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CHEV > SEC Filings for CHEV > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for CHEVIOT FINANCIAL CORP.


12-Nov-2013

Quarterly Report


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

Forward Looking Statements

This report on Form 10-Q contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements are subject to significant risks, assumptions and uncertainties that could affect the actual outcome of future events. Because of these uncertainties, actual future results may be materially different from the results indicated by these forward-looking statements.

Recent Developments

On April 23, 2013, shareholders approved the 2013 Equity Incentive Plan. The 2013 Equity Incentive Plan provides for the grant of up to 467,500 options to buy shares of common stock and the awards of shares of restricted stock. As of the date of this report, no stock grants or option awards have been made under the 2013 Equity Incentive Plan.

Subsequent to September 30, 2013 the Corporation amended the authorization of a stock repurchase plan. Under this program the Corporation is authorized to repurchase 341,845 shares constituting 5% of the outstanding shares of common stock.

Critical Accounting Policies

Cheviot Financial considers accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. The Corporation considers the accounting method used for the allowance for loan losses to be a critical accounting policy.

The allowance for loan losses is the estimated amount considered necessary to cover inherent, but unconfirmed credit losses in the loan portfolio at the balance sheet date. The allowance is established through the provision for losses on loans 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 Cheviot Financial.

Management performs a quarterly evaluation of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan review and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change.

The analysis has two components, specific and general allocations. Specific allocations are made for unconfirmed losses related to loans that are determined to be impaired. Impairment 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. If the fair value of the loan is less than the loan's carrying value, the loan is written down to fair value. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. Management also analyzes historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance. Actual loan losses may be significantly more than the allowances that has been established which could result in a material negative effect on financial results.

The acquired assets and assumed liabilities of First Franklin were measured at estimated fair values, as required by FASB under Business Combinations. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management measured loan fair values based on loan file reviews (including borrower financial statements or tax returns), appraised collateral values, expected cash flows and historical loss factors of Franklin Savings. Real estate acquired through foreclosure was primarily valued based on appraised collateral values. The Corporation also recorded an identifiable intangible asset representing the core deposit base of Franklin Savings based on management's evaluation of the cost of such deposits relative to alternative funding sources. Management used significant estimates including the average lives of depository accounts, future interest rate levels, the cost of servicing various depository products and other significant estimates. Management used market quotations to determine the fair value of investment securities and FHLB advances.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Critical Accounting Policies (continued)

The acquired assets of First Franklin and Franklin Savings include loans receivable. Loans receivable acquired with a deteriorated credit quality amounted to $25.0 million with a related credit quality discount of $5.5 million. The method of measuring carrying value of purchased loans differs from loans originated by the Corporation, and as such, the Corporation identifies purchased loans and purchased loans with a credit quality discount.

The Corporation classifies investments in debt and equity securities as either held-to-maturity or available-for-sale. Securities classified as held-to maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Estimated fair values are obtained from a third party service. This service's fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting the statements of financial position, results of operations and cash flows. If the estimated value of investments is less than the cost or amortized cost, management evaluates whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and it is determined that the impairment is other-than-temporary, the impairment of the investment is expensed in the period in which the event or change occurred. Management also considers how long a security has been in a loss position in determining if it is other than temporarily impaired. Management also assesses the nature of the unrealized losses taking into consideration factors such as changes in risk- free interest rates, general credit spread widening, market supply and demand, creditworthiness of the issuer, and quality of the underlying collateral.

Discussion of Financial Condition Changes at September 30, 2013 and December 31, 2012

Total assets decreased $40.2 million, or 6.4%, to $591.7 million at September 30, 2013, from $632.0 million at December 31, 2012. The decrease in total assets primarily reflects a $31.5 million decrease in investment securities as $106.2 million in investment securities matured during the nine months ended September 30, 2013 and a $3.4 million decrease in loans receivable as a result of selling $33.3 million of loans in the secondary market.

