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EBMT > SEC Filings for EBMT > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for EAGLE BANCORP MONTANA, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for EAGLE BANCORP MONTANA, INC.


13-Nov-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company's primary activity is its ownership of its wholly owned subsidiary, American Federal Savings Bank (the "Bank"). The Bank is a federally chartered savings bank, engaging in typical banking activities: acquiring deposits from local markets and originating loans and investing in securities. Recent federal legislation mandated that the consolidated regulatory functions of The Office of Thrift Supervision ("OTS") over the Bank and the Company be transferred to two federal agencies and that the OTS be merged into the Office of the Comptroller of the Currency (the "OCC"). Thus, as a result of the enactment in July of 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), the Federal Reserve Board (the "FRB") became, as of July 21, 2011, the principal federal bank regulatory agency for the Company and the OCC the principal federal regulator for the Bank. The Bank's charter was not affected and the Bank continues to operate as a federal stock savings bank. Its deposits are insured by the Federal Deposit Insurance Corporation. Because the Dodd-Frank Act did not eliminate the thrift charter under which the Bank has historically operated, the Bank's traditional lending and investment activities have not been affected. Further, to ensure regulatory continuity, the Dodd-Frank Act requires that the OCC designate a new Deputy Comptroller who will be responsible for the supervision and examination of federal savings associations.

The Bank's primary component of earnings is its net interest margin (also called spread or margin), the difference between interest income and interest expense. The net interest margin is managed by management (through the pricing of its products and by the types of products offered and kept in portfolio), and is affected by changes in market interest rates. The Bank also generates noninterest income in the form of fee income and gain on sale of loans.

The Bank has a strong mortgage lending focus, with the majority of its loan originations represented by single-family residential mortgages. The Bank has also successfully marketed home equity loans to its customers, as well as a wide range of shorter term consumer loans for various personal needs (automobiles, recreational vehicles, etc.). In recent years the Bank has focused on adding commercial loans to its portfolio, both real estate and non-real estate. The purpose of this diversification is to mitigate the Bank's dependence on the residential mortgage market, as well as to improve its ability to manage its spread. The Bank's management recognizes the need for sources of fee income to complement its margin, and the Bank now maintains a significant loan servicing portfolio which generates income. The gain on sale of loans also provides significant fee income in periods of high mortgage loan origination volumes. Fee income is also supplemented with fees generated from the Bank's deposit accounts, its mortgage banking business and its wealth management business. The Bank has a high percentage of non-maturity deposits, such as checking accounts and savings accounts, which allows management flexibility in managing its spread. Non-maturity deposits do not automatically reprice as interest rates rise, as do certificates of deposit.

For the past several years, management's focus has been on improving the Bank's core earnings. Core earnings can be described as income before taxes, with the exclusion of gain on sale of loans and adjustments to the market value of the Bank's loan servicing portfolio. Management believes that the Bank will need to continue to focus on increasing net interest margin, other areas of fee income, and control of operating expenses to achieve earnings growth going forward. Management's strategy of growing the bank's loan portfolio and deposit base is expected to help achieve these goals as follows: loans typically earn higher rates of return than investments; a larger deposit base should yield higher fee income; increasing the asset base will reduce the relative impact of fixed operating costs. The biggest challenge to the strategy is funding the growth of the Bank's balance sheet in an efficient manner. Deposit growth will be difficult to maintain due to significant competition for deposits and it is likely that wholesale funding (which is usually more expensive than retail deposits) will be needed to supplement it.

The level and movement of interest rates impacts the Bank's earnings as well. The Federal Reserve's Federal Open Market Committee ("FOMC") did not change the federal funds target rate which remained at 0.25% during the three months ended September 30, 2013.

