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

Show all filings for MBT FINANCIAL CORP

Form 10-Q for MBT FINANCIAL CORP


14-Nov-2012

Quarterly Report


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

Introduction

MBT Financial Corp. (the "Company") is a bank holding company with one subsidiary, Monroe Bank & Trust ("the Bank"). The Bank is a commercial bank with a wholly owned subsidiary, MB&T Financial Services. MB&T Financial Services is an insurance agency which sells insurance policies to the Bank. The Bank operates 17 branch offices in Monroe County, Michigan and 7 offices in Wayne County, Michigan. The Bank's primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. The discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

Executive Overview

The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management products and services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving asset quality, profitability, and capital.

The national economic recovery is continuing slowly, and conditions in southeast Michigan are also slowly improving. Local unemployment rates improved significantly over the past year, and are now comparable to the state and national averages, but remain above the historical norms. Commercial and residential development property values continue to show some stability with some areas improving slightly. Our total problem assets, which include nonperforming loans, other real estate owned, non accrual investments, and performing loans that are internally classified as potential problems, increased $5.0 million, or 3.9% during the third quarter of 2012, but decreased $10.3 million or 7.2% compared to a year ago. The improvement in our asset quality over the past year and the decrease in our net charge offs in each of the last three quarters allowed us to decrease our Allowance for Loan and Lease Losses (ALLL) from $19.5 million to $19.1 million in the third quarter. The loan portfolio decreased $17.4 million during the quarter, and the ALLL as a percent of loans increased from 2.91% to 2.94%. Although local property values and the unemployment rate have stabilized over the past several quarters, we anticipate that the recovery in our local markets will continue at a slower than normal pace though 2013. We will continue to focus our efforts on improving asset quality, maintaining liquidity, strengthening capital, and controlling expenses.

Net Interest Income decreased $335,000 compared to the third quarter of 2011 even though the average earning assets increased $1.6 million, or 0.1% as the net interest margin decreased from 3.16% to 3.05%. The provision for loan losses decreased from $2.7 million in the third quarter of 2011 to $1.55 million in the third quarter of 2012. Decreases in the historical loss rates and in the amount of specific allocations during the quarter decreased the amount of ALLL required. As a result, we were able to record a provision that was smaller than the net charge offs for the quarter. Non interest income decreased $296,000 or 6.9%, as the decrease in gains on securities transactions exceeded the increases in wealth management fees and mortgage loan origination income. Non interest expenses decreased $254,000, or 2.6% as credit related costs, including collection costs, losses on Other Real Estate Owned (OREO), and OREO carrying costs decreased significantly. We expect credit related expenses to continue to improve, but still remain above normal levels, into 2013.

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Critical Accounting Policies

The Company's Allowance for Loan Losses, Deferred Tax Asset Valuation Allowance, Fair Value of Investment Securities, and Other Real Estate Owned are "critical accounting estimates" because they are estimates that are based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Company's financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

Income tax accounting standards require companies to assess whether a valuation allowance should be established against deferred tax assets based on the consideration of all evidence using a "more likely than not" standard. We reviewed our deferred tax asset, considering both positive and negative evidence and analyzing changes in near term market conditions as well as other factors that may impact future operating results. Significant negative evidence is our net operating losses for the last three full years, combined with a difficult economic environment and the slow pace of the economic recovery in southeast Michigan. Positive evidence includes our history of strong earnings prior to 2008, our fifth consecutive quarterly profit in the third quarter of 2012, our strong capital position, our steady core earnings, our improving asset quality, and our non interest expense control initiatives. Based on our analysis of the evidence, we believed that it was appropriate to maintain a valuation allowance of $24.9 million, which is equal to the full amount of the deferred tax asset as of September 30, 2012. If the amount of positive evidence continues to increase, we may begin to recognize a tax benefit in late 2012 or early 2013.

