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

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Form 10-K for NB&T FINANCIAL GROUP INC


19-Mar-2013

Annual Report


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

The following discussion and analysis comparing 2012 to prior years should be read in conjunction with the audited consolidated financial statements at December 31, 2012 and 2011 and for the three years ended December 31, 2012.

FORWARD-LOOKING STATEMENTS

Statements preceded by, followed by or that otherwise include the words "believes," "expects," "anticipates," "intends," "estimates," "plans," "may increase," "may fluctuate," "will likely result," and similar expressions or future or conditional verbs such as "will," "should," "would," and "could" are generally forward-looking in nature and not historical facts. Results could differ materially from those expressed in such forward-looking statements due to a number of factors, including (1) changes in interest rates; (2) changes in national and local economic and political conditions including the effects of implementation of the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012 and the continuing economic uncertainty in various parts of the world; (3) competitive pressures in the retail banking, financial services, insurance and other industries; (4) changes in laws and regulations, including changes in accounting standards; (5) changes in policy by regulatory agencies; and (6) changes in the securities markets. Any forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions, and actual results could differ materially from those contemplated by those forward-looking statements. Many of the factors that will determine these results are beyond the Company's ability to control or predict. The Company disclaims any duty to update any forward-looking statements, all of which are qualified by the statements in this section. See Item 1.A. "Risk Factors" in this annual report for further discussion of the risks affecting the business of the Company and the value of an investment in its shares.

PURCHASE AND ASSUMPTION OF AMERICAN NATIONAL BANK

On March 19, 2010, the Company acquired, through the Bank, the banking operations of American National Bank ("ANB"), based in Parma, Ohio, under a Purchase and Assumption agreement with the FDIC. The Office of the Comptroller of the Currency declared ANB closed and appointed the FDIC as receiver. The Bank did not pay the FDIC a premium for the deposits of ANB. In addition to assuming all of the deposits of the failed bank, the Bank agreed to purchase essentially all of the assets. The book value of the net assets of ANB were acquired from the FDIC at a $10.0 million discount. The acquisition did not include the mortgage servicing business conducted by ANB by its division Leader Financial Services. The FDIC and the Bank entered into a loss-share transaction on $48.2 million of ANB assets. The Bank will share in the losses on the asset pools covered under the loss-share agreement. Under the loss-share agreement, the Bank shares in 20% of losses for the first $8.0 million in losses and 5% for any losses in excess of $8.0 million.

The transaction resulted in a gain on bargain purchase of $7.6 million for the year ended December 31, 2010. The more significant fair value adjustments in our purchase accounting for the purchase and assumption of ANB's business were to loans and the FDIC loss share receivable. Certain of the loans acquired from ANB have evidence of deterioration since origination, and it is probable that we will not collect all contractually required principal and interest payments. Such credit-impaired loans are recorded at fair value, and the related allowance for loan losses was not carried forward. Of the $42.2 million in loans purchased, $4.2 million were determined to be credit-impaired. The estimation of fair value of credit-impaired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at market rates of interest. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Subsequent decreases to the expected cash flows will generally result in a charge to the provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent increases in cash flows result in reversal of any nonaccretable difference (or allowance for loan losses to the extent any has been recorded) with a positive impact on interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, foreclosure or troubled debt restructurings, result in removal of the loan from the acquired credit-impaired portfolio at its carrying amount.


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Because acquired credit-impaired loans are written down to an amount estimated to be collectible, such loans are no longer classified as nonaccrual even though they may be contractually past due. We expect to fully collect the new carrying values of such loans (that is the new cost basis arising out of our acquisition accounting). Acquired credit-impaired loans are also excluded from the disclosure of loans 90 days or more past due and still accruing interest even though substantially all of them are 90 days or more contractually past due. Under accounting standards, such loans are considered to be accruing because the interest income on these loans relates to the establishment of an accretable yield. Loans acquired from ANB but not considered credit impaired are recorded net of an adjustment to reflect market rates and an estimate of potential credit losses for the pool of loans. The allowance for loan losses was not carried forward. The FDIC loss share receivable was estimated based on a review of the credit quality of the loan portfolio and expected losses.

As a result of the application of the new accounting standards related to the purchase of loans from ANB, certain ratios of the combined company cannot be used to compare a portfolio that includes acquired loans against one that does not (for example, in comparing peer companies), and cannot be used to compare ratios across years, such as comparing 2010 ratios, which include the ANB purchase, against prior periods, which do not. The ratios particularly affected include the allowance for loan losses as a percentage of loans and nonperforming assets, and nonaccrual loans and nonperforming assets as a percentage of loans.

RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

Net income for 2012 was $3.9 million, or $1.13 per share, compared to net income of $3.8 million for 2011, or $1.11 per share. Net income increased primarily due to an increase of $817,000 in non-interest income and a reduction of $1.6 million in non-interest expenses, offset by a decline in net interest income and increased provision for loan losses.

