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BKOR > SEC Filings for BKOR > Form 10-Q on 14-Nov-2011All Recent SEC Filings

Show all filings for OAK RIDGE FINANCIAL SERVICES, INC.

Form 10-Q for OAK RIDGE FINANCIAL SERVICES, INC.


14-Nov-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion and analysis is intended to assist readers in understanding and evaluating our consolidated financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

We are a commercial bank holding company, incorporated in 2007. The accompanying consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiary, the Bank. All significant intercompany transactions and balances are eliminated in consolidation.

The Bank was incorporated and began banking operations in 2000. The Bank is engaged in commercial banking predominantly in Guilford and Forsyth Counties, North Carolina. The Bank is operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation ("FDIC") and the North Carolina Commissioner of Banks. The Bank's primary source of revenue is derived from loans to customers, who are predominantly individuals and small to medium size businesses in Guilford County.

Executive Overview

Executive Summary

For the first nine months of 2011, with the continuing impact of a sluggish economy, management has continued to focus on managing credit quality, building liquidity sources and managing capital. As always, we continue our on-going efforts of meeting the financial services needs of our customers and communities, especially in this challenging economic environment.

Managing Credit Quality

Senior management continues to work closely with credit administration and our lending staff to insure that adequate resources are in place to proactively manage through the current slowdown in the real estate markets and overall economy. When problems are identified, management remains diligent in assessing the situation, moving quickly to minimize losses, while being sensitive to the borrower's effectiveness as an operator, the long-term viability of the business or project, and the borrower's commitment to working with the Bank to achieve an acceptable resolution of the credit. As the economic slowdown has continued, we have experienced a rise in non-performing assets, and we address each situation on a case-by-case basis. When faced with possible loss situations, management may determine it is in the shareholders' best long-term interest to work with the borrower or oversee a viable project through to completion.

We anticipate that a prolonged economic slowdown will place significant pressure on the consumers and businesses in North Carolina. We have attempted to proactively address the needs of the Bank, our borrowers, and the community through our Community Loan Investment Program, which has been in place since February 2009, and offers incentives to buyers of our builder's homes financed by the Bank. Through our Community Loan Investment Program, which is being utilized by the majority of our builders', as of September 30, 2011 we have been able to move 17 out of 19 jumbo homes and 16 out of 19 conventional homes out of our builder construction portfolio-either to permanent mortgages placed with other lenders or permanent mortgages financed by the Bank to qualified borrowers. The program has resulted in the reduction of our exposure to jumbo homes from $10.5 million to $1.2 million, and the reduction of our exposure to conventional homes from $4.9 million to $704 thousand. This program can be accessed through our website at www.bankofoakridge.com.

We have also extended the Community Loan Investment Program to cover the residential lot inventory of our development borrowers, and rolled out an incentive program targeted specifically at our financed lots in April of 2011.

Building Liquidity Sources

Management has continued to focus on providing additional liquidity sources, both on-balance sheet and off. During the nine months ended September 30, 2011, we had a continuation of the significant shift that was present in 2010 in our deposit mix, as noninterest-bearing and interest-bearing checking accounts increased $5.7 million and $6.5 million, respectively, from December 31, 2010 to September 30, 2011, driven by what we believe was a move away from large financial institutions to smaller community banks like ours. The increase in noninterest-bearing and interest-bearing checking accounts allowed us to decrease time deposits by $13.4 million from December 31, 2010 to September 30, 2011.


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Managing Capital

The Company was able to bolster its capital levels through its $7.7 million participation in the Capital Purchase Program ("CPP") on January 30, 2009. Of the total $7.7 million CPP funds received, to date $4.6 million of the CPP funds have been contributed to the Bank as additional equity capital. Approximately $3.3 million in unused capital, which includes approximately $100,000 in earnings since the Company received the CPP funds, are retained by the Company but could be pushed down to the Bank if needed. With total risk-based capital levels at the Bank of 13.5% at September 30, 2011, the Bank is above the minimum 10% requirement to be classified as well-capitalized. If the remaining $3.3 million of available capital at the Company were contributed to the Bank as additional equity capital, the Bank's total risk-based capital ratio would be 14.8% at September 30, 2011 and would place it well above the minimum well-capitalized requirement of 10%. Despite healthy capital levels, due to significant uncertainty surrounding the depth or the length of the current economic slowdown, management continues to be diligent in its efforts to maintain healthy levels of excess capital above minimum requirements. In early 2011, the Company's Board of Directors and senior executives had two separate presentations with investment firms to look at the feasibility of raising common equity to allow the Company to repay the U.S. Treasury for its $7.7 million investment in the Company through the CPP. The Company has concluded that at the current time it is not feasible, due to weak equity market conditions, or preferable, due to the potential dilution of current shareholders, to raise equity in the open markets. However, the Company established an Employee Stock Ownership Plan ("ESOP") in the second quarter of 2010 as one possible vehicle to generate equity. During the year ended December 31, 2010, the Company, at the request of the Board of Directors, made a $900,000 pre-tax ESOP accrual that may be converted to common equity of the Company at a later date. The Company believes that there are many advantages to an ESOP as a vehicle to raise capital, with the principal ones being favorable tax treatment of ESOP contributions, possible lower dilution to existing shareholders' compared to an equity offering, and the promotion in our marketplace of every employee as a participant in the ESOP owning a part of the Company.

