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FFBH > SEC Filings for FFBH > Form 10-Q on 31-Jul-2013All Recent SEC Filings

Show all filings for FIRST FEDERAL BANCSHARES OF ARKANSAS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for FIRST FEDERAL BANCSHARES OF ARKANSAS INC


31-Jul-2013

Quarterly Report


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

Management's discussion and analysis of financial condition and results of operations ("MD&A") is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein. References to the Company and the Bank throughout MD&A are made using the first person notations of "we", "us" or "our".

The Bank is a federally chartered stock savings and loan association that was formed in 1934. As of June 30, 2013, the Bank conducted business from its home office, one limited service office, twelve full service branch offices located in a five county area in Arkansas (comprised of Benton and Washington counties in Northwest Arkansas; Boone, Marion and Baxter counties in North-central Arkansas) and a loan production office located in Little Rock, Arkansas. The Company also has executive offices in Little Rock, Arkansas. The Bank sold its Berryville, Arkansas branch in June 2013 and plans to close its Rogers Elm Street branch in August 2013 and has entered into an agreement to sell its Farmington, Arkansas branch, which is estimated to close in the third quarter of 2013. The branch sales and closure are part of the Bank's overall strategy to improve operational efficiency and to support its expansion into other areas of the state.

The Bank is a community-oriented financial institution offering a wide range of retail and commercial deposit accounts, including noninterest-bearing and interest-bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, e-statements, and bill payment; mobile banking, including remote deposit capture and funds transfer; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.

OVERVIEW

The Company's net income was $84,000 and $387,000 for the three and six months ended June 30, 2013, respectively, compared to net income of $709,000 and $901,000 for the same periods in 2012, respectively. The primary reason for the decrease in net income during each comparative period was a decrease in gains on sales of investment securities. The decrease in net income for each of the comparative periods was also due to decreases in net interest income and deposit fee income, partially offset by decreases in operating expenses.

The Bank continued to reduce its level of nonperforming assets during the first half of 2013. Total nonperforming assets at June 30, 2013, including nonaccrual loans and real estate owned, totaled $25.7 million, or 4.98% of total assets, a reduction of $9.8 million compared to December 31, 2012, and a reduction of $21.4 million compared to June 30, 2012. The Bank also reduced its level of classified loans to $18.3 million at June 30, 2013 compared to $34.5 million at December 31, 2012 and $38.0 million at June 30, 2012.

While the Bank is continuing its focus on reducing nonperforming assets, it is equally focused on improving its operational performance through improving its net interest margin, increasing noninterest income, and controlling noninterest expense.

MERGER AGREEMENT

On July 1, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with First National Security Company ("FNSC") of Hot Springs, Arkansas, pursuant to which FNSC will merge with and into the Company (the "Merger"). Pursuant to the Merger Agreement, shareholders of FNSC will receive, in the aggregate, 6,252,400 shares of Company common stock and $74 million in cash in exchange for their shares of FNSC common stock. Consummation of the Merger is subject to certain conditions, including, among others, approval of the Merger by Company and FNSC shareholders, the receipt of all required governmental regulatory approvals, accuracy of specified representations and warranties of each party, the performance in all material respects by each party of its obligations under the Merger Agreement, effectiveness of the registration statement to be filed by the Company with the SEC to register shares of Company common stock to be offered to FNSC shareholders, FNSC's receipt of a tax opinion, and the absence of any injunctions or other legal restraints.

The Merger Agreement contains termination rights which may be exercised by the Company or FNSC in specific circumstances, such as the following: a required regulatory approval has been denied by final, non-appealable action of a governmental entity; the parties are unable to complete the Merger by March 31, 2014; the other party has committed a breach of a representation, warranty or covenant which would prevent a closing condition from being satisfied and the breach is not or cannot be cured within 30 days; or the other party's board of directors has withdrawn or modified its recommendation of the Merger to its shareholders. If the Merger Agreement is terminated under certain circumstances and either party closes a "superior competing transaction" by March 31, 2015, such party will pay the other party a termination fee of $3 million.


