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Non-Interest Expense | Furniture and equipment steadily increases as we continue to add facilities and invest in technology. Annual maintenance costs continue to grow and become a greater piece of the overall cost. As new services are provided to our customers, the backroom cost to supply them continues to rise. The Company accepts it is an expected cost of doing business and keeping our services relevant to the industry. Data processing costs were actually lower in 2017 as compared to 2016 by $196 thousand. Two reasons for the improvement was the negotiation of an extended contract with our core processor and 2016 had the additional cost of upgrading Bank customer debit cards to incorporate EMV chip card technology. Both already better align with our future strategies while controlling costs. Data processing expense increased $105 thousand during 2018 as compared to 2017. As we continue to expand this line item is expected to also increase.As the pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the growth from the newer offices and overall Bank growth. Overall, data processing expense for 2019 will be higher than 2018 with the addition of the six Indiana offices. The FDIC assessment has a decreasing cost trend over the years shown. This line item speaks to the health of the Bank and the financial industry. The assessment for 2018 was down only $4 thousand from 2017 and the assessment for 2017 was down $77 thousand from 2016.The last line items with significant variation in noninterest expense to discuss is “consulting fees” and “other general and administrative.” Two main events are behind the increase of $865 thousand in 2018 as compared to 2017 in this line item. Both events incurred one-time costs which required the use of outside consultants. First related to the use of an executive recruiter firm to conduct a search for a CEO due to an upcoming retirement. The second related to the costs of researching, analyzing and negotiating possible mergers and acquisition opportunities. The consulting fees were beneficial in both instances as a new CEO was hired and a merger was closed on January 1, 2019. Consulting fees increased by $551.2 thousand in 2018 over 2017. Acquisition costs incurred in 2018 total $742.1 thousand with expenses being recorded in multiple line items. Though 2017 did not increase by as large an amount as 2016 had when compared to 2015, it was still an increase of $207 thousand. The two main reasons behind the increase in 2017 were the costs associated with listing on the NASDAQ stock market and the cost of offering the Insured Cash Sweep product. Both of these costs have been previously explained along with the benefits that have been provided by incurring said costs. Advertising and public relations increased also in 2018 by $129.9 thousand following an increase of $113 thousand in 2017. With the addition of new offices in both years behind the increases, 2019 is also expected to increase due to additional offices being added. The Bank also celebrates the anniversary of office openings with a special event in each community. |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2018 | | | | 2017 | | | | 2016 | | |
| Beginning Year | | $ | 2,299 | | | $ | 2,192 | | | $ | 2,056 | |
| Capitalized Additions | | | 450 | | | | 460 | | | | 555 | |
| Amortization | | | (364 | ) | | | (353 | ) | | | (419 | ) |
| Valuation Allowance | | | - | | | | - | | | | - | |
| End of Year | | $ | 2,385 | | | $ | 2,299 | | | $ | 2,192 | |
| FMAO/10-K/0001564590-19-004731 |
Securities | The following table sets forth the maturities of investment securities as of December 31, 2018 and the weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a twenty-one percent rate, have been made in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included. Maturities of mortgage-backed securities are based on the stated maturity date of the security. Due to prepayments, actual maturities may be different. |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2018 | | | | 2017 | | | | 2016 | | |
| U.S. Treasury | | $ | 22,830 | | | $ | 20,978 | | | $ | 24,775 | |
| U.S. Government agencies | | | 69,327 | | | | 80,466 | | | | 82,474 | |
| Mortgage-backed securities | | | 36,262 | | | | 39,510 | | | | 48,461 | |
| State and local governments | | | 40,028 | | | | 55,444 | | | | 62,817 | |
| | | $ | 168,447 | | | $ | 196,398 | | | $ | 218,527 | |
| FMAO/10-K/0001564590-19-004731 |
Securities | As of December 31, 2018, the Bank did not hold a large block of any one investment security in excess of 10% of stockholders’ equity. The largest segment of holdings is in U.S. Government agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $3.7 million. This is required in order to obtain Federal Home Loan Bank loans. |
| | | After Five Years | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % |
| U.S. Government agencies | | | 16,815 | | | | 2.12 | % | | | - | | | | 0.00 | % |
| Mortgage-backed securities | | | 3,347 | | | | 2.12 | % | | | 31,533 | | | | 2.27 | % |
| State and local governments | | | 16,612 | | | | 1.85 | % | | | 1,195 | | | | 1.65 | % |
| Taxable state and local governments | | | 2,573 | | | | 4.05 | % | | | - | | | | 0.00 | % |
| FMAO/10-K/0001564590-19-004731 |
Loan Portfolio | The following table shows the maturity of loans as of December 31, 2018: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Loans: | | 2018 | | | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | |
| Consumer Real Estate | | $ | 80,766 | | | $ | 83,620 | | | $ | 86,234 | | | $ | 88,189 | | | $ | 97,426 | |
| Agricultural Real Estate | | | 68,609 | | | | 64,073 | | | | 62,375 | | | | 57,277 | | | | 50,560 | |
| Agricultural | | | 108,495 | | | | 95,111 | | | | 84,563 | | | | 82,654 | | | | 74,611 | |
| Commercial Real Estate | | | 419,784 | | | | 410,520 | | | | 377,481 | | | | 322,762 | | | | 270,188 | |
| Commercial and Industrial | | | 121,793 | | | | 126,275 | | | | 109,256 | | | | 100,125 | | | | 100,126 | |
| Consumer | | | 41,953 | | | | 37,757 | | | | 33,179 | | | | 27,770 | | | | 24,277 | |
| Industrial Development Bonds | | | 5,889 | | | | 6,415 | | | | 5,732 | | | | 6,491 | | | | 4,698 | |
| | | $ | 847,289 | | | $ | 823,771 | | | $ | 758,820 | | | $ | 685,268 | | | $ | 621,886 | |
| FMAO/10-K/0001564590-19-004731 |
Loan Portfolio | The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or 2) floating or adjustable interest rates (variable): |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | After One | | | | | | |
| | | Within | | | | Year Within | | | | After | | |
| | | One Year | | | | Five Years | | | | Five Years | | |
| Consumer Real Estate | | $ | 4,226 | | | $ | 16,495 | | | $ | 60,045 | |
| Agricultural Real Estate | | | 615 | | | | 4,818 | | | | 63,176 | |
| Agricultural | | | 70,505 | | | | 28,073 | | | | 9,917 | |
| Commercial Real Estate | | | 16,339 | | | | 160,783 | | | | 242,662 | |
| Commercial and Industrial | | | 61,382 | | | | 52,678 | | | | 7,733 | |
| Consumer | | | 5,211 | | | | 27,369 | | | | 9,373 | |
| Industrial Development Bonds | | | 600 | | | | 270 | | | | 5,019 | |
| | | $ | 158,878 | | | $ | 290,486 | | | $ | 397,925 | |
| FMAO/10-K/0001564590-19-004731 |
Loan Portfolio | The following table summarizes the Company’s nonaccrual, past due 90 days or more and still accruing loans, and accruing troubled debt restructurings as of December 31 for each of the last five years: |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Fixed | | | | Variable | | | | | | |
| | | Rate | | | | Rate | | | | Total | | |
| Consumer Real Estate | | | 70,990 | | | | 5,550 | | | | 76,540 | |
| Agricultural Real Estate | | | 55,357 | | | | 12,637 | | | | 67,994 | |
| Agricultural | | | 37,164 | | | | 826 | | | | 37,990 | |
| Commercial Real Estate | | | 283,622 | | | | 119,823 | | | | 403,445 | |
| Commercial and Industrial | | | 54,218 | | | | 6,193 | | | | 60,411 | |
| Consumer | | | 36,724 | | | | 18 | | | | 36,742 | |
| Industrial Development Bonds | | | 5,289 | | | | - | | | | 5,289 | |
| | | | 543,364 | | | | 145,047 | | | | 688,411 | |
| FMAO/10-K/0001564590-19-004731 |
Loan Portfolio | Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $99 thousand for 2018, $205.4 for 2017 and $116.1 thousand for 2016. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $69 thousand for 2018, $57 thousand for 2017 and $64 thousand for 2016. Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The Bank had nonaccrual loan balances of $542 thousand at December 31, 2018 compared to balances of $1.0 and $1.4 million as of year-end 2017 and 2016. All of the balances of nonaccrual loans for the past three years were collaterally secured. As of December 31, 2018, the Bank had $7.9 million of loans which it considers to be “potential problem loans” in that the borrowers are experiencing financial difficulties. At December 31, 2017, the Bank had $21.2 million of these loans. The decrease is largely attributed to the payoff of one relationship. At December 31, 2016, the Bank had $20.4 million of these loans. These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential problem loans was considered in management’s review of the loan loss reserve at December 31, 2018 and 2017.In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the bank’s borrowers.As of December 31, 2018, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $108.5 million with an additional $68.6 million in agricultural real estate loans these compared to $95.1 and $64.1 million respectively as of December 31, 2017. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2018, the Bank had $178.1 thousand of its loans that were classified as troubled debt restructurings, of which $74.4 thousand are included in non-accrual loans. This compares to $0.7 million as of same date 2017 and 2016. Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred.To determine observable market value, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the existing collateral value used.Performing “non-watch list” loans secured in whole or in part by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List loans secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to values as found in the Bank’s loan policies irrespective of their grade. The Bank’s watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Bank’s loans are made in the market by lenders who live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check. On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Bank’s senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Bank’s watch list. In addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Bank’s general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Bank’s loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by loan category.The unallocated portion of the reserve for loan losses is determined based on management’s assessment of general economic conditions as well as specific economic factors in the Bank’s marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition and other current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the allocated component of the allowance.Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.As presented in the table on the next page, charge-offs increased to $580 thousand for 2018. 61.9% of the charge-offs stemmed from the consumer related portfolios. Charge-offs were $288 thousand for 2017, $550 thousand for 2016, preceded by $1.0 million for 2015 and $778 thousand for 2014. Recoveries were $163 thousand in 2018 compared to $150, $156, $557, and $298 thousand for 2017, 2016, 2015 and 2014, respectively. The net charge-offs for the last five years were all under $1 million. 2017 was the lowest at $138 thousand. Higher provision expense was used to fund the ALLL for loan growth in 2014 and 2016. For 2015 and 2017, the provision was used to replenish the balance decreased by the net charge-off activity. Overall, the ALLL increased from $5.9 million at yearend 2014 to $6.8 million at yearend 2018. After adding the allowance for unfunded loan commitments, the ACL ended 2018 just over $7.0 million. As the ratios on the bottom of the following table show, the trends for each have continually improved over the five years shown. Asset quality and the ACL are both strong and emphasize the level of credit quality. In reviewing the bigger picture of the allowance for credit loss, the years with the higher percentage of ACL to total nonperforming loans ratio account for the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. 2014’s significant and continued loan growth since fourth quarter 2013 was the reason behind 2014’s higher balances as asset quality remained strong. The ratio of ACL to nonperforming loans increased significantly in 2014 which is why provision loan expense was lower in 2015 in comparison. The ACL to nonperforming loans for 2015 remained more than adequate and emphasizes the existing strong level of credit quality. 2018 did not warrant a large provision as the asset quality continued to strengthen. Loan growth occurred, though not at the double-digit percentage increases of 2015 and 2016.The following table presents a reconciliation of the allowance for credit losses for the years ended December 31, 2018, 2017, 2016, 2015 and 2014: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2018 | | | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | |
| Non-accrual loans | | $ | 542 | | | $ | 1,003 | | | $ | 1,384 | | | $ | 2,041 | | | $ | 1,705 | |
| Accruing loans past due 90 days or more | | | - | | | | - | | | | - | | | | - | | | | - | |
| Troubled Debt Restructurings, not included above | | | 104 | | | | 534 | | | | 559 | | | | 878 | | | | 471 | |
| Total | | $ | 646 | | | $ | 1,537 | | | $ | 1,943 | | | $ | 2,919 | | | $ | 2,176 | |
| FMAO/10-K/0001564590-19-004731 |
Loan Portfolio | *Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual.Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans is as follows: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2018 | | | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | |
| Loans | | $ | 846,374 | | | $ | 823,024 | | | $ | 758,094 | | | $ | 684,630 | | | $ | 621,467 | |
| Daily average of outstanding loans | | $ | 831,614 | | | $ | 783,140 | | | $ | 724,076 | | | $ | 627,194 | | | $ | 581,483 | |
| Allowance for Loan Losses - Jan 1 | | $ | 6,868 | | | $ | 6,784 | | | $ | 6,057 | | | $ | 5,905 | | | $ | 5,194 | |
| Loans Charged off: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 63 | | | | 4 | | | | 106 | | | | 38 | | | | 168 | |
| Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
| Agricultural | | | - | | | | - | | | | 21 | | | | - | | | | - | |
| Commercial Real Estate | | | 16 | | | | 21 | | | | 93 | | | | 143 | | | | 229 | |
| Commercial and Industrial | | | 142 | | | | - | | | | 20 | | | | 536 | | | | - | |
| Consumer | | | 359 | | | | 263 | | | | 310 | | | | 313 | | | | 381 | |
| | | | 580 | | | | 288 | | | | 550 | | | | 1,030 | | | | 778 | |
| Loan Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 18 | | | | 13 | | | | 28 | | | | 41 | | | | 34 | |
| Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
| Agricultural | | | 8 | | | | 8 | | | | 10 | | | | 64 | | | | 44 | |
| Commercial Real Estate | | | 10 | | | | 15 | | | | 20 | | | | 204 | | | | 4 | |
| Commercial and Industrial | | | 13 | | | | 12 | | | | 11 | | | | 91 | | | | 20 | |
| Consumer | | | 114 | | | | 102 | | | | 87 | | | | 157 | | | | 196 | |
| | | | 163 | | | | 150 | | | | 156 | | | | 557 | | | | 298 | |
| Net Charge Offs | | | 417 | | | | 138 | | | | 394 | | | | 473 | | | | 480 | |
| Provision for loan loss | | | 324 | | | | 222 | | | | 1,121 | | | | 625 | | | | 1,191 | |
| Acquisition provision for loan loss | | | - | | | | - | | | | - | | | | - | | | | - | |
| Allowance for Loan & Lease Losses - Dec 31 | | | 6,775 | | | | 6,868 | | | | 6,784 | | | | 6,057 | | | | 5,905 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit - Dec 31 | | | 274 | | | | 227 | | | | 217 | | | | 208 | | | | 207 | |
| Total Allowance for Credit Losses - Dec 31 | | $ | 7,049 | | | $ | 7,095 | | | $ | 7,001 | | | $ | 6,265 | | | $ | 6,112 | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.05 | % | | | 0.02 | % | | | 0.05 | % | | | 0.08 | % | | | 0.08 | % |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 1249.57 | % | | | 684.83 | % | | | 490.39 | % | | | 293.75 | % | | | 346.30 | % |
| FMAO/10-K/0001564590-19-004731 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following tables show changes in interest income, interest expense and net interest resulting from changes in
volume and rate variances for major categories of earnings assets and interest bearing liabilities. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | **2014** | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | Average | | | | Interest/ | | | | | | |
| | | Balance | | | | Dividends | | | | Yield/Rate | | |
| **ASSETS** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 581,483 | | | $ | 28,070 | | | | 4.83 | % |
| Taxable investment securities | | | 189,003 | | | | 3,570 | | | | 1.89 | % |
| Tax-exempt investment securities | | | 65,520 | | | | 1,794 | | | | 4.15 | % |
| Federal funds sold & interest bearing deposits | | | 8,992 | | | | 19 | | | | 0.21 | % |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | | 844,998 | | | $ | 33,453 | | | | 4.07 | % |
| | | | | | | | | | | | | |
| **Non-Interest Earning Assets:** | | | | | | | | | | | | |
| Cash and cash equivalents | | | 23,634 | | | | | | | | | |
| Other assets | | | 79,296 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Assets** | | $ | 947,928 | | | | | | | | | |
| | | | | | | | | | | | | |
| **LIABILITIES AND SHAREHOLDERS EQUITY** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 394,690 | | | $ | 1,449 | | | | 0.37 | % |
| Other time deposits | | | 214,680 | | | | 2,009 | | | | 0.94 | % |
| Other borrowed money | | | 158 | | | | 4 | | | | 2.53 | % |
| Federal funds purchased and securties sold under agreement to repurchase | | | 60,989 | | | | 254 | | | | 0.42 | % |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | | 670,517 | | | $ | 3,716 | | | | 0.55 | % |
| | | | | | | | | | | | | |
| **Non-Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 152,155 | | | | | | | | | |
| Other | | | 14,622 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities** | | | 837,294 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Shareholders Equity** | | | 110,634 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities and Shareholders Equity** | | $ | 947,928 | | | | | | | | | |
| | | | | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 33,453 | | | | 4.07 | % |
| Interest Expense / yield | | | | | | | 3,716 | | | | 0.55 | % |
| | | | | | | | | | | | | |
| Net Interest Spread | | | | | | $ | 29,737 | | | | 3.52 | % |
| | | | | | | | | | | | | |
| Net Interest Margin | | | | | | | | | | | 3.63 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Non-Interest Income The discussion now turns to the noninterest activity of 2016 operations, beginning with the revenue portion. In comparing line items of the consolidated
statements of income for years ended 2014 through 2016, it can be seen where the Company has been spending its time and the impact of the recession and slow recovery. This section will focus on the significant noninterest items that impacted the
operations of the Company. The Company has concerns with the increased costs associated with regulatory compliance such as the possible loss
of revenue from new regulations stemming from the Dodd-Frank Act. History has proven the concern is justified. One area of revenue impacted was overdraft fees. The Bank has ended each of the last 3 years with a lower revenue stream from overdraft
fees. This has occurred in spite of the addition of the new offices. Each year, the number of checking accounts has increased along with the balances; however average collected overdraft fees per account decreased. Overdraft fees in 2016 and 2015
accounted for $2.4 million in noninterest income, compared to $2.5 million in 2014 and $2.7 million for 2013. The Bank had made this an area of focus for 2015 as this revenue stream remains under intense regulator review. In 2015, the
Bank adjusted its overdraft program and renamed it Courtesy Pay. Courtesy Pay establishes dynamic limits based on a customers behavior and likelihood of repayment. The Bank has sought to better service the customers needs
while decreasing the need for collections and improving profitability. At the current time, profitability has not been impacted and in 2016 it only slowed the amount of decrease. Service charges on checking accounts also leveled off in 2016.
Excluding Health Savings Accounts, service charges were up $120 thousand for 2015 and $208.7 thousand for 2014. This improvement is credited to the new checking accounts mentioned previously. The Bank has long promoted the use of debit cards by its customers and continued that philosophy with the introduction of additional new products. 2016
revenue improved $122.4 thousand, 2015 revenue improved $142.9 thousand and 2014 revenue improved $250.5 from ATM/debit card usage as compared to each of the respective prior years. The Bank receives interchange revenue from each use by a
customer of a Bank issued ATM/debit the card. In 2011, this revenue stream was at risk of being reduced by the Federal Reserve regulation of the interchange fee. The establishment by the Federal Reserve of a tiered pricing for banks under
$10 billion has helped to protect the profitability from such fees, although the concern remains as to how long this tiered pricing will remain in effect. While this revenue stream continues to improve with more depositors using electronic
methods for purchasing, the expense attributable to card fraud has offset a portion of the revenue gain. Further discussion can be found in the non-interest expense section regarding the net effect of debit
card activity. Noninterest income from net gain on sales of loans increased for 2016 after having decreased for both 2015 and 2014. The change may be
related to the increase in rates after the long duration of the flat rate interest environment. The net gain on sale of loans is derived from sales of real estate loans into the secondary market. Of these loan types, the Bank sells 100% of the
residential loans and 90% of the agricultural loans into the secondary market. Gains of $683.7 and $204.0 thousand were recorded for residential an agricultural real estate respectively for 2016. Gains of $559.6 and $140.8 thousand were
recorded for residential and agricultural real estate respectively for 2015 compared to gains of $452.7 and $194.3 thousand respectively for 2014. In conjunction with these sales, the Bank maintains servicing rights and those income amounts
during all three years are included in the customer service fees line item and accounted for over $400 thousand in revenue for 2016 and 2015. The
last line item in the noninterest income section is the net gain on sale of investments. The Bank has taken advantage of this opportunity the last three years and expects to continue as long as the rates remain low and the yield curve is favorable
to the transaction. The Bank will not increase short-term gains at the sacrifice of long-term profitability. All of the sales of securities in 2016, 2015 and 2014 of $85.7, $47.0 and $57.9 million respectively were used to fund loan growth.
This is a source of funds that will continue to be analyzed for use in the coming year. Gains of $588 thousand were recorded for 2016, $451 thousand for 2015 as compared to $494 thousand for 2014. Customer service fees show an improvement of $271 thousand collected in 2016 as compared to 2015. 2015 experienced an even higher increase in customer
service fees of $623 thousand over 2014. Almost $200 thousand can be attributed to classifying foreign ATM fees out of service charges into miscellaneous fees in 2015. Other fees included in this line item are the interchange fee mentioned
previously, fees for wire activity, safe deposit box rent and profit on sales of checks to name a few. Overall, noninterest income increased
$580 thousand in 2016 preceded by a year where it had increased $604 thousand. Some of the revenue may not be easily duplicated as it is dependent on economic and market conditions to provide the opportunity. However, the increased revenue
amounts from deposit and loan services should continue to provide improved profitability in the future. Management expects gains on sales to continue in the near term. Non-Interest Expense Noninterest expense increased 5.2% in 2016 as compared to 2015 and was preceded by a 3.4% increase in 2015 as compared to 2014. Represented in dollars, 2016
was $1.4 million higher than 2015 and 2015 was $854 thousand higher
than 2014. The largest factor behind the increase both years was the expense of employee salaries and wages. During 2016, an additional $713 thousand was spent over 2015 which correlates to
a 6.5% increase. When making the same analysis for 2015 as compared to 2014, 2015s costs increased $721 thousand or 7.1%. Three main components flow into salaries and wages: base salary, deferred costs, and incentives composed of the
expense of restricted stock awards and performance incentives. Base pay has increased with the addition of the three offices of Huntertown, Bowling Green and Sylvania, as well as from the operations of the Captive and through normal yearly increases
to the remainder of the employees. Base pay was up $669.7 thousand for 2016 over the previous year and 2015 was up $559.3 thousand over 2014. The full time equivalent number of employees at each yearend increased to 273 for 2016, to 265
for 2015 compared to 2014s 260. Incentive pay as it related to performance was up $177.4 thousand in 2016 over 2015. Measurements used for
award incentive pay had improved in 2016 and 2015 and employees benefited accordingly. The expense for the restricted stock awards has also increased each of the last three years as more shares have been granted to a larger number of employees and
the market value of the shares has increased. 2016s cost for this program was $87.9 thousand higher than 2015 and 2015 was $82 thousand higher than 2014. The awards incorporate a three year vesting period so the increase of any one
year carries forward through the next two years. This expense should continue to increase as the Company continues its expansion strategy. For further discussion in incentive pay and restricted stock awards, see note 11 of the consolidated financial
statements. Employee benefits decreased in 2016 which correlated directly to a lower level of medical expense. As the Bank is partially self-insured,
lower claims during 2016 decreased the expense. Employee group insurance was down $266.9 thousand for 2016. Overall, employee benefits were down $232 thousand or 6.5% from 2015. Employee benefits increased by a similar percentage as the salaries and wages for 2015 increased by 6.9% over 2014. The cost of the 401-K retirement plan increased each year as the profit share component increased along with the number of employees participating. Being partially self-insured has helped with lower claim experience though it is an
unknown each year what that experience will be. For 2014 and 2015, a switch in the medical provider and comparison pricing also assisted to control the cost. Employees do participate in any premium increases. Net occupancy expense typically increases as the Company expands, which is what has occurred for 2016 and 2015. One factor that can offset occupancy expense
is the receipt by the Company of building rent as it is netted out of occupancy expense. The greatest contributor to building rent comes from the division of FM Investments within the Bank. This division experienced a strong 2014; however the
department was short staffed most of 2015 and 2016. This has been remedied in 2017 and performance is expected to improve. While net loss on sale of
other assets owned, mainly ORE property, does not represent income for the years presented, the decrease in the amount of the loss for 2015 as compared to 2014, did contribute to improved profitability. For 2016, the loss was higher at
$81 thousand than 2015s $47 thousand. Loss on sale of assets included any write downs in the carrying values of ORE property on the Banks balance sheet. In 2016 and 2015, the number of properties and the corresponding carrying
values decreased as compared to 2014. The Bank also sold its St. Joe, Indiana property during 2015. While taking a loss for the sale, the Bank eliminated the continued maintenance expense of an unoccupied building. An easement was agreed upon to
enable the ATM located on the property to remain operational. The 1-4 family mortgage refinancing activity has
been slow over the last three years though increasing slightly each year. A correlating expense to that activity is the amortization of mortgage servicing rights. The amortization is the expense that offsets the income recognized when the loan is
first made. Income is recorded when the mortgage loan is first sold with servicing retained and is therefore recognized within one year. The amortization, however, is calculated over the life of the loan and accelerated as loans are paid off early.
An increase in this expense can be driven by two activities: an increase in the number of sold loans and/or by the acceleration of the expense from payoff and refinance activity. The best picture of the bottom line impact is achieved by netting the
income with the expense each year. 2015 had net income of $33 thousand, a switch from 2014 which had net expense of $42.7 thousand. Of course, the value (or income) of the mortgage servicing right when sold also impacts the net position.
2016 has net income of $136 thousand and 2015 had higher additions and lower amortization expense from refinanced loans. The number of loans and balances also indicates this as the levels have remained fairly constant. 2014 was a year with
limited sales and the amortization expense was therefore higher than the capitalized additions. As of December 31, 2016, 3,599 loans are being serviced with corresponding balances of $279.4 million. This is almost identical to the
December 31, 2015 number and balance of loans 1-4 family being serviced. As of December 2015, 3,598 loans are being serviced with balances of $275.7 million. As of December 31, 2014, there were
3,638 loans serviced with balances of $275.4 million. The impact of mortgage servicing rights to both noninterest income and expense is shown in the following table: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2016 vs 2015 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 4,410 | | | $ | 4,537 | | | $ | (127 | ) |
| Taxable investment securities | | | (78 | ) | | | (82 | ) | | | 4 | |
| Tax-exempt investment securities | | | (284 | ) | | | (373 | ) | | | 89 | |
| Federal funds sold & interest bearing deposits | | | 29 | | | | (11 | ) | | | 40 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | 4,077 | | | $ | 4,071 | | | $ | 6 | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 133 | | | $ | 131 | | | $ | 2 | |
| Other time deposits | | | 215 | | | | 44 | | | | 171 | |
| Other borrowed money | | | 147 | | | | 92 | | | | 55 | |
| Federal funds purchased and securities sold under agreement to repurchase | | | 141 | | | | 38 | | | | 103 | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | 636 | | | $ | 305 | | | $ | 331 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | 2015 vs 2014 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 1,223 | | | $ | 2,210 | | | $ | (987 | ) |
| Taxable investment securities | | | (762 | ) | | | (211 | ) | | | (551 | ) |
| Tax-exempt investment securities | | | (281 | ) | | | 26 | | | | (307 | ) |
| Federal funds sold & interest bearing deposits | | | 17 | | | | 11 | | | | 6 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | 197 | | | $ | 2,036 | | | $ | (1,839 | ) |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 108 | | | $ | 65 | | | $ | 43 | |
| Other time deposits | | | (297 | ) | | | (233 | ) | | | (64 | ) |
| Other borrowed money | | | (3 | ) | | | (1 | ) | | | (2 | ) |
| Federal funds purchased and securities sold under agreement to repurchase | | | 63 | | | | (13 | ) | | | 76 | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | (129 | ) | | $ | (182 | ) | | $ | 53 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Furniture and equipment steadily increases as we continue to add facilities and invest in technology. Annual maintenance costs
continue to grow and become a greater piece of the overall cost. As new services are provided to our customers, the backroom cost to supply them continues to rise. The Company accepts it is an expected cost of doing business and keeping our services
relevant to the industry. Data processing expense increased $109 thousand during 2016 as compared to an increased $50 thousand during 2015 and
by $38 thousand in 2014 over 2013. The Company continues to investigate ways to reduce this expense. The pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the growth from the
newer offices and overall Bank growth. The Bank began conducting a review of its core operating system in 2015 which culminated with a decision in the
summer 2016 to extend the contract with the Banks existing provider, FiServ, for an additional seven year period. The Bank expects to see a current reduction in monthly expenses, though that reduction will be utilized to provide additional new
product offerings and fund growth. Overall, data processing expense for 2017 may be similar to 2016 with a wider variety of customer offerings. The FDIC
assessment has a decreasing cost trend and that is expected to continue into 2017 as the fourth quarter 2016 assessment was again below that of the previous quarter. This line item speaks to the health of the Bank and the financial industry. The
assessment for 2016 was down $78 thousand from 2015. The last line item with significant variation in noninterest expense to discuss is other
general and administrative. The line item increased by $439 thousand during 2016 to end at $6.1 million as of December 31, 2016. $249 thousand of the increased expense was a result of managements decision to
accelerate the issuance of chip debit cards along with the normal replacement of cards due to fraud and expiration dates. The chip enhanced cards were to help decrease fraud and establish liability with the merchant if the chip was not
used in the transaction. The Banks cost due to fraud was not lower yet in 2016; however it is hoped it will help mitigate fraud losses in 2017. Advertising and public relations increased also in 2016 by $113 thousand. With the addition of
new offices, the credit card launch in conjunction with Bowling Green State Universitys athletic department, it was expected to be higher than 2015. The Bank also celebrates the anniversary of office openings with a special event in each
community. 2015 experienced a decrease in the other general and administrative line item. The decrease of $348 thousand for 2015 as
compared to 2014 can be mainly attributed to a $195.7 thousand reduction in marketing and consulting costs. A renegotiation of one service provider contract along with the maturity of another during 2015 led to the decrease. Another contributor
to the reduction was lower losses due to NSF and fraud. The Bank applauds the work of our front-line staff to recognize possible fraud and scams attempted on our customers and stopping them before they can occur. An investment in additional fraud
detection software has also helped our back office personnel to detect possible digital fraud. This was down $60.2 thousand in 2015 compared to an increase in 2014 of $40.9 thousand. Allowance for Credit Losses Provision expense increased
by $496 thousand for 2016 in response to the significant loan growth for the period. It decreased by $566 thousand for 2015, following an increase of $333 thousand for 2014. The decrease for 2015 was due to the consistent strong asset
quality of the Banks loan portfolio as evidenced by low levels of both net charge-offs and delinquencies. The increase for 2014 was needed to account for the loan growth and the net charge-off activity
of
2014. Sustained strong asset quality kept the provision expense lower than the growth alone would have warranted. Net charge-offs were $394, $473, and $480 thousand for 2016, 2015 and 2014,
respectively. Commercial and Industrial loans had the largest charge-off activity in 2015. The consumer portfolios had the highest levels of charge-off activity in 2016
and 2014. The Company segregates its Allowance for Credit Losses (ACL) into two reserves: The ACL and the Allowance for Unfunded Loan Commitments and
Letters of Credit (AULC). When combined, these reserves constitute the total ACL. The AUCL is included in other liabilities on the consolidated balance sheets. The Banks ALLL methodology captures trends in leading, current, and lagging indicators which will directly affect the Banks allocation amount. The
Bank monitors trends in such leading indicators as delinquency, unemployment changes in the Banks service area, experience and ability of staff, regulatory trends, and credit concentrations. A current indicator such as the total watch list
loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as well. A matrix formed by loan type from these indicators is used in making ALLL adjustments. Watch list loan balances are comprised of loans graded 5-8. These loan balances increased $14.3 million as of
December 31, 2016 as compared to same date 2015. The largest increases occurring in the lowest risk grade of 5. The loan grades of 7, which have a greater likelihood of default, all decreased for 2016. The Bank is mindful of the grade 5 loans
but expects the number to decrease during first half 2017. All other measurements of asset quality improved during 2016. The watch list loan balances decreased 53.6% or $7.2 million from December 31, 2014 to December 31, 2015. The
balances decreased mainly due to successful results from collection efforts. Given the size of the decrease, it is no surprise it is attributed mainly to the commercial real estate portfolio decreasing by $5.9 million. Three customers made up
the bulk of the balances with one of three finding funding elsewhere. Commercial loans (non-real estate) on the Banks watch list also had a nice decrease during 2015, though just not as high at
$1.9 million. At yearend 2016, 59.7% of the watch list was comprised of loans classified as special mention, with an additional 39.0% classified as
substandard and the remaining 1.3% classified as doubtful. The large increases in special mention and substandard are mainly driven by two loan relationships in the Banks commercial real estate portfolio. Of the aggregate watch list loan balances, as of December 31, 2015, special mention accounted for 36.6% with substandard comprising 49.1% and doubtful
accounting for the final 14.3%. In comparison to 2014, special mention was down $7.2 million, substandard up slightly by $161 thousand and doubtful down almost exactly the same amount at $162 thousand. For 2014, the increase in special mention is offset by significant decreases in the substandard classifications of those same commercial related portfolios.
Overall, substandard and doubtful loans decreased 42.5% or $2.9 million as compared to yearend 2013. In response to these fluctuations and loan growth during 2014 and 2015, the Bank changed ALLL to outstanding loan coverage percentage changed
to 0.89% as of December 31, 2016, 0.88% as of December 31, 2015, and 0.95% as of December 31, 2014. The above indicators impacting ALLL
are reviewed quarterly. Some of the indicators are quantifiable and, as such, will automatically adjust the ALLL once calculated. These indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and the ratio
of watch list loans to capital, with the watch list made up of loans graded 5, 6 or 7 on a scale of 1 (best) to 7 (worst). Other indicators consist of more subjective data used to evaluate the potential for inherent losses in the Banks loan
portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market area to help determine whether the ALLL should be adjusted. At the end of each of 2014, 2015 and 2016, a slight improvement was noted
in unemployment figures. All aggregate commercial and agricultural credits including real estate loans of $250,000 and over are reviewed annually by both
credit committees and internal loan review to look for early signs of deterioration. To establish the specific reserve allocation for real estate, a
discount to the market value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Banks Loan Policy. However, unique or unusual
circumstances may be present which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management. The ACL increased $736, $153 and $755 thousand during 2016, 2015 and 2014 respectively. The large increase
in 2016 directly correlates to the large increase in loan balances. With the improved asset quality, the metrics upon which the ACL is calculated did not support a larger increase in 2015 even though loan growth occurred. The percentage of ACL to
the total loan portfolio was 0.98% as of December 31, 2014, 0.91% as of December 31, 2015 and 0.92% as of December 31, 2016. December 31, 2016 had the lowest loans past due 30+ day percentage at 0.23% in the last ten years.
December 31, 2014 and 2015 were still at respectable lows of 0.37% and 0.32%. Please see Note 4 in the consolidated financial statement for
additional tables regarding the composition of the ACL. Federal Income Taxes Effective tax rates were 28.53%, 26.97%, and 28.64% for 2016, 2015 and 2014 respectively. The effect of tax-exempt
interest from holding tax-exempt securities and Industrial Development Bonds (IDBs) was $468, $554, and $634 thousand for 2016, 2015, and 2014, respectively. All years included an increase into a higher
tax bracket for income over $10 million. Behind the decrease in 2015 is one of the benefits from the establishment of the Captive subsidiary. Material Changes in Financial Condition The shifts in
the balance sheet during 2016 and 2015 have positioned the Company for continued improvement in profitability. On the asset side, interest income increased primarily from loan growth with funding for the increase provided by a decrease in the
investment portfolio, growth in core deposits and growth in other borrowings generated in 2015 which carried over to 2016. The cost of funds was impacted by the shift of interest bearing liabilities to noninterest and the limited use of time
deposits in 2016 with a decrease in time deposits in 2015. Both contributed to improved profitability in 2016 and 2015, and the Company expects continued improvement through 2017 and into 2018. Average earning assets increased throughout 2016 and 2015. Loan growth in both years was the main factor. 2014 was also aided by the Custar acquisition which
took place in December 2013 and brought in $29 million in deposits. 2015 also benefited from the Sylvania office having been in office for a full year along with the growth in the other newer offices. 2016 had two offices open, one in each half
of the year. Securities The investment portfolio is
primarily used to provide overall liquidity for the Bank. It is also used to provide required collateral for pledging to the Banks Ohio public depositors for amounts on deposit in excess of the FDIC coverage limits. It may also be used to
pledge for additional borrowings from third parties. Investments are made with the above criteria in mind while still seeking a fair market rate of return, and looking for maturities that fall within the projected overall strategy of the Bank. The
possible need to fund growth is also a consideration. During 2016, the Bank began to utilize Promontorys ICS, product to replace pledged
securities; thereby increasing liquidity. ICS utilizes a nation-wide bank network to provide FDIC insurance coverage to the Banks depositors. The Bank is using the product to replace pledged securities to the Banks Ohio public customers
and for commercial sweep customers previously utilizing daily repurchase agreements to protect balances over $250 thousand. All of the Banks
security portfolio is categorized as available for sale and as such is recorded at market value. Security balances as of December 31 are summarized below: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2016 | | | | 2015 | | | | 2014 | | |
| Beginning Year | | $ | 2,056 | | | $ | 2,023 | | | $ | 2,066 | |
| Capitalized Additions | | | 555 | | | | 407 | | | | 301 | |
| Amortization | | | (419 | ) | | | (374 | ) | | | (344 | ) |
| Valuation Allowance | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| End of Year | | $ | 2,192 | | | $ | 2,056 | | | $ | 2,023 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table sets forth the maturities of investment securities as of December 31, 2016 and the weighted average
yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate, have been made
in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included. Maturities of mortgage-backed securities are based on the stated maturity date of the security. Due to prepayments, actual
maturities may be different. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2016 | | | | 2015 | | | | 2014 | | |
| U.S. Treasury | | $ | 24,775 | | | $ | 38,505 | | | $ | 25,393 | |
| U.S. Government agencies | | | 82,474 | | | | 98,220 | | | | 119,234 | |
| Mortgage-backed securities | | | 48,461 | | | | 26,324 | | | | 29,562 | |
| State and local governments | | | 62,817 | | | | 72,066 | | | | 74,303 | |
| | | | | | | | | | | | | |
| | | $ | 218,527 | | | $ | 235,115 | | | $ | 248,492 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | As of December 31, 2016 the Bank did not hold a large block of any one investment security in excess of 10% of
stockholders equity. The largest segment of holdings is in US Governments. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $3.7 million. This is required in order to obtain Federal Home Loan Bank loans.
