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WAYN > SEC Filings for WAYN > Form 10-K on 25-Mar-2013All Recent SEC Filings

Show all filings for WAYNE SAVINGS BANCSHARES INC /DE/ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for WAYNE SAVINGS BANCSHARES INC /DE/


25-Mar-2013

Annual Report


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

General

The consolidated financial statements include Wayne Savings Bancshares, Inc. and its wholly owned subsidiary, Wayne Savings Community Bank. Intercompany transactions and balances are eliminated in the consolidated financial statements.

The Company's net income is primarily dependent on its net interest income, which is the difference between interest income earned on its loans, mortgage-backed securities and investments, and its cost of funds consisting of interest paid on deposits and borrowings. The Company's net income also is affected by its provision for loan losses, as well as the amount of noninterest income, including deposit service charges and gain on the sale of loans into the secondary market, and noninterest expense, such as salaries and employee benefits, federal deposit insurance premiums, occupancy and equipment costs, and income taxes. Earnings of the Company also are affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities as more fully described under "Risk Factors" above.

Business Strategy

The Company's current business strategy is to operate a well-capitalized, profitable and community-oriented Bank dedicated to providing quality service and products to its customers. The Company has sought to implement this strategy in recent years by: (1) closely monitoring the needs of customers and providing personal, quality customer service; (2) continuing the origination of a wide array of loan products in the Company's market area; (3) managing interest rate risk exposure by better matching asset and liability maturities and rates; (4) increasing fee income, including participation in the secondary mortgage market;
(5) managing asset quality; (6) maintaining a strong retail deposit base; (7) maintaining capital in excess of regulatory minimum requirements; and (8) emphasizing the commercial loan program to add high quality, higher yielding and shorter duration assets to the Company's loan portfolio.

Strategic Initiatives

As part of the aforementioned business strategy, the Company pursues an ongoing strategic planning process, which includes annual plan updates and regular progress reviews by the Board of Directors. The Company is engaged in several initiatives to improve the returns to shareholders over a foreseeable time horizon. These continuing initiatives include the development of a comprehensive marketing and sales program to increase top line revenue of the Company through loans and fee income generating activities, an ongoing review of the branch facilities and staff to identify opportunities for cost effective reductions to improve operational efficiency, and evaluation of information technology solutions to improve internal efficiency and customer service.

In addition, the Board of Directors has established the position of Chief Risk Officer, with responsibility for the development of a comprehensive Enterprise Risk Management (ERM) program to ensure that the earnings generated through existing and contemplated activities are commensurate with the risks assumed in those activities and consistent with legal requirements, regulatory requirements and general economic conditions.

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Forward Looking Statements

In addition to the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. Economic circumstances, the Company's operations, and actual results could differ significantly from those discussed in forward-looking statements. Some of the factors that could cause or contribute to such differences are discussed herein but also include changes in the economy and interest rates in the nation and the Company's general market area. The forward-looking statements contained herein include, but are not limited to, those with respect to the following matters: (1) management's determination of the amount and adequacy of the allowance for loan losses; (2) the effect of changes in interest rates; (3) management's opinion as to the effects of recent accounting pronouncements on the Company's consolidated financial statements; and (4) management's opinion as to the Bank's ability to maintain regulatory capital at current levels.

Critical Accounting Policies

Allowance for Loan Losses The Company considers the allowance for loan losses and related loss provision to be a critical accounting policy. The Company has established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish a sufficient allowance for loan losses. The allowance for loan losses is based on management's current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision, and considers all known internal and external factors that affect loan collectability as of the reporting date. Such evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, management's knowledge of inherent risks in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance.

Goodwill The Company recorded all assets and liabilities acquired in prior purchase acquisitions, including goodwill and other intangibles, at fair value as required. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using the straight-line method, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.

Management has discussed the development and selection of these critical accounting policies with the audit committee of the Board of Directors.

