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HOME > SEC Filings for HOME > Form 10-K on 15-Mar-2013All Recent SEC Filings

Show all filings for HOME FEDERAL BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report on Form 10-K contains forward-looking statements, which can be identified by the use of words such as "believes," "intends," "expects," "anticipates," "estimates" or similar expressions. Forward-looking statements include, but are not limited to:

statements of our goals, intentions and expectations;

statements regarding our business plans, prospects, growth and operating strategies;

statements regarding the quality of our loan and investment portfolios; and

estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

changes in general economic conditions, either nationally or in our market areas;

changes in the levels of general interest rates, and the relative differences between short-term and long-term interest rates, deposit interest rates, our net interest margin and funding sources;

risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;

fluctuations in the demand for loans, the number of unsold homes and properties in foreclosure and fluctuations in real estate values in our market areas;

results of examinations of the Company by the Federal Reserve Board and of our bank subsidiary by the Federal Deposit Insurance Corporation (FDIC) and the Idaho Department of Finance or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings and could increase our deposit premiums;

legislative or regulatory changes, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") and its implementing regulations that adversely affect our business, as well as changes in regulatory policies and principles or the interpretation of regulatory capital or other rules, including as a result of Basel III;

our ability to attract and retain deposits;

increases in premiums for deposit insurance;

our ability to realize the residual values of our leases;

our ability to control operating costs and expenses;

the use of estimates in determining the fair value of certain of our assets or cash flows on purchased credit impaired loans, which estimates may prove to be incorrect and result in significant declines in valuation;

difficulties in reducing risks associated with the loans on our balance sheet;

staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

computer systems on which we depend could fail or experience a security breach;

our ability to retain key members of our senior management team;

costs and effects of litigation, including settlements and judgments;

the possibility that the expected benefits from acquisitions will not be realized;

increased competitive pressures among financial services companies;

changes in consumer spending, borrowing and savings habits;

the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

our ability to pay dividends on our common stock;

adverse changes in the securities markets and the value of our investments;

the inability of key third-party providers to perform their obligations to us;

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changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described as detailed from time to time in our filings with the SEC, including this our 2012 Form 10-K. Such developments could have an adverse impact on our financial position and our results of operations.

Some of these and other factors are discussed in this Annual Report on Form 10-K under the caption "Risk Factors" and elsewhere in this document and in the documents incorporated by reference herein. Such developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements that we make in this annual report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. We undertake no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for fiscal year 2013 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect our financial condition, liquidity and operating and stock price performance.


In January 2012, we announced the change in the Company's fiscal year end from September 30 to December 31, effective January 1, 2012. As a result, the Company's current fiscal year comprises the twelve months ended December 31, 2012. Our previous fiscal year ended September 30, 2011. Consequently, we filed a transition report on Form 10-QT for the three month period ended December 31, 2011, and have included disclosures and narrative related to that transition period in this Form 10-K. Additionally, under SEC rules, while the income statement and related disclosures for the transition period have been audited, we do not present an audited balance sheet as of December 31, 2011. Therefore, balance sheet comparisons in this discussion and analysis are as of December 31, 2012, and September 30, 2011. Comparisons of operating results relate to the twelve months ended December 31, 2012, and September 30, 2011 and the three months ended December 31, 2011 and 2010.

Our primary source of revenue and earnings is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. We diversify the mix of our assets by reducing the percentage of our assets that are long-term, fixed-rate one-to-four family residential loans and increasing the percentage of our assets consisting of commercial loans that we believe have higher risk-adjusted returns and less interest rate risk than long-term fixed-rate one-to-four family residential loans.

Our operating expenses consist primarily of compensation and benefits, occupancy and equipment, data processing, and professional services expenses. Compensation and benefits consist primarily of the salaries and wages paid to our employees, non-cash expense related to our stock-based and deferred compensation plans, our 401(k) and Employee Stock Ownership Plan (KSOP), payroll taxes, and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.

Our results of operations may also be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. See "Item 1A. Risk Factors" in this Annual Report on Form 10-K for additional discussion on the risks we face related to these items.

