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BYFC > SEC Filings for BYFC > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for BROADWAY FINANCIAL CORP \DE\

Form 10-K for BROADWAY FINANCIAL CORP \DE\


31-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and other factors that have affected our reported results of operations and financial condition or may affect our future results or financial condition. Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K.

Overview

During the third quarter of 2013, we completed a recapitalization of the Company's balance sheet that included: a private placement of new common stock; exchanges of common equity capital for preferred stock, associated accumulated dividends, and senior debt; and a modification of the terms of the remaining senior debt. Collectively, these transactions have strengthened the balance sheets of the Company and the Bank, significantly simplified the capital structure of the Company, reduced the Company's annual requirements for servicing debt and preferred stock by $1.2 million, eliminated all cumulative dividends on preferred stock and improved the capital and liquidity of both the Company and the Bank. See "Capital Resources" for more information on these transactions and their effects.

During 2013, we continued to take aggressive actions to reduce our classified assets, including loan sales, foreclosures on properties securing defaulted loans, and sales of REO. Also, during the latter part of 2013, we began to pursue prudent growth in our loan portfolio to increase interest income. Our focus on loan growth is targeted on selective niches within the multi-family and investor-owned single family residential loan markets, which are markets that our current senior management has successfully served at other institutions in the past and which are consistent with the Company's focus on low-to-moderate income communities in Southern California.

Total assets decreased by $41.2 million during 2013, primarily due to a $25.6 million decrease in our loan portfolio as we focused on divesting problem assets. The decrease in our loan portfolio, including loans held for sale, consisted of a decrease of $19.2 million in our one-to-four family residential real estate loan portfolio, a decrease of $15.8 million in our commercial real estate loan portfolio, a decrease of $12.6 million in our church loan portfolio, a decrease of $311 thousand in our construction loan portfolio and a decrease of $1.8 million in our commercial loan portfolio. These decreases were partially offset by an increase of $24.1 million in our multi-family residential real estate loan portfolio.

Corresponding to the decrease in assets during 2013, we decreased our total deposits by $42.7 million, primarily by decreasing certificates of deposit ("CDs"), in particular CDs with higher interest costs that were obtained through deposit listing services, and 36-month CDs. FHLB borrowings remained the same during 2013 while senior debt, including the deferred gain resulting from interest forgiveness on our senior loan, decreased by $2.1 million because of the debt exchange that was part of the Recapitalization.

We recorded a net loss of $301 thousand for the year ended December 31, 2013, compared to net income of $588 thousand for the year ended December 31, 2012. Results during 2012 included a gain of $2.5 million from the sale of our former headquarters building during the second quarter of 2012, whereas results for 2013 included a gain of $1.2 million from the forgiveness of interest that was part of the Recapitalization completed during the third quarter of 2013. During 2013 we generated lower net interest income before provision for loan losses compared to 2012 as the average balance of our loan portfolio decreased by $65.3 million. The decrease in net interest income was partially offset by decreases in the provision for loan losses and non-interest expense.


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Regulatory Matters

During the first nine months of 2013, the Orders issued to us effective September 9, 2010 limited the increase in the Bank's total assets during any quarter to an amount equal to the net interest credited on deposit liabilities during the prior quarter without the prior written notice to and receipt of notice of non-objection from the OCC. This specific growth restriction was eliminated on October 30, 2013 when the Bank entered into a Consent Order with the OCC, which superseded the Order that was applicable to the Bank. The Bank is subject to the requirements of the new Consent Order, which includes requirements that the Bank develop a Strategic Plan and a Capital Plan and that the Bank not begin to implement those plans, or any diversions from those plans, until it has submitted the plans, or any proposed diversions, to the OCC for a written statement that the OCC has no supervisory objection thereto. The Bank submitted a Strategic Plan and a Capital Plan to the OCC in late January 2014.

Comparison of Operating Results for the Years Ended December 31, 2013 and 2012

General

Our most significant source of income is net interest income, which is the difference between our interest income and our interest expense. Generally, interest income is generated from our loans and investments (interest-earning assets) and interest expense is incurred from deposits and borrowings (interest-bearing liabilities). Our results of operations are also affected by our provision for losses, non-interest income generated from service charges and fees on loan and deposit accounts, gains or losses on the sale of loans, REO and securities, non-interest expenses and income taxes.

