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CAFI > SEC Filings for CAFI > Form 10-K on 19-Mar-2013All Recent SEC Filings

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Annual Report

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


Since its incorporation in 1970, Camco Financial Corporation ("Camco" or the "Corporation") has evolved into a full-service provider of financial products through its subsidiary, Advantage Bank ("Advantage" or "Bank"). Utilizing a common marketing theme based on Camco's commitment to personalized customer service, Camco has grown from $22.8 million of consolidated assets in 1970 to $764.3 million of consolidated assets at December 31, 2012. Camco's rate of growth is largely attributable to its acquisitions and its expansion of product lines from the limited deposit and loan offerings which the Bank could offer in the heavily regulated environment of the 1970s to the wider array of financial service products that commercial banks traditionally offer.

Management believes that continued success in the financial services industry will be achieved by those institutions with a rigorous dedication to building value-added customer-oriented organizations. Toward this end, each of the Bank's regions has the ability to make local decisions for customer contacts and services, however back-office operations are consolidated and centralized. Based on consumer and business preferences, the Bank's management designs financial service products with a view towards differentiating each of the constituent regions from its competition. Management believes that the Bank regions' ability to rapidly adapt to consumer and business needs and preferences is essential to them as community-based financial institutions competing against the larger regional and money-center bank holding companies.

Camco's profitability depends primarily on its level of net interest income, which is the difference between interest income on interest-earning assets, principally loans, mortgage-backed securities and investment securities, and interest expense on deposit accounts and borrowings. In recent years, Camco's operations have also been heavily influenced by its credit losses and the need for additional provision for loan losses, the level of other income, including mortgage banking income and other fee income. Camco's operations are also affected by general, administrative and other expenses, including employee compensation and benefits, occupancy expense, data processing, franchise taxes, advertising, other operating expenses and federal income tax expense.


During 2012, the economic environment for financial services companies improved slightly, but continued to be challenging. Bankruptcies, foreclosures and prolonged unemployment have continued and the oversupply of housing continues to depress property values. Due to the decreased property values, the government has expanded the Home Affordable Refinance Program ("HARP") for borrowers that are current with payments on their mortgages. HARP enables them to refinance up to 125% loan to value. This coupled with interest rates decreasing in 2012, has created a higher loan application level, but has also decreased the value of our seasoned loans within our mortgage servicing rights asset.

We continued to execute our long-term strategic plan to diversify the balance sheet, and improve delinquency, loan quality and our funding mix by reducing borrowings and increasing transaction-based deposits.

In 2012, total deposits decreased $2.0 million or 0.3% as we continued our goal of decreasing higher yielding certificates of deposits while increasing "core" deposit growth related to a number of organizational and product development initiatives, which included our suite of commercial and small business checking accounts, online business cash management system, and remote deposit capture solutions. We have continued to build our deposits with these new products and believe these products will continue to help us be more competitive for business checking accounts. Competition for deposits continues to put pressure on marginal funding costs, despite continued low rates in 2012, but our goal is to continue our strategy and build core customer accounts that are normally a lower cost of funding.

During 2012, Camco experienced improving trends in asset quality metrics. Nonperforming loans decreased $5.3 million, or 21.4% from $24.9 million at December 31, 2011 to $19.6 million at the end of 2012. Net charge offs totaled $2.5 million during 2012 compared to $4.6 million during 2011. These decreases demonstrate our continued diligence in managing our delinquencies and working with our loan customers in order to reduce losses for them, as well as our Corporation. Additionally, the amount of classified loans has decreased not only due to charge offs and sales of various assets, but also due to upgrading the loan quality ratings of various commercial loans related to improved borrower financial performance combined, in some cases, with restructured credit facilities, which has resulted in lower provisions for loan losses.

The Corporation engaged an investment banking firm in 2010 to evaluate capital plan initiatives such as balance sheet reduction, the sale of branches, and issuing common stock, preferred stock, debt or some combination of those issuances, or other financing alternatives that would be treated as capital. On November 8, 2012, Camco announced the successful and fully subscribed closing of a $10.0 million rights and private offering. Net proceeds of $9.4 million, net of offerings costs of $619,000 were invested in Advantage to improve its regulatory capital position. See Note-K for additional information.

We believe we are taking significant steps forward in managing our operational efficiency. In 2011, we launched online statements, a more convenient way of banking for many customers, and we are continuing our focus on improving noninterest income and controlling noninterest expense by refining our operations. We continue to analyze new products to deepen relationships with our "core" customers and improve the structure of our balance sheet and create efficiency throughout.

On March 4, 2011, Camco was notified by the FRB that by March 31, 2011 it must divest of activities conducted pursuant to section 4(k) of the BHC Act, which meant Camco Title Agency, and that it must decertify as a financial holding company. Camco complied with this request by liquidating Camco Title Agency and decertifying on March 31, 2011. After it decertified, Camco remained a bank holding company.

