Item 1. BUSINESS
General
First Savings Financial Group, Inc., an Indiana corporation, was incorporated in May 2008 to serve as the holding company for First Savings Bank, F.S.B. (the “Bank” or “First Savings Bank”), a federally-chartered savings bank. On October 6, 2008, in accordance with a Plan of Conversion adopted by its board of directors and approved by its members, the Bank converted from a mutual savings bank to a stock savings bank and became the wholly-owned subsidiary of First Savings Financial Group. In connection with the conversion, the Company issued an aggregate of 2,542,042 shares of common stock at an offering price of $10.00 per share. In addition, in connection with the conversion, First Savings Charitable Foundation was formed, to which the Company contributed 110,000 shares of common stock and $100,000 in cash. The Company’s common stock began trading on the NASDAQ Capital Market on October 7, 2008 under the symbol “FSFG”.
First Savings Financial Group’s principal business activity is the ownership of the outstanding common stock of First Savings Bank. First Savings Financial Group does not own or lease any property but instead uses the premises, equipment and other property of First Savings Bank with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement. Accordingly, the information set forth in this annual report including the consolidated financial statements and related financial data contained herein, relates primarily to the Bank.
First Savings Bank operates as a community-oriented financial institution offering traditional financial services to consumers and businesses in its primary market area. We attract deposits from the general public and use those funds to originate primarily residential mortgage loans and, to a lesser but growing extent, commercial mortgage loans and commercial business loans. We also originate residential and commercial construction loans, multi-family loans, land and land development loans, and consumer loans. We conduct our lending and deposit activities primarily with individuals and small businesses in our primary market area.
On September 30, 2009, First Savings Bank acquired Community First Bank (“Community First”), an Indiana-chartered commercial bank. The acquisition expanded First Savings Bank’s presence into Harrison, Crawford and Washington Counties in Indiana.
On July 6, 2012 First Savings Bank acquired the four Indiana branches of First Federal Savings Bank of Elizabethtown, Inc. (“First Federal”), a Kentucky-chartered commercial bank, two of which were consolidated into the existing operations of First Savings Bank immediately subsequent to the acquisition. The acquisition enhanced First Savings Bank’s presence in Harrison and Floyd Counties in Indiana.
Our website address is www.fsbbank.net. Information on our website should not be considered a part of this annual report.
Market Area
We are located in South Central Indiana along the axis of Interstate 65 and Interstate 64, directly across the Ohio River from Louisville, Kentucky. We consider Clark, Floyd, Harrison, Crawford and Washington counties, Indiana, in which all of our offices are located, and the surrounding areas to be our primary market area. The current top employment sectors in these counties are the private retail, service and manufacturing industries, which are likely to continue to be supported by the projected growth in population and median household income. These counties are well-served by barge transportation, rail service, and commercial and general aviation services, including the United Parcel Service’s major hub, which are located in our primary market area.
Competition
We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the several financial institutions operating in our primary market area and from other financial service companies such as securities and mortgage brokerage firms, credit unions and insurance companies. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2013, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held approximately 12.95%, 2.82%, 29.40%, 80.12% and 10.00% of the FDIC-insured deposits in Clark, Floyd, Harrison, Crawford and Washington Counties, Indiana, respectively. This data does not reflect deposits held by credit unions with which we also compete. In addition, banks owned by large national and regional holding companies and other community-based banks also operate in our primary market area. Some of these institutions are larger than us and, therefore, may have greater resources.
Our competition for loans comes primarily from financial institutions in our primary market area and from other financial service providers, such as mortgage companies, mortgage brokers and credit unions. Competition for loans also comes from non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty and captive finance companies.
We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowing banks to expand their geographic reach by providing services over the Internet, and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Changes in federal law now permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit our growth in the future.
Lending Activities
The Bank is in the process of transforming the composition of its balance sheet from that of a traditional thrift institution to that of a commercial bank. We intend to continue to emphasize residential lending, primarily secured by owner-occupied properties, but also to continue concentrating on ways to expand our consumer/retail banking capabilities and our commercial banking services with a focus on serving small businesses and emphasizing relationship banking in our primary market area. This transformation is enhanced by the Community First acquisition and by an expanded commercial lending staff dedicated to growing commercial real estate and commercial business loans.
The largest segment of our loan portfolio is real estate mortgage loans, primarily one- to four-family residential loans, including non-owner occupied residential loans that were predominately originated before 2005, and, to a lesser but growing extent, multi-family real estate, commercial real estate and commercial business loans. We also originate residential and commercial construction loans, land and land development loans, and consumer loans. We generally originate loans for investment purposes, although, depending on the interest rate environment and our asset/liability management goals, we may sell into the secondary market the 25-year and 30-year fixed-rate residential mortgage loans that we originate. We do not offer, and have not offered, Alt-A, sub-prime or no-documentation loans and acquired no such loans in the acquisition of Community First or the First Federal branches.
One- to Four-Family Residential Loans. Our origination of residential mortgage loans enables borrowers to purchase or refinance existing homes located in Clark, Floyd, Harrison, Crawford and Washington Counties, Indiana, and the surrounding areas. A significant portion of the residential mortgage loans that we had originated before 2005 are secured by non-owner occupied properties. Loans secured by non-owner occupied properties generally carry a greater risk of loss than loans secured by owner-occupied properties, and our non-performing loan balances have increased in recent periods primarily because of delinquencies in our non-owner occupied residential loan portfolio. See “Item 1A.
Item 1A. RISK FACTORS
Our concentration in non-owner occupied residential real estate loans may expose us to increased credit risk.
At September 30, 2013, $38.2 million, or 20.7% of our residential mortgage loan portfolio and 9.1% of our total loan portfolio, consisted of loans secured by non-owner occupied residential properties. Loans secured by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner occupied properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below that of owner occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties. Furthermore, some of our non-owner occupied residential loan borrowers have more than one loan outstanding with us. At September 30, 2013, we had 11 non-owner occupied residential loan relationships, each having an outstanding balance over $500,000, with aggregate outstanding balances of $11.2 million. Consequently, an adverse development with respect to one credit relationship may expose us to a greater risk of loss compared to an adverse development with respect to an owner occupied residential mortgage loan. At September 30, 2013, non-performing non-owner occupied residential loans amounted to $2.1 million. Non-owner occupied residential properties held as real estate owned amounted to $300,000 at September 30, 2013. For more information about the credit risk we face, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
Our recent emphasis on commercial real estate lending and commercial business lending may expose us to increased lending risks.
At September 30, 2013, $149.4 million, or 35.7%, of our loan portfolio consisted of commercial real estate loans and commercial business loans. Subject to market conditions, we intend to increase our origination of these loans. Commercial real estate loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers. Commercial real estate loans also typically involve larger loan balances to single borrowers or groups of related borrowers both at origination and at maturity because many of our commercial real estate loans are not fully-amortizing, but result in “balloon” balances at maturity. Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, some of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship may expose us to a greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. At September 30, 2013, non-performing commercial business loans and non-performing commercial real estate loans totaled $218,000 and $4.8 million, respectively. For more information about the credit risk we face, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
Our unseasoned commercial real estate loan and commercial business loan portfolios may expose us to increased lending risks.
A significant amount of our commercial real estate loans and commercial business loans are unseasoned, meaning that they were originated recently. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. Furthermore, these loans have not been subjected to unfavorable economic conditions. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could adversely affect our future performance.
Our construction loan and land and land development loan portfolios may expose us to increased credit risk.
At September 30, 2013, $30.7 million, or 7.3% of our loan portfolio consisted of construction loans, and land and land development loans, and $11.2 million, or 56.3% of the construction loan portfolio, consisted of speculative construction loans at that date. While recently the demand for construction loans has declined due to the decline in the housing market and tighter lending standards, historically, construction loans, including speculative construction loans, have been a material part of our loan portfolio. Speculative construction loans are loans made to builders who have not identified a buyer for the completed property at the time of loan origination. Subject to market conditions, we intend to continue to emphasize the origination of construction loans and land and land development loans. These loan types generally expose a lender to greater risk of nonpayment and loss than residential mortgage loans because the repayment of such loans often depends on the successful operation or sale of the property and the income stream of the borrowers and such loans typically involve larger balances to a single borrower or groups of related borrowers. In addition, many borrowers of these types of loans have more than one loan outstanding with us so an adverse development with respect to one loan or credit relationship can expose us to significantly greater risk of non-payment and loss. Furthermore, we may need to increase our allowance for loan losses through future charges to income as the portfolio of these types of loans grows, which would hurt our earnings. For more information about the credit risk we face, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
We may suffer losses in our loan portfolio despite our underwriting practices.
Our results of operations are significantly affected by the ability of borrowers to repay their loans. Lending money is an essential part of the banking business. However, borrowers do not always repay their loans. The risk of non-payment is historically small, but if nonpayment levels are greater than anticipated, our earnings and overall financial condition, as well as the value of our common stock, could be adversely affected. No assurance can be given that our underwriting practices or monitoring procedures and policies will reduce certain lending risks. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our stockholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect profitability. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. For more information about the credit risk we face, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
Our allowance for loan losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan losses to provide for probable incurred losses due to loan defaults, non-performance, and other qualitative factors. Our allowance for loan losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, loan portfolio performance, fair value of collateral securing the loans, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses could materially and adversely affect its financial results. For more information about our analysis and determination of allowance for loan losses, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
If an other-than-temporary-impairment is recorded in connection with our investment portfolio it could have a negative impact on our profitability.
Our investment portfolio consists primarily of U.S. government agency and sponsored enterprises securities, mortgage backed securities and collateralized mortgage obligations issued by U.S. government agencies and sponsored enterprises, municipal bonds, and privately-issued collateralized mortgage obligations and asset-backed securities. We must evaluate these securities for other-than-temporary impairment loss (“OTTI”) on a periodic basis. The privately-issued collateralized mortgage obligations and asset-backed securities exhibit signs of weakness, which may necessitate an OTTI charge in the future should the financial condition of the pools deteriorate further. Also, given the current economic environment and possible further deterioration in economic conditions, we may need to record an OTTI charge for our other investments should the issuers of those securities experience financial difficulties. Any future OTTI charges could significantly impact our earnings.
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.
A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and increased unemployment levels may result in higher than expected loan delinquencies, increases in our levels of non-performing and classified assets and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
Changing interest rates may hurt our earnings and asset value.
Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates-up or down-could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yield catches up. Changes in the slope of the “yield curve”-or the spread between short-term and long-term interest rates-could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our income. At September 30, 2013, approximately $230.9 million, or 55.2% of the total loan portfolio, consisted of fixed-rate mortgage loans. This investment in fixed-rate mortgage loans exposes the Company to increased levels of interest rate risk.
Changes in interest rates also affect the value of our interest-earning assets, and in particular our securities portfolio. Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity. For further discussion of how changes in interest rates could impact us, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations -Risk Management - Interest Rate Risk Management.”
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
If the goodwill that we recorded in connection with a business acquisition becomes impaired, it could have a negative impact on our profitability.
Goodwill represents the amount of acquisition cost over the fair value of net assets we acquired in the purchase of another financial institution. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate the carrying value of the asset might be impaired. We determine impairment by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. At September 30, 2013, our goodwill totaled $7.9 million. While we have recorded no such impairment charges since we initially recorded the goodwill, there can be no assurance that our future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on our financial condition and results of operations.
Regulation of the financial services industry is undergoing major changes and future legislation could increase our cost of doing business or harm our competitive position.
In 2010 and 2011, in response to the financial crisis and recession that began in 2008, significant regulatory and legislative changes resulted in broad reform and increased regulation impacting financial institutions. The Dodd-Frank Act has created a significant shift in the way financial institutions operate. The Dodd-Frank Act also creates a new federal agency to administer consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs. Any future legislative changes could have a material impact on our profitability, the value of assets held for investment or collateral for loans. Future legislative changes could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.
In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies have taken stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the recent economic crisis. The actions include entering into written agreements and cease and desist orders that place certain limitations on operations. Federal bank regulators have also been using with more frequency their ability to impose individual minimum capital requirements on banks, which requirements may be higher than those required under the Dodd-Frank Act or that would otherwise qualify a bank as being “well capitalized” under applicable prompt corrective action regulations. If we were to become subject to a regulatory agreement or higher individual minimum capital requirements, such action may have a negative impact on our ability to execute our business plan, as well as our ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in our operations.
Additionally, in early July 2013, the Federal Reserve approved revisions to their capital adequacy guidelines and prompt corrective action rules that implement the revised standards of Basel III and address relevant provisions of the Dodd-Frank Act. Basel III and the regulations of the federal banking agencies require bank holding companies and banks to undertake significant activities to demonstrate compliance with the new and higher capital standards. Compliance with these rules will impose additional costs on the Company and the Bank.
Increased and/or special FDIC assessments will hurt our earnings.
The recent economic recession has caused a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $217,000. In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $2.1 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.
Strong competition within our primary market area could hurt our profits and slow growth.
We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and attract deposits. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. At June 30, 2013, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held approximately 12.95%, 2.82%, 29.40%, 80.12% and 10.00% of the FDIC-insured deposits in Clark, Floyd, Harrison, Crawford and Washington Counties, Indiana, respectively. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our primary market area. See “Item 1. Business - Market Area” and “Item 1. Business - Competition” for more information about our primary market area and the competition we face.
Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.
Operational risk is the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company and Bank, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to our reputation.
Our business may be adversely affected by internet fraud.
We are inherently exposed to many types of operational risk, including those caused by the use of computer, internet and telecommunications systems. These risks may manifest themselves in the form of fraud by employees, by customers, other outside entities targeting us and/or our customers that use our internet banking, electronic banking or some other form of our telecommunications systems. Given the growing level of use of electronic, internet-based, and networked systems to conduct business directly or indirectly with our clients, certain fraud losses may not be avoidable regardless of the preventative and detection systems in place.
We may experience interruptions or breaches in our information system security.
We rely heavily on communications and information systems to conduct our business. Any failure or interruption 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 or interruption of these information systems, there can be no assurance that any such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures or interruptions of these 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.
A failure in or breach, including cyber attacks, of our operational or security systems, or those of our third party vendors and other service providers, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
As a financial institution, we are susceptible to fraudulent activity that may be committed against us or our clients and that may result in financial losses to us or our clients, privacy breaches against our clients, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, and other dishonest acts. In recent periods, there has been a rise in electronic fraudulent activity within the financial services industry, especially in the commercial banking sector, due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity in recent periods.
In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks and those of our customers may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber attacks and other events that could have an adverse security impact and result in significant losses by us and/or our customers. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties, such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or the threats may originate from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.
We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.
Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the outsourcing of some of our business operations, and the continued uncertain global economic environment. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy will afford coverage for all possible losses or would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third party’s systems failing or experiencing attack.
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
The Bank is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency, its chartering authority, and by the Federal Deposit Insurance Corporation, as insurer of its deposits. The Company is also subject to regulation and supervision by the Federal Reserve Bank of St. Louis. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of the Company’s common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. If our regulators require us to charge-off loans or increase our allowance for loan losses, our earnings would suffer. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. For a further discussion, see “Item 1. Business - Regulation and Supervision.”
Our ability to pay dividends is subject to certain limitations and restrictions, and there is no guarantee that we will be able to continue paying the same level of dividends in the future that we paid in 2013 or that we will be able to pay future dividends at all.
Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of the Bank to pay dividends to the Company is limited by its obligations to maintain sufficient capital and liquidity, and by other regulatory restrictions. The Office of the Comptroller of the Currency and other banking regulators have proposed guidelines seeking greater liquidity and have issued regulations requiring greater capital requirements. If these regulatory requirements are not met, the Bank will not be able to pay dividends to the Company, and consequently we may be unable to pay dividends on our common stock. In addition, as a savings and loan holding company, our ability to declare and pay dividends is subject to the guidelines of the Federal Reserve Bank of St. Louis regarding capital adequacy and dividends.
