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OFED > SEC Filings for OFED > Form 10-K on 26-Sep-2013All Recent SEC Filings

Show all filings for OCONEE FEDERAL FINANCIAL CORP.

Form 10-K for OCONEE FEDERAL FINANCIAL CORP.


26-Sep-2013

Annual Report


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

Overview

Oconee Federal Savings and Loan Association has historically operated as a traditional thrift institution headquartered in Seneca, South Carolina. Our principal business consists of attracting retail deposits from the general public in our market area and investing those deposits, together with funds generated from operations, in one- to four-family residential mortgage loans and, to a much lesser extent, non-residential mortgage, construction and land and other loans. We also invest in U.S. Government and federal agency securities and mortgage-backed securities. Our revenues are derived principally from the interest on loans and securities and loan fees and service charges. Our primary sources of funds are deposits and principal and interest payments on loans and securities. At June 30, 2013, we had total assets of $370.1 million, total deposits of $292.4 million and total equity of $76.2 million.

A significant majority of our assets consist of long-term, fixed-rate residential mortgage loans and, to a much lesser extent, investment-quality securities, which we have funded primarily with deposit accounts and the repayment of existing loans. We generally do not rely on outside borrowings. Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities (including U.S. Government and federal agency securities and mortgage-backed securities) and other interest-earning assets, primarily interest-earning deposits at other financial institutions, and the interest paid on our interest-bearing liabilities, consisting primarily of savings and transaction accounts and certificates of deposit. Our results of operations also are affected by our provisions for loan losses, non-interest income and non-interest expense. Non-interest income currently consists primarily of service charges on deposit accounts and miscellaneous other income. Non-interest expense currently consists primarily of compensation and employee benefits, occupancy and equipment expenses, data processing, professional and supervisory fees, office expense and other operating expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

Other than our loans for the construction of one- to four-family residential mortgage loans, we do not offer "interest only" mortgage loans on one- to four-family residential properties (where the borrower pays interest 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 his or her 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 (generally defined as loans having less than full documentation).

Our securities are typically high-quality securities issued or guaranteed by the U.S. government or by Freddie Mac, Fannie Mae or Ginnie Mae, all of which are U.S. government-sponsored enterprises.

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


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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. Our allowance for loan losses is the estimated amount considered necessary to reflect probable losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of the most critical for us. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.

Management performs a quarterly evaluation of the allowance for loan losses. The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating classified loans from the remaining loans, and then categorizing each group by type of loan. Loans within each type exhibit common characteristics including terms, collateral type, and other risk characteristics. In determining the amount of the allowance for loan losses, we apply loss factors to each category of loan. We estimate our loss factors taking into consideration both quantitative and qualitative aspects that would affect our estimation of probable incurred losses. These aspects include, but are not limited to historical charge-offs; loan delinquencies and foreclosure trends; current economic trends and demographic data within Oconee County and the other surrounding areas, such as unemployment rates and population trends; current trends in real estate values within the Oconee County market area; charge-off trends of other comparable institutions; the results of any internal loan reviews; loan-to-value ratios; our historically conservative credit risk policy; the strength of our underwriting and ongoing credit monitoring function; and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions. 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.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.

Real Estate Owned Valuation. Real estate acquired through loan foreclosure is carried at the lower of carrying amount or fair value less estimated costs to sell. Any initial losses at the time of foreclosure


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are charged against the allowance for loan losses. Valuation of these assets are periodically reviewed by management with the carrying value of such assets adjusted through non-interest expense to the then estimated fair value, net of estimated selling costs, if lower, until disposition. Fair values of real estate owned are generally based on third party appraisals or other valuations of the property.

Business Strategy

We have focused primarily on improving the execution of our community oriented retail banking strategy. Highlights of our current business strategy include the following:


Continue to Focus on Residential Lending. We have been and will continue to be primarily a one-to four-family residential mortgage lender for borrowers in our market area. As of June 30, 2013, $204.4 million, or 91.6%, of our total loan portfolio consisted of one- to four-family residential mortgage loans (including home equity loans). In the future, we may gradually increase our residential construction and home equity loan portfolios.


Maintain a Modest Portfolio of Non-residential Mortgage Loans. We have historically maintained a small portfolio of non-residential mortgage loans, primarily loans to churches located in our market area. As of June 30, 2013, $8.5 million, or 3.8%, of our total loan portfolio, were non-residential mortgages or non-residential construction and land loans, of which $8.4 million were loans to churches. We believe that loans to churches enhance our presence in the community and help expand our financial services business as congregation members become familiar with us.