We entered into two purchase and assumption agreements with the FDIC to purchase certain assets and assume certain liabilities of Community First Bank, Prineville, Oregon, and LibertyBank, Eugene, Oregon, on August 7, 2009, and July 30, 2010, respectively. The acquisitions increased our total assets by $880 million, based on the fair value of assets purchased on the acquisition dates. These acquisitions have been reported on a prospective basis in the accompanying financial statements. Nearly all loans, leases and real estate owned acquired in both FDIC-assisted transactions are covered under FDIC loss sharing agreements which significantly reduce the Company's credit loss exposure. We refer to these assets as "covered assets." Loans and REO in the Bank's organic operations and purchased assets not included

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in the loss sharing agreements are referred to as "noncovered assets." We expect to recover 80% of losses and certain expenses associated with the covered assets of Community First Bank on the first $34 million of losses. After that, we expect to recover 95% of losses and expenses on those covered assets. We expect to recover 80% of losses and certain expenses associated with the covered assets of LibertyBank. The loss sharing agreements for covered assets that are non-single family loans and REO expire five years from the acquisition date, which will be in September 2014 for covered assets in the CFB Acquisition and September 2015 for the LibertyBank Acquisition. The loss sharing agreements provide indemnification for losses on single-family loans and REO for a period of 10 years from the acquisition date. After the expiration of the loss sharing agreements, we will no longer be protected against credit losses through FDIC indemnification.


Fiscal year 2012 (the twelve months ended December 31, 2012) was a year of stabilization as the operations of our acquisitions have been fully integrated and our core system conversions were completed. While economies in our markets have improved and stabilized, growth in economic output is still below average. However, our Idaho Region enjoyed strong growth in employment, declining unemployment, and increased construction activity during the second half of 2012. As a result, our construction loan portfolios grew during the year. We were unable, however, to originate new loans at a pace fast enough to offset overall declines in our loan portfolio during 2012. Most of the declines in our loan portfolios occurred in our one-to-four family residential loan and equipment finance portfolios. We no longer originate those loans for our portfolios. To a lesser extent, commercial real estate loans also declined, reflecting the currently weak economic conditions and lack of demand from credit-worthy borrowers. Additionally, nonperforming loans declined significantly during 2012, which also contributed to loan portfolio reductions.

We recognize the need to accelerate loan production and generate growth in net loans and intend to do so without reducing our credit underwriting standards. However, competition for loans is very strong and we experienced significant pressure to reduce new loan rates. We also observed competitors sacrificing prudent underwriting standards by loosening loan terms in order to originate new loans, including lower collateral and guarantor support and long-term final maturity dates with long amortization periods. We hired several commercial lending relationship managers in the fourth quarter of 2012 and in January 2013, which we believe will result in increased loan production as our market economies are expected to continue to improve in 2013.

We opened a builder finance loan production office in Portland in 2012 and believe that the construction loan portfolio will grow in 2013 as well. We are also considering another construction loan production office in Salt Lake City. We recognize the higher inherent risk in construction loans, but believe we have strong underwriting criteria and credit administration procedures as loan approval and construction site inspections are performed by our Credit Administration Team, which is not compensated based on loan production. We have also set concentration limits on the size of our construction loan portfolio, which is currently at 55% of the Bank's Tier 1 capital, plus the allowance for loan losses.

Additionally, we plan to implement a streamlined small business lending process in the second quarter of fiscal year 2013. This new program is currently under design and development and will include new products, underwriting processes and improved sales training as we continue to transition the focus of our branch teams to small business lending.

We have been diligent and very selective in our pursuit of acquisition opportunities. The FDIC-assisted acquisition of the assets and liabilities of Community First Bank and LibertyBank nearly doubled our total assets at the time of the LibertyBank Acquisition. The LibertyBank Acquisition increased our deposit market share in Central Oregon where we had developed an initial presence through the CFB Acquisition. We also benefited through the branch offices acquired which expanded our lending markets in Portland, Eugene, Bend, Grants Pass, and Medford, Oregon, diversified our footprint beyond the Boise-Nampa MSA and, we believe, increased our franchise value.

