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CBKW > SEC Filings for CBKW > Form 10-Q on 14-Nov-2011All Recent SEC Filings

Show all filings for CHOICE BANCORP, INC.



Quarterly Report

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

Forward Looking Statements

This Report contains certain statements that are forward-looking within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, the forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as "may," "should," "could," "predict," "potential," "believe," "will likely result," "expect," "anticipate," "seek," "estimate," "intend," "plan," "projection," "would" and "outlook," and other similar expressions or future or conditional verbs. Readers of this Report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this Report. All forward-looking statements contained in this Report or which may be contained in future statements made for or on behalf of the Company are based upon information available at the time the statement is made and the Company assumes no obligation to update any forward-looking statement.

These forward-looking statements implicitly and explicitly reflect the assumptions underlying the statements and other information with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates, financial condition, results of operations, future performance and business, including management's expectations and estimates with respect to revenues, expenses, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors, some of which are beyond the Company's control. Forward-looking statements are subject to significant risks and uncertainties and the Company's actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to, the factors set forth under "Risk Factors," Item 1A of the Bank's Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the FDIC on March 31, 2011 as well as Part II, Item 1A herein and any other risks identified in this Report. New factors emerge from time to time, and it is not possible for the Company to predict which factor, if any, will materialize. In addition, the Company cannot assess the potential impact of each factor on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

The Reorganization

In May 2010, the Board of Directors of the Bank adopted, subject to shareholder approval, a plan to reorganize the Bank (the "Reorganization") as a wholly owned subsidiary of the Company. At a special meeting held on August 3, 2010, the shareholders of the Bank adopted a resolution approving the Reorganization, subject to the satisfaction of certain conditions, including the receipt of all applicable regulatory approvals. Such approvals were received in late February 2011.

On and effective as of the close of business on March 10, 2011, the Reorganization was consummated and each issued and outstanding share of Bank common stock was converted solely into the right to receive one (1) share of Company common stock and the outstanding warrants for Bank common stock were converted into warrants to acquire Company common stock.

The Company was organized to serve as the holding company for the Bank and, prior to consummation of the Reorganization on March 10, 2011, had no assets or liabilities and had not conducted any business other than that of an organizational nature.


Regulatory Considerations

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") into law. The Dodd-Frank Act makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. While the full effects of the Dodd-Frank Act on the Company and the Bank cannot yet be determined, this legislation is generally perceived as negatively impacting the banking industry. The Dodd-Frank Act may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect the business of the Company and the Bank, perhaps materially.

Critical Accounting Policies

The Company's accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The Company's significant accounting policies are described in the notes to the financial statements. Certain accounting policies require management to make significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, and the Company considers these to be critical accounting policies. The estimates and assumptions used are based on historical experience and other factors that management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and results of operations for the reporting periods. The Company believes the following critical accounting policies require the most significant estimates and assumptions that are particularly susceptible to a significant change in the preparation of its financial statements.

Income Taxes

Deferred income taxes and liabilities are determined using the liability method.
Under this method deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the current enacted tax rates that will be in effect when these differences are expected to reverse. Provision (credit) for deferred taxes is the result of changes in the deferred tax assets and liabilities. A deferred tax valuation allowance is established if it is more likely than not that all or a portion of the deferred tax assets will not be realized.

The Company may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the difference between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Interest and penalties related to unrecognized tax benefits are classified as income taxes.

Allowance for Loan Losses

Management's evaluation process used to determine the appropriateness of the allowance for loan losses ("ALL") is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors:
management's ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable loan losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the appropriateness of the ALL, could change significantly. As an integral part of their examination process, various regulatory agencies also review the ALL. Such agencies may require that certain loan balances be classified differently or charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination.

Management considers the policies related to the ALL as critical to the financial statement presentation. The ALL represents management's assessment of the risk associated with extending credit and its evaluation of the quality of the loan portfolio. That assessment includes thorough review of the portfolio, with analysis of past-due and potentially impaired loans on an individual basis, based upon the following factors:

A. Specific Reserves for individually analyzed impaired loans. B. General Reserves for groups of similar loans analyzed for impairment. C. General Reserves for groups of similar loans not analyzed for impairment.

The analysis, and the loan loss provision, is reviewed and approved by the Board of Directors on a quarterly basis.