Cash, federal funds and interest-earning deposits decreased $9.2 million, or 36.8% to $15.9 million at September 30, 2013. The decrease in cash and cash equivalents at September 30, 2013 was due to a $11.2 million decrease in federal funds sold and a decrease of $407,000 in cash and due from banks, which was partially offset by an increase of $2.4 million in interest-earning deposits. Investment securities decreased $31.5 million, or 16.1%, to $164.5 million at September 30, 2013. The decrease in investment securities is primarily the result of $106.2 million of investment securities maturing, which was partially offset by investing approximately $80.9 million in U.S. Government agencies and $1.9 million in corporate securities during the nine months ended September 30, 2013. At September 30, 2013, all investment securities were classified as available for sale.

Mortgage-backed securities increased $3.4 million, or 35.4%, to $13.0 million at September 30, 2013, from $9.6 million at December 31, 2012. The increase in mortgage-backed securities was due primarily to the purchase of $5.0 million in mortgage-backed securities designated as available for sale, which was partially offset by $1.5 million in principal repayments. At September 30, 2013, $9.8 million of mortgage-backed securities were classified as available for sale, while $3.2 million were classified as held to maturity. As of September 30, 2013, none of the mortgage-backed securities were considered other than temporarily impaired.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Discussion of Financial Condition Changes at September 30, 2013 and December 31, 2012 (continued)

Loans receivable, including loans held for sale, decreased $3.4 million, or 1.0%, to $337.0 million at September 30, 2013, from $340.4 million at December 31, 2012. The change in net loans receivable reflects loan sales totaling $33.3 million and loan principal repayments of $53.3 million, which were partially offset by loan originations of $85.8 million. In addition, approximately $2.4 million in loans receivable were transferred to real estate acquired through foreclosure. The change in the composition of the Corporation's assets reflects management's decision to service our customer base by originating loans for sale and recording gains, while simultaneously managing interest rate risk. Due to increases in mortgage interest rates and customer demand, loan originations decreased during the period.

The allowance for loan losses totaled $1.6 million and $2.2 million at September 30, 2013 and December 31, 2012, respectively. In determining the adequacy of the allowance for loan losses at any point in time, management and the board of directors apply a systematic process focusing on the risk of loss in the portfolio. First, the loan portfolio is segregated by loan types to be evaluated collectively and loan types to be evaluated individually. Delinquent multi-family and commercial loans are evaluated individually for potential impairments in their carrying value. Second, the allowance for loan losses entails utilizing the Corporation's historic loss experience by applying such loss percentage to the loan types to be collectively evaluated in the portfolio. The $925,000 provision for losses on loans during the nine months ended September 30, 2013 reflected these factors, as well as, replenishing the allowance for charge-offs and the need to provide approximately $796,000 in specific reserves for nine residential properties with principal balances totaling $2.0 million that were transferred to real estate owned during the nine months ended September 30, 2013. The analysis of the allowance for loan losses requires an element of judgment and is subject to the possibility that the allowance may need to be increased, with a corresponding reduction in earnings. To the best of management's knowledge, all known and inherent losses that are probable and that can be reasonably estimated have been recorded at September 30, 2013.

Originated non-performing and impaired loans totaled $3.5 million and $5.7 million at September 30, 2013 and December 31, 2012, respectively. At September 30, 2013, originated non-performing and impaired loans were comprised of thirty-three loans secured by one- to four-family residential real estate totaling $2.5 million, one multi-family loan totaling $95,000 and five commercial and non-residential loans totaling $892,000. At September 30, 2013 and December 31, 2012 real estate acquired through foreclosure was $4.2 million and $4.0 million, respectively. The allowance for loan losses represented 35.4% and 28.7% of Cheviot Financial's originated non-performing and impaired loans at September 30, 2013 and December 31, 2012, respectively. Although management believes that the Corporation's allowance for loan losses conforms to generally accepted accounting principles based upon the available facts and circumstances, there can be no assurance that additions to the allowance will not be necessary in future periods, which would adversely affect results of operations.