The Bank also owns stock of Farmer Mac with a carrying value of $37.4 thousand which is required to participate loans in the program. Loan
Portfolio The Banks various loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio
diversification and through standardization of lending policies and procedures. Risks are mitigated through an adherence to the Banks loan
policies, with any exception being recorded and approved by senior management or committees comprised of senior management. The Banks loan policies define parameters to essential underwriting guidelines such as
loan-to-value ratio, cash flow and debt-to-income ratio, loan requirements and covenants,
financial information tracking, collection practice and others. The maximum loan amount to any one
borrower is limited by the Banks legal lending limits and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to any one
business or agricultural sector by an approved sector percentage to capital limitation. The following table shows the Banks loan portfolio by
category of loan as of December 31st of each year, including loans held for sale: |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Maturities(Amounts in Thousands) | | | | | | | | | | | | | | |
| | | | | | | | | | | After One Year | | | | | | |
| | | Within One Year | | | | | | | | Within Five Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | 10,542 | | | | 0.61 | % | | $ | 14,233 | | | | 1.11 | % |
| U.S. Government agencies | | | | | | | 0.00 | % | | | 43,245 | | | | 1.29 | % |
| Mortgage-backed securities | | | | | | | 0.00 | % | | | 4,144 | | | | 2.59 | % |
| State and local governments | | | 7,805 | | | | 2.14 | % | | | 18,927 | | | | 2.11 | % |
| Taxable state and local governments | | | 884 | | | | 2.02 | % | | | 5,185 | | | | 1.75 | % |
| | | | | | | | | | | | | | | | | |
| | | After Five Years | | | | | | | | | | | | | | |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | | | | | 0.00 | % | | $ | | | | | 0.00 | % |
| U.S. Government agencies | | | 39,229 | | | | 1.97 | % | | | | | | | 0.00 | % |
| Mortgage-backed securities | | | 3,224 | | | | 2.92 | % | | | 41,093 | | | | 2.03 | % |
| State and local governments | | | 23,784 | | | | 2.00 | % | | | 3,662 | | | | 1.98 | % |
| Taxable state and local governments | | | 2,570 | | | | 4.50 | % | | | | | | | 0.00 | % |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table shows the maturity of loans as of December 31, 2016: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | | | 2012 | | |
| Loans: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | $ | 87,273 | | | $ | 88,189 | | | $ | 97,550 | | | $ | 92,438 | | | $ | 80,287 | |
| Agricultural Real Estate | | | 63,391 | | | | 58,525 | | | | 50,895 | | | | 44,301 | | | | 40,143 | |
| Agricultural | | | 84,563 | | | | 82,654 | | | | 74,611 | | | | 65,449 | | | | 57,770 | |
| Commercial Real Estate | | | 377,481 | | | | 322,762 | | | | 270,188 | | | | 248,893 | | | | 199,999 | |
| Commercial and Industrial | | | 109,256 | | | | 100,125 | | | | 100,126 | | | | 99,498 | | | | 101,624 | |
| Consumer | | | 33,179 | | | | 27,770 | | | | 24,277 | | | | 21,406 | | | | 20,413 | |
| Industrial Development Bonds | | | 5,732 | | | | 6,491 | | | | 4,698 | | | | 4,358 | | | | 1,299 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 760,875 | | | $ | 686,516 | | | $ | 622,345 | | | $ | 576,343 | | | $ | 501,535 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or
2) floating or adjustable interest rates (variable): |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | | | | | After One | | | | | | |
| | | Within | | | | Year Within | | | | After | | |
| | | One Year | | | | Five Years | | | | Five Years | | |
| Consumer Real Estate | | $ | 2,900 | | | $ | 12,258 | | | $ | 72,115 | |
| Agricultural Real Estate | | | 911 | | | | 3,156 | | | | 59,324 | |
| Agricultural | | | 51,411 | | | | 22,771 | | | | 10,381 | |
| Commercial real estate | | | 7,636 | | | | 105,377 | | | | 264,468 | |
| Commercial and Industrial | | | 49,757 | | | | 35,400 | | | | 24,099 | |
| Consumer | | | 5,880 | | | | 20,212 | | | | 7,087 | |
| Industrial Development Bonds | | | 1,031 | | | | 85 | | | | 4,616 | |
| | | | | | | | | | | | | |
| | | $ | 119,526 | | | $ | 199,259 | | | $ | 442,090 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table summarizes the Companys nonaccrual, past due 90 days or more and still accruing loans,
and accruing troubled debt restructurings as of December 31 for each of the last five years: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Fixed | | | | Variable | | | | | | |
| | | Rate | | | | Rate | | | | Total | | |
| Consumer Real Estate | | $ | 78,607 | | | $ | 5,766 | | | $ | 84,373 | |
| Agricultural Real Estate | | | 50,932 | | | | 11,548 | | | | 62,480 | |
| Agricultural | | | 32,236 | | | | 916 | | | | 33,152 | |
| Commercial Real Estate | | | 291,128 | | | | 78,717 | | | | 369,845 | |
| Commercial and Industrial | | | 47,787 | | | | 11,712 | | | | 59,499 | |
| Consumer | | | 27,299 | | | | | | | | 27,299 | |
| Industrial Development Bonds | | | 4,701 | | | | | | | | 4,701 | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Although loans may be classified as non-performing, some pay on a regular basis, and
many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $116.1 thousand for 2016, $117.1 for 2015 and
$52.3 thousand for 2014. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific
allocation is applied to the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $64 thousand for 2016, $96 thousand for 2015 and $87 thousand for 2014.
$20.6 thousand of interest collected in 2015 was applied to reduce the specific allocation and was applied for the same reason in 2014. Loans are
placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The Bank had nonaccrual loan balances of $1.4 million at December 31, 2016
compared to balances of $2.0 and $1.7 million as of year-end 2015 and 2014. All of the balances of nonaccrual loans for the past three years were collaterally secured. As of December 31, 2016 the Bank had $20.4 million of loans which it considers to be potential problem loans in that the borrowers are
experiencing financial difficulties. At December 31, 2015, the Bank had $7.0 million of these loans. The increase in 2016 relates to mainly two relationships. These loans are subject to constant management attention and are reviewed at
least monthly. The amount of the potential problem loans was considered in managements review of the loan loss reserve at December 31, 2016 and 2015. In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established
by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due
loan-loss experience and the financial condition of the banks borrowers. As of December 31, 2016, the Bank had loans outstanding to
individuals and firms engaged in the various fields of agriculture in the amount of $84.6 million with an additional $63.4 million in agricultural real estate loans these compared to $82.7 and $58.5 million respectively as of
December 31, 2015. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities. Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing
financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2016, the Bank had $0.7 million of its loans that were classified as troubled debt restructurings, of which
$138.3 thousand are included in non-accrual loans. This compares to $1.1 million as of same date 2015 and the Bank had almost $797.2 thousand classified as such as of December 31, 2014.
Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank may also require an updated appraisal of a
watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred. To determine observable market value, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated
appraisals are received, the Bank may discount the existing collateral value used. Performing non-watch list loans secured in whole or in part
by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List loans secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to
values as found in the Banks loan policies irrespective of their grade. The Banks watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Banks loans are made in the market by lenders who live and work in the market. Thus, their evaluation of the independent valuation
is also valuable and serves as a double check. On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing
commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use
any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Banks senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be
impaired or on the Banks watch list. In addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the
value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to
management regarding market conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion
on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but
lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Banks general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Banks loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components,
allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected
losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a
predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For
those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is
established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by
loan category. The unallocated portion of the reserve for loan losses is determined based on managements assessment of general economic conditions
as well as specific economic factors in the Banks marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to
uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrowers financial condition and other current risk factors that may not have yet manifested themselves in the Banks
historical loss factors used to determine the allocated component of the allowance. Actual charge-off of loan
balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral. As presented in the table below, charge-offs decreased to $550 thousand for 2016, the lowest level of the five years presented. 75.6% of the charge-offs
stemmed from the consumer related portfolios. Charge-offs were $1.0 million for 2015, preceded by $778 thousand for 2014, $1.3 million for 2013, and $891 thousand for 2012. Recoveries were also the lowest in 2016 at
$156 thousand compared to $557, $298, $374 and $286 thousand for 2015, 2014, 2013 and 2012, respectively. The net charge-offs for the last five years were all under $1 million. 2016 was the lowest at $394 thousand. Higher provision expense was used to fund the ALLL for loan growth in 2014 and 2016. For 2012, 2013 and 2015, the
provision was used to replenish the balance decreased by the net charge-off activity. Overall, the ALLL increased from $5.2 million at yearend 2012 to $6.8 million at yearend 2016. After adding the
allowance for unfunded loan commitments, the ACL ended 2016 just over $7 million. As the ratios on the bottom of the following table show, the trends for each have continually improved over the five years shown. Asset quality and the ACL are
both strong and emphasize the level of credit quality. In reviewing the bigger picture of the allowance for credit loss, the years with the higher
percentage of ACL to total nonperforming loans ratio account for the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. In 2012,
the provision expense was to offset the higher year-end watch list values. A smaller portion of the allowance was needed to fund the impaired loans as collateral remained sufficient to cover the outstanding
amounts in most cases. 2014s significant and continued loan growth since fourth quarter 2013 was the reason behind 2014s higher balances as asset quality remained strong. The ratio of ACL to nonperforming loans increased significantly in
2014 which is why provision loan expense was lower in 2015 in comparison. The ACL to nonperforming loans for 2015 remained more than adequate and emphasizes the existing strong level of credit quality. The following table presents a reconciliation of the allowance for credit losses for the years ended
December 31, 2016, 2015, 2014, 2013 and 2012: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | | | 2012 | | |
| Non-accrual loans | | $ | 1,384 | | | $ | 2,041 | | | $ | 1,705 | | | $ | 3,329 | | | $ | 4,828 | |
| Accruing loans past due 90 days or more | | | | | | | | | | | | | | | | | | | 1 | |
| Troubled Debt Restructurings, not included above | | | 559 | | | | 878 | | | | 471 | | | | 485 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,943 | | | $ | 2,919 | | | $ | 2,176 | | | $ | 3,814 | | | $ | 4,829 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | *
Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual. Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans
is as follows: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | | | 2012 | | |
| Loans | | $ | 760,149 | | | $ | 685,878 | | | $ | 621,926 | | | $ | 576,113 | | | $ | 501,402 | |
| | | | | | | | | | | | | | | | | | | | | |
| Daily average of outstanding loans | | $ | 724,076 | | | $ | 627,194 | | | $ | 581,483 | | | $ | 507,126 | | | $ | 492,697 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan Losses-Jan 1 | | $ | 6,057 | | | $ | 5,905 | | | $ | 5,194 | | | $ | 5,224 | | | $ | 5,091 | |
| Loans Charged off: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 106 | | | | 38 | | | | 168 | | | | 147 | | | | 246 | |
| Agricultural Real Estate | | | | | | | | | | | | | | | | | | | | |
| Agricultural | | | 21 | | | | | | | | | | | | | | | | 6 | |
| Commercial Real Estate | | | 93 | | | | 143 | | | | 229 | | | | 164 | | | | 98 | |
| Commercial and Industrial | | | 20 | | | | 536 | | | | | | | | 513 | | | | 47 | |
| Consumer | | | 310 | | | | 313 | | | | 381 | | | | 438 | | | | 494 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 550 | | | $ | 1,030 | | | $ | 778 | | | $ | 1,262 | | | $ | 891 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | $ | 28 | | | $ | 41 | | | $ | 34 | | | $ | 20 | | | $ | 60 | |
| Agricultural Real Estate | | | | | | | | | | | | | | | | | | | | |
| Agricultural | | | 10 | | | | 64 | | | | 44 | | | | 5 | | | | 12 | |
| Commercial Real Estate | | | 20 | | | | 204 | | | | 4 | | | | 23 | | | | 7 | |
| Commercial and Industrial | | | 11 | | | | 91 | | | | 20 | | | | 141 | | | | 30 | |
| Consumer | | | 87 | | | | 157 | | | | 196 | | | | 185 | | | | 177 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 156 | | | $ | 557 | | | $ | 298 | | | $ | 374 | | | $ | 286 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net Charge Offs | | $ | 394 | | | $ | 473 | | | $ | 480 | | | $ | 888 | | | $ | 605 | |
| Provision for loan loss | | | 1,121 | | | | 625 | | | | 1,191 | | | | 858 | | | | 738 | |
| Acquisition provision for loan loss | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses - Dec 31 | | $ | 6,784 | | | $ | 6,057 | | | $ | 5,905 | | | $ | 5,194 | | | $ | 5,224 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 | | | 217 | | | | 208 | | | | 207 | | | | 163 | | | | 162 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses - Dec 31 | | $ | 7,001 | | | $ | 6,265 | | | $ | 6,112 | | | $ | 5,357 | | | $ | 5,386 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.05 | % | | | 0.08 | % | | | 0.08 | % | | | 0.18 | % | | | 0.12 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 490.39 | % | | | 293.75 | % | | | 346.30 | % | | | 156.03 | % | | | 108.20 | % |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Deposits The amount of
outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2016 are as follows:
(In Thousands)
Over Three
Over Six
Months
Months Less
Over
Under
Less than
Than One
One
Three Months
Six Months
Year
Year
Time Deposits
$
21,606
$
9,038
$
13,071
$
56,225
The following table presents the average amount of and average rate paid on each deposit category: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2016 | | | | | | | | 2015 | | | | | | | | 2014 | | | | | | | | 2013 | | | | | | | | 2012 | | | | | | |
| | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | |
| | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | |
| Balance at End of Period Applicable To: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | $ | 316 | | | | 11.43 | | | $ | 338 | | | | 12.82 | | | $ | 537 | | | | 15.69 | | | $ | 257 | | | | 16.05 | | | $ | 368 | | | | 16.01 | |
| Agricultural Real Estate | | | 241 | | | | 8.33 | | | | 211 | | | | 8.52 | | | | 184 | | | | 8.18 | | | | 131 | | | | 7.69 | | | | 113 | | | | 8.01 | |
| Agricultural | | | 616 | | | | 11.14 | | | | 582 | | | | 12.07 | | | | 547 | | | | 12.00 | | | | 326 | | | | 11.36 | | | | 290 | | | | 11.52 | |
| Commercial Real Estate | | | 3,250 | | | | 49.59 | | | | 2,516 | | | | 46.98 | | | | 2,367 | | | | 43.43 | | | | 2,107 | | | | 43.19 | | | | 1,749 | | | | 39.89 | |
| Commercial and Industrial | | | 1,318 | | | | 15.14 | | | | 1,229 | | | | 15.56 | | | | 1,421 | | | | 16.86 | | | | 1,359 | | | | 18.03 | | | | 2,183 | | | | 20.53 | |
| Consumer | | | 394 | | | | 4.37 | | | | 337 | | | | 4.05 | | | | 323 | | | | 3.84 | | | | 292 | | | | 3.68 | | | | 268 | | | | 4.04 | |
| Unallocated | | | 649 | | | | 0.00 | | | | 844 | | | | 0.00 | | | | 526 | | | | 0.00 | | | | 722 | | | | 0.00 | | | | 253 | | | | 0.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses | | $ | 6,784 | | | | 100.00 | | | $ | 6,057 | | | | 100.00 | | | $ | 5,905 | | | | 100.00 | | | $ | 5,194 | | | | 100.00 | | | $ | 5,224 | | | | 100.00 | |
| Off Balance Sheet Commitments | | | 217 | | | | | | | | 208 | | | | | | | | 207 | | | | | | | | 163 | | | | | | | | 162 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses | | $ | 7,001 | | | | | | | $ | 6,265 | | | | | | | $ | 6,112 | | | | | | | $ | 5,357 | | | | | | | $ | 5,386 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Liquidity Liquidity remains adequate though down from prior years as the Bank has decreased the investment portfolio to fund loans. The Bank has access to
$58 million of unsecured borrowings through correspondent banks and $71.9 million of unpledged securities which may be sold or used as collateral. The amount of unpledged securities increase almost $42.5 million as compared to 2015.
This was accomplished with utilizing Promontorys ICS product to protect Ohio public fund depositors and commercial sweep customers with FDIC coverage rather than pledged securities. For the Bank, an additional $4.7 million is also
available from the Federal Home Loan Bank based on current collateral pledging with up to $115.7 million available provided adequate collateral is pledged. Maintaining sufficient funds to meet depositor and borrower needs on a daily basis continues to be among managements top priorities. This is
accomplished not only by immediate liquid resources of cash, due from banks and federal funds sold, but also by the Banks available for sale securities portfolio. The average aggregate balance of these assets was $228.0 for 2016 and
$262.1 million for 2015, and $296.5 million for 2014. This represented 22.3%, 28.0% and 31.8% of total average assets, respectively. Of the almost $201.2 million of debt securities in the banks portfolio as of December 31,
2016, $16.7 million, or 8.3% of the portfolio, is expected to receive payments or mature in 2017. This liquidity provides the opportunity to fund loan growth by analysis of the lowest cost and source of funds whether by increasing deposits,
sales or runoff of investments or utilizing debt. In addition to the Banks investment portfolio, the Company has $17.3 million held in the
holding companys investment portfolio. $2.6 million of those investments will mature or receive payments in the next twelve months. These funds provide liquidity to the Company. The Bank has been declaring additional dividends each
quarter to provide this liquidity to the Company. In future years, the Captive will also upstream dividends to the Company once reserve levels are adequately provided for. This will also provide additional liquidity for Company activities. Historically, the primary source of liquidity has been core deposits that include noninterest bearing and interest bearing demand deposits, savings, money
market accounts and time deposits of individuals. Core deposit balances as of year-end 2016 increased in all categories. Overall deposits increased an average of $39.7 million in 2016, $2.6 million
in 2015 and $913 thousand in 2014. The Bank also utilized Federal Funds purchased at times during 2014 through 2016. The average balance for 2016 and 2015 was $1.9 million and $1.2 million respectively. The Bank used this temporary
funding source heavier in December 2015 while it secured more permanent funding. During 2016, it was used heavily in the third quarter. The Bank is comfortable accessing these funds on a regular basis. Historically, the primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and
for business development. The use of new funds for loans is measured by the loan to deposit ratio. The Banks average loan to deposit ratio was 87.9% for 2016, 80.7% for 2015 and 76.4% for 2014. The Banks goal is for this ratio to be
higher in the 80-90 percent range with loan growth being the driver. The Bank ended the year 2016 at an 89.4% loan to deposit ratio. Short-term debt such as federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt
for both federal funds purchased and securities sold under agreement to repurchase amounted to $70.3 at December 31, 2016, $78.8 million at the end of 2015 compared to $56.0 million at the end of 2014. These accounts are used to
provide a sweep product to the Banks commercial customers. As ICS is implemented, the sweep balances will move into interest bearing deposits. Other borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then
used to provide loans in our community. The Bank utilized this funding source in December 2015 by borrowing $10 million. Prior borrowings from this source had decreased by $4.5 million to none at December 31, 2014. This compares to
consistent borrowings during 2016 of $10 million. The decreased borrowings were payoffs of matured notes in 2013 and 2014. Asset/Liability
Management The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest
earning assets and interest bearing liabilities. It involves the management of the balance sheet mix, maturities, re-pricing characteristics and pricing components to provide an adequate and stable net
interest margin with an acceptable level of risk. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. Changes in net income, other than those related to volume arise when interest rates on assets re-price in a time frame or interest rate environment that is different from that of the re-pricing period for liabilities. Changes in net interest income also arise from
changes in the mix of interest-earning assets and interest-bearing liabilities. Historically, the Bank has maintained liquidity through cash flows
generated in the normal course of business, loan repayments, maturing earning assets, the acquisition of new deposits, and borrowings. The Banks asset and liability management program is designed to maximize net interest income over the long
term while taking into consideration both credit and interest rate risk. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans
that are tied to the market rate differ considerably from long-term investment securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings
accounts. The Bank utilizes shock analysis to examine the amount of exposure an instant rate change of 100, 200, 300 and 400 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings
and equity at risk are established and decisions are made to maintain those levels based on the shock results. Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of the Companys operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Companys
performance than do the effects of 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 service. Contractual Obligations Contractual Obligations of the
Company totaled $263.2 million as of December 31, 2016. Time deposits represent contractual agreements for certificates of deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is
further defined in Note 4 and 9 of the Consolidated Financial Statements. |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | Non-Interest | | | | Interest | | | | Savings | | | | Time | | |
| | | DDAs | | | | DDAs | | | | Accounts | | | | Accounts | | |
| December 31, 2016: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 169,510 | | | $ | 207,057 | | | $ | 239,939 | | | $ | 194,753 | |
| Average rate | | | 0.00 | % | | | 0.61 | % | | | 0.18 | % | | | 0.99 | % |
| December 31, 2015: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 162,028 | | | $ | 184,941 | | | $ | 227,328 | | | $ | 189,822 | |
| Average rate | | | 0.00 | % | | | 0.62 | % | | | 0.18 | % | | | 0.90 | % |
| December 31, 2014: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 152,155 | | | $ | 178,285 | | | $ | 216,405 | | | $ | 214,680 | |
| Average rate | | | 0.00 | % | | | 0.51 | % | | | 0.17 | % | | | 0.94 | % |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Capital Resources Stockholders equity was $125.6 million as of December 31, 2016 compared to $120.1 million at December 31, 2015. Dividends declared
during 2016 were $0.91 per share totaling $4.2 million and dividends declared during 2015 were $0.87 per share totaling $3.99 million. Throughout 2016, the Company purchased 7,000 shares and awarded 16,150 shares of restricted stock awards
to 74 employees. During 2015, the Company purchased 30,685 shares and awarded 16,000 shares of restricted stock to 67 employees. For a summary of activity as it relates to the Companys restricted stock awards, please refer to Note 11: Employee
Benefit Plans in the consolidated financial statements. On December 31, 2016 the Company held 579,125 shares in Treasury Stock and 43,150 unvested shares of restricted stock. At yearend 2015, the Company held 587,466 shares in Treasury stock
and 38,995 unvested shares of restricted stock. On January 20, 2017 the Company announced the authorization by its Board of Directors for the Companys repurchase,
either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 20, 2017 and ending December 31, 2017. The
Company has a history of approving a similar resolution to be in effect each year for at least the last five years. The Company continues to have a
strong capital base and maintains regulatory capital ratios that are above the defined regulatory capital ratios. At December 31, 2016, the Bank and the Company had total risk-based capital ratios of 12.73% and 15.28%, respectively. Core
capital to risk-based asset ratios of 11.91% and 14.46% for the Bank and the Company, respectively, are well in excess of regulatory guidelines. The Banks leverage ratio of 9.75% is also substantially in excess of regulatory guidelines, as is
the Companys at 11.77%. Under Basel III, the common equity Tier 1 Capital to risk-weighted assets ratios are also well above the required 4.50% and the 6.50% well capitalized levels with the Company at 14.46% and the Bank at 11.91%. For
further discussion and analysis of regulatory capital requirements, refer to Note 15 of the Audited Financial Statements. The Companys subsidiaries
are restricted by regulations from making dividend distributions in excess of certain prescribed amounts. Upon prior regulatory approval, the Bank may be allowed to pay above the prescribed amount. |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Payment Due by Period (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | Less than | | | | 1-3 | | | | 3-5 | | | | More than | | |
| Contractual Obligations | | Total | | | | 1 year | | | | Years | | | | Years | | | | 5 years | | |
| Securities sold under agreement to repurchase | | $ | 53,324 | | | $ | 32,814 | | | $ | 20,510 | | | $ | | | | $ | | |
| Time Deposits | | | 198,830 | | | | 79,407 | | | | 72,563 | | | | 46,037 | | | | 823 | |
| Dividends Payable | | | 1,053 | | | | 1,053 | | | | | | | | | | | | | |
| Long Term Debt | | | 10,000 | | | | | | | | 10,000 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 263,207 | | | $ | 113,274 | | | $ | 103,073 | | | $ | 46,037 | | | $ | 823 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-17-051316 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following tables show changes in interest income, interest expense and net interest resulting from changes in
volume and rate variances for major categories of earnings assets and interest bearing liabilities. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | **2012** | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | AverageBalance | | | | Interest/Dividends | | | | Yield/Rate | | |
| **ASSETS** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 492,697 | | | $ | 26,489 | | | | 5.41 | % |
| Taxable investment securities | | | 289,864 | | | | 4,802 | | | | 1.66 | % |
| Tax-exempt investment securities | | | 65,330 | | | | 1,936 | | | | 4.49 | % |
| Federal funds sold & interest bearing deposits | | | 32,068 | | | | 46 | | | | 0.14 | % |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | | 879,959 | | | $ | 33,273 | | | | 3.92 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Non-Interest Earning Assets:** | | | | | | | | | | | | |
| Cash and cash equivalents | | | 16,814 | | | | | | | | | |
| Other assets | | | 39,342 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Assets** | | $ | 936,115 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **LIABILITIES AND SHAREHOLDERS EQUITY** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 372,997 | | | $ | 1,982 | | | | 0.53 | % |
| Other time deposits | | | 285,214 | | | | 3,592 | | | | 1.26 | % |
| Other borrowed money | | | 15,333 | | | | 434 | | | | 2.83 | % |
| Federal funds purchased and securities sold under agreement to repurchase | | | 54,776 | | | | 242 | | | | 0.44 | % |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | | 728,320 | | | $ | 6,250 | | | | 0.86 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Non-Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 88,588 | | | | | | | | | |
| Other | | | 11,458 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities** | | | 828,366 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Shareholders Equity** | | | 107,749 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities and Shareholders Equity** | | $ | 936,115 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 33,273 | | | | 3.92 | % |
| Interest Expense / yield | | | | | | $ | 6,250 | | | | 0.86 | % |
| | | | | | | | | | | | | |
| Net Interest Spread | | | | | | $ | 27,023 | | | | 3.06 | % |
| | | | | | | | | | | | | |
| Net Interest Margin | | | | | | | | | | | 3.21 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | As mentioned in the discussion earlier, in reviewing the 2014 to 2013, the change in volume is the main driver for the
improved ratio which is opposite of the change between 2013 to 2012 where an impact in change due to volume is evident; however the largest impact was due to rate. The strategy since 2010 is to extend the maturities of time deposit
specials to over 24 months to prepare for rising rates. The other strategy employed since 2011 was to increase core deposits by offering innovative products focused on customer needs, such as higher interest rates and fraud notification.
In exchange for these accounts, customers were asked to utilize services that benefited both the Bank and themselves. Smaller time deposit rate shoppers had an option to perhaps change their behavior of banking or allow those deposits to run off.
The new core deposit products were indeed embraced by our customers and have helped to attain the deposit portfolio mix sought by the Bank. Non-Interest Income The discussion now turns to the noninterest activity of 2014 operations, beginning with the revenue portion. In comparing line items of the consolidated
statement of income for years ended 2012 through 2014, it can be seen where the Company has been spending its time and the impact of the recession and slow recovery. This section will focus on the significant noninterest items that impacted the
operations of the Company. The Company has concerns with the increased costs associated with regulatory compliance such as the possible loss of revenue
from new regulations stemming from the Dodd-Frank Act. History has proven the concern is justified. One area of revenue impacted was overdraft fees. Updated Regulation E guidelines were implemented on August 15, 2010 and the Bank has ended each
year since with a lower revenue stream. This has occurred in spite of the addition of the new offices since 2010. At year-end 2012 and 2013, the number of checking accounts again increased along with the balances; however average collected overdraft
fees per account decreased as compared to 2011. In the last two years, 2013 and 2014, checking balances have increased while average revenue per account continued to decline. Overdraft fees in 2014 accounted for $2.5 million in noninterest income
and $2.7 million for 2013. This represents 65.45% of the line item service charges and fees on the income statement which was down from 2013s percentage of 71.5%. The Bank has made this an area of focus for 2014 as this revenue stream remains
under intense regulator review. The decrease in the percentage is due to an increase in the service charge revenue on checking accounts with the new offerings and discontinuation of some checking products. Service charges on checking accounts,
excluding Health Savings Accounts, were up $208.7 thousand for 2014 as compared to 2013. The Bank has long promoted the use of debit cards by its
customers and continued that philosophy with the introduction of additional new products. 2014 revenue improved $250.5 and $558.8 thousand from ATM/debit
card usage as compared to 2013 and 2012, respectively. The Bank receives interchange revenue from each swipe of the card. In 2011, this revenue stream was at risk of being reduced by the Federal Reserve regulation of the interchange fee.
The establishment of a tiered pricing for banks under $10 billion has helped to protect the profitability from such fees, although the concern remains as to how long this tiered pricing will remain in effect. While this revenue stream continues to
improve with more depositors using electronic methods for purchasing, the expense of fraud has offset a portion of the revenue gain. Further discussion can be found in the non-interest expense section regarding the net effect of debit card activity.
Overall, noninterest income decreased for 2014 as compared to both 2013 and 2012. Unfortunately, this has become a trend mainly due to the duration of
the flat rate interest environment. In 2012, the largest positive impact on the income statement was derived from sales activity; including net gain on
sale of loans and net gain on sale of securities. During 2012, the net gain on sale of loans, which is derived from sales of real estate loans into the secondary market, was the most significant factor for this category. The gain on residential real
estate loans accounted for $1.3 million and $725 thousand was derived from gain on sales of agricultural real estate. Both of these programs are offered to our customers to enable them to have a fixed rate loan while the Bank limits its interest
rate risk exposure. Of these loan types, the Bank sells 100% of the residential loans and 90% of the agricultural loans into the secondary market. 2013 or 2014 activity did not reach the same high levels as 2012. Gains of $452.7 and $194.3 thousand
were recorded for residential and agricultural real estate respectively for 2014 along with gains of $865 and $258 thousand were recorded for residential and agricultural real estate respectively for 2013. In conjunction with these sales, the Bank
maintains servicing rights and those income amounts during all three years are included in the customer service fees line item and account for over a $1 million in revenue each year. However, new sales in 2012 catapulted this income higher than 2013
or 2014. The last line item in the noninterest income section as was discussed previously is the net gain on sale of investments. The Bank has taken
advantage of this opportunity the last three years and expects to continue as long as the rates remain low and the yield curve is favorable to the transaction. The Bank will not increase short-term gain at the sacrifice of long-term profitability.
All of the sales of securities in 2014 of $57.9 million were used to fund loan growth while only some of the $91 million in proceeds realized on the sale of securities in 2013 were used to fund loan growth. This is a source of funds that will
continue to be analyzed for use in the coming year. Gains of $494 thousand were recorded for 2014 as compared to $775 and $852 thousand for 2013 and 2012 respectively. Overall, noninterest income decreased $654 thousand in 2014 following a year where it had decreased $758
thousand. Some of the revenue may not be easily duplicated as it is dependent on economic and market conditions to provide the opportunity. However, the increased revenue amounts from deposit and loan services should continue to provide improved
profitability in the future. Gains on sales should also continue in the near term though when it will change is unknown at this time. Moving to the
noninterest expense side, overall, noninterest expense increased 4.2% in 2014 as compared to 2013 and 2012 which were basically equal at $24.2 million. The largest factor behind the higher 2014 level was the impact of employee salaries and wages on
the income statement. Employee wages increased $633.3 thousand in 2014 over 2013; they increased $513.4 thousand in 2013 compared to 2012. Three main components flow into salaries and wages: base salary, deferred costs, and incentives composed of
the expense of restricted stock awards and performance incentives. Base pay has increased with the addition of the three offices of Waterville, Custar and Sylvania and through normal yearly increases to the remainder of the employees. Base was up
$474.1 thousand for 2014 over the previous year and 2013 was up $408.1 thousand over 2012. The full time equivalent number at each yearend of employees increased to 260 for 2014 compared to 2012s 248. Incentive pay as it related to performance was up $209.5 thousand in 2014 over 2013. Both measurements used to award incentive pay had improved in 2014 and
employees benefited accordingly. This followed a year in which the incentive performance pay was down $110.1 thousand from 2012. The Banks performance was not up to the level of 2012, even though the number of employees receiving an incentive
was higher. (For further discussion in incentive pay, see note 11 of the consolidated financial statements.) While net loss on sale of other assets
owned, mainly OREO property, does not represent income for the years presented, the decrease in the amount of the loss for 2014 and 2013, as compared to 2012, does contribute to improved profitability. The loss of $634 thousand for 2012 stems not
only from sales but also from write-downs in the carrying value of those properties still held on the Banks balance sheet. The number of properties decreased and the carrying value declined in 2014 to $1.1 million and 2013 to $2.3 million from
$3.6 million in 2012. The mortgage refinancing activity has declined over the last three years. A correlating expense to that activity is the
amortization of mortgage servicing rights. The amortization is the expense that offsets the income recognized when the loan is first made. Income is recorded when the mortgage loan is first sold with servicing retained and is therefore recognized
within one year. The amortization, however, is calculated over the life of the loan and accelerated as loans are paid off early. An increase in this expense can be driven by two activities: an increase in the number of sold loans and/or by the
acceleration of the expense from payoff and refinance activity. The best picture of the bottom line impact is achieved by netting the income with the expense each year. 2014 had net expense of $42.7 thousand, 2013 had a net income of $2 thousand and
2012 had net expense of $8 thousand. Of course, the value (or income) of the mortgage servicing right when sold also impacts the net position. While gain on sale of these loans was high in 2012, the net position was an expense indicating the
activity was mainly refinance. 2013 had new loan activity and lower refinance activity making the additions and amortization almost equal. The number of loans and balances also indicates this as the levels have remained fairly constant. 2014 was a
year with limited sales and the amortization expense was therefore higher than the capitalized additions. As of December 31, 2014, there were 3,638 loans serviced with balances of $275.4 million. As of December 2013, there were 3,684 loans
serviced with balances of $282.1 million. As of December 2012, there were 3,674 loans serviced with balances of $280.4 million. The impact of mortgage
servicing rights to both noninterest income and expense is shown in the following table: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2014 vs 2013 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 3,092 | | | $ | 3,667 | | | $ | (575 | ) |
| Taxable investment securities | | | (1,027 | ) | | | (1,577 | ) | | | 550 | |
| Tax-exempt investment securities | | | (25 | ) | | | 50 | | | | (75 | ) |
| Federal funds sold & interest bearing deposits | | | (15 | ) | | | (20 | ) | | | 5 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | 2,025 | | | $ | 2,120 | | | $ | (95 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | (26 | ) | | $ | (20 | ) | | $ | (6 | ) |
| Other time deposits | | | (709 | ) | | | (391 | ) | | | (318 | ) |
| Other borrowed money | | | (159 | ) | | | (159 | ) | | | | |
| Federal funds purchased and securities sold under agreement to repurchase | | | 6 | | | | 30 | | | | (24 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | (888 | ) | | $ | (540 | ) | | $ | (348 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | 2013 vs 2012 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | (1,511 | ) | | $ | 781 | | | $ | (2,292 | ) |
| Taxable investment securities | | | (205 | ) | | | (35 | ) | | | (170 | ) |
| Tax-exempt investment securities | | | (117 | ) | | | (44 | ) | | | (73 | ) |
| Federal funds sold & interest bearing deposits | | | (12 | ) | | | (14 | ) | | | 2 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | (1,845 | ) | | $ | 688 | | | $ | (2,533 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | (507 | ) | | $ | 144 | | | $ | (651 | ) |
| Other time deposits | | | (874 | ) | | | (434 | ) | | | (440 | ) |
| Other borrowed money | | | (271 | ) | | | (245 | ) | | | (26 | ) |
| Federal funds purchased and securities sold under agreement to repurchase | | | 6 | | | | 6 | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | (1,646 | ) | | $ | (529 | ) | | $ | (1,117 | ) |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Occupancy expense decreased by $144 thousand in 2014 as compared to 2013 and by $168 thousand in 2013 as compared to 2012.