Our core strategies continue to be (1) grow the loan portfolio while maintaining high asset quality; (2) increase noninterest income; (3) grow core deposits;
(4) manage expenses; and (5) make strategic investments in personnel and technology to increase revenue and increase efficiency.


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Challenges

We have grown steadily since the opening of the Bank in April of 2000, and our business has become more dynamic and complex in recent years as we have enhanced or added delivery channels, products and services, and lines of businesses. While the achievement of our strategic initiatives and established long-term financial goals is subject to many uncertainties and challenges, management has identified the challenges that are most relevant and most likely to have a near-term effect on operations, which are presented below:

Continuing to maintain our asset quality, especially in an uncertain and weak economic environment;

Addressing the challenges associated with a weak economic environment in our geographic market;

Improving efficiency and controlling noninterest expenses;

Maintaining our net interest margin in the current interest rate environment;

Increasing core deposits;

Increasing interest and noninterest revenue;

Controlling costs associated with the current heightened regulatory environment;

Volatility in the mortgage banking business;

Competition from bank and nonbank financial service providers; and

Intense price competition.

Comparison of Results of Operations for the Three- and nine-month Periods Ending September 30, 2011 and 2010

Net Income

The following table summarizes components of income and expense and the changes in those components for the three- and nine-month periods ended September 30, 2011 as compared to the same period in 2010.

Condensed Consolidated Statements of Income (Dollars in thousands)



                                       For the Three                                   For the Nine
                                          Months             Changes from the             Months              Changes from the
                                           Ended                Prior Year                 Ended                 Prior Year
                                       September 30,                                   September 30,
                                           2011            Amount          %               2011             Amount          %

Total interest income                 $         4,281      $  (231 )        (5.1 )    $        13,116      $   (477 )        (3.5 )
Total interest expense                            798         (351 )       (30.5 )              2,620        (1,047 )       (28.6 )


Net interest income                             3,483          120           3.6               10,496           570           5.7
Provision for loan losses                         960          199          26.1                2,827           929          48.9

Net interest income after provision
for loan losses                                 2,523          (79 )        (3.0 )              7,669          (359 )        (4.5 )
Noninterest income                                836         (166 )       (16.6 )              2,794          (419 )       (13.0 )
Noninterest expense                             3,302         (257 )        (7.2 )             10,087          (114 )        (1.1 )

Income (loss) before income taxes                  57           12          26.7                  376          (664 )       (63.8 )
Income tax expense (benefit)                      (18 )        (22 )      (550.0 )                 30          (316 )       (91.3 )

Net income                                         75           34          82.9                  346          (348 )       (50.1 )
Preferred stock dividend and
accretion of discount                            (163 )         (4 )         2.5                 (490 )         (22 )         4.7

Net income available to common
shareholders                          $           (88 )    $    30         (25.4 )    $          (144 )    $   (370 )      (163.7 )

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended September 30, 2011 was $3.5 million, an increase of $120 thousand or 3.6% when compared to net interest income of $3.4 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, net interest income was $10.5 million, an increase of $570 thousand or 5.7% when compared to net interest income of $9.9 million for the same period in 2010.


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The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as non interest bearing deposits.

Interest income decreased $231 thousand or 5.1% for the three months ended September 30, 2011 compared to the same three months of 2010. Interest income decreased $477 thousand or 3.5% for the nine months ended September 30, 2011 compared to the same nine months in 2010. The decreases for the three and nine months ended September 30, 2011 are primarily due to decreases in rates earned on these assets. The yield on average earning assets decreased 30 basis points for the three months ended September 30, 2011 to 5.19% from 5.49% for the same period in 2010. For the first nine months of 2011, the yield on average earning assets decreased 29 basis points to 5.29% compared to 5.58% at September 30, 2010. Management attributes the decrease in the yield on our earning assets to the decline in yields available on investments as well as a slight decline in the offering rates on new loans.

