Item 1. Business
Organization
The Company, a Maryland corporation, was organized by Home Federal MHC (MHC), Home Federal Bancorp, Inc., and Home Federal Bank (“Bank”) to facilitate the “second-step” conversion of the Bank from the mutual holding company structure to the stock holding company structure (Conversion). Upon consummation of the Conversion, which occurred on December 19, 2007, the Company became the holding company for Home Federal Bank and now owns all of the issued and outstanding shares of Home Federal Bank’s common stock. As part of the Conversion, shares of the Company’s common stock were issued and sold in an offering to certain depositors of Home Federal Bank and others. Concurrent with the offering, each share of Home Federal Bancorp, Inc.’s common stock owned by public shareholders was exchanged for 1.136 shares of the Company’s common stock, which resulted in an 853,133 increase in outstanding shares, with cash being paid in lieu of issuing any fractional shares.
As part of the Conversion, a total of 9,384,000 new shares of the Company were sold in the offering at $10 per share. Proceeds from the offering totaled $87.8 million, net of offering costs of approximately $5.9 million. The Company contributed $48.0 million or approximately 50% of the net proceeds to the Bank in the form of a capital contribution. The Company loaned $8.2 million to the Bank’s Employee Stock Ownership Plan (ESOP) and the ESOP used those funds to acquire 816,000 shares of the Company’s common stock at $10 per share.
The Conversion was accounted for as a reorganization in corporate form with no change in the historical basis of the Company’s assets, liabilities or stockholders’ equity. All references to the number of shares outstanding, including references for purposes of calculating per share amounts, are restated to give retroactive recognition to the exchange ratio applied in the Conversion.
On May 31, 2011, the Company completed its reorganization from a savings and loan holding company to a bank holding company regulated by the Board of Governors of the Federal Reserve System (Federal Reserve). In connection with the Company’s holding company reorganization, the Bank completed its charter conversion by converting from a federally-chartered stock savings bank to an Idaho commercial bank. As a result of the holding company reorganization and charter conversion, the Company’s primary regulator changed from the Office of Thrift Supervision (OTS) to the Federal Reserve and the Bank’s primary regulator changed from the OTS to the Idaho Department of Finance (Department). The Bank continues to be regulated by the FDIC as insurer of its deposits.
Acquisition of Assets and Liabilities of Community First Bank. On August 7, 2009, the Bank entered into a purchase and assumption agreement with loss sharing agreements with the FDIC to assume all of the deposits (excluding brokered deposits) and certain assets of Community First Bank, a full-service commercial bank, headquartered in Prineville, Oregon (the CFB Acquisition). Community First Bank operated eight locations in central Oregon. Home Federal Bank assumed approximately $142.8 million of the deposits of Community First Bank. Additionally, Home Federal Bank purchased approximately $142.3 million in loans and $12.9 million of real estate and other repossessed assets (REO). The loans and REO purchased are covered by loss sharing agreements between the FDIC and Home Federal Bank which affords the Bank significant protection. Under the loss sharing agreements, Home Federal Bank will share in the losses on assets covered under the agreement (referred to as covered assets). The FDIC has agreed to reimburse Home Federal Bank for 80% of the first $34.0 million of losses and 95% of losses that exceed that amount. In addition, Home Federal Bank purchased cash and cash equivalents and investment securities of Community First Bank valued at $37.7 million at the date of the CFB Acquisition, and assumed $18.3 million in Federal Home Loan Bank advances and other borrowings. This acquisition was accounted for as a purchase under Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations (SFAS No. 141), with the assets acquired and liabilities assumed recorded at their respective fair values.
Acquisition of Assets and Liabilities of LibertyBank. On July 30, 2010, the Bank entered into a purchase and assumption agreement with loss sharing agreements with the FDIC to assume all of the deposits and certain assets of LibertyBank, a full service commercial bank headquartered in Eugene, Oregon (the LibertyBank Acquisition). LibertyBank operated fifteen locations in central and western Oregon. The LibertyBank Acquisition consisted of assets with a preliminary fair value estimate of approximately $690.6 million, including $373.1 million of cash and
cash equivalents, $197.6 million of loans and leases and $34.7 million of securities. Liabilities with a preliminary fair value estimate of $688.6 million were also assumed, including $682.6 million of deposits.
Included in the LibertyBank Acquisition were three subsidiaries of LibertyBank, which have become subsidiaries of Home Federal Bank. Two of the subsidiaries, Liberty Funding, Inc. and Liberty Investment Services, Inc., are inactive with no business activities. The third subsidiary, Commercial Equipment Lease Corporation (CELC) finances and leases equipment under equipment finance agreements and lease contracts, typically for terms of less than 5 years. The book value of the stock of CELC was $10.3 million. CELC conducts business in all fifty states, with a primary focus on Oregon, California and Washington State. Home Federal Bank intends to continue the wind down of the operations of CELC and the accounts of CELC have been consolidated in the accompanying Consolidated Financial Statements.
Home Federal Bank also entered into loss sharing agreements with the FDIC in the LibertyBank Acquisition. Under the loss sharing agreements, the FDIC has agreed to reimburse Home Federal for 80% of losses on purchased REO, nearly all of the loans and leases of LibertyBank and CELC and certain related expenses. Total losses on the loans and leases of CELC are limited to the sum of the book value of the Bank’s investment in CELC and the Bank’s outstanding balance on a line of credit to CELC as of the acquisition date. These amounts totaled $57.0 million at July 30, 2010, and are eliminated upon consolidation.
In September 2020, approximately ten years following the LibertyBank Acquisition date, the Bank is required to make a payment to the FDIC in the event that losses on covered assets under the loss share agreements have been less than the intrinsic loss estimate, which was determined by the FDIC prior to the LibertyBank Acquisition. The payment amount will be 50% of the excess, if any, of 20% of the Total Intrinsic Loss Estimate of $60.0 million, which equals $12.0 million, less the sum of the following:
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20% of the Net Loss Amount, which is the sum of all loss amounts on covered assets less the sum of all recovery amounts realized. This amount is not yet known;
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25% of the asset premium (discount). This amount is ($7.5) million; and
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3.5% of the total covered assets under the loss share agreements. This amount is $10.1 million.
The Company has estimated the minimum level of losses to avoid a true-up provision payment to the FDIC to be $46.7 million.
Business Activities
Home Federal Bancorp’s primary business activity is the ownership of the outstanding capital stock of Home Federal Bank. Home Federal Bancorp neither owns nor leases any property but instead uses the premises, equipment and other property of Home Federal Bank with the payment of appropriate management fees, as required by applicable law and regulations. At September 30, 2011, Home Federal Bancorp has no significant assets, other than $26.8 million of cash and cash equivalents, $16.3 million of mortgage-backed securities and all of the outstanding shares of Home Federal Bank, and no significant liabilities.
Home Federal Bank was founded in 1920 as a building and loan association and reorganized as a federal mutual savings and loan association in 1936. Home Federal Bank’s deposits are insured by the FDIC up to applicable legal limits under the Deposit Insurance Fund. The Bank has been a member of the Federal Home Loan Bank (FHLB) System since 1937. Home Federal Bank’s primary regulators are the FDIC and the Department.
We are in the business of attracting deposits from consumers and businesses in our market areas and utilizing those deposits to originate loans. We offer a wide range of loan products to meet the credit needs of our clients. The Board of Directors and the management team have undertaken efforts to change the Company’s strategy from that of a traditional savings and loan association to a full-service community commercial bank. This transition includes a reduced reliance on one-to-four family loans originated for the Bank’s portfolio. As a result, the Bank’s lending activities have expanded in recent years to include commercial business lending, including commercial real estate and builder finance loans. The CFB Acquisition and the LibertyBank Acquisition significantly increased the Bank’s commercial loan concentration.
At September 30, 2011, the Company had total assets of $1.2 billion, net loans held for investment of $468.2 million, deposit accounts of $959.5 million and stockholders’ equity of $194.7 million.
Operating Lines
Home Federal Bancorp’s sole subsidiary is Home Federal Bank. Management has determined that the Bank, as a whole, is the sole reporting unit and that no reportable operating segments exist other than Home Federal Bank.
Market Area
Home Federal Bank currently has operations in three distinct market areas. The Bank’s primary market area is the Boise, Idaho, metropolitan statistical area (MSA) and surrounding communities, together known as the Treasure Valley region of southwestern Idaho, including Ada, Canyon, Elmore and Gem counties. The CFB Acquisition resulted in the Bank’s entrance into the Tri-County Region of Central Oregon, including the counties of Crook, Deschutes and Jefferson. Through the LibertyBank Acquisition, Home Federal Bank expanded its markets into Lane, Josephine, Jackson and Multnomah counties in Western Oregon, including the communities of Eugene, Grants Pass and Medford, Oregon, in addition to deepening its presence in Central Oregon.
At September 30, 2011, the Bank operated through 33 full-service branches and delivery channels for the Bank’s products included automated teller machines and Internet banking services. In September 2011, the Bank announced plans to close five of its branches between October 1, 2011 and January 5, 2012, in addition to one branch closed during September 2011. We monitor the performance of our branches and analyze market growth opportunities, current market share, and client transaction levels in determining underperforming branches. We identified branches located in Terrebonne, Bend and LaPine in Oregon and two branches in Boise, Idaho, including the Bank's only remaining Walmart in-store branch, as those branches least likely to provide profitable returns in the long-term and decided to close them and transition clients to our nearest branch upon closure. Those branches are noted in the table under “Item 2. Properties.”
The following table summarizes key economic and demographic information about these market areas:
(1)
Not seasonally adjusted. September 2011 is preliminary.
(2)
In millions. Excludes deposits in credit unions.
Source: FDIC, SNL Financial, Bureau of Labor Statistics
Idaho Region. The local economy is primarily urban with Boise, the state capital of Idaho, being the most populous city in Idaho, followed by Nampa, the state’s second largest city. Nearly 40% of the state’s population lives and/or works in the four counties of Ada, Canyon, Elmore and Gem that are served by Home Federal Bank.
The regional economy is well diversified with government, healthcare, manufacturing, high technology, call centers and construction providing sources of employment. In addition, agriculture and related industries continue to be key components of the economy in southwestern Idaho. Generally, sources of employment are concentrated in Ada and Canyon counties and include the headquarters of Micron Technology, J.R. Simplot Company and Boise Cascade, LLC. Other major employers include Hewlett-Packard, Supervalu, two regional medical centers and Idaho state government agencies. Boise is also home to Boise State University, the state’s largest university.
The Treasure Valley has enjoyed strong population growth over the last ten years, which led to an increase in residential community developments. Historically, the unemployment rate has been lower than the national rate. The current economic slowdown, which has been led by significant deterioration in residential home sales, has caused acceleration in unemployment in the Treasure Valley. This slowdown has created an over-supply of speculative construction and land development projects. During the build-up of residential construction, commercial real estate construction accelerated and many speculative construction commercial projects, as well as existing commercial buildings, are now vacant, contributing to falling property values. Continued deterioration in the local economy may result in additional losses in the Bank’s loan portfolio, restrict management’s ability to execute the Company’s growth plans or impact the Bank’s liquidity due to a shrinking deposit base. See “Risk Factors” under Item 1A
Item 1A. Risk Factors
Our business, and an investment in our common stock, involves risks. Summarized below are the risk factors which we believe are material to our business and could negatively affect our operating results, financial condition and the trading value of our common stock. Other risks factors, not currently known to us, or that we currently deem to be immaterial or unlikely, also could adversely affect our business. In assessing the following risk factors, you should also refer to the other information contained in this Annual Report on Form 10-K and our other filings with the Securities and Exchange Commission.
The current economic conditions in the market areas we serve may continue to adversely impact our earnings and could increase the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Idaho and Oregon. A continuing decline in the economies of the markets in which we operate, could have a material adverse effect on our business, financial condition, results of operations and prospects. In particular, Idaho and Oregon have experienced substantial home price declines and increased foreclosures and have experienced above average unemployment rates.
A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
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loan delinquencies, problem assets and foreclosures may increase;
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we may increase our allowance for loan losses;
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demand for our products and services may decline;
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collateral for loans made may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans; and
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the amount of our low-cost or noninterest bearing deposits may decrease.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values to satisfy the debt, our financial condition and profitability could be adversely affected.
Our business strategy includes significant growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to pursue a significant growth strategy for our business. We regularly evaluate potential acquisitions and expansion opportunities. If appropriate opportunities present themselves, we expect to engage in selected acquisitions of financial institutions in the future, including FDIC-assisted transactions, or other business growth initiatives or undertakings. There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.
Our growth initiatives may require us to recruit experienced personnel to assist in such initiatives. Accordingly, the failure to identify and retain such personnel would place significant limitations on our ability to successfully execute our growth strategy. In addition, to the extent we expand our lending beyond our current market areas, we could incur additional risk related to those new market areas. We may not be able to expand our market presence in our existing market areas or successfully enter new markets.
If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill or core deposit intangible had been impaired, that conclusion would result in an impairment charge to us, which would adversely affect our results of operations. While we believe we have the executive management resources and internal systems in place to successfully manage our future growth, there can be no assurance that growth opportunities will be available or that we will successfully manage our growth. Our strategy of pursuing acquisitions exposes us to financial, execution and operational risks that could adversely affect us.
We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy, however, including the following:
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we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
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prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we will experience this condition in the future;
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the acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal adverse effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful. These risks are present in our recently completed FDIC-assisted transactions; and
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to finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing stockholders.
We have completed two acquisitions during the past two fiscal years that enhanced our rate of growth. We may not be able to continue to sustain our past rate of growth or to grow at all in the future. Although we expect our net interest income will increase following an acquisition, we also expect our general and administrative expenses and consequently our efficiency ratio will also increase, as in the case of our recent acquisitions. Ultimately, we would expect our efficiency ratio to improve; however if we are not successful in our integration process, this may not occur, or may occur at a slower rate than originally anticipated, and our acquisitions may not be accretive to earnings in the short or long-term.
We may engage in additional FDIC-assisted transactions, which could present additional risks to our business.
We may have additional opportunities to acquire the assets and liabilities of failed banks in FDIC-assisted transactions. Although these FDIC-assisted transactions typically provide for FDIC assistance to an acquirer to mitigate certain risks, such as sharing exposure to loan losses and providing indemnification against certain liabilities of the failed institution, we are (and would be in future transactions) subject to many of the same risks we would face in acquiring another bank in a negotiated transaction, including risks associated with maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we expect. In addition, because these acquisitions are structured in a manner that would not allow us the time and access to information normally associated with preparing for and evaluating a negotiated acquisition, we may face additional risks in FDIC-assisted transactions, including additional strain on management resources, management of problem loans, problems related to integration of personnel and operating systems and impact to our capital resources requiring us to raise additional capital. We cannot give assurance that we will be successful in overcoming these risks or any other problems encountered in connection with our FDIC-assisted transactions. Our inability to overcome these risks could have a material adverse effect on our business, financial condition and results of operations.
Our earnings may be diminished until we can invest the additional liquidity from the acquisition of LibertyBank.
The recent acquisition of LibertyBank resulted in a significant increase in cash as a result of the excess of liabilities assumed over assets purchased and the amount of LibertyBank loans retained by the FDIC. We expect that the significant increase in cash balances will result in a decrease in our net interest margin until these additional funds can be invested in loans and securities. This influx of cash and the additional expense burden will keep our earnings below optimal levels until we can generate meaningful loan growth. As a result of the current environment, there is a lack of demand for loans, or a diminished supply of creditworthy lending opportunities, as well as an increase in residential loan refinancing, limits our ability to increase outstanding organic loan balances. Alternative investments
are also unattractive as investment securities offer very low yields within management’s credit and interest rate risk tolerances. If we are unable to invest this additional liquidity, our earnings may be adversely affected.
We are highly dependent on key individuals and a number of the members of executive and senior management have been with the Company for five years or less.
Consistent with our policy of focusing on select growth initiatives we are highly dependent on the continued services of a limited number of our executive officers and key management personnel. The loss of services of any of these individuals may have a material adverse impact on our operations because other officers may not have the experience and expertise to readily replace these individuals.
We believe we have in place qualified individuals and have provided for an orderly transition. Additional changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and profitability. Moreover, our anticipated growth is expected to place increased demands on our human resources and will require the recruitment of additional middle management personnel. The competition to hire experienced banking professionals is also intense. If we are unable to attract qualified banking professionals, our expansion plans could be delayed or curtailed and our business, financial condition, and profitability may be adversely affected.
The price of our common stock may be volatile or may decline.
The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could adversely affect the market price of our common stock. Among the factors that could affect our stock price are:
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actual or anticipated quarterly fluctuations in our operating results and financial condition;
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changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts;
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failure to meet analysts’ revenue or earnings estimates;
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speculation in the press or investment community;
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strategic actions by us or our competitors, such as acquisitions or restructurings;
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actions by institutional shareholders;
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fluctuations in the stock price and operating results of our competitors;
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general market conditions and, in particular, developments related to market conditions for the financial services industry both domestically and internationally;
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proposed or adopted regulatory changes or developments;
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anticipated or pending investigations, proceedings or litigation that involve or affect us; or
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domestic and international economic factors unrelated to our performance.
The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility in recent years. As a result, the market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, or other factors. Market volatility during the past couple of years is unprecedented. The capital and credit markets have been experiencing volatility and disruption for more than a year. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.
Fluctuating interest rates can adversely affect our profitability.
Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., The Wall Street Journal prime rate) may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected. In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates could materially affect our net interest spread, asset quality, origination volume, and overall profitability.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.
Our loan portfolio possesses increased risk due to our increasing percentage of commercial real estate and commercial business loans.
We have been increasing, and intend to continue to increase, our origination of commercial and multifamily real estate loans and commercial business loans in the future. The credit risk related to these types of loans is considered to be greater than the risk related to one-to-four family residential loans because the repayment of commercial real estate loans and commercial business loans typically is dependent on the successful operation and income stream of the borrowers’ business and the real estate securing the loans as collateral, which can be significantly affected by economic conditions.
Several of our borrowers have more than one commercial real estate loan outstanding with us and commercial real estate loans tend to have larger balances than one-to-four family residential loans. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Finally, if we foreclose on a commercial real estate loan, our holding period for the collateral, if any, typically is longer than for one-to-four family residential mortgage loan because there are fewer potential purchasers of the collateral. Since we plan to continue to increase our originations of these loans, it may be necessary to increase the level of our allowance for loan losses due to the increased risk characteristics associated with these types of loans. Any increase to our allowance for loan losses would adversely affect our earnings. In addition, these loans generally carry larger balances to single borrowers or related groups of borrowers than one-to-four family loans. Any delinquent payments or the failure to repay these loans would hurt our earnings.
A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate. Continued deterioration in the real estate markets or other segments of our loan portfolio could lead to additional losses, which could have a material negative effect on our financial condition and results of operations.
As a result of increased levels of residential and commercial loan delinquencies and declining real estate values, which reduce the customer’s borrowing power and the value of the collateral securing the loan, we have experienced increasing levels of charge-offs and provisions for loan losses. Continued increases in delinquency levels or continued declines in real estate values, which cause our loan-to-value ratios to increase, could result in additional charge-offs and provisions for loan losses. This could have a material negative effect on our business and results of operations.
Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because either we originated upon purchase a first mortgage with an 80% loan-to-value ratio or because of the decline in home values in our market areas. Residential loans with high loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and, therefore, may
experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the sale. As a result, these loans may experience higher rates of delinquencies, defaults and losses.
Our loan portfolio has a concentration of loans secured by commercial real estate, which is primarily secured by nonowner-occupied investment properties. Continued deterioration in the local economy may result in additional losses on loans. Generally, deterioration in the performance and collectability of a loan secured by owner-occupied real estate can be better monitored than a nonowner-occupied real estate loan as we typically do not have the ability to assess the financial performance of tenants who are leasing from borrowers on investment property loans. We regularly review financial information of borrowers on owner-occupied loans whereas we can typically review only vacancy and rent rolls of tenants of borrowers on nonowner-occupied loans.
Vacancies in office, retail and industrial real estate projects are higher than historical levels in the Bank’s markets. Continued deterioration in the general economy may increase vacancies further, which may result in decreased cash flow to our borrowers and further declines in value on foreclosed commercial real estate causing additional provisions for loan and REO losses.
Our construction loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate.
We make land purchase, lot development and real estate construction loans to individuals and builders, primarily for the construction of residential properties and, to a lesser extent, commercial and multifamily real estate projects. We will originate these loans whether or not the collateral property underlying the loan is under contract for sale. Residential real estate construction loans include single-family tract construction loans for the construction of entry level residential homes.
Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the finished project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, our estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. This risk has been compounded by the current slowdown in both the residential and the commercial real estate markets, which has negatively affected real estate values and the ability of our borrowers to liquidate properties or obtain adequate refinancing. If our estimate of the value of a project at completion proves to be overstated, we may have inadequate security for repayment of the loan and we may incur a loss. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
Commercial business loans include leases to finance the purchase of personal property, business equipment and titled vehicles and construction equipment. All of these financing leases were leases of CELC, the operations of which were assumed by the Bank in the LibertyBank Acquisition, and nearly all of them are covered under a loss share agreement with the FDIC. Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We make our commercial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial loans may depreciate over time, be difficult to appraise and fluctuate in value. In addition, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect the amounts due from its customers. Accordingly, we make our commercial loans primarily based on the historical and expected cash flow of the borrower and secondarily on underlying collateral provided by the borrower.
Our lease loans entail many of the same types of risks as our commercial business loans. As with commercial business loans, the collateral securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We rely on the lessee’s continuing financial stability, rather than the value of the leased equipment, for the repayment of all required amounts under lease loans. In the event of a default on a lease loan, it is unlikely that the proceeds from the sale of the leased equipment will be sufficient to satisfy the outstanding unpaid amounts under the terms of the loan.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings and capital levels could be reduced.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and evaluate economic conditions. Management recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover actual losses, resulting in additions to our allowance. Material additions to our allowance could materially decrease our net income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities could have a material adverse effect on our financial condition and profitability.
Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses.
The weakened housing market may result in a decline in fair value of REO.
In recent months we have foreclosed on certain real estate development and commercial real estate loans and have taken possession of several residential subdivision properties as well as single family residential properties. REO is initially recorded at its estimated fair value less costs to sell. Because of the weak housing market and declining property values, we may incur losses to write-down REO to new fair values or losses from the final sale of properties. Moreover, our ability to sell REO properties is affected by public perception that banks are inclined to accept large discounts from market value to quickly liquidate properties. Write-downs on REO or an inability to sell REO properties will have a material adverse effect on our results of operations and financial condition.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
We are currently subject to extensive regulation, supervision and examination by the Idaho Department of Finance, the Federal Deposit Insurance Corporation and the Federal Reserve Board. Such regulators govern the activities in which we may engage, primarily for the protection of depositors and the Deposit Insurance Fund. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Financial reform legislation, entitled the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), has been enacted by Congress is changing and will continue to change the banking regulatory framework, creating an independent consumer protection bureau that has assumed the consumer protection responsibilities of various federal banking agencies, and established more stringent capital standards for banks and bank holding companies. The legislation has also resulted in new regulations affecting the lending, funding, trading and investment activities of banks and bank holding companies. Any further changes in such regulation and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material impact on our operations. Because our business is highly regulated, the laws and applicable regulations are subject to frequent change. Any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, and noninterest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.
The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
The Dodd-Frank Act created a new consumer financial protection bureau that has the authority to promulgate rules intended to protect consumers in the financial products and services market. The creation of this bureau could result in new regulatory requirements and raise the cost of regulatory compliance. The Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on our competitors’ responses, this change could materially increase our interest expense.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. However, compliance with this law and its implementing regulations is expected to result in additional operating costs that could have a material adverse effect on our financial condition and results of operations.
Continued deterioration in the financial position of the Federal Home Loan Bank of Seattle may result in future impairment losses of our investment in Federal Home Loan Bank stock.
At September 30, 2011, we owned $17.7 million of stock of the FHLB of Seattle. As a condition of membership at the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB. Our FHLB stock has a par value of $100, is carried at cost, and is subject to impairment testing. The FHLB has announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the FHFA), its primary regulator, and that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the FHLB has not paid a dividend since the fourth quarter of 2008. The FHLB has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB’s private-label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in its balance sheet. As a result, we have not recorded an other-than-temporary impairment on our investment in FHLB stock. However, continued deterioration in the FHLB’s financial position may result in impairment in the value of those securities. In addition, in October 2010, the FHLB received a consent order from the FHFA. Management has reviewed the impact of this consent order, and continues to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and advances from the FHLB of Seattle, the Federal Reserve Bank of San Francisco (FRB) and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change. Our access to funding sources in amounts adequate to finance our activities on terms which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general. These factors include, among others, a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. Factors that could detrimentally impact our access to
liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Idaho or Oregon markets where our loans are concentrated or adverse regulatory action against us.
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If that happens, our financial condition, results of operations, growth and future prospects could be materially adversely affected. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs.
The United States economy remains weak and unemployment levels are high. A prolonged recession, especially one affecting our geographic market area, will adversely affect our business and financial results.
The United States experienced a severe economic recession beginning in 2008, which effects have continued through 2011. Recent growth has been slow and unemployment remains at very high levels and is not expected to improve in the near future. Loan portfolio quality has deteriorated at many financial institutions reflecting, in part, the weak United States economy and high unemployment rates. In addition, the value of real estate collateral supporting many commercial loans and home mortgages has declined and may continue to decline, increasing the risk that we would incur losses if borrowers default on their loans.
Continued negative developments in the financial services industry and the domestic and international credit markets may significantly affect the markets in which we do business, the market for and value of our loans and investments, and our ongoing operations, costs and profitability. Continued declines in both the volume of real estate sales and the sale price coupled with the current recession and the associated increase in unemployment may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or lack of growth or a decrease in deposits. These potential negative events may cause us to incur losses, adversely affect our capital, liquidity, financial condition and business operations. These declines may have a greater affect on our earnings and capital than on the earnings and capital of financial institutions whose loan portfolios are more diversified. Moreover, continued declines in the stock market in general, or stock values of financial institutions and their holding companies specifically, could adversely affect our stock performance.
Any future Federal Deposit Insurance Corporation insurance premiums and/or special assessments will adversely impact our earnings.
Due to the costs of resolving the increasing numbers of bank failures in 2008 and 2009, on May 22, 2009, the FDIC adopted a final rule levying a five basis point special insurance premium assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. Any further special assessments that the FDIC levies will be recorded as an expense during the appropriate period. In addition, the FDIC increased the general assessment rate and, therefore, our federal deposit general insurance premium expense will increase compared to prior periods.
The FDIC also issued a final rule pursuant to which all insured depository institutions were required to prepay on December 30, 2009 their estimated assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. The assessment rate for the fourth quarter of 2009 and for 2010 was based on each institution’s total base assessment rate for the third quarter of 2009, modified to assume that the assessment rate in effect on September 30, 2009 had been in effect for the entire third quarter, and the assessment rate for 2011 and 2012 would be equal to the modified third quarter assessment rate plus an additional three basis points. In addition, each institution’s base assessment rate for each period was calculated using its third quarter assessment base, adjusted quarterly for an estimated 5% annual growth rate in the assessment base through the end of 2012.
In the event that the special assessment and the prepayment do not provide sufficient funds for the FDIC to resolve future bank failures, the FDIC may require another special assessment or increase assessment rates for all FDIC insured institutions. An increase in assessments will adversely affect our results of operations.
Our litigation related costs might continue to increase.
The Bank is subject to a variety of legal proceedings that have arisen in the ordinary course of its business. In the current economic environment the Bank’s involvement in litigation has increased significantly, primarily as a result of defaulted borrowers asserting claims in order to defeat or delay foreclosure proceedings. The Bank believes that it has meritorious defenses in legal actions where it has been named as a defendant and is vigorously defending these suits. Although management, based on discussion with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of the Bank, there can be no assurance that a resolution of any such legal matters will not result in significant liability to the Bank nor have a material adverse impact on its financial condition and results of operations or the Bank’s ability to meet applicable regulatory requirements. Moreover, the expenses of pending legal proceedings will adversely affect the Bank’s results of operations until they are resolved. There can be no assurance that the Bank’s loan workout and other activities will not expose the Bank to additional legal actions, including lender liability or environmental claims.
We face strong competition from other financial institutions, financial service companies and other organizations offering services similar to those offered by us, which could limit our growth and profitability.
We face direct competition from a significant number of financial institutions, many with a state-wide or regional presence, and in some cases a national presence, in both originating loans and attracting deposits. Competition in originating loans comes primarily from other banks, mortgage companies and consumer finance institutions that make loans in our primary market areas. We also face substantial competition in attracting deposits from other banking institutions, money market and mutual funds, credit unions and other investment vehicles.
In addition, banks with larger capitalization and non-bank financial institutions that are not governed by bank regulatory restrictions have large lending limits and are better able to serve the needs of larger customers. Many of these financial institutions are also significantly larger and have greater financial resources than us, have been in business for a long period of time and have established customer bases and name recognition.
We compete for loans principally on the basis of interest rates and loan fees, the types of loans we originate and the quality of service we provide to borrowers. Our ability to attract and retain deposits requires that we provide customers with competitive investment opportunities with respect to rate of return, liquidity, risk and other factors. To effectively compete, we may have to pay higher rates of interest to attract deposits, resulting in reduced profitability. If we are not able to effectively compete in our market area, our profitability may be negatively affected, potentially limiting our ability to pay dividends. The greater resources and deposit and loan products offered by some of our competitors may also limit our ability to increase our interest-earning assets.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in our financial reporting, which could materially adversely affect our business, the trading price of our common stock and our ability to attract additional deposits.
In connection with the enactment of the Sarbanes-Oxley Act of 2002 (Act) and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Act. This requires us to prepare an annual management report on our internal control over financial reporting, including among other matters, management’s assessment of the
effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments. If we fail to identify and correct any deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, which could materially adversely affect our business, financial condition and results of operations, the trading price of our common stock and our ability to attract additional deposits.
Failure to comply with the terms of the loss share agreements with the FDIC may result in significant losses.
In connection with the CFB and LibertyBank Acquisitions, Home Federal Bank entered in to loss sharing agreements with the FDIC that significantly reduces the Bank’s credit loss exposure. Losses on covered assets in the CFB Acquisition are indemnified by the FDIC at the rate of 80% on the first $34 million of losses and at a rate of 95% after that. Losses on covered assets in the LibertyBank Acquisition are indemnified by the FDIC at a rate of 80%.
The purchase and assumption agreements and the loss sharing agreements for the Community First Bank and LibertyBank Acquisitions have specific, detailed and cumbersome compliance, servicing, notification and reporting requirements. Our failure to comply with the terms of the agreements or to properly service the loans and REO under the requirements of the loss sharing agreements may cause individual loans or large pools of loans to lose eligibility for loss share payments from the FDIC. This could result in material losses that are currently not anticipated.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we report and record our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in a retrospective adjustment to prior financial statements.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
At September 30, 2011, we conducted business from 33 full service banking offices. 18 of the locations are owned (four of which are scheduled to close during approximately the next three months), 13 locations are leased (two of which is scheduled to close during approximately the next three months) and two locations are owned with the land being leased. At September 30, 2011, the net book value of our investment in properties and equipment was $32.7 million. The net book value of the data processing and computer equipment utilized by us at September 30, 2011 was $1.7 million.
The following table sets forth certain information relating to our offices as of September 30, 2011:
(1)
Includes a full-service branch.
(2)
Per the Company’s announcement on September 28, 2011, this branch is scheduled to be closed within approximately the next three months.
(3)
Walmart location.
Item 3.
Item 3. Legal Proceedings
From time to time we are involved as a plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of such litigation, nor do we expect any material impact on our financial position, results of operations or cash flows.
Item 4.
Item 4. Removed and Reserved
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Home Federal Bancorp’s common stock is currently listed on the NASDAQ Global Market under the symbol “HOME,” and there is an established market for such common stock. As of November 29, 2011, there were approximately 867 stockholders of record, excluding persons or entities that hold stock in nominee or “street name” accounts with brokers.
The following table sets forth the high and low closing trading prices for Home Federal Bancorp common stock, as reported by The Nasdaq Stock Market LLC, and cash dividends paid for each quarter during the fiscal years ended September 30, 2011 and 2010:
Dividends
Home Federal Bancorp has paid quarterly cash dividends since the quarter ended June 30, 2005. The dividend rate and the continued payment of dividends depends on a number of factors, including our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurance can be given that we will continue to pay dividends or that they will not be reduced in the future.
Dividend payments by us may depend upon dividends received by the Company from the Bank. Under federal regulations, the amount of dividends the Bank may pay is dependent upon its capital position and recent net income. Generally, if the Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the FDIC regulations. However, institutions that have converted to a stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12, of this Form 10-K is incorporated herein by reference.
Issuer Purchases of Equity Securities
The following table provides information about purchases of common stock by the Company during the quarter ended September 30, 2011:
On September 28, 2011 the Company announced a stock repurchase of up to 900,000 shares of its outstanding common stock, inclusive of all remaining shares from previously announced repurchase plans. No shares have been purchased under this stock repurchase plan.
Performance Graph
The following graph compares the cumulative total stockholder return on the Company’s common stock with the cumulative total return on the Russell 2000 Index and the SNL Bank Index. Stock prices prior to December 19, 2007, the effective date of the Conversion, relate to old Home Federal Bancorp. The CFB Acquisition and the LibertyBank Acquisition have significantly changed the composition of Home Federal Bank’s assets and liabilities and management is committed to further transformation of Home Federal Bank to a commercial community bank. As a result, the Company believes that the SNL Bank Index best reflects the performance of Home Federal Bancorp, Inc, compared to similarly-structured institutions and no longer includes the SNL Thrift Index in the performance graph. The graph assumes that total return includes the reinvestment of all dividends, and that the value of the investment in Home Federal Bancorp’s common stock and each index was $100 on September 30, 2006. Historical stock prices are not necessarily indicative of future stock performance.
Item 6.
Item 6. Selected Financial Data
The following table sets forth certain information concerning the consolidated financial position and results of operations at and for the dates indicated and has been derived from our audited consolidated financial statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements and “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995
This annual report on Form 10-K contains forward-looking statements, which can be identified by the use of words such as “believes,” “intends,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not limited to:
·
statements of our goals, intentions and expectations;
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statements regarding our business plans, prospects, growth and operating strategies;
·
statements regarding the quality of our loan and investment portfolios; and
·
estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
·
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
·
changes in general economic conditions, either nationally or in our market areas;
·
changes in the levels of general interest rates, and the relative differences between short-term and long-term interest rates, deposit interest rates, our net interest margin and funding sources;
·
risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;
·
fluctuations in the demand for loans, the number of unsold homes, properties and fluctuations in real estate values in our market areas;
·
results of examinations by the Federal Reserve Board and our bank subsidiary by the Federal Deposit Insurance Corporation (FDIC) and the Idaho Department of Finance or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings and could increase our deposit premiums;
·
legislative or regulatory changes, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and its implementing regulations that adversely affect our business, as well as changes in regulatory policies and principles or the interpretation of regulatory capital or other rules;
·
our ability to attract and retain deposits;
·
further increases in premiums for deposit insurance;
·
our ability to realize the residual values of our leases;
·
our ability to control operating costs and expenses;
·
the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
·
difficulties in reducing risks associated with the loans on our balance sheet;
·
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
·
computer systems on which we depend could fail or experience a security breach;
·
our ability to retain key members of our senior management team;
·
costs and effects of litigation, including settlements and judgments;
·
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired, including the Community First Bank and LibertyBank transactions described in this report, or may in the future acquire from our merger and acquisition activities into our operations, our ability to retain clients and employees and our ability to realize related revenue synergies and cost savings within expected time frames, or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;
·
the possibility that the expected benefits from the FDIC-assisted acquisitions will not be realized;
·
increased competitive pressures among financial services companies;
·
changes in consumer spending, borrowing and savings habits;
·
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
·
our ability to pay dividends on our common stock;
·
adverse changes in the securities markets and the value of our investment securities;
·
the inability of key third-party providers to perform their obligations to us;
·
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and
·
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described as detailed from time to time in our filings with the SEC, including this 2011 Form 10-K and subsequently filed Quarterly Reports on Form 10-Q. Such developments could have an adverse impact on our financial position and our results of operations.
Some of these and other factors are discussed in this Annual Report on Form 10-K under the caption “Risk Factors” and elsewhere in this document and in the documents incorporated by reference herein. Such developments could have an adverse impact on our financial position and our results of operations.
Any of the forward-looking statements that we make in this annual report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. We undertake no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for fiscal year 2012 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect our financial condition, liquidity and operating and stock price performance.
GENERAL
Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. We intend to diversify the mix of our assets by reducing the percentage of our assets that are lower-yielding residential loans and mortgage-backed securities and increasing the percentage of our assets consisting of commercial loans that we believe have higher risk-adjusted returns.
Our operating expenses consist primarily of compensation and benefits, occupancy and equipment, data processing, marketing, postage and supplies, professional services and deposit insurance premiums. Compensation and benefits consist primarily of the salaries and wages paid to our employees, non-cash expense related to our employee stock ownership plan (ESOP), payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.
Our results of operations may also be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. See “Item 1A. Risk Factors" in this Annual Report on Form 10-K for additional discussion on the risks we face related to these items.
We entered into two purchase and assumption agreements with the FDIC to purchase certain assets and assume certain liabilities of Community First Bank, Prineville, Oregon, and LibertyBank, Eugene, Oregon, on August 7, 2009, and July 30, 2010, respectively. The acquisitions increased our total assets by $880 million, based on the fair value of assets purchased on the acquisition dates. These acquisitions have been reported on a prospective basis in the accompanying financial statements. Where appropriate in this discussion and analysis, we have attempted to provide detail on the impact of the acquisitions on our financial statements for the years prior to fiscal 2010.
Nearly all loans, leases and real estate owned acquired in both FDIC-assisted transactions are covered under FDIC loss-sharing agreements which significantly reduce the Company’s credit loss exposure. We refer to these assets as “covered assets.” Loans and REO in the Bank’s organic operations are referred to as “noncovered assets.” We expect to recover 80% of losses and certain expenses associated with the covered assets of Community First Bank on the first $34 million of losses. After that, we expect to recover 95% of losses and expenses on those covered assets. We expect to recover 80% of losses and certain expenses associated with the covered assets of LibertyBank.
OVERVIEW
While we did not consummate an acquisition during fiscal year 2011, we nonetheless continued to build a scalable operating platform that can accommodate additional acquisitions. We started the fiscal year on a new core operating system after converting our legacy Idaho Region and the operating system assumed in the CFB Acquisition in August 2010. We completely rebuilt our information technology infrastructure and converted the LibertyBank operating system to our new platform in March 2011. While our information technology, credit, accounting and executive offices remain in Nampa, Idaho, we transferred our bank operations to Eugene, Oregon under the direction of a new Senior Vice President of Bank Operations. These activities include loan and deposit operations and electronic banking services. We believe these initiatives, while expensive and inwardly-focused, were necessary in order to ensure efficient integration of the operations of future acquisitions.
We have been diligent and very selective in our pursuit of acquisition opportunities. The FDIC-assisted acquisition of the assets and liabilities of LibertyBank was attractive to us for a variety of reasons. The acquisition nearly doubled our total assets, with the estimated fair value of assets acquired totaling $691 million at the acquisition date. It increased our deposit market share in Central Oregon where we recently developed a presence through the CFB Acquisition. The Bank also benefitted with new lending markets in Portland, Eugene, Grants Pass and Medford, Oregon, which diversifies our footprint beyond the economically stressed communities of Bend, Oregon and Boise, Idaho. Both of these acquisitions included loss sharing agreements on nearly all of the purchased loans, leases and REO.
While we believe the LibertyBank Acquisition will increase the Company’s long-term earnings potential, fiscal year 2010 and 2011 expenses were higher than expected as we incurred significant costs to consummate the acquisition and we did not centralize our back office operations, particularly information technology systems, until May 2011. Additionally, the LibertyBank Acquisition resulted in a significant increase in cash due to the excess of liabilities assumed over assets purchased and the retention by the FDIC of approximately $297 million of loans in the LibertyBank portfolio. This significant increase in cash balances put pressure on our net interest margin and will continue to do so until we have successfully deployed all of this cash received in the acquisition into loans.
In the fourth quarter of fiscal year 2011, we announced a number of key initiatives that we believe will accelerate the Company’s return to profitability. The net impact of these initiatives described below reduced pre-tax income from operations by approximately $3.5 million for the fiscal year ended September 30, 2011, but we believe the result will be a reduction in operating expenses of approximately $3.6 million over the next twelve months. The following items summarize key initiatives we implemented during the fourth quarter of fiscal year 2011:
·
We merged the Home Federal Bank 401(k) Plan and the Home Federal Bancorp, Inc., Employee Stock Ownership Plan (ESOP) into the Home Federal 401(k) Plan and Employee Stock Ownership Plan (KSOP) and will refinance the ESOP loans, which we estimate will reduce pre-tax compensation expense by approximately $700,000 annually.
·
We extinguished all outstanding debt with the FHLB of Seattle, which resulted in a prepayment penalty of $2.0 million, pre-tax, but will reduce interest expense in fiscal years 2012 and 2013 by $1.5 million and $600,000, respectively.
·
The Bank sold $28.2 million of mortgage-backed securities that were at high-risk of prepayment by borrowers, which would have resulted in negative returns due to the acceleration of premium amortization. The pre-tax gain on the sale of securities totaled $607,000 during the quarter.
·
We will close five branches between October 1, 2011, and January 5, 2012, and we closed our Portland branch in September 2011. Three branches are located in Terrebonne, Bend and LaPine in Oregon and two branches are located in Idaho, including the Bank’s only remaining Walmart in-store branch. Rent termination penalties totaled approximately $60,000 and the impairment charge related to owned facilities totaled $1.4 million, pre-tax.
·
We flattened the organizational chart to improve operating efficiency and reduce noninterest expense.
·
The Bank will change the delivery channel of its mortgage program by exiting the secondary market model and entering into an agreement with an indirect third party origination broker. The Bank will continue to offer residential mortgage loans, but generally will not originate them directly.
·
The Board of Directors of the Company approved the repurchase of up to 900,000 shares of the Company’s common stock through September 30, 2012.
We monitor the performance of our branches and we analyze market growth opportunities, current market share, and client transaction levels in determining underperforming branches. These reviews identified branches in Portland, Terrebonne, Bend and LaPine, Oregon and two branches in Boise, Idaho, including the Bank's only remaining Walmart in-store branch, as those branches least likely to provide profitable returns in the long-term. As a result, we have scheduled the closure of these branches between October 1, 2011 and January 5, 2012, and will transition clients to our nearest existing branch upon closure.
Since 2006, we have originated residential mortgage loans primarily for sale in the secondary market with servicing released to investors. In December 2008, we sold all of our remaining servicing rights to a third party. Starting in November 2011, the Bank will refer nearly all of its residential mortgage loan applications through a third party originator that will underwrite and close the mortgage funding for the Bank's clients. While we may choose to directly originate some residential mortgage loans from time to time, we currently expect very few residential mortgage loans will be originated by the Bank for its portfolio or for sale in the secondary market under this new model. While compensation expense will be reduced due to the elimination of mortgage loan officer positions, we will also experience a reduction in income with the new delivery model since gains on loan sales will no longer be recorded. However, we believe compensation and expense reductions will exceed income reduction, improving overall profitability starting in the second quarter of fiscal year 2012.
The following list summarizes additional key strategic initiatives undertaken by management and factors affecting performance of the Company during fiscal year 2011:
·
We hired a seasoned Region President for Western Oregon, who also leads all commercial banking initiatives across all regions. We also hired a new commercial banking team in our Western Oregon Region.