Acquisition of Sterling Savings Bank Branches

From time to time the Bank has considered growth through mergers or acquisition as an alternative to its strategy of organic growth. In this connection, on June 29, 2012, the Bank entered into a definitive agreement with Sterling Savings Bank, a Washington state-chartered bank, to acquire Sterling's banking operations in the state of Montana, including seven branch locations, certain deposit liabilities, loans and other assets and liabilities associated with such branch locations. As a result of this acquisition, which closed on November 30, 2012, the Bank acquired approximately $182.5 million in additional assets, including approximately $41.3 million of pass-rated performing loans and assumed $181.6 million in new deposits. The Bank expects that the increase in its branch network as a result of the Sterling branch acquisition will substantially increase its loan origination volume and, due to the substantial increase in deposits, fee income. In addition, the acquisition of the branches is expected to increase certain of the Bank's expenses, including salaries and employee benefits and occupancy and equipment expense. The Bank received approximately $130.1 million in cash in the transaction, which may not be able to be immediately used to fund loans. While a substantial amount of the cash has been invested in securities, it may require additional time to deploy all of the proceeds to fund loans. The Company anticipates that the Sterling acquisition will be accretive to earnings per share in the first year after the acquisition. However, the size of the acquisition may cause integration challenges that could delay or reduce the expected benefits of the acquisition.

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EAGLE BANCORP MONTANA, INC. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Overview - continued

Acquisition of Sterling Savings Bank Branches - continued

The branch acquisition complements the Bank's existing growth strategy by expanding into the southern Montana market and more than doubling the Bank's retail branch network from six to 13 locations. Of the seven acquired branches six are in new markets for the Bank, including two in Missoula, one in Billings, and one each in Hamilton, Livingston and Big Timber. The seventh is in Bozeman where the Bank already has a presence. After the acquisition, the Bank became the sixth largest Montana-based banking institution.

In addition, the transaction also strengthens the Bank's mortgage origination franchise and adds a wealth management business headquartered in Bozeman, Montana. The addition of Sterling's Montana mortgage banking unit will double the Bank's mortgage banking business. This increase in the mortgage banking business and the addition of a wealth management business is expected to increase the Bank's noninterest income and further the Bank's strategy to increase fee income to complement its margin.

Financial Condition

Comparisons of financial condition in this section are between September 30, 2013 and June 30, 2013.

Total assets at September 30, 2013 were $513.86 million, an increase of $3.33 million, or 0.7%, from $510.53 million at June 30, 2013. Loans receivable increased by $18.67 million, or 8.7%, to $233.35 million at September 30, 2013, from $214.68 million at June 30, 2013. Residential mortgage loans increased by $5.56 million, commercial real estate loans increased by $5.00 million and commercial loans increased by $5.15 million. These were the largest increases among the various loan types. Home equity, consumer loans, and construction loans increased more moderately. Total loan originations were $97.72 million for the three months ended September 30, 2013, with single family mortgages accounting for $71.81 million of the total. Home equity and construction loan originations totaled $2.70 million and $4.55 million, respectively, for the same period. Commercial real estate and land loan originations totaled $12.39 million. Consumer loans originated totaled $2.68 million. Commercial loans originated totaled $3.59 million, with $2.90 million originating from loan syndication programs with borrowers residing outside of Montana. Loans held-for-sale decreased $90,000, to $20.72 million at September 30, 2013 from $20.81 million at June 30, 2013.

Total cash and cash equivalents increased by $965,000, and securities available-for-sale decreased $17.13 million. Though most security categories decreased during the period, the largest decrease was in the collateralized mortgage obligation category, dropping $8.53 million, or 17.9%.

Deposits increased $10.53 million, or 2.5%, to $428.28 million at September 30, 2013 from $417.75 million at June 30, 2013. Growth occurred across most deposit products with the exception of time certificates of deposits which decreased slightly during the period. Management attributes the organic increase in deposits to increased marketing of checking accounts as well as customers' preference for placing funds in secure, federally insured accounts.

The ability of the Bank to continue to grow its retail deposit base during the period enabled the Bank to decrease wholesale funding during the period. Advances from the Federal Home Loan Bank and other borrowings decreased $6.39 million, or 18.3%, to $28.47 million at September 30, 2013 from $34.86 million at June 30, 2013.

Total stockholders' equity decreased $1.04 million or 2.1%, to $48.19 million at September 30, 2013 from $49.23 million at June 30, 2013. This was a result of a decrease in accumulated other comprehensive income of $1.47 million mainly due to a decrease in net unrealized gains on securities available-for-sale and dividends paid of $283,000, partially offset by net income of $667,000.