Although real estate taxes and building depreciation were higher on our office locations, these were offset by the increased rental income from the Banks investment services. $97.7 thousand more was collected in 2014 as compared to 2013 and
2013 collected $217 thousand more than 2012. Data processing expense increased $38 thousand during 2014 and by $93 thousand in 2013. The Company continues to
investigate ways to reduce this expense. The pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the growth from the newer additions of the Waterville, Custar and Sylvania offices and
overall Bank growth. The FDIC assessment decreased in 2012 as new regulation changed the method of calculation in the summer of 2011. 2012 represented
the first full year under the new method. As can be seen, the change to calculations based on asset size rather than deposits has been very beneficial to F&M. 2013 was higher than 2012 as the Bank grew in size by $19.3 million over 2012 and was
lower in 2014 by $32 thousand as the Bank decreased in size by $24.7 million. The last line item in the noninterest expense is other general and
administrative. While it is higher by $461 thousand in 2014 following a smaller increase of $449 thousand in 2013 over 2012s $5.1 million, the fluctuation is not isolated to a single source. The primary factors impacting this fluctuation
in 2014 and 2013 are increases in both ATM expense and core deposit intangible expenses. The increased expense of $52.7 and $376.3 thousand relating to ATM and debit cards in 2014 and 2013 respectively, over the previous year is caused by many
factors. First, 2012 was lower due to incentive credits received by the Bank for switching providers and these credits were depleted early in 2013. Increased usage during both years corresponds to increases in both revenue and cost. Finally, fraud
increases cost as new cards have to be issued to limit the risk exposure. The fraud losses themselves are not recognized in this breakout, however the cost of replacement cards is. The Bank is not currently deploying chip technology within its
cards; however the Bank is aware the adoption of embedded chips will increase this expense in the coming years. 2014 experienced additional expense over 2013 in consulting ($161.7 thousand), audit and accounting fees ($166.5 thousand) and
advertising ($101.3 thousand). The first two line items increased related to the new deposit products offered and the establishment of an affiliate
subsidiary by the Company. To establish the new subsidiary, actuarial studies and consulting services were utilized to determine the feasibility and benefit thereof. By establishing at yearend, the Company has enabled 2015 to fully capture the
benefits with limited additional cost. The affiliate is a Captive insurance company insuring the Company and the Bank in addition to their coverage before the formation. The Captive has provided additional coverage that was not available from our
current carriers or was cost prohibitive. The Captive also provides a tax benefit to the Company with its formation in Nevada. The increase in advertising expense is warranted with the Banks increased marketing area. Provision for loan losses is the last non-interest line item to discuss. The provision expense increased $333 thousand for 2014. The increase was needed to
offset account for the loan growth and the net charge-off activity of 2014. Sustained strong asset quality kept the provision expense lower than the growth alone would have warranted. The provision expense for 2013 was higher than for 2012 by $120
thousand. Net charge-offs of $480 and $888 thousand for 2014 and 2013, respectively, were in the middle of the $605 thousand recorded for 2012. Commercial and Industrial loans had the largest charge-off activity in 2013, while 2014 and 2012 were
impacted with higher levels in the consumer portfolios. Further analysis by loan type is presented in the discussion of the allowance for credit losses. Allowance for Credit Losses The Company segregates its
Allowance for Credit Losses (ACL) into two reserves: The ACL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total ACL. The AUCL is included in other liabilities on the
consolidated balance sheets. The Banks ALLL methodology captures trends in leading, current, and lagging indicators which will directly affect the
Banks allocation amount. The Bank monitors trends in such leading indicators as delinquency, unemployment changes in the Banks service area, experience and ability of staff, regulatory trends, and credit concentrations. A current
indicator such as the total watch list loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as well. A matrix formed by loan type from these indicators is used in making ALLL adjustments. Special mention loan balances increased 21.2% or $1.7 million overall as of yearend 2014 compared to same date 2013. The increase is in the commercial and
commercial real estate portfolios. The largest increase of $2.1 million was in the commercial real estate caused mainly by one large relationship being downgraded. Agricultural real estate showed a decrease of $618 thousand offsetting the above
increase. Special Mention loan balances decreased 40.6% or $5.4 million as of December 31, 2013 as compared to
December 31, 2012. The balances decreased due to pay offs received and improved performance of the companies, thereby resulting in an upgrade out of special mention. This improvement was preceded by an increase of 26.5% or $2.8 million from
2011 to 2012. For 2014, the increase in special mention is offset by significant decreases in the substandard classifications of those same commercial related portfolios. Overall, substandard and doubtful loans decreased 42.5% or $2.9 million as
compared to yearend 2013. A similar level of improvement is evident in substandard and doubtful loans during the same time frames for a year ago. 2013 had a decrease of 71.1%, or $2.5 million, compared to 2012. In response to these fluctuations and
loan growth during 2014, the Bank changed ALLL to outstanding loan coverage percentage to .95% as of December 31, 2014 from .90% as of December 31, 2013 and 1.04% as of December 31, 2012. The above indicators are reviewed quarterly. Some of the indicators are quantifiable and, as such, will automatically adjust the ALLL once calculated. These
indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and watch list loans to capital ratios, with the watch list made up of loans graded 5, 6 or 7 on a scale of 1 (best) to 7 (worst). Other indicators
use more subjective data to the extent possible to evaluate the potential for inherent losses in the Banks loan portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market area to help
determine whether the ALLL should be adjusted. At the end of each of 2012, 2013 and 2014, a slight improvement was noted in unemployment figures and several local firms were calling a small number of employees back from layoff while planning some
expansion. All aggregate commercial and agricultural credits including real estate loans of $250,000 and over are reviewed annually by both credit
committees and internal loan review to look for early signs of deterioration. To establish the specific reserve allocation for real estate, a discount to
the market value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Banks Loan Policy. However, unique or unusual circumstances may
be present which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management. The ACL increased $755 thousand during 2014, which was preceded by a $29 thousand decrease during 2013. The large increase in 2014 directly correlates to the
large increase in loan balances. With the improved asset quality, the percentage of ACL to the total loan portfolio actually decreased from 1.07% as of December 31, 2012 to .93% as of December 31, 2013 and .95% as of December 31,
2014. December 31, 2013 had the lowest loans past due 30+ day percentage at .25% in the Banks known history, December 31, 2014 was still at a respectable low of .37%. Please see Note 4 in the consolidated financial statement for additional tables regarding the composition of the ACL. Federal Income Taxes Effective tax rates were 28.64%,
28.53% and 28.51% for 2014, 2013 and 2012 respectively. The effect of tax-exempt interest from holding tax-exempt securities and Industrial Development Bonds (IDBs) was $649, $640, and $677 thousand for 2014, 2013, and 2012, respectively. All years
included an increase into a higher tax bracket for income over $10 million. Material Changes in Financial Condition The shifts in the balance sheet during 2014 have positioned the Company for continued improvement in profitability. On the asset side, the Company experiences
an increase in asset yield due to loan growth with funding provided by a decrease in the investment portfolio. The cost of funds was impacted by the shift of interest bearing liabilities to noninterest and the decrease in time deposits and other
borrowed money. Both contributed to improved profitability in 2014 and expected liabilities improvement in future years. Average earning assets increased
$1.5 million during 2013 over 2012. The main cause of fluctuation was the opening of the Waterville office in 2013 and the repositioning of the balance sheet. The Custar acquisition had minimal effect on the average balance of earning assets, given
that it took place in December 2013. The $29 million of deposits from the Custar acquisition impacted 2014. Average interest bearing liabilities decreased $16.5 thousand over 2012. The decrease in balances was due to the runoff of time deposits and
payoff of debt from FHLB. Savings deposits increased nicely in 2013 due to the success of the KASASA suite of products and Health Savings Accounts. Securities The investment portfolio is primarily used to provide overall liquidity for the Bank. It is also used to provide required collateral for pledging to the
Banks Ohio public depositors for amounts on deposit in excess of the FDIC coverage limits. It may also be used to pledge for additional borrowings from third parties. Investments are made with the above criteria in mind while still seeking a
fair market rate of return, and looking for maturities that fall within the projected overall strategy of the Bank. The possible need to fund growth is also a consideration. All of the Banks security portfolio is categorized as available for sale and as such is recorded at market value. Security balances as of December 31 are summarized below: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2014 | | | | 2013 | | | | 2012 | | |
| Beginning Year | | $ | 2,066 | | | $ | 2,063 | | | $ | 2,071 | |
| Capitalized Additions | | | 301 | | | | 429 | | | | 761 | |
| Amortization | | | (344 | ) | | | (426 | ) | | | (769 | ) |
| Valuation Allowance | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| End of Year | | $ | 2,023 | | | $ | 2,066 | | | $ | 2,063 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table sets forth the maturities of investment securities as of December 31, 2014 and the weighted average
yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate, have been made in yields on obligations of state and
political subdivisions. Stocks of domestic corporations have not been included. [Remainder of this page intentionally left blank.] |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2014 | | | | 2013 | | | | 2012 | | |
| U.S. Treasury | | $ | 25,393 | | | $ | 25,272 | | | $ | 10,568 | |
| U.S. Government agency | | | 119,234 | | | | 172,972 | | | | 220,200 | |
| Mortgage-backed securities | | | 29,562 | | | | 44,792 | | | | 53,006 | |
| State and local governments | | | 74,303 | | | | 81,473 | | | | 72,131 | |
| | | | | | | | | | | | | |
| | | $ | 248,492 | | | $ | 324,509 | | | $ | 355,905 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | As of December 31, 2013 the Bank did not hold a large block of any one investment security, except for U.S. Government
agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $3.7 million. This is required in order to obtain Federal Home Loan Bank loans. The Bank also acquired stock in the Federal Home Loan Bank of Indianapolis
at a cost of $231.4 thousand through its acquisition of Knisely Bank. There were no borrowings at the time of acquisition associated with Federal Home Loan Bank of Indianapolis. The Bank had requested Federal Home Loan Bank of Indianapolis to buy
back its stock when the acquisition of Knisely was completed in January 2008. A five year waiting period was imposed and the stock was ultimately redeemed in full during 2013. An early redemption of 42,000 shares occurred in 2010 with another 41,000
shares redeemed in 2011. These decreased the aggregate holdings to a value of $148.4 thousand which was redeemed in 2013. The Bank also owns stock of Farmer Mac with a carrying value of $37.4 thousand which is required to participate loans in the
program. Loan Portfolio The Banks various
loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio diversification and through standardization of lending policies and procedures. Risks are mitigated through an adherence to the Banks loan policies, with any exception being recorded and approved by senior management or committees
comprised of senior management. The Banks loan policies define parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow and debt-to-income ratio, loan requirements and covenants, financial information tracking,
collection practice and others. The maximum loan amount to any one borrower is limited by the Banks legal lending limits and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to
any one business or agricultural sector by an approved sector percentage to capital limitation. The following table shows the Banks loan portfolio by category of loan as of December 31st of each year, including loans held for sale: |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Maturities(Amounts in Thousands) | | | | | | | | | | | | | | |
| | | | | | | | | | | After One Year | | | | | | |
| | | Within One Year | | | | | | | | Within Five Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | | | | | | | | $ | 20,174 | | | | 0.89 | % |
| U.S. Government agency | | | 16,571 | | | | 2.40 | % | | | 92,163 | | | | 1.32 | % |
| Mortgage-backed securities | | | | | | | | | | | | | | | | |
| State and local governments | | | 5,922 | | | | 1.85 | % | | | 38,352 | | | | 2.38 | % |
| Taxable state and local governments | | | 1,012 | | | | 3.00 | % | | | 6,092 | | | | 1.78 | % |
| | | | | | | | | | | | | | | | | |
| | | After Five Years | | | | | | | | | | | | | | |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | 5,218 | | | | 1.28 | % | | $ | | | | | | |
| U.S. Government agency | | | 10,501 | | | | 1.58 | % | | | | | | | | |
| Mortgage-backed securities | | | 12,250 | | | | 2.69 | % | | | 17,312 | | | | 2.33 | % |
| State and local governments | | | 14,754 | | | | 3.11 | % | | | 5,881 | | | | 2.29 | % |
| Taxable state and local governments | | | 997 | | | | 2.60 | % | | | 1,293 | | | | 5.57 | % |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table shows the maturity of loans as of December 31, 2014: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| Loans: | | 2014 | | | | 2013 | | | | 2012 | | | | 2011 | | | | 2010 | | |
| Commercial real estate | | $ | 270,188 | | | $ | 248,893 | | | $ | 199,999 | | | $ | 198,266 | | | $ | 194,268 | |
| Agricultural real estate | | | 50,895 | | | | 44,301 | | | | 40,143 | | | | 31,993 | | | | 33,650 | |
| Consumer real estate | | | 97,550 | | | | 92,438 | | | | 80,287 | | | | 84,477 | | | | 86,036 | |
| Commercial and industrial | | | 100,126 | | | | 99,498 | | | | 101,624 | | | | 114,497 | | | | 117,344 | |
| Agricultural | | | 74,611 | | | | 65,449 | | | | 57,770 | | | | 52,598 | | | | 65,400 | |
| Consumer | | | 24,277 | | | | 21,406 | | | | 20,413 | | | | 23,375 | | | | 29,008 | |
| Industrial Development Bonds | | | 4,698 | | | | 4,358 | | | | 1,299 | | | | 1,196 | | | | 1,965 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 622,345 | | | $ | 576,343 | | | $ | 501,535 | | | $ | 506,402 | | | $ | 527,671 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or
2) floating or adjustable interest rates (variable): |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | WithinOne Year | | | | After OneYear WithinFive Years | | | | AfterFive Years | | | | Total | | |
| Commercial Real Estate | | $ | 27,291 | | | $ | 92,076 | | | $ | 150,821 | | | $ | 270,188 | |
| Agricultural Real Estate | | | 3,546 | | | | 14,289 | | | | 33,060 | | | | 50,895 | |
| Consumer Real Estate | | | 11,118 | | | | 19,377 | | | | 67,055 | | | | 97,550 | |
| Commercial and industrial | | | 58,741 | | | | 36,159 | | | | 5,226 | | | | 100,126 | |
| Agricultural | | | 47,831 | | | | 22,826 | | | | 3,954 | | | | 74,611 | |
| Consumer | | | 5,652 | | | | 14,265 | | | | 4,360 | | | | 24,277 | |
| Industrial Development Bonds | | | 2,499 | | | | 126 | | | | 2,073 | | | | 4,698 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 156,678 | | | $ | 199,118 | | | $ | 266,549 | | | $ | 622,345 | |
| | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table summarizes the Companys nonaccrual and past due 90 days or more and still accruing loans as of
December 31 for each of the last five years: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | FixedRate | | | | VariableRate | | | | Total | | |
| Commercial Real Estate | | $ | 181,908 | | | $ | 60,989 | | | $ | 242,897 | |
| Agricultural Real Estate | | | 35,306 | | | | 12,043 | | | | 47,349 | |
| Consumer Real Estate | | | 75,894 | | | | 10,538 | | | | 86,432 | |
| Commercial and industrial loans | | | 39,617 | | | | 1,768 | | | | 41,385 | |
| Agricultural | | | 25,842 | | | | 938 | | | | 26,780 | |
| Consumer, Master Card and Overdrafts | | | 18,625 | | | | | | | | 18,625 | |
| Industrial Development Bonds | | | 2,199 | | | | | | | | 2,199 | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay
interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $52.3 thousand for 2014, $139.1 thousand for 2013 and $544.8 thousand for
2012. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to
the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $87 thousand for 2014, $60 thousand for 2013 and $26 thousand for 2012. None of the interest collected in 2012 was applied to
reduce a specific allocation. $12.8 thousand dollars of interest collected in 2014 was applied to reduce the specific allocation. Loans are placed on
nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The loss of interest due to the high balances in nonaccruals as of 2012 impacted the yield on
loans. The Bank had nonaccrual loan balances of $4.8 million at December 21, 2012 compared to balances of $3.3 and $1.7 million as of year-end 2013 and 2014, respectively. All of the balances of nonaccrual loans for the past three years were
collaterally secured. As of December 31, 2014 the Bank had $13.5 million of loans which it considers to be potential problem loans in
that the borrowers are experiencing financial difficulties. At December 31, 2013, the Bank had $14.8 million of these loans. These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential
problem loans was considered in managements review of the loan loss reserve at December 31, 2014 and 2013. In extending credit to families,
businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the
risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the banks borrowers. As of December 31, 2014, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $74.6
million with an additional $50.1 million in agricultural real estate loans these compared to $65.4 and $44.3 million respectively as of December 31, 2013. The ratio of this segment of loans to the total loan portfolio is not considered unusual
for a bank engaged in and servicing rural communities. Loan modifications granted are typically for seasonality issues where cash flow has decreased. The
time period involved is generally quite short in relation to the loan term. For example, a typical modification may consist of interest only payments for 90 days. We consider this treatment of interest only payments for a short time as an
insignificant delay in payment. Consequently, we do not consider these occurrences as troubled debt restructurings. Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor,
where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2014, the Bank had $797.2 thousand of its loans that were classified as
troubled debt restructurings. This compares to $911.2 thousand as of same date 2013 and the Bank had almost $5.5 million classified as such as of December 31, 2012. The Bank is occasionally ordered by the courts to give terms to a borrower that
are better than what the Bank would like for the risk associated with that credit but not below or beyond rates and terms available for better credits in our market. Therefore, the Bank has not done any modifications that it would classify as
troubled debt restructurings under those circumstances. Updated appraisals are required on all collateral dependent loans once they are
deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events
that may indicate a change in value has occurred. To determine observable market price, collateral asset values securing an impaired loan are
periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that
updated appraisals are received, the Bank may discount the existing collateral value used. Performing non-watch list loans secured in whole
or in part by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List loans secured in whole or in part by real
estate require updated appraisals every two years. All loans are subject to loan to values as found in the Banks loan policies irrespective of their grade. The Banks watch list is
reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Banks loans are made in the
market by lenders who live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check. On
extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining
when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Banks senior
management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Banks watch list. In addition to analyzing the recent performance of these loans, management and the Loan Review
Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding
certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors is considered, and lenders familiar with a particular
commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on
the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even
though one may not be required under the Banks general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be
reviewed for additional tables dealing with the Banks loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan
portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated. Management considers several different risk
assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan
category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic
conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower,
the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical
loan loss portion is determined using a historical loss analysis by loan category. The unallocated portion of the reserve for loan losses is determined
based on managements assessment of general economic conditions as well as specific economic factors in the Banks marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but
undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrowers financial condition and other current risk factors that
may not have yet manifested themselves in the Banks historical loss factors used to determine the allocated component of the allowance. Actual
charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and
collateral. As presented below, charge-offs decreased to $778 thousand for 2014 and increased to $1.3 million for 2013 and decreased to $891 thousand for
2012 and $2.7 million for 2011. The provision expense also decreased in 2012 and 2011 and increased for 2013 and 2014. 2014 and 2013 had provision expense of $1.2 million and $858 thousand respectively. 2012 had provision expense of $738 thousand
with 2011 having provision expense of $1.7 million. The Commercial and Industrial portfolio had the largest net charge-off position in 2011 through 2014. Consumer real estate and consumer & other loans were the loan categories which had the
largest net charge-off position in 2012. The ratio of
net charge offs to average loans outstanding is evidence of the recognition of troubled loans and the write down of collateral values in 2011. The improvement in asset quality during the periods
shown is reflected in the increased percentage of the allowance for loan loss to nonperforming loans. The years with the higher percentage of ACL to
total loans ratio account for the higher level of nonaccrual and watch list loans, which demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. The ALLL for 2010 and 2011 decreased due
to the improvement in the asset quality as the balances in impaired loans and nonaccruals were drastically reduced over the same time periods. In 2012, the increase in provision expense was to offset the higher year-end watch list values.
2013s lower balance again recognizes the improvement in asset quality. The monetary decrease is minimal. However, the decrease as a percentage of loans is wider as compared to 2012 due to loan growth during 2013. A smaller portion of the
allowance was needed to fund the impaired loans as collateral remained sufficient to cover the outstanding amounts in most cases. 2014s significant and continued loan growth since fourth quarter 2013 was the reason behind 2014s higher
balances as asset quality remained strong. [Remainder of this page intentionally left blank.] The following table presents a reconciliation of the allowance for credit losses for the years ended
December 31, 2014, 2013, 2012, 2011 and 2010: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2014 | | | | 2013 | | | | 2012 | | | | 2011 | | | | 2010 | | |
| Non-accrual loans | | $ | 1,705 | | | $ | 3,329 | | | $ | 4,828 | | | $ | 2,131 | | | $ | 5,844 | |
| Accruing loans past due 90 days or more | | | | | | | | | | | 1 | | | | | | | | 48 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,705 | | | $ | 3,329 | | | $ | 4,829 | | | $ | 2,131 | | | $ | 5,892 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | *
Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual. Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans
is as follows: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2014 | | | | 2013 | | | | 2012 | | | | 2011 | | | | 2010 | | |
| Loans | | $ | 621,926 | | | $ | 576,113 | | | $ | 501,402 | | | $ | 506,215 | | | $ | 527,589 | |
| | | | | | | | | | | | | | | | | | | | | |
| Daily average of outstanding loans | | $ | 592,162 | | | $ | 507,126 | | | $ | 492,697 | | | $ | 504,058 | | | $ | 550,698 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan Losses - Jan 1 | | $ | 5,194 | | | $ | 5,224 | | | $ | 5,091 | | | $ | 5,706 | | | $ | 6,008 | |
| Loans Charged off: | | | | | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | | 229 | | | | 164 | | | | 98 | | | | 360 | | | | 1,147 | |
| Ag Real Estate | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 168 | | | | 147 | | | | 246 | | | | 423 | | | | 507 | |
| Commercial and Industrial | | | | | | | 513 | | | | 47 | | | | 1,500 | | | | 4,188 | |
| Agricultural | | | | | | | | | | | 6 | | | | 24 | | | | 136 | |
| Consumer & other loans | | | 381 | | | | 438 | | | | 494 | | | | 374 | | | | 444 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 778 | | | $ | 1,262 | | | $ | 891 | | | $ | 2,681 | | | $ | 6,422 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 4 | | | $ | 23 | | | $ | 7 | | | $ | 32 | | | $ | 52 | |
| Ag Real Estate | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 34 | | | | 20 | | | | 60 | | | | 61 | | | | 55 | |
| Commercial and Industrial | | | 20 | | | | 141 | | | | 30 | | | | 19 | | | | 515 | |
| Agricultural | | | 44 | | | | 5 | | | | 12 | | | | 67 | | | | 17 | |
| Consumer & other loans | | | 196 | | | | 185 | | | | 177 | | | | 172 | | | | 156 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 298 | | | $ | 374 | | | $ | 286 | | | $ | 351 | | | $ | 795 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net Charge Offs | | $ | 480 | | | $ | 888 | | | $ | 605 | | | $ | 2,330 | | | $ | 5,627 | |
| Provision for loan loss | | | 1,191 | | | | 858 | | | | 738 | | | | 1,715 | | | | 5,325 | |
| Acquisition provision for loan loss | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses - Dec 31 | | $ | 5,905 | | | $ | 5,194 | | | $ | 5,224 | | | $ | 5,091 | | | $ | 5,706 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 | | | 207 | | | | 163 | | | | 162 | | | | 130 | | | | 153 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses - Dec 31 | | $ | 6,112 | | | $ | 5,357 | | | $ | 5,386 | | | $ | 5,221 | | | $ | 5,859 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.08 | % | | | 0.18 | % | | | 0.12 | % | | | 0.46 | % | | | 1.02 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 346.30 | % | | | 156.03 | % | | | 108.20 | % | | | 238.90 | % | | | 97.63 | % |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Deposits The amount of
outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2014 are as follows:
(In Thousands)
UnderThree Months
Over ThreeMonthsLess thanSix Months
Over SixMonths LessThan OneYear
OverOneYear
Time Deposits
$
9,536
$
14,218
$
16,858
$
40,985
The following table presents the average amount of and average rate paid on each deposit category: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2014 | | | | | | | | 2013 | | | | | | | | 2012 | | | | | | | | 2011 | | | | | | | | 2010 | | | | | | |
| | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | |
| | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | |
| Balance at End of Period Applicable To: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 2,367 | | | | 43.43 | | | $ | 2,107 | | | | 43.19 | | | $ | 1,749 | | | | 39.89 | | | $ | 2,087 | | | | 39.74 | | | $ | 1,868 | | | | 36.82 | |
| Ag Real Estate | | | 184 | | | | 8.18 | | | | 131 | | | | 7.69 | | | | 113 | | | | 8.01 | | | | 140 | | | | 6.32 | | | | 122 | | | | 6.38 | |
| Consumer Real Estate | | | 537 | | | | 15.69 | | | | 257 | | | | 16.05 | | | | 368 | | | | 16.01 | | | | 260 | | | | 16.12 | | | | 258 | | | | 16.31 | |
| Commercial and Industrial | | | 1,421 | | | | 16.10 | | | | 1,359 | | | | 17.27 | | | | 2,183 | | | | 20.27 | | | | 1,948 | | | | 22.62 | | | | 2,354 | | | | 22.24 | |
| Agricultural | | | 547 | | | | 12.00 | | | | 326 | | | | 11.36 | | | | 290 | | | | 11.52 | | | | 267 | | | | 10.38 | | | | 327 | | | | 12.40 | |
| Consumer, Overdrafts and other loans | | | 323 | | | | 3.84 | | | | 292 | | | | 3.68 | | | | 268 | | | | 4.04 | | | | 315 | | | | 4.58 | | | | 380 | | | | 5.48 | |
| Unallocated | | | 526 | | | | 0.76 | | | | 722 | | | | 0.76 | | | | 253 | | | | 0.26 | | | | 74 | | | | 0.24 | | | | 397 | | | | 0.37 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses | | $ | 5,905 | | | | 100.00 | | | $ | 5,194 | | | | 100.00 | | | $ | 5,224 | | | | 100.00 | | | $ | 5,091 | | | | 100.00 | | | $ | 5,706 | | | | 100.00 | |
| Off Balance Sheet Commitments | | | 207 | | | | | | | | 163 | | | | | | | | 162 | | | | | | | | 130 | | | | | | | $ | 153 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses | | $ | 6,112 | | | | | | | $ | 5,357 | | | | | | | $ | 5,386 | | | | | | | $ | 5,221 | | | | | | | $ | 5,859 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Liquidity Liquidity remains high though down from prior years as the Bank has decreased the investment portfolio to fund loans. The Bank has access to $58 million of
unsecured borrowings through correspondent banks and $71.6 million of unpledged securities which may be sold or used as collateral. An additional $15.0 million is also available from the Federal Home Loan Bank based on current collateral pledging
with up to $112.6 million available provided adequate collateral is pledged. Maintaining sufficient funds to meet depositor and borrower needs on a daily
basis continues to be among managements top priorities. This is accomplished not only by immediate liquid resources of cash, due from banks and federal funds sold, but also by the Banks available for sale securities portfolio. The
average aggregate balance of these assets was $296.5 for 2014 and $387.7 million for 2013, and $397.3 million for 2012. This represented 31.8 percent and 42.5 percent of total average assets, respectively. Of the almost $248.5 million of debt
securities in the companys portfolio as of December 31, 2014, $23.5 million, or 9.5 percent of the portfolio, is expected to receive payments or mature in 2015. The availability of the funds may be reduced by the need to utilize
securities for pledging purposes on public deposits. This liquidity provides the opportunity to fund loan growth by analysis of the lowest cost and source of funds whether by increasing deposits, sales or runoff of investments or utilizing debt.
Historically, the primary source of liquidity has been core deposits that include noninterest bearing and interest bearing demand deposits, savings,
money market accounts and time deposits of individuals. Core deposit balances as of year-end 2014 increased in all categories with the exception of time deposits. Overall deposits increased an average of $913 thousand in 2014, $4.7 million during
2013 and $20.7 million in average deposits in 2012. The Bank also utilized Federal Funds purchased at times during 2012 through 2014. The average balance for 2014 and 2013 was $1.4 million and $785.5 thousand respectively, which was mainly for
verification of borrowing procedures should the need arise and while awaiting the influx of deposits from the Custar acquisition. Historically, the
primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and for business development. The use of new funds for loans is measured by the loan to deposit ratio. The
Banks average loan to deposit ratio was 76.4 percent for 2014, 66.2 percent for 2013 and 65 percent for 2012. The lower ratios in 2013 and 2012 were due to the success of the deposit gathering function, the residential mortgage loans being
sold in the secondary market and the lack of loan demand. The Banks goal is for this ratio to be higher in the 80-90 percent range with loan growth being the driver. Short-term debt such as federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt
for both federal funds purchased and securities sold under agreement to repurchase amounted to $56.0 million at the end of 2014 compared to $69.8 million at the end of 2013 and to $51.3 million at the end of 2012. These accounts are used to provide
a sweep product to the Banks commercial customers. Though no federal funds were purchased at year end, the Bank does have arrangements with correspondent Banks that can be utilized when necessary. Other borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then
used to provide fixed rate mortgage loans secured by homes in our community. Borrowings from this source decreased by $4.5 million to none at December 31, 2014. This compares to decreased borrowings during 2013 of $7.1 million and decreased
borrowings during 2012 of $5.1 million to $11.6 million to end at December 31, 2012. The decreased borrowings were payoffs of matured notes in 2013 and 2014. Sufficient funds were available to fund growth so new advances were not needed. Asset/Liability Management The primary functions of
asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. It involves the management of the balance sheet mix, maturities, re-pricing
characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of
net interest income through periods of changing interest rates. Changes in net income, other than those related to volume arise when interest rates on
assets re-price in a time frame or interest rate environment that is different from that of the re-pricing period for liabilities. Changes in net interest income also arise from changes in the mix of interest-earning assets and interest-bearing
liabilities. Historically, the Bank has maintained liquidity through cash flows generated in the normal course of business,
loan repayments, maturing earning assets, the acquisition of new deposits, and borrowings. The Banks asset and liability management program is designed to maximize net interest income over the long term while taking into consideration both
credit and interest rate risk. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans that are tied to the market rate differ
considerably from long-term investment securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings accounts. The Bank utilizes shock analysis to
examine the amount of exposure an instant rate change of 100, 200, 300 and 400 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings and equity at risk are established and decisions are
made to maintain those levels based on the shock results. Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the
increased cost of the Companys operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Companys performance than
do the effects of 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 service. Contractual Obligations Contractual Obligations of the
Company totaled $252.4 million as of December 31, 2014. Time deposits represent contractual agreements for certificates of deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is further
defined in Note 4 and 9 of the Consolidated Financial Statements. |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | Non-Interest | | | | Interest | | | | Savings | | | | Time | | |
| | | DDAs | | | | DDAs | | | | Accounts | | | | Accounts | | |
| December 31, 2014: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 151,752 | | | $ | 207,103 | | | $ | 216,405 | | | $ | 214,680 | |
| Average rate | | | 0.00 | % | | | 0.51 | % | | | 0.17 | % | | | 0.92 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2013: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 104,024 | | | $ | 202,914 | | | $ | 197,157 | | | $ | 250,737 | |
| Average rate | | | 0.00 | % | | | 0.53 | % | | | 0.19 | % | | | 1.06 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2012: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 84,217 | | | $ | 190,273 | | | $ | 182,724 | | | $ | 285,214 | |
| Average rate | | | 0.00 | % | | | 0.70 | % | | | 0.33 | % | | | 1.24 | % |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Capital Resources Stockholders equity was $114.5 million as of December 31, 2014 compared to $108.6 million at December 31, 2013. Dividends declared during 2014
were $.84 per share totaling $3.86 million and during 2013 were $0.81 per share totaling $3.75 million. During 2014, the Company purchased 23,570 shares and awarded 13,250 restricted shared to 61 employees. During 2013, the Company purchased 56,000
shares and awarded 11,000 restricted shares to 53 employees. For a summary of activity as it relates to the Companys restricted stock awards, please refer to Note 11: Employee Benefit Plans in the consolidated financial statements. At yearend
2014, the Company held 572,772 shares in Treasury stock and 33,390 unvested shares of restricted stock. At year-end 2013, the Company held 561,562 shares in Treasury stock and 31,890 unvested shares of restricted stock. On January 16, 2015 the
Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 16,
2015 and ending December 31, 2015. The decrease in the equity balance of 2013 as compared to 2012 was due to the market value fluctuation of our
available for sale investment portfolio. The Company continues to have a strong capital base and maintains regulatory capital ratios that are above the
defined regulatory capital ratios. At December 31, 2014, the Bank and the Company had total risk-based capital ratios of 14.35% and 16.68%, respectively. Core capital to risk-based asset ratios of 13.46% and 15.79% for the Bank and the Company,
respectively, are well in excess of regulatory guidelines. The Banks leverage ratio of 10.01% is also substantially in excess of regulatory guidelines, as is the Companys at 11.70%. For further discussion and analysis of regulatory
capital requirements, refer to Note 15 of the Audited Financial Statements. The Companys subsidiaries are restricted by regulations from making
dividend distributions in excess of certain prescribed amounts. Upon prior regulatory approval, the Bank may be allowed to pay above the prescribed amount. |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Payment Due by Period (In Thousands) | | | | | | | | | | | | | | | | | | |
| Contractual Obligations | | Total | | | | Less than1 year | | | | 1-3Years | | | | 3-5Years | | | | More than5 years | | |
| | | | | | | | | | | | | | | | | | | | | |
| Securities sold under agreement to repurchase | | $ | 55,962 | | | $ | 55,962 | | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | | | | | | |
| Time Deposits | | | 195,500 | | | | 97,439 | | | | 69,220 | | | | 27,917 | | | | 924 | |
| | | | | | | | | | | | | | | | | | | | | |
| Dividends Payable | | | 965 | | | | 965 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Long Term Debt | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 252,427 | | | $ | 154,366 | | | $ | 69,220 | | | $ | 27,917 | | | $ | 924 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-15-061460 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Salaries and wages increased $172 thousand in 2010 over 2009. Three main components flow into
salaries and wages: base salary, deferred costs from loans and incentive pay. Base salaries
decreased during 2010 even with the addition of the Hicksville office by $338 thousand. The
deferred costs component actually decreased by $318 thousand which in effect increases salary
expense and incentive pay increased $192 thousand. (For further discussion on incentive pay, see
note 11 of the consolidated financial statements). During the first part of 2009, some of the
Banks lending officers were also very busy in auto loan financing. This activity was spurred by
government and auto manufacturer incentives along with large banks exiting the market in the first
half of the year. The consumer loan portfolio grew by 26%, or almost $6 million. This increased
activity offset the increased salary expense as deferred costs from these loans are recorded as a
deduction to the salary expense when the loans are made. While salaries and wages decreased in
2009 |
| | | | | | | | | | | | | |
| | | **December 31** | | | | **December 31** | | | | **December 31** | | |
| | | **2010** | | | | **2009** | | | | **2008** | | |
| | | | | **(In thousands)** | | | | | | | | |
| | | | | | | | | | | | | |
| Capitalized Additions (Noninterest income) | | $ | 685 | | | $ | 1,158 | | | $ | 447 | |
| | | | | | | | | | | | | |
| Amortizations (Noninterest expense) | | | (684 | ) | | | (933 | ) | | | (370 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Net Noninterest income | | $ | 1 | | | $ | 225 | | | $ | 77 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following tables show changes in interest income, interest expense and net interest
resulting from changes in volume and rate variances for major categories of earnings assets and
interest bearing liabilities. |
| | | | | | | | | | | | | |
| | | **2008** | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | |
| | | **Average** | | | | **Interest/** | | | | | | |
| | | **Balance** | | | | **Dividends** | | | | **Yield/Rate** | | |
| **ASSETS** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans (1) | | $ | 544,310 | | | $ | 34,994 | | | | 6.46 | % |
| Taxable investment securities | | | 146,877 | | | | 6,963 | | | | 4.74 | % |
| Tax-exempt investment securities | | | 42,361 | | | | 1,594 | | | | 5.70 | % |
| Federal funds sold & interest bearing deposits | | | 9,423 | | | | 273 | | | | 2.90 | % |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | | 742,971 | | | $ | 43,824 | | | | 6.03 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Non-Interest Earning Assets:** | | | | | | | | | | | | |
| Cash and cash equivalents | | | 19,399 | | | | | | | | | |
| Other assets | | | 35,317 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Assets** | | $ | 797,687 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **LIABILITIES AND SHAREHOLDERS EQUITY** | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 240,880 | | | $ | 2,760 | | | | 1.15 | % |
| Other time deposits | | | 314,005 | | | | 12,467 | | | | 3.97 | % |
| Other borrowed money | | | 38,110 | | | | 1,747 | | | | 4.58 | % |
| Federal funds purchased and securities sold under agreement to repurchase | | | 49,014 | | | | 1,127 | | | | 2.30 | % |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | | 642,009 | | | $ | 18,101 | | | | 2.82 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Non-Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 53,208 | | | | | | | | | |
| Other | | | 12,928 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities** | | | 708,145 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Shareholders Equity** | | | 89,542 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities and Shareholders Equity** | | $ | 797,687 | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 43,824 | | | | 6.03 | % |
| Interest Expense / yield | | | | | | $ | 18,101 | | | | 2.82 | % |
| | | | | | | | | | | | | |
| Net Interest Spread | | | | | | $ | 25,723 | | | | 3.21 | % |
| | | | | | | | | | | | | |
| Net Interest Margin | | | | | | | | | | | 3.60 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | As mentioned in the discussion earlier, in reviewing the 2010 to 2009 comparison, an impact in
change due to volume is evident, where as the 2009 to 2008 comparison shows the impact was due
mainly to rate. What did remain the same in the two comparisons is that the change in interest in
total is still due mainly to rate change. The strategy during 2010 and currently is to extend the
maturities of time deposit specials to over 24 months to prepare for rising rates. The other
strategy employed during 2009 and 2010 was to increase core deposits by offering innovative
products focused on customer needs: higher interest rates. In exchange for a high
interest-bearing checking account, customers were asked to utilize services that benefited both
the Bank and themselves. Smaller time deposit rate shoppers had an option to perhaps change their
behavior of banking or those deposits were allowed to run off. The new core deposit products were
indeed embraced by our customers and have helped to reach the deposit portfolio mix the Bank was
after. |
| | | | | | | | | | | | | |
| | | **2009 vs 2008** | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | |
| | | **Net** | | | | **Due to change in** | | | | | | |
| | | **Change** | | | | **Volume** | | | | **Rate** | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| **Loans** | | **$** | **(1,409** | **)** | | **$** | **941** | | | **$** | **(2,350** | **)** |
| **Taxable investment securities** | | | **(1,165** | **)** | | | **(0** | **)** | | | **(1,165** | **)** |
| **Tax-exempt investment securities** | | | **92** | | | | **249** | | | | **(157** | **)** |
| **Federal funds sold & interest bearing deposits** | | | **(228** | **)** | | | **73** | | | | **(301** | **)** |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | **$** | **(2,710** | **)** | | **$** | **1,263** | | | **$** | **(3,973** | **)** |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | **$** | **(1,005** | **)** | | **$** | **189** | | | **$** | **(1,194** | **)** |
| **Savings deposits** | | | **(3,215** | **)** | | | **143** | | | | **(3,358** | **)** |
| **Other time deposits** | | | **(20** | **)** | | | **18** | | | | **(38** | **)** |
| **Other borrowed money** | | | | | | | **** | | | | | |
| **Federal funds purchased and securities sold under agreement to repurchase** | | | **(641** | **)** | | | **(71** | **)** | | | **(570** | **)** |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | **$** | **(4,881** | **)** | | **$** | **279** | | | **$** | **(5,160** | **)** |
| | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table sets forth the maturities of investment securities as of December 31,
2010 and the weighted average yields of such securities calculated on the basis of cost and
effective yields weighted for the scheduled maturity of each security. Tax-equivalent
adjustments, using a thirty-four percent rate have been made in yields on obligations of state and
political subdivisions. Stocks of domestic corporations have not been included. |
| | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | |
| | | **2010** | | | | **2009** | | | | **2008** | | |
| | | | | | | | | | | | | |
| U.S. Treasury | | $ | 32,278 | | | $ | 5,219 | | | $ | | |
| U.S. Government agency | | | 165,704 | | | | 104,676 | | | | 82,675 | |
| Mortgage-backed securities | | | 24,531 | | | | 36,848 | | | | 51,826 | |
| State and local governments | | | 64,804 | | | | 60,538 | | | | 43,160 | |
| | | | | | | | | | | | | |
| | | $ | 287,317 | | | $ | 207,281 | | | $ | 177,661 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | As of December 31, 2010 the Bank did not hold a large block of any one investment security,
except for U.S. Government agencies. The Bank also holds stock in the Federal Home Loan Bank of
Cincinnati at a cost of $4.2 million. This is required in order to obtain Federal Home Loan Bank
Loans. The Bank also acquired stock in the Federal Home Loan Bank of Indianapolis at a cost of
$231.4 thousand and Bankers Bancorp, Inc at a cost of $50.8 thousand through its acquisition of
Knisely Bank. There were no borrowings at the time of acquisition associated with Federal Home
Loan Bank of Indianapolis. The Bank had requested Federal Home Loan Bank of Indianapolis to buy
back its stock when the acquisition of Knisely was completed in January 2008. A five year waiting
period was imposed and the stock will be redeemed in full by January 3, 2013. An early redemption
of 42,000 shares occurred in November 2010, decreasing the holdings to a value of $189.4 thousand.
