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

Show all filings for CHEVIOT FINANCIAL CORP.

Form 10-Q for CHEVIOT FINANCIAL CORP.


14-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the three and nine months ended September 30, 2012 and 2011

ITEM 2.

Forward Looking Statements

This report on Form 10-Q contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements are subject to significant risks, assumptions and uncertainties that could affect the actual outcome of future events. Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Completion of Second Step Conversion

On July 12, 2011, Cheviot Mutual Holding Company and the Corporation adopted a Plan of Conversion whereby the mutual holding company would convert from mutual to stock form. As part of the Plan of Conversion the pro forma value of the 62% of the Corporation owed by the Mutual Holding Company was sold in an offering to the public. The Plan of Conversion obtained regulatory approval as well as the approval of the Mutual Holding Company's members and the Corporation's stockholders.

As a result, on January 18, 2012, Cheviot Financial Corp., a Maryland corporation (the "Company"), completed its second-step conversion and related public stock offering. Cheviot Savings Bank is now 100% owned by the Company and the Company is 100% owned by public stockholders. The Company sold a total of 4,675,000 shares of common stock in a subscription, community and syndicated community offerings, including 187,000 shares to the Company's employee stock ownership plan. All shares were sold at a purchase price of $8.00 per share. Shareholders of the Corporation received 0.857 shares of stock in the new Corporation for each share of common stock they hold in the Corporation.

Acquisition of First Franklin Corporation

On March 16, 2011, Cheviot Financial, and its wholly owned subsidiary, Cheviot Savings Bank, completed the acquisition of First Franklin and its wholly-owned subsidiary, Franklin Savings. The acquisition was consummated in accordance with an Agreement and Plan of Merger (the "Merger Agreement"), dated as of October 12, 2010, by and among Cheviot Financial Corp., Cheviot Savings Bank, Cheviot Merger Subsidiary, Inc., First Franklin and Franklin Savings.

At the effective time of the acquisition, each share of common stock, par value $0.01 per share, of First Franklin (other than shares owned by First Franklin, Cheviot Financial, Cheviot Savings Bank and Merger Subsidiary) was converted into the right to receive $14.50 in cash. Each First Franklin stock option outstanding at the time of the closing was converted into an amount of cash equal to the positive difference, if any, between $14.50 and the exercise price of such stock option. The aggregate cash consideration paid in the acquisition (including the cancellation of stock options) totaled of approximately $24.7 million.

The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. First Franklin's loans were deemed impaired at the acquisition date if Cheviot Financial did not expect to receive all contractually required cash flows due to concerns about credit quality. Such loans were fair valued and the difference between contractually required payments at the acquisition date and cash flows expected to be collected was recorded as a nonaccretable difference. At the acquisition date, Cheviot Financial recorded $25.0 million of purchased credit-impaired loans subject to a fair value adjustment of $5.5 million. The method of measuring carrying value of purchased loans differs from loans originated by the Corporation (originated loans), and as such, the Corporation identifies purchased loans and purchased loans with a credit quality discount and originated loans at amortized cost.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Acquisition of First Franklin Corporation (continued)

First Franklin's loans without evidence of credit deterioration were fair valued by discounting both expected principal and interest cash flows using an observable discount rate for similar instruments that a market participant would consider in determining fair value. Additionally, consideration was given to management's best estimates of default rates and payment speeds. At acquisition, First Franklin's loan portfolio without evidence of credit deterioration totaled $173.2 million and was recorded at a fair value of $171.6 million.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the accounting method used for the allowance for loan losses and the estimation of fair value of assets to be critical accounting policies.

The allowance for loan losses is the estimated amount considered necessary to cover inherent, but unconfirmed credit losses in the loan portfolio at the balance sheet date. The allowance is established through the provision for losses on loans which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of the most critical for Cheviot Financial.

Management performs a quarterly evaluation of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlining collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change.

The analysis has two components, specific and general allocations. Specific allocations can be made for unconfirmed losses related to loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. If the fair value of the loan is less than the loan's carrying value, a charge-off is recorded for the difference. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve. Actual loan losses may be significantly more than the allowances we have established which could result in a material negative effect on our financial results.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Critical Accounting Policies (continued)

The acquired assets and assumed liabilities of First Franklin were measured at estimated fair values, as required by FASB under Business Combinations. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management measured loan fair values based on loan file reviews (including borrower financial statements or tax returns), appraised collateral values, expected cash flows and historical loss factors of Franklin Savings. Real estate acquired through foreclosure was primarily valued based on appraised collateral values. The Corporation also recorded an identifiable intangible asset representing the core deposit base of Franklin Savings based on management's evaluation of the cost of such deposits relative to alternative funding sources. Management used significant estimates including the average lives of depository accounts, future interest rate levels, the cost of servicing various depository products and other significant estimates. Management used market quotations to determine the fair value of investment securities and FHLB advances.