This Management Discussion and Analysis is intended to give stockholders a more comprehensive review of the issues facing management than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data elsewhere in this annual report. As used herein and except as the context may otherwise require, references to "Camco," "the Corporation", "we," "us," or "our" means, collectively, Camco Financial Corporation and its wholly owned subsidiary, Advantage Bank.

Critical Accounting Policies

"Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as disclosures found elsewhere in this annual report, are based upon Camco's consolidated financial statements, which are prepared in accordance with US GAAP. The preparation of these financial statements requires Camco 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.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of mortgage servicing rights, the fair value of other real estate owned and the valuation of deferred tax assets. Actual results could differ from those estimates.

Summary. We believe the accounting estimates related to the allowance for loan losses, the capitalization, amortization, and valuation of mortgage servicing rights, the value of other real estate owned and deferred income taxes are "critical accounting estimates" because: (1) the estimates are highly susceptible to change from period to period because they require us to make assumptions concerning the changes in the types and volumes of the portfolios, rates of future prepayments, and anticipated economic conditions, (2) the impact of recognizing an impairment or loan loss could have a material effect on Camco's assets reported on the balance sheet as well as its net earnings,
(3) the value of real estate owned could change materially due to the current economy and unemployment rates, and (4) assumptions and conditions could be incorrect related to the valuation allowance and the amount of income taxes payable may need to be adjusted by way of a charge to expense.

Allowance for Loan Losses

The procedures for assessing the adequacy of the allowance for loan losses reflect management's evaluation of credit risk after careful consideration of all information available to management. In developing this assessment, management must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown such as economic factors, developments affecting companies in specific industries and issues with respect to single borrowers. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or a decrease in the allowance for loan losses.

Each quarter, management analyzes the adequacy of the allowance for loan losses based on a review of the loans in the portfolio along with an analysis of external factors (including current housing price depreciation, homeowners' loss of equity, etc) and historical delinquency and loss trends. The allowance is developed through specific components: 1) the specific allowance for loans subject to individual analysis, 2) the allowance for classified loans not otherwise subject to individual analysis and 3) the allowance for non-classified loans (primarily homogenous).

Classified loans with indication or acknowledgment of deterioration are subject to individual analysis. Loan classifications are those used by regulators consisting of Special Mention, Substandard, Doubtful and Loss. In evaluating these loans for impairment, the measure of expected loss is based on the present value of the expected future cash flows discounted at the loan's effective interest rate, a loan's observable market price or the fair value of the collateral if the loan is collateral dependent. All other classified assets and non-classified assets are combined with the homogenous loan pools and segregated into loan segments. The segmentation is based on grouping loans with similar risk characteristics (one-to-four family, home equity, etc.). Loss rate factors are developed for each loan segment, which are used to estimate losses and determine an allowance. The loss factors for each segment are derived from historical delinquency, classification, and charge-off rates adjusted for economic factors and an estimated loss scenario.

The allowance is reviewed by management to determine whether the amount is considered adequate to absorb probable losses to the loan portfolio. Management's evaluation of the adequacy of the allowance is an estimate based on management's current judgment about the credit quality of the loan portfolio. This evaluation includes specific loss estimates on certain individually reviewed loans, statistical loss estimates for loan pools that are based on historical loss experience, and general loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower's ability to repay, and current economic and industry conditions. Management also considers trends in delinquencies and loan losses for the bank specifically, the region, the nation, and other economic factors. While the Corporation strives to reflect all known risk factors in its evaluations, judgment errors may occur.

Mortgage Servicing Rights

To determine the fair value of its mortgage servicing rights ("MSRs") each reporting quarter, the Corporation provides information representing loan information in each pooling period accompanied by escrow amounts to a third party valuation firm. The third party then evaluates the possible impairment of MSRs as described below.

MSRs are recognized as separate assets or liabilities when loans are sold with servicing retained. A pooling methodology, in which loans with similar characteristics are "pooled" together, is applied for valuation purposes. Once pooled, each group of loans is evaluated on a discounted earnings basis to determine the present value of future earnings that the Bank expects to realize from the portfolio. Earnings are projected from a variety of sources including loan service fees, net interest earned on escrow balances, miscellaneous income and costs to service the loans. The present value of future earnings is the estimated fair value for the pool, calculated using consensus assumptions that a third party purchaser would utilize in evaluating a potential acquisition of the MSR's.

