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IROQ > SEC Filings for IROQ > Form 10-K on 23-Sep-2013All Recent SEC Filings

Show all filings for IF BANCORP, INC.

Form 10-K for IF BANCORP, INC.


23-Sep-2013

Annual Report


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

Overview

We have grown our organization to $547.5 million in assets at June 30, 2013 from $377.2 million in assets at June 30, 2009. We have increased our assets primarily through increased investment securities and loan growth.

Historically, we have operated as a traditional thrift institution. As recently as June 30, 2009, $163.6 million, or approximately 72.4% of our loan portfolio, consisted of longer-term, one- to four-family residential real estate loans. However, in recent years, we have increased our focus on the origination of commercial real estate loans, multi-family real estate loans and commercial business loans, which generally provide higher returns than one- to four-family residential mortgage loans, have shorter durations and are often originated with adjustable rates of interest. As a result, our net interest rate spread (the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities) increased to 2.75% for the year ended June 30, 2013 from 2.53% for the year ended June 30, 2009. This contributed to a corresponding increase in net interest income (the difference between interest income and interest expense) to $14.5 million for the fiscal year ended June 30, 2013 from $9.5 million for the fiscal year ended June 30, 2009.

Our emphasis on conservative loan underwriting has resulted in relatively low levels of non-performing assets at a time when many financial institutions are experiencing significant asset quality issues. Our non-performing assets totaled $4.7 million or 0.87% of total assets at June 30, 2013.

Other than our loans for the construction of one- to four-family residential properties and the draw portion of our home equity lines of credit, we do not offer "interest only" mortgage loans on one- to four-family residential properties (where the borrower pays interest but no principal for an initial period, after which the loan converts to a fully amortizing loan). We also 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 their loan, resulting in an increased principal balance during the life of the loan. We do not offer "subprime loans" (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (traditionally defined as loans having less than full documentation). We also do not own any private label mortgage-backed securities that are collateralized by Alt-A, low or no documentation or subprime mortgage loans.

The Association's legal lending limit to any one borrower is 15% of unimpaired capital and surplus. On July 30, 2012 the Association received approval from the Office of the Comptroller of the Currency to participate in the Supplemental Lending Limits Program (SLLP). This program allows eligible savings associations to make additional residential real estate loans or extensions of credit to one borrower, small business loans or extensions of credit to one borrower, or small farm loans or extensions of credit to one borrower. For our association this additional limit (or "supplemental limit(s)") for one- to four-family residential real estate, small business, or small farm loans is 10% of our Association's capital and surplus. In addition, the total outstanding amount of the Association's loans or extensions of credit or parts of loans and extensions of credit made to all of its borrowers under the SLLP may not exceed 100% of the Association's capital and surplus. By Association policy, participation of any credit facilities in the SLLP is to be infrequent and all credit facilities are to be with prior Board approval.

All of our mortgage-backed securities have been issued by Freddie Mac, Fannie Mae or Ginnie Mae, U.S. government-sponsored enterprises. These entities guarantee the payment of principal and interest on our mortgage-backed securities.

On July 7, 2011 we completed our initial public offering of common stock in connection with Iroquois Federal's mutual-to-stock conversion, selling 4,496,500 shares of common stock at $10.00 per share, including 384,900 shares sold to Iroquois Federal's employee stock ownership plan, and raising approximately $45.0 million of gross proceeds. In addition, we issued 314,755 shares of our common stock to the Iroquois Federal Foundation.


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We have received regulatory clearance to open a new branch office at 108 Arbours Drive, Savory, Illinois, in Champaign County. We expect to open the new branch in the fourth calendar quarter or 2013 or the first calendar quarter 2014.

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 -Allowance for Loan Losses."

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 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


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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 June 30, 2013 and no valuation allowance was necessary.

Comparison of Financial Condition at June 30, 2013 and June 30, 2012

Total assets increased $36.2 million, or 7.1%, to $547.5 million at June 30, 2013 from $511.3 million at June 30, 2012. The increase was primarily due to a $56.9 increase in net loans, partially offset by a decrease of $22.5 million in investment securities and a decrease of $1.6 million in cash and cash equivalents.

