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MBTF > SEC Filings for MBTF > Form 10-Q on 14-Nov-2013All Recent SEC Filings

Show all filings for MBT FINANCIAL CORP

Form 10-Q for MBT FINANCIAL CORP


14-Nov-2013

Quarterly Report


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

Introduction
MBT Financial Corp. (the "Company") is a bank holding company with one subsidiary, Monroe Bank & Trust ("the Bank"). The Bank is a commercial bank with a wholly owned subsidiary, MB&T Financial Services. MB&T Financial Services is an insurance agency which sells insurance policies to the Bank. The Bank operates 17 branch offices in Monroe County, Michigan and 7 offices in Wayne County, Michigan. The Bank's primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. The discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

Executive Overview
The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management products and services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving asset quality, profitability, and capital.

The net profit of $21,287,000 for the quarter ended September 30, 2013 was significantly impacted by the Company's elimination of the valuation allowance on its deferred tax asset. In 2010 the Company established a valuation allowance against its deferred tax asset due to its recent operating losses and uncertainty about its ability to utilize its tax loss carry forwards. In 2012, following six consecutive quarterly profits and based on its expectations for future earnings, the Company reversed $5 million of its then $24.2 million valuation allowance. This quarter the company achieved its ninth consecutive quarterly profit and has achieved a cumulative profit for the past twelve quarters. In addition, the Company has exceeded its earnings projections for 2013 and revised its future earnings projections. Based on this information, the Company has determined that it more likely than not will be able to fully utilize its tax loss carry forwards and determined that it was appropriate to reverse the remaining $18.8 million deferred tax asset valuation allowance by recording a credit to tax expense during the quarter.

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The national economic recovery is continuing slowly, and the recovery in southeast Michigan is gaining strength. Local unemployment rates improved significantly since 2011, and while they are now comparable to the state and national averages, they remain above the historical norms. Commercial and residential development property values are beginning to improve slightly, but remain below pre-recession levels. Our total problem assets, which include nonperforming loans, other real estate owned, non accrual investments, and performing loans that are internally classified as potential problems, improved significantly during the third quarter of 2013. Problem assets went down $14.4 million, or 12.5% during the third quarter of 2013, and decreased $30.5 million or 23.1% compared to a year ago. Overall asset quality has improved over the past year and net charge offs were only $629,000 in the third quarter of 2013. Improving economic conditions and improving historical loss ratios enabling us to decrease our Allowance for Loan and Lease Losses (ALLL) from $17.2 million to $16.8 million in the third quarter. The loan portfolio held for investment decreased during the quarter, and the ALLL as a percent of loans decreased slightly from 2.79% to 2.74%. We anticipate that the recovery in our local markets will continue at a slow pace into 2014, which may result in increased lending activity and problem asset reductions. We will continue to focus our efforts on improving asset quality, maintaining liquidity, strengthening capital, and controlling expenses.

Net Interest Income decreased $82,000 compared to the third quarter of 2012 as the average earning assets decreased $60.5 million but the net interest margin increased from 3.05% to 3.17%. The decrease in the average earning assets was due to the use of short term investments to pay off maturing borrowings in the second quarter of 2013. The cost of those borrowings was higher than the yield on the assets used to retire the borrowings, and this caused the net interest margin to increase. The provision for loan losses decreased $1.35 million compared to the third quarter of 2012 as decreases in the historical loss rates and in the amount of loans compared to a year ago decreased the amount of ALLL required. Non interest income for the quarter increased $93,000, primarily due to an increase in rent income on Other Real Estate Owned. Non interest expenses increased $274,000, as salaries and employee benefits increased and losses on sales of other real estate owned (OREO) increased. The increase in OREO losses was due to the write down of one large commercial real estate property in the third quarter of 2013, and we expect credit related expenses to improve into 2014.

