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BKOR > SEC Filings for BKOR > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for OAK RIDGE FINANCIAL SERVICES, INC.

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


14-Nov-2012

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, 2011.

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 2012, with the continuing impact of a sluggish economy, management has continued to focus on managing credit quality, managing capital, and growing noninterest income and managing noninterest expense. 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.

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 $5.0 million of the CPP funds have been contributed to the Bank as additional equity capital. Approximately $2.7 million in unused capital 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 13.6% at September 30, 2012, the Bank is above the minimum 10% requirement to be classified as well-capitalized. If the remaining $2.7 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 14.7% at September 30, 2012 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 liability by expensing the plan 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 are to: (1) grow the loan portfolio while improving asset quality by either improving or disposing of problem assets; (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.


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, 2012 and 2011

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 June 30, 2012 as compared to the same period in 2011.

Condensed Consolidated Statements of Income (Dollars in thousands)

                        For the Three                                                For the Nine
                         Months Ended           Changes from the Prior Year          Months Ended         Changes from the Prior Year
                        September 30,                                                September 30,
                             2012             Amount                    %                2012             Amount                 %

Total interest income   $        3,867     $        (414 )                  (9.7 )   $      11,992     $     (1,124 )                (8.6 )
Total interest
expense                            509              (289 )                 (36.2 )           1,844             (776 )               (29.6 )
Net interest income              3,358              (125 )                  (3.6 )          10,148             (348 )                (3.3 )
Provision for loan
losses                             833              (127 )                 (13.2 )           3,419              592                  20.9
Net interest income
after provision for
loan losses                      2,525                 2                     0.1             6,729             (940 )               (12.3 )
Noninterest income                 922                86                    10.3             2,853               63                   2.3
Noninterest expense              3,431               129                     3.9            10,781              698                   6.9
Income before income
taxes                               16               (41 )                 (71.9 )          (1,199 )         (1,575 )              (418.9 )
Income tax expense                 (43 )             (25 )                 138.9              (591 )           (621 )            (2,070.0 )
Net income                          59               (16 )                 (21.3 )            (608 )           (954 )              (275.7 )
Preferred stock
dividend and
accretion of discount             (168 )              (5 )                   3.1              (508 )            (18 )                 3.7
Net income (loss)
available to common
shareholders            $         (109 )   $         (21 )                  23.9     $      (1,116 )   $       (972 )               675.0

Results of Operations

Net income for the quarter ended September 30, 2012 was $59 thousand before preferred dividends, compared to net income of $75 thousand in the same period of 2011. Net loss to common shareholders for the three-month periods ending September 30, 2012 and 2011 were $109 thousand and $88 thousand, respectively. Basic and diluted loss per common share was $0.06 and $0.05 for the three-month periods ending September 30, 2012.

Net loss for the nine month period ended September 30, 2012 was $608 thousand before preferred dividends, compared to net income of $346 thousand in the same period of 2011. Net loss to common shareholders for the nine-month periods ending September 30, 2012 and 2011 were $1.1 million and $144 thousand, respectively. Basic and diluted loss per common share was $0.62 and $0.08 for the nine-month periods ending September 30, 2012.

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, 2012 was $3.4 million, a decrease of $125 thousand or 3.6% when compared to net interest income of $3.5 million for the three months ended September 30, 2011.

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 noninterest bearing deposits.

Interest income decreased $414 thousand or 9.7% for the three months ended September 30, 2012 compared to the same three months of 2011. The decrease for the three months ended September 30, 2012 is primarily due to decreases on rates earned on these assets. The yield on average earning assets decreased 47 basis points for the three months ending September 30, 2012 to 5.19% from the same period in 2011. Management attributes the decrease in the yield on our earning assets to the decline in offering rates on new and renewed loans, as well as a decrease in the yield on investment securities.


Our average cost of funds during the three months ended September 30, 2012 was 0.74%, a decrease of 37 basis points when compared to 1.11% for the three months ended September 30, 2011. Average rates paid on deposits decreased 73 basis points from 1.10% for the three months ended September 30, 2011 to 0.69% for the three months ended September 30, 2012, while our average cost of borrowed funds increased 58 basis points during the three months ended September 30, 2012 compared to the same period in 2011. Total interest expense decreased $289 thousand or 36.2% during the three months ended September 30, 2012 compared to the same period in 2011, 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, 2012 was 4.15% compared to 4.28% for the same period in 2011, while our net interest spread for the three months ended September 30, 2012 was 3.98% compared to 4.08% for the same period in 2011.

Net interest income for the nine months ended September 30, 2012 was $10.1 million, a decrease of $348 thousand or 3.3% when compared to net interest income of $10.5 million for the nine months ended September 30, 2011.