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We continued to execute our strategy to increase core deposits and reduce reliance on high-cost certificates of deposit and borrowings.
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Noncovered nonperforming loans increased $3.2 million from September 30, 2010, and totaled 3.94% of noncovered loans.
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Economic conditions in our primary markets continued to be distressed as a result of rising unemployment, bankruptcies and foreclosures and declining real estate values.
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Net interest margin net interest income increased due to higher balances of earning assets and improved performance of loans purchased in the LibertyBank Acquisition;
·
Changes in overdraft regulations significantly reduced fee income;
·
The Company maintained its strong capital position with a total risk-based capital ratio of 41.26% and a Tier-1capital ratio of 14.91% at September 30, 2011.
As noted above, nearly all of the loans and REO purchased in the CFB Acquisition and the LibertyBank Acquisition are covered by loss sharing agreements between the FDIC and Home Federal Bank which affords the Bank significant protection. Under the loss sharing agreements, Home Federal Bank will share in the losses on assets covered under the agreement. In this discussion and analysis, we refer to loans and REO subject to the loss sharing agreements as “covered loans” and “covered REO” (collectively referred to as “covered assets”).
The acquisition of two failed banks has significantly increased our nonperforming assets and traditional asset quality metrics may not be applicable to our financial statements without further review and scrutiny of our footnote disclosure and our discussion and analysis that accompanies our financial statements. Covered loans totaled $155.0 million and comprised 32.1% of our total loan portfolio at September 30, 2011, which means a significant portion of our loan portfolio has protection against credit losses. While nonperforming loans totaled $24.6 million at September 30, 2011, only $12.9 million related to noncovered loans. Additionally, our allowance for loan losses at September 30, 2011, was $14.4 million with $9.2 million allocated to noncovered loans. The ratio of the allowance
for noncovered loans to noncovered loans totaled 2.81%. While we can provide no assurance that additional provisions for loan losses will not be necessary in the future, based on our current estimates and when considered with the loss sharing agreements and the loss indemnification provided under them, we believe we have significant protection and reserves against credit losses at September 30, 2011.
Additionally, we continue to hold excess capital, which we believe provides support against further economic deterioration and loan losses, but also provides a solid foundation for additional growth. The current economic and interest rate environments continue to challenge our organic growth plans. A lack of demand for loans, or more importantly a diminished supply of creditworthy lending opportunities, as well as an increase in residential loan refinancing, limited our ability to increase outstanding organic loan balances. Alternative investments are also unattractive as investment securities offer very low yields within management’s credit and interest rate risk tolerances. Therefore, we intend to continue to seek additional acquisitions that are within our core markets as we believe that acquisitive growth is the best short-term alternative to build an operational and retail structure that will allow us to thrive profitably when the economy recovers.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as disclosures found elsewhere in this Annual Report on Form 10-K, are based upon the Company’s consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under US GAAP.
Management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the determination of the allowance for loan losses (including the evaluation of impaired loans and the associated provision for loan losses), accounting for acquired loans and covered assets, the valuation of noncovered real estate owned, as well as deferred income taxes and the associated income tax expense. Management reviews the allowance for loan losses for adequacy on a quarterly basis and establishes a provision for loan losses that it believes is sufficient for the loan portfolio growth expected and the loan quality of the existing portfolio. The carrying value of real estate owned is also assessed on a quarterly basis. Income tax expense and deferred income taxes are calculated using an estimated tax rate and are based on management’s and our tax advisor’s understanding of our effective tax rate and the tax code. These estimates are reviewed by our independent auditor on an annual basis and by our regulators when they examine Home Federal Bank.
Allowance for Loan Losses. Management recognizes that losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Management assesses the allowance for loan losses on a quarterly basis by analyzing several factors including delinquency rates, charge-off rates and the changing risk profile of the Bank’s loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies and vacancy rates of business and residential properties.
The Company believes that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about probable incurred losses inherent in the loan portfolio at the balance sheet date. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.
The Company’s methodology for analyzing the allowance for loan losses consists of specific allocations on significant individual credits and a general allowance amount, including a range of losses. The specific allowance component is determined when management believes that the collectability of an individually reviewed loan has been impaired and a loss is probable. The general allowance component relates to assets with no well-defined
deficiency or weakness and takes into consideration loss that is inherent within the portfolio but has not been identified. The general allowance is determined by applying a historical loss percentage to various types of loans with similar characteristics and classified loans that are not analyzed specifically. Adjustments are made to historical loss percentages to reflect current economic and internal environmental factors such as changes in underwriting standards and unemployment rates that may increase or decrease those loss factors. As a result of the imprecision in calculating inherent and potential losses, a range is added to the general allowance to provide an allowance for loan losses that is adequate to cover losses that may arise as a result of changing economic conditions and other qualitative factors that may alter historical loss experience.
The allowance for loan losses is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries. Provisions for losses on covered loans are recorded gross of recoverable amounts from the FDIC under the loss sharing agreements. The recoverable portion of the provision for loan losses on covered loans is recorded in other income.
The allowance for loan losses on noncovered originated loans consists of specific reserves allocated to individually reviewed loans and general reserves on al other noncovered originated loans. Commencing in April 2011, we changed our accounting policy for specific allowances on noncovered originated loans in process of foreclosure. Previously, we would maintain a specific reserve on these noncovered impaired loans. Since April 2011, we now treat such deficiencies on loans in process of foreclosure as “Loss” under our credit grading process and the loan balance is charged down to the estimated net recoverable value, which removes the specific reserve previously recorded. A general allowance for loan losses is recorded on loans purchased in the CFB Acquisition that are not accounted for under ASC 310-30. Loans purchased in the CFB Acquisition that are accounted for under ASC 310-30 are partially charged down to the estimated net recoverable value if estimated losses exceed the fair value discount established on the acquisition date. Lastly, an allowance for loans purchased in the LibertyBank Acquisition is not established unless the net present value of cash flows expected to be received for loans in the acquired loan pools become impaired.
The Company also estimates a reserve related to unfunded loan commitments. In assessing the adequacy of the reserve, the Company uses a similar approach used in the development of the allowance for loan losses. The reserve for unfunded loan commitments is included in other liabilities on the Consolidated Balance Sheets. The provision for unfunded commitments is charged to noninterest expense.
Acquired Loans. Loans acquired in the CFB Acquisition were valued as of the acquisition date in accordance with SFAS No. 141, Business Combinations. At the time of the CFB Acquisition, the Company applied SFAS No. 141, which was superseded by SFAS No. 141(R). The Company was not permitted to adopt SFAS No. 141(R) prior to its effective date, which was October 1, 2009, due to the Company’s fiscal year. ASC Topic 310-30 applies to a loan with evidence of deterioration of credit quality since origination, acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. For loans purchased in the CFB Acquisition that were accounted for under ASC 310-30, management determined the value of the loan portfolio based on work provided by an appraiser. Factors considered in the valuation were projected cash flows for the loans, type of loan and related collateral, classification status and current discount rates. Management also estimated the amount of credit losses that were expected to be realized for the loan portfolio primarily by estimating the liquidation value of collateral securing loans on non-accrual status or classified as substandard or doubtful. At September 30, 2011, a majority of these loans were valued based on the liquidation value of the underlying collateral, because the expected cash flows are primarily based on the liquidation of the underlying collateral. Loans purchased in the CFB Acquisition accounted for under ASC 310-30 were not aggregated into pools and are accounted for on a loan-by-loan basis. An allowance for loan losses was established for loans purchased in the CFB Acquisition that are not accounted for under ASC 310-30.
Loans purchased in the LibertyBank Acquisition are valued as of acquisition date in accordance with ASC 805 Business Combinations, formerly SFAS 141(R). Further, the Company elected to account for all other loans purchased in the LibertyBank Acquisition within the scope of ASC 310-30 using the same methodology. Under ASC 805 and ASC 310-30, loans purchased in the LibertyBank Acquisition were recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date, unlike the loans purchased in the CFB Acquisition, which are accounted for under previous guidance as described above. In situations where loans have similar risk characteristics, loans were aggregated into pools to estimate cash flows under ASC 310-30. A pool
is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The Company aggregated all of the loans purchased in the LibertyBank Acquisition into 22 different pools, based on common risk characteristics such as loan classification, loan structure, nonaccrual status and collateral type.
The cash flows expected over the life of the pools are estimated using an internal cash flow model that projects cash flows and calculates the carrying values of the pools, book yields, effective interest income and impairment, if any, based on pool level events. Assumptions as to cumulative loss rates, loss curves and prepayment speeds are utilized to calculate the expected cash flows. Under ASC 310-30, the excess of the expected cash flows at acquisition over the fair value is considered to be the accretable yield and is recognized as interest income over the life of the loan or pool. The excess of the contractual cash flows over the expected cash flows is considered to be the nonaccretable difference. Subsequent increases in cash flow over those expected at purchase date in excess of fair value are recorded as an adjustment to accretable difference on a prospective basis. Any subsequent decreases in cash flow over those expected at purchase date are recognized by recording an allowance for loan losses. Any disposals of loans, including sales of loans, payments in full or foreclosures result in the removal of the loan from the ASC 310-30 portfolio at the carrying amount.
Covered Assets. All of the loans and leases purchased in the CFB Acquisition and the majority of loans purchased in the LibertyBank Acquisition are included under various loss sharing agreements with the FDIC and are referred to as “covered loans.” Covered loans, and provisions for loan losses, charge offs and recoveries, are reported exclusive of the expected cash flow reimbursements expected from the FDIC. All REO acquired in the CFB Acquisition and the LibertyBank Acquisition are also included in the loss sharing agreements and are referred to as “covered REO.” Covered REO is reported exclusive of expected reimbursement cash flows from the FDIC. Upon transferring covered loan collateral to covered REO status, acquisition date fair value discounts on the related loan are also transferred to covered REO. Fair value adjustments on covered REO result in a reduction of the covered REO carrying amount and a corresponding increase in the estimated FDIC reimbursement, with the estimated net loss to the Bank charged against earnings. The Bank is reimbursed by the FDIC on losses and reimbursable expenses on covered assets purchased in the CFB Acquisition at a rate of 80% on the first $34.0 million of losses and at a rate of 95% on losses thereafter. The Bank is reimbursed by the FDIC on losses and reimbursable expenses on covered assets purchased in the LibertyBank Acquisition at a rate of 80%.
FDIC Indemnification Asset. In conjunction with the CFB Acquisition and the LibertyBank Acquisition, the Bank entered into shared-loss agreements with the FDIC for amounts receivable under the shared-loss agreements. In some cases the FDIC indemnification agreement may be terminated on a loan by loan basis if the Bank renews or extends individual loans. At each acquisition date the Company elected to account for amounts receivable under the loss sharing agreements as an indemnification asset. Subsequent to the acquisitions the indemnification asset is tied to the loss in the covered loans and is not being accounted for under fair value. The FDIC indemnification asset is accounted for on the same basis as the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the shared-loss agreements. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted or amortized into noninterest income over the life of the FDIC indemnification asset.
The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any increases in cash flow of the loans over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the loans over those expected will increase the FDIC indemnification asset. The FDIC indemnification asset will be reduced as losses are recognized on covered assets, if losses in future periods are projected to decline, and loss sharing payments are received from the FDIC. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.
Noncovered Real Estate Owned. Real estate properties acquired through, or in lieu of, loan foreclosure that are not covered under a loss sharing agreement with the FDIC (noncovered REO) are initially recorded at fair value at the date of foreclosure minus estimated costs to sell. Any valuation adjustments required at the time of foreclosure are charged to the allowance for loan losses. After foreclosure, the properties are carried at the lower of carrying value or fair value less estimated costs to sell. Any subsequent valuation adjustments, operating expenses or income, and gains and losses on disposition of such properties are recognized in current operations. The valuation allowance is established based on our historical realization of losses and adjusted for current market trends.
Deferred Income Taxes. Deferred income taxes are reported for temporary differences between items of income or expense reported in the financial statements and those reported for income tax purposes. Deferred taxes are computed using the asset and liability approach as prescribed in ASC Topic 740, Income Taxes. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in an institution’s income tax returns. The deferred tax provision for the year is equal to the net change in the net deferred tax asset from the beginning to the end of the year, less amounts applicable to the change in value related to investments available-for-sale. The effect on deferred taxes of a change in tax rates is recognized as income in the period that includes the enactment date. The primary differences between financial statement income and taxable income result from depreciation expense, mortgage servicing rights, loan loss reserves, deferred compensation, mark to market adjustments on our available-for-sale securities, and dividends received from the FHLB of Seattle. Deferred income taxes do not include a liability for pre-1988 bad debt deductions allowed to thrift institutions that may be recaptured if the institution fails to qualify as a bank for income tax purposes in the future.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2011 AND 2010
Total assets decreased $305.6 million, or 20.6%, to $1.2 billion at September 30, 2011, from $1.5 billion at September 30, 2010. Total liabilities decreased $295.2 million, or 23.1%, to $982.6 million. These decreases were primarily a result of the maturity and repayment of certificates of deposit in the branches purchased in the LibertyBank Acquisition and due to the repayment of all FHLB borrowings during fiscal year 2011.
Assets. The increases and decreases in total assets were primarily concentrated in the following asset categories (dollars in thousands):
Cash and Amounts Due From Depository Institutions. Cash and amounts due from depository institutions declined $225.7 million as excess liquidity, which was derived from the LibertyBank Acquisition, was used to reduce certificates of deposit and FHLB borrowings and to purchase investment securities. Total cash acquired in the LibertyBank Acquisition was $373.1 million in July 2010. Current economic conditions, including the low interest rate environment, are presenting challenges as the number of creditworthy borrowers has decreased substantially and locating medium-term securities that provide an attractive return has also proven difficult. Additionally, we have conserved cash balances as liquidity support for the possible acquisition of troubled institutions that may not have adequate liquidity. Nearly all the amounts due from depository institutions are held at the Federal Reserve Bank of San Francisco in order to minimize our credit risk.
Securities. Securities increased $105.7 million during fiscal year 2011. Our purchases of securities in fiscal 2011, and going forward into 2012, have focused on high-quality investments with an average duration, or average life, of approximately 2.7 years. We have given preference to short and medium-term securities in anticipation of rising interest rates and increases in loan demand in the next 18 to 24 months. Additionally, we intend to mitigate price sensitivity to protect capital if we need to sell significant amounts of securities in the future to increase liquidity.
We continually analyze our investment portfolio and during fiscal year 2011 we identified approximately $28.2 million of securities that evidenced a high risk of prepayment and the possibility of negative book yields due to accelerated amortization of the purchase premiums on those securities if the prepayment speeds accelerated. With the recent rally in the bond market, we ascertained the likelihood of early prepayments and negative yields was now much higher. Therefore, we sold those securities and recorded a pre-tax gain of $607,000.
Most of the Company’s mortgage-backed securities were issued by U.S. Government-sponsored enterprises, primarily Fannie Mae and Freddie Mac. While the U.S. Government has recently affirmed its support for government-sponsored enterprises and the mortgage-backed securities they issued, significant deterioration in the financial strength of Fannie Mae, Freddie Mac or mortgage-backed security insurers may have a material effect on
the valuation and performance of the Company’s mortgage-backed securities portfolio in future periods. At September 30, 2011, we held one private label security with a fair value of $325,000 which carried a Moody’s rating of Ba3. Management has reviewed the delinquency status, credit support and collateral coverage of the loans pooled in this security and has concluded it was not other-than-temporarily impaired at September 30, 2011.
Loans and Leases. Loans and leases receivable, net, decreased $152.8 million to $468.2 million at September 30, 2011, from $621.0 million at September 30, 2010, as loans and leases in the portfolio of CELC, the leasing subsidiary of LibertyBank, declined rapidly and the Bank’s one-to-four family residential loan portfolio continues to shrink. Additionally, the workout and foreclosure on nonperforming loans reduced outstanding loan balances, in many cases favorably. Covered loans totaled $155.0 million at September 30, 2011, compared to $269.6 million at September 30, 2010.
Commercial business loans declined $58.3 million, or 53.9% during fiscal year 2011. At September 30, 2011, approximately $19.1 million of the commercial business loans and $2.8 million of leases purchased in the LibertyBank Acquisition were financing agreements that were originated by CELC, and had remaining terms of less than five years. We intend to wind down the operations of CELC and anticipate these balances will be substantially paid off within the next three years. Loans and leases in this portfolio totaled $20.4 million and $49.6 million at September 30, 2011 and 2010, respectively. We also experienced a high level of prepayments on commercial business loans purchased in the LibertyBank Acquisition, including a few commercial loans with balances above $10 million. While many of these commercial business loans were adversely classified during the year, they were loans in a performing status until their refinancing at other institutions.
One-to-four family residential loans declined $31.9 million, or 20.3% during fiscal year 2011. The reduction of one-to-four family residential loans is consistent with our strategy to reduce the portfolio’s concentration in those loans in favor of increasing the mix of commercial and commercial real estate loans in order to improve interest rate sensitivity and net interest margin. We began selling nearly all new one-to-four family loan originations in the secondary market in 2006. The sale of one-to-four family residential real estate loans to investors in the secondary market in connection with our mortgage banking activities requires us to make representations and warranties about the underlying assets conforming to specified guidelines. If the underlying assets do not conform to the specifications, we may have an obligation to repurchase the assets or indemnify the purchaser against loss. We believe that the potential for significant loss under these arrangements is remote due to our conservative underwriting standards. However, past performance may not be representative of future performance on sold loans and we may experience losses in the future. We recorded losses totaling $65,000 in connection with these arrangements during fiscal year 2010, but no losses were incurred during fiscal year 2011.
Real estate construction loans declined $23.2 million, or 47.8%, during fiscal year 2011, primarily due to the foreclosure and refinancing of covered loans purchased in the FDIC-assisted acquisitions as our noncovered construction portfolios decreased to $14.8 million at September 30, 2011 from $17.4 million at September 30, 2010.
As mentioned earlier, the economic recession has significantly slowed business activity and reduced opportunities to provide commercial lending solutions and our legacy residential loans and equipment leasing and financing portfolios continue to shrink rapidly. As a result, we are concerned that the Bank will not be able to grow the loan portfolio organically through fiscal 2012.
Allowance for Loan Losses. The allowance for loan losses decreased to $14.4 million at September 30, 2011, from $15.4 million at September 30, 2010. At September 30, 2011, we had an allowance of $9.2 million on noncovered loans, an allowance of $3.1 million on covered loans purchased in the CFB Acquisition and an allowance of $2.1 million on loan pools purchased in the LibertyBank Acquisition. Commencing April 1, 2011, we changed our accounting policy for noncovered loans that are in process of foreclosure. Previously, such noncovered impaired loans were allocated a specific reserve within the allowance for loan losses. These specific reserves are now classified by the Company as “Loss” and the loan balance is charged-down, which results in a reduction in the balance of the allowance for loan losses. At September 30, 2011, loan balances classified as loss that were charged-down totaled $1.9 million, which in previous reporting periods have been disclosed in the balance of the allowance for loan losses. The balance of the allowance for noncovered loan losses that has been specifically allocated to individual noncovered loans totaled $1.4 million at September 30, 2011.
The allowance for loan losses on the noncovered loan portfolio was approximately 2.81% of noncovered loans at September 30, 2011, with only $1.4 million of the $9.2 million allowance for losses on noncovered loans specifically allocated to impaired noncovered loans. As noted above, approximately $1.9 million of partial charge downs were made to loans in process of foreclosure at September 30, 2011. Had we not prospectively changed our policy for these loans during fiscal year 2011, the ratio of the noncovered allowance for loan losses to noncovered loans would have been 3.42% at September 30, 2011. Nonperforming noncovered loans totaled $12.9 million at September 30, 2011, compared to $9.7 million at September 30, 2010.
See “Asset Quality” on page 17 of this Form 10-K for additional discussion on the loss sharing agreements and our estimate of losses under the agreement. Page 25 of this Form 10-K discloses the allocation of the allowance for loan losses.
FDIC Indemnification Asset. As part of the purchase and assumption agreements for the acquisitions, we entered into loss sharing agreements with the FDIC. These agreements cover realized losses on covered assets purchased from the FDIC in the CFB Acquisition and the LibertyBank Acquisition. Losses on covered assets in the CFB Acquisition are indemnified 80% on the first $34.0 million of losses and at a rate of 95% thereafter. LibertyBank covered assets are indemnified at a rate of 80% on all losses on covered assets. The decrease in the FDIC indemnification receivable during fiscal year 2011 was due to the receipt of payments on previous loss claims made to the FDIC and due to the net reduction in estimated future losses on LibertyBank covered assets. At September 30, 2011, the FDIC indemnification receivable for estimated losses on covered assets in the LibertyBank Acquisition totaled $25.2 million. The receivable for estimated losses on covered assets in the CFB Acquisition was $8.6 million at September 30, 2011, compared to $7.1 million at September 30, 2010. Claims for losses on covered assets under the loss sharing agreements in the CFB Acquisition and the LibertyBank Acquisition have totaled $33.5 million and $28.8 million, respectively, since the acquisition dates.
Property and Equipment. Property and equipment increased $4.8 million primarily due to the LibertyBank Acquisition and the implementation of new information technology systems during fiscal year 2011. We did not acquire the branches of LibertyBank at the same time as the closing of the LibertyBank Acquisition. Under the purchase and assumption agreement with the FDIC, we had a 90-day option period after the transaction date, which was July 30, 2010, to review the banking facilities of the failed institution and obtain appraisals of the branches and their contents. In the first quarter of fiscal 2011, we provided the FDIC notice that we did not intend to purchase two of the branches of LibertyBank or assume the lease for LibertyBank’s operations center and that we would assume the remaining banking offices, leases and furniture and equipment of LibertyBank. The cost of the land, buildings, furniture and fixtures purchased in the LibertyBank Acquisition totaled $6.2 million.
