MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
INTRODUCTION
In the following pages, management presents an analysis of the consolidated
financial condition of DCB Financial Corp (the "Corporation") at June 30, 2009,
compared to December 31, 2008, and the consolidated results of operations for
the three and six months ended June 30, 2009, compared to the same periods in
2008. This discussion is designed to provide a more comprehensive review of the
operating results and financial position than could be obtained from reading the
consolidated financial statements alone. This analysis should be read in
conjunction with the consolidated financial statements and related footnotes and
the selected financial data included elsewhere in this report.
FORWARD-LOOKING STATEMENTS
Certain statements in this report constitute "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, such as
statements relating to the financial condition and prospects, lending risks,
plans for future business development and marketing activities, capital spending
and financing sources, capital structure, the effects of regulation and
competition, and the prospective business of both the Corporation and its
wholly-owned subsidiary The Delaware County Bank & Trust Company (the "Bank").
Where used in this report, the word "anticipate," "believe," "estimate,"
"expect," "intend," and similar words and expressions, related to the
Corporation or the Bank or their respective management, identify forward-looking
statements. Such forward-looking statements reflect the current views of the
Corporation and are based on information currently available to the management
of the Corporation and the Bank and upon current expectations, estimates, and
projections about the Corporation and its industry, management's belief with
respect thereto, and certain assumptions made by management. These
forward-looking statements are not guarantees of future performance and are
subject to risks, uncertainties, and other factors that could cause actual
results to differ materially from those expressed or implied by such
forward-looking statements. Potential risks and uncertainties include, but are
not limited to: (i) significant increases in competitive pressure in the banking
and financial services industries; (ii) changes in the interest rate environment
which could reduce anticipated or actual margins; (iii) changes in political
conditions or the legislative or regulatory environment; (iv) general economic
conditions, either nationally or regionally (especially in central Ohio),
becoming less favorable than expected resulting in, among other things, a
deterioration in credit quality of assets; (v) changes occurring in business
conditions and inflation; (vi) changes in technology; (vii) changes in monetary
and tax policies; (viii) changes in the securities markets; and (ix) other risks
and uncertainties detailed from time to time in the filings of the Corporation
with the Commission.
The Corporation does not undertake, and specifically disclaims any obligation,
to publicly revise 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 of the second quarter of 2009
The Bank provides customary retail and commercial banking services to its
customers, including checking and savings accounts, time deposits, IRAs, safe
deposit facilities, personal loans, commercial loans, real estate mortgage
loans, installment loans, trust, and other wealth management services. The Bank
also provides treasury management, bond registrar and paying agent services.
The Corporation, through the Bank, grants residential real estate, commercial
real estate, consumer and commercial loans to customers located primarily in
Delaware, Franklin, Licking, Morrow, Marion and Union Counties, Ohio. General
economic conditions in the Corporation's market area have been under some
pressures mainly attributable to an overall
Table of Contents
DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
slowdown in economic activity and related increases in unemployment levels, loan
foreclosure volume and a decline in real estate values. The Corporation's
business has been under pressure due primarily to market interest rate
conditions, competition and a slowdown in the economy. Real estate values,
especially in the Bank's core geographic area, have declined during the past
year and the lower values have continued into the first six months of 2009.
• The Corporation's assets totaled $691,199 at June 30, 2009, compared to
$712,564 at December 31, 2008, a decrease of $21,365, or 3.0%. The decline
is due primarily to an overall slowdown in loan volume.
• Net loss for the three and six months ended June 30, 2009 totaled $209 and
$1,280, respectively, compared to net income in the same periods in 2008 of
$1,224 and $2,522, respectively,
• The provision for loan losses totaled $5,142 for the six months ended
June 30, 2009 compared to $1,200 in the first six months of 2008. This
increase is mainly attributed to declines in overall credit quality and
reserves for specific impaired loans. DCB maintains an allowance for loan
losses at a level to absorb management's estimate of probable inherent
credit losses in its portfolio.
• An overall decline in loan balances, period to period, contributed to the
reduced interest income. The Corporation's net interest margin for the
second quarter increased slightly compared to the second quarter 2008, from
3.50% to 3.55%. Compared to the first quarter 2009, the margin improved from
3.39% to 3.55%. This is attributed to improved deposit and loan pricing,
core deposit growth and reduced high cost broker deposits and long-term
debt.