Interest income decreased $1.1 million or 8.6% for the nine months ended September 30, 2012 compared to the same nine months of 2011. The decrease for the nine months ended September 30, 2012 is primarily due to decreases on rates earned on these assets. The yield on average earning assets decreased 50 basis points for the nine months ending September 30, 2012 to 5.29% from the same period in 2011. Management attributes the decrease in the yield on our earning assets to the decline in offering rates on new and renewed loans, as well as a decrease in the yield on investment securities.

Our average cost of funds during the nine months ended September 30, 2012 was 0.86%, a decrease of 35 basis points when compared to 1.21% for the nine months ended September 30, 2011. Average rates paid on deposits decreased 39 basis points from 1.21% for the nine months ended September 30, 2011 to 0.82% for the nine months ended September 30, 2012, while our average cost of borrowed funds increased 91 basis points during the nine months ended September 30, 2012 compared to the same period in 2011. Total interest expense decreased $776 thousand or 29.6% during the nine months ended September 30, 2012 compared to the same period in 2011, primarily the result of decreased market rates paid on these liabilities.

Our annualized net interest margin for the nine months ended September 30, 2012 was 4.04% compared to 4.22% for the same period in 2011, while our net interest spread for the nine months ended September 30, 2012 was 3.93% compared to 4.08% for the same period in 2011.

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 unable to maintain or increase the yield on average earning assets while maintaining or decreasing the cost of funds on borrowings.


Noninterest Income

Noninterest income decreased 12.1% and 1.7% for the three- and six-month periods, respectively, ending June 30, 2012 compared to the same period in 2011.

Sources of Noninterest Income (Dollars in thousands)

                         For the Three                                                 For the Nine
                         Months Ended            Changes from the Prior Year           Months Ended         Changes from the Prior Year
                         September 30,                                                September 30,
                             2012              Amount                    %                 2012            Amount                 %

Service charge on
deposit accounts        $           165     $          78                    89.7     $          374     $        (8 )                (2.1 )
Gain on sale of
securities                            -                 -                     N/A                  -            (258 )              (100.0 )
Gain (loss) on sale
of equipment                         51                51                       -                 58              62                    nm
Mortgage loan
origination fees                    202               142                   236.7                493             325                 193.5
Investment and
insurance commissions                56              (228 )                 (80.3 )              602            (157 )               (20.7 )
Fee income from
accounts receivable
financing                           187                 2                     1.1                524             (76 )               (12.7 )
Debit card
interchange income                  204                39                    23.6                589             130                  28.3
Income earned on bank
owned life insurance                 35                (2 )                  (5.4 )              104              (6 )                (5.5 )
Other service charges
and fees                             22                 4                    22.2                109              51                  87.9
Total noninterest
income                  $           922     $          86                    10.3     $        2,853     $        63                   2.3

Noninterest income increased $86 thousand or 10.3% to $922 thousand for the three months ended September 30, 2012 compared to $836 thousand for the same period in 2011. The increase in noninterest income in the three months ended September 30, 2012 is primarily due to increases in service charge on deposit accounts, gain (loss) on sale of equipment, mortgage loan origination fees, and debit card interchange income, offset by decreases in investment and insurance commissions. Service charges on deposit accounts increased $78 thousand for the three months ended September 30, 2012 as compared to the same period in 2011. The primary reasons for the increase were increases in non-sufficient funds fees and service charges and related fees on deposit accounts. Gain on sale of equipment was $51 thousand in the three months ended September 30, 2012 with no gains during the same period in 2011. The gain on sale of equipment in 2012 was a result of the sale of equipment to the Bank's former wealth management division in the third quarter of 2012. Mortgage loan origination fees increased $142 thousand for the three months ended September 30, 2012 as compared to the same period in 2011. The primary reason for this increase were new mortgage loan officers hired near the end of 2011 that were more productive than those employed by the Bank during the three months ended September 30, 2011, as well as an increase in the mortgage refinancing demand in 2012 compared to 2011. Debit card interchange income increased $39 thousand for the three months ended September 30, 2012 as compared to the same period in 2011. The primary reason for the increase was the continued growth of consumer checking accounts with debit cards at the Bank during 2011 and the first nine months of 2012. Investment and insurance commissions decreased $228 thousand for the three months ended September 30, 2012 as compared to the same periods in 2011. The declines were due to the sale of the Bank's wealth management division on July 1, 2012. On July 1, 2012, the Bank entered into an alliance agreement with the wealth management division whereby the Bank gets a percentage of gross revenue generated from the non-deposit product sales. Along with the agreement, the Bank will incur no expenses related to the wealth management division after July 1, 2012.

