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

Show all filings for TOWER FINANCIAL CORP

Form 10-Q for TOWER FINANCIAL CORP


8-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following presents management's discussion and analysis of the consolidated financial condition of the Company as of September 30, 2013 and December 31, 2012 and results of operations for the three- and nine-month periods ended September 30, 2013 and September 30, 2012. This discussion should be read in conjunction with the Company's consolidated condensed financial statements and the related notes appearing elsewhere in this report and the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

Executive Overview

Net income for the nine months ended September 30, 2013 and 2012 was $5.7 million and $4.0 million, respectively. The 41.5% increase in net income was the result of decreasing loan provision expense by $3.1 million and an increase in noninterest income of $840,336. These increases to net income were offset by a decrease in net interest income of $1.3 million, an increase in income tax expense of $659,048, and an increase in noninterest expense of $336,676. Loan provision expenses decreased due to improvements in asset quality, declining historical loss rates, and a decrease in adversely rated credits. The increase in noninterest income was led by increases in gains on available-for-sale securities and trust and brokerage income, and was offset by decreases in our mortgage banking income. Increases in noninterest expense were the led by increases in salaries and benefits, loan and professional, and data processing expenses of $485,719, $290,314, and $256,072, respectively. These increases were offset by decreases in other real estate owned (OREO) expenses of $692,453 and FDIC insurance premiums of $136,699.

Total assets increased $17.9 million, or 2.6%, from $684.0 million at December 31, 2012 to $701.9 million at September 30, 2013. This increase was the result of an $11.2 million increase in investment securities, a $3.2 million increase in bank owned life insurance (BOLI), and a $1.1 million increase in total loans. The increase in investment securities was primarily in the tax-exempt municipal and mortgage-backed security sectors. The increase in total loans was the result of increases in commercial and commercial real estate loans in the amount of $8.8 million and $5.5 million, respectively; offset by decreases in residential real estate, home equity, and consumer loans totaling $13.1 million. Of those decreases, the decrease in residential real estate loans of $7.3 million was primarily the result of existing loans being refinanced in the current low interest rate environment. As these loans were refinanced, management chose to sell the majority of new loans originated and let the existing balance decline in an effort to reduce our exposure to long-term, low rate loans.

Total deposits increased by $29.2 million, or 5.2%, from December 31, 2012 to September 30, 2013. The increase in total deposits to $590.2 million at September 30, 2013 was primarily related to increases of $15.3 million in health savings accounts (HSAs), $4.6 million in savings accounts, $6.8 million in money market accounts, and $9.5 million in brokered deposits. The increase in HSAs, which are included in interest-bearing checking accounts, was primarily due to the annual employer funded contributions made to their employees' HSAs in January. The increase in brokered deposits was strategically planned by management to fund the remaining portion of the municipal bond leverage strategy. Offsetting the increase was a decrease of approximately $8.8 million of interest-bearing commercial and consumer checking accounts, excluding HSAs.

Financial Condition

Total assets were $701.9 million at September 30, 2013 compared to total assets of $684.0 million at December 31, 2012. The increase was primarily due to the $11.2 million increase in investment securities and the $3.2 million increase in BOLI.

Cash and Cash Equivalents. Cash and cash equivalents, which include federal funds sold, were $16.2 million at September 30, 2013. This represents a $1.4 million, or 9.2%, increase from December 31, 2012. This balance tends to fluctuate on a daily basis as new funds come in and others are sent out to fund commitments, such as new loans or investment purchases.

Investment Securities:

Trading Securities. At September 30, 2013, the Company held $230,300 in trading securities. This asset is an investment in mutual funds that is associated with a nonqualified deferred compensation plan for the Company's executive officers. The Company attempts to mirror investment performance in the participant deemed deferred compensation accounts, which allows for reduced risk for the Company since changes in the nonqualified participant liabilities will tend to be offset by similar changes in the corporate trading assets.


Securities Available for sale. Available-for-sale securities increased by $11.0 million, or 6.3%, from December 31, 2012. This increase was primarily due to purchases of residential mortgage-backed securities and tax-exempt municipal securities. We are focused on preserving net interest income while maintaining a consistent level of quality earning assets. Due to this focus, we have increased our portfolio of available-for-sale securities to supplement the decline in interest income from lower loan and investment yields as a result of the extended low-rate interest environment. At September 30, 2013, available-for-sale securities made up 26.4% of total assets compared to 25.4% of total assets at December 31, 2012.

