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WBKC > SEC Filings for WBKC > Form 10-K on 1-Apr-2013All Recent SEC Filings

Show all filings for WOLVERINE BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for WOLVERINE BANCORP, INC.


1-Apr-2013

Annual Report


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

Overview

At December 31, 2012, we had total assets of $285.3 million, compared to total assets of $293.7 million at December 31, 2011. During the year ended December 31, 2012, we had net income of $1.6 million. For the year ended December 31, 2011, we had a net income of $1.1 million.

Our results of operations depend primarily on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we incur on our deposits and, to a lesser extent, our borrowings. Results of operations are also affected by service charges and other fees, provision for loan losses, gains on sales of loans originated for sale and other income. Our noninterest expense consists primarily of salaries and employee benefits, net occupancy and equipment expense, information technology, professional and services fees, FDIC deposit insurance and other real estate owned expense.

Our results of operations are also significantly affected by general economic and competitive conditions, as well as changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.

Historically, substantially all of our loans have been collateralized by real estate and at December 31, 2012 and 2011, one- to four-family residential mortgage loans including home equity loans and lines of credit, commercial real estate loans including multifamily loans and land loans and construction loans, comprised 97.0% and 96.6%, of our total loan portfolio, respectively.

We do not offer loans that provide for negative amortization of principal, such as "Option ARM" loans, where the borrower can pay less than the interest owed on his or her loan, resulting in an increased principal balance during the life of the loan. We generally do not offer "subprime loans" (loans that are made with low down-payments to borrowers that have had payment delinquencies, previous loan charge-offs, judgments and bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (generally defined as loans having less than full documentation).

Business Strategy

Our business strategy is to remain a profitable, community-oriented financial institution offering deposit and loan products to retail and business customers in our primary market area. Additionally, we are seeking to expand our presence in new markets. We were established in 1933 and have operated continuously in the Great Lakes Bay Region of Michigan since that date. We are committed to meeting the financial needs of the communities in which we operate, and we are dedicated to providing quality personal service to our customers. We offer a broad range of financial services to consumers and businesses from our four banking offices and two loan centers. Our business strategy includes the following elements:


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Growing our loan portfolio by continuing to emphasize the origination of commercial and residential real estate loans, including increasing our loan participations, while maintaining strong asset quality. At December 31, 2012, commercial real estate loans, including multifamily loans and land loans, comprised 67.0% of our total loan portfolio. These loans generally are higher-yielding than one- to four-family residential mortgage loans, and also generally have a shorter term than our one- to four-family residential mortgage loans which helps our interest rate risk management. We intend to continue to make these types of loans a significant part of our total loan portfolio. We currently participate with other community banks that serve as the lead lender in commercial mortgage loans, one- to four-family residential mortgage loans and commercial non-mortgage loans collateralized by properties that are located both within and outside of our primary market area. We intend to increase the amount of our loan participations in an effort to continue to grow our loan portfolio. However, we still apply our prudent underwriting standards to any potential participation loan and this is causing slow growth in our participation loan portfolio.

Maintaining prudent underwriting standards and aggressively monitoring our loan portfolio to maintain asset quality. We introduce loan products only when we are confident that our staff has the necessary expertise to originate and administer such loans, and that sound underwriting and collection procedures are in place. Our goal is to continue to improve our asset quality through prudent underwriting standards and the diligence of our loan collection personnel. At December 31, 2012, our ratio of non-performing loans to total loans was 4.1%. At December 31, 2012, our ratio of allowance for loan losses to non-performing loans was 61.8%, and our ratio of allowance for loan losses to total loans was 2.6%.

