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EMCF > SEC Filings for EMCF > Form 10-K on 22-Mar-2013All Recent SEC Filings

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Form 10-K for EMCLAIRE FINANCIAL CORP


22-Mar-2013

Annual Report


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

The following discussion and analysis represents a review of the Corporation's consolidated financial condition and results of operations for the years ended December 31, 2012 and 2011. This review should be read in conjunction with the consolidated financial statements beginning on page F-3.

Overview

The Corporation reported a decrease in net income available to common stockholders of $155,000 or 4.7% for 2012 as consolidated net income available to common stockholders amounted to $3.2 million or $1.80 per common share for 2012, compared to $3.3 million or $1.98 per common share for 2011. Net income available to common stockholders was impacted by the following:

Net interest income increased $379,000, or 2.5% in 2012. This increase primarily related to a decrease in interest expense of $896,000 or 15.3% as the Corporation's cost of funds decreased 25 basis points to 1.08% for 2012 from 1.33% for 2011.

Noninterest income increased $1.1 million, or 27.4% to $4.9 million for the year ended December 31, 2012 from $3.8 million for 2011. This increase primarily related to an $878,000 increase in nonrecurring securities gains, which was partially offset by other than temporary impairment charges recorded in 2012 totaling $103,000. Also contributing to the increase, customer service fees and other noninterest income increased $118,000 and $173,000, respectively.

Provision for loan losses increased $1.7 million to $2.2 million for the year ended December 31, 2012 from $420,000 for 2011. This increase was primarily the result of the deterioration of a $3.4 million commercial real estate credit relationship.

Noninterest expense decreased $108,000 primarily due to decreases in premises and equipment expense, intangible asset amortization, professional fees and FDIC expense of $183,000, $96,000, $34,000 and $23,000, respectively, which were partially offset by increases in compensation and benefits and other noninterest expense of $56,000 and $172,000, respectively.

Changes in Financial Condition

Total assets increased $17.1 million or 3.5% to $509.0 million at December 31, 2012 from $491.9 million at December 31, 2011. This increase primarily related to an increase in net loans receivable, bank owned life insurance and other assets of $21.3 million, $4.3 million and $2.3 million, respectively. Partially offsetting these increases, cash equivalents and investment securities decreased $7.8 million and $2.9 million, respectively.

The Corporation's asset growth was primarily funded by increases in customer deposits of $16.0 million and stockholders' equity of $1.0 million.

Cash and cash equivalents. Cash and cash equivalents decreased $7.8 million, or 27.6%, to $20.4 million at December 31, 2012 from $28.2 million at December 31, 2011. This decrease primarily resulted from the funding of loans. Typically, cash accounts are increased by net operating results, deposits by customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds. Decreases result from customer deposit withdrawals, new loan originations or other loan fundings, security purchases, repayments of borrowed funds and cash dividends to stockholders.

K-22

Securities. Securities decreased $3.0 million, or 2.4%, to $120.2 million at December 31, 2012 from $123.2 million at December 31, 2011. This decrease was partly related to the utilization of cash received from investment security calls and sales to fund loan originations.

Loans receivable. Net loans receivable increased $21.3 million, or 6.8%, to $333.8 million at December 31, 2012 from $312.5 million at December 31, 2011. The increase was primarily driven by growth in the Corporation's home equity, commercial real estate, residential mortgage and commercial business loan portfolios of $14.4 million, $4.1 million, $3.6 million and $1.8 million, respectively. This growth was partially offset by a $756,000 decrease in consumer loans and a $1.8 million increase in the allowance for loan losses.

Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days past due and still accruing, repossessions and real estate owned. Nonperforming assets were $7.2 million, or 1.41%, of total assets at December 31, 2012 compared to $5.9 million, or 1.19%, of total assets at December 31, 2011. Nonperforming assets consisted of nonperforming loans and real estate owned of $7.0 million and $180,000, respectively, at December 31, 2012 and $5.6 million and $307,000, respectively, at December 31, 2011. This increase in nonperforming loans was primarily due to the deterioration of a $3.4 million commercial real estate credit relationship. At December 31, 2012, nonperforming loans consisted primarily of consumer, commercial mortgage and residential mortgage loans.