The value of the stock in Bankers Bancorp, Inc was written down to zero at the end of 2009 as the
institution was taken over by its regulators. The Bank also owns stock of Farmer Mac with a
carrying value of $27.4 thousand which is required to participate loans in the program.
Loan Portfolio
The Banks various loan portfolios are subject to varying levels of credit risk. Management
mitigates these risks through portfolio diversification and through standardization of lending
policies and procedures.
Risks are mitigated through an adherence to Loan Policy with any exception being recorded and
approved by Senior Management or committees comprised of Senior Management. Loan Policy defines
parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow and
debt-to-income ratio, loan requirements and covenants, financial information tracking, collection
practice and others. Limitation to any one borrower is defined by the Banks legal lending limits
and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in
comparison to Bank capital to any one business or agricultural sector by an approved sector
percentage to capital limitation.
The following table shows the Banks loan portfolio by category of loan as of December
31st of each year, including loans held for sale: |
| | | | | | | | | | | | | | | | | |
| | | **Maturities** | | | | | | | | | | | | | | |
| | | **(Amounts in Thousands)** | | | | | | | | | | | | | | |
| | | **After Five Years** | | | | | | | | | | | | | | |
| | | **Within Ten Years** | | | | | | | | **After Ten Years** | | | | | | |
| | | **Amount** | | | | **Yield** | | | | **Amount** | | | | **Yield** | | |
| | | | | | | | | | | | | | | | | |
| U.S. Treasury | | $ | 9,552 | | | | 1.62 | % | | | | | | $ | 0.00 | % |
| U.S. Government agency | | | 38,814 | | | | 2.26 | % | | | | | | | 0.00 | % |
| Mortgage-backed securities | | | 2,564 | | | | 4.70 | % | | | 18,198 | | | | 4.63 | % |
| State and local governments | | | 28,795 | | | | 3.31 | % | | | 15,078 | | | | 4.23 | % |
| Taxable state and local governments | | | 967 | | | | 3.14 | % | | | | | | | 0.00 | % |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table shows the maturity of loans as of December 31, 2010: |
| | | | | | | | | | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | | | | | | | | | | |
| **Loans:** | | **2010** | | | | **2009** | | | | **2008** | | | | **2007** | | | | **2006** | | |
| | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 185,033 | | | $ | 214,849 | | | $ | 226,761 | | | $ | 181,340 | | | $ | 162,363 | |
| Agricultural real estate | | | 33,650 | | | | 41,045 | | | | 48,607 | | | | 45,518 | | | | 49,564 | |
| Consumer real estate | | | 95,271 | | | | 98,599 | | | | 89,773 | | | | 102,660 | | | | 86,688 | |
| Commercial and industrial | | | 117,344 | | | | 120,543 | | | | 112,526 | | | | 104,188 | | | | 101,788 | |
| Agricultural | | | 65,400 | | | | 59,813 | | | | 56,322 | | | | 58,809 | | | | 69,301 | |
| Consumer | | | 29,008 | | | | 32,581 | | | | 26,469 | | | | 27,796 | | | | 27,388 | |
| Industrial Development Bonds | | | 1,965 | | | | 2,552 | | | | 7,572 | | | | 9,289 | | | | 7,335 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 527,671 | | | $ | 569,982 | | | $ | 568,030 | | | $ | 529,600 | | | $ | 504,427 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table presents the total of loans due after one year which has either 1)
predetermined interest rates (fixed) or 2) floating or adjustable interest rates (variable): |
| | | | | | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | | | | | |
| | | | | | | **After One** | | | | | | | | | | |
| | | **Within** | | | | **Year Within** | | | | **After** | | | | | | |
| | | **One Year** | | | | **Five Years** | | | | **Five Years** | | | | **Total** | | |
| | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 36,523 | | | $ | 105,168 | | | $ | 43,342 | | | $ | 185,033 | |
| Agricultural Real Estate | | | 2,738 | | | | 13,546 | | | | 17,366 | | | | 33,650 | |
| Consumer Real Estate | | | 8,009 | | | | 23,094 | | | | 64,168 | | | | 95,271 | |
| Commercial and industrial loans | | | 83,554 | | | | 25,387 | | | | 8,403 | | | | 117,344 | |
| Agricultural | | | 48,038 | | | | 14,196 | | | | 3,166 | | | | 65,400 | |
| Consumer, Credit Card and Overdrafts | | | 6,002 | | | | 20,723 | | | | 2,283 | | | | 29,008 | |
| Industrial Development Bonds | | | 556 | | | | 446 | | | | 963 | | | | 1,965 | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | The following table summarizes the Companys nonaccrual and past due loans as of December 31
for each of the last five years: |
| | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | |
| | | **Fixed** | | | | **Variable** | | | | | | |
| | | **Rate** | | | | **Rate** | | | | **Total** | | |
| | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 57,162 | | | $ | 91,314 | | | $ | 148,476 | |
| Agricultural Real Estate | | | 18,918 | | | | 11,682 | | | | 30,600 | |
| Consumer Real Estate | | | 74,095 | | | | 13,267 | | | | 87,362 | |
| Commercial and industrial loans | | | 26,831 | | | | 6,324 | | | | 33,155 | |
| Agricultural | | | 17,138 | | | | 224 | | | | 17,362 | |
| Consumer, Master Card and Overdrafts | | | 23,006 | | | | 3,664 | | | | 26,670 | |
| Industrial Development Bonds | | | 1,409 | | | | | | | | 1,409 | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Although loans may be classified as non-performing, some pay on a regular basis, and many
continue to pay interest irregularly or at less than original contractual rates. Interest income
that would have been recorded under the original terms of these loans was $0.91 million for 2010,
$2.0 for 2009, and $1.4 for 2008. Any collections of interest on nonaccrual loans are included in
interest income when collected unless it is on an impaired loan with a specific allocation. A
collection of interest on an impaired loan with a specific allocation is applied to the loan
balance to decrease the allocation needed. Total interest collections amounted to $41 thousand for
2010, $290 thousand for 2009, and $332 thousand for 2008. $3 thousand of interest collected in
2010 was applied to reduce the specific allocation, $6 thousand of interest collected in 2009 and
$20 thousand of interest collected in 2008 was applied to reduce the specific allocations. |
| | | | | | | | | | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | | | | | | | | | |
| | | **2010** | | | | **2009** | | | | **2008** | | | | **2007** | | | | **2006** | | |
| | | | | | | | | | | | | | | | | | | | | |
| Nonaccrual loans | | $ | 5,844 | | | $ | 14,054 | | | $ | 13,575 | | | | 4918 | | | | 4254 | |
| Accruing loans past due 90 days or more | | | 48 | | | | 69 | | | | 2,524 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 5,892 | | | $ | 14,123 | | | $ | 16,099 | | | $ | 4,918 | | | $ | 4,254 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | *
Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days
not on nonaccrual.
Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category
to total loans is as follows: |
| | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | |
| | | **2010** | | | | **2009** | | | | **2008** | | |
| | | | | | | | | | | | | |
| Loans | | $ | 527,589 | | | $ | 569,919 | | | $ | 568,030 | |
| | | | | | | | | | | | | |
| Daily average of outstanding loans | | $ | 550,698 | | | $ | 558,869 | | | $ | 544,859 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Allowance for Loan Losses-Jan 1 | | $ | 6,008 | | | $ | 5,496 | | | $ | 5,922 | |
| Loans Charged off: | | | | | | | | | | | | |
| Commercial Real Estate | | | 1,147 | | | | | | | | | |
| Ag Real Estate | | | | | | | | | | | | |
| Consumer Real Estate | | | 507 | | | | 452 | | | | 194 | |
| Commercial and Industrial | | | 4,188 | | | | 2,235 | | | | 71 | |
| Agricultural | | | 136 | | | | 230 | | | | 1,912 | |
| Consumer & other loans | | | 444 | | | | 371 | | | | 384 | |
| | | | | | | | | | | | | |
| | | | 6,422 | | | | 3,288 | | | | 2,561 | |
| | | | | | | | | | | | | |
| Loan Recoveries: | | | | | | | | | | | | |
| Commercial Real Estate | | | 52 | | | | | | | | | |
| Ag Real Estate | | | | | | | | | | | | |
| Consumer Real Estate | | | 55 | | | | 11 | | | | 87 | |
| Commercial and Industrial | | | 515 | | | | 72 | | | | 78 | |
| Agricultural | | | 17 | | | | 6 | | | | 4 | |
| Consumer & other loans | | | 156 | | | | 153 | | | | 179 | |
| | | | | | | | | | | | | |
| | | | 795 | | | | 242 | | | | 348 | |
| | | | | | | | | | | | | |
| Net Charge Offs | | | 5,627 | | | | 3,046 | | | | 2,213 | |
| Provision for loan loss | | | 5,325 | | | | 3,558 | | | | 1,787 | |
| Acquisition provision for loan loss | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses Dec 31 | | $ | 5,706 | | | $ | 6,008 | | | $ | 5,496 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 | | | 153 | | | | 227 | | | | 226 | |
| | | | | | | | | | | | | |
| Total Allowance for Credit Losses Dec 31 | | $ | 5,859 | | | $ | 6,235 | | | $ | 5,722 | |
| | | | | | | | | | | | | |
| Ratio of net charge-offs to average Loans outstanding | | | 1.02 | % | | | 0.55 | % | | | 0.41 | % |
| | | | | | | | | | | | | |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 97.63 | % | | | 42.75 | % | | | 40.48 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Deposits
The amount of outstanding time certificates of deposits and other time deposits in amounts of
$100,000 or more by maturity as of December 31, 2010 are as follows:
(In Thousands)
Over Three
Over Six
Months
Months Less
Over
Under
Less than
Than One
One
Three Months
Six Months
Year
Year
Time Deposits
$
30,925
$
25,178
$
24,969
$
51,299
The following table presents the average amount of and average rate paid on each deposit
category: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | **2010** | | | | | | | | **2009** | | | | | | | | **2008** | | | | | | | | **2007** | | | | | | | | **2006** | | | | | | |
| | | **Amount (000s)** | | | | **%** | | | | **Amount (000s)** | | | | **%** | | | | **Amount (000s)** | | | | **%** | | | | **Amount (000s)** | | | | **%** | | | | **Amount (000s)** | | | | **%** | | |
| Balance at End of Period Applicable To: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 1,868 | | | | 35.07 | | | $ | 1,810 | | | | 37.69 | | | $ | 1,810 | | | | 39.92 | | | $ | 1,358 | | | | 34.24 | | | $ | 1,221 | | | | 32.19 | |
| Ag Real Estate | | | 122 | | | | 6.38 | | | | 120 | | | | 7.20 | | | | 130 | | | | 8.56 | | | | 117 | | | | 8.59 | | | | 162 | | | | 9.83 | |
| Consumer Real Estate | | | 258 | | | | 16.31 | | | | 439 | | | | 17.30 | | | | 386 | | | | 15.80 | | | | 381 | | | | 19.38 | | | | 288 | | | | 17.19 | |
| Commercial and Industrial | | | 2,354 | | | | 14.23 | | | | 2,494 | | | | 21.15 | | | | 2,278 | | | | 19.81 | | | | 1,859 | | | | 19.67 | | | | 2,721 | | | | 20.18 | |
| Agricultural | | | 327 | | | | 22.24 | | | | 647 | | | | 10.49 | | | | 413 | | | | 9.92 | | | | 1,676 | | | | 11.10 | | | | 250 | | | | 13.74 | |
| Consumer, Overdrafts and other loans | | | 777 | | | | 5.77 | | | | 498 | | | | 6.16 | | | | 479 | | | | 5.99 | | | | 531 | | | | 7.00 | | | | 634 | | | | 6.88 | |
| Unallocated | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 318 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses | | | 5,706 | | | | 100.00 | | | | 6,008 | | | | 100.00 | | | | 5,496 | | | | 100.00 | | | | 5,922 | | | | 100.00 | | | | 5,594 | | | | 100.00 | |
| Off Balance Sheet Commitments | | | 153 | | | | | | | | 227 | | | | | | | | 226 | | | | | | | | 156 | | | | | | | | 168 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses | | $ | 5,859 | | | | | | | $ | 6,235 | | | | | | | $ | 5,722 | | | | | | | $ | 6,078 | | | | | | | $ | 5,762 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Liquidity
Liquidity remains high with the Bank also having access to $27 million of
unsecured borrowings through correspondent banks and $76 million of unpledged
securities which may be sold or used as collateral. An additional $6.2 million
is also available from the Federal Home Loan Bank based on current collateral
pledging with up to $115 million available provided adequate collateral is
pledged.
Maintaining sufficient funds to meet depositor and borrower needs on a daily basis continues
to be among our managements top priorities. This is
accomplished not only by the immediately liquid resources of cash, due from banks and federal funds
sold, but also by the Banks available for sale securities portfolio. The average aggregate
balance of these assets was $274 million for 2010, compared to $216 million for 2009, and $220
million for 2008. This represented 31.25 percent, 26.3 percent, and 28.0 percent of total average
assets, respectively. Of the almost $288 million of debt securities in the companys portfolio as
of December 31, 2010, $39 million or 13.7 percent of the portfolio is expected to receive payments
or mature in 2011. Taking into consideration possible calls of the debt |
| | | | | | | | | | | | | | | | | |
| | | **(In Thousands)** | | | | | | | | | | | | | | |
| | | **Non-Interest** | | | | **Interest** | | | | **Savings** | | | | **Time** | | |
| | | **DDAs** | | | | **DDAs** | | | | **Accounts** | | | | **Accounts** | | |
| December 31, 2010: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 60,489 | | | $ | 167,382 | | | $ | 138,044 | | | $ | 321,018 | |
| Average rate | | | 0.00 | % | | | 0.96 | % | | | 0.42 | % | | | 2.16 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2009: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 55,793 | | | $ | 145,259 | | | $ | 112,086 | | | $ | 317,619 | |
| Average rate | | | 0.00 | % | | | 1.02 | % | | | 0.24 | % | | | 2.91 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2008: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 52,152 | | | $ | 130,887 | | | $ | 109,993 | | | $ | 314,005 | |
| Average rate | | | 0.00 | % | | | 1.46 | % | | | 0.77 | % | | | 3.97 | % |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Other borrowings are also a source of funds. Other borrowings consist of loans from the
Federal Home Loan Bank of Cincinnati. These funds are then used to provide fixed rate mortgage
loans secured by homes in our community. Borrowings from this source decreased by $4.3 million to
$29.9 million at December 31, 2010. This compares to decreased borrowings during 2009 of $11.4
million to $34.2 million at December 31,
2009 and increased borrowings during 2008 of $13.8 million to $45.6 million to end at December 31,
2008. The increased borrowings in 2008 and 2007 were used to fund loan growth and were a cheaper
source of funds than certificate of deposits. The decreased borrowings were payoffs of matured
notes in 2009. Sufficient funds were available to fund growth so new advances were not needed in
2009. |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | **Daily Securities Sold Under Agreement to Repurchase** | | | | | | | | | | | | | | |
| | | | | | | | | | | **Maximum Amount** | | | | | | | | | | |
| | | **Amount Outstanding** | | | | | | | | **Borrowings Outstanding** | | | | **Approximate Average** | | | | **Approximate Weighted** | | |
| | | **at End of Period** | | | | **Weighted Average Rate** | | | | **Month End** | | | | **Outstanding in Period** | | | | **Average Interest Rate** | | |
| | | **(000S)** | | | | **End of Period** | | | | **(000s)** | | | | **(000s)** | | | | **For the period** | | |
| 2010 | | $ | 37,191 | | | | 0.36 | % | | $ | 37,501 | | | $ | 34,046 | | | | 0.36 | % |
| 2009 | | $ | 33,457 | | | | 0.42 | % | | $ | 40,530 | | | $ | 37,696 | | | | 0.48 | % |
| 2008 | | $ | 40,014 | | | | 0.50 | % | | $ | 47,644 | | | $ | 40,113 | | | | 1.96 | % |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Capital Resources
Stockholders equity was $94.4 million as of December 31, 2010 compared to $93.6 million at
December 31, 2009. Dividends declared during 2010 were $0.73 per share totaling $3.44 million and
2009 were $0.72 per share totaling $3.41 million. During 2010, the Company purchased 48,130 shares
and awarded 10,150 restricted shares to 53 employees under its long term incentive plan. During
2009, the Company purchased 28,907 shares and awarded 10,000 restricted shares to 49 employees.
For a summary of activity as it relates to the Companys restricted stock awards, please refer to
Note 11: Employee Benefit Plans in the consolidated financial statements. At year end 2010, the
Company held 477,106 shares in Treasury stock and 28,925 shares in unearned stock awards as
compared to 2009, the Company held 437,551 shares in Treasury stock and 27,775 in unearned stock
awards. On January 21, 2011 the Company announced the authorization by its Board of Directors for
the Companys repurchase, either on the open market, or in privately negotiated transactions, of
up to 200,000 shares of its outstanding common stock commencing January 21, 2011 and ending
December 31, 2011.
The Company continues to have a strong capital base and to maintain regulatory capital ratios that
are significantly above the defined regulatory capital ratios.
At December 31, 2010, The Farmers & Merchants State Bank and Farmers & Merchants Bancorp, Inc had
total risk-based capital ratios of 14.88% and 14.95%, respectively. Core capital to risk-based
asset ratios of 11.56% and 14.02% are well in excess of regulatory guidelines. The Banks leverage
ratio of 8.1% is also substantially in excess of regulatory guidelines as is the Companys at
9.82%.
The Companys subsidiaries are restricted by regulations from making dividend distributions in
excess of certain prescribed amounts. |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | **Payment Due by Period (In Thousands)** | | | | | | | | | | | | | | |
| | | | | | | **Less than** | | | | **1-3** | | | | **3-5** | | | | **More than** | | |
| **Contractual Obligations** | | **Total** | | | | **1 year** | | | | **Years** | | | | **Years** | | | | **5 years** | | |
| Securities sold under agreement to repurchase | | $ | 51,241 | | | $ | 51,241 | | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | | | | | | |
| Time Deposits | | | 317,364 | | | | 176,254 | | | | 106,498 | | | | 33,211 | | | | 1,401 | |
| | | | | | | | | | | | | | | | | | | | | |
| Dividends Payable | | | 894 | | | | 894 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Long Term Debt | | | 29,874 | | | | 13,212 | | | | 12,162 | | | | 4,500 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 399,373 | | | $ | 241,601 | | | $ | 118,660 | | | $ | 37,711 | | | $ | 1,401 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0000950123-11-020919 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Salaries and wages decreased $173 thousand in 2012 as compared to 2011. 2011 had increased over 2010 by $439 thousand.
Base salary, incentive, deferred costs from loans and restricted stock awards are compiled in this line item. One similarity between 2012 and 2011 is the increase in the incentive pay for the past two years and is reflective of the Company
outperforming its budget and performing better than the peer average. Base salaries decreased all three years even with the addition of the Hicksville office in July of 2010. Lower loan activity, continued increase in volume of transactions
processed electronically, and a continuing decrease in lobby traffic allowed the Company to decrease the workforce through attrition. Deferred costs from loans, which is an offset to salary expense, was larger in 2012 by $474 thousand
than 2011 and 2011 was smaller by $201.7 thousand than 2010. Again, 2012 is reflective of large refinancing activity of which 2011 experienced lower levels. Occupancy expense decreased by $82 thousand in 2012 as compared to 2011. Although real estate taxes and building repairs were higher, these were offset by lower insurance and utilities costs. Occupancy
expense increased by $45 thousand in 2011 as compared to 2010. The largest expense increase in 2011 occupancy expense was utilities, which was driven by the additional office added in July 2010. Data processing expense increased $141 thousand during 2012 and by only $25 thousand in 2011. A positive reduction in data processing expense of $183
thousand occurred in 2010. The larger reduction in 2010 was mainly due to the reduction of costs as the Bank switched its core service provider in February. The Company continues to investigate ways to reduce this expense. The pricing on many
services, however, is based on number of accounts and the Bank fully expects those to increase with the addition of the Waterville office and overall Bank growth. The FDIC assessment continues to decrease as new regulation changed the method of calculation in the summer of 2011. 2012 represented the first full year under the new method. As can be seen, the change
to calculations based on asset size rather than deposits has been very beneficial to F&M. The last line item in the noninterest expense
is other general and administrative. While it is higher by $944 thousand in 2012 following a decrease of $176 thousand in 2011 over 2010s $4.3 million, the fluctuation is not isolated to a single source. The largest fluctuation relates to
legal and loan collection expenses. 2011 included a reimbursement of over $300 thousand in costs with the collection of one relationship that took three years to complete. ATM expense, consulting and state taxes continue to trend upwards.
The largest cost decrease of $3.6 million to the Bank in 2011 was the Provision for Loan Losses and it was the largest increase in 2010. In
2012, it decreased another $977 thousand as compared to 2011. A tough economic environment existed for most businesses in our primary market area during 2007 through 2010. Gross charge-offs were $6.4 million for 2010 and $2.7 million for 2011, and
$891 thousand for 2012. Recoveries were $286, $351, and $795 thousand for 2012, 2011, and 2010, respectively. For all three years, activity was mainly commercial and commercial real estate driven in the provision allocation with charge-off activity
related to consumer portfolios, including real estate, in 2012. Further analysis by loan type is presented in the discussion of the allowance for credit losses. Net Interest Income The primary source of the Companys traditional banking revenue
is net interest income. Net interest income is the difference between interest income on interest earning assets, such as loans and securities, and interest expense on liabilities used to fund those assets, such as interest bearing deposits and
other borrowings. Net interest income is
affected by changes in both interest rates and the amount and composition of earning assets and liabilities. The change in net interest income is most often measured as a result of two statistics
interest spread and net interest margin. The difference between the yields on earning assets and the rates paid for interest bearing liabilities supporting those funds represents the interest spread. Because noninterest bearing sources of
funds such as demand deposits and stockholders equity also support earning assets, the net interest margin exceeds the interest spread. Overall, we continue to see compression in the net interest margin and spread with the risk remaining fairly constant. The net interest margin decreased
by 26 basis points and the net interest spread decreased by 24 basis points in comparing 2012 to 2011, with both sides of the equation having lower yields. Major improvement occurred in the decrease of nonaccrual and watch list loans in 2011 with a
slight uptick in 2012 due to one commercial relationship. Nonaccruals had increased during the first part of 2010 and decreased due to charge-off and payoff during the second half, specifically the fourth quarter. In first quarter of 2011, the Bank
collected $640 thousand of nonaccured interest from a large agricultural loan that took three years to collect. During the fourth quarter 2011, the Bank again collected on a large agricultural loan that was in nonaccrual though the collection period
was all in 2011. This was why the loan yield only decreased 4 basis points from 2010. During third quarter 2012, a commercial relationship caused the nonaccrual and impaired loan totals to increase over 2011 yearend levels. Short term rates remained
flat throughout the years and long term rates lowered during the year 2012. Earning assets increased during the year in actual and average
balance. The interest collected on the earning assets decreased; the yield decreasing for 2012 as compared to 2011 and 2010 in all portfolios. The largest decrease in yield occurred in the loans. As a reminder, 2011 included a collection of over
$600 thousand in nonaccrual interest which aided the yield. 2012 was hampered by negative loan growth, lower variable loan repricing and overall loan refinancing. Investment securities had lower yields due to the large amount of calls on government
sponsored agencies and the yield on new purchases as the growth in the portfolio was over $38.2 million in average. It was not unusual for a called security to be replaced with a new security with a yield lower by 50 basis points or more. Overall,
this portfolios yield was 23 basis points lower in 2012 than in 2011, preceded by a 87 basis points drop in 2011 as compared to 2010. Loans which have the highest earning asset yield decreased in average by $11.4 million when comparing 2012 to 2011 average balance and having decreased
$46.6 million in average balance between 2011 and 2010. While the overall change in yield in the loan portfolio for 2011 was due mainly to the change in balance rather than to the change in rate, the 2012 yield was impacted more by rate decrease
than the change in balance. Given that the loan portfolio represented only 56% of the earning assets in 2012 as compared to 59% in 2011 and 67% in 2010, it stands to reason that the overall asset yield decreased in every year since 2009. Coupling
this with the growth in earning assets being invested in securities and Federal Funds Sold and interest bearing bank balances, the overall yield on earning assets decreased 50 basis points as compared to 2011 and 108 basis points lower than 2010.
Spread is the difference between what the Company earns on its assets and what it pays on its liabilities. It is on this spread that the
Company must fund its operations and generate profit. When the asset yield decreases so must the cost of funds to maintain profitability. It becomes increasingly challenging as the asset yield gets closer to the prime lending rate, or the break-even
point, of operations. Looking at the other side of the balance sheet and the interest cost of funds, a decrease in the cost is apparent for
2012 as compared to both 2011 and 2010. Unfortunately, in the three years presented the asset yield decreased more than the cost of funds decreased and the net interest margin and spread decreased as compared to 2009. The impact of the change in the portfolio mix was a factor in the liabilities as it was in the assets. All portfolios decreased in cost of funds in
comparing 2012 to 2011and 2011 to 2010. The growth in balances was related to the growth in the new KASASA product offerings which rewarded customers by paying a higher interest rate for deposits which was offset by noninterest related Bank earnings
and savings. By participating in the KASASA Saver product, a customer may have earned as much as 135 basis points more than the Banks basic savings account. Even with the increased interest cost to the Bank for offering these products, the
Bank was still able to decrease its cost of funds by 26 basis points. Time deposits and other borrowed money both decreased in cost and balances. The Bank borrowed funds from the Federal Home Loan Bank in the first quarter of 2010, to lock in lower
rates to replace maturities coming due in the second through fourth quarter of the year. The Bank did not borrow any additional funds in 2011 or 2012, and the cost of those funds was again lower in 2012 since the associated expense of the matured
advances was gone for a full year. The Bank paid off $5.1 and $3.2 million of FHLB borrowings during 2012 and 2011 respectively. The average balance of other borrowed money was lower by $10.1 and $12.1 million at December 31, 2012 and 2011,
respectively. The following tables present net interest income, interest spread and net interest margin for the three
years 2010 through 2012, comparing average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and expense. The tables show their corresponding average rates of interest earned and paid. The
tax-exempt asset yields have been tax adjusted to reflect a marginal corporate tax rate of 34%. Average outstanding loan balances include non-performing loans and mortgage loans held for sale. Average outstanding security balances are computed based
on carrying values including unrealized gains and losses on available-for-sale securities. The percentage of interest earning assets to total
assets increased in 2012 over 2011 and 2011 over 2010 and remained above 90% at a respectable 94% and 93.9% for 2012 and 2011, respectively. As stated previously, the decreased yield on the assets was greater than the decreased cost of funds during all presented years. While the average
balance on interest bearing liabilities increased, the costs on those funds were significantly lower. The average cost for 2012 was .86% compared to 2011s 1.12% and 2010s 1.53%. The balances in noninterest bearing liabilities also
increased during the last three years. The largest fluctuation in the cost of funds was in the other time deposits. The cost on savings
decreased 10 basis points while on time deposits the cost decreased 33 basis points. The Bank has focused on increasing its core deposit base to lessen the dependency on higher cost time deposits. The Bank has also attempted to increase the duration
of the time deposits; however, customers have maintained a short-term, twelve month focus. The yield on Tax-Exempt investment securities
shown in the following charts were computed on a tax equivalent basis. The yield on Loans has been tax adjusted for the portion of tax-exempt IDB loans included in the total. Total Interest Earning Assets is therefore also reflecting a tax
equivalent yield in both line items, also with the Net Interest Spread and Margin. The adjustments were based on a 34% tax rate. [Remainder of this page intentionally left blank.] |
| | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | |
| | | 2012 | | | | 2011 | | |
| Beginning Year | | $ | 2,071 | | | $ | 2,178 | |
| Capitalized Additions | | | 761 | | | | 391 | |
| Amortization | | | (769 | ) | | | (498 | ) |
| Valuation Allowance | | | | | | | | |
| | | | | | | | | |
| End of Year | | $ | 2,063 | | | $ | 2,071 | |
| | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following tables show changes in interest income, interest expense and net interest resulting from changes in volume
and rate variances for major categories of earnings assets and interest bearing liabilities. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | **2010** | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | Average | | | | Interest/ | | | | | | |
| | | Balance | | | | Dividends | | | | Yield/Rate | | |
| **ASSETS** | | | | | | | | | | | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans (1) | | $ | 550,698 | | | $ | 32,860 | | | | 6.00 | % |
| Taxable investment securities | | | 176,885 | | | | 4,847 | | | | 2.74 | % |
| Tax-exempt investment securities | | | 59,537 | | | | 2,091 | | | | 5.32 | % |
| Federal funds sold & interest bearing deposits | | | 35,195 | | | | 95 | | | | 0.27 | % |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | | 822,315 | | | $ | 39,893 | | | | 5.00 | % |
| | | | | | | | | | | | | |
| **Non-Interest Earning Assets:** | | | | | | | | | | | | |
| Cash and cash equivalents | | | 14,046 | | | | | | | | | |
| Other assets | | | 42,096 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Assets** | | $ | 878,457 | | | | | | | | | |
| | | | | | | | | | | | | |
| **LIABILITIES AND SHAREHOLDERS EQUITY** | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 305,426 | | | $ | 2,190 | | | | 0.72 | % |
| Other time deposits | | | 321,018 | | | | 6,936 | | | | 2.16 | % |
| Other borrowed money | | | 37,517 | | | | 1,459 | | | | 3.89 | % |
| Federal funds purchased and securties sold under agreement to repurchase | | | 46,530 | | | | 278 | | | | 0.60 | % |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | | 710,491 | | | $ | 10,863 | | | | 1.53 | % |
| | | | | | | | | | | | | |
| **Non-Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 63,108 | | | | | | | | | |
| Other | | | 10,207 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities** | | | 783,806 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Shareholders Equity** | | | 94,651 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities and Shareholders Equity** | | $ | 878,457 | | | | | | | | | |
| | | | | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 39,893 | | | | 5.00 | % |
| Interest Expense / yield | | | | | | $ | 10,863 | | | | 1.53 | % |
| | | | | | | | | | | | | |
| Net Interest Spread | | | | | | $ | 29,030 | | | | 3.47 | % |
| | | | | | | | | | | | | |
| Net Interest Margin | | | | | | | | | | | 3.68 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | As mentioned in the discussion earlier, in reviewing the 2012 to 2011 and the 2011 to 2010 comparison, an impact in
change due to volume is evident; however the largest impact was due to rate. The strategy during 2010, 2011 and beyond is to extend the maturities of time deposit specials to over 24 months to prepare for rising rates. The other strategy
employed during 2010 through 2012 was to increase core deposits by offering innovative products focused on customer needs: higher interest rates. In exchange for a high interest-bearing checking account, customers were asked to utilize services that
benefited both the Bank and themselves. Smaller time deposit rate shoppers had an option to perhaps change their behavior of banking or allow those deposits to run off. The new core deposit products were indeed embraced by our customers and have
helped to attain the deposit portfolio mix sought by the Bank. Allowance for Credit Losses The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these
reserves constitute the total Allowance for Credit Losses (ACL). The Banks ALLL methodology captures trends in leading, current, and
lagging indicators which will directly affect the Banks allocation amount. Trends in such leading indicators as delinquency, unemployment changes in the Banks service area, experience and ability of staff, regulatory trends, and credit
concentrations are employed. A current indicator such as the total watch list loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as well. A matrix is formed by loan type from these indicators that is
responsive in making ALLL adjustments. Special Mention loan balances increased 26.5% or $2.8 million as of 2012 compared to same date 2011.
Substandard and doubtful loan balances increased 7.1% or $793 thousand comparing the same dates as above. In response to this change, the Bank increased its ALLL to outstanding loan coverage percentage to 1.04% as of December 31, 2012 as
compared to 1.01% as of December 31, 2011. The Bank experienced a 4.5% decrease in Special Mention loan balances as of December 31, 2011 as compared to December 31, 2010. The Bank also experienced a 38.5% decrease or $7 million
decrease in Substandard and Doubtful loan balances as of December 31, 2011 as compared to 2010. The above indicators are reviewed
quarterly. Some of the indicators are quantifiable and as such will automatically adjust the ALLL once calculated. These indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and watch list to capital
ratios with the watch list made up of loans graded 5, 6 or 7 on a 1 to 7 scale, 1 being the best rating. Other indicators use more subjective data to the extent possible to evaluate the potential for inherent losses in the Banks loan
portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market area to help determine whether the ALLL should be adjusted. At the end of 2011 and 2012, a slight improvement was noted in
unemployment figures and several local firms were calling a small number of employees back from layoff while planning some expansion. The current recalls do not begin to approximate the number of positions lost. All aggregate commercial and agricultural credits including real estate loans of $250,000 and over are reviewed annually by both credit committees and
internal loan review to look for early signs of deterioration. To establish the specific reserve allocation in the instance of real estate, a
discount to the market value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Banks Loan Policy. However, unique or unusual
circumstances may be present which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management. The ACL increased $165 thousand during 2012, preceded by a $638 thousand decrease during 2011. With the decrease in loan balances, the percentage of ACL to the total loan portfolio actually increased from
1.03% as of December 31, 2011 to 1.07% as of December 31, 2012. As of December 31, 2011, the percentage of ACL to the total loan portfolio decreased to 1.03% from 1.12% as of December 31, 2010, due to the improvement in troubled
loan totals and a past due 30+ days percentage of .67%. This was the lowest since yearend 2006. Please see Note 4 in the consolidated
financial statement for additional tables regarding the composition of the ACL. Federal Income Taxes Effective tax rates were 28.51%, 25.36%, and 25.44%, for 2012, 2011, and 2010, respectively. The effect of tax-exempt interest from holding tax-exempt
securities and Industrial Development Bonds (IDBs) was $677, $689, and $744 thousand for 2012, 2011, and 2010, respectively. 2012 included an increase into a higher tax bracket for income over $10 million. Financial Condition Average earning assets increased $23.5 million during 2012 over 2011 and 2011s were higher by $34.2 million as compared to 2010. The main cause of fluctuation was the Hicksville acquisition and the
repositioning of the balance sheet. Average interest bearing liabilities increased $69 thousand over 2011 and 2011s increased $17.8 million from 2010. The increase in balances was due to the success of the KASASA suite of products to attract
funds into the savings deposit bucket and an increase in Health Savings Accounts. The increases there were larger than the decreases due to debit pay down. Securities The investment portfolio is primarily used to provide overall liquidity for the
Bank. It is also used to provide required collateral for pledging to the Banks Ohio public depositors for amounts on deposit over the FDIC coverage limits. It may also be used to pledge for additional borrowings from third parties. Investments
are made with the above criteria in mind while still seeking a fair market rate of return, and looking for maturities that fall within the projected overall strategy of the Bank. The possible need to fund growth is also a consideration. All of the Banks security portfolio is categorized as available for sale, with the exception of stock, and as such is recorded at market value.
Security balances as of December 31 are summarized below: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2011 vs 2010 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | Net | | | | Due to change in | | | | | | |
| | | Change | | | | Volume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | (3,020 | ) | | $ | (2,799 | ) | | $ | (221 | ) |
| Taxable investment securities | | | (54 | ) | | | 2,158 | | | | (2,212 | ) |
| Tax-exempt investment securities | | | (135 | ) | | | 97 | | | | (232 | ) |
| Federal funds sold & interest bearing deposits | | | (24 | ) | | | 1 | | | | (25 | ) |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | (3,233 | ) | | $ | (543 | ) | | $ | (2,690 | ) |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 11 | | | $ | 318 | | | $ | (307 | ) |
| Other time deposits | | | (2,158 | ) | | | (424 | ) | | | (1,734 | ) |
| Other borrowed money | | | (576 | ) | | | (469 | ) | | | (107 | ) |
| Federal funds purchased and securities sold under agreement to repurchase | | | 16 | | | | 30 | | | | (14 | ) |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | (2,707 | ) | | $ | (545 | ) | | $ | (2,162 | ) |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table sets forth the maturities of investment securities as of December 31, 2012 and the weighted
average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate have been made in yields on obligations of
state and political subdivisions. Stocks of domestic corporations have not been included. [Remainder of this page
intentionally left blank.] Securities (Continued) |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2012 | | | | 2011 | | | | 2010 | | |
| U.S. Treasury | | $ | 10,568 | | | $ | 26,691 | | | $ | 32,278 | |
| U.S. Government agency | | | 220,200 | | | | 177,797 | | | | 165,704 | |
| Mortgage-backed securities | | | 53,006 | | | | 55,413 | | | | 24,531 | |
| State and local governments | | | 72,131 | | | | 67,618 | | | | 64,804 | |
| | | | | | | | | | | | | |
| | | $ | 355,905 | | | $ | 327,519 | | | $ | 287,317 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | As of December 31, 2012 the Bank did not hold a large block of any one investment security, except for U.S.
