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PBCP > SEC Filings for PBCP > Form 10-K on 29-Mar-2013All Recent SEC Filings

Show all filings for POLONIA BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for POLONIA BANCORP INC


29-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The objective of this section is to help potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the consolidated balance sheets as of December 31, 2012 and 2011, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended.

Overview

FDIC-Assisted Acquisition. On December 10, 2010, Polonia Bank acquired certain assets and assumed certain liabilities of Earthstar Bank from the FDIC, as receiver of Earthstar Bank. Earthstar Bank operated four community banking branches within Chester and Philadelphia counties, Pennsylvania. Polonia Bank's bid to purchase Earthstar Bank included the purchase of certain Earthstar assets at a discount of $7.0 million in exchange for assuming certain Earthstar Bank deposits and certain other liabilities. Based on the terms of this transaction, the FDIC paid Polonia Bank $30.5 million ($30.8 million less a settlement of approximately $324,000), resulting in a pre-tax gain of $4.6 million. No cash or other consideration was paid by Polonia Bank. Polonia Bank and the FDIC entered into loss sharing agreements regarding future losses incurred on loans existing at the acquisition date. Under the terms of the loss sharing agreements, the FDIC will reimburse Polonia Bank for 80 percent of net losses on covered assets during the term of the agreements.

Under the terms of the loss sharing agreements, the FDIC will reimburse the Bank for 80 percent of net losses on covered assets. The term for loss sharing on residential real estate loans is ten years, while the term for loss sharing on nonresidential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. The loss sharing agreements includes clawback provisions should losses not meet the specified thresholds and other conditions not be met. As a result of the loss sharing agreements with the FDIC, Polonia Bank recorded an indemnification asset, net of estimated clawback provisions, of $5.4 million at the time of acquisition. For additional information regarding the FDIC indemnification asset See Note 1 "Summary of Significant Accounting Policies - FDIC Indemnification Asset" in the consolidated financial statements included in this prospectus.

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At December 31, 2012, covered loans were comprised of $11.7 million of one- to four-family mortgage loans, $9.6 million of multi-family and commercial real estate loans and $29,000 of commercial loans.

Income.Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and securities, and interest expense, which is the interest that we pay on our deposits and FHLB borrowings. Other significant sources of pre-tax income are service charges on deposit accounts and other loan fees (including loan brokerage fees and late charges). In addition, we recognize gains or losses from the sale of loans and investments in years that we have such sales.

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and value of the portfolio, information about specific borrower situations, and estimated collateral values, economic conditions, and other factors. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off.

Expenses.The non-interest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy and equipment expenses, marketing expenses and various other miscellaneous expenses.

Salaries and employee benefits consist primarily of: salaries and wages paid to our employees; payroll taxes; and expenses for health insurance and other employee benefits.

Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to 40 years.

Marketing expenses include expenses for advertisements, promotions, third-party marketing services and premium items.

FDIC and regulatory assessments are a specified percentage of assessable deposits, depending on the risk characteristics of the institution. Due to losses incurred by the Deposit Insurance Fund in 2008 from failed institutions, and anticipated future losses, the FDIC increased its assessment rates for 2009 and charged a special assessment to increase the balance of the insurance fund. Our special assessment amounted to $103,000. We also are assessed by our banking regulators.

Other expenses include expenses for supplies, telephone and postage, data processing, contributions and donations, director and committee fees, insurance and surety bond premiums and other fees and expenses.

Our Business Strategy

Our mission is to operate and grow a profitable, independent community-oriented financial institution serving primarily retail customers and small businesses in our market areas. The following are key elements of our business strategy:

Continuing our community-oriented focus. As a community-oriented financial institution, we emphasize providing exceptional customer service as a means to attract and retain customers. We believe that our community orientation is attractive to our customers and distinguishes us from the large banks that operate in our market area. Our ability to succeed in our communities is enhanced by the stability of our senior management. We intend to continue to leverage these strengths in our markets for the purpose of originating new deposits and loans, particularly through our branch offices, while continuing to focus on profitability.