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EAGLE BANCORP MONTANA, INC. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Results of Operations for the Three Months Ended September 30, 2013 and 2012

Net Income. Eagle's net income for the quarter was $667,000 versus $422,000 of net income for the three months ended September 30, 2012. The increase of $245,000, or 58.1%, was due to increases in net interest income of $958,000 and noninterest income of $1.52 million, and reductions in provision for loan losses of $76,000 and income tax expense of $106,000. These were partially offset by an increase in noninterest expense of $2.42 million. The increase in noninterest income resulted from an increase in home mortgage refinancing activity, resulting in increased gain on sale of loans. The increase was also attributable to an increase in the gain on sale of available-for-sale securities of $364,000. The provision for loan losses decreased $76,000 from the prior period due to improved credit indicators such as delinquencies. Eagle's tax provision was $106,000 lower in the current period. This reduction in tax expense is primarily attributable to a new market tax credit project that was initiated during the previous year. This project resulted in the Company receiving $2.9 million in federal new markets tax credits that can be used over the next seven years. Basic earnings per share were $0.17 for the current period, and $0.11 per share for the prior comparable period.

Net Interest Income. Net interest income increased to $3.62 million for the quarter ended September 30, 2013, from $2.66 million for the previous year's quarter. This increase of $958,000 was the result of an increase in interest and dividend income of $916,000 and by a decrease in interest expense of $42,000.

Interest and Dividend Income. Total interest and dividend income was $4.14 million for the quarter ended September 30, 2013, compared to $3.23 million for the quarter ended September 30, 2012, an increase of $916,000, or 28.4%. Interest and fees on loans increased to $3.12 million for the three months ended September 30, 2013 from $2.55 million for the same period ended September 30, 2012. This increase of $570,000, or 22.3%, was due to an increase in the average balance of loans partially offset by a decrease in the average yield of loans for the quarter ended September 30, 2013. The average interest rate earned on loans receivable decreased by 54 basis points, from 5.64% to 5.10%. Average balances for loans receivable, net, including loans held for sale, for the quarter ended September 30, 2013 were $244.57 million, compared to $180.78 million for the prior year period. This represents an increase of $63.79 million, or 35.29%. Interest and dividends on investment securities available-for-sale (AFS) increased by $350,000 for the quarter ended September 30, 2013 from $669,000 for the same quarter last year. Average balances on investments increased to $210.77 million for the quarter ended September 30, 2013, from $91.56 million for the quarter ended September 30, 2012. The average interest rate earned on investments decreased to 1.93% from 2.92%. Interest on deposits with banks decreased to $1,000 from $5,000, due to a decrease in average balances partially offset by an increase in the average rates. Average balances on deposits with banks decreased to $1.49 million for the quarter ended September 30, 2013, compared to $11.93 million for the quarter ended September 30, 2012 and the average rates on such deposits with banks increased from 0.17% at September 30, 2012 to 0.27% at September 30, 2013.

Interest Expense. Total interest expense declined in the quarter to $524,000 from $566,000 for the quarter ended September 30, 2012, a decrease of $42,000, or 7.4%. The decrease was attributable to decreases in interest on borrowings while interest on deposits increased. The average rates on deposits, which includes non-interest bearing deposits, decreased from 45 basis points to 30 basis points, but this was offset by the growth in average deposit balances. This increase in average balances is the result of both the Sterling branch acquisition and organic growth. The organic growth was likely the result of the Bank's customers continuing to opt for the safety of federally insured deposits, notwithstanding historically low rates on such deposits, over the risks and uncertainty of the capital markets. The average balances increased from $219.52 million to $422.30 million, an increase of $202.78 million. All account types experienced some decrease in average rates. Money market accounts declined one basis point to 12 basis points down from 13 basis points. Interest bearing checking account rates declined one basis point to 4 basis points down from 5 basis points. Savings account rates declined to 0.05% from 0.10%, and certificates of deposit rates decreased from 1.10% to 0.72%. Because of the increase in retail funding due to deposit growth average balances in borrowings decreased to $40.34 million for the quarter ended September 30, 2013, compared to $40.92 million for the same quarter in the previous year. The average rate paid, along with the decrease in average borrowing balances, resulted in a decrease in interest paid on borrowings to $203,000 for the quarter ended September 30, 2013 versus $294,000 paid in the previous year's quarter. The average rate paid on borrowings decreased from 3.11% last year to 2.02% for the quarter ended September 30, 2013. The average rate paid on all interest-bearing liabilities decreased 44 basis points from the quarter ended September 30, 2012 to the quarter ended September 30, 2013.

