|
|
|
Nine
Months Ended
September
30, 2007
|
|
Nine
Months Ended
September
30, 2006
|
|
|
|
|
Income
|
|
Weighted
Average Shares
|
|
Per
Share Amount
|
|
Income
|
|
Weighted
Average Shares
|
|
Per
Share Amount
|
|
|
Basic
earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
available to common shareholders
|
|
$
|
899,236
|
|
|
5,049,746
|
|
$
|
.18
|
|
$
|
2,405,156
|
|
|
5,044,712
|
|
$
|
.
48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive RRP awards and stock options
|
|
|
|
|
|
123,151
|
|
|
|
|
|
|
|
|
122,819
|
|
|
|
|
|
Diluted
earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
available to common shareholders and assumed conversions
|
|
$
|
899,236
|
|
|
5,172,897
|
|
$
|
.17
|
|
$
|
2,405,156
|
|
|
5,167,531
|
|
$
|
.
47
|
|
Options
to purchase 131,000 shares of common stock at exercise prices of $17.58 to
$19.15 per share were outstanding at September 30, 2007, but were not included
in the computation of diluted earnings per share because the options were
anti-dilutive.
Option
s
to
purchase
126,500
shares
of common stock at
exercise prices of
$17.69 to $18.75 per share were outstanding at
September 30, 2006
,
but were not included in the
computation of diluted earnings per share because the options were
anti-dilutive
.
Note
3: Recent Accounting Pronouncements
In
March
2006, the Financial Accounting Standards Board (FASB) issued Statement No.
156,
Accounting for Servicing of Financial Assets-an amendment of FASB Statement
No. 140
. This Statement provides the following: 1) revised guidance on when
a servicing asset and servicing liability should be recognized; 2) requires
all
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable; 3) permits an entity to elect to
measure
servicing assets and servicing liabilities at fair value each reporting date
and
report changes in fair value in earnings in the period in which the changes
occur; 4) upon initial adoption, permits a one-time reclassification of
available-for-sale securities to trading securities for securities which
are
identified as offsetting the entity's exposure to changes in the fair value
of
servicing assets or liabilities that a servicer elects to subsequently measure
at fair value; and 5) requires separate presentation of servicing assets
and
servicing liabilities subsequently measured at fair value in the statement
of
financial position and additional footnote disclosures. This standard is
effective as of the beginning of an entity's first fiscal year that begins
after
September 15, 2006 with the effects of initial adoption being reported as
a
cumulative-effect adjustment to retained earnings. Management did not elect
to
carry servicing rights at fair value but instead is amortizing those servicing
rights over the period of estimated net servicing income and assessing the
servicing assets for impairment.
The
Company or one of its subsidiaries files income tax returns in the U.S. federal
and Indiana jurisdictions. With few exceptions, the Company is no longer
subject
to U.S. federal, state and local examinations by tax authorities for years
before 2003.
The
Company adopted the provisions of the Financial Accounting Standards Board
(FASB) Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109
, on January 1, 2007.
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. As a result of the implementation of
FIN 48,
the Company did not identify any uncertain tax positions that it believes
should
be recognized in the financial statements.
In
September 2006, the FASB issued Statement No. 157,
Fair Value
Measurements
. This Statement defines fair value, establishes a framework
for measuring fair value and expands disclosures about fair value measurements.
This Statement establishes a fair value hierarchy about the assumptions used
to
measure fair value and clarifies assumptions about risk and the effect of
a
restriction on the sale or use of an asset. The standard is effective for
fiscal
years beginning after November 15, 2007. The Company is currently evaluating
and
has not yet determined the impact the new standard is expected to have on
its
financial position and results of operations.
In
September 2006, the FASB Emerging Issues Task Force (EITF) finalized Issue
No.
06−5,
Accounting for Purchases of Life Insurance - Determining the Amount
That Could Be Realized in Accordance with FASB Technical Bulletin No. 85−4
(Accounting for Purchases of Life Insurance). This issue requires that a
policyholder consider contractual terms of a life insurance policy in
determining the amount that could be realized under the insurance contract.
It
also requires that if the contract provides for a greater surrender value
if all
individual policies in a group are surrendered at the same time, that the
surrender value be determined based on the assumption that policies will
be
surrendered on an individual basis. Lastly, the issue discusses whether the
cash
surrender value should be discounted when the policyholder is contractually
limited in its ability to surrender a policy. This issue is effective for
fiscal
years beginning after December 15, 2006. The adoption of EITF No. 06-5 did
not
have a material impact on financial condition or results of
operations.
On
February 15, 2007, the FASB issued its Statement No. 159,
The Fair Value
Option for Financial Assets and Financial Liabilities—Including an Amendment of
FASB Statement No. 115
. FAS 159 permits entities to elect to report most
financial assets and liabilities at their fair value with changes in fair
value
included in net income. The fair value option may be applied on an
instrument-by-instrument or instrument class-by-class basis. The option is
not
available for deposits withdrawable on demand, pension plan assets and
obligations, leases, instruments classified as stockholders’ equity, investments
in consolidated subsidiaries and variable interest entities and certain
insurance policies. The new standard is effective at the beginning of the
Company’s fiscal year beginning January 1, 2008, and early application may be
elected in certain circumstances. The Company expects to first apply the
new
standard at the beginning of its 2008 fiscal year. The Company is currently
evaluating and has not yet determined the impact the new standard is expected
to
have on its financial position and results of operations.