Our average cost of funds during the three months ended September 30, 2011 was 1.11%, a decrease of 47 basis points when compared to 1.58% for the three months ended September 30, 2010. Average rates paid on deposits decreased 50 basis points from 1.60% for the three months ended September 30, 2010 to 1.10% for the three months ended September 30, 2011, while our average cost of borrowed funds increased 21 basis points during the three months ended September 30, 2011 compared to the same period in 2010. Total interest expense decreased $351 thousand or 30.5% during the three months ended September 30, 2011 compared to the same period in 2010, primarily the result of decreased market rates paid on these liabilities. For the nine months ended September 30, 2011, our cost of funds was 1.21%, a decrease of 48 basis points when compared to 1.69% for the same period in 2010. Average rates on deposits decreased 51 basis points from 1.72% to 1.21% for the first nine months of 2011, while our cost of borrowed funds increased 6 basis points compared to the same period a year ago. Total interest expense decreased $1.0 million or 28.6% during the nine months of 2011 compared to the same period in 2010, primarily the result of decreased market rates paid on these liabilities.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest bearing deposits in earning assets.

Our annualized net interest margin for the three months ended September 30, 2011 was 4.08% compared to 3.91% for the same period in 2010, while our net interest spread increased 13 basis points during the same period. For the nine months ended September 30, 2011, our net interest margin was 4.08% compared to 3.89% for the nine months ended September 30, 2010 while our net interest spread increased 16 basis points.

Management plans to continue to improve net interest income by growing our balance sheet while maintaining a constant or improving interest margin, however, it will be difficult to improve net interest income in the future if the growth in earning assets does not occur and we are is unable to maintain or increase the yield on average earning assets while maintaining or decreasing the cost of funds on borrowings.


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Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to net income. The following table presents the components of noninterest income for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands).

Sources of Noninterest Income (Dollars in thousands)



                                      For the Three                                  For the Nine
                                         Months            Changes from the             Months           Changes from the
                                          Ended               Prior Year                Ended               Prior Year
                                      September 30,                                 September 30,
                                          2011            Amount          %              2011           Amount          %

Service charges on deposit
accounts                             $            87     $    (76 )      (46.6 )    $          382     $   (175 )      (31.4 )
Gain on sale of securities                        -            -           N/A                 258         (128 )      (33.2 )
Mortgage loan origination fees                    60         (128 )      (68.1 )               168         (204 )      (54.8 )
Investment and insurance
commissions                                      284           36         14.5                 759           41          5.7
Fee income from accounts
receivable financing                             185          (27 )      (12.7 )               600          (38 )       (6.0 )
Debit card interchange income                    165           36         27.9                 459          104         29.3
Income earned on bank owned life
insurance                                         37           (5 )      (11.9 )               110          (16 )      (12.7 )
Other service charges and fees                    18           (2 )      (10.0 )                58           (3 )       (4.9 )

Total noninterest income             $           836     $   (166 )      (16.6 )    $        2,794     $   (419 )      (13.0 )

Noninterest income decreased $166 thousand or 16.6% to $836 thousand for the three months ended September 30, 2011 compared to $1.0 million for the same period in 2010. For the nine months ended September 30, 2011 noninterest income decreased $419 thousand or 13.0% to $2.8 million compared to $3.2 million for the same period in 2010. The decrease in noninterest income in the three months ended September 30, 2011 is primarily due to decreases from 2010 to 2011 in service charges on deposit accounts and mortgage loan origination fees. The year to date decrease in noninterest income is the result of decreases in the majority of noninterest income categories with the exception of investment and insurance commissions and debit card interchange income. Service charges on deposit accounts decreased $76 thousand and $175 thousand, respectively for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. The primary reason for this decline were decreases in non sufficient funds fees due to a greater customer awareness of such fees and regulations regarding such fees that affect the entire banking industry. Gain on sale of securities decreased $128 thousand for the nine months ended September 30, 2011 compared to the same period of 2010. The decline in the nine months ended September 30, 2011 compared to the same period in 2010 was due to a greater gain on sale of securities in 2010 as compared to 2011. Mortgage loan origination fees decreased $128 thousand and $204 thousand, respectively for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. The primary reason for the decrease was a decline in mortgage closings from 2010 to 2011 as the overall market for home purchases and refinancing remained relatively weak. Investment and insurance commissions increase $36 thousand and $41 thousand, respectively for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. Fee income from accounts receivable financing decreased $27 thousand and $38 thousand, respectively for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. The primary reason for the decrease was lower receivables of existing clients in 2011 as compared to 2010. Debit card interchange income increased $36 thousand and $104 thousand for the three and nine months ended September 30, 2011, respectively, as compared to the same periods in 2010. The primary reason for the increase was primarily the result of continued emphasis by management in the promotion of a debit card rewards program that caused higher cardholder usage in 2011 as compared to 2010. To a lesser extent, some of the increases were caused by the continued growth of checking accounts at the Bank during the three and nine months ending September 30, 2011 as compared to the same periods in 2010.