On August 11, 2011, we issued shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A to the United States Department of the Treasury as a result of participation in its Small Business Lending Fund program. We are prohibited from continuing to pay dividends on our common stock unless we have fully paid all required dividends on the senior preferred stock. Although we expect to be able to pay all required dividends on the senior preferred stock, there is no guarantee that we will be able to do so.
If we are unable to redeem the Senior Non-cumulative Perpetual Preferred Stock, Series A after an initial four-and-one-half year period, the cost of this capital will increase substantially.
If we are unable to redeem the Senior Non-cumulative Preferred Stock, Series A prior to February 11, 2016, the cost of this capital to us will increase from approximately $171,000 annually (based on the average dividend rate for 2013, or 1.0% per annum of the Series A preferred stock liquidation value) to $1.5 million annually (9.0% per annum of the Series A preferred stock liquidation value). This increase in the annual dividend rate on the Senior Non-cumulative Preferred Stock, Series A would have a material negative effect on the earnings we can retain for growth and to pay dividends on our common stock.
There is a limited trading market for our stock and you may not be able to resell your shares at or above the price you paid for them.
The price of the common stock purchased may decrease significantly. Although our common stock is quoted on the NASDAQ Capital Market under the symbol "FSFG", trading activity in the stock historically has been sporadic. A public trading market having the desired characteristics of liquidity and order depends on the presence in the market of willing buyers and sellers at any given time. The presence of willing buyers and sellers depends on the individual decisions of investors and general economic conditions, all of which are beyond our control.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. PROPERTIES
We conduct our business through our main office and branch offices. The following table sets forth certain information relating to these facilities as of September 30, 2013.
Location
Year
Opened
Owned/
Leased
Main Office:
Clarksville Main Office
501 East Lewis & Clark Parkway
Clarksville, Indiana
Owned
Branch Offices:
Jeffersonville - Allison Lane Office
2213 Allison Lane
Jeffersonville, Indiana
Owned
Charlestown Office
1100 Market Street
Charlestown, Indiana
Owned
Floyd Knobs Office
3711 Paoli Pike
Floyd Knobs, Indiana
Owned
Georgetown Office
1000 Copperfield Drive
Georgetown, Indiana
Owned
Jeffersonville - Court Avenue Office
202 East Court Avenue
Jeffersonville, Indiana
Owned
Sellersburg Office
125 Hunter Station Way
Sellersburg, Indiana
Owned
Corydon Office
900 Hwy 62 NW
Corydon, Indiana
Owned
Salem Office
1336 S Jackson Street
Salem, Indiana
Owned
English Office
200 Indiana Avenue
English, Indiana
Owned
Marengo Office
125 W Old Short Street
Marengo, Indiana
Owned
Leavenworth Office
510 Hwy 62
Leavenworth, Indiana
Owned
Lanesville Office
7340 Main Street NE
Lanesville, Indiana
Owned
Elizabeth Office
8160 Beech Street SE
Elizabeth, Indiana
Owned
New Albany Office
2218 State Street
New Albany, Indiana
Owned
The Bank owns one former branch office location that has been closed and consolidated into existing branch office operations. This is located in Milltown, Indiana, valued at the amount of $250,000, held for sale and included in other real estate owned, held for sale at September 30, 2013 on the balance sheet of the Consolidated Financial Statements beginning on page of this annual report.
The Company owns a 4.077 acre parcel of land in New Albany, Indiana, which it has developed for retail purposes through a subsidiary of the Bank, FFCC, Inc. The retail development includes over 36,000 square feet of leasable class-A retail space and includes the Bank’s New Albany branch office location. See Note 8 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding the real estate development and construction.
The Company purchased an 8.097 acre parcel of land in Jeffersonville, Indiana, in July 2013 upon which it may locate a new main office and also develop for retail purposes in future years. However, there were no formal plans as of September 30, 2013 to proceed with a new main office location or development of the additional acreage. This land, with a carrying value of approximately $1.73 million, was included in premises and equipment at September 30, 20103 on the balance sheet of the Consolidated Financial Statements beginning on page of this annual report.
Item 3.
Item 3. LEGAL PROCEEDINGS
Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for Common Equity and Related Stockholder Matters
The Company’s common stock is listed on the NASDAQ Capital Market (“NASDAQ”) under the trading symbol “FSFG.” As of December 13, 2013, the Company had approximately 277 holders of record and 2,262,305 shares of common stock outstanding. The figure of shareholders of record does not reflect the number of person whose shares are in nominee or “street” name accounts through brokers. See Item 1, “Business-Regulation and Supervision-Limitation on Capital Distributions” and Note 26 of the Notes to Consolidated Financial Statements beginning on page of this annual report for information regarding dividend restrictions applicable to the Company.
The following table provides quarterly market price and dividend information per common share for the fiscal years ended September 30, 2013 and 2012 as reported by NASDAQ.
On November 21, 2013, the Company declared a quarterly cash dividend of $0.10 per share on its outstanding common stock, payable on or about December 31, 2013 to stockholders of record as of the close of business on December 1, 2013. The Company currently intends to maintain a policy of paying regular quarterly cash dividends; however, the Company cannot guarantee that it will pay dividends or that if paid, it will not reduce or eliminate dividends in the future.
Purchases of Equity Securities
The following table presents information regarding the Company’s stock repurchase activity during the quarter ended September 30, 2013:
_______________
(1) On November 16, 2012, the Company announced that its Board of Directors authorized a stock repurchase program to acquire up to 230,217 shares, or 10.0% of the Company’s outstanding common stock. Under the program, repurchases are to be conducted through open market purchases or privately negotiated transactions, and are to be made from time to time depending on market conditions and other factors. There is no guarantee as to the exact number of shares to be repurchased by the Company. Repurchased shares will be held in treasury.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following tables contain certain information concerning our consolidated financial position and results of operations, which is derived in part from our audited consolidated financial statements. The following is only a summary and should be read in conjunction with the audited consolidated financial statements and notes thereto beginning on page of this annual report.
(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost on average interest-bearing liabilities. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 34%.
(2) Represents net interest income as a percent of average interest-earning assets. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 34%.
(3) Represents other expenses divided by the sum of net interest income and other income.
(4) Represents the capital ratios of only the Bank.
(5) The significant increase from 2011 to 2012 is due primarily to 5,826 deposit accounts acquired in the acquisition of the First Federal branches.
(6) The significant increase from 2011 to 2012 is due primarily to 768 loans acquired in the acquisition of the First Federal branches.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Other significant sources of pre-tax income are service charges (mostly from service charges on deposit accounts and loan servicing fees), increases in the cash surrender value of life insurance, fees from sale of mortgage loans originated for sale in the secondary market, commissions on sales of securities and insurance products, and net realized and unrealized gains on trading account securities. We also recognize income from the sale of investment securities.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, data processing expenses, professional service fees, federal deposit insurance premiums, advertising, net losses on foreclosed real estate and other miscellaneous expenses. Our noninterest expenses increased for the year ended September 30, 2013 when compared to 2012 primarily as a result of nonrecurring expenses in 2013 relating to the opening of the new State Street branch in New Albany, Indiana. These 2013 additional expenses consisted primarily of compensation and benefits and occupancy and equipment.
Salaries and employee benefits consist primarily of: salaries and wages paid to our employees; payroll taxes; and expenses for health insurance, retirement plans and other employee benefits. We also recognize annual employee compensation expenses related to the equity incentive plan as the equity incentive awards vest. See Note 17 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding the stock based compensation plans.
Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to 50 years.
Data processing expenses are the fees we pay to third parties for processing customer information, deposits and loans. Our data processing expenses decreased in the year ended September 30, 2013 when compared to 2012 primarily as a result of nonrecurring expenses in 2012 relating to the integration of the First Federal branches with the Bank’s core operating system. These nonrecurring charges associated with the integration of the First Federal branches with the Bank’s core operating system amounted to $327,000 during 2012.
Professional fees expense represents the fees we pay to third parties for legal, accounting, investment advisory and other consulting services. Our professional fees decreased in the year ended September 30, 2013 when compared to 2012 primarily as a result of nonrecurring expenses in 2012 relating to the acquisition and integration of the First Federal branches. The 2012 nonrecurring charges associated with the acquisition and integration of the First Federal branches amounted to $194,000.
Federal deposit insurance premiums are payments we make to the Federal Deposit Insurance Corporation for insurance of our deposit accounts.
Other expenses include expenses for office supplies, postage, telephone, insurance, regulatory assessments and other miscellaneous operating expenses.
Critical Accounting Policies
The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company’s financial condition, changes in financial condition or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles. Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the Notes to Consolidated Financial Statements. The policies considered to be the critical accounting policies are described below.
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, periodically reviews our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. Note 1 of the Notes to Consolidated Financial Statements beginning on page of this annual report describes the methodology used to determine the allowance for loan losses. The Company has not made any substantive changes to its methodology for determining the allowance for loan losses during the fiscal year ended September 30, 2013, and there have been no material changes in the assumptions or estimation techniques compared to prior years.
Other-Than-Temporary Impairment of Securities. The Company reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment (“OTTI”) on a periodic basis. In evaluating the investment portfolio for OTTI, management considers the issuer’s credit rating, credit outlook, payment status and financial condition, the length of time the investment has been in a loss position, the size of the loss position and other meaningful information. Generally changes in market interest rates that result in a decline in value of an investment security are considered to be temporary, since the value of such investment can recover in the foreseeable future as market interest rates return to their original levels. However, such declines in value that are due to the underlying credit quality of the issuer or other adverse conditions that cannot be expected to improve in the foreseeable future, may be considered to be other-than-temporary. The Company recognizes credit-related OTTI on debt securities in earnings, while noncredit-related OTTI on debt securities not expected to be sold is recognized in accumulated other comprehensive income. Management believes this is a critical accounting policy because this evaluation of the underlying credit or analysis of other conditions contributing to the decline in value involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. No other-than-temporary write-down charges to earnings were recognized during 2013 or 2012. See Note 4 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding OTTI.
Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as investment securities. However, for those items for which market-based prices do not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include goodwill and other intangible assets, foreclosed and other repossessed assets, estimated present value of impaired loans, value ascribed to stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company’s results of operations.
Operating Strategy
Our mission is to operate and grow a profitable community-oriented financial institution. We plan to achieve this by executing our strategy of:
· continuing our historical focus on residential mortgage lending but de-emphasizing residential mortgage lending secured by non-owner occupied properties;
· pursuing opportunities to increase commercial real estate lending and commercial business lending;
· improving customer service and product offerings by leveraging the Bank’s investment in new technology, including the core operating system;
· providing exceptional customer service to attract and retain customers;
· promoting our presence, brand image and product offerings in our primarily market area using our newly designed logo and marketing promotions that were launched in September 2011;
· continuing to monitor asset quality and credit risk in the loan and investment portfolios;
· recognizing improvements in noninterest income with respect to service charges on deposits as a result of restructuring deposit account types and fees, interchange income as a result of promoting increased debit card usage, commission income related to non-deposit investment products and gains on sales of mortgage loans sold in the secondary market;
· expanding our market share and market area by opening new branch offices and pursuing opportunities to acquire other financial institutions or branches; and
· increasing shareholder value through stock repurchase programs and dividends.
Continuing our historical focus on residential mortgage lending but de-emphasizing residential mortgage lending secured by non-owner occupied properties.
Our predominant lending activity has been residential mortgage lending in our primary market area. A significant portion of the residential mortgage loans that we had originated before 2005 are secured by non-owner occupied properties. Loans secured by non-owner occupied properties generally carry a greater risk of loss than loans secured by owner-occupied properties, and our non-performing loan balances have increased in recent periods primarily because of delinquencies in our non-owner occupied residential loan portfolio. Since 2005, when we hired a new President and Chief Executive Officer, we have de-emphasized non-owner occupied residential mortgage lending and have focused, and intend to continue to focus, our residential mortgage lending primarily on originating residential mortgage loans secured by owner-occupied properties. At September 30, 2013, 44.1% of our total loans were residential mortgage loans and 20.7% of our residential mortgage loans were secured by non-owner occupied properties. We intend to expand our emphasis on residential mortgage lending because this type of lending generally carries lower credit risk and has contributed to our historically favorable asset quality.
Pursuing opportunities to increase commercial real estate lending and commercial business lending.
In recent periods, we have begun to focus on commercial real estate and commercial business lending and intend to continue this focus. Commercial real estate loans and commercial business loans give us the opportunity to earn more income because these loans have higher interest rates than residential mortgage loans in order to compensate for the increased credit risk. At September 30, 2013, commercial real estate loans and commercial business loans represented 28.17% and 7.56%, respectively, of our total loans. We intend to continue to pursue these lending opportunities in our primary market area. In addition, the Company’s participation in the United States Department of the Treasury’s Small Business Lending Fund program, as discussed further in Note 25 of the Notes to Consolidated Financial Statements beginning on page of this annual report, also provides an incentive and capital to increase commercial lending.
During 2013, we began a commercial real estate lending program that is focused on loans to high net worth individuals that are secured by low loan-to-value, single-tenant commercial properties that are leased to investment grade national-brand retailers. This program is designed to diversify the Company’s geographic and credit risk profile given the geographic dispersion of the loans and collateral, and the investment grade credit of the national-brand lessees. The Company originated $17.5 million of these loans during 2013 and the portfolio balance was $17.4 million at September 30, 2013.
Continuing to integrate the Community First and First Federal offices, customers and product lines.
During 2010, we began to integrate the Community First offices and customers by integrating the core operating systems of the Bank and Community First onto a single core operating system, which was successfully completed in August 2010. This single system permits Bank customers to utilize all office locations, permits Bank officers and staff to extract and monitor a standard set of information available from all office locations and allows the Bank to offer a uniform set of product offerings focus. In addition, during 2011 and 2012, we successfully rebranded all office locations, including those operating under the Community First name, with a new ‘look’ and logo for First Savings Bank in order to provide uniformity to our existing and prospective customer base. In 2012 and 2013 we integrated the First Federal offices and customers into the existing First Savings franchise.
Providing exceptional customer service to attract and retain customers.
As a community-oriented financial institution, we emphasize providing exceptional customer service as a means to attract and retain customers. We deliver personalized service and respond with flexibility to customer needs. We believe that our community orientation is attractive to our customers and distinguishes us from the larger banks that operate in our primary market area.
Continuing to monitor asset quality and credit risk.
Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. During 2013 and 2012, we have placed special emphasis on the improvement of asset quality and reductions in the levels of classified and criticized assets, which has resulted in significant improvements. For more information about our monitoring of credit risk and improvement in levels of classified and criticized assets, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management.”
Recognizing improvements in noninterest income.
The Company has recognized significant improvement in its levels of noninterest income for 2013 and 2012 as compared to prior fiscal years due primarily to net gains on sales of loans, net gains on trading securities, increases in cash surrender value of life insurance, real estate lease income, and surcharge and interchange income. However, the Company still underperforms compared to its peers, particularly with respect to service charges on deposit fee income. Therefore, the Company engaged a consulting firm in September 2013 for the purposes of enhancing noninterest income and reducing noninterest expense, the results from which are expected to begin being realized during 2014.
Expanding our market share and market area.
The 2009 acquisition of Community First expanded our market area into Harrison, Crawford and Washington Counties, Indiana, while the 2012 acquisition of the First Federal branches enhanced our presence in Harrison and Floyd Counties, Indiana. As previously discussed, we successfully rebranded the twelve office locations during 2011 and 2012 with a new look and logo for First Savings Bank and have also expanded our marketing efforts as a result of such. In addition, we intend to continue to pursue opportunities to expand our market share and market area by seeking to open additional branch offices and pursuing opportunities to acquire other financial institutions or branches of other financial institutions in our primary market area and surrounding areas.