Item
2: Management’s Discussion and Analysis of Financial Condition and Results of
Operations
General
The
Company was organized in September 1998. On December 30, 1998, it acquired
the
common stock of Lincoln upon the conversion of Lincoln from a federal mutual
savings bank to a federal stock savings bank. The Bank converted from a federal
thrift charter to a state commercial bank charter on November 1,
2006.
Lincoln
Bank was originally organized in 1884 as Ladoga Federal Savings and Loan
Association, located in Ladoga, Indiana. In 1979 Ladoga Federal merged with
Plainfield First Federal Savings and Loan Association, a federal savings
and
loan association located in Plainfield, Indiana, which was originally organized
in 1896. Following the merger, the Bank changed its name to Lincoln Federal
Savings and Loan Association and, in 1984, adopted the name, Lincoln Federal
Savings Bank. On September 1, 2003, the Bank adopted the name Lincoln Bank.
On
August 2, 2004, the Company acquired First Shares Bancorp, Inc., the holding
company of First Bank, an Indiana commercial Bank. First Shares was merged
with
and into the Company and immediately thereafter, First Bank was merged into
Lincoln Bank. As noted above, the Bank converted from a federal thrift charter
to a state commercial bank charter on November 1, 2006, and provides full
banking services in a single significant business segment. As a state chartered
bank, the Bank is subject to regulation by the Department of Financial
Institutions, State of Indiana and the Federal Deposit Insurance
Corporation.
Lincoln
currently conducts its business from 17 full-service offices located in
Hendricks, Johnson, Morgan, Clinton, Montgomery, and Brown Counties, Indiana,
with its main office located in Plainfield. The Bank also has 2 loan production
offices located in Carmel and Greenwood, Indiana. Lincoln offers a variety
of
lending, deposit and other financial services to its retail and commercial
customers. The Bank’s principal business consists of attracting deposits from
the general public and originating fixed-rate and adjustable-rate loans secured
by commercial real estate, inventory, accounts receivable as well as first
mortgage liens on one- to four-family residential real estate. Lincoln’s deposit
accounts are insured up to applicable limits by the Deposit Insurance Fund
of
the Federal Deposit Insurance Corporation. Lincoln offers a number of financial
services, which includes: (i) one-to four-family residential real estate
loans;
(ii) commercial real estate loans; (iii) real estate construction loans;
(iv)
land loans; (v) multi-family residential loans; (vi) consumer loans, including
home equity loans and automobile loans; (vii) commercial loans; (viii) money
market demand accounts; (ix) savings accounts; (x) checking accounts; (xi)
NOW
accounts; (xii) certificates of deposit; and (xiii) financial
planning.
Lincoln
currently owns three subsidiaries. First, LF Service, whose assets consist
of an
investment in Bloomington Housing Associates, L.P. (“BHA”). BHA is an Indiana
limited partnership that was organized to construct, own and operate a 130-unit
apartment complex in Bloomington, Indiana (the “BHA Project”). Development of
the BHA Project was completed in 1993 and the project is performing as planned.
Second, Citizens Loan and Service Corporation (“CLSC”), which primarily engages
in the purchase and development of tracts of undeveloped land. Because CLSC
engages in activities that are not permissible for a national bank, FDIC
regulations prohibit Lincoln from including its investment in CLSC in its
calculation of regulatory capital. CLSC purchases undeveloped land, constructs
improvements and infrastructure on the land, and then sells lots for residential
home construction. Third, LF Portfolio, which is located in Nevada, holds
and
manages a significant portion of Lincoln’s investment portfolio. As noted above,
effective November 1, 2006, the Bank changed its charter from a federal savings
bank charter to an Indiana commercial bank charter. Unlike federal savings
banks, commercial banks are not permitted to participate in real estate
development joint ventures. Under terms of the approval granted by the Federal
Reserve Bank of Chicago the Company agreed to cause Lincoln Bank to conform
the
existing direct and indirect nonbanking activities and investments conducted
by
CLSC, including by divestiture if necessary, to the requirements of the Bank
Holding Company Act within two years of the consummation of the charter
conversion.
Lincoln’s
results of operations depend primarily upon the level of net interest income,
which is the difference between the interest income earned on interest-earning
assets, such as loans and investments, and costs incurred with respect to
interest-bearing liabilities, primarily deposits and borrowings. We have
experienced a decline in our net interest margin and net interest spread
as
discussed more fully below in our comparison of operating results. The “flat”,
to at some points, “inverted” interest rate yield curve has put stress on our
net interest margin as shorter term interest bearing deposits have generally
repriced at a faster pace than our interest earning assets. Although we do
not
expect this stress to abate in the near term, we are working to grow our
higher
yielding loan portfolio and, as funding needs demand, use proceeds from lower
yielding securities maturities and repayments. We are also reemphasizing
our
focus on the entire customer relationship, which we anticipate will include
a
component of lower cost demand deposits. Results of operations also depend
upon
the level of Lincoln’s non-interest income, including fee income and service
charges and the level of its non-interest expenses, including general and
administrative expenses.
