007 fees were a result of implementation of Sarbanes-Oxley, as well as additional costs arising from the litigation described in Item 1 of Part II of this Form 10-Q) and in the amortization expense relative to servicing rights on mortgages sold to Freddie Mac (FM) (due to declines in FM sales over the past three years) offset some of the expense increase.
INCOME TAXES
The provision for income taxes totaled $618,000 for the nine months ended September 30, 2008, an increase of $32,000, or 5.4%, over the $586,000 for the same period in 2007. The effective tax rate for the nine months ended September 30, 2008 was 25.1% as compared to 26.5% for the same period in 2007. The decrease continues to reflect the effect of tax-exempt income from cash surrender value life insurance and municipal investments.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
GENERAL
The Corporation's net income for the three months ended September 30, 2008, totaled $645,000, with an increase of $113,000 or 21.1% from the $532,000 reported for the period ended September 30, 2007. The Corporation experienced several positive events that contributed to this increase including, but not limited to, a widening of the spread between interest earned and interest expensed, and increases in fees earned on overdrawn checking accounts. Meanwhile expense increases included increased ATM costs and staffing, occupancy, and . . .
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