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

Financial Condition

National economic conditions began to recover in the second half of 2009, but regional conditions remained weak until 2010. Local unemployment and property values stabilized during 2011 and began to improve in 2012. The economic environment in southeast Michigan is continuing to slowly improve. Our nonperforming assets increased 9.2% during the quarter, from $81.9 million to $89.4 million, and total problem assets increased from $126.8 million to $131.8 million. Both of these measures were impacted by a small number of large credit relationships, and both still reflect improvement compared to the third quarter of 2011. Total loans decreased $17.4 million during the quarter as payments received in the ordinary course of business, transfers to OREO, and charge offs of existing loans exceeded new loan production. The decrease in loans caused an increase in lower yielding cash and investments, which, along with the prolonged historically low interest rate environment caused a decrease in our net interest margin. As the local economy is slowly recovering, lending opportunities are beginning to increase. We expect the slow recovery to continue in our market area into 2013. The Company expects low deposit growth and a reduction in total assets due to a reduced use of non deposit funding in 2013. Management intends to continue to focus efforts on improving credit quality, managing capital, and mitigating enterprise risk.

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Since December 31, 2011, total loans decreased $29.3 million (4.3%) because the loan demand did not result in enough new loan activity to offset write downs recorded and payments received. At the same time, deposits decreased $1.9 million, or 0.2% as maturities of brokered certificates of deposit were partially offset by an increase in local deposit activity. The reductions in loans and deposits resulted in a decrease of $2.0 million (0.2%) in total assets since the end of 2011. Total capital increased $3,387,000 or 4.5%, due to the year to date profit of $2.9 million and the increase of $386,000 in the accumulated other comprehensive income (AOCI). AOCI increased mainly due to an increase in the value of our securities available for sale. The decrease in total assets and the increase in capital caused the capital to assets ratio to increase from 6.12% at December 31, 2011 to 6.40% at September 30, 2012.

The amount of nonperforming assets ("NPAs") decreased $5.8 million or 6.1% during the first three quarters of 2012. NPAs include non performing loans, which decreased 3.7% from $75.5 million to $72.7 million, and Other Real Estate Owned and Other Assets ("OREO"), which decreased 17.5% from $16.7 million to $13.8 million. Total problem assets, which includes all NPAs and performing loans that are internally classified as substandard, decreased $5.0 million, or 3.6%. The Company's Allowance for Loan and Lease Losses ("ALLL") decreased $1.7 million since December 31, 2011, due to a decrease in the size of the portfolio and an improvement in the quality of the assets in the loan portfolio. The ALLL is now 2.94% of loans, down from 3.07% at December 31, 2011 and 3.11% at September 30, 2011. The ALLL is 26.29% of nonperforming loans ("NPLs"), compared to 27.63% at year end and 29.66% at September 30, 2011. In light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in the loan portfolio.

Results of Operations - Third Quarter 2012 vs. Third Quarter 2011

Net Interest Income - A comparison of the income statements for the three months ended September 30, 2011 and 2012 shows a decrease of $335,000, or 3.7%, in Net Interest Income. Interest income on loans decreased $1.3 million or 13.3% as the average loans outstanding decreased $52.5 million and the average yield on loans decreased from 5.58% to 5.23%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $149,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $54.1 million but the yield decreased from 2.25% to 1.88%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit helped reduce the funding costs. The interest expense on deposits decreased $1,158,000 or 43.8% as the average deposits decreased $5.9 million and the average cost of deposits decreased from 1.02% to 0.58%. The cost of borrowed funds increased $14,000 even though the average amount of borrowed funds decreased $4.2 million as the average cost of the borrowings increased from 2.63% to 2.83%.