Critical
Accounting Policies
Note
1 to
the consolidated financial statements contains a summary of the Company’s
significant accounting policies presented on pages 32 and 33 of the Annual
Report to Shareholders for the year ended December 31, 2006, which was filed
on
Form 10-K with the Securities and Exchange Commission on March 16, 2007.
Certain
of these policies are important to the portrayal of the Company’s financial
condition, since they require management to make difficult, complex or
subjective judgments, some of which may relate to matters that are inherently
uncertain. Management believes that its critical accounting policies include
determining the allowance for loan losses, the valuation of mortgage servicing
rights, and the valuation of intangible assets.
Allowance
for loan losses
The
allowance for loan losses represents management’s estimate of probable losses
inherent in the Company’s loan portfolios. In determining the appropriate amount
of the allowance for loan losses, management makes numerous assumptions,
estimates and assessments.
The
Company’s strategy for credit risk management includes conservative, centralized
credit policies, and uniform underwriting criteria for all loans as well
as an
overall credit limit for each customer below legal lending limits. The strategy
also emphasizes diversification on a geographic, industry and customer level,
regular credit quality reviews and quarterly management reviews of large
credit
exposures and loans experiencing deterioration of credit quality. A standard
credit scoring system is used to assess credit risks during the loan approval
process of all consumer loans while commercial loans are individually reviewed
by a credit analyst with formal presentations to the Bank’s Loan
Committee.
The
Company’s allowance consists of three components. The Company estimates probable
losses from individual reviews of specific loans and probable losses from
historical loss rates. Also, factors affecting probable losses resulting
from
economic or environmental factors that may not be captured in the first two
components of the allowance are considered.
Larger
commercial loans that exhibit probable or observed credit weaknesses are
subject
to individual review. Where appropriate, reserves are allocated to individual
loans based on management’s estimate of the borrower’s ability to repay the loan
given the availability of collateral, other sources of cash flow and legal
options available to the Company. Included in the review of individual loans
are
those that are impaired as provided in SFAS No. 114,
Accounting by Creditors
for Impairment of a Loan
. Any allowances for impaired loans are measured
based on the present value of expected future cash flows discounted at the
loan’s effective interest rate or fair value of the underlying
collateral.
The
Company evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual. Estimated loss rates are applied to
other
commercial loans not subject to specific reserve allocations.
Homogenous
loans, such as consumer installment and residential mortgage loans are not
individually risk graded. Rather, standard credit scoring systems are used
to
assess credit risks. Loss rates are based on the average net charge-off
estimated by loan category. Allowances on individual loans and historical
loss
rates are reviewed quarterly and adjusted as necessary based on changing
borrower and/or collateral conditions.
The
Company’s primary market area for lending is central Indiana. When evaluating
the adequacy of the allowance, consideration is given to this regional
geographic concentration and the closely associated effect changing economic
conditions have on the Company’s customers. The Company has not substantively
changed any aspect to its overall approach in the determination of the allowance
for loan losses. There have been no material changes in assumptions or
estimation techniques as compared to prior periods that impacted the
determination of the current period allowance.
Mortgage
servicing rights
The
Company recognizes the rights to service sold mortgage loans as separate
assets
in the consolidated balance sheet. The total cost of loans when sold is
allocated between loans and mortgage servicing rights based on the relative
fair
values of each. Mortgage servicing rights are subsequently carried at the
lower
of the initial carrying value, adjusted for amortization, or fair value.
Mortgage servicing rights are evaluated for impairment based on the fair
value
of those rights.
Factors
included in the calculation of fair value of the mortgage servicing rights
include, estimating the present value of future net cash flows, market loan
prepayment speeds for similar loans, discount rates, servicing costs, and
other
economic factors. Servicing rights are amortized over the estimated period
of
net servicing revenue. It is likely that these economic factors will change
over
the life of the mortgage servicing rights, resulting in different valuations
of
the mortgage servicing rights. The differing valuations will affect the carrying
value of the mortgage servicing rights on the consolidated balance sheet
as well
as the amounts recorded in the consolidated income statement. See Note 3
for a
discussion of (SFAS) No. 156,
Accounting for Servicing of Financial
Assets-an amendment of FASB Statement No. 140
.
Intangible
assets
Management
periodically assesses the impairment of its goodwill and the recoverability
of
its core deposit intangible. Impairment is the condition that exists when
the
carrying amount of goodwill exceeds its implied fair value. If actual external
conditions and future operating results differ from management’s judgments,
impairment and/or increased amortization charges may be necessary to reduce
the
carrying value of these assets to the appropriate value.
