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MBTF > SEC Filings for MBTF > Form 10-Q on 13-May-2013All Recent SEC Filings

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Form 10-Q for MBT FINANCIAL CORP


13-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

MBT Financial Corp. (the "Company") is a bank holding company with one subsidiary, Monroe Bank & Trust ("the Bank"). The Bank is a commercial bank with a wholly owned subsidiary, MB&T Financial Services. MB&T Financial Services is an insurance agency which sells insurance policies to the Bank. The Bank operates 17 branch offices in Monroe County, Michigan and 7 offices in Wayne County, Michigan. The Bank's primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. The discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

Executive Overview

The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management products and services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving asset quality, profitability, and capital.

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The national economic recovery is continuing slowly, and conditions in southeast Michigan are also slowly improving. Local unemployment rates improved significantly since 2011, and are now comparable to the state and national averages, but remain above the historical norms. Commercial and residential development property values continue to show some stability with some areas improving slightly. Our total problem assets, which include nonperforming loans, other real estate owned, non accrual investments, and performing loans that are internally classified as potential problems, increased $0.3 million, or 0.2% during the first quarter of 2013, but decreased $3.7 million or 2.8% compared to a year ago. Although overall asset quality has improved over the past year and net charge offs were only $0.9 million in the first quarter of 2013, we increased our Allowance for Loan and Lease Losses (ALLL) from $17.3 million to $17.9 million in the first quarter. The increase in the ALLL was mainly due to an increase of $351,000 in specifically identified impairments. In addition, even though the size of the loan portfolio decreased during the quarter, an increase in some of the risk factors caused us to increase the general allocation in the ALLL by $249,000. The loan portfolio held for investment decreased $12.5 million during the quarter, and the ALLL as a percent of loans increased from 2.75% to 2.90%. Although local property values improved in the second half of 2012 and the unemployment rate stabilized over the past few quarters, we anticipate that the recovery in our local markets will continue at a slower than normal pace though 2013. We will continue to focus our efforts on improving asset quality, maintaining liquidity, strengthening capital, and controlling expenses.

Net Interest Income decreased $884,000 compared to the first quarter of 2012 even though the average earning assets increased $32.7 million, or 2.9% as the net interest margin decreased from 3.19% to 2.82%. The provision for loan losses decreased from $2.25 million in the first quarter of 2012 to $1.5 million in the first quarter of 2013. Decreases in the historical loss rates and in the amount of specific allocations compared to a year ago decreased the amount of ALLL required. Also, net charge offs were $0.9 million in the first quarter of 2013 compared to $2.6 million in the first quarter of 2012, allowing the reduction in the provision for loan losses. Non interest income decreased $689,000 or 14.7% due to higher than normal gains on securities transactions in the first quarter of 2012. Wealth management fees and mortgage loan origination income increased due to improvements in the financial and local real estate markets. Non interest expenses decreased $594,000, or 5.9% as occupancy, equipment, marketing, legal fees, losses on Other Real Estate Owned (OREO), and OREO carrying costs decreased. We expect credit related expenses to continue to improve, but still remain above normal levels, throughout 2013.

Critical Accounting Policies

The Company's Allowance for Loan Losses, Deferred Tax Asset Valuation Allowance, Fair Value of Investment Securities, and Other Real Estate Owned are "critical accounting estimates" because they are estimates that are based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Company's financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

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Income tax accounting standards require companies to assess whether a valuation allowance should be established against deferred tax assets based on the consideration of all evidence using a "more likely than not" standard. We reviewed our deferred tax asset, considering both positive and negative evidence and analyzing changes in near term market conditions as well as other factors that may impact future operating results. Significant negative evidence is our net operating losses for the years 2009 through 2011, combined with a difficult economic environment and the slow pace of the economic recovery in southeast Michigan. Positive evidence includes our history of strong earnings prior to 2008, our seventh consecutive quarterly profit in the first quarter of 2013, our strong capital position, our steady core earnings, our improving asset quality, our non interest expense control initiatives, and our projections for future taxable earnings. Based on our analysis of the evidence, we believed that it was appropriate to reduce our valuation allowance by $5 million in the fourth quarter of 2012. The valuation allowance is now $19.7 million, compared to the deferred tax asset of $24.7 million as of March 31, 2013. We will continue to assess the evidence and if the amount of positive evidence continues to increase, we may recognize additional tax benefits in late 2013.

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

Financial Condition

National economic conditions began to recover in the second half of 2009, but regional conditions remained weak through 2010. Local unemployment and property values stabilized during 2011 and began to improve in 2012. The economic environment in southeast Michigan is continuing to slowly improve, and we expect the slow recovery to continue in our market area throughout 2013. Management intends to continue to focus efforts on improving credit quality, managing capital, and mitigating enterprise risk.