The acquired assets of First Franklin and Franklin Savings include loans receivable. Loans receivable acquired with a deteriorated credit quality amounted to $25.0 million with a related credit quality discount of $5.5 million. The method of measuring carrying value of purchased loans differs from loans originated by the Corporation, and as such, the Corporation identifies purchased loans and purchased loans with a credit quality discount. See Note 11 to Notes to consolidated financial statements for more information regarding the acquisition of First Franklin and the accounting treatment of the assets acquired and the liabilities assumed.

We classify our investments in debt and equity securities as either held-to-maturity or available-for-sale. Securities classified as held-to maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. We obtain our estimated fair values from a third party service. This service's fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting our financial position, results of operations and cash flows. If the estimated value of investments is less than the cost or amortized cost, we evaluate whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and we determine that the impairment is other-than-temporary, we expense the impairment of the investment in the period in which the event or change occurred. We also consider how long a security has been in a loss position in determining if it is other than temporarily impaired. Management also assesses the nature of the unrealized losses taking into consideration factors such as changes in risk -free interest rates, general credit spread widening, market supply and demand, creditworthiness of the issuer, and quality of the underlying collateral.

Discussion of Financial Condition Changes at September 30, 2012 and at December 31, 2011

Total assets increased $17.1 million, or 2.8%, to $633.4 million at September 30, 2012, from $616.3 million at December 31, 2011. The increase in total assets is primarily the result of the investment of a portion of the net proceeds from our stock offering into investment securities partially offset by a decrease in loans receivable.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Discussion of Financial Condition Changes at September 30, 2012 and at December 31, 2011 (continued)

Cash, federal funds sold and interest-earning deposits decreased $9.8 million, or 21.7%, to $35.4 million at September 30, 2012, from $45.1 million at December 31, 2011. The decrease in cash and cash equivalents at September 30, 2012 was due to a $4.6 million decrease in federal funds sold, a $7.2 million decrease in interest-earning deposits, which was partially offset by a $2.0 million increase in cash and due from banks. These funds were reinvested in higher yielding investment securities. Investment securities increased $70.0 million to $191.0 million at September 30, 2012. The increase in investment securities is primarily the result of investing $193.2 million in new securities, partially offset by $121.3 million of investment securities that matured during the nine month period. At September 30, 2012, all investment securities were classified as available for sale. As of September 30, 2012, none of our investment securities are considered impaired.

Mortgage-backed securities decreased $1.5 million, or 13.0%, to $10.1 million at September 30, 2012, from $11.6 million at December 31, 2011. The decrease in mortgage-backed securities was due primarily to $1.5 million in principal prepayments and repayments. At September 30, 2012, $3.7 million of mortgage-backed securities were classified as held to maturity, while $6.4 million were classified as available for sale. As of September 30, 2012, none of the mortgage-backed securities are considered other than temporarily impaired.

Loans receivable, including loans held for sale, decreased $40.5 million, or 10.5%, to $343.8 million at September 30, 2012, from $384.3 million at December 31, 2011. The change in loans receivable reflects loan sales totaling $55.2 million and loan principal repayments of $72.7 million, which were partially offset by loan originations of $87.0 million. The change in the composition of the Corporation's assets reflects management's decision to manage the risk of our assets in a low interest rate environment by investing in investment securities and selling certain mortgage loans and recording gains.

The allowance for loan losses totaled $2.0 million and $1.4 million at September 30, 2012 and December 31, 2011, respectively. In determining the adequacy of the allowance for loan losses at any point in time, management and the board of directors apply a systematic process focusing on the risk of loss in the portfolio. First, the loan portfolio is segregated by loan types to be evaluated collectively and loan types to be evaluated individually. Delinquent multi-family and commercial loans are evaluated individually for potential impairments in their carrying value. Second, the allowance for loan losses entails utilizing our historic loss experience by applying such loss percentage to the loan types to be collectively evaluated in the portfolio. The $990,000 provision for losses on loans during the nine months ended September 30, 2012 reflected these factors, as well as, weaker economic conditions in the greater Cincinnati area and the need to charge-off approximately $437,000 in loans receivable. The analysis of the allowance for loan losses requires an element of judgment and is subject to the possibility that the allowance may need to be increased, with a corresponding reduction in earnings. As stated previously, Cheviot Financial's allowance at September 30, 2012 does not include any credit quality discount related to loans acquired from First Franklin, other than $405,000 added during the third quarter 2012 for certain one to four Family Residential Real Estate Loans. To the best of management's knowledge, all known and inherent losses that are probable and that can be reasonably estimated have been recorded at September 30, 2012.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Discussion of Financial Condition Changes at September 30, 2012 and at December 31, 2011 (continued)