Net Income (Loss)

For the year ended December 31, 2013, we recorded a net loss of $301 thousand and a loss allocable to common stockholders of $1.1 million, or $0.13 loss per diluted common share. For the year ended December 31, 2012, we recorded net income of $588 thousand and a loss allocable to common stockholders of $693 thousand, or $0.38 loss per diluted common share.

The change from net income for the year 2012 to a net loss for the year 2013 was primarily due to a gain of $2.5 million on the sale of our former headquarters building in the second quarter of 2012, which was partially offset by a gain of $1.2 million on our senior debt restructuring in the third quarter of 2013. In addition, the decrease during 2013 was attributable to lower net interest income before provision for loan losses, which was partially offset by a lower provision for loan losses and lower non-interest expenses for the year ended December 31, 2013 as compared to 2012. Also, earnings per share were significantly impacted during 2013 because we issued a combined total of 18.2 million shares of common stock, representing over 90% of our total shares of common stock then outstanding, in connection with the Recapitalization that closed on August 22, 2013.

Net Interest Income

For the year ended December 31, 2013, net interest income before provision for loan losses totaled $11.1 million, down $2.4 million, or 18%, from $13.5 million of net interest income before provision for loan losses for the same period a year ago. The decrease of $2.4 million in net interest income primarily resulted from a decrease of $53.2 million in average interest-earning assets and a decrease of 15 basis points in net interest margin.

Interest income decreased $3.9 million, or 20%, to $16.0 million for the year 2013 from $19.9 million for the year 2012. The decrease in interest income was primarily due to a decrease of $53.2 million in average


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interest-earning assets, primarily reflecting a decrease of $65.3 million in the average balance of loans receivable, and a decrease of $4.7 million in the average balance of securities, offset by an increase of $18.7 million in the average balance of federal funds sold. The decrease of $65.3 million in average loans receivable from $325.0 million for the year 2012 to $259.7 million for the year 2013 resulted in a reduction of $3.9 million in interest income. The average yield on loans decreased from 5.93% for the year 2012 to 5.90% for the year 2013 primarily due to payoffs of loans which carried a higher average yield than the average yield of loans receivable and lower yields on loan originations as a result of the low interest rate environment. The average yield on total interest-earning assets decreased from 5.13% for the year 2012 to 4.77% for the year 2013, as our loan yield decreased and a higher percentage of our total interest-earning assets were invested in lower yielding federal funds sold. The reduction in the average size of the loan portfolio during 2013 reflected the Company's strategy to improve the quality of its assets, in part through asset sales and loan payoffs of certain categories of loans, such as loans secured by church properties. During 2013, we sold $15.5 million of non-accrual loans and $4.6 million of non-accrual loans were paid off or returned to accrual status. Also, in the second half of 2013, we began to refocus on originating loans, primarily loans secured by multi-family properties, and rebuilding our loan portfolio to improve the yield on interest-earning assets and grow total interest income. The combination of the improvement in the quality of our loan portfolio and refocus on loan originations allowed us to increase the average yield on our loans and our interest rate margin during the fourth quarter of 2013. During the fourth quarter, the average yield on our loans increased to 5.99% from 5.75% in the fourth quarter of 2012 and our interest rate margin increased to 3.73% from 3.29% during the same period. We intend to finance loan growth in the near term by using excess federal funds sold.

Interest expense decreased $1.5 million, or 24%, to $4.9 million for the year 2013 from $6.4 million for the year 2012. The decrease in interest expense was primarily attributable to a decrease of $42.3 million in the average balance of deposits from $275.2 million for the year 2012 to $232.9 million for the year 2013, which resulted in a reduction of $562 thousand in interest expense. Additionally, the average cost of deposits decreased 22 basis points from 1.18% for the year 2012 to 0.96% for the year 2013, which resulted in a reduction of $445 thousand in interest expense. The decreases in the average balance and average cost of deposits reflect the maturities of certificates of deposit bearing higher rates. Also contributing to the decrease in interest expense during 2013 was a lower average balance and average cost of FHLB advances. The average balance of FHLB advances decreased $3.2 million, from $82.7 million for the year 2012 to $79.5 million for the year 2013, which resulted in a decrease of $90 thousand in interest expense. The average cost of FHLB advances decreased 35 basis points, from 2.95% for the year 2012 to 2.60% for the year 2013, which resulted in a decrease of $280 thousand in interest expense. The decrease in the average cost of FHLB advances was primarily due to the refinancing of $20.0 million of higher costing FHLB advances in the second and fourth quarters of 2012 and another $28 million in the second quarter of 2013.