With respect to credit quality, our nonperforming assets ("NPAs") increased 0.6% during the quarter, from $87.1 million to $87.7 million, and total problem assets increased from $125.2 million to $125.5 million. Both of these measures were impacted by a small number of large credit relationships, and both still reflect improvement compared to the first quarter of 2012. Over the last twelve months, NPAs decreased $882,000, or 1.0%, with nonperforming loans decreasing 2.7% from $71.4 million to $69.5 million, and Other Real Estate Owned ("OREO") increasing 6.3% from $14.3 million to $15.2 million. Total problem assets, which includes all NPAs and performing loans that are internally classified as substandard, decreased $3.7 million, or 2.8%. The Company's Allowance for Loan and Lease Losses ("ALLL") decreased $2.6 million over the last four quarters due to a decrease in the size of the portfolio and an improvement in the quality of the assets in the loan portfolio. The ALLL is now 2.90% of loans, down from 3.07% at March 31, 2012. The ALLL is 25.77% of nonperforming loans ("NPLs"), compared to 24.78% at year end and 28.69% at March 31, 2012. In light of current economic conditions, we believe that this level of ALLL adequately estimates the potential losses in the loan portfolio.

Since December 31, 2012, total loans decreased 2.0% because new loan activity was not sufficient to cover payments received and other reductions. Total loans held for investment decreased $12.5 million during the quarter as payments received in the ordinary course of business, transfers to OREO, and charge offs of existing loans exceeded new loan production. The decrease in loans caused an increase in lower yielding cash and investments, which, along with the prolonged historically low interest rate environment caused a decrease in our net interest margin. As the local economy is slowly recovering, lending opportunities and loan requests are beginning to increase.

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Since December 31, 2012, deposits increased $13.6 million, or 1.3% due to normal seasonal fluctuations in local deposit activity. The increase in deposits funded an increase of $17.6 million (1.4%) in total assets since the end of 2012. The Company expects low deposit growth and a reduction in total assets due to a reduction in non deposit funding in 2013.

Total capital increased $2.4 million, or 2.8%, due to the profit of $1.1 million and a private placement stock offering of $1.7 million, offset partially by the decrease of $521,000 in the accumulated other comprehensive income (AOCI). AOCI decreased mainly due to a decrease in the value of our securities available for sale. Even with the increase in total assets, the increase in capital caused the capital to assets ratio to increase from 6.59% at December 31, 2012 to 6.68% at March 31, 2013.

Results of Operations - First Quarter 2013 vs. First Quarter 2012

Net Interest Income - A comparison of the income statements for the three months ended March 31, 2012 and 2013 shows a decrease of $884,000, or 9.9%, in Net Interest Income. Interest income on loans decreased $1.2 million or 13.5% as the average loans outstanding decreased $50.5 million and the average yield on loans decreased from 5.46% to 5.15%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $398,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $83.2 million but the yield decreased from 2.17% to 1.57%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit helped reduce the funding costs. The interest expense on deposits decreased $626,000 or 34.0% as the average deposits increased $26.9 million and the average cost of deposits decreased from 0.72% to 0.47%. The cost of borrowed funds decreased $125,000 as the average amount of borrowed funds decreased $5.0 million and the average cost of the borrowings decreased from 2.94% to 2.67%.

Provision for Loan Losses - The Provision for Loan Losses decreased from $2.25 million in the first quarter of 2012 to $1.5 million in the first quarter of 2013. Net charge offs were $0.9 million during the first quarter of 2013, compared to $2.6 million in the first quarter of 2012. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, and a decrease in the historical loss percentages, the amount of provision required to maintain an adequate ALLL in the first quarter of 2013 decreased 33.3% compared to the amount required in the first quarter of 2012. The ALLL is 2.90% of loans as of March 31, 2013, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income - Non interest income decreased $689,000, or 14.7% compared to the first quarter of 2012. The income in the first quarter of 2012 included gains on securities transactions that were the result of restructuring activity in the investment portfolio in that quarter. Excluding securities gains in both years, non interest income increased $401,000 or 11.2%. Wealth management income increased $129,000 due to an increase in the market value of assets managed and new business brought in to the bank. Origination fees on mortgage loans sold increased $167,000, or 136.9%, due to an increase in mortgage loan origination volume compared to 2012, and other non interest income increased $133,000 primarily due to commissions on brokerage and credit card services and check supplies.