Federal bank stocks. Federal bank stocks were comprised of FHLB stock and FRB stock of $1.9 million and $984,000, respectively, at December 31, 2012. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships between the Corporation and the banks. The FHLB repurchased $779,000 of the Bank's excess capital stock during 2012.

Bank-owned life insurance (BOLI).The Corporation maintains single premium life insurance policies on certain current and former officers and employees of the Bank. During 2012, the Corporation purchased additional policies on current employees amounting to $4.0 million. In addition to providing life insurance coverage, whereby the Bank as well as the officers and employees receive life insurance benefits, the appreciation of the cash surrender value of the BOLI will serve to offset and finance existing and future employee benefit costs. Increases in this account are typically associated with an increase in the cash surrender value of the policies, partially offset by certain administrative expenses.

Premises and equipment. Premises and equipment increased $154,000, or 1.7%, to $9.2 million at December 31, 2012 from $9.0 million at December 31, 2011. The overall increase in premises and equipment during the year was due to capital expenditures of $831,000, partially offset by normal depreciation and amortization of $677,000.

Goodwill. Goodwill was $3.7 million at December 31, 2012 and 2011. Goodwill is evaluated for impairment at least annually and more frequently if events and circumstances indicate that the asset might be impaired. Management evaluated goodwill and concluded that no impairment existed at December 31, 2012.

K-23

Core deposit intangible. The core deposit intangible was $1.2 million at December 31, 2012. In connection with the assumption of deposits in the 2009 Titusville branch acquisition, the Bank recorded a core deposit intangible of $2.8 million. This asset represents the long-term value of the core deposits acquired. Fair value was determined using a third-party valuation expert specializing in estimating fair values of core deposit intangibles. The fair value was derived using an industry standard financial instrument present value methodology. All-in costs and runoff balances by year were discounted by comparable term FHLB advance rates, used as an alternative cost of funds measure. This intangible asset amortizes utilizing the double declining balance method of amortization over a weighted average estimated life of nine years. The core deposit intangible asset is not estimated to have a significant residual value. The Corporation recorded $345,000 and $441,000 of intangible amortization in 2012 and 2011, respectively.

Deposits. Total deposits increased $16.0 million, or 3.8%, to $432.5 million at December 31, 2012 from $416.5 million at December 31, 2011. Noninterest bearing deposits increased $13.7 million, or 16.1%, during the year while interest bearing deposits decreased $2.3 million.

Borrowed funds. Borrowed funds were unchanged at $20.0 million at December 31, 2012 and 2011. During 2012, $15.0 million of the $20.0 million in outstanding FHLB long-term advances were exchanged and modified.

Stockholders' equity. Stockholders' equity increased $1.0 million or 2.0% to $51.7 million at December 31, 2012 from $50.7 million at December 31, 2011. The increase primarily related to an increase in retained earnings of $1.7 million and a decrease in accumulated other comprehensive income of $854,000. The decrease in accumulated other comprehensive income resulted from a change in the net unrealized losses on securities available for sale and to a lesser extent the change in the funded status of the Corporation's defined benefit plan.

K-24

Changes in Results of Operations

The Corporation reported net income before accumulated preferred stock dividends and discount accretion of $3.7 million and $3.8 million in 2012 and 2011, respectively. The following "Average Balance Sheet and Yield/Rate Analysis" and "Analysis of Changes in Net Interest Income" tables should be utilized in conjunction with the discussion of the interest income and interest expense components of net interest income.

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

(Dollar amounts in
thousands)                                                Year ended December 31,
                                              2012                                      2011
                               Average                     Yield /       Average                     Yield /
                               Balance      Interest        Rate         Balance      Interest        Rate

