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BCSB > SEC Filings for BCSB > Form 10-K on 22-Dec-2011All Recent SEC Filings

Show all filings for BCSB BANCORP INC.

Form 10-K for BCSB BANCORP INC.


22-Dec-2011

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

General

The Company is a Maryland corporation which was organized to be the stock holding company for the Bank in connection with our second-step conversion and reorganization completed on April 10, 2008, discussed further below. On September 30, 2011, the Bank converted its charter from a federally chartered savings Bank to a Maryland-chartered commercial bank. The charter conversion is not expected to have any significant financial or regulatory impact or affect the Company's and the Bank's current activities. The Bank's deposit accounts are insured up to a maximum of $250,000 by the FDIC. The Bank's noninterest-earning demand deposit accounts have unlimited FDIC insurance.

The Company's net income is dependent primarily on its net interest income, which is the difference between interest income earned on its interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities ("interest rate spread"); and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. To a lesser extent, the Company's net income also is affected by the level of other income, which primarily consists of fees and charges, and levels of noninterest expenses such as salaries and related expenses.

The operations of the Company are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in the Company's market area.

Critical Accounting Policies and Estimates

Management's discussion and analysis of the Company's financial condition is based on the consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such 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.

Management believes the allowance for loan losses is a critical accounting policy that requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimated loss and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and management's estimation of losses. The use of different estimates or assumptions could produce different provisions for loan losses. Refer to the discussion of "Allowance for Loan Losses" in Note 1 to the Consolidated Financial Statements for a detailed description of management's estimation process and methodology related to the allowance for loan losses.

Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. The term "other-than-temporary" is not necessarily intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Under the revised guidance, for recognition and presentation of other-than-temporary impairments the amount of other-than-temporary impairment that is recognized through earnings for debt securities is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.


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The Company accounts for income taxes under the asset/liability method. Deferred tax assets are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years 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 indicated by the enactment date. A valuation allowance is established for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond the Company's control. It is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

Repurchase of Series A Preferred Stock

On January 26, 2011, the Company repurchased all $10.8 million of its Series A Preferred Stock issued to the U.S. Treasury in March 2008 pursuant to the TARP Capital Purchase Program. The Company completed the repayment without raising additional capital. The TARP repayment will save the Company a minimum of $540,000 in future annual preferred dividends. As a result of the redemption, the Company accelerated accretion of the remaining discount on the preferred stock and recorded a reduction in retained earnings, thereby reducing net income available to common shareholders by approximately $310,000 in the second quarter of fiscal 2011. As a result of the redemption of the Series A Preferred Stock, the TARP restrictions on the payment of dividends and executive compensation were also lifted.

The warrant (the "Warrant") issued to the U.S. Treasury to purchase 183,465 shares of the Company's common stock has not been repurchased and remains outstanding. The Warrant term is 10 years and it is immediately exercisable, in whole or in part, at an exercise price of $8.83 per share. The Company and the Bank met all regulatory requirements to be considered well-capitalized under the federal prompt corrective action regulations as of September 30, 2011. For more information on the Series A Preferred Stock and Warrant issued to the U.S. Treasury in connection with the TARP Capital Purchase program. See Note 16 of Notes to Consolidated Financial Statements and "-Liquidity and Capital Resources."

Asset/Liability Management

The Company strives to achieve consistent net interest income and reduce its exposure to adverse changes in interest rates by attempting to match the terms to re-pricing of its interest-sensitive assets and liabilities. Factors beyond the Bank's control, such as market interest rates and competition, may also have an impact on the Bank's interest income and interest expense.

In the absence of any other factors, the overall yield or return associated with the Bank's earning assets generally will increase from existing levels when interest rates rise over an extended period of time, and conversely interest income will decrease when interest rates decrease. In general, interest expense will increase when interest rates rise over an extended period of time, and conversely interest expense will decrease when interest rates decrease. By managing the increases and decreases in its interest income and interest expense which are brought about by changes in market interest rates, the Bank can significantly influence its net interest income.