Financial
Condition
Assets
totaled $889.4 million at September 30, 2007, an increase from December 31,
2006
of $5.8 million. Substantial growth, totaling $63.0 million, in
commercial and commercial real estate loans was offset by a reduction in
mortgage loans of $49.8 million. The reduction in mortgage loans is
the result of the second quarter balance sheet restructuring as well as normal
repayments. As part of the restructuring, we securitized $37.3
million of residential mortgages and sold the resulting
securities. The majority of this cash was used to purchase securities
for our investment portfolio at yields greater than the loans in the
restructuring. A portion of the cash was used to fund commercial loan
growth. Cash flow from these securities will be used to fund future
commercial loan growth. Generally, the Bank continues to sell the majority
of our residential mortgage loan production in the secondary
market. Consumer loans, excluding mortgages, declined by $5.2
million from December 31, 2007.
Restructuring
Strategy:
Lincoln Bank continued its transformation from a traditional
savings and loan to a commercial bank. As previously announced, the Bank
converted its charter from a thrift to a state-chartered commercial
bank November 1, 2006. In late March, 2007, management approved a
strategic restructuring of a portion of the Bank’s balance sheet effective March
31, 2007, including the sale of certain securities as well as a portion of
the
Bank’s fixed rate mortgage loan portfolio. The restructuring was completed
during the second quarter.
Repositioning
the Balance Sheet:
The sale of mortgage loans continued the process of
transforming the balance sheet from a traditional thrift asset and liability
mix
to a commercial bank structure. In addition, the reinvestment into securities
allowed the Bank to structure expected cash flows that will support its planned
increase in commercial and commercial real estate lending. Both the mortgages
and the securities sold were generally those of lower yield in our portfolio
of
assets. The Company expects to realize immediate benefit in current earnings
as
a result of reinvesting in the new securities and additional benefit as cash
flows from the new securities are received over the next several years,
providing funding for our expected commercial growth. Lastly, the sale of
mortgages and the reinvestment into securities should have a risk based capital
benefit, helping offset some of the capital pressures caused by our current
commercial growth.
Restructuring
Securities:
As a part of the planned restructuring, the Bank transferred
securities with a market value at March 31, 2007 of $29.7 million from available
for sale securities into trading securities and recognized a pretax loss
of
$419,000. As a result of movements in interest rates the actual loss incurred
when these securities were sold totaled only $356,000. The average yield
for
this group of securities was approximately 4.64%. The reinvestment of the
proceeds yielded 5.48% for investments purchased and approximately 7.50%
for
proceeds used to fund commercial loan originations. Approximately $22.7 million
of the sale proceeds were reinvested in securities and the remainder was
used to
fund current commercial growth. The transaction is expected to improve net
interest margin through redeployment of the proceeds into higher yielding
assets.
Restructuring
Loans:
The securitization and sale of approximately $44.2 million of
residential mortgage loans with an average yield of approximately 5.01% was
also
approved as part of the restructuring. The loans were transferred from our
held
for investment portion of our loan portfolio to held for sale at the lower
of
cost or market. We recognized a pretax loss of $1,327,000 in the quarter
ending
March 31, 2007 when we marked the loans to market value. An additional market
value loss of $753,000 was recognized in the quarter ending June 30, 2007.
Ultimately, held for sale loans totaling $3.65 million were transferred back
into loans held for investment at their fair market value of $3.50
million. The securitized loans had an original maturity of 10 and 15
years and were seasoned an average of nearly 3 years. Total proceeds from
the
sale of the securitized loans were approximately $37.3 million. Of
these proceeds, approximately $33.8 million was reinvested into
available-for-sale securities with a weighted average yield of approximately
5.60%. The remainder of the proceeds were used to fund commercial loan
growth. A gain on sale totaling $303,000, net of costs, was recognized when
the
securitized loans were sold.
Estimated
EPS Increase from Restructuring:
We continue to believe that the result of
this restructuring will positively impact annual earnings per share in the
range
of $.06 to $.09.
Interest
rate increases in the external market following our March 31, 2007 valuation
affected the sales price of the assets sold in the
restructuring. Generally, this market movement would have resulted in
a greater restructuring loss overall than the loss that was recognized at
March
31, 2007. However, as a part of the restructuring, management entered
into a forward sale contract early in the second quarter to deliver certain
securities at a certain interest rate. The intent of this transaction
was to partially protect against interest rate movements during the time
it took
to complete the securitization of the mortgage loans and the ultimate sale
of
the resulting securities. In addition, the Bank retained the servicing rights
on
the mortgages securitized and sold which resulted in the creation of mortgage
servicing rights. The gain on these servicing rights totaled $296,000
and is also included as part of the restructuring transaction.