Interest-earning assets:
Loans, taxable                $ 309,559     $  16,594          5.36 %   $ 296,551     $  16,935          5.71 %
Loans, tax-exempt                19,331           879          4.55 %      12,521           650          5.19 %
Total loans receivable          328,890        17,473          5.31 %     309,072        17,585          5.69 %
Securities, taxable             102,135         2,246          2.20 %      91,306         2,370          2.59 %
Securities, tax-exempt           36,834         1,635          4.44 %      36,213         1,848          5.10 %
Total securities                138,969         3,881          2.79 %     127,519         4,218          3.31 %
Interest-earning deposits
with banks                       23,233            85          0.37 %      24,679           173          0.70 %
Federal bank stocks               3,320            65          1.96 %       3,873            55          1.42 %
Total interest-earning cash
equivalents                      26,553           150          0.56 %      28,552           228          0.80 %
Total interest-earning
assets                          494,412        21,504          4.35 %     465,143        22,031          4.73 %
Cash and due from banks           2,376                                     2,534
Other noninterest-earning
assets                           22,761                                    21,628
Total Assets                  $ 519,549                                 $ 489,305
Interest-bearing
liabilities:
Interest-bearing demand
deposits                      $ 207,689           440          0.21 %   $ 182,038           492          0.27 %
Time deposits                   139,092         3,605          2.59 %     149,794         4,196          2.80 %
Total interest-bearing
deposits                        346,781         4,045          1.17 %     331,832         4,688          1.41 %
Borrowed funds, short-term           27             -          0.00 %       3,414           159          4.66 %
Borrowed funds, long-term        20,000           931          4.66 %      22,068         1,025          4.64 %
Total borrowed funds             20,027           931          4.65 %      25,482         1,184          4.65 %
Total interest-bearing
liabilities                     366,808         4,976          1.36 %     357,314         5,872          1.64 %
Noninterest-bearing demand
deposits                         96,048             -             -        82,697             -             -
Funding and cost of funds       462,856         4,976          1.08 %     440,011         5,872          1.33 %
Other noninterest-bearing
liabilities                       4,870                                     3,879
Total Liabilities               467,726                                   443,890
Stockholders' Equity             51,823                                    45,415
Total Liabilities and
Stockholders' Equity          $ 519,549                                 $ 489,305
Net interest income                         $  16,528                                 $  16,159
Interest rate spread
(difference between
weighted average rate on
interest-earning assets and
interest-bearing
liabilities)                                                   2.99 %                                    3.09 %
Net interest margin (net
interest income as a
percentage of average
interest-earning assets)                                       3.34 %                                    3.47 %

K-25

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

(Dollar amounts in thousands)                   2012 versus 2011
                                           Increase (decrease) due to
                                        Volume           Rate       Total
Interest income:
Loans                                  $   1,091       $ (1,203 )   $ (112 )
Securities                                   357           (694 )     (337 )
Interest-earning deposits with banks         (10 )          (78 )      (88 )
Federal bank stocks                           (9 )           19         10
Total interest-earning assets              1,429         (1,956 )     (527 )

Interest expense:
Deposits                                     204           (847 )     (643 )
Borrowed funds                              (253 )            -       (253 )
Total interest-bearing liabilities           (49 )         (847 )     (896 )

Net interest income                    $   1,478       $ (1,109 )   $  369

2012 Results Compared to 2011 Results

The Corporation reported net income before accumulated preferred stock dividends and discount accretion of $3.7 million and $3.8 million for 2012 and 2011, respectively. The $179,000, or 4.7%, decrease in net income was attributed to an increase in provision for loan losses of $1.7 million and a decrease in provision for income taxes of $16,000, partially offset by an increase in net interest income and noninterest income of $379,000 and $1.1 million, respectively, and a decrease in noninterest expense of $108,000.

Net interest income. The primary source of the Corporation's revenue is net interest income. Net interest income is the difference between interest income on earning assets such as loans and securities, and interest expense on liabilities, such as deposits and borrowed funds, used to fund the earning assets. Net interest income is impacted by the volume and composition of interest-earning assets and interest-bearing liabilities, and changes in the level of interest rates. Tax equivalent net interest income increased $369,000 or 2.3% to $16.5 million for 2012, compared to $16.2 million for 2011. This increase in net interest income can be attributed to a decrease in interest expense of $896,000, partially offset by a decrease in tax equivalent interest income of $527,000.

Interest income. Tax equivalent interest income decreased $527,000, or 2.4%, to $21.5 million for 2012, compared to $22.0 million for 2011. This decrease can be attributed to decreases in interest earned on loans, securities and interest earning deposits of $112,000, $337,000 and $88,000, respectively, partially offset by an increase in interest earned on federal bank stocks of $10,000.

