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

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Form 10-Q for DCB FINANCIAL CORP


14-Nov-2012

Quarterly Report


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

INTRODUCTION

In the following pages, management presents an analysis of the Corporation's consolidated financial position at September 30, 2012, compared to December 31, 2011, and the consolidated results of operations for the three and nine months ended September 30, 2012, compared to the same periods in 2011. This discussion is designed to provide shareholders with a more comprehensive review of the operating results and financial position than could be obtained from reading the consolidated financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report.

The Corporation, through the Bank, provides customary retail banking services to its customers, including checking and savings accounts, time deposits, IRAs, safe deposit facilities, personal loans, real estate mortgage loans and installment loans. The Bank also provides trust and wealth management products and services through its own trust department and its Raymond James affiliation. It also offers a variety of commercial and commercial real estate loans along with treasury management services to various commercial businesses.

The Corporation, through the Bank, grants residential real estate, commercial real estate, consumer and commercial loans to customers located primarily in Delaware, Franklin, Licking, Morrow, Marion and Union Counties, Ohio. The economic conditions in the Corporation's market are one of the strongest within the State of Ohio; however, these conditions continue to present challenges to the banking industry. While economic activity is slowly starting to recover, there are still increases in unemployment levels, increased loan foreclosure volume and a decline in real estate values. The Corporation's business has been under pressure due primarily to decreased market activity, which has resulted in declining loan portfolios. Real estate values, especially in the Bank's core geographic area, have declined during the past several years and have not shown signs of increased prices or activity during 2012.

FORWARD-LOOKING STATEMENTS

Certain statements in this report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to the financial condition and prospects, lending risks, plans for future business development and marketing activities, capital spending and financing sources, capital structure, the effects of regulation and competition, and the prospective business of both the Corporation and the Bank. Where used in this report, the words "anticipate," "believe," "estimate," "expect," "intend," and similar words and expressions, related to the Corporation or the Bank or their respective management, identify forward-looking statements. Such forward-looking statements reflect the current views of the Corporation and are based on information currently available to the management of the Corporation and the Bank and upon current expectations, estimates, and projections about the Corporation and its industry, management's belief with respect thereto, and certain assumptions made by management. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements.

Potential risks and uncertainties include, but are not limited to:
(i) significant increases in competitive pressure in the banking and financial services industries; (ii) changes in the interest rate environment which could reduce anticipated or actual margins; (iii) changes in political conditions or the legislative or regulatory environment; (iv) general economic conditions, either nationally or regionally (especially in central Ohio), becoming less favorable than expected resulting in, among other things, a deterioration in credit quality of assets; (v) changes occurring in business conditions and inflation; (vi) changes in technology; (vii) changes in monetary and tax policies; (viii) changes in the securities markets; and (ix) other risks and uncertainties detailed from time to time in the filings of the Corporation with the Securities and Exchange Commission.


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The Corporation does not undertake, and specifically disclaims any obligation, to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

OVERVIEW OF THE THIRD QUARTER OF 2012

The following is a summary of financial highlights from the three and nine months ended September 30, 2012:

The Corporation's total assets declined slightly compared to December 31, 2011, decreasing 5.5% to $494,199. The decrease was mainly attributed to the decline in the loan portfolio, partially offset by an increase in total cash and cash equivalents.

As previously reported, in October 2010, the Bank entered into a Consent Agreement with the FDIC, and a written agreement with the Ohio Division of Financial Institutions ("Ohio Division"), both of which require that Tier 1 and Total Risk Based Capital ratios reach 9.0% and 13.0%, respectively. As of September 30, 2012, the Bank's capital ratios, were not at these levels. The Tier-1 capital ratio was 8.98%, while the Total Risk Based Capital was 10.19% at September 30, 2012. On October 16, 2012, the Company announced a rights offering to existing shareholders as part of a $13,200 capital raise. Upon completion of the capital raise, the Bank anticipates that it will meet the levels required by the Consent Agreement and written Agreement.

Net income for the nine months ended September 30, 2012 totaled $748, an improvement over a net loss of $1,547 for the same period in 2011. The increase in net income is driven by a $3,041 decrease in the provision for loan losses and a $1,855 decrease in noninterest expenses, partially offset by a $1,718 decrease in net interest income and a $497 decrease in noninterest income.