The LibertyBank Acquisition resulted in a significant increase in cash due to the excess of liabilities assumed over assets purchased and the retention by the FDIC of approximately half of the loans in the LibertyBank portfolio. This significant increase in cash balances put pressure on our net interest margin and will continue to do so until we have successfully deployed all of this cash received in the LibertyBank acquisition into loans. In the meantime, our liquidity ratio is strong, however, the excess liquidity places significant pressure on our net interest margin due to the current historically-low interest rate environment. Losses in the LibertyBank Acquisition portfolio have been significantly less than we estimated at the time of the acquisition in 2010. As a result, our net interest margin is higher than it would be if interest income on the purchased loans were accrued at the underlying note rate. However, the impact of lower losses

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and faster prepayments on loans has accelerated the accretion of the fair value purchase discounts (generically, "accretable yield") recorded on LibertyBank loans at acquisition. As this loan portfolio declines, the impact of accretable yield diminishes and our net interest margin declines. We believe the impact of accretable yield will be immaterial to interest income during the next two years, based on our current expected cash flows.

Asset quality improved significantly during the last 15 months as nonperforming loans declined $10.2 million to $14.4 million at December 31, 2012, compared to $24.6 million at September 30, 2011. REO also declined $13.1 million during that period to $10.4 million at December 31, 2012. We also experienced declining delinquencies and fewer classified and criticized loans during 2012, which we believe provides momentum for continued improvement in asset quality in 2013.

We continue to hold excess capital, which we believe provides support against further economic deterioration and loan losses, and also provides a solid foundation for additional growth through acquisition. The current economic and interest rate environments continue to challenge our organic growth plans. Alternative investments are also unattractive as investment securities offer very low yields within management's credit and interest rate risk tolerances. Therefore, we intend to seek additional acquisitions that are within our core markets as we believe that acquisitive growth is the best short-term alternative to build an operational structure that will allow us to thrive profitably over the long-term.

While we constantly monitor branch performance and noninterest expense, our low net interest margin necessitates a heightened awareness of operating inefficiencies. Additionally, our broad network of branches exacerbates our higher than peer expense levels. We monitor the performance of our branches and analyze market growth opportunities, current market share, and client transaction levels in determining underperforming branches. In November 2012, we announced the plan to close four branches located in Grants Pass, Medford and Bend, Oregon, by February 28, 2013. We determined these branches were least likely to provide profitable returns in the long-term and decided to close them and transition clients to our nearest branch upon closure. Charges recorded during the fourth quarter of fiscal year 2012 reduced pre-tax income from operations by approximately $539,000 for the quarter and year ended December 31, 2012.

In September 2011, we announced a number of key initiatives that accelerated the Company's return to profitability. The net impact of those initiatives reduced pre-tax income from operations by approximately $3.5 million for the fiscal year ended September 30, 2011, however, the reduction in operating expenses was approximately $3.6 million over the subsequent twelve months. These key initiatives included the merger of the Home Federal Bank 401(k) Plan and the Home Federal Bancorp, Inc., Employee Stock Ownership Plan (ESOP) into the Home Federal 401(k) Plan and Employee Stock Ownership Plan (KSOP) to reduce compensation expense; the repayment of all outstanding debt with the FHLB of Seattle, which resulted in a prepayment penalty of $2.0 million, pre-tax, however, interest expense should be reduced in 2012 and 2013; the closure of six branches and modified the organizational chart to improve operating efficiency and reduce compensation expense. Nearly all of those initiatives began to improve profitability by January 1, 2012, and further improved our operating efficiency after the successful integration of the back office operations of LibertyBank during the first half of calendar year 2011. As a result of these initiatives, noninterest expenses during the year ended December 31, 2012, were $10.0 million lower than the year ended September 30, 2011.

From 2006 through December 31, 2011, we originated residential mortgage loans primarily for sale in the secondary market with servicing released to investors. In December 2008, we sold all of our remaining servicing rights to a third party. Starting in December 2011, we began referring nearly all of our residential mortgage loan applications to a third party originator that underwrites and closes the mortgage funding for the Bank's clients. While we may choose to directly originate some residential mortgage loans from time to time, we currently expect very few residential mortgage loans will be originated by the Bank for its portfolio or for sale in the secondary market under this new model.

