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MNRK > SEC Filings for MNRK > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for MONARCH FINANCIAL HOLDINGS, INC.

Form 10-Q for MONARCH FINANCIAL HOLDINGS, INC.


7-Aug-2014

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Company. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data.
We generate a significant amount of our income from the net interest income earned by Monarch Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the average amount of interest-earning assets outstanding during the period and the interest rates thereon. Monarch Bank's cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of our assets further influences the amount of interest income lost due to non-accrual loans and the amount of additions to the allowance for loan losses.
We also generate income from non-interest sources. Non-interest income sources include fee income from residential and commercial mortgage sales, bank related service charges, fee income from the sale of investment and insurance services, fee income from title services, income from bank owned life insurance ("BOLI") policies, as well as gains or losses from the sale of investment securities. This report contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:
General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances.

Changes in interest rates could reduce income.

Competitive pressures among financial institutions may increase.

The businesses that we are engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards.

New products developed or new methods of delivering products could result in a reduction in our business and income.

Adverse changes may occur in the securities market.

Other factors described from time to time in our reports with the Securities and Exchange Commission.

This section should be read in conjunction with the description of our "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013.

CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those applications of accounting principles or practices that require considerable judgment, estimation, or sensitivity analysis by management. In the financial service industry, examples, though not an all inclusive list, of disclosures that may fall within this definition are the determination of the adequacy of the allowance for loan losses, valuation of derivatives or securities without a readily determinable market value, and the valuation of the fair value of intangibles and goodwill. Except for the determination of the adequacy of the allowance for loan losses, derivative financial instrument estimations and fair value estimations related to foreclosed real estate, we do not believe there are other practices or policies that require significant sensitivity analysis, judgments, or estimations.


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Our financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Our critical accounting policies are listed below. A summary of our significant accounting policies is set forth in Item 8, Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2013. Allowance for Loan Losses
Our allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on GAAP guidance which requires that losses be accrued when they have a probability of occurring and are estimable and that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses along with various economic factors and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur may be mitigated. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified loans. Historical loss information, expected cash flows and fair value of collateral are used to estimate these losses. The unallocated allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. The use of these values is inherently subjective, and our actual losses could be greater or less than the estimates. Derivative Financial Instruments
We use derivatives to manage risks related to interest rate movements. Interest rate swap contracts designated and qualifying as cash flow hedges are reported at fair value. The gain or loss on the effective portion of the hedge initially is included as a component of other comprehensive income and is subsequently reclassified into earnings when interest on the related debt is paid. We document our risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Our interest rate risk management strategy is to stabilize cash flow requirements by maintaining interest rate swap contracts to convert variable-rate debt to a fixed rate. We do not hold or issue derivative financial instruments for trading purposes.
We utilize a "best efforts" delivery program for mortgage loans. With best efforts we commit to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding. This 15 to 90 day commitment is an interest rate lock commitment (IRLC). To protect the Company from changes in interest rate, we enter into loan purchase agreements with third party investors that provide for the investor to purchase loans at the same terms, including interest rate, as committed to the borrower. Under the contractual relationship with these third party investors, the Company is obligated to sell the loan to the investor, and the investor is obligated to buy the loan, only if the loan closes. Accounting guidance requires the Company to treat these commitments as if they were paired with the sale of a notional security bearing similar attributes, thereby creating a derivative.
Periodically, we participate in a "mandatory" delivery program for mortgage loans. Under the mandatory delivery system, loans with interest rate locks are paired with the sale of a notional security bearing similar attributes. Interim income or loss on the pairing of the loans and securities is recorded in mortgage banking income on our income statement. In addition, at the time the loan is delivered to an investor, matched securities are repurchased and a gain or loss on the pairing is recorded in mortgage banking income on our income statement. Management has elected to limit our exposure to this form of delivery to $50 million in outstanding loans. We were not participating in the mandatory delivery program at June 30, 2014 or December 31, 2013. Fair Value Measurements
Under GAAP we are permitted to choose to measure many financial instruments and certain other items at fair value. The estimation of fair value is significant to certain assets, including loans held-for-sale, available-for-sale securities, and foreclosed real estate owned. These assets are recorded at fair value or lower of cost or fair value, as applicable. The fair values of loans held-for-sale are based on commitments from investors. The fair values of available-for-sale securities are based on published market or dealer quotes for similar securities. The fair values of rate lock commitments are based on net fees currently charged to enter into similar agreements. The fair value of foreclosed real estate owned is estimated based on current appraisals, but may be further adjusted based upon our evaluation of the fair value of similar properties.