Net income for 2011 declined to $3.8 million, or $1.11 per share, from $8.8 million, or $2.58 per share, for 2010. Net income for 2010 was higher largely due to the bargain purchase pre-tax gain of approximately $7.6 million in the FDIC assisted acquisition of certain of the assets and liabilities of ANB. In addition, the Company realized a pre-tax gain of $1.4 million on the sale of its insurance agency subsidiary in January 2010.

Net interest income has decreased approximately 5.7% and 3.5% for the last two years, respectively, due to continued weakness in the economy and the historically-low interest rate environment. The Company's low funding cost leaves little room for reduction in interest expense while loans and securities either refinance or reprice to lower market rates. The four-year old recession has continued to negatively impact certain borrowers in specific business sectors also, resulting in higher loan charge-offs and provision for loan loss expense in 2011 and 2012. In addition, the Company has reduced non-interest expenses from $26.5 million in 2010 to $23.5 million in 2012 to help offset the decline in net interest income and additional provision expense.

NET INTEREST INCOME

Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the most significant component of the Company's earnings. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. Table 1 reflects the components of the Company's net interest income for each of the three years ended December 31, 2012, setting forth: (i) average assets, liabilities and shareholders' equity, (ii) interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average costs incurred on interest-bearing liabilities, and (iv) the net interest margin (i.e., net interest income divided by average interest-earning assets). Non-accrual loans have been included in the average loan balances.


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              TABLE 1-NET INTEREST INCOME AND NET INTEREST MARGIN

                             (Dollars in thousands)



                                                            2012                                              2011                                                2010
                                           Average                         Interest          Average                         Interest          Average
                                         Outstanding        Yield /         Earned/        Outstanding        Yield /         Earned/        Outstanding        Yield /           Interest
                                           Balance           Rate            Paid            Balance           Rate            Paid            Balance           Rate           Earned /Paid
Assets
Loans (1)                               $     397,203           5.49 %     $  21,808      $     405,809           5.88 %     $  23,873      $     419,701           6.25 %     $       26,228
Taxable securities                            130,517           1.87           2,436            138,591           2.70           3,745            145,609           3.20                4,662
Tax-exempt securities (2)                      27,190           3.07             835              9,951           3.86             384             12,130           4.84                  587
Deposits in banks                              79,422            .25             200             67,722            .25             169             55,795            .24                  135
Federal funds sold                                359              0               0                373            .06               1                446            .13                    1

Total interest-earning assets                 634,691           3.98          25,279            622,446           4.53          28,172            633,681           4.99               31,613
Non-earning assets                             53,868                                            58,212                                            59,644

Total assets                            $     688,559                                     $     680,658                                     $     693,325

Liabilities and Stockholder's Equity
Interest-bearing demand deposits        $     133,941            .04              50      $     122,896            .07              90      $     110,109            .14                  151
Savings deposits                              217,743            .15             317            202,704            .26             536            178,167            .44                  784
Time deposits                                 137,773           1.53           2,103            168,056           1.91           3,206            195,668           2.22                4,342
Short-term borrowings                              56              0               0              1,284           2.43              31             12,164           4.83                  588
Junior subordinated debentures                 10,310           5.41             558             10,310           7.08             730             10,310           7.08                  730
FHLB advances                                   5,000           2.82             141              5,000           2.82             141             17,563           4.20                  738

Total interest-bearing liabilities            504,823            .63           3,169            510,250            .93           4,734            523,981           1.40                7,333

Non-interest-bearing demand deposits    $     106,068                                     $      92,349                                     $      93,405
Other liabilities                               6,467                                             6,772                                             6,296
Equity                                         71,201                                            71,287                                            69,643

Total liabilities and equity            $     688,559                                     $     680,658                                     $     693,325

Net interest income                                                        $  22,110                                         $  23,438                                         $       24,280

Net interest margin                                             3.48 %                                            3.77 %                                            3.83 %

(1) Includes nonaccrual loans and loan fees.

(2) Yields are not on a tax equivalent basis.

Net interest income was $22.1 million for 2012, compared to $23.4 million for 2011. Net interest margin decreased to 3.48% for 2012, compared to 3.77% for the previous year. The net interest margin decreased primarily due to a change in asset mix from higher-yielding loans to lower-yielding securities. Average loans, which had an average rate of 5.49%, declined $8.6 million, while average overnight investments and securities, with an average rate of 1.46%, increased $20.9 million in 2012, compared to 2011. As shown in Table 2, a decline in interest rates on loans and securities also contributed to the decline in the net interest margin with adjustable-rate loans repricing to lower rates and increased cash flows on maturing or prepaying loans and securities being reinvested at lower market rates.

