Item 1. Business
General
Alaska Pacific Bancshares, Inc. (“Company”), an Alaska corporation, was organized on March 19, 1999 for the purpose of becoming the holding company for Alaska Pacific Bank (“Alaska Pacific” or the “Bank”) upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”). The Conversion was completed on July 1, 1999. At December 31, 2011, the Company had total assets of $172.1 million, total deposits of $147.2 million and stockholders’ equity of $20.5 million. The Company has not engaged in any significant activity other than holding the stock of the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank.
Alaska Pacific was founded as “Alaska Federal Savings and Loan Association of Juneau” in 1935 and changed its name to “Alaska Federal Savings Bank” in October 1993. In connection with the Conversion, Alaska Pacific changed its name from “Alaska Federal Savings Bank” to its current title. The Bank, as a federally-chartered savings institution, is regulated by the Office of the Comptroller of the Currency (“OCC”), its primary federal regulator and successor to the Office of Thrift Supervision (“OTS”), and the Federal Deposit Insurance Corporation (“FDIC”), as its deposit insurer. The Company is regulated by the Board of Governors of the Federal Reserve System (“Federal Reserve”), its primary federal regulator. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund administered by the FDIC. The Bank has been a member of the Federal Home Loan Bank (“FHLB”) System since 1937.
Alaska Pacific operates as a community oriented financial institution and is devoted to serving the needs of its customers. The Bank’s business consists primarily of attracting retail deposits from the general public and using those funds to originate one-to-four-family mortgage loans, commercial business loans, consumer loans, construction loans and commercial real estate loans.
Participation in the U.S. Treasury’s Capital Purchase Program.
On February 9, 2009, the Company received $4.8 million from the U.S. Treasury Department as part of the Treasury’s Troubled Asset Relief (“TARP”) Capital Purchase Program. The Company issued $4.8 million in senior preferred stock, with a related warrant to purchase up to $717,150 in common stock, to the U.S. Treasury. The warrant provides the Treasury the option to purchase up to 175,772 shares of the Company’s common stock at a price of $4.08 per share at any time during the next ten years. The preferred stock pays a 5% dividend for the first five years, after which the rate will increase to 9% if the preferred shares are not redeemed by the Company. During the second quarter of 2010, pursuant to restrictions imposed on the Company and the Bank by the OTS, the Company suspended its dividend payments on its senior preferred stock and its common stock and continued to defer these payments through December 31, 2010. During the first quarter of 2011, the restrictions were lifted by the OTS and the Company paid all deferred dividends payable in arrears on its senior preferred stock.
The terms and conditions of the transaction and the preferred stock conform to those provided by the U.S. Treasury. A summary of the Capital Purchase Program can be found on the Treasury’s web site at www.ustreas.gov/initiatives/eesa. The additional capital enhances our capacity to support the communities we serve through expanded lending activities and economic development. This capital will also add flexibility in considering strategic opportunities that may be available to us as the financial services industry continues to consolidate.
Regulatory Matters
On September 28, 2010, the Company and the Bank each entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist with the OTS (individually an “Order” and collectively the “Orders”). As a result of the elimination of the OTS on July 21, 2011, compliance with the Orders is now determined by the Company’s new primary regulator, the Federal Reserve, and the Bank’s new primary regulator, the OCC. For
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purposes of this discussion regarding the Order, the Federal Reserve and the OCC are collectively referred to as the “Banking Regulators.”
Under the terms of the Orders, the Company and the Bank, without the prior written approval of the Banking Regulators, may not:
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Increase assets during any quarter;
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Pay dividends;
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Increase brokered deposits;
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Repurchase shares of the Company’s outstanding common stock;
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Issue any debt securities or incur any debt (other than that incurred in the normal course of business); and
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Make payments on any existing debt.
Other material provisions of the Orders require the Bank and the Company to:
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develop a capital plan for preserving and enhancing capital levels that is acceptable to the Banking Regulators;
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develop a business plan for enhancing, measuring and maintaining profitability, increasing earnings, acceptable to the Banking Regulators;
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submit a comprehensive plan for reducing classified assets, acceptable to the Banking Regulators;
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develop and submit a policy for the management and maintenance of liquidity, which includes a contingency plan for anticipating funding needs and alternative funding sources, acceptable to the Banking Regulators;
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develop and submit a plan to internally audit the nature, scope and risk of activities and operations, acceptable to the Banking Regulators;
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revise and submit a plan to comply with applicable consumer and related compliance laws and regulations, including a risk assessment process to measure such compliance, acceptable to the Banking Regulators;
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develop and submit a plan regarding information technology (“IT”) management, including a succession plan for key personnel, duties/responsibilities and training of IT personnel, acceptable to the Banking Regulators;
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develop and implement a risk based IT audit program that complies with all laws and regulations;
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develop and submit a plan for addressing contingency planning related to any back-up IT server(s);
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not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without notifying the Banking Regulators;
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not enter into, renew, extend or revise any compensation or benefit agreements for directors or senior executive officers;
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not make any indemnification, severance or golden parachute payments;
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not enter into any arrangement or contract with a third party service provider that is significant to the overall operation or financial condition of the Bank, or that is outside the normal course of business;
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ensure the Bank’s compliance with applicable laws, rules, regulations and agency guidelines, including the terms of the order; and
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prepare and submit progress reports to the Banking Regulators regarding compliance with the capital plan, business plan, certain classified assets.
The Orders will remain in effect until modified or terminated by the Banking Regulators.
The Company and the Bank have implemented a comprehensive plan to achieve full compliance with the Orders. The Orders will remain in effect until modified or terminated by the Banking Regulators. A copy of the Order were attached to the Form 8-K that was filed with the Securities and Exchange Commission (“SEC”) on October 4, 2010. See also Item 1A.
Item 1A - Risk Factors
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements. This report is qualified in its entirety by these risk factors.
We are subject to certain regulatory restrictions and lack of compliance could result in monetary penalties and/or additional regulatory actions.
On September 28, 2010, Alaska Pacific Bancshares, Inc. and Alaska Pacific Bank each entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist with the OTS (individually an “Order” and collectively the “Orders”). As a result of the elimination of the OTS on July 21, 2011, compliance with the Orders is now determined by the Company’s new primary regulator, the Federal Reserve, and the Bank’s new primary regulator, the OCC. Under the terms of the Orders, the Company and the Bank are required, among other things, to take certain measures in the areas of capital, classified assets, loan loss allowance determination, lending, liquidity management, and board oversight. Specifically, the Order for the Bank requires that the Bank maintain a Tier 1 capital ratio equal of at least 8% after the funding of the allowance for loan and lease losses and a total risk-based capital ratio of at least 12% and 12% by September 30, 2010. The Bank must also submit an updated strategic business plan, revise its classified asset reduction plan, internal audit program, consumer compliance plan, including developing a written liquidity and funds management policy and a written plan for information technology management, and submit such revised plans and policies to regulators. The Bank must also obtain prior regulatory approval before paying a dividend to the Company and prior to engaging in any new transactions with affiliates.
The Order for the Company requires that the Company ensure the Bank’s compliance with applicable laws, rules and regulations and the terms and conditions of the Bank’s Order. In addition to providing a written capital plan, as discussed below, the Company also must submit an operations plan that addresses how the Company will meet its financial obligations. The Order also restricts the Company from paying dividends and repurchasing shares of its common stock and also may not incur any new debt, increase any current lines of credit, or guarantee the debt of any entity without prior regulatory approval.
Under the Orders, the Bank and Company must submit a written plan to maintain the Bank’s capital at the levels set forth in the Orders. The Orders also provide that the Bank and the Company must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer or pay pursuant to or by entering into certain severance and other forms of compensation agreements. The Orders specify certain timeframes for meeting these requirements, and the Company and the Bank must furnish periodic progress reports to the FDIC and DFI regarding its compliance with the Orders.
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At December 31, 2011, the Bank exceeded all current regulatory capital requirements, including the requirements specified in the Order. The Bank has implemented a comprehensive plan to achieve compliance with all conditions in the Order. For information regarding the Bank’s compliance with its capital requirements at December 31, 2011, see Item 1, "Business - Regulation -Regulation and Supervision of Savings Institutions - Capital Requirements," and Note 3 of the Notes to the Consolidated Financial Statements for additional information regarding regulatory capital requirements for the Bank for the year ended December 31, 2011.
The Orders will remain in effect until stayed, modified, terminated or suspended by the Federal Reserve and the OCC. If either the Company or the Bank failed to comply with the respective Orders, they could be subject to various remedies, including among others, the regulator's exercise of powers to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to direct an increase in capital, to restrict growth, to remove officers and/or directors and to assess civil monetary penalties. Management of the Bank and the Company have been taking action and implementing programs to comply with the requirements of the Order. Although compliance will be determined by the Federal Reserve and the OCC, management believes that the Bank and the Company will comply in all material respects with the Orders. The Federal Reserve and the OCC may determine at their sole discretion that the matters covered in the Orders have not been addressed satisfactorily, or that any current or past actions, violations, or deficiencies could be the subject of further regulatory enforcement actions. Such enforcement actions could involve penalties or limitations on our business and negatively affect our ability to implement our business plan, pay dividends on our common stock, or the value of our common stock as well as our financial condition and results of operations.
Our business may continue to be adversely affected by downturns in the national economy and the states where our out of market area loans are located.
Since the latter half of 2007, depressed economic conditions have prevailed in portions of the United States outside of our primary area of Southeast Alaska, including areas where the Bank has participation loans, specifically in the States of Washington, Oregon, Idaho, California, Minnesota and Colorado. We provide banking and financial services to customers located in our primary market of Southeast Alaska, which to date, up to this point in time and based upon its geographic location and diverse resource-based economy has not experienced the serious problems as those of markets in the lower-48 states. If there were to be a further decline of the economic conditions in our primary market, this could have an adverse effect on our business, financial condition, results of operations and prospects.
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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demand for our products and services may decline possibly resulting in a decrease in our total loans or assets;
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collateral for loans, especially real estate, may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans;
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the amount of our low-cost or non-interest-bearing deposits may decrease; and
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the price of our common stock may decrease.
Our emphasis on commercial real estate lending may expose us to increased lending risks.
Our current business strategy includes the expansion of small business lending in the region, with a focus on owner-occupied commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. A further downturn in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure.
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At December 31, 2011, we had $3.0 million of multifamily residential and $70.9 million of commercial real estate loans, representing 2.0% and 48.0%, respectively, of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily mortgage loans also expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate.
A secondary market for most types of commercial real estate loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial or multifamily real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial and multifamily real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve and the OCC have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we have a concentration in commercial real estate lending under the foregoing standards because our $70.9 million balance in commercial real estate loans at December 31, 2011 represented 345% or more of total capital. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
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.
At December 31, 2011, we had $19.2 million or 13.0% of total loans in commercial business loans. Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. Our commercial loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things.
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Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower.
Our business may be adversely affected by credit risk associated with residential property.
At December 31, 2011, $24.6 million, or 16.6% of our total loan portfolio, was secured by one-to-four single-family mortgage loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. Continued declines in the housing market and the economy and the associated increases 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 and liquidity, and damage our financial condition and business operations. These declines may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose loan portfolios are more diversified.
High loan-to-value ratios on a portion of our residential mortgage loan portfolio exposes us to greater risk of loss.
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, have originated a home equity loan with a combined loan-to-value ratio of up to 90% 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 allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business, and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
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the cash flow of the borrower and/or the project being financed;
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changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
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the duration of the loan;
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the credit history of a particular borrower; and
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changes in economic and industry conditions.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:
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our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events; and
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our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new
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information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Our allowance for loan losses was 1.26% of total loans held for investment and 66.9% of nonperforming loans at December 31, 2011. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and our capital.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as real estate owned (“REO”), and at certain other times during the assets holding period. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s net book value over its fair value less cost to sell. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our net book value in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations.
In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by such regulators, may have a material adverse effect on our financial condition and results of operations.
We may suffer losses in our loan portfolio despite our underwriting practices.
We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. 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.
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 (“FHLB”), 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 or the terms of which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general - such as 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 our primary market area of Southeast Alaska where our loans are concentrated or adverse regulatory action against us. In connection with Alaska Pacific Bank’s Order, we are required to submit a policy for the management and maintenance of liquidity. For additional information, see “Item 1, Business - Regulatory Matters.”