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

At December 31, 2012, total assets decreased to $402.1 million from the $410.1 million at December 31, 2011 mainly due to a decrease in cash and cash equivalents of $7.8 million, and a $17.1 million, or 12.9%, decrease in securities, partially offset by an increase in loans of $15.8 million, or 6.8%, and a $1.5 million increase in bank-owned life insurance. During the year ended December 31, 2012, the Bank originated and retained $54.1 million of loans, received payments of $47.7 million and transferred $302,000 to foreclosed assets held for sale. As loan volume increased during the period ended December 31, 2012, management used the cash flow from securities to fund this growth. The Bank also used cash to pay down $5.5 million of FHLB borrowings as they matured.

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At December 31, 2012 and December 31, 2011, the allowance for loan losses totaled $3.3 million, or 1.33% of gross loans and $3.9 million, or 1.63%, of gross loans, respectively. In determining the amount of the loan loss allowance at any point of time, management systematically determines the risk of loss in the portfolio. First, delinquent nonresidential, multi-family and commercial loans are evaluated for potential impairment in carrying value. At December 31, 2012, all delinquent and classified residential, nonresidential, multi-family and commercial loans were analyzed, with $1.4 million of the reserve being allocated to these categories of loans. The largest loan in this category consisted of a commercial real estate loan amounting to $931,000 at December 31, 2012. The Company took several partial chargeoffs which reduced this figure from December 2011 of $2.3 million as management evaluated the probability of the repayment of principal. Also assisting this reduction were several relationships which were refinanced in which the Bank received additional collateral or repayment. The second step in determining the allowance for loan losses entails the application of historic loss experience to individual loan types in the portfolio. In addition to the historic loss percentage, management employs an additional risk percentage tailored to the perception of the overall risk in the economy. Finally, to provide additional assurance regarding the validity of the commercial loan risk rating system, management engages a third party loan reviewer who provides independent validation of the Bank's loan grading process. Management recorded a $773,000 provision for losses on loans for the year ended December 31, 2012, a decrease of $33,000 from the $806,000 recorded for the nine months ended December 31, 2011.

Goodwill of $1.7 million is carried on the Company's balance sheet as a result of the acquisition of Stebbins Bancshares in June 2004. In accordance with FASB ASC 350, this goodwill is tested for impairment on at least an annual basis. Management evaluated the goodwill using an analysis of required measures of value, including the current stock price as an indicator of minority interest value, change of control multiples as a measure of controlling interest value and discounted cash flow analysis as a measure of going concern value and applied a weighting based on appraisal standards to arrive at a valuation conclusion that indicated no impairment at December 31, 2012.

A prepaid asset of $1.5 million was created in the third fiscal quarter of 2010 due to the FDIC imposing a prepaid assessment on all insured institutions, including the Company's subsidiary. The amount of the prepaid premium covered the fourth calendar quarter of 2009 and all of calendar years 2011, 2012 and 2013 and included a 5% deposit growth assumption. Actual deposit insurance premium expense is calculated by the FDIC on a quarterly basis, with the expense being charged to the prepaid asset. Any balance remaining in June 2013, will be refunded to the Company's subsidiary bank. The balance at December 31, 2012 was $596,000.

Deposits totaled $327.7 million at December 31, 2012, a decrease of $6.1 million, or 1.8%, from December 31, 2011. Demand accounts increased $3.9 million, or 5.1%, and savings and money market accounts increased by $3.3 million, or 3.0%, which were offset by a decrease in certificates of deposit of $13.3 million, or 9.0%. The Company experienced an increase in low cost liquid deposit accounts as customers chose to keep funds in more liquid types of accounts due to the low level of market interest rates and as management exercised discipline during the period with regard to the pricing of retail certificates. In general, management attempts to benchmark retail certificate of deposit pricing to the cost of alternate sources of funds, including FHLB advances and brokered deposits. Exceptions are made to defend customer relationships with significant value to the Bank while allowing rate sensitive certificate of deposit customers with no relationship with the Bank to move to other alternatives.