Other factors considered in the analysis of General Reserves include:

Annual loan review performed by the Bank's Risk Management Officer;

Changes in the national and local economy and business conditions, including underwriting standards, collections, charge off and recovery practices;

The asset quality of individual loans;

Changes in the nature and volume of the loan portfolio;

Changes in the experience, ability and depth of the Bank's lending staff and management;

Possible deterioration in collateral segments or other portfolio concentrations;

Changes in the quality of the Bank's loan review system and the degree of oversight by its board of directors;

The effect of external factors such as competition and the legal and regulatory requirement on the level of estimated credit losses in the Bank's current loan portfolio; and

Off-balance sheet credit risks.

The factors cited above have been, and will continue to be, evaluated at least quarterly. Changes in the asset quality of individual loans will be evaluated more frequently as needed. Following guidelines established by the FDIC and the Wisconsin Department of Financial Institutions ("DFI"), the Bank has established minimum General Reserves based on the asset quality of the loan. General Reserve factors applied to each type of loan are based upon management's experience and common industry and regulatory guidelines. After a loan is underwritten and booked, loans are monitored or reviewed by the account officer, management, and external loan review personnel during the life of the loan.
Payment performance is monitored monthly for the entire loan portfolio. Account officers contact customers in the ordinary course of business and may be able to ascertain if weaknesses are developing with the borrower. External loan personnel perform an independent review annually, and federal and state banking regulators perform periodic reviews of the loan portfolio. If weaknesses develop in an individual loan relationship and are detected, the loan will be downgraded and higher reserves will be assigned based upon management's assessment of the weaknesses in the loan that may affect full collection of the debt. If a loan does not appear to be fully collectible as to principal and interest, the loan will be recorded as a non-accruing loan and further accrual of interest will be discontinued while previously accrued but uncollected interest is reversed against income. If a loan will not be collected in full, the allowance for loan losses is increased to reflect management's estimate of potential exposure of loss.

The Bank believes the level of the ALL is appropriate as recorded in the financial statements. See further discussion in the section below titled "Allowance for Loan Losses".

Management's Discussion & Analysis

The following discussion describes the Company's consolidated results of operations for the three-month and nine-month periods ended September 30, 2011, as compared to the Bank's results of operations for the three-month and nine-month periods ended September 30, 2010 and also compares the Company's consolidated financial condition as of September 30, 2011 to the Bank's financial condition at December 31, 2010. Since the consummation of the Reorganization, the Company's sole asset is its investment in the Bank and the Company's operations are conducted solely through the Bank. Accordingly, management believes that comparisons of Company financial information on a consolidated basis for dates and periods from and after the March 10, 2011 Reorganization Date with financial information for the Bank for dates and periods prior to the Reorganization Date are appropriate and meaningful.

Like most community banks, the Bank derives most of its income from interest it receives on its loans and investments. The Bank's primary source of funds for making its loans and investments is its deposits, most of which are interest-bearing. Consequently, one of the key measures of the Bank's success is net interest income, which is the difference between income on interest-earning assets, such as loans and investments, and expense on interest-bearing liabilities, such as deposits and borrowed funds. Another key measure is the spread between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities.

The Bank maintains the ALL to absorb probable losses on existing loans that may become uncollectible. The Bank establishes and maintains the ALL by charging a provision for loan losses against operating earnings. The following section includes a further discussion of this process.

In addition to earning interest on loans and investments, the Bank earns income through fees charged to customers for services provided. These fees include the origination of long-term, fixed rate mortgage loans, which are sold with servicing released in the secondary market.

Non-interest expenses include personnel, facilities, marketing, FDIC insurance premiums, audit and legal, and other costs related to the conduct of the Bank's business.

The various components of non-interest income and non-interest expense are described in the following discussion which also identifies significant factors that have affected the Bank's financial position and operating results during the periods included in the accompanying financial statements. This discussion and analysis should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

The Bank received its charter and opened for business on July 24, 2006. The table and graph below show the increases and decreases in end-of-quarter assets of the Bank since that time.

[[Image Removed: [choicebancorp10q002.gif]]]

        July 2006 thru December 2008             March 2009 thru September 2011

     Date      Total Assets     % Growth      Date        Total Assets     % Growth

    Jul-06    $    20,824,545                Mar-09      $   121,815,492          2%
    Sep-06    $    26,737,176        28%     Jun-09      $   121,626,414          0%
    Dec-06    $    32,600,536        22%     Sep-09      $   118,964,450         -2%
    Mar-07    $    39,447,477        21%     Dec-09      $   120,807,482          2%
    Jun-07    $    44,966,989        14%     Mar-10      $   122,940,295          2%
    Sep-07    $    58,190,302        29%     Jun-10      $   147,394,234         20%
    Dec-07    $    71,851,968        23%     Sep-10      $   161,221,291          9%
    Mar-08    $    86,699,212        21%     Dec-10      $   163,697,874          2%
    Jun-08    $    92,258,664         6%     Mar-11      $   159,438,965         -3% [1]
    Sep-08    $   105,211,742        14%     Jun-11      $   167,825,844          5% [1]
    Dec-08    $   119,041,620        13%     Sep-11      $   175,169,581          4% [1]

[1] Reflects assets of the Company subsequent to the reorganization.