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Noninterest Expense

Noninterest expense decreased 7.2% for the three months ended September 30, 2011 compared to the same period in 2010, and decreased 1.1% for the nine months ended September 30, 2011 compared to the same period in 2010.

Sources of Noninterest Expense (Dollars in thousands)



                                           For the Three                                   For the Nine
                                              Months             Changes from the             Months            Changes from the
                                               Ended                Prior Year                 Ended               Prior Year
                                           September 30,                                   September 30,
                                               2011            Amount          %               2011           Amount          %

Salaries                                  $         1,551      $    58           3.9      $         4,442     $   231           5.5
Employee benefits                                     211           80         (58.0 )                577         132          29.7
Employee Stock Ownership Plan                         (25 )       (375 )      (107.1 )                 -         (650 )      (100.0 )
Occupancy expense                                     231           13           6.0                  649         (29 )        (4.3 )
Equipment expense                                     225           10           4.7                  652          18           2.8
Data and items processing                             247           17           7.4                  691         (33 )        (4.6 )
Professional and advertising                          277           66          31.3                  830          35           4.4
Stationary and supplies                                89           10          12.7                  315         107          51.4
Net loss on sale of foreclosed and
repossessed assets                                      3            3           N/A                  257         212         471.1
Expenses of foreclosed and repossessed
assets                                                 95           79         493.8                  137          45          48.9
Telecommunications expense                             54           (2 )        (3.6 )                164          (9 )        (5.2 )

FDIC assessment                                         7         (108 )       (93.9 )                285         (99 )       (25.8 )
Accounts receivable financing expense                  57          (11 )       (16.2 )                188         (23 )       (10.9 )
Total other-than-temporary impairment
loss                                                   -            -            N/A                   -          (21 )      (100.0 )

Other expense                                         280          (97 )       (25.7 )                900         (30 )        (3.2 )

Total noninterest expense                 $         3,302      $  (257 )        (7.2 )    $        10,087     $  (114 )        (1.1 )

Salary expense for the three and nine months ended September 30, 2011 increased $58 thousand and $231 thousand, respectively, compared to the same prior year periods. The increases were due to regular salary increases and market adjustments that went into effect for all employees on January 1, 2011, as well as new positions that were added during the nine months ended September 30, 2011.

Employee benefits for the three and nine months ended September 30, 2011 increased $80 thousand and $132 thousand, respectively, over the same prior year periods. The principal reason for this increase were increases in health care premiums for the Bank and its employees that went into effect on June 1, 2011, as well as a higher number of employees during 2011 than 2010.

Employee Stock Ownership Plan expense for the three and nine months ended September 30, 2011 decreased $375 thousand and $650 thousand, respectively, over the same prior year periods. The principal reason for these decreases were that no contributions were made to Employee Stock Ownership Plan accrual in the three and nine months ended September 30, 2011 compared to the same period in 2010.

Occupancy, equipment and data and items processing expenses for the three and nine months ended September 30, 2011 were relatively unchanged compared to the same prior year periods.

Professional and advertising expenses for the three and nine months ended September 30, 2011 increased $66 thousand and $35 thousand, respectively, over the same prior year period. In both the three and nine month periods, increases in marketing and advertising expenses offset by decreases in audit and consulting fees accounted for the net increase.

Stationary and supplies expenses for the three and nine months ended September 30, 2011 increased $10 thousand and $107 thousand, respectively, over the same prior year period. In both the three and nine month periods, greater mailings to customers and prospects accounted for the majority of the increase.

Net loss on sale of foreclosed and repossessed assets for the three and nine months ended September 30, 2011 increased $3 thousand and $212 thousand, respectively, over the same prior year periods. The primary reason was higher write-downs on other real estate during the three and nine months in 2011 when compared to same periods in 2010.


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Expenses of foreclosed and repossessed assets for the three and nine months ended September 30, 2011 increased $79 thousand and $45 thousand, respectively, over the same prior year periods. The primary reason was a higher level of carrying expenses in 2011 compared to 2010.

Telecommunications expense for the three and nine months ended September 30, 2011 was relatively unchanged compared to the same prior year periods.

FDIC assessment for the three and nine months ended September 30, 2011 decreased $108 thousand and $99 thousand, respectively, over the same prior year period. The FDIC assessment expense is primarily due to the expensing of a prepaid asset . . .

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