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

Show all filings for COMMUNITY FINANCIAL CORP /VA/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for COMMUNITY FINANCIAL CORP /VA/


14-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ESULTS OF OPERATIONS.

EXECUTIVE SUMMARY

The following information is intended to provide investors a better understanding of the financial position and the operating results of Community Financial Corporation. The following is primarily from management's perspective and may not contain all information that is of importance to the reader. Accordingly, the information should be considered in the context of the consolidated financial statements and other related information contained herein.

Net income (loss) for the quarter ended September 30, 2011 increased $1.2 million to $709,000 compared to $(525,000) for the quarter ended September 30, 2010. Net income for the quarter increased primarily due to a provision for loan loss decrease of $1.6 million, or 58.9%, and an increase of $421,000, or 7.9% in net interest income resulting primarily from a decrease in interest expense. The decreased provision for the period was primarily related to lower charge-offs and management's analysis of the Bank's loan portfolio.

Net interest income for the quarter ended September 30, 2011 increased $421,000, or 7.9%, to $5.7 million compared to the quarter ended September 30, 2010. Net interest income, which is the difference between the interest income we earn on our interest-earning assets, such as loans and investment securities, and the interest we pay on interest-bearing liabilities, which are primarily deposits and borrowings. The primary factor contributing to the increase in net interest income for the quarter ended September 30, 2011 was lower rates paid on interest-bearing liabilities.

Management will continue to monitor asset growth to manage the level of regulatory capital and liquidity requirements. We continue to monitor the impact changing interest rates may have on both the growth in interest-earning assets and our interest rate spread. The Bank has approximately $348.6 million in adjustable rate loans, or 76.5% of total loans, which reprice in five years or less, many of which are subject to annual and lifetime interest rate limits. The pace and extent of future interest rate changes will impact the Company's interest rate spread as will limitations on interest rate adjustments on certain adjustable rate loans.

Our continued emphasis on acquiring interest and non-interest bearing transaction accounts, combined with a falling interest rate environment, has impacted the composition of our interest-bearing liabilities. Deposits were down approximately $9.8 million, or 2.6%, at September 30, 2011 from March 31, 2011, due to decreases in time deposits, partially offset by increases in interest bearing transaction accounts. Management plans to remain competitive in our deposit pricing. Due to relative pricing advantages, we have utilized brokered deposits and borrowings during the September 30, 2011 quarter. During the September 30, 2011 quarter, we experienced continuing competition for time deposits. Management is cognizant of the potential for compression in the Bank's margin related to the need to acquire funds and the pace of interest rate changes. Management will continue to monitor the level of deposits and borrowings in relation to the current interest rate environment.

The Bank's loan portfolio decreased $17.8 million from March 31, 2011 to September 30, 2011. This decrease was primarily in residential real estate loans, construction loans and consumer loans. We expect our future loan growth to be slow or moderate due to a slower economy and underwriting changes to limit funding of speculative construction loans. We have experienced reduced construction activity in our market areas and existing commercial real estate activity continues to be weak. At September 30, 2011, our assets totaled $516.8 million, including net loans receivable of $460.5 million, compared to total assets of $530.1 million, including net loans receivable of $478.3 million, at March 31, 2011. Commercial real estate loans were $181.3 million or 38.8%, residential real estate loans were $184.1 million or 39.4%, construction loans totaled $17.1 million or 3.7%, and commercial business loans were $49.3 million or 10.5% of our total loan portfolio at September 30, 2011 compared to commercial real estate loans of $181.8 million or 37.5%, residential real estate loans of $195.1 million or 40.1%, construction loans of $20.7 million or 4.3%, and commercial business loans of $49.1 million or 10.1% at March 31, 2011.

At September 30, 2011, non-performing assets totaled $23.3 million or 4.51% of assets compared to $16.6 million or 3.12% of assets at March 31, 2011. Our allowance for loan losses to non-performing loans was 62.0% and to total loans was 1.62% at September 30, 2011 compared to 69.8% and 1.67%, respectively at March 31, 2011. The increase in nonperforming assets consisted of a $6.1 million increase in nonaccrual loans and $641,000 in real estate owned and repossessed assets. Due primarily to the slow economy, we recognize the possibility of an increase in non-performing assets in the future. Charge-offs of $2.2 million during the six month period consisted primarily of $1.6 million of residential real estate loans, $403,000 of commercial real estate loans, $83,000 of commercial business loans and $124,000 of automobile loans.

Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. We have experienced stable to moderate declines in real estate values in our market areas. General downward economic trends, reduced availability of commercial credit and continuing high unemployment have negatively impacted the performance of commercial and consumer credit, resulting in additional write-downs. While there have been increases in unemployment and announced layoffs by certain employers in our markets, there has not been a dramatic or widespread increase in unemployment to date. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by other financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased delinquencies relative to the historical norm, lack of customer confidence, increased market volatility and widespread reduction in general business activity.

