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HFFC > SEC Filings for HFFC > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for HF FINANCIAL CORP


8-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q ("Form 10-Q"), as well as other reports issued by HF Financial Corp. (the "Company") include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, the Company's management may make forward-looking statements orally to the media, securities analysts, investors and others from time to time. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Words such as "optimism," "look-forward," "bright," "believe," "expect," "anticipate," "intend," "hope," "plan," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may," are intended to identify these forward-looking statements.
These forward-looking statements might include one or more of the following:
projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.

descriptions of plans or objectives of management for future operations, products or services, transactions, investments and use of subordinated debentures payable to trusts.

forecasts of future economic performance.

use and descriptions of assumptions and estimates underlying or relating to such matters.


Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
adverse economic and market conditions of the financial services industry in general, including, without limitation, the credit markets;

the effect of recent legislation to help stabilize the financial markets;

increase of non-performing loans and additional provisions for loan losses;

the failure of assumptions underlying the establishment of reserves for loan losses and other estimates;

the failure to maintain our reputation in our market area;

prevailing economic, political and business conditions in South Dakota and Minnesota;

the effects of competition from a wide variety of local, regional, national and other providers of financial services;

compliance with existing and future banking laws and regulations, including, without limitation, regulatory capital requirements and FDIC insurance coverages and costs;

changes in the availability and cost of credit and capital in the financial markets;

the effects of FDIC deposit insurance premiums and assessments;

the risks of changes in market interest rates on the composition and costs of deposits, loan demand, net interest income, and the values and liquidity of loan collateral, and our ability or inability to manage interest rate and other risks;

changes in the prices, values and sales volumes of residential and commercial real estate;

an extended period of low commodity prices, significantly reduced yields on crops, reduced levels of governmental assistance to the agricultural industry, and reduced farmland values;

soundness of other financial institutions;

the risks of future acquisitions and other expansion opportunities, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and expense savings from such transactions;

security and operations risks associated with the use of technology;

the loss of one or more of our key personnel, or the failure to attract, assimilate and retain other highly qualified personnel in the future;

changes in or interpretations of accounting standards, rules or principles; and

other factors and risks described under Part I, Item 2-"Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 3-Quantitative and Qualitative Disclosures About Market Risk" in this Form 10-Q.

Forward-looking statements speak only as of the date they are made. Forward-looking statements are based upon management's then-current beliefs and assumptions, but management does not give any assurance that such beliefs and assumptions will prove to be correct. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this Form 10-Q or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, except to the extent required by federal securities laws. Based upon changing conditions, should any one or more of the above risks or uncertainties materialize, or should any of our underlying beliefs or assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statement.
References in this Form 10-Q to "we," "our," "us" and other similar references are to the Company, unless otherwise expressly stated or the context requires otherwise.
Executive Summary