The following list summarizes additional key strategic initiatives undertaken by management and factors affecting the Company's performance during fiscal year 2012:

         We continued to execute our strategy of reducing reliance on high-cost
          certificates of deposit and borrowings as core deposits (defined as
          interest-bearing and noninterest-bearing checking, savings and money
          market accounts) increased to 75.4% of total deposits at December 31,
          2012, compared to 67.7% at September 30, 2011;

         Nonperforming assets decreased $23.2 million from September 30, 2011 to
          December 31, 2012, and nonperforming noncovered loans declined to 2.88%
          of noncovered loans at December 31, 2012, compared to 3.94% at
          September 30, 2011;

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         Economic conditions in our primary markets improved as unemployment,
          bankruptcies and foreclosures declined during 2012 and real estate
          values began to rise;

         Noninterest expenses declined $10.0 million during the year ended
          December 31, 2012 compared to the year ended September 30, 2011;

         The Company maintained its strong capital position with a total
          risk-based capital ratio of 38.57% and a Tier-1capital ratio of 15.36%
          at December 31, 2012;

         Capital management activity remained strong during fiscal year 2012 as
          the Company repurchased 1,251,943 shares at an average cost of $9.86
          per share and 390,131 shares during the three months ended December 31,
          2011, at an average cost of $10.02 per share, all at significant
          discounts to tangible book value; and,

         The Company increased its quarterly dividend during 2012, paying $0.23
          per share in regular dividends and the Company declared and paid an
          additional special dividend of $0.12 per share in the fourth quarter of


This Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as disclosures found elsewhere in this Annual Report on Form 10-K, are based upon the Company's consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under US GAAP.

Management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the determination of the allowance for loan losses (including the evaluation of impaired loans and the associated provision for loan losses), accounting for acquired loans and covered assets, the valuation of noncovered real estate owned, as well as deferred income taxes and the associated income tax expense. Management reviews the allowance for loan losses for adequacy on a quarterly basis and establishes a provision for loan losses that it believes is sufficient for the loan portfolio growth expected and the loan quality of the existing portfolio. The carrying value of real estate owned is also assessed on a quarterly basis. Income tax expense and deferred income taxes are calculated using an estimated tax rate and are based on management's and our tax advisor's understanding of our effective tax rate and the tax code. These estimates are reviewed by our independent auditor on an annual basis and by our regulators when they examine Home Federal Bank.

Allowance for Loan Losses. Management recognizes that losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Management assesses the allowance for loan losses on a quarterly basis by analyzing several factors including delinquency rates, charge-off rates and the changing risk profile of the Bank's loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies and vacancy rates of business and residential properties.

The Company believes that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about probable incurred losses inherent in the loan portfolio at the balance sheet date. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

The Company's methodology for analyzing the allowance for loan losses consists of specific allocations on significant individual credits and a general allowance amount, including a range of losses. The specific allowance component is determined when management believes that the collectability of an individually reviewed loan has been impaired and a loss is probable. The general allowance component relates to assets with no well-defined deficiency or weakness and takes into consideration loss that is inherent within the portfolio but has not been identified. The general allowance is determined by applying a historical loss percentage to various types of loans with similar characteristics and classified loans that are not analyzed specifically. Adjustments are made to historical loss percentages to reflect current economic and internal environmental factors such as changes in underwriting standards and unemployment rates that may increase

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or decrease those loss factors. As a result of the imprecision in calculating inherent and potential losses, a range is added to the general allowance to provide an allowance for loan losses that is adequate to cover losses that may arise as a result of changing economic conditions and other qualitative factors that may alter historical loss experience.

The allowance for loan losses is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries. Provisions for losses on covered loans are recorded gross of recoverable amounts from the FDIC under the loss sharing agreements. The recoverable portion of the provision for loan losses on covered loans is recorded in other income.

The allowance for loan losses on noncovered originated loans consists of specific reserves allocated to individually reviewed loans and general reserves on all other noncovered originated loans. Commencing in April 2011, management changed its accounting policy for specific allowances on noncovered originated loans in process of foreclosure. Previously, the Bank would maintain a specific reserve on these noncovered impaired loans. Since April 2011, such deficiencies on loans in process of foreclosure are classified as "Loss" under our credit grading process and the loan balance is charged down to the estimated net recoverable value, which removes the specific reserve previously recorded. A general allowance for loan losses is recorded on loans purchased in the CFB Acquisition that are not accounted for under ASC 310-30. Loans purchased in the CFB Acquisition that are accounted for under ASC 310-30 are partially charged . . .

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