Loans. Total loans increased $1.1 million from December 31, 2012 to $451.5 million at September 30, 2013. While loan growth was only 0.23% from December 31, 2012 to September 30, 2013, there was significant movement within the loan portfolio. Over the nine-month period in 2013, commercial and commercial real estate loans grew by $8.8 million and $5.5 million, respectively. Of the $5.5 million increase in commercial real estate, there was growth of $9.9 million in owner-occupied and investment purpose commercial real estate properties offset by a $4.4 million reduction in commercial real estate construction loans; otherwise known as, acquisition and development loans. Offsetting the increases were decreases in residential real estate loans of $7.3 million, home equity loans of $4.8 million, and consumer loans of $1.0 million. The $7.3 million decrease in residential mortgage loans was primarily the result of existing loans being refinanced in the current low interest rate environment. As these loans were refinanced, management chose to sell the majority of new loans originated and let the existing balances decline in an effort to reduce our exposure to long-term, low rate loans. New residential mortgage loan originations during the first nine months of 2013 totaled $58.8 million, of which only $18.2 million was retained. While new commercial and commercial real estate loans are regularly added to the portfolio, they continue to be offset by amortization and pay downs on existing loans as business customers are using excess cash reserves to pay down loan balances. New commercial and commercial real estate loan volume during the first nine months of 2013 was approximately $109.2 million. Competition and declining rates in the local and national lending environment also continues to be a challenge as the Company looks to replace these paid off and paid down loans with new loans meeting the asset quality, price, and risk deemed acceptable by our lending policies and management.

Nonperforming Assets. Nonperforming assets include impaired securities, nonperforming loans, OREO, and other impaired assets. Nonperforming loans include loans 90 days past due and still accruing interest, nonperforming restructured loans, and nonaccrual loans. Nonperforming assets decreased by $8.9 million from $18.8 million, or 2.7% of total assets, at December 31, 2012 to $9.9 million, or 1.4% of total assets, at September 30, 2013. This decrease was primarily due to payoffs and pay downs totaling $3.4 million on nonaccrual loans; one troubled debt restructured commercial loan in the amount of $1.2 million being reclassified as performing TDRs; the sale of one nonaccrual commercial and one nonaccrual commercial real estate loan totaling $2.1 million; partial charge-offs in the amount of $975,086; sales of OREO properties totaling $1.7 million; and upgrades to remove from nonaccrual status of approximately $763,000. These reductions were primarily offset by the addition of new nonperforming relationships totaling $1.2 million, which were predominantly made up of six small business commercial relationships totaling $893,237.

The following table summarizes the Company's recorded investment in nonperforming assets at the dates indicated:

                                                       September 30,   December 31,
                                                           2013            2012

Loans past due over 90 days and still accruing         $     742,931   $     109,888
Nonperforming restructured loans                                   -       1,645,224
Nonaccrual loans                                           6,762,484      14,967,886
Total nonperforming loans                              $   7,505,415   $  16,722,998
Other real estate owned                                    2,351,694       1,908,010
Other impaired assets owned                                   50,516         129,853
Total nonperforming assets                             $   9,907,625   $  18,760,861

Nonperforming assets to total assets                            1.41 %          2.74 %

Nonperforming loans to total loans                              1.66 %          3.71 %


TDR loans decreased $1.2 million from December 31, 2012 to September 30, 2013. The decrease was mainly due to the sale of one commercial real estate loan with a principal balance of $1.1 million at December 31, 2012 and the payoff of one commercial loan in the amount of $425,253. These decreases were offset by the addition of one commercial loan with a balance at September 30, 2013 of $319,700. This commercial loan was deemed a TDR due renewing a collateral deficient loan to a borrower experiencing financial difficulty. We had two TDR loan relationships totaling $1.6 million that were reported as impaired, nonperforming TDRs at December 31, 2012. As of September 30, 2013, one of those loans in the amount of $1.2 million has been reclassified as an impaired, performing TDRs, while the other was moved to nonaccrual status as a nonperforming TDR. Our general policy for TDRs is to reclassify the loans to performing once timely payments have been received for over 6 months since their restructurings. It is the Company's policy to continue to base its measure of loan impairment on the contractual terms specified by the loan agreement in accordance with paragraphs ASC 310-10-35-20 through 35-26 and ASC 310-10-35-37. At September 30, 2013, management believes it has allocated adequate specific reserves for the risks associated with the loan portfolio.