Other Expenses - Total non interest expenses decreased $594,000, or 5.9% compared to the first quarter of 2012. Salaries and Employee Benefits increased $217,000, or 4.2%, as salaries increased due to an increase in the number of employees and annual merit increases. Equipment expense decreased $103,000 due to lower computer and data processing expenses. Losses on Other Real Estate Owned (OREO) properties decreased $309,000 compared to the first quarter of 2012 as the property values stabilized over the last year, requiring fewer write downs of properties owned, and some of the OREO property sales that closed during the quarter produced gains. Other OREO expenses decreased $95,000 due to lower property tax and maintenance costs.

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As a result of the above activity, the Profit Before Income Taxes in the first quarter of 2013 was $1,114,000, a decrease of $229,000 compared to the pre tax profit of $1,343,000 in the first quarter of 2012. Due to our net operating loss carry forward, we did not record a federal income tax expense in the first quarter of 2013. If we did not have the benefit of the NOL carry forward, we would have incurred a federal income tax expense of $155,000, for an effective tax rate of 13.9%. The income tax expense of $126,000 that was recorded in the first quarter of 2012 was to accrue for an audit adjustment. The Net profit for the first quarter of 2013 was $1,114,000, a decrease of 8.5% compared to the net profit of $1,217,000 in the first quarter of 2012.

Cash Flows

Cash flows provided by operating activities increased $1.5 million compared to the first three months of 2012 as the non cash charges for the provision for loan losses and write downs of Other Real Estate Owned that are included net income decreased $1.1 million. Cash flows from investing activities decreased $26.7 million in the first three months of 2013 compared to the first three months of 2012 as the amount of securities that were called or that matured decreased $52.6 million, and the amount of securities sold decreased $10.0 million due to a restructuring transaction in the first three months of 2012. This activity was partially offset by a decrease of $38.5 million in securities purchases. The amount of cash provided by financing activities increased $2.1 million in the first three months of 2013 compared to the first three months of 2012 mainly due to a larger amount of stock issued, which was the result of the $1.7 million private placement of common stock in the first three months of 2013. Total cash and cash equivalents increased $5.5 million in the first three months of 2013 compared to $28.6 million in the first three months of 2012.

Liquidity and Capital

The Company believes it has sufficient liquidity to fund its lending activity and allow for fluctuations in deposit levels. Internal sources of liquidity include the maturities of loans and securities in the ordinary course of business as well as our available for sale securities portfolio. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, the Federal funds line that has been established with our correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. As of March 31, 2013, the Bank utilized $107.0 million of its authorized limit of $265 million with the Federal Home Loan Bank of Indianapolis, none of its $10 million overdraft line of credit with the Federal Home Loan Bank of Indianapolis, and none of its $25 million of federal funds line with a correspondent bank.

The Company's Funds Management Policy includes guidelines for desired amounts of liquidity and capital. The Funds Management Policy also includes contingency plans for liquidity and capital that specify actions to take if liquidity and capital ratios fall below the levels contained in the policy. Throughout the first three months of 2013 the Company was in compliance with its Funds Management Policy regarding liquidity and capital.

Total stockholders' equity of the Company was $85.9 million at March 31, 2013 and $83.6 million at December 31, 2012. The ratio of equity to assets was 6.68% at March 31, 2013 and 6.59% at December 31, 2012. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be well capitalized if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, and the Leverage Capital Ratio is at least 5%.

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The following table summarizes the capital ratios of the Company and the Bank:

                                                                     Minimum to Qualify as
                                                Actual                 Well Capitalized
                                          Amount       Ratio          Amount           Ratio
As of March 31, 2013:
Total Capital to Risk-Weighted Assets
Consolidated                             $ 92,667       11.96 %   $       77,472           10 %
Monroe Bank & Trust                        91,694       11.85 %           77,395           10 %
Tier 1 Capital to Risk-Weighted Assets
Consolidated                               82,855       10.69 %           46,483            6 %
Monroe Bank & Trust                        81,843       10.57 %           46,437            6 %
Tier 1 Capital to Average Assets
Consolidated                               82,855        6.50 %           63,699            5 %
Monroe Bank & Trust                        81,843        6.43 %           63,662            5 %




                                                                             Minimum to Qualify as
                                                  Actual                       Well Capitalized
                                           Amount         Ratio            Amount              Ratio
As of December 31, 2012:
Total Capital to Risk-Weighted Assets
Consolidated                             $   89,615          11.53 %   $       77,691                 10 %
Monroe Bank & Trust                          88,992          11.46 %           77,623                 10 %
Tier 1 Capital to Risk-Weighted Assets
Consolidated                                 79,776          10.27 %           46,615                  6 %
Monroe Bank & Trust                          79,113          10.19 %           46,574                  6 %
Tier 1 Capital to Average Assets
Consolidated                                 79,776           6.43 %           62,041                  5 %
Monroe Bank & Trust                          79,113           6.38 %           62,008                  5 %