Deposits totaled $471.5 million at September 30, 2013, a decrease of $19.2 million, or 3.9% from $490.6 million at December 31, 2012. Advances from the Federal Home Loan Bank of Cincinnati decreased by $4.2 million, or 17.3%, to $20.1 million at September 30, 2013, from $24.3 million at December 31, 2012. The decrease is a result of approximately $4.1 million in repayments during the nine months ended September 30, 2013.

Shareholders' equity decreased $14.8 million, or 13.7%, from December 31, 2012. The decrease primarily resulted from purchasing 759,654 shares through the stock buyback program at a total cost of $8.6 million, dividend payments on common stock of $1.9 million and an increase in the unrealized loss on securities designated as available for sale of $5.4 million. These decreases were partially offset by net income of $1.1 million.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Discussion of Financial Condition Changes at September 30, 2013 and December 31, 2012 (continued)

Liquidity and Capital Resources

The Corporation monitors its liquidity position on a daily basis using reports that summarize all deposit activity and loan commitments. A significant portion of the deposit base is comprised of time deposits. At September 30, 2013, $115.8 million of time deposits are due to mature within one year. The daily deposit activity report allows management to price time deposits competitively. Because of this and the Corporation's deposit retention experience, the Corporation anticipates that a significant portion of maturing time deposits will be retained. At September 30, 2013, the Corporation had loan commitments of $1.9 million. Loan commitments are funded or expire within 45 days from the date of the commitment.

Borrowings from the Federal Home Loan Bank of Cincinnati decreased $4.2 million during the nine months ended September 30, 2013 and totaled $20.1 million at September 30, 2013. At September 30, 2013, the Corporation had the ability to increase such borrowings by approximately $122.6 million. The additional borrowings can be used to offset any decrease in customer deposits or to fund loan commitments. The Corporation's other borrowings were primarily limited to $599,000 of lease obligations.

Comparison of Operating Results for the Nine-Month Period Ended September 30, 2013 and 2012

General

Net earnings for the nine months ended September 30, 2013 totaled $1.1 million, a $1.5 million decrease from the $2.6 million in net earnings reported for the September 2012 period. The decrease in net earnings reflects a decrease in net interest income of $772,000 and a decrease in other income of $1.3 million and an increase in general, administrative and other expense of $73,000, which were partially offset by a decrease of $65,000 in the provision for losses on loans and a decrease in the provision for federal income taxes of $559,000.

Net Interest Income

Total interest income decreased $1.8 million, or 10.8%, to $14.6 million for the nine-months ended September 30, 2013, from the comparable quarter in 2012. Interest income on loans decreased $2.0 million, or 14.4%, to $11.8 million during the 2013 period from $13.8 million for the 2012 period. This decrease was due primarily to a $30.9 million decrease in the average balance of loans outstanding and a 32 basis point decrease in the average yield to 4.71% from 5.03% in the 2013 nine month period.

Interest income on mortgage-backed securities decreased $22,000, or 13.9%, to $136,000 for the nine months ended September 30, 2013, from $158,000 for the 2012 period, due primarily to a 16 basis point decrease in the average yield and a $650,000 decrease in the average balance of securities outstanding period to period. Interest income on investment securities increased $233,000, or 11.0%, to $2.4 million for the nine months ended September 30, 2013, compared to $2.1 million for the same period in 2012, due primarily to an increase of $21.6 million, or 14.1%, in the average balance of investment securities outstanding, which was partially offset by a 5 basis point decrease in the average yield to 1.79% for the 2013 period. Interest income on other interest-earning deposits decreased $1,000, or 0.3%, to $290,000 for the nine months ended September 30, 2013, as compared to the same period in 2012.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2013 and 2012 (continued)

Interest expense decreased $1.0 million, or 23.1%, to $3.3 million for the nine months ended September 30, 2013, from $4.3 million for the same period in 2012. Interest expense on deposits decreased by $841,000, or 23.2%, to $2.8 million from $3.6 million, due primarily to a $16.1 million decrease in the average balance outstanding, which was partially offset by 20 basis point decrease in the average cost of deposits to 0.77% during the 2013 period. Interest expense on borrowings decreased by $161,000, or 22.7%, due primarily to a $6.1 million, or 21.6%, decrease in the average balance outstanding and a 5 basis point decrease in the average cost of borrowings.