The following table summarizes the Company's TDR loans as of the dates indicated:

                                                       September 30,     December 31,
                                                           2013              2012

Nonperforming TDR loans                                $           -     $   1,645,224
Nonperforming TDR loans included in nonaccrual loans       1,487,455         2,241,937
Total nonperforming TDR loans                          $   1,487,455     $   3,887,161

Performing TDR loans                                       1,949,736           795,703
Total TDR loans                                        $   3,437,191     $   4,682,864

Loans reported as impaired decreased to $11.7 million from the $18.2 million reported at December 31, 2012. The decrease in our impaired loans was primarily due to payoffs and pay downs totaling $3.7 million, the sale of two commercial nonaccrual loans in the amount of $2.1 million, partial charge-offs in the amount of $975,086, the transfer of four nonaccrual loans to OREO in the amount of $2.4 million, and the reclassification of one commercial real estate loan to unimpaired in the amount of $641,577. These decreases were offset primarily by the addition of one impaired commercial loan totaling $3.3 million.

During the nine months ended September 30, 2013, we added $920,775 in loans to non-accrual status, which primarily included two commercial loans totaling $765,652, which were already deemed impaired at December 31, 2012 and had no impact on total impaired loans. Adding these types of loans to non-accrual status is a typical migration as we work to dispose of these assets. This growth in non-accruals was offset by the pay offs, charge-offs, dispositions, or payments on loans previously placed on nonaccrual as described in aforementioned paragraph.

Adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property that include certain assumptions and unobservable inputs used many times by appraisers, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Whenever a new fair value is determined, which is typically done on an annual basis in the OREO category, we report the property at that new value. Our internal policy on OREO properties generally requires an updated appraisal every 12 to 24 months based on the property type. OREO increased by $443,684 in the first nine months of 2013 as a result of the addition of three commercial real estate properties totaling $1.1 million and one residential real estate property in the amount of $1.0 million. These increases were offset by sales of two commercial real estate properties in the amount of $802,112 and various lot sales on five commercial real estate development projects totaling $842,011, and the receipt of insurance proceeds on one commercial property in the amount of $35,660. All OREO sales during the nine month period in 2013 resulted in a net gain on sales of $395,394.

Allowance for Loan Losses. Each quarter our allowance for loan losses is adjusted to the amount management believes is necessary to maintain the allowance at adequate levels. Management allocates specific portions of the allowance for loan losses to specific problem loans. Problem loans are identified through a loan risk rating system and monitored through watch list reporting. Specific reserves are determined for each identified problem loan based on delinquency rates, collateral and other risk factors specific to that problem loan. Management's allocation of the allowance to other loan pools considers various factors including historical loss experience, the present and prospective financial condition of borrowers, industry concentrations within the loan portfolio, general economic conditions, and peer industry data of comparable banks.


The allowance for loan losses at September 30, 2013 was $6.8 million, or 1.51% of total loans outstanding, a decrease of $1.5 million from $8.3 million, or 1.84% of total loans outstanding, at December 31, 2012. The provision for loan losses for the first nine months in 2013 resulted in a benefit of $825,000 compared to an expense of $2.3 million for the first nine months in 2012. The decrease in the allowance for loans losses was due to management's continued focus on improving asset quality and profitability by reducing the balance of "watch list" or adversely rated loans categorized as "special mention", "substandard", or "doubtful". Adversely rated loans decreased from a recorded investment of $37.6 million at December 31, 2012 to $27.8 million at September 30, 2013, which was a $9.8 million decrease. The reduction in these credits was the result of payoffs and pay downs, charge-offs, upgrades in rating, loan sales and refinancing through another institution. Improving asset quality has led to a decline in historical loss rates over the last couple of years, which has also been a primary cause for the decrease in our allowance for loan losses.

For the first nine months of 2013, we were in a net charge-off position of $655,306 compared to a net charge-off position of $3.2 million for the first nine months of 2012. Of the $975,086 in gross charge-offs, $705,449 were from two commercial relationships, which had $793,000 of specific reserves at December 31, 2012.