Also on July 1, 2013, an independent special committee of the Board of Directors of the Company authorized management of the Company to (i) sell up to 2,531,645 shares of Company common stock at a price per share equal to $7.90 (the closing price of the Company's common stock on June 28, 2013) in a private placement to certain accredited investors that have pre-existing relationships with the Company, including Bear State Financial Holdings, LLC ("Bear State") and certain members of Bear State (the "Private Placement") and (ii) enter into commitment letter agreements (each a "Commitment Letter") with five members of Bear State (the "Investors"), which Investors include Richard N. Massey, the Company's Chairman, and Scott T. Ford, a director of the Company, whereby each Investor agreed to "backstop" a portion of the Private Placement and agreed to purchase up to 506,329 shares of Company common stock in the event the Company is unable to cause the Private Placement to be fully subscribed or is otherwise unable to raise sufficient funds from other sources. The Company anticipates that the proceeds from the Private Placement will be applied to the cash portion of the Merger consideration to be paid by the Company in the Merger. In exchange for providing a Commitment Letter, each Investor was issued warrants to purchase 35,443 shares of common stock on the same terms as in the Private Placement. The Investors will be entitled to customary registration rights with respect to the shares of common stock to be issued pursuant to the Commitment Letters as well as the shares of common stock underlying the warrants. On July 12, 2013, the Company approached Bear State and inquired as to Bear State's interest in participating in the Private Placement. In the event that Bear State agrees to purchase less than the full 2,531,645 shares in the Private Placement, the Company intends to utilize the commitments of the Investors to backstop the Private Placement. The Company anticipates the closing of the Private Placement will occur immediately prior to the closing of the Merger.

The foregoing summary of the Merger Agreement and terms of the Commitment Letters and the warrants are qualified in their entirety by reference to the full text of the Merger Agreement and the form of Commitment Letter, which are attached as Exhibit 2.1 and Exhibit 10.1, respectively, to the Current Report on Form 8-K filed with the SEC on July 3, 2013, and are incorporated herein by reference.

CRITICAL ACCOUNTING POLICIES

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, the following estimates, due to the judgments, estimates and assumptions inherent in those policies, are critical to preparation of our financial statements:

? Determination of our allowance for loan and lease losses ("ALLL")

? Valuation of real estate owned

? Valuation of investment securities

? Valuation of our deferred tax assets

These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Condensed Consolidated Financial Statements included herein. We believe that the judgments, estimates and assumptions used in the preparation of our condensed consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our condensed consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to the portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.

The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders' equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company's investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company's financial condition, results of operations and liquidity.


The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company evaluates its deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, our actual results and other factors.

RESULTS OF OPERATIONS

Three and Six Months Ended June 30, 2013 Compared to Three and Six Months Ended June 30, 2012

Net Income. Net income decreased to $84,000 for the three months ended June 30, 2013 compared to $709,000 for the three months ended June 30, 2012. Net income decreased to $387,000 for the six months ended June 30, 2013 compared to $901,000 for the six months ended June 30, 2012.

The primary reason for the decrease in net income during each comparative period was a decrease in gains on sales of investment securities. The decrease in net income for each of the comparative periods was also due to decreases in net interest income and deposit fee income, partially offset by decreases in operating expenses.

Net Interest Income. The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income for the second quarter of 2013 was $3.6 million compared to $3.9 million for the same period in 2012. Net interest income for the six months ended June 30, 2013 was $7.3 million compared to $7.8 million for the same period in 2012. The decrease in net interest income resulted from changes in interest income and interest expense discussed below.