• Investment securities totaling $16,977 were sold resulting in a gain on sale
of $462. Advances from the Federal Home Loan Bank totaling $13,410 were
prepaid and the Corporation incurred a prepayment fee of $533. Management
expects the decrease of long term debt corresponding to a similar decrease
in investable cash balances will provide an overall benefit by increasing
net interest margin. It will also provide additional pledged assets that can
be used to secure other long term borrowing options.
• FDIC insurance premiums increased by $609 for the six months ended June 30,
2009, compared to the same period in 2008, including a one-time special
assessment.
• The ability to generate earnings is impacted in part by competitive pricing
on loans and deposits, and by changes in the rates on various U.S. Treasury,
U. S. Government Agency and State and political subdivision issues which
comprise a significant portion of the Bank's investment portfolio. The Bank
is competitive with interest rates and loan fees that it charges, in pricing
and the variety of accounts it offers to the depositor. The Corporation
confirms this by completing regular rate shops and comparisons versus
competing financial services companies. The dominant pricing mechanism on
loans is the prime interest rate as published in the Wall Street Journal, on
a fixed rate plus spread over funding costs. The interest spread depends on
the overall account relationship and the creditworthiness of the borrower.
• Deposit rates are reviewed weekly by management and are generally discussed
by the Asset/Liability Committee on a monthly basis. The Bank's primary
objective in setting deposit rates is to remain competitive in the market
area and to develop funding opportunities while earning an adequate interest
rate margin.
• Total borrowings decreased by 20.8%, from $88,384 at December 31, 2008, to
$69,996 at June 30, 2009. This is mainly due to management's decision to
prepay long term debt to reduce cash balances and decrease other costs on
borrowed funds.
Table of Contents
DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
ANALYSIS OF FINANCIAL CONDITION
The Corporation's assets totaled $691,199 at June 30, 2009, compared to $712,564
at December 31, 2008, a decrease of $21,365, or 3.0%. The decrease is due to an
overall decline in loan volume attributable to reduced activity in our primary
markets and planned portfolio runoff.
Cash and cash equivalents increased from $33,632 at December 31, 2008 to $54,375
at June 30, 2009 as a result of the Bank's initiatives to increase liquidity.
Total securities decreased from $119,362 at December 31, 2008 to $89,237 at
June 30, 2009. The decrease in securities balances is attributed primarily to
the sale of $16,977 of investments. Management elected to use proceeds from such
sales to prepay long-term debt totaling $13,410. The Corporation invests
primarily in U.S. Treasury notes, U.S. government agencies, municipal bonds,
corporate obligations and mortgage-backed securities. The mortgage-backed
securities portfolio, totaling $36,803 at June 30, 2009, provides the
Corporation with a constant cash flow stream from principal repayments and
interest payments. Mortgage-backed securities include Federal Home Loan Mortgage
Corporation ("FHLMC"), Government National Mortgage Association ("GNMA") and
Federal National Mortgage Association ("FNMA") participation certificates. The
Corporation held no structured notes during any period presented.
Total loans, including loans held for sale, decreased $8,682, or 1.7%, from
$514,296 at December 31, 2008 to $505,614 at June 30, 2009. The Company
continues to see good quality loan opportunities, as many large banks have cut
back on lending, but as previously stated, has experienced an overall decline in
loan volume, due to reduced activity in our primary markets and planned
portfolio runoff. Retail loan production including credit card and home equity
loans experienced stable activity within the branch network. Management
continued to run-off its indirect paper and investment property portfolios and
residential mortgages declined due to increased refinance activities.
Total deposits decreased $1,546, or 0.3%, from $565,153 at December 31, 2008 to
$563,607 at June 30, 2009. Deposit growth occurred in CDARS balances, which
provide increased levels of FDIC insurance coverage for CDs. The Bank had
approximately $151,000 in CDARS deposits outstanding at June 30, 2009.
Noninterest-bearing deposits increased $934, or 1.9%, and interest bearing
deposits decreased $2,480, or 0.5% during the quarter ended June 30, 2009. In
addition, brokered CD's declined $5.4 million, or 69.2%, from December 31, 2008
to $2,400 at June 30, 2009. The Corporation utilizes a variety of alternative
funding sources due to competitive challenges within its primary market. Total
borrowings decreased $18,388, or 20.8% from $88,384 at December 31, 2008, to
$69,996 at June 30, 2009, in a planned effort to reduce long-term debt and
remove the pledges of related collateral to provide additional liquidity.