Provision for Loan Losses - The Provision for Loan Losses decreased from $2.7 million in the third quarter of 2011 to $1.55 million in the third quarter of 2012. Net charge offs were $1.9 million during the third quarter of 2012, compared to $3.5 million in the third quarter of 2011. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, and a decrease in the historical loss percentages, we were able to maintain an adequate ALLL in the third quarter of 2012 even though we recorded a provision that was less than our net charge offs. The ALLL is 2.94% of loans as of September 30, 2012, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

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Other Income - Non interest income decreased $296,000, or 6.9% compared to the third quarter of 2011. Excluding gains on securities transactions, non interest income increased $160,000 or 4.3% Wealth management income increased $91,000 due to an increase in the market value of assets managed and new business brought in to the bank. Origination fees on mortgage loan sold increased $196,000, or 192.2% due to an increase in mortgage loan origination volume compared to 2011.

Other Expenses - Total non interest expenses decreased $254,000, or 2.6% compared to the third quarter of 2011. Salaries and Employee Benefits increased $191,000, or 3.9%, as an increase in salaries was partially offset by a decrease in the retirement plan contribution. Occupancy expense decreased $74,000 due to lower depreciation and property tax expenses. Marketing expense decreased $63,000, or 29.4% due to the elimination of our debit card rewards program and a reduction in advertising activity due to the reduced need to attract deposits. Losses on Other Real Estate Owned (OREO) properties decreased $445,000 compared to the third quarter of 2011 as the property values stabilized over the last year, requiring fewer write downs of properties owned, and some of the OREO property sales that closed during the quarter produced gains. Other OREO expenses decreased $236,000 as the reduction in OREO properties owned resulted in a decrease in insurance, property tax, and maintenance costs. Other non interest expense increased $367,000, or 49.7% mainly due to the accrual of $126,000 for an excise tax payment in the third quarter of 2012 and an increase of $122,000 in state tax expense due to a refund received in the third quarter of 2011. The expense was also impacted by increases in employee training and other insurance expenses in 2012.

As a result of the above activity, the Profit Before Income Taxes in the third quarter of 2012 was $1,405,000, an improvement of $773,000 compared to the profit of $632,000 in the third quarter of 2011. Due to our net operating loss carry forward, we are not recording a federal income tax expense, however, we expensed an alternative minimum tax payment of $17,000 in the third quarter of 2012. No income tax benefit or expense was recorded in the third quarter of 2011 due to the net operating loss carry forwards and the uncertainty of our expected ability to utilize our deferred tax assets. The Net profit for the third quarter of 2012 was $1,388,000, an increase of 119.6% compared to the net profit of $632,000 in the third quarter of 2011.

Results of Operations - Nine months ended September 30, 2012 vs. Nine months ended September 30, 2011

Net Interest Income - A comparison of the income statements for the nine months ended September 30, 2011 and 2012 shows an increase of $30,000, or 0.1%, in Net Interest Income. Interest income on loans decreased $3.6 million or 11.8% as the average loans outstanding decreased $59.5 million and the average yield on loans decreased from 5.59% to 5.36%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $148,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $52.5 million but the yield decreased from 2.33% to 2.03%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit caused the funding costs to decrease also. The interest expense on deposits decreased $3,657,000 or 42.4% as the average deposits decreased $11.6 million and the average cost of deposits decreased from 1.11% to 0.65%. The cost of borrowed funds only decreased $118,000 as the average amount of borrowed funds decreased $11.2 million while the average cost of the borrowings increased from 2.77% to 2.89%.