On July 12, 2010, the Bank entered into a Consent Order with its state and federal regulators. While the Bank is under the Consent Order, it is classified as "adequately capitalized" even though its ratios meet the "well capitalized" guidelines. The Consent Order requires the Bank to raise its Tier 1 Leverage ratio to 9% and its Total Risk Based Capital Ratio to 12%. As of March 31, 2013, the Bank is not in compliance with the capital requirements of the Consent Order. The table below indicates the amount of capital the Bank needed to be in compliance with the Consent Order as of March 31, 2013:

                                                                                                     Additional
                                                                                                      Capital
                                                                 Minimum Capital Required           Required to
                                   Actual Capital                    by Consent Order               Comply with
                                Amount         Ratio             Amount               Ratio        Consent Order
Total Capital to
Risk-Weighted Assets          $   91,694          11.85 %   $         92,874                12 %   $        1,180
Tier 1 Capital to Average
Assets                        $   81,843           6.43 %   $        114,592                 9 %   $       32,749

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The Company increased its common shares authorized in 2011 and is continuing to monitor the capital market conditions. Currently, the Company does not believe that the market conditions are suitable for a bank holding company of our size located in the Midwest to conduct an offering large enough to generate the amount of capital required to comply with the Consent Order. Since the Consent Order was issued, the Company completed two private placement offerings, raising a total of $3.1 million, of which $2.5 million has been invested in the Bank. While we continue to monitor the capital market conditions, we are focusing our efforts to improve our capital position on generating capital by improving our earnings. We are also improving our capital ratios by reducing the size of our balance sheet by repaying our non deposit funding as it matures. This is expected to include the repayment of $95 million of Federal Home Loan Bank advances that are scheduled to mature in the second quarter of 2013.

Market risk for the Bank, as is typical for most banks, consists mainly of interest rate risk and market price risk. The Bank's earnings and the economic value of its equity are exposed to interest rate risk and market price risk, and monitoring this risk is the responsibility of the Asset/Liability Management Committee (ALCO) of the Bank. The Bank's market risk is monitored monthly and it has not changed significantly since year-end 2012.

Internal Revenue Service Audit

Since the fourth quarter of 2010, the Internal Revenue Service (IRS) has been conducting an audit of our tax returns for the 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The IRS is nearing completion of the audit and has proposed adjustments to our taxable income, mainly challenging our treatment of interest on non accrual loans, OREO valuations, OREO carrying costs, and loan charge-offs. Although our loan charge-offs were in compliance with state and federal bank regulatory agency guidelines, the IRS examining agent conducting the audit has called into question the deductibility of certain charge-offs for income tax purposes based on the facts and circumstances of a loan at the time of the charge-off and certain differences between tax and financial accounting for charge-offs. We believe that the charge-off deductions were proper when taken, and our belief is supported by confirmation of our charge off methodology by our federal and state banking regulators.

According to ASC 740, Accounting for Uncertainty in Income Taxes, an entity is required to evaluate the validity of uncertain tax positions and determine if the relevant taxing authority would conclude that it is more likely than not (greater than fifty percent) that the position taken will be sustained, based upon technical merits, upon examination. We have reviewed our tax positions and have concluded that it is appropriate to record a liability for potential reimbursement to the IRS.

Since the audit began in 2010, the Company has incurred over $200,000 of professional fees expenses with its accountants and lawyers for assistance in resolution. In order to resolve the audit without incurring significant additional expenses, the Company offered a settlement proposal to the IRS in the the third quarter of 2012. The Company's proposal resulted in a current tax liability of $2.0 million. The Company has concluded that its offer to settle of $2.0 million is the best estimate of potential liability at this time. The Company expects the audit to be resolved without incurring significant additional tax or professional fees expenses.

Although the timing of the resolution and/or closure of the audit remains highly uncertain, the Company believes it is reasonably possible that the IRS will conclude this audit within the next three months. Adjustments could be necessary in future periods to the estimated potential federal income tax payable noted above based on issues raised by the IRS. Management will re-evaluate the estimate quarterly based on current, relevant facts.

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Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements which are based on various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, changes in the financial and securities markets, including changes with respect to the market value of our financial assets, the availability of and costs associated with sources of liquidity, and the ability of the Company to resolve or dispose of problem loans.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

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