The Company's net income for the first three months of fiscal 2014 was $1.0 million, or $0.14 in basic and diluted earnings per common share, compared to $2.1 million, or $0.29 in basic and diluted earnings per common share, for the same period of fiscal 2013. This resulted in a return on average equity (i.e., net income divided by average equity) of 4.05% for the first three months of fiscal 2014, compared to 8.42% for the same period of the prior fiscal year. For the same respective periods, the return on average assets (i.e., net income divided by average assets) was 0.32% compared to 0.71%.
Net interest income for the first three months of fiscal 2014 was $6.8 million, a decrease of $572,000, or 7.8%, compared to the same period a year ago. For the comparative time-frames, average interest-earning assets and average interest-bearing liabilities increased 7.2% and 4.5%, respectively. The average yield on interest-earning assets decreased to 3.14% for the first three months of fiscal 2014, compared to 3.75% a year ago, a decrease of 61 basis points, due primarily to the repricing of adjustable rate loans and competitive pricing pressures in a low interest rate environment. In addition, this economic environment impacts the yields on investment securities and other short-term investments and prepayment speeds of mortgage-backed securities purchased at a premium. For the same period, cost of deposits, which include all interest-bearing and noninterest-bearing deposits, decreased by 20 basis points to 0.45%, compared to 0.65% in the previous year.
The net interest margin expressed on a fully taxable equivalent basis ("Net Interest Margin, TE") for the three months ended September 30, 2013 was 2.36%, which is a decrease of 36 basis points from the same period of the prior fiscal year. The yield on interest-earning assets decreased by 61 basis points and resulted in a decrease of net interest income of $1.5 million. Loan interest rates earned primarily impacted this reduction, but investment security yield declines also contributed to the overall income decrease due to rates. Increased loan activity and an increase in overall balances of investment securities helped to offset part of the loss of interest income due to rates, with a $476,000 increase in interest income due to growth in loan and investment security balances. In addition, average deposit rates and average borrowing rates declined and contributed to a $710,000 decrease to interest costs, while increases in volume of interest-bearing liabilities led to a $238,000 increase to interest expense. A sustained overall decline in the interest rate yield curve has affected both the yield for the interest-earning assets and the interest-bearing liabilities. The average balances for these categories increased when compared to the same period of the prior year. Net Interest Margin, TE is a non-GAAP financial measure. See "Analysis of Net Interest Income" for a calculation of this non-GAAP financial measure and for further discussion as to the reasons we believe this non-GAAP financial measure is useful.
Total loans increased by $64.6 million during the most recent quarter to $760.4 million at September 30, 2013, compared to total loans at June 30, 2013 of $695.8 million and from $695.6 million at September 30, 2012. Commercial real estate and agricultural lending portfolios increased by $50.2 million and $12.7 million, respectively, during the recent quarter, while strong underwriting standards remain in place. Residential mortgage loan originations continued strong production with the majority of these loans sold into the secondary market, though the recent rise in long term interest rates has begun to slow refinancing activity. Refinancing of single family loans has contributed to a decline in the consumer home equity portfolio. We believe the increase in average loan balances was attributable to a gradual improvement in general economic conditions, resulting in the willingness of borrowers to consider incurring more debt to support growth in their businesses, while also acknowledging that we continue to operate in uncertain national economic and fiscal conditions. We believe that the operating environment has resulted in increased competition among financial institutions for loan demand from credit-worthy borrowers.
The allowance for loan and lease losses increased by $20,000 to $10.8 million at September 30, 2013, compared to June 30, 2013. The ratio of allowance for loan and lease losses to total loans and leases was 1.42% compared to 1.54% at June 30, 2013. The overall loan balances increased by $64.6 million during the first three months of fiscal 2014, but the amount of classified assets decreased by $9.2 million to $31.0 million at September 30, 2013. The Company continues to pro-actively manage its problem assets which have been enhanced by improving conditions in the regional commercial and agricultural markets. The provision for loan and lease losses, which results from adjusting the allowance for loan and lease losses to the estimated amount needed to reserve for the loan and lease portfolio, was $276,000 for the first three months of fiscal 2014. Total nonperforming assets at September 30, 2013 were $21.5 million as compared to $23.2 million at June 30, 2013. The ratio of nonperforming assets to total assets decreased to 1.72% at September 30, 2013, compared to 1.90% at June 30, 2013. Net charge-offs for the three month period ended September 30, 2013 were $256,000. The valuation allowance recorded in accordance with ASC 310 on identified impaired loans decreased to $2.0 million at September 30, 2013, compared to $2.5 million at June 30, 2013, while the valuation allowance recorded in accordance with ASC 450 increased by $486,000 due to the effects of the increase in applicable loan balances and management's assessment of the allowance using historical charge-off activity and environmental factor information. Approximately 51% of the valuation allowance on impaired loans relates to agricultural loans and, more specifically, 49% are within the dairy sector. All identified impaired loans are reviewed to assess the borrower's ability to make payments under the terms of the loan and/or a shortfall in collateral value that would result in charging off the loan or the portion of the loan that was impaired.