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Implementing a controlled growth strategy to prudently increase profitability and enhance stockholder value. Our primary lending activity is the origination of one- to four-family mortgage loans secured by homes in our local market area. We intend to pursue a controlled growth strategy for the foreseeable future until the local economy materially improves. As a result, we anticipate moderate growth in our one- to four-family residential mortgage loan portfolio and in our investment securities portfolio. Accordingly, we expect that our weighted average yield on interest-earning assets will decrease in future periods because one- to four-family mortgage loans and investment securities generally yield less than nonresidential and multi-family real estate loans that were acquired in the Earthstar Bank acquisition. We believe our existing infrastructure and our recent branch acquisition, along with the capital raised in the mutual-to-stock conversion offering, will enable us to originate new loans, subject to the foregoing strategy, both to replace existing loans as they are repaid and to prudently grow our loan portfolio.

Improve our funding mix by attracting lower cost core deposits. Core deposits (demand, money market and savings accounts) comprised 42.6% of our total deposits at December 31, 2012. We value core deposits because they represent longer-term customer relationships and a lower cost of funding compared to certificates of deposit.

Use conservative underwriting practices to maintain asset quality. We have sought to maintain a high level of asset quality and moderate credit risk by using underwriting standards that we believe are conservative. While the delinquencies in our loan portfolio have increased during the recent economic recession, non-performing, non-covered loans were 2.29% of our non-covered loan portfolio at December 31, 2012. Although we intend to continue our efforts to originate commercial real estate and business loans, we intend to continue our philosophy of managing loan exposures through our conservative approach to lending.

Increase our noninterest income through the expansion of our FHA lending activity. Historically, we have originated FHA loans on a limited basis in order to accommodate customers who may not qualify for a conventional mortgage loan. FHA loans have mortgage insurance provided by the federal government. The loans are up to 96.5% of the lesser of the appraised value or purchase price and are originated and underwritten manually according to private investor and FHA guidelines. We have recently expanded our FHA lending activities by hiring an experienced team of originators in an effort to increase noninterest income through gains on the sale of loans. Our FHA lending team has been expanded from two (2) to 10 employees. We originate FHA loans from within our market area with the intention of selling the loans on a flow basis to the U.S. Department of Housing and Urban Development ("HUD") and other private investors with servicing released. Our new Retail Mortgage Banking Division, which began operation in the second quarter of 2012, generates primarily FHA loans for resale to various investors. During the year ended December 31, 2012, we generated $39.4 million in loans for sale to various investors.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be our critical accounting policies: allowance for loan losses, deferred income taxes and other-than-temporary impairment of securities.

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover probable incurred credit losses in the loan portfolio at the statement of financial condition date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance on a quarterly basis and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings. For additional discussion, see note 5 of the notes to the consolidated financial statements included in this annual report on Form 10-K.

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Deferred Income Taxes. We use the asset and liability method of accounting for income taxes as prescribed by United States Generally Accepted Accounting Principles (U.S. GAAP). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance would result in additional income tax expense in the period, which would negatively affect earnings.

Other-Than-Temporary Impairment of Securities. U.S. GAAP requires companies to perform periodic reviews of individual securities in their investment portfolios to determine whether a decline in the value of a security is other than temporary. Securities are periodically reviewed for other-than-temporary impairment based upon a number of factors, including, but not limited to, the length of time and extent to which the market value has been less than cost, the financial condition of the underlying issuer, the ability of the issuer to meet contractual obligations, the likelihood of the security's ability to recover any decline in its market value, management's intent and ability to hold the security for a period of time sufficient to allow for a recovery in market value and whether or not we intend to sell the security or whether it is more likely than not that we would be required to sell the security before its anticipated recovery in market value. Among the factors that are considered in determining management's intent and ability is a review of our capital adequacy, interest rate risk position, and liquidity. The assessment of a security's ability to recover any decline in market value, the ability of the issuer to meet contractual obligations, and management's intent and ability requires considerable judgment. A decline in value that is considered to be other than temporary is recorded as a loss within noninterest income.

Fair value of assets acquired and liabilities assumed pursuant to business combination transactions. Assets acquired and liabilities assumed in business combinations are recorded at estimated fair value on their purchase date. Purchased loans acquired in a business combination, including covered loans, are recorded at estimated fair value with no carryover of the related allowance for loan and lease losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, and net present value of cash flows expected to be received.

The estimated fair value of the FDIC indemnification asset is based on the net present value of expected future cash proceeds. See note 1 "Summary of Significant Accounting Policies - FDIC Indemnification Asset" in the consolidated financial statements included in this annual report on Form 10-K. The discount rates used are derived from current market rates and reflect the level of inherent risk in the assets. The expected cash flows are determined based on contractual terms, expected performance, default timing assumptions, property appraisals and other factors.