Management will continue to analyze opportunities to reduce high cost long-term
debt.
Total borrowings decreased by $18,388, or 20.8%, to $69,996 during the six month
period ended June 30, 2009, compared to December 31, 2008. The decrease was due
primarily to the prepayment of $13,410 of FHLB advances. Typically, the Company
utilizes a matched funding methodology for its borrowing and deposit activities.
This is done by matching the rates, terms and expected cash flows of its loans
to the various liability products. This matching principle is used to not only
provide funding, but also as a means of mitigating interest rate risk associated
with originating longer-term fixed-rate loans. Continued reliance on borrowings
outside of normal deposit growth may increase the Corporation's overall cost of
funds. Management intends to continue to develop new products, and to monitor
the rate structure of its deposit products to encourage growth in its deposit
liabilities.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS
ENDED JUNE 30, 2009 AND JUNE 30, 2008
Net Income (Loss). The Corporation reported a net loss for the three months
ended June 30, 2009 totaling $209, compared to net income of $1,224 for the same
period in 2008. The per share loss was $0.06 for the three months ended June 30,
2009 compared to $0.33 earnings per share for the three months ended June 30,
2008. Operating results were negatively impacted by increases in the provision
for loan losses expense associated with commercial and commercial real estate
loan portfolios. Additionally, operating expenses increased due to a special
FDIC insurance assessment and higher premium rates, professional fees associated
with loan workouts, increased franchise taxes and pre-payment penalties related
to the early payoff of long-term debt. Some of these costs were offset by gains
from the sale of securities, used to fund the early payoffs.
Table of Contents
DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Net Interest Income. Net interest income represents the amount by which interest
income on interest-earning assets exceeds interest paid or accrued on
interest-bearing liabilities. Net interest income is the largest component of
the Corporation's income, and is affected by the interest rate environment, the
volume, and the composition of interest-earning assets and interest-bearing
liabilities.
Net interest income was $5,579 for the three months ended June 30, 2009 compared
to $5,661 for the three months ended June 30, 2008. A small decline in loan
balances, period to period, contributed to the reduced interest income. The
Corporation's net interest margin for the second quarter increased slightly
compared to the second quarter 2008, from 3.50% to 3.55%. Compared to the first
quarter 2009, the margin improved from 3.39% to 3.55%. This is attributed to
improved deposit and loan pricing, core deposit growth and reduced high cost
broker deposits and long-term debt.
Loan origination volume remained sluggish during the second quarter. The current
mortgage refinancing activity paying off existing balances and indirect
portfolio run-offs drove the reduction in loan balances. Other portfolios were
generally level to prior years' balances. However, the Bank experienced good
growth in many deposit products, which has helped reduce overall funding costs
by accelerating the repayment of more expensive brokered CDs and other long-term
debt. The Bank still holds substantial cash like balances, which provide the
necessary liquidity to the Bank's balance sheet, because of the increased
competition in the Bank's primary marketplace, management has continued to
recognize the importance of offering special rates on certain deposit products.
These special deposit rates tend to negatively affect the Corporation's net
interest margin.
Total deposits decreased $1,546, or 0.3%, from $565,153 at December 31, 2008 to
$563,607 at June 30, 2009. Deposit growth occurred in CDARS balances, which
provide increased levels of FDIC insurance coverage for CDs. The Bank had
approximately $151,000 in CDARS deposits outstanding at June 30, 2009.
Noninterest-bearing deposits increased $934, or 1.9%, and interest bearing
deposits decreased $2,480, or 0.5% during the quarter ended June 30, 2009. In
addition, brokered CD's declined $5.4 million, or 69.2%, from December 31, 2008
to $2,400 at June 30, 2009. The Corporation utilizes a variety of alternative
funding sources due to competitive challenges within its primary market. Total
borrowings decreased $18,388, or 20.8% from $88,384 at December 31, 2008, to
$69,996 at June 30, 2009, in a planned effort to reduce long-term debt and
remove the pledges of related collateral to provide additional liquidity.
Management will continue to analyze opportunities to reduce high cost long-term
debt.