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more difficult and complex under these difficult market and economic conditions. We may be required to pay higher FDIC premiums if financial institution failures continue to deplete the FDIC insurance fund and reduce the FDIC's ratio of reserves to insured deposits.

We do not expect these difficult conditions to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.

Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act that was enacted on July 21, 2010, provides, among other things, for new restrictions and an expanded framework of regulatory oversight for financial institutions and their holding companies, including the Company and the Bank. Under the new law, the Bank's primary regulator, the Office of Thrift Supervision, was eliminated and existing federal thrifts are subject to regulation and supervision by the Office of Comptroller of the Currency, which supervises and regulates all national banks. In addition all financial institution holding companies, including the Company, are now regulated by the Board of Governors of the Federal Reserve System, and this regulation will eventually include the application of federal capital requirements similar to those imposed on all commercial banks and may result in additional restrictions on investments and other holding company activities. The law also created a new consumer financial protection bureau that has the authority to promulgate rules intended to protect consumers in the financial products and services market. The creation of this independent bureau could result in new regulatory requirements and raise the cost of regulatory compliance. In addition, new regulations mandated by this Act could require changes in regulatory capital requirements, loan loss provisioning practices, and compensation practices and will require holding companies to serve as a source of strength for their financial institution subsidiaries. Effective July 21, 2011, financial institutions may pay interest on demand deposits, which could increase our future interest expense. We cannot determine the impact of the new law on our business and operations at this time. Any legislative or regulatory changes in the future could adversely affect our operations and financial condition.

CRITICAL ACCOUNTING POLICIES

General

The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant

extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that are inherent in our loan portfolio. The allowance is based on generally accepted accounting principles which require that losses be accrued when they are probable of occurring and estimable and that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The allowance for loan losses is maintained at a level considered by management to be adequate to absorb future loan losses currently inherent in the loan portfolio. Management's assessment of the adequacy of the allowance is based upon type and volume of the loan portfolio, past loan loss experience, existing and anticipated economic conditions, and other factors which deserve current recognition in estimating future loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Additions to the allowance are charged to operations. Subsequent recoveries, if any, are credited to the allowance. Loans are charged-off partially or wholly at the time management determines collectability is not probable. Management's assessment of the adequacy of the allowance is subject to evaluation and adjustment by the Company's regulators.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers special mention and non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

FINANCIAL CONDITION

The Company's total assets decreased $13.3 million to $516.8 million at September 30, 2011 from $530.1 million at March 31, 2011 due to decreases in loans receivable of $17.8 million, partially offset by increases in cash of $3.0 million, real estate owned of $641,000 and investment securities of $1.2 million. As stated above, the decline in our loan portfolio was primarily in residential real estate loans, construction loans and consumer loans. We expect our future loan growth to be slow or moderate due to a slower economy and underwriting changes to limit funding of

speculative construction loans. We have also experienced reduced construction activity in our market areas while existing commercial real estate activity continues to be weak.

Deposits decreased $9.8 million, or 2.6% to $369.3 million at September 30, 2011, from $379.1 million at March 31, 2011. The decrease was primarily due to a decrease in time deposits of $25.5 million and savings of $436,000, partially offset by increases in non-interest bearing accounts of $3.9 million and money market and interest checking accounts of $12.2 million. The decrease in deposits was related to the decrease in our assets and funding needs. The decrease in deposits was generally achieved by lowering the rates offered on our time deposit products. FHLB advances decreased $4.0 million and other borrowings decreased $765,000 at September 30, 2011 from March 31, 2011.

Stockholders' equity increased by $941,000 to $50.7 million at September 30, 2011, from $49.8 million at March 31, 2011, due to income for the six months ended September 30, 2011 of $1.3 million, partially offset by cash dividend payments on our preferred stock.

At September 30, 2011, non-performing assets totaled $23.3 million or 4.51% of assets compared to $16.6 million or 3.12% of assets at March 31, 2011. Non-performing assets at September 30, 2011 were comprised of repossessed assets of $11.0 million and non accrual loans of $12.3 million. Included in the total non-performing assets at September 30, 2011, was one single family non accrual property totaling $2.2 million and one hotel non accrual property totaling $3.3 million. At September 30, 2011, our allowance for loan losses to non-performing loans was 62.0% and to total loans was 1.62% compared to 69.8% and 1.67%, respectively at March 31, 2011. Our allowance for loan losses decreased $247,000 at September 30, 2011 compared to March 31, 2011 due to allowances for specific loans and decreased loan balances. Charged off loans during the September 30, 2011 quarter included loans on which specific reserves had been established at March 31, 2011. Based on current market values of the properties securing our loans, management anticipates no significant losses in excess of the allowance for losses previously recorded. Although management believes that it uses the best information available to make such determinations, future adjustments to allowances may be necessary, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations. We also had $21.4 million of loans that were classified as Troubled Debt Restructurings (TDRs) at September 30, 2011, of which $2.5 million were included in nonaccrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