Events that may significantly affect the estimates used are changes in interest rates and the related impact on mortgage loan prepayment speeds and the payment performance of the underlying loans. The interest rate for net interest earned on escrow balances, which is supplied by management, takes into consideration the investment portfolio average yield as well as current short duration investment yields. Management believes this methodology provides a reasonable estimate. Mortgage loan prepayment speeds are calculated by a third party provider utilizing the Economic Outlook as published by the Office of the Chief Economist of Freddie Mac in estimating prepayment speeds and provides a specific scenario with each evaluation. Based on the assumptions discussed, pre-tax projections are prepared for each pool of loans serviced. These earnings are used to calculate the approximate cash flow that could be received from the servicing portfolio. Valuation results are presented quarterly to management. At that time, management reviews the information and MSR's are marked to lower of amortized cost or fair value for the current quarter.

Deferred Income Taxes

Camco recognizes expense for federal income taxes currently payable as well as for deferred federal taxes for estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the consolidated balance sheets. Realization of a deferred tax asset is dependent upon generating sufficient taxable income in either the carry forward or the carry back periods to cover net operating losses generated by the reversal of temporary differences. A valuation allowance is provided by way of a charge to income tax expense if it is determined that it is more likely than not that some or all of the deferred tax asset will not be realized. If different assumptions and conditions were to prevail, the valuation allowance may not be adequate to absorb unrealized deferred taxes and the amount of income taxes payable may need to be adjusted by way of a charge to expense. Furthermore, income tax returns are subject to audit by the IRS. Income tax expense for current and prior periods is subject to adjustment based upon the outcome of such audits. Camco believes it has adequately accrued for all probable income taxes payable. Accrual of income taxes payable and valuation allowances against deferred tax assets are estimates subject to change based upon the outcome of future events. See Note I for additional information related to the current 100% valuation allowance and IRS appeals process.

Other Real Estate Owned

Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value. If fair value declines, a valuation allowance is recorded through expense. Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.

Discussion of Financial Condition Changes from December 31, 2012 to December 31, 2011

At December 31, 2012, Camco's consolidated assets totaled $764.3 million, a decrease of $2.8 million, or 0.4%, from the December 31, 2011 total. The decrease in total assets was comprised primarily of decreases in loans receivable offset partially by increases in securities available for sale and interest bearing deposits in other financial institutions.

Loans receivable has decreased due to continued paydowns and refinancing from adjustable rate to fixed rate loans. Our strategy of selling fixed rate products continues to shift the loan portfolio toward commercial loans. Current and upcoming loan rates may slow or increase residential lending and the sale of fixed rate loans. Due to the continued low interest rate environment over the past few years, we believe that is not likely that the profits on gain on sale of mortgage loans will be as strong in 2013 as the margins continue to decrease and many customers have already refinanced into the lower available rates. Possible growth in deposits, related to our strategic planning would most likely be used to purchase investments or fund commercial loan growth. Management continues its overall focus on managing credit, reducing risk within the loan portfolio and enhancing liquidity and capital in the current economic environment. Continuous progress is being made on addressing these issues, but we expect the distressed economic environment to continue through 2013, which may slow expectations.

Cash and interest-bearing deposits in other financial institutions totaled $58.4 million at December 31, 2012, an increase of $20.0 million, or 52.1%, from December 31, 2011 levels. Cash has increased as we have begun to restructure the balance sheet by decreasing assets and liabilities when possible to improve our capital position in conjunction with ensuring loan concentration levels and on-hand liquidity as appropriate. Additionally, Federal Reserve balances have increased from $2.2 million at December 31, 2011 to $39.2 million at December 31, 2012 in relation to risk based capital considerations and higher yield on the excess cash.

Securities totaled $86.2 million at December 31, 2012, an increase of $65.3 million, or 311.9%, from December 31, 2011 due to securities purchases of $99.2 million, which were partially offset by the sale of $4.3 million in securities and principal repayments, calls and maturities of $29.8 million. New purchases were primarily investment securities at a weighted rate of 0.67%. The securities portfolio has a weighted maturity that is relatively short in order to minimize extension risk. We have purchased callable agencies to maximize yield and liquidity. Approximately $19.5 million or 22.6% of the portfolio has a callable option which management expects to be exercised during the year. If the investments are not called, final maturity dates range from January, 2013 to March, 2014.

Loans receivable net and loans held for sale totaled $561.1 million at December 31, 2012, a decrease of $86.1 million, or 13.3%, from the total at December 31, 2011. The decrease resulted primarily from principal repayments of $290.4 million, loan sales of $109.2 million and $5.1 million of loans transferred to real estate owned, offset partially by loan funding totaling $318.5 million. Principal repayments are higher than 2011 related to our inability to originate certain types of commercial loans in early 2012 because of our concentration levels, which was coupled with large commercial payoffs in November and December of 2012. The commercial pipeline going into 2013 is strong and we expect originations to partially offset the payoffs that occurred in the fourth quarter of 2012. Additionally, the reduction in residential real estate loan balances was intensified by the secondary market offering historically low long-term fixed rates throughout 2012. Customers continue to refinance in 2012 to record low interest rates.