Tax equivalent interest earned on loans receivable decreased $112,000 to $17.5 million for 2012, compared to $17.6 million for 2011. The average yield on loans decreased 38 basis points to 5.31% for 2012, versus 5.69% for 2011 causing a $1.2 million decrease in interest income. Offsetting this unfavorable yield decline, the average balance of loans increased $19.8 million, or 6.4%, generating $1.1 million of additional interest income on loans.

K-26

Tax equivalent interest earned on securities decreased $337,000, or 8.0%, to $3.9 million for 2012 compared to $4.2 million for 2011. The average yield on securities decreased 52 basis points to 2.79% for 2012 versus 3.31% for 2011 causing a $694,000 decrease in interest income. Offsetting this unfavorable yield decline, the average balance of securities increased $11.5 million, or 9.0%, generating $357,000 in additional interest income on securities.

Interest earned on interest-earning deposit accounts decreased $88,000, or 50.9%, to $85,000 for 2012 compared to $173,000 for 2011. The average yield on these accounts decreased 33 basis points to 37 basis points for 2012 versus 70 basis points for 2011 causing a $78,000 decrease in interest income. Additionally, the average balance of interest-earning deposits decreased $1.4 million, or 5.9%, causing a $10,000 decrease in interest income.

Interest earned on federal bank stocks increased $10,000, or 18.2%, to $65,000 for 2012 compared to $55,000 for 2011. The average yield on these accounts increased 54 basis points to 1.96% for 2012 versus 1.42% for 2011 generating a $19,000 increase in interest income. Offsetting this favorable yield variance, average federal bank stocks decreased $553,000, or 14.3%, causing a $9,000 decrease in interest income.

Interest expense. Interest expense decreased $896,000, or 15.3%, to $5.0 million for 2012 compared to $5.9 million for 2011. This decrease can be attributed to decreases in interest incurred on interest-bearing deposits and borrowed funds of $643,000 and $253,000, respectively.

Deposit interest expense decreased $643,000, or 13.7%, to $4.0 million for 2012 compared to $4.7 million for 2011. The rate on interest-bearing deposits decreased by 24 basis points to 1.17% for 2012 versus 1.41% for 2011 causing an $847,000 decrease in interest expense. Offsetting this favorable cost variance, the average balance of interest-bearing deposits increased $14.9 million, or 4.5%, accounting for $204,000 in additional interest expense.

Interest expense on borrowed funds decreased $253,000, or 21.4%, to $931,000 for 2012 compared to $1.2 million for 2011. Average borrowed funds decreased $5.5 million, or 21.4%, causing a decrease in interest expense of $253,000. The average rate on borrowed funds remained constant at 4.65% for 2012 and 2011.

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

Nonperforming loans increased $1.4 million, or 25.6%, to $7.0 million at December 31, 2012 from $5.6 million at December 31, 2011. This increase was primarily due to the deterioration of a $3.4 million commercial real estate credit relationship.

The provision for loan losses increased $1.7 million to $2.2 million for 2012 compared to $420,000 for 2011. This increase was primarily due to the aforementioned deterioration of a $3.4 million commercial real estate credit relationship which required a specific reserve of $1.4 million at December 31, 2012. The Corporation's allowance for loan losses amounted to $5.4 million, or 1.58% of the Corporation's total loan portfolio at December 31, 2012 compared to $3.5 million or 1.12% of total loans at December 31, 2011. The allowance for loan losses as a percentage of nonperforming loans at December 31, 2012 and 2011 was 76.6% and 63.5%, respectively.

K-27

Noninterest income. Noninterest income includes revenue that is not related to interest rates, but rather to services rendered and activities conducted in the financial services industry, including fees on depository accounts, general transaction and service fees, commissions on financial services, title premiums, security and loan gains and losses, and earnings on BOLI. Noninterest income increased $1.1 million, or 27.4%, to $4.9 million for 2012 compared to $3.8 million for 2011. This increase was primarily due to an $878,000 increase in net gains on securities available for sale to $1.4 million in 2012 from $482,000 in 2011. Included in the 2012 gains, $424,000 was related to a gain realized on the sale of a marketable equity security obtained during 2012 through the election of stock associated with an acquisition of an equity security held by the Corporation. Partially offsetting these gains, the Corporation recorded $103,000 in other than temporary impairment charges during 2012 on two marketable equity securities. Included in the 2011 gains, $355,000 was related to a balance sheet management strategy whereby securities were sold to prepay long term FHLB advances and associated security gains were used to offset the prepayment penalties related to the early retirement of the advances. Also contributing to the increase, earnings on bank owned life insurance, interchange fee income and customer service fees increased $61,000, $137,000 and $118,000, respectively. Partially offsetting these increases, commissions on financial services decreased $54,000.