The
following table summarizes by quarter the final results of the restructuring
transaction and the financial statement income line affected. No
further transactions affected third quarter 2007 results.
|
|
Included
in income
statement
line
|
|
Quarter
ending June 30, 2007
|
|
|
Quarter
ending March 31, 2007
|
|
|
Year-to-date
September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans–
loss on mark-to market and reclassification to securities
|
Net
gains (losses) on loans held for sale
|
|
$
|
(752,776
|
)
|
|
$
|
(1,327,359
|
)
|
|
$
|
(2,080,135
|
)
|
|
Loans
securitized and sold – establish mortgage servicing right
|
Net
gains (losses) on loans held for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
Net
gains (losses) on loans held for sale
|
|
|
(456,424
|
)
|
|
|
(1,327,359
|
)
|
|
|
(1,783,783
|
)
|
|
Sale
of securitized mortgage loan security
|
Net
realized gains (losses) on sales of securities
|
|
|
303,100
|
|
|
|
-0-
|
|
|
|
303,100
|
|
|
Gains
(losses) on trading securities
|
Net
realized gains (losses) on sales of securities
|
|
|
62,670
|
|
|
|
(418,723
|
)
|
|
|
(356,053
|
)
|
|
Income
related to forward sale contract termination
|
Gain
on termination of forward commitment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
of restructuring effect on pre-tax net income
|
|
|
|
268,096
|
|
|
|
(1,746,082
|
)
|
|
|
(1,477,986
|
)
|
|
Tax
effect on above transactions
|
|
|
|
|
|
|
|
(671,944
|
)
|
|
|
(568,668
|
)
|
|
Net
income effect of restructuring
|
|
|
$
|
|
|
|
$
|
(1,074,138
|
)
|
|
$
|
(909,318
|
)
|
Total
deposits were $678.2 million at September 30, 2007, an increase of $22.5
million
since December 31, 2006. Growth occurred primarily in certificates of
deposit, up $18.0 million. We also experienced growth of $3.7 million in
our
interest bearing demand category where we introduced new products in combination
with a direct mail and premium campaign. Generally, this program has
worked well in creating new relationships with the Bank. Our money market
products grew $14.3 million while our savings products declined by $12.4
million. The money market growth occurred primarily as customers shifted
funds
from savings into our higher competitively priced money market
accounts. Securities sold under agreement to repurchase were $15.5
million and borrowings were $87.2 million at September 30, 2007. Both declined
by $1.4 million and $16.4 million, respectively, from year end 2006. The
decline
in borrowings was the result of repayment of short-term Federal Home Loan
Bank
advances from cash as a result of increased deposit balances.
Shareholders’
equity declined slightly from $99.3 million at December 31, 2006 to $98.7
million at September 30, 2007. The majority of the decline was the result
of
dividends paid out in excess of earnings resulting from the restructuring
losses
absorbed in the first quarter. In addition, net unrealized losses on
available-for-sale securities, net of net realized losses, increased $311,000
from December 31, 2006 to September 30, 2007. Management’s review of
available-for-sale securities in a loss position determined that the impairments
were not other-than-temporary impairment because the fluctuation in values
was
primarily the result of changes in interest rates. As of September 30,
2007 management has both the ability and the intent to hold these securities
until recovery. Management does classify these securities as
“available-for-sale” under the definition of Statement of Financial Accounting
Standards No. 115,
Accounting for Certain Investments in Debt and Equity
Securities
so certain circumstances, such as changes in market interest
rates and related changes in the security's prepayment risk, needs for liquidity
(for example, due to the withdrawal of deposits, increased demand for loans),
changes in the availability of and the yield on alternative investments or
changes in funding sources and terms could change management’s assessment of its
ability and intent to hold these securities. As noted above, the Company
began a
major restructuring of its balance sheet during the first quarter of 2007.
As a
part of this process management identified certain securities for which its
intent to hold until recovery changed. As a result of this change in intent
these securities were immediately moved to the Company’s trading portfolio and
appropriate losses were recognized through the income statement as of March
31,
2007. Also as noted above management sold these securities during the second
quarter of 2007 and reinvested the proceeds. Subsequent changes in value
and/or
additional gains or losses were recognized through the income statement at
that
time.
Comparison
of Operating Results for the Three Months Ended September 30, 2007 and
2006
Net
income for the quarter ended September 30, 2007 was $521,000, or $.10 for
both
basic diluted earnings per share. This compared to net income for the comparable
period in 2006 of $840,000, or $.17 for basic and $.16 for diluted earnings
per
share.
Net
interest income for the third quarter of 2007 was $5,501,000 compared
to $5,530,000 for the same period in 2006. Net interest margin fell to 2.69%
for
the three-month period ended September 30, 2007 compared to 2.70% for the
same
period in 2006. The average yield on earning assets increased 27 basis points
for the third quarter of 2007 compared to the same period in 2006 while the
average cost of interest-bearing liabilities increased 27 basis points in
2007
compared to 2006. Interest rate spread remained nearly identical for
the two periods at 2.22% for the quarter ending September 30, 2007 and 2.23%
for
the like quarter in 2006. Competitive pressures in the current flat yield
curve
environment combined with the customers’ perceived lack of benefit in longer
maturity certificates of deposit over the last year has resulted in a more
liability sensitive position for the Bank. Consequently our shorter-term
liabilities have been repricing at a faster rate than our earning assets
in what
was a rising interest rate environment. The restructuring described
above, combined with fewer maturing certificates repricing up at substantially
higher rates, have combined for the leveling off of our decline in net interest
spread experienced in previous quarters.