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Fair values can be volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, and market conditions, among others. Since these factors can change significantly and rapidly, fair values are difficult to predict and subject to material changes that could impact our financial condition and results of operation.

RESULTS OF OPERATIONS
Net Income
Our consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, after all significant inter-company transactions have been eliminated. Net income attributable to our non-controlling interests of $121 thousand and $429 thousand are deducted for the quarters ended, and $137 thousand and $713 thousand, respectively, for the six months ended June 30, 2014 and 2013, to arrive at net income attributable to Monarch Financial Holdings, Inc. The ensuing references and ratios are related to net income attributable to Monarch Financial Holdings, Inc., (hereon referred to as "net income") after net income attributable to non-controlling interests has been deducted.
Net Income Attributable to Monarch Financial Holdings, Inc.

                                     For the Three Months Ended June 30,           For the Six Months Ended June 30,
                                         2014                   2013                  2014                   2013
Net income                       $       3,304,495       $       3,495,178     $      5,858,244       $      7,238,210
Less: Net income attributable to
non-controlling interests                 (120,921 )              (428,540 )           (137,405 )             (713,443 )
Net income attributable to
Monarch Financial Holdings, Inc. $       3,183,574       $       3,066,638     $      5,720,839       $      6,524,767

Net income for the quarter ended June 30, 2014 was $3.2 million, an increase of $117 thousand or 3.8% over the same quarter in 2013. Net income for the first half of 2014 was $5.7 million, a decrease of $804 thousand or 12.3% compared to 2013. Basic and diluted earnings per share for the second quarter of 2014 and 2013 were $0.30 and $0.29, respectively. Basic and diluted earnings per share were $0.54 for the first six months of 2014. Basic earnings per share were $0.66 in the first half of 2013, while diluted earnings per share were $0.62. Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on equity (net income as a percentage of average stockholders' equity). Our annualized return on assets ("ROA") for the three months ended June 30, 2014 was 1.29% compared to 1.19% for the same respective period in 2013. Year to date, our ROA was 1.18% in 2014 compared to 1.23% in 2013. Our annualized return on equity ("ROE") for the second quarter of 2014 were 12.63% compared to 13.42% in 2013, while ROE for the first six months of 2014 was 11.57% compared to 14.61%, one year prior. Net interest income declined $211 thousand or 2.2% in the second quarter and $1.2 million or 5.8% in the first half of 2014 compared to 2013. Non-interest income declined $3.1 million or 14.7% in the second quarter and $7.0 million or 18.1% in the first half of 2014 compared to 2013. Non-interest expense declined $3.2 million or 12.1% in the second quarter and $6.3 million or 13.1% in the first half of 2014 compared to 2013. These declines are related to an over 35% decrease in production in our loans held for sale between comparative quarters and year to date. This lower production impacted interest income, with regard to closed loans awaiting delivery to investors, earnings on loan production and commission expenses on the loans.
Our provision for loan losses in all periods presented was zero. We reported net charge offs of $143 thousand in the second quarter of 2014 and recoveries in excess of charge offs of $9 thousand in the first half of 2014. We reported recoveries in excess of charge offs of $532 thousand and $409 thousand in the second quarter and first half of 2013.
Net Interest Income
Net interest income, which is the excess of interest income over interest expense, is a major source of banking revenue. A number of factors influence net interest income, including the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets, the average volume of interest-earning assets and interest bearing liabilities, and the mix of interest-earning assets and interest bearing liabilities.
Interest rates have been at a record low since December 2008, when the federal funds rate set by the Federal Reserve Bank's Federal Open Market Committee was reduced to 0.25%. Wall Street Journal Prime Rate ("WSJ"), which generally moves with the federal funds rate, has been 3.25% since December 2008, as well. With rates low but stable, we believe we have been able to