All Other Assets. All other assets increased $4.8 million as a result of increases in other investments in the amount of $4.0 million, BOLI in the amount of $3.2 million, and the deferred tax asset on net unrealized holding losses on securities available for sale in the amount of $2.3 million. Other investments increased due to the Company's participation in a Section 42 Low Income Housing project in the amount of $2.0 million and due to a $2.0 million investment in 2,000 shares of non-market traded Senior Housing Crime Prevention's preferred stock. BOLI increased by $3.2 million due to the Company investing in additional policies in the amount of $2.8 million and compounded earnings during the period. These increases were offset by decreases in other assets receivable, current and deferred assets on our income taxes, and prepaid FDIC insurance in the amounts of $2.2 million, $1.4 million, and $925,337, respectively. The $2.3 million decrease in other assets receivable was due to receiving cash for three security sales that traded in December of 2012, but settled in January of 2013. The decrease in our current and deferred assets on income taxes was primarily due to the increase in our taxable income. Prepaid FDIC insurance decreased by $925,337 due to being charged our first quarter premiums for 2013 and receiving a refund for our remaining prepaid balance with the FDIC.

Deposits. Total deposits were $590.2 million at September 30, 2013 compared to $561.0 million at December 31, 2012. The increase in total deposits was primarily related to increases of $15.3 million HSAs, $4.6 million in savings accounts, $6.8 million in money market accounts, and $9.5 million in brokered deposits. HSAs increased from a balance of $79.3 million at December 31, 2012 to $94.6 million at September 30, 2013, which is a 19.3% increase. The increase in HSAs, which are included in interest-bearing checking accounts, was largely due to the annual employer and employee funded contributions to HSAs, which is expected during the month of January each year. Generally, after the large increase in the balance of HSAs during the first quarter, the balance tends to remain somewhat flat for the remainder of the year with fluctuations coming from accountholders making qualified contributions and withdrawals. Brokered deposits increased from $90.2 million at December 31, 2012 to $99.7 million at September 30, 2013, which is a 10.5% increase. The majority of this increase in brokered deposits occurred during the first quarter of 2013 and was strategically planned by management to fund the remaining portion of the $25.0 million municipal bond leverage strategy. As described in our Annual Report Form 10-K for December 31, 2012, this strategy was implemented in the fourth quarter of 2012 to preserve net interest income. This strategy will add approximately $250,000 annually to net interest income, but will cause a decrease in net interest margin. Offsetting the increases in deposits was a decrease of approximately $8.8 million of interest-bearing checking accounts, excluding HSAs.


The following table summarizes the Company's deposit balances at the dates indicated:

                                    September 30, 2013             December 31, 2012
                                    Balance           %           Balance           %
Core deposits:
Noninterest-bearing demand       $ 110,828,555        18.8 %   $ 108,147,229        19.3 %
Interest-bearing checking          176,523,260        29.9 %     170,047,196        30.4 %
Money market                       127,073,228        21.5 %     120,253,915        21.4 %
Savings                             33,501,881         5.7 %      28,874,130         5.1 %
Time, under $100,000                24,604,477         4.2 %      25,934,861         4.6 %
Total core deposits                472,531,401        80.1 %     453,257,331        80.8 %
Non-core deposits:
In-market non-core deposits:
Time, $100,000 and over             17,947,305         3.0 %      17,521,247         3.1 %
Out-of-market non-core deposits:
Money market                        12,046,795         2.0 %      12,035,072         2.1 %
Brokered certificate of deposits    87,710,000        14.9 %      78,193,688        14.0 %
Total out-of-market deposits        99,756,795        16.9 %      90,228,760        16.1 %
Total non-core deposits            117,704,100        19.9 %     107,750,007        19.2 %

Total deposits                   $ 590,235,501       100.0 %   $ 561,007,338       100.0 %

Borrowings. The Company had borrowings of $44.3 million at September 30, 2013 compared to $54.9 million at December 31, 2012. The decrease of $10.6 million during the first nine months of the year was due to three long-term fixed rate FHLB advances maturing in the amount of $8.0 million and reducing our variable rate, short-term borrowings with the FHLB by $4.6 million. These decreases were offset by replacing the matured FHLB Advances with a 0.62% fixed rate bullet for $2.0 million. The current weighted average rate on the FHLB advances is 0.61% with a weighted average remaining maturity of 1.4 years. We also had $17.5 million of aggregate principal amount in junior subordinated debenture outstanding at September 30, 2013 and December 31, 2012. We currently have two statutory trust subsidiaries, TCT2 and TCT 3. TCT 2 has a variable rate of LIBOR plus 1.34% on $8.0 million of debt. TCT 3 has a variable rate of LIBOR plus 1.69% on the remaining $9.0 million of debt. Interest rates at September 30, 2013 for TCT 2 and TCT 3 were 1.59% and 1.95%, respectively.