Foreclosed real estate and other properties totaled $226,000 at September 30, 2013, compared to $564,000 at June 30, 2013, or a decrease of $338,000. The balance at September 30, 2013 consists of residential loans that were foreclosed and remained unsold at quarter end.
The allowance for loan and lease losses is calculated based on loan and lease levels, loan and lease loss history over 12, 36, and 60 month time periods, credit quality of the loan and lease portfolio, and environmental factors such as economic health of the region and management experience. This risk rating analysis is designed to give the Company a consistent and systematic methodology to determine proper levels for the allowance at a given time. Management intends to continue its disciplined credit administration and loan underwriting processes and to remain focused on the creditworthiness of new loan originations. Management believes that it has identified the most significant nonperforming assets in the loan portfolio and is working to clarify and resolve the credit, credit administration, and environmental factor issues related to these assets to obtain the most favorable outcome for the Company.
Total deposits at September 30, 2013, were $944.3 million, an increase of $45.5 million from June 30, 2013. This increase was primarily due to the $14.3 million increase in non-public fund deposits, $18.1 million increase in public fund deposits and $13.1 million increase in out-of-market certificate of deposits. Public funds have seasonal fluctuations due to semiannual tax collection and subsequent disbursement to entities. Interest rates on deposits, which are one of the primary factors affecting the amount of interest expense paid, decreased to the average rate paid of 0.55% on interest-bearing deposits for the three month period ended September 30, 2013, compared to 0.77% for the same period of the prior year.
On October 28, 2013, the Company announced it will pay a quarterly cash dividend of 11.25 cents per common share for the first quarter of fiscal 2014. The dividend will be paid on November 15, 2013, to stockholders of record on November 8, 2013.
The total risk-based capital ratio of 14.92% at September 30, 2013, decreased by 91 basis points from 15.83% at June 30, 2013. Tier I capital decreased 24 basis points to 9.32% at September 30, 2013 when compared to 9.56% at June 30, 2013. These decreases are due primarily to the use of excess capital to expand the loan portfolio during the current quarter. These ratios continue to place the Company in the "well-capitalized" category within financial institution regulation at September 30, 2013 and are consistent with the "well-capitalized" regulatory category in which the Company plans to operate. The Company historically has been able to manage the size of its assets through secondary market loan sales of single-family mortgages.
Noninterest income was $4.2 million for the three months ended September 30, 2013, compared to $4.1 million for the same period in the prior fiscal year, an increase of $55,000. This increase was due to an increase in net loan servicing income of $660,000 and offset by a decrease in the net gain on sale of loans and fees on deposits of $228,000 and $428,000, respectively. Loan servicing income increased primarily by the recapture of previously expensed valuation allowances on the portfolio and reduced amortization expenses, which were affected by the reduced prepayment speeds in the current quarter for the portfolio. The decrease in net gain on the sale of loans reflects reduced refinancing activities on residential lending in the current fiscal year when compared to the same period in the prior fiscal year. Going forward we expect that maintaining this level of fee income will be more dependent on customer purchase activity for new loan originations and less dependent on refinance transactions, as many borrowers have already taken advantage of historically low market interest rates. Fees on deposits decreased when compared to the same quarter of the prior year due to the additional income received in September 2012 of $600,000 for nonrecurring vendor incentive fees. The current period reflects an increase in point-of-sale interchange fees of $146,000 resulting from an increased fee per transaction and a higher volume of transactions overall.
Noninterest expense was $9.3 million for the three months ended September 30, 2013, as compared to $8.8 million for the same period of the prior fiscal year, an increase of $507,000, or 5.7%. The increase was attributed primarily to increases in compensation and employee benefits of $559,000 and professional fees of $83,000. Compensation costs increased due in part to an increase of 4.7% in the number of average full-time equivalents ("FTE's") for the first three months of fiscal 2014 compared to the same period in the prior fiscal year. Staffing additions have been directed toward revenue-based functions which have produced positive net growth in loan volume. In addition, severance for an executive and closed branch staff added $85,000 of compensation expense. As part of employee benefits, pension plan expenses increased by $51,000 for the three month period ended September 30, 2013, as compared to the same period of the prior year. The annual actuarial valuation computed that net periodic pension costs increased by $202,000 for fiscal 2014, or 24.9% over fiscal 2013, with the remaining $151,000 to be recognized over the remaining periods of the current fiscal year. Professional fees increased due primarily to additional services provided by outside vendors related to financial statements and internal audit engagements. Occupancy and equipment decreased by $27,000 when compared to the same period of the prior year because of efficiency initiatives which continue to be implemented, including an additional branch closure during the fourth quarter of fiscal 2013.