Manage Interest Rate Risk While Maintaining or Enhancing, to the Extent Practicable, our Net Interest Margin. Subject to market conditions, we have sought to enhance net interest income by emphasizing controls on the cost of funds, particularly on the deposit products that we offer, rather than attempting to maximize asset yields, as loans with high yields often involve greater credit risk and may be repaid during periods of decreasing market interest rates. In addition, in view of our strong capital position, from time to time, we place more emphasis on enhancing our net interest income than on limiting our interest rate risk.


Rely on Community Orientation and High Quality Service to Maintain and Build a Loyal Local Customer Base and Maintain our Status as an Independent Community-Based Institution. We were established in 1924 and have been operating continuously in Oconee County since that time. By using our recognized brand name and the goodwill developed over years of providing timely, efficient banking services, we have been able to attract a solid base of local retail customers on which to continue to build our banking business. We have historically focused on promoting relationships within our community rather than specific banking products, and we expect to continue to build our customer base by relying on customer referrals and referrals from local builders and realtors.


Adhere to Conservative Underwriting Guidelines to Maintain Strong Asset Quality. We have emphasized maintaining strong asset quality by following conservative underwriting guidelines, sound loan administration, and focusing on loans secured by real estate located within our market area only. Our non-performing assets and troubled debt restructurings totaled $3.0 million, or 0.82% of total assets at June 30, 2013. Our total nonperforming loans to total loans ratio was 0.89% at June 30, 2013. Total loan delinquencies, 30 days or more past due, as of June 30, 2013, were $10.1 million, or 4.5% of total loans.

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

Our total assets decreased $7.7 million, or 2.0%, to $370.1 million at June 30, 2013 from $377.8 million at June 30, 2012. The decrease in total assets of $7.7 million was largely due to the


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repurchase of $7.8 million of shares of common stock during the year ended June 30, 2013 coupled with a decrease in our total deposits of $946 thousand. These decreases and the purchase of $8.0 million of bank owned life insurance during the year resulted in a decrease of total cash and cash equivalents of $9.7 million at June 30, 2013. Total net loans decreased $28.7 million, or 11.5%, to $221.2 million at June 30, 2013, offset partially by an increase in securities available-for-sale of $23.4 million, or 36.3%, to $88.0 million at June 30, 2013 from $64.5 million at June 30, 2012 as we continued to redeploy funds from loan repayments to purchase high-quality investments primarily bonds issued by government sponsored enterprises. Loans continued to decrease due to lower demand for our loan products and increased competition from other lenders in our market area offering lower fixed rate mortgage products during this period of very low mortgage rates.

Deposits decreased modestly by $946 thousand, or 0.32%, to $292.4 million at June 30, 2013 from $293.4 million at June 30, 2012. The decrease in deposits reflected a decrease in certificates of deposit of $7.8 million, or 3.5%, offset partially by an increase in NOW, money market and regular savings accounts of $6.9 million, or 10.2%. The declining interest rate environment has slowed overall deposit growth, particularly in certificates of deposit, which historically have yielded higher rates. We generally do not accept brokered deposits, and no brokered deposits were accepted during the 12 months ended June 30, 2013.

We had no advances from the Federal Home Loan Bank of Atlanta as of June 30, 2013 and 2012. We have credit available under a loan agreement with the Federal Home Loan Bank of Atlanta in the amount of 11% of total assets, or approximately $41.1 million at June 30, 2013.

Total equity decreased $6.8 million, or 8.2%, to $76.2 million at June 30, 2013, compared with $83.0 million at June 30, 2012. The decrease resulted from the repurchase of $7.8 million of shares of our common stock during the year ended June 30, 2013, payment of dividends of $2.4 million, and a change in accumulated other comprehensive income of $1.2 million, which was offset partially by net income of $4.0 million.

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

General. Net income remained relatively the same at $4.0 million for the years ended June 30, 2013 and 2012. Net interest income before the provision for loan losses decreased $249 thousand, or, 2.1%, to $11.8 million for the year ended June 30, 2013 from $12.1 million for the year ended June 30, 2012. Noninterest income remained relatively unchanged at $410 thousand for the year ended June 30, 2013 as compared with $412 thousand for the year ended June 30, 2012. Total noninterest expenses decreased $128 thousand, or 2.3%, to $5.5 million for the year ended June 30, 2013 from $5.6 million at June 30, 2012.

Interest Income. Interest income decreased $1.3 million, or 8.4%, to $14.0 million for the year ended June 30, 2013 from $15.3 million for the year ended June 30, 2012. The decrease was the result of both a decrease in the average yield on earnings assets to 3.85% for the year ended June 30, 2013 from 4.18% for the year ended June 30, 2012, and a decrease in the average balances of interest earning assets to $363.9 million from $364.9 million for the same periods. The decline in the average balances of interest earning assets is primarily a reflection of the decline in average loans due to the decline in demand in our market area.