The fair values of investment securities acquired in business combinations are generally based on quoted market prices, broker quotes, comprehensive interest rate tables or pricing matrices or a combination thereof.

The fair value of assumed liabilities in business combinations on their date of purchase is generally the amount payable by the Company necessary to completely satisfy the assumed obligation.

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Financial Condition

Total assets at December 31, 2012 were $267.5 million, an increase of $2.4 million, or 0.9%, from total assets of $265.1 million at December 31, 2011. The increase in assets resulted primarily from a $12.1 million increase in loans held for sale and a $7.7 million increase in cash and cash equivalents, partially offset by a $15.8 million decrease in total loans. Total liabilities at December 31, 2012 were $226.3 million compared to $237.4 million at December 31, 2011, a decrease of $11.1 million, or 4.7%. The decrease in liabilities was primarily due to a $6.3 million decrease in deposits and a $5.6 million decrease in FHLB advances long-term. Total stockholders' equity increased to $41.2 million at December 31, 2012 from $27.6 million at December 31, 2011, an increase of $13.6 million, or 49.3%, primarily as a result of the receipt of proceeds from the second-step conversion, (net of the loan made to the ESOP.)

Cash and cash equivalents increased to $25.1 million from $17.4 million during the year ended December 31, 2012, an increase of $7.7 million, or 44.3%. The increase in cash and cash equivalents was attributable, in part, to a $15.8 million decrease in total loans as a result of net loan payments and payoffs and $14.0 million in net proceeds from the recently completed second-step conversion, partially offset by a $12.1 million increase in loans held for sale, a $6.3 million decrease in deposits and a $5.6 million decrease in FHLB advances long-term.

Investment securities available for sale decreased to $16.1 million from $17.3 million during the year ended December 31, 2012, a decrease of $1.2 million, or 6.9%. The decrease in investment securities available for sale was attributable to payments and maturities received of $5.2 million, partially offset by an increase of $3.8 million in purchases.

Investment securities held to maturity increased to $58.6 million from $56.6 million during the year ended December 31, 2012, an increase of $2.0 million, or 3.5%. The increase in investment securities held to maturity was attributable, in part, to the purchase of $15.4 million in mortgaged-backed securities, partially offset by $13.2 million in payments received.

Loans held for sale increased to $12.1 million during the year ended December 31, 2012. The increase was attributable, in part, to the new Retail Mortgage Banking Division which originated a total of $39.4 million in loans and sold $29.7 million in loans.

Loans receivable decreased to $138.8 million from $154.6 million during the year ended December 31, 2012, a decrease of $15.8 million or 10.2%. The decrease in loans receivable was mainly due to payoffs and repayments during the period.

Total deposits decreased to $196.7 million from $203.0 million during the year ended December 31, 2012, a decrease of $6.3 million, or 3.1%. The decrease in deposits was attributable, in part, to the outflow of $3.8 million in money market accounts, as rates offered were below rates offered in the marketplace, a $1.8 million decrease in now accounts and a $1.5 million decrease in time deposits, partially offset by a $1.0 million increase in noninterest bearing demand deposits.

We utilize borrowings from the FHLB of Pittsburgh to supplement our supply of funds for loans and investments. The $5.6 million decrease in FHLB advances long-term was due to maturities of FHLB advances long-term as the Company decided not to renew these borrowings.

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The following table sets forth the composition of our loan portfolio at the dates indicated.

                                                                                  At December 31,
                                  2012                       2011                       2010                       2009                       2008
                          Amount       Percent       Amount       Percent       Amount       Percent       Amount       Percent       Amount       Percent
                                                                               (Dollars in thousands)
Real estate loans:
One-to-four-family       $ 101,793        73.22 %   $ 111,272        71.82 %   $ 119,085        69.40 %   $ 131,571        86.84 %   $ 144,508        87.68 %
Multi-family and
commercial real estate       8,501         6.11         9,439         6.09        10,272         5.99        10,214         6.74        12,020         7.29
Home equity loans            2,489         1.79         2,818         1.82         2,918         1.70         3,372         2.23         4,172         2.53
Home equity lines of
credit                       1,853         1.33         1,767         1.14         2,023         1.18         3,036         2.00         1,361         0.83
Total real estate
loans:                     114,636        82.45       125,296        80.87       134,298        78.27       148,193        97.81       162,061        98.33