Reducing our overall cost of funds by emphasizing lower cost core deposits, including low cost public funds from municipalities, townships and non-profit organizations and reducing our borrowings. We offer interest-bearing and noninterest-bearing checking accounts, money market accounts and savings accounts (collectively referred to as core deposits), which generally are lower-cost sources of funds than certificates of deposit, and are less sensitive to withdrawal when interest rates fluctuate. At December 31, 2012, 58.7% of our total deposits consisted of these lower cost core deposits compared to 55.6% and 50.2% of total deposits at December 31, 2011 and 2010, respectively. Additionally, at December 31, 2012 we held approximately $28.3 million of low-cost checking and money market account funds from Michigan cities, townships, counties and nonprofit organizations (which we call "public funds") due, we believe, to our successful marketing efforts, community ties, and financial stability and strength. We intend to continue emphasizing our core deposits, including public funds, as a source of funds. Additionally, we intend to reduce our borrowings from the FHLB of Indianapolis. With respect to our commercial real estate customers, we encourage commercial banking borrowers to open checking accounts with us at the time they establish a borrowing relationship with us, and we intend to continue to pursue this strategy to grow this source of lower cost deposits.

Managing interest rate risk. Successfully managing interest rate risk is, and will continue to be, an integral part of our business strategy. Management and the Board of Directors evaluate the interest rate risk inherent in our assets and liabilities, and determine the level of risk that is appropriate and consistent with our capital levels, liquidity and performance objectives. In particular, during the current low interest rate environment, we have sought to minimize the risk of originating long-term, fixed-rate one- to four-family residential mortgage loans by originating such loans for sale in the secondary market and, in particular, selling substantially all of our conforming fixed-rate one- to four-family residential mortgage loans with terms of 15 years or greater. In addition, a significant portion of our loan portfolio consists of commercial real estate mortgage loans which generally have shorter terms and provide higher yields than one- to four-family residential mortgage loans. We also monitor the mix of our deposits. Our strategy is to continue managing interest rate risk in response to changes in the local and national economy.


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Expanding our banking franchise. We currently operate from four banking offices and two loan centers. One of the two loan centers began operations in the 4th quarter of 2012. Additionally, we added two loan officers in the existing loan center. We intend to evaluate additional branch expansion opportunities through acquisitions and de novo branching. In addition, we intend to evaluate acquisitions of other financial institutions, or the deposits and assets of other institutions, including in FDIC-assisted acquisitions, as opportunities present themselves (although we currently have no understandings or agreements to acquire other banks, thrifts, branches thereof or other financial services companies).

The successful implementation of these strategies will allow us to offer our clients a broad range of financial products and services. Our goal is to have full relationship banking with our clients.

Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions 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. We believe that the allowance for loan losses and related provision for loan losses are particularly susceptible to change in the near term, due to changes in credit quality which are evidenced by trends in charge-offs and in the volume and severity of past due loans. In addition, our portfolio is comprised of a substantial amount of commercial real estate loans which generally have greater credit risk than one- to four-family residential mortgage and consumer loans because these loans generally have larger principal balances and are non-homogenous.

The allowance for loan losses is maintained at a level to cover probable credit losses inherent in the loan portfolio at the balance sheet date. Based on our estimate of the level of allowance for loan losses required, we record a provision for loan losses as a charge to earnings to maintain the allowance for loan losses at an appropriate level. The estimate of our credit losses is applied to two general categories of loans:

loans that we evaluate individually for impairment under ASC 310-10, "Receivables;" and

groups of loans with similar risk characteristics that we evaluate collectively for impairment under ASC 450-20, "Loss Contingencies."

The allowance for loan losses is evaluated on a regular basis by management and reflects consideration of all significant factors that affect the collectability of the loan portfolio. The factors used to evaluate the collectability of the loan portfolio include, but are not limited to, current economic conditions, our historical loss experience, the nature and volume of the loan portfolio, the financial strength of the borrower, and estimated value of any underlying collateral. This evaluation is inherently subjective as it requires estimates that are subject to significant revision as more information becomes available. Actual loan losses may be significantly more than the allowance for loan losses we have established which could have a material negative effect on our financial results. See also "Business of Wolverine Bank-Allowance for Loan Losses."


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Income Tax Accounting. The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return. 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. 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. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. Under U.S. GAAP, a valuation allowance is required to be recognized if it is more likely than not that a deferred tax asset will not be realized. The determination as to whether we will be able to realize the deferred tax assets is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carryback years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. Any required valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings. Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense.