Net interest income was $23.4 million for 2011, compared to $24.3 million for 2010. Net interest margin declined to 3.77% for 2011 from 3.83% for 2010. The net interest margin decreased primarily due to a decline in higher-yielding loans. Average loans outstanding for 2011, which had an average rate of 5.88%, decreased to


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$405.8 million from $419.7 million for 2010. Due to increased liquidity from lower loan demand, the Company lowered rates on interest-bearing deposits and reduced higher cost Federal Home Loan Bank debt by $12.8 million, decreasing the cost of interest-bearing liabilities from 1.40% for 2010 to .93% for 2011.

Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. Table 2 presents an analysis of increases and decreases in interest income and expense in terms of changes in volume and interest rates during the three years ended December 31, 2012. Changes attributable to both rate and volume are allocated to each of rate and volume on an equal basis.

                TABLE 2-NET INTEREST INCOME-RATE/VOLUME ANALYSIS

                             (Dollars in thousands)



                                          Years ended December 31,                             Years ended December 31,
                                               2012 vs. 2011                                         2011 vs. 2010
                                         Increase (decrease) due to                           Increase (decrease) due to
                                        Volume               Rate             Total             Volume              Rate           Total
Interest income attributable to:
Loans                                 $     (581 )       $      (1,483 )     $ (2,064 )     $         (871 )      $  (1,485 )     $ (2,356 )
Taxable securities                          (183 )              (1,126 )       (1,309 )                (57 )           (860 )         (917 )
Tax-exempt securities                        598                  (147 )          451                  (95 )           (108 )         (203 )
Deposits in banks                             29                     1             30                   29                5             34
Federal funds sold                             0                     0              0                    0                0              0

Total interest-earning assets               (137 )              (2,755 )       (2,892 )               (994 )         (2,448 )       (3,442 )

Interest expense attributable to:
Interest-bearing demand deposits               6                   (45 )          (39 )                 13              (75 )          (62 )
Savings deposits                              28                  (247 )         (219 )                 88             (336 )         (248 )
Time deposits                               (519 )                (585 )       (1,104 )               (570 )           (565 )       (1,135 )
Short-term borrowings                        (16 )                 (15 )          (31 )               (395 )           (162 )         (557 )
Junior subordinated debentures                 0                  (172 )         (172 )                  0                0              0
FHLB advances                                  0                     0              0                 (441 )           (156 )         (597 )

Total interest-bearing liabilities          (501 )              (1,064 )       (1,565 )             (1,305 )         (1,294 )       (2,599 )

Net interest income                   $      364         $      (1,691 )     $ (1,327 )     $          311        $  (1,154 )     $   (843 )

NON-INTEREST INCOME

Table 3 details the components of non-interest income, excluding securities gains and losses, and the percentage change from the two previous years. Total non-interest income was $10.5 million in 2012, $9.7 million in 2011 and $16.4 million in 2010. In 2012, non-interest income was primarily higher due to the Bank's termination of its rights under the single-family FDIC loss share guarantee for which approximately $405,000 was received in 2012. This payment was considered fair compensation for the expected risk remaining in that portfolio consisting of four single-family loans and one OREO property. The Bank still maintains an FDIC loss share guarantee on approximately $30.0 million of non-single family loans. The Company also realized non-taxable income of approximately $359,000 on a bank-owned life insurance death benefit in excess of surrender value received in 2012. In 2012, service charges on deposits also increased by $283,000, or 9%, over 2011 due to higher overdraft fees resulting from a higher number of overdraft items.

The higher non-interest income for 2010, compared to 2011, is largely due to the bargain purchase gains of $7.6 million from the ANB acquisition and the $1.4 million gain on the sale of NB&T's insurance agency subsidiary. Other service charges and fees increased by $266,000, or 16.0%, in 2011 due to additional fee income on debit card transactions. In addition, investment services commissions increased in 2011 due to higher brokerage and annuity sales.


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The Company recognized an impairment charge of $35,000 in 2012 and $50,000 in 2010 related to the credit impairment on a $656,000 private-label mortgage-backed security, which has been downgraded by three major bond rating agencies. Through December 31, 2012, the bond had realized losses of approximately $116,000, which were in line with prior period projections.