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
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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 additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected. In addition, the Bank may not incur additional debt without the prior written non-objection of the OCC. 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.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. Nonetheless, we may at some point need to raise additional capital to support continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition and liquidity, results of operations and prospects.
There are regulatory and contractual limitations that may limit or prevent us from paying dividends on our common stock and we may limit or eliminate our dividends to shareholders.
As an Alaska corporation, under Alaska law we are subject to restrictions on the payment of dividends. In addition, as a savings and loan holding company, the Company’s ability to declare and pay dividends is dependent on certain federal regulatory considerations. Alaska Pacific Bancshares is an entity separate and distinct from its principal subsidiary, Alaska Pacific Bank, and derives substantially all of its revenue in the form of dividends from this subsidiary. Accordingly, the Company is and will be dependent upon dividends from Alaska Pacific Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. Alaska Pacific Bank’s ability to pay dividends is subject to their ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to Alaska Pacific Bancshares, the Company may not be able to pay its obligations or pay dividends on its common stock. Under the Orders, the Company and the Bank may not pay dividends without the prior written approval of the Banking Regulators. See “Regulation - Regulation and Supervision of Savings Institutions - Limitations on Capital Distributions” and Note 3 of the Notes to Consolidated Financial Statements. Also, Alaska Pacific Bancshares’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.
Alaska Pacific Bancshares is also subject to certain regulatory restrictions that could prohibit it from declaring or paying dividends or making liquidation payments on its common stock. See “Regulation - Regulation and Supervision of the Company - Dividend Payments and Common Stock Repurchases” above. In addition, the securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock. The securities purchase agreement between us and Treasury provides that prior to the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) increase the cash dividend on our common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock other than the Series A Preferred Stock or trust preferred securities. In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock.
Our board of directors regularly reviews our dividend policy in light of current economic conditions for financial institutions as well as our capital needs and any applicable contractual restrictions. On a quarterly basis, the board of directors determines whether a dividend will be paid and in what amount, if any.
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New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a company's stockholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business -- Regulation.” These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.
Our investment in Federal Home Loan Bank of Seattle stock may become impaired.
At December 31, 2011, we owned $1.8 million of stock of the Federal Home Loan Bank of Seattle, or FHLB. 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 recoverability testing. The FHLB announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the "FHFA"), its primary regulator, as of December 31, 2008, 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 impairment on our investment in FHLB stock. However, further deterioration in the FHLB's financial position may result in impairment in the value of those securities. In addition, on October 25, 2010, the FHLB received a consent order from the FHFA. The potential impact of the consent order is unknown at this time. We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.
Continued weak or worsening credit availability could limit our ability to replace deposits and fund loan demand, which could adversely affect our earnings and capital levels.
Continued weak or worsening credit availability and the inability to obtain adequate funding to replace deposits and fund continued loan growth may negatively affect asset growth and, consequently, our earnings capability and capital levels. In addition to any deposit growth, maturity of investment securities and loan payments, we rely from time to time on advances from the FHLB to fund loans and replace deposits. If the economy does not improve or continues to deteriorate, this additional funding source could be negatively affected, which could limit the funds available to us. Our liquidity position could be significantly constrained if we are unable to access funds from the FHLB.
The maturity and repricing characteristics of our assets and liabilities are mismatched and subject us to interest rate risk which could adversely affect our net earnings and economic value.
Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Significant changes in market interest rates or errors or misjudgments in our interest rate risk management procedures could have a material adverse effect on our net earnings and economic value. We currently believe that rising interest rates will adversely affect our near-term net earnings.
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Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on our earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of our assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance.
We believe that the greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for our rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us.
Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income and net market value of equity resulting from those movements under different rate environments. We update and prepare our simulation modeling at least quarterly for review by senior management and our directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net market value of our equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used and, as a result, our interest rate risk management strategies may prove to be inadequate.
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Market Risk and Asset/Liability Management” for additional information concerning interest rate risk.
If external funds were not available, this could adversely impact our growth and prospects.
We rely on deposits and advances from the FHLB of Seattle and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we might not be able to replace such funds in the future if our financial condition or the financial condition of the FHLB of Seattle or market conditions were to change. While we consider such sources of funds adequate for our liquidity needs, we may be compelled or elect to seek additional sources of financing in the future. Likewise, we may seek additional debt in the future to achieve our long-term business objectives, in connection with future acquisitions or for other reasons. Additional borrowings, if sought, may not be available to us or, if available, may not be on reasonable terms. If additional financing sources are unavailable or not available on reasonable terms, our financial condition, results of operations and future prospects could be materially adversely affected.
The Dodd-Frank Wall Street Reform and Consumer Protection Act will, among other things, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new laws and regulations that are expected to increase our costs of operations.
The Dodd-Frank Act has had a significant impact on the bank regulatory structure for financial institutions, as well as the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. Much of the impact of the Dodd-Frank Act still remains to be seen in the coming months or years, as the effective dates of the many implementing regulations of the Dodd-Frank Act are gradually phased in.
Among the many requirements in the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 18 months after the date of enactment of the Dodd-Frank Act. These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations. Generally, trust preferred securities will no longer be eligible as Tier 1 capital and outstanding TARP preferred securities will continue to qualify as Tier 1 capital. In addition, the banking regulators are required to seek to make
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capital requirements for banks and bank holding companies, countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on us. For example, effective July 21, 2011 a federal prohibition on the payment of interest on demand deposits was elminated, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact our interest expense.
In addition, the Dodd-Frank Act created a new Consumer Financial Protection Bureau, or CFPB, with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Financial institutions with $10 billion or less in assets, such as the Bank, will continue to be examined for compliance with the consumer laws by their primary bank regulators.
As the Company and Bank continue to monitor developments under the Dodd-Frank Act and to assess the ultimate impact of the legislation and yet to be written implementing rules and regulations on community banks, at a minimum we expect to experience an increase in our operating and compliance costs, which is expected to continue and further impact our interest expense.
Increases in deposit insurance premiums and special FDIC assessments will negatively impact our earnings.
FDIC insurance premiums increased significantly in 2009 and we may pay higher FDIC premiums in the future.
The Dodd-Frank Act established 1.35% as the minimum reserve ratio. The FDIC has adopted a plan under which it will meet this ratio by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the minimum reserve ratio to 1.35% from the former minimum of 1.15%. The FDIC has not announced how it will implement this offset. In addition to the statutory minimum ratio, the FDIC must set a designated reserve ratio or DRR, which may exceed the statutory minimum. The FDIC has set 2.0 as the DRR.
As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution's total assets minus its tangible equity instead of its deposits. While our FDIC insurance premiums initially will be reduced by these regulations, it is possible that our future insurance premiums will increase under the final regulations.
Because of our participation in the TARP Capital Purchase Program, we are subject to several restrictions including restrictions on compensation paid to our executives.
Our ability to attract and retain key officers and employees may be impacted by legislation and regulation affecting the financial services industry. In 2009, the American Recovery and Reinvestment Act (ARRA) became law. The ARRA, through the implementing regulations of the U.S. Treasury, significantly expanded the executive compensation restrictions originally imposed on TARP participants, including us. Among other things, these restrictions limit our ability to pay bonuses and other incentive compensation and make severance payments. These restrictions will continue to apply to us for as long as the preferred stock we issued pursuant to the TARP Capital Purchase Program remains outstanding. These restrictions may negatively affect our ability to compete with financial institutions that are not subject to the same limitations.
The loss of key members of our senior management team could adversely affect our business.
We believe that our success depends largely on the efforts and abilities of our senior management. Their experience and industry contacts significantly benefit us. The competition for qualified personnel in the financial services industry is intense, and the loss of any of our key personnel or an inability to continue to attract, retain
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and motivate key personnel could adversely affect our business. In addition, the American Recovery and Reinvestment Act has imposed significant limitations on executive compensation for recipients, such as us, of funds under the TARP Capital Purchase Program, which may make it more difficult for us to retain and recruit key personnel.
Our real estate lending also exposes us to the risk of environmental liabilities.
In the course of our business, we may foreclose and take title to real estate, and we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We rely on dividends from Alaska Pacific Bank for most of our revenue.
Alaska Pacific Bancshares is a separate and distinct legal entity from Alaska Pacific Bank. We receive substantially all of our revenue from dividends from Alaska Pacific Bank. These dividends are the principal source of funds to pay dividends on our common stock. Various federal laws and regulations limit the amount of dividends that Alaska Pacific Bank may pay to Alaska Pacific Bancshares. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to the Company, we may not be able to pay obligations or pay dividends on Alaska Pacific’s common stock.
In addition, Alaska Pacific Bank is subject to restrictions on its ability to pay dividends to Alaska Pacific Bancshares under the terms of the Order with the Office of the Comptroller of the Currency. Alaska Pacific Bancshares also is subject to restrictions on its ability to pay dividends to stockholders under the terms of the Order with the Federal Reserve. Further, Alaska Pacific Bancshares also is subject to restrictions on its ability to pay dividends pursuant to the terms of the securities purchase agreement between it and the U.S. Treasury. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. See Item 1, “Business - Regulation - Limitations on Capital Distributions.”
Our concentration of operations in Alaska and specifically the Southeast areas of Alaska make us more exposed to downturns in the State of Alaska and those areas.
Substantially all of our business is derived from operations in Alaska and specifically the Southeast areas of Alaska. The majority of our lending has been with Alaska businesses and individuals. Substantially all of these loans are collateralized and repayment is expected from the borrowers’ cash flow or, secondarily, the collateral. Our exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is proved to be of no value. The State of Alaska and Southeast areas rely primarily upon the natural resources industries, particularly
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mining and oil production, as well as tourism, government and U.S. military spending for their economic success. Our business is and will remain sensitive to economic factors that relate to these industries and local and regional business conditions. As a result, local or regional economic downturns, or downturns that disproportionately affect one or more of the key industries in regions served by the Company, may have a more pronounced effect upon its business than they might on an institution that is less geographically concentrated. The extent of the future impact of these events on economic and business conditions cannot be predicted; however, prolonged or acute fluctuations could have a material and adverse impact upon our results of operation and financial condition.
Our assets as of December 31, 2011, include a deferred tax asset, the full value of which we may not be able to realize.
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The net deferred tax asset results primarily from our provisions for loan losses recorded for financial reporting purposes, which has been significantly larger than net loan charge-offs deducted for tax reporting proposes. We regularly review our deferred tax assets for recoverability based on our history of earnings, expectations for future earnings, expected timing of reversals of temporary differences, and tax planning strategies. As a result of that review, management determined that a valuation allowance of $94,000 was required at December 31, 2011. We believe the remaining net deferred tax asset at December 31, 2011 of $544,000, is more than likely to be realized based on our expected future earnings; however, it is possible that an additional valuation allowance may be required, which could have a further adverse effect on our future results of operations and financial condition.
Our estimated allowance for off-balance sheet liabilities may be inadequate.
In the normal course of business, the Bank incurs various off-balance sheet liabilities and contingent liabilities that are not presented in its financial statements. These off-balance sheet commitments and contingent liabilities include various guarantees and commitments to extend credit. In addition, the Bank originates, and subsequently sells, nearly all residential real estate loans into the secondary market. The Bank may be required to repurchase sold loans under certain circumstances. A separate reserve for probable off-balance sheet liabilities has not been established for potential losses and there can be no assurance that a reserve to cover off-balance sheet liability losses would be sufficient.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
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Item 2.
Item 2. Properties
The following table sets forth certain information regarding Alaska Pacific’s offices at December 31, 2011.
_____________
(1)
Lease expires in January 2019, with one 10-year option to renew.
(2)
Lease expires in February 2013, with option to renew for five-year term.
(3)
Lease extension expires in May 2012, with one 6-month option to renew.
(4)
Lease expires in December 2013, with option to renew for five-year term.
(5)
Lease expires in October 2013
Alaska Pacific maintains 11 automated teller machines including six in the Juneau area, two in the Sitka area, two in the Ketchikan area, and one in Hoonah. At December 31, 2011, the net book value of Alaska Pacific’s properties and its fixtures, furniture and equipment was $2.5 million.