We do not intend to construct new banking offices in the near future as population growth in our markets has slowed. Rather, we will seek acquisition opportunities to complement and leverage the Bank’s existing footprint and will consider closing inefficient banking offices in the future. As noted earlier, we closed our Portland, Oregon, office on September 30, 2011, as the lease for that facility matured and we had less than $1.0 million of deposits at that branch. However, we kept one relationship manager in the Portland market to manage the covered loans remaining in that area. We also intend to close three additional Oregon branches in Terrebonne, Bend and LaPine and two branches in Boise, Idaho, including the Bank’s only remaining Walmart in-store branch, between December 15, 2011, and January 5, 2012. The anticipated closure of these branches resulted in accelerated rent and facility impairments of approximately $1.4 million during fiscal year 2011.
Bank Owned Life Insurance. The value of bank owned life insurance increased $412,000 to $12.8 million. The policy premiums are invested in insurance companies which each have a rating of at least ‘A’ by Standard & Poor’s and A.M. Best. We continue to monitor the financial performance, capital levels and financial ratings of the companies that have issued the Bank’s “general account” life insurance policies.
Real Estate and Other Property Owned (REO). REO declined $7.0 million during fiscal year 2011 to $23.4 million due to the sale of foreclosed assets during the year. Covered REO totaled $16.2 million at September 30, 2011, compared to $20.5 million at September 30, 2010. Noncovered REO totaled $7.3 million at September 30, 2011, compared to $10.0 million at September 30, 2010.
Deferred Taxes. As of September 30, 2011, the Company had a net deferred tax asset of $3.9 million compared to a net deferred tax liability of $2.2 million at September 30, 2010. The difference is primarily due to a $6.0 million change in purchase accounting adjustments and a $1.3 million
decrease in the deferred tax liability that was recorded in connection with the change in the unrealized gain in available-for-sale securities. All other items, net, increased $1.4 million during fiscal 2011.
Deposits. Deposits decreased $230.2 million, or 19.3%, to $959.5 million at September 30, 2011, from $1.2 billion at September 30, 2010 primarily due to the planned runoff of higher rate certificates of deposit assumed in the LibertyBank Acquisition. The following table details the changes in total deposit accounts (dollars in thousands):
Certificates of deposit comprised the majority of the deposit liabilities assumed in the LibertyBank Acquisition. Since we received a significant balance of cash in connection with the LibertyBank Acquisition, we executed a managed reduction in certificates of deposit in the LibertyBank portfolio. As interest rates continued to fall and economic conditions failed to improve during fiscal year 2011, our loan production remained weak, so we reduced our deposit rates to continue to shrink certificates of deposit. As a result, certificates of deposit declined $265.7 million during fiscal year 2011. Despite also lowering interest rates on our core deposits, we had growth in core deposit balances of $35.6 million during fiscal year 2011.
We believe increasing core deposits and reducing reliance on certificates of deposits is an important component in the strategy to transform our balance sheet toward a commercial bank. The investment in free-standing full-service banking offices, reduced reliance on in-store branches, and changes made in the management team and the organizational alignment of our retail banking program will help increase core deposit accounts, despite the significant challenges in our markets.
Our deposit portfolio includes a concentration of low-cost health savings accounts. Health savings accounts totaled $23.0 million and $22.2 million at September 30, 2011 and 2010, respectively. Most of these accounts are originated through broker relationships throughout the United States. We have limited control over these accounts as they are not local to our operating markets. Additionally, changes in tax law or the structure of health savings accounts could cause the balances to be withdrawn.
Borrowings. FHLB advances and other borrowings decreased $62.7 million to $4.9 million at September 30, 2011, as we prepaid our advances as they matured during the year and, in September 2011, repaid all remaining FHLB advances. As noted earlier, weak loan production and an unattractive interest rate environment assisted with our decision to extinguish our remaining FHLB borrowings before maturity. The prepayment penalty recorded during fiscal year 2011 was $2.0 million, before income taxes. Other borrowings also include retail repurchase agreements that are collateralized by various investment securities. Repurchase agreements totaled $4.9 million and $8.8 million at September 30, 2011 and 2010, respectively.
Equity. Stockholders’ equity decreased $10.4 million to $194.7 million at September 30, 2011, from $205.1 million at September 30, 2010. The net loss for the year of $4.6 million as well as the payment of dividends of $3.4 million were the primary causes for the decrease in retained earnings in stockholders’ equity. Stockholders’ equity also declined $7.4 million due to the repurchase of 708,182 shares of our common stock during fiscal year 2011. These declines in stockholders’ equity during fiscal 2011 were partially offset by a $2.2 million increase in the unrealized gain on securities available for sale, net of tax, during the year. In September 2011, the Board announced that the Company could repurchase up to an additional 900,000 shares through September 30, 2012. We do not anticipate purchasing shares at a price per share that is higher than the Company’s tangible book value per share, which was $11.92 at September 30, 2011. We believe the preservation of capital is critical to executing our acquisition strategy.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2011 AND 2010
General. Net loss for the year ended September 30, 2011 was ($4.6 million), or ($0.30) per diluted share, compared to a net loss of ($4.1 million), or ($0.26) per diluted share, for the year ended September 30, 2010. The net loss for the fiscal year ended September 30, 2011, included a number of charges related to strategic initiatives undertaken in the fourth quarter of fiscal year 2011, described earlier in this Management’s Discussion and Analysis (MD&A). The net loss for the fiscal year ended September 30, 2010 included a $3.2 million bargain purchase gain related to the LibertyBank Acquisition.
In addition to results presented in accordance with GAAP, this MD&A contains certain non-GAAP financial measures. We believe certain non-GAAP financial measures provide investors with information useful in understanding the Company’s financial performance; however, readers of this report are urged to review these non-GAAP financial measures in conjunction with the GAAP results as reported.
We believe net income (loss) excluding restructuring items is a useful financial measure because it enables investors to assess the Company’s ability to generate income from core operations. Net income (loss) excluding restructuring items is equal to loss before taxes, decreased for charges and increased by gains related to non-recurring strategic initiatives and income tax expense, as adjusted for the non-recurring items. The following table presents net income excluding restructuring items (non-GAAP) for the periods presented (in thousands):
The LibertyBank Acquisition was consummated on July 30, 2010, during the fourth quarter of fiscal year 2010. The LibertyBank Acquisition has been incorporated prospectively in the Company’s Consolidated Financial Statements from that date; therefore, year over year results of operations from fiscal year 2010 may not be comparable.
Net Interest Income. Net interest income increased $14.8 million, or 54.5%, to $42.0 million for the year ended September 30, 2011, from $27.2 million for the year ended September 30, 2010. The increase in net interest income was primarily attributable to the increase in net earning assets due to the acquisitions and lower interest expense during fiscal year 2011. Additionally, net interest margin increased to 3.51% during fiscal 2011 from 3.09% in fiscal 2011 primarily due to the impact of accretable yield on loans purchased in the LibertyBank Acquisition.
The following table sets forth the results of balance sheet growth and changes in interest rates to our net interest income (in thousands). The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.
Interest and Dividend Income. Total interest and dividend income for the year ended September 30, 2011, increased $13.5 million, or 36.1%, to $51.1 million, from $37.6 million for fiscal year 2010. The increase during the period was primarily attributable to the increase in interest-earning balances purchased in the acquisitions. Interest income on loans was significantly higher in fiscal year 2011 due to the impact of accretable yield on loans purchased in the LibertyBank Acquisition. The incremental accretion income represents the amount of income recorded on the acquired loans above the contractual rate stated in the individual loan notes and stems from the discount established at the time these loan portfolios were acquired.
Despite the increase in accretable yield, the Company’s net interest income and net interest margin continues to be reduced by an unfavorable interest-earning asset mix that is heavily weighted toward cash and securities (52.3% of interest earning assets at September 30, 2011). This excess liquidity is primarily the result of the cash received in the LibertyBank Acquisition, which is exacerbated by a weak lending and investing environment. While we expect accretable yield will continue to incrementally increase loan income over the next several quarters, we believe the underlying net interest margin will continue to perform below optimal levels due to the unfavorable asset mix. The following table compares detailed average earning asset balances, associated yields, and resulting changes in interest and dividend income for the years ended September 30, 2011 and 2010 (dollars in thousands):
Interest Expense. Despite a 49.4% increase in average interest-bearing liabilities during fiscal 2011, interest expense decreased $1.3 million, or 12.4%, to $9.1 million for the year ended September 30, 2011. The decrease is primarily attributable to the decline in our cost of funds, which decreased from 1.57% in the prior year to 0.92% in the current year and lower FHLB balances in 2011. These effects were offset somewhat by higher balances of deposits due to organic core deposit growth and the acquisitions. Average interest-bearing liabilities (primarily deposits) increased to $985.3 million during fiscal 2011 from $659.5 million during fiscal 2010. Fair value adjustments from the CFB and LibertyBank Acquisitions reduced interest expense by $2.9 million during fiscal 2011.
The following table details average balances, cost of funds and the change in interest expense for the years ended September 30, 2011 and 2010 (dollars in thousands):
Approximately $193.8 million of certificates of deposit are scheduled to mature during fiscal year 2012.
Provision for Loan Losses. A provision for loan losses of $11.4 million, including a provision of $10.3 million on covered loans, was recorded in connection with our analysis of losses in the loan portfolio for the year ended September 30, 2011, compared to a provision for loan losses of $10.3 million for fiscal year 2010, which included a $1.1 million provision on covered loans. The estimated indemnifiable portion of the provision for loan losses on covered loans is recorded as an increase to the FDIC indemnification asset and an increase in other income, which totaled $9.3 million and $1.3 million in fiscal years 2011 and 2010, respectively.
We consider the allowance for loans losses at September 30, 2011, to be our best estimate of probable incurred losses inherent in the loan portfolio as of that date based on the assessment of the above-mentioned factors affecting the loan portfolio. While we believe the estimates and assumptions used in the determination of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provision that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
Noninterest Income. Noninterest income decreased $1.6 million, or 9.8%, to $15.0 million for the year ended September 30, 2011 from $16.7 million for the year ended September 30, 2010. The following table provides a detailed analysis of the changes in components of noninterest income (dollars in thousands):
During fiscal 2011, service fees and charges increased $666,000 to $9.8 million with most of the increase attributable to the LibertyBank Acquisition. Checking fee income historically represented a larger percentage of our total revenues than many of our peers due to a deposit strategy implemented many years ago that we no longer pursue. Historically, the Bank focused on high-transaction, low-balance “free checking” accounts that would result in high overdraft fee income. We changed our strategy on deposit aggregation in 2006 to focus on building deeper relationships with our depositors that may result in fewer accounts with higher, more stable balances because we believe relationship-based customers improve the Company’s franchise value and provide a stable, low-cost funding source for loans, which results in higher net interest income. While we began this strategic initiative several years ago, we have retained a significant number of those low-balance, high overdraft free checking accounts.
These new overdraft fee regulations that became effective in the fourth quarter of fiscal 2010 had a significant impact on overdraft fee income in fiscal 2011. In addition to changes in operational processing, customers are now explicitly required to “opt-in” to use our overdraft services on debit card and ATM transactions. We continue to monitor the impact of these changes. While total organic checking account balances were higher in fiscal 2011, fees from overdrafts, excluding the LibertyBank Acquisition, declined $2.5 million, or 54.3%, in fiscal 2011, compared to fiscal 2010. However, the change in checking account composition has had a positive impact on earnings through fewer checking account balance charge offs. Net losses on checking accounts totaled $277,000 in fiscal 2011 compared to $621,000 in fiscal 2010.
Service charges and fees also includes revenue from our non-banking lines of business, including merchant cards and investment services. Before the LibertyBank Acquisition, we referred merchant banking accounts to a third party in exchange for a referral fee. However, in connection with the LibertyBank Acquisition, we changed merchant services providers and hired a staff of salespersons to generate merchant accounts internally as an agent for the third party. Revenue for merchant banking services totaled $607,000 in fiscal 2011 compared to $111,000 in fiscal 2010. However, since this is a new program, personnel and other expenses directly related to the merchant banking program resulted in minimal profitability in fiscal year 2011. Similarly, we have hired additional personnel to our investment services team since the LibertyBank Acquisition, which has increased compensation expense, but has also increased revenue. In fiscal 2011, commissions on non-deposit product investment services revenue totaled $876,000 compared to $440,000 in fiscal 2010. We believe the profitability of these lines of business will improve as our client base increases and recurring revenues exceed our fixed costs.
Interchange fee income totaled $4.0 million in fiscal 2011, an increase of $922,000 compared to $3.1 million in fiscal 2010. Organically, our interchange fees increased $275,000, or 11.5%. Currently, we do not anticipate the Dodd-Frank Act will have a direct, significant impact on our interchange income as the pricing limits imposed by this legislative action is targeted at financial institutions much larger than the Bank. However, market forces could result in negative pressure on transaction-level fee income as the new price controls are implemented by retailers.
Nonrecurring items recorded in noninterest income include the prepayment penalty on FHLB advances of $2.0 million in fiscal 2011 and a bargain purchase gain of $3.2 million in connection with the LibertyBank Acquisition recorded in fiscal 2010.
Accretable income is recorded on the FDIC indemnification receivable related to the passage of time. If actual and projected future losses are less than previously estimated, the FDIC indemnification asset is reduced by amortizing expense to noninterest income. During the first nine months of fiscal year 2011, the Company accreted $ 1.9 million. During the fourth quarter of fiscal year 2011, we updated our loss estimates and cash flows for the pools of loans purchased in the LibertyBank Acquisition, which resulted in lower loss projections than previously estimated. As a result, we recorded net amortization of the FDIC indemnification asset of $6.9 million. During fiscal year 2010, accretable income totaled $1.4 million. The amortization of the indemnification asset may continue in future quarters but may be highly volatile as our estimates of credit losses and the timing of such losses requires significant judgment and actual results could be material different than our original estimates.
An FDIC indemnification recovery of $9.3 million and $1.3 million were recorded in fiscal years 2011 and 2010, respectively, representing the increase in the FDIC indemnification asset due to a provision for loan losses of $10.1 million and $1.1 million recorded in fiscal years 2011 and 2010, respectively, on covered loans.
Other income includes net gains on the sale of REO of $355,000 in fiscal year 2011 and net losses on the sale of REO of $265,000 in fiscal 2010. Additionally, other income in fiscal year 2010 includes a recovery of $198,000 on loans that were charged off by LibertyBank prior to our acquisition. These charged-off loans were not included in the loss sharing agreements of the LibertyBank Acquisition; therefore the recovery does not need to be shared with the FDIC and were not recorded as purchase adjustments since the loans were not on the book of LibertyBank on the acquisition date.
Noninterest Expense. Noninterest expense increased $12.7 million, or 31.0%, to $53.5 million for the year ended September 30, 2011, due to the significant increase in operations undertaken with the LibertyBank Acquisition. The LibertyBank Acquisition occurred in July 2010 and added 13 branches. Additionally, we maintained two core operating platforms until March 2011 when the LibertyBank core conversion was completed and two operations teams until May 2011 when our operations tasks and personnel were consolidated in Eugene, Oregon. Therefore, we incurred significant compensation, data processing and professional services expenses during most of fiscal year 2011 to complete the operational integration. We believe noninterest expense should decrease significantly in future periods now that the integration projects are nearly complete.
The following table provides a detailed analysis of the changes in components of noninterest expense (dollars in thousands):
Compensation and benefits increased $7.6 million or 36.8% to $28.1 million for the year ended September 30, 2011 from $20.6 million for the same period a year ago. The largest factor in the increase was compensation which increased $6.2 million or 47.7% due primarily to the increase in employees after the LibertyBank Acquisition. Payroll taxes also increased $608,000, or 44.7%, from the prior year. A large component of the increase in payroll taxes was unemployment expense which increased $202,000, or 79.5%. Commission expense also increased $649,000, or 123.8%. These increases were offset by a decrease in share-based compensation costs of $420,000, or 32.8%, and ESOP expense of $254,000 or 17.1% due to a lower average price of the Company’s common stock. No bonuses were paid to the executive officers of the Company in fiscal years 2011 or 2010.
Occupancy and equipment, data processing, professional services, and insurance and taxes all increased primarily due to the Community First Bank and LibertyBank Acquisitions. Although the integration of the CFB Acquisition was completed near the end of fiscal 2010, the core conversion and integration of operations for the LibertyBank Acquisition was not completed until March 2011, resulting in several months of parallel back offices.
REO and other property owned decreased to $23.4 million at September 30, 2011 from $30.5 million one year earlier. Partially as a result of this, we experienced a decrease in provision for REO to $1.4 million in fiscal 2011 compared to $3.2 million in fiscal 2010. On a quarterly basis, all REO is evaluated and the respective carrying balances are adjusted downward if warranted. The $1.4 million of provision for REO expense represents additional adjustments downward in the carrying value of REO subsequent to foreclosure.
Other noninterest expense for fiscal year 2011 includes postage and supplies expense of $1.3 million, an increase from the $848,000 in fiscal 2010, and other operating expenses, which increased $1.4 million from fiscal 2010 due to the acquisitions.
Income Tax Benefit. Income tax benefit from continuing operations was $3.2 million based on a pre-tax loss from operations of $7.9 million. This compares to income tax benefit from continuing operations in the prior year of $2.9 million based on $7.3 million in pre-tax loss. We did not recognize an extraordinary gain in fiscal 2011, while the extraordinary gain in fiscal 2010 was $305,000, net of $195,000 in taxes, and was the result of a purchase price adjustment by the FDIC on the CFB Acquisition.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009
General. Net loss for the year ended September 30, 2010 was $4.1 million, or $0.26 per diluted share, compared to net income of $8.1 million, or $0.51 per diluted share, for the year ended September 30, 2009. The net loss for the fiscal year ended September 30, 2010 included a $3.2 million bargain purchase gain related to the LibertyBank Acquisition. Net income for the fiscal year ended September 30, 2009, included a $15.3 million after-tax extraordinary gain related to the CFB Acquisition. The LibertyBank Acquisition resulted in a significant increase in cash due to the excess of liabilities assumed over assets purchased and the retention by the FDIC of approximately $297 million of loans in the LibertyBank portfolio. The CFB Acquisition was consummated on August 7, 2009, during the fourth fiscal quarter of fiscal year 2009. The LibertyBank Acquisition was consummated on July 30, 2010, during the fourth quarter of fiscal year 2010. Each acquisition has been accounted for prospectively from the acquisition date; therefore, year over year results of operations from fiscal year 2009 may not be comparable.
Net Interest Income. Net interest income increased $3.3 million, or 14.0%, to $27.2 million for the year ended September 30, 2010, from $23.9 million for the year ended September 30, 2009. The increase in net interest income was primarily attributable to the increase in net earning assets due to the acquisitions and lower FHLB advance balances during fiscal year 2010. Despite the increase in net interest income, net interest margin declined to 3.09% during fiscal year 2010 from 3.50% in fiscal year 2009 due to the shift in the mix of interest-earning assets from loans to interest-bearing deposits in banks and investment securities. The net interest margin for the fourth quarter of fiscal year 2010 was 2.89%.
The following table sets forth the results of balance sheet growth and changes in interest rates to our net interest income (in thousands). The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.
Interest and Dividend Income. Total interest and dividend income for the year ended September 30, 2010 increased $1.7 million, or 4.7%, to $37.5 million, from $35.8 million for the same period of the prior year. The increase during the period was primarily attributable to the increase in interest-earning balances purchased in the acquisitions. The impact of the increase in balances acquired was offset somewhat by yields on interest-earning assets which decreased to 4.27% from 5.26% in the prior year. Interest-bearing deposits in other banks was the primary cause for the decrease in the total asset yield as the average outstanding balances of those deposits increased from $18.4 million in fiscal year 2009 to $156.4 million in fiscal year 2010.
Loans and leases purchased in the LibertyBank Acquisition increased interest income by $2.9 million in fiscal year 2010. Additionally, the amortization of fair value adjustments on purchased loans reduced interest income by $681,000 in fiscal year 2010.
The following table compares detailed average earning asset balances, associated yields, and resulting changes in interest and dividend income for the years ended September 30, 2010 and 2009 (dollars in thousands):
Interest Expense. Interest expense decreased $1.6 million, or 13.5%, to $10.4 million for the year ended September 30, 2010 from $12.0 million for the year ended September 30, 2009. The decrease was primarily attributable to the decline in our cost of funds, which decreased from 2.57% in the prior year to 1.57% in the current year and lower FHLB balances in 2010. These effects were offset somewhat by higher balances of deposits due to organic core deposit growth and the acquisitions. Liabilities (primarily deposits) assumed in the LibertyBank Acquisition increased interest expense by $331,000 in fiscal year 2010. Fair value adjustments from the CFB Acquisition and the LibertyBank Acquisition reduced interest expense by $420,000 and $1.1 million, respectively, in fiscal year 2010. The accretion of fair value purchase accounting adjustments was expected to reduce interest expense by $2.8 million, $353,000 and $48,000 in fiscal years 2011, 2012 and 2013, respectively.
The following table details average balances, cost of funds and the change in interest expense for the year ended September 30, 2010 and 2009 (dollars in thousands):
Approximately $369.8 million and $12.1 million of certificates of deposit and FHLB advances, respectively, were scheduled to mature during fiscal year 2011.
Provision for Loan Losses. A provision for loan losses of $10.3 million, including a provision of $1.1 million on covered loans, was recorded in connection with our analysis of losses in the loan portfolio for the year ended September 30, 2010, compared to a provision for loan losses of $16.1 million for the same period of 2009. The provision took into account the increase in classified assets, nonperforming loans and loan losses during fiscal 2010 as well as the current downturn in the real estate market, internal changes in our lending and underwriting policies and the general economy. The estimated indemnifiable portion (95%) of the $1.1 million provision for loan losses on covered loans was recorded as an increase to the FDIC indemnification assets and an increase in other income, which totaled $998,000 in fiscal 2010.