The graph and table above show that asset growth was significant during the Bank's initial two and a half years of operation. Asset growth slowed subsequent to December 31, 2008 as management curtailed lending in the recessionary environment. However, the Bank took advantage of a special growth opportunity in April 2010 when it added another seasoned commercial lending officer with established ties to the Oshkosh community. This addition had an immediate impact, enabling the Bank to increase total loans by about $32.2 million during the last three quarters of 2010. Total asset growth for 2010 was $42.9 million or 35.5%. Management

has implemented a measured growth strategy for 2011 in accordance with the Bank's capital management guidelines. Total asset growth is $11.5 million or 7.0% for the nine-month period ended September 30, 2011.

The Company intends to continue to adhere to a business plan that includes:

Serving as a community bank from two locations in Oshkosh, Wisconsin;

Attracting primarily local deposits;

Maintaining loan growth without sacrificing credit quality; and

Concentrating on banking services and products, rather than ancillary services.

These fundamental tenets will be pursued with appropriate modifications made for changes in budgeted growth, interest rate assumptions, product/service offerings, and staffing. Management has identified capital enhancement as a priority for 2011. The near term focus will be on improving earnings while containing asset growth.

Allowance for Loan Losses and Provision for Loan Losses

The provision for loan losses charged to earnings for the nine-month period ended September 30, 2011 was $900,000 compared to $815,000 for the same period in 2010. Although the $900,000 provision represents an increase from the provision for the same period last year, it reflects the growth in total loans and the continued effect the state of the economy has had in the Bank's market area. As of September 30, 2011, the loan portfolio increased $20.7 million or 14.8% compared to the loan portfolio balance as of December 31, 2010. The provision for loan losses for the nine-month period ended September 30, 2011 is supported by Management's ongoing assessment of risk associated with the current loan portfolio.

In March 2011, the Bank sold a property held as Other Real Estate Owned ("OREO") valued on its balance sheet at $850,000 for a total sales price of $1.2 million.
The Bank financed the sale under terms that defer recognition of the sale, including any gain, until sufficient loan payments are received under the installment method of accounting for sales of real estate. In addition, the Bank is required to classify the loan as non-accruing until sufficient loan payments are received for conversion to full-accrual accounting. Management expects that the loan will convert to full-accrual status in the first quarter 2012, but there can be no assurance that it will be able to do so at that time, or ever.

A summary of past due and non-accruing loans as of September 30, 2011 is reported in the table below:

                                                      Over 90 days
    Past Due Loans      30 - 59 days   60 - 89 days    nonaccruing        Total

    Principal balance    $         0    $         0    $  1,151,339    $  1,151,339
    Number of loans                0              0               4               4
    % of Gross Loans           0.00%          0.00%           0.73%           0.73%

Per Bank policy, and regulation, loans past due 90 days or more are placed on non-accrual status and all interest accrued up to that point is reversed out of interest income. In addition, loans less than 90 days past due will be classified as non-accrual if circumstances exist that jeopardize the borrower's ability to meet contractual payment requirements. No further interest accrues on any such loan as long as the loan remains in non-accrual status. Such loans are considered to be on a cash basis, so any payments received are recognized as principal reductions or as income depending upon the circumstances of the borrower. Even if payments reduce the delinquency to less than 90 days, the loan remains classified as non-accrual until all past due principal and interest is collected.

For the quarter ended September 30, 2011, interest payments of $15,373 were received on loans classified as non-accrual. The amount of additional interest that would have been recorded as interest income had the non-accrual loans been current during the quarter ended September 30, 2011 is approximately $2,364.

Historical performance is not an indicator of future performance, particularly considering the Bank's relatively short operating history. Future results could differ materially. However, management believes, based upon known factors, management's judgment, regulatory methodologies, and generally accepted accounting principles that the current methodology used to determine the adequacy of the ALL is reasonable.

The ALL is also subject to regulatory examinations and determinations as to its adequacy, which may take into account such factors as the methodology used to calculate the ALL and the size of the ALL in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, regulatory agencies may require a bank to make additional provisions to its ALL when, in the opinion of the regulators, credit evaluations and ALL methodology differ materially from those of management. While it is the Bank's policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans.