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Provision for Loan Losses - The Provision for Loan Losses decreased from $11.3 million in the first nine months of 2011 to $4.85 million in the first nine months of 2012. Net charge offs were $6.6 million during the first nine months of 2012, compared to $10.7 million in the first nine months of 2011. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, a decrease in the historical loss percentages, and a decrease in the specific allocations, we were able to maintain an adequate ALLL in the first nine months of 2012 even though we recorded a provision that was less than our net charge offs. The ALLL is 2.94% of loans as of September 30, 2012, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income - Non interest income increased $424,000, or 3.6% compared to the first nine months of 2011, primarily because gains on the sales of securities increased $588,000. Some federal government agency securities were sold in 2012 to rebalance the Bank's interest rate risk. The sales had the additional benefit of producing the gain, which improved the bank's capital ratios. Wealth management fees decreased $96,000, or 3.2% as a fee refund to a large employee benefit account in 2012 offset increases created by new business activity and higher market values of assets managed. Service charges and other fees on deposit accounts decreased $130,000, or 3.7%, primarily due to a decrease in overdraft fees on checking accounts. Origination fees on mortgage loan sold increased $353,000, or 130.3% due to an increase in mortgage loan origination volume in 2012. Income on Bank Owned Life Insurance policies decreased $129,000, or 10.7% due to a decrease in the yields on the policies this year and a decrease in the cash surrender value enhancement feature on some of the policies this year. Other non interest income decreased $162,000, or 5.0% due to decreases in rental income on OREO properties and commission income on brokerage activity and check sales.

Other Expenses - Total non interest expenses decreased $1.7 million, or 5.5% compared to the first nine months of 2011. Salaries and Employee Benefits increased $517,000, or 3.5%, as salaries increased $541,000 or 4.9%. Benefits decreased slightly, as increases in life insurance and payroll tax expenses were offset by decreases in medical insurance and retirement contributions. Occupancy expense decreased $188,000 due to lower maintenance costs as a result of the mild winter weather in 2012 and lower property taxes due to a successful appeal of the assessment of one of our branches in 2012. Equipment expense increased $62,000 due to higher computer expenses. Marketing expense decreased $171,000, or 24.6% due to the elimination of our debit card rewards program and a reduction in our advertising activity. Professional fees decreased $187,000, or 10.2% due to a decrease in credit related legal fees, partially offset by an increase in accounting and legal fees due to the IRS audit. Losses on Other Real Estate Owned (OREO) properties decreased $2.1 million compared to the first nine months of 2011 as the property values stabilized in the second half of 2011 and sales have been completed at prices close to the carrying values in 2012. Other OREO expenses decreased $200,000 as the reduction in OREO properties owned resulted in a decrease in insurance, property tax, and maintenance costs. FDIC deposit insurance premium expense decreased $187,000, or 8.3%, due to a change in the assessment method in 2011.

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As a result of the above activity, the Profit Before Income Taxes in the first nine months of 2012 was $4.4 million, an improvement of $8.6 million compared to the loss of $4.2 million in the first nine months of 2011. In the first nine months of 2012, we recorded a federal income tax expense of $1.6 million. The Company is currently being audited by the IRS, and the ultimate resolution of the exam is still uncertain. This accrual, along with the $500,000 accrued in the fourth quarter of 2011, reflects the amount of a settlement offer that we made to the IRS in an attempt to resolve the audit. The issues being challenged mainly involve the timing of income recognition and would normally result in an increase in the deferred tax asset. However, the Company is maintaining a valuation allowance against 100% of its deferred tax asset, so the estimated tax adjustment was expensed. No income tax benefit or expense was recorded in the first nine months of 2011 due to the net operating loss carry forwards and the uncertainty of our expected ability to utilize our deferred tax assets. The Net profit for the first nine months of 2012 was $2,858,000, compared to a net loss of $4,193,000 in the first nine months of 2011.

Cash Flows

Cash flows provided by operating activities increased $7.8 million compared to the first nine months of 2011 as the net income increased mainly due to the decreases in the provision for loan losses and other non interest expenses. Cash flows from investing activities decreased $16.1 million in the first nine months of 2012 compared to the first nine months of 2011 as more of the cash provided by sales and redemptions of investment securities and loan payments was reinvested in securities. The amount of cash used for financing activities decreased $8.9 million in the first nine months of 2012 compared to the first nine months of 2011 as less non deposit funding matured in 2012. Total cash and cash equivalents decreased $9.7 million as of September 30, 2012 compared to September 30, 2011 as the Company has invested more of its excess cash in order to improve its interest income.