We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact on our net income and the carrying value of our assets. We believe our tax liabilities and assets are properly recorded in the consolidated financial statements at December 31, 2012 and 2011 and no valuation allowance was necessary.

Comparison of Financial Condition at December 31, 2012 and December 31, 2011

Total assets decreased $8.4 million, or 2.9%, to $285.3 million at December 31, 2012 from $293.7 million at December 31, 2011. The decrease resulted from a decrease of $21.1 million in interest-earning time deposits, offset in part by an increase of $10.2 million in net loans.

Interest-earning demand deposits increased $2.4 million, or 17.5%, to $16.1 million at December 31, 2012 from $13.7 million at December 31, 2011. The increase in interest-earning demand deposits was primarily due to holding a higher balance in our Federal Reserve account reflecting normal cash management. Interest-earning time deposits decreased $21.1 million, or 100%, to $0 at December 31, 2012 from $21.1 million at December 31, 2011. Due to the low interest rate environment, funds were shifted from interest-earning time deposits to overnight deposits. Funds received from maturing interest-earning time deposits were used to pay down Federal Home Loan Bank advances, customer certificates of deposits and funded of loan originations.

Mortgage loans held for sale increased $2.0 million at December 31, 2012, or 271%, to $2.6 million at December 31, 2012 from $666,000 at December 31, 2011 due to normal fluctuation in mortgage secondary market activities.


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Net loans increased $10.2 million, or 4.1%, to $253.8 million at December 31, 2012 from $243.7 million at December 31, 2011 as our commercial real estate loans increased by $18.6 million, to $108.1 million at December 31, 2012 from $89.5 million at December 31, 2011. Additionally our one- to four-family residential mortgage loans decreased by $10.1 million, to $58.2 million at December 31, 2012 from $68.3 million at December 31, 2011, primarily due to repayments and refinances. We do not hold a significant amount of fixed rate one- to four-family residential mortgage loans in our portfolio in the current interest rate environment. Additionally home equity loans decreased $2.8 million to $10.8 million from $13.6 million, commercial non-mortgage loans decreased $936,000, to $6.7 million from $7.7 million, and construction loans decreased $7.4 million, or 37.8%, to $12.3 million from $19.7 million. These items were offset by increases in multifamily loans of $9.3 million, or 18.2%, to $60.8 million, from $51.4 million at December 31, 2011. The majority of the $9.3 million consists of five multifamily loans that were opened in 2012 that totaled $9.1 million at December 31, 2012. Commercial real estate also had increases of $18.6 million, or 20.8%, to $108.1 million from $89.5 million. During 2012, we opened three construction loans and four commercial real estate loans, which totaled $7.6 million and $8.8 million, respectively, at December 31, 2012.

The decrease in our allowance for loan losses was due to the charging off of $3.8 million of specific reserves on collateral-dependent impaired loans in the three months ended March 31, 2012. These charge offs were considered confirmed losses and the majority of the charge offs were based off of recent appraisal values. The allowance for loan losses as a percentage of total loans decreased to 2.56% as of December 31, 2012, from 3.7% at December 31, 2011, which management believes is adequate.

Securities held to maturity, consisting of one municipal security at December 31, 2012, decreased $74,000 to $241,000 at December 31, 2012 from $315,000 at December 31, 2011.

Real estate owned decreased $521,000, or 38.2%, to $844,000 at December 31, 2012 from $1.4 million at December 31, 2011. The decrease in other real estate owned resulted from write-downs of $100,000 and sales of $1.0 million offset by new foreclosures of $623,000, primarily composed of eight commercial mortgage properties totaling $407,000 and four residential properties totaling $216,000.

Other assets, consisting primarily of prepaid FDIC assessments and deferred federal taxes, decreased $1.3 million, or 21.9%, to $4.4 million at December 31, 2012, from $5.7 million at December 31, 2011. The decrease was primarily attributable to a decrease in federal income taxes and an increase in other investments.