Provision and Allowance for Loan Losses. The provision for loan losses
represents the charge to income necessary to adjust the allowance for loan
losses to an amount that represents management's assessment of the losses known
and inherent in the Bank's loan portfolio. All lending activity contains
associated risks of loan losses and the Bank recognizes these credit risks as a
necessary element of its business activity.
The provision for loan losses totaled $1,707 for the three months ended June 30,
2009, compared to $600 for the same period in 2008. DCB maintains an allowance
for loan losses at a level to absorb management's estimate of probable inherent
credit losses in its portfolio. Charge-offs during the three months ended
June 30, 2009 were mainly attributed to the commercial investment property and
commercial loan portfolios. Non-accrual loans at June 30, 2009 decreased
significantly to $5,242 from $10,360 at December 31, 2008. The majority of
non-accrual balances are attributed to loans in the investment real estate and
commercial real estate sectors that were not generating sufficient cash flow to
service the debt. In addition, delinquent loans over thirty days decreased to
1.15% at June 30, 2009 from 1.92% at December 31, 2008. Management will continue
to focus on activities related to monitoring, collection, and workout of
delinquent loans.
Net charge-offs for the three months ended June 30, 2009 increased slightly to
$732 compared to $691 for the three months ended June 30, 2008. However, net
charge-offs decreased $1,820 for the quarter ending June 30, 2009 from the first
quarter of 2009. Annualized net charge-offs for the three months ended June 30,
2009 were 0.58% compared to 0.53% at June 30, 2008 and 1.98% for the first
quarter 2009. The balance of allowance for loan losses was $7,995, or 1.60% of
total loans at June 30, 2009, compared to $6,137, or 1.20% of total loans at
December 31, 2008.
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DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Noninterest Income. Total noninterest income increased $369, or 24.3%, for the
three months ended June 30, 2009, compared to the three months ended June 30,
2008. The increase was attributable to a $462 gain on sales of investment
securities, as management elected to realign the Bank's balance sheet through
sales of securities and a corresponding repayment of long-term debt.
Additionally, the Bank's gains on sale of newly originated loans increased $64
over the three months ended June 30, 2008. These increases in noninterest income
were partially offset by an increase in losses on sales of foreclosed properties
and a decline in wealth management, data processing and other
transactional-based revenue streams, due primarily to the continuing slow
economic environment.
Noninterest Expense. Total noninterest expense increased $1,328, or 26.8%, for
the three months ended June 30, 2009, compared to the three months ended
June 30, 2008. The increase was primarily the result of $533 in pre-payment
penalties on FHLB borrowings related to the aforementioned balance sheet
realignment, a $472 increase in FDIC deposit insurance premiums and special
deposit insurance assessment, an increase of $47 in state franchise taxes and an
increase of $110 in professional fees incurred with loan workouts. The Bank has
continued to manage its problem credits with the involvement of various
consultants with expertise in property management and workout.
Income Taxes. The Corporation recorded a tax credit totaling $308 for the three
months ended June 30, 2009, compared to a tax expense of $407 in 2008. The
change in income tax expense (benefit) is primarily attributable to the decrease
in pre-tax income coupled with an increase in tax exempt income. The 2008 period
included a $227 credit for the resolution of a tax contingency.
COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS
ENDED JUNE 30, 2009 AND JUNE 30, 2008
Net Income (Loss). The Corporation's net loss for the six months ended June 30,
2009 totaled $1,280, compared to net income of $2,522 for the same period in
2008. The per share loss was $0.34 for the six months ended June 30, 2009
compared to earnings per share of $0.68, for the six months ended June 30, 2008.
The decrease was attributable to the increases in the provision for loan losses
expense associated with commercial and commercial real estate loan portfolios.
In addition, the Corporation's operating expenses increased due to a special
FDIC insurance assessment and higher premium rates, professional fees associated
with loan workouts, increased franchise taxes and pre-payment penalties related
to the early payoff of long-term debt. Some of these costs were offset by gains
from the sale of securities, used to fund the early payoffs during the six
months ended June 30, 2009.
Net Interest Income. Net interest income was $10,856 for the six months ended
June 30, 2009, compared to $11,131 for the same period in 2008. The $275
decrease was mainly attributed to a decrease in loan balances offset by a
favorable decline in interest expense on deposits. Strong deposit pricing
competition and lower rates have continued to pressure the net interest margin.
However, management continues to focus on productive pricing initiatives in both
loans and deposits, as the Corporation's needs continue to change.
