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
2008 was an unprecedented year for the banking industry. Margin issues, credit issues and liquidity, as well as securities impairment, all consumed significant resources for the industry. In the midst of these challenges, the Company has been successful in growing local deposits and increasing total loans. 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 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. FDIC insurance premiums would have been $230,000 in 2008, however, the Company was able to apply credits of $175,000 for a net expense of $55,000. In December, 2008, the FDIC board approved a 7 basis points
(bps) increase in premiums charged to banks for deposit insurance, boosting the rate to between 12 cents and 50 cents per $100 of domestic deposits from a range of five cents to 43 cents due to market developments that have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. On February 27, 2009, the FDIC passed an interim rule that allows it to charge banks a special assessment of 20 bps on insured deposits to replenish the deposit insurance fund. This special assessment will be collected in the third quarter of 2009. Additionally, beginning April 1, 2009, the FDIC will increase its base fees on insured deposits, the combination of which would increase the Company's 2009 deposit premiums approximately $1.2 million. See "Federal Deposit Insurance Premiums" in Supervision and Regulation in Item 1 hereof, Business, for more information on the FDIC premiums. 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 decreased 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, including the provision and allowance for loan losses, the provision for income taxes, and the evaluation of investment securities for other-than-temporary impairment. 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.

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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 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 Financial Condition-Allowance For Loan Losses, 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 evaluation of the impairment of the securities portfolio requires a 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 impaired securities to identify those for which impairment may be other-than-temporary. Impaired securities are monitored and evaluated based upon the above considerations and if the decline in fair value 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 $761.3 million at December 31, 2008 up from $621.7 million at December 31, 2007. The increase in asset size is mainly attributable to strong loan growth since year end 2007 of $94.5 million, an increase of $34.0 million in investment securities available for sale portfolio and an increase in federal funds sold amounting to $6.4 million. The funding of the asset growth was derived from an increase of $41.1 million in total borrowed funds coupled with an increase in deposits of $86.6 million since 2007.
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, the 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 $675.6 million in 2008, an increase of $113.0 million or 20.1% from 2007. 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 $77.8 million in 2008 to $404.0 million.

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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 the Treasury and government-sponsored enterprise obligations, mortgage-backed securities, other bonds and equity securities, and short-term investments amounted to $271.6 million in 2008 as compared to $236.4 million in 2007. These securities represent 38.9% of the Company's total average assets at December 31, 2008 versus 40.8% of total average assets at December 31, 2007.
INVESTMENT SECURITIES
The investment portfolio totaled $264.6 million and $230.6 million, respectively, at December 31, 2008 and 2007, reflecting an increase of $34.0 million or 14.7% in 2008. The change in 2008 resulted from an increase in mortgage-backed securities totaling $50.5 million partially offset by decreases of $13.1 million and $3.7 million in collateralized mortgage obligations and equity securities, respectively. 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:

                                                           2008                             2007
                                                  Amount          Percent          Amount          Percent

(Dollars in Thousands)
U. S. Treasury obligations                       $   6,004             2.3 %      $   5,541             2.4 %
Government-sponsored enterprise obligations         15,722             5.9 %         15,810             6.9 %
Mortgage-backed securities                         187,206            70.8 %        136,703            59.3 %
Collateralized mortgage obligations                 47,059            17.8 %         60,147            26.1 %
Corporate obligations                                5,683             2.1 %          5,820             2.5 %
Mutual funds                                           958             0.4 %            959             0.4 %
Equity securities                                    1,929             0.7 %          5,616             2.4 %

Total                                            $ 264,561           100.0 %      $ 230,596           100.0 %

There were no securities held to maturity during 2008 and 2007.
The maturities and weighted average yields of investment securities available for sale at December 31, 2008, follow:

                             Within          Weighted          One to          Weighted           Five           Weighted           Over
                               One           Average            Five           Average           to Ten          Average             Ten           Average                          Average
                              Year            Yield            Years            Yield            Years            Yield             Years           Yield            Total           Yield

(Dollars in Thousands)
U. S. Treasury bonds
and
government-sponsored
enterprise obligations      $ 5,568             3.22 %       $ 16,158             3.76 %       $      -                - %       $       -              - %       $  21,726           3.62 %
Mortgage-backed
securities                      713             3.64 %         11,853             3.74 %         10,616             4.78 %         164,024           5.78 %         187,206           5.59 %
Collateralized
mortgage obligations              -                -               88             5.88 %          9,740             4.04 %          37,231           4.79 %          47,059           4.64 %
Corporate obligations         1,964             5.44 %          3,719             5.48 %              -                - %               -              - %           5,683           5.47 %

Total                       $ 8,245             3.79 %       $ 31,818             3.96 %       $ 20,356             4.43 %       $ 201,255           5.60 %       $ 261,674           5.25 %

LOANS
Total loans at December 31, 2008 and 2007 amounted to $452.6 million and $358.1 million, respectively, reflecting an increase of $94.5 million or 26.4% in 2008. Corporate loans increased $64.2 million or 25.3% during 2008. Commercial real estate loans increased $45.0 million or 25.3% and commercial and construction loans increased $5.3 million or 18.7% and $13.9 million or 29.0%, respectively. Retail loans increased $30.3 million or 29.2%. Residential real estate loans and home equity loans increased $29.5 million or 37.0% and $926,000 or 4.0%, respectively, while consumer loans decreased $176,000 or 17.5%. 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.

