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HBK > SEC Filings for HBK > Form 10-K on 27-Jun-2014All Recent SEC Filings

Show all filings for HAMILTON BANCORP, INC.

Form 10-K for HAMILTON BANCORP, INC.


27-Jun-2014

Annual Report


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

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the audited consolidated financial statements, which appear beginning on page F-1 of this Annual Report. You should read the information in this section in conjunction with the business and financial information regarding Hamilton Bancorp, Inc. provided in this Annual Report.

Overview

Total assests have decreased from $335.4 million at March 31, 2011, to $302.8 million at March 31, 2014. Assets have decreased in two of the last three years as a conscious effort has been made to reduce the Bank's dependency on higher costing certificates of deposits and focus on growing lower costing core deposits, specifically commercial checking and money market accounts. Total deposits have decreased from $298.6 million at March 31, 2011 to $238.8 million at March 31, 2014, a decrease of $59.8 million or 20.0% over those three years. Assets increased during fiscal year 2013 as a result of the mutual to stock conversion that was completed on October 10, 2012 in which 3,703,000 shares of common stock were sold. Net proceeds from the offering were approximately $35.6 million.

As a result of the 2007 to 2009 financial recession and slow economic growth henceforth, the Bank has not needed to grow deposits to fund loan demand and has decreased the size of the Bank through deposit runoff, particulary higher costing certificates of deposit as previously mentioned. The result of this strategy has been an increase in the net interest margin from 2.37% for the year ended March 31, 2011 to 2.85% for the year ended March 31, 2014 as management has been able to reduce our cost of funds over this period in a declining interest rate environment faster than the decline in the yield on interest earning assets.

Hamilton Bank historically had very few non-performing loans. Beginning in fiscal year 2012 we experienced an increase in delinquencies and non-performing commercial business and commercial real estate loans, particularly in our loan participations and purchased loans. During fiscal 2012, non-performing loans increased $5.8 million, or 354%, from $1.6 million at March 31, 2011 to $7.4 million at March 31, 2012. Over the past two fiscal years the Bank has diligently been working through this increase in non-performing loans. During fiscal 2013, we had net charge-offs of $3.2 million, including $2.9 million of commercial business and commercial real estate loans (including commercial construction loans) and reduced non-performing loans to $5.1 million at March 31, 2013. We continued to work through our non-performing loans in fiscal year 2014 by charging-off $2.1 million in commercial business and commercial real estate loans and reducing our non-performing loans slightly to $5.0 million, including $4.2 million loans that were on non-accrual. Over this two year period, the Bank has been able to reduce non-performing assets as a percentage of total assets from 2.55% at March 31, 2012 to 1.88% at March 31, 2014 and non-performing loans as a percentage of total loans from 4.25% at March 31, 2012 to 3.48% at March 31, 2014. At March 31, 2014, commercial business loans and commercial real estate loans accounted for $2.5 million and $1.9 million of the $5.0 million in non-performing loans, respectively. Of the $4.4 million of non-performing commercial business and commercial real estate loans at March 31, 2014, $3.6 million were on non-accrual.

In connection with our recent emphasis on commercial business and commercial real estate lending, as well as the history of increases in such loans that are delinquent or non-performing, we have increased our lending staff and back office personnel to enhance our delinquent loan monitoring system to ensure that management and the board of directors receive more up-to-date information on delinquent loans. We also established a formal loan delinquency committee in fiscal year 2013 to address delinquent and non-performing loans. However, we can make no assurances that delinquencies or loan losses related to our commercial real estate loans and commercial business loans will be reduced or will not increase as we continue to emphasize this type of lending activity. See "Risk Factors-Our recent emphasis on commercial real estate loans and commercial business loans has increased our credit risk" and "-Our entry into commercial real estate and commercial business lending has resulted in higher losses on our loans."


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At March 31, 2014, our investment portfolio consisted entirely of bonds and mortgage-backed securities issued by U.S. Government agencies, municipalties or U.S. Government-sponsored enterprises, including stock in the Federal Home Loan Mortgage Corporation. The principal and interest on our mortgage-backed securities are guaranteed by the issuing entity.