As a result of the foregoing changes in interest income and interest expense, net interest income decreased by $772,000, or 6.4%, to $11.3 million for the nine months ended September 30, 2013. The average interest rate spread decreased 9 basis points to 2.81% for the nine months ended September 30, 2013 from 2.90% for the nine months ended September 30, 2012. The net interest margin decreased to 2.85% for the nine months ended September 30, 2013 from 2.94% for the nine months ended September 30, 2012.

Provision for Losses on Loans

As a result of an analysis of historical experience, the volume and type of lending conducted by the Savings Bank, the status of past due principal and interest payments, general economic conditions, particularly as such conditions relate to the Savings Bank's market area, and other factors related to the collectability of the Savings Bank's loan portfolio, management recorded a $925,000 provision for losses on loans for the nine months ended September 30, 2013 and $990,000 for the nine months ended September 30, 2012. Non-performing originated loans were 1.6% and 2.8% of net originated loans at September 30, 2013 and December 31, 2012, respectively. The 2013 provision for loan losses reflects the amount necessary to maintain an adequate allowance based on the Corporation's historical loss experience and other external factors. These other external factors, economic conditions, and collateral value changes, have had a negative impact on non-owner-occupied loans in the portfolio. There can be no assurance that the loan loss allowance will be sufficient to cover losses on non-performing loans in the future; however, management believes they have identified all known and inherent losses that are probable and that can be reasonably estimated within the loan portfolio, and that the allowance is adequate to absorb such losses.

Other Income

Other income decreased $1.3 million, or 39.2%, to $2.0 million for the nine months ended September 30, 2013, compared to the same period in 2012, due primarily to a loss of $255,000 on sale of office premises and equipment comprised of the former Franklin Savings headquarters, a decrease in the gain on sale of loans of $710,000 and the absence during the 2013 period of a gain on death benefits from life insurance of $492,000.

General, Administrative and Other Expense

General, administrative and other expense increased $73,000, or 0.7%, to $11.0 million for the nine months ended September 30, 2013, from $10.9 million for the comparable period in 2012. The increase is a result of an increase of $227,000 in other operating expense. The increase in other operating expense is a result of real estate tax expense for real estate acquired through foreclosure.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2013 and 2012 (continued)

Federal Income Taxes

The provision for federal income taxes decreased $559,000, or 62.8%, for the nine months ended September 30, 2013. Cheviot Financial has approximately $3.5 million in remaining operating loss carryforwards to offset future taxable income for 20 years. These losses are subject to the Internal Revenue Code
Section 382 net operating loss limitations of $1.1 million allowed on an annual basis. The effective tax rate for the nine months ended September 30, 2013 and 2012 was 23.5% and 25.6%, respectively.

Comparison of Operating Results for the Three-Month Periods Ended September 30, 2013 and 2012

General

Net earnings for the three months ended September 30, 2013 totaled $21,000, a $478,000 decrease from the $499,000 earnings reported in the September 2012 period. The decrease in net earnings reflects a decrease of $625,000 in other income, primarily mortgage banking fee income and a decrease of $388,000 in net interest income, which was partially offset by a decrease of $5,000 in the provision for losses on loans, a decrease in general, administrative and other expenses of $280,000 and by a decrease of $250,000 in the provision for federal income taxes.