Noninterest expense. Noninterest expense decreased $108,000 to $13.9 million for 2012, compared to $14.0 million for 2011. This decrease was primarily related to decreases in premises and equipment expense, intangible asset amortization, professional fees and FDIC insurance expense, partially offset by increases in compensation and employee benefits and other noninterest expense.

The largest component of noninterest expense, compensation and employee benefits, increased $56,000 to $7.2 million for 2012 compared to $7.1 million for 2011. This increase primarily related to normal compensation increases, an increase in employee health insurance costs and higher deferred loan costs. Partially offsetting these increases, there was no expense recognized for incentive programs in 2012 as compared to $228,000 of incentive compensation expense recognized during 2011.

Premises and equipment expense decreased $183,000, or 8.3%, to $2.0 million for 2012 compared to $2.2 million for 2011. This decrease primarily related to a decrease in fixed asset depreciation and lower building repair and maintenance costs.

The Corporation recognized $345,000 of intangible amortization in 2012 compared to $441,000 in 2011 associated with a core deposit intangible asset of $2.8 million that was recorded in connection with the 2009 Titusville branch acquisition.

Professional fees decreased $34,000, or 4.8%, to $672,000 for 2012 compared to $706,000 for 2011. This decrease primarily related to a decrease in legal and accounting fees, partially offset by an increase in consulting fees.

FDIC expense decreased $23,000, or 5.6%, to $387,000 for 2012 compared to $410,000 for 2011. This decrease primarily related to 2011 legislative changes that adjusted the assessment base, which reduced the assessment rate for the Bank and favorably impacted premium expense.

Other noninterest expense increased $172,000, or 5.4%, to $3.3 million for 2012 compared to $3.2 million for 2011. Contributing to this increase, check card reward expense, MAC processing, debit card losses and shares tax increased $244,000, $99,000, $55,000 and $51,000, respectively. Included in this category in 2011 was $334,000 related to prepayment penalties assessed on the early retirement of FHLB advances.

The provision for income taxes decreased $16,000, or 1.7%, to $934,000 for 2012 compared to $950,000 for 2011 primarily due to higher pre-tax income in 2011.

K-28

Market Risk Management

Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. The Corporation is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Corporation does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets.

The primary objective of the Corporation's asset liability management function is to maximize the Corporation's net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Corporation's operating environment, capital and liquidity requirements, balance sheet mix, performance objectives and overall business focus. One of the primary measures of the exposure of the Corporation's earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities.

The Corporation's Board of Directors has established a Finance Committee, consisting of four outside directors, the President and Chief Executive Officer (CEO), Treasurer and Chief Financial Officer (CFO) and Principal Accounting Officer (PAO), to monitor market risk, including primarily interest rate risk. This committee, which meets at least quarterly, generally establishes and monitors the investment, interest rate risk and asset liability management policies of the Corporation.

In order to minimize the potential for adverse affects of material and prolonged changes in interest rates on the Corporation's results of operations, the Corporation's management team has implemented and continues to monitor asset liability management policies to better match the maturities and repricing terms of the Corporation's interest-earning assets and interest-bearing liabilities. Such policies have consisted primarily of (i) originating adjustable-rate mortgage loans; (ii) originating short-term secured commercial loans with the rate on the loan tied to the prime rate or reset features in which the rate changes at determined intervals; (iii) emphasizing investment in shorter-term
(15 years or less) investment securities; (iv) selling longer-term (30-year)
fixed-rate residential mortgage loans in the secondary market; (v) maintaining a high level of liquid assets (including securities classified as available for sale) that can be readily reinvested in higher yielding investments should . . .

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