Government agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $4.2 million. This is required in order to obtain Federal Home Loan Bank loans. The Bank also acquired stock in the Federal Home Loan Bank of
Indianapolis at a cost of $231.4 thousand through its acquisition of Knisely Bank. There were no borrowings at the time of acquisition associated with Federal Home Loan Bank of Indianapolis. The Bank had requested Federal Home Loan Bank of
Indianapolis to buy back its stock when the acquisition of Knisely was completed in January 2008. A five year waiting period was imposed and the stock will be redeemed in full in 2013. An early redemption of 42,000 shares occurred in 2010 with
another 41,000 shares redeemed in 2011. These decreased the holdings to a value of $148.4 thousand. The Bank also owns stock of Farmer Mac with a carrying value of $37.4 thousand which is required to participate loans in the program. Loan Portfolio The Banks various
loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio diversification and through standardization of lending policies and procedures. Risks are mitigated through an adherence to Loan Policy with any exception being recorded and approved by senior management or committees comprised of
senior management. Loan Policy defines parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow and debt-to-income ratio, loan requirements and covenants, financial information tracking, collection practice and others.
Limitation to any one borrower is defined by the Banks legal lending limits and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to any one business or agricultural sector by an
approved sector percentage to capital limitation. The following table shows the Banks loan portfolio by category of loan as of
December 31st of each year, including loans held for
sale: |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Maturities | | | | | | | | | | | | | | |
| | | (Amounts in Thousands) | | | | | | | | | | | | | | |
| | | | | | | | | | | After One Year | | | | | | |
| | | Within One Year | | | | | | | | Within Five Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | | | | | | | | $ | | | | | | |
| U.S. Government agency | | | 34,999 | | | | 1.17 | % | | | 129,414 | | | | 1.56 | % |
| Mortgage-backed securities | | | | | | | | | | | 200 | | | | 4.34 | % |
| State and local governments | | | 8,634 | | | | 2.49 | % | | | 23,770 | | | | 2.42 | % |
| Taxable state and local governments | | | | | | | | | | | 3,579 | | | | 2.85 | % |
| | | | | | | | | | | | | | | | | |
| | | Maturities | | | | | | | | | | | | | | |
| | | (Amounts in Thousands) | | | | | | | | | | | | | | |
| | | After Five Years | | | | | | | | | | | | | | |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | 10,568 | | | | 1.14 | % | | $ | | | | | | |
| U.S. Government agency | | | 55,787 | | | | 1.38 | % | | | | | | | | |
| Mortgage-backed securities | | | 20,955 | | | | 2.36 | % | | | 31,851 | | | | 2.03 | % |
| State and local governments | | | 24,301 | | | | 3.27 | % | | | 8,979 | | | | 4.63 | % |
| Taxable state and local governments | | | 1,322 | | | | 2.32 | % | | | 1,546 | | | | 5.57 | % |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table shows the maturity of loans as of December 31, 2012: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| Loans: | | 2012 | | | | 2011 | | | | 2010 | | | | 2009 | | | | 2008 | | |
| Commercial real estate | | $ | 199,999 | | | $ | 198,266 | | | $ | 194,268 | | | $ | 214,849 | | | $ | 226,761 | |
| Agricultural real estate | | | 40,143 | | | | 31,993 | | | | 33,650 | | | | 41,045 | | | | 48,607 | |
| Consumer real estate | | | 80,287 | | | | 84,477 | | | | 86,036 | | | | 98,599 | | | | 89,773 | |
| Commercial and industrial | | | 101,624 | | | | 114,497 | | | | 117,344 | | | | 120,543 | | | | 112,526 | |
| Agricultural | | | 57,770 | | | | 52,598 | | | | 65,400 | | | | 59,813 | | | | 56,322 | |
| Consumer | | | 20,413 | | | | 23,375 | | | | 29,008 | | | | 32,581 | | | | 26,469 | |
| Industrial Development Bonds | | | 1,299 | | | | 1,196 | | | | 1,965 | | | | 2,552 | | | | 7,572 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 501,535 | | | $ | 506,402 | | | $ | 527,671 | | | $ | 569,982 | | | $ | 568,030 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table presents the total of loans due after one year which has either 1) predetermined interest rates
(fixed) or 2) floating or adjustable interest rates (variable): |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | | | | | After One | | | | | | | | | | |
| | | Within | | | | Year Within | | | | After | | | | | | |
| | | One Year | | | | Five Years | | | | Five Years | | | | Total | | |
| Commercial Real Estate | | $ | 25,448 | | | $ | 103,857 | | | $ | 70,694 | | | $ | 199,999 | |
| Agricultural Real Estate | | | 3,337 | | | | 10,136 | | | | 26,670 | | | $ | 40,143 | |
| Consumer Real Estate | | | 9,535 | | | | 14,424 | | | | 56,328 | | | $ | 80,287 | |
| Commercial and industrial | | | 58,744 | | | | 39,716 | | | | 3,164 | | | $ | 101,624 | |
| Agricultural | | | 37,153 | | | | 18,116 | | | | 2,501 | | | $ | 57,770 | |
| Consumer | | | 5,345 | | | | 13,238 | | | | 1,830 | | | $ | 20,413 | |
| Industrial Development Bonds | | | 417 | | | | 490 | | | | 392 | | | $ | 1,299 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 139,979 | | | $ | 199,977 | | | $ | 161,579 | | | $ | 501,535 | |
| | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table summarizes the Companys nonaccrual and past due 90 days or more and still accruing
loans as of December 31 for each of the last five years: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Fixed | | | | Variable | | | | | | |
| | | Rate | | | | Rate | | | | | | |
| Commercial Real Estate | | $ | 112,939 | | | $ | 60,786 | | | $ | 173,725 | |
| Agricultural Real Estate | | | 28,002 | | | | 8,843 | | | $ | 36,845 | |
| Consumer Real Estate | | | 64,162 | | | | 6,865 | | | $ | 71,027 | |
| Commercial and industrial loans | | | 35,620 | | | | 7,512 | | | $ | 43,132 | |
| Agricultural | | | 19,939 | | | | 631 | | | $ | 20,570 | |
| Consumer, Master Card and Overdrafts | | | 15,068 | | | | 3,557 | | | $ | 18,625 | |
| Industrial Development Bonds | | | 882 | | | | | | | $ | 882 | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest
irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans was $544.8 thousand for 2012, $101.6 thousand for 2011, and $910 thousand for 2010. Any collections of
interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to
decrease the allocation needed. Total interest collections whether on an accrued or cash basis amounted to $26 thousand for 2012, $1.2 million for 2011 and $61 thousand for 2010. None of the interest collected in 2012 or 2011 was applied to reduce a
specific allocation. $3 thousand of interest collected in 2010 was applied to reduce the specific allocation. Loans are placed on nonaccrual
status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The loss of interest due to the high balances in nonaccruals as of 2010 and 2012 impacted the yield on loans.
The collection of interest on nonaccrual loans helped the yield in 2011. December 31, 2012 had nonaccrual loan balances of $4.8 million compared to $2.1 and $5.8 million nonaccrual loan balances as of yearend 2011 and 2010, respectively.
All of the balances of nonaccrual loans for the three years were secured. As of December 31, 2012 the Bank had $24.7 million of loans
which it considers to be potential problem loans in that the borrowers are experiencing financial difficulties compared to December 31, 2011 when the Bank had $22.7 million of these loans. These loans are subject to constant management
attention and are reviewed at least monthly. The amount of the potential problem loans was considered in managements review of the loan
loss reserve required at December 31, 2012 and 2011. In extending credit to families, businesses and governments, banks accept a measure
of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense, used to enlarge a banks allowance for loan losses, is determined by management based on a detailed monthly review of
the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the banks borrowers. As of December 31, 2012, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $57.8
million with an additional $40.1 million in agricultural real estate loans. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities. Loan modifications granted are typically for seasonality issues where cash flow is decreased. The time period involved is generally quite short in
relation to the loan term. For example, a typical modification may consist of interest only payments for 90 days. We consider this treatment of interest only payments for a short time as an insignificant delay in payment. Consequently, we do not
consider these occurrences as troubled debt restructurings. Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty
and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2012, the Bank had $5.5 million of its loans that were classified as troubled debt restructurings. The Bank had almost $3.2 million
classified as such as of December 31, 2011. The Bank is occasionally ordered by the courts to give terms to a borrower that are better than what the Bank would like for the risk associated with that credit but not below or beyond rates and
terms available for better credits in our market. Therefore, the Bank has not done any modifications that it would classify as troubled debt restructurings under those circumstances. Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank
may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a
change in value has occurred. To determine observable market price, collateral asset values securing an impaired loan are periodically
evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals
are received, the Bank may discount the existing collateral value used. Performing non-watch list customers secured in whole or in part by
real estate do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List customers secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to
values as found in Loan Policy no matter what their grade. Our watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Banks loans are made in the market by lenders that live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check.
On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans
without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for
applying such adjustments. However, on a quarterly basis as part of its normal operations, the Banks senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Banks
Watch List. In addition to analyzing the recent performance of these loans, management and the Loan Review Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate
collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market
conditions impacting a specific property or other relevant factors is considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the
available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific
information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Banks general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Banks loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two
components, allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component
of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit
rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific
allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a
reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss
analysis by loan category. The unallocated portion of the reserve for loan losses is determined based on managements assessment of
general economic conditions as well as specific economic factors in the Banks marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that
are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrowers financial condition and other current risk factors that may not have yet manifested themselves in
the Banks historical loss factors used to determine the allocated component of the allowance. Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management.
These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral. As presented below, charge-offs decreased to $891 thousand for 2012 and $2.7 million for 2011 preceded by an increase to $6.4 million for 2010. The provision also decreased in 2012 and 2011 and increased
for 2010. 2012 had provision expense of $738 thousand compared 2011 had provision expense of $1.7 million and 2010 expense of $5.3 million. The Commercial and Industrial portfolio had the largest net charge-off position in 2009 thru 2011. The loan
categories, consumer real estate and consumer & other loans, had the largest net charge-off position in 2012. The ratio of net charge offs to average loans outstanding is evidence of the recognition of troubled loans and the write down of
collateral values. The improvement in asset quality during the periods shown is reflected in the increased percentage of the allowance for loan loss to nonperforming loans. The increase percentage of ACL to total loans ratio provides for the high level of nonaccrual and watch list loans and recognizes the extended time period with which it has taken to achieve resolution
and/or collection of these loans. The ALLL for 2010 and 2011 decreased due to the improvement in the asset quality as the balances in impaired loans and nonaccruals were drastically reduced over the same time periods. In 2012, the increase is to
offset the higher yearend watch list values. A smaller portion of the allowance was needed to fund the impaired loans as collateral remained sufficient to cover the outstanding amounts in most cases. [Remainder of this page intentionally left blank.] The following table presents a reconciliation of the allowance for credit losses for the years ended
December 31, 2012, 2011 and 2010: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2012 | | | | 2011 | | | | 2010 | | | | 2009 | | | | 2008 | | |
| Non-accrual loans | | $ | 4,828 | | | $ | 2,131 | | | $ | 5,844 | | | $ | 14,054 | | | $ | 13,575 | |
| Accruing loans past due 90 days or more | | | 1 | | | | | | | | 48 | | | | 69 | | | | 2,524 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 4,829 | | | $ | 2,131 | | | $ | 5,892 | | | $ | 14,123 | | | $ | 16,099 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | *
Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual. Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total
loans is as follows: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2012 | | | | 2011 | | | | 2010 | | |
| Loans | | $ | 501,402 | | | $ | 506,215 | | | $ | 527,589 | |
| | | | | | | | | | | | | |
| Daily average of outstanding loans | | $ | 492,697 | | | $ | 504,058 | | | $ | 550,698 | |
| | | | | | | | | | | | | |
| Allowance for Loan Losses-Jan 1 | | $ | 5,091 | | | $ | 5,706 | | | $ | 6,008 | |
| Loans Charged off: | | | | | | | | | | | | |
| Commercial Real Estate | | | 98 | | | | 360 | | | | 1,147 | |
| Ag Real Estate | | | | | | | | | | | | |
| Consumer Real Estate | | | 246 | | | | 423 | | | | 507 | |
| Commercial and Industrial | | | 47 | | | | 1,500 | | | | 4,188 | |
| Agricultural | | | 6 | | | | 24 | | | | 136 | |
| Consumer & other loans | | | 494 | | | | 374 | | | | 444 | |
| | | | | | | | | | | | | |
| | | $ | 891 | | | $ | 2,681 | | | $ | 6,422 | |
| | | | | | | | | | | | | |
| Loan Recoveries: | | | | | | | | | | | | |
| Commercial Real Estate | | | 7 | | | | 32 | | | | 52 | |
| Ag Real Estate | | | | | | | | | | | | |
| Consumer Real Estate | | | 60 | | | | 61 | | | | 55 | |
| Commercial and Industrial | | | 30 | | | | 19 | | | | 515 | |
| Agricultural | | | 12 | | | | 67 | | | | 17 | |
| Consumer & other loans | | | 177 | | | | 172 | | | | 156 | |
| | | | | | | | | | | | | |
| | | $ | 286 | | | $ | 351 | | | $ | 795 | |
| | | | | | | | | | | | | |
| Net Charge Offs | | $ | 605 | | | $ | 2,330 | | | $ | 5,627 | |
| Provision for loan loss | | | 738 | | | | 1,715 | | | | 5,325 | |
| Acquisition provision for loan loss | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Allowance for Loan & Lease LossesDec 31 | | $ | 5,224 | | | $ | 5,091 | | | $ | 5,706 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 | | | 162 | | | | 130 | | | | 153 | |
| | | | | | | | | | | | | |
| Total Allowance for Credit LossesDec 31 | | $ | 5,386 | | | $ | 5,221 | | | $ | 5,859 | |
| | | | | | | | | | | | | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.12 | % | | | 0.46 | % | | | 1.02 | % |
| | | | | | | | | | | | | |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 108.20 | % | | | 238.90 | % | | | 97.63 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Deposits The amount of outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2012
are as follows:
(In Thousands)
Over Three
Over Six
Months
Months Less
Over
Under
Less than
Than One
One
Three Months
Six Months
Year
Year
Time Deposits
$
12,600
$
19,226
$
31,545
$
58,404
The following table presents the average amount of and average rate paid on each deposit category: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2012 | | | | | | | | 2011 | | | | | | | | 2010 | | | | | | | | 2009 | | | | | | | | 2008 | | | | | | |
| | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | |
| | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | |
| Balance at End of Period Applicable To: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial Real Estate | | $ | 1,749 | | | | 39.89 | | | $ | 2,087 | | | | 39.74 | | | $ | 1,868 | | | | 36.82 | | | $ | 1,810 | | | | 39.99 | | | $ | 1,810 | | | | 39.92 | |
| Ag Real Estate | | | 113 | | | | 8.01 | | | | 140 | | | | 6.32 | | | | 122 | | | | 6.38 | | | | 120 | | | | 7.20 | | | | 130 | | | | 8.56 | |
| Consumer Real Estate | | | 368 | | | | 16.01 | | | | 260 | | | | 16.12 | | | | 258 | | | | 16.31 | | | | 439 | | | | 15.01 | | | | 386 | | | | 15.80 | |
| Commercial and Industrial | | | 2,183 | | | | 20.27 | | | | 1,948 | | | | 22.62 | | | | 2,354 | | | | 22.24 | | | | 2,494 | | | | 21.15 | | | | 2,278 | | | | 19.81 | |
| Agricultural | | | 290 | | | | 11.52 | | | | 267 | | | | 10.39 | | | | 327 | | | | 12.40 | | | | 647 | | | | 10.49 | | | | 413 | | | | 9.92 | |
| Consumer, Overdrafts and other loans | | | 268 | | | | 4.04 | | | | 315 | | | | 4.58 | | | | 380 | | | | 5.48 | | | | 479 | | | | 5.72 | | | | 479 | | | | 5.99 | |
| Unallocated | | | 253 | | | | 0.26 | | | | 74 | | | | 0.24 | | | | 397 | | | | 0.37 | | | | 19 | | | | 0.45 | | | | 0 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses | | $ | 5,224 | | | | 100.00 | | | $ | 5,091 | | | | 100.00 | | | $ | 5,706 | | | | 100.00 | | | $ | 6,008 | | | | 100.00 | | | | 5,496 | | | | 100.00 | |
| Off Balance Sheet Commitments | | | 162 | | | | | | | | 130 | | | | | | | $ | 153 | | | | | | | $ | 227 | | | | | | | | 226 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses | | $ | 5,386 | | | | | | | $ | 5,221 | | | | | | | $ | 5,859 | | | | | | | $ | 6,235 | | | | | | | $ | 5,722 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Liquidity Liquidity remains high and the Bank has access to $42 million of unsecured borrowings through correspondent banks and $159 million of unpledged securities which may be sold or used as collateral. An
additional $6.2 million is also available from the Federal Home Loan Bank based on current collateral pledging with up to $128 million available provided adequate collateral is pledged. Maintaining sufficient funds to meet depositor and borrower needs on a daily basis continues to be among our managements top priorities. This is accomplished not only by the immediately liquid
resources of cash, due from banks and federal funds sold, but also by the Banks available for sale securities portfolio. The average aggregate balance of these assets was $397.3million for 2012, compared to $356 million for 201, and $274
million for 2010. This represented 42.5 percent, 39 percent, and 31.3 percent of total average assets, respectively. Of the almost $356 million of debt securities in the companys portfolio as of December 31, 2012, $50.7million or 14.3
percent of the portfolio is expected to receive payments or mature in 2013. The availability of the funds may be reduced by the need to utilize securities for pledging purposes on public deposits. This liquidity provides the opportunity to fund loan
growth without having to aggressively price deposits. Historically, the primary source of liquidity has been core deposits that include
noninterest bearing and interest bearing demand deposits, savings, money market accounts and time deposits of individuals. Core deposits increased as of yearend balances in 2012, in all categories. Overall deposits increased an average of $20.7
million during 2012 compared to 2011s increase over 2010 of $34.6 million in average deposits. These represent changes of 2.9 percent and 8.3 percent in average total deposits, respectively. The Bank also utilized Federal Funds purchased at
times during 2011 and 2012. The average balance for 2012 was $2 thousand, which was mainly for verification of borrowing procedures should the need arise. Again, historically, the primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and for business development. The use of
new funds for loans is measured by the loan to deposit ratio. The Companys average loan to deposit ratio for 2012 was 65 percent, 2011 was 68.24 percent and 2010 was 78.13 percent. The lower ratios in 2012 and 2011 were due to the success of
the deposit gathering function, the residential mortgage loans being sold in the secondary market and the lack of loan demand. The Companys goal is for this ratio to be higher with loan growth being the driver; however, this was and may be
difficult to achieve in 2013 with borrowers still taking a conservative approach to increasing their liabilities. Short-term debt such as
federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt for both federal funds purchased and securities sold under agreement to repurchase amounted to $51.3 million at the
end of 2012 compared to $52.4 million at the end of 2011 and to $51.2 million at the end of 2010. These accounts are used to provide a sweep product to the Banks commercial customers. Though no federal funds were purchased at year end, the Bank does have arrangements with correspondent Banks that can be utilized when necessary. Other borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then used to provide fixed rate mortgage loans secured by
homes in our community. Borrowings from this source decreased by $5.1 million to $11.6 million at December 31, 2012. This compares to decreased borrowings during 2011 of $13.2 million to $16.7 million at December 31, 2011 and increased
borrowings during 2010 of $4.3 million to $29.9 million to end at December 31, 2010. The decreased borrowings were payoffs of matured notes in 2011 and 2012. Sufficient funds were available to fund growth so new advances were not needed.
Asset/Liability Management The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets
and interest bearing liabilities. It involves the management of the balance sheet mix, maturities, re-pricing characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk. Interest
rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. Changes in net income, other than those related to volume arise when interest rates on assets re-price in a time frame or interest rate environment that is different from that of the re-pricing period for
liabilities. Changes in net interest income also arise from changes in the mix of interest-earning assets and interest-bearing liabilities. Historically, the Bank has maintained liquidity through cash flows generated in the normal course of
business, loan repayments, maturing earning assets, the acquisition of new deposits, and borrowings. The Banks asset and liability management program is designed to maximize net interest income over the long term while taking into
consideration both credit and interest rate risk. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans that are tied to the
market rate differ considerably from long-term investment securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings accounts. The Bank utilizes
shock analysis to examine the amount of exposure an instant rate change of 100, 200, and 300 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings and equity at risk are established and
decisions are made to maintain those levels based on the shock results. Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in
the increased cost of the Companys operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Companys performance
than do the effects of 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 service. Contractual Obligations Contractual Obligations of the Company totaled $333.4 million as
of December 31, 2012. Time deposits represent contractual agreements for certificates of deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is further defined in Note 4 and 9 of the
Consolidated Financial Statements. |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | Non-Interest | | | | Interest | | | | Savings | | | | Time | | |
| | | DDAs | | | | DDAs | | | | Accounts | | | | Accounts | | |
| December 31, 2012: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 84,217 | | | $ | 190,273 | | | $ | 182,724 | | | $ | 285,214 | |
| Average rate | | | | | | | 0.70 | % | | | 0.33 | % | | | 1.24 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2011: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 70,547 | | | $ | 185,463 | | | $ | 164,352 | | | $ | 301,394 | |
| Average rate | | | | | | | 0.81 | % | | | 0.43 | % | | | 1.59 | % |
| | | | | | | | | | | | | | | | | |
| December 31, 2010: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 60,489 | | | $ | 167,382 | | | $ | 138,044 | | | $ | 321,018 | |
| Average rate | | | | | | | 0.96 | % | | | 0.42 | % | | | 2.16 | % |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Capital Resources Stockholders equity was $110.2 million as of December 31, 2012 compared to $105.1 million at December 31, 2011. Dividends declared during 2012 were $0.78 per share totaling $3.64 million
and 2011 were $0.76 per share totaling $3.56 million. During 2012, the Company purchased 42,144 shares and awarded 11,000 restricted shares to 54 employees. For a summary of activity as it relates to the Companys restricted stock awards,
please refer to Note 11: Employee Benefit Plans in the consolidated financial statements. At yearend 2012, the Company held 515,942 shares in Treasury stock and 30,670 shares in unearned stock awards as compared to 2011, the Company held 483,663
shares in Treasury stock and 29,715 in unearned stock awards. On January 18, 2013 the Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated
transactions, of up to 200,000 shares of its outstanding common stock commencing January 18, 2013 and ending December 31, 2013. Capital Resources (Continued) The Company continues to have a strong capital base and to maintain regulatory capital ratios that are significantly above the defined regulatory capital ratios. At December 31, 2012, The Farmers & Merchants State Bank and Farmers & Merchants Bancorp, Inc had total risk-based capital ratios
of 14.74% and 17.35%, respectively. Core capital to risk-based asset ratios of 13.85% and 16.45% are well in excess of regulatory guidelines. The Banks leverage ratio of 8.92% is also substantially in excess of regulatory guidelines as is the
Companys at 10.67%. For further discussion and analysis of regulatory capital requirements, refer to Note 14 of the Audited Financial Statements. The Companys subsidiaries are restricted by regulations from making dividend distributions in excess of certain prescribed amounts. Upon prior regulatory approval, the Bank may be allowed to pay
above the prescribed amount. |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Payment Due by Period (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | Less than | | | | 1-3 | | | | 3-5 | | | | More than | | |
| Contractual Obligations | | Total | | | | 1 year | | | | Years | | | | Years | | | | 5 years | | |
| Securities sold under agreement to repurchase | | $ | 51,312 | | | $ | 35,173 | | | $ | 16,139 | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | | | | | | |
| Time Deposits | | | 269,507 | | | | 132,584 | | | | 113,048 | | | | 22,153 | | | | 1,722 | |
| | | | | | | | | | | | | | | | | | | | | |
| Dividends Payable | | | 931 | | | | 931 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Long Term Debt | | | 11,600 | | | | 7,100 | | | | 4,500 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 333,350 | | | $ | 175,788 | | | $ | 133,687 | | | $ | 22,153 | | | $ | 1,722 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-13-073008 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following tables show changes in interest income, interest expense and net interest resulting from changes in
volume and rate variances for major categories of earnings assets and interest bearing liabilities. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | **2015** | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | AverageBalance | | | | Interest/Dividends | | | | Yield/Rate | | |
| **ASSETS** | | | | | | | | | | | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 627,194 | | | $ | 29,293 | | | | 4.68 | % |
| Taxable investment securities | | | 177,833 | | | | 2,808 | | | | 1.58 | % |
| Tax-exempt investment securities | | | 66,156 | | | | 1,513 | | | | 3.47 | % |
| Federal funds sold & interest bearing deposits | | | 14,359 | | | | 36 | | | | 0.25 | % |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | | 885,542 | | | $ | 33,650 | | | | 3.90 | % |
| | | | | | | | | | | | | |
| **Non-Interest Earning Assets:** | | | | | | | | | | | | |
| Cash and cash equivalents | | | 21,333 | | | | | | | | | |
| Other assets | | | 47,284 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Assets** | | $ | 954,159 | | | | | | | | | |
| | | | | | | | | | | | | |
| **LIABILITIES AND SHAREHOLDERS EQUITY** | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 412,269 | | | $ | 1,557 | | | | 0.38 | % |
| Other time deposits | | | 189,822 | | | | 1,712 | | | | 0.90 | % |
| Other borrowed money | | | 108 | | | | 1 | | | | 0.93 | % |
| Federal funds purchased and securities sold under agreement to repurchase | | | 57,918 | | | | 317 | | | | 0.55 | % |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | | 660,117 | | | $ | 3,587 | | | | 0.54 | % |
| | | | | | | | | | | | | |
| **Non-Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 162,028 | | | | | | | | | |
| Other | | | 14,461 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities** | | | 836,606 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Shareholders Equity** | | | 117,553 | | | | | | | | | |
| | | | | | | | | | | | | |
| **Total Liabilities and Shareholders Equity** | | $ | 954,159 | | | | | | | | | |
| | | | | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 33,650 | | | | 3.89 | % |
| Interest Expense / yield | | | | | | | 3,587 | | | | 0.54 | % |
| | | | | | | | | | | | | |
| Net Interest Spread | | | | | | $ | 30,063 | | | | 3.35 | % |
| | | | | | | | | | | | | |
| Net Interest Margin | | | | | | | | | | | 3.49 | % |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Non-Interest Income In
comparing line items of the consolidated statements of income for years ended 2015 through 2017, it can be seen where the Company has been spending its time and the impact of the recession and slow recovery. This section will focus on the
significant noninterest items that impacted the operations of the Company. Non-interest income decreased in total for 2017 as compared to 2016, ending at
$10.7 million. 2016 had non-interest income of $11.4 million which had exceeded 2015s $10.8 million. The Company has concerns with the increased costs associated with regulatory compliance such as the possible loss
of revenue from new regulations stemming from the Dodd-Frank Act. History has proven the concern is justified. One area of revenue impacted was overdraft fees. The Bank has ended each of the last 4 years with a lower revenue stream from overdraft
fees. This has occurred in spite of the addition of the new offices. Each year, the number of checking accounts has increased along with the balances; however average collected overdraft fees per account decreased. Overdraft fees in 2017 accounted
for $2.3 million, 2016 and 2015 accounted for $2.4 million in noninterest income. The Bank had made this an area of focus for 2015 as this revenue stream remains under intense regulator review. In 2015, the Bank adjusted its overdraft program and
renamed it Courtesy Pay. Courtesy Pay establishes dynamic limits based on a customers behavior and likelihood of repayment. The Bank has sought to better service the customers needs while decreasing the need for collections
and improving profitability. At the current time, profitability has not improved and in 2016 it only slowed the amount of decrease. Service charges on checking accounts increased for 2017. During the second quarter 2017, new business checking
products were announced and existing business accounts were converted to one of three new products, Business Essential, Edge or Elite. The new products provided customers with new options to bundle services and for the Bank to utilize the full
relationship to determine pricing. This was the next step of implementation for the Banks earn to free strategic initiative. Upgrades to our digital products and services continue to occur in both retail and business lines.
Increases in the number of accounts and the number of services being utilized by our customers accounted for the increase in fees. These fees were up $292.7 thousand in 2017 as compared to 2016. Service charges on checking accounts had leveled off
in 2016 only $67.7 thousand higher than 2015. This improvement is credited to the new checking accounts mentioned previously. The Bank has long promoted
the use of debit cards by its customers and continued that philosophy with the introduction of additional new products. 2017 revenue improved $172.5 thousand, 2016 revenue improved $122.4 thousand, and 2015 revenue improved $142.9 thousand from
ATM/debit card usage as compared to each of the respective prior years. The Bank receives interchange revenue from each use by a customer of a Bank issued ATM/debit the card. While this revenue stream continues to improve with more depositors using
electronic methods for purchasing, the expense attributable to card fraud has offset a portion of the revenue gain. Further discussion can be found in the non-interest expense section regarding the net effect of debit card activity. Noninterest income from net gain on sales of loans was the highest in 2016 of the three year periods shown. The change may be related to the increase in rates
after the long duration of the flat interest rate environment. The net gain on sale of loans is derived from sales of real estate loans into the secondary market. Of these loan types, the Bank sells 100% of the residential loans and 90% of the
agricultural loans into the secondary market. Gains of $648.9 and $162.2 thousand were recorded for residential and agricultural real estate respectively for 2017. Gains of $683.7 and $204.0 thousand were recorded for residential and agricultural
real estate respectively for 2016. Gains of $559.6 and $140.8 thousand were recorded for residential and agricultural real estate respectively for 2015. In conjunction with these sales, the Bank maintains servicing rights and those income amounts
during all three years are included in the customer service fees line item and accounted for $460 thousand in 2017, $555.3 thousand in 2016 and $406.5 thousand in revenue for 2015. The last line item in the noninterest income section is the net gain on sale of investments. The Bank has taken advantage of this opportunity the last three
years and expects to continue as long as the yield curve is favorable to the transaction. The Bank will not increase short-term gains at the sacrifice of long-term profitability. The opportunity greatly lessened in 2017 with the increase in rates.
The available for sale security portfolio switched from an unrealized gain position into an unrealized loss position. The decrease in the balance of the security portfolio was due to calls and maturities and not sales made during 2017. Sales were
made early in the first quarter before the additional rate hike in March and in May before the rate hike in June occurred and with much lower gains than in the prior years. All of the sales of securities in 2017, 2016 and 2015 of $13.6, $85.7, and
$47.0 million respectively were used to fund loan growth. This is a source of funds that will continue to be analyzed for use in the coming year. Gains of $47 thousand were recorded for 2017, $588 thousand for 2016, and $451 thousand for 2015. This
line item was largely responsible for the lower non-interest income of 2017 as compared to 2016 and 2015. Non-Interest Expense Noninterest expense increased 4.7% in 2017 as compared to 2016 and was preceded by a 5.2% increase in 2016 as compared to 2015. Represented in dollars, 2017
was $1.3 million higher than 2016 and 2016 was $1.4 million higher than 2015. The largest factor behind the increase in both years was the expense of employee salaries and wages. During 2017, an additional $993 thousand was spent over 2016 which
correlates to an 8.6% increase. When making the same analysis for 2016 as compared to 2015, 2016s costs increased $713 thousand or 6.5%. Three main components flow
into salaries and wages: base salary, deferred costs, and incentives composed of the expense of restricted stock awards and performance incentives. Base pay has increased with the addition of the
three offices of Huntertown, Bowling Green and Sylvania, as well as from the operations of the Captive and through normal yearly increases to the remainder of the employees. Base pay was up $731.2 thousand for 2017 over the previous year and 2016
was up $669.7 thousand over 2015. The full time equivalent number of employees at each yearend increased to 275 for 2017, to 273 for 2016 compared to 2015s 265. Incentive pay as it related to performance was up $234.2 thousand in 2017 over 2016 and up $177.4 thousand in 2016 over 2015. Measurements used for award
incentive pay had improved in 2017 and 2016 and employees benefited accordingly. The expense for the restricted stock awards has also increased each of the last three years as more shares have been granted to a larger number of employees and the
market value of the shares has increased. The market value of the Companys stock increased significantly with the listing on NASDAQ and being included in the Russell 3000 Index during the second quarter of 2017. An equivalent number of
restricted shares were awarded as compared to 2016 though the value of these rewards was higher; therefore the expense for 2017 was higher by $105.3 thousand as compared to 2016 and will likely be higher in 2018 due to the value of the 2017 awards.
2016s cost for this program was $87.9 thousand higher than 2015. The awards incorporate a three year vesting period so the increase of any one year carries forward through the next two years. This expense should continue to increase as the
Company continues its expansion strategy. For further discussion in incentive pay and restricted stock awards, see Note 11 of the consolidated financial statements. Along with the salary and wage increase was an increase in employee benefits in 2017 as compared to 2016. Employee group insurance accounted for the largest
portion of the cost, which was an increase of $181.9 thousand over 2016. This was due to an increase in the cost to provide to a larger number of employees along with a higher level of medical claims. The cost of the 401-K retirement plan also
increased $72.7 thousand for 2017 as compared to 2016. Overall, employee benefits increased $312 thousand or 9.4% from 2016. Employee benefits decreased
in 2016 which correlated directly to a lower level of medical expense. As the Bank is partially self-insured, lower claims during 2016 decreased the expense. The cost of the 401-K retirement plan increased each year as the profit share component
increased along with the number of employees participating. Employee group insurance was down $266.9 thousand for 2016. Overall, employee benefits were down $232 thousand or 6.5% from 2015. Net occupancy expense typically increases as the Company expands, which is what has occurred for 2017 and 2016. One factor that can offset occupancy expense
is the receipt by the Company of building rent as it is netted out of occupancy expense. The greatest contributor to building rent comes from the division of FM Investments within the Bank. This division experienced a stronger 2017; however the
department was short staffed most of 2015 and 2016. The improved performance of $85.9 thousand in 2017 assisted in keeping the overall increase to net occupancy to $30 thousand. The 1-4 family mortgage refinancing activity has been slow over the last three years though increasing slightly each year. A correlating expense to that
activity is the amortization of mortgage servicing rights. The amortization is the expense that offsets the income recognized when the loan is first made. Income is recorded when the mortgage loan is first sold with servicing retained and is
therefore recognized within one year. The amortization, however, is calculated over the life of the loan and accelerated as loans are paid off early. An increase in this expense can be driven by two activities: an increase in the number of sold
loans and/or by the acceleration of the expense from payoff and refinance activity. The best picture of the bottom line impact is achieved by netting the income with the expense each year. The line items for 2017 indicate a higher number of new
loans versus refinances as compared to 2016. The net income for 2017 was $107 thousand; 2016 had net income of $136 thousand and was preceded by net income of $33 thousand for 2015. Of course, the value (or income) of the mortgage servicing right
when sold also impacts the net position. As of December 31, 2017, 3,636 loans are being serviced with corresponding balances of $288.6 million. 2016 had 3,599 loans serviced with corresponding balances of $280.4 million. This was almost
identical to the December 31, 2015 number and balance of loans 1-4 family being serviced. As of December 2015, 3,598 loans were being serviced with balances of $275.7 million. The impact of mortgage servicing rights to both noninterest income and expense is shown in the following table: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2017 vs 2016 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 3,492 | | | $ | 2,757 | | | $ | 735 | |
| Taxable investment securities | | | 85 | | | | (294 | ) | | | 379 | |
| Tax-exempt investment securities | | | (184 | ) | | | (108 | ) | | | (76 | ) |
| Federal funds sold & interest bearing deposits | | | 128 | | | | 18 | | | | 110 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | 3,521 | | | $ | 2,373 | | | $ | 1,148 | |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 612 | | | $ | 274 | | | $ | 338 | |
| Other time deposits | | | 254 | | | | (62 | ) | | | 316 | |
| Other borrowed money | | | (1 | ) | | | (1 | ) | | | | |
| Federal funds purchased and securities sold under agreement to repurchase | | | 39 | | | | (231 | ) | | | 270 | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | 904 | | | $ | (20 | ) | | $ | 924 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | 2016 vs 2015 | | | | | | | | | | |
| | | (In Thousands) | | | | | | | | | | |
| | | NetChange | | | | Due to change inVolume | | | | Rate | | |
| **Interest Earning Assets:** | | | | | | | | | | | | |
| Loans | | $ | 4,410 | | | $ | 4,537 | | | $ | (127 | ) |
| Taxable investment securities | | | (78 | ) | | | (82 | ) | | | 4 | |
| Tax-exempt investment securities | | | (284 | ) | | | (373 | ) | | | 89 | |
| Federal funds sold & interest bearing deposits | | | 29 | | | | (3 | ) | | | 32 | |
| | | | | | | | | | | | | |
| **Total Interest Earning Assets** | | $ | 4,077 | | | $ | 4,079 | | | $ | (2 | ) |
| | | | | | | | | | | | | |
| **Interest Bearing Liabilities:** | | | | | | | | | | | | |
| Savings deposits | | $ | 133 | | | $ | 131 | | | $ | 2 | |
| Other time deposits | | | 215 | | | | 44 | | | | 171 | |
| Other borrowed money | | | 147 | | | | 92 | | | | 55 | |
| Federal funds purchased and securities sold under agreement to repurchase | | | 141 | | | | 38 | | | | 103 | |
| | | | | | | | | | | | | |
| **Total Interest Bearing Liabilities** | | $ | 636 | | | $ | 305 | | | $ | 331 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Furniture and equipment steadily increases as we continue to add facilities and invest in technology. Annual maintenance costs
continue to grow and become a greater piece of the overall cost. As new services are provided to our customers, the backroom cost to supply them continues to rise. The Company accepts it is an expected cost of doing business and keeping our services
relevant to the industry. Data processing costs were actually lower in 2017 as compared to 2016 by $196 thousand. Two reasons for the improvement was the
negotiation of an extended contract with our core processor and 2016 had the additional cost of upgrading Bank customer debit cards to incorporate EMV chip card technology. Both already better align with our future strategies while controlling
costs. Data processing expense increased $109 thousand during 2016 as compared to an increased $50 thousand during 2015. The Bank began conducting a
review of its core operating system in 2015 which culminated with a decision in the summer 2016 to extend the contract with the Banks existing provider, Fiserv, for an additional seven year period. The Bank saw a current reduction in monthly
expenses, though that reduction will be utilized to provide additional new product offerings and fund growth. The pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the growth from the
newer offices and overall Bank growth. Overall, data processing expense for 2018 may be similar or slightly higher to 2017 with a wider variety of customer offerings. The FDIC assessment has a decreasing cost trend and that is expected to continue into 2018 as the fourth quarter 2017 assessment was again below that of the
previous quarter. This line item speaks to the health of the Bank and the financial industry. The assessment for 2017 was down $77 thousand from 2016 and the assessment for 2016 was down $78 thousand from 2015. The last line item with significant variation in noninterest expense to discuss is other general and administrative. Though 2017 did not increase
by as large an amount as 2016 had when compared to 2015, it was still an increase of $200 thousand. The two main reasons behind the increase were the costs associated with listing on the NASDAQ stock market and the cost of offering the Insured Cash
Sweep product. Both of these costs have been previously explained along with the benefits that have been provided by incurring said costs. The increase in 2016 over 2015 was much higher at $439 thousand. $249 thousand of the increased expense was a
result of managements decision to accelerate the issuance of chip debit cards along with the normal replacement of cards due to fraud and expiration dates. The chip enhanced cards were to help decrease fraud and establish liability
with the merchant if the chip was not used in the transaction. The Banks cost due to fraud was not lower in 2016; however it helped to mitigate fraud losses in 2017. Advertising and public relations increased also in 2016 by $113 thousand.