Net Interest Income

Total interest income decreased $686,000, or 12.8%, to $4.7 million for the three-months ended September 30, 2013, from the comparable quarter in 2012. Interest income on loans decreased $583,000, or 13.2%, to $3.8 million during the 2013 quarter from $4.4 million for the 2012 quarter. This decrease was due primarily to a $18.6 million, or 5.3%, decrease in the average balance of loans outstanding and by a 42 basis point decrease in the average yield on loans to 4.55% for the 2013 quarter from 4.97% for the three months ended September 30, 2012.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2013 and 2012

Comparison of Operating Results for the Three-Month Periods Ended September 30, 2013 and 2012 (continued)

Net Interest Income (continued)

Interest income on mortgage-backed securities increased $5,000, or 10.2%, to $54,000 for the three months ended September 30, 2013, from $49,000 for the comparable 2012 quarter, due primarily to a $2.1 million, or 20.2% increase in the average balance of securities outstanding, which was partially offset by a 16 basis point decrease in the average yield. Interest income on investment securities decreased $99,000, or 12.2%, to $712,000 for the three months ended September 30, 2013, compared to $811,000 for the same quarter in 2012, due primarily to a decrease of $16.4 million, or 9.0% in the average balance of investment securities outstanding and by a 6 basis point decrease in the average yield to 1.73% in the 2013 quarter. Interest income on other interest-earning deposits decreased $9,000, or 8.7% to $94,000 for the three months ended September 30, 2013.

Interest expense decreased $298,000, or 21.9% to $1.1 million for the three months ended September 30, 2013, from $1.4 million for the same quarter in 2012. Interest expense on deposits decreased by $249,000, or 21.8%, to $894,000, from $1.1 million, due primarily to a 17 basis point decrease in the average cost of deposits to 0.75% and a $21.7 million, or 4.4% decrease in the average balance of deposits outstanding. The decrease in the average cost of deposits is due to the overall changes in the deposit composition and lower market rates for the period. Interest expense on borrowings decreased by $49,000, or 22.3%, due primarily to a $5.5 million decrease in the average balance outstanding, and due to a 5 basis point decrease in the average cost of borrowings.

As a result of the foregoing changes in interest income and interest expense, net interest income decreased by $388,000, or 9.7%, to $3.6 million for the three months ended September 30, 2013, as compared to the same quarter in 2012. The average interest rate spread decreased to 2.75% for the three months ended September 30, 2013 from 2.82% for the three months ended September 30, 2012. The net interest margin decreased to 2.79% for the three months ended September 30, 2013 from 2.89% for the three months ended September 30, 2012.

Provision for Losses on Loans

Management recorded a $585,000 provision for losses on loans for the three months ended September 30, 2013, compared to a $590,000 provision for losses on loans for the three months ended September 30, 2012. The provision for loan losses during the three months ended September 30, 2013 reflects the amount necessary to maintain an adequate allowance based on the historical loss experience and other external factors. There can be no assurance that the loan loss allowance will be sufficient to cover losses on non-performing loans in the future, however management believes they have identified all known and inherent losses that are probable and that can be reasonably estimated within the loan portfolio, and that the allowance for loan losses is adequate to absorb such losses.

Other Income

Other income decreased $625,000, or 55.0%, to $511,000 for the three months ended September 30, 2013, compared to the same quarter in 2012. The decrease is due primarily to a decrease in the gain on sale of loans of $583,000.

Cheviot Financial Corp.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

For the three and nine months ended September 30, 2013 and 2012

Comparison of Operating Results for the Three-Month Periods Ended September 30, 2013 and 2012 (continued)

General, Administrative and Other Expense

General, administrative and other expense decreased $280,000, or 7.3%, to $3.6 million for of the three months ended September 30, 2013. This decrease is primarily a result of a decrease in employee compensation and benefits of $153,000, a decrease in real estate owned impairment of $161,000 and a decrease in property, payroll and other taxes of $90,000, which was partially offset by an increase in other operating expense of $234,000 as a result of real estate tax expense for real estate acquired through foreclosure.

Federal Income Taxes

The provision for federal income taxes decreased $250,000, or 128.9%, for the three months ended September 30, 2013. Cheviot Financial has approximately $3.5 million in remaining operating loss carryforwards to offset future taxable income for 20 years. These losses are subject to the Internal Revenue Code
Section 382 net operating loss limitations of $1.1 million allowed on an annual basis. There was a tax benefit for the three months ended September 30, 2013 of $56,000.

Cheviot Financial Corp.

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