Increasing shareholder value through stock repurchase programs and dividends.
The Company has been active in the repurchase of its common shares and has purchased and committed 242,388 shares to treasury as of September 30, 2013, which represents 9.54% of the 2,542,042 common shares issued in its public offering in October 2008. In addition, the Company has 226,706 common shares remaining for repurchase under the stock repurchase program approved by its Board of Directors on November 16, 2012. Under the program, repurchases are to be conducted through open market purchases or privately negotiated transactions, and are to be made from time to time depending on market conditions and other factors. There is no guarantee as to the exact number of shares to be repurchased by the Company. For more information about our stock repurchases, see “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
The Company paid a special cash dividend of $0.40 per common share during the quarter ended December 31, 2012 and implemented quarterly a cash dividend plan of $0.10 per common share beginning with the quarter ended March 31, 2013, under which it paid $0.10 per common share for the quarters ended March 31, June 30 and September 30, 2013, for a total of $0.70 per common share paid during the fiscal year ended September 30, 2013. The Company currently intends to maintain a policy of paying regular quarterly cash dividends; however, the Company cannot guarantee that it will pay dividends or that if paid, it will not reduce or eliminate dividends in the future. For more information about our dividends, see “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
Issuance of Preferred Stock under the U.S. Department of the Treasury’s Small Business Lending Fund
On August 11, 2011, First Savings Financial Group entered into and consummated a Securities Purchase Agreement (the “Purchase Agreement”) with the Secretary of the Treasury, pursuant to which First Savings Financial Group issued 17,120 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $17.1 million. The Purchase Agreement was entered into, and the Series A Preferred Stock was issued, pursuant to the Small Business Lending Fund program, a $30 billion fund established under the Small Business Jobs Act of 2010, that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion. See Note 25 of the Notes to Consolidated Financial Statements beginning of page of this annual report for additional information regarding the terms of the Series A Preferred Stock.
Balance Sheet Analysis
Cash and Cash Equivalents. At September 30, 2013 and 2012, cash and cash equivalents totaled $20.8 million and $38.8 million, respectively. The Bank is required to maintain reserve balances on hand and with the Federal Reserve Bank which are unavailable for investment but interest-bearing and the average amount of those reserve balances for the year ended September 30, 2013 was approximately $6.3 million.
Loans. Our primary lending activity is the origination of loans secured by real estate. We originate one-to four-family mortgage loans, multifamily loans, commercial real estate loans, commercial business loans and construction loans. To a lesser extent, we originate various consumer loans including home equity lines of credit.
Residential mortgage loans comprise the largest segment of our loan portfolio. At September 30, 2013, these loans totaled $184.4 million, or 44.1% of total loans, compared to $191.0 million, or 47.7% of total loans at September 30, 2012. Total residential mortgage loan balances decreased in 2013 primarily due to repayments and refinancings that were sold in the secondary market. We generally originate loans for investment purposes, although, depending on the interest rate environment, we typically sell 25-year and 30-year fixed-rate residential mortgage loans that we originate into the secondary market in order to limit exposure to interest rate risk and to earn noninterest income. Management intends to continue offering short-term adjustable rate residential mortgage loans and sell long-term fixed rate mortgage loans in the secondary market with servicing released.
Commercial real estate loans totaled $117.8 million, or 28.2% of total loans at September 30, 2013, compared to $90.3 million, or 22.6% of total loans at September 30, 2012. The balance of commercial real estate loans has increased primarily due to greater opportunity to originate these loans during 2013 as a result of our increased commercial lending personnel. Management continues to focus on pursuing nonresidential loan opportunities in order to further diversify the loan portfolio.
Consumer loans totaled $26.9 million, or 6.4% of total loans, at September 30, 2013 compared to $30.6 million, or 7.7% of total loans, at September 30, 2012. In general, organic consumer loans including automobile loans, home equity lines of credit, unsecured loans and loans secured by deposits, have declined due to pay-downs, payoffs, charge-offs and management’s decision to focus on other lending opportunities with less inherent credit risk. In the aggregate, home equity lines of credit decreased $1.2 million, or 6.4%, while automobile loans decreased $1.7 million, or 20.7%, from September 30, 2012 to September 30, 2013.
Commercial business loans totaled $31.6 million, or 7.6% of total loans, at September 30, 2013 compared to $36.2 million, or 9.0% of total loans, at September 30, 2012. The balance of commercial business loans has decreased primarily due to repayments, payoffs, charge-offs and increased competition in the marketplace. Management continues to focus on pursuing commercial business loan opportunities in order to further diversify the loan portfolio.
Multi-family real estate loans totaled $26.8 million, or 6.4% of total loans at September 30, 2013, compared to $23.9 million, or 6.0% of total loans at September 30, 2012. The balance of multi-family real estate loans increased primarily due to greater opportunity to originate these loans during 2013.
Residential construction loans totaled $12.5 million, or 3.0% of total loans, at September 30, 2013 of which $7.7 million were speculative construction loans. At September 30, 2012, residential construction loans totaled $10.7 million, or 2.7% of total loans, of which $6.4 million were speculative loans. The general slowdown in the housing market in our primary market area and, to a lesser extent, increased competition in the market for these loans has somewhat decreased the opportunity to originate these loans and significantly grow this segment of the portfolio. We intend to continue pursuing quality construction lending opportunities as the housing market continues to recover.
Commercial construction loans totaled $6.7 million, or 1.6% of total loans, at September 30, 2013 compared to $5.2 million, or 1.3% of total loans at September 30, 2012. The general slowdown of commercial construction in our primary market area and increased competition in the marketplace has decreased the opportunity to originate these loans and grow this segment of the portfolio.
Land and land development loans totaled $11.4 million, or 2.7% of total loans at September 30, 2013, compared to $12.3 million, or 3.1% of total loans at September 30, 2012. These loans are primarily secured by vacant lots to be improved for residential and nonresidential development and farmland. The general slowdown of residential and commercial construction in our primary market area and increased competition in the marketplace has decreased the opportunity to originate these loans and grow this segment of the portfolio.
The following table sets forth the composition of our loan portfolio at the dates indicated.
Loan Maturity
The following table sets forth certain information at September 30, 2013 regarding the dollar amount of loan principal repayments becoming due during the period indicated. The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity, are reported as due in one year or less.
(1) Includes multi-family loans.
(2) Includes farmland and land and land development loans.
(3) Includes construction loans for which the Bank has committed to provide permanent financing.
Fixed vs. Adjustable Rate Loans
The following table sets forth the dollar amount of all loans at September 30, 2013 that are due after September 30, 2014, and have either fixed interest rates or adjustable interest rates. The amounts shown below exclude unearned loan origination fees.
(1) Includes multi-family loans.
(2) Includes farmland and land and land development loans.
Loan Activity
The following table shows loans originated, purchased and sold during the periods indicated.
(1) Includes multi-family loans.
(2) Includes farmland and land and land development loans.
Trading Account Securities. Our trading account securities represent an investment in a managed brokerage account in May 2012 that invests in small and medium lot, investment grade municipal bonds. The brokerage account is managed by an investment advisory firm registered with the U.S. Securities and Exchange Commission. At September 30, 2013, trading account securities recorded at fair value totaled $3.2 million, comprised of investment grade municipal bonds. See Note 4 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding trading account securities.
Securities Available for Sale. Our available for sale securities portfolio consists primarily of U.S. government agency and sponsored enterprises securities, mortgage backed securities and collateralized mortgage obligations issued by U.S. government agencies and sponsored enterprises, municipal bonds, and privately-issued collateralized mortgage obligations and asset-backed securities. Available for sale securities increased by $11.6 million from September 30, 2012 to September 30, 2013 primarily due to purchases of $51.0 million, which more than offset unrealized losses of $6.3 million, maturities and calls of $12.2 million, sales of $801,000 and principal repayments of $19.3 million.
Securities Held to Maturity. Our held to maturity securities portfolio consists primarily of mortgage-backed securities issued by government sponsored enterprises and municipal bonds. Held to maturity securities decreased by $1.4 million from September 30, 2012 to September 30, 2013 primarily due to maturities and principal repayments of $1.4 million.
The following table sets forth the amortized costs and fair values of our investment securities at the dates indicated.
The following table sets forth the activity in our investment available for sale and held to maturity securities portfolio during the periods indicated.
(1) At fair value.
The following table sets forth the stated maturities and weighted average yields of debt securities at September 30, 2013. Weighted average yields on tax-exempt securities are presented on a tax equivalent basis using a federal marginal tax rate of 34%. Certain mortgage-backed securities and collateralized mortgage obligations have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. Weighted average yield calculations on investments available for sale do not give effect to changes in fair value that are reflected as a component of equity.
As of September 30, 2013, we did not own any investment securities of a single issuer that had an aggregate book value in excess of 10% of the Company’s stockholders’ equity at that date, other than securities and obligations issued by U.S. government agencies and sponsored enterprises.
Deposits. Deposit accounts, generally obtained from individuals and businesses throughout our primary market area, are our primary source of funds for lending and investments. Our deposit accounts are comprised of noninterest-bearing accounts, interest-bearing savings, checking and money market accounts and certificates of deposits. Deposits decreased $16.5 million from September 30, 2012 to September 30, 2013. In the aggregate, the Bank recognized decreases in noninterest-bearing checking accounts of $409,000 and certificates of deposit of $41.8 million, partially offset by increases in interest-bearing checking accounts of $13.2 million, money market deposit accounts of $7.6 million and interest-bearing savings accounts of $4.9 million when comparing the two years. Brokered certificates of deposit totaled $3.0 million at both September 30, 2013 and 2012. We have continued to promote relationship-oriented deposit accounts but at times utilize a certain level of brokered certificates of deposit as a lower-cost alternative to retail certificates of deposit. In addition, we have continued to develop and promote cash management services including sweep accounts and remote deposit capture during 2013 in order to increase the level of commercial deposit accounts. We believe that the development and promotion of these products has made us more competitive in attracting commercial deposits during recent periods.
The following table sets forth the balances of our deposit accounts at the dates indicated.
The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of September 30, 2013. Jumbo certificates of deposit require minimum deposits of $100,000.
The following table sets forth time deposits classified by rates at the dates indicated.
The following table sets forth the amount and maturities of time deposits at September 30, 2013.
The following table sets forth deposit activity for the periods indicated.
Borrowings. We use borrowings from the Federal Home Loan Bank of Indianapolis (FHLBI) consisting of advances and borrowings under a line of credit arrangement to supplement our supply of funds for loans and investments. We also utilize retail and broker repurchase agreements as sources of borrowings.
The following table sets forth certain information regarding the Bank’s use of FHLBI borrowings.
The outstanding balance of borrowings from the FHLBI increased $36.2 million from $53.1 million at September 30, 2012 to $89.3 million at September 30, 2013. FHLBI borrowings are primarily used to fund loan demand and to purchase available for sale securities. See Note 13 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding FHLBI borrowings.
The following table sets forth certain information regarding the Bank’s use of borrowings under retail repurchase agreements.
The following table sets forth certain information regarding the Bank’s use of borrowings under repurchase agreements with broker-dealers.
See Note 12 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding repurchase agreements.
Other Long-Term Debt. On July 27, 2012, FFCC, Inc. entered into a loan agreement with another financial institution to finance the retail development project discussed in Note 6 of the Notes to Consolidated Financial Statements beginning on page of this annual report. The loan has a maximum commitment of $5 million and FFCC, Inc. had borrowed $5.0 million under the loan at September 30, 2013. See Note 14 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding other long-term debt.
Results of Operations for the Years Ended September 30, 2013 and 2012
Overview. The Company reported net income of $4.7 million and net income available to common shareholders of $4.5 million ($1.99 per common share diluted; weighted average common shares outstanding of 2,269,063, as adjusted) for the year ended September 30, 2013, compared to net income of $4.3 million and net income available to common shareholders of $4.1 million ($1.85 per common share diluted; weighted average common shares outstanding of 2,230,188, as adjusted) for the year ended September 30, 2012.
As discussed in “Noninterest Expense” below, the Company recognized nonrecurring pretax charges totaling $597,000 during the year ended September 30, 2012 for the acquisition and integration of the First Federal branches, including data processing costs of $327,000, professional fees of $194,000 and other miscellaneous expenses of $76,000.
Net Interest Income. Net interest income increased $1.9 million, or 9.0%, from $21.3 million for the year ended September 30, 2012 to $23.2 million for the year ended September 30, 2013 primarily as the result of an increase in the average balance of interest earning assets from 2012 to 2013, which more than offset a decrease in the interest rate spread from 2012 to 2013. The interest rate spread, the difference between the average tax-equivalent yield on interest-earning assets and the average cost of interest-bearing liabilities, decreased from 4.07% for 2012 to 3.98% for 2013 due primarily to a decrease in the average tax-equivalent yield on interest-earning assets from 5.11% for 2012 to 4.75% for 2013, which more than offset a decrease in the average cost of interest-bearing liabilities from 1.04% for 2012 to 0.77% for 2013.
Total interest income increased $1.2 million, or 4.5% from $26.0 million for the year ended September 30, 2012 to $27.2 million for the year ended September 30, 2013. The increase in total interest income is due primarily to an increase in the average balance of interest earning assets of $68.3 million from $522.7 million for 2012 to $591.0 million for 2013, which more than offset the change in total interest income due to a decrease in the average tax-equivalent yield on interest-earning assets from 5.11% for 2012 to 4.75% for 2013. The increase in the average balance of interest-earning assets primarily relates to increases in the average balance of loans of $31.4 million, investment securities of $34.5 million and interest-bearing deposits with banks of $1.9 million.
Interest income on loans increased $515,000, or 2.5%, from $20.6 million for 2012 to $21.1 million for 2013 despite a decrease in the average tax-equivalent yield on loans from 5.58% for 2012 to 5.27% for 2013, due to an increase in the average balance of loans outstanding of $31.3 million from $371.1 million for 2012 to $402.4 million for 2013. The increase in the average balance of loans outstanding is due primarily to an increase in commercial real estate loans. In an effort to increase the size and diversity of the loan portfolio, the Bank offered competitive rates on short-term commercial real estate mortgage loans and was successful in originating these loans, which minimized the attrition in the residential real estate, commercial business and consumer loan portfolios.
Interest income on investment securities increased $599,000, or 11.5%, from $5.2 million for 2012 to $5.8 million for 2013. The increase in interest income on investment securities is due primarily to an increase in the average balance of investment securities of $34.5 million, or 25.1%, from $137.4 million for 2012 to $171.9 million for 2013, which more than offset the change in interest income on investment securities due to a decrease in the average tax-equivalent yield on investments securities from 4.26% for 2012 to 3.86% for 2013. During 2013, in an effort to maximize earnings and diversify the asset portfolio, the Bank increased its investments in CMOs issued by U.S. government agencies and sponsored enterprises, and municipal bonds.
Total interest expense decreased $739,000, or 15.7%, due primarily to a decrease in the average cost of funds from 1.04% for 2012 to 0.77% for 2013, which more than offset the change in total interest expense due to a $62.7 million increase in the average balance of interest-bearing liabilities from $450.0 million for 2012 to $512.7 million for 2013. The average balance of interest-bearing deposits increased $59.9 million, or 15.9%, from $378.3 million for 2012 to $438.2 million for 2013 and the average cost of funds for deposits was 0.92% for 2012 compared to 0.64% for 2013. The increase in the average balance of deposits is due primarily to the acquisition of the First Federal branches in July 2012. The average balance of borrowings increased $2.8 million, or 3.8%, from $71.7 million for 2012 to $74.5 million for 2013 and the average cost of funds for borrowings was 1.67% for 2012 compared to 1.53% for 2013. The average cost of interest-bearing liabilities decreased for 2013 primarily as a result of a reduction in the rates offered on deposit accounts during 2013, the repricing of time deposits at lower market rates during 2013, and the use of a certain level of lower-cost borrowings.