General
The Company is a financial services provider and, as such, has inherent risks that must be managed in order to achieve net income. Primary risks that affect net income include credit risk, liquidity risk, operational risk, regulatory compliance risk and reputation risk. The Company's net income is derived by management of the net interest margin, the ability to collect fees from services provided, by controlling the costs of delivering services and the management of loan and lease losses. The primary source of revenues is the net interest margin, which represents the difference between income on interest-earning assets (i.e. loans and investment securities) and expense on interest-bearing liabilities (i.e. deposits and borrowed funding). The net interest margin is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Fees earned include charges for deposit and debit card services, trust services and loan services. Personnel costs are the primary expenses required to deliver the services to customers. Other costs include occupancy and equipment and general and administrative expenses. Financial Condition Data
At September 30, 2013, the Company had total assets of $1.25 billion, an increase of $33.1 million from the level at June 30, 2013. Total loans and leases receivable increased $64.6 million, while total investment securities decreased by $32.3 million. Total liabilities increased by $34.3 million primarily due to an increase in deposits of $45.5 million and partially offset by a decrease in advances from the FHLB and other borrowings of $15.2 million. Stockholders' equity decreased by $1.2 million since June 30, 2013, primarily due to an increase in accumulated other comprehensive loss of $1.5 million, and partially offset by net income and reduced by the payment of dividends. The increase in net loans and leases receivable, which excludes loans in process and deferred fees, was $64.6 million due to the increase in loan balances and only minimally reduced by the increase to the allowance for loan and lease losses. Commercial real estate and agricultural loans increased by $50.2 million and $12.7 million, respectively. The investment securities available for sale decreased by $39.1 million due primarily to the sale of securities and principal cash flow during the first three months of fiscal 2014. Total proceeds on the sale of securities available for sale during the fiscal year were $24.7 million for a net gain on sale of $273,000. During the first quarter of fiscal 2014, the Company purchased investment securities classified as held to maturity and carried an amortized cost of $6.7 million at September 30, 2013, compared to no securities classified as held to maturity at June 30, 2013.
Loans held for sale decreased $3.9 million, to $5.3 million at September 30, 2013, primarily due to timing of mortgage financing activity sold to secondary market investors and the resulting amount of one-to four-family loans held for sale.
See the Consolidated Statement of Cash Flows for a detailed analysis of the change in cash and cash equivalents.
Deposits increased $45.5 million, to $944.3 million at September 30, 2013, due to a $14.3 million increase in non-public fund deposits, an increase of $18.1 million in public fund deposits and a $13.1 million increase in out-of-market certificate of deposits. Advances from the FHLB and other borrowings decreased $15.2 million, to $151.9 million at September 30, 2013 as compared to June 30, 2013, due to reduced funding needs resulting from increased deposits. Stockholders' equity decreased $1.2 million at September 30, 2013 when compared to June 30, 2013. Stockholders' equity increased due to net income of $1.0 million, but was reduced by a net increase in accumulated other comprehensive loss of $1.5 million and the payment of cash dividends of $794,000. Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.
Average Balances, Interest Rates and Yields. The following tables present for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The tables do not reflect any effect of income taxes. Average balances consist of daily average balances for the Bank with simple average balances for all other subsidiaries of the Company. The average balances include nonaccruing loans and leases. The yields on loans and leases include origination fees, net of costs, which are considered adjustments to yield.