During 2012, the average yield on loans was 5.17% a decrease of 33 basis points as compared to 5.50% for 2011. The decrease in yield is due to lower average loan balances within our commercial and consumer loan portfolios, which are generally higher yielding assets. This was coupled with lower effective rates in the loan portfolio during 2012. Adjustable rate loans continued to re-price lower in 2012 due to the current low rate environment and new loans are also being originated at these lower market rates. Adjustable rate loans for home equity lines of credits and residential first mortgage have floors that range from 3-4% and 2.75-3% respectively after reaching the first adjustment period. In 2012 many of the higher rate commercial real estate loans were refinanced by other financial institutions and our new loans had to be priced at a lower competitive net interest margin that did not include floors on real estate projects like in previous years.

The allowance for loan losses totaled $12.1 million and $14.5 million at December 31, 2012 and 2011, respectively, representing 62.0% and 58.3% of nonperforming loans at those dates. Nonperforming loans (three monthly payments or more delinquent plus nonaccrual loans) totaled $19.6 million and $24.9 million at December 31, 2012 and 2011, respectively, constituting 3.5% and 3.8% of total net loans, including loans held for sale, at those dates. Net charge-offs totaled $2.5 million for 2012 and were primarily comprised of $2.6 million of residential real estate. See Note C to the financial statements for additional information.

The following table details delinquent and nonperforming loans at December 31, 2012 and 2011:

                                                                                        Accruing                                                             Accruing
                                                                                        Loans 90          Loans 30-59                                        Loans 90
                                       Loans 30-       Loans 60-                         or More             Days           Loans 60-                         or More
                                        59 Days         89 Days           Non-          Days Past            Past            89 Days           Non-          Days Past
                                       Past Due        Past Due        Performing          Due                Due           Past Due        Performing          Due
(in thousands)                                                    2012                                                                2011
Construction                          $         0     $         0     $         14     $         0       $           0     $         0     $         19     $         0
Land, Farmland & Ag                            65              32              709               0                 103               0              367               0
Residential                                 4,825           2,087           16,347               0               6,018           2,086           22,277               0
Commercial                                      0               0            1,967               0                 462             527            1,879               0
Consumer                                      100               1              491               0                  54              77              113               0
Commercial and industrial                       0               0               66               0                  45               0              212               0
Multi Family                                  227               0                0               0                   0               0               51               0

Total                                 $     5,217     $     2,120     $     19,594     $         0       $       6,682     $     2,690     $     24,918     $         0

The economy has a major effect on the unemployment rate which continues to be higher than normal. Joblessness can affect the capability of businesses and homeowners to pay for their loan payments and can lead to increased delinquencies. However, initial un-employment insurance claims remain steady nationwide, in Ohio and in the Bank's markets. As of the fourth quarter of 2012, Ohio's un-employment rate is 6.80% and the national un-employment rate is 7.80%. The average un-employment rate in the Bank's market areas decreased .07% to 6.67% when comparing third quarter 2012 to fourth quarter 2012. The labor force weighted un-employment rate in the Bank's markets is 6.03% which is below the Ohio average and the national average. The Ohio un-employment rate has declined for twenty consecutive months prior to August 2011 then continued the downward trend in December 2011 for another thirteen consecutive months.

The Corporation works with borrowers to avoid foreclosure if possible and we continue to aggressively work with borrowers to mitigate additional losses. If it becomes inevitable that a borrower will not be able to retain ownership of their property, the Corporation often seeks a deed in lieu of foreclosure in order to gain control of the property earlier in the recovery process. The strategy of pursuing deeds in lieu of foreclosure should result in a reduction in the holding period for nonperforming assets and ultimately reduce economic losses.

At December 31, 2012, the Corporation's real estate owned (REO) consisted of 150 repossessed properties with a net book value of $10.6 million compared to $10.9 million at December 31, 2011. When property is acquired through foreclosure or deed in lieu of foreclosure, it is initially recorded at the fair value of the related assets at the date of foreclosure, less estimated costs to sell the property. Initial loss is recorded as a charge to the allowance for loan losses within 90 days of being transferred to REO. Thereafter, if there is a further deterioration in value, a specific valuation allowance is established and charged to operations. The Corporation reflects costs to carry REO as period costs in operations when incurred.

Deposits totaled $627.2 million at December 31, 2012 a decrease of $2.0 million, or 0.32% from December 31, 2011. The following table details our deposit portfolio balances and the average rate paid on our deposit portfolio at December 31, 2012 and December 31, 2011:

                                                                            At December 31,
                                               2012                             2011                             Change
                                                     average                        Weighted-                          Weighted-
. . .
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