Other short term borrowings increased $1.8 million as a result of an increase in commercial repurchase agreements by rate sensitive customers.

Advances from the FHLB decreased $5.4 million, from $26.6 million at December 31, 2011 to $21.2 million at December 31, 2012 mainly due to the maturity of fixed rate and term advances. During December 2010, the Bank prepaid $8.5 million of existing fixed rate and term advances to reduce the carrying cost and extend the maturity dates of those advances into 2014 and 2015 to take advantage of the low interest rate environment at that time and to again extend liability duration at a cost lower than the use of retail certificates of deposit. As part of this restructuring transaction, a $526,000 prepayment penalty was paid and deferred. The remaining unamortized balance of $283,000 is reflected as a reduction in the carrying value of advances and will be amortized into interest expense over the remaining term of the new advances.

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At December 31, 2012, stockholders' equity totaled $39.8 million, an increase of $70,000, or 0.2%, compared to the balance at December 31, 2011. This increase is primarily due to $1.7 million in net income and amortization of the ESOP shares of $72,000. These increases were partially offset by a decrease in the unrealized gains on available-for-sale securities of $249,000, a reduction in the pension unrecognized net loss of $46,000, an unrecognized loss in the split-dollar benefit plan of $246,000, the repurchase of treasury stock of $393,000 and cash dividends totaling $790,000 during the year ended December 31, 2012. In August 2012, the Board of Directors authorized a stock repurchase program for up to 5% of the Company's common stock. At December 31, 2012, $1.0 million of retained earnings remained committed to the completion of this program in future periods subject to market conditions and regulatory requirements.

Comparison of operating results for the twelve month period ended December 31, 2012 and nine month period ended December 31, 2011

General

Net income totaled $1.7 million for the year ended December 31, 2012, and $1.3 million for the nine months ended December 31, 2011. The increase in net income was primarily attributable to the Company's change in fiscal year end to December 31, from March 31, resulting in a nine month period ended December 31, 2011 compared to a twelve month period ended December 31, 2012.

Interest Income

Interest income increased $2.7 million, or 21.4%, to $15.3 million for the twelve months ended December 31, 2012, compared to the nine months ended December 31, 2011. The interest income increased for the period ended December 31, 2012 mainly due to the twelve month current period compared to the December 31, 2011 nine month period. This aforementioned increase was partially offset by a decline in the average yield on interest-earning assets of 25 basis points to 4.09% for December 31, 2012, from 4.34% for the nine month period ending December 31, 2011 causing a decline in interest income of $1.2 million as a result of the overall market rate decline. These rate decreases have negatively affected the yields earned on the Company's interest-earning assets. Additionally, there was also a decrease in the average balance of interest-earning assets to $374.2 million for the year ended December 31, 2012, from $385.4 million for the nine months ended December 31, 2011.

Interest income on loans increased $2.6 million, or 28.4%, for the twelve months ended December 31, 2012, compared to the nine months ended December 31, 2011, due primarily to a shortened fiscal year end period ended December 31, 2011 and an increase of $2.5 million, or 1.1%, in the average balance of loans for the period ended December 31, 2012, partially offset by a 23 basis point decrease in the weighted-average yield on loans outstanding to 5.01%. The decrease in the yield was due to the decrease in market interest rates and the corresponding downward impact on new originations.

Interest income on securities increased $12,000, or 37.9%, during the twelve months ended December 31, 2012, compared to the nine months ended December 31, 2011, due primarily to a twelve month fiscal period ended December 31, 2012, offset with a decline of 65 basis points in the weighted-average yield to 2.50% as compared to 3.15%, for the nine month fiscal year ended December 31, 2011, generally reflecting reinvestment in lower yielding mortgage-backed securities as higher yielding securities prepaid or matured, as well as a decrease of $6.5 million, or 4.8%, in the average balance.