Critical Accounting Policies
The Company's Allowance for Loan Losses, Deferred Tax Asset Valuation Allowance, Fair Value of Investment Securities, and Other Real Estate Owned are "critical accounting estimates" because they are estimates that are based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Company's financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

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Income tax accounting standards require companies to assess whether a valuation allowance should be established against deferred tax assets based on the consideration of all evidence using a "more likely than not" standard. We reviewed our deferred tax asset, considering both positive and negative evidence and analyzing changes in near term market conditions as well as other factors that may impact future operating results. Significant negative evidence is our net operating losses for the years 2009 through 2011, combined with a difficult economic environment and the slow pace of the economic recovery in southeast Michigan. Positive evidence includes our history of strong earnings prior to 2008, our ninth consecutive quarterly profit in the third quarter of 2013, our cumulative pre tax profits in the last twelve quarters, our strong capital position, our improving core earnings, our improving asset quality, our non interest expense control initiatives, and our projections for future taxable earnings. Based on our analysis of the evidence, we believed that it was appropriate to eliminate our valuation allowance in the third quarter of 2013.

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

Financial Condition
National economic conditions began to recover in the second half of 2009, but regional conditions remained weak through 2010. Local unemployment and property values stabilized during 2011 and began to improve in 2012. The economic environment in southeast Michigan is continuing to slowly improve, and we expect the slow recovery to continue in our market area throughout 2013. Management intends to continue to focus efforts on improving credit quality, managing capital, and mitigating enterprise risk.

With respect to credit quality, our nonperforming assets ("NPAs") decreased 8.6% during the quarter, from $78.9 million to $72.1 million, and total problem assets decreased from $115.7 million to $101.3 million. Both of these measures were impacted by a small number of large credit relationships, and both reflect improvement compared to a year ago. Over the last twelve months, NPAs decreased $17.3 million, or 19.4%, with nonperforming loans decreasing 20.4% from $72.7 million to $57.9 million, and Other Real Estate Owned ("OREO") decreasing 21.4% from $13.8 million to $10.8 million. Total problem assets, which includes all NPAs and performing loans that are internally classified as substandard, decreased $30.5 million, or 23.1%. The Company's Allowance for Loan and Lease Losses ("ALLL") decreased $2.4 million over the last four quarters due to a decrease in the size of the portfolio and an improvement in the quality of the assets in the loan portfolio. The ALLL is now 2.74% of loans, down from 2.94% at September 30, 2012. The ALLL is 28.94% of nonperforming loans ("NPLs"), compared to 24.78% at year end and 26.29% at September 30, 2012. In light of current economic conditions, we believe that this level of ALLL adequately estimates the potential losses in the loan portfolio.

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Since December 31, 2012, total loans held for investment decreased 2.6% because new loan activity was not sufficient to cover payments received and other reductions. New loan production increased in the second and third quarters of 2013, but payoffs of some large problem credit relationships resulted in a net reduction of total loans held for investment. As local economic activity increases, the amount of loans in our pipeline is increasing, and new loan production may exceed run off, resulting in an increase in loans outstanding.

Since December 31, 2012, deposits increased $5.3 million, or 0.5% due to normal seasonal fluctuations in local deposit activity. We repaid $95.0 million of borrowings from the Federal Home Loan Bank of Indianapolis in the second quarter of 2013. This reduction in funding was offset by a reduction in cash and investment securities, causing our total assets to decrease $70.5 million, or 5.6% since the end of 2012. The cost of the non deposit funding exceeded the yield on the assets utilized to pay off the debt, so this reduction in assets improved our net interest income in the third quarter of 2013. Our net interest margin improved from 2.92% in the second quarter of 2013 to 3.17% in the third quarter, and our net interest income increased from $8.1 million in the second quarter of 2013 to $8.5 million in the third quarter of 2013. The Company expects deposit funding to remain relatively stable for the next few quarters.

Total capital increased $17.3 million, or 20.6%, during the first nine months of 2013 as the profit of $23.9 million and a private placement stock offering of $1.7 million were partially offset by the decrease of $8.5 million in the accumulated other comprehensive income (AOCI). AOCI decreased mainly due to a decrease in the value of our securities available for sale. The increase in capital and the decrease in total assets caused the capital to assets ratio to increase from 6.59% at December 31, 2012 to 8.42% at September 30, 2013.