Net loans receivable, including loans held for sale, increased by $56.9 million, or 22.0%, to $315.8 million at June 30, 2013 from $258.9 million at June 30, 2012. The increase in net loans receivable during this period was due primarily to a $41.8 million, or 126.8%, increase in commercial real estate loans, a $19.9 million, or 51.6%, increase in multi-family loans and a $5.8 million, or 41.5%, increase in commercial business loans. These increases were partially offset by a $5.9 million, or 70.3%, decrease in construction loans and a $3.9 million, or 28.8% decrease in consumer loans.

Investment securities, consisting entirely of securities available for sale, decreased $22.5 million, or 10.1%, to $200.8 million at June 30, 2013 from $223.3 million at June 30, 2012. The decrease was primarily due to security sales to reposition our portfolio and to fund loans. We had no securities held to maturity at June 30, 2013 or June 30, 2012.

As of June 30, 2013, other assets decreased $381,000 to $807,000, Federal Home Loan Bank stock increased $1.3 million to $5.4 million, other real estate owned decreased $850,000 to $418,000, and deferred income tax increased $3.3 million from ($128,000) to $3.2 million. Federal Home Loan Bank stock increased due to stock purchases to support fluctuations in Federal Home Loan Bank advances as we funded loans and repositioned our investment portfolio. The decrease in other assets resulted from a decrease in prepaid insurance due to the timing of multi-year premiums and also from a decrease in accounts receivable due to the receipt of a receivable that was outstanding as of June 30, 2012. The decrease in other real estate owned is due to the sale of other real estate owned and the increase in deferred income tax was mostly attributable to deferred income tax on the reduction of unrealized gains on investment securities.

At June 30, 2013, our investment in bank-owned life insurance was $7.8 million, an increase of $262,000 from $7.5 million at June 30, 2012. We invest in bank-owned life insurance to provide us with a funding source for our benefit plan obligations. Bank-owned life insurance also generally provides us noninterest income that is non-taxable. Federal regulations generally limit our investment in bank-owned life insurance to 25% of the Association's Tier 1 capital plus our allowance for loan losses, which totaled $16.6 million at June 30, 2013.

Deposits increased $26.7 million, or 7.8%, to $371.2 million at June 30, 2013 from $344.5 million at June 30, 2012. Savings, NOW and money market accounts decreased $1.9 million, or 1.4%, to $131.8 million, brokered certificates of deposit increased $26.3 million, or 228.9%, to $37.8 million, and noninterest bearing demand accounts increased $2.2 million, or 20.9%, to $12.8 million. Non-brokered certificates of deposit increased $83,000, or 0.04%, to $188.8 million.

Advances from the Federal Home Loan Bank of Chicago increased $12.5 million, or 16.7%, to $87.5 million at June 30, 2013 from $75.0 million at June 30, 2012. We increased our borrowings to support loan growth. Current interest rates on borrowings are more favorable than rates paid on deposits. Repurchase agreements increased $1.7 million to $1.7 million as they were utilized for the first time during the year ended June 30, 2013.

Other liabilities increased $168,000 to $2.1 million at June 30, 2013.


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Total equity decreased $4.9 million, or 5.7%, to $81.7 million at June 30, 2013 from $86.6 million at June 30, 2012. Equity decreased due to a decrease in unrealized gains on securities available for sale of $5.5 million and the repurchase of 240,563 shares of common stock at an aggregate cost of approximately $3.3 million, partially offset by a net income of $3.7 million. The decrease in unrealized gains on securities available for sale was due to a fluctuation in interest rates and a $724,000 net realized gain on sale of available-for-sale securities included in income. A stock repurchase program was adopted during the year ended June 30, 2013, which authorized the Company to repurchase up to 240,563 shares of its common stock, or approximately 5% of then current outstanding shares. During the year ended June 30, 2013, the Company acquired 240,563 shares of its outstanding common stock at an average purchase price of approximately $13.88 per share.

Comparison of Operating Results for the Years Ended June 30, 2013 and 2012

General. Net income increased $2.3 million, or 165%, to $3.7 million net income for the year ended June 30, 2013 from $1.4 million net income for the year ended June 30, 2012. The increase was primarily due to a decrease in noninterest expense, which occurred because the year ended June 30, 2013 included a $3.6 million expense for the contribution to our newly established charitable foundation. This increase was also impacted by an increase in noninterest income, a decrease in interest expense, and a decrease in provision for loan losses, partially offset by a decrease in interest and dividend income.