Interest Income. Interest income for the second quarter of 2013 was $4.5 million compared to $5.0 million for the same period in 2012. Interest income for the six months ended June 30, 2013 was $9.0 million compared to $10.2 million for the same period in 2012. The decrease in interest income for the three and six months ended June 30, 2013 compared to comparable periods in 2012 was primarily related to a decrease in yields earned on loans receivable and, to a lesser degree, a decrease in the average balance of investment securities. The decrease in yields earned on loans receivable is due to origination during the period of high quality loans with average market rates lower than the weighted average rate of the Bank's portfolio in the same period last year. The average balance of investment securities decreased due to calls and maturities of investment securities.

Interest Expense. Interest expense for the second quarter of 2013 was $830,000 compared to $1.1 million for the same period in 2012. Interest expense for the six months ended June 30, 2013 was $1.7 million compared to $2.4 million for the same period in 2012. The decrease in interest expense for the three and six months ended June 30, 2013 compared to comparable periods in 2012 was primarily due to a decrease in the average rates paid on deposit accounts and, to a lesser degree, decreases in the average balances of deposits and borrowings. The decrease in the average rates paid on deposit accounts reflects decreases in market interest rates and Bank management's pricing of its deposits at such levels to maintain deposit balances commensurate with its overall balance sheet management and liquidity position.


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 each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (change in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change.

                                               Three Months Ended June 30,
                                                      2013 vs. 2012
                                           Increase (Decrease)
                                                  Due to
                                                                             Total
                                                              Rate/        Increase
                                     Volume        Rate       Volume      (Decrease)
                                                      (In Thousands)
Interest income:
Loans receivable                     $    17      $ (468 )   $     (1 )   $      (452 )
Investment securities                    (61 )         8           (1 )           (54 )
Other interest-earning assets             (7 )        (8 )          1             (14 )
Total interest-earning assets            (51 )      (468 )         (1 )          (520 )

Interest expense:
Deposits                                 (41 )      (247 )          8            (280 )
Other borrowings                         (16 )        (3 )          2             (17 )
Total interest-bearing liabilities       (57 )      (250 )         10            (297 )
Net change in net interest income    $     6      $ (218 )   $    (11 )   $      (223 )




                                                 Six Months Ended June 30,
                                                       2013 vs. 2012
                                            Increase (Decrease)
                                                  Due to
                                                                              Total
                                                               Rate/         Increase
                                     Volume        Rate        Volume       (Decrease)
                                                       (In Thousands)
Interest income:
Loans receivable                     $   (13 )   $ (1,001 )   $      2     $     (1,012 )
Investment securities                   (122 )        (14 )          2             (134 )
Other interest-earning assets            (33 )         33           (4 )             (4 )
Total interest-earning assets           (168 )       (982 )         --           (1,150 )

Interest expense:
Deposits                                (119 )       (564 )         28             (655 )
Other borrowings                         (34 )         (7 )          4              (37 )
Total interest-bearing liabilities      (153 )       (571 )         32             (692 )
Net change in net interest income    $   (15 )   $   (411 )   $    (32 )   $       (458 )


Average Balance Sheets. The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods.

                                                  Three Months Ended June 30,
                                        2013                                       2012
                                                      Average                                    Average
                         Average                      Yield/        Average                      Yield/
                         Balance       Interest        Cost         Balance       Interest        Cost
                                                     (Dollars in Thousands)
Interest-earning
assets:
Loans receivable(1)     $ 351,591     $    3,970          4.54 %   $ 350,249     $    4,422          5.08 %
Investment
securities(2)              50,225            349          2.80        59,143            403          2.74
Other
interest-earning
assets                     86,287            138          0.64        90,181            152          0.67
Total
interest-earning
assets                    488,103          4,457          3.67       499,573          4,977          4.01
Noninterest-earning
assets                     51,625                                     61,258
Total assets            $ 539,728                                  $ 560,831
Interest-bearing
liabilities:
Deposits                $ 462,973            817          0.71     $ 481,077          1,097          0.92
Other borrowings            2,862             13          1.77         6,251             30          1.95
Total
interest-bearing
liabilities               465,835            830          0.72       487,328          1,127          0.93
Noninterest-bearing
liabilities                 2,146                                      3,750
Total liabilities         467,981                                    491,078
Stockholders' equity       71,747                                     69,753
Total liabilities and
stockholders' equity    $ 539,728                                  $ 560,831

Net interest income                   $    3,627                                 $    3,850
Net earning assets      $  22,268                                  $  12,245
Interest rate spread                                      2.95 %                                     3.08 %
Net interest margin                                       2.98 %                                     3.09 %
Ratio of
interest-earning
assets to
Interest-bearing
liabilities                                             104.78 %                                   102.51 %



(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.