Results of Operations - Third Quarter 2013 vs. Third Quarter 2012 Net Interest Income - A comparison of the income statements for the three months ended September 30, 2012 and 2013 shows a decrease of $82,000, or 1.0%, in Net Interest Income. Interest income on loans decreased $1.1 million or 12.5% as the average loans outstanding decreased $49.7 million and the average yield on loans decreased from 5.23% to 4.94%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $132,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks decreased $10.7 million and the yield decreased from 1.88% to 1.81%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings helped reduce the funding costs. The interest expense on deposits decreased $455,000 or 30.6% even though the average deposits increased $35.6 million because the average cost of deposits decreased from 0.58% to 0.39%. The cost of borrowed funds decreased $686,000 as the average amount of borrowed funds decreased $96.6 million and the average cost of the borrowings decreased from 2.83% to 2.82%.

Provision for Loan Losses - The Provision for Loan Losses decreased from $1.55 million in the third quarter of 2012 to $200,000 in the third quarter of 2013. Net charge offs were $629,000 during the third quarter of 2013, compared to $1.9 million in the third quarter of 2012. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, an improvement in portfolio risk indicators, and a decrease in the historical loss percentages, the amount of provision required to maintain an adequate ALLL in the third quarter of 2013 decreased 87.1% compared to the amount required in the third quarter of 2012. The ALLL is 2.74% of loans as of September 30, 2013, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

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Other Income - Non interest income increased $93,000, or 2.3% compared to the third quarter of 2012. Service charges and other fees decreased $49,000, or 4.2% due to a decrease in the amount of checking account overdraft activity. Debit card income increased $23,000 or 4.7% as debit card usage continues to grow. Securities gains increased $43,000 as the Bank sold available for sale securities in the third quarter of 2013 in order to maintain adequate cash liquidity. Origination fees on mortgage loans sold decreased $165,000, or 55.4% as a sharp increase in market interest rates near the end of the second quarter of 2013 significantly decreased mortgage refinance activity in the third quarter of 2013. Other non interest income increased $238,000 primarily due to higher rental income on OREO properties.

Other Expenses - Total non interest expenses increased $274,000, or 2.8% compared to the third quarter of 2012. Salaries and Employee Benefits increased $241,000, or 4.8%, as salaries increased due to an increase in the number of employees, annual merit increases, and the reinstatement of the accrual for the officer incentive program. Occupancy expense increased $30,000 due to higher maintenance costs. Equipment expense decreased $27,000 due to lower computer and data processing expenses. Marketing expense increased $29,000 due to higher advertising and sales promotion expenses. Losses on Other Real Estate Owned (OREO) properties increased $259,000 compared to the third quarter of 2012 mainly due to a valuation adjustment on one large commercial real estate property. Other OREO expenses decreased $188,000 as property tax expense decreased due to the reduction in the amount of properties owned.

As a result of the above activity, the Profit Before Income Taxes in the third quarter of 2013 was $2,492,000, an increase of $1,087,000 compared to the pre tax profit of $1,405,000 in the third quarter of 2012. Since 2010, the Company has maintained a valuation allowance against all or part of its deferred tax asset. This quarter, after a review of the positive and negative evidence, we determined that it is more likely than not that we will utilize all of our net operating loss carry forwards before they expire. As a result, we decided that it was appropriate to reverse the remaining deferred tax asset valuation allowance of $18.8 million by recording a credit to federal income tax expense. If we did not have the valuation allowance reversal and the benefit of the NOL carry forward, we would have incurred a federal income tax expense for the quarter of $634,000, for an effective tax rate of 25.4%. The income tax expense of $17,000 that was recorded in the third quarter of 2012 was for an Alternative Minimum Tax payment. The Net profit for the third quarter of 2013 was $21,287,000, an increase of 1,433.6% compared to the net profit of $1,388,000 in the third quarter of 2012.

Results of Operations - Nine months ended September 30, 2013 vs. Nine months ended September 30, 2012
Net Interest Income - A comparison of the income statements for the nine months ended September 30, 2012 and 2013 shows a decrease of $1,661,000, or 6.3%, in Net Interest Income. Interest income on loans decreased $3.7 million or 13.7% as the average loans outstanding decreased $50.3 million and the average yield on loans decreased from 5.36% to 5.01%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $784,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $36.4 million but the yield decreased from 2.03% to 1.68%. The yield on investments decreased because the Company increased its strong liquidity position in 2013 by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit helped reduce the funding costs. The interest expense on deposits decreased $1,603,000 or 32.3% even though the average deposits increased $30.2 million because the average cost of deposits decreased from 0.65% to 0.43%. The cost of borrowed funds decreased $1,187,000 as the average amount of borrowed funds decreased $50.6 million and the average cost of the borrowings decreased from 2.89% to 2.72%.