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest revenue, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on deposits and borrowings. Other significant sources of pre-tax income are customer service fees (mostly from service charges on deposit accounts), loan servicing fees, gain on sale of residential one- to four-family morgtgages in the secondary market, and income from bank-owned life insurance.

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. Management evaluates the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.

Expenses. The non-interest expenses the Company incurs in operating its business consists of salaries and employee benefits, occupancy and equipment, professional services, data processing and other expenses.

Salaries and employee benefits consist primarily of salaries and wages paid to the Bank's employees, stock-based compensation, payroll taxes, expenses for health insurance, retirement plans, and other employee benefits.

Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to forty years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the expected term of the lease. The expected term includes lease option periods to the extent that the exercise of such options is reasonably assured.

Professional services include the fees that we pay to our outside accountants, attorneys and other consultants.

Data processing expenses are the fees paid to third parties for processing customer information, deposits and loans.

Other expenses include expenses for marketing, office supplies, postage, telephone, insurance, charitable contributions, FDIC deposit insurance and OCC assessments and other miscellaneous operating expenses.

Critical Accounting Policies

The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity with generally accepted accounting principles used in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be critical accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.

On April 5, 2012, the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act") was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company" we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We have chosen to take advantage of the benefits of this extended transition period. Accordingly, our consolidated financial statements may not be comparable to companies that comply with such new or revised accounting standards.


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The following represent our critical accounting policies:

Allowance for Loan Losses. 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 our most critical accounting policies.

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 reviews 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 percentage allocations can be 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, a charge is recorded for the difference. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze 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 reserve. Actual loan losses may be significantly more than the allowances we have established which could result in a material negative effect on our financial results.

Securities Valuation and Impairment. We classify our 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. We obtain our fair values 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 our financial position, results of operations and cash flows.

If the estimated value of investments is less than the cost or amortized cost, we evaluate 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 we determine that the impairment is other-than-temporary, we record the impairment of the investment in the period in which the event or change occurred. We also consider 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. At March 31, 2014, all of our securities were either issued by U.S. government agencies, U.S. government-sponsored enterprises, or municipalities and the principal and interest on 96.8% of our securities were guaranteed by the issuing entity.

Goodwill Impairment. Goodwill represents the excess purchase price paid for our Pasadena branch over the fair value of the net assets acquired. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company is considered the Reporting Unit for purposes of impairment testing. Impairment testing requires that the fair value of the Company be compared to the carrying amount of the Company's net assets, including goodwill. If the fair value


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of the Company exceeds the book value, no write-down of recorded goodwill is required. If the fair value of the Company is less than book value, an expense may be required to write-down the related goodwill to the proper carrying value. We test for impairment of goodwill during February of each year. We estimate the fair value of the Company utilizing four valuation methods including the Comparable Transactions Approach, the Control Premium Approach, the Public Market Peers Approach, and the Discounted Cash Flow Approach.

Based on our impairment testing during February 2014, there was no evidence of impairment of the Company's goodwill or intangible assets.

Income Taxes. We account for income taxes under the asset/liability method. We recognize deferred tax assets for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

Comparison of Financial Condition at March 31, 2014 and March 31, 2013

Assets. Total assets decreased $29.2 million, or 8.8%, to $302.8 million at March 31, 2014 from $332.0 million at March 31, 2013. The decrease in assets is primarily attributable to a $16.4 million decrease in net loans and a $12.7 million decrease in investment securities during the fiscal year ended March 31, 2014.

Loans. Net loans receivable, including loans held for sale, decreased by $16.4 million, or 10.3%, to $142.9 million at March 31, 2014 from $159.3 million at March 31, 2013. The decrease in loans receivable during this period was primarily due to a decrease of $7.6 million, or 9.5%, in total one- to four-family mortgage loans, a decrease of $2.1 million, or 15.1%, in home equity loans and lines of credit, and a decrease of $11.3 million, or 41.9%, in commercial business loans, partially offset by a $5.2 million, or 14.3%, increase in commercial real estate loans. The decrease in one- to four-family mortgage loans was primarily due to principal paydowns, prepayments, pay offs and the sale of newly originated residential mortgage loans in the secondary market. The decrease in commercial business loans was primarily due to charge-offs and the pay-off of several larger commercial loan borrowers who opted to refiance with other financial institutions. The increase in commercial real esate loans reflected our continued emphasis on originating these types of loans.