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Interest Expense

Interest expense for the twelve months ended December 31, 2012, totaled $2.8 million, a decrease of $181,000, or 6.1%, compared to interest expense for the nine months ended December 31, 2011. The decrease in interest expense resulted from a decrease in the weighted-average cost of funds of 30 basis points to 0.78% for the fiscal period ended December 31, 2012, and a decrease of $7.6 million, or 2.1%, in the average balance of deposits and borrowings outstanding, partially offset by twelve months in the current year period, compared to the nine months in the prior period ended December 31, 2011.

Interest expense on deposits totaled $2.1 million for the twelve months ended December 31, 2012, a decrease of $102,000, or 4.6%, compared to the nine months ended December 31, 2011. The decrease in deposit costs resulted from a decrease of 25 basis points in the weighted-average cost of deposits to 0.65% for the fiscal period ended December 31, 2012, and a decrease in the average balance outstanding of $305,000, partially offset by twelve months in the current year period, compared to the nine months in the prior period ended December 31, 2011. In addition, a shift in the composition of deposits from higher cost time deposits to lower cost checking, money market and savings accounts contributed to the decrease in the cost of deposits, along with a general decline in overall market rates.

Interest expense on other short-term borrowings totaled $10,000 for both the twelve and nine months ended December 31, 2012 and 2011. There was an increase of $6,000 due to the nine month period ended December 31, 2011 due primarily to three additional months combined with an average balance increase of $1.2 million, or 22.1% in fiscal 2012, fully offset by a decrease in the weighted-average cost of other short-term borrowings to 0.15% in the current year period from 0.24% for the nine months ended December 31, 2011.

Interest expense on Federal Home Loan Bank advances totaled $670,000 for the twelve months ended December 31, 2012, a decrease of $79,000, or 10.6%, compared to the nine months ended December 31, 2011, due primarily to a decrease in the average balance of $8.5 million, or 26.0%, combined with a rate decline of 27 basis points to 2.78% for the fiscal period ended December 31, 2012, partially offset by twelve months in the current year period, compared to the nine months in the prior period ended December 31, 2011. The decrease in the average balance was due to higher rate advance maturities, as funds from deposit growth were used to repay advances.

Net Interest Income

Net interest income totaled $12.5 million for the twelve month period ended December 31, 2012, an increase of $2.9 million, or 29.9%, from the amount for the nine month fiscal year ended December 31, 2011. The increase in net interest income was mainly due to the twelve month fiscal year partially offset with the repricing effect of the overall low rate environment. The average interest rate spread increased to 3.31% for the twelve month period ended December 31, 2012. The net interest margin also increased to 3.34% for the year ended December 31, 2012. The 25 basis point decrease in the yield on average interest-earning assets was more than offset by the 30 basis point decrease in the cost of funds. As noted earlier, a decrease in overall market interest rates and shift in the composition of deposits from higher cost time deposits to lower cost checking, money market and savings accounts contributed to the decrease in the cost of deposits.

Provision for Losses on Loans

The Company recorded a provision for loan losses totaling $773,000 for the twelve months ended December 31, 2012, compared to $806,000 for the nine months ended December 31, 2011. The principal reason for the high level of provision for loans loss was due to increased chargeoffs related to commercial real estate properties partially offset with refinancings in which the bank received additional collateral reducing the amounts required to be allocated within the allowance for loan losses to address loans individually evaluated for impairment. In the opinion of management, as of December 31, 2012, the carrying value of all non-performing loans as of December 31, 2012, is expected to be realized.

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Noninterest Income

Noninterest income, consisting primarily of earnings on bank-owned life insurance policies, gains on sale of loans, trust income and deposit service fees increased by $454,000, or 30.6%, to $1.9 million for the twelve months ended December 31, 2012, from $1.5 million for the nine months ended December 31, 2011. The increase was primarily due to the nine month fiscal period ended December 31, 2011 compared to the twelve month year ended December 31, 2012, and a $171,000 increase in gain on sale of loans. As described under Item 1 above, management engages in sales of newly originated loans to limit the buildup of interest rate risk on the balance sheet and to provide liquidity to accommodate additional refinancing activity. The Company sold $2.5 million of loans during the nine months ended December 31, 2011 compared to $6.1 million during fiscal year ended December 31, 2012.