                                                   Six Months Ended June 30,
                                        2013                                       2012
                                                      Average                                    Average
                         Average                      Yield/        Average                      Yield/
                         Balance       Interest        Cost         Balance       Interest        Cost
                                                     (Dollars in Thousands)
Interest-earning
assets:
Loans receivable(1)     $ 354,072     $    8,051          4.59 %   $ 354,574     $    9,063          5.14 %
Investment
securities(2)              51,311            716          2.81        59,892            850          2.85
Other
interest-earning
assets                     79,896            271          0.68        90,714            275          0.61
Total
interest-earning
assets                    485,279          9,038          3.76       505,180         10,188          4.05
Noninterest-earning
assets                     51,983                                     60,420
Total assets            $ 537,262                                  $ 565,600
Interest-bearing
liabilities:
Deposits                $ 460,823          1,663          0.73     $ 485,735          2,318          0.96
Other borrowings            2,966             26          1.77         6,407             63          1.98
Total
interest-bearing
liabilities               463,789          1,689          0.74       492,142          2,381          0.97
Noninterest-bearing
liabilities                 2,468                                      3,978
Total liabilities         466,257                                    496,120
Stockholders' equity       71,005                                     69,480
Total liabilities and
stockholders' equity    $ 537,262                                  $ 565,600

Net interest income                   $    7,349                                 $    7,807
Net earning assets      $  21,490                                  $  13,038
Interest rate spread                                      3.02 %                                     3.08 %
Net interest margin                                       3.05 %                                     3.10 %
Ratio of
interest-earning
assets to
Interest-bearing
liabilities                                             104.63 %                                   102.65 %



(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.


Provision for Loan Losses. The provision for loan losses includes charges to maintain the ALLL at a level considered adequate by the Bank to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Bank based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral and other qualitative factors.

Management determined that no provision for loan losses was required for the three or six months ended June 30, 2013, primarily due to decreases in nonperforming and classified loans and continued improvement in the Bank's loan portfolio. The ALLL as a percentage of loans receivable was 3.8% at June 30, 2013, compared to 4.4% at December 31, 2012. The ALLL as a percentage of classified loans was 72.5% at June 30, 2013, compared to 45.4% at December 31, 2012. See "Allowance for Loan and Lease Losses" in the "Asset Quality" section.

Noninterest Income. Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, and earnings on life insurance policies. Total noninterest income of $1.3 million for the second quarter of 2013 decreased from $2.0 million for the second quarter of 2012. Total noninterest income of $2.6 million for the six months ended June 30, 2013 decreased from $3.7 million for the same period in 2012. These decreases were primarily due to a decrease in gains on sales of investment securities and a decrease in deposit fee income, primarily due to a decrease in insufficient funds fee revenue.

Noninterest Expense. Noninterest expense consists primarily of employee compensation and benefits, office occupancy expense, data processing expense, real estate owned expense, and other operating expense. Total noninterest expense decreased $258,000 or 5% during the second quarter of 2013 compared to the second quarter of 2012. Total noninterest expense decreased $1.0 million or 10% during the six months ended June 30, 2013 compared to the same period in 2012. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense decrease being primarily related to the decrease in nonperforming assets and improvements in the Bank's operational efficiency and overall staffing levels.

Real estate owned, net. The changes in the composition of this line item are presented below (in thousands):

                         Three Months Ended                       Six Months Ended
. . .
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