Noninterest Income. Noninterest income increased $7.4 million, or 79.5%, to $16.7 million for the year ended September 30, 2010 from $9.3 million for the year ended September 30, 2009. The following table provides a detailed analysis of the changes in components of noninterest income (dollars in thousands):
During fiscal 2010, service fees and charges increased $855,000 to $9.2 million with $761,000 of the increase attributable to the LibertyBank Acquisition. Checking fee income represented a larger percentage of our total revenues than many of our peers due to a deposit strategy implemented many years ago that we no longer pursue.
Historically, the Bank focused on high-transaction, low-balance “free checking” accounts that would result in high overdraft fee income. We changed our strategy on deposit aggregation in 2006 to focus on building deeper relationships with our depositors that may result in fewer accounts with higher, more stable balances because we believe relationship-based customers improve the Company’s franchise value and provide a stable, low-cost funding source for loans, which results in higher net interest income. While we began this strategic initiative several years ago, we have retained a significant number of those low-balance, high overdraft free checking accounts.
These new overdraft fee regulations that became effective in the fourth quarter of fiscal 2010 began, and will continue, to have a significant impact on overdraft fee income. In addition to changes in operational processing, customers were explicitly required to “opt-in” to use our overdraft services on debit card and ATM transactions. While total organic checking account balances were higher in the fourth quarter of fiscal 2010, fees from overdrafts, excluding the LibertyBank Acquisition, declined $591,000, or 37%, in the fourth quarter of 2010, compared to the fourth quarter of 2009.
A bargain purchase gain of $3.2 million was recorded in connection with the LibertyBank Acquisition. Due to a change in the applicable accounting guidance, the gain on the LibertyBank Acquisition was recorded as an item in noninterest income whereas the gain recognized on the CFB Acquisition in prior fiscal 2009 was classified as an extraordinary gain, net of tax. A bargain purchase gain occurs when the fair value of assets acquired exceeds the fair value of liabilities assumed. The preliminary estimated fair value of assets acquired in the LibertyBank Acquisition totaled $690.6 million and the preliminary estimated fair value of liabilities assumed was $687.4 million, excluding the impact of income taxes. The determination of the preliminary estimated fair values of assets acquired and liabilities assumed required significant estimates and assumptions about the assets and liabilities acquired. The amount that we ultimately realize on these assets could differ materially from the carrying value reflected in our financial statements, based upon the timing and amount of collections on the acquired loans in future periods.
Accretable income of $1.4 million and $0 was realized in fiscal years 2010 and 2009, respectively, related to the accretion of discount applied to the FDIC indemnification assets from the acquisitions.
A FDIC indemnification recovery of $998,000 was recorded in fiscal year 2010 representing the increase in the FDIC indemnification asset due to a $1.1 million provision for loan losses recorded in the current year on covered loans purchased in the CFB Acquisition. Additionally, in the third fiscal quarter of 2010, we made adjustments to the original estimated fair values of loans purchased in the CFB Acquisition, which resulted in an FDIC indemnification recovery of $278,000.
While mortgage rates fell to historic lows during most of fiscal year 2010, the gain on sale of loans declined 46.8% to $648,000 from $1.2 million in fiscal year 2009 due to a reduction in the volume of loans originated for sale. We have reorganized our mortgage banking team and hired new leadership to improve the volume and profitability per transaction. However, continuing declines in residential real estate values and persistently high unemployment reduced the volume of residential real estate transactions in our Idaho and Central Oregon markets and limited the number of applicants who could qualify for refinancing. LibertyBank did not have any meaningful one-to-four family residential loan origination programs before it was taken in FDIC receivership.
In fiscal 2009, we repaid FHLB advances assumed in the CFB Acquisition shortly after the transaction was consummated. However, rates fell precipitously in the days following the acquisition which resulted in a prepayment penalty of $498,000 in excess of the fair value adjustments recorded on the date of the CFB Acquisition. We also extinguished the FHLB advances assumed in the LibertyBank Acquisition. We recorded a gain of approximately $8,000 in fiscal year 2010 on that repayment as rates had increased slightly after the LibertyBank acquisition date.
Other income includes rent on REO and the $278,000 fair value adjustment noted above. Additionally, other income in fiscal year 2010 included a recovery of $198,000 on loans that were charged off by LibertyBank prior to our acquisition.
Noninterest Expense. Noninterest expense increased $11.9 million, or 41.0%, to $40.8 million for the year ended September 30, 2010 from $29.0 million for the year ended September 30, 2009. Operating expenses of LibertyBank comprised $3.4 million of the increase. Operating expenses were $4.6 million higher in 2010 as a result of the CFB Acquisition, which occurred in August 2009. Provision for REO was $1.3 million higher in 2010 and direct expenses related to the LibertyBank Acquisition totaled $800,000 in fiscal year 2010.
The following table provides a detailed analysis of the changes in components of noninterest expense (dollars in thousands):
Compensation and benefits increased $4.6 million or 29.2% to $20.6 million for the year ended September 30, 2010 from $15.9 million for the same period a year ago. The largest factor in the increase was compensation which increased $3.3 million or 33.5% due primarily to the increase in employees after the LibertyBank and CFB Acquisitions. Payroll taxes also increased $459,000, or 50.9%, from the prior year. A large component of the increase in payroll taxes was unemployment expense which increased $169,000, or 198.0%. ESOP expense increased $516,000 or 53.3% due to a higher price of the Company’s common stock, on average, in fiscal 2010 compared to fiscal 2009. These increases were offset by a decrease in incentive expense of $663,000 or 91% as bonuses paid for fiscal 2010 were significantly lower than in the prior year. No bonuses were paid to the executive officers of the Company in fiscal year 2010.
Occupancy and equipment, data processing, professional services, and insurance and taxes all increased primarily due to the CFB and LibertyBank Acquisitions. Parallel back offices were maintained for both the Idaho and the Central Oregon regions until the core conversion and integration of the operations of the CFB Acquisition was completed in August 2010. In addition, we incurred two months of similar expenses related to the LibertyBank Acquisition that occurred on July 30, 2010.
The increase in provision for REO was primarily due to the significant increase in REO balances from the prior year and the continuing decline in real estate values. The REO balance increased from $18.4 million as of September 30, 2009 to $30.5 million as of September 30, 2010. On a quarterly basis, all REO is evaluated and the respective carrying balances are adjusted downward if warranted. The $3.2 million of provision for REO expense represents additional adjustments downward in the carrying value of REO subsequent to foreclosure.
Other noninterest expense for fiscal year 2010 includes postage and supplies expense of $848,000, which increased $274,000 from 2009 due to the acquisitions, expenses to maintain REO of $209,000 and losses on debit card disputes and fraud of $214,000.
Income Tax Benefit. Income tax benefit from continuing operations was $2.9 million based on a pre-tax loss from operations of $7.3 million. This compares to income tax benefit from continuing operations in the prior year of $4.8 million based on $11.9 million in pre-tax loss. The extraordinary gain realized in fiscal 2010 was $305,000, net of $195,000 in taxes, and was the result of a purchase price adjustment by the FDIC on the CFB Acquisition.
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST
The following table sets forth for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin, and the ratio of average interest-earning assets to average interest-bearing liabilities (dollars in thousands). Average balances have been calculated using the average of daily balances during the period. Interest and dividends are reported on a tax-equivalent basis.
(1)
Non-accrual loans are included in the average balance. Loan fees are included in interest income on loans and are insignificant.
(2)
Net interest margin, otherwise known as yield on interest earning assets, is calculated as net interest income divided by average interest-earning assets.
The following table sets forth (on a consolidated basis) for the periods and at the dates indicated, the weighted average yields earned on our assets, the weighted average interest rates paid on our liabilities, together with the net yield on interest-earning assets:
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing rates and volumes on our net interest income (in thousands). Information is provided with respect to: (1) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (2) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
General. Our Board of Directors has established an asset and liability management policy to guide management in maximizing net interest rate spread by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate sensitivity, changes in net interest income, credit risk and profitability. The policy includes the use of an Asset Liability Management Committee whose members include certain members of senior management. The Committee’s purpose is to communicate, coordinate and manage our asset/liability positions consistent with our business plan and Board-approved policies, as well as to price savings and lending products, and to develop new products.
The Asset Liability Management Committee meets to review various areas including:
·
economic conditions;
·
interest rate outlook;
·
asset/liability mix;
·
interest rate risk sensitivity;
·
change in net interest income
·
current market opportunities to promote specific products;
·
historical financial results;
·
projected financial results; and
·
capital position.
The Committee also reviews current and projected liquidity needs. As part of its procedures, the Asset Liability Management Committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential change in market value of portfolio equity that is authorized by the Board of Directors.
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Our loans generally have longer maturities than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
In recent years, we primarily have utilized the following strategies in our efforts to manage interest rate risk:
·
we have increased our originations of shorter term loans and particularly, construction and land development loans and home equity loans;
·
we have structured our borrowings with maturities that match fund our loan and investment portfolios;
·
we have attempted, where possible, to reduce our concentration of fixed-rate deposits, which typically have shorter average lives than core deposits such as checking accounts, in order to extend the average lives of our deposit accounts; and
·
we have invested in securities with relatively short anticipated lives, generally two to four years.
How We Measure the Risk of Interest Rate Changes. We measure our interest rate sensitivity on a monthly basis utilizing an internal model. Management uses various assumptions to evaluate the sensitivity of our operations to changes in interest rates. Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual experience differs from such assumptions. The assumptions we use are based upon proprietary and market data and reflect historical results and current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets under the various interest rate scenarios. An independent service was used to provide decay rates and market rates of interest and certain interest rate assumptions to determine prepayments and maturities of real estate loans, investments and borrowings. Time deposits are modeled to reprice to market rates upon their stated maturities. We assumed that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates. In the past, we have demonstrated that the tiering structure of
our deposit accounts during changing rate environments results in relatively low volatility and less than market rate changes in our interest expense for deposits. Our deposit accounts are tiered by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers).
When interest rates rise, we generally do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon an analysis of our customer base, competitive factors and historical experience. The following table shows the change in our net portfolio value at September 30, 2011, that would occur upon an immediate change in interest rates based on our assumptions, but without giving effect to any steps that we might take to counteract that change (dollars in thousands). The net portfolio value is calculated based upon the present value of the discounted cash flows from assets and liabilities. The difference between the present value of assets and liabilities is the net portfolio value and represents the market value of equity for the given interest rate scenario. Net portfolio value is useful for determining, on a market value basis, how much equity changes in response to various interest rate scenarios. Large changes in net portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.
(1)
Represents the decrease of the estimated net portfolio value at the indicated change in interest rates compared to the base net portfolio value.
(2)
Calculated as the estimated net portfolio value divided by the portfolio value of total assets.
(3)
Calculated as the decrease of the net portfolio value ratio assuming the indicated change in interest rates over the base net portfolio value ratio.
The following table illustrates the change in net interest income at September 30, 2011, that would occur in the event of an immediate change in interest rates, but without giving effect to any steps that might be taken to counter the effect of that change in interest rates (dollars in thousands):
(1)
Represents the increase of the estimated net interest income at the indicated change in interest rates compared to net interest income assuming no change in interest rates.
We use certain assumptions in assessing our interest rate risk. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates and the market values of certain assets under differing interest rate scenarios, among others. The table above also includes projected balances for loans and deposits, actual results for which may be materially different from those estimates.
As with any method of measuring interest rate risk, shortcomings are inherent in the method of analysis presented in the foregoing tables. For example, although assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in the market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in calculating the table.
LIQUIDITY AND COMMITMENTS
We are required to have sufficient cash flow in order to maintain liquidity to ensure a safe and sound operation. Liquidity management is both a daily and long-term function of business management. On a monthly basis, we review and update cash flow projections to ensure that adequate liquidity is maintained. Excess liquidity is generally invested in short-term investments such as overnight deposits or mortgage-backed securities. On a longer-term basis, we maintain a strategy of investing in loans
Our primary sources of funds are from customer deposits, loan repayments, loan sales, maturing investment securities and advances from the Federal Home Loan Bank of Seattle. These funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, to fund loan commitments and to maintain our portfolio of mortgage-backed securities and investment securities. Alternatively, we may also liquidate assets to meet our funding needs.
We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due. Liquidity (and funding) risk occurs when funds cannot be raised at reasonable prices, or in a reasonable time frame, to meet our normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage effectively our liquidity and funding requirements.
We believe that our current liquidity position is sufficient to fund all of our existing commitments. We currently maintain cash flow above the minimum level believed to be adequate to meet the requirements of normal operations, including potential deposit outflows, as we continue to seek acquisition opportunities and need to ensure adequate liquidity to support the integration of the acquired balance sheet.
Certificates of deposit scheduled to mature in one year or less at September 30, 2011, totaled $193.8 million, which represented 62.5% of our certificates of deposit portfolio at September 30, 2011. Management’s policy is to generally maintain deposit rates at levels that are competitive with other local financial institutions. Historically, the Bank has been able to retain a significant amount of deposits as they mature. However, recent deterioration in credit quality and capital levels at many of our competitors have limited their sources of wholesale funding, which has resulted in a highly price-competitive market for retail certificates of deposit. These rates currently exceed alternative costs of borrowings and are high compared to historical spreads to U.S. Treasury note rates. Additionally, since loan demand has slowed, we have been reluctant to offer rates in excess of wholesale borrowing costs. This has resulted in some deposit runoff as customers are moving their maturing balances to competitors at a higher pace than the Bank has historically experienced. Nonetheless, we believe the Company has adequate resources to fund all loan commitments through FHLB advances, loan repayments, maturing investment securities, and the sale of mortgage loans in the secondary markets. We had the ability at September 30, 2011, to borrow an additional $125.8 million from the Federal Home Loan Bank of Seattle. We are also approved at the Discount Window of the Federal Reserve Bank of San Francisco and could use that facility as a funding source to meet commitments and for liquidity purposes.
We had no borrowed funds from the FHLB at September 30, 2011; however, we are dependent on the FHLB of Seattle to provide the primary source of wholesale funding for immediate liquidity and borrowing needs. The failure of the FHLB of Seattle or the FHLB system in general may materially impair our ability to meet our growth plans or to meet short and long term liquidity demands. However, our mortgage backed securities are marketable and could be sold to obtain cash to meet liquidity demands should our access to FHLB funding be impaired.
CONTRACTUAL OBLIGATIONS
Through the normal course of operations, we have entered into certain contractual obligations. Our obligations generally relate to funding of operations through deposits and borrowings as well as leases for premises. Lease terms generally cover a five-year period, with options to extend, and are non-cancelable.
At September 30, 2011, scheduled maturities of contractual obligations were as follows (in thousands):
(1)
Disclosed at the September 30, 2011 present value of estimated payments assuming all future vesting conditions are met.
OFF-BALANCE SHEET ARRANGEMENTS
We are party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of our customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Our maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Because some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We use the same credit policies in making commitments as we do for on-balance sheet instruments. Collateral is not required to support commitments.
Undisbursed balances of loans closed include funds not disbursed but committed for construction projects. Unused lines of credit include funds not disbursed, but committed to, home equity, commercial and consumer lines of credit.
Commercial letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily used to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral is required in instances where we deem it necessary.
The following is a summary of commitments and contingent liabilities with off-balance sheet risks as of September 30, 2011 (in thousands):
CAPITAL
Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well capitalized” institution in accordance with regulatory standards. Home Federal Bank’s total equity capital was $150.1 million at September 30, 2011 or 12.95%, of total assets on that date. As of September 30, 2011, we exceeded all regulatory capital requirements. We did not apply for government assistance through the Capital Purchase Program under the U.S. Treasury Department’s Troubled Asset Relief Program (TARP) or the Small Business Lending Fund. See “How We Are Regulated - Regulation and Supervision of Home Federal Bank - Capital Requirements” and Note 15 to the Consolidated Financial Statements under Item 8 to this Annual Report on Form 10-K.
The following table discloses the regulatory capital ratios for the Company and the Bank at September 30, 2011 and 2010:
(1)
A holding company such as Home Federal Bancorp does not have a “Well-capitalized” measurement. “Well-capitalized” only applies to the Bank.
(2)
The Company reorganized as a bank holding company in May 2011. Previously, as a savings and loan holding company, the Company did not report consolidated regulatory capital ratios.
Covered assets and the FDIC indemnification receivable from the CFB Acquisition and the LibertyBank Acquisition are assessed a risk-weight of 20% during the period such assets are covered under the loss sharing agreements. While the risk-based capital ratios would be lower if the covered assets and the FDIC indemnification receivable were risk-weighted at their normal levels, the Bank’s capital ratios would still exceed the minimum requirements to be considered well capitalized.
The Company’s total capital was $194.7 million and $205.1 million at September 30, 2011 and 2010, respectively, as Home Federal Bancorp, Inc. retained some of the capital raised in the second conversion in 2007 and did not inject all of the capital raised into the Bank. This additional capital is held in cash and highly liquid mortgage-backed securities and supports the payment of dividends to shareholders and could be used for acquisitions, repurchases of the Company’s common stock or other corporate purposes.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. The primary impact of inflation is reflected in the increased cost of our operations. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. In a period of rapidly rising interest rates, the liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels of interest rates, is in the area of noninterest expense. Expense items such as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in dollar value of the collateral securing loans that we have made. Our management is unable to determine the extent, if any, to which properties securing loans have appreciated in dollar value due to inflation.
Deflation, or a decrease in overall prices from one period to the next, could have a negative impact on the Company’s operations and financial condition. Deflationary periods impute a higher borrowing cost to debtors as the purchasing power of a dollar increases with time. This may decrease the demand for loan products offered by the Bank.
Inflation also indirectly impacts the Company through the pressure it may place on consumer and commercial borrowers. For example, as commodity prices rose rapidly during calendar year 2008, national delinquency rates on loans increased as the cost of gasoline and food significantly eroded disposable income available to consumers. As a result, they were unable to service their debt obligations as a greater share of their income was used to meet ordinary daily expenditures.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-08, Testing Goodwill for Impairment (Topic 350). ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU 2011-08 is effective for interim and annual periods beginning after December 15, 2011. Early adoption is permitted. The Company did not early adopt this standard, which is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). ASU 2011-05 attempts to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The effective date of ASU 2011-05 will be the first interim or fiscal period beginning after December 15, 2011 and should be applied retrospectively. Early adoption is permitted. The Company early adopted this standard, and presented the Consolidated Statements of Comprehensive Income (Loss) as a separate statement rather than part of the Consolidated Statements of Shareholders’ Equity.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (International Financial Reporting Standards). This guidance is effective for the first interim or annual period beginning on or after December 15, 2011, and will be applied prospectively beginning in the period of adoption. The amendments change the wording used to describe requirements for measuring fair value under U.S. GAAP to be more consistent with IFRSs. The adoption of this guidance is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In April 2011, the FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements (Topic 860). ASU 2011-03 attempts to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before maturity. The effective date of ASU 2011-03 will be the first interim or annual period beginning after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.
In April 2011, FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. ASU 2011-02 clarifies when a loan modification or restructuring is considered a troubled debt restructuring. This guidance became effective for the first interim or annual period beginning on or after June 15, 2011, and will be applied retrospectively to the beginning of the annual period of adoption. The adoption of this guidance is not expected to have a material effect on the Company’s Consolidated Financial Statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” of this Annual Report on Form 10-K is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Management’s Annual Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets as of September 30, 2011 and 2010
Consolidated Statements of Operations For the Years Ended September 30, 2011, 2010 and 2009
Consolidated Statements of Comprehensive Income (Loss) For the
Years Ended September 30, 2011, 2010 and 2009
Consolidated Statements of Stockholders’ Equity For the
Years Ended September 30, 2011, 2010 and 2009
Consolidated Statements of Cash Flows For the Years Ended September 30, 2011, 2010 and 2009
Selected Notes to Consolidated Financial Statements
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Home Federal Bancorp, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
This process includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, and can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Furthermore, because of changes in conditions, the effectiveness of internal control may vary over time.
The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2011. Management’s assessment was based on criteria described in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that assessment, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of September 30, 2011.
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2011 has been audited by Crowe Horwath LLP, the Company’s independent registered public accounting firm who audits the Company’s consolidated financial statements.
/s/ Len E. Williams /s/ Eric S. Nadeau
Len E. Williams Eric S. Nadeau
President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
Dated: December 14, 2011
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Home Federal Bancorp, Inc. and Subsidiary
Nampa, Idaho
We have audited the accompanying consolidated balance sheets of Home Federal Bancorp, Inc. and Subsidiary (the Company) as of September 30, 2011 and 2010, and the related consolidated statements of operations, statements of comprehensive income (loss), changes in stockholders’ equity and cash flows for the years then ended. We also have audited the Company’s internal control over financial reporting as of September 30, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Home Federal Bancorp, Inc. and Subsidiary as of September 30, 2011 and 2010, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion, Home Federal Bancorp, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of September 30, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
As described in Note 17 to the consolidated financial statements, on October 1, 2009, the Company changed its method of computing earnings per common share to comply with new accounting guidance. All previously reported
earnings per common share amounts have been retrospectively adjusted to conform to the new accounting guidance. We audited the adjustments described in Note 17 that were applied to revise earnings per common share for the year ended September 30, 2009. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2009 financial statements of the Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2009 financial statements taken as a whole.
/s/ Crowe Horwath LLP
Crowe Horwath LLP
Cleveland, Ohio
December 14, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Home Federal Bancorp, Inc. and Subsidiary
Nampa, Idaho
We have audited, before the effects of the adjustments to retrospectively apply the change in accounting described in Note 17, the consolidated statement of operations, comprehensive income (loss), stockholders’ equity, and cash flows of Home Federal Bancorp, Inc. and Subsidiary (the Company) for the year ended September 30, 2009 (the financial statements before the effects of the adjustments discussed in Note 17 are presented herein). These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2009 consolidated financial statements, before the effects of the adjustments to retrospectively apply the change in accounting described in Note 17, present fairly, in all material respects, the consolidated results of operations and cash flows of Home Federal Bancorp, Inc. and Subsidiary for the year ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America.
We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively apply the change in accounting and disclosure for the impact of participating securities on earnings per share in Note 17 and, accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied. Those adjustments were audited by Crowe Horwath LLP.