Average Balances and Yields.
The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Nonaccrual loans are included in average balances only. Loan fees are included in interest income on loans and are not material. Tax exempt income on loans and investment securities has been calculated on a tax equivalent basis using a federal marginal tax rate of 34%.
(1) Includes Federal Home Loan Bank borrowings, repurchase agreements and other long-term debt.
Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume have been allocated proportionally based on the absolute dollar amounts of change in each.
Provision for Loan Losses. The provision for loan losses increased $326,000, or 21.3%, from $1.5 million for the year ended September 30, 2012 to $1.9 million for the year ended September 30, 2013. During 2013, the Bank had net charge-offs of $1.2 million compared to $1.3 million for 2012. The gross loan portfolio increased $17.9 million from $400.2 million at September 30, 2012 to $418.1 million at September 30, 2013, primarily in the commercial real estate mortgage portfolio. Nonperforming loans increased $3.3 million from $5.8 million at September 30, 2012 to $9.1 million at September 30, 2013, due primarily to a single commercial real estate loan with an outstanding balance of $4.0 million that was placed on nonaccrual status as of September 30, 2013 based on regulatory guidance. This loan is classified as a troubled debt restructuring, but the loan was current and performing according to the terms of the note as of September 30, 2013. The consistent application of management’s allowance for loan losses methodology resulted in an increase in the level of the allowance for loan losses consistent with the growth in the commercial real estate mortgage loan portfolio and the increase in nonperforming loans during 2013. See “Analysis of Nonperforming and Classified Assets” included herein. It is management’s assessment that the allowance for loan losses at September 30, 2013 was adequate and appropriately reflected the inherent risk of loss in the Bank’s loan portfolio at that date.
Noninterest Income. Noninterest income increased $836,000, or 24.4%, from $3.4 million for the year ended September 30, 2012 to $4.3 million for the year ended September 30, 2013. The increase is due primarily to an increase in net gain on sale of loans of $313,000 from $197,000 in 2012 to $510,000 in 2013, and an increase in real estate lease income of $317,000, which was new in 2013 and relates to the real estate development discussed in Note 6 of the Notes to Consolidated Financial Statements beginning on page of this annual report, and an increase in net gain on trading securities of $247,000 from $217,000 in 2012 to $464,000 in 2013. These increases and additional gains were partially offset by a gain on a life insurance policy of $324,000 that was recognized in 2012.
Noninterest Expense. Noninterest expenses increased $1.7 million, or 9.5%, from $17.5 million for the year ended September 30, 2012 to $19.1 million for the year ended September 30, 2013. The increase was due primarily to increases in compensation and benefits expense of $1.4 million and occupancy and equipment expense of $385,000, which more than offset decreases in advertising of $160,000 and data processing of $157,000. The increase in compensation and benefits expense is due primarily to normal salary, wages and benefits increases, plus the addition of employees as a result of the acquisition of the First Federal branches and increased ESOP compensation expense of approximately $399,000 primarily due to the accelerated repayment of the ESOP loan during the December 2012 quarter. The increase in occupancy and equipment expense is due primarily to the operation of the acquired First Federal branches and the Bank’s new branch location in New Albany, Indiana, which opened in August 2013. The decrease in advertising expense was due primarily to a rebranding and advertising campaign for the Bank’s new ‘look’ and logo in 2012. The decreases in data processing are due primarily to expenditures associated with the acquisition and integration of the First Federal branches in 2012.
Income Tax Expense. The Company recognized income tax expense of $1.8 million for the year ended September 30, 2013, for an effective tax rate of 27.8%, compared to income tax expense of $1.5 million, for an effective tax rate of 25.4%, for the year ended September 30, 2012. The higher effective tax rate for the year ended September 30, 2013 was due primarily to a lower level of tax exempt income for 2013. See Note 18 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding income taxes.
Risk Management
Overview. Managing risk is essential to successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue or in the value of our common stock once we become a public company. The Company implemented an enterprise risk management structure during 2012 in order to better manage and mitigate these identified and perceived risks.
Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans.
When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a late notice is sent to the borrower and a late fee is assessed. When the loan becomes 30 days past due, a more formal letter is sent. Between 15 and 30 days past due, telephone calls are also made to the borrower. After 30 days, we regard the borrower as in default. The borrower may be sent a letter from our attorney and we may commence collection proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Generally, when a consumer loan becomes 60 days past due, we institute collection proceedings and attempt to repossess any personal property that secures the loan. Generally, we institute foreclosure proceedings when a loan is 60 days past due. Management obtains the approval of the Board of Directors to proceed with foreclosure of property. Management informs the Board of Directors monthly of all loans in nonaccrual status, all loans in foreclosure and all repossessed property and assets that we own.
Analysis of Nonperforming and Classified Assets. We consider non-accrual loans, troubled debt restructurings, repossessed assets and loans that are 90 days or more past due to be nonperforming assets. Loans are generally placed on non-accrual status when they become 90 days delinquent at which time the accrual of interest ceases and the allowance for any uncollectible accrued interest is established and charged against operations. Typically, payments received on a non-accrual loan are first applied to the outstanding principal balance.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired it is recorded at its fair market value less estimated costs to sell at the date of foreclosure. Holding costs and declines in fair value after acquisition of the property result in charges against income. See Note 8 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding foreclosed real estate.
The following table provides information with respect to our nonperforming assets at the dates indicated. Included in nonperforming loans are loans for which the Bank has modified the repayment terms, and therefore are considered to be troubled debt restructurings. The Bank had twenty-three troubled debt restructurings totaling $5.9 million, which were performing according to their terms and on accrual status, as of September 30, 2013. See Note 5 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding trouble debt restructurings.
(1) Total nonaccrual loans at September 30, 2010 includes four trouble debt restructurings totaling $592,000 that were on non-accrual as of that date. Total nonaccrual loans at September 30, 2013 includes seven trouble debt restructurings totaling $4.8 million that were on non-accrual as of that date.
Federal regulations require us to review and classify our assets on a regular basis. In addition, the Office of the Comptroller of the Currency has the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution, without establishment of a specific allowance or charge-off, is not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. When we classify an asset as doubtful we may establish a specific allowance for loan losses. If we classify an asset as loss, we charge off an amount equal to 100% of the portion of the asset classified loss.
The following table shows the aggregate amounts of investment in classified and criticized assets at the dates indicated.
(1) Includes substandard loans and investment securities, other real estate owned and repossessed assets.
Classified assets includes loans that are classified due to factors other than payment delinquencies, such as lack of current financial statements and other required documentation, insufficient cash flows or other deficiencies, and, therefore, are not included as non-performing assets. Other than as disclosed in the above tables, there are no other loans where management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms. Classified assets also include investment securities that have experienced a downgrade of the security’s credit quality rating by various rating agencies.
At September 30, 2013, the Company held twenty privately-issued CMO and ABS securities with an aggregate amortized cost of $2.9 million and fair value of $4.2 million that have been downgraded to a substandard regulatory classification due to a downgrade of the security’s credit quality rating by various rating agencies. Based on an independent third party analysis, the Bank expects to collect the contractual principal and interest cash flows for these securities and, as a result, no other-than-temporary impairment has been recognized on the privately-issued CMO or ABS portfolio. At September 30, 2012, the Company held eighteen privately-issued CMO and ABS securities with an aggregate amortized cost of $3.0 million and fair value of $3.9 million that had been downgraded to a substandard regulatory classification due to a downgrade of the security’s credit quality rating by various rating agencies.
Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.
Analysis and Determination of the Allowance for Loan Losses.
The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a specific allowance required for identified problem loans; (2) a general allowance on the remainder of the loan portfolio; and (3) an unallocated allowance to cover uncertainties that could affect management’s estimate of probable losses. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available to absorb losses in the loan portfolio.
Specific Allowance Required for Identified Problem Loans. For substandard and doubtful loans that are also classified as impaired we establish a specific allowance when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan.
General Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not currently classified as impaired in order to recognize the inherent losses associated with lending activities. The general allowance covers unimpaired loans and is based on historical loss experience adjusted for qualitative factors such as changes in economic conditions, changes in the volume of past due and non-accrual loans and classified assets, changes in the nature and volume of the portfolio, changes in the value of underlying collateral for collateral dependent loans, concentrations of credit, and other factors.
Unallocated Allowance. We may establish an unallocated allowance to cover uncertainties that could affect management’s estimate of probable losses. Any unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimate specific and general losses in the loan portfolio. There was no unallocated allowance for loan losses at September 30, 2013, 2012 and 2011.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that the Office of the Comptroller of the Currency, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses. The Office of the Comptroller of the Currency may require us to increase our allowance for loan losses based on judgments different from ours. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
Analysis of Loan Loss Experience.
The following table sets forth an analysis of the allowance for loan losses for the periods indicated.
Interest Rate Risk Management. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes: adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration and generally selling in the secondary market substantially all newly originated, fixed rate one-to four-family residential real estate loans. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments; however, we acquired an interest rate cap contract in the acquisition of Community First. See Note 23 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding the use of derivative instruments.
We have an Asset/Liability Management Committee, which includes members of management approved by the Board of Directors, to communicate, coordinate and control all aspects involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.
Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income and net income.
Market Risk Analysis. An element in our ongoing process is to measure and monitor interest rate risk using a Net Interest Income at Risk simulation to model the interest rate sensitivity of the balance sheet and to quantify the impact of changing interest rates on the Company. The model quantifies the effects of various possible interest rate scenarios on projected net interest income over a one-year horizon. The model assumes a semi-static balance sheet and measures the impact on net interest income relative to a base case scenario of hypothetical changes in interest rates over twelve months and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The scenarios include prepayment assumptions, changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates in order to capture the impact from re-pricing, yield curve, option, and basis risks.
Results of our simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company’s net interest income could change as follows over a one-year horizon, relative to our base case scenario, based on September 30, 2013 and 2012 financial information.
At September 30, 2013, our simulated exposure to an increase in interest rates shows that an immediate and sustained increase in rates of 1.00% will decrease our net interest income by $69,000 or 0.31% over a one year horizon compared to a flat interest rate scenario. Furthermore, rate increases of 2.00% and 3.00% would cause net interest income to decrease by 0.50% and 0.45%, respectively.
The Company also has longer term interest rate risk exposure, which may not be appropriately measured by Net Interest Income at Risk modeling, and therefore uses an Economic Value of Equity (“EVE”) interest rate sensitivity analysis in order to evaluate the impact of its interest rate risk on earnings and capital. This is measured by computing the changes in net EVE for its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE modeling involves discounting present values of all cash flows for on and off balance sheet items under different interest rate scenarios and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The discounted present value of all cash flows represents the Company’s EVE and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. The amount of base case EVE and its sensitivity to shifts in interest rates provide a measure of the longer term re-pricing and option risk in the balance sheet.
Results of our simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that Company’s EVE could change as follows, relative to our base case scenario, based on September 30, 2013 and 2012 financial information.
The previous table indicates that at September 30, 2013, the Company would expect a decrease in its EVE in the event of a sudden and sustained 100 to 300 basis point increase and/or 100 basis point decrease in prevailing interest rates. The expected decrease in the Company’s EVE given a larger increase in rates is primarily attributable to the relatively high percentage of fixed-rate loans in the Company’s loan portfolio, which at September 30, 2013 comprised approximately 55.2% of the loan portfolio.
The models are driven by expected behavior in various interest rate scenarios and many factors besides market interest rates affect the Company’s net interest income and EVE. For this reason, we model many different combinations of interest rates and balance sheet assumptions to understand its overall sensitivity to market interest rate changes. Therefore, as with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables and it’s recognized that the model outputs are not guarantees of actual results. 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.
Liquidity Management. Liquidity is the ability to meet current and future short-term financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the FHLBI. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The Bank regularly adjusts its investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.
The Bank’s most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2013, cash and cash equivalents totaled $20.8 million. Securities classified as trading and available-for-sale, amounting to $3.2 million and $164.2 million, respectively, at September 30, 2013, provide additional sources of liquidity. At September 30, 2013, we had the ability to borrow a total of approximately $110.0 million from the FHLBI, of which $89.3 million was borrowed and outstanding. See Note 13 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding FHLBI borrowings. In addition, we had the ability to borrow the lesser of $10 million or 25% of the Bank’s equity capital, excluding reserves, using a federal funds purchased line of credit facility with another financial institution at September 30, 2013. The Bank had no outstanding federal funds purchased under the facility at September 30, 2013. See Note 11 of the Notes to Consolidated Financial Statements beginning on page of this annual report for additional information regarding federal funds purchased borrowings.
At September 30, 2013, the Bank had $64.5 million in commitments to extend credit outstanding. Certificates of deposit due within one year of September 30, 2013 totaled $85.4 million, or 48.9% of certificates of deposit. We believe the large percentage of certificates of deposit that mature within one year reflects customers’ hesitancy to invest their funds for long periods due to the recent low interest rate environment and local competitive pressure. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2014. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
The Company is a separate legal entity from the Bank and must provide for its own liquidity to pay its operating expenses and other financial obligations, to pay any dividends and to repurchase any of its outstanding common stock. The Company’s primary source of income is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company in any calendar year, without the receipt of prior approval from the Office of the Comptroller of the Currency (“OCC”) but with prior notice to OCC, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. At September 30, 2013, the Company had liquid assets of $1.7 million.
The following tables present certain of our contractual obligations as of September 30, 2013.
(1) Includes deferred compensation agreement with a former officer that calls for annual payments of $9,000 until his death.
(2) Represents outstanding principal balance on a $5.0 million loan agreement with another financial institution to finance a retail development project. The loan calls for 12 interest only monthly payments, followed by 107 monthly payments sufficient to fully amortize the loan over a 20 year period and a balloon payment of all outstanding principal and interest at maturity on July 27, 2022.
Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts and FHLBI borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive. Occasionally, we offer promotional rates on certain deposit products to attract deposits.
Financing and Investing Activities
The following table presents our primary investing and financing activities during the periods indicated.
Capital Management. The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2013, the Bank exceeded all of its regulatory capital requirements. The Bank is considered “well capitalized” under regulatory guidelines. See “Item 1. Business - Regulation and Supervision - Regulation of Federal Savings Associations - Capital Requirement,” and Note 27 of the Notes to Consolidated Financial Statements beginning on page of this annual report.
On July 9, 2013, the federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with Basel III and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. The rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. See “Item 1. Business- Regulation and Supervision -Basel III.”
Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments and unused lines of credit, see Note 19 of the Notes to Consolidated Financial Statements beginning on page of this annual report.
For the year ended September 30, 2013, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Impact of Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see Note 1 of the Notes to Consolidated Financial Statements beginning on page of this annual report.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented in this annual report have been prepared according to accounting principles generally accepted in the United States, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item is included herein beginning on page.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
(b) Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision 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 accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2013, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of September 30, 2013 is effective.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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 rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
(c) Changes to Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2013 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information relating to the directors and officers of the Company, information regarding compliance with Section 16(a) of the Exchange Act and information regarding the audit committee and audit committee financial expert is incorporated herein by reference to the sections captioned “Item 1 - Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Audit Committee” in the Company’s Proxy Statement for the 2014 Annual Meeting of Stockholders (the “Proxy Statement”).