Net Interest Income. Net interest income increased by $294,000, or 2.1%, to $14.5 million for the year ended June 30, 2013 from $14.2 million for the year ended June 30, 2012. The increase was due to a decrease of $685,000 in interest expense, partially offset by a decrease of $391,000 in interest income. The decrease in interest expense was primarily the result of lower rates paid on certificates of deposit. We had a $40.3 million, or 8.6%, increase in the average balance of interest earning assets, partially offset by a $34.8 million, or 8.9% increase in the average balance of interest bearing liabilities. Our interest rate spread decreased 14 basis points to 2.75% for the year ended June 30, 2013 from 2.89% for the year ended June 30, 2012, and our net interest margin decreased by 18 basis points to 2.86% for the year ended June 30, 2013 from 3.04% for the year ended June 30, 2012.

Interest and Dividend Income. Interest and dividend income decreased $391,000, or 2.2%, to $17.6 million for the year ended June 30, 2013 from $18.0 million for the year ended June 30, 2012. The decrease in interest income was primarily due to a decrease in interest income on securities, partially offset by an increase in interest income on loans. Interest on securities decreased $661,000, or 11.4%, as a $5.3 million increase in the average balance of securities to $213.0 million at June 30, 2013, was more than offset by a 38 basis point decrease in the average yield on securities from 2.79% to 2.41%. An increase of $268,000, or 2.2%, in interest on loans resulted from a $34.2 million, or 13.6%, increase in the average balance of loans to $285.0 million for the year ended June 30, 2013, partially offset by a 49 basis point, or 10.1%, decrease in the average yield on loans from 4.86% to 4.37%. The decrease in the average yield on loans and securities reflected a reduction in the current interest rates charged on loans originated and paid on securities purchased during the period versus the average rates on loans and securities in the portfolio in the prior period.

Interest Expense. Interest expense decreased $685,000, or 18.1%, to $3.1 million for the year ended June 30, 2013 from $3.8 million for the year ended June 30, 2012. The decrease was primarily due to lower market interest rates during the period, partially offset by increased average balances of deposits and borrowings.

Interest expense on interest-bearing deposits decreased $642,000, or 22.3%, to $2.2 million for the year ended June 30, 2013 from $2.9 million for the year ended June 30, 2012. This decrease was primarily due to a decrease of 22 basis points in the average cost of interest-bearing deposits to 0.66% for the year ended June 30, 2013 from 0.88% for the year ended June 30, 2012. We experienced decreases in the average cost across all categories of interest-bearing deposits for the year ended June 30, 2013, reflecting lower market interest rates as compared to the prior period. The decrease in average cost was partially offset by a $12.7 million, or 3.9%, increase in the average balance of interest-bearing deposits to $340.0 million for the year ended June 30, 2013 from $327.3 million for the year ended June 30, 2012.

Interest expense on borrowings, including FHLB advances and repurchase agreements, decreased $43,000, or 4.7%, to $865,000 for the year ended June 30, 2013 from $908,000 for the year ended June 30, 2012. This decrease was due to a 40 basis point decrease in the average cost of such borrowings to 0.98% for the year ended June 30, 2013 from 1.38% for the year ended June 30, 2012, largely offset by an increase in the average balance of borrowings to $87.9 million for the year ended June 30, 2013 from $65.8 million for the year ended June 30, 2012.


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Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb probable credit losses inherent in our loan portfolio. We recorded a provision for loan losses of $595,000 for the year ended June 30, 2013, compared to a provision for loan losses of $1.1 million for the year ended June 30, 2012. The allowance for loan losses was $3.9 million, or 1.23% of total loans, at June 30, 2013, compared to $3.5 million, or 1.34% of total loans, at June 30, 2012. Non-performing loans decreased during the year ended June 30, 2013 due to one large credit returning to performing status following two years of performance and a global positive cash flow. During the year ended June 30, 2013 and 2012, $187,000 and $743,000 in net charge-offs were recorded.