/s/ Moss Adams LLP
Spokane, Washington
December 11, 2009
See accompanying notes.
See accompanying notes.
See accompanying notes.
HOME FEDERAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
See accompanying notes.
See accompanying notes.
See accompanying notes.
HOME FEDERAL BANCORP, INC. AND SUBSIDIARY
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Nature of Business and Reorganization. Home Federal Bancorp, Inc. (the Company), was formed as the new stock holding company for Home Federal Bank (the Bank) in connection with the Company’s conversion from a mutual holding company structure to a stock holding company structure, which was completed on December 19, 2007 (Conversion). Prior to the completion of the Conversion, the Bank was the subsidiary of Home Federal Bancorp, Inc., a federally-chartered stock mid-tier holding company (old Home Federal Bancorp), which was a subsidiary of Home Federal MHC, a federally-chartered mutual holding company. The Bank formed Home Federal MHC in December 2004. As a result of the Conversion, Home Federal MHC and old Home Federal Bancorp ceased to exist and were replaced by the Company as the successor to old Home Federal Bancorp.
As part of the Conversion, a total of 9,384,000 new shares of the Company were sold at $10 per share in subscription, community and syndicated community offerings through which the Company received proceeds of approximately $87.8 million, net of offering costs of approximately $5.9 million. The Company contributed $48.0 million or approximately 50% of the net proceeds to the Bank in the form of a capital contribution. The Company loaned $8.2 million to the Bank’s Employee Stock Ownership Plan (ESOP) and the ESOP used those funds to acquire 816,000 shares of the Company’s common stock at $10 per share. As part of the Conversion, shares of outstanding common stock of old Home Federal Bancorp were exchanged for 1.136 shares of the Company’s common stock. No fractional shares were issued. Instead, cash was paid to stockholders at $10 per share for any fractional shares that would otherwise be issued. The exchange resulted in an additional 852,865 outstanding shares of the Company for a total of 17,325,901 outstanding shares as of the closing of the Conversion, after giving effect to the redemption of fractional shares.
Additionally, on May 31, 2011, the Bank converted to an Idaho-chartered commercial bank, and as a result, the Company reorganized as a bank holding company. Previously, the Company was a federally-chartered savings and loan holding company and the Bank was a federal savings bank.
The Bank was founded in 1920 as a building and loan association and reorganized as a federal mutual savings and loan association in 1936. The Bank is a community-oriented financial institution dedicated to serving the financial service needs of consumers and businesses within its market areas. The Bank’s primary business is attracting deposits from the general public and using these funds to originate loans.
Home Federal Bank currently has operations in three distinct market areas. The Boise, Idaho, and surrounding area known as the Treasure Valley region of southwestern Idaho, which includes Ada, Canyon, Elmore, and Gem counties, the Tri-County Region of Central Oregon including the counties of Deschutes, Crook and Jefferson, and Western Oregon including Lane, Josephine, Jackson, & Multnomah counties. In total the Bank has 33 full-service banking offices, various administrative locations, and Internet banking services.
Home Federal Bank has five wholly-owned subsidiaries, Idaho Home Service Corporation, Liberty Funding Inc., Liberty Insurance Services, Inc., all of which are currently inactive. Commercial Equipment Lease Corporation was purchased in connection with the July 30, 2010, acquisition of LibertyBank in Eugene, Oregon, (the LibertyBank Acquisition) and specializes in commercial leasing activities. Community First Real Estate, LLC, was purchased in connection with the August 7, 2009, acquisition of Community First Bank in Prineville, Oregon (the CFB Acquisition). See Note 2 for additional information regarding these acquisitions.
Principles of Consolidation. The consolidated financial statements of the Company include the accounts of the Company, the Bank and its wholly-owned subsidiaries, Idaho Home Service Corporation, Liberty Funding Inc., Liberty Insurance Services, Inc., Commercial Equipment Lease Corporation and Community First Real Estate LLC. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates. To prepare financial statements in conformity with U.S. generally accepted accounting principles management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.
Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses (including the evaluation of impaired loans and the associated provision for loan losses), accounting for acquired loans and covered assets, the valuation of noncovered real estate owned, as well as deferred income taxes and the associated income tax expense.
Management believes that the allowance for loan losses reflects the best estimate of probable incurred losses inherent in the loan portfolio at the balance sheet dates presented and that the valuation of real estate owned (REO) and computation of deferred taxes are proper. While management uses currently available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Cash Flows. Cash and cash equivalents include cash, deposits with other financial institutions with original maturities of less than 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.
The Company is required to maintain an average reserve balance with the Federal Reserve Bank, or maintain such reserve in cash on hand. The amount of this required reserve balance at September 30, 2011 and 2010 was $3.4 million and $6.1 million, respectively.
Securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized gains and losses reported in other comprehensive income, net of taxes. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Federal Home Loan Bank (FHLB) Stock. As a member of the FHLB of Seattle, the Bank is required to maintain a minimum level of investment in capital stock of the FHLB based on specific percentages of its outstanding FHLB advances, total assets and mortgages. The Bank’s investment in FHLB of Seattle stock is carried at par value ($100 per share), which reasonably approximates its fair value. The Bank may request redemption at par value of any stock in excess of the amount the Bank is required to hold. FHLB stock is restricted as to purchase, sale, and redemption.
Loans Held for Sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Loan commitments related to the origination of mortgage loans held for sale and the corresponding sales contracts are considered derivative instruments as defined by Accounting Standards Codification (ASC) 815, Derivatives and Hedging. If material, these derivatives are recognized on the Consolidated Balance Sheets in other assets and other liabilities at fair value.
Loans. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of purchase premiums and discounts, deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level yield method without anticipating prepayments.
Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with the Company’s policy, typically after 90 days of non-payment.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Purchased Loans. In connection with the acquisitions discussed in Note 2, the Bank has purchased loans of failed banks, some of which have shown evidence of credit deterioration since origination. These purchased loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.
Loans purchased in the CFB Acquisition were accounted for under Statement of Accounting Standard No. 141, which has since been superseded by ASC 805, and under the guidance of ASC 310-30. An allowance for loan losses was recorded on loans purchased in the CFB Acquisition that did not show evidence of credit deterioration on the acquisition date. Loans purchased in the CFB Acquisition that are accounted for under ASC 310-30 were not aggregated into pools of loans but are accounted for individually.
The LibertyBank Acquisition was accounted for under ASC 805 and all related purchased loans are accounted for under ASC 310-30. Such purchased loans are aggregated into pools of loans based on common risk characteristics such as credit risk and loan type. The Company estimates the amount and timing of expected cash flows for each purchased loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance for loan losses on noncovered originated loans consists of specific reserves allocated to individually reviewed loans and general reserves on all other noncovered originated loans. Valuation deficiencies on noncovered
originated loans in process of foreclosure are treated as “Loss” under the Bank’s credit grading process and the loan balance is reduced to the estimated net recoverable value, which removes the specific reserve previously recorded. The Bank records a general allowance on loans purchased in the CFB Acquisition that are not accounted for under ASC 310-30. Loans purchased in the CFB Acquisition that are accounted for under ASC 310-30 are partially charged down to the estimated net recoverable value if estimated losses exceed the fair value discount established on the acquisition date. Lastly, an allowance for loans purchased in the LibertyBank Acquisition is not established unless the net present value of cash flows expected to be received for loans in the acquired loan pools become impaired.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Loans accounted for under ASC 310-30 are not considered impaired loans.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Nonhomogeneous loans, such as commercial and multifamily, construction and commercial business loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and one-to-four family residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of the reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the last one to three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified:
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Real Estate: the Bank originates both fixed-rate loans and adjustable-rate loans in our one- to four- family residential lending program to meet the requirements of Fannie Mae and Freddie Mac for sale in the secondary market to investors. One-to-four family loans are generally underwritten based on the applicant’s employment, debt to income levels, credit history and the appraised value of the subject property. Generally, the Bank will lend up to 80% of the lesser of the appraised value or purchase price for one-to-four family residential loans. In situations where a loan with a loan-to-value ratio is in excess of 80%, the Bank generally requires private mortgage insurance in order to reduce our exposure to 80% or less. Properties securing our one-to-four family loans are generally appraised by independent fee appraisers who have been approved by us. The Bank requires our borrowers to obtain title and hazard insurance, and flood insurance, if necessary, in an amount equal to the regulatory maximum. Multifamily and commercial real estate loans typically have higher loan balances, are more difficult to evaluate and monitor, and involve a greater degree of risk than one-to-four family residential loans. Often payments on loans secured by multifamily or commercial properties are dependent on the successful operation and management of the property; therefore, repayment of these loans may be affected by adverse conditions in the real estate
market or the economy. The Bank generally requires loan guarantees from financially capable parties based upon the review of personal financial statements. If the borrower is a corporation, the Bank generally requires personal guarantees from the corporate principals based upon a review of their personal financial statements and individual credit reports. Commercial real estate loans are primarily secured by office and warehouse space, professional buildings, retail sites, multifamily residential buildings, industrial facilities and restaurants located in our primary market areas. The maximum loan-to-value ratio for commercial and multifamily real estate loans is generally 75% on purchases and refinances. The Bank obtains appraisals of all properties securing commercial and multifamily real estate loans from independent appraisers.
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Real Estate Construction: All builder/borrower loans are underwritten to the same standards as other commercial loan credits, requiring liquid working capital, sufficient net worth and established cash reserves to carry projects through construction completion and sale of the project. The maximum loan-to-value ratio on both pre-sold and speculative projects is generally 80%. The Bank originates construction and site development loans to contractors and builders primarily to finance the construction of single-family homes and subdivisions, which homes typically have an average price ranging from $150,000 to $400,000. Loans to finance the construction of single-family homes and subdivisions are generally offered to experienced builders in our primary market areas. The maximum loan-to-value limit applicable to construction and site development loans is 80% and 70%, respectively, of the appraised market value upon completion of the project. Maturity dates for residential construction loans are largely a function of the estimated construction period of the project, and generally do not exceed 36 months for residential subdivision development loans.
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Consumer Loans: Consumer loans, including home equity loans and lines of credit, savings account loans, automobile loans, recreational vehicle loans and personal unsecured loans entail greater risk than do residential first-lien mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles, and in second-lien loans such as home equity lines of credit in markets where residential property values have declined significantly since fiscal year 2007. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment when allowed by law. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. Home equity loans and lines of credit have greater credit risk than one-to-four family residential mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property.
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Commercial Business Loans: Commercial business loans include lines of credit and term loans and are typically secured by collateral and are used for general business purposes, including working capital financing, equipment financing, capital investment and general investment. Commercial business loans typically have shorter terms to maturity than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. The Bank focuses on small- to medium-sized, privately-held companies with local or regional businesses that operate in the Bank’s market area. The Bank’s commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of the credit analysis, as repayment of commercial business loans is generally dependent on the cash flows of the borrower. Generally, personal guarantees are required on commercial business loans. Commercial business loans also include equipment finance agreements for the purchase of personal property, business equipment and titled vehicles and construction equipment. Generally these agreements have terms of 60 months or less and the lessee is granted title to the collateral at the end of the term.
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Leases: The Company also has leases on personal property and business assets. At the end of the lease term, the collateral is returned to CELC and the Bank, at which point the collateral is sold through a nationwide network of brokers. Our leases entail many of the same types of risks as our commercial
business loans. As with commercial business loans, the collateral securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The Bank relies on the lessee’s continuing financial stability, rather than the value of the leased equipment, for the repayment of all required amounts under lease loans. In the event of a default on a lease, it is unlikely that the proceeds from the sale of the leased equipment will be sufficient to satisfy the outstanding unpaid amounts under the terms of the loan.
The allowance for loan losses on loans covered by loss sharing agreements with the Federal Deposit Insurance Corporation (FDIC) are reported gross of amounts to be recovered from the FDIC. The provision for loan losses is also recorded gross of amounts recoverable from the FDIC. The amount of the provision for loan losses on covered loans that is expected to be recovered from the FDIC is recorded as an increase to the FDIC indemnification asset with an increase in noninterest income.
Concentrations of Credit Risk. The Bank accepts deposits and grants credit primarily within the Treasure Valley region of southwestern Idaho, the tri-county region of central Oregon, and western Oregon. The Bank has a diversified loan portfolio and grants consumer, residential, commercial, and construction real estate loans, and is not dependent on any industry or group of clients. The Bank has a diversified loan portfolio, however, a substantial portion of its loans are real estate-related. The ability of the Bank’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area. The Bank also regularly monitors real-estate related loans that include terms that may give rise to a concentration of credit risk, including high loan-to-value loans and interest-only loans.
Transfers of Financial Assets. Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Foreclosed Assets. Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. The carrying amount of real estate and other property owned was $23.4 million and $30.5 million at September 30, 2011 and 2010, respectively. Covered real estate and other property owned totaled $16.2 million and $20.5 million at September 30, 2011 and 2010, respectively.
Property and Equipment. Properties and equipment are stated at cost, less accumulated depreciation and amortization. Leasehold improvements are amortized over the term of the lease or the estimated useful life of the improvements, whichever is less. Depreciation and amortization are generally computed using the straight-line method for financial statement purposes over the following estimated useful lives and lease periods:
The normal costs of maintenance and repairs are charged to expense as incurred.
Bank Owned Life Insurance. The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
FDIC Indemnification Asset. Under the terms of the loss sharing agreements with the FDIC, which is a significant component of the acquisitions discussed in Note 2, the FDIC will absorb most of the losses and certain related expenses and share in loss recoveries on loans, leases and REO covered under the loss share agreements. The FDIC indemnification asset is measured separately from each of the covered asset categories. The indemnification asset represents the present value of the estimated cash payments expected to be received from the FDIC for future losses on covered assets based on the credit adjustment estimated for each covered asset and the loss sharing percentages.
These cash flows are discounted at a market-based rate to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC. The FDIC indemnification asset will be reduced as losses are recognized on covered assets and loss sharing payments are received from the FDIC. Realized losses in excess of acquisition date estimates will increase the FDIC indemnification asset and the indemnifiable loss recovery is recorded in noninterest income. Conversely, if realized losses are less than acquisition date estimates, the FDIC indemnification asset will be reduced by a charge to earnings and is included with accretion (impairment) of FDIC indemnification asset in noninterest income.
Intangible Assets. Intangible assets acquired in a purchase business combination with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Intangible assets on the Company’s Consolidated Balance Sheets consist of a core deposit intangible asset arising from whole bank acquisitions. The core deposit intangible is initially measured at fair value and then is amortized on an accelerated method over the estimated useful life, which has been estimated to be 10 years. The original amount of core deposit intangibles was $4.1 million, with a balance at September 30, 2011 of $3.2 million.
The following table shows estimated amortization expense (in thousands):
Income Taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company analyzed its tax positions, including the permanent and temporary differences as well as the major components of income and expense, and determined that it had no uncertain tax positions that would rise to the level of having a material effect on its Consolidated Financial Statements at September 30, 2011 or 2010.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Comprehensive Income. Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale, which are also recognized as separate components of equity.
Advertising Costs. Advertising costs are expensed as incurred. Advertising expense for the years ended September 30, 2011, 2010 and 2009, was $1.1 million, $1.2 million and $913,000 respectively.
Stock-Based Compensation. Compensation cost is recognized for stock options and restricted stock awards issued to employees and directors, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Retirement Plans. Employee 401(k) plan expense is the amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.
Employee Stock Ownership Plan. The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of shareholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest.
Earnings Per Share. Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. ESOP shares are considered outstanding for this calculation unless unearned. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.
Loss Contingencies. Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Fair Value of Financial Instruments. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Operating Segments. While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial services operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications. Certain reclassifications have been made to prior year’s financial statements in order to conform to the current year presentation. The reclassifications had no effect on previously reported net income or equity.
Recent Accounting Pronouncements. In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-08, Testing Goodwill for Impairment (Topic 350). ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU 2011-08 is effective for interim and annual periods beginning after December 15, 2011. Early adoption is permitted. The Company did not early adopt this standard, which is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). ASU 2011-05 attempts to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The effective date of ASU 2011-05 will be the first interim or fiscal period beginning after December 15, 2011 and should be applied retrospectively. Early adoption is permitted. The Company early adopted this standard, and presented the Consolidated Statements of Comprehensive Income (Loss) as a separate statement rather than part of the Consolidated Statements of Stockholders’ Equity.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (International Financial Reporting Standards). This guidance is effective for the first interim or annual period beginning on or after December 15, 2011, and will be applied prospectively beginning in the period of adoption. The amendments change the wording used to describe requirements for measuring fair value under U.S. GAAP to be more consistent with IFRSs. The adoption of this guidance is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In April 2011, the FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements (Topic 860). ASU 2011-03 attempts to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before maturity. The effective date of ASU 2011-03 will be the first interim or annual period beginning after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.
In April 2011, FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. ASU 2011-02 clarifies when a loan modification or restructuring is considered a troubled debt restructuring. This guidance became effective for the first interim or annual period beginning on or after June 15, 2011, and will be applied retrospectively to the beginning of the annual period of adoption. The adoption of this guidance is not expected to have a material effect on the Company’s Consolidated Financial Statements.
Note 2 - Acquisitions
On August 7, 2009, the Bank entered into an agreement with the FDIC and acquired certain assets and assumed certain liabilities of Community First Bank, a full service community bank that was formerly headquartered in Prineville, Oregon. The results of operations for fiscal year 2009 include the impact of the CFB Acquisition from the acquisition date through September 30, 2009. The CFB Acquisition consisted of assets with a preliminary estimated fair value of $189.8 million and liabilities with a preliminary estimated fair value of $174.5 million on the acquisition date. Through the CFB Acquisition, the Bank acquired a wholly-owned subsidiary, Community First Real Estate LLC, which owned three of the Bank’s banking offices in Central Oregon.
On July 30, 2010, the Bank entered into an agreement with the FDIC and acquired certain assets and assumed certain liabilities of LibertyBank, a full service community bank that was formerly headquartered in Eugene, Oregon (the LibertyBank Acquisition). The results of operations for fiscal year 2010 and beyond include the impact of the LibertyBank Acquisition from the acquisition date of July 30, 2010. The LibertyBank Acquisition consisted of assets with a preliminary estimated fair value of $690.6 million and liabilities with a preliminary estimated fair value of $688.6 million on the acquisition date. Through the LibertyBank Acquisition, the Bank acquired three wholly-owned subsidiaries, two of which are inactive with no business activities. The third was Commercial Equipment Lease Corporation (CELC), which engages in the business of equipment lease financing. Leases are generally for terms of five years or less. Equipment financing agreements, or financing leases, are reported as commercial loans in the Company’s balance sheet. Other leases are included in loans, but reported separately in the accompanying footnotes.
In addition to the assets purchased and liabilities assumed, the Bank and the FDIC entered into loss sharing agreements. These agreements cover realized losses and certain expenses on nearly all of the loans (“covered loans”) and foreclosed real estate purchased in the acquisitions (together “covered assets”). Under the agreements, the FDIC will reimburse the Bank for 80% of the first $34.0 million of realized losses and reimbursable expenses on covered assets and 95% on realized losses that exceed $34.0 million on covered assets from the CFB Acquisition. The FDIC will reimburse the Bank for 80% of the losses on covered assets from the LibertyBank Acquisition. Consumer loans purchased in the LibertyBank Acquisition that were not secured by real estate (such as automobile and deposit secured loans) are excluded from the loss sharing agreements. Additionally, total losses on the loans and leases of CELC are limited to the sum of the book value of the Bank’s investment in CELC and the Bank’s outstanding balance on a line of credit balance to CELC as of the date of the LibertyBank Acquisition. These amounts totaled $57.0 million at July 30, 2010, and are eliminated upon consolidation. The FDIC will also share in any recoveries on covered assets at the same rates as the loss sharing provisions.
Realized losses covered by the loss sharing agreements include loan contractual balances (and related unfunded commitments that were acquired), accrued interest on loans for up to 90 days, the book value of foreclosed real estate acquired, and certain direct costs, less cash or other consideration received by the Bank. The loss sharing agreements and recovery provisions for one-to-four family loans is in effect for 10 years from the acquisition dates. For all other covered loans and leases, the loss sharing agreements and recovery provisions are in effect for five years and eight years, respectively. The reimbursable losses from the FDIC are based on the book value of the relevant loans and foreclosed assets as determined by the FDIC as of the dates of the acquisitions. The expected
reimbursements under the loss sharing agreements were recorded as an indemnification asset at their estimated fair value on the acquisition date.
The FDIC indemnification asset is measured separately from each of the covered asset categories. The indemnification asset represents the present value of the estimated cash payments expected to be received from the FDIC for losses on covered assets based on the credit adjustment estimated for each covered asset and the loss sharing percentages. These cash flows are discounted at a market-based rate to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC. The discount applied to the FDIC indemnification asset was between 6.25% and 7.00% during the years ended September 30, 2011 and 2010, respectively.
In September 2020, approximately ten years following the LibertyBank Acquisition date, the Bank is required to make a payment to the FDIC in the event that losses on covered assets under the loss share agreements have been less than the intrinsic loss estimate, which was determined by the FDIC prior to the Acquisition. The payment amount will be 50% of the excess, if any, of (i) 20% of the Total Intrinsic Loss Estimate of $60.0 million, which equals $12.0 million, less the sum of the following:
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20% of the Net Loss Amount, which is the sum of all loss amounts on covered assets less the sum of all recovery amounts realized. This amount is not yet known;
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25% of the asset premium (discount). This amount is ($7.5) million; and
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3.5% of the total covered assets under the loss share agreements. This amount is $10.1 million.
The Company has estimated the minimum level of losses to avoid a true-up provision payment to the FDIC to be $46.7 million. The maximum amount of the true-up provision is $4.7 million, if there are no losses in the covered loan portfolio.