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Provision for Loan Losses - The Provision for Loan Losses decreased from $4.85 million in the first nine months of 2012 to $2.1 million in the first nine months of 2013. Net charge offs were $2.6 million during the first nine months of 2013, compared to $6.6 million in the first nine months of 2012. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, an improvement in portfolio risk indicators, and a decrease in the historical loss percentages, the amount of provision required to maintain an adequate ALLL in the first nine months of 2013 decreased 56.7% compared to the amount required in the first nine months of 2012. The ALLL is 2.74% of loans as of September 30, 2013, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income - Non interest income decreased $171,000, or 1.4% compared to the first nine months of 2012. The income in the first nine months of 2012 included gains on securities transactions that were the result of restructuring activity in the investment portfolio. Excluding securities gains in both years, non interest income increased $762,000 or 6.9%. Wealth management income increased $397,000 due to an increase in the market value of assets managed, new business brought in to the bank, and the effect of a non recurring charge to income in 2012. Service charges on deposit accounts decreased $164,000, or 4.8% compared to 2012 due a decrease in deposit account overdraft activity in 2013. Other non interest income increased $477,000 primarily due to higher income on brokerage services and higher rental income on OREO properties.

Other Expenses - Total non interest expenses increased $240,000, or 0.8% compared to the first nine months of 2012. Salaries and Employee Benefits increased $719,000, or 4.8%, as salaries increased due to an increase in the number of employees, annual merit increases, and the reinstatement of the officer incentive plan. Equipment expense decreased $202,000 due to lower computer and data processing expenses. Losses on Other Real Estate Owned (OREO) properties increased $467,000 compared to the first nine months of 2012 due to valuation write downs of properties owned and liquidation of some large properties at losses in an auction in 2013. Other OREO expenses decreased $429,000 as property tax and maintenance costs were lower due to the decrease in the number of properties owned. Other non interest expense decreased $338,000, or 10.1% in the first nine months of 2013 due to lower directors' fees and lower debit card fraud losses.

As a result of the above activity, the Profit Before Income Taxes in the first nine months of 2013 was $5,102,000, an increase of $678,000 compared to the pre tax profit of $4,424,000 in the first nine months of 2012. Since 2010, the Company maintained a valuation allowance against all or part of its deferred tax asset. In the third quarter of 2013, after a review of the positive and negative evidence, we determined that it is more likely than not that we will utilize all of our net operating loss carry forwards before they expire. As a result, we decided that it was appropriate to reverse the remaining deferred tax asset valuation allowance of $18.8 million by recording a credit to federal income tax expense in the third quarter of 2013. If we did not have the valuation allowance reversal and the benefit of the NOL carry forward, we would have incurred a federal income tax expense for the nine months of $1,086,000, for an effective tax rate of 21.3%. The income tax expense of $1,566,000 that was recorded in the first nine months of 2012 was primarily to accrue for an estimated audit adjustment. The Net profit for the first nine months of 2013 was $23,897,000, an increase of 736.1% compared to the net profit of $2,858,000 in the first nine months of 2012.

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Cash Flows
Cash flows provided by operating activities decreased $0.8 million compared to the first nine months of 2012 as the increase in net income was due to improvements in non cash items, including the decrease in the provision for loan losses and the increase in the deferred tax asset. Cash flows from investing activities decreased $8.0 million in the first nine months of 2013 compared to the first nine months of 2012 mainly because the amount of securities maturing or redeemed prior to maturity decreased $158.6 million because the increase in market interest rates in 2013 caused a decrease in early redemptions. This was partially offset by an increase of $23.6 million in sales of investment securities and a decrease of $135.4 million in purchases of investment securities. The amount of cash used for financing activities increased $81.2 million primarily due to the repayment of $95.0 million of maturing Federal Home Loan Bank advances in the first nine months of 2013. The amount of cash provided from deposit growth was $7.2 million higher in the first nine months of 2013 than in the first nine months of 2012. The Company also issued $1.7 million of common stock in a private placement in the first nine months of 2013. Total cash and cash equivalents decreased $77.1 million in the first nine months of 2013 compared to the increase of $12.9 million in the first nine months of 2012 mainly due to the use of cash to pay off maturing debt in 2013.