Item 3.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Bank, mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. The Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Bank.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is traded on the over-the-counter market through the OTC “Electronic Bulletin Board” under the symbol “AKPB.” As of December 31, 2011, there were approximately 353 stockholders of record and 654,486 shares outstanding. The following table sets forth market price information of the Company’s stock for 2011 and 2010. In 2008 the Board of Directors determined to suspend the payment of dividends until the Company’s earnings improved. As a result, no dividend payments have been made during the years ended December 31, 2011 and 2010.
Dividends
Generally, if the Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the OCC regulations. However, an institution that has converted to the 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 which was established in connection with the institution’s mutual-to-stock conversion.
The Bank is restricted by the amount of dividends it may pay to the Company. It is generally limited to the net income of the current fiscal year and that of the two previous fiscal years, less dividends already paid during those periods. Based on this calculation, at December 31, 2011, none of the Bank’s retained earnings were available for the payment of dividends to the Company. However, payment of dividends may be further restricted by Banking Regulators if such payment would reduce the Bank’s capital ratios below required minimums or would otherwise be considered to adversely affect the safety and soundness of the institution.
In addition, the Bank is subject to restrictions on its ability to pay dividends to the Company under the terms of the Order with the OCC. The Company also is subject to restrictions on its ability to pay dividends to stockholders under the terms of the Order with the Federal Reserve. Further, the Company also is subject to restrictions on its ability to pay dividends pursuant to the terms of the securities purchase agreement between the Company and the U.S. Treasury.
For additional information regarding the Company’s and the Bank’s restrictions on the payment of dividends, see Item 1A, Risk Factors - Risk Factors -- We are subject to certain regulatory restrictions and lack of compliance could result in monetary penalties and/or additional regulatory actions.” and “ - There are regulatory and contractual limitations that may limit or prevent us from paying dividends on our common stock and we may limit or eliminate our dividends to shareholders.” And see “ -Because of our participation in the TARP Capital
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Purchase Program, we are subject to several restrictions including restrictions on compensation paid to our executives.”
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 11 of this Form 10-K is incorporated herein by reference.
Issuer Purchases of Equity Securities
During the year ended December 31, 2011, the Company had no purchases of its Common Stock.
Item 6.
Item 6. Selected Financial Data
Not Applicable
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is not engaged in any significant business activity other than holding the stock of the Bank. Accordingly, the information in this discussion applies primarily to the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes included in Item 8 of this annual report. In the following discussion, except as otherwise noted, references to “2011” or “2010” indicate the year ended December 31, 2011 or 2010, respectively.
The Bank’s results of operations depend primarily on its net interest income, which is the difference between the income earned on its interest-earning assets, consisting of loans and investments, and the cost of its interest-bearing liabilities, consisting of deposits and FHLB borrowings. Among other things, fee income, provisions for loan losses, operating expenses and income tax provisions also affect the Bank’s net income. General economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the attendant actions of the regulatory authorities also significantly affect the Bank’s results of operations.
Operating Strategy
The Company’s strategy is to operate a community-oriented financial institution devoted to serving the needs of its customers. The Company’s business consists primarily of attracting retail deposits from the general public and using those funds to originate residential real estate loans, land, construction, commercial real estate loans, commercial business loans, and a variety of consumer loans.
Financial Condition
Total assets were $172.1 million at December 31, 2011, compared with $174.4 million at December 31, 2010. The $2.3 million, or 1.3%, decrease was primarily the result of a decline in cash and cash equivalents.
Loans increased $5.9 million, or 4.1%, to $147.8 million at December 31, 2011 from $141.9 million at December 31, 2010. The increase is largely attributable to an increase in commercial real estate loans and land loans offset by a decrease in home equity loans.
Total commercial real estate loans increased 7.3% to $70.9 million, or 48.0% of the portfolio at December 31, 2011, from $66.1 million, or 46.6% of the portfolio at December 31, 2010. Land loans increased 29.2% to $8.4 million, or 5.7% of the portfolio at December 31, 2011, from $6.5 million, or 4.6% of the portfolio at December 31, 2010. Total commercial business loans decreased 1.0% to $19.2 million, or 13.0% of the portfolio at December 31, 2011, from $19.4 million, or 13.6% of the portfolio at December 31, 2010.
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Production of one-to-four-family mortgage loans declined in 2011. Originations totaled $20.3 million in 2011, a 33.4% decrease over the $30.5 million originated in 2010. Most of these loans were sold in the secondary market and, as a result, total one-to-four-family mortgages declined to 16.6% of the loan portfolio at December 31, 2011, compared with 17.8% of the loan portfolio at December 31, 2010.
Cash and cash equivalents decreased $9.9 million to $11.1 million at December 31, 2011, compared to $21.0 million at December 31, 2010.
Available-for-sale securities increased $3.5 million to $5.7 million at December 31, 2011, compared to $2.2 million at December 31, 2010. The increase was the result of investments purchased net of normal principal reductions on mortgage-backed securities.
Premises and equipment decreased $134,000 to $2.5 million at December 31, 2011, from $2.6 million at December 31, 2010.
Total deposits decreased $347,000 to $147.2 million at December 31, 2011 from $147.5 million at December 31, 2010. Money market accounts increased a total of $894,000 to $27.8 million at December 31, 2011 compared to $27.0 million a year ago. During the same period, however, interest bearing demand deposits decreased $1.1 million to $33.0 million and non-interest bearing demand deposits increased $2.7 million to $31.7 million. Certificates of deposit decreased $4.0 million to $33.6 million at December 31, 2011 from $37.6 million at December 31, 2010.
At December 31, 2011 and 2010, $377,000 and $1.9 million, respectively, of the certificates of deposit were brokered certificates of deposit obtained through the Certificate of Deposit Account Registry Service (“CDARS”). These deposits carry interest rates that are generally higher than locally obtained certificates of deposit, but which are generally lower than FHLB advances.
FHLB advances decreased $2.0 million to $3.0 million at December 31, 2011 from $5.0 million at December 31, 2010.
Results of Operations
Net Income. For the year ended December 31, 2011, the Company reported net income available to common shareholders of $631,000, or $0.87 per diluted share, after recording $373,000 provision for loan losses and no provision or benefit for income tax. This compares to a net income available to common shareholders of $539,000, or $0.76 per diluted share, after recording an $899,000 provision for loan losses and $255,000 benefit for income tax. The net income in 2011 is primarily attributable to a decrease in noninterest expense, and a decrease in the provision for loan losses. For purposes of comparison, net income available to common shareholders may be separated into major components as follows:
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Net Interest Income. Net interest income decreased $591,000, or 7.0%, to $7.9 million in 2011 from $8.5 million in 2010. The increase is due to a combination of factors, including a decrease in interest expense. See the tables in “--Average Balances, Interest and Average Yields/Cost” and in “--Rate/Volume Analysis” elsewhere in this discussion. The net interest margin on average earning assets was 5.08% for 2011 compared with 5.34% in 2010 reflecting a decrease in yield on interest earning assets offset with a decline in cost of funds. Nonaccrual loans were $2.8 million and $448,000 at December 31, 2011 and 2010, respectively. As of December 31, 2011 and 2010, approximately $75,000 and $13,000, respectively, of interest would have been recorded if these loans had been current according to their original terms and had been outstanding throughout the year.
Average loans (including nonperforming loans and loans held for sale) decreased $8.1 million, or 5.3%, to $145.6 million in 2011 from $153.7 million in 2010.
Noninterest Income. The gain on sale of loans decreased $238,000 to $286,000 in 2011 from $524,000 in 2010 as a result of a decline in gain on sale of loans and origination fees/costs associated with the decline in the production of one-to-four family mortgage loans.
Excluding gain on sale of loans, noninterest income decreased $148,000, or 11.7%, to $1.1 million in 2011 compared with $1.3 million in 2010. The decrease is primarily in mortgage servicing income due to the fair value adjustment to mortgage servicing rights of $(144,000). Additionally, other income of $46,000 was recognized in 2010 from the gain on sale of commercial loans.
Noninterest Expense. Noninterest expense decreased $804,000, or 9.1%, to $8.0 million in 2011 from $8.8 million in 2010. The net decrease in expense is attributable to lower real estate owned and repossessed asset expense, lower professional and consulting expense and lower FDIC premiums.
Income Tax. During the fourth quarter of 2011, the Company reduced its net deferred tax asset and the valuation allowance in the amount of $377,000 primarily due to the utilization of net operating losses for federal and state purposes. The remaining balance of the valuation allowance at December 31, 2011 of $94,000 is due to uncertainty about the Company’s ability to generate sufficient taxable income in the near term. The Company will not be able to recognize the tax benefits on future losses until it can show that it is more likely than not that the remaining $544,000 net deferred tax asset will be realized based on projected future earnings.
Provision and Allowance for Loan Losses
Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered by management to be adequate to provide for known and inherent risks in the loan portfolio, including management's continuing analysis of factors underlying the quality of the loan portfolio.
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The provision for loan losses decreased $526,000 to $373,000 for 2011 from $899,000 for 2010. The provision for both years was considered appropriate in order for the allowance for loan losses to reflect management's best estimate of losses inherent in the loan portfolio. The allowance for loan losses increased $282,000, or 17.8%, to $1.9 million at December 31, 2011 from $1.6 million at December 31, 2010. The provision and the resulting allowance are reflective of numerous factors, including the following:
·
Loan losses. Net loan charge offs were $91,000 (0.06% of total loans) in 2011 compared with $1.1 million (0.8% of total loans) in 2010.
·
Growth and composition of the portfolio. Total loans increased $5.9 million to $147.8 million at December 31, 2011 compared with $141.9 million at December 31, 2010. The increase reflects gradual changes in the loan portfolio composition away from single-family mortgages and home equity loans, moving to a greater proportion of commercial real estate. Management considered the higher relative risk of these loans in assessing the adequacy of the allowance.
·
Management analysis of loans. As part of an assessment of the adequacy of the allowance, management performed a detailed review of individual loans for which full collectability may not be assured. Loans judged to be impaired amounted to $12.0 million (8.1% of total loans) at December 31, 2011, compared with $9.6 million (6.8% of total loans) at December 31, 2010. An allowance for loan loss at December 31, 2011 and 2010 for estimated impairments of $473,000 and $310,000, respectively, was established for these loans.
·
Past-due Loans. At December 31, 2011, $329,000, or 0.2% of all loan balances were past due 30 days or more, compared with $623,000, or $0.4% at December 31, 2010.
·
Nonperforming and classified loans. Nonaccrual loans were $2.6 million (1.8% of total loans) at December 31, 2011, compared with $448,000 (0.3% of total loans) at December 31, 2010. Loans classified as “substandard” or “doubtful” were $6.7 million (4.6% of total loans) at December 31, 2011 compared with $7.1 million (5.0% of total loans) at December 31, 2010.
·
Economic conditions. Management considered known economic conditions in each of the geographic areas in which the Bank makes loans. For the last several years, Southeast Alaska’s economy has been relatively “flat” but stable, and management knows of no current economic conditions that warrant expectations of significant decline in the Bank’s markets. However, uncertainties in both the national and local economies have been considered in assessing the allowance.
The Company’s evaluation of the adequacy of the allowance for loan losses is one of its most critical management processes and is also the most subjective. While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions and other events might result in adjustment to the allowance if circumstances differ substantially from the assumptions used in making the final determination. One or more of these events could have a significant effect on net income, and the effect could be both material and adverse.
For further information on the Bank’s accounting for the allowance for loan losses as well as how loan impairment is determined, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
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Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the yield on interest-earning assets, which consist primarily of loans and investments, and the cost of interest-bearing liabilities, which consist primarily of deposit accounts and borrowings, as well as the relative size of the Company’s interest-earning assets and interest-bearing liabilities.
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 ratio of average interest-earning assets to average interest-bearing liabilities. Average balances are generally daily averages for the period.
(1)
Average loans include nonperforming loans and loans held for sale. Interest income does not include interest on nonaccrual loans. Average
investment securities includes FHLB stock.
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Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on net interest income of the Company. Information is provided with respect to effects on interest income attributable to changes in volume, which are changes in volume multiplied by prior rate; effects on interest income attributable to changes in rate, which are changes in rate multiplied by prior volume; and changes in rate/volume, which is a change in rate multiplied by change in volume.