Based upon the acquisition date preliminary fair values estimate of the net assets acquired, no goodwill was recorded in either transaction. The CFB Acquisition was accounted for under SFAS No. 141 and resulted in a pre-tax gain of $25.0 million, which was classified as an extraordinary gain in the Company’s Consolidated Statement of Operations for the year ended September 30, 2009, net of income taxes. Due to the difference in tax bases of the assets acquired and liabilities assumed, the Company recorded a deferred tax liability of $9.7 million, resulting in an after-tax gain of $15.3 million. The LibertyBank Acquisition was accounted for under ASC 805 and a bargain purchase gain of $3.2 million was recorded in other income in the Company’s Consolidated Statement of Operations for the year ended September 30, 2010. The tax liability associated with the bargain purchase gain from the LibertyBank Acquisition was $1.3 million at the acquisition date.
The determination of the initial fair value of loans purchased in the acquisitions and the initial fair value of the related FDIC indemnification asset involved a high degree of judgment and complexity. The carrying value of the acquired loans and the FDIC indemnification asset reflected management’s best estimate of the amount to be realized on each of these assets. However, the amount the Company realizes on these assets could differ materially from the carrying value reflected in these financial statements, based upon the timing of collections on the acquired loans in future periods. Because of the loss sharing agreements with the FDIC on these assets, the Company does not expect to incur any excessive losses. To the extent the actual values realized for the acquired loans are different from the estimates, the FDIC indemnification asset will generally be impacted in an offsetting manner due to the loss sharing support from the FDIC.
In its assumption of the deposit liabilities, the Company believed that the customer relationships associated with these deposits have intangible value. The Company applied ASC 350, Intangibles - Goodwill and Other, which prescribes the accounting for goodwill and other intangible assets, such as core deposit intangibles. The Company determined the fair value of a core deposit intangible asset was approximately $2.1 million in the CFB Acquisition and $4.1 million in the LibertyBank Acquisition. In accordance with the provisions of SFAS No. 141, the Company allocated the excess of fair value of net assets acquired over cost to the fair value of the core deposit intangible asset in the CFB Acquisition, thus reducing the carrying value of the intangible asset to zero. At September 30, 2011, the $3.2 million core deposit intangible reported on the Company’s balance sheet relates to the LibertyBank Acquisition. In determining the valuation of this intangible asset, deposits were analyzed based on factors such as type of deposit, deposit retention, interest rates and age of deposit relationships.
The loss sharing agreements and recovery provisions for one-to-four family loans is in effect for 10 years from the acquisition dates. For all other covered loans and leases, the loss sharing agreement and recovery provision is in effect for five years and eight years, respectively, from the Acquisition Date.
The LibertyBank Acquisition provided an opportunity to broaden and deepen the Bank’s deposit franchise. The Company’s management has from time to time become aware of acquisition opportunities and has performed various levels of review related to potential acquisitions in the past. This particular transaction was attractive for a variety of reasons, including the:
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ability to expand into non-overlapping yet complementary markets on the outer rim of the Company’s targeted growth markets;
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ability to achieve improvement in branch performance in the Bank’s Central Oregon region due to overlap of banking offices;
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ability to compete against banks in LibertyBank’s markets based on Home Federal’s relative capital strength;
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diversification of the Bank’s loan portfolio by introducing a significant level of commercial business loans;
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attractiveness of immediate core deposit growth with low cost of funds. Over the past several years, organic core deposit growth has been difficult as financial institutions competed over core deposits. The LibertyBank Acquisition allowed the Bank to immediately increase core deposits at an attractive cost.
A summary of the net assets purchased in the LibertyBank Acquisition and the estimated fair value adjustments were as follows at the acquisition date (in thousands):
The operating results of the Company for the years ended September 30, 2011, 2010 and 2009, include the operating results of the acquired assets and assumed liabilities since the acquisition dates of July 30, 2010 for the LibertyBank Acquisition and August 7, 2009, for the CFB Acquisition. Due primarily to the significant amount of fair value adjustments and the loss sharing agreements included in the acquisitions, historical results of LibertyBank and Community First Bank are not believed to be relevant to the Company’s results; therefore, pro forma information is not presented herein. Expenses during fiscal 2010 related to the LibertyBank Acquisition totaled approximately $520,000 and were recorded in professional fees in the Consolidated Statement of Operations.
Note 3 - Fair Value Measurement
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate fair value:
Investment Securities. The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.
Impaired Loans. The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Real Estate Owned (REO). Nonrecurring adjustments to certain commercial and residential real estate properties classified as REO are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
The following table summarized the Company’s financial assets that were measured at fair value on a recurring basis at September 30, 2011 and 2010 (in thousands):
Additionally, certain assets are measured at fair value on a non-recurring basis. These adjustments to fair value generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment.
The following table summarizes the Company’s assets that were measured at fair value on a non-recurring basis at September 30, 2011 and 2010 (in thousands):
Impaired loans, which are measured for impairment using the fair value of the collateral at September 30, 2011, had a carrying amount of $10.2 million, net of specific valuation allowances totaling $1.4 million. The specific valuation allowance on impaired loans during the fiscal years ended September 30, 2011 and 2010, required a provision of $8.4 million and $7.0 million, respectively.
Real estate owned, which is recorded at estimated fair value less costs to sell, had a carrying amount of $10.7 million at September 30, 2011, which is comprised of the outstanding balance of $10.7 million, with no valuation allowance. At September 30, 2010, real estate owned measured at fair value less costs to sell had a carrying value of
$8.3 million, which is made up of the outstanding balance of $11.2 million, net of a valuation allowance of $2.9 million. The provision for declines in the value of real estate owned totaled $1.4 million and $3.2 million for the years ended September 30, 2011 and 2010, respectively, net of amounts recoverable from the FDIC under loss sharing agreements.
The estimated fair values of the Company’s financial instruments are as follows (in thousands):
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Cash and Cash Equivalents. The carrying amount approximates fair value.
Investment Securities. The Company’s investment securities available-for-sale consist primarily of securities issued by U.S. Government sponsored enterprises that trade in active markets. These securities are included under Level 2 because there may or may not be daily trades in each of the individual securities and because the valuation of these securities may be based on instruments that are not exactly identical to those owned by the Company.
Loans Held for Sale. The carrying amount approximates fair value.
FHLB Stock. The determination of fair value of FHLB stock was impractical due to restrictions on the transferability of the stock.
Loans Receivable. Fair values for all performing loans are estimated using a discounted cash flow analysis, utilizing interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. In addition, the fair value reflects the decrease in loan values as estimated in the allowance for loan losses calculation. Leases are excluded from the table above.
FDIC Indemnification Asset. Carrying value approximates fair value as the receivable is recorded at the net present value of estimated cash flows.
Accrued Interest Receivable. The carrying amount approximates fair value.
Deposits. The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit are estimated using discounted cash flow analysis using the rates currently offered for deposits of similar remaining maturities.
FHLB Advances and Other Borrowings. The fair value of the borrowings is estimated by discounting the future cash flows using the current rate at which similar borrowings with similar remaining maturities could be made.
Advances by Borrowers for Taxes and Insurance. The carrying amount approximates fair value.
Accrued Interest Payable. The carrying amount approximates fair value.
Off-Balance Sheet Instruments. Fair values of off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the borrower’s credit standing. The fair value of the fees at September 30, 2011 and 2010, were insignificant.
Note 4 - Securities
The Company’s investment policies are designed to provide and maintain adequate liquidity and to generate favorable rates of return without incurring undue interest rate or credit risk, and generally limit investments to mortgage-backed securities, U.S. Government and agency securities, municipal bonds, certificates of deposit and marketable corporate debt obligations. Investment securities available-for-sale consisted of the following at September 30, 2011 and 2010 (dollars in thousands):
For the years ended September 30, 2011, 2010 and 2009, proceeds from sales of securities available-for-sale amounted to $28.2 million, $2.7 million and $10.9 million, respectively. Gross realized gains for the years ended September 30, 2011, 2010 and 2009 were $607,000, $105,000 and $121,000, respectively. Gross realized losses for the years ended September 30, 2011, 2010 and 2009 were $0, $7,000 and $324,000 respectively. All gain and losses were included in other noninterest income on the Consolidated Statements of Operations.
The fair value of securities with unrealized losses, the amount of unrealized losses and the length of time these unrealized losses existed as of September 30, 2011 and 2010, are as follows (in thousands):
Management has evaluated these securities and has determined that the decline in the value is not other than temporary and not related to the underlying credit quality of the issuers or an industry specific event. The declines in value are on securities that have contractual maturity dates and future principal payments that will be sufficient to recover the current amortized cost of the securities. The Company does not have the intent to sell these securities and it is likely that it will not be required to sell these securities before their anticipated recovery.
The contractual maturities of investment securities available-for-sale are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers have the right to prepay obligations without prepayment penalties.
As of September 30, 2011 and 2010, the Bank pledged investment securities for the following obligations (in thousands):
At September 30, 2011, our holdings of securities of any one issuer in an amount greater than 10% of stockholders’ equity (at fair value) were obligations of U.S. GSEs ($82.3 million) and mortgage-backed securities to GSEs: Fannie Mae ($132.0 million), Freddie Mac ($99.6 million) and Ginnie Mae ($46.9 million).
Note 5 - Loans Receivable and the Allowance for Loan Losses
Loans receivable are summarized as follows at September 30, 2011 and 2010 (dollars in thousands):
The majority of residential mortgage loans are pledged as collateral for potential FHLB advances (see Note 9).
The following tables present loans at their recorded investment. Recorded investment includes the unpaid principal balance or the carrying amount of loans plus accrued interest less charge offs and net deferred loan fees. Accrued interest on loans was $1.2 million and $1.5 million as of September 30, 2011 and 2010, respectively.
The following table presents the recorded investment in nonperforming loans and an aging of performing loans by class as of September 30, 2011 (in thousands):
The recorded investment in nonperforming loans as of September 30, 2010 was $35.0 million.
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by
classifying the loans as to credit risk. This analysis is performed on a monthly basis. The Company uses the following definitions for risk classification ratings:
Watch. Loans that possess some reason for additional management oversight, such as correctable documentation deficiencies, recent financial setbacks, deteriorating financial position, industry concerns, and failure to perform on other borrowing obligations. Loans with this classification are to be monitored in an effort to correct deficiencies and upgrade the credit if warranted. At the time of this classification, they are not believed to expose the Bank to significant risk.
Special Mention. Performing loans that have developed minor credit weaknesses since origination. Evidence of credit weakness include the primary source of repayment has deteriorated and no longer meets debt service requirements as defined in policy, the borrower may have a short track record and little depth of management, inadequate current financial information, marginal capitalization, and susceptibility to negative industry trends. The primary source of repayment remains viable but there is increasing reliance on collateral or guarantor support.
Substandard. A loan is considered substandard if it is inadequately protected by the current net worth, liquidity and paying capacity of the borrower or collateral pledged. Substandard assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable on the basis of currently existing facts, conditions and values.
Loans not meeting the criteria above are considered to be Pass rated loans. As of September 30, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
A loan is considered impaired when, based upon currently known information, it is deemed probable that the Company will be unable to collect all amounts due as scheduled according to the original terms of the agreement with the borrower. The following table summarizes impaired loans at September 30, 2011 and 2010 (in thousands):
As of September 30, 2011 and 2010, accruing loans that were contractually past due 90 days or more totaled $0 and $116,000, respectively. Nonaccrual loans totaled $24.6 million and $34.7 million at September 30, 2011 and 2010, respectively. Interest income recognized on impaired loans during the fiscal years ended September 30, 2011 and 2010 was immaterial.
The following table presents loans deemed impaired by class of loans as of and during the year ended September 30, 2011 (in thousands):
Troubled debt restructurings totaled $7.0 million and $10.1 million at September 30, 2011 and 2010, respectively, and are included in the impaired loan disclosures above. Of these amounts, $440,000 and $4.7 million were covered under loss share agreements with the FDIC at September 30, 2011 and 2010, respectively. The Company has allocated $1.2 million and $1.1 million of specific reserves to customers whose loan terms have been modified in
TDRs as of September 30, 2011 and 2010. There were no commitments to lend additional amounts to customers with outstanding loans that are classified as TDRs.
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2011 (in thousands):
Activity in the allowance for loan losses for the year ended September 30, 2011 was as follows (in thousands):
Activity in the allowance for loan losses for the year ended September 30, 2010 and 2009 was as follows (in thousands):
Statement of Financial Accounting Standards No. 141 permits an allocation period for the identification and valuation of assets and liabilities acquired in a business combination, usually lasting up to twelve months after the acquisition date. The identification and reclassification of loans subject to ASC 310-30 was also included in the allocation period review. During this allocation period, the Company identified additional loans purchased in the CFB Acquisition that were credit impaired on the date of acquisition resulting in a reclassification of the preliminary estimated losses from the allowance for loan losses to the net discount on estimated cash flows of credit impaired loans. Additionally, adjustments were made to the original preliminary loss estimates on loans that were not credit
impaired on the date of acquisition. These adjustments and reclassifications of estimated losses resulted in the reduction of the allowance for loan losses of $9.2 million during the year ended September 30, 2010.
The Bank has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. At the acquisition date, management estimated the fair value of the acquired loan portfolios which represented the expected cash flows from the portfolio discounted at a market-based rate. Included in the estimate of fair value was a discount credit adjustment that reflected expected credit losses. In estimating the preliminary fair value, management calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”) and estimated the amount and timing of undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the life of the loans. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The nonaccretable difference represents an estimate of the credit risk in the acquired loan and lease portfolio at the acquisition date. The following table details activity of accretable yield (in thousands):
The carrying amount of loans for which income is not being recognized on loans individually accounted for under ASC 310-30 totaled $8.8 million and $20.6 million at September 30, 2011 and 2010, respectively, all of which were purchased in the CFB Acquisition. At September 30, 2011 and 2010, the allowance for losses on purchased credit impaired loans was $2.0 million and $0, respectively. The provision for loan losses and reductions in the allowance for purchased credit impaired loans was $2.9 million and $864,000, respectively, during the year ended September 30, 2011.
On July 30, 2010, the Bank consummated the LibertyBank Acquisition. At the acquisition date, management estimated the fair value of the acquired loan portfolio to be $197.6 million, which represents the expected cash flows from the portfolio discounted at a market-based rate and includes leases with a preliminary estimated fair value of $7.4 million. After detailed review by management and competent independent third parties, loans acquired in the LibertyBank Acquisition that were placed on nonaccrual status, designated as troubled debt restructurings prior to the acquisition, graded substandard or doubtful or exhibited other evidence of credit impairment since origination were grouped into 11 pools based on loan type, collateral and credit risk characteristics. The Company accounts for these loans with specifically-identified credit deficiencies under ASC 310-30. The preliminary estimated fair value of purchased loans with specifically-identified credit deficiencies in the LibertyBank Acquisition was $40.7 million on the date of acquisition.
All remaining loans purchased in the LibertyBank Acquisition were grouped into 11 pools with common risk characteristics, including loan type and collateral. These loans were then evaluated to determine estimated fair value as of the acquisition date. Although no specific credit deficiencies are specifically identifiable, management believes there is an element of risk as to whether all contractual cash flows will be eventually received. Factors that were considered included the poor economic environment both nationally and locally as well as the unfavorable real estate market particularly in Oregon and the Pacific Northwest. In addition, these loans were acquired from a failed financial institution which implies poor, or at least questionable, underwriting. Based on management’s preliminary estimate of fair value, each of these pools was assigned a discount credit adjustment that reflects expected credit losses. The Company applies ASC 310-30 accounting by analogy to these loans. Leases are excluded from the application of ASC 310-30.
In estimating the preliminary fair value, management calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”) and estimated the amount and timing of undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). The amount by
which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the life of the loans. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The nonaccretable difference represents an estimate of the credit risk in the acquired loan and lease portfolio at the acquisition date.
In calculating expected cash flows, management made several assumptions regarding prepayments, collateral cash flows, the timing of defaults and the loss severity of defaults. Voluntary prepayment rates were applied to the principal balances. Other factors considered in determining the preliminary estimated fair value of acquired loans included loan level estimated cash flows, type of loan and related collateral, risk classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing and current discount rates.
The following table summarizes information regarding loans purchased in the LibertyBank Acquisition and accounted for under ASC 310-30 (in thousands):
The carrying amount of loans for which income is not being recognized on loans individually accounted for under ASC 310-30 totaled $8.8 million and $20.6 million at September 30, 2011 and 2010, which were purchased in the CFB Acquisition. The carrying amount of purchased credit impaired loans acquired in the CFB Acquisition totaled $8.8 million and $21.9 million at September 30, 2011 and 2010, respectively. At September 30, 2011, purchased credit impaired loans acquired in the LibertyBank Acquisition totaled $95.3 million.
Pursuant to the terms of the loss sharing agreements with the FDIC, the FDIC is obligated to reimburse the Company for a significant portion of losses on covered loans. See Note 2 for additional information on the loss sharing agreements. Net covered loans totaled $149.9 million and $266.0 million at September 30, 2011 and 2010, respectively.
Note 6 - FDIC Indemnification Receivable
Activity in the FDIC indemnification receivable for the year ended September 30, 2011 and 2010 was as follows (in thousands):
For the CFB Acquisition, amounts receivable from the FDIC have been estimated at 80% of losses on covered assets (acquired loans and REO) up to $34.0 million. Reimbursable losses in excess of $34.0 million have been estimated at 95% of the amount recoverable from the FDIC. For the LibertyBank Acquisition, amounts receivable from the FDIC have been estimated at 80% of losses on all covered assets. The discount rate applied to estimated future cash flows was between 6.25% and 7.00%.
Note 7 - Property and Equipment
Property and equipment at September 30, 2011 and 2010 are summarized as follows (in thousands):
Repairs and maintenance are charged against income as incurred; major remodels and improvements are capitalized. Depreciation charged against operations for the years ended September 30, 2011, 2010 and 2009, was $2.6 million, $2.1 million and $1.7 million, respectively.
In October 2010, the Bank notified the FDIC of its intent to purchase the property of, or assume the leases, on all but two of the banking offices of LibertyBank under a purchase option available in the purchase and assumption agreement for the LibertyBank Acquisition. The purchase price for the land and buildings was approximately $10.7 million. Additionally the Bank agreed to purchase furniture and equipment in these banking offices at a purchase price of approximately $700,000.
Note 8 - Deposit Accounts
Deposit information by type and weighted average rates are summarized as follows (dollars in thousands):
Scheduled maturities of certificates of deposit are as follows during the fiscal years presented (in thousands):
At September 30, 2011 and 2010, certificates of deposit of $100,000 or greater were $112.4 million and $228.1 million, respectively.
Interest expense by type of deposit account is summarized as follows (in thousands):
Accrued interest on deposit accounts at September 30, 2011 and 2010 was $249,000 and $422,000, respectively.
Note 9 - Federal Home Loan Bank Advances and Other Borrowings
The Bank has the ability to borrow up to 40% of its total assets from the FHLB of Seattle, limited by available collateral. Advances are collateralized by all FHLB stock owned by the Bank, deposits with the FHLB of Seattle, and certain residential mortgages and mortgage-backed securities. The outstanding balances on FHLB advances at September 30, 2010 were $58.9 million. No FHLB borrowings were outstanding at September 30, 2011. The Bank repaid all outstanding borrowings with the FHLB, totaling $48.3 million on September 22, 2011, and incurred a $2.0 million prepayment penalty from this transaction.
Other borrowings include securities sold under obligations to repurchase (repurchase agreements) that are originated directly with commercial and retail customers. These borrowings are collateralized with securities issued by U.S. Government sponsored enterprises. Repurchase agreements totaled $4.9 million and $8.8 million at September 30, 2011 and 2010, respectively, and had average rates of 1.72% and 1.45% at those dates, respectively.
The Bank’s borrowings consisted of the following during the years ended September 30, 2011 and 2010 (dollars in thousands):
Scheduled maturities of the Company’s borrowings are as follows during the fiscal years presented (dollars in thousands):
Note 10 - Employee Retirement Plans
401(k) Plan. The Company has a 401(k) retirement plan covering substantially all of its employees. During the period January 1, 2010 through December 31, 2011, the Company matches 50% of employee contributions up to the employee’s first 6% contributed to the Plan. This plan was modified in October 2011, and effective January 1, 2012, the Company will match 100% of employee contributions up to the employee’s first 4% contributed to the Plan. For the years ended September 30, 2011, 2010 and 2009, total Company contributions were $353,000, $291,000 and $251,000, respectively.
During September 2011, the Home Federal Bank 401(k) Plan and the Home Federal Bancorp, Inc., Employee Stock Ownership Plan were merged into a new plan, the Home Federal 401(k) Plan and Employee Stock Ownership Plan (KSOP) and will refinance the ESOP loans.
Salary Continuation Plan. As a supplement to the 401(k) retirement plan (and after January 1, 2012, the KSOP plan), the Company has adopted a Salary Continuation Plan pursuant to agreements with certain executive officers of the Company and its subsidiaries. Under the Salary Continuation Plan, an executive will be entitled to a stated
annual benefit for a period of 15 years (i) upon retirement from the Company after attaining age 65, or (ii) upon attaining age 65 if his or her employment had been previously terminated due to disability. In the event the executive dies while in active service, the Company shall pay the beneficiary the normal retirement projected benefit for a period of 15 years commencing with the month following the executive’s death. At September 30, 2011, this death benefit contingency totaled $5.5 million and is not reported on the Consolidated Balance Sheets. In the event the executive dies after age 65, but before receiving the full 15 years of annual benefits, the remaining payments shall be paid to his or her beneficiaries. Upon termination of employment, the annual benefit amount is 50% of the officer’s average final 36 months base salary. Benefits under the Plan vest over ten years. Upon early retirement, the Company shall pay the executive the vested accrual balance as of the end of the month prior to the early retirement date. The Company will pay the early retirement benefit in 180 equal installments.
The accrued liability for the salary continuation plan was $2.6 million and $2.4 million at September 30, 2011 and 2010, respectively. The amounts recognized in compensation expense were $336,000, $265,000 and $141,000 for the years ended September 30, 2011, 2010 and 2009, respectively.