Provision for Loan Losses. Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level considered adequate by management of the Bank, to provide for probable loan losses based on prior loss experience, volume and type of lending conducted by the Bank, national and local economic conditions, and past due loans in portfolio. The Bank's policies require a review of assets on a quarterly basis. The Bank classifies loans as well as other assets if warranted. While the Bank believes it uses the best information available to make a determination with respect to the allowance for loan losses, it recognizes that future adjustments may be necessary. The Bank recorded $159,000 in provision for loan losses for the quarter ended September 30, 2013 and $235,000 in the quarter ended September 30, 2012. This decrease from 2012 was based on an analysis of a variety of factors including delinquencies within the loan portfolio. Total nonperforming loans, including restructured loans, net decreased from $2.29 million at September 30, 2012 to $959,000 at September 30, 2013. The Bank currently has $496,000 in foreclosed real estate property and other repossessed property.

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EAGLE BANCORP MONTANA, INC. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Results of Operations for the Three Months Ended September 30, 2013 and 2012 - continued

Noninterest Income. Due to the continued historic low long term interest rates, the Bank continued to experience significant refinancing activity in residential real estate as well as benefiting from operating the mortgage banking activities resulting from the Sterling acquisition which augmented our existing mortgage lending. This increased activity had a significant effect on the amount of noninterest income with total noninterest income increasing to $3.10 million for the quarter ended September 30, 2013, from $1.58 million for the quarter ended September 30, 2012, an increase of $1.52 million or 96.2%. Of this amount, net gain on sale of loans increased to $1.59 million for the quarter ended September 30, 2013 from $812,000 for the quarter ended September 30, 2012. During this period, $71.81 million of 1-4 family mortgage loans were originated compared to $40.52 million in the quarter ended September 30, 2012. In addition, $63.67 million of mortgage loans were sold during the period compared to $42.67 million sold in the quarter ended September 30, 2012, an increase of $21.0 million. The gain on sale of securities also contributed to the increase in noninterest income. Gain on sale of securities increased to $431,000 from the prior period's amount of $67,000.

Noninterest Expense. Noninterest expense was $5.85 million for the quarter ended September 30, 2013, and $3.44 million for the quarter ended September 30, 2012. The primary cause of this increase was the increase in salaries and employee benefits of $1.90 million resulting from the increase in staff from the Sterling acquisition. The valuation losses on OREO were zero compared to $68,000 in the same period last year. This decrease was due to stabilizing values in the Company's foreclosed properties. Consulting fees increased from $26,000 to $86,000 due to a couple of special projects currently underway. Amortization of core deposit intangible and tax credits expense was $109,000 compared to zero for the prior period. This amortization expense relates to the equity investment in the new markets tax credit project, which will be amortized over the life of these federal tax credits, and the amortization of the core deposit intangible. Occupancy and equipment expense, data processing, advertising, and federal insurance premiums all increased as the result of the Sterling acquisition and now operating a larger entity. Acquisition costs fell from $477,000 for the previous period to zero as the acquisition was fully completed by the third quarter of fiscal year 2013.