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Yields Earned and Rates Paid
The following table sets forth, at the date and for the periods indicated, the weighted average yields earned on the Company’s assets and the weighted average interest rates paid on the Company’s liabilities, together with the net yield on interest-earning assets.
Liquidity and Capital Resources
The Bank’s primary sources of funds are deposits, proceeds from principal and interest payments on loans and mortgage-backed securities, and FHLB advances. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The primary investing activity of the Bank has been the origination of loans, including one-to-four-family mortgages, commercial real estate loans, commercial business loans, and consumer loans, deposits, FHLB borrowings, and principal repayments on loans and mortgage-backed securities were the primary means for funding these activities.
The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. The Bank’s sources of funds include deposits, principal and interest payments from loans and investments, and FHLB advances. During 2011 and 2010, the Bank used its sources of funds primarily to fund new loans and to pay maturing certificates and other deposit withdrawals. At December 31, 2011, the Bank had loan commitments including unused portions of lines of credit and undisbursed construction loans, of $14.8 million.
At December 31, 2011, the Bank had $168,000 of net unrealized gains on investment securities classified as available for sale, which represented 3.05% of the amortized cost ($5.5 million) of the securities. This represented an increase of $78,000 compared with $90,000 of net unrealized gains at December 31, 2010,
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primarily as a result of changes in market demand. Movements in market interest rates will continue to affect the unrealized gains and losses in these securities. However, assuming that the securities are held to their individual dates of maturity, even in periods of increasing market interest rates, as the securities approach their dates of maturity, any unrealized gains or losses will begin to decrease and will eventually be eliminated.
At December 31, 2011, certificates of deposit amounted to $33.6 million, or 22.8% of the Bank’s total deposits, including $24.7 million scheduled to mature by December 31, 2012. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. Management believes it has adequate resources to fund all loan commitments with deposits and, as needed, FHLB advances and sale of mortgage loans and that it can adjust the offering rates of certificates of deposits to retain deposits in changing interest rate environments. In addition, the Bank has available a line of credit with the FHLB generally equal to the lower of 25% of the Bank’s total assets, or pledged collateral of approximately $40.0 million at December 31, 2011, of which $37.0 million was unused. At December 31, 2011, there was $3.0 million outstanding on the line.
Given these sources of liquidity and our expectations for cash needs, we believe our sources of liquidity to be sufficient in the foreseeable future. However, continued deterioration in the FHLB of Seattle’s financial position may result in impairment in the value of our FHLB stock, the requirement that the Company contribute additional funds to recapitalize the FHLB of Seattle, or a reduction in the Company’s ability to borrow funds from the FHLB of Seattle, impairing the Company’s ability to meet liquidity demands.
The Bank is required to maintain specific amounts of capital pursuant to regulator requirements and the provisions set out in the Orders. As of December 31, 2011, the Bank was in compliance with all regulatory capital requirements that were imposed as of this date, including those effective by the Order, with tangible, core, and risk-based capital ratios of 11.81%, 11.81% and 16.71%, respectively. For further information, see Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Recent Accounting Pronouncements
See “Item 8. Financial Statements and Supplementary Data -- Notes to Consolidated Financial Statements -- Note 1 Recent Accounting Pronouncements.”
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Qualitative Analysis - Risks When Interest Rates Change. The Bank’s profitability depends primarily on its net interest income, which is the difference between the income it receives on its loan and investment portfolios and its cost of funds, which consists of interest paid on deposits and borrowings. The relative amounts of interest-earning assets and interest-bearing liabilities also affect net interest income. When interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The Bank’s profitability is also affected by the level of noninterest income and expenses. Noninterest income includes service charges and fees and gain on sale of loans and investments. Noninterest expenses primarily include compensation and benefits, occupancy and equipment expenses, deposit insurance premiums and data processing expenses. General economic and competitive conditions, particularly changes in market interest rates, government legislation and regulation, and monetary and fiscal policies also significantly affect the Bank’s results of operations.
Quantitative Analysis - How the Bank Measures Its Risk of Interest Rate Changes. The Bank does not maintain a trading account for any class of financial instrument nor does it engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Bank has no significant foreign currency exchange rate risk or commodity price risk.
The Bank has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. Principal elements in achieving this objective include increasing the interest-rate sensitivity of the Bank’s interest-earning assets by originating for its portfolio loans with interest rates that periodically adjust to market conditions, as well as continuing decisions to sell fixed-rate mortgage production versus keeping them in the portfolio. The Bank relies on retail deposits as its primary source of funds. Historically, retail deposits, compared to brokered deposits and
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borrowed funds, tend to reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds.
In order to encourage institutions to reduce interest rate risk, the federal banking regulators adopted a rule incorporating an interest rate risk component into its risk-based capital rules. Using data compiled by the OTS, the Bank receives a report that measures interest rate risk by modeling the change in net portfolio value over a variety of interest rate scenarios. The OTS will cease to compile and provide a report that measures interest rate risk after the December 31, 2011 reporting period. After that period, the Bank will compile and measure interest rate risk utilizing an Asset and Liability Management software program. The OTS net portfolio value is the present value of expected cash flows from assets, liabilities and off-balance-sheet contracts. The calculation is intended to illustrate the change in net portfolio value that will occur upon an immediate change in interest rates of at least 200 basis points with no effect given to any steps that management might take to counter the effect of that interest rate movement. Under OCC regulations, an institution with a greater than “normal” level of interest rate risk takes a deduction from total capital for purposes of calculating its risk-based capital. An institution with a “normal” level of interest rate risk is defined as one whose “measured interest rate risk” is less than 2.0%. Institutions with assets of less than $300 million and a risk-based capital ratio of more than 12.0% are exempt. The Bank is exempt because of its asset size and risk-based capital ratio. Based on the Bank’s regulatory capital levels at December 31, 2011, the Bank believes that, if the proposed regulation had been implemented at that date, the Bank’s level of interest rate risk would not have caused it to be treated as an institution with greater than “normal” interest rate risk.
The following table illustrates the change in net portfolio value at December 31, 2011, based on OTS assumptions that would occur in the event of an immediate change in interest rates, with no effect given to any steps which management might take to counter the effect of that interest rate movement.
(1)
Represents the increase (decrease) of the estimated net portfolio value at the indicated change in interest rates compared to the net portfolio value assuming no change in interest rates.
(2)
Calculated as the estimated net portfolio value divided by the portfolio value of total assets.
(3)
Calculated as the increase (decrease) of the net portfolio value ratio assuming the indicated change in interest rates over the estimated net portfolio value ratio assuming no change in interest rates.
The above table illustrates, for example, that at December 31, 2011 an instantaneous 200 basis point increase in market interest rates would increase the Bank’s net portfolio value by $1.1 million, or 4%, and an instantaneous 100 basis point decrease in market interest rates would decrease the Bank’s net portfolio value by $504,000.
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The following table summarizes key exposure measures for the dates indicated. They measure the change in net portfolio value ratio for an adverse change in interest rates of 200 basis points (“bp”) upward.
These measures indicate a relatively low level of interest-rate risk at the present time. Among other factors, this is attributable to management’s decisions in recent years to effect a relative decrease in fixed-rate mortgages and a gradual shift to earning assets that tend to reprice with greater frequency.
The OTS used certain assumptions in assessing the interest rate risk of thrift institutions. 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. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in 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, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in calculating the table.
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Item 8.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2011 and 2010
Consolidated Statements of Income For the Years Ended
December 31, 2011 and 2010
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income For the
Years Ended December 31, 2011 and 2010
Consolidated Statements of Cash Flows For the Years Ended
December 31, 2011 and 2010
Notes to Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Alaska Pacific Bancshares, Inc. and Subsidiary
Juneau, Alaska
We have audited the accompanying consolidated balance sheets of Alaska Pacific Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for the years then ended. 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 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 audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alaska Pacific Bancshares, Inc. and Subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/Moss Adams, LLP
Everett, Washington
March 21, 2012
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Alaska Pacific Bancshares, Inc. and Subsidiary
Consolidated Balance Sheets
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Alaska Pacific Bancshares, Inc. and Subsidiary
Consolidated Statements of Income
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Alaska Pacific Bancshares, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income
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Alaska Pacific Bancshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
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Alaska Pacific Bancshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies
General: The accompanying consolidated financial statements include the accounts of Alaska Pacific Bancshares, Inc. (the “Company”) and its wholly owned subsidiary, Alaska Pacific Bank (the “Bank”). The Company and the Bank are collectively referred to as the “Company.” All significant intercompany transactions have been eliminated in consolidation.
The Company was formed in 1999 when the Bank converted from a federally chartered mutual savings bank to a federally chartered stock savings bank, issuing 655,415 shares in a subscription and community offering. Concurrent with the conversion, the Bank changed its name from Alaska Federal Savings Bank to Alaska Pacific Bank.
The Bank provides a range of financial services to individuals and small businesses in Southeast Alaska. The Bank’s financial services include accepting deposits from the general public and making residential and commercial real estate loans, consumer loans, and commercial loans. The Bank also originates, sells, and services residential mortgage loans under several federal and state mortgage-lending programs.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, mortgage servicing rights, fair value of financial instruments, and deferred tax assets. Actual results could differ from these estimates.
SUBSEQUENT EVENTS: The Company has evaluated events and transactions for potential recognition and disclosure through the day the financial statements were issued.
RECLASSIFICATIONS: Certain amounts in prior-period financial statements have been reclassified to conform to the current-period presentation. These reclassifications had no effect on net income or shareholders equity.
Cash and Cash Equivalents: Cash equivalents are any highly liquid investment with a remaining maturity of three months or less at the date of purchase. The Company has cash and cash equivalents on deposit with other banks and financial institutions in amounts that periodically exceed the federal insurance limit. The Company evaluates the credit quality of these banks and financial institutions to mitigate its credit risk.
Statement of Cash Flows: The statement of cash flows has been prepared using the “indirect” method for presenting cash flows from operating activities. For purposes of this statement, cash and cash equivalents include cash and due from banks and interest-bearing deposits with banks.
Investment Securities: Securities are classified based on management’s intention on the date of purchase. All securities are classified as available for sale and are presented at fair value. Unrealized gains or losses on securities available for sale are excluded from net income but are included as separate components of other comprehensive income, net of taxes. Purchase premiums or discounts on securities available for sale are amortized or accreted into income using the interest method over the terms of the individual securities. The Company performs a quarterly assessment to determine whether a decline in fair value below amortized cost is other-than-temporary. Amortized cost includes adjustments made to the cost of an investment for accretion, amortization, collection of cash and previous other-than temporary impairment recognized in earnings. Other-than-temporary impairment exists when it is probable that the
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Company will be unable to recover the entire amortized cost basis of the security. If the decline in fair value is judged to be other than temporary, the security is written down to fair value which becomes the new cost basis and an impairment loss is recognized.
In performing the quarterly assessment for debt securities, management considers whether or not the Company expects to recover the entire amortized cost basis of the security. In addition, management must determine its position with respect to its intent to sell the security and whether it is more likely than not that it will not have to sell the security before recovery of its cost basis. The total amount recognized in earnings when there are credit losses associated with an impaired debt security and management asserts that it does not have the intent to sell the security and it is more likely than not that it will not have to sell the security before recovery of its cost basis is separated into (a) the amount representing a credit loss and (b) the amount related to non-credit factors. The amount of impairment related to credit losses is recognized in earnings. The credit loss component of other-than-temporary impairment, representing an increase in credit risk, is determined by the Company using its best estimate of the present value of cash flows expected to be collected from the debt security. The amount of impairment related to non-credit factors is recognized in other comprehensive income. The previous cost basis less impairment recognized in earnings becomes the new cost basis of the security and is not adjusted for subsequent recoveries in fair value. However, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted as interest income. The total other-than-temporary impairment is presented in the consolidated statements of income with a reduction for the amount of other-than-temporary impairment that is recognized in other comprehensive income, if any.
Realized gains or losses on sales of securities available for sale are recorded using the specific identification method. No securities were designated as trading or held to maturity at December 31, 2011 or 2010.
Loans: Loans are reported at the principal amount outstanding, adjusted for net deferred loan fees and costs and other unamortized premiums or discounts.
Interest is accrued as earned unless management doubts the collectibility of the loan or the unpaid interest. Interest accrual is generally discontinued and loans are transferred to nonaccrual status when they become 90 days past due or earlier if the loan is impaired and collection is considered doubtful. All previously accrued but uncollected interest is deducted from interest income upon transfer to nonaccrual status. Income from nonaccrual loans is recorded only when interest payments are received.