Originated non-performing and impaired loans totaled $6.2 million and $5.7 million at September 30, 2012 and December 31, 2011, respectively. At September 30, 2012, originated non-performing and impaired loans were comprised of 48 loans secured by one- to four-family residential real estate, one loan secured by multi-family residential real estate and four loans secured by nonresidential real estate. At September 30, 2012 and December 31, 2011, real estate acquired through foreclosure totaled $3.7 million and $3.8 million, respectively. The allowance for loan losses represented 25.7% and 25.2% of originated non-performing and impaired loans at September 30, 2012 and December 31, 2011, respectively. During the third quarter of 2012 Management determined an additional allowance was recorded for certain one to four family purchased loans. This allowance for loan losses represented 19.0% of purchased non-performing and impaired one to four family residential real estate loans. Although management believes that the Corporation's allowance for loan losses conforms to generally accepted accounting principles based upon the available facts and circumstances, there can be no assurance that additions to the allowance will not be necessary in future periods, which would adversely affect our results of operations.

Deposits increased $2.6 million, or 0.5%, to $494.9 million at September 30, 2012, from $492.3 million at December 31, 2011. Advances from the Federal Home Loan Bank of Cincinnati decreased by $5.9 million, or 18.9%, to $25.4 million at September 30, 2012, from $31.3 million at December 31, 2011. The decrease is a result of approximately $5.9 million in repayments of outstanding advances during the nine months ended September 30, 2012.

Shareholders' equity increased $34.5 million, or 47.3%, to $107.4 million at September 30, 2012, from $72.9 million at December 31, 2011. The increase primarily resulted from $33.3 million in net proceeds from the stock conversion and net earnings of $2.6 million, which was partially offset by the cancelation of treasury stock of $12.9 million, dividends paid of $1.8 million and an increase of $413,000 in the unrealized gain on securities designated as available for sale.

Liquidity and Capital Resources

We monitor our liquidity position on a daily basis using reports that recap all deposit activity and loan commitments. A significant portion of our deposit base is made up of time deposits. At September 30, 2012, $125.2 million of time deposits are due to mature within twelve months. The daily deposit activity report allows us to price our time deposits competitively. Because of this and our deposit retention experience, we anticipate that a significant portion of maturing time deposits will be retained.

Borrowings from the Federal Home Loan Bank of Cincinnati decreased $5.9 million during the nine months ended September 30, 2012. At September 30, 2012, we have the ability to increase such borrowings by approximately $145.2 million. The additional borrowings can be used to offset any decrease in customer deposits or to fund loan commitments. Additional information regarding our liquidity and capital resources can be found at Note 3 to Notes to Consolidated Financial Statements.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2012 and 2011

General

Net earnings for the nine months ended September 30, 2012 totaled $2.6 million, a $165,000 increase from the $2.4 million of net earnings reported for the same period in 2011. The increase in net earnings reflects increases in net interest income of $192,000 and in other income of $1.4 million, which were partially offset by an increase of $590,000 in the provision for losses on loans, an increase of $682,000 in general, administrative and other expense and an increase of $156,000 in the provision for federal income taxes.

Net Interest Income

Total interest income increased $107,000 or 0.7%, to $16.4 million for the nine-months ended September 30, 2012, from the comparable period in 2011. The increase in interest income was due to increases in interest income from investment securities and interest-earning deposits, partially offset by decreases in interest income from loans and mortgage-backed securities. Interest income on loans decreased $412,000, or 2.9%, to $13.8 million during the 2012 period. This decrease was due primarily to a decrease in the average yield on loans to 5.03% for the 2012 period from 5.29% for the 2011 period, which was partially offset by an increase of $7.2 million, or 2.0%, in average loans outstanding.