                          TABLE 3-NON-INTEREST INCOME

                             (Dollars in thousands)



                                                                                            Percent Change
                                    2012           2011           2010           2012 vs. 2011          2011 vs. 2010
Trust                             $  1,124        $ 1,030       $    936                   9.13 %                10.04 %
Service charges on deposits          3,212          2,929          2,873                   9.66                   1.95
Other service charges                2,076          1,925          1,659                   7.84                  16.03
Investment services
commissions                            361            396            362                  (8.84 )                 9.39
Net realized gains on sales
of available-for-sale
securities                           1,174          1,820              0                 (35.49 )                   NM
Income from BOLI                       478            486            479                  (1.65 )                 1.46
Death benefit in excess of
life insurance cash value              359              0              0                     NM                     NM
Bargain purchase gain                    0              0          7,572                     NM                     NM
Gain on sale of insurance
agency                                   0              0          1,390                     NM                     NM
Security impairment charge             (35 )            0            (50 )                   NM                     NM
Other                                1,792          1,138          1,176                  57.47                  (3.23 )

Total                             $ 10,541        $ 9,724       $ 16,397                   8.40 %               (40.70 )%

Gross gains of $1,174,000 and gross losses of $0 were realized on security sales of approximately $14.8 million in 2012. Gross gains of $1,830,000 and gross losses of $10,000 were realized on security sales of approximately $45.4 million in 2011. There were no security sales in 2010.

NON-INTEREST EXPENSE

Table 4 details the components of non-interest expense and the percentage change from the two previous years.

                          TABLE 4-NON-INTEREST EXPENSE

                             (Dollars in thousands)



                                                                                            Percent Change
                                     2012           2011           2010          2012 vs. 2011           2011 vs. 2010
Salaries & employee benefits       $ 11,263       $ 11,971       $ 13,448                 (5.91 )%               (10.98 )%
Occupancy                             2,259          2,382          2,484                 (5.16 )                 (4.11 )
Equipment                             1,426          1,480          1,441                 (3.65 )                  2.71
Data processing                       1,740          1,611          1,651                  8.01                   (2.42 )
Professional fees                     1,647          1,867          1,932                (11.78 )                 (3.36 )
Marketing                               500            648            677                (22.84 )                 (4.28 )
Printing, postage and supplies          674            834            864                (19.18 )                 (3.47 )
State franchise tax                     907            829            842                  9.41                   (1.54 )
FDIC Insurance                          512            622            846                (17.68 )                (26.48 )
Amortization of intangibles             275            353            396                (22.10 )                (10.86 )
Expenses related to OREO                922          1,259            281                (26.77 )                348.04
Other                                 1,369          1,267          1,596                  8.05                  (20.61 )

Total                              $ 23,494       $ 25,123       $ 26,458                 (6.48 )%                (5.05 )%


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Total non-interest expense was $23.5 million in 2012, compared to $25.1 million in 2011. The decline in expense is due to focus by management on overall expense reduction primarily in the areas of personnel, benefit costs, branch hours, occupancy, equipment, office supplies and marketing . The cost of FDIC insurance also declined 17.7% in 2012, compared to 2011, due to a decline in total assets. In addition, the cost to maintain other-real-estate properties has declined in the past year as the number of properties held declined from twenty five properties at December 31, 2011 to fifteen properties at December 31, 2012. Property values have stabilized after the Company's market area experienced declines in overall property values in the past several years.

Total non-interest expense for 2011 was $25.1 million, compared to $26.5 million for 2010. Salaries and employee benefits expense declined almost 11% in 2011 primarily due to a reduction in executive management bonuses and full allocation of the shares in the Company's ESOP in 2010, resulting in a combined expense reduction of approximately $1.4 million. FDIC insurance expense declined 26% in 2011 due to a reduction in the FDIC assessment rate, which was implemented by the FDIC at the beginning of 2011. Expenses related to other real estate owned ("OREO") increased approximately $978,000 in 2011. Approximately $226,000 relates to losses on sales of OREO, and approximately $506,000 relates to declines in appraised values on properties still held by the Company. In addition, the Company realized higher expenses related to property maintenance and real estate taxes in 2011. Other expense was higher in 2010, compared to 2011, largely due to the prepayment penalty of approximately $416,000 on the early payoff of $12.5 million in FHLB debt.

INCOME TAXES

In 2012, the effective tax rate was 20.4%, compared to 25.5% in 2011 and 30.1% in 2010. The higher effective tax rate for 2010 was primarily due to the increase in taxable income, including the bargain purchase gain and gain on sale of insurance agency, at the full 34% marginal rate. The lower effective tax rate for 2012 is primarily due to a decrease in taxable income, including approximately $359,000 in non-taxable bank-owned life insurance death benefit, at the full 34% marginal rate.

FINANCIAL CONDITION

ASSETS

Total assets declined from $675.6 million at December 31, 2011 to $651.1 million at December 31, 2012. The decrease is primarily attributable to a reduction in deposit liabilities of $21.8 million since December 31, 2011. Most of the decline in deposit liabilities was in higher-rate time deposits, and as those deposits left, the Company reduced its interest-earning deposit assets from $61.4 million at the end of 2011 to $50.0 million at the end of 2012. In addition, securities declined $6.7 million during 2012, primarily due to the sale of approximately $14.8 million in securities in the third quarter of 2012, which were sold to realize gains in the portfolio. Net loans also declined $2.6 million in 2012 due to decreased loan demand and increased competitive factors.

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