Loans or portions of loans are charged off against the allowance for loan losses when considered uncollectible. Prior to charging a loan off, a loss allowance may be recognized on impaired loans for an estimated probable loss.
Loan origination fees and direct loan origination costs are deferred and recognized as an adjustment to interest income over the contractual life of the loan using the level yield method. When loans are sold, the related net unamortized loan fees and costs are included in the determination of the gain on sale of loans.
Loans Held for Sale: Loans held for sale consist primarily of residential mortgage loans and are individually valued at the lower of cost or fair value less estimated selling costs. Loans are recorded as sold when the loan documents are sent to the investor. Gains or losses on sale of loans are recognized at settlement date based on the difference between the selling price and the carrying value of the related loans sold. Loan sales are made with and without recourse.
Allowance For Loan Losses: The Company accounts for the credit risk associated with lending activities through its allowance for loan and lease losses and provision for loan and lease losses. The provision is the expense recognized in the consolidated statements of income to adjust the allowance to the levels deemed appropriate by management, as determined through application of the Company’s allowance methodology procedures. The provision for loan and lease losses reflects management’s judgment of the adequacy of the allowance for loan and lease losses. Loan and lease losses are charged against the allowance when management believes the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance.
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The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses is maintained at a level believed to be sufficient to absorb losses probable and inherent in the loan portfolio.
The allowance consists of general, specific and unallocated components. The general component covers loans not specifically measured for impairment and is based on historical loss experience adjusted for qualitative factors. The specific component relates to loans that are impaired. For impaired loans an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The unallocated allowance provides for other credit losses inherent in the Company’s loan portfolio that may not have been contemplated in the general and specific components of the allowance. This unallocated amount generally comprises less than 10% of the allowance. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.
Loans are deemed to be impaired when management determines that it is probable that all amounts due under the contractual terms of the loan agreements will not be collectible in accordance with the original loan agreement. All problem-graded loans are evaluated for impairment. Impairment is measured by comparing the fair value of the collateral or present value of future cash flows to the recorded investment in the loan. Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.
Mortgage Servicing Rights: Effective January 1, 2010, the Company adopted ASC 860-50, Servicing Assets and Liabilities, which provides the option of making an irrevocable decision to subsequently measure a class of servicing assets at fair value at the beginning of any fiscal year, which was elected by the Company. The Company uses a model derived valuation methodology to estimate the fair value of mortgage servicing rights, (“MSR”), obtained from an independent broker on an annual basis. The model pools loans into buckets of homogeneous characteristics and performs a present value analysis of the future cash flows. The buckets are created by individual loan characteristics such as note rate, product type, and the remittance schedule. Current market rates are utilized for discounting the future cash flows. Significant assumptions used in the valuation of MSR include discount rates, projected prepayment speeds, escrow calculations, ancillary income, delinquencies and option adjusted spreads.
Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed on the straight-line method over the estimated useful lives of the assets: 20 to 50 years for buildings, five to ten years for leasehold improvements depending on lease term, and three to 10 years for furniture and equipment. Expenditures for improvements and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred.
Long-lived assets are assessed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, estimated future cash flows expected to result from the use of the asset and its eventual disposition are compared with the carrying value, and a direct writedown is recorded for the amount of impairment, if any.
Other Real estate owned and Repossessed Assets: Real estate or other collateral acquired in satisfaction of a loan is initially recorded in repossessed assets at the lower of cost or estimated fair value less estimated selling costs, with any difference from the loan balance charged to the allowance for loan losses. Subsequent changes in estimated fair value result in writing down the properties, directly or through valuation accounts. Such writedowns and gains and losses on disposal, as well as operating income and costs incurred during the period of ownership, are recognized currently in noninterest expense.
Federal Home Loan Bank Stock: The Bank’s investment in Federal Home Loan Bank of Seattle (“FHLB”) stock is
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carried at cost because there is no active market for the stock. As a member of the FHLB System, the Bank is required to maintain a minimum level of investment in FHLB stock based on specified percentages of its outstanding mortgages, total assets or FHLB advances. The Bank’s minimum investment requirement was approximately $216,000 and $273,100 at December 31, 2011 and 2010, respectively. The Bank may request redemption at par value on any stock in excess of the amount the Bank is required to hold. Stock redemptions are granted at the discretion of the FHLB. This security is reported at par value, which represents the Company’s cost. Management reviews for impairment based on the ultimate recoverability of the cost basis in the FHLB stock.
Management periodically evaluates FHLB stock for other-than-temporary or permanent impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB. As of December 31, 2011, management has concluded that the Bank’s investment in FHLB stock is not impaired.
Advertising Expense: Advertising costs are expensed as incurred. Advertising expense was $165,000 and $183,000 for the years ended December 31, 2011 and 2010, respectively.
Income Taxes: The Company accounts for income tax using the asset and liability method. The asset and liability method recognizes the amount of tax payable at the date of the financial statements as a result of all events that have been recognized in the financial statements, as measured by the provisions of current enacted tax laws and rates. Net deferred tax assets are evaluated and reduced through a valuation allowance to the extent that it is more likely than not that such assets will not be fully recovered in the future.
Treasury Stock: Treasury stock is accounted for on the basis of average cost, or $12.375 per share at December 31, 2011 and 2010.
Employee Stock Ownership Plan: Compensation expense under the Company’s Employee Stock Ownership Plan (“ESOP”) is based upon the number of shares allocated to employees each year multiplied by the average share price for the year. Expense is reduced by the amount of dividends paid on unallocated shares. No shares held by the ESOP were unallocated at December 31, 2011 and 2010. In computing earnings per share, shares outstanding are reduced by shares held by the ESOP that have not yet been allocated to employees.
EARNINGS PER SHARE: The Company calculates earnings per common share (“EPS”) using the two-class method in accordance with the Earnings per Share topic of the FASB ASC. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. Under authoritative guidance, all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities. The Company grants restricted shares under a share-based compensation plan that qualifies as participating securities. Restricted shares issued under the Company’s share-based compensation plan are entitled to dividends at the same rate as common stock.
Basic EPS are computed by dividing distributed and undistributed earnings available to common shareholders by the weighted average number of common shares outstanding for the period. Distributed and undistributed earnings available to common shareholders represent net income reduced by preferred stock dividends and distributed and undistributed earnings available to participating securities. Common shares outstanding include common stock and vested restricted stock awards. Diluted EPS reflect the assumed conversion of all potential dilutive securities.
Stock Option Plan: The Company accounts for its stock option plans in accordance with the provisions of ASC 718, Stock Compensation, which establishes accounting and disclosure requirements using a fair-value-based method of
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accounting for stock-based employee compensation plans and requires that the compensation cost relating to share-based payment transactions such as stock options be recognized in the Company’s financial statements over the period the options are earned by employees. Recognized stock compensation expense was not reduced by estimated forfeitures because management believes the future effect to be minimal. Estimated forfeitures will be continually evaluated in subsequent periods and may change based on new facts and circumstances.
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 these estimates.
Segment Reporting: The Company has identified a single segment at the entity-wide level used by senior management to make operating decisions.
Other Comprehensive Income: The Company’s only item of “other comprehensive income” is net unrealized gains or losses on investment securities available for sale. Comprehensive income is calculated in the following table:
Transfers of Financial Assets. Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, (ii) 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 (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Recent Accounting Pronouncements: Significant recent accounting pronouncements are described below.
During the year ended December 31, 2011, the following Accounting Standards Updates (“ASU”) were issued or became effective:
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210). ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013 and should be applied retrospectively for all comparative periods presented. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.
In September 2011, the FASB issued 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. This ASU did not have any impact on the Company's financial condition or results of operations.
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
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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. In December 2011, the FASB issued ASU 2011-11, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-11 deferred the effective date for certain amendments related to the presentation of reclassification of items out of accumulated other comprehensive income. The Company adopted the remaining applicable amendments in ASU 2011-05 during the current period and the adoption of this ASU had no impact on the Company's financial condition or results of operations.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRS”) (Topic 820). ASU 2011-04 developed common requirements between GAAP and IFRS for measuring fair value and for disclosing information about fair value measurements. The effective date of ASU 2011-04 will be during 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, the Financial Accounting Standards Board issued ASU 2011-02, A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring (Topic 310). ASU 2011-02 clarifies the criteria for a restructuring to be classified as a Troubled Debt Restructuring ("TDR"). The Company adopted this ASU during the current period as well as the related disclosure requirements which were included in ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310). Adoption of this ASU had no impact on the Company's financial condition or results of operations. See Note 5 for expanded disclosure requirements related to TDR’s.
In April 2011, the FASB issued Accounting Standards Update ("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.
Note 2 - Cash and Cash Equivalents
The Company is required to maintain prescribed reserves with the Federal Reserve Bank of San Francisco in the form of cash. Cash reserve requirements are computed by applying prescribed percentages to various types of deposits. The Company is required to maintain a $25,000 minimum average daily balance with the Federal Reserve Bank for purposes of settling financial transactions and charges for Federal Reserve Bank services. The Company is also required to maintain cash balances or deposits with the Federal Reserve Bank sufficient to meet its statutory reserve requirements. The average reserve requirement for years ended, December 31, 2011 and 2010 was $291,000 and $539,000, respectively.
Note 3 - Regulatory Capital Requirements and Restrictions
The Bank is restricted on the amount of dividends it may pay to the Company. It is generally limited to the net income of the current fiscal year and that of the two previous fiscal years, less dividends already paid during those periods. Based on this calculation, at December 31, 2011, none of the Bank’s retained earnings were available for dividends to the Company. However, payment of dividends may be further restricted by the Bank’s regulatory agency if such payment would reduce the Bank’s capital ratios below required minimums or would otherwise be considered to adversely affect the safety and soundness of the institution.
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The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (“PCA”), the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The Company and the Bank each signed agreements with their former regulator, the Office of Thrift Supervision (“OTS”), to consent to the issuance of an Order to Cease and Desist (individually an “Order” and collectively the “Orders”) effective September 30, 2010. The Orders are formal actions by the OTS requiring the Company and the Bank to continue to take corrective measures in a number of areas to strengthen their financial condition and operations. As a result of the elimination of the OTS on July 21, 2011, compliance with the Orders is now determined by the Company’s new primary regulator, the Board of Governors of the Federal Reserve System (“Federal Reserve”), and the Bank’s new primary regulator, the Office of the Comptroller of the Currency (“OCC”).
Pursuant to the Order the Bank, among other requirements, is required to maintain its Tier 1 (Core) Capital Ratio equal to or greater than 8% after providing for an adequate allowance for loan and lease losses and Total Risk-Based Capital Ratio equal to or greater than 12%.
At December 31, 2011, the Bank exceeded each of the Capital Ratio requirements of the Order. Under OCC regulations, however, an institution that enters into a written order (such as the Order) is automatically considered to be not “well capitalized.” Therefore the Bank is deemed “adequately capitalized” for OCC purposes at December 31, 2011.
The following table summarizes the Bank's regulatory capital position and minimum requirements of the Order at December 31, 2011:
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During the second quarter of 2010, pursuant to restrictions imposed on the Company and the Bank by the OTS, the Company suspended its dividend payments on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) issued under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program and its common stock and continued to defer these payments through December 31, 2010. At December 31, 2010 accumulated deferred dividend payments on the Series A Preferred Stock were $150,000. During the first quarter of 2011, the restrictions were lifted by the OTS and the Company has paid all dividends payable and deferred dividends payable through December 31, 2011 on its Series A Preferred Stock. There can be no assurances that our regulators will approve such payments or dividends in the future.
At December 31, 2011, the Bank exceeded each of the three current minimum quantitative regulatory capital requirements under the “prompt corrective action” regulatory framework. The following table summarizes the Bank's regulatory capital position and minimum requirements under the “prompt corrective action” regulatory framework at December 31, 2011 and December 31, 2010:
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Note 4 - Investment Securities Available for Sale
Amortized cost and fair values of investment securities available for sale, including mortgage-backed securities, are summarized as follows:
Available for sale securities at December 31, 2011 that have been in a continuous unrealized loss position are as follows:
Available for sale securities at December 31, 2010 that have been in a continuous unrealized loss position are as follows:
One and five securities with unrealized losses at December 31, 2011 and 2010, respectively, were mortgage-backed or other securities issued by the U.S. government and agencies; collectability of principal and interest is considered to be reasonably assured. The fair values of individual securities fluctuate significantly with interest rates and with market demand for securities with specific structures and characteristics. Management does not consider these unrealized losses to be other than temporary.