The
Bank’s provision for loan losses for the third quarter of 2007 was $150,000
compared to $120,000 for the same period in 2006. Non-performing loans to
total
loans at September 30, 2007 were .43% compared to .38% at December 31, 2006,
while non-performing assets to total assets were .33% at September 30, 2007
compared to .31% at December 31, 2006. The allowance for loan losses as a
percent of loans was .97% at September 30, 2007 and .96% at December 31,
2006.
During the third quarter of 2007, the Bank incurred $114,000 in net charged
off
loans compared to net charged off loans in the same quarter of 2006 totaling
$17,000.
Other
income for the three months ended September 30, 2007 was $1,577,000 compared
to
income of $1,426,000 for the same quarter of 2006 or an increase of
$151,000. Service charges on deposit accounts and point of sale
income totaled $621,000 and $238,000, respectively. This resulted in increases
of $62,000 and $55,000 respectively, when compared to the same period last
year.
As noted above, a new consumer marketing program was instituted in early
2007
resulting in additional transaction accounts that have increased these income
sources. Cash value of life insurance income was $213,000 for the
third quarter of 2007. This was an increase of $45,000 from 2006 to 2007
as a
result of additional insurance being purchased in the fourth quarter of 2006
as
well as increased yields on the variable rate policies. The increased loss
recognized in connection with our investment in a low income housing partnership
was responsible for much of the decline in other miscellaneous
income.
Other
expenses were $6,331,000 for the three months ended September 30, 2007, a
$602,000 increase compared to $5,729,000 for the same three months of 2006.
Data processing fees totaled $698,000 for the third quarter of 2007
or $159,000 more than the same quarter in 2006 as a result of new services
as
well as additional activity relating to new deposit accounts opened. Net
occupancy expenses were $632,000 for the third quarter of 2007, an increase
of $141,000 over the same three month period in 2006. Substantial
increases in our real estate taxes have caused over half of this
increase. Much of the remainder is due to the cost of additional
facilities added in the first quarter of 2007. Other expense increased $106,000
across various categories and totaled $715,000 for the three months ended
September 30, 2007 compared to the same period in 2006. A reduction in gain
on
sale of other real estate was one of the larger increases in other expenses.
Salaries and employee benefits totaled $3,008,000 for the third quarter of
2007
compared to $2,947,000 during the same quarter of 2006. The primary reason
for
the increase was an increase in higher compensated commissioned sales
staff. Full-time equivalent employees averaged 228 for the third
quarter of 2007 compared to 231 for the same quarter in 2006.
Income
tax expense for the three months ended September 30, 2007 was $76,000 or
12.7%
of income before income tax expense. This compares to $267,000 or 24.1% of
income before income tax expense for the period ended September 30, 2006.
The
difference between the actual rate recorded and the statutory rates was
primarily due to permanent, non-taxable income recorded such as qualifying
municipal interest and increases in cash value of life insurance and the
benefit
of a low income housing tax credit.
Comparison
of Operating Results for the Nine Months Ended September 30, 2007 and
2006
Net
income for the nine month period ended September 30, 2007 was $899,000, or
$.18
for basic and $.17 for diluted earnings per share. This compared to net income
for the comparable period in 2006 of $2,405,000 or $.48 for basic and $.47
for
diluted earnings per share. As noted above, during the first quarter
of 2007, the Bank began a strategy to restructure its balance sheet and,
as a
result, incurred a first quarter after-tax loss. The restructuring
was completed during the second quarter of 2007. The total year-to-date effect
of the restructuring was an after tax net loss of $909,000, or $.18 for both
basic and diluted earnings per share.
Net
interest income year-to-date through September 30, 2007 declined by $652,000
from $16.8 million year-to-date 2006 to $16.2 million year-to-date in 2007.
The
Bank continues to be challenged by a combination of factors including its
liability sensitive balance sheet position as well as the relatively flat
interest rate curve. Over the last eighteen to twenty-four months the
Bank has experienced a substantial volume of lower rate, longer term
certificates of deposit that have matured and then renewed into a substantially
higher rate and generally shorter term maturity. While the Bank did
have new assets and assets re-pricing during this period there were not as
many
assets re-pricing nor was the increase in yield on those assets as great
as the
increase in rate on the certificates of deposit. Net interest
margin fell to 2.62% for the nine-month period ended September 30, 2007 compared
to 2.77% for the same period in 2006. The average yield on earning assets
increased 29 basis points for the nine month period ending September 30,
2007
compared to the same period in 2006 while the average cost of interest-bearing
liabilities increased 47 basis points in 2007 compared to 2006. This decreased
interest rate spread from 2.33% for the 2006 period to 2.15% for the 2007
period, or 18 basis points.
The
Bank’s provision for loan losses year-to-date through September 30, 2007 was
$457,000 compared to $622,000 for the same period in 2006. Through September
30,
2007, the Bank incurred $304,000 of net charged-off loans compared to $330,000
for the same period of 2006.