The senior officers of the Bank meet on a regular basis to monitor the Bank's interest rate risk position and to set prices on loans and deposits to manage interest rate risk within the parameters set by the Board of Directors. The President of the Bank reports to the Board of Directors on a regular basis on interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Board of Directors reviews the maturities of the Bank's assets and liabilities and establishes policies and strategies designed to regulate the Bank's flow of funds and to coordinate the sources, uses and pricing of such funds. The first priority in structuring and pricing the Bank's assets and


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liabilities is to maintain an acceptable interest rate spread while reducing the net effects of changes in interest rates. The Bank's management is responsible for administering the policies and determinations of the Board of Directors with respect to the Bank's asset and liability goals and strategies.

Market Risk

Management measures the Bank's interest rate risk by computing estimated changes in the net portfolio value ("NPV") of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is the difference between incoming and outgoing discounted cash flows from assets and liabilities, with adjustments made for off-balance sheet items. These computations estimate the effect on the Bank's NPV of sudden and sustained increases and decreases in market interest rates. The Bank's Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in the Bank's estimated NPV in the event of increases or decreases in market interest rates. The following table presents the Bank's projected change in NPV for the various rate shock levels at September 30, 2011.


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                                            Net Portfolio Value                                       NPV as % of Portfolio Value of Assets
Change in Rates         $ Amount             $ Change (1)             % Change (2)               NPV Ratio (3)                     Change (4)
                              (Dollars in Thousands)
+300 bp                 $  68,639           $      (12,992 )                    (16 )%                     11.01 %                         -155bp
+200 bp                    74,309                   (7,322 )                     (9 )                      11.73                            -83bp
+100 bp                    78,638                   (2,993 )                     (4 )                      12.24                            -32bp
+ 50 bp                    80,056                   (1,575 )                     (2 )                      12.39                            -17bp
    0 bp                   81,631                                                                          12.55
-  50 bp                   83,187                    1,556                        2                        12.73                             17bp
- 100 bp                   85,821                    3,890                        5                        13.03                             48bp

(1) Represents the excess (deficiency) of the estimated NPV assuming the indicated change in interest rates minus the estimated NPV assuming no change in interest rates.

(2) Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates.

(3) Calculated as the estimated NPV divided by average total assets.

(4) Calculated as the excess (deficiency) of the NPV ratio assuming the indicated change in interest rates over the estimated NPV ratio assuming no change in interest rates.

***Risk Measures: 200 bp rate shock***

                                                                 At September 30,
                                                                2011          2010
 Pre-Shock NPV Ratio: NPV as % of Portfolio Value of Assets      12.55 %       13.85 %
 Exposure Measure: Post Shock NPV Ratio                          11.73         12.95
 Sensitivity Measure: Change in NPV Ratio                       (83 bp )      (90 bp )

The above table indicates that at September 30, 2011, in the event of sudden and sustained increases in prevailing market interest rates, the Bank's NPV would be expected to decrease, and that in the event of a sudden and sustained decrease in prevailing market interest rates, the Bank's NPV would be expected to increase. The Bank's Board of Directors reviews the Bank's NPV position quarterly, and, if estimated changes in NPV are not within the targets established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board approved targets. At September 30, 2011, the Bank's estimated changes in NPV were within the targets established by the Board of Directors. NPV is calculated by the Office of the Comptroller of the Currency by using information provided by the Bank. The calculation is based on the net present value of discounted cash flows utilizing market prepayment assumptions.

Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates.

Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections set forth in the table, should market conditions vary from assumptions used in the preparation of the table. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In addition, the proportion of adjustable-rate loans in the Bank's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinance activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the tables. Finally, the ability of many borrowers to repay their adjustable-rate debt may decrease in the event of an interest rate increase.


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Average Balance, Interest and Average Yields and Rates

The following table sets forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yield and cost are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the years ended September 30, 2011, September 30, 2010 and September 30, 2009. Total average assets are computed using month-end balances. No tax-equivalent adjustments have been made as the Company did not invest in any tax exempt assets during the periods presented. The table also presents information for the periods indicated with respect to the differences between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or "interest rate spread," which banks have traditionally used as an indicator of profitability. Another indicator of net interest income is "net interest margin," which is its net interest income divided by the average balance of interest-earning assets.

                                                                                                         Year Ended September 30,
                                                                     2011                                          2010                                          2009
                                                    Average                      Average          Average                      Average          Average                      Average
                                                    Balance      Interest       Yield/Cost        Balance      Interest       Yield/Cost        Balance      Interest       Yield/Cost
                                                                                                          (Dollars in thousands)
Interest-earning assets:
Loans receivable (1)                               $ 376,951     $  22,909             6.08 %    $ 399,771     $  24,363             6.09 %    $ 397,984     $  24,565             6.17 %
Mortgage-backed securities                            96,562         3,386             3.51         83,288         4,264             5.12         92,157         5,148             5.59
Investment securities and FHLB stock                  12,137           413             3.40          2,102            33             1.62          2,052            37             1.80
Other interest-earning assets                         98,168           227              .23         77,480           202              .26         43,076           189              .44

Total interest earning assets                        583,818        26,935             4.61        562,641        28,862             5.13        535,269        29,939             5.59
Bank-owned life insurance                             15,943                                        15,280                                        14,658
Noninterest-earning assets                            25,060                                        24,675                                        30,568

Total assets                                       $ 624,821                                     $ 602,596                                     $ 580,495

Interest-bearing liabilities:
Deposits                                           $ 546,446     $   7,942             1.45 %    $ 516,729     $   9,173             1.78 %    $ 492,830     $  12,438             2.52 %
FHLB advances short-term                                  -             -                -              -             -                -           6,319           284             4.49
FHLB advances long-term                                   -             -                -              -             -                -              -             -                -
Junior subordinated debentures                        17,011           608             3.57         17,011           621             3.64         17,011           892             5.24
Other liabilities                                        936            -                -           1,385            -                -           1,918            -                -

Total interest-bearing liabilities                   564,393         8,550             1.51        535,125         9,794             1.83        518,078        13,614             2.63

Noninterest-bearing liabilities                        3,673                                         6,950                                         4,273

Total liabilities                                    568,066                                       542,075                                       522,351
Stockholders' equity                                  56,755                                        60,521                                        58,144

Total liabilities and stockholders' equity         $ 624,821                                     $ 602,596                                     $ 580,495

Net interest income                                              $  18,385                                     $  19,068                                     $  16,325

Interest rate spread                                                                   3.10 %                                        3.30 %                                        2.96 %

Net interest margin (2)                                                                3.15 %                                        3.39 %                                        3.05 %

Ratio of average interest-earning assets to
average interest-bearing liabilities                                                 103.44 %                                      105.14 %                                      103.32 %

(1) Includes nonaccrual loans.

(2) Represents net interest income divided by the average balance of interest-earning assets.


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Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by old rate); (ii) changes in rates (change in rate multiplied by old volume); and (iii) changes in rate/volume (changes in rate multiplied by the changes in volume).

                                                                              Year Ended September 30,
                                                         2011 v. 2010                                           2010 v. 2009
                                                                                 Increase (Decrease)
                                                                                       Due to
                                                                    Rate/                                                 Rate/
                                        Volume         Rate        Volume        Total        Volume         Rate        Volume        Total
                                                                                   (In thousands)
Interest income:
Loans receivable                       $ (1,390 )    $    (40 )    $   (24 )    $ (1,454 )    $   110      $   (311 )    $    (1 )    $   (202 )
Mortgage-backed securities                  680        (1,344 )       (214 )        (878 )       (496 )        (430 )         42          (884 )
Investment securities and FHLB stock        158            38          184           380            1            (5 )         -             (4 )
Other interest-earning assets                54           (23 )         (6 )          25          152           (77 )        (62 )          13

Total interest-earning assets              (498 )      (1,369 )        (60 )      (1,927 )       (233 )        (823 )        (21 )      (1,077 )
Interest expense:
Deposits                                    528        (1,705 )        (54 )      (1,231 )        603        (3,689 )       (179 )      (3,265 )
FHLB advances short-term                     -             -            -             -          (284 )          -            -           (284 )
FHLB advances long-term                      -             -            -             -            -             -            -             -
Subordinate debentures                       -            (13 )         -            (13 )         -           (271 )         -           (271 )
Other liabilities                            -             -            -             -            -             -            -             -

Total interest-bearing liabilities          528        (1,718 )        (54 )      (1,244 )        319        (3,960 )       (179 )      (3,820 )

Change in net interest income          $ (1,026 )    $    349      $    (6 )    $   (683 )    $  (552 )    $  3,137      $   158      $  2,743

Comparison of Financial Condition at September 30, 2011 and 2010

During the twelve months ended September 30, 2011, total assets increased by $4.3 million, or .69%, from $620.6 million at September 30, 2010 to $624.9 million at September 30, 2011. Our cash and cash equivalents decreased $48.8 million, or 44.8% from $108.9 million at September 30, 2010 to $60.1 million at September 30, 2011, primarily due to the deployment of available liquidity to invest in mortgage-backed securities. During the twelve months ended September 30, 2011, investment securities decreased by $11.6 million, or 62.4%, from $18.4 million at September 30, 2010 to $6.9 million at September 30, 2011. The decline was primarily due to contractual maturities since there were no sales of investment securities during the period. Mortgage-backed securities available for sale increased by $84.9 million, or 128.7%, from $66.0 million at September 30, 2010 to $150.9 million at September 30, 2011. The increase was primarily due to funds available from the declining loan portfolio and increased deposit portfolio. Net loans receivable decreased $23.2 million, or 6.0%, from $388.0 million at September 30, 2010 to $364.8 million at September 30, 2011. The decrease relates primarily to a decline in residential mortgages due to accelerated repayments and sales of new loan production. The Company has employed a strategy of selling newly originated long term fixed rate residential loans into the secondary loan market. Management's lending strategy remains focused on commercial real estate, commercial business and home equity lending.

Deposits increased by $15.6 million, or 2.9%, from $534.4 million at September 30, 2010 to $550.0 million at September 30, 2011. The Bank has been successful in attracting new deposits without increasing the overall cost for such funds.

Stockholders' equity decreased by $9.4 million, or 15.4%, from $61.4 million at September 30, 2010 to $52.0 million at September 30, 2011. This decrease was due primarily to the repurchase in January of 2011 of all $10.8 million of Series A Preferred Stock issued to the U.S. Treasury in December 2008 pursuant to the TARP Capital Purchase Program. The Company completed the repayment without raising additional capital.


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Asset Quality. At September 30, 2011, we had $20.6 million in nonperforming assets, consisting of $1.0 million in single-family residential loans, $6.7 million in single-family rental property loans, $5.1 million in commercial loans, $4.5 million in construction loans, $214,000 in commercial lines of credit, $50,000 in commercial leases, $20,000 in consumer loans and $3.0 million in other real estate owned. Included in the above-noted nonperforming loans are $8.7 million in troubled debt restructurings, of which $8.6 million are not delinquent. Reporting guidance requires disclosure of these loans as nonperforming even though they are current in terms of modified loan payments. At September 30, 2010, we had $12.8 million in nonperforming assets, consisting of $656,000 in single-family residential loans, $1.7 million in single-family rental property loans, $6.0 million in commercial loans, $3.9 million in construction loans, $240,000 in commercial leases, $267,000 in commercial loans secured and $23,000 in consumer loans. Included in the above-noted nonperforming loans at September 30, 2010 are $4.0 million in troubled debt restructurings, of which $3.3 million were not delinquent.

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