Analysis of Net Interest Income

Net interest income is the difference between income on interest-earning assets and the expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. The yields set forth below include the effect of deferred loan fees, and discounts and premiums that are amortized or accreted to interest income or


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expense. We do not accrue interest on loans on non-accrual status; however, the balance of these loans is included in the total average balance, which has the effect of reducing average loan yields.

                                              For the year ended December 31,
                                          2013                                2012
                                                    Average                             Average
                             Average                 Yield/      Average                 Yield/
(Dollars in Thousands)       Balance    Interest      Cost       Balance    Interest      Cost
Assets
Interest-earning assets:
Interest-earning deposits   $   4,832    $     21       0.43 %  $   6,559    $     22       0.34 %
Federal Funds sold and
other short-term
investments                    55,375         120       0.22 %     36,723          38       0.10 %
Investment securities               -           -          -          481          24       4.99 %
Residential
mortgage-backed
securities                     10,707         306       2.86 %     14,946         467       3.12 %
Loans receivable (1)          259,747      15,331       5.90 %    325,029      19,279       5.93 %
FHLB stock                      3,822         188       4.92 %      3,939          61       1.55 %


Total interest-earning
assets                        334,483    $ 15,966       4.77 %    387,677    $ 19,891       5.13 %


Non-interest-earning
assets                         15,330                               6,738


Total assets                $ 349,813                           $ 394,415




Liabilities and
Stockholders' Equity
Interest-bearing
liabilities:
Money market deposits       $  16,585    $     64       0.39 %  $  18,980    $     82       0.43 %
Passbook deposits              37,376         120       0.32 %     36,530         118       0.32 %
NOW and other demand
deposits                       33,600          27       0.08 %     37,814          27       0.07 %
Certificate accounts          145,366       2,028       1.40 %    181,849       3,019       1.66 %


Total deposits                232,927       2,239       0.96 %    275,173       3,246       1.18 %
FHLB advances                  79,544       2,067       2.60 %     82,694       2,437       2.95 %
Junior subordinated
debentures (2)                  6,000         203       3.38 %      6,000         183       3.05 %
Senior debt (3)                 4,127         355       8.60 %      5,000         560      11.20 %


Total interest-bearing
liabilities                   322,598    $  4,864       1.51 %    368,867    $  6,426       1.74 %


Non-interest-bearing
liabilities                     6,782                               6,776
Stockholders' Equity           20,433                              18,772


Total liabilities and
stockholders' equity        $ 349,813                           $ 394,415




Net interest rate
spread (4)                               $ 11,102       3.26 %               $ 13,465       3.39 %




Net interest rate
margin (5)                                              3.32 %                              3.47 %
Ratio of interest-earning
assets to
interest-bearing
liabilities                                           103.68 %                            105.10 %
Return on average assets                               (0.09 %)                             0.15 %
Return on average equity                               (1.47 %)                             3.13 %
Average equity to average
assets ratio                                            5.84 %                              4.76 %
Dividend payout ratio (6)                                  -                                   -


--------------------------------------------------------------------------------
    (1)


Amount is net of deferred loan fees, loan discounts, and loans in process, and includes loans held for sale. (2)
Includes compounding on past due interest. (3)
Includes default rate margin that was in effect to August 22, 2013. No interest expense was recognized on the senior debt post restructuring because the floating interest rate on the remaining modified loan did not exceed the floor rate of 6% during the remainder of 2013. (4)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. (5)
Net interest rate margin represents net interest income as a percentage of average interest-earning assets. (6)
Percentage is calculated based on dividends paid on common stocks divided by net income (loss) less dividends and accretion on preferred stocks.