The fair value and amortized cost of investment securities at December 31, 2011 is presented below by contractual maturity. Actual maturities may vary due to prepayment of the underlying loans.
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The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at December 31, 2011 was $5.5 million and $5.7 million, respectively. The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at December 31, 2010 were $2.1 million and $2.2 million, respectively.
There were no sales of securities during 2011 or 2010.
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Note 5 - Loans
Loans are summarized as follows:
Loans are net of deferred loan fees and other discounts amounting to $513,000 and $495,000 at December 31, 2011 and 2010, respectively.
Loans include overdrawn balances of deposit accounts of $50,000 and $24,000 at December 31, 2011 and 2010, respectively.
Interest income from tax-exempt loans was $22,000 and $27,000 in 2011 and 2010, respectively.
Real estate loans are secured primarily by properties located in Southeast Alaska. Commercial real estate loans are generally secured by warehouse, retail, and other improved commercial properties. Commercial business loans are generally secured by equipment, inventory, accounts receivable, or other business assets.
Impaired Loans. Loans are deemed to be impaired when management determines that it is probable that all amounts due under the contractual terms of the loan agreements will not be collectible in accordance with the original loan agreement. All problem-graded loans are evaluated for impairment. Impairment is measured by comparing the fair value of the collateral or present value of future cash flows to the recorded investment in the loan. Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.
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Impaired loans are set forth in the following table as of December 31, 2011.
Impaired loans are set forth in the following table as of December 31, 2010.
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The following table presents interest income and average recorded investment of impaired loans for the periods ended:
Troubled Debt Restructurings. As a result of adopting the amendments in Accounting Standards Update (“ASU”) No. 2011-02, the Company reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as troubled debt restructurings. The troubled debt restructurings of certain receivables identified are deemed impaired. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement for those receivables newly identified as impaired. As of December 31, 2011 and 2010, the recorded investment in receivables that have been modified in a troubled debt restructuring and that are impaired was $9.6 million, and $7.1 million, respectively. Included in these amounts, the Company had $9.6 million and $4.6 million of troubled debt restructurings as of December 31, 2011 and December 31, 2010, respectively, which were performing in accordance with their modified loan terms. The Company has not committed any additional amounts to lend to borrowers with loans considered to be troubled debt restructurings.
Modification Categories: The Bank considers a variety of modifications to borrowers. The types of modifications considered can generally be described in the following categories:
·
Rate Modification: A modification in which the interest rate is changed.
·
Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.
·
Interest Only Modification: A modification in which the loan is converted to interest only payments for a period of time.
·
Payment Modification: A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.
·
Combination Modification: Any other type of modification, including the use of multiple categories above.
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The following table presents the accrual status of troubled debt restructurings as of December 31, 2011:
The following table presents newly restructured loans that occurred during the twelve months ended December 31, 2011:
For the periods presented in the table above, the outstanding recorded investment was the same pre and post modification.
There was one commercial business loan for $1.4 million modified as a troubled debt restructuring within the previous 12 months for which there was a payment default during the year ended December 31, 2011.
The Bank’s policy is that loans placed in nonaccrual may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected. In general, the Bank’s policy refers to six months of payment performance as sufficient to warrant a return to accrual status. There were no loans modified in a troubled debt restructuring that were modified in 2011 and that subsequently defaulted.
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An age analysis of past due loans, segregated by class of loans, as of December 31, 2011 were as follows:
An age analysis of past due loans, segregated by class of loans, as of December 31, 2010 were as follows:
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Year end non-accrual loans, segregated by class of loans, were as follows:
As of December 31, 2011 and 2010, approximately $75,000 and $13,000, respectively, of interest would have been recorded if these non-accrual loans had been current according to their original terms and had been outstanding throughout the year. There were no loans 90 days past due and still accruing interest at December 31, 2011 and 2010.
Credit Quality / Risk Rating System: The Bank utilizes a risk rating system to segment the risk profile of its loan portfolio. As part of this on-going monitoring system of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends in past due and nonaccrual loans, gross and net charge-offs, and movement in loan balances within the risk classifications. The Bank’s risk rating system is comprised of nine ranges (1-9) based upon industry best practice and regulator definitions. A brief summary of the general characteristics of the nine risk classes is as follows:
·
Ratings 1-2: Include loans with the highest credit quality based upon financial performance, high net worth borrowers, an industry category with very positive trends, collateral of readily marketable government securities, time certificates or cash value of life insurance, and other strong financial performance ratios.
·
Ratings 3-4: Include loans with satisfactory financial performance, adequate liquidity and compare favorably to industry performance measurements. Loans in these categories are typically secured by real estate, inventory, accounts receivable or other collateral that may not be as easily converted to cash. Loans graded in the lower of the two categories (4) might be loans where the company’s business is tied to a cyclical or seasonal industry such as tourism and fishing.
·
Rating 5: This is a “Pass/Watch” category requiring additional management attention. These are performing loans where there is still no perception of unwarranted or undue credit risk, but because of external events in the marketplace, management change, a shift in financial performance or other conditions, which if not addressed could cause further problems. This is typically a temporary classification.
·
Rating 6: These are “Special Mention” loans which are currently performing as agreed but have developed a financial weakness, which if not corrected, pose unwarranted risk to the bank. This classification is used when the degree of risk initially evaluated has increased beyond conditions that would have prevented the loan from being made in the beginning. Prompt corrective action is needed.
·
Rating 7: These are “Substandard” loans which are no longer protected by adequate cash flow, net work, or collateral. There is a well-defined weakness that jeopardizes the repayment of the debt and subjects the institution to the possibility of loss. Loans in this category may or may not have specific valuation allowance assigned to the loan depending on conditions.
·
Ratings 8: These are loans classified as “Doubtful” which, based upon a variety of negative conditions, will more than likely result in a loss if a set of events do not occur. These loans have specific valuation allowance to the extent of the calculated impairment.
·
Ratings 9: These are loans classified as “Loss”. They are to be charged-off or charged-down based upon the fact that repayment is uncertain or when the timing or value of payments cannot be determined. This classification does not imply that the loan will never be paid, nor does it imply that there has been a forgiveness of debt, but does indicate that the value will not be carried on the books of the institution as an earning asset.
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The loan portfolio, segmented by risk range at December 31, 2011, is shown below:
The Company’s Asset Classification Policy requires an ongoing quarterly assessment of the probable estimated losses in the portfolios. The Asset Classification Committee reviews the following information to analyze the credit risk inherent in the Company’s portfolio:
·
All loans classified during the previous analysis. Current information as to payment history or actions taken to correct the deficiency is reviewed, and if justified, the loan is no longer classified. If conditions have not improved, the loan classification is reviewed to ensure that the appropriate action is being taken to mitigate loss.
·
Growth and composition of the portfolio. The Committee considers changes in composition of loan portfolio and the relative risk of these loan portfolios in assessing the adequacy of the allowance.
·
Historical loan losses. The Committee reviews the Bank’s historical loan losses and historical industry losses in considering losses inherent in the loan portfolio.
·
Past due loans. The Committee reviews loans that are past due 30 days or more, taking into consideration the borrower, nature of the collateral and its value, the circumstances that have caused the delinquency, and the likelihood of the borrower correcting the conditions that have resulted in the delinquent status. The Committee may recommend more aggressive collection activity, inspection of the collateral, or no change in its classification.
·
Reports from the Bank’s managers and analysis of potential problem loans. Lending managers may be aware of a borrower’s circumstances that have not yet resulted in any past due payments but has the potential for problems in the future. Each lending manager reviews their respective lending unit’s loans and identifies any that may have developing weaknesses. This “self identification” process is an important component of maintaining credit quality, as each lender is accountable for monitoring as well as originating loans.
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·
Current economic conditions. The Bank takes into consideration economic conditions in its market area, the state’s economy, and national economic factors that could influence the quality of the loan portfolio in general. The unique, isolated geography of the Bank’s market area of Southeast Alaska requires that each community’s economic activity be reviewed. The Bank also reviews out of market economic data associated with participation loans and their respective markets.
·
Trends in the Bank’s delinquencies. The Bank’s market area has seasonal trends and as a result, the portfolio tends to have similar fluctuations. Prior period statistics are reviewed and evaluated to determine if the current conditions exceed expected trends.
The amount that is to be added to allowance for loan losses is based upon a variety of factors. An important component is a loss percentage set for each major category of loan that is based upon the Bank’s past loss experience. In certain instances, the Bank’s own loss experience has been minimal, and the related loss factor is modified based on consideration of published national loan loss data. The loss percentages are also influenced by economic factors as well as management experience.
Each individual loan, previously classified by management or newly classified during the quarterly review, is evaluated for loss potential, and any specific estimates of impairment are added to the overall required reserve amount. As a result of the size of the institution, the size of the portfolio, and the relatively small number of classified loans, most members of the asset classification committee are often directly familiar with the borrower, the collateral or the circumstances giving rise to the concerns. For the remaining portion of the portfolio, comprised of “pass” loans, the loss percentages discussed above are applied to each loan category.
The calculated amount is compared to the actual amount recorded in the allowance at the end of each quarter, and a determination is made as to whether the allowance is adequate or needs to be increased. Management increases the amount of the allowance for loan losses by charges to income and decreases it by loans charged off (net of recoveries).
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The following table details activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2011. Allocation of a portion of the allowance to one segment of loans does not preclude its availability to absorb losses in other categories.
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The following table details activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2010.
The Company’s recorded investment in loans as of December 31, 2011 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:
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The Company’s recorded investment in loans as of December 31, 2010 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:
Related Party Loans: In the ordinary course of business, the Company makes loans to executive officers and directors of the Company and to their affiliates. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions. The aggregate dollar amount of these loans was $4.3 million and $4.5 million at December 31, 2011 and 2010, respectively. During the years ended December 31, 2011 and 2010, new loans of this type were $248,000 and $5.7 million, respectively, and repayments were $388,000 and $4.4 million, respectively.
Real Estate Owned and Repossessed Assets: The Company held real estate owned and repossessed assets of $880,000 and $1.8 million at December 31, 2011 and 2010, respectively. During 2011, the Company received $1.4 million in proceeds from the sale of real estate owned and repossessed assets and recognized $57,000 of net losses on sales and impairment of real estate owned and repossessed assets. During 2010, the Company received $2.5 million in proceeds from the sale of real estate owned and repossessed assets and recognized $224,000 of net losses on sales and impairment of real estate owned and repossessed assets. The Company also incurred $83,000 and $237,000 in operating expenses related to real estate owned and repossessed assets in 2011 and 2010, respectively.
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Note 6 - Mortgage Loan Servicing
The Company generally retains the right to service mortgage loans sold to others. Loans serviced for others at December 31, 2011 and 2010 was $138.5 million and $129.1 million, respectively. The Company accounts for mortgage servicing rights (“MSR”) in accordance with ASC 860-50, Servicing Assets and Liabilities, which provides that changes in fair value will be reported in earnings in the period in which the change occurs. The Company uses a model derived valuation methodology to estimate the fair value of MSR obtained from an independent financial advisor on an annual basis. The model pools loans into tranches of homogeneous characteristics and performs a present value analysis of the future cash flows. The tranches are created by individual loan characteristics such as note rate, product type, and the remittance schedule. Current market rates are utilized for discounting the future cash flows. Significant assumptions used in the valuation of MSR include discount rates, projected repayment speeds, escrow calculations, ancillary income, delinquencies and option adjusted spreads. Related servicing income, net amounted to $211,000 and $287,000 for 2011 and 2010, respectively. Custodial escrow balances maintained for loans serviced for others was $542,000 and $533,000 at December 31, 2011 and December 31, 2010, respectively. Key assumptions used in measuring the fair value of MSR as of December 31, 2011 and 2010 were as follows:
The change in the balance of mortgage servicing assets is included in the following table:
Note 7 - Premises and Equipment
Following is a summary of premises and equipment:
Depreciation and amortization expense for the years ended December 31, 2011 and 2010 amounted to $278,000 and $288,000, respectively.