The following table sets forth information regarding the allowance for loan losses and nonperforming assets at the dates indicated:

                                                      Year Ended                 Year Ended
                                                    June 30,  2013             June 30,  2012
Allowance to non-performing loans                             91.12 %                    65.95 %
Allowance to total loans outstanding at the
end of the period                                              1.23 %                     1.34 %
Net charge-offs to average total loans
outstanding during the period, annualized                      0.07 %                     0.30 %
Total non-performing loans to total loans                      1.35 %                     2.03 %
Total non-performing assets to total assets                    0.87 %                     1.30 %

Noninterest Income. Noninterest income increased $784,000, or 21.2%, to $4.5 million for the year ended June 30, 2013 compared to $3.7 million for the year ended June 30, 2012. The increase was primarily due to increases in mortage banking income, net realized gains on the sale of securities available for sale, and brokerage commissions, partially offset by a decrease in customer service fees. For the year ended June 30, 2013, mortgage banking income increased $356,000 to $673,000, net realized gains on the sale of securities available for sale increased $201,000 to $724,000 and brokerage commissions increased $95,000 to $616,000, while customer service fees decreased $53,000 to $547,000. The increase in mortgage banking income was due to an increase in mortgage servicing rights as a result of increased market rates and an increased balance of loans sold. The increase in net realized gain on the sale of securities available for sale was due to the rate environment during the year ended June 30, 2013 that allowed for profits to be gained when repositioning the investment portfolio that were not available in the year ended June 30, 2012. The increase in brokerage commissions was a result of increased activity due to movement in interest rates. The decrease in customer service fees reflects fewer service fees and charges collected on deposit accounts.

Noninterest Expense. Noninterest expense decreased $2.2 million, or 14.8%, to $12.6 million for the year ended June 30, 2013 from $14.8 million for the year ended June 30, 2012. The largest components of this decrease were charitable contributions, which decreased $3.6 million, or 99.6%, and audit and examinations, which decreased $65,000, or 17.8%. The decrease in charitable contributions was a result of a donation of $3.6 million in stock and cash to fund our charitable foundation in the year ended June 30, 2012. The decrease in audit and examinations was the result of increased costs associated with transitioning to a public company in the year ended June 30, 2012. These decreases were partially offset by increases in compensation and benefits of $703,000, and equipment expense of $223,000. Normal salary increases and increases in executive incentives, payroll taxes, medical insurance, ESOP and 401(k) primarily accounted for the increase in compensation and benefits expense. Increases in equipment expense were due to routine technology upgrades and expenses incurred to move our information technology department to a more secure and efficient location.

Income Tax Expense. We recorded a provision for income tax of $2.1 million for the year ended June 30, 2013, compared to a provision for income tax of $559,000 for the year ended June 30, 2012, reflecting effective tax rates of 35.7% and 28.5%, respectively. The increased tax rate for the year ended June 30, 2013 was a result of a lower taxable income in the year ended June 30, 2012, due to a contribution of $3.6 million to establish our charitable foundation, Iroquois Federal Foundation, Inc.


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Asset Quality and Allowance for Loan Losses

For information regarding asset quality and allowance for loan loss activity, see "Item 1. Business-Non-performing and Problem Assets" and "Item 1. Business-Allowance for Loan Losses."

Average Balances and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. Tax-equivalent yield adjustments have not been made for tax-exempt securities. All average balances are based on month-end balances, which management deems to be representative of the operations of Iroquois Federal. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

                                                                                            For the Fiscal Years Ended June 30,
                                                              2013                                          2012                                          2011
                                               Average                                       Average                                       Average
                                             Outstanding                     Yield/        Outstanding                     Yield/        Outstanding                     Yield/
                                               Balance         Interest       Rate           Balance         Interest       Rate           Balance         Interest       Rate
                                                                                                   (Dollars in thousands)
Interest-earning assets:
Loans:
Real estate loans:
One- to four-family (1)                     $     146,005      $   5,874        4.02 %    $     147,438      $   6,668        4.52 %    $     149,203      $   7,417        4.97 %
Multi-family                                       45,841          2,085        4.55             30,857          1,524        4.94             23,623          1,248        5.28
Commercial                                         54,193          2,511        4.63             30,667          1,723        5.62             26,195          1,586        6.05
Home equity lines of credit                         8,579            357        4.16              9,408            400        4.25              9,616            409        4.25
Construction loans                                  4,133            146        3.53              5,240            231        4.41              1,990             91        4.57
Commercial business loans                          15,109            744        4.92             12,679            688        5.43             12,941            752        5.81
Consumer loans                                     11,114            728        6.55             14,513            943        6.50             16,389          1,142        6.97

Total loans                                       284,974         12,445        4.37            250,802         12,177        4.86            239,957         12,645        5.27

Securities:
U.S. government, federal agency and
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