The Bank has seen deposit growth primarily in products such as time deposits and
money market accounts, which generally carry higher costs compared to checking
and savings products. These higher cost deposit products and other borrowings
may continue to be utilized by management, which may further negatively impact
the net interest margin in future periods.
Provision and Allowance for Loan Losses. The provision for loan losses totaled
$5,142 for the six months ended June 30, 2009, compared to $1,200 for the same
period in 2008. The Bank maintains an allowance for loan losses at a level to
absorb management's estimate of probable inherent credit losses in its
portfolio.
Annualized net charge-offs for the six months ended June 30, 2009 were 1.29%
compared to 0.70% for the same period in 2008. The largest percentage of
charge-offs during the six months ended June 30, 2009 was attributed to economic
conditions that primarily affected the Columbus investment properties, and to a
lesser extent the Corporation's commercial business portfolio. The majority of
non-accrual balances are attributed to loans in the investment real estate
sector that were not generating sufficient cash flow to service the debt.
Delinquent loans over thirty days from period to period decreased to 1.15% at
June 30, 2009 from 2.91% at June 30, 2008, and again are mainly attributed to
the real estate investment portfolio.
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DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Management will continue to focus on activities related to monitoring,
collection, and workout of delinquent loans. Management also continues to
monitor exposure to industry segments, and believes that the loan portfolio
remains adequately diversified.
Noninterest Income. Total noninterest income decreased by $11, or 0.3%, for the
six months ended June 30, 2009, compared to the same period in 2008. The change
in noninterest revenues from period to period is attributable to an increase in
losses on sales of foreclosed properties and a decline in wealth management,
data processing and other transactional-based revenue streams, due primarily to
the continuing slow economic environment, all of which were offset by a $462
gain on sales of investment securities, as management elected to realign the
Bank's balance sheet through sales of securities and a corresponding repayment
of long-term debt.
Noninterest Expense. Total noninterest expense increased $1,552, or 15.8%, for
the six months ended June 30, 2009, compared to the same period in 2008. The
increase was primarily due to an increase in occupancy and equipment of $89, or
4.3%, professional services of $114, or 27.9%, state franchise taxes of $147, or
77.0%, pre-payment penalties on FHLB borrowings of $533 related to the
aforementioned balance sheet realignment and increased FDIC deposit insurance
premiums and special deposit insurance assessment of $609. The Corporation
experienced an increase in consulting and professional fees primarily due to the
management of OREO properties and non-performing loans.
Income Taxes. The Corporation recorded a tax credit totaling $1,072 for the six
months ended June 30, 2009, compared to a tax expense of $906 for the same
period in 2008. The change in income tax expense (benefit) is primarily
attributable to the decrease in pre-tax income coupled with an increase in tax
exempt income.
LIQUIDITY
Liquidity is the ability of the Corporation to fund customers' needs for
borrowing and deposit withdrawals. The purpose of liquidity management is to
assure sufficient cash flow to meet all of the financial commitments and to
capitalize on opportunities for business expansion. This ability depends on the
financial strength, asset quality and types of deposit and investment
instruments offered by the Corporation to its customers.
The Corporation's principal sources of funds are deposits, loan and security
repayments, maturities of securities, sales of securities available for sale and
other funds provided by operations. The Bank also has the ability to borrow from
the FHLB. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan and mortgage-backed
security prepayments are more influenced by interest rates, general economic
conditions, and competition. The Corporation maintains investments in liquid
assets based upon management's assessment of (1) need for funds, (2) expected
deposit flows, (3) yields available on short-term liquid assets and
(4) objectives of the asset/liability management program.
Cash and cash equivalents increased $20,743, or 61.7%, to $54,375 at June 30,
2009 compared to $33,632 at December 31, 2008. Cash and equivalents represented
7.9% of total assets at June 30, 2009 and 4.7% of total assets at December 31,
2008. The Corporation has the ability to borrow funds from both the Federal
Reserve and the Federal Home Loan Bank, and has various correspondent banking
partners to purchase overnight federal funds should the Corporation need to
supplement its liquidity needs. Management believes the Corporation's liquidity
position is adequate based on its current level of cash, cash equivalents, core
deposits, the stability of its other funding sources, and the support provided
by its capital base.
Table of Contents
DCB FINANCIAL CORP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
CAPITAL RESOURCES
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