Noninterest Expense

Noninterest expense increased by $2.8 million, or 32.4%, totaling $11.6 million for the twelve month period ended December 31, 2012. The increase in noninterest expense was primarily due to increased operating expenses due to the short nine month fiscal period ended December 31, 2011 compared to the full twelve month period ended December 31, 2012. The Company also incurred additional costs to complete the Trust Transfer and Assumption Agreement with Thomasville National Bank of approximately $354,000. Benefits costs increased primarily from increased employee healthcare and other employee benefit costs combined with additional staffing for the marketing initiative to increase the community's awareness of the Bank's products and services. Also the Company incurred other operating costs related to the strategic marketing program of a direct mail campaign and additional consulting services to negotiate vendor contracts.

Federal Income Taxes

Provision for Federal income taxes was $378,000 for the twelve months ended December 31, 2012, reflecting an increase of $144,000 from the nine months ended December 31, 2011, primarily due to a $532,000 increase in pre-tax income, partially offset by additional tax-exempt income recognized during the twelve months ended December 31, 2012. The difference in the effective tax rate of 18.0% for the year ended December 31, 2012 from the 34% statutory rate was mainly due to the beneficial effects of income from the cash surrender value of life insurance and other tax-exempt obligations.

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Average Balance sHEET

The following tables set forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

                                                            Year ended December 31,                 Nine month period ended December 31
                                                                      2012                                         2011
                                                       Average                    Average         Average                           Average
                                                       Balance      Interest        Rate          Balance            Interest         Rate
                                                                                      (Dollars in thousands)
Interest-earning assets:
Loans receivable, net (1)                             $ 235,894     $  11,828         5.01 %   $     233,371       $      9,209         5.24 %
Investment securities (2)                               129,694         3,242         2.50           136,196              3,230         3.15
Interest-earning deposits (3)                             8,600           233         2.71            15,789                169         1.42
Total interest-earning assets                           374,188        15,303         4.09           385,356             12,608         4.34
Non-interest-earning assets                              28,747                                       23,876

Total assets                                          $ 402,935                                $     409,232

Interest-bearing liabilities:
Deposits                                              $ 327,415         2,118         0.65     $     327,720              2,220         0.90
Other short term borrowings                               6,767            10         0.15             5,541                 10         0.24
Borrowings                                               24,134           670         2.78            32,619                749         3.05
Total interest-bearing liabilities                      358,316         2,798         0.78           365,880              2,979         1.08

Non-interest-bearing liabilities                          4,366                                        3,753

Total liabilities                                       362,682                                      369,633

Stockholders' equity                                     40,253                                       39,599

Total liabilities and stockholders' equity            $ 402,935                                $     409,232

Net interest income                                                 $  12,505                                      $      9,629
Interest rate spread (4)                                                              3.31 %                                            3.26 %

Net yield on interest-earning assets (5)                                              3.34 %                                            3.32 %
Ratio of average interest-earning assets to average
interest-bearing liabilities                                                        104.43 %                                          105.32 %

(1) Includes non-accrual loan balances.

(2) Includes mortgage-backed securities designated as available-for-sale.

(3) Includes federal funds sold and interest-bearing deposits in other financial institutions.

(4) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.

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Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For the year ended December 31, 2011 there were only nine months of activity for each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) Decrease due to number of months is calculated using the nine months income or expense divided by 275 days multiplied by 365 days to get a twelve month equivalent; (ii) changes in average volume (changes in average volume multiplied by old rate); and (iii) changes in rate (change in rate multiplied by old average volume). Changes in rate-volume (changes in rate multiplied by the change in average volume) have been allocated proportionately between changes in rate and changes in volume;

                                                         Year ended December 31, 2012 vs                             Nine months ended December 31, 2011
                                                       Nine months ended December 31, 2011                              vs Year ended March 31, 2011
. . .
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