The Company has adopted a code of ethics and business conduct which applies to all of the Company’s and the Bank’s directors, officers and employees. A copy of the code of ethics and business conduct is available to stockholders on the Investor Relations portion of the Bank’s website at www.fsbbank.net.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information regarding executive compensation is incorporated herein by reference to the sections captioned “Director Compensation” and “Executive Compensation” in the Proxy Statement.
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 “Stock Ownership” in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no 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 registrant.
(d) Equity Compensation Plan Information
The following table sets forth information as of September 30, 2013 about Company common stock that may be issued under the Company’s equity compensation plans. All plans were approved by the Company’s stockholders.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information relating to certain relationships and related transactions and director independence is incorporated herein by reference to the sections captioned “Transactions with Related Persons” and “Director Independence” in the Proxy Statement.
Item 14.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information relating to the principal accountant fees and expenses is incorporated herein by reference to the section captioned “Ratification of the Independent Registered Public Accounting Firm” in the Proxy Statement.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) The financial statements required in response to this item are incorporated by reference from Item 8 of this Annual Report on Form 10-K.
(2) All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3) Exhibits
No.
Description
3.1
Articles of Incorporation of First Savings Financial Group, Inc. (1)
3.2
Articles of Amendment to the Articles of Incorporation for the Series A Preferred Stock (2)
3.3
Bylaws of First Savings Financial Group, Inc. (1)
4.0
Specimen Stock Certificate of First Savings Financial Group, Inc. (1)
10.1
Amended and Restated Employment Agreement by and among First Savings Financial Group, Inc., First Savings Bank, F.S.B. and Larry W. Myers, dated October 7, 2009* (3)
10.2
Amended and Restated Employment Agreement by and among First Savings Financial Group, Inc., First Savings Bank, F.S.B. and John P. Lawson, Jr., dated October 7, 2009* (3)
10.3
Amended and Restated Employment Agreement by and among First Savings Financial Group, Inc., First Savings Bank, F.S.B. and Anthony A. Schoen, dated October 7, 2009* (3)
10.4
Amended and Restated Employment Agreement by and among First Savings Financial Group, Inc., First Savings Bank, F.S.B. and Samuel E. Eckart, dated October 7, 2009* (3)
10.5
First Savings Bank, F.S.B. Employee Severance Compensation Plan* (4)
10.6
First Savings Bank, F.S.B. Supplemental Executive Retirement Plan* (4)
10.7
Securities Purchase Agreement, dated August 11, 2011, between the Company and the Secretary of the Treasury with respect to the Series A Preferred Stock (2)
10.8
Amended and Restated Director Deferred Compensation Agreement* (1)
21.0
Subsidiaries of the Registrant
23.0
Consent of Monroe Shine & Co., Inc.
31.1
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer
31.2
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer
32.0
Section 1350 Certificate of Chief Executive Officer and Chief Financial Officer
*
Management contract or compensatory plan, contract or arrangement
(1)
Incorporated herein by reference to the exhibits to the Company’s Registration Statement on Form S-1 (File No. 333-151636), as amended, initially filed with the Securities and Exchange Commission on June 13, 2008.
(2)
Incorporated by reference to the exhibits to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 17, 2011.
(3)
Incorporated herein by reference to the exhibits to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 8, 2009.
(4)
Incorporated herein by reference to the exhibits to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 10, 2008.
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.
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.
Name
Title
Date
/s/ Larry W. Myers
President, Chief Executive Officer
December 30, 2013
Larry W. Myers
and Director
(principal executive officer)
/s/ Anthony A. Schoen
Chief Financial Officer
December 30, 2013
Anthony A. Schoen
(principal accounting and financial officer)
/s/ John P. Lawson, Jr.
Chief Operating Officer and Director
December 30, 2013
John P. Lawson, Jr.
/s/ Samuel E. Eckart
Executive Vice President and Director
December 30, 2013
Samuel E. Eckart
/s/ Charles E. Becht, Jr.
Director
December 30, 2013
Charles E. Becht, Jr.
/s/ Cecile A. Blau
Director
December 30, 2013
Cecile A. Blau
/s/ Gerald Wayne Clapp, Jr.
Director
December 30, 2013
Gerald Wayne Clapp, Jr.
/s/ Michael F. Ludden
Director
December 30, 2013
Michael F. Ludden
/s/ Douglas A. York
Director
December 30, 2013
Douglas A. York
/s/ Vaughn K. Timberlake
Director
December 30, 2013
Vaughn K. Timberlake
/s/ Frank N. Czeschin
Director
December 30, 2013
Frank N. Czeschin
/s/ John E. Colin
Director
December 30, 2013
John E. Colin
FIRST SAVINGS FINANCIAL GROUP, INC.
AND SUBSIDIARIES -
CLARKSVILLE, INDIANA
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED
SEPTEMBER 30, 2013 AND 2012
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONTENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
First Savings Financial Group, Inc.
Clarksville, Indiana
We have audited the accompanying consolidated balance sheets of First Savings Financial Group, Inc. and Subsidiaries as of September 30, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended. The Company's management is responsible for these consolidated financial statements. 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 audits 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, 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 financial position of First Savings Financial Group, Inc. and Subsidiaries as of September 30, 2013 and 2012, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
New Albany, Indiana
December 30, 2013
Monroe Shine & Co., Inc. ¨ Certified Public Accountants and Business Consultants
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2013 AND 2012
See notes to consolidated financial statements.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 2013 AND 2012
See notes to consolidated financial statements.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED SEPTEMBER 30, 2013 AND 2012
See notes to consolidated financial statements.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2013 AND 2012
See notes to consolidated financial statements.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2013 AND 2012
See notes to consolidated financial statements.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 AND 2012
(1)
SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
First Savings Financial Group, Inc. (the “Company”) is the savings and loan holding company of First Savings Bank, F.S.B. (the “Bank”), a wholly-owned subsidiary. The Bank is a federally-chartered savings bank which provides a variety of banking services to individuals and business customers through fourteen locations in southern Indiana. The Bank attracts deposits primarily from the general public and uses those funds, along with other borrowings, primarily to originate residential mortgage, commercial mortgage, construction, commercial business and consumer loans, and to a lesser extent, to invest in mortgage-backed securities and other securities.
The Bank has three-wholly owned subsidiaries: First Savings Investments, Inc., a Nevada corporation that manages a securities portfolio, FFCC, Inc., which is an Indiana corporation that participates in commercial real estate development and leasing, and Southern Indiana Financial Corporation, which is currently inactive.
Basis of Consolidation and Reclassifications
The consolidated financial statements include the accounts of the Company and its subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Intercompany balances and transactions have been eliminated. Certain prior year amounts have been reclassified to conform with current year presentation.
Statements of Cash Flows
For purposes of the statements of cash flows, the Company has defined cash and cash equivalents as cash on hand, amounts due from banks (including cash items in process of clearing) and interest-bearing deposits with other banks having an original maturity of 90 days or less.
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. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate and other assets acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and other real estate owned, management obtains independent appraisals for significant properties.
A majority of the Bank’s loan portfolio consists of single-family residential and commercial real estate loans in the southern Indiana area. Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio and the recovery of the carrying amount of other real estate owned are susceptible to changes in local market conditions.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Use of Estimates - continued
While management uses available information to recognize losses on loans and other real estate owned, further reductions in the carrying amounts of loans and other real estate owned may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and other real estate owned. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible the estimated losses on loans and other real estate owned may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
Investment Securities
Trading Account Securities: Securities purchased with the intention of recognizing short-term profits or which are actively bought and sold are classified as trading account securities and reported at fair value. The net realized and unrealized gains and losses on trading account securities are reported in other noninterest income. Realized gains and losses on trading account securities are determined using the specific identification method.
Securities Available for Sale: Securities available for sale consist primarily of mortgage-backed and other debt securities and are stated at fair value. The Company holds mortgage-backed securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), government-sponsored enterprises, as well as privately-issued collateralized mortgage obligations (“CMOs”), privately-issued asset-backed securities (“ABSs”) and other mortgage-backed securities. The Company also holds a pass-through asset-backed security guaranteed by the Small Business Administration (“SBA”) representing participating interests in pools of long-term debentures issued by state and local development companies certified by the SBA. Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by issuers of the securities. CMOs and ABSs are complex mortgage-backed securities that restructure the cash flows and risks of the underlying mortgage collateral. The Company also holds debt securities issued by government-sponsored enterprises and municipal bonds.
Amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity, adjusted for anticipated prepayments. Unrealized gains and losses, net of tax, on securities available for sale are included in other comprehensive income and the accumulated unrealized holding gains and losses are reported as a separate component of equity until realized. Realized gains and losses on the sale of securities available for sale are determined using the specific identification method and are included in other noninterest income and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income.
Securities Held to Maturity: Debt securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts that are recognized in interest income using methods approximating the interest method over the period to maturity, adjusted for anticipated prepayments. The Company classifies certain mortgage-backed securities and municipal obligations as held to maturity.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Declines in the fair value of individual available for sale and held to maturity securities below their amortized cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value.
Investments in non-marketable equity securities such as Federal Home Loan Bank (“FHLB”) stock are carried at cost. Impairment testing on these investments is based on applicable accounting guidance and the cost basis is reduced when impairment is deemed to be other-than-temporary.
Derivative Financial Instruments
The Company applies Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging, in accounting for derivative financial instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Derivative financial instruments are recognized in the consolidated balance sheet at fair value.
Mortgage Banking Activities
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. Aggregate market value is determined based on the quoted prices under a “best efforts” sales agreement with a third party. Net unrealized losses are recognized through a valuation allowance by charges to income. Realized gains on sales of mortgage loans are included in noninterest income. Mortgage loans are sold with servicing released.
Commitments to originate mortgage loans held for sale are considered derivative financial instruments to be accounted for at fair value. The Bank’s mortgage loan commitments subject to derivative accounting are fixed rate mortgage loan commitments at market rates when initiated. At September 30, 2013, the Bank had commitments to originate $1.3 million in fixed-rate mortgage loans intended for sale in the secondary market after the loans are closed. Fair value is estimated based on fees that would be charged on commitments with similar terms.
Loans and Allowance for Loan Losses
Loans Held for Investment
Loans are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses. The Company grants real estate mortgage, commercial business and consumer loans. A substantial portion of the loan portfolio is represented by residential and commercial mortgage loans to customers in southern Indiana. The ability of the Company customers to honor their contracts is dependent upon the real estate and general economic conditions in this area.
Loan origination and commitment fees, as well as certain direct costs of underwriting and closing loans, are deferred and amortized as a yield adjustment to interest income over the lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Loans and Allowance for Loan Losses - continued
Nonaccrual Loans
The recognition of income on a loan is discontinued and previously accrued interest is reversed, when interest or principal payments become 90 days past due unless, in the opinion of management, the outstanding interest remains collectible. Past due status is determined based on contractual terms. Generally, by applying the cash receipts method, interest income is subsequently recognized only as received until the loan is returned to accrual status. The cash receipts method is used when the likelihood of further loss on the loan is remote. Otherwise, the Company applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance until the loan qualifies for return to accrual status. Interest income on impaired loans is recognized using the cost recovery method, unless the likelihood of further loss is considered remote.
A loan is restored to accrual status when all principal and interest payments are brought current and the borrower has demonstrated the ability to make future payments of principal and interest as scheduled, which generally requires that the borrower demonstrate a period of performance of at least six consecutive months.
Loan Charge-Offs
For portfolio segments other than consumer loans, the Company’s practice is to charge off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or for other reasons. A partial charge-off is recorded on a loan when the uncollectibility of a portion of the loan has been confirmed, such as when a loan is discharged in bankruptcy, the collateral is liquidated, a loan is restructured at a reduced principal balance, or other identifiable events that lead management to determine the full principal balance of the loan will not be repaid. A specific reserve is recognized as a component of the allowance for estimated losses on loans individually evaluated for impairment. Partial charge-offs on nonperforming and impaired loans are included in the Company’s historical loss experience used to estimate the general component of the allowance for loan losses as discussed below. Specific reserves are not considered charge-offs in management’s analysis of the allowance for loan losses because they are estimates and the outcome of the loan relationship is undetermined.
During the years ended September 30, 2013 and 2012, the Company recognized partial charge-offs on loans totaling $306,000 and $219,000, respectively. At September 30, 2013 and 2012, the Company had three outstanding loans with an aggregate recorded investment of $920,000 on which partial charge-offs totaling $525,000 had been recorded.
Consumer loans are typically charged off at 90 days past due, or earlier if deemed uncollectible, unless the loans are in the process of collection. Overdrafts are charged off after 45 days past due. Charge-offs are typically recorded on loans secured by real estate when the property is foreclosed upon when the carrying value of the loan exceeds the property’s fair value less the estimated costs to sell.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Loans and Allowance for Loan Losses - continued
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The Company uses a disciplined process and methodology to evaluate the allowance for loan losses on at least a quarterly basis that 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 consists of specific and general components. The specific component relates to loans that are individually evaluated for impairment or loans otherwise classified as doubtful, substandard, or special mention. For such loans that are classified as impaired, 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 general component covers non-classified loans and classified loans that are found, upon individual evaluation, to not be impaired. Such loans are pooled by segment and losses are modeled using annualized historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 36-month period. This actual loss experience is then adjusted for qualitative factors that are reviewed on a quarterly basis based on the risks present for each portfolio segment. Management considers changes and trends in the following qualitative loss factors: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in the volume and term of new loan originations; national and local economic trends and conditions; changes in lending policies, procedures and practices; changes in the experience and ability of lending management and other staff; changes in the quality and depth of the internal loan review process; trends in collateral valuation in the Company’s lending area; and other factors as determined by management. Each qualitative factor is evaluated and a qualitative factor adjustment is applied to the actual historical loss factors in determining the adjusted loss factors used in management’s allowance for loan losses adequacy calculation.
Management exercises significant judgment in evaluating the relevant historical loss experience and the qualitative factors. Management also monitors the differences between estimated and actual incurred loan losses for loans considered impaired in order to evaluate the effectiveness of the estimation process and make any changes in the methodology as necessary.
The following portfolio segments are considered in the allowance for loan loss analysis: residential real estate, commercial real estate, multi-family residential real estate, construction, land and land development, commercial business and consumer.
Residential real estate loans primarily consist of loans to individuals for the purchase or refinance of their primary residence, with a smaller portion of the segment secured by non-owner-occupied residential investment properties. The risks associated with residential real estate loans are closely correlated to the local housing market and general economic conditions, as repayment of the loans is primarily dependent on the borrower’s or tenant’s personal cash flow and employment status.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Loans and Allowance for Loan Losses - continued
Commercial real estate loans are comprised of loans secured by various types of collateral including office buildings, warehouses, retail space and mixed use buildings located in the Company’s primary lending area. Risks related to commercial real estate lending are related to the market value of the property taken as collateral, the underlying cash flows and general economic condition of the local real estate market. Repayment of these loans is generally dependent on the ability of the borrower to attract tenants at lease rates that provide for adequate debt service and can be impacted by local economic conditions which impact vacancy rates. The Company generally obtains loan guarantees from financially capable parties for commercial real estate loans.
Multi-family residential real estate loans primarily consist of loans secured by apartment buildings and other multi-tenant developments. Repayment of these loans is primarily dependent on the borrower’s ability to attract tenants and collect rents that provide for adequate debt service. The risks associated with these loans are closely correlated to the local housing market and general economic conditions.
The Company’s construction loan portfolio consists of single-family residential properties, multi-family properties and commercial projects, and includes both owner-occupied and speculative investment properties. Risks inherent in construction lending are related to the market value of the property held as collateral, the cost and timing of constructing or improving a property, the borrower’s ability to use funds generated by a project to service a loan until a project is completed, movements in interest rates and the real estate market during the construction phase, and the ability of the borrower to obtain permanent financing.