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position our balance sheet to respond quickly in the future when rates begin to rise, and thereby buffer the potential impact of those rising rates. Net interest income was $9.6 million in the second quarter of 2014 compared to $9.8 million for the same quarter in 2013, a decrease of $211 thousand or 2.2%. Interest income, which was $10.6 million in the second quarter of 2014, declined $418 thousand when compared to the same quarter of 2013. Interest expense was $977 thousand in 2014 compared to $1.2 million in the second quarter of 2013, a reduction of $207 thousand. Year to date, net interest income was $19.0 million in 2014 compared to $20.2 million, one year prior. Interest income declined $1.8 million in 2014 compared to 2013 while interest expense declined $674 thousand. Our greatest earning assets are loans which are comprised of two major portfolio classifications: loans held for sale and loans held for investment. The declines in interest income noted in both the second quarter and first half of 2014 compared to 2013 is attributable to decreased earnings on our loans held for sale. Asset yield was 4.61% in the second quarter of 2014 compared to 4.60% in 2013. Year to date asset yield was 4.65% for both periods presented. Loans held for sale, which are residential mortgages originated by our mortgage division and sold to investors, earn interest while on our books but at rates typically lower than our loans held for investment portfolio. This portfolio is also subject to greater fluctuations in outstanding balances due to a combination of market demand, economic conditions and the prevailing mortgage rates. Interest income on our loans held for sale was $1.3 million, $499 thousand less than the $1.8 million earned in the second quarter of 2013. However, this represents a positive trend and an improvement in production levels over the prior quarter when interest income had declined $2.0 million compared to 2013. Year to date interest on our loans held for sale declined $2.5 million to $2.0 million when compared to $4.5 million in interest income in 2013. Shifts in the directionality of loan volume in this portfolio indicate a return to growth that is evident when comparing the average balances for the periods presented. Average volume in the second quarter of 2014 has increased $46 million over the first quarter of 2014. Conversely, average volume in the second quarter of 2013 had declined $115 million from the first quarter of that year. Balances continued declining in the first half of 2013 to $166.6 million from the record high of $419.1 million at year end 2012. Changes in mortgage rates in the later part of 2013 resulted in a sharp decline in volume that bottomed out in the first quarter of 2014. This is supported by balances at June 30, 2014 of $156.6 million, $56.9 million above $99.7 million at year end 2013 and the improvements noted in average balances. Despite these positive trends and a quarter over quarter and year over year increase in yield, of 83 basis points and 87 basis points to 4.37% and 4.39%, income was adversely impacted by average volume.
Loans held for investment are commercial, real estate, and consumer loans originated and maintained on the Bank's books. Interest income on our loans held for investment portfolio for the second quarter of 2014 increased $49 thousand to $9.1 million. Year to date, interest income increased $553 thousand to $18.6 million. Second quarter yield was 5.22%, a decline of 14 basis points from second quarter 2013. Year to date interest yield has declined 7 basis points to 5.36%. Market competition is strong, creating downward pressure on loan pricing which is impacting earnings. During the first quarter of 2014, we took an interest adjustment of $417 thousand related to the payoff of a loan we had purchased at a discount which had a positive impact on yield.
Interest expense declined $207 thousand in the quarter and $674 thousand in the first half of 2014 compared to 2013, driven by interest savings on our time deposit accounts coupled with lower borrowing expense. Average interest bearing liabilities declined $54 million in the second quarter of 2014 due to an $84.4 million decline in average time deposits. Additional cost savings were the result of rate modifications to our money market savings products. Year to date, average interest bearing liabilities declined $99.2 million primarily due to a $74.8 million decline in time deposits but secondarily due to a $58.3 million decline in borrowings. Growth in our non-interest bearing demand accounts and lower volume in our loans held for sale portfolio have temporarily reduced the need for short term borrowings. The decline in time deposit balances resulted in interest savings of $327 thousand. A $58.4 million decline in borrowings resulted in interest expense savings of $297 thousand. Interest expense on money market savings accounts declined $5 thousand in the quarter and $38 thousand year to date despite roughly $35 million in higher volume. Interest cost declined 7 basis points quarter over quarter and 10 basis points year to date. For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as bank owned life insurance ("BOLI") and state and municipal securities. A tax rate of 35% was used in both 2014 and 2013 when adjusting interest on BOLI and tax-exempt securities to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the "FTE" adjustment) and the cost of the supporting funds is measured by net interest margin.
Our net interest rate spread on a tax-equivalent basis increased 8 basis points in the quarter to 4.01% and 10 basis points to 4.05% in the first half of 2014 compared to 2013. Our net interest margin for the second quarter and first half of 2014 was 4.18% and 4.22%, respectively. This represents an increase over 2013 of 7 basis points quarter over quarter and 10 basis points year to date from 4.11% and 4.12%.