Net interest income for the nine months ended September 30, 2012 totaled $11,710, compared to $13,428 in the same period in the prior year, the decrease is due to a smaller interest-earning asset base and an overall decline in interest rates.

Overall net loan balances continue to decline due to lower market activity. Net loans stood at $314,087 at September 30, 2012 compared to $350,183 at December 31, 2011, a decline of $36,096.

Total borrowings decreased by $23,347 at September 30, 2012 from $40,036 at December 31, 2011. This is a result of paying off long-term debt with excess cash generated from the overall decrease in loans and the improved ability to secure deposits from its core customer base.

ANALYSIS OF FINANCIAL CONDITION

The Corporation's assets totaled $494,199 at September 30, 2012, compared to $522,881 at December 31, 2011, a decrease of $28,682, or 5.5%. Cash and cash equivalents increased by $8,843 from year end, totaling $48,157 at September 30, 2012 as a result of payoffs and paydowns in the loan portfolios. Total securities remained steady at $88,693, representing a 0.4% decrease from December 31, 2011. Management utilizes investment securities to provide the Corporation with the flexibility to move funds into loans as demand warrants, and as collateral for various borrowing opportunities.

Total loans decreased $37,529, or 10.4%, during the first nine months of 2012. The decline in outstanding loan balances is due to payoffs and paydowns within the problem portfolio, as a result of management's focus on problem credits. As the economy has improved within the markets in which the Bank operates, lending opportunities are beginning to increase.


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Total deposits decreased 1.3% from $445,428 at December 31, 2011 to $439,537 at September 30, 2012. Noninterest-bearing deposits grew by 19.7%, or $16,199, from year-end. Total deposits decreased due to a reduction in time deposits, however some of the maturities were reapplied to non interest bearing accounts.

Total borrowings decreased $23,347 during the nine months ended September 30, 2012. The decline in long-term borrowings was mainly attributed to the Bank reducing its FHLB debt through the early pay-off of existing balances. In previous years, the Corporation utilized a matched funding methodology for its borrowing and deposit activities. However, with its current deposit base and adequate cash balances, there has been less need for the utilization of borrowed funds.


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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 AND SEPTEMBER 30, 2011

Net Income. The Corporation reported net income of $306 for the three month period ended September 30, 2012, compared to $276 for the same period in 2011. The improvement was mainly attributed to reduced provision expense of $560, and reduced noninterest expense of $256, offset by a decline in net interest income of $492 and a reduction in noninterest income of $171.

Net Interest Income. Net interest income represents the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities. Net interest income is the largest component of the Corporation's income, and is affected by the interest rate environment and the volume and the composition of interest-earning assets and interest-bearing liabilities.

Net interest income was $3,836 for the three month period ended September 30, 2012, and $4,328 for the same period in 2011. This decline is attributed to lower interest earning assets, primarily from the previously mentioned decline in loan balances. As noted, the current economic activity in the Corporation's market area is slowly recovering; however, loan origination activity remains low. Additionally, management has focused on reducing risk in its portfolios by tightening credit standards, further reducing the universe of quality loan originations available.

As noted, the Corporation continues to reduce its overall borrowings, mainly through the FHLB, by either replacing them with customer deposits or by reducing the overall size of the balance sheet through deposit run-off. Deposits normally are less expensive than borrowings and contribute to the stable net interest margin the Bank has experienced. Net interest margin for the third quarter 2012 was 3.33%, compared to 3.36% for the first quarter 2012 and the third quarter 2011. The decrease is a result of decreased yields on loans, partially offset by a decrease in deposit costs.

The Asset/Liability Management Committee, which is responsible for determining deposit rates, continues to closely monitor the Bank's cost of funds to take advantage of pricing and cash flow opportunities. Additionally, because of the increased competition in the Bank's primary marketplace, management recognizes the importance of offering special rates on certain deposit products. These special deposit rates tend to negatively affect the Corporation's net interest margin. This strategy has yet to have a significant impact on the Bank's cost of funds, as any increase in customer deposit rates is more than offset by a reduction in the amount of higher costing FHLB borrowings.

Provision and Allowance for Loan Losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents management's assessment of the losses known and inherent in the Bank's loan portfolio. All lending activity contains associated risks of loan losses and the Bank recognizes these credit risks as a necessary element of its business activity.