As of September 30, 2011, there were also $37.6 million in loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the security properties have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing loan categories. These loans are comprised primarily of non-owner occupied commercial and residential real estate loans with an average balance of approximately $166,000. The largest individual loan or lending relationship in this category has a balance of $3.2 million and is secured by a hotel. This loan is of concern due to cash flow issues. There are also seven additional loans with balances greater than $1.0 million. A loan 60 days delinquent is generally included in this category and monitored until it has been current for six months. Certain loans that are not delinquent may be included due to the nature of the loan's purpose such as construction or where the loan exhibits other potential weaknesses.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of funds are customer deposits, advances from the Federal Home Loan Bank of Atlanta, amortization and prepayment of loans, and funds provided from operations. Management maintains investments in liquid assets based upon its assessment of (i) the need for funds, (ii) expected deposit flows, (iii) the yields available on short-term liquid assets, (iv) the liquidity of our loan portfolio and (v) the objectives of our asset/liability management program. Management believes that the Bank will continue to have adequate liquidity for the foreseeable future. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is provided. As of September 30, 2011, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings and current borrowings) was 3.6% compared to 2.5% for the same quarter last year.

The Bank has a line of credit with the FHLB equal to 26% of the Bank's assets, subject to the amount of collateral pledged. Under the terms of its collateral agreement with the FHLB, the Bank provides a blanket lien covering all of its residential first mortgage loans, home equity lines of credit, multi-family loans and commercial loans. In addition, the Bank pledges as collateral its capital stock in and deposits with the FHLB. Based on the collateral pledged as of September 30, 2011, the total amount of borrowing available under the FHLB line of credit was approximately $131.2 million. At September 30, 2011, principal obligations to the FHLB consisted of $93.0 million in fixed-rate short term borrowings and we had a $4.0 million letter of credit to the Treasurer of Virginia securing public deposits.

At September 30, 2011, we had commitments to purchase or originate $3.8 million of loans. Certificates of deposit scheduled to mature in one year or less at September 30, 2011, totaled $151.3 million. Based on our historical experience, management believes that a significant portion of such deposits will remain with us. Management further believes that loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs. Due to the weak economy, the Bank has experienced reduced loan demand and anticipates a reduced liquidity need for loan funding. At September 30, 2011, we had brokered or internet time deposits of $11.8 million compared to $15.3 million at March 31, 2011.

The Bank's regulatory capital is characterized as "well capitalized" due to the issuance of preferred stock under the U.S. Treasury Capital Purchase Program. The Company received $12,643,000 from the U.S. Treasury through the sale of 12,643 shares of preferred stock. The Company also issued to the U.S. Treasury a warrant to purchase 351,194 shares of common stock at $5.40 per share. The preferred shares pay a cumulative dividend of 5% per year for the first five years and 9% per year thereafter. The preferred shares are redeemable at any time by the Company at 100% of the issue price, subject to the approval of the Company's and the Bank's federal regulators.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2011 and 2010.

General. Net income (loss) for the three months ended September 30, 2011 increased $1.2 million to $709,000 from ($525,000) for the three months ended September 30, 2010. Net interest income increased $421,000, the provision for loan losses decreased $1.6 million, non-interest income decreased $54,000 and non-interest expense decreased $15,000 during the three months ended September 30, 2011 compared to the same period in 2010. Return on equity for the three months ended September 30, 2011 was 5.63% compared to (4.24)% for the three month period ended September 30, 2010. Return on assets was .55% for quarter ended September 30, 2011 compared to (.38)% for the same period in the previous fiscal year.

Interest Income. Total interest income decreased $173,000, or 2.5% to $6.6 million for the three months ended September 30, 2011, from $6.8 million for the three months ended September 30, 2010, due to a decrease in the volume of our portfolio. The average yield earned on interest-earning assets was 5.53% for the three months ended September 30, 2011 compared to 5.58% for the three months ended September 30, 2010.