Securities. Investment securities decreased $12.7 million, or 10.9%, to $103.6 million at March 31, 2014, from $116.2 million at March 31, 2013. The decrease in securities during fiscal 2014 was primarily due to a $3.3 million decrease in the fair value of the investment portfolio due to rising interest rates over the past year, as well as the need to fund a $21.3 million decrease in deposits as part of our business strategy to allow higher costing certificates of deposit to run off at maturity, and gradually replace them with lower-cost core deposits. The decrease in investments was partially offset by the proceeds received from the $16.4 million decrease in net loans receivable from March 31, 2013 to March 31, 2014.

Cash and Cash Equivalents. During the year ended March 31, 2014, cash and cash equivalents decreased by $895,000, or 2.6%, to $33.1 million.

Bank-Owned Life Insurance. We invest in bank-owned life insurance to provide us with a funding source for our benefit plan obligations. Bank-owned life insurance also generally provides us noninterest income that is tax-exempt. Federal regulations generally limit our investment in bank-owned life insurance to 25% of our Tier 1 capital plus our allowance for loan losses. At March 31, 2014, our investment in bank-owned life insurance was $12.0 million, an increase of $379,000 from $11.6 million at March 31, 2013. The increase is primarily attributable to the increase in the cash surrender value of the insurance policies.


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Deposits. Total deposits decreased $21.3 million, or 8.2%, to $238.8 million at March 31, 2014 from $260.1 million at March 31, 2013. The decrease is attributable to our on-going efforts to reduce our reliance on certificates of deposit as a funding source. We continued to allow higher costing certificates of deposit to runoff at maturity during fiscal 2014 and 2013, as we focused on increasing the level of core deposits. During fiscal 2014, certificates of deposit decreased $25.9 million, or 13.2%, to $170.1 million, while noninterest bearing checking increased $3.8 million, or 32.7%, to $15.3 million. Statement savings, NOW and money market accounts all increased slightly from fiscal 2013. Statement savings accounts increased $469,000, or 3.0%, to $16.0 million, NOW accounts increased $208,000, or 2.3%, to $9.1 million and money market accounts increased $182,000, or 0.6%, to $28.4 million.

Borrowings. We had no borrowings outstanding at March 31, 2014 or 2013. At March 31, 2014, we had the ability to borrow approximately $58.1 million from the Federal Home Loan Bank of Atlanta, subject to our pledging sufficient assets. At that date we also had the ability to borrow $5.0 million under a secured Line of Credit, along with a $1.0 million unsecured Line of Credit with a correspondent financial institution.

Equity. Total equity decreased $5.7 million, or 8.4%, to $61.8 million at March 31, 2014 from $67.4 million at March 31, 2013. The decrease was primarily attributable to a 5.0% stock buyback program completed in November 2013 for $2.8 million. In addition, there was a $2.0 million decrease in accumulated other comprehensive income and a $1.2 million net loss for the fiscal year ended March 31, 2014. The decrease in accumulated other comprehensive income was due to the negative impact of rising interest rates over the past year on the market value of the investment portfolio.

Comparison of Results of Operations for the Years Ended March 31, 2014 and March 31, 2013

General. Net loss increased $1.0 million to a net loss of $1.2 million for the year ended March 31, 2014 compared to a net loss of $172,000 for the year ended March 31, 2013. The primary reason for the decrease was a $1.8 million increase in noninterest expenses, including increases in salaries and benefits, legal services, other professional services and costs associated with foreclosed real estate along with an increase of $144,000 in the provision for loan losses. The increase in noninterest expenses was partially offset by a $237,000 increase in net interest income and a $685,000 increase in the income tax benefit.