The provision for loan losses totaled $65 for the three months ended September 30, 2012, compared to $625 for the same period in 2011. This decline from the prior year quarter is mainly attributed to the overall improvement in credit quality within the Bank's loan portfolios. Other contributing factors include improvement in delinquencies, improved workout results and stabilized real estate values, after periods of decline, within the Bank's market area. Management maintains an allowance for loan losses at a level to absorb management's estimate of probable inherent credit losses in its portfolio.

Nonaccrual loans at September 30, 2012 were $5,468, a decrease of $4,107 from the December 31, 2011 balance of $9,576. The portfolio of problem loans has continued to decrease in response to workout activities, and fewer new problem loans have surfaced. The majority of nonaccrual balances are attributed to loans in the investment real estate sector that are not generating sufficient cash flow to service the debt.

The allowance for loan losses was $8,151, or 2.53% of total loans at September 30, 2012, compared to $9,584, or 2.66% of total loans at December 31, 2011. While charge-offs for the three months ended September 30, 2012 are significant they have contributed to significant decreases in delinquencies and nonaccrual loans. This has reduced the need for additions to the allowance for loan losses. Management will continue to monitor the credit quality of the loan portfolio and may recognize additional provisions in the future if needed to maintain the allowance for loan losses at an appropriate level.


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Noninterest Income. Total noninterest income was $1,158 for the three months ended September 30, 2012, a decline from the $1,329 recognized in the third quarter 2011. The decline is attributed to reduced data processing revenue as a result of the sale of all outstanding contracts that were owned by Datatasx LLC.

Noninterest Expense. Total noninterest expense was $4,750 for the three months ended September 30, 2012, a 4.9% decrease compared to noninterest expense of $4,995 for the same period in 2011. The decrease is primarily the result of restructuring that included branch closures in 2011, driving a $215 decrease in occupancy and equipment. The Corporation has also seen a reduction in professional services of $199 as much of this cost related to the workout of problem credits, which have decreased throughout the year. This is partially offset by an increase in salaries and benefits of $287 that is a result of the addition of senior management positions during the year that were not filled in 2011.

Income Taxes. The Corporation recorded an income tax credit of $127 for the three months ended September 30, 2012, compared to an income tax credit of $239 in the same period in 2011. In 2010, management recognized a full allowance on the net deferred tax asset. Management is maintaining its full allowance tax position each quarter.

COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND SEPTEMBER 30, 2011

Net Income (Loss). The Corporation reported net income of $748 for the nine month period ended September 30, 2012, compared to a loss of $1,547 for the same period in 2011. The improvement in profitability was attributed to reduced provision expense and reduced noninterest expenses, partially offset by a decrease in net interest income and a decrease in noninterest income.

Net Interest Income. Net interest income was $11,710 for the nine month period ended September 30, 2012, and $13,428 for the same period in 2011. The decline in net interest income is mainly attributed to lower interest earning assets when compared to the same period in 2011. The Corporation has been reducing its balance sheet in order to increase capital ratios, but has also experienced a decline in loan originations as the economy is slowly recovering.

As noted earlier, the Corporation has been able to reduce its overall borrowings, by paying down debt with cash generated from the declining loan portfolio, and from an increase in retail deposits. Deposits normally are less expensive than borrowing which contributes to the stable net interest margin the Bank has experienced

Provision and Allowance for Loan Losses. The provision for loan losses totaled $795 for the nine months ended September 30, 2012, compared to $3,836 for the same period in 2011. This decline in provision expense from the previous year's quarter is mainly attributed to the overall improvement in credit quality within the Bank's loan portfolios. Overall, problem loans have declined since year-end 2010, and delinquencies are down. Management maintains an allowance for loan losses at a level to absorb management's estimate of probable inherent credit losses in its portfolio.

The allowance for loan losses was $8,151, or 2.53% of total loans at September 30, 2012, compared to $9,584, or 2.66 % of total loans at December 31, 2011. Net charge-offs for the nine month period ended September 30, 2011 were $2,229, which were mainly attributed to commercial real estate loans. Management will continue to monitor the credit quality of the loan portfolio and may recognize additional provisions in the future if needed to maintain the allowance for loan losses at an appropriate level.

Noninterest Income. Total noninterest income decreased $497 to $4,080 for the nine months ended September 30, 2012, compared to the same period in 2011. The decline is attributed to reduced data processing revenue as a result of the sale of all outstanding contracts that were owned by Datatasx LLC in the prior year and a decline in retail fee production due to new consumer protection regulatory guidelines that were issued in 2011.