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Note 8 - Deposits
Certificates of deposit of $100,000 and more at December 31, 2011 and 2010 were $12.9 million and $10.1 million, respectively.
The scheduled maturities of certificates of deposit as of December 31, 2011, are as follows:
Interest expense on deposits consists of the following:
The weighted averages interest rates paid on deposits are as follows:
Deposits from the Company’s executive officers, directors, and their related companies were $3.7 million and $4.5 million at December 31, 2011 and 2010, respectively.
Note 9 - Federal Home Loan Bank Advances
FHLB advances consist of the following:
FHLB advances at December 31, 2011 with final maturities of more than one year have scheduled maturities as follows:
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The average balance of FHLB advances outstanding during 2011 and 2010 was $3.5 million and $9.0 million, respectively. The maximum amount of advances outstanding at any month end during 2011 and 2010 was $5.0 million and $13.2 million, respectively. Under a blanket pledge agreement, all funds on deposit at the FHLB, as well as all unencumbered qualifying loans and investment securities, are available to collateralize FHLB advances.
The Bank has available a line of credit, subject to collateral limits, with the FHLB generally equal to 25% of the Bank’s total assets, or approximately $40.0 million at December 31, 2011. The line is secured by a blanket pledge of the Company’s assets. At December 31, 2011 and 2010, there was $3.0 million and $5.0 million outstanding on the line, respectively.
Note 10 - Stock-Based Compensation
Stock Option Plan: In previous years, the Board of Directors, upon stockholder approval, approved two stock option plans (the “Plans”); one for key employees and one for directors of the Company. The Incentive and Director Stock Option Plan permits the grant of stock options to authorized key employees for up to 65,574 shares of common stock plus (i) the number of shares repurchased by the Company in the open market or otherwise with an aggregate price no greater than the cash proceeds received by the Company from the exercise of options granted under the Plan; plus (ii) any shares surrendered to the Company in payment of the exercise price of options granted under the Plan. The Committee of the Plans shall determine the time or times at which an option may be exercised. Previous option awards generally vest based on five years of continuous service. The term of each option award shall be no greater than 10 years in the case of an Incentive Stock Option or 15 years in the case of a Non-Qualified Stock Option. Option awards under the Plans shall not be less than 100% of the Market Value (as defined in the Plans) of a share on the date of grant of such option. Stock options granted are eligible for adjustment in the event that the outstanding common stock of the Company changes as a result of a stock dividend, stock split, or other changes to existing stock. Under the terms of the 2000 Stock Option Plan, no new options can be awarded after July 2, 2010. Under the terms of the 2003 Stock Option Plan, no new options can be awarded after May 22, 2013.
In 2000, the Company’s shareholders approved the 2000 Stock Option Plan, providing for the granting of options for up to 65,542 shares. Options for 65,542 shares were granted in 2000, with an exercise price equal to the market price of the stock at the date of grant, or $9.75. Options on 3,400 shares were granted in 2003, replacing forfeitures, with an exercise price of $17.50.
In 2003, the Company’s shareholders approved the 2003 Stock Option Plan, providing for the granting of options for up to 32,000 shares. Options for 22,600 shares were granted in 2007, with an exercise price equal to the market price of the stock at the date of grant, or $25.50. Options become exercisable in five equal annual installments commencing one year after the date of grant, and unexercised options expire ten years after the date of grant.
The expected volatility is based on historical volatility. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on historical exercise experience. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.
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Following is a summary of the changes in stock options:
There were no options exercised during the years ended December 31, 2010 and 2011. Stock options outstanding at December 31, 2011 are summarized as follows:
ASC 718 requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated income statement based on their fair values. Compensation cost is recorded as if each vesting portion of the award is a separate award. Stock compensation expense was $16,800 and $24,000 for the years ended December 31, 2011 and 2010. There was $10,000 in unamortized stock-based compensation expense at December 31, 2011 with a weighted average expense period of 0.6 years.
Note 11 - Retirement Plans
The Bank has a salary deferral 401(k) plan. Employees who are at least 18 years of age and have completed three months of service are eligible to participate in the plan. Employees may contribute on a pretax basis a portion of their annual salary up to a maximum limit under the law. Since 2006, the Bank has matched 100% of employee contributions of up to 4% of compensation. For the years ended December 31, 2011 and 2010, the Bank contributed $95,900 and $107,000, respectively, to the plan, including administrative expenses.
The Company has an Employee Stock Ownership Plan (“ESOP”) that was established in connection with the mutual to stock conversion. Eight percent of the shares issued in the conversion, or 52,433 shares, were purchased by the ESOP in exchange for a note payable to the Company. The shares are allocated to employees over a ten-year period in proportion to the principal and interest paid on the note at the end of each year. All employees who have completed one year’s service automatically participate in the plan, and each year’s allocation is distributed in proportion to total compensation of employees. Employees are vested in the plan over a seven-year period. Dividends paid on allocated shares are credited to employee’s accounts, but dividends on unallocated shares are used to reduce the expense of the plan. At
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December 31, 2011 and 2010, 52,433 shares were allocated to employees. The Company’s expense for the plan, including administrative expenses, amounted to $15,400 and $13,000 for the years ended December 31, 2011 and 2010, respectively.
Note 12 - Operating Leases
The Bank leases certain of its premises and equipment under non-cancelable operating leases with terms in excess of one year. Future minimum lease payments under these leases at December 31, 2011, are summarized as follows:
Rent expense was $507,000 and $502,000 for the years ended December 31, 2011 and 2010, respectively. Rental income on owned premises amounted to $20,000 and $35,000 for the years ended December 31, 2011 and 2010, respectively. Rental income under signed lease agreements is anticipated to be approximately $17,000 per year for the next five years.
Note 13 - Income Tax
The expense (benefit) for income tax consisted of the following:
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A reconciliation of taxes computed at federal statutory corporate tax rates (34% in 2011 and 2010) to tax expense, as shown in the accompanying statements of operations and changes in shareholders’ equity and comprehensive income, is as follows:
Deferred federal income tax is provided for the temporary differences between the tax basis and financial statement carrying amounts of assets and liabilities. Components of the Company’s net deferred tax assets consisted of the following:
In August 1996, the Small Business Job Protection Act of 1996 (“the Act”) was signed into law. Under the Act, the percentage of taxable income method of accounting for tax basis bad debts is no longer available effective for the years ending after December 31, 1995. As a result, the Bank is required to use the experience method of accounting for tax basis bad debts for 1998 and later years. In addition, the Act requires the recapture of post-1987 (the base year) additions to the tax bad debt reserves made pursuant to the percentage of taxable income method. The Bank is not subject to this recapture in 2011 or 2010, as its tax bad debt reserves do not exceed its base year reserve. As a result of the bad debt deductions, shareholders’ equity as of December 31, 2011, includes accumulated earnings of approximately $1.8 million for which federal income tax has not been provided. If, in the future, this portion of retained earnings is used for any purpose other than to absorb losses on loans or on property acquired through foreclosure, federal income tax may be imposed at then-applicable rates.
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On January 1, 2007, the Bank adopted FASB ASC 740, Income Taxes. ASC 740 provides guidance on derecognition, classification, interest and penalties, and accounting in interim periods; and requires expanded disclosure with respect to the Company’s methodology for estimating and reporting uncertain tax positions.
Currently, the Company is subject to U.S. federal income tax and income tax in the state of Alaska. The federal and state income taxes paid for the calendar years ended December 31, 2011, 2010, 2009, and 2008 may remain subject to examination by the applicable authorities. The Company recognizes interest and penalties related to unrecognized tax benefits as income tax expense in the Statements of operations. During the years ended December 31, 2011 and 2010, the Company recognized no interest and penalties.
The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for the open years based on an assessment of many factors, including past experience and interpretations of tax law. The Company had no unrecognized tax benefits which would require an adjustment to the January 1, 2011, beginning balance of retained earnings. The Company had no unrecognized tax benefits at December 31, 2011 or 2010. As of December 31, 2011 and 2010, the Company had federal and state net operating loss carry forwards of $70,000 and $55,000, respectively. Both carry forwards will expire on December 31, 2031.
Note 14 - Commitments and Contingencies
Commitments: Commitments to extend credit, including unused lines of credit, totaled $10.6 million and $9.5 million at December 31, 2011 and 2010, respectively. Commitments to extend credit, generally at a variable interest rate, are arrangements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates creditworthiness for commitments on an individual customer basis.
There are no commitments to lend additional funds to debtors’ whose loan terms have been modified in troubled debt restructurings.
Undisbursed loan proceeds, primarily for real estate construction loans, totaled $4.2 million and $1.4 million at December 31, 2011 and 2010, respectively. These amounts are excluded from the balance of loans at year end.
Concentrations: More than 75% of all loans in the Bank’s portfolio are secured by real estate located in communities of Southeast Alaska.
Note 15 - Preferred Stock
On February 6, 2009, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company sold (i) 4,781 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 175,772 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), for an aggregate issuance price of $4.8 million in cash.
The Series A Preferred Stock qualifies as Tier 1 capital and is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may be redeemed by the Company after three years. Prior to the end of three years, the Series A Preferred Stock may be redeemed by the Company only with proceeds from the sale of qualifying equity securities of the Company (a “Qualified Equity Offering”). The restrictions on redemption are set forth in the Certificate of Designation attached to the Statement of Establishment and
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Designation of Series of Preferred Stock, which amends the Company’s Articles of Incorporation (the “Certificate of Designation”).
The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.08 per share of the Common Stock. Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant that it holds.
Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) is be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($0.10) declared on the Common Stock prior to February 6, 2009. The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also is restricted. These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the Series A Preferred Stock, (b) the date on which the Series A Preferred Stock has been redeemed in whole, and (c) the date Treasury has transferred all of the Series A Preferred Stock to third parties.
In addition, pursuant to the Certificate of Designation, the ability of the Company to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its Junior Stock and Parity Stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series A Preferred Stock.
“Junior Stock” means the Common Stock and any other class or series of stock of the Company the terms of which expressly provide that it ranks junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company. “Parity Stock” means any class or series of stock of the Company the terms of which do not expressly provide that such class or series will rank senior or junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company (in each case without regard to whether dividends accrue cumulatively or non-cumulatively).
In accordance with the relevant accounting pronouncements, the Company recorded the Series A Preferred Stock and Warrants within Stockholders’ Equity on the Consolidated Balance Sheets. The Series A Preferred Stock and Warrants were initially recognized based on their relative fair values at the date of issuance. As a result, the Series A Preferred Stock’s carrying value is at a discount to the liquidation value or stated value. In accordance with the SEC’s Staff Accounting Bulletin No. 68, Increasing Rate Preferred Stock, the discount is considered an unstated dividend cost that is amortized over the period preceding commencement of the perpetual dividend using the effective interest method, by charging the imputed dividend cost against retained earnings and increasing the carrying amount of the Series A Preferred Stock by a corresponding amount. The discount is therefore being amortized over five years using a 6.71% effective interest rate. The total stated dividends (whether or not declared) and unstated dividend cost combined represents a period’s total preferred stock dividend, which is deducted from net income to arrive at net income available to common shareholders on the Consolidated Statements of Income.
The Series A Preferred Stock and Warrants were initially recognized based on their relative fair values at the date of issuance in accordance with ASU 470-20, Debt with Conversion and Other Topics. As a result, the value allocated to the Warrant is different than the estimated fair value of the Warrant as of the grant date. The following assumptions were used to determine the fair value of the Warrant as of the grant date:
Dividend yield 1.50%
Expected life (years) 10.0
Expected volatility 37%
Risk-free rate 3.05%
Fair value per warrant at grant date $ 4.15
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Note 16 - Earnings per Share
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average number of common shares outstanding during the period less treasury stock, unvested stock awards under the Management Recognition Plan (“unvested stock awards”). Diluted EPS is calculated by dividing net income by the weighted-average number of common shares used to compute basic EPS plus the incremental amount of potential common stock from unvested stock awards and stock options, determined by the treasury stock method. The following table shows the calculation of basic and diluted EPS.