Land and land development loans primarily consist of loans secured by farmland and vacant land held for long-term investment or development. The risks associated with land and land development loans are related to the market value of the property taken as collateral and the underlying cash flows for loans secured by farmland, and general economic conditions.
Commercial business loans includes lines of credit to businesses, term loans and letters of credit secured by business assets such as equipment, accounts receivable, inventory, or other assets excluding real estate and are generally made to finance capital expenditures or fund operations. Commercial loans contain risks related to the value of the collateral securing the loan and the repayment is primarily dependent upon the financial success and viability of the borrower. As with commercial real estate loans, the Company generally obtains loan guarantees from financially capable parties for commercial business loans.
Consumer loans consist primarily of home equity lines of credit and other loans secured by junior liens on the borrower’s personal residence, home improvement loans, automobile and truck loans, boat loans, mobile home loans, loans secured by savings deposits and other personal loans. The risks associated with these loans are related to the local housing market and local economic conditions including the unemployment level.
There were no significant changes to the Company’s accounting policies or methodology used to estimate the allowance for loan losses during the years ended September 30, 2013 and 2012.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(1 - continued)
Loans and Allowance for Loan Losses - continued
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Values for collateral dependent loans are generally based on appraisals obtained from independent licensed real estate appraisers, with adjustments applied for estimated costs to sell the property, costs to complete unfinished or repair damaged property and other known defects. New appraisals are generally obtained for all significant properties when a loan is identified as impaired. Generally, a property is considered significant if the value of the property is estimated to exceed $250,000. Subsequent appraisals are obtained as needed or if management believes there has been a significant change in the market value of a collateral property securing an impaired loan. In instances where it is not deemed necessary to obtain a new appraisal, management would base its impairment and allowance for loan loss analysis on the original appraisal with adjustments for current conditions based on management’s assessment of market factors and management’s inspection of the property.
Troubled Debt Restructurings
The modification of a loan is considered to be a troubled debt restructuring (TDR) if the debtor is experiencing financial difficulties and the Company grants a concession to the debtor that it would not otherwise consider. By granting the concession, the Company expects to obtain more cash or other value from the debtor, or to increase the probability of receipt, than would be expected by not granting the concession. The concession may include, but is not limited to, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount of the debt. A concession will be granted when, as a result of the restructuring, the Company does not expect to collect all amounts due, including interest at the original stated rate. A concession may also be granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. The Company’s determination of whether a loan modification is a TDR considers the individual facts and circumstances surrounding each modification.
A TDR can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Generally, a nonaccrual loan that is restructured in a TDR remains on nonaccrual status for a period of at least six months following the restructuring to ensure that the borrower performs in accordance with the restructured terms including consistent and timely payments of at least six consecutive months according to the restructured terms.
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(1 - continued)
Real Estate Development and Construction
Real estate that is developed and on which buildings are constructed for the purpose of leasing or sale to third parties by the Company is stated at cost, including interest capitalized during the construction period, less accumulated depreciation. The Company uses the straight line method of computing depreciation at rates adequate to amortize the cost of the applicable assets over their estimated useful lives. Maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of assets sold, or otherwise disposed of, are removed from the related accounts and any gain or loss is included in earnings.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. The Company uses the straight line method of computing depreciation at rates adequate to amortize the cost of the applicable assets over their estimated useful lives. Maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of assets sold, or otherwise disposed of, are removed from the related accounts and any gain or loss is included in earnings.
Other Real Estate Owned
Other real estate owned includes formally foreclosed property, in-substance foreclosed property and former banking facilities held for sale. In-substance foreclosed properties are those properties for which the Company has taken physical possession, regardless of whether formal foreclosure proceedings have taken place.
At the time of foreclosure, foreclosed real estate is recorded at its fair value less estimated costs to sell, which becomes the property’s new basis. Any write-downs based on the property’s fair value at date of acquisition are charged to the allowance for loan losses. After foreclosure or the decision to classify property as held for sale, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Costs incurred in maintaining other real estate owned and subsequent impairment adjustments to the carrying amount of a property, if any, are included in noninterest expense.
Cash Surrender Value of Life Insurance
The Bank has purchased life insurance policies on certain directors, officers and key employees to help offset costs associated with the Bank’s compensation and benefit programs. Bank-owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Goodwill and Other Intangibles
Goodwill recognized in a business combination represents the excess of the cost of the acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. Goodwill is carried at its implied fair value and is evaluated for possible impairment at least annually or more frequently upon the occurrence of an event or change in circumstances that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. If the carrying amount of the goodwill exceeds its implied fair value, an impairment loss is recognized in earnings equal to that excess amount. The loss recognized cannot exceed the carrying amount of goodwill. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill is its new accounting basis.
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Goodwill and Other Intangibles - continued
Other intangible assets consist of acquired core deposit intangibles. Core deposit intangibles are amortized over the estimated economic lives of the acquired core deposits. The carrying amount of core deposit intangibles and the remaining estimated economic life are evaluated annually or whenever events or circumstances indicate the carrying amount may not be recoverable or the remaining period of amortization requires revision. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset is its new accounting basis.
Securities Lending and Financing Arrangements
Securities purchased under agreements to resell (reverse repurchase agreements) and securities sold under agreements to repurchase (repurchase agreements) are treated as collateralized lending and borrowing transactions, respectively, and are carried at the amounts at which the securities were initially acquired or sold.
Benefit Plans
The Bank provides a contributory defined contribution plan available to all eligible employees. The Company established a leveraged employee stock ownership plan (“ESOP”) on October 6, 2008 that includes substantially all employees. The Company accounts for the employee stock ownership plan in accordance with ASC Topic 718-40, Employee Stock Ownership Plans. Dividends declared on allocated shares are recorded as a reduction of retained earnings and paid to the participants’ accounts or used for additional debt service on the ESOP loan. Dividends declared on unallocated shares are not considered dividends for financial reporting purposes and are used for additional debt service on the ESOP loan. As shares are committed to be released for allocation to participants’ accounts, compensation expense is recognized based on the average fair value of the shares and the shares become available for earnings per share calculations.
Stock Based Compensation
The Company has adopted the fair value based method of accounting for stock-based compensation prescribed in ASC Topic 718 for its stock plan.
Income Taxes
When income tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while other positions are subject to some degree of uncertainty regarding the merits of the position taken or the amount of the position that would be sustained. The Company recognizes the benefits of a tax position in the consolidated financial statements of the period during which, based on all available evidence, management believes it is more-likely-than-not (more than 50 percent probable) that the tax position would be sustained upon examination. Income tax positions that meet the more-likely-than-not threshold are measured as the largest amount of income tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with the income tax positions claimed on income tax returns that exceeds the amount measured as described above is reflected as a liability for unrecognized income tax benefits in the consolidated balance sheets, along with any associated interest and penalties that would be payable to the taxing authorities, if there were an examination. Interest and penalties associated with unrecognized income tax benefits are classified as additional income taxes in the consolidated statements of income.
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Income Taxes - continued
Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred income taxes. Income tax reporting and financial statement reporting rules differ in many respects. As a result, there will often be a difference between the carrying amount of an asset or liability as presented in the accompanying consolidated balance sheets and the amount that would be recognized as the tax basis of the same asset or liability computed based on the effects of tax positions recognized, as described in the preceding paragraph. These differences are referred to as temporary differences because they are expected to reverse in future years. Deferred income tax assets are recognized for temporary differences where their future reversal will result in future tax benefits. Deferred income tax assets are also recognized for the future tax benefits expected to be realized from net operating loss or tax credit carryforwards. Deferred income tax liabilities are recognized for temporary differences where their future reversal will result in the payment of future income taxes. Deferred income tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Advertising Costs
Advertising costs are charged to operations when incurred.
Comprehensive Income
Comprehensive income consists of reported net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses that are recorded as an element of equity but are excluded from reported net income. Other comprehensive income includes changes in the unrealized gains and losses on securities available for sale.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Recent Accounting Pronouncements
The following are summaries of recently issued accounting pronouncements that impact the accounting and reporting practices of the Company:
In December 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210). The update requires an entity to disclose information about offsetting and related arrangements to enable users of the financial statements to understand the effect of netting arrangements on the entity’s financial position. The scope includes derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. ASU No. 2013-01 was issued in January 2013 to address implementation issues and clarify the scope of ASU No. 2011-11. The amendments in the updates are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, with disclosures required by the amendments provided retrospectively for all comparative periods presented. The adoption of these updates is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
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Recent Accounting Pronouncements - continued
In October 2012, the FASB issued ASU No. 2012-06, Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. The update indicates that when a reporting entity initially recognizes an indemnification asset as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification agreement and the remaining life of the indemnified assets). The amendments in the update are effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012, and should be applied prospectively to any new indemnification assets acquired after the date of adoption and to indemnification assets existing as of the date of adoption. Early adoption is permitted. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The update does not change the current requirements for reporting net income or other comprehensive income in financial statements. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. For public entities, the amendments in the update are effective prospectively for reporting periods beginning after December 15, 2012. Early adoption is permitted. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The amendments in ASU No. 2013-11 to Topic 740, Income Taxes, provide guidance on the financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
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(2) ACQUISITION OF BRANCHES
The Company acquired the Indiana branch offices of Elizabethtown, Kentucky-based First Federal Savings Bank of Elizabethtown, Inc. (“First Federal”) on July 6, 2012, pursuant to an Agreement to Purchase Assets and Assume Liabilities dated February 8, 2012 (the “Agreement”). The offices are located in Corydon, Elizabeth, Georgetown and Lanesville, Indiana. The Company has consolidated the operations of the acquired Corydon and Georgetown offices with its existing Corydon and Georgetown offices because of their close proximities. The acquisition expanded the Company’s presence in Harrison and Floyd Counties, Indiana, and the Company expects to benefit from growth in this market area as well as from expansion of the banking services provided to the existing customers of First Federal.
Pursuant to the terms of the Agreement, the Company assumed certain deposit and other liabilities and purchased certain performing loans, real estate and other assets associated with the four First Federal banking offices. The transaction was accounted for using the purchase method of accounting. Under the purchase method of accounting, the purchase price was assigned to the assets acquired and liabilities assumed based on their estimated fair values, net of applicable income tax effects. The excess of cost over the fair value of the acquired net assets of $2.0 million has been recorded as goodwill.
Following is a condensed balance sheet showing the fair values of the assets acquired and the liabilities assumed as of the date of acquisition:
In accounting for the acquisition, $566,000 was assigned to a core deposit intangible which is amortized over a weighted-average estimated economic life of 11.3 years. It is not anticipated that the core deposit intangible will have a significant residual value. The $2.0 million of goodwill arising in the acquisition is deductible for income tax purposes.
ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to a loan with evidence of deterioration of credit quality since origination, acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. No loans with evidence of deterioration of credit quality were acquired in the acquisition. The gross contractual amount receivable from the acquired loans was $30.4 million and the fair value of the acquired loans was $32.4 million at the acquisition date. All contractual cash flows from the acquired loans were expected to be collected at the acquisition date.
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(3)
RESTRICTION ON CASH AND DUE FROM BANKS
The Bank is required to maintain reserve balances on hand and with the Federal Reserve Bank which are unavailable for investment but are interest-bearing. The average amount of those reserve balances was approximately $6.3 million and $2.8 million for the years ended September 30, 2013 and 2012, respectively.
(4)
INVESTMENTSECURITIES
Investment securities have been classified according to management’s intent.
Trading Account Securities
On May 31, 2012, the Company invested in a managed brokerage account that invests in small and medium lot, investment grade municipal bonds. The brokerage account is managed by an investment advisory firm registered with the U.S. Securities and Exchange Commission. Trading account securities recorded at fair value totaled $3.2 million and $3.6 million as of September 30, 2013 and 2012, respectively, comprised of investment grade municipal bonds. During the year ended September 30, 2013, the Company reported net gains on trading account securities of $464,000, including net realized gains on the sale of securities of $472,000, partially offset by net unrealized losses on securities still held as of the balance sheet date of $8,000. During the year ended September 30, 2012, the Company reported net gains on trading account securities of $217,000, including net realized gains on the sale of securities of $165,000 and net unrealized gains on securities still held as of the balance sheet date of $52,000.
Securities Available for Sale and Held to Maturity
The amortized cost of securities available for sale and held to maturity and their approximate fair values are as follows:
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The amortized cost and fair value of available for sale and held to maturity debt securities as of September 30, 2013 by contractual maturity are shown below. Expected maturities of mortgage and other asset-backed securities may differ from contractual maturities because the mortgages and other assets underlying the obligations may be prepaid without penalty.
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Information pertaining to securities with gross unrealized losses at September 30, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position, follows:
At September 30, 2013, the Company did not have any securities held to maturity with an unrealized loss.
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
The total available for sale debt securities in loss positions at September 30, 2013 had depreciated approximately 3.71% from the Company’s amortized cost basis and are fixed and variable rate securities with a weighted-average yield of 2.28% and a weighted-average coupon rate of 3.41% at September 30, 2013.
U.S. government agency notes, mortgage-backed securities and CMOs, and municipal bonds in loss positions at September 30, 2013 had depreciated approximately 3.71% from the Company’s amortized cost basis as of September 30, 2013. All of the agency and municipal securities are issued by U.S. government-sponsored enterprises and municipal governments, and are generally secured by first mortgage loans and municipal project reserves.
The Company evaluates the existence of a potential credit loss component related to the decline in fair value of the privately-issued CMO and ABS portfolios each quarter using an independent third party analysis. At September 30, 2013, the Company held twenty privately-issued CMO and ABS securities acquired in a 2009 bank acquisition with an aggregate carrying value of $2.9 million and fair value of $4.2 million that have been downgraded to a substandard regulatory classification due to a downgrade of the security’s credit quality rating by various rating agencies.
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At September 30, 2013, the two privately-issued CMOs in loss positions had depreciated approximately 1.38% from the Company’s carrying value and include securities collateralized by residential mortgage loans and residential home equity lines of credit. These two securities had an aggregate fair value of $143,000 and an aggregate unrealized loss of $2,000 at September 30, 2013 and were rated below investment grade by a nationally recognized statistical rating organization (“NRSRO”). Based on the independent third party analysis of the expected cash flows, management has determined that the declines in value for these securities are temporary and, as a result, no other-than-temporary impairment has been recognized on the privately-issued CMO and ABS portfolios. While the Company did not recognize a credit-related impairment loss at September 30, 2013, additional deterioration in market and economic conditions may have an adverse impact on the credit quality in the future and therefore, require a credit-related impairment charge.
The unrealized losses on U.S. government agency notes, mortgage-backed securities and CMOs, and municipal bonds relate principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government, its agencies, or other governments, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. As management has the ability to hold debt securities to maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.
During the year ended September 30, 2013, the Company realized gross gains on sales of available for sale U.S. government agency notes of $1,000. The Company realized gross gains on sales of available for sale U.S. government agency notes of $18,000 and municipal bonds of $12,000 for the year ended September 30, 2012.
Certain available for sale debt securities were pledged under repurchase agreements during the years ended September 30, 2013 and 2012, and may be pledged to secure federal funds borrowings and FHLB borrowings (see Notes 11, 12 and 13).
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(5)
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans at September 30, 2013 and 2012 consisted of the following:
Mortgage loans serviced for the benefit of others amounted to $138,000 and $189,000 at September 30, 2013 and 2012, respectively. No mortgage servicing rights have been capitalized since the year ended September 30, 1999.
At September 30, 2013, the recorded investment in residential mortgage loans secured by one-to-four family residential properties with loan-to-value ratios exceeding 90% amounted to $10.3 million, of which some do not have private mortgage insurance or government guaranty.