Interest Expense. Total interest expense decreased $593,000, or 39.7% to $900,000 for the quarter ended September 30, 2011, from $1.5 million for the quarter ended September 30, 2010. Interest on deposits decreased $418,000 to $861,000 for the quarter ended September 30, 2011 from $1.3 million for the quarter ended September 30, 2010 due to a decrease in the average rate paid and lower average deposit balances. The average rate paid on deposits was .92% during the three months ended September 30, 2011 compared to 1.31% for the three months ended September 30, 2010. The decrease in the average rate paid on deposits was due primarily to market interest rate changes as well as a change in our deposit mix to more low cost transaction account deposits and fewer higher cost certificate accounts. Interest expense on borrowed money decreased $175,000 to $39,000 for the quarter ended September 30, 2011 compared to $214,000 for the quarter ended September 30, 2010. A decrease in the average rate paid on borrowings from 0.81% for the September 30, 2010 quarter to 0.16% for the September 30, 2011 quarter and a decrease in the average balance of borrowings from $104.5 million to $96.6 million accounted for the decrease. The average rate paid on all interest-bearing liabilities was 0.77% during the three months ended September 30, 2011 compared to 1.21% for the three months ended September 30, 2010.

Provision for Loan Losses. The provision for loan losses decreased $1.6 million, or 58.9%, to $1.1 million for the three months ended September 30, 2011, from $2.7 million for the three months ended September 30, 2010, primarily as a result of the decreased level of charge-offs during the period.

Noninterest Income. Noninterest income decreased $54,000, or 5.0%, to $1.0 million for the three months ended September 30, 2011, from $1.1 million for the three months ended September 30, 2010. Service charges, fees and commissions decreased $108,000, or 10.9%, due to a decrease in service charge and fees on loan accounts and secondary mortgage market fee income. The Bank has established relationships with other institutions where the Bank receives fees in return for completed customer mortgage loan applications for the institution's approval and funding. We anticipate these relationships will continue to be a source of fee and service charge income for the Bank. Other noninterest income increased $54,000, or 56.4%, to $148,000 for the three months ended September 30, 2011 compared to the same period in 2010, primarily due to increases in rental income from OREO properties that were not present in the 2010 period.

Noninterest Expense. Noninterest expense decreased $15,000, or .03%, to $4.5 million for the three months ended September 30, 2011 compared to $8.6 million for the same period last year. The decrease in noninterest expense for the current period resulted primarily from a $104,000, or 59.6% decrease in FDIC insurance premiums and a $64,000, or 49.3% decrease in professional expenses partially offset by a $104,000 or 5.7% increase in compensation related expenses due to cost of living increases in the current fiscal year.

Taxes. Taxes (benefit) increased $753,000 to $400,000 for the three months ended September 30, 2011, from ($353,000) for the three months ended September 30, 2010. The effective tax rate for the September 30, 2011 quarter was 36.1%.

Six Months Ended September 30, 2011 and 2010.

General. Net income for the six months ended September 30, 2011 increased $795,000 to $1.3 million from $462,000 for the six months ended September 30, 2010. Net income for the six months increased due primarily to an increase in net interest income and decrease in the provision for loan losses and was partially offset by an increase in other noninterest expenses. Return on equity for the six months ended September 30, 2011 was 4.94% compared to 1.84% for the six month period ended September 30, 2010. Return on assets was .48% for six months ended September 30, 2011 compared to .17% for the same period in the previous fiscal year.

Interest Income. Total interest income decreased $559,000, or 4.0%, to $13.5 million for the six months ended September 30, 2011, from $14.1 million for the six months ended September 30, 2010 due to a decrease in average loan balances. The yield on loans and securities increased from 5.52% to 5.61% for the same periods.

Interest Expense. Total interest expense decreased $1.2 million, or 38.9%, to $1.9 million for the six months ended September 30, 2011, from $3.1 million for the six months ended September 30, 2010. Interest on deposits decreased to $864,000 for the six months ended September 30, 2011, from $2.7 million for the same period last year due to a decrease in the average rate paid on deposit balances and decrease in average deposit balances. The rate paid on deposits decreased from 1.37% for the six months ended September 30, 2010 to .98% for the same period in the current fiscal year. The decrease in the average rate paid on deposits was due primarily to market changes. Interest expense on borrowed money decreased to $347,000 for the six months ended September 30, 2011 from $431,000 for the six months ended September 30, 2010 due to a decrease in the average rate on borrowing balances and a decrease in the average outstanding balance on borrowings. The average balance on borrowings decreased from $102.5 million for the six months ended September 30, 2010 to $96.4 million for the six months ended September 30, 2011. The average rate paid on borrowings decreased from .84% for the six months ended September 30, 2010 to .17% for the six month period ended September 30, 2011.

Provision for Loan Losses. The provision for loan losses decreased $1.9 million, or 51.5%, to $1.8 million for the six months ended September 30, 2011 from $3.7 million for the six months ended September 30, 2010, primarily as a result of the decreased level of charge-offs during the period. Charge-offs totaled $2.2 million during the six month period ended September 30, 2011, compared to $4.3 million during the same period in 2010, were related to residential real estate . . .

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