Net Interest Income. Net interest income increased by $237,000, or 2.9%, to $8.3 million for the year ended March 31, 2014 from $8.1 million for the year ended March 31, 2013. The increase resulted from a decrease of $886,000 in interest expense, partially offset by a decrease of $649,000 in interest and dividend income. These decreases were driven by both declining market interest rates and average balances during the year ended March 31, 2014. The average cost of our interest-bearing liabilities declined 26 basis points to 0.82% while the the average yield on our interest-earning assets remained relatively flat at 3.51%. In addition, the average balance on our interest-bearing liabilities decreased $25.9 million, or 10.0%, compared to a decrease of $17.1 million, or 5.5%, in our average interest-earning assets. Overall, our net interest-earning assets increased $8.8 million during fiscal 2014. As a result, our net interest margin and interest rate spread increased 23 and 24 basis points to 2.85% and 2.68% for the year ended March 31, 2014 from 2.62% and 2.44%, respectively, for the year ended March 31, 2013.

Interest and Dividend Revenue. Interest and dividend revenue decreased $649,000 to $10.2 million for the year ended March 31, 2014 from $10.9 million for the year ended March 31, 2013. The decrease resulted primarily from a $930,000 decrease in interest revenue on loans, partially offset by a $329,000 increase in interest on securities.

Interest revenue on loans decreased $930,000, or 10.3%, to $8.1 million for the year ended March 31, 2014 from $9.0 million for the year ended March 31, 2013. This decrease primarily resulted from a 22 basis point decrease in the average yield on loans to 5.28% for the year ended March 31, 2014 from 5.50% for the year ended March 31, 2013, reflecting decreases in market interest rates. The decrease was also due in part to a decrease in the average balance of loans of $10.9 million, or 6.7%, to $153.0 million for the year ended March 31, 2014 from $163.9 million for the year ended March 31, 2013.


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Interest and dividend revenue on total securities increased $329,000 to $2.1 million for the year ended March 31, 2014 from $1.8 million for the year ended March 31, 2013. The increase resulted from a $162,000 increase in interest revenue on mortgage-backed securities and a $167,000 increase in interest revenue on other investment securities. The increase in interest revenue from mortgage-backed securities was due to a $6.6 million increase in the average balance of mortgage-backed securities in conjunction with a 5 basis point increase in the average yield from 1.80% to 1.85%. The increase in interest revenue on other investment securities was primarily due to an $8.7 million increase in the average balance of other investment securities while the average yield remained flat at 1.91% compared to fiscal year 2013. The slight increase in the overall average yield reflects the steady nature of interest rates on securities experienced during fiscal year 2014.

Interest Expense. Interest expense, consisting entirely of the cost of interest-bearing deposits, decreased $886,000, or 31.6%, to $1.9 million for the year ended March 31, 2014 from $2.8 million for the year ended March 31, 2013. The decrease in the cost of interest-bearing deposits was due to a decrease of 26 basis points in the average rate paid on interest-bearing deposits to 0.82% for the year ended March 31, 2014 from 1.08% for the year ended March 31, 2013. We experienced decreases in the cost of all categories of interest-bearing deposits, except NOW accounts which remained flat at 0.05%, for the year ended March 31, 2014. The most significant decrease in the average rate paid on interest-bearing deposits was in certificate of deposit, reflecting lower market interest rates. The decrease in interest expense was also due to a $25.9 million, or 10.0%, decrease in the average balance of interest-bearing deposits to $232.9 million for the year ended March 31, 2014 from $258.8 million for the year ended March 31, 2013. The decline in the average balance of interest-bearing deposits was primarily due to our strategy to allow higher costing certificates of deposit to runoff, and gradually replace them with lower-cost core deposits. The average balance of certificates of deposit decreased $29.0 million for the year ended March 31, 2014 compared to the year ended March 31, 2013, while the average balances of money market and NOW accounts accounts increased $1.1 million, or 3.9%, and $1.9 million, or 24.4%, respectively. The average balance of noninterest bearing demand accounts decreased $1.1 million, or 6.9%, to $14.9 million for the year ended March 31, 2014. The higher average balance for noninterest bearing demand deposits during fiscal 2013 is primarily attributable to the excess proceeds received leading up to the completion of the stock offering in October 2012.


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Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances have been calculated using daily average balances, nonaccrual loans are included in average balances only, and loan fees are included in interest income on loans.

                                                                       Years Ended March 31,
                                                          2014                                        2013
                                                         Interest                                    Interest
                                          Average           and         Yield/        Average           and         Yield/
                                          Balance        Dividends       Cost         Balance        Dividends       Cost
                                                                       (Dollars in thousands)
Interest-earning assets:
. . .
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