Changes in our net interest income are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth information regarding changes in our interest income and expense for the years indicated. Information is provided in each category with respect


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to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the total change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

                          Year ended December 31, 2013          Year ended December 31, 2012
                                   Compared to                           Compared to
                          Year ended December 31, 2012          Year ended December 31, 2011
                           Increase (Decrease) in Net            Increase (Decrease) in Net
                                 Interest Income                       Interest Income
                         Due to        Due to                  Due to        Due to
                         Volume         Rate       Total       Volume         Rate       Total
                                                    (In thousands)
Interest-earning
assets:
Interest-earning
deposits                $       (7 )   $      6   $     (1 )  $        1     $      7   $      8
Federal funds sold
and other short term
investments                     26           56         82            18            6         24
Investment
securities, net                (24 )          -        (24 )         (26 )          -        (26 )
Mortgage backed
securities, net               (124 )        (37 )     (161 )        (141 )        (42 )     (183 )
Loans receivable,
net                         (3,854 )        (94 )   (3,948 )      (4,147 )       (950 )   (5,097 )
FHLB stock                      (2 )        129        127             -           50         50


Total
interest-earning
assets                      (3,985 )         60     (3,925 )      (4,295 )       (929 )   (5,224 )


Interest-bearing
liabilities:
Money market
deposits                       (10 )         (8 )      (18 )         (22 )          6        (16 )
Passbook deposits                3           (1 )        2            (5 )         (6 )      (11 )
NOW and other demand
deposits                        (3 )          3          -            (4 )         (9 )      (13 )
Certificate accounts          (552 )       (439 )     (991 )        (611 )       (596 )   (1,207 )


Total deposits                (562 )       (445 )   (1,007 )        (642 )       (605 )   (1,247 )
FHLB advances                  (90 )       (280 )     (370 )        (129 )       (133 )     (262 )
Junior subordinated
debentures                       -           20         20             -           12         12
Senior debt                    (88 )       (117 )     (205 )           -         (128 )     (128 )


Total
interest-bearing
liabilities                   (740 )       (822 )   (1,562 )        (771 )       (854 )   (1,625 )


Change in net
interest income         $   (3,245 )   $    882   $ (2,363 )  $   (3,524 )   $    (75 ) $ (3,599 )

Provision and Allowance for Loan Losses

We record a provision for loan losses as a charge to earnings when necessary in order to maintain the ALLL at a level sufficient, in management's judgment, to absorb probable incurred losses in the loan portfolio. At least quarterly we conduct an assessment of the overall quality of the loan portfolio and general economic trends in the local market. The determination of the appropriate level for the allowance is based on that review, considering such factors as historical loss experience for each type of loan, the size and composition of our loan portfolio, the levels and composition of our loan delinquencies, non-performing loans and net loan charge-offs, the value of underlying collateral on problem loans, regulatory policies, general economic conditions, and other factors related to the collectability of loans in the portfolio.

Our ALLL decreased by $1.8 million from $11.9 million, or 4.51% of our loans receivable held for investment, at December 31, 2012, to $10.1 million, or 3.95% of our loans receivable held for investment, at December 31, 2013. For the year ended 2013, our provision for loan losses totaled $414 thousand and net loan charge-offs totaled $2.1 million, compared to $1.2 million of provision for loan losses and


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$6.6 million of net loan charge-offs for the year ended 2012. The decrease in the ALLL and loan loss provision during 2013 primarily reflected the improvement in our asset quality as evident in lower loan delinquencies and lower loan charge-offs in 2013, as well as a decrease of $6.2 million in our gross loan portfolio from one year ago, and lower historical loss reserve factors because periods with higher loan losses are beginning to be replaced with periods with lower loan losses as part of our rolling three-year look back analysis.