With the addition of new offices, the credit card launch in conjunction with Bowling Green State Universitys athletic department, it was expected to be higher than 2015. The Bank also celebrates the anniversary of office openings with a
special event in each community. Allowance for Credit Losses Provision expense decreased by $899 thousand for 2017 as compared to 2016. Provision expense increased by $496 thousand for 2016 in response to the significant
loan growth for the period. The decrease for 2017 was due to the consistent strong asset quality of the Banks loan portfolio as evidenced by low levels of both net charge-offs and delinquencies. Sustained strong asset quality kept the
provision expense lower than the growth alone would have warranted. Net charge-offs were $138, $394, and $473 thousand for 2017, 2016 and 2015, respectively. The consumer portfolios had the highest levels of charge-off activity in 2017 and 2016 at
$263 and $310 thousand
respectively. Net charge offs in the consumer portfolio was $161 and $223 thousand for 2017 and 2016 respectively. The Company segregates its Allowance for Credit Losses (ACL) into two reserves: The ACL and the Allowance for Unfunded Loan Commitments and Letters of Credit
(AULC). When combined, these reserves constitute the total ACL. The AUCL is included in other liabilities on the consolidated balance sheets. The
Banks ALLL methodology captures trends in leading, current, and lagging indicators which will directly affect the Banks allocation amount. The Bank monitors trends in such leading indicators as delinquency, unemployment changes in the
Banks service area, experience and ability of staff, regulatory trends, and credit concentrations. A current indicator such as the total watch list loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as
well. A matrix formed by loan type from these indicators is used in making ALLL adjustments. Watch list loan balances are comprised of loans graded 5-8.
At yearend December 31, 2017 these loans totaled $20.8 million and were $75.9 thousand lower than December 31, 2016. The balances were very similar; however, approximately $1.3 million moved from Agricultural to Commercial Real Estate
between yearend 2017 and 2016. Grade 5 decreased $1.8 million in 2017 as compared to 2016 and Grade 6 increased in the same comparison. The majority of the downgrade is represented by one commercial customer. Those associated loans are adequately
secured by collateral. These loan balances increased $14.3 million as of December 31, 2016 as compared to same date 2015. The largest increases occurring in the lowest risk grade of 5. The loan grades of 7, which have a greater likelihood of
default, all decreased for 2016. All other measurements of asset quality improved during 2016. At December 31, 2017, 49.8% of the watch list was
classified as special mention, with an additional 49.3% classified as substandard. A very small 0.6% or $111.3 thousand of the $20.8 million watch list was classified as doubtful. At yearend 2016, 59.7% of the watch list was comprised of loans
classified as special mention, with an additional 39.0% classified as substandard and the remaining 1.3% classified as doubtful. The large increases in special mention and substandard were mainly driven by two loan relationships in the Banks
commercial real estate portfolio. Of the aggregate watch list loan balances, as of December 31, 2015, special mention accounted for 36.6% with
substandard comprising 49.1% and doubtful accounting for the final 14.3%. In response to these fluctuations and loan growth during 2015 through 2017, the
Banks ALLL to outstanding loan coverage percentage changed to 0.83% as of December 31, 2017, 0.89% as of December 31, 2016, and 0.88% as of December 31, 2015. The above indicators impacting ALLL are reviewed quarterly. Some of the indicators are quantifiable and, as such, will automatically adjust the ALLL once
calculated. These indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and the ratio of watch list loans to capital, with the watch list made up of loans graded 5, 6 or 7 on a scale of 1 (best) to 7
(worst). Other indicators consist of more subjective data used to evaluate the potential for inherent losses in the Banks loan portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market
area to help determine whether the ALLL should be adjusted. At the end of each of 2015, 2016 and 2017, improvements were noted in unemployment figures. All aggregate commercial and agricultural credits including real estate loans of $250,000 and over are reviewed annually by both credit committees and
internal loan review to look for early signs of deterioration. To establish the specific reserve allocation for real estate, a discount to the market
value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Banks Loan Policy. However, unique or unusual circumstances may be present
which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management. The
ACL increased $94, $736, and $153 thousand during 2017, 2016 and 2015 respectively. The large increase in 2016 directly correlates to the large increase in loan balances. With the improved asset quality, the metrics upon which the ACL is calculated
did not support a larger increase in 2017 even though loan growth occurred. The percentage of ACL to the total loan portfolio was 0.91% as of December 31, 2015 and 0.92% as of December 31, 2016, and 0.86% as
of December 31, 2017. December 31, 2017 had the lowest loans past due 30+ day percentage at 0.13% in the last ten years. December 31, 2015 and 2016 were still at respectable lows
of 0.32% and 0.23%. Please see Note 4 in the consolidated financial statement for additional tables regarding the composition of the ACL. Federal Income Taxes Effective tax rates were 28.95%,
28.53%, and 26.97%, for 2017, 2016 and 2015 respectively. The effect of tax-exempt interest from holding tax-exempt securities and Industrial Development Bonds (IDBs) was $413, $468, and $554 thousand for 2017, 2016, and 2015, respectively. All
years included an increase into a higher tax bracket for income over $10 million. Behind the decrease in 2015 is one of the benefits from the establishment of the Captive subsidiary. Material Changes in Financial Condition The shifts in
the balance sheet during 2017 and 2016 have positioned the Company for continued improvement in profitability. On the asset side, interest income increased primarily from loan growth with funding for the increase provided by a decrease in the
investment portfolio, growth in core deposits and growth in other borrowings generated in 2015 which carried over to 2016 and most of 2017. $5 million of other borrowings were paid off in December of 2017. The cost of funds was impacted by the
increase of both interest bearing liabilities and noninterest bearing deposits. Both contributed to improved profitability in 2017 and 2016, and the Company expects continued improvement through 2018. Average earning assets increased in balances throughout 2017 and 2016. Newer offices have contributed the most towards new loan production. Loan growth in
both years was the main factor. 2016 had two offices open, one in each half of the year and operating fully throughout 2017. An additional office will open in early 2018. Securities The investment portfolio is primarily used to
provide overall liquidity for the Bank. It is also used to provide required collateral for pledging to the Banks Ohio public depositors for amounts on deposit in excess of the FDIC coverage limits. It may also be used to pledge for additional
borrowings from third parties. Investments are made with the above criteria in mind while still seeking a fair market rate of return, and looking for maturities that fall within the projected overall strategy of the Bank. The possible need to fund
future loan growth is also a consideration. During 2016, the Bank began to utilize Promontorys ICS, product to replace pledged securities; thereby
increasing liquidity. ICS utilizes a nation-wide bank network to provide FDIC insurance coverage to the Banks depositors. The Bank is using the product to replace pledged securities to the Banks Ohio public customers and for commercial
sweep customers previously utilizing daily repurchase agreements to protect balances over $250 thousand. The majority of the commercial accounts converted in 2017 and is evidenced by the movement of funds out of repurchase agreements into interest
bearing deposits. All of the Banks security portfolio is categorized as available for sale and as such is recorded at market value. Security balances as of December 31 are summarized below: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2017 | | | | 2016 | | | | 2015 | | |
| Beginning Year | | $ | 2,192 | | | $ | 2,056 | | | $ | 2,023 | |
| Capitalized Additions | | | 460 | | | | 555 | | | | 407 | |
| Amortization | | | (353 | ) | | | (419 | ) | | | (374 | ) |
| Valuation Allowance | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| End of Year | | $ | 2,299 | | | $ | 2,192 | | | $ | 2,056 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table sets forth the maturities of investment securities as of December 31, 2017 and the
weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate, have been made in yields on
obligations of state and political subdivisions. Stocks of domestic corporations have not been included. Maturities of mortgage-backed securities are based on the stated maturity date of the security. Due to prepayments, actual maturities may be
different. |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | 2017 | | | | 2016 | | | | 2015 | | |
| U.S. Treasury | | $ | 20,978 | | | $ | 24,775 | | | $ | 38,505 | |
| U.S. Government agencies | | | 80,466 | | | | 82,474 | | | | 98,220 | |
| Mortgage-backed securities | | | 39,510 | | | | 48,461 | | | | 26,324 | |
| State and local governments | | | 55,444 | | | | 62,817 | | | | 72,066 | |
| | | | | | | | | | | | | |
| | | $ | 196,398 | | | $ | 218,527 | | | $ | 235,115 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | As of December 31, 2017 the Bank did not hold a large block of any one investment security in excess of 10% of
stockholders equity. The largest segment of holdings is in US Governments. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $3.7 million. This is required in order to obtain Federal Home Loan Bank loans. The
Bank also owns stock of Farmer Mac with a carrying value of $37.4 thousand which is required to participate loans in the program. Loan Portfolio
The Banks various loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio
diversification and through standardization of lending policies and procedures. Risks are mitigated through an adherence to the Banks loan
policies, with any exception being recorded and approved by senior management or committees comprised of senior management. The Banks loan policies define parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow
and debt-to-income ratio, loan requirements and covenants, financial information tracking, collection practice and others. The maximum loan amount to any one borrower is limited by the Banks legal lending limits and is stated in policy. On a
broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to any one business or agricultural sector by an approved sector percentage to capital limitation. The following table shows the Banks loan portfolio by category of loan as of December 31st of each year, excluding loans held for sale: |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Maturities | | | | | | | | | | | | | | |
| | | (Amounts in Thousands) | | | | | | | | | | | | | | |
| | | | | | | | | | | After One Year | | | | | | |
| | | Within One Year | | | | | | | | Within Five Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | | | | | 0.00 | % | | $ | 20,978 | | | | 1.30 | % |
| U.S. Government agencies | | | 10,449 | | | | 1.27 | % | | | 42,818 | | | | 1.61 | % |
| Mortgage-backed securities | | | | | | | 0.00 | % | | | 2,711 | | | | 2.64 | % |
| State and local governments | | | 11,169 | | | | 1.65 | % | | | 16,813 | | | | 2.16 | % |
| Taxable state and local governments | | | | | | | 0.00 | % | | | 3,076 | | | | 2.19 | % |
| | | | | | | | | | | | | | | | | |
| | | After Five Years | | | | | | | | | | | | | | |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | | | | | 0.00 | % | | $ | | | | | 0.00 | % |
| U.S. Government agencies | | | 27,199 | | | | 2.00 | % | | | | | | | 0.00 | % |
| Mortgage-backed securities | | | 2,118 | | | | 2.92 | % | | | 34,681 | | | | 2.00 | % |
| State and local governments | | | 15,983 | | | | 1.63 | % | | | 2,775 | | | | 2.03 | % |
| Taxable state and local governments | | | 5,628 | | | | 3.27 | % | | | | | | | 0.00 | % |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table shows the maturity of loans as of December 31, 2017: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| Loans: | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | |
| Consumer Real Estate | | $ | 83,620 | | | $ | 86,234 | | | $ | 88,189 | | | $ | 97,426 | | | $ | 91,882 | |
| Agricultural Real Estate | | | 64,073 | | | | 62,375 | | | | 57,277 | | | | 50,560 | | | | 44,301 | |
| Agricultural | | | 95,111 | | | | 84,563 | | | | 82,654 | | | | 74,611 | | | | 65,449 | |
| Commercial Real Estate | | | 410,520 | | | | 377,481 | | | | 322,762 | | | | 270,188 | | | | 248,893 | |
| Commercial and Industrial | | | 126,275 | | | | 109,256 | | | | 100,125 | | | | 100,126 | | | | 99,498 | |
| Consumer | | | 37,757 | | | | 33,179 | | | | 27,770 | | | | 24,277 | | | | 21,406 | |
| Industrial Development Bonds | | | 6,415 | | | | 5,732 | | | | 6,491 | | | | 4,698 | | | | 4,358 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 823,771 | | | $ | 758,820 | | | $ | 685,268 | | | $ | 621,886 | | | $ | 575,787 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or
2) floating or adjustable interest rates (variable): |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | | | | | After One | | | | | | |
| | | Within | | | | Year Within | | | | After | | |
| | | One Year | | | | Five Years | | | | Five Years | | |
| Consumer Real Estate | | $ | 1,185 | | | $ | 13,979 | | | $ | 68,456 | |
| Agricultural Real Estate | | | 756 | | | | 5,910 | | | | 57,407 | |
| Agricultural | | | 60,164 | | | | 25,499 | | | | 9,448 | |
| Commercial real estate | | | 29,728 | | | | 125,694 | | | | 255,098 | |
| Commercial and Industrial | | | 71,521 | | | | 36,402 | | | | 18,352 | |
| Consumer | | | 5,634 | | | | 23,946 | | | | 8,177 | |
| Industrial Development Bonds | | | 800 | | | | 65 | | | | 5,550 | |
| | | | | | | | | | | | | |
| | | $ | 169,788 | | | $ | 231,495 | | | $ | 422,488 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | The following table summarizes the Companys nonaccrual, past due 90 days or more and still accruing loans,
and accruing troubled debt restructurings as of December 31 for each of the last five years: |
| | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (in Thousands) | | | | | | | | | | |
| | | Fixed | | | | Variable | | | | | | |
| | | Rate | | | | Rate | | | | Total | | |
| Consumer Real Estate | | $ | 76,836 | | | $ | 5,599 | | | $ | 82,435 | |
| Agricultural Real Estate | | | 50,971 | | | | 12,346 | | | | 63,317 | |
| Agricultural | | | 34,248 | | | | 699 | | | | 34,947 | |
| Commercial Real Estate | | | 289,452 | | | | 91,340 | | | | 380,792 | |
| Commercial and Industrial | | | 45,730 | | | | 9,024 | | | | 54,754 | |
| Consumer | | | 32,101 | | | | 22 | | | | 32,123 | |
| Industrial Development Bonds | | | 5,615 | | | | | | | | 5,615 | |
| | | | | | | | | | | | | |
| | | $ | 534,953 | | | $ | 119,030 | | | $ | 653,983 | |
| | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly
or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $205.4 thousand for 2017, $116.1 for 2016 and $117.1 thousand for 2015. Any collections of
interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to
decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $57 thousand for 2017, $64 thousand for 2016, $96 thousand for 2015 and $87 thousand for 2014. Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is
not expected. The Bank had nonaccrual loan balances of $1.0 million at December 31, 2017 compared to balances of $1.4 and $2.0 million as of year-end 2016 and 2015. All of the balances of nonaccrual loans for the past three years were
collaterally secured. As of December 31, 2017 the Bank had $20.8 million of loans which it considers to be potential problem loans in
that the borrowers are experiencing financial difficulties. At December 31, 2016, the Bank had $20.6 million of these loans. The increase in 2016 relates to mainly two relationships. At December 31, 2015, the Bank had $7.0 million of these
loans. These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential problem loans was considered in managements review of the loan loss reserve at December 31, 2017 and 2016. In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established
by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due
loan-loss experience and the financial condition of the banks borrowers. As of December 31, 2017, the Bank had loans outstanding to
individuals and firms engaged in the various fields of agriculture in the amount of $95.1 million with an additional $64.1 million in agricultural real estate loans these compared to $84.6 and $62.4 million respectively as of December 31, 2016.
The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities. Interest
rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt
restructuring. As of December 31, 2017, the Bank had $0.7 million of its loans that were classified as troubled debt restructurings, of which $149.1 thousand are included in non-accrual loans. This compares to $0.7 million as of same date 2016
and the Bank had $1.1 million classified as such as of December 31, 2015. Updated appraisals are required on all collateral dependent loans once
they are deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider
market events that may indicate a change in value has occurred. To determine observable market value, collateral asset values securing an impaired loan
are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real
estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the existing collateral value
used. Performing non-watch list loans secured in whole or in part by real estate, do not require an updated appraisal unless the loan is
rewritten and additional funds advanced. Watch List loans secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to values as found in the Banks loan policies irrespective of their
grade. The Banks watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of
the Banks loans are made in the market by lenders who live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check. On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an
updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such
adjustments. However, on a quarterly basis as part of its normal operations, the Banks senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Banks watch list. In
addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate
collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market
conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the
available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific
information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Banks general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Banks loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components,
allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected
losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a
predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For
those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is
established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by
loan category. The unallocated portion of the reserve for loan losses is determined based on managements assessment of general economic conditions
as well as specific economic factors in the Banks marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to
uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrowers financial condition and other current risk factors that may not have yet manifested themselves in the Banks
historical loss factors used to determine the allocated component of the allowance. Actual charge-off of loan balances is based upon periodic evaluations
of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral. As presented in the table on the next page, charge-offs decreased to $288 thousand for 2017, the lowest level of
the five years presented. 91.3% of the charge-offs stemmed from the consumer related portfolios. Charge-offs were $550 thousand for 2016, $1.0 million for 2015, preceded by $778 thousand for 2014 and $1.3 million for 2013. Recoveries were also the
lowest in 2017 at $150 thousand compared to $156, $557, $298, and $374 thousand for 2016, 2015, 2014 and 2013, respectively. The net charge-offs for the last five years were all under $1 million. 2017 was the lowest at $138 thousand. Higher provision expense was used to fund the ALLL for loan growth in 2014 and 2016. For 2013 and 2015, the provision was used to replenish the balance
decreased by the net charge-off activity. Overall, the ALLL increased from $5.2 million at yearend 2013 to $6.9 million at yearend 2017. After adding the allowance for unfunded loan commitments, the ACL ended 2017 just under $7.1 million. As the
ratios on the bottom of the following table show, the trends for each have continually improved over the five years shown. Asset quality and the ACL are both strong and emphasize the level of credit quality. In reviewing the bigger picture of the allowance for credit loss, the years with the higher percentage of ACL to total nonperforming loans ratio account for
the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. 2014s significant and continued loan growth since fourth quarter
2013 was the reason behind 2014s higher balances as asset quality remained strong. The ratio of ACL to nonperforming loans increased significantly in 2014 which is why provision loan expense was lower in 2015 in comparison. The ACL to
nonperforming loans for 2015 remained more than adequate and emphasizes the existing strong level of credit quality. 2017 did not warrant a large provision as the asset quality continued to strengthen. Loan growth occurred, though not at the double
digit percentage increases of 2015 and 2016. The following table presents a reconciliation of the allowance for credit losses for the years ended
December 31, 2017, 2016, 2015, 2014 and 2013: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | |
| Non-accrual loans | | $ | 1,003 | | | $ | 1,384 | | | $ | 2,041 | | | $ | 1,705 | | | $ | 3,329 | |
| Accruing loans past due 90 days or more | | | | | | | | | | | | | | | | | | | | |
| Troubled Debt Restructurings, not included above | | | 534 | | | | 559 | | | | 878 | | | | 471 | | | | 485 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,537 | | | $ | 1,943 | | | $ | 2,919 | | | $ | 2,176 | | | $ | 3,814 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | *
Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual. Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans
is as follows: |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | 2017 | | | | 2016 | | | | 2015 | | | | 2014 | | | | 2013 | | |
| Loans | | $ | 823,024 | | | $ | 758,094 | | | $ | 684,630 | | | $ | 621,467 | | | $ | 575,557 | |
| | | | | | | | | | | | | | | | | | | | | |
| Daily average of outstanding loans | | $ | 783,140 | | | $ | 724,076 | | | $ | 627,194 | | | $ | 581,483 | | | $ | 507,126 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan Losses-Jan 1 | | $ | 6,784 | | | $ | 6,057 | | | $ | 5,905 | | | $ | 5,194 | | | $ | 5,224 | |
| Loans Charged off: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 4 | | | | 106 | | | | 38 | | | | 168 | | | | 147 | |
| Agricultural Real Estate | | | | | | | | | | | | | | | | | | | | |
| Agricultural | | | | | | | 21 | | | | | | | | | | | | | |
| Commercial Real Estate | | | 21 | | | | 93 | | | | 143 | | | | 229 | | | | 164 | |
| Commercial and Industrial | | | | | | | 20 | | | | 536 | | | | | | | | 513 | |
| Consumer | | | 263 | | | | 310 | | | | 313 | | | | 381 | | | | 438 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | 288 | | | | 550 | | | | 1,030 | | | | 778 | | | | 1,262 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 13 | | | | 28 | | | | 41 | | | | 34 | | | | 20 | |
| Agricultural Real Estate | | | | | | | | | | | | | | | | | | | | |
| Agricultural | | | 8 | | | | 10 | | | | 64 | | | | 44 | | | | 5 | |
| Commercial Real Estate | | | 15 | | | | 20 | | | | 204 | | | | 4 | | | | 23 | |
| Commercial and Industrial | | | 12 | | | | 11 | | | | 91 | | | | 20 | | | | 141 | |
| Consumer | | | 102 | | | | 87 | | | | 157 | | | | 196 | | | | 185 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | 150 | | | | 156 | | | | 557 | | | | 298 | | | | 374 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net Charge Offs | | | 138 | | | | 394 | | | | 473 | | | | 480 | | | | 888 | |
| Provision for loan loss | | | 222 | | | | 1,121 | | | | 625 | | | | 1,191 | | | | 858 | |
| Acquisition provision for loan loss | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease LossesDec 31 | | | 6,868 | | | | 6,784 | | | | 6,057 | | | | 5,905 | | | | 5,194 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 | | | 227 | | | | 217 | | | | 208 | | | | 207 | | | | 163 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit LossesDec 31 | | $ | 7,095 | | | $ | 7,001 | | | $ | 6,265 | | | $ | 6,112 | | | $ | 5,357 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.02 | % | | | 0.05 | % | | | 0.08 | % | | | 0.08 | % | | | 0.18 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of the Allowance for Loan Loss to Nonperforming Loans | | | 684.83 | % | | | 490.39 | % | | | 293.75 | % | | | 346.30 | % | | | 156.03 | % |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Deposits The amount of
outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2017 are as follows:
(In Thousands)
Over Three
Over Six
Months
Months Less
Over
Under
Less than
Than One
One
Three Months
Six Months
Year
Year
Time Deposits
$
9,264
$
18,821
$
15,858
$
48,424
The following table presents the average amount of and average rate paid on each deposit category: |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2017 | | | | | | | | 2016 | | | | | | | | 2015 | | | | | | | | 2014 | | | | | | | | 2013 | | | | | | |
| | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | | | Amount | | | | | | |
| | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | | | (000s) | | | | % | | |
| Balance at End of Period Applicable To: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | $ | 343 | | | | 10.11 | | | $ | 316 | | | | 11.33 | | | $ | 338 | | | | 12.85 | | | $ | 537 | | | | 15.68 | | | $ | 257 | | | | 15.97 | |
| Agricultural Real Estate | | | 244 | | | | 7.78 | | | | 241 | | | | 8.22 | | | | 211 | | | | 8.35 | | | | 184 | | | | 8.13 | | | | 131 | | | | 7.70 | |
| Agricultural | | | 667 | | | | 11.57 | | | | 616 | | | | 11.17 | | | | 582 | | | | 12.09 | | | | 547 | | | | 12.00 | | | | 326 | | | | 11.37 | |
| Commercial Real Estate | | | 3,149 | | | | 49.81 | | | | 3,250 | | | | 49.72 | | | | 2,516 | | | | 47.07 | | | | 2,367 | | | | 43.48 | | | | 2,107 | | | | 43.24 | |
| Commercial and Industrial | | | 1,546 | | | | 16.14 | | | | 1,318 | | | | 15.18 | | | | 1,229 | | | | 15.58 | | | | 1,421 | | | | 16.87 | | | | 1,359 | | | | 18.04 | |
| Consumer | | | 441 | | | | 4.59 | | | | 394 | | | | 4.38 | | | | 337 | | | | 4.06 | | | | 323 | | | | 3.84 | | | | 292 | | | | 3.68 | |
| Unallocated | | | 478 | | | | 0.00 | | | | 649 | | | | 0.00 | | | | 844 | | | | 0.00 | | | | 526 | | | | 0.00 | | | | 722 | | | | 0.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan & Lease Losses | | $ | 6,868 | | | | 100.00 | | | $ | 6,784 | | | | 100.00 | | | $ | 6,057 | | | | 100.00 | | | $ | 5,905 | | | | 100.00 | | | $ | 5,194 | | | | 100.00 | |
| Off Balance Sheet Commitments | | | 227 | | | | | | | | 217 | | | | | | | | 208 | | | | | | | | 207 | | | | | | | | 163 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Allowance for Credit Losses | | $ | 7,095 | | | | | | | $ | 7,001 | | | | | | | $ | 6,265 | | | | | | | $ | 6,112 | | | | | | | $ | 5,357 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Liquidity Liquidity remains adequate though down from prior years as the Bank has decreased the investment portfolio to fund loans. The Bank has access to $69 million of
unsecured borrowings through correspondent banks and $94.6 million of unpledged securities which may be sold or used as collateral. The amount of unpledged securities increase almost $22.8 million as compared to 2016. This was accomplished with
utilizing Promontorys ICS product to protect Ohio public fund depositors and commercial sweep customers with FDIC coverage rather than pledged securities. For the Bank, an additional $5.7 million is also available from the Federal Home Loan
Bank based on current collateral pledging with up to $116.8 million available provided adequate collateral is pledged. Maintaining sufficient funds to
meet depositor and borrower needs on a daily basis continues to be among managements top priorities. This is accomplished not only by immediate liquid resources of cash, due from banks and federal funds sold, but also by the Banks
available for sale securities portfolio. The average aggregate balance of these assets was $206.3 for 2017, $228.0 for 2016 and $262.1 million for 2015. This represented 19.2%, 22.3%, and 28.0% of total average assets, respectively. Of the almost
$196.4 million of debt securities in the banks portfolio as of December 31, 2017, $21.6 million, or 11.0% of the portfolio, is expected to receive payments or mature in 2018. This liquidity provides the opportunity to fund loan growth by
analysis of the lowest cost and source of funds whether by increasing deposits, sales or runoff of investments or utilizing debt. In addition to the
Banks investment portfolio, the Company has $18.9 million held in the holding companys investment portfolio. $5.1 million of those investments will mature or receive payments in the next twelve months. These funds provide liquidity to
the Company. The Bank has been declaring additional dividends each quarter to provide this liquidity to the Company. The Captive has also upstreamed dividends to the Company and is expected to continue annually as long as reserve levels are
adequately provided for. This provides additional liquidity for Company activities. Historically, the primary source of liquidity has been core deposits
that include noninterest bearing and interest bearing demand deposits, savings, money market accounts and time deposits of individuals. Core deposit balances increased in all categories with the exception of time deposits as of December 31,
2017 compared to same date 2016. Average total savings balances increased $72.6 million in 2017 as compared to 2016. Core deposit balances as of year-end 2016 increased in all categories. Overall deposits increased an average of $47.1 million in
2016 and $2.6 million in 2015. The Bank also utilized Federal Funds purchased at times during 2015 through 2017. The average balance for 2017 was $2.2 million, for 2016 and 2015 was $1.9 million and $1.2 million respectively. The Bank used this
temporary funding source heavier in December 2015 while it secured more permanent funding. During 2016, it was used heavily in the third quarter. The Bank is comfortable accessing these funds on a regular basis. Historically, the primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and
for business development. The use of new funds for loans is measured by the loan to deposit ratio. The Banks average loan to deposit ratio was 88.2% for 2017, 87.9% for 2016, and 80.7% for 2015. The Banks goal is for this ratio to be
higher in the 80-90 percent range with loan growth being the driver. The Bank ended the year 2017 at an 89.6% loan to deposit ratio. Short-term debt such
as federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt for both federal funds purchased and securities sold under agreement to repurchase amounted to $39.5 million at
December 31, 2017, $70.3 million at December 31, 2016, and $78.8 million at the end of 2015. These accounts are used to provide a sweep product to the Banks commercial customers and for some term deposits. As ICS was implemented, the
sweep balances moved into interest bearing deposits and for yearend 2017 the repurchase agreements are for term deposits only. Other
borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then used to provide loans in our community. The Bank utilized this funding source in December 2015 by
borrowing $10 million. These remained consistent borrowings during 2016 and in December of 2017 $5 million matured and was paid off. Asset/Liability Management The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and
interest bearing liabilities. It involves the management of the balance sheet mix, maturities, re-pricing characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk. Interest rate
sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. Changes in net income, other than those related to volume arise when interest rates on assets re-price in a time frame or interest rate environment that is
different from that of the re-pricing period for liabilities. Changes in net interest income also arise from changes in the mix of interest-earning assets and interest-bearing liabilities. Historically, the Bank has maintained liquidity through cash flows generated in the normal course of business, loan repayments, maturing earning assets, the
acquisition of new deposits, and borrowings. The Banks asset and liability management program is designed to maximize net interest income over the long term while taking into consideration both credit and interest rate risk. Interest rate
sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans that are tied to the market rate differ considerably from long-term investment
securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings accounts. The Bank utilizes shock analysis to examine the amount of exposure an instant
rate change of 100, 200, 300 and 400 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings and equity at risk are established and decisions are made to maintain those levels based on
the shock results. Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the
increased cost of the Companys operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Companys performance than
do the effects of 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 service. Contractual Obligations Contractual Obligations of the
Company totaled $569 million as of December 31, 2017. Excluded from the chart is Federal Funds Purchased of $10.4 million which are immediately payable the next business day. Time deposits represent contractual agreements for certificates of
deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is further defined in Note 4 and 9 of the Consolidated Financial Statements. |
| | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | | | | | |
| | | Non-Interest | | | | Interest | | | | Savings | | | | Time | | |
| | | DDAs | | | | DDAs | | | | Accounts | | | | Accounts | | |
| December 31, 2017: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 180,129 | | | $ | 286,912 | | | $ | 232,668 | | | $ | 188,443 | |
| Average rate | | | 0.00 | % | | | 0.76 | % | | | 0.14 | % | | | 1.16 | % |
| December 31, 2016: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 169,510 | | | $ | 207,057 | | | $ | 239,939 | | | $ | 194,753 | |
| Average rate | | | 0.00 | % | | | 0.61 | % | | | 0.18 | % | | | 0.99 | % |
| December 31, 2015: | | | | | | | | | | | | | | | | |
| Average balance | | $ | 162,028 | | | $ | 184,941 | | | $ | 227,328 | | | $ | 189,822 | |
| Average rate | | | 0.00 | % | | | 0.62 | % | | | 0.18 | % | | | 0.90 | % |
| FMAO/10-K/0001193125-18-062514 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Capital Resources Stockholders equity was $134.1 million as of December 31, 2017 compared to $125.6 million at December 31, 2016. Dividends declared during 2017
were $0.50 per share totaling $4.6 million and dividends declared during 2016 were $0.46 per share totaling $4.2 million. Throughout 2017, the Company awarded 32,000 shares of restricted stock awards to 74 employees. During 2016, the Company
purchased 14,000 shares and awarded 32,300 shares of restricted stock to 74 employees. For a summary of activity as it relates to the Companys restricted stock awards, please refer to Note 11: Employee Benefit Plans in the consolidated
financial statements. On December 31, 2017 the Company held 1,134,120 shares in Treasury Stock and 92,350 unvested shares of restricted stock. At yearend 2016, the Company held 1,158,250 shares in Treasury stock and 86,300 unvested shares of
restricted stock. On January 19, 2018 the Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated transactions, of up to 400,000 shares of its
outstanding common stock commencing January 19, 2018 and ending December 31, 2018. The Company has a history of approving a similar resolution to be in effect each year for at least the last five years. The Company continues to have a strong capital base and maintains regulatory capital ratios that are above the defined regulatory capital ratios. At
December 31, 2017, the Bank and the Company had total risk-based capital ratios of 12.84% and 15.52%, respectively. Core capital to risk-based asset ratios of 12.04% and 14.73% for the Bank and the Company, respectively, are well in excess of
regulatory guidelines. The Banks leverage ratio of 9.92% is also substantially in excess of regulatory guidelines, as is the Companys at 12.02%. Under Basel III, the common equity Tier 1 Capital to risk-weighted assets ratios are also
well above the required 4.50% and the 6.50% well capitalized levels with the Company at 14.73% and the Bank at 12.04%. For further discussion and analysis of regulatory capital requirements, refer to Note 15 of the Audited Financial Statements. The Companys subsidiaries are restricted by regulations from making dividend distributions in excess of certain prescribed amounts. Upon prior
regulatory approval, the Bank may be allowed to pay above the prescribed amount. |
| | | | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Payment Due by Period (In Thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | Less than | | | | 1-3 | | | | 3-5 | | | | More than | | |
| Contractual Obligations | | Total | | | | 1 year | | | | Years | | | | Years | | | | 5 years | | |
| Securities sold under agreement to repurchase | | $ | 29,070 | | | $ | 27,060 | | | $ | 2,010 | | | $ | | | | $ | | |
| Time Deposits | | | 187,566 | | | | 83,734 | | | | 64,061 | | | | 39,142 | | | | 629 | |
| Dividends Payable | | | 1,600 | | | | 1,600 | | | | | | | | | | | | | |
| Building Leases | | | 345,818 | | | | 66,818 | | | | 72,000 | | | | 77,000 | | | | 130,000 | |
| Long Term Debt | | | 5,000 | | | | 5,000 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 569,054 | | | $ | 184,212 | | | $ | 138,071 | | | $ | 116,142 | | | $ | 130,629 | |
| | | | | | | | | | | | | | | | | | | | | |
| FMAO/10-K/0001193125-18-062514 |
Financial – Exposures | *Includes Owner Occupied Report on Adjusted Loans as of December 31, 2020Our credit administration is closely monitoring and analyzing these higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. The Bank is in frequent contact with our borrowers during this time of uncertainty and has had only one COVID-19 related downgrade which was less than $10 million during 2020. The Bank has stress tested our top five commercial concentrations which include retail commercial real estate, hotels, multi-family, industrial commercial real estate and assisted living. An outside third party has reviewed 55% of our commercial portfolio along with our internal credit department having reviewed 75% of our loan portfolio as a result of new money, renewals or annual reviews. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, we expect to be able to manage the economic risks and uncertainties associated with the pandemic and remain adequately capitalized. |
| Industry Segments (Dollars in Thousands) | | Outstanding Loan Balance | | | | Percent of Total Loan Portfolio | | | | Payment Deferment | | | | Percent of Total Loans Adjusted with Deferment | | | | Interest Only Modifications | | | | Percent of Total Loans Adjusted with Interest Only | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Hospitality (Hotels) | | $ | 88,160 | | | | 6.75 | % | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % |
| Restaurants | | | 20,610 | | | | 1.58 | % | | | - | | | | 0.00 | % | | | 13 | | | | 0.36 | % |
| Retail Commercial Real Estate \* | | | 105,785 | | | | 8.10 | % | | | - | | | | 0.00 | % | | | 2,321 | | | | 64.85 | % |
| Entertainment | | | 25,230 | | | | 1.93 | % | | | - | | | | 0.00 | % | | | 1,245 | | | | 34.79 | % |
| Car Dealers | | | 30,301 | | | | 2.32 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % |
| Gas Stations | | | 19,830 | | | | 1.52 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % |
| Other | | | 735,433 | | | | 56.34 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % |
| Total | | $ | 1,025,349 | | | | 78.54 | % | | $ | - | | | | 0.00 | % | | $ | 3,579 | | | | 100.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| # of Customers | | | | | | | | | | | - | | | | | | | 5 | | | | | | |
| FMAO/10-K/0001564590-21-007929 |
Net Interest Income | The following tables show changes in interest income, interest expense and net interest resulting from changes in volume and rate variances for major categories of earnings assets and interest bearing liabilities. |
| | | 2018 | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | (In Thousands) | | | | | | | | | | |
| | | Average | | | | Interest/ | | | | | | |
| | | Balance | | | | Dividends | | | | Yield/Rate | | |
| ASSETS | | | | | | | | | | | | |
| Interest Earning Assets: | | | | | | | | | | | | |
| Loans | | $ | 831,614 | | | $ | 42,303 | | | | 5.09 | % |
| Taxable investment securities | | | 147,186 | | | | 2,863 | | | | 1.95 | % |
| Tax-exempt investment securities | | | 48,059 | | | | 930 | | | | 2.45 | % |
| Federal funds sold & interest bearing deposits | | | 21,218 | | | | 333 | | | | 1.57 | % |
| Total Interest Earning Assets | | | 1,048,077 | | | $ | 46,429 | | | | 4.46 | % |
| Non-Interest Earning Assets: | | | | | | | | | | | | |
| Cash and cash equivalents | | | 35,486 | | | | | | | | | |
| Other assets | | | 28,650 | | | | | | | | | |
| Total Assets | | $ | 1,112,213 | | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | |
| Savings deposits | | $ | 551,746 | | | $ | 3,453 | | | | 0.63 | % |
| Other time deposits | | | 183,512 | | | | 2,536 | | | | 1.38 | % |
| Other borrowed money | | | 4,946 | | | | 80 | | | | 1.62 | % |
| Federal funds purchased and securities sold under agreement to repurchase | | | 26,252 | | | | 503 | | | | 1.92 | % |
| Total Interest Bearing Liabilities | | | 766,456 | | | $ | 6,572 | | | | 0.86 | % |
| Non-Interest Bearing Liabilities: | | | | | | | | | | | | |
| Non-interest bearing demand deposits | | | 194,548 | | | | | | | | | |
| Other | | | 13,570 | | | | | | | | | |
| Total Liabilities | | | 974,574 | | | | | | | | | |
| Shareholders' Equity | | | 137,639 | | | | | | | | | |
| Total Liabilities and Shareholders' Equity | | $ | 1,112,213 | | | | | | | | | |
| Interest/Dividend income/yield | | | | | | $ | 46,429 | | | | 4.46 | % |
| Interest Expense/cost | | | | | | | 6,572 | | | | 0.86 | % |
| Net Interest Spread | | | | | | $ | 39,857 | | | | 3.60 | % |
| Net Interest Margin | | | | | | | | | | | 3.83 | % |
| FMAO/10-K/0001564590-21-007929 |