Income Tax Expense. Our income tax expense was $36,000 for the quarter ended September 30, 2013, compared to $142,000 for the quarter ended September 30, 2012. The effective tax rate for the quarter ended September 30, 2013 was 5.12% and was 25.17% for the quarter ended September 30, 2012. Though pretax income is higher in the current period the percent of tax free municipal bond income and Bank owned life insurance income to total income increased. Likewise, the deductibility of goodwill that resulted from the acquisition, for tax purposes has helped to reduce the effective tax rate. The effective tax rate was furthered reduced by new markets tax credits that were first taken during the second quarter of fiscal year 2013. The Company has equity investments in Certified Development Entities which have received allocations of New Markets Tax Credits ("NMTC"). Administered by the Community Development Financial Institutions Fund of the U.S. Department of the Treasury, the NMTC program is aimed at stimulating economic and community development and job creation in low-income communities. The federal income tax credits received are claimed over a seven-year credit allowance period. The federal tax credit benefits were $95,000 for the quarter ended September 30, 2013.

Liquidity, Interest Rate Sensitivity and Capital Resources

The Bank is required to maintain minimum levels of liquid assets as defined by the Office of the Comptroller of the Currency ("OCC") regulations. The OCC has eliminated the statutory requirement based upon a percentage of deposits and short-term borrowings. The OCC states that the liquidity requirement is retained for safety and soundness purposes, and that appropriate levels of liquidity will depend upon the types of activities in which the company engages. For internal reporting purposes, the Bank uses policy minimums of 1.0%, and 8.0% for "basic surplus" and "basic surplus with FHLB" as internally defined. In general, the "basic surplus" is a calculation of the ratio of unencumbered short-term assets reduced by estimated percentages of CD maturities and other deposits that may leave the Bank in the next 90 days divided by total assets. "Basic surplus with FHLB" adds to "basic surplus" the additional borrowing capacity the Bank has with the FHLB of Seattle. The Bank exceeded those minimum ratios as of both September 30, 2013 and September 30, 2012.

The Bank's primary sources of funds are deposits, repayment of loans and mortgage-backed and collateralized mortgage obligation securities, maturities of investments, funds provided from operations, and advances from the Federal Home Loan Bank of Seattle and other borrowings. Scheduled repayments of loans and mortgage-backed and collateralized mortgage obligation securities and maturities of investment securities are generally predictable. However, other sources of funds, such as deposit flows and loan prepayments, can be greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses liquidity resources principally to fund existing and future loan commitments. It also uses them to fund maturing certificates of deposit, demand deposit withdrawals and to invest in other loans and investments, maintain liquidity, and meet operating expenses.

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EAGLE BANCORP MONTANA, INC. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Liquidity, Interest Rate Sensitivity and Capital Resources - continued

Liquidity may be adversely affected by unexpected deposit outflows, higher interest rates paid by competitors, and similar matters. Management monitors projected liquidity needs and determines the level desirable, based in part on commitments to make loans and management's assessment of the Bank's ability to generate funds.

At August 31, 2013, the Bank's measure, as internally determined, of sensitivity to interest rate movements, as measured by a 200 basis point rise in interest rates scenario, decreased the economic value of equity ("EVE") by 17.2%. The Bank is well within the guidelines set forth by the Board of Directors for interest rate risk sensitivity. The Bank's tier I core capital ratio, as measured under OCC rules, decreased from 13.86% as of September 30, 2012 to 8.62% as of September 30, 2013. The Bank's strong capital position helps to mitigate its interest rate risk exposure.

As of September 30, 2013, the Bank's regulatory capital was in excess of all applicable regulatory requirements. At September 30, 2013, the Bank's tangible, core, and risk-based capital ratios amounted to 8.62%, 8.62%, and 15.60%, respectively, compared to regulatory requirements of 1.50%, 3.00%, and 8.00%, respectively. See the following table (dollars in thousands):

                        At September 30, 2013
                             (Unaudited)
                         Dollar           % of
                         Amount          Assets
Tangible capital:
Capital level         $     43,773          8.62
Requirement                  7,620          1.50
Excess                      36,153          7.12

Core capital:
Capital level               43,773          8.62
Requirement                 15,240          3.00
Excess                      28,533          5.62

Risk-based capital:
Capital level               45,773         15.60
Requirement                 23,480          8.00
Excess                      22,293          7.60

Impact of Inflation and Changing Prices

Our financial statements and the accompanying notes have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of our operations. Interest rates have a greater impact on our performance than do the general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

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EAGLE BANCORP MONTANA, INC. AND SUBSIDIARY

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