Noninterest income increased $63 thousand or 2.3% to $2.9 million for the nine months ended September 30, 2012 compared to $2.8 million for the same period in 2011. The increase in noninterest income in the nine months ended September 30, 2012 is primarily due to gain (loss) on sale of equipment, mortgage loan origination fees, debit card interchange income, and other service charges and fees, offset by decreases in gain on sale of securities, investment and insurance commissions, and fee income from accounts receivable financing. Gain(loss) on sale of equipment were $58 thousand in the nine months ended September 30, 2012 with a loss of $4 thousand during the same period in 2011. The gain on sale of equipment in 2012 was a result of the sale of equipment to the Bank's former wealth management division in the third quarter of 2012. Mortgage loan origination fees increased $325 thousand for the nine months ended September 30, 2012 as compared to the same period in 2011. The primary reason for this increase were new mortgage loan officers hired near the end of 2011 that were more productive than those employed by the Bank during the nine months ended September 30, 2011, as well as an increase in the mortgage refinancing demand in 2012 compared to 2011. Debit card interchange income increased $130 thousand for the nine months ended September 30, 2012 as compared to the same period in 2011. The primary reason for the increase was the continued growth of consumer checking accounts with debit cards at the Bank during 2011 and the first nine months of 2012. Other service charges and fees increased by $50 thousand for the nine months ended September 30, 2012 as compared to the same period in 2011. The primary reason for the increase was a reimbursement in excess of actual expenses from a previously charged off loan. Gain on sale of securities was $258 thousand for the nine months ended September 30, 2012. The Bank had no sales of investment securities in the first nine months of 2011. Investment and insurance commissions decreased $157 thousand for the nine months ended September 30, 2012 as compared to the same periods in 2011. The declines were due to the sale of the Bank's wealth management division on July 1, 2012. On July 1, 2012, the Bank entered into an alliance agreement with the wealth management division whereby the Bank gets a percentage of gross revenue generated from the non-deposit product sales. Along with the agreement, the Bank will incur no expenses related to the wealth management division after July 1, 2012. Fee income from accounts receivable financing decreased $76 thousand for the nine months ended September 30, 2012 as compared to the same period in 2011. The primary reason for the decrease was lower receivables of existing clients and fewer clients in 2012 as compared to 2011.


Noninterest Expense

Noninterest expense increased 3.9% and 6.9% for the three- and nine-month periods, respectively, ending September 30, 2012 compared to the same period in 2011.

Sources of Noninterest Expense (Dollars in thousands)

                        For the Three                                     For the nine
                        Months Ended      Changes from the Prior Year     Months Ended         Changes from the Prior Year
                                                                            Sept 30,
                        Sept 30, 2012       Amount             %              2012           Amount                   %
Salaries                $       1,486     $      (65 )           (4.2 )   $      4,801     $       359                      8.1
Employee benefits                 193            (16 )          100.0              620              43                      7.5
Occupancy expense                 188            (43 )          (18.6 )            609             (40 )                   (6.2 )
Equipment expense                 235             10              4.4              678              26                      4.0
Data and items
processing                        317             70             28.3              879             188                     27.2
Professional and
advertising                       279              2               .7              810             (20 )                   (2.4 )
Stationary and
supplies                           72            (17 )          (19.1 )            244             (71 )                  (22.5 )
Net cost of
foreclosed assets                  98              -              N/A              527             133                     33.8
Telecommunications
expense                            85             31             57.4              238              74                     45.1
FDIC assessment                    79             72          1,028.6              233             (52 )                  (18.2 )
Accounts receivable
financing expense                  51             (6 )          (10.5 )            152             (36 )                  (19.1 )
Other than temporary
impairment loss                     1              1            100.0                1               1                      N/A
Other expense                     347             90             23.9              989              89                      9.9
Total noninterest
expense                 $       3,431     $      129              3.9     $     10,781     $       694                      6.9

Salary expense for the three months ended September 30, 2012 decreased $65 thousand as compared to the same prior year period. Employee benefits for the three months ended September 30, 2012 decreased $16 thousand over the same prior year period. The principal reason for this decrease was the transition of the Oak Ridge Wealth Management advisory group to an independent entity. Occupancy and Equipment expenses for the three months ended September 30, 2012 decreased $33 thousand as compared to the same prior year period. These decreases were primarily due to the sale of the Oak Ridge Wealth Management advisory group to an independent entity in the third quarter of 2012.

Data and other processing expenses increased $70 thousand over the same prior year period, primarily due to increased expenses associated with higher levels of debit card interchange income, and to a lesser extent, enhancements to the Bank's internet banking bill payment systems as well as the purchase of other internet based products in the second half of 2011.

Professional and advertising expenses for the three months ended September 30, 2012 increased $2 thousand over the same prior year period. The majority of the increase was due to higher legal fees mostly related to past due loans for the three months ended June 30, 2012 compared to the same period in 2011.

Stationary and supplies expenses for the three months ended September 30, 2012 decreased $17 thousand over the same prior year period. The decline was caused by decreases in mailings to customers.

Net cost of foreclosed assets for the three months ended September 30, 2012 were relatively unchanged compared to the same prior year period.

Telecommunications expense for the three months ended September 30, 2012 increased $31 thousand over the same prior year period. The increase was caused by an upgrade of the Bank's telecommunication capacity in 2012.


FDIC assessment for the three months ended September 30, 2012 increased $72 . . .

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