Consumer:
Education                    2,228         1.60         2,885         1.86         3,179         1.85         3,281         2.17         2,690         1.63
Other consumer                 901         0.65         1,032         0.67         1,300         0.76            33         0.02            60         0.04
Total consumer loans         3,129         2.25         3,917         2.53         4,479         2.61         3,314         2.19         2,750         1.67
Total loans excluding
covered loans              117,765        84.70       129,213        83.40       138,777        80.88       151,507       100.00       164,811       100.00
Covered loans               21,260        15.30        25,708        16.60        32,808        19.12             -         0.00             -         0.00
Total loans                139,025       100.00 %     154,921       100.00 %     171,585       100.00 %     151,507       100.00 %     164,811       100.00 %
Net deferred loan fees        (222 )                     (290 )                     (278 )                     (215 )                     (195 )
Allowance for loan
losses on non-covered
loans                       (1,508 )                   (1,206 )                     (834 )                   (1,115 )                     (857 )
Allowance for loan
losses on covered
loans                            -                        (73 )                        -                          -                          -
Loans, net               $ 137,295                  $ 153,352                  $ 170,473                  $ 150,177                  $ 163,759

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The following table sets forth certain information at December 31, 2012 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

                                                              Multi-Family
                                            One-to-Four-           and           Home Equity
                                               Family          Commercial         Loans and
                                            Real Estate        Real Estate        Lines of         Consumer      Covered        Total
                                               Loans              Loans            Credit           Loans         Loans         Loans
                                                                              (Dollars in thousands)
Amounts due in:
One year or less                           $          671     $       1,136     $       1,408     $    1,038     $  1,701     $   5,954
More than one to five years                         2,558             2,242               409            317        3,736         9,262
More than five years                               98,564             5,123             2,525          1,774       15,823       123,809
Total                                      $      101,793     $       8,501     $       4,342     $    3,129     $ 21,260     $ 139,025

The following table sets forth the dollar amount of all loans at December 31, 2012 that are due after December 31, 2013 and that have either fixed interest rates or adjustable interest rates. The amounts shown below exclude unearned interest on consumer loans and deferred loan fees.

                                                              Adjustable
                                             Fixed Rate          Rate           Total

  Real Estate Loans:
  One-to-four-family                        $    101,122     $          -     $ 101,122
  Multi-family and commercial real estate          7,365                -         7,365
  Home equity loans and lines of credit            1,081            1,853         2,934
  Consumer Loans                                   2,091                -         2,091
  Covered Loans                                    7,322           12,237        19,559
  Total                                     $    118,981     $     14,090     $ 133,071

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Securities. The following table sets forth the amortized cost and fair values of our securities portfolio at the dates indicated.

                                                                At December 31,
                                         2012                         2011                         2010
                                Amortized        Fair        Amortized        Fair        Amortized        Fair
                                  Cost          Value          Cost          Value          Cost          Value
                                                             (Dollars in thousands)
Securities
available-for-sale:
Fannie Mae                     $     3,361     $  3,625     $     5,049     $  5,413     $     7,558     $  7,999
Freddie Mac                            128          138             226          243           1,062        1,116
Government National Mortgage
 Association                           694          794             891        1,014           1,054        1,179
Collateralized mortgage
obligations -
Government- sponsored
entities                             2,167        2,210           3,750        3,811           6,237        6,245
Total mortgage-backed
securities                           6,350        6,767           9,916       10,481          15,911       16,539
Corporate securities                 9,171        9,372           6,972        6,867          10,551       10,802
Total debt securities               15,521       16,139          16,888       17,348          26,462       27,341
Equity securities-financial
services                                 -            -               -            -              19            9
Total                          $    15,521     $ 16,139     $    16,888     $ 17,348     $    26,481     $ 27,350




                                                                    At December 31,
                                             2012                         2011                         2010
                                    Amortized        Fair        Amortized        Fair        Amortized        Fair
                                      Cost          Value          Cost          Value          Cost          Value
                                                                 (Dollars in thousands)
Securities held-to-maturity:
Fannie Mae                         $    44,893     $ 47,404     $    46,772     $ 48,763     $    22,611     $ 22,563
Freddie Mac                             13,712       14,212           9,825       10,229           3,516        3,512
Total mortgage-backed securities   $    58,605     $ 61,616     $    56,597     $ 58,992     $    26,127     $ 26,075

. . .

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