All Other Liabilities. All other liabilities were $5.3 million at September 30, 2013, an increase of $1.0 million compared to December 31, 2012. This increase was primarily due to an increase of $1.2 million in other accounts payables to fund the remaining investment for the Company's participation in a Section 42 Low Income Housing project. Offsetting this increase was a decrease of $120,650 in other accrued amounts, including accrued salaries, commissions, and SERP payments.

Results of Operations

For the Three-Month Periods Ended September 30

Results of operations for the three-month period ended September 30, 2013 reflected net income of $2.1 million, or $0.45 per diluted share. This was a $521,454 increase from net income of $1.6 million, or $0.32 per diluted share, reported for the three-month period ending September 30, 2012. The increase in net income was the result of decreasing loan provision expense by $1.5 million. Offsetting the increase was a decrease in net interest income of $467,140, an increase in noninterest expense of $295,809, and a decrease of noninterest income of $26,391.

Performance Ratios             September 30
                             2013        2012

Return on average assets *     1.20 %      0.96 %
Return on average equity *    13.64 %      9.43 %
Net interest margin (TEY) *    3.46 %      3.87 %
Efficiency ratio              72.58 %     64.21 %

* annualized


Net Interest Income. Net interest income for the three-month periods ended September 30, 2013 and 2012 was $5.1 million and $5.6 million, respectively. The reduction in net interest income of $467,140 from the third quarter of 2012 compared to 2013 was the result of a decrease in net interest margin. This decrease was due to a decline in loan and investment yields and a shift in the components that make up our earning assets. The tax equivalent net interest margin for the third quarter of 2013 was 3.46%, while the tax equivalent net interest margin for the third quarter of 2012 was 3.87%, which equates to a 41 basis point reduction.

The primary cause for the decrease in net interest margin was the decrease in average loans of $25.7 million coupled with a 42 basis point decrease in loan yield, which amounted to a $747,410 decrease in interest income for the third quarter of 2013 compared to the third quarter of 2012. Loan yield has decreased as a result of continual declines in lending rates in the local and national markets. Also contributing to the decrease in net interest margin was a decline in the tax equivalent investment yield to 3.00% at September 30, 2013 from 3.61% at September 30, 2012. This decline was predominantly due to a decline in reinvestment rates on securities, both taxable and tax exempt. In an effort to decrease the impact of the decline in investment yield on net interest income, the average balance of investment securities was increased by $58.0 million for the same period primarily due to the implementation of management's municipal bond leverage strategy.

At September 30, 2013 and 2012, average loans made up 69.1% and 77.0% of average earning assets, respectively, and average investment securities made up 29.6% and 21.5% of average earning assets, respectively. As the mix of average earning assets has shifted with more weight on the portfolio of investment securities, the tax equivalent net interest margin has declined due to this type of portfolio naturally earning a lower yield than the loan portfolio.

Our decrease in interest income was offset by a decrease in interest expense due to our cost of funds ratio decreasing from 0.73% at September 30, 2012 to 0.53% at September 30, 2013. This 20 basis point reduction was mainly due to the low interest rate environment and the shift in our deposit portfolio. As reflected in the following table, we have experienced a shift in our deposit portfolio from certificates of deposit and money markets to lower-cost, interest bearing checking accounts, which has contributed to the decrease in cost of funds. The increase in our interest-bearing checking has primarily come from our HSA product with growth in the average quarterly balance of $16.4 million from September of 2012 to September of 2013. The shift in deposit products and the lowering of rates caused interest expense to decrease by $167,586 in the third quarter of 2013 compared to the third quarter of 2012.


The following table reflects the average balance, interest earned or paid, and yields or costs of the Company's assets, liabilities and stockholders' equity at and for the dates indicated:

                                                   As of and For The Three Month Period Ended
                                         September 30, 2013                           September 30, 2012
                                             Interest      Annualized                     Interest      Annualized
                               Average        Earned          Yield         Average        Earned          Yield
($ in thousands)               Balance       or Paid         or Cost        Balance       or Paid         or Cost
Assets
Short-term investments and
interest-earning deposits     $   1,908     $        4            0.83 %   $   1,162     $        6            2.05 %
Federal funds sold                3,082              1            0.13 %       3,071              1            0.13 %
. . .
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