The Bank has entered into loan transactions with certain directors, officers and their affiliates (related parties). In the opinion of management, such indebtedness was incurred in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than normal risk of collectability or present other unfavorable features.
The following is a summary of activity for related party loans for the years ended September 30, 2013 and 2012:
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The following table provides the components of the recorded investment in loans as of September 30, 2013:
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The following table provides the components of the recorded investment in loans as of September 30, 2012:
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An analysis of the allowance for loan losses as of and for the year ended September 30, 2013 is as follows:
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An analysis of the allowance for loan losses as of and for the year ended September 30, 2012 is as follows:
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The following table presents impaired loans individually evaluated for impairment as of and for the year ended September 30, 2013. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the year ended September 30, 2013.
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The following table presents impaired loans individually evaluated for impairment as of and for the year ended September 30, 2012. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the year ended September 30, 2012.
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Nonperforming loans consists of nonaccrual loans and loans over 90 days past due and still accruing interest. The following table presents the recorded investment in nonperforming loans at September 30, 2013 and 2012:
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The following table presents the aging of the recorded investment in past due loans at September 30, 2013:
The following table presents the aging of the recorded investment in past due loans at September 30, 2012:
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The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, public information, historical payment experience, credit documentation, and current economic trends, among other factors. The Company classifies loans based on credit risk at least quarterly. The Company uses the following regulatory definitions for risk ratings:
Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss: Loans classified as loss are considered uncollectible and of such little value that their continuance on the Company’s books as an asset, without establishment of a specific valuation allowance or charge-off, is not warranted.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. The following table presents the recorded investment in loans by risk category as of the date indicated:
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Troubled Debt Restructurings
The following table summarizes the Company’s TDRs by accrual status at September 30, 2013 and 2012. There was no specific reserve included in the allowance for loan losses related to TDRs at September 30, 2013 and 2012.
The following table summarizes information in regard to TDRs that were restructured during the years ended September 30, 2013 and 2012.
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The Company has not committed to lend any additional amounts as of September 30, 2013 and 2012 to customers with outstanding loans that are classified as TDRs.
For the TDRs listed above, the terms of modification included temporary interest-only payment periods, reduction of the stated interest rate, reduction of principal balance, extension of the maturity date, and the renewal of matured loans where the debtor was unable to access funds elsewhere at a market interest rate for debt with similar risk characteristics.
There were no principal charge-offs recorded as a result of TDRs during the years ended September 30, 2013 and 2012. There was no specific allowance for loan losses related to TDRs modified during the years ended September 30, 2013 and 2012. In the event that a TDR subsequently defaults, the Company evaluates the restructuring for possible impairment. As a result, the related allowance for loan losses may be increased or charge-offs may be taken to reduce the carrying amount of the loan.
During the year ended September 30, 2013, the Company had four TDRs totaling $220,000 that were modified within the previous twelve months for which there was a payment default (defined as more than 90 days past due or in the process of foreclosure). The total consisted of two residential real estate loans with a balance of $204,000, one commercial business loan with a balance of $14,000 and one consumer loan with a balance of $2,000 at the date of default. As of September 30, 2013, two of the defaulted TDRs totaling $143,000 were on nonaccrual status and one defaulted TDR with a balance of $75,000 was accruing and performing in agreement with the modified terms after curing the default. The Company recognized a net charge-off of $2,000 on the remaining defaulted TDR during the year ended September 30, 2013.
During the year ended September 30, 2012, the Company had one residential real estate TDR loan with a balance of $262,000 that was modified within the previous twelve months for which there was a payment default (defined as more than 90 days past due or in the process of foreclosure). The Company recognized a net charge-off of $42,000 for this TDR during the year ended September 30, 2012.
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(6)
REAL ESTATE DEVELOPMENT AND CONSTRUCTION
On March 22, 2011, the Company acquired a parcel of land in New Albany, Indiana for $2.97 million. On April 5, 2012, the Bank received approval from the Office of the Comptroller of the Currency (“OCC”) to develop the land for retail purposes through its subsidiary, FFCC, Inc. and on July 27, 2012 the Company transferred ownership of the property to FFCC, Inc. The total cost of the development is expected to be approximately $7.5 million, including the $7.3 million paid as of September 30, 2013. The development costs were partially funded by a loan from another financial institution (see Note 14). The development is substantially completed, with only certain tenant improvements in a multi-tenant retail building to be completed for current and future lessees, and seven tenants have commenced occupancy as of September 30, 2013.
Development and construction period interest of $87,000 and $8,000 was capitalized as part of the real estate carrying value during the years ended September 30, 2013 and 2012, respectively.
Real estate development and construction consisted of the following at September 30, 2013 and 2012:
Depreciation expense of $87,000 was recognized for real estate development and construction for the year ended September 30, 2013. No depreciation expense was recognized for real estate development and construction for the year ended September 30, 2012.
The Bank and FFCC lease commercial retail space to tenants under noncancelable operating leases with terms of five to twenty years. The following is a schedule by years of future minimum lease payments under the leases as of September 30, 2013:
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(7)
PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
Depreciation expense of $810,000 and $689,000 was recognized for premises and equipment for the years ended September 30, 2013 and 2012, respectively.
(8)
OTHER REAL ESTATE OWNED
At September 30, 2013 and 2012, the Bank had other real estate owned held for sale of $799,000 and $2.1 million, respectively, including $250,000 and $600,000 in former banking facilities held for sale, respectively. During the years ended September 30, 2013 and 2012, foreclosure losses in the amount of $191,000 and $755,000, respectively, were charged-off to the allowance for loan losses. The losses on subsequent write downs of other real estate owned amounted to $165,000 and $94,000 for the years ended September 30, 2013 and 2012, respectively, and were aggregated with realized gains and losses from the sale of other real estate owned, and real estate taxes and other expenses of holding other real estate owned. Net realized gains from the sale of other real estate owned amounted to $125,000 and $41,000 for the years ended September 30, 2013 and 2012, respectively. Real estate taxes, other expenses of holding other real estate owned and net of income received from the operation of other real estate owned held for sale amounted to $140,000 and $147,000 for the years ended September 30, 2013 and 2012, respectively. The net loss is reported in noninterest expense. Realized gains from the sale of other real estate owned totaling $93,000 and $36,000 for the years ended September 30, 2013 and 2012, respectively, were deferred because the sales were financed by the Bank and did not qualify for recognition under generally accepted accounting principles. At September 30, 2013 and 2012, aggregate deferred gains on the sale of other real estate owned financed by the Bank amounted to $214,000 and $132,000, respectively.
(9)
GOODWILL AND OTHER INTANGIBLES
Goodwill and the core deposit intangibles acquired in the acquisitions of Community First Bank (“Community First”) on September 30, 2009 and the First Federal branches on July 6, 2012 are evaluated for impairment at least annually or more frequently upon the occurrence of an event or when circumstances indicate that the carrying amount is greater than its fair value. No impairment of goodwill or the core deposit intangibles was recognized during 2013 or 2012.
The changes in the carrying amount of goodwill for the years ended September 30, 2013 and 2012 are summarized as follows:
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(9 - continued)
The following is a summary of other intangible assets subject to amortization:
Amortization expense of intangibles amounted to $344,000 and $307,000 for the years ended September 30, 2013 and 2012, respectively. Estimated amortization expense for the core deposit intangibles for each of the ensuing five years and in the aggregate is as follows:
(10)
DEPOSITS
The aggregate amount of time deposit accounts (certificates of deposit) with balances of $100,000 or more was $52.9 million and $71.8 million at September 30, 2013 and 2012, respectively.
At September 30, 2013, scheduled maturities of certificates of deposit were as follows:
The Bank held deposits of $5.3 million for related parties at both September 30, 2013 and 2012.
(11)
FEDERAL FUNDS PURCHASED
The Bank has entered into a federal funds purchased line of credit facility with another financial institution that established a line of credit not to exceed the lesser of $10 million or 25% of the Bank’s equity capital excluding reserves. Availability under the line of credit is subject to continued borrower eligibility and expires on June 30, 2014 unless it is extended. The line of credit is intended to support short-term liquidity needs, and the agreement states that the Bank may borrow under the facility for up to seven consecutive days without pledging collateral to secure the borrowing. At September 30, 2013 and 2012, the Bank had no outstanding federal funds purchased under the facility.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(12)
REPURCHASE AGREEMENTS
Repurchase agreements include retail repurchase agreements representing overnight borrowings from deposit customers and long-term repurchase agreements with broker-dealers.
Repurchase agreements at September 30, 2013 and 2012 are summarized as follows:
The debt securities underlying the retail repurchase agreements were under the control of the Bank at September 30, 2013 and 2012. The securities underlying broker-dealer repurchase agreements are delivered to the broker-dealer who arranged the transactions.
Information concerning borrowings under retail repurchase agreements as of and for the years ended September 30, 2013 and 2012 is summarized as follows:
Information concerning borrowings under repurchase agreements with broker-dealers as of and for the year ended September 30, 2012 is summarized as follows:
Interest expense on repurchase agreements for the years ended September 30, 2013 and 2012 is summarized as follows:
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(13)
BORROWINGS FROM FEDERAL HOME LOAN BANK
At September 30, 2013 and 2012 borrowings from the FHLB were as follows:
The Bank entered into an Advances, Pledge and Security Agreement with the Federal Home Loan Bank of Indianapolis (“FHLBI”), allowing the Bank to initiate advances from the FHLBI. The advances are secured under a blanket collateral agreement. At September 30, 2013, the eligible blanket collateral included residential mortgage loans with a carrying value of $178.2 million.
On August 12, 2013, the Bank entered into an Overdraft Line of Credit Agreement with the FHLBI which established a line of credit not to exceed $25.0 million secured under the blanket collateral agreement. This agreement expires on February 12, 2014. At September 30, 2013, $9.3 million was outstanding under this agreement.
(14)
OTHER LONG-TERM DEBT
On July 27, 2012, FFCC, Inc. entered into a loan agreement with another financial institution to finance the retail development and construction project discussed in Note 6. The loan had a maximum commitment of $5.0 million and is for a ten-year term with a fixed interest rate of 4.0% for the first six years of the loan term, then adjusting annually thereafter to the one-year LIBOR rate plus 250 basis points. The loan provided for 12 interest only monthly payments through July 27, 2013, followed by 107 monthly payments sufficient to fully amortize the loan over a 20 year period and a balloon payment of all outstanding principal and interest at maturity on July 27, 2022. The loan is secured by a mortgage and assignment of leases and rents on the retail development property, which had a carrying amount of $7.2 million at September 30, 2013. The outstanding principal balance of the loan was $5.0 million and $2.1 million at September 30, 2013 and 2012, respectively.
Interest expense of $72,000 was recognized on other long-term debt for the year ended September 30, 2013. No interest expense was recognized for the year ended September 30, 2012.
Future maturities of other long-term debt, based on the amount outstanding under the loan agreement at September 30, 2013, are as follows for the years ending September 30, 2014, 2015, 2016, 2017, 2018 and later years: $168,000, $175,000, $182,000, $189,000, $197,000 and $4.1 million, respectively.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(15)
DEFERRED COMPENSATION PLANS
The Bank has deferred compensation agreements with former officers who are receiving benefits under these agreements. The agreements provide for the payment of specific benefits following retirement. Deferred compensation expense was $18,000 and $21,000 for the years ended September 30, 2013 and 2012, respectively.
2>The Company has a directors’ deferred compensation plan whereby a director, at his or her election on an annual basis, may defer all or a portion of the director fees into an account with the Company. The Company accrues interest on the deferred obligation at an annual rate equal to the prime rate for the immediately preceding calendar quarter plus 2%, but in no event at a rate in excess of 8%. The deferral period extends until separation from service by the director. The benefits under the plan are payable in a lump sum or in monthly installments over a period of up to ten years following the separation from service; however, the agreements provide for payment of benefits in the event of disability, early retirement, termination of service or death. Deferred compensation expense for this plan was $160,000 and $120,000 for the years ended September 30, 2013 and 2012, respectively.
(16)
BENEFIT PLANS
Defined Contribution Plan:
The Bank has a qualified contributory defined contribution plan available to all eligible employees. The plan allows participating employees to make tax-deferred contributions under Internal Revenue Code Section 401(k). Company contributions to the plan amounted to $336,000 and $304,000 for the years ended September 30, 2013 and 2012, respectively.
Employee Stock Ownership Plan:
On October 6, 2008, the Company established a leveraged employee stock ownership plan (“ESOP”) covering substantially all employees. The ESOP trust acquired 203,363 shares of Company common stock at a cost of $10.00 per share financed by a term loan with the Company. The employer loan and the related interest income are not recognized in the consolidated financial statements as the debt is serviced from Company contributions. Dividends payable on allocated shares are charged to retained earnings and are satisfied by the allocation of cash dividends to participant accounts or by utilizing the dividends as additional debt service on the ESOP loan. Dividends payable on unallocated shares are not considered dividends for financial reporting purposes. Shares held by the ESOP trust are allocated to participant accounts based on the ratio of the current year principal and interest payments to the total of the current year and future years’ principal and interest to be paid on the employer loan. Compensation expense is recognized based on the average fair value of shares released for allocation to participant accounts during the year with a corresponding credit to stockholders’ equity. Compensation expense recognized for the years ended September 30, 2013 and 2012 amounted to $652,000 and $252,000, respectively. Company common stock held by the ESOP trust at September 30, 2013 and 2012 was as follows:
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(17)
STOCK BASED COMPENSATION PLANS
In December 2009, the Company adopted the 2010 Equity Incentive Plan (“Plan”), which the Company’s shareholders approved in February 2010. The Plan provides for the award of stock options, restricted shares and performance shares. The aggregate number of shares of the Company’s common stock available for issuance under the Plan may not exceed 355,885 shares. The Company may grant both non-statutory and statutory (i.e., incentive) stock options that may not have a term exceeding ten years. An award of a performance share is a grant of a right to receive shares of the Company’s common stock contingent upon the achievement of specific performance criteria or other objectives set at the grant date. Awards granted under the Plan may be granted either alone, in addition to, or in tandem with any other award granted under the Plan. The terms of the Plan include a provision whereby all unearned options and shares become immediately exercisable and fully vested upon a change in control.
In April 2010, the Company funded a trust, administered by an independent trustee, which acquired 101,681 common shares in the open market at a price per share of $13.60 for a total cost of $1.4 million. These acquired common shares were granted to directors, officers and key employees in the form of restricted stock in May 2010 at a price per share of $13.25 for a total of $1.3 million. The difference between the purchase price and grant price of the common shares issued as restricted stock, totaling $41,000, was recognized by the Company as a reduction of additional paid in capital. The vesting period of the restricted stock is five years beginning one year after the date of grant of the awards. Compensation expense is measured based on the fair market value of the restricted stock at the grant date and is recognized ratably over the period during which the shares are earned (the vesting period). Compensation expense related to restricted stock recognized for both years ended September 30, 2013 and 2012 amounted to $260,000. A summary of the Company’s nonvested restricted shares for the year ended September 30, 2013 is as follows:
There were no restricted shares granted during the years ended September 30, 2013 and 2012. The total fair value of restricted shares that vested during the years ended September 30, 2013 and 2012 was $441,000 and $346,000, respectively. At September 30, 2013, there was $422,000 of total unrecognized compensation expense related to nonvested restricted shares. The compensation expense is expected to be recognized over the remaining vesting period of 1.63 years.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(17 - continued)
In May 2010, the Company awarded 177,549 incentive and 76,655 non-statutory stock options to directors, officers and key employees. The options granted vest ratably over five years and are exercisable in whole or in part for a period up to ten years from the date of the grant. Compensation expense is measured based on the fair market value of the options at the grant date and is recognized ratably over the period during which the shares are earned (the vesting period). The fair market value of stock options granted was estimated at the date of grant using the Binomial option pricing model. Expected volatilities are based on historical volatility of the Company’s stock and that of peer institutions located in its geographic market area. The expected term of options granted represents the period of time that options are expected to be outstanding. The risk free rate for the expected life of the options is based on the U.S. Treasury yield curve in effect at the grant date.