Deposits decreased $2.8 million, or 1.8%, to $158.6 million at December 31, 2012 from $161.4 million at December 31, 2011. Certificates of deposit decreased $6.3 million, or 8.8%, to $65.3 million at December 31, 2012 from $71.6 million at December 31, 2011. Our core deposits (consisting of interest-bearing and noninterest-bearing checking accounts, money market accounts and savings accounts) increased $3.5 million, or 3.9%, to $93.3 million at December 31, 2012 from $89.8 million at December 31, 2011. We believe the increase in our core deposits resulted primarily from continuing to build relationships with our existing customers as well as our marketing efforts with new customers.

Federal Home Loan Bank advances decreased $3.9 million to $61.9 million at December 31, 2012 from $65.8 million at December 31, 2011 as a result of paying off maturing advances.

Total stockholders' equity decreased $2.5 million, or 3.9%, to $62.5 million at December 31, 2012 from $65.0 million at December 31, 2011. The decrease is primarily a result of the net effect of a special dividend of $2.5 million and stock repurchases of $2.2 million, offset by net income of $1.6 million.


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Comparison of Operating Results for the Years Ended December 31, 2012 and 2011

General. We recorded net income of $1.6 million for the year ended December 31, 2012 compared to net income of $1.1 million for the year ended December 31, 2011. The increase in net income for 2012 is primarily due to increased income from the sale of loans, which increased $1.9 million to $2.6 million for year ended December 31, 2012 from $724,000 for the year ended December 31, 2011. This was partially offset by an increase in noninterest expense, specifically in salaries and employee benefits of $1.2 million to $5.1 million year end December 31, 2012 from $3.8 million year ended December 31, 2011.

Interest and Dividend Income. Interest and dividend income decreased $232,000, or 1.6%, to $14.2 million for the year ended December 31, 2012 from $14.4 million for the year ended December 31, 2011, as the average balance of interest-earning assets decreased $14.8 million to $278.5 million for the year ended December 31, 2012 from $293.3 million for the year ended December 31, 2011, offset in part by an 18 basis points increase in the average yield on interest-earning assets to 5.08% during 2012 from 4.91% during 2011. The increase in our average yield on interest-earning assets was due primarily to an increased yield on FHLB stock and a decrease in the average balances of lower interest-earning other assets.

The biggest component decrease in average interest-earning assets was in other interest-earning assets, which decreased $22.7 million, or 48.0%, to $24.6 million for the year ended December 31, 2012 from $47.4 million for the year ended December 31, 2011. The average yield on other interest-earning assets increased 9 basis points to 0.55% for the year ended December 31, 2012 from 0.46% for the year ended December 31, 2011. This was offset by an increase in the average balance of total net loans of $8.1 million, or 3.4%, to $249.2 million for the year ended December 31, 2012 from $241.1 million for the year ended December 31, 2011.

Interest income on loans decreased $184,000, or 1.3%, to $13.9 million for the year ended December 31, 2012 from $14.0 million for the year ended December 31, 2011, as the average yield on net loans decreased 27 basis points to 5.56% for the year ended December 31, 2012 from 5.83% for the year ended December 31, 2011 reflecting the lower market interest rate environment.

Interest income on investment securities, other interest-earning assets and FHLB of Indianapolis stock, decreased $48,000, or 14.1%, to $293,000 for the year ended December 31, 2012 from $341,000 for the year ended December 31, 2011. This includes interest income on interest-earning demand deposits, interest-earning time deposits and held-to-maturity securities. The decreased interest income is primarily due to the maturity of interest-earning time deposits.

Interest Expense. Interest expense decreased $1.2 million, or 25.0%, to $3.7 million for the year ended December 31, 2012 from $5.0 million for the year ended December 31, 2011, as the average balance of interest-bearing liabilities decreased $18.2 million, or 7.7%, to $218.7 million for the year ended December 31, 2012 from $237.0 million for the year ended December 31, 2011, and the average rate we paid on these liabilities decreased 39 basis points to 1.71% from 2.10%. The biggest component of the decrease was in interest expense on borrowed funds, consisting entirely of Federal Home Loan Bank advances, which decreased $673,000, or 21.1%, to $2.5 million for the year ended December 31, 2012 from $3.2 million for the year ended December 31, 2011, resulting from a $7.9 million decrease in average Federal Home Loan Bank Advances, as we paid off maturing advances.