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Bank Owned Life Insurance (BOLI) has been included in interest earning assets. We purchased $6.0 million in BOLI during the fourth quarter of 2005. The income on BOLI is not subject to federal income tax, giving it a tax-effective yield of 4.85% for the second quarter and first half of 2014 compared to 5.03% in 2013. In July 2006, we increased capital through the issuance of $10,000,000 in trust preferred securities. These securities are treated as subordinated debt and have been included in borrowings. The cost on trust preferred securities is fixed at 4.86%. In June 2012, we added a short term holding company loan from PNC Bank for $5.0 million. We repaid this line June 7, 2013. The line, which qualified as Tier 1 capital for the Bank, was carried in short term borrowings.
The following tables set forth average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and the related income, expense and corresponding weighted average yields and costs.


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The following is an analysis of net interest income, on a taxable equivalent basis.

                          NET INTEREST INCOME ANALYSIS
                                       For Three Months Period Ended June 30, 2014                 For Three Months Period Ended June 30, 2013
                                        Average                 Income/           Yield             Average                  Income/           Yield
                                        Balance                 Expense         Rate (1)            Balance                  Expense         Rate (1)
ASSETS
Securities, at amortized cost    $        23,835,235       $         97,179        1.64 %   $          16,450,943       $         62,562        1.53 %
Loans, held for investment, net          698,850,584              9,089,071        5.22 %             676,893,847              9,040,004        5.36 %
Loans, held for sale                     116,850,723              1,274,498        4.37 %             200,733,403              1,773,692        3.54 %
Federal funds sold                        40,546,791                 24,179        0.24 %              44,726,993                 25,312        0.23 %
Dividend-earning restricted
equity securities                          3,160,577                 22,410        2.84 %               3,786,185                 69,225        7.33 %
Deposits in other banks                   36,816,672                 54,905        0.60 %              15,020,300                  9,952        0.27 %
Bank owned life insurance (2)              7,491,315                 90,623        4.85 %               7,260,613                 91,123        5.03 %
Total earning assets                     927,551,897             10,652,865        4.61 %             964,872,284             11,071,870        4.60 %
Less: Allowance for loan losses           (9,147,748 )                                                (10,822,651 )
Nonperforming loans                        8,179,965                                                    3,142,906
Total non-earning assets                  66,418,610                                                   75,152,608
Total assets                     $       993,002,724                                        $       1,032,345,147
LIABILITIES and STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Demand                           $        50,993,350       $         21,457        0.17 %   $          51,755,109       $         24,216        0.19 %
Savings                                   24,191,063                 24,617        0.41 %              22,394,665                 22,809        0.41 %
Money market savings                     370,019,702                359,068        0.39 %             335,915,363                363,834        0.43 %
Time deposits                            198,414,649                434,161        0.88 %             282,828,125                610,054        0.87 %
Total interest-bearing deposits          643,618,764                839,303        0.52 %             692,893,262              1,020,913        0.59 %
Borrowings                                11,150,214                137,583        4.95 %              15,865,579                163,010        4.12 %
Total interest-bearing
liabilities                              654,768,978       $        976,886        0.60 %             708,758,841       $      1,183,923        0.67 %
Non-interest-bearing liabilities
Demand deposits                          223,598,147                                                  205,779,322
Other non-interest-bearing
liabilities                               13,543,821                                                   26,169,286
Total liabilities                        891,910,946                                                  940,707,449
Stockholders' equity                     101,091,778                                                   91,637,698
Total liabilities and
stockholders' equity             $       993,002,724                                        $       1,032,345,147
Net interest income (2)                                    $      9,675,979                                             $      9,887,947
Interest rate spread (2)(3)                                                        4.01 %                                                       3.93 %
Net interest margin (2)(4)                                                         4.18 %                                                       4.11 %

(1) Yields are annualized and based on average daily balances.

(2) Income and yields are reported on a taxable equivalent basis assuming a federal tax rate of 35%, with a $36,968 adjustment for 2014 and a $37,153 adjustment for 2013.

(3) Represents the differences between the yield on total average earning assets and the cost of total interest-bearing liabilities.

(4) Represents the ratio of net interest-earnings to the average balance of interest-earning assets.


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                       NET INTEREST INCOME ANALYSIS - CONTINUED
                                     For Three Months Period Ended June 30, 2012
                                       Average                 Income/          Yield
                                       Balance                 Expense          Rate
ASSETS
Securities, at amortized cost   $        10,010,901       $         56,130      2.26 %
Loans, held for investment, net         606,213,746              8,590,781      5.70 %
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