The fair value of options granted was determined using the following assumptions:
A summary of stock option activity under the plan as of September 30, 2013, and changes during the year then ended is presented below.
There were no stock options granted or exercised during the years ended September 30, 2013 and 2012. The Company recognized compensation expense related to stock options of $152,000 for both years ended September 30, 2013 and 2012. At September 30, 2013, there was $246,000 of unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining vesting period of 1.63 years.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(18) INCOME TAXES
The Company and its subsidiaries file consolidated income tax returns. The components of consolidated income tax expense were as follows for the years ended September 30, 2013 and 2012:
The reconciliation of income tax expense with the amount which would have been provided at the federal statutory rate of 34 percent follows for the years ended September 30, 2013 and 2012:
Significant components of the Company’s deferred tax assets and liabilities as of September 30, 2013 and 2012 are as follows:
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(18 - continued)
At September 30, 2013 and 2012, the Company had no liability for unrecognized income tax benefits and does not anticipate any increase in the liability for unrecognized tax benefits during the next twelve months. The Company believes that its income tax positions would be sustained upon examination and does not anticipate any adjustments that would result in a material change to its financial position or results of operations. The Company files U.S. federal and Indiana state income tax returns. Returns filed in these jurisdictions for tax years ended on or after September 30, 2010 are subject to examination by the relevant taxing authorities.
Prior to October 1, 1996, the Bank was permitted by the Internal Revenue Code to deduct from taxable income an annual addition to a statutory bad debt reserve subject to certain limitations. Retained earnings at September 30, 2013 and 2012 include $4.6 million of cumulative deductions for which no deferred federal income tax liability has been recorded. Reduction of these reserves for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes subject to the then current corporate income tax rate. The unrecorded deferred liability on these amounts was $1.5 million at September 30, 2013 and 2012.
Federal legislation enacted in 1996 repealed the use of the qualified thrift reserve method of accounting for bad debts for tax years beginning after December 31, 1995. As a result, the Bank discontinued the calculation of the annual addition to the statutory bad debt reserve using the percentage-of-taxable-income method and adopted the experience reserve method for banks for tax years through September 30, 2010. Under this method, the Bank computed its federal tax bad debt deduction based on actual loss experience over a period of years. Beginning with its tax year ended September 30, 2011, the Bank is required to use the specific charge-off method to compute its federal tax bad debt deduction. The 1996 legislation also provided that the Bank will not be required to recapture its pre-1988 statutory bad debt reserves if it ceases to meet the qualifying thrift definitional tests and if the Bank continues to qualify as a “bank” under existing provisions of the Internal Revenue Code.
(19) COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding various commitments and contingent liabilities, such as commitments to extend credit and legal claims, which are not reflected in the accompanying consolidated financial statements.
Commitments under outstanding standby letters of credit totaled $556,000 at September 30, 2013.
The following is a summary of the commitments to extend credit at September 30, 2013 and 2012:
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(20) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments (see Note 19). The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements 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. 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 each customer’s creditworthiness on a case-by-case basis. The amount and type of collateral obtained, if deemed necessary by the Bank upon extension of credit, varies and is based on management’s credit evaluation of the counterparty.
Standby letters of credit are conditional lending commitments issued by the Bank to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit.
The Bank has not been obligated to perform on any financial guarantees and has incurred no losses on its commitments in 2013 or 2012.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2013 AND 2012
(21)
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes the carrying value and estimated fair value of financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2013 and 2012.
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SEPTEMBER 30, 2013 AND 2012
(21 - continued)
The carrying amounts in the preceding table are included in the consolidated balances sheets under the applicable captions. The contract or notional amounts of the Bank’s financial instruments with off-balance-sheet risk are disclosed in Note 19, and the fair value of these instruments is considered immaterial.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate:
Cash and Cash Equivalents and Interest-Bearing Time Deposits
For cash and short-term instruments, including cash and due from banks and interest-bearing deposits with banks, and interest-bearing time deposits with other financial institutions, the carrying amount is a reasonable estimate of fair value.
Debt and Equity Securities
For marketable equity securities, the fair values are based on quoted market prices. For debt securities, the Company obtains fair value measurements from an independent pricing service and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. For FHLB stock, a restricted equity security, the carrying amount is a reasonable estimate of fair value because it is not marketable.
Loans
The fair value of loans, excluding loans held for sale, is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and terms. Impaired loans are valued at the lower of their carrying value or fair value. The carrying amount of accrued interest receivable approximates its fair value.
The fair value of loans held for sale is estimated based on specific prices of underlying contracts for sales to investors.
Deposits
The fair value of demand and savings deposits and other transaction accounts is the amount payable on demand at the balance sheet date. The fair value of fixed-maturity time deposits is estimated by discounting the future cash flows using the rates currently offered for deposits with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.
Borrowed Funds
Borrowed funds include borrowings from the FHLB, repurchase agreements and other long-term debt. Fair value for FHLB advances and long-term repurchase agreements is estimated by discounting the future cash flows at current interest rates for FHLB advances of similar maturities. For short-term repurchase agreements, FHLB line of credit borrowings and other debt, the carrying value is a reasonable estimate of fair value.
Derivative Financial Instruments
For derivative financial instruments, the fair values generally represent an estimate of the amount the Company would receive or pay upon termination of the agreement at the reporting date, taking into account the current interest rates, and exclusive of any accrued interest.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(22) FAIR VALUE MEASUREMENTS
FASB ASC Topic 820, Fair Value Measurements, provides the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are described as follows:
Level 1:
Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted market price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
Level 2:
Inputs to the valuation methodology include quoted market prices for similar assets or liabilities in active markets; quoted market prices for identical or similar assets or liabilities in markets that are not active; or inputs that are derived principally from or can be corroborated by observable market data by correlation or other means.
Level 3:
Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets carried at fair value or the lower of cost or fair value.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(22 - continued)
The table below presents the balances of financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2013. The Company had no liabilities measured at fair value as of September 30, 2013.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(22 - continued)
The table below presents the balances of financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2012. The Company had no liabilities measured at fair value as of September 30, 2012.
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SEPTEMBER 30, 2013 AND 2012
(22 - continued)
Fair value is based upon quoted market prices, where available. If quoted market prices are not available, fair value is based on internally-developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters or a matrix pricing model that employs the Bond Market Association’s standard calculations for cash flow and price/yield analysis and observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, or the lower of cost or fair value. These adjustments may include unobservable parameters. Any such valuation adjustments have been applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Trading Account Securities and Securities Available for Sale. Securities classified as trading and available for sale are reported at fair value on a recurring basis. These securities are classified as Level 1 of the valuation hierarchy where quoted market prices from reputable third-party brokers are available in an active market. If quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service. These securities are reported using Level 2 inputs and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. For securities where quoted market prices, market prices of similar securities or prices from an independent third party pricing service are not available, fair values are calculated using discounted cash flows or other market indicators and are classified within Level 3 of the fair value hierarchy. Changes in fair value of trading account securities are reported in noninterest income. Changes in fair value of securities available for sale are recorded in other comprehensive income, net of income tax effect.
Derivative Financial Instruments. Derivative financial instruments consist of an interest rate cap contract. As such, significant fair value inputs can generally be verified by counterparties and do not involve significant management judgments (Level 2 inputs).
Impaired Loans. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of impaired loans is classified as Level 3 in the fair value hierarchy.
Impaired loans are measured at the present value of estimated future cash flows using the loan's effective interest rate or the fair value of the collateral if the loan is a collateral-dependent loan. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and its fair value is generally determined based on real estate appraisals or other independent evaluations by qualified professionals. The appraisals are then discounted to reflect management’s estimate of the fair value of the collateral given the current market conditions and the condition of the collateral. At September 30, 2013, the significant unobservable inputs used in the fair value measurement of impaired loans included a discount from appraised value ranging from 0.0% to 15.0% and estimated costs to sell the collateral ranging from 0.0% to 6.0%. During the year ended September 30, 2013, the Company recognized provisions for loan losses of $416,000 for impaired loans.
Loans Held for Sale. Loans held for sale are carried at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value is based on specific prices of underlying contracts for sales to investors. These measurements are carried at Level 2.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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SEPTEMBER 30, 2013 AND 2012
(22 - continued)
Other Real Estate Owned. Other real estate owned held for sale is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. Fair value of other real estate owned is classified as Level 3 in the fair value hierarchy.
Other real estate owned is reported at fair value less estimated costs to dispose of the property. The fair values are determined by real estate appraisals which are then discounted to reflect management’s estimate of the fair value of the property given current market conditions and the condition of the collateral. At September 30, 2013, the significant unobservable inputs used in the fair value measurement of other real estate owned included a discount from appraised value ranging from 0.0% to 15.0% and estimated costs to sell the property ranging from 0.0% to 6.0%. The Company recognized charges of $165,000 and $94,000 to write down other real estate owned to fair value for the years ended September 30, 2013 and 2012, respectively.
Transfers Between Categories. There have been no changes in the valuation techniques and related inputs used for assets measured at fair value on a recurring and nonrecurring basis during the years ended September 30, 2013 and 2012. There were no transfers into or out of Level 3 financial assets or liabilities for the years ended September 30, 2013 or 2012. In addition, there were no transfers into or out of Levels 1 and 2 of the fair value hierarchy during the years ended September 30, 2013 or 2012.
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(23)
DERIVATIVE INSTRUMENTS
The Company has an interest rate cap contract that is not designated as a hedge. Realized and unrealized gains and losses on derivatives not designated for hedge accounting are recognized in noninterest income. The following is a summary of the terms of the interest rate cap contract reported in the consolidated balance sheet in other assets at September 30, 2013:
The notional amounts of derivatives do not represent amounts exchanged by the parties, but provide the basis for calculating payments. For interest rate caps, the notional amounts are not a measure of exposure to credit or market risk. Counterparties to financial instruments expose the Company to credit-related losses in the event of nonperformance, but the Company does not expect any counterparties to fail to meet their obligations. The Company deals only with highly rated counterparties. The current credit exposure of derivatives is represented by the fair value of contracts at the reporting date. (Also see Notes 21 and 22)
(24)
STOCKHOLDERS’ EQUITY
Liquidation Account
Upon completion of its conversion from mutual to stock form on October 6, 2008, the Bank established a liquidation account in an amount equal to its retained earnings at March 31, 2008, totaling $29.3 million. The liquidation account is maintained for the benefit of depositors as of the March 31, 2007 eligibility record date (or the June 30, 2008 supplemental eligibility record date) who maintain their deposits in the Bank after conversion.
In the event of complete liquidation, and only in such an event, each eligible depositor is entitled to receive a liquidation distribution from the liquidation account in the proportionate amount of the then current adjusted balance for deposits held, before any liquidation distribution may be made with respect to the stockholders. Except for the repurchase of stock and payment of dividends by the Bank, the existence of the liquidation account does not restrict the use or application of retained earnings of the Bank.
FIRST SAVINGS FINANCIAL GROUP, INC. AND SUBSIDIARIES
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(25)
PREFERRED STOCK
On August 11, 2011, the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) with the United States Department of the Treasury, pursuant to which the Company issued 17,120 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $17,120,000. The Purchase Agreement was entered into, and the Series A Preferred Stock was issued, pursuant to the Small Business Lending Fund (“SBLF”) program, a $30 billion fund established under the Small Business Jobs Act of 2010, that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion.
Holders of the Series A Preferred Stock are entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first ten quarters during which the Series A Preferred Stock is outstanding and may be adjusted between 1.0% and 5.0% per annum, to reflect the amount of change in the Bank’s level of Qualified Small Business Lending (“QSBL”) (as defined in the Purchase Agreement) over the baseline level calculated under the terms of the Purchase Agreement (“Baseline”). In addition to the dividend, in the event the Bank’s level of QSBL has not increased relative to the Baseline, at the beginning of the tenth calendar quarter, the Company will be subject to an additional lending incentive fee equal to 2.0% per annum. For the eleventh dividend period through the eighteenth dividend period, inclusive, and that portion of the nineteenth dividend period before, but not including, the four and one half (4½) year anniversary of the date of issuance, the dividend rate will be fixed at between 1.0% and 7.0% per annum based upon the increase in QSBL as compared to the Baseline. After four and one half (4½) years from issuance, the dividend rate will increase to 9.0%. Based upon the Bank’s level of QSBL over the Baseline for purposes of calculating the dividend rate for the initial dividend period, the dividend rate for the initial dividend period ended September 30, 2011 was 4.84%. The dividend rate for the ninth dividend period ended September 30, 2013 was 1.0% and the weighted average dividend rate for the years ended September 30, 2013 and 2012 was 1.0%.
The Series A Preferred Stock is non-voting, except in limited circumstances. In the event that the Company fails to timely make five dividend payments, whether or not consecutive, the holder of the Series A Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s board of directors.
The Series A Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of one hundred percent (100%) of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of its federal banking regulator.
The Series A Preferred Stock was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register the Series A Preferred Stock under certain circumstances set forth in the Purchase Agreement. The Series A Preferred Stock is not subject to any contractual restrictions on transfer.
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DIVIDEND RESTRICTION
As an Indiana corporation, the Company is subject to Indiana law with respect to the payment of dividends. Under Indiana law, the Company may pay dividends so long as it is able to pay its debts as they become due in the usual course of business and its assets exceed the sum of its total liabilities, plus the amount that would be needed, if the Company were to be dissolved at the time of the dividend, to satisfy any rights that are preferential to the rights of the persons receiving the dividend. The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company.
The payment of dividends by the Bank is subject to regulation by the OCC. The Bank must also file prior notice with the Federal Reserve Board before the Bank may declare and pay dividends to the Company. The amount of dividends that the Bank may declare and pay to the Company in any calendar year cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. The Bank may not declare or pay a cash dividend or repurchase any of its capital stock if the effect thereof would cause the regulatory capital of the Bank to be reduced below regulatory capital requirements imposed by the OCC or below the amount of the liquidation account established upon completion of the conversion.
(27) REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by its primary federal regulator, the OCC. 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 Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, 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.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier I capital to risk-weighted assets (as defined in the regulations), Tier I capital to adjusted total assets (as defined) and tangible capital to adjusted total assets (as defined). Management believes, as of September 30, 2013, that the Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 2013, the most recent notification from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution’s category.
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The Bank’s actual capital amounts and ratios are also presented in the table. No amount was deducted from capital for interest-rate risk in either year.
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SUPPLEMENTAL DISCLOSURE FOR EARNINGS PER SHARE
Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the periods presented. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, restricted stock and other potentially dilutive securities outstanding. Earnings and dividends per share are restated for stock splits and dividends through the date of issuance of the financial statements. Earnings per share information is presented below for the years ended September 30, 2013 and 2012.
Unearned ESOP and nonvested restricted stock shares are not considered as outstanding for purposes of computing weighted average common shares outstanding.
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(29) PARENT COMPANY CONDENSED FINANCIAL INFORMATION
Condensed financial information for First Savings Financial Group, Inc. (parent company only) follows:
Balance Sheets
(In thousands)
Statements of Income
(In thousands)
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Statements of Cash Flows
(In thousands)
(30) CONCENTRATION OF CREDIT RISK
At September 30, 2013 and 2012, the Bank had a concentration of credit risk with correspondent banks in excess of the federal deposit insurance limit of $7.9 million and $1.2 million, respectively.
(31) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
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(32) SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)