Liquidity and Capital

The Company believes it has sufficient liquidity to fund its lending activity and allow for fluctuations in deposit levels. Internal sources of liquidity include the maturities of loans and securities in the ordinary course of business as well as our available for sale securities portfolio. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, the Federal funds line that has been established with our correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. As of September 30, 2012, the Bank utilized $107.0 million of its authorized limit of $265 million with the Federal Home Loan Bank of Indianapolis, none of its $10 million overdraft line of credit with the Federal Home Loan Bank of Indianapolis, and none of its $25 million of federal funds line with a correspondent bank.

The Company's Funds Management Policy includes guidelines for desired amounts of liquidity and capital. The Funds Management Policy also includes contingency plans for liquidity and capital that specify actions to take if liquidity and capital ratios fall below the levels contained in the policy. Throughout the first nine months of 2012 the Company was in compliance with its Funds Management Policy regarding liquidity and capital.

Total stockholders' equity of the Company was $79.1 million at September 30, 2012 and $75.7 million at December 31, 2011. The ratio of equity to assets was 6.40% at September 30, 2012 and 6.12% at December 31, 2011. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be well capitalized if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, and the Leverage Capital Ratio is at least 5%.

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The following table summarizes the capital ratios of the Company and the Bank:

                                                                     Minimum to Qualify as
                                                Actual                  Well Capitalized
                                          Amount       Ratio          Amount           Ratio
As of September 30, 2012:
Total Capital to Risk-Weighted Assets
Consolidated                             $ 87,657       11.20 %   $       78,265           10 %
Monroe Bank & Trust                        87,226       11.15 %           78,216           10 %
Tier 1 Capital to Risk-Weighted Assets
Consolidated                               77,730        9.93 %           46,959            6 %
Monroe Bank & Trust                        77,239        9.88 %           46,929            6 %
Tier 1 Capital to Average Assets
Consolidated                               77,730        6.27 %           61,957            5 %
Monroe Bank & Trust                        77,239        6.24 %           61,931            5 %




                                                                           Minimum to Qualify as
                                                   Actual                     Well Capitalized
                                            Amount         Ratio           Amount             Ratio
As of December 31, 2011:
Total Capital to Risk-Weighted Assets
Consolidated                               $  84,970         10.48 %   $       81,084               10 %
Monroe Bank & Trust                           84,441         10.42 %           81,033               10 %
Tier 1 Capital to Risk-Weighted Assets
Consolidated                                  74,695          9.21 %           48,650                6 %
Monroe Bank & Trust                           74,106          9.15 %           48,620                6 %
Tier 1 Capital to Average Assets
Consolidated                                  74,695          6.07 %           61,505                5 %
Monroe Bank & Trust                           74,106          6.03 %           61,481                5 %

On July 12, 2010, the Bank entered into a Consent Order with its state and federal regulators. While the Bank is under the Consent Order, it is classified as "adequately capitalized" even if its ratios meet the "well capitalized" guidelines. The Consent Order requires the Bank to raise its Tier 1 Leverage ratio to 9% and its Total Risk Based Capital Ratio to 12%. As of September 30, 2012, the Bank is not in compliance with the capital requirements of the Consent Order. The table below indicates the amount of capital the Bank needed to be in compliance with the Consent Order as of September 30, 2012:

                                                                                                      Additional
                                                                                                        Capital
                                                                  Minimum Capital Required            Required to
                                      Actual Capital                  by Consent Order                Comply with
                                   Amount         Ratio            Amount              Ratio         Consent Order
Total Capital to Risk-Weighted
Assets                            $  87,226         11.15 %   $         93,859               12 %   $         6,633
Tier 1 Capital to Average
Assets                            $  77,239          6.24 %   $        111,476                9 %   $        34,237

The Company increased its common shares authorized in 2011 and is monitoring the capital market conditions. Currently, the Company does not believe that the market conditions are suitable for a bank holding company of our size located in the Midwest to conduct an offering large enough to generate the amount of capital required to comply with the Consent Order. While we continue to monitor . . .

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