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The components of the loan portfolio at December 31, follow:

                                     2008                              2007                              2006                              2005                              2004
                            Balance          Percent          Balance          Percent          Balance          Percent          Balance          Percent          Balance          Percent
(Dollars in
Thousands)
Residential real
estate loans:
Fixed rate                $  68,040            15.0 %       $  49,513            13.8 %       $  39,076            13.5 %       $  34,028            14.5 %       $  33,061            14.2 %
Adjustable rate              41,236             9.1            30,230             8.4            30,800            10.7            28,159            12.0            26,996            11.6
Loans held for sale               -               -                 -               -                 -               -               472             0.2                 -               -

                            109,276            24.1            79,743            22.2            69,876            24.2            62,659            26.7            60,057            25.8

Home equity loans:
Fixed rate                   12,398             2.7            13,821             3.9            11,170             3.9             3,592             1.5             3,535             1.5
Adjustable rate              11,574             2.6             9,225             2.6             9,169             3.2             6,820             2.9             5,334             2.3

                             23,972             5.3            23,046             6.5            20,339             7.1            10,412             4.4             8,869             3.8

Consumer loans                  831             0.2             1,007             0.3               975             0.3               468             0.2               699             0.3

Total retail loans          134,079            29.6           103,796            29.0            91,190            31.6            73,539            31.3            69,625            29.9


Construction loans           61,769            13.6            47,885            13.4            43,283            15.0            24,137            10.3            15,211             6.5

Commercial real
estate loans:
Fixed rate                   57,757            12.8            33,920             9.5            17,434             6.1            14,793             6.3            18,629             8.0
Adjustable rate             165,220            36.5           144,048            40.2           125,386            43.5           112,824            48.1           112,976            48.5

                            222,977            49.3           177,968            49.7           142,820            49.6           127,617            54.4           131,605            56.5

Commercial loans             33,796             7.5            28,464             7.9            10,870             3.8             9,318             4.0            16,369             7.1

Total corporate
loans                       318,542            70.4           254,317            71.0           196,973            68.4           161,072            68.7           163,185            70.1


Total loans                 452,621           100.0 %         358,113           100.0 %         288,163           100.0 %         234,611           100.0 %         232,810           100.0 %

Allowance for loan
losses                        5,885                             4,810                             4,309                             4,126                             4,140

Loans, net                $ 446,736                         $ 353,303                         $ 283,854                         $ 230,485                         $ 228,670

The maturity distribution for construction and commercial loans at December 31, 2008, follows:

                                             Due After
                            Due Within      One Through      Due After
                             One Year        Five Years      Five Years      Total

          (In Thousands)
          Construction      $   42,821       $   12,979       $  5,969     $ 61,769
          Commercial            12,265           14,676          6,855       33,796

          Total             $   55,086       $   27,655       $ 12,824     $ 95,565

Of construction loans and commercial loans maturing more than one year after December 31, 2008, $5.9 million have fixed rates and $43.8 million have floating or variable rates.
At December 31, 2008, the Bank had commercial loan balances participated out to various banks amounting to $11.1 million, compared to $8.2 million at December 31, 2007. 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 $11.4 million and $14.0 million, respectively, at December 31, 2008 and December 31, 2007. The Bank performs an independent credit analysis of each commitment prior to participation in the loan.
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 2008 level of the allowance for loan losses to be appropriate and adequate. The allowance as a percentage of total loans was 1.30% at December 31, 2008 and 1.34% at December 31, 2007. Notwithstanding the increase in non-performing loans at December 31, 2008 and December 31, 2007, 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

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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 1.30% as of December 31, 2008. See Note 1 to the Consolidated Financial Statements for a discussion of the accounting policy related to the allowance for loan losses.
"Impaired loans" are corporate 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 2008 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 provision for loan losses of $1.3 million in the year 2008 compared to a provision in 2007 in the amount of $645,000. The Company had net charge-offs of $210,000 in 2008 compared to $144,000 in 2007.
The following table summarizes changes in the allowance for loan losses for the years ended December 31:

                                         2008            2007            2006            2005            2004

(Dollars in Thousands)
Balance at beginning of year          $ 4,810         $ 4,309         $ 4,126         $ 4,140         $ 4,220
Charge-offs by loan type:
Residential mortgage                        -               -               -               -             (25 )
Commercial                                (80 )             -               -               -               -
Commercial real estate                   (111 )          (121 )             -               -               -
Construction                              (20 )             -               -               -               -
Consumer                                   (3 )           (36 )           (30 )           (25 )           (20 )

Total charge-offs                        (214 )          (157 )           (30 )           (25 )           (45 )


Recoveries by loan type:
Residential mortgage                        -               -               -               -               -
Commercial                                  -               -               -               -               -
Commercial real estate                      3               3              32               2             254
Construction                                -               -               -               -               -
Consumer                                    1              10              21               9              11

Total recoveries                            4              13              53              11             265

Net (charge-offs) recoveries             (210 )          (144 )            23             (14 )           220
Provision (credit) for loan
losses                                  1,285             645             160               -            (300 )

Ending balance                        $ 5,885         $ 4,810         $ 4,309         $ 4,126         $ 4,140

Ratio of net (charge-offs)
recoveries to average loans
outstanding during the period           (0.05 )%        (0.04 )%         0.01 %         (0.01 )%         0.10 %

Allowance as a % of total loans          1.30 %          1.34 %          1.50 %          1.76 %          1.78 %

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 . . .