Interest income on mortgage-backed securities decreased $50,000, or 24.0%, to $158,000 for the nine months ended September 30, 2012, from $208,000 for the same period in 2011, due primarily to a 43 basis point decrease in the average yield and by a $880,000 decrease in the average balance of securities. Interest income on investment securities increased $500,000, or 30.8%, to $2.1 million for the nine months ended September 30, 2012, compared to $1.6 million for the same period in 2011, due primarily to an increase of $59.9 million, or 63.4%, increase in the average balance of investment securities outstanding, which was partially offset by a decrease in the average yield of 47 basis points to 1.84% in the 2012 period. Interest income on interest-earning deposits increased $69,000, or 31.1% to $291,000 for the nine months ended September 30, 2012, as compared to the same period in 2011.

Interest expense decreased $85,000, or 1.9% to $4.3 million for the nine months ended September 30, 2012, from $4.4 million for the same period in 2011. Interest expense on deposits increased by $118,000, or 3.4%, to $3.6 million for the nine months ended September 30, 2012, from $3.5 million for the same period in 2011 due primarily to a 15 basis point decrease in the average cost of deposits to 0.97% during the 2012 period, which was partially offset by a $79.8 million, or 19.2%, increase in the average balances outstanding. The decrease in the average cost of deposits is due to the overall changes in the deposit composition and lower market rates for the period. Interest expense on borrowings decreased by $203,000, or 22.3%, due primarily to a decrease of $11.7 million, or 29.2%, in the average balance outstanding, which was partially offset by a 30 basis point increase in the average cost of borrowings.

As a result of the foregoing changes in interest income and interest expense, net interest income increased by $192,000, or 1.6%, to $12.1 million for the nine months ended September 30, 2012. The average interest rate spread decreased to 2.90% for the nine months ended September 30, 2012 from 3.27% for the nine months ended September 30, 2011. The net interest margin decreased to 2.94% for the nine months ended September 30, 2012 from 3.32% for the nine months ended September 30, 2011.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2012 and 2011 (continued)

Provision for Losses on Loans

As a result of an analysis of historical experience, the volume and type of lending conducted by the Savings Bank, the status of past due principal and interest payments, general economic conditions, particularly as such conditions relate to the Savings Bank's market area, and other factors related to the collectability of the Savings Bank's loan portfolio, management recorded a $990,000 provision for losses on loans for the nine months ended September 30, 2012, compared to a $400,000 provision for losses on loans for the nine months ended September 30, 2011. The provision for loan losses for the nine months ended September 30, 2012 reflects the amount necessary to maintain an adequate allowance based on the Corporation's historical loss experience, the need to charge off $437,000 in loans receivable, as well as consideration of other external factors. These other external factors, economic conditions, and collateral value changes, have had a negative impact on non-owner-occupied loans in the portfolio. There can be no assurance that the loan loss allowance will be sufficient to cover losses on non-performing loans in the future; however, management believes they have identified all known and inherent losses that are probable and that can be reasonably estimated within the loan portfolio, and that the allowance is adequate to cover actual losses incurred in the loan portfolio.

Other Income

Other income increased $1.4 million, or 74.2%, to $3.3 million for the nine months ended September 30, 2012, compared to the same period in 2011, due primarily to an increase in earnings on bank-owned life insurance of $513,000, an increase in the gain on sale of loans of $715,000 and an increase of $178,000 in other operating income, which was partially offset by a decrease in the gain on sale of real estate acquired through foreclosure of $15,000. The increase in earnings on bank-owned life insurance is a result of death benefit proceeds received in accordance with the bank-owned life insurance policies. The increase in the gain on sale of loans is due to selling $55.2 million in loans in the secondary market during the nine months ended September 30, 2012 compared to selling $37.2 million in loan in the secondary market during the nine months ended September 30, 2011. The increase in other operating income is a result of increased service fees on deposit accounts. During the nine months ended September 30, 2012, the Corporation sold 25 real estate owned properties resulting in proceeds of $1.9 million.

General, Administrative and Other Expense

General, administrative and other expense increased $682,000, or 6.7%, to $10.9 million for the nine months ended September 30, 2012, from $10.2 million for the comparable period in 2011. The increase is a result of $330,000 in occupancy and equipment expense and an increase of $470,000 in other operating expense, which was partially offset by a decrease of $56,000 in legal and professional expense. The increase in occupancy and equipment expense during the nine months ended September 30, 2012 reflects a full nine months of operations from the Franklin acquisition as compared to the prior period. The increase in other operating expense is the result of fair market value adjustments in real estate properties acquired through foreclosure.


Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2012 and 2011

Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2012 and 2011 (continued)

FDIC Premiums

The FDIC imposes an assessment against institutions for deposit insurance. This assessment is based on the risk category of the institution. Federal law requires that the designated reserve ratio for the deposit insurance fund be established by the FDIC at 1.15% to 1.50% of estimated insured deposits. If the . . .

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