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Noninterest Expense. Total noninterest expense decreased $1,844 to $14,403 for the first nine months of the year compared to 2011. The decrease is attributable to a restructuring that reduced staff and closed branches, the Corporation incurring lower legal and consulting expenses related to problem credits as the loan portfolio has improved, and a decrease in FDIC premiums that are based on asset size, which has decreased throughout the year.

Income Taxes. The Corporation recorded an income tax credit of $156 for the nine months ended September 30, 2012, compared to a credit of $531 in the same period in 2011. In 2010, management recognized a full allowance on the net deferred tax asset, and continues to record a full valuation allowance.

LIQUIDITY

Liquidity is the ability of the Corporation to fund customers' needs for borrowing and deposit withdrawals. The purpose of liquidity management is to assure sufficient cash flow to meet all of the financial commitments and to capitalize on opportunities for business expansion. This ability depends on the financial strength, asset quality and types of deposit and investment instruments offered by the Corporation to its customers. The Corporation's principal sources of funds are deposits, loan and security repayments, maturities of securities, sales of securities available for sale and other funds provided by operations. The Bank also has the ability to borrow from the FHLB. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan and mortgage-backed security prepayments are more influenced by interest rates, general economic conditions, and competition. The Corporation maintains investments in liquid assets based upon management's assessment of (1) need for funds, (2) expected deposit flows,
(3) yields available on short-term liquid assets and (4) objectives of the asset/liability management program.

Cash and cash equivalents increased to $48,157 at September 30, 2012 as compared to $39,314 at December 31, 2011. The Bank continues to offer a number of retail deposit programs to increase core deposits while reducing reliance on large depositors and CDARS deposits. Cash and equivalents represented 9.7% of total assets at September 30, 2012 and 7.5% of total assets at December 31, 2011. The Corporation has the ability to borrow funds from the FHLB and the Federal Reserve should the Corporation need to supplement its future liquidity needs. Management believes the Corporation's liquidity position is adequate based on its current level of cash, cash equivalents, core deposits, the stability of its other funding sources, and the support provided by its capital base.


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CAPITAL RESOURCES

Total shareholders' equity increased $1,054 between December 31, 2011 and September 30, 2012. The increase is primarily due to net income of $784 and a decrease in accumulated other comprehensive loss.

Tier 1 capital is shareholders' equity excluding the unrealized gain or loss on securities and intangible assets. Total capital includes Tier 1 capital plus the allowance for loan losses, not to exceed 1.25% of risk-weighted assets. Risk-weighted assets are the Corporation's total assets after such assets are assessed for risk and assigned a weighting factor defined by regulation based on their inherent risk.

For the Bank, the total risk-based capital ratio was 10.19% at September 30, 2012, while the Tier 1 risk-based capital ratio was 8.98%. Regulatory minimums call for Tier 1 capital and total risk-based capital ratios of 4.0% and 8.0% at September 30, 2012, respectively. The Bank's Tier 1 leverage ratio, defined as Tier 1 capital divided by average assets, was 7.12% at September 30, 2012. As previously reported, in October 2010, the Bank entered into a Consent Agreement with the FDIC and a written agreement with the Ohio Division which require that Tier-1 and total risk based capital percentages be 9.0% and 13.0% respectively. As a result, the Bank is currently not in compliance with these orders. The Corporation has been exploring alternatives for raising capital. On October 16, 2012, the Corporation announced the launch of a rights offering and private placement to standby purchasers for up to $13.2 million of the Corporation's common shares. The Corporation expects that it will be able to meet the Bank's Capital requirements when the rights offering is completed.

The following table sets forth the Corporation's obligations and commitments to make future payments under contract as of September 30, 2012.

                                                                     Payment Due by Year
                                                        Less than 1                                       More than
Contractual Obligations                    Total           year           1-3 years       3-5 years        5 years
FHLB advances                             $ 16,689     $       8,872     $     3,854     $     1,792     $     2,171
Operating lease obligations                  2,583               601             988             795             199
Loan and line of credit commitments         75,756            43,232              -               -           32,524

Total Contractual Obligations             $ 95,028     $      52,705     $     4,842     $     2,587     $    34,894


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