The ratio of the ALLL to non-performing loans increased to 57.32% at December 31, 2013 from 32.00% at December 31, 2012, primarily due to the sale of $15.5 million of non-accrual loans and, to a lesser extent, $2.9 million of loan repayments and reinstatements. When reviewing the adequacy of the ALLL as a percentage of non-performing loans, we consider the impact of charge-offs. Also, we update our estimates of collateral values on non-performing loans at least every nine months. If the estimated fair value of the loan collateral less estimated selling costs is less than the recorded investment in the loan, a charge-off for the difference is recorded to reduce the loan to its estimated fair value, less estimated selling costs. Therefore certain losses inherent in our total non-performing loans have already been recognized periodically through charge-offs. The impact of updating these estimates of collateral value and recognizing any required charge-offs is to increase charge-offs and reduce the ALLL required on these loans. As of December 31, 2013, 69.6% of our non-performing loans, or $9.2 million after charge-offs of $10.3 million in prior years, had already been written down to their estimated fair value less estimated selling costs. The remaining 30.4% of our non-performing loans, or $8.5 million, at year-end had specific reserves or were reported at cost because the fair value of collateral less estimated selling costs exceeded the recorded investment in the loan. Also, in connection with our review of the adequacy of our ALLL, we track the amount and percentage of our non-performing loans that are paying currently, but nonetheless must be classified as non-performing loans for reasons unrelated to payments. As of December 31, 2013, $8.2 million of our total non-performing loans of $17.7 million were current in their payments.

Loan charge-offs during 2013 were $2.8 million, or 1.09% of average loans, compared to $7.1 million, or 2.20% of average loans, during 2012. Of the $2.8 million in charge-offs, $1.5 million of the charge-offs resulted from the bulk sale of certain classified loans secured by multi-family and commercial real estate properties in April 2013 and the sales of certain non-performing church loans during 2013. The loans were reclassified from loans held for investment to loans receivable held for sale at the lower of cost or fair value, less estimated selling costs. The remaining $1.3 million of charge-offs were related to losses on other impaired loans. Charge-offs on commercial real estate loans totaled $1.2 million and represented 42% of charge-offs during 2013. Of the $1.2 million of charge-offs in commercial real estate loans, $697 thousand of the charge-offs resulted from write-downs of loans to fair value upon the transfer of such loans to loans held for sale. Charge-offs on church loans totaled $770 thousand and represented 27% of charge-offs during 2013. Of the $770 thousand of charge-offs in church loans, $193 thousand of the charge-offs resulted from write-downs of loans to fair value upon the transfer of such loans to loans held for sale. Charge-offs on multi-family residential real estate loans totaled $661 thousand and represented 23% of charge-offs during 2013. Of the $661 thousand of charge-offs in multi-family loans, $638 thousand of the charge-offs resulted from write-downs of loans to fair value upon the transfer of such loans to loans held for sale. Charge-offs on one-to-four family residential real estate loans totaled $220 thousand and represented 8% of charge-offs during 2013.

Impaired loans at December 31, 2013 were $33.5 million, compared to $44.4 million at December 31, 2012. Specific reserves for impaired loans were $2.2 million, or 6.53% of the aggregate impaired loan amount at December 31, 2013, compared to $2.7 million, or 6.16%, at December 31, 2012. Excluding specific reserves for impaired loans, our coverage ratio (general allowance as a percentage of total non-impaired loans) was 3.56% at December 31, 2013, compared to 4.18% at December 31, 2012. The decrease in our coverage ratio during 2013 was primarily due to the $29.9 million increase in our multi-family loan portfolio, which has the lowest historical loss reserve factors. Of the $33.5 million impaired loans, $19.6 million had specific


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reserves recorded as of December 31, 2013. Of the $19.6 million of impaired loans with specific reserves, $3.7 million were collateral dependent loans measured at fair value with a valuation allowance of $321 thousand and $15.9 million were evaluated based on the loans' present value of expected cash flows with a valuation allowance of $1.9 million. On $4.7 million of impaired loans, the fair value of collateral less estimated selling costs exceeded the recorded investment in the loan and did not require a specific reserve or charge-off. The remaining $9.2 million of impaired loans had been written down to fair value after charge-offs of $10.3 million in prior years.

Management believes that the ALLL is adequate to cover probable incurred losses in the loan portfolio as of December 31, 2013, but there can be no assurance that actual losses will not exceed the estimated amounts. In addition, the OCC and the FDIC periodically review the ALLL as an integral part of their examination process. These agencies may require an increase in the ALLL based on their judgments of the information available to them at the time of their examinations.

Non-Interest Income

Non-interest income for the year 2013 decreased $1.0 million from $3.1 million for the year 2012 to $2.1 million for the year 2013. The decrease in . . .

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