Interest income on loans decreased $1.5 million, or 10.6%, to $12.7 million for the year ended June 30, 2013 from $14.3 million for the year ended June 30, 2012, reflecting shrinking loan demand. The average balance of loans decreased $23.7 million, or 9.1% to $235.6 million for the year ended June 30, 2013 from $259.2 million for the year ended June 30, 2012. The yield on loans declined by 9 basis points to 5.41% for the year ended June 30, 2013 from 5.50% for the year ended June 30, 2012. Interest income on investment securities increased $291 thousand, or 33.1%, to $1.2 million for the year ended June 30, 2013 from $879 thousand for the year ended June 30, 2012, reflecting an increase


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of $28.0 million, or 50.7%, in the average balances of securities to $83.3 million from $55.3 million for the years ended June 30, 2013 and 2012, respectively, which offset the 19 basis-point decrease in the yield on such securities to 1.40% at June 30, 2013 from 1.59% at June 30, 2012.

Interest Expense. Interest expense decreased $1.0 million, or 32.1%, to $2.2 million for the year ended June 30, 2013 from $3.2 million for the year ended June 30, 2012. The decrease reflected a 36 basis point decrease in the average rate paid on deposits in fiscal year 2013 to 0.75% from 1.11% in fiscal year 2012, which more than offset the slight increase in the average balance of such deposits.

Interest expense on certificates of deposit decreased $989 thousand, or 32.3%, to $2.1 million for the year ended June 30, 2013 from $3.1 million for the year ended June 30, 2012. The decrease in interest expense on certificates of deposit reflected a decrease of $4.8 million, or 2.1%, in the average balance of certificates of deposit to $222.8 million for the year ended June 30, 2013 from $227.6 million for the year ended June 30, 2012 and a decrease of 41 basis points in the average cost on certificates of deposit to 0.93% from 1.34% for the same periods ended. Interest expense on money market deposits, NOW and demand deposits, and regular savings and other deposits decreased by $39 thousand to $104 thousand for the year ended June 30, 2013 from $143 thousand for the year ended June 30, 2012. The decrease was due to the decrease of 8 basis points in the yield on such deposits to 0.16% for the year ended June 30, 2013 from 0.24% for the year ended June 30, 2012. The decrease in yields more than offset the increase in the average balance of these deposits by $5.6 million, or 9.4%, to $65.3 million for the year ended June 30, 2013 from $59.7 million for the year ended June 30, 2012.

Net Interest Income. Net interest income decreased $249 thousand, or 2.1%, to $11.8 million for the year ended June 30, 2013 from $12.1 million for the year ended June 30, 2012. The decrease of 6 basis points reflected the decrease in our net interest margin to 3.25% for the year ended June 30, 2013 from 3.31% at June 30, 2012. The decrease in net interest margin more than offset the 2 basis-point increase in our interest rate spread to 3.10% from 3.07%. Our ratio of average interest-earning assets to average interest bearing liabilities decreased to 1.26X for the year ended June 30, 2013 from 1.27X for the year ended 2012.

Provision for Loan Losses. We recorded a provision for loan losses of $260 thousand for the year ended June 30, 2013, compared with a provision for loan losses of $270 thousand for the year ended June 30, 2012. The slight decrease in the provision for loan losses reflected a decrease in our total impaired loans to $2.0 million at June 30, 2013 from $2.5 million at June 30, 2012 and a decrease in our total loan portfolio. Impaired loans consist of all of our nonperforming loans and any other loans evidencing credit deterioration such that the likelihood of not receiving all contractual principal and interest payments is probable. The amount of impairment or specific portion of our allowance on impaired loans at June 30, 2013 was $27 thousand as compared with $101 thousand at June 30, 2012. The decrease in the amount of impaired loans and related impairment coupled with the decline in the balance of our loan portfolio of $29.1 million for the year ended June 30, 2013 resulted in a smaller provision for loan losses. The allowance for loan losses was $751 thousand, or 0.34% of total loans, at June 30, 2013, compared with $857 thousand, or 0.34%, of total loans, at June 30, 2012. Real estate owned was $1.0 million at June 30, 2013, compared with $854 thousand at June 30, 2012, an increase of $193 thousand. Although there was a slight increase in total real estate owned at June 30, 2013, total real estate owned is made up of only 5 single family residences.