                                                           Three Months Ended September 30,
                                                    2013                                      2012
                                      Average         Interest                  Average        Interest
                                    Outstanding       Earned/      Yield/     Outstanding       Earned/     Yield/
                                      Balance           Paid        Rate        Balance          Paid        Rate
                                                                (Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable(1)(3)  $    726,345     $    8,302      4.53 %   $    703,470     $   9,006      5.08 %
Investment securities(2)(3)             425,081            828      0.77          371,721         1,186      1.27
Correspondent bank stock                  9,288             69      2.95            7,977            51      2.54
Total interest-earning assets         1,160,714     $    9,199      3.14 %      1,083,168     $  10,243      3.75 %
Noninterest-earning assets               72,158                                    83,133
Total assets                       $  1,232,872                              $  1,166,301
Interest-bearing liabilities:
Deposits:
Checking and money market          $    347,036     $      234      0.27 %   $    336,643     $     397      0.47 %
Savings                                 110,970             56      0.20          112,365            74      0.26
Certificates of deposit                 271,864            726      1.06          278,278           935      1.33
Total interest-bearing deposits         729,870          1,016      0.55          727,286         1,406      0.77
FHLB advances and other borrowings      188,067          1,054      2.22          147,241         1,061      2.86
Subordinated debentures payable to
trusts                                   24,837            353      5.64           27,837           428      6.10
Total interest-bearing liabilities $    942,774     $    2,423      1.02 %   $    902,364     $   2,895      1.27 %
Noninterest-bearing deposits            163,785                                   131,901
Other liabilities                        30,359                                    34,163
Total liabilities                     1,136,918                                 1,068,428
Equity                                   95,954                                    97,873
Total liabilities and equity       $  1,232,872                              $  1,166,301
Net interest income; interest rate
spread(4)                                           $    6,776      2.12 %                    $   7,348      2.48 %
Net interest margin(4)(5)                                           2.32 %                                   2.69 %
Net interest margin, TE(6)                                          2.36 %                                   2.72 %


_____________________________________


(1) Includes loan fees and interest on accruing loans and leases past due 90 days or more.

(2) Includes federal funds sold and interest earning reserve balances at the Federal Reserve Bank.

(3) Yields do not reflect the tax-exempt nature of loans, equipment leases and municipal securities.

(4) Percentages for the three months ended September 30, 2013 and 2012 have been annualized.

(5) Net interest income divided by average interest-earning assets.

(6) Net interest margin expressed on a fully taxable equivalent basis ("Net Interest Margin, TE") is a non-GAAP financial measure. See the following Non-GAAP Disclosure Reconciliation of Net Interest Income (GAAP) to Net Interest Margin, TE (Non-GAAP). The tax-equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and adjusting for federal and state exemption of interest income and certain other permanent income tax differences. We believe that it is a standard practice in the banking industry to present net interest margin expressed on a fully taxable equivalent basis, and accordingly believe the presentation of this non-GAAP financial measure may be useful for peer comparison purposes. As a non-GAAP financial measure, Net Interest Margin, TE should be considered supplemental to and not a substitute for or superior to, financial measures calculated in accordance with GAAP. As other companies may use different calculations for Net Interest Margin, TE, this presentation may not be comparable to similarly titled measures reported by other companies.


The reconciliation of the Net Interest Income (GAAP) to Net Interest Margin, TE (non-GAAP) is as follows:

                                    Three Months Ended September 30,
                                       2013                   2012
                                         (Dollars in Thousands)
Net interest income             $         6,776         $         7,348
. . .
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