Non-Interest Expense | Furniture and equipment steadily increase as we continue to add facilities and invest in technology. Annual maintenance costs continue to grow and become a greater piece of the overall cost. As new services are provided to our customers, the backroom cost to supply them continues to rise. The Company accepts it is an expected cost of doing business and keeping our services relevant to the industry. Data processing costs were lower in 2020 as compared to 2019 by $785.0 thousand of which $867.6 thousand was acquisition related for termination fees incurred in 2019. Overall, data processing expense for 2019 was expected to be higher with the addition of the six acquired Indiana offices. Data processing expense increased $1.2 million during 2019 as compared to 2018. As the pricing on many services is based on number of accounts and the Bank fully expects those to increase with the growth from the newer offices and overall Bank growth, this line item is expected to also increase.The FDIC assessment increased over 2019 while 2019 decreased as compared to 2018. This line item speaks to the health of the Bank and the financial industry. The assessment for 2020 was up $450.0 thousand compared to 2019 as a result of the total assessment base increasing. In 2020, Small Bank Assessment Credits of $125.9 thousand were applied to first quarter’s invoice. Credits in the amount of $204.2 thousand were applied to third and fourth quarter 2019’s invoice. The assessment for 2019 was down $143.0 thousand from 2018.The last line items with significant variation in noninterest expense to discuss is “consulting fees” and “other general and administrative.” Consulting fees increased by $300.0 thousand in 2020 over 2019 while decreased $259.9 thousand in 2019 compared to 2018. In 2020, $167.0 thousand was paid to the firm who assisted with identifying profit enhancements, $48.0 thousand for Chief Information Officer search, $25.0 thousand to Kasasa for contract termination and $34.0 thousand to develop a predictive customer behavior model. During 2019, consultants were used to complete a pay study review, assist with developing a three year strategic plan and to identify profit enhancement initiatives. Acquisition costs incurred in 2019 and 2018 total $1.28 million and $742.1 thousand respectively with expenses being recorded in multiple line items. Core deposit intangible expense which is included in the other general and administrative line decreased in 2020 compared to 2019 by $7.0 thousand; however, increased in 2019 compared to 2018 by $560.0 thousand with the acquisition. Advertising and public relations decreased in 2020 by $237.0 thousand with many events canceled due to the pandemic; however, had increased in 2019 by $682 thousand over 2018. With the addition of new offices in both years behind the increases, 2020 was expected to increase due to additional offices being added. The Bank also celebrates the anniversary of office openings with a special event in each community. |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2020 | | | | 2019 | | | | 2018 | | |
| Beginning of Year | | $ | 2,629 | | | $ | 2,385 | | | $ | 2,299 | |
| Capitalized Additions | | | 1,722 | | | | 731 | | | | 450 | |
| Amortization | | | (1,031 | ) | | | (487 | ) | | | (364 | ) |
| Valuation Allowance | | | - | | | | - | | | | - | |
| End of Year | | $ | 3,320 | | | $ | 2,629 | | | $ | 2,385 | |
| FMAO/10-K/0001564590-21-007929 |
Securities | The following table sets forth the maturities of investment securities as of December 31, 2020 and the weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a twenty-one percent rate, have been made in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included. Maturities of mortgage-backed securities are based on the stated maturity date of the security. Due to prepayments, actual maturities may be different. |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2020 | | | | 2019 | | | | 2018 | | |
| U.S. Treasury | | $ | - | | | $ | 10,021 | | | $ | 22,830 | |
| U.S. Government agencies | | | 124,241 | | | | 62,445 | | | | 69,327 | |
| Mortgage-backed securities | | | 113,056 | | | | 95,197 | | | | 36,262 | |
| State and local governments | | | 70,515 | | | | 54,630 | | | | 40,028 | |
| | | $ | 307,812 | | | $ | 222,293 | | | $ | 168,447 | |
| FMAO/10-K/0001564590-21-007929 |
Securities | As of December 31, 2020, the Bank did not hold a large block of any one investment security in excess of 10% of stockholders’ equity. The largest segment of holdings is in U.S. Government agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati and Indianapolis at a cost of $5.8 million. This is required in order to obtain Federal Home Loan Bank loans. |
| | | After Five Years | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Within Ten Years | | | | | | | | After Ten Years | | | | | | |
| | | Amount | | | | Yield | | | | Amount | | | | Yield | | |
| U.S. Treasury | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % |
| U.S. Government agencies | | | 83,610 | | | | 1.12 | % | | | - | | | | 0.00 | % |
| Mortgage-backed securities | | | 7,409 | | | | 1.70 | % | | | 105,426 | | | | 1.60 | % |
| State and local governments | | | 8,318 | | | | 1.79 | % | | | 1,749 | | | | 1.86 | % |
| Taxable state and local governments | | | 34,702 | | | | 2.06 | % | | | - | | | | 1.79 | % |
| FMAO/10-K/0001564590-21-007929 |
Loan Portfolio | The following table shows the maturity of loans excluding fair value adjustments as of December 31, 2020: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Loans: | | 2020 | | | | 2019 | | | | 2018 | | | | 2017 | | | | 2016 | | |
| Consumer Real Estate | | $ | 175,588 | | | $ | 165,349 | | | $ | 80,766 | | | $ | 83,620 | | | $ | 86,234 | |
| Agricultural Real Estate | | | 189,159 | | | | 199,105 | | | | 68,609 | | | | 64,073 | | | | 62,375 | |
| Agricultural | | | 94,358 | | | | 111,820 | | | | 108,495 | | | | 95,111 | | | | 84,563 | |
| Commercial Real Estate | | | 588,825 | | | | 551,309 | | | | 419,784 | | | | 410,520 | | | | 377,481 | |
| Commercial and Industrial | | | 189,246 | | | | 135,631 | | | | 121,793 | | | | 126,275 | | | | 109,256 | |
| Consumer | | | 52,540 | | | | 49,237 | | | | 41,953 | | | | 37,757 | | | | 33,179 | |
| Other | | | 15,757 | | | | 8,314 | | | | 5,889 | | | | 6,415 | | | | 5,732 | |
| | | $ | 1,305,473 | | | $ | 1,220,765 | | | $ | 847,289 | | | $ | 823,771 | | | $ | 758,820 | |
| FMAO/10-K/0001564590-21-007929 |
Loan Portfolio | The following table presents the total of loans excluding fair value adjustments due after one year which has either 1) predetermined interest rates (fixed) or 2) floating or adjustable interest rates (variable): |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | After One | | | | | | |
| | | Within | | | | Year Within | | | | After | | |
| | | One Year | | | | Five Years | | | | Five Years | | |
| Consumer Real Estate | | $ | 5,810 | | | $ | 31,538 | | | $ | 138,295 | |
| Agricultural Real Estate | | | 5,612 | | | | 4,045 | | | | 180,123 | |
| Agricultural | | | 53,083 | | | | 27,835 | | | | 13,443 | |
| Commercial Real Estate | | | 21,532 | | | | 307,834 | | | | 259,571 | |
| Commercial and Industrial | | | 61,416 | | | | 109,373 | | | | 18,642 | |
| Consumer | | | 1,520 | | | | 38,099 | | | | 12,900 | |
| Other | | | 2,223 | | | | 134 | | | | 13,397 | |
| | | $ | 151,196 | | | $ | 518,858 | | | $ | 636,371 | |
| FMAO/10-K/0001564590-21-007929 |
Loan Portfolio | The following table summarizes the Company’s nonaccrual, past due 90 days or more and still accruing loans, and accruing troubled debt restructurings as of December 31 for each of the last five years: |
| | | (In Thousands) | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Fixed | | | | Variable | | | | | | |
| | | Rate | | | | Rate | | | | Total | | |
| Consumer Real Estate | | $ | 157,784 | | | $ | 12,049 | | | $ | 169,833 | |
| Agricultural Real Estate | | | 159,431 | | | | 24,737 | | | | 184,168 | |
| Agricultural | | | 38,273 | | | | 3,005 | | | | 41,278 | |
| Commercial Real Estate | | | 470,321 | | | | 97,084 | | | | 567,405 | |
| Commercial and Industrial | | | 112,523 | | | | 15,492 | | | | 128,015 | |
| Consumer | | | 50,999 | | | | - | | | | 50,999 | |
| Other | | | 13,531 | | | | - | | | | 13,531 | |
| | | $ | 1,002,862 | | | $ | 152,367 | | | $ | 1,155,229 | |
| FMAO/10-K/0001564590-21-007929 |
Loan Portfolio | Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $272 thousand for 2020, $193 for 2019 and $99 thousand for 2018. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $269 thousand for 2020, $117 thousand for 2019 and $69 thousand for 2018. Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The Bank had nonaccrual loan balances of $9.4 million at December 31, 2020 compared to balances of $3.4 million and $542.0 thousand as of year-end 2019 and 2018. All of the balances of nonaccrual loans for the past three years were collaterally secured. As of December 31, 2020, the Bank had $56.3 million of loans which it considers to be “potential problem loans” in that the borrowers are experiencing financial difficulties which are not reflected in the table above. At December 31, 2019, the Bank had $60.2 million of these loans. At December 31, 2018, the Bank had $7.9 million of these loans. These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential problem loans was considered in management’s review of the loan loss reserve at December 31, 2020 and 2019.In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the bank’s borrowers.As of December 31, 2020, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $94.4 million with an additional $189.2 million in agricultural real estate loans which compared to $111.8 and $199.1 million respectively as of December 31, 2019. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2020, the Bank had $6.5 million of its loans that were classified as troubled debt restructurings, of which $5.6 million are included in non-accrual loans. This compares to $956.3 thousand of troubled debt restructurings, of which $50.3 thousand are included in non-accrual loans for 2019 and $178.1 thousand of troubled debt restructuring, of which $74.4 thousand are included in non-accrual loans for 2018. Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred.To determine observable market value, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the existing collateral value used.Performing “non-watch list” loans secured in whole or in part by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List loans secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to values as found in the Bank’s loan policies irrespective of their grade. The Bank’s watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Bank’s loans are made in the market by lenders who live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check. On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Bank’s senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Bank’s watch list. In addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Bank’s general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Bank’s loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by loan category.The unallocated portion of the reserve for loan losses is determined based on management’s assessment of general economic conditions as well as specific economic factors in the Bank’s marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition and other current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the allocated component of the allowance.Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.As presented in the table on the next page, charge-offs decreased to $720 thousand for 2020. 52.8% of the charge-offs stemmed from the consumer related portfolios. Charge-offs were $841 thousand for 2019, $580 thousand for 2018, preceded by $288 thousand for 2017 and $550 thousand for 2016. Recoveries were $183 thousand in 2020 compared to $156, $163, $150 and $156 thousand for 2019, 2018, 2017 and 2016, respectively. The net charge-offs for the last five years were all under $700 thousand. 2017 was the lowest at $138 thousand. Higher provision expense was used to fund the ALLL for loan growth in 2016 and 2019. 2020 had higher provision expense due to the uncertainty surrounding COVID-19 and its impact on individuals and businesses. For 2017 and 2018, the provision was used to replenish the balance decreased by the net charge-off activity. Overall, the ALLL increased from $6.8 million at year-end 2016 to $13.7 million at year-end 2020. After adding the allowance for unfunded loan commitments, the ACL ended 2020 at $14.3 million. As the ratios on the bottom of the following table show, the trends for each have improved or remained constant over the five years shown. Asset quality and the ACL are both strong and emphasize the level of credit quality. In reviewing the bigger picture of the allowance for credit loss, the years with the higher percentage of ACL to total nonperforming loans ratio account for the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. The ratio of ACL to nonperforming loans increased beginning in 2016 with a significant drop in 2019 followed by a slight drop in 2020. 2020’s provision expense was the highest of the five years shown largely due to the uncertainty surrounding COVID-19. Loan growth occurred in 2020 and 2019 reaching a double-digit percentage increase like 2016. The ACL to nonperforming loans for all years remained more than adequate and emphasizes the existing strong level of credit quality. The following table presents a reconciliation of the allowance for credit losses for the years ended December 31, 2020, 2019, 2018, 2017 and 2016: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2020 | | | | 2019 | | | | 2018 | | | | 2017 | | | | 2016 | | |
| Non-accrual loans | | $ | 9,404 | | | $ | 3,400 | | | $ | 542 | | | $ | 1,003 | | | $ | 1,384 | |
| Accruing loans past due 90 days or more | | | - | | | | - | | | | - | | | | - | | | | - | |
| Troubled Debt Restructurings, not included above | | | 941 | | | | 980 | | | | 104 | | | | 587 | | | | 559 | |
| Total | | $ | 10,345 | | | $ | 4,380 | | | $ | 646 | | | $ | 1,590 | | | $ | 1,943 | |
| FMAO/10-K/0001564590-21-007929 |
Loan Portfolio | *Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual.Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans is as follows: |
| | | (In Thousands) | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2020 | | | | 2019 | | | | 2018 | | | | 2017 | | | | 2016 | | |
| Loans | | $ | 1,302,990 | | | $ | 1,218,999 | | | $ | 846,374 | | | $ | 823,024 | | | $ | 758,094 | |
| Daily average of outstanding loans | | $ | 1,313,675 | | | $ | 1,129,231 | | | $ | 831,614 | | | $ | 783,140 | | | $ | 724,076 | |
| Allowance for Loan Losses - Jan 1 | | $ | 7,228 | | | $ | 6,775 | | | $ | 6,868 | | | $ | 6,784 | | | $ | 6,057 | |
| Loans Charged off: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 35 | | | | 98 | | | | 63 | | | | 4 | | | | 106 | |
| Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
| Agricultural | | | - | | | | 37 | | | | - | | | | - | | | | 21 | |
| Commercial Real Estate | | | 8 | | | | - | | | | 16 | | | | 21 | | | | 93 | |
| Commercial and Industrial | | | 297 | | | | 215 | | | | 142 | | | | - | | | | 20 | |
| Consumer | | | 380 | | | | 491 | | | | 359 | | | | 263 | | | | 310 | |
| | | | 720 | | | | 841 | | | | 580 | | | | 288 | | | | 550 | |
| Loan Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Consumer Real Estate | | | 9 | | | | - | | | | 18 | | | | 13 | | | | 28 | |
| Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
| Agricultural | | | - | | | | 3 | | | | 8 | | | | 8 | | | | 10 | |
| Commercial Real Estate | | | 10 | | | | 11 | | | | 10 | | | | 15 | | | | 20 | |
| Commercial and Industrial | | | 24 | | | | 22 | | | | 13 | | | | 12 | | | | 11 | |
| Consumer | | | 140 | | | | 120 | | | | 114 | | | | 102 | | | | 87 | |
| | | | 183 | | | | 156 | | | | 163 | | | | 150 | | | | 156 | |
| Net Charge Offs | | | 537 | | | | 685 | | | | 417 | | | | 138 | | | | 394 | |
| Provision for loan loss | | | 6,981 | | | | 1,138 | | | | 324 | | | | 222 | | | | 1,121 | |
| Acquisition provision for loan loss | | | - | | | | - | | | | - | | | | - | | | | - | |
| Allowance for Loan & Lease Losses - Dec 31 | | | 13,672 | | | | 7,228 | | | | 6,775 | | | | 6,868 | | | | 6,784 | |
| Allowance for Unfunded Loan Commitments & Letters of Credit - Dec 31 | | | 641 | | | | 479 | | | | 274 | | | | 227 | | | | 217 | |
| Total Allowance for Credit Losses - Dec 31 | | $ | 14,313 | | | $ | 7,707 | | | $ | 7,049 | | | $ | 7,095 | | | $ | 7,001 | |
| Ratio of net charge-offs to average Loans outstanding | | | 0.04 | % | | | 0.06 | % | | | 0.05 | % | | | 0.02 | % | | | 0.05 | % |
| Ratio of the Allowance for Loan & Lease Losses to Nonperforming Loans | | | 145.47 | % | | | 209.70 | % | | | 1249.57 | % | | | 684.83 | % | | | 490.39 | % |
| FMAO/10-K/0001564590-21-007929 |
22 | *We
have already paid $172,000 toward this total.If
we are able to successfully develop our drug, PT00114, and obtain FDA approval, we could then begin marketing and selling it in
the United States and generate revenue. FDA approval to begin commercial sales is the singular gating item that will allow us
to begin generating sales revenue in the U.S., so it will have an enormous impact on our business plan and our financial condition.
It is anticipated that the sale of our drug will allow the Company to generate enough sales revenue to support all of our operations
and to generate a profit. However, given the stage of development, even if FDA Approval is obtained, we do not anticipate generating
any revenue from sales prior to 2024.Development
Milestones (upcoming developmental milestones)Upcoming
development milestones include confirming efficacy of our lead drug candidate in an animal model in a CRO, conducting toxicology
testing in two animal species, and filing an IND application to begin human clinical trials.Human
Resources (current state of employees and future plans towards employeesThe
Company has two part-time employees: Garo H. Armen, PhD, the Executive Chairman, and Alexander K. Arrow, MD, the Chief Financial
Officer. The Company also has three paid consultants: Andrew Slee, PhD, Development Advisor, Dalia Barsyte, PhD, Chief Technology
Advisor, David Lovejoy, PhD, Chief Scientific Advisor, and Christina Fam Faragalla, Director of Project Management.Financing
– Capital NeedsIn
addition to the working capital being generated via the Note Private Offering, the Company anticipates that it will need to raise
additional capital in the next year or so to support its research and development activities as it prepares to commence and commences
human clinical trials. The Company does not have any commitments for such additional capital.Over
the next two years, we anticipate conducting the following research and development activities at the following estimated costs
and expense: |
| | | Estimated Cost | | |
| --- | --- | --- | --- | --- |
| 2Q 2020 | | | | |
| Final Dosing work for Phase I | | $ | 55,000 | |
| Final Safety and Toxicology Animal studies | | $ | 421,000 | \* |
| | | | | |
| 3Q 2020 | | | | |
| Complete Stability and Formulation | | $ | 85,000 | |
| IND application write-up and filing | | $ | 120,000 | |
| | | | | |
| 4Q 2020 | | | | |
| Site selection, patient enrollment | | $ | 850,000 | \* |
| | | | | |
| 1H 2021 | | | | |
| Human Safety Data generated from Phase I trial | | $ | 450,000 | |
| | | | | |
| 2H 2021 | | | | |
| Human Efficacy Data generated from Phase II trial | | $ | 600,000 | |
| PTIX/10-K/0001493152-20-007286 |
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | (1)
As described above, we currently
aggregate revenues based on the type of user activity monetized. Our
objective is to optimize total revenues from the user experiences.
Accordingly, this factor should be considered in evaluating the relative
revenues generated from our Subscription and Transactional
Services.
Revenues
decreased approximately $44.8 million, or 39%, to $69.1 million for the year
ended December 31, 2009, compared to $113.9 million for the year ended December
31, 2008.Subscription
revenue consists of content applications billed direct to consumers via mobile
or land based telephone lines or credit card. These services are
delivered through the Internet to PCs, or mobile phones, or through other
Internet-connected devices. Subscription revenue decreased by
approximately $22.0 million, or 50%, to $22.2 million for the year ended
December 31, 2009, compared to $44.2 million for the year ended December 31,
2008. The decrease in subscription service revenue was principally attributable
to a decrease in the number of billable subscribers during the period. At
December 31, 2009 the number of subscribers was 338,000 compared to 501,000 at
December 31, 2008. This also compares to 346,000 subscribers at
September 30, 2009. The decrease in billable subscribers from a year ago
was due primarily to a significant reduction in mobile customer acquisition
rates, offset by approximately 70,000 net billable additions from the
introduction of the Kazaa music subscription service. Net billable
additions refers to the number of subscribers added during the period, less
attrition. During 2009, we reduced our mobile marketing spends, which
directly impacted customer acquisition rates. We elected to cut our mobile
marketing spends because of the uncertain regulatory and legal environment
associated with marketing mobile subscription services and due to the less
profitable economics – a result of higher customer acquisition costs – of our
mobile subscription service offerings.Transactional
revenue is derived from our online marketing and lead generation activities,
which are targeted and measurable online campaigns and programs for marketing
partners, corporate advertisers, or their agencies, generating qualified
customer leads, online responses and activities, or increased brand recognition.
Transactional revenue decreased by approximately $22.9 million or 33% to $46.8
million for the year ended December 31, 2009 compared to $69.7 million for the
year ended December 31, 2008. The decrease is principally attributed to the
reduction in discretionary advertising spending by our search
customers.We also
experienced weakness in our marketing services and lead generation business,
including a reduction in page views, site visits, and registrations, which
manifested itself in lower revenue for these service lines on a year-over-year
basis. As a result of the slow-down in economic activity in the
United States during 2009, spending on advertising decreased markedly, leading
to increased competition in the Internet marketing and lead generation markets
which, in turn, created significant downward pricing pressure on our offerings
and resulted in a lower volume of registrations and leads that could be sourced
at an attractive price.Operating
Expenses |
| | | For the Year | | | | | | | | Change | | | | Change | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | December 31, | | | | | | | | Inc.(Dec.) | | | | Inc.(Dec.) | | |
| | | 2009 | | | | 2008 | | | | $ | | | | % | | |
| | | | | | | | | | | | | | | | | |
| Subscription | | $ | 22,254 | | | $ | 44,196 | | | $ | (21,942 | ) | | | -50 | % |
| Transactional | | | 46,835 | | | | 69,688 | | | | (22,853 | ) | | | -33 | % |
| | | | | | | | | | | | | | | | | |
| Total Revenues (1) | | $ | 69,089 | | | $ | 113,884 | | | $ | (44,795 | ) | | | -39 | % |
| PTIX/10-K/0001144204-10-016818 |
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Cost
of MediaCost of
Media – 3rd party
decreased by $31.2 million to $43.3 million for the year ended December 31, 2009
from $74.5 million for the year ended December 31, 2008. Cost of Media – 3 rd party
includes media purchased for monetization of both transactional and subscription
revenues. Because of its strictly variable nature, this decrease was
proportionately correlated to the decline in the related revenue. As
a percentage of revenue, Cost of Media -3rd party
improved to 63% for the year ended December 31, 2009 from 65% for the year ended
December 31, 2008. This improvement in Cost of Media -3rd party
margin is attributable to reductions in the pace of mobile customer acquisition,
partially offset by increased search marketing spend associated with the Kazaa
music subscription service. It is to be expected that for businesses with a
significant recurring revenue component, if direct marketing expense is
significantly curtailed, the business, as a result of the recurring nature of
revenue generated by the subscription service, will exhibit a short term period
of improved Cost of Media – 3 rd party
margins.Product
and DistributionProduct
and distribution expense increased by $0.8 million to $10.5 million in the year
ended December 31, 2009 as compared to $9.7 million for the year ended December
31, 2008. Product and distribution expenses are costs necessary to develop and
maintain proprietary content and support and maintain our websites and
technology platforms – which drive both our transactional and subscription based
revenues. In 2009, we experienced higher product and distribution
expense as a result of costs incurred to further develop the Kazaa music
service, greater royalty and license expense, also associated with Kazaa, and
other general marketing and distribution technology-related
expense. These higher technology and royalty costs were offset by a
reduction in product and distribution salary expense. Included in product and
distribution cost is stock compensation expense of $111,000 and $7,000 for the
year ended December 31, 2009 and 2008, respectively.Selling
and marketingSelling
and marketing expense decreased by $1.6 million to $8.4 million in the year
ended December 31, 2009 as compared to $10.0 million for the year ended December
31, 2008. The decrease is primarily due to a reduction in salaries and other
marketing costs, in accordance with the decrease in our revenue over the same
period. This decrease in selling and marketing expense was partially
offset by higher customer service expense as a result of new service offerings
and call center activity.General,
Administrative and Other OperatingGeneral
and administrative expenses decreased by approximately $1.4 million to $14.7
million for the year ended December 31, 2009 compared to $16.1 million for the
year ended December 31, 2008. The decrease is due primarily due to a reduction
in labor and related costs, professional and consulting fees, facilities and
related costs, partially offset by an increase in Sarbanes Oxley consulting
fees, legal expense and severance payments and accruals to former executives.
While we consider it important to make appropriate and modest investments in
labor, facilities, and utilization of third party professional service providers
to support our continued growth, business development, and corporate governance
initiatives, management has also made steps to reduce our overall cost structure
as a result of the challenging and competitive business environment, and the
associated decrease in revenue and unfavorable operating results we have
experienced over the last year. We continue to look for opportunities
to leverage our existing infrastructure or to generate appropriate cost savings
without affecting employee morale or jeopardizing business development
opportunities. Included in general and administrative expense is severance of
$1.1 million for the year ended December 31, 2009 and stock compensation expense
of $0.7 million and $1.3 million for the year ended December 31, 2009 and 2008,
respectively.Depreciation
and amortizationDepreciation
and amortization expense decreased $2.2 million to $3.7 million for the year
ended December 31, 2009 compared to $5.9 million for the year ended December 31,
2008 principally as a result of a reduction in capital expenditure and a
decrease of $1.4 million of Ringtone subscriber database amortization expense
from 2008 to 2009. The database was fully amortized by the second quarter of
2009.Impairment
of Goodwill and Intangible AssetsThe
Company conducts its annual impairment test in the fourth quarter of the year,
unless an event occurs prior to the fourth quarter that would more likely than
not reduce the fair value of the Company below its carrying amount. In
connection with our annual goodwill impairment testing conducted in the fourth
quarter, and for the year ended December 31, 2009, we determined there was
impairment of the carrying value of goodwill and intangible assets and recorded
a non-cash charge of $17.3 million compared to an impairment charge of $114.8
million in 2008. The goodwill and intangibles impairment, the majority of which
is not deductible for income tax purposes, is primarily due to our declining
market price, reduced expectations for future operating results and reduced
valuation multiples. Such negative factors are reflected in our stock price and
market capitalization.Loss
from OperationsOperating
loss decreased to approximately $28.9 million for the year ended December 31,
2009 compared to $117.1 million for the year ended December 31, 2008. Excluding
the effect of goodwill and intangibles impairment in 2009 and 2008, operating
loss increased to approximately $11.6 million for the year ended December 31,
2009, compared to $2.3 million for the year ended December 31, 2008. The higher
operating loss is the result of the revenue decrease, together with
proportionately higher product and distribution expense, selling and marketing
expense and general and administrative expense, offset by an improvement in the
Cost of Media – 3rd party
margin.Interest
income and dividends Interest
and dividend income decreased approximately $676,000 to $72,000 for the year
ended December 31, 2009, compared to $748,000 for the year ended December 31,
2008. The reduction is mainly due to a decrease in the balances of cash and
marketable securities at December 31, 2009 compared to December 31, 2008, as
well as a reduction in the rate of return on invested capital.Interest
expenseInterest
expense was $76,000 for the year ended December 31, 2009 compared to $147,000
for the year ended December 31, 2008. The interest paid is primarily related to
the note payable to Ringtone which was paid in January 2009.Other
Income (Expense)Other
income was $5,000 for the year ended December 31, 2009 compared to other expense
of ($153,000) for the year ended December 31, 2008. The 2008 expense was due to
a loss on sale of marketable securities.Income
Taxes Income
tax expense (benefit), before noncontrolling interest and equity in income of
investee, for the year ended December 31, 2009 and 2008 was $0.6 million and
($0.9) million, respectively and reflects an effective tax rate of 2.2% and 0.7%
respectively. The effective tax rates were computed taking into consideration
non-deductible impairment charges of $12.1 million and $114.8 million for 2009
and 2008, respectively, and the establishment of an income tax valuation
allowance of $11.0 million for 2009.Equity
in Loss of InvesteeEquity in
income of investee was $59,000, net of taxes at December 31, 2009 and represents
our 36% interest in The Billing Resource, LLC (TBR). We acquired the interest in
TBR in the 4th Quarter
2008 and the operating results were de minimis.Net Loss (Income) Attributable to Noncontrolling
InterestNet loss attributable to noncontrolling
interest was $28,000 for the year ended December 31, 2009 as compared to net
income of ($24,000) for the year ended December 31, 2008. This related to our
investment in MECC which was dissolved in June 2009.Net
Loss Attributable to Atrinsic, Inc.Net loss attributable to Atrinsic Inc., decreased by
$86.3 million to $29.5 million for the year ended December 31, 2009 as compared
$115.8 million for the year ended December 31, 2008. This decrease resulted from
the factors described above.Liquidity
and Capital ResourcesWe
continually project anticipated cash requirements, which may include business
combinations, capital expenditures, and working capital requirements. As of
December 31, 2009, we had cash and cash equivalents of approximately $16.9
million and working capital of approximately $15.3 million. We used
approximately $3.0 million in cash for operations for the year ended December
31, 2009 and, contingent on prospective operating performance, may require
reductions in discretionary variable costs and other realignments to permanently
reduce fixed operating costs. We generated $2.4 million in cash from investing
activities, principally from proceeds from sale of marketable securities and a
distribution from The Billing Resource, offset by the investment in ShopIt. Cash
used in financing activities was $2.8 million and was principally attributable
to repayment of the Ringtone note payable of $1.8 million and stock repurchases.
Our Board of Directors authorized a share repurchase program which expired in
May 2009. Under this share repurchase program we purchased 832,392 shares of our
common stock for an aggregate price of $939,000.We
believe that our existing cash and cash equivalents and anticipated cash flows
from operating activities will be sufficient to fund minimum working capital and
capital expenditure needs for at least the next twelve months. The extent of our
future capital requirements will depend on many factors, including our results
of operations. If our cash flows from operations is less than anticipated or our
working capital requirements or capital expenditures are greater than
expectations, or if we expand our business by acquiring or investing in
additional products or technologies, we may need to secure additional debt or
equity financing. We are continually evaluating various financing strategies to
be used to expand our business and fund future growth. There can be no assurance
that additional debt or equity financing will be available on acceptable terms,
if at all. The potential inability to obtain additional debt or equity
financing, if required, could have a material adverse effect on our
operations.Critical
Accounting Policies and EstimatesPrinciples
of ConsolidationThe
consolidated financial statements include the accounts of all majority and
wholly-owned subsidiaries and significant intercompany balances and transactions
have been eliminated.The
equity method is used to account for investments in entities in which we have an
ownership of less than 50% and have significant influence over the operating and
financial policies of the affiliate.Use
of EstimatesThe
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and expenses as well
as the disclosure of contingent assets and liabilities. Management continually
evaluates its estimates and judgments including those related to allowances for
doubtful accounts, useful lives of property, plant and equipment and intangible
assets, fair value of stock options granted, forfeiture rate of equity based
compensation grants, probable losses associated with pre-acquisition
contingencies, income taxes and other contingencies. Management bases its
estimates and judgments on historical experience and other factors that are
believed to be reasonable in the circumstances. Actual results may differ from
those estimates. Macroeconomic conditions may directly, or indirectly through
our business partners and vendors, impact our financial performance and
available resources. Such conditions may, in turn, impact the aforementioned
estimates and assumptions. Management has discussed the development, selection
and disclosure of these estimates and assumptions with the Audit Committee of
the Board of Directors. Accounts
Receivable and Related AllowancesThe
Company maintains allowances for doubtful accounts for estimated losses which
may result from the inability of its customers to make required payments. The
Company bases its allowances on the likelihood of recoverability of
accounts receivable by customer, based on past experience, the age of the
accounts receivable balance, the credit quality of the Company’s customers, and,
taking into account current collection trends. If specific customer
circumstances change or industry trends worsen beyond the Company’s estimates,
the Company would be required to increase its allowances for doubtful accounts.
Alternatively, if trends improve beyond the Company’s estimates, the Company
would be required to decrease its allowance for doubtful accounts. The Company’s
estimates are reviewed periodically, and adjustments are reflected through bad
debt expense in the period they become known. Changes in the Company’s bad debt
experience can materially affect its results of operations.The
Company also makes estimates for refunds and provides for these probable
uncollectible amounts through a reduction of recorded revenues in the period for
which the sale occurs, based on analyses of previous rates and
trends.Due to
the payment terms of the carriers requiring in excess of 60 days from the date
of billing or sale, at its sole discretion, the Company can elect to use trade
discounts in order to facilitate quicker payment. This discount or fee allows
for payments of approximately 80% of the prior month’s billings 15 to 20 days
after the end of the month. The Company records revenue net of that fee, if
incurred, which is 3.5% to 5% of the associated revenue.Goodwill
and Intangible AssetsGoodwill
represents the excess of cost over fair value of net assets of businesses
acquired. In accordance with ASC 350 formerly Statement of Financial Accounting
Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”,
the value assigned to goodwill and indefinite lived intangible assets is not
amortized to expense, but rather it is evaluated at least on an annual basis to
determine if there is a potential impairment. If the fair value of the reporting
unit is less than its carrying value, an impairment loss is recorded to the
extent that the implied fair value of the reporting unit goodwill is less than
the carrying value. If the fair value of an indefinite lived intangible is less
than its carrying amount, an impairment loss is recorded. Fair value is
determined based on discounted cash flows, market multiples or appraised values
as appropriate. Discounted cash flow analysis requires assumptions about the
timing and amount of future cash inflows and outflows, risk, the cost of
capital, and terminal values. Each of these factors can significantly affect the
value of the intangible asset. The estimates of future cash flows, based on
reasonable and supportable assumptions and projections, require management’s
judgment. Any changes in key assumptions about the Company’s businesses and
their prospects, or changes in market conditions, could result in an impairment
charge. Some of the more significant estimates and assumptions inherent in the
intangible asset valuation process include: the timing and amount of projected
future cash flows; the discount rate selected to measure the risks inherent in
the future cash flows; and the assessment of the asset’s life cycle and the
competitive trends impacting the asset, including consideration of any
technical, legal or regulatory trends.The
Company has determined that there was an impairment of the carrying value
of goodwill and non-amortizable intangible assets as a result of
completing its annual impairment analysis as of December 31, 2009. In
performing the related valuation analysis the company used various valuation
methodologies including probability weighted discounted cash flows, comparable
transaction analysis, and market capitalization and comparable company multiple
comparison. The results of this review and impact of the impairment are more
fully described in Note 7 - “Goodwill and Intangible
Assets”.Intangible
assets subject to amortization primarily consist of customer lists, trade names
and trademarks, and restrictive covenants that were acquired. The
intangible asset values assigned to the identified assets for each acquisition
were generally determined based upon the expected discounted aggregate cash
flows to be derived over the estimated useful life. The method of amortizing the
intangible asset values reflects, based upon the Company’s historical
experience, an accelerated rate of attrition in the subscriber database based
over the expected life of the underlying subscriber database after considering
turnover. Accordingly, the Company amortizes the value assigned to
subscriber database based on the actual depletion of the acquired subscriber
database. The Company reviews the recoverability of its finite-lived intangible
assets for recoverability whenever events or circumstances indicated that the
carrying amount of an asset may not be recoverable. Recoverability is assessed
by comparison to associated undiscounted cash flows. In the fourth quarter of
2009, and prior to ASC 350 evaluation, the Company recognized an impairment of
$2.1 million under ASC 360.Stock-Based
CompensationThe
Company records stock based compensation in accordance with ASC 718 formerly
Financial Accounting Standard Board Statement of Financial Accounting Standards
No. 123 (revised 2004). In estimating the grant date fair value at stock option
awards and performance based restricted stock, we use the Black Scholes option
pricing model and other binomial pricing models where appropriate. The key
assumptions for these models to derive fair value include expected term, rate of
risk free returns and volatility. If different assumptions and estimates were
used, the amounts charged to compensation expense would be
different.Revenue
RecognitionThe
Company monetizes a portion of its user activities through subscription based
sources by providing on-going monthly access to and usage of premium products
and services. In general, customers are billed at standard rates, at
the beginning of the month, and revenues are recognized upon receipt of
information confirming an arrangement. The Company estimates a provision for
refunds and credits which is recorded as a reduction to revenues. In determining
the estimate for refunds and credits, the Company relies upon historical data,
contract information and other factors. The estimated provision for refunds can
vary from actual results.The
Company effectuates its subscription revenues through a carrier or distributors
who are paid a transaction fee for their services. In accordance with
ASC 605 formerly Emerging Issues Task Force (“EITF” No 99-19) “Reporting
Revenues Gross as Principal Versus Net as an Agent”, the Company recognizes as
revenues the net amount received from the carrier or distributor, net of their
fee. The
Company monetizes a portion of its user activities through transactional based
services generated primarily from (a) fees earned, primarily on a Cost Per Click
basis, from search syndication services; (b) fees earned for the Company's
search engine marketing ("SEM") services; and (c) other fees for marketing
services including data and list management services, which can be either
periodic or transactional. Commission fee revenue is recognized in the period
that the Company's advertiser customer generates a sale or other agreed-upon
action on the Company's affiliate marketing networks or as a result of the
Company's SEM services, provided that no significant Company obligations remain,
collection of the resulting receivable is reasonably assured, and the fees are
fixed or determinable. All transaction services revenues are recognized on a
gross basis in accordance with the provisions of EITF 99-19, due to the
fact that the Company is the primary obligor and bears all credit risk to its
customer, and publisher expenses that are directly related to a
revenue-generating event are recorded as a component of 3rd part Media
Cost.Income
TaxesThe
Company uses the asset and liability method of financial accounting and
reporting for income taxes required by ASC 740 formerly Statement of Financial
Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”.