Other
income year-to-date through September 30, 2007 was $3,281,000 compared to
income
of $3,929,000 for the same year-to-date period of 2006. Other income
for the period ended September 30, 2007 included a net $1,478,000 of
expense related to the balance sheet restructuring discussed
above. This is illustrated in the table presented in the Financial
Condition section. Excluding the balance sheet restructuring
charges other income would have increased $830,000 to
$4,759,000. Much of this increase was due to selling substantially
all of our mortgage loan production in 2007. Through most of the
first and second quarters of 2006 we retained a substantial portion of our
mortgage loan production. Excluding the expenses related to the
balance sheet repositioning, net gains on sales of loans would have increased
$526,000 from year-to-date September 30, 2006. We have also started to see
the
benefit of the increased account openings resulting from our consumer checking
account campaign. Service charges on deposit accounts have increased from
$1,601,000 year-to-date through September 30, 2006 to $1,807,000 year-to-date
through September 30, 2007 or $206,000. Also, with the new accounts
we added our point of sale income has also increased, from $533,000 year-to-date
through September 30, 2006 to $666,000 year-to-date through September 30,
2007. Loan servicing fees did decline slightly as mortgages were sold
with servicing released and normal payments and payoff’s reduced the average
outstanding serviced loans balance. The restructuring described above
should reverse this trend since servicing was retained on the loans that
were
securitized. The increase of $141,000 in cash value of life insurance
income to a total of $636,000 through September 30, 2007, was the result
of
additional insurance being purchased in the fourth quarter of 2006 as well
as
increased yields on the variable rate policies. Other income, within the
“Other
income” section, decreased by $180,000 to $558,000 for the first nine months of
2007. Year-to-date loss recorded on our low income housing tax partnership
is
responsible for the majority of this variance.
Other
expenses for the nine month period ended September 30, 2007 were $18,463,000,
an
increase of $1,444,000 over the same period in 2006. Most of the
increase was in salaries and employee benefit costs, up $581,000 over the
same
period in 2006 for essentially the same reasons mentioned for the quarter
and
described above. Advertising and business development increased $282,000 to
$878,000 to support expanded marketing for our new checking products and
our
efforts to increase core deposit relationships through direct marketing.
Net
occupancy expenses and data processing fees expense increased $251,000 and
$167,000, respectively over the same nine month period in 2006 to total
$1,769,000 and $1,904,000, respectively. The reasons for these
increases are essentially the same as discussed in the quarter-to-date results
presented above.
Income
tax benefit for the nine months ended September 30, 2007 was $340,000 on
$559,000 of pre-tax income. This compares to income tax expense of $733,000
on
$3,138,000 of income before income tax for the nine month period ended September
30, 2006. The difference between the actual rate recorded and the statutory
rates was primarily due to permanent, non-taxable income recorded such as
qualifying municipal interest and increases in cash value of life insurance
as
well as the benefit of a low income housing tax credit.
Asset
Quality
The
Company currently classifies loans as special mention, substandard, doubtful
and
loss to assist management in addressing collection risks and pursuant to
regulatory requirements. Special mention loans represent credits that have
potential weaknesses that deserve management’s close attention. If left
uncorrected, these potential weaknesses may result in deterioration of the
repayment prospects or Lincoln’s credit position at some future date.
Substandard loans represent credits characterized by the distinct possibility
that some loss will be sustained if deficiencies on the loans are not corrected.
Doubtful loans possess the characteristics of substandard loans, but collection
or liquidation in full is doubtful based upon existing facts, conditions
and
values. A loan classified as a loss is considered uncollectible. Lincoln
had
$16.9 million and $7.4 million of loans classified as special mention as
of
September 30, 2007 and December 31, 2006, respectively. The increase in special
mention loans was primarily due to three unrelated credits. In addition,
Lincoln
had $5.3 million and $5.6 million of loans classified as substandard at
September 30, 2007 and December 31, 2006, respectively. Loans classified
as
doubtful totaled $.4 million at September 30, 2007 and also at December 31,
2006. At September 30, 2007 and December 31, 2006 there were no loans classified
as loss. At September 30, 2007, and December 31, 2006, non-accrual loans
were
$2.5 million. At September 30, 2007 and December 31, 2006, respectively,
accruing loans delinquent 90 days or more totaled $254,000 and $1,000. At
September 30, 2007 and December 31, 2006, the allowance for loan losses was
$6.3
million and $6.1 million, respectively or .97% of loans at September 30,
2007
and .96% at December 31, 2006.
Liquidity
and Capital Resources
The
Company’s primary sources of funds are deposits, borrowings and the proceeds
from principal and interest payments on loans. In addition, securities
maturities and amortization of mortgage-backed securities are structured
to
provide a source of liquidity. Sales of loans and available for sale securities
can also provide liquidity should the need arise. While maturities and scheduled
amortization of loans and mortgage-backed securities are a predictable source
of
funds, deposit flows and mortgage and mortgage-backed securities prepayments
are
greatly influenced by general interest rates, economic conditions and
competition. Liquidity management is both a daily and long-term function
of the
Company’s management strategy. In the event that the Company should require
funds beyond its ability to generate them internally, additional funds are
available through the use of FHLB advances, brokered deposits and federal
funds
purchased.
Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the subsidiary bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital
(as
defined) to average assets (as defined).
Management
believes, as of September 30, 2007, that the Company and the Bank meet all
capital adequacy requirements to which they are subject. The Company and
Bank’s
actual capital amounts and ratios under the state charter are presented in
the
following table.
|
|
|
|
|
|
For
Capital Adequacy Purposes
|
|
|
To
Be Well Capitalized Under Prompt Corrective Action
Provisions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of June 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital (to Risk-Weighted Assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
79,344
|
|
|
|
11.2
|
%
|
|
$
|
56,643
|
|
|
|
8.0
|
%
|
|
|
|
|
N/A
|
|
|
Bank
|
|
|
77,696
|
|
|
|
11.0
|
|
|
|
56,532
|
|
|
|
8.0
|
|
|
$
|
70,665
|
|
|
|
10.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
I Capital (to Risk-Weighted Assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
73,061
|
|
|
|
10.3
|
|
|
|
28,322
|
|
|
|
4.0
|
|
|
|
|
|
|
N/A
|
|
|
Bank
|
|
|
71,414
|
|
|
|
10.1
|
|
|
|
28,266
|
|
|
|
4.0
|
|
|
|
42,399
|
|
|
|
6.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
I Capital (to Average Assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
73,061
|
|
|
|
8.5
|
|
|
|
34,426
|
|
|
|
4.0
|
|
|
|
|
|
|
N/A
|
|
|
Bank
|
|
|
71,414
|
|
|
|
8.3
|
|
|
|
34,363
|
|
|
|
4.0
|
|
|
|
42,954
|
|
|
|
5.0
|
|
Other
The
Securities and Exchange Commission maintains a Web site that contains reports,
proxy information statements, and other information regarding registrants
that
file electronically with the Commission, including the Company. The address
is
http://www.sec.gov.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
An
important component of Lincoln Bank’s asset/liability management policy includes
examining the interest rate sensitivity of its assets and liabilities and
monitoring the expected effects of interest rate changes on the economic
value
of its assets. An asset or liability is interest rate sensitive within
a
specific time period if it will mature or reprice within that time period.
If
Lincoln Bank’s assets mature or reprice more quickly or to a greater extent than
its liabilities, economic value and net interest income would tend to increase
during periods of rising interest rates, but decrease during periods of
falling
interest rates. Conversely, if Lincoln Bank’s assets mature or reprice more
slowly or to a lesser extent than its liabilities, economic value and net
interest income would tend to decrease during periods of rising interest
rates
but increase during periods of falling interest rates.
The
Bank’s board of directors has delegated responsibility for the day-to-day
management of interest rate risk to the Asset/Liability (“ALCO”) Committee. The
ALCO Committee meets monthly to manage and review Lincoln Bank’s assets and
liabilities. The ALCO Committee reviews interest rates for deposits and
loan
product pricing. The committee considers the bank’s interest rate risk position,
liquidity needs and competitive pricing.
Presented
below, as of September 30, 2007 is an analysis showing the present value
impact
of changes in interest rates, assuming a comprehensive mark-to-market
environment. Noninterest sensitive assets and liabilities such as cash,
accounts
receivable, fixed assets, and other liabilities are excluded from the
analysis.
|
|
|
Economic
Value
|
|
|
|
|
Present
Value at September 30, 2007
Change
in Interest Rates of:
|
|
|
|
|
-2%
|
|
-1%
|
|
Current
|
|
+1%
|
|
+2%
|
|
|
|
|
(In
Thousands)
|
|
|
Interest
Sensitive Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments
|
|
$
|
171,211
|
|
$
|
169,866
|
|
$
|
166,467
|
|
$
|
160,542
|
|
$
|
154,059
|
|
|
Loans
|
|
|
654,792
|
|
|
645,532
|
|
|
635,624
|
|
|
626,757
|
|
|
619,029
|
|
|
Total
interest sensitive assets
|
|
|
826,003
|
|
|
815,398
|
|
|
802,091
|
|
|
787,299
|
|
|
773,088
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Sensitive Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
(683,932
|
)
|
|
(677,411
|
)
|
|
(670,235
|
)
|
|
(662,462
|
)
|
|
(655,238
|
)
|
|
Borrowings
and repurchase agreements
|
|
|
(106,580
|
)
|
|
(104,558
|
)
|
|
(103,189
|
)
|
|
(102,111
|
)
|
|
(101,483
|
)
|
|
Total
interest sensitive liabilities
|
|
|
(789,512
|
)
|
|
(781,969
|
)
|
|
(773,424
|
)
|
|
(764,573
|
)
|
|
(756,721
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
market value as of June 30, 2007
|
|
$
|
36,491
|
|
$
|
33,429
|
|
$
|
28,667
|
|
$
|
22,726
|
|
$
|
16,367
|
|
|
Change
from current
|
|
$
|
7,824
|
|
$
|
4,762
|
|
$
|
---
|
|
$
|
(5,941
|
)
|
$
|
(12,300
|
)
|