Deferred Tax Asset Valuation Allowance
ASC 740 guidance requires that a corporation assess whether a valuation allowance should be established against its deferred tax asset based on the consideration of all available evidence using a "more likely than not" standard. In making such judgments, the corporation should consider both positive and negative evidence and analyze changes in near term market conditions as well as other factors which may impact future operating results. The Company first established a valuation allowance of $13.8 million against its $17 million deferred tax asset effective December 31, 2009. The valuation allowance was increased to 100% of the $20.9 million deferred tax asset effective December 31, 2010. The valuation allowance was maintained at 100% of the deferred tax asset, which increased to $24.2 million during 2011. Based on its evaluation of the positive and negative evidence, the Company determined that it would utilize a significant portion of its net operating loss carry forwards in future periods and that it was "more likely than not" that it would utilize a portion of its deferred tax assets. As a result, management elected to reduce the Company's deferred tax asset valuation allowance by $5 million as of December 31, 2012.

The negative evidence evaluated as of September 30, 2013 consists primarily of the economic conditions and the Company's financial results during the 2008-2010 period. In 2008, the southeast Michigan region led the nation into a prolonged recession due to weak sales in the automotive sector. In the years leading up to the recession, housing values increased rapidly, and when unemployment began to rise, the housing market suffered and real estate values declined. The decline in real estate values resulted in an abrupt reduction in mortgage loan originations and the ability of homeowners to use the equity in their homes to fund their spending. The Bank's loan portfolio primarily consisted of loans secured by real estate, including residential and commercial development and 1-4 family residential property, and we experienced significant increases in defaults in these loans. Non performing loans as a percent of total loans increased from 3.39% as of December 2007 to 10.84% as of December 31, 2010, and net charge offs as a percent of average loans increased from 0.49% in 2007 to 2.89% in 2010. Due to the deterioration of the Bank's loan portfolio, we needed to increase our allowance for loan losses from $13.8 million at the end of 2006 to $24.1 million at the end of 2009. This required an increase in our provision for loan losses from $11.4 million in 2007 to $36.0 million in 2009, and our net income decreased from a profit of $7.7 million in 2007 to a loss of $34.3 million in 2009. Recent negative evidence includes the slow pace of the economic recovery and the uncertainty of the economic conditions in southeast Michigan due to the bankruptcy of the City of Detroit. Although the Company does not have any direct exposure to the City of Detroit, the impact of the bankruptcy on the region's economy is currently unknown.

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The positive evidence evaluated as of September 30, 2013 consists of the improvements in the economic conditions beginning in 2011, the improvements in the Bank's asset quality and earnings beginning in 2011 and continuing through the first three quarters of 2013, the expectations of future earnings improvements for the Company, and the Company's long history of strong financial performance prior to 2008. During the recession, the national unemployment rate increased from 5.0% at the end of 2007 to its peak of 10.0% in October, 2009. Since the recovery began, the national unemployment rate declined to 7.2% at the end of the third quarter of 2013. During the same period, the unemployment rate for Michigan increased from 7.2% to a high of 14.2% in August, 2009 and has declined to 9.0% in the third quarter of 2013. From December 2007 to December 2009, the Case Shiller housing price index for southeast Michigan decreased 29.8%, and from that point, the index recovered 27.5% as of August 2013. These economic improvements have resulted in asset quality and earnings improvements at the Bank. Problem assets declined $53.9 million, or 34.7% from 2010 to September 2013 and net charge offs decreased from 3.36% of loans in 2009 to 0.64% through the first three quarters of 2013, annualized. The improvement in asset quality has enabled the Bank to reduce its allowance for loan losses 21.0% over the same period. The asset quality improvement has led to an improvement in earnings for the Company, which has posted nine consecutive quarterly profits . . .

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