Management is intent upon maintaining the quality of the loan portfolio. The Bank's loan staff is constantly monitoring the performance of its loans, and working with borrowers to assist in finding solutions to potential problems.

Financial Condition

The breakdown of the Company's and the Bank's balance sheets at the dates indicated by dollar balances and percentage of total assets is shown below.

During the nine-months ended September 30, 2011, total assets increased by $11.5 million or approximately 7.0%. This change reflected net loan growth of $19.9 million, a decrease of $4.7 million in cash and equivalents, a decrease of $2.1 million in investment securities, and decline of $1.6 million in other assets, including a $0.9 million decrease in other real estate owned as discussed in detail under "Allowance for Loan Losses" above.

For the nine months ended September 30, 2011, total deposits increased $9.4 million and other liabilities, including borrowings increased $0.6 million.

The composition of the balance sheet has changed to include 8.0% liquid assets, (cash and cash equivalents and securities), compared to 12.7% as of December 31, 2010. Management utilized liquid assets and increased term deposits to fund loan growth during the first nine months of 2011. The Company shifted lower yielding liquid assets into higher yielding loans. This effort was intended to increase the earnings capacity of the Company's balance sheet while limiting total asset growth during the nine-months ended September 30, 2011.

                             Choice Bancorp, Inc.
                                 Consolidated                      Choice Bank

                              September 30, 2011                December 31, 2010

Assets                     Dollar Amount         %         Dollar Amount           %

Cash and equivalents      $       4,361,715     2.49%     $       9,091,935        5.55%
Securities available
for sale                          9,615,602     5.49%            11,762,431        7.18%
Loans held for sale                 231,000     0.13%               638,131        0.39%
Loans                           157,089,205    89.68%           137,187,579       83.81%
Other real estate
owned                             1,042,200     0.60%             1,892,200        1.16%
Other assets                      2,829,859     1.61%             3,125,598        1.91%

Total Assets              $     175,169,581   100.00%     $     163,697,874      100.00%

Liabilities and

Deposits                  $     160,195,910    91.45%     $     150,818,896       92.13%
Borrowed funds                      290,000     0.17%                     0        0.00%
Other liabilities                   886,431     0.50%               623,533        0.38%
Stockholders' equity             13,797,240     7.88%            12,255,445        7.49%

Total Liabilities
and Equity                $     175,169,581   100.00%     $     163,697,874      100.00%


As shown in the table below, gross loans increased $20.7 million from December 31, 2010 to September 30, 2011. The primary source for new loans has been the commercial real estate and residential real estate market segments. The Bank intends to continue to pursue loan opportunities when it is able to do so without sacrificing prudent underwriting standards.

The Bank has managed its loan portfolio to achieve diversification, both in types of loans made and location. Fifteen-year and thirty-year fixed-rate mortgage loans are sold in the secondary market, with servicing released to the purchaser. The components of the loan portfolio at September 30, 2011 and December 31, 2010 are summarized as follows:

Type of Loans                 September 30, 2011       %        December 31, 2010        %

Commercial                     $      28,365,119      17.63%     $      26,428,301      18.84%
Real estate:
Commercial                            73,405,580      45.61%            62,208,710      44.36%
Residential                           39,536,183      24.57%            32,477,382      23.16%
Construction & Development            11,528,709       7.16%            11,514,963       8.21%
Second Mortgages                       1,766,743       1.10%             1,903,147       1.36%
Equity lines of credit                 5,639,586       3.50%             5,059,613       3.61%
Consumer                                 692,620       0.43%               641,195       0.46%
Subtotals                            160,934,540     100.00%           140,233,311     100.00%

Allowance for loan losses              3,845,335       2.39%             3,045,732       2.17%
Loans, net                     $     157,089,205      97.61%     $     137,187,579      97.83%

As of September 30, 2011, approximately 46% of loans were made to finance commercial real estate, approximately 18% of loans were made to finance commercial enterprises, and approximately 25% of loans were made to finance residential property. There were no other loan categories that exceeded 10% of total loans as of September 30, 2011.


The estimated fair market value of the investment portfolio as of September 30, 2011 was $9,615,602 including a pre-tax unrealized gain of $345,720. As of December 31, 2010, estimated fair market value was $11,762,431 including pre-tax unrealized gain of $309,771. There were no significant pre-tax unrealized losses at September 30, 2011 or December 31, 2010.

The Company's investment strategies are aimed at maximizing income, preserving principal, managing interest rate risk, and avoiding credit risk. Although the Company has no immediate plans to sell any securities, all investments are classified as "available for sale." This classification strengthens the . . .

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