Interest expense on certificates of deposit decreased $495,000, or 33.8%, to $967,000 for the year ended December 31, 2012 from $1.5 million for the year ended December 31, 2011, resulting from a


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$12.9 million decrease in the average balance of certificates of deposits to $64.6 million for the year ended December 31, 2012 from $77.6 million for the year ended December 31, 2011, and a 38 basis point decrease in the cost of these funds to 1.50% for 2012 from 1.88% for 2011.

The average balance of our core deposits, consisting of checking accounts, money market accounts and savings accounts, increased $2.6 million, or 2.9%, to $91.8 million for the year ended December 31, 2012 from $89.2 million for the year ended December 31, 2011 and the interest on core deposits decreased $78,000 to $263,000 for 2012 from $341,000 for 2011. The cost of these funds decreased 9 basis points to 0.29% for the year ended December 31, 2012, from 0.38% for the year ended December 31, 2011.

Net Interest Income. Net interest income increased $1.0 million, or 10.8%, to $10.4 million for the year ended December 31, 2012 from $9.4 million for the year ended December 31, 2011, as our net interest earning assets increased to $59.9 million from $56.4 million, our net interest rate spread increased 57 basis points to 3.37% from 2.80% and our net interest margin increased 53 basis points to 3.63% from 3.10%. The increases in our net interest rate spread and net interest margin reflected our ongoing interest rate risk strategy of selling long-term, fixed-rate one- to four-family residential mortgage loans during the current low interest rate environment, a shift from lower yielding interest-earning demand deposits to interest-earning time deposits and loans, paying off and restructuring Federal Home Loan Bank advances and a shift from higher costing certificate of deposit liabilities to core deposits.

Provision for Loan Losses. Based on our analysis of the factors described in "Critical Accounting Policies - Allowance for Loan Losses," we recorded a provision for loan losses of $2.2 million for the year ended December 31, 2012 and a provision for loan losses of $1.4 million for the year ended December 31, 2011. The factors used to evaluate the adequacy of the allowance and provision for loan losses of the loan portfolio include, but are not limited to, current economic conditions, our historical loss experience, the nature and volume of the loan portfolio, the financial strength of the borrower, and estimated value of any underlying collateral. At December 31, 2012, non-performing assets totaled $11.3 million, or 4.16% of total loans, as compared to $16.0 million, or 6.3% of total loans, at December 31, 2011. The decrease in non-performing assets was primarily in the one-to four family and land categories. The allowance for loan losses to total loans receivable decreased to 2.56% at December 31, 2012 from 3.73% at December 31, 2011. The decrease in our allowance for loan losses to total loans receivable was primarily due to the charge off and elimination of all previously established specific valuation allowances, which totaled $3.8 million in the three months ended March 31, 2012. We are not required to maintain an allowance for loan losses on these loans as the loan balance has already been written down to the estimated collateral values on our collateral dependent impaired loans. Therefore, the ratio of the allowance for loan losses to total loans and the ratio of the allowance for loan losses to non-performing loans has been adversely affected by these charge offs.

The allowance for loan losses as a percentage of non-performing loans decreased to 64.0% at December 31, 2012 from 65.3% at December 31, 2011, while our non-performing loans decreased by $4.1 million from December 31, 2011 to December 31, 2012 primarily due decreased nonaccrual loans. To the best of our knowledge, we have provided for all losses that are both incurred and reasonable to estimate at December 31, 2012 and 2011.

Noninterest Income. Noninterest income increased $1.5 million, or 104.5%, to $2.9 million for the year ended December 31, 2012 from $1.4 million for the year ended December 31, 2011. The increase was due primarily to an increase of $1.9 million in gain on the sale of mortgage loans, which was a result of heightened loan volume attributable to the low interest rate environment. This was offset by a $254,000 decrease in loan fees earned, which are now netted against the fees paid to our mortgage loan processing provider that was engaged in 2012. . . .

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