Options to purchase an additional 23,000 and shares of common stock were not included in the computation of diluted earnings per share as of December 31, 2011 and 2010 because their exercise price resulted in them being anti-dilutive and consideration to options was not given as the impact would be anti-dilutive. The warrant issued to the U.S. Treasury to purchase up to 175,772 shares of common stock was included in the computation of diluted EPS for the year ended December 31, 2011 and 2010 because the warrant’s exercise price was less than the average market price of the Company’s common shares during the period.
Note 17 - Fair Value of Financial Instruments
The Company has elected to record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP standard (ASC 820) establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. The standard requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 - Unadjusted quoted prices for identical instruments in active markets;
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Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and
Level 3 - Instruments whose significant value drivers are unobservable.
An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The following table sets forth the Company’s assets and liabilities by level within the fair value hierarchy that were measured at fair value on a recurring and non-recurring basis at December 31, 2011 and 2010.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Securities: The fair value of investment securities is based upon estimated market prices obtained from independent safekeeping agents. Securities available-for-sale are recorded at fair value on a recurring basis. Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated based on quoted market prices of comparable instruments with similar characteristics or discounted cash flows. Changes in fair market value are recorded in other comprehensive income, as the securities are available for sale.
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Mortgage servicing rights: MSR are measured at fair value on a recurring basis. These assets are classified as Level 3 as quoted prices are not available and the Company uses a model derived valuation methodology to estimate the fair value of MSR obtained from an independent financial advisor on an annual basis. The model pools loans into buckets of homogeneous characteristics and performs a present value analysis of the future cash flows. The buckets are created by individual loan characteristics such as note rate, product type, and the remittance schedule. Current market rate assumptions are utilized for discounting the future cash flows. Significant assumptions used in the valuation of MSR include discount rates, projected prepayment speeds, escrow calculations, ancillary income, delinquencies and option adjusted spreads. These assets are recorded at fair value.
Impaired loans: Impaired loans are measured at fair value on a non-recurring basis. These assets are classified as Level 3 where significant value drivers are unobservable. The fair value of impaired loans are determined using the fair value of each loan’s collateral for collateral-dependent loans as determined, when possible, by an appraisal of the property, less estimated costs related to liquidation of the collateral. The appraisal amount may also be adjusted for current market conditions. Impaired loans were $2.5 million and $3.2 million at December 31, 2011 and 2010, respectively, with estimated reserves for impairment of $473,000 and $310,000, respectively.
Other Real estate owned and repossessed assets: The $1.8 million in real estate owned and repossessed assets reflected in the table above represents impaired real estate and repossessed assets that has been adjusted to fair value. Real estate owned and repossessed assets primarily represents real estate and other assets which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned and repossessed assets are recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations when possible, by an appraisal of the property, such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on other real estate owned and repossessed assets are recognized within results of operations.
The following table sets forth the estimated fair values of the Company’s financial instruments at December 31, 2011 and 2010:
Cash and cash equivalents: The fair value of cash and cash equivalents and accrued interest receivable is estimated to be equal to the carrying value, due to their short-term nature.
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FHLB stock: The fair value of FHLB stock is considered to be equal to its carrying value, since it may be redeemed at that value.
Loans: The fair value of loans is estimated using present value methods which discount the estimated cash flows, including prepayments as well as contractual principal and interest, using current interest rates appropriate for the type and maturity of the loans.
Deposits and other liabilities: For demand and savings deposits and accrued interest payable, fair value is considered to be carrying value.
Certificates of Deposit: The fair values of fixed-rate certificates of deposit are estimated using present value methods and current offering rates for such deposits.
FHLB Advances: The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated by discounting future cash flows using current interest rates for similar financial instruments.
Note 18 - Parent Company Financial Information
Summarized financial information for Alaska Pacific Bancshares, Inc. (parent company only) is presented below:
Parent Company Condensed Balance Sheet
Parent Company Condensed Income Statement
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Parent Company Condensed Statement of Cash Flows
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
No disagreement with the Company’s independent accountants on accounting and financial disclosure has occurred during the two most recent fiscal years.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Section 13(a)-15(e) of the Securities Exchange Act of 1934 (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 within the 90-day period preceding the filing date of this annual report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect 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 SEC’s rules and forms.
(b) Report of Management on Internal Control over Financial Reporting: Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). The Company's internal control over financial reporting is a process designed under the supervision of the Company's management, including its Chief Executive Officer and its Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting purposes in accordance with generally accepted accounting principles in the United States of America.
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The Company's internal control over financial reporting includes policies and procedures that: pertain to the maintenance of records which, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and 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 Company's financial statements.
Management recognizes that there are inherent limitations in the effectiveness of any system of internal control and, accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation and fair presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, the Company conducted an assessment of the effectiveness of the Company's internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Company's internal control over financial reporting as of December 31, 2011 is effective.
/s/ Craig E. Dahl
/s/ Julie M. Pierce
Craig E. Dahl
Julie M. Pierce
President and Chief Executive Officer
(Principal Executive Officer)
Senior Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
(c) Changes in Internal Controls: For the year ended December 31, 2011, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.
(d) Attestation report: This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
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
The information contained under the section captioned “Proposal I -- Election of Directors” in the Company’s Definitive Proxy Statement for the 2011 Annual Meeting of Stockholders (“Proxy Statement”) is incorporated herein by reference. For information regarding the executive officers of the Company, see “Item 1. Business - Executive Officers.”
Audit Committee Financial Expert
The Audit Committee consisting of Directors Milner (Chairman), Thomas, Corbus and Rule are responsible for reviewing the internal auditors’ report and results of their examination prior to review by and with the entire Board of
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Directors and retains and establishes the scope of the engagement of the Company’s independent auditors. The Board of Directors has designated Director Milner as the Audit Committee financial expert, as defined by the SEC, by the Bank’s Board of Directors. Although the Company’s common stock is not listed on NASDAQ, its Board of Directors has chosen to apply the definition of “independent “under the NASDAQ rules. Using this definition, the Board has determined that Director Milner is independent.
Compliance with Section 16(a)
Section 16(a) of the Exchange Act requires Company directors and executive officers, and persons who own more than 10% of a registered class of its equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.
Reference is made to the cover page of this Annual Report on Form 10-K, and the information under the section captioned “Compliance with Section 16(a) of the Exchange Act” in the Proxy Statement is incorporated herein by reference, with regard to compliance with Section 16(a) of the Exchange Act.
Code of Ethics
The Board of Directors adopted a Code of Ethics for the Company’s officers (including its senior financial officers), directors, and employees, which was filed is included as Exhibit 14 to the Company’s Annual Report on Form 10-K for the year ended 2005. The Code of Ethics requires the Company’s officers, directors, and employees to maintain the highest standards of professional conduct. The Company has elected to provide a copy of its Code of Ethics without charge to anyone who requests it.
Shareholder Recommendations for Board Nominations
No material changes have been made to the procedures by which security holders may recommend nominees to the Company’s Board of Directors. See the sections captioned "Meetings and Committees of the Board of Directors and Corporate Governance Matters -- Committees and Committee Charters" and "Stockholder Proposals" in the Proxy Statement, which are incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information contained under the sections captioned “Executive Compensation” in the Proxy Statement is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners: Information required by this item is incorporated herein by reference to the section captioned “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement.
(b) Security Ownership of Management: Information required by this item is incorporated herein by reference to the sections captioned and “Security Ownership of Certain Beneficial Owners and Management” and “Proposal I - Election of Directors” in the Proxy Statement.
(c) Changes in Control: The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
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(d) Equity Compensation Plan Information: The following table summarizes share and exercise price information about the Company’s equity compensation plans as of December 31, 2011.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated herein by reference to the section captioned “Meetings and Committees of the Board of Directors and Corporate Governance Matters - Corporate Governance - Related Party Transactions" and “Meetings and Committees of the Board of Directors and Corporate Governance Matters - Corporate Governance -Director Independence" in the Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information set forth under the section captioned “Proposal II - Ratification of Appointment of Independent Auditors” in the Proxy Statement is incorporated herein by reference.
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Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) Exhibits
3.1
Articles of Incorporation of Alaska Pacific Bancshares, Inc. (1)
3.2
Statement of Establishment and Designations of Series of Preferred Stock for the Series A Preferred Stock (2)
3.3
Bylaws of Alaska Pacific Bancshares, Inc. (3)
4.1
Warrant For Purchase of Shares of Common Stock (2)
4.2
Letter Agreement dated February 6, 2009 between Alaska Pacific Bancshares, Inc. and United States Department of the Treasury, will respect to the issuance and sale of the Series A Preferred Stock and the Warrant(2)
10.1
Employment Agreement with Craig E. Dahl (4)
10.2
Severance Agreement with Julie M. Pierce (9)
10.3
Severance Agreement with Thomas C. Sullivan (4)
10.4
Severance Agreement with Tammi L. Knight (4)
10.5
Severance Agreement with John E. Robertson (6)
10.6
Severance Agreement with Christopher P. Bourque (9)
10.7
Alaska Federal Savings Bank 401(k) Plan (1)
10.8
Alaska Pacific Bancshares, Inc. Employee Stock Ownership Plan (4)
10.9
Alaska Pacific Bancshares, Inc. Employee Severance Compensation Plan (4)
10.10
Alaska Pacific Bancshares, Inc. 2000 Stock Option Plan (5)
10.11
Alaska Pacific Bancshares, Inc. 2003 Stock Option Plan (7)
10.12
Form of Compensation Modification Agreement (2)
Code of Ethics (8)
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
Certification of Principal Executive Officer of Alaska Pacific Bancshares, Inc. to Chief Compliance Officer of the Troubled Asset Relief Program Pursuant to 31 CFR § 30.15
99.2
Certification of Principal Financial Officer of Alaska Pacific Bancshares, Inc. to Chief Compliance Officer of the Troubled Asset Relief Program Pursuant to 31 CFR § 30.15
The following materials from Alaska Pacific Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss); (d) Consolidated Statements of Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements *
_____________
*
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.
(1)
Incorporated by reference to the registrant’s Registration Statement on Form SB-2 (333-74827).
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(2)
Incorporated by reference to the registrant’s current report on Form 8-K filed on February 6, 2009.
(3)
Incorporated by reference to the registrant’s Registration Statement on Form SB-2 (333-74827), except for amended Article III, Section 2, which was incorporated by reference to the registrant’s quarterly report on Form 10-QSB for the quarterly period ended March 31, 2004.
(4)
Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended December 31, 1999.
(5)
Incorporated by reference to the registrant’s annual meeting proxy statement dated May 5, 2000.
(6)
Incorporated by reference to the registrant’s quarterly report on Form 10-QSB for the quarterly period ended March 31, 2004.
(7)
Incorporated by reference to the registrant’s annual meeting proxy statement dated April 10, 2004.
(8)
Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended December 31, 2005
(9)
Incorporated by reference to the registrant’s quarterly report on Form 10-QSB for the quarterly period ended September 30, 2007.
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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.
ALASKA PACIFIC BANCSHARES, INC.
Date: March 21, 2012
/s/ Craig E. Dahl
Craig E. Dahl
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements 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.
/s/ Craig E. Dahl
March 21, 2012
Craig E. Dahl
Date
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Julie M. Pierce
March 21, 2012
Julie M. Pierce
Date
Senior Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ William A. Corbus
March 21, 2012
William A. Corbus
Date
Director
/s/ BethAnn Chapman
March 21, 2012
BethAnn Chapman
Date
Director
/s/ Scott C. Milner
March 21, 2012
Scott C. Milner
Date
Director
/s/ Hugh N. Grant
March 21, 2012
Hugh N. Grant
Date
Director
/s/ Linda C. Thomas
March 21, 2012
Linda Thomas
Date
Director
/s/ Maxwell S. Rule
March 21, 2012
Maxwell S. Rule
Date
Director
/s/ Doug Andrew
March 21, 2012
Doug Andrew
Date
Director
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Exhibit Index
Exhibit No. Description
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
Certification of Principal Executive Officer of Alaska Pacific Bancshares, Inc. to Chief Compliance Officer of the Troubled Asset Relief Program Pursuant to 31 CFR § 30.15
99.2
Certification of Principal Financial Officer of Alaska Pacific Bancshares, Inc. to Chief Compliance Officer of the Troubled Asset Relief Program Pursuant to 31 CFR § 30.15
The following materials from Alaska Pacific Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss); (d) Consolidated Statements of Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements