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FFBH > SEC Filings for FFBH > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for FIRST FEDERAL BANCSHARES OF ARKANSAS INC

Form 10-Q for FIRST FEDERAL BANCSHARES OF ARKANSAS INC


1-Nov-2012

Quarterly Report


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

EXECUTIVE SUMMARY

Management's discussion and analysis of financial condition and results of operations is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein.

The Bank is a federally chartered stock savings and loan association that was formed in 1934. As of September 30, 2012, the Bank conducted business from its main office located in Harrison, Arkansas and fourteen full-service branch offices located in a six county area in Arkansas (comprised of Benton and Washington counties in Northwest Arkansas; Carroll, Boone, Marion and Baxter counties in North-central Arkansas) and a loan production office located in Little Rock, Arkansas. The Company also has executive offices in Little Rock, Arkansas. In February 2012, three full service branches in Northwest Arkansas were closed. Customers from closed branch locations are being serviced by other Bank branch locations in the area. As a result, these branch closings are not reported as discontinued operations. The Bank's primary focus will continue in this six county area as well as the Little Rock and Central Arkansas area. Other markets will also be considered that present opportunities for profitable growth.


The Bank is a community-oriented financial institution offering a wide range of retail and commercial deposit accounts, including noninterest-bearing and interest-bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. However, the Bank is currently subject to lending restrictions as a result of the provisions of the Bank Order. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, e-statements, and bill payment; mobile banking; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.

The Company's net income was $1.3 million for the nine months ended September 30, 2012, compared to a net loss of $5.8 million for the same period in 2011. The primary reason for the increase in net income was an increase in net gains on sales of investment securities of $1.0 million and a decrease in net REO expenses of $6.4 million. The decrease in net REO expenses was primarily attributable to a $4.3 million decrease in loss provisions on REO and a $1.9 million increase in net gains on sales of REO properties. In December 2011, the Bank posted write-downs of REO of $11.3 million. This was a result of management's evaluation of the overall REO portfolio and based on the decision to more aggressively market certain properties. A consequence of this write-down was a reduction in the loss provision on REO for the three and nine months ended September 30, 2012, as minimal additional changes to REO values since year end were necessary.

The Company's net income was $353,000 for the three months ended September 30, 2012, compared to a net loss of $2.0 million for the three months ended September 30, 2011. The primary reason for the increase in net income was a $2.5 million decrease in net REO expenses attributable to a $1.6 million decrease in loss provisions on REO and a $933,000 increase in net gains on sales of REO properties.

The Bank has made substantial progress in reducing its level of nonperforming assets during 2012. Total nonperforming assets at September 30, 2012, including nonaccrual loans, real estate owned, and restructured loans, totaled $45.9 million, or 8.44% of total assets, a reduction of $21.8 million compared to December 31, 2011, and a reduction of $41.1 million compared to September 30, 2011. The Bank has also reduced its level of classified loans by 52% to $36.2 million at September 30, 2012 compared to $75.0 million at December 31, 2011.

While the Bank is continuing its focus on reducing nonperforming assets, it is equally focused on improving its operational performance through improving its net interest margin, increasing noninterest income, and controlling noninterest expense.

RECENT DEVELOPMENTS

New Proposed Capital Rules. On June 7, 2012, the Federal Reserve issued proposed rules that would substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The FDIC and the OCC subsequently issued these proposed rules on June 12, 2012. The proposed rules implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. "Basel III" refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011. The proposed rules are subject to a comment period running through October 22, 2012.

The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would refine the definition of what constitutes "capital" for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to the Company and the Bank under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%;
(ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions would take effect January 1, 2015.

Based on our current capital composition and levels, we believe that we would be in compliance with the requirements as set forth in the proposed rules if they were presently in effect. Currently, the Bank is under a Bank Order which specifically requires the Bank to maintain a Tier 1 (core) capital ratio of at least 8% and a total risk-based capital ratio of at least 12.0% and maintain these higher ratios for as long as the Bank Order is in effect.


CRITICAL ACCOUNTING POLICIES

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, the following estimates, due to the judgments, estimates and assumptions inherent in those policies, are critical to preparation of our financial statements:

? Determination of our allowance for loan and lease losses ("ALLL")

? Valuation of real estate owned

? Valuation of investment securities

? Valuation of our deferred tax assets

These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management's Discussion and Analysis and in the Notes to the Condensed Consolidated Financial Statements included herein. We believe that the judgments, estimates and assumptions used in the preparation of our condensed consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our condensed consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to the portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.

The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, and are reported as a separate component of stockholders' equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not

available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company's investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company's financial condition, results of operations and liquidity.

The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company evaluates its deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, our actual results and other factors.


ANALYSIS OF RESULTS OF OPERATIONS

The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by the level of nonperforming assets as they provide no interest earnings to the Company. The Company's results of operations are also affected by the provision for loan and lease losses and the level of its noninterest income and expenses. Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, loan fee income, and earnings on life insurance policies. Noninterest expense consists primarily of employee compensation and benefits, office occupancy expense, data processing expense, real estate owned expense, and other operating expense.

Interest Income and Interest Expense

Interest Income. The decreases in interest income in the three and nine month comparative periods ended September 30, 2012 and 2011 were primarily related to decreases in the average balances of and yields earned on loans receivable and investment securities. The average balance of loans receivable decreased due to repayments, maturities and charge-offs or transfers to real estate owned. The average balance of investment securities decreased due to sales and calls of investment securities.

Interest Expense. The decreases in interest expense in the three and nine month comparative periods ended September 30, 2012 and 2011 was primarily due to decreases in the average balances of deposits and borrowings as well as a decrease in average rates paid on deposits. The decrease in the average rates paid on deposit accounts reflects decreases in market interest rates.


Average Balance Sheets

The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods.

                                                     Three Months Ended September 30,
                                              2012                                      2011
                                                           Average                                   Average
                               Average                      Yield/       Average                      Yield/
                               Balance       Interest        Cost        Balance       Interest        Cost
                                                          (Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)           $ 358,990     $    4,318         4.79 %   $ 371,968     $    5,005         5.34 %
Investment securities(2)         56,992            387         2.70        68,273            591         3.43
Other interest-earning
assets                           75,859            135         0.71        98,353            125         0.50
Total interest-earning
assets                          491,841          4,840         3.92       538,594          5,721         4.21
Noninterest-earning assets       58,243                                    69,809
Total assets                  $ 550,084                                 $ 608,403
Interest-bearing
liabilities:
Deposits                      $ 472,661          1,046         0.88     $ 509,727          1,572         1.22
Other borrowings                  3,933             23         2.35        10,434             74         2.82
Total interest-bearing
liabilities                     476,594          1,069         0.89       520,161          1,646         1.25
Noninterest-bearing
liabilities                       3,515                                     4,609
Total liabilities               480,109                                   524,770
Stockholders' equity             69,975                                    83,633
Total liabilities and
stockholders' equity          $ 550,084                                 $ 608,403

Net interest income                         $    3,771                                $    4,075
Net earning assets
(interest-bearing
liabilities)                  $  15,247                                 $  18,433
Interest rate spread                                           3.02 %                                    2.96 %
Net interest margin                                            3.04 %                                    3.00 %
Ratio of interest-earning
assets to Interest-bearing
liabilities                                                  103.20 %                                  103.54 %

                                                     Nine Months Ended September 30,
                                              2012                                     2011
                                                          Average                                   Average
                               Average                     Yield/       Average                     Yield/
                               Balance      Interest        Cost        Balance      Interest        Cost
                                                          (Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)           $ 356,057     $  13,381         5.02 %   $ 384,035     $  15,511          5.40 %
Investment securities(2)         58,918         1,237         2.80        74,265         2,219          3.99
Other interest-earning
assets                           85,726           409         0.64        69,271           209          0.40
Total interest-earning
assets                          500,701        15,027         4.01       527,571        17,939          4.55
Noninterest-earning assets       59,689                                   72,924
Total assets                  $ 560,390                                $ 600,495
Interest-bearing
liabilities:
Deposits                      $ 481,345         3,363         0.93     $ 518,216         4,917          1.27
Other borrowings                  5,576            86         2.06        16,973           281          2.22
Total interest-bearing
liabilities                     486,921         3,449         0.95       535,189         5,198          1.30
Noninterest-bearing
liabilities                       3,823                                    4,640
Total liabilities               490,744                                  539,829
Stockholders' equity             69,646                                   60,666
Total liabilities and
stockholders' equity          $ 560,390                                $ 600,495

Net interest income                         $  11,578                                $  12,741
Net earning assets
(interest-bearing
liabilities)                  $  13,380                                $  (7,618 )
Interest rate spread                                          3.06 %                                    3.25 %
Net interest margin                                           3.08 %                                    3.23 %
Ratio of interest-earning
assets to interest-bearing
liabilities                                                 102.83 %                                   98.58 %



(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.


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 assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (change in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and
(iv) the net change.

                                                Three Months Ended September 30,
                                                         2012 vs. 2011
                                              Increase (Decrease)
                                                     Due to
                                                                                   Total
                                                                    Rate/        Increase
                                      Volume           Rate         Volume      (Decrease)
                                                         (In Thousands)
Interest income:
Loans receivable                     $    (175 )     $    (531 )   $     19     $      (687 )
Investment securities                      (98 )          (127 )         21            (204 )
Other interest-earning assets              (29 )            50          (11 )            10
Total interest-earning assets             (302 )          (608 )         29            (881 )

Interest expense:
Deposits                                  (114 )          (444 )         32            (526 )
Other borrowings                           (46 )           (13 )          8             (51 )
Total interest-bearing liabilities        (160 )          (457 )         40            (577 )
Net change in net interest income    $    (142 )     $    (151 )   $    (11 )   $      (304 )

                                               Nine Months Ended September 30,
                                                        2012 vs. 2011
                                            Increase (Decrease)
                                                   Due to
                                                                               Total
                                                                Rate/         Increase
                                      Volume        Rate        Volume       (Decrease)
                                                       (In Thousands)
Interest income:
Loans receivable                     $ (1,130 )   $ (1,079 )   $     79     $     (2,130 )
Investment securities                    (459 )       (659 )        136             (982 )
Other interest-earning assets              50          121           29              200
Total interest-earning assets          (1,539 )     (1,617 )        244           (2,912 )

Interest expense:
Deposits                                 (350 )     (1,296 )         92           (1,554 )
Other borrowings                         (189 )        (19 )         13             (195 )
Total interest-bearing liabilities       (539 )     (1,315 )        105           (1,749 )
Net change in net interest income    $ (1,000 )   $   (302 )   $    139     $     (1,163 )


CHANGES IN RESULTS OF OPERATIONS



The table below presents a comparison of results of operations for the three
months ended September 30, 2012 and 2011 (dollars in thousands except share
data). Specific changes in certain line items are discussed following the table.



                                          Three Months Ended
                                             September 30,
                                                                                           Percentage
                                         2012             2011         Dollar Change         Change
Interest income:
Loans receivable                      $     4,318      $    5,005     $          (687 )           (13.7 )%
Investment securities                         387             591                (204 )           (34.5 )
Other                                         135             125                  10               8.0
Total interest income                       4,840           5,721                (881 )           (15.4 )
Interest expense:
Deposits                                    1,046           1,572                (526 )           (33.5 )
Other borrowings                               23              74                 (51 )           (68.9 )
Total interest expense                      1,069           1,646                (577 )           (35.1 )
Net interest income                         3,771           4,075                (304 )            (7.5 )
Provision for loan losses                      --              21                 (21 )          (100.0 )
Net interest income after
provision for loan losses                   3,771           4,054                (283 )            (7.0 )
Noninterest income:
Deposit fee income                            904           1,297                (393 )           (30.3 )
Earnings on life insurance                    198             191                   7               3.7
Gain on sale of loans                         250             156                  94              60.3
Other                                          97              98                  (1 )            (1.0 )
Total noninterest income                    1,449           1,742                (293 )           (16.8 )
Noninterest expenses:
Salaries and employee benefits              2,681           2,749                 (68 )            (2.5 )
Net occupancy expense                         625             661                 (36 )            (5.4 )
Real estate owned, net                        118           2,612              (2,494 )           (95.5 )
FDIC insurance premium                        286             317                 (31 )            (9.8 )
Supervisory assessments                        72              76                  (4 )            (5.3 )
Data processing                               395             370                  25               6.8
Professional fees                             158             193                 (35 )           (18.1 )
Advertising and public relations               54             109                 (55 )           (50.5 )
Postage and supplies                           86             108                 (22 )           (20.4 )
Other                                         392             634                (242 )           (38.2 )
Total noninterest expenses                  4,867           7,829              (2,962 )           (37.8 )
Income (loss) before income taxes             353          (2,033 )             2,386             117.4
Income tax provision                           --              --                  --                --
Net income (loss)                     $       353      $   (2,033 )   $         2,386             117.4

Basic earnings per share              $      0.02      $    (0.11 )   $          0.13             116.6 %
Diluted earnings per share            $      0.02      $    (0.11 )   $          0.13             116.6 %

Interest rate spread                         3.02 %          2.96 %
Net interest margin                          3.04 %          3.00 %

Average full-time equivalents                 190             204
Full service offices                           15              18


The table below presents a comparison of results of operations for the nine months ended September 30, 2012 and 2011 (dollars in thousands except share data). Specific changes in certain line items are discussed following the table.

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