We used the same methodology in assessing the allowances for both periods ended. Our allowance at June 30, 2013 reflects both a general valuation component of $724 thousand and a specific component of $27 thousand for loans determined to be impaired based upon an analysis of certain individual loans determined to be impaired. In comparison, our allowance at June 30, 2012 consisted of a general valuation component of $756 thousand and a specific component of $101 thousand. The decrease in both the general valuation component and the specific component at June 30, 2013 is both a result in improvements in our loan credit quality and a decline in the balance of our outstanding


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loans. Individually impaired loans were evaluated using the estimated fair value of the underlying real estate collateral. We did not record a specific allowance for loans where the fair value of the collateral was in excess of the outstanding principal of the loan. To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the years ended June 30, 2013 and 2012.

Noninterest Income. Noninterest income remained relatively the same for both years ended June 30, 2013 and 2012 at $410 thousand and $412 thousand, respectively. The increase of $49 thousand in income on bank owned life insurance is related to the purchase of $8.0 million of new bank owned life insurance in late April of 2013. The increase in bank owned life insurance income was offset partially by decreases in gains of sales of real estate owned and gains on sales of securities of $66 thousand and $52 thousand, respectively, for the year ended June 30, 2013. Other noninterest income of $65 thousand is primarily composed of $64 thousand of gain recognized on foreclosure of certain loans whereby the estimated fair value of the real estate collateral exceeded the carrying value of the foreclosed loans.

Noninterest Expense. Noninterest expense decreased $128 thousand, or 2.3%, to $5.5 million for the year ended June 30, 2013 from $5.6 million for the year ended June 30, 2012. The decrease in noninterest expenses was primarily related to a decrease in the provision for real estate owned and related expenses of $452 thousand, or 76.1%, to $142 thousand for the year ended June 30, 2013 from $594 thousand and to a lesser extent by decreases in data processing expenses of $45 thousand and FDIC deposit insurance expense of $46 thousand. These decreases more than offset the increase in salaries and employee benefits of $469 thousand. Approximately $217 thousand of the increase in salaries and employee benefits is related to the increase in ESOP expense and expense associated with our equity incentive plans. ESOP expense increased $47 thousand, or 21.7%, to $264 thousand for the year ended June 30, 2013 from $217 thousand for the year ended June 30, 2012, which was primarily a result of increases in our stock prices during the year ended 2013 used in determining compensation expense for ESOP shares earned. Stock based compensation expense for the year ended June 30, 2013 was $227 thousand compared with $57 thousand for the year ended June 30, 2012. The reason was due to the fact that we did not recognize a full year's expense related to our equity incentive plans during the year ended June 30, 2012 because the initial grant of options and awards under the equity incentive plans occurred in the third quarter of that fiscal year and expenses associated with options and awards are recognized ratably over the vesting period. The remaining portion of the increase is related to the addition of a new banking officer to serve as the Company's controller and pay increases of approximately 5% for each employee.

Income Tax Expense. The provision for income taxes was $2.4 million for year ended June 30, 2013 compared with $2.6 million at June 30, 2012. Our effective tax rates for the years ended June 30, 2013 and 2012 were and , respectively. The decrease in our effective tax rates is primarily related to the increase income from bank owned life insurance, which is not taxable for income tax purposes.

Analysis of Net Interest Income

Net interest income represents the difference between the income we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.

The following tables set forth average balance sheets, average yields and costs, and certain other information at the dates and for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the


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tables 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.

                                                             For the Year Ended June 30,
                                    2013                                2012                                2011
                                   Interest                            Interest                            Interest
                       Average        and       Yield/     Average        and       Yield/     Average        and       Yield/
                       Balance     Dividends     Cost      Balance     Dividends     Cost      Balance     Dividends     Cost
                                                               (Dollars in Thousands)
Assets:
Interest-earning
assets:
Loans                 $ 235,594    $   12,749      5.41 % $ 259,245    $   14,264      5.50 % $ 265,752    $   14,686      5.53 %
Investment
securities               83,342         1,170      1.40      55,296           879      1.59      15,914           474      2.98
Other
interest-earning
assets                   44,954            73      0.16      50,364           126      0.25      68,860            82      0.12

Total
interest-earning
assets                  363,890        13,992      3.85     364,905        15,269      4.18     350,526        15,242      4.35
Noninterest-earning
assets                   11,268                              11,881                              11,921

Total assets          $ 375,158                           $ 376,786                           $ 362,447

Liabilities and
equity:
Interest-bearing
liabilities:
NOW and demand
deposits              $  17,584    $       12      0.07 % $  14,475    $       16      0.11 % $  11,273    $       37      0.33 %
Money market
deposits                 11,859            25      0.21      10,847            27      0.25       9,448            49      0.52
Regular savings and
other deposits           35,849            67      0.19      34,384           100      0.29      34,265           210      0.61
. . .
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