Deferred Incentive Compensation. The Company has deferred incentive compensation agreements with certain former executive officers and certain members of the Board of Directors. Under the agreements, the Company is obligated to provide payments for each such former executive and board member or his beneficiaries during a period of fifteen or ten years after the death, disability, or retirement of the executive or board member. Until October 1, 2006, the plan provided an incentive award percentage determined by reference to Home Federal’s return on assets and return on equity for the year. The resulting amount was set aside in an unfunded deferral account for participants. Although the incentive award has been discontinued, members of the Board of Directors may still elect to defer all or a part of their directors’ fees into the deferral account under the plan. The deferral accounts are credited annually with an interest credit that is based on the growth rate of Home Federal Bank’s net worth in Home Federal, subject to a maximum of 12% per year.
The Company accrues annual interest on the unfunded liability under the plan based upon a formula relating to the change in retained earnings of the Bank, which amounted to 0%, 0% and 11.56% for the years ended September 30, 2011, 2010 and 2009, respectively. The accrued liability for the deferred incentive compensation agreements was $2.5 million and $2.5 million at September 30, 2011 and 2010, respectively. The amounts recognized in compensation expense were $170,000, $141,000 and $152,000 for the years ended September 30, 2011, 2010 and 2009, respectively.
Director Retirement Plan. Home Federal Bancorp adopted a director retirement plan, effective January 1, 2005, that replaced prior plans. The plan is an unfunded nonqualified retirement plan for directors. Upon the later of attaining age 72 or termination of service, the director will receive an annual benefit equal to 50 percent of the fees paid to the director for the preceding year, payable in monthly installments over 15 years. The accrued benefit vests at a rate of 10 percent per year, except in the event of disability, in which case the vested percentage is 100 percent. If the director terminates service within 24 months following a change in control, he will receive 100 percent of his accrued benefit, plus a change in control benefit equal to 2.99 times his or her directors fees for the prior year. Change in control payments are subject to reduction to avoid excise taxes under Section 280G of the Internal Revenue Code. In the event a director dies before termination of service, his beneficiary would receive his projected benefit, which is the final benefit the director would have received had he attained age 72, assuming a 4% annual increase in the directors’ fees. In the event the director dies after separation from service, but before receiving the full 15 years of annual benefits, the remaining payments shall be paid to his or her beneficiaries. In-service distributions are permitted in limited circumstances.
The accrued liability for the director retirement plans was $630,000 and $609,000 at September 30, 2011 and 2010, respectively. The amounts recognized in compensation expense were $67,000, $63,000 and $53,000 for the years ended September 30, 2011, 2010 and 2009, respectively.
The Company’s deferred compensation agreements and supplemental executive retirement plans are unfunded plans and have no plan assets. The following table reconciles the accumulated liability for the benefit obligation of these contracts (in thousands). The benefit obligation represents the net present value of future payments to individuals under the agreements.
Note 11 - Stock-Based Compensation
At September 30, 2011, the Company maintained multiple long-term stock-based benefit plans that enable the Company to grant stock options, stock appreciation rights and restricted stock awards to employees and directors. The plans include the 2005 Stock Option Plan, the 2005 Recognition and Retention Plan and the 2008 Equity Incentive Plan. The plans were approved by shareholders in 2005 and 2009.
Restricted Stock Awards. The Company grants restricted stock awards to promote the long-term interests of the Company and its stockholders by providing restricted stock as a means for attracting and retaining directors and key employees. The maximum number of restricted shares that may be awarded under the plans is 692,143. The fair value of restricted stock awards are accrued ratably as compensation expense over the vesting period of the award. The amounts recognized in compensation expense were $433,000, $831,000 and $703,000 for the years ended September 30, 2011, 2010 and 2009 respectively. The Company has an aggregate of 231,687 restricted shares available for future issuance.
Restricted stock activity is summarized in the following table:
Stock Option Awards. The Company grants stock options to promote the long-term interests of the Company and its stockholders by providing an incentive to directors and key employees who contribute to the operating success of the Company. The maximum number of stock options and stock appreciation rights that may be issued under the plans is 1,730,356. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant. The options typically vest over five years and expire ten years from the date of grant. The Company has an aggregate of 589,758 stock options available for future issuance.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life of options granted represents the period of time that options granted are expected to be outstanding. Expected volatilities are based on historical volatility of the Company’s stock. Expected forfeiture rate is the estimated forfeiture rate based upon the circumstances of the individuals that received stock options. Expected dividends represent the Company’s estimated annual dividend rate over the expected life.
Stock option activity is summarized in the following table:
Options outstanding at September 30, 2011, were as follows:
(1)
As Home Federal Bancorp’s stock price was $7.82 as of September 30, 2011, the options outstanding and exercisable have no intrinsic value.
Cash proceeds received from the exercise of stock options were $542,000, $161,000 and $353,000 for the years ended September 30, 2011, 2010 and 2009, respectively. The total intrinsic value of stock options exercised were $78,000, $50,000 and $6,000 for the years ended September 30, 2011, 2010 and 2009, respectively. The amounts recognized in compensation expense were $422,000, $449,000 and $385,000 for the years ended September 30, 2011, 2010 and 2009, respectively. Tax benefits related to stock option exercises were $7,000, $8,000 and $5,000 for the years ended September 30, 2011, 2010 and 2009, respectively. It is the Company’s general policy to issue new shares for the exercise of stock options.
As of September 30, 2011, the compensation expense yet to be recognized for stock-based awards that have been awarded but not vested was as follows (in thousands):
Note 12 - Employee Stock Ownership Plan
In connection with the minority stock offering in 2004, the Company established an ESOP for the benefit of its employees. The ESOP covers all employees with at least one year and 1,000 hours of service. Shares are released for allocation at the discretion of the Board of Directors. In 2004, the Company issued 566,137 shares of common stock to the ESOP in exchange for a ten-year note of approximately $5.0 million. These shares are expected to be released over a ten-year period. In 2007, the ESOP acquired an additional 816,000 shares of the Company’s common stock in exchange for a fifteen-year note of approximately $8.2 million. These shares are expected to be released over a fifteen-year period. As loan payments are made, shares are released from collateral and allocated to participants based on relative compensation, and expense is recorded. The Company reports compensation expense equal to the average market price of the shares allocated. ESOP compensation expense included in salaries and benefits was $1.2 million, $1.5 million and $969,000 for the years ended September 30, 2011, 2010 and 2009, respectively. Dividends on allocated ESOP shares reduce retained earnings; dividends on unallocated ESOP shares reduce principal or interest on the ESOP loan.
ESOP share activity is summarized in the following table:
From the inception of the ESOP through September 30, 2011, 146,294 shares have been taken out of the ESOP via distributions to former employees. At September 30, 2011, a total of 1,235,843 shares remained in the ESOP, excluding shares purchased by the plan through dividends on ESOP shares. Contributions to the plan totaled $1.2 million during each of the years ended September 30, 2011, 2010 and 2009.
Note 13 - Commitments and Contingencies
Lease Commitments. The Company has entered into non-cancelable operating leases for land and buildings that require future minimum rental payments in excess of one year as of September 30, 2011. Certain lease payments may be adjusted periodically in accordance with changes in the Consumer Price Index.
As of September 30, 2010, the Bank was leasing seventeen banking offices from the FDIC in connection with the LibertyBank Acquisition. The Company closed its Portland, Oregon, office on September 30, 2011, as the lease for that facility matured and less than $1.0 million of deposits was serviced at that branch. The Company intends to close three branches in Terrebonne, Bend and LaPine, Oregon, and two branches in Boise, Idaho, between December 15, 2011, and January 5, 2012. The anticipated closure of these branches resulted in accelerated rent and facility impairments of approximately $1.4 million during fiscal year 2011. See Note 7 for more information on facilities.
The estimated future minimum annual rental payments, exclusive of taxes and other charges, are summarized as follows (in thousands):
Total rent expense for the years ended September 30, 2011, 2010 and 2009, was $2.1 million, $897,000 and $501,000, respectively.
Commitments to Extend Credit. In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities that are not presented in the accompanying Consolidated Financial Statements. The commitments and contingent liabilities include various guarantees and commitments to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of the credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include securities, accounts receivable, inventory, fixed assets, and/or real estate properties. The distribution of commitments to extend credit approximates the distribution of loans outstanding.
At September 30, 2011 and 2010, commitments to extend credit were as follows (in thousands):
Most of the Bank’s business activity is with customers located in the States of Idaho and Oregon. Loans to one borrower are generally limited, by federal banking regulation, to 15% of the Bank’s regulatory capital. As of September 30, 2011 and 2010, the Bank had no individual industry concentrations of credit risk.
Note 14 - Related Party Transactions
In the normal course of business, the Company may make loans to its executive officers, directors and companies affiliated with these individuals. An analysis of activity with respect to loans receivable from directors, executive officers and their affiliates is as follows (in thousands):
The Company also accepts deposits from its executive officers, directors, and affiliated companies. The aggregate dollar amounts of these deposits were $1.9 million and $2.4 million at September 2011 and 2010, respectively.
Note 15 - Capital Requirements
Home Federal Bancorp is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve. Home Federal Bank, as a state-chartered federally insured commercial bank, is subject to the capital requirements established by the FDIC. The Federal Reserve requires Home Federal Bancorp to maintain capital adequacy that generally parallels the FDIC requirements.
Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets (leverage ratio) is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a core capital to risk-weighted assets ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by Home Federal Bank to comply with applicable capital requirements would, if unremedied, result in progressively
more severe restrictions on their respective activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
FDIC regulations recognize two types, or tiers, of capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1 capital generally includes common stockholders’ equity and qualifying noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which is recognized up to 100% of Tier 1 capital for risk-based capital purposes (after any deductions for disallowed intangibles and disallowed deferred tax assets), includes such items as qualifying general loan loss reserves (up to 1.25% of risk-weighted assets), cumulative perpetual preferred stock, long-term preferred stock, certain perpetual preferred stock, hybrid capital instruments including mandatory convertible debt, term subordinated debt, intermediate-term preferred stock (original average maturity of at least five years), and net unrealized holding gains on equity securities (subject to certain limitations); provided, however, the amount of term subordinated debt and intermediate term preferred stock that may in included in Tier 2 capital for risk-based capital purposes is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution’s capital using a leverage limit together with certain risk-based ratios. The FDIC’s minimum leverage capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage ratio of at least 3% to 4% of total assets. The FDIC retains the right to require a particular institution to maintain a higher capital level based on an institution’s particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed in one of four categories and given a percentage weight: 0%, 20%, 50% or 100%, based on the relative risk of the category. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets must be at least 4%. In evaluating the adequacy of a bank’s capital, the FDIC may also consider other factors that may affect the bank’s financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management’s ability to monitor and control financial operating risks.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, including off-balance-sheet risk, managerial resources and/or the future earnings prospects of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for the bank is greater than the minimum standards established in the regulation. As of September 30, 2011 and 2010, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category. However, due to the Bank’s net loss during fiscal years 2011 and 2010, the Bank may not declare or pay cash dividends to the Company without regulatory approval. This limitation does not currently affect Home Federal Bancorp’s ability to pay dividends to stockholders, although no assurance can be provided that the Company will continue to pay dividends to stockholders.
Management believes that as of September 30, 2011, the Company and Bank meet all capital adequacy requirements to which they are subject. The following table shows the regulatory capital ratios of the Company and the Bank and the minimum regulatory requirements (dollars in thousands):
(1)
On May 31, 2011, the Bank converted to an Idaho-chartered commercial bank and, as a result, the Company reorganized as a bank holding company. Previously, the Company was a savings and loan holding company and the Bank was a federal savings bank. As such, the bank holding company was not required to calculate comparable prior year capital ratios.
The following table is a reconciliation of the Bank’s capital, calculated according to generally accepted accounting principles, to total Tier 1 capital (in thousands):
Note 16 - Income Taxes
The extraordinary gain realized from the CFB Acquisition during the year ended September 30, 2010, is presented on the Consolidated Statement of Operations net of applicable state and federal income taxes. The following table presents income tax expense (benefit) included in the consolidated statement of income for the years ended September 30, 2011, 2010 and 2009 (in thousands):
Income tax expense (benefit) consisted of the following (in thousands):
Income tax expense differs from that computed at the statutory corporate tax rate as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities consist of the following (in thousands):
Included in retained earnings at September 30, 2011 and 2010 is approximately $2.1 million in bad debt reserves for which no deferred income tax liability has been recorded. This amount represents allocations of income to bad debt deductions for tax purposes only. Reduction of these reserves for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes, which would be subject to the then-current corporate income tax rate. The unrecorded deferred liability on this amount was approximately $818,000 at September 30, 2011 and 2010.
The Company determined that it was not required to establish a valuation allowance for deferred tax assets in accordance with ASC 740, Accounting for Income Taxes, since it is more likely than not that the deferred tax asset will be realized through carryback to taxable income in prior years, future reversals of existing taxable temporary differences, and, to a lesser extent, future taxable income. The Company's net deferred tax asset is recorded in the consolidated financial statements as a component of Other Liabilities on the balance sheet.
At September 30, 2011 and September 30, 2010, the Company had no ASC 740-10 unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Company recognizes interest and penalties on unrecognized tax benefits as a component of income tax expense.
The Company and the Bank are subject to U.S. federal income tax as well as an income tax in the states of Idaho, Oregon and various other state jurisdictions. The Company and the Bank are no longer subject to examination by taxing authorities for years before September 30, 2008.
Note 17 - Earnings (Loss) Per Share
Effective October 1, 2009, the Company adopted new authoritative accounting guidance under ASC Topic 260, Earnings Per Share, which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The Company has determined that its outstanding non-vested stock awards are participating securities. Accordingly, effective October 1, 2009, earnings
per common share is computed using the two-class method prescribed under ASC Topic 260. All previously reported earnings per common share data has been retrospectively adjusted to conform to the new computation method. The impact of adopting this new method of computing earnings per share decreased basic and diluted earnings per common share after extraordinary item from $0.52 to $0.51 for 2009.
Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards, but excludes awards considered participating securities. ESOP shares are not considered outstanding for earnings per share purposes until they are committed to be released.
The following table presents the computation of basic and diluted earnings (loss) per share for the periods indicated (in thousands, except share and per share data):
Note 18 - Parent Only Financial Information
Home Federal Bancorp was formed to serve as the stock holding company for the Bank. The following are the condensed financial statements for Home Federal Bancorp (in thousands):
Note 19 - Selected Quarterly Financial Data (unaudited)
(In thousands, except share data)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On December 18, 2009, the Audit Committee of the Board of Directors of the company notified Moss Adams LLP of its decision not to renew the engagement of Moss Adams LLP to serve as the Company’s independent registered public accounting firm. The decision to change certifying accountants was approved by the Audit Committee of the Board of Directors, which subsequently advised the Board of Directors of its decision, on December 15, 2009.
During the fiscal year ended September 30, 2009, and the subsequent interim period through December 18, 2009, there were no: (1) disagreements with Moss Adams LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to their satisfaction, would have caused them to make reference in connection with their opinion to the subject matter of the disagreement, or (2) reportable events (as defined in Regulation S-K Item 304 (a)(1)(v)). Moss Adams LLP issued an unqualified opinion on the Company’s financial statements as of September 30, 2009, and for the year then ended.
On December 15, 2009, the Audit Committee engaged the firm of Crowe Horwath LLP as independent certified public accountants of the Company and its subsidiaries for the fiscal year ending September 30, 2010. During the fiscal years ended September 30, 2011 and 2010, there were no disagreements with Crowe Horwath LLP and Crowe Horwath LLP issued an unqualified opinion on the Company’s Consolidated Financial Statements as of September 30, 2011 and 2010, and for the years then ended.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Section 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this annual report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as in effect as of September 30, 2011, are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commission’s rules and forms.
Management’s Annual Report on Internal Control Over Financial Reporting and Auditor’s Attestation: The “Management’s Annual Report on Internal Control Over Financial Reporting” included in Item 8 of this Annual Report on Form 10-K is incorporated herein by reference.
Attestation Report of the Registered Public Accounting Firm: The “Report of Independent Registered Public Accounting Firm” included in Item 8 of this Annual Report on Form 10-K is incorporated herein by reference.
Changes in Internal Controls: During the period ended September 30, 2011, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
There was no information to be disclosed by the Company in a report on Form 8-K during the fourth quarter of fiscal 2011 that was not so disclosed.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
DIRECTORS
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the sections captioned “Proposal 1 - Election of Directors” and “Meetings and Committees of the Board of Directors and Corporate Governance Matters” are incorporated herein by reference.
EXECUTIVE OFFICERS
See the information under the section captioned “Executive Officers of the Registrant” under “Part I - Item 1. Business” in this Annual Report on Form 10-K.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.
AUDIT COMMITTEE AND AUDIT COMMITTEE FINANCIAL EXPERT
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the section captioned “Meetings and Committees of the Board of Directors and Corporate Governance Matters” is incorporated herein by reference.
CODE OF ETHICS
We have a Code of Ethics for our officers (including its senior financial officers), directors and employees. The Code of Ethics requires our officers, directors and employees to maintain the highest standards of professional conduct. A copy of our Code of Ethics was filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended September 30, 2004 and is available on our website at www.myhomefed.com/ir.
Item 11.
Item 11. Executive Compensation
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the section captioned “Directors’ Compensation” and “Executive Compensation” are incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plan Information
(1)
Includes 445,704 stock options and 175,501 shares of restricted stock in column (c).
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the section captioned “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information contained in the Company’s Proxy Statement for the 2012 Annual Meeting under the section captioned “Meetings and Committees of the Board of Directors and Corporate Governance Matters” are incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
The information contained in the Company’s Proxy Statement for the 2012Annual Meeting under the sections captioned “Proposal 2 - Ratification of the Appointment of the Independent Registered Public Accounting Firm” are incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Financial Statements
See Index to Consolidated Financial Statements on page 96.
(b) Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or the Notes thereto or in Part I, Item 1.
(c)
Exhibits
2.1
Purchase and Assumption Agreement for Community First Bank Transaction (1)
2.2
Purchase and Assumption Agreement for LibertyBank Transaction (11)
3.1
Articles of Incorporation of the Registrant (2)
3.2
Bylaws of the Registrant (2)
10.1
Amended Employment Agreement entered into by Home Federal Bancorp, Inc. with Len E. Williams (8)
10.2
Amended Severance Agreement with Eric S. Nadeau (8)
10.3
Amended Severance Agreement with R. Shane Correa (8)
10.4
Amended Severance Agreement with Cindy L. Bateman (8)
10.5
Form of Home Federal Bank Employee Severance Compensation Plan (3)
10.6
Form of Director Indexed Retirement Agreement entered into by Home Federal Savings and Loan Association of Nampa with each of its Directors (2)
10.7
Form of Director Deferred Incentive Agreement entered into by Home Federal Savings and Loan Association of Nampa with each of its Directors (2)
10.8
Form of Executive Deferred Incentive Agreement, and amendment thereto, entered into by Home Federal Savings and Loan Association of Nampa with Daniel L. Stevens, Robert A. Schoelkoph, and Lynn A. Sander (2)
10.9
Form of Amended and Restated Salary Continuation Agreement entered into by Home Federal Savings and Loan Association of Nampa with Daniel L. Stevens (2)
10.10
Amended and Restated Salary Continuation Agreement entered into by Home Federal Savings and Loan Association of Nampa with Len E. Williams (8)
10.11
Amended and Restated Salary Continuation Agreement entered into by Home Federal Savings and Loan Association of Nampa with Eric S. Nadeau (8)
10.12
Amended and Restated Salary Continuation Agreement entered into by Home Federal Bank with R. Shane Correa*†
10.13
2005 Stock Option and Incentive Plan approved by stockholders on June 23, 2005 and Form of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreement (4)
10.14
2005 Recognition and Retention Plan approved by stockholders on June 23, 2005 and Form of Award Agreement (4)
10.15
Director Retirement Plan entered into by Home Federal Bank with each of its Independent Directors (5)
10.16
Transition Agreement with Daniel L. Stevens (6)
10.17
2008 Equity Incentive Plan (7)
Statement regarding computation of per share earnings (9)
Code of Ethics (10)
Subsidiaries of the Registrant *†
23.1
Consent of Independent Registered Public Accounting Firm, Crowe Horwath LLP *†
23.2
Consent of Independent Registered Public Accounting Firm Moss Adams LLP*†
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act *
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act *
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act *
The following materials from the Company’s Annual Report on Form 10-K for the year ended September 30, 2011, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Operations; (3) Consolidated Statements of Stockholders’ Equity; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements.* (12)
* Filed herewith
†
Copies of these exhibits are available upon written request to Eric S. Nadeau, Secretary, Home Federal Bancorp, Inc., 500 12th Avenue South, Nampa, Idaho 83651.
(1) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated August 7, 2009.
(2)
Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (333-146289)
(3)
Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2008
(4)
Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (333-127858)
(5)
Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated October 21, 2005
(6)
Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated August 21, 2006
(7)
Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (333-157540)
(8)
Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011
(9)
Reference is made to Note 17 - Earnings Per Share in the Selected Notes to Consolidated Financial Statements under Item 8 herein
(10)
Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at.www.myhomefed.com/ir
(11)
Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated July 30, 2010.
(12)
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto, duly authorized.
HOME FEDERAL BANCORP, INC.
Date: December 14, 2011 /s/ Len E. Williams
Len E. Williams
President and
Chief Executive Officer
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
Subsidiaries of the Registrant †
23.1
Consent of Independent Registered Public Accounting Firm, Crowe Horwath LLP †
23.2
Consent of Independent Registered Public Accounting Firm Moss Adams LLP †
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
The following materials from the Company’s Annual Report on Form 10-K for the year ended September 30, 2011, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Operations; (3) Consolidated Statements of Stockholders’ Equity; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements.*
*
Filed herewith
†
Copies of these exhibits are available upon written request to Eric S. Nadeau, Secretary, Home Federal Bancorp, Inc., 500 12th Avenue South, Nampa, Idaho 83651.