Under ASC 740, deferred income taxes reflect the tax impact of temporary
differences between the amount of assets and liabilities recognized for
financial reporting purposes and the amounts recognized for tax
purposes.We
maintain valuation allowances where it is more likely than not that all or a
portion of a deferred tax asset will not be realized.Effective
January 1, 2007, the Company adopted FIN No. 48, “Accounting for
Uncertainty in Income Taxes” subsequently codified under ASC 740-10-25 which
resulted in no material adjustment in the liability for unrecognized tax
benefits. The Company classifies interest expense and penalties related to
unrecognized tax benefits as income tax expense. ASC 740 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with ASC 740 and prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The
evaluation of a tax position in accordance with this Interpretation is a
two-step process. The first step is recognition, in which the enterprise
determines whether it is more likely than not that a tax position will be
sustained upon examination, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The second
step is measurement. A tax position that meets the more-likely-than-not
recognition threshold is measured to determine the amount of benefit to
recognize in the financial statements.The
Company and its subsidiaries file income tax returns in the U.S and Canada. The
Company is subject to federal, state and Canadian examinations. The
statute of limitations for 2008 and 2009 in all jurisdictions remains open and
are subject to examination by tax authorities.Contractual
Obligations and Off-Balance Sheet ArrangementsAt
December 31, 2009, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, the Company is not
exposed to any financing, liquidity, market or credit risk that could arise if
it had engaged in such relationships.The
following table shows the Company’s future commitments for future minimum lease
payments required under operating leases that have remaining non cancellable
lease terms in excess of one year, future commitments under investment and
marketing agreements and future commitments under employment agreements as of
December 31, 2009: |
| | | For the Year | | | | | | | | Change | | | | Change | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | December 31, | | | | | | | | Inc.(Dec.) | | | | Inc.(Dec.) | | |
| | | 2009 | | | | 2008 | | | | $ | | | | % | | |
| Operating Expenses | | | | | | | | | | | | | | | | |
| Cost of Media – 3rd party | | $ | 43,313 | | | $ | 74,541 | | | $ | (31,228 | ) | | | -42 | % |
| Product and distribution | | | 10,559 | | | | 9,749 | | | | 810 | | | | 8 | % |
| Selling and marketing | | | 8,386 | | | | 9,974 | | | | (1,588 | ) | | | -16 | % |
| General, administrative and other operating | | | 14,706 | | | | 16,060 | | | | (1,354 | ) | | | -8 | % |
| Depreciation and Amortization | | | 3,698 | | | | 5,867 | | | | (2,169 | ) | | | -37 | % |
| Impairment of Goodwill and Intangible Assets | | | 17,289 | | | | 114,783 | | | | (97,494 | ) | | | -85 | % |
| | | | | | | | | | | | | | | | | |
| Total Operating Expenses | | $ | 97,951 | | | $ | 230,974 | | | $ | (133,023 | ) | | | -58 | % |
| PTIX/10-K/0001144204-10-016818 |
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS | Recent
Accounting PronouncementsAdopted
in 2009In August
2009, the FASB issued ASU 2009-05 “Measuring Liabilities at Fair Value” (“ASC
820-10”). ASC 820-10 is effective for interim and annual reporting periods
beginning after August 27, 2009. It clarifies the application of
certain valuation techniques in circumstances in which a quoted price in an
active market for the identical liability is not available and clarifies that
when estimating the fair value of a liability, the fair value is not adjusted to
reflect the impact of contractual restrictions that prevent its transfer.
We adopted ASC 820-10 for the year ended December 31, 2009 and it did not
have a material impact on our consolidated financial statements.In the
third quarter of 2009, the Company adopted the Financial Accounting Standards
Board (“FASB”) Accounting Standards Codification (“ASC”). The ASC is the source
of authoritative, nongovernmental GAAP, except for rules and interpretive
releases of the Securities and Exchange Commission (SEC). The
adoption of the ASC did not have an impact on the Company’s results of
operations or financial position.In June
2009, the FASB issued SFAS No. 165, “Subsequent Events”, which has been
superseded by the FASB codification and included in ASC 855-10. ASC 855-10
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are
issued. The effective date of ASC 855-10 is interim or annual
financial periods ending after June 15, 2009. The adoption of ASC
855-10 did not have a material effect on the Company’s consolidated financial
statements.In
June 2008, the FASB issued Staff Position No. EITF 03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities” which has been superseded by the FASB codification ASC
260-10 gives guidance as to the circumstances when unvested share-based payment
awards should be included in the computation of EPS. ASC 260-10 is effective for
fiscal years beginning after December 15, 2008. The adoption of ASC 260-10
did not have an impact on the Company’s financial statements. In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” which has
been superseded the FASB codification and included in ASC 805. ASC 805
establishes the principles and requirements for how an acquirer: (i) recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree; (ii)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and (iii) determines what information to disclose
to enable users of the financial statements to evaluate the nature and financial
effects of the business combination. ASC 805 is to be applied prospectively to
business combinations consummated on or after the beginning of the first annual
reporting period on or after December 15, 2008, with early adoption prohibited.
Previously, any release of valuation allowances for certain deferred tax assets
would serve to reduce goodwill, whereas under the new standard any release of
the valuation allowance related to acquisitions currently or in prior periods
will serve to reduce our income tax provision in the period in which the reserve
is released. Additionally, under ASC 805 transaction-related expenses, which
were previously capitalized, will be expensed as incurred. The adoption of ASC
805 did not have a material effect on our results of operations or financial
position.In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which has been superseded by the FASB
codification and included in ASC 810-10-65-1 and establishes requirements for
ownership interests in subsidiaries held by parties other than us (minority
interests) be clearly identified and disclosed in the consolidated statement of
financial position within equity, but separate from the parent's equity. Any
changes in the parent's ownership interests are required to be accounted for in
a consistent manner as equity transactions and any noncontrolling equity
investments in deconsolidated subsidiaries must be measured initially at fair
value. ASC 810-10-65-1 is effective, on a prospective basis, for fiscal years
beginning after December 15, 2008; however, presentation and disclosure
requirements must be retrospectively applied to comparative financial
statements. Except for presentation and disclosure requirements, the adoption of
ASC 810-10-65-1 had no material impact on the Company’s financial
statements.Not
Yet AdoptedIn
June 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded
by the FASB Codification and included in ASC 810 to require an enterprise to
perform an analysis to determine whether the enterprise’s variable interest or
interests give it a controlling financial interest in a variable interest
entity. This analysis identifies the primary beneficiary of a variable interest
entity as one with the power to direct the activities of a variable interest
entity that most significantly impact the entity’s economic performance and the
obligation to absorb losses of the entity that could potentially be significant
to the variable interest. These revisions to ASC 810 will be effective as of the
beginning of the annual reporting period commencing after November 15, 2009
and will be adopted by the Company in the first quarter of 2010. We do not
believe that the adoption of these revisions to ASC 810 will have a material
impact to our results of operations or financial position.In
October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue
08-01, Revenue Arrangements with Multiple Deliverables which has been superseded
by FASB codification and included in ASC 605-25. This statement provides
principles for allocation of consideration among its multiple-elements, allowing
more flexibility in identifying and accounting for separate deliverables under
an arrangement. The EITF introduces an estimated selling price method for
valuing the elements of a bundled arrangement if vendor-specific objective
evidence or third-party evidence of selling price is not available, and
significantly expands related disclosure requirements. This standard is
effective on a prospective basis for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010.
Alternatively, adoption may be on a retrospective basis, and early application
is permitted. The Company is currently evaluating the impact of adopting this
pronouncement. |
| | | Operating | | | | Employment | | | | Total | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| (in thousands) | | Leases | | | | Agreements | | | | Obligations | | |
| 2010 | | $ | 1,165 | | | $ | 717 | | | $ | 1,882 | |
| 2011 | | | 1,127 | | | | 135 | | | | 1,262 | |
| 2012 | | | 886 | | | | - | | | | 886 | |
| 2013 | | | 936 | | | | - | | | | 936 | |
| 2014 | | | 987 | | | | - | | | | 987 | |
| 2015 and thereafter | | | 3,618 | | | | - | | | | 3,618 | |
| | | | | | | | | | | | | |
| | | $ | 8,719 | | | $ | 852 | | | $ | 9,571 | |
| PTIX/10-K/0001144204-10-016818 |
37 | *This
expenditure may depend on a successful capital raising event. |
| | | Estimated Cost | | |
| --- | --- | --- | --- | --- |
| 1Q 2018 | | | | |
| Completion of ELISA tests | | $ | 45,000 | |
| Complete Custom antibodies as an alternative to ELISA | | $ | 21,000 | |
| | | | | |
| 2Q 2018 | | | | |
| Complete Stability and Formulation | | $ | 85,000 | |
| Write our first IND application | | $ | 80,000 | |
| | | | | |
| 3Q 2018 | | | | |
| Possibly Complete toxicology studies in two species | | $ | 850,000 | \* |
| | | | | |
| 4Q 2018 | | | | |
| Submit our first IND application | | $ | 60,000 | |
| | | | | |
| 1Q 2019 | | | | |
| Begin dosing healthy volunteers in Phase I trial | | $ | 175,000 | |
| PTIX/10-K/0001493152-18-004567 |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Revenues decreased approximately $29.1 million, or 42%, to $40.0 million for the year ended December 31, 2010, compared to $69.1 million for the year ended December 31, 2009.Subscription revenue consists of content applications billed direct to consumers via mobile or land based telephone lines or credit card. These services are delivered through the Internet to PCs, or mobile phones, or through other Internet-connected devices. Subscription revenue decreased by approximately $3.2 million, or 15%, to $19.0 million for the year ended December 31, 2010, compared to $22.2 million for the year ended December 31, 2009. Subscription revenue for the year ended December 31, 2010 includes an increase in Kazaa revenue of $8.0 million compared to the year ended December 31, 2009, without which, our subscription revenue would have decreased by 50%, or $11.0 million year-over-year. As of December 31, 2010, the Company had approximately 205,000 subscribers, compared to 338,000 as of December 31, 2009. This decrease in subscribers was partly offset by a 22% increase in average revenue per user (“ARPU”) to approximately $6.11 for the year ended December 31, 2010, compared to the year ended December 31, 2009. The increase in ARPU was the result of the higher retail price point of the Kazaa digital music subscription service and improvements in billing efficiency. As of December 31, 2010, the Company has approximately 77,000 Kazaa subscribers. Relative to the approximately 80,000 Kazaa subscribers we had at the end of 2009, for all of 2010, we experienced a net decrease of 3,000 Kazaa subscribers (new subscriber additions, net of attrition).Transactional revenue is principally derived from our search marketing agency business, which consists of targeted and measurable online campaigns and programs for advertisers, to generate qualified customer leads, sales transactions, or increased brand recognition. Transactional revenue decreased by approximately $25.8 million or 55% to $21.0 million for the year ended December 31, 2010 compared to $46.8 million for year ended December 31, 2009. The decrease in revenue was attributable to the loss of accounts and a reduction in discretionary advertising expenditures by our clients, as well as a result of a restructuring of our agency activities. Beginning in the second quarter, and substantially completed by the end of the third quarter, the Company took proactive steps to eliminate any unprofitable or marginally profitable lead generation campaigns and marketing programs from its Transactional offerings. These steps had the effect of curtailing lead generation sales volume, contributing to the decrease in revenue compared to the year ago period. As a result of this restructuring, the bulk of our Transactional revenue now consists of revenue generated from our search agency business, together with higher yielding marketing campaigns.Operating Expenses |
| | | (in thousands) | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | | | | | Change | | | | Change | | |
| | | For the Year Ended December 31, | | | | | | | | Increase (Decrease) | | | | Increase (Decrease) | | |
| | | 2010 | | | | 2009 | | | | $ | | | | | % | |
| | | | | | | | | | | | | | | | | |
| Subscription | | $ | 19,021 | | | $ | 22,254 | | | $ | (3,233 | ) | | | -15 | % |
| Transactional | | | 21,005 | | | | 46,835 | | | | (25,830 | ) | | | -55 | % |
| | | | | | | | | | | | | | | | | |
| Total Revenues | | $ | 40,026 | | | $ | 69,089 | | | $ | (29,063 | ) | | | -42 | % |
| PTIX/10-K/0001144204-11-020599 |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Cost of MediaCost of Media – 3rd party decreased by $20.8 million to $22.5 million for the year ended December 31, 2010 from $43.3 million for the year ended December 31, 2009. Cost of Media – 3rd party includes media purchased for monetization of both Transactional and Subscription revenues. The decrease in Cost of Media – 3rd party was due to two primary factors. First, approximately 85% of the decrease in Cost of Media – 3rd party was due to the decline in Transactional related revenue which resulted in a corresponding reduction in purchased media. Second, the remaining 15% of the decrease in Cost of Media – 3rd party was due to significantly lower subscriber acquisition rates, and in turn, a lower number of subscribers acquired.The rate of subscriber acquisitions is based on a number of factors, not least of which is subscriber acquisition cost, or “SAC.” During the year ended December 31, 2010, management moderated and limited the rate of subscriber acquisitions in response to (i) the need to preserve cash, (ii) changes in its alternative billing processes, and (iii) anticipated improvements and enhancements to the Kazaa digital music service.During the year ended December 31, 2010, the Company added approximately 396,000 new subscribers, over half of which were Kazaa subscribers. This level of customer acquisition was not sufficient to replace the Company’s existing subscriber base during the year: “Net Adds,” which represents the number of subscribers acquired, net of subscriber attrition, which was a negative 133,000 for the year ended December 31, 2010. Cost of media for the year ended December 31, 2010 includes an increase in Kazaa-related Cost of Media – 3rd party of $2.3 million compared to the year ended December 31, 2009. We anticipate that our share of the future cash flows of the Kazaa music service to exceed these Kazaa cost of media expenses, although there can be no assurance of this.During 2010, the Company estimates that its SAC per subscriber was approximately $15.34, which reflects a 10% increase in SAC from the year ago period. SAC is dependent on a number of factors, including prevailing market conditions, the type of media, and the ability of the Company to convert leads into subscribers. The Company expects that SAC will fluctuate from period to period based on all of these factors. Management will continue to monitor SAC closely to ensure that the Company acquires customers in a cost effective manner for both its transactional and subscription services. Because of its strictly variable nature, this decrease was proportionately correlated to the decline in the related revenue.Product and DistributionProduct and distribution expense increased by $9.7 million to $20.2 million in the year ended December 31, 2010 as compared to $10.5 million for the year ended December 31, 2009. Product and distribution expenses are costs necessary to provide licensed content and development and support for our products, websites and technology platforms – which drive both our Transactional and Subscription-based revenues. Compared to the year ended December 2009, in the year ended December 31, 2010 we experienced higher product and distribution expenses of $10.2 million as a result of costs incurred to further develop the Kazaa music service and greater royalty and license expense payable to content owners, also associated with Kazaa. We anticipate that our share of the future cash flows of the Kazaa music service to exceed these Kazaa product and distribution expenses, although there can be no assurance of this. This increase in costs related to Kazaa was partly offset by decreases in staffing costs as we have reduced the number of employees companywide during 2010. Included in product and distribution cost is stock compensation expense of $54,000 and $111,000 for the years ended December 31, 2010 and 2009, respectively.Selling and marketingSelling and marketing expense decreased by $4.4 million to $4.0 million in the year ended December 31, 2010 as compared to $8.4 million for the year ended December 31, 2009. The decrease is primarily due to a reduction in salaries and other marketing costs, in accordance with the decrease in our revenue over the same period. Included in selling and marketing cost is stock compensation expense of $43,000 for the year ended December 31, 2010.General, Administrative and Other OperatingGeneral and administrative expenses decreased by approximately $5.6 million to $9.1 million for the year ended December 31, 2010 compared to $14.7 million for the year ended December 31, 2009. The decrease is primarily due to a reduction in workforce, and associated savings, a decrease in professional fees and other efforts to reduce the Company’s overall levels of overhead. The rate of decrease in general, administrative and other operating expense, on a year-over-year basis, is slower than for some other components of operating expenses because of the fixed nature of general and administrative costs, relative to the more variable based costs inherent in other categories of operating expense. Included in general and administrative expense is stock compensation expense of $1.0 million and $0.7 million for the year ended December 31, 2010 and 2009.Depreciation and amortizationDepreciation and amortization expense decreased $2.1 million to $1.6 million for the year ended December 31, 2010 compared to $3.7 million for the year ended December 31, 2009 as a result of a reduction in amortization for intangibles, due to the fact that we recorded an impairment charge of $4.1 million at December 31, 2009. This was partly offset by an increase in depreciation due to a write-off of $0.4 million in property, plant and equipment related to the decision to shut down the Canada facility.Impairment of Goodwill and Intangible AssetsThe Company conducts its annual impairment test in the fourth quarter of the year, unless an event occurs prior to the fourth quarter that would more likely than not reduce the fair value of the Company below its carrying amount. In connection with our annual indefinite lived intangible asset impairment testing conducted in the fourth quarter, and for the year ended December 31, 2010, we determined there was impairment of the carrying value of indefinite lived intangible assets and recorded a non-cash charge of $1.5 million compared to an impairment charge of $2.0 million in 2009. In 2009, goodwill of $13.1 million was also impaired. The goodwill and indefinite lived intangibles impairment, the majority of which is not deductible for income tax purposes, is primarily due to our declining market price, reduced expectations for future operating results and reduced valuation multiples. Such negative factors are reflected in our stock price and market capitalization.As a result of significant adverse changes in the business climate, the Company concluded that triggering events had occurred and the Company tested long-lived assets for impairment as of December 31, 2010 and 2009. The Company determined the fair value of such long lived assets and recognized an impairment charge of $3.4 million and $2.2 million for the years ended December 31, 2010 and 2009 respectively.Loss from OperationsOperating loss decreased to approximately $22.3 million for the year ended December 31, 2010 compared to $28.9 million for the year ended December 31, 2009. Excluding the effect of intangible asset impairment in 2010 and 2009, operating loss increased to approximately $17.4 million for the year ended December 31, 2010, compared to $11.6 million for the year ended December 31, 2009. The higher operating loss is the result of the revenue decrease, together with proportionately higher product and distribution expense offset by an improvement in the Cost of Media – 3rd party margin, selling and marketing expenses and general and administrative expenses.Interest income and dividendsInterest and dividend income decreased approximately $62,000 to $10,000 for the year ended December 31, 2010, compared to $72,000 for the year ended December 31, 2009. The reduction is mainly due to a decrease in the balances of cash and marketable securities at December 31, 2010 compared to December 31, 2009, as well as a reduction in the rate of return on invested capital.Interest expenseInterest expense was $16,000 for the year ended December 31, 2010 compared to $76,000 for the year ended December 31, 2009.Other IncomeOther income was $1.7 million for the year ended December 31, 2010 compared to other income of $5,000 for the year ended December 31, 2009. Other income for 2010 was principally comprised of legal settlements and awards (see “Item 3 – Legal Proceedings”)Income TaxesIncome tax (benefit) expense, before noncontrolling interest and equity in loss (income) of investee, for the year ended December 31, 2010 and 2009 was $(1.1) million and $0.6 million, respectively and reflects an effective tax rate of (5.2)% and 2.2% respectively. The effective tax rates were computed taking into consideration non-deductible impairment charges of $12.1 million for 2009, and the change in the income tax valuation allowance of $8.2 million and $11.1 million for 2010 and 2009, respectively.Equity in (Loss) Income of InvesteeEquity in loss of investee was $183,000 net of taxes at December 31, 2010 compared to equity in income of $59,000 for the year ended December 31, 2009, and represents our 36% interest in The Billing Resource, LLC (TBR).Net Loss Attributable to Noncontrolling InterestNet loss attributable to noncontrolling interest was $28,000 for the year ended December 31, 2009. This related to our investment in MECC which was dissolved in June 2009.Net Loss Attributable to Atrinsic, Inc.Net loss attributable to Atrinsic Inc., decreased by $9.8 million to $19.7 million for the year ended December 31, 2010 as compared $29.5 million for the year ended December 31, 2009. This decrease resulted from the factors described above.Liquidity and Capital ResourcesWe continually project anticipated cash requirements, which may include business combinations, capital expenditures, and working capital requirements. As of December 31, 2010, we had cash and cash equivalents of approximately $6.3 million and working capital of approximately $2.1 million. We used approximately $11.2 million in cash for operations during the year ended December 31, 2010 and, contingent on prospective operating performance may require reductions in discretionary variable costs and other realignments to permanently reduce fixed operating costs. We generated $0.7 million in cash from investing activities, principally from a return of capital from The Billing Resource. Cash used in financing activities was minimal during the fiscal year ended December 31, 2010.In order to fund operations, we need to raise additional capital. We are currently working with an independent financial advisory firm to assist us in structuring a financing and to engage an investment bank to raise debt or equity capital to fund our immediate cash needs and to finance our longer term growth to further develop the Kazaa business and grow our subscriber base. We currently have no formal arrangements with respect to additional financing in place and there is no guaranty funding will be available on favorable terms or at all. If we cannot obtain such funds, we will need to significantly curtail or cease our operations. In addition, the sale of additional equity securities or convertible debt could result in dilution to our stockholders.We continue to evaluate the sale of certain of our assets and businesses. We cannot provide any assurance that we will be successful in finding suitable purchasers for the sale of such assets. Even if we are able to find purchasers, we may not be able to obtain attractive terms and conditions for such sales, including attractive pricing. In addition, divestitures of businesses involve a number of risks, including the diversion of management and employee attention, significant costs and expenses, the loss of customer relationships, a decrease in revenues associated with the divested business, and the disruption of operations in the affected business. Furthermore, divestitures potentially involve significant post-closing separation activities, which could involve the expenditure of significant financial and employee resources. An inability to consummate identified asset sales or manage the post-separation transition arrangements could adversely affect our business, financial condition, results of operations and cash flows.There is substantial doubt about our ability to continue as a going concern. Our consolidated financial statements included in this Annual Report on Form 10-K are prepared using accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The historical consolidated financial statements included in this Annual Report on Form 10-K do not include any adjustments that might be necessary if we are unable to continue as a going concern. The report of our independent registered public accountants, KPMG LLP, includes an explanatory paragraph related to our ability to continue as a going concern.The assessment of our ability to continue as a going concern was made by management considering, among other factors: (i) our current levels of expenditures, including subscriber acquisition costs, operating expense, including product development, and overhead, (ii) our ongoing working capital needs, (iii) the uncertainty concerning the outcome of any financing, (iv) our fiscal year net loss of $19.7 million and $29.5 million for the years ending December 31, 2010 and 2009, respectively, (v) our $11.2 million and $3.0 million of cash used for operating activities during the years ending December 31, 2010 and 2009, respectively, (vi) the outstanding balance of cash and cash equivalents of $6.3 million as of December 31, 2010, and (vii) our budgets and financial projections of future operations, including the likelihood of achieving operating profitability without the need for additional financing.For periods subsequent to December 31, 2010, we expect losses to continue if we continue expenditures to develop the Kazaa service, acquire subscribers for the Kazaa digital music service, and are not able to reduce other operating expenses and overhead sufficiently to a level in line with our level of revenues. If we are unable to increase revenues sufficiently or decrease our expenditures to a sustainable level, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about our ability to continue as a going concern.Based on current financial projections, we believe the continuation of our Company as a going concern is primarily dependent on our ability to, among other factors: (i) consummate a suitable financing, or obtain financing from the sale of our assets or lines of business, (ii) scale our Kazaa subscriber base to a level where the monthly revenue generated from our subscriber base exceeds subscriber acquisition costs, net of expenses required to operate Kazaa, (iii) continue to generate revenue from our legacy subscription products without billing or service disruption, (iv) eliminate or reduce operating and overhead expenditures to a level more in line with our revenue, (v) improve utilization of the Kazaa digital music service and improve LTVs of subscribers to that service, and (vi) acquire profitable subscribers to the Kazaa digital music service at cost effective rates, (vii) grow our search marketing agency revenue base through the addition of new customers or expansion of business with existing customers and, (viii) expand margins in our search marketing agency and on our affiliate platform. While we address these operating matters, we must continue to meet expected near-term obligations, including normal course operating cash requirements and costs associated with developing and operating the Kazaa digital music service, as well as funding overhead and the working capital needs of our other businesses. If we are not able to obtain sufficient funds through a financing, or if we experience adverse outcomes with respect to our operational forecasts, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. See Item 1A—“Risk Factors” included in this Annual Report on Form 10-K regarding additional risks we face with respect to these matters.In the near term, we are focused on: (i) raising debt or equity capital to fund our immediate cash needs and to finance our longer term growth to further develop the Kazaa business and grow our subscriber base, and (ii) pursuing various means to minimize operating costs and increase cash. We cannot provide assurance that we will be able to realize the cost reductions in our operations, or that we can obtain additional cash through asset sales or the issuance of equity. If we are unsuccessful in our efforts we will be required to further reduce our operations, including further reductions of our employee base, or we may be required to cease certain or all of our operations in order to offset the lack of available funding.Critical Accounting Policies and EstimatesPrinciples of ConsolidationThe consolidated financial statements include the accounts of all majority and wholly-owned subsidiaries and significant intercompany balances and transactions have been eliminated.The equity method is used to account for investments in entities in which we have an ownership of less than 50% and have significant influence over the operating and financial policies of the affiliate.Use of EstimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions. Management has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors. Accounts Receivable and Related AllowancesThe Company maintains allowances for doubtful accounts for estimated losses which may result from the inability of its customers to make required payments. The Company bases its allowances on the likelihood of recoverability of accounts receivable by customer, based on past experience, the age of the accounts receivable balance, the credit quality of the Company’s customers, and, taking into account current collection and economic trends. If specific customer circumstances change or industry trends worsen beyond the Company’s estimates, the Company would be required to increase its allowances for doubtful accounts. Alternatively, if trends improve beyond the Company’s estimates, the Company would be required to decrease its allowance for doubtful accounts. The Company’s estimates are reviewed periodically, and adjustments are reflected through bad debt expense in the period they become known. Changes in the Company’s bad debt experience can materially affect its results of operations.The Company also makes estimates for refunds and provides for these probable uncollectible amounts through a reduction of recorded revenues in the period for which the sale occurs, based on analyses of historical trends as well as an evaluation of the impact of current and projected economic conditions.The Company effectuates its subscription revenues through a carrier or distributors who are paid a transaction fee for their services. Due to the payment terms of the carriers requiring in excess of 60 days from the date of billing or sale, at its sole discretion, the Company can elect to use trade discounts in order to facilitate quicker payment. This discount or fee allows for payments of approximately 80% of the prior month’s billings 15 to 20 days after the end of the month. The Company records revenue net of that fee, if incurred, which is 3.5% to 5% of the associated revenue.Goodwill and Intangible AssetsGoodwill represents the excess of cost over fair value of net assets of businesses acquired. In accordance with ASC 350 formerly Statement of Financial Accounting Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”, the value assigned to goodwill and indefinite lived intangible assets is not amortized to expense, but rather it is evaluated at least on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value. If the fair value of an indefinite lived intangible is less than its carrying amount, an impairment loss is recorded. Fair value is determined based on discounted cash flows, market multiples or appraised values as appropriate. Discounted cash flow analysis requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about the Company’s businesses and their prospects, or changes in market conditions, could result in an impairment charge. Some of the more significant estimates and assumptions inherent in the intangible asset valuation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory trends.The Company has determined that there was an impairment of the carrying value of goodwill for the fiscal year ended December 31, 2009, and non-amortizable intangible assets in each of the fiscal years ended December 31, 2010 and 2009 as a result of completing annual impairment analysis for such periods. In performing the related valuation analysis the company used various valuation methodologies including probability weighted discounted cash flows, comparable transaction analysis, and market capitalization and comparable company multiple comparison. The results of this review and impact of the impairment are more fully described in Note 6 to the Consolidated Financial Statements – “Goodwill and Intangible Assets”.Intangible assets subject to amortization primarily consist of customer lists, trade names and trademarks, and restrictive covenants that were acquired. The intangible asset values assigned to the identified assets for each acquisition were generally determined based upon the expected discounted aggregate cash flows to be derived over the estimated useful life. The intangible assets are amortized in a manner that reflects the pattern of the projected net cash inflows to the Company that are expected to occur, or when such pattern does not exist, using the straight-line basis over their respected estimated useful lives. The Company reviews the recoverability of its finite-lived intangible assets for recoverability whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable.The Company has determined that there was an impairment of intangible assets during the fourth quarters of 2010 and 2009. The results of this assessment are more fully described in Note 6 of the Company’s Financial Statement – “Goodwill and Intangible Assets.”Stock-Based CompensationThe Company records stock based compensation in accordance with ASC 718 formerly Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123 (revised 2004). In estimating the grant date fair value of stock option awards and performance based restricted stock, we use the Black Scholes option pricing model where appropriate. The key assumptions for this models to derive fair value include expected term, rate of risk free returns and volatility. If different assumptions and estimates were used, the amounts charged to compensation expense would be different.Revenue RecognitionIn accordance with ASC 605 and SEC Accounting Bulletin 104, the Company monetizes a portion of its user activities through subscription based sources by providing on-going monthly access to and usage of premium products and services. In general, customers are billed at standard rates, during the month, and revenues are recognized upon receipt of information confirming an arrangement in that same month. The Company estimates a provision for refunds and credits which is recorded as a reduction to revenues. In determining the estimate for refunds and credits, the Company relies upon historical data, contract information and other factors. The estimated provision for refunds can vary from actual results.The Company effectuates its subscription revenues through a carrier or distributors who are paid a transaction fee for their services. In accordance with ASC 605 formerly Emerging Issues Task Force (“EITF” No 99-19) “Reporting Revenues Gross as Principal Versus Net as an Agent”, the Company recognizes as revenues the net amount received from the carrier or distributor, net of their fee.The Company monetizes a portion of its user activities through transactional based services generated primarily from (a) fees earned, primarily on a Cost Per Click basis, from search syndication services; (b) fees earned for the Company's search engine marketing ("SEM") services; and (c) other fees for marketing services including data and list management services, which can be either periodic or transactional. Commission fee revenue is recognized in the period that the Company's advertiser customer generates a sale or other agreed-upon action on the Company's affiliate marketing networks or as a result of the Company's SEM services, provided that no significant Company obligations remain, collection of the resulting receivable is reasonably assured, and the fees are fixed or determinable. All transaction services revenues are recognized on a gross basis in accordance with the provisions of ASC 605-45, due to the fact that the Company is the primary obligor and bears all credit risk to its customer, and publisher expenses that are directly related to a revenue-generating event are recorded as a component of 3rd part Media Cost.Income TaxesThe Company uses the asset and liability method of financial accounting and reporting for income taxes required by ASC 740 formerly Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”. Under ASC 740, deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized.Under ASC 740-10-25 the Company classifies interest expense and penalties related to unrecognized tax benefits as income tax expense. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with this Interpretation is a two-step process. The first step is recognition, in which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.The Company and its subsidiaries file income tax returns in the U.S and Canada. The Company is subject to federal, state and Canadian examinations. The statute of limitations for 2007 through 2009 in all jurisdictions (except California includes 2006 through 2009) remain open and income tax returns filed for such periods are subject to potential examination by tax authorities.Contractual Obligations and Off-Balance Sheet ArrangementsAt December 31, 2010, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if it had engaged in such relationships.The following table shows the Company’s future commitments for future minimum lease payments required under operating leases that have remaining non cancellable lease terms in excess of one year, future commitments under investment and marketing agreements and future commitments under employment agreements as of December 31, 2010: |
| | | (in thousands) | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | | | | | Change | | | | Change | | |
| | | For the Years Ended December 31, | | | | | | | | Increase (Decrease) | | | | Increase (Decrease) | | |
| | | 2010 | | | | 2009 | | | | $ | | | | | % | |
| Operating Expenses | | | | | | | | | | | | | | | | |
| Cost of Media – 3rd party | | $ | 22,513 | | | $ | 43,313 | | | $ | (20,800 | ) | | | -48 | % |
| Product and distribution | | | 20,193 | | | | 10,559 | | | | 9,634 | | | | 91 | % |
| Selling and marketing | | | 4,038 | | | | 8,386 | | | | (4,348 | ) | | | -52 | % |
| General, administrative and other operating | | | 9,083 | | | | 14,706 | | | | (5,623 | ) | | | -38 | % |
| Depreciation and Amortization | | | 1,644 | | | | 3,698 | | | | (2,054 | ) | | | -56 | % |
| Impairment of Goodwill and Intangible Assets | | | 4,850 | | | | 17,289 | | | | (12,439 | ) | | | -72 | % |
| | | | | | | | | | | | | | | | | |
| Total Operating Expenses | | $ | 62,321 | | | $ | 97,951 | | | $ | (35,630 | ) | | | -36 | % |
| PTIX/10-K/0001144204-11-020599 |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | Subsequent to December 31, 2010, the Company entered into a surrender of lease agreement with its landlord for the former Traffix office located in Pearl River, New York. In consideration for the lease termination, the Company agreed to pay the landlord a cancellation fee of $0.2 million in the form of an unsecured note payable. The termination of this resulted in a reduction of 2011 operating lease payments of $0.3 million. The table above does not reflect any obligation relating to this lease.Recent Accounting PronouncementsAdopted in 2010In September 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded by the FASB Codification and included in ASC 810 to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the variable interest. These revisions to ASC 810 are effective as of January 1, 2010 and the adoption of these revisions to ASC 810 had no impact on our results of operations or financial position.Not Yet AdoptedIn October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue 08-01, Revenue Arrangements with Multiple Deliverables which has been superseded by the FASB codification and included in ASC 605-25. This statement provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. The EITF introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after September 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company is currently evaluating the impact of adopting this pronouncement.In December 2010, the FASB issued ASU 2010-28, Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (“ASU 2010-28”). Upon adoption of ASU 2010-28, an entity with reporting units that have carrying amounts that are zero or negative is required to assess the likelihood of the reporting units’ goodwill impairment. ASU 2010-28 is effective January 1, 2011 and we do not believe that the adoption of ASU 2010-28 will have a significant impact on our results of operations and financial position. |
| | | | | | | Less than | | | | 1-3 | | | | 4-5 | | | | More than | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | Total | | | | 1 year | | | | years | | | | years | | | | 5 years | | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating leases | | $ | 7,287 | | | $ | 861 | | | $ | 1,822 | | | $ | 2,004 | | | $ | 2,600 | |
| Employment agreements | | | 973 | | | | 535 | | | | 438 | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 8,260 | | | $ | 1,396 | | | $ | 2,260 | | | $ | 2,004 | | | $ | 2,600 | |
| PTIX/10-K/0001144204-11-020599 |
STRATEGIC
INITIATIVES | (1)
As
described above, the Company currently aggregates revenues based on the
type of user activity monetized. The company’s objective is to optimize
total revenues from the user experiences. Accordingly, this factor should
be considered in evaluating the relative revenues generated from our
Subscription and Transactional
Services.
Revenues
increased approximately by $76.9 million, or 208%, to $113.9 million for the
year ended December 31, 2008, compared to $37.0 million for the year ended
December 31, 2007. Subscription based revenue increased by approximately $7.2
million, or 20%, to $44.2 million for the year ended December 31, 2008, compared
to $37.0 million for the year ended December 31, 2007. The increase in
subscription service revenue was principally attributable to an increase in the
average number of billable subscribers added during the period and our purchase
of Ringtone.com, coupled with our efforts to improve subscriber retention.
Although we ended 2008 with approximately 501,000 subscribers as compared to
approximately 840,000 subscribers at the end of 2007, during 2008 the average
number of monthly billable subscribers was higher than in 2007 and the number of
subscribers increased disproportionally at the end of 2007. The number of
subscribers is largely, but not precisely, correlated to the periodic reported
revenues as a result of inter-period volatility and the circumstance that
subscribers are billed on a monthly basis.Transactional
revenues increased by $69.7 million or 100% in 2008. The increase is
attributable to the service offerings acquired in connection with our
acquisition of Traffix, Inc which took place in February 4, 2008.Operating
Expenses |
| | | For the Year December 31 | | | | | | | | Change Inc.(Dec.) | | | | Change Inc.(Dec.) | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2008 | | | | 2007 | | | | $ | | | | | % | |
| | | | | | | | | | | | | | | | | |
| Subscription | | $ | 44,196 | | | $ | 36,982 | | | $ | 7,214 | | | | 20 | % |
| Transactional | | $ | 69,688 | | | $ | - | | | $ | 69,688 | | | | 100 | % |
| | | | | | | | | | | | | | | | | |
| Total Revenues (1) | | $ | 113,884 | | | $ | 36,982 | | | $ | 76,902 | | | | 208 | % |
| PTIX/10-K/0001144204-09-016416 |
STRATEGIC
INITIATIVES | Cost
of MediaCost of
Media increased by $45.5 million to $74.5 million in 2008 from $29 million in
2007. For 2008, Cost of Media – 3rd party
includes media purchased for monetization of both transactional and subscription
revenues. The increase was principally attributed to the media necessary to
source the revenue acquired with the acquisition of Traffix, Inc. which took
place February 4, 2008.Product and
DistributionProduct
and distribution increased by $6.6 million to $9.7 million for the year ended
December 31, 2008 compared to $3.1 million for the year ended December 31, 2007.
The increase was principally attributed to the acquisition of Traffix, Inc.
which took place February 4, 2008. Product and distribution expenses are costs
necessary to develop and maintain proprietary content, support and maintain our
websites and user data, technology platforms which drives both transactional and
subscription based revenue. Included in product and distribution cost is stock
compensation expense of $6,593 and $288,443 for 2008 and 2007
respectively.Selling
and marketingSelling
and marketing expense increased by $8.4 million to $9.9 million in 2008 as
compared to $1.5 million for the year ended December 31, 2007. The increase is
primarily due to an increase in fixed and variable labor, principally attributed
to the acquisition of Traffix, Inc. which took place February 4, 2008. In
addition, the company incurred approximately $2.2 million of bad debt expense in
2008 and none in 2007.General,
Administrative and Other OperatingGeneral
and administrative expenses increased by approximately $8.7 million to $16.1
million for the year ended December 31, 2008 compared to $7.4 million for the
year ended December, 31, 2007. The increase is primarily due to an increase in
labor and related costs necessary to support core operations, professional and
consulting fees, facilities and related costs principally attributable to the
growth the company experienced as of result of the acquisition of Traffix, Inc.
Management has taken action to achieve approximately $4.0 million of
efficiencies resulting from the acquisition of Traffix, however the Company
continues to make appropriate and modest investments in labor, facilities,
technology infrastructure, and utilization of third party professional service
providers to support its continued growth, business development and corporate
governance initiatives. Included in general and administrative expense is stock
compensation expense of $1.3 million and $828,045 for 2008 and 2007
respectively.Depreciation
and amortizationDepreciation
and amortization expense increased $4.5 million to $5.9 million for the year
ended December 31, 2008 compared to $1.3 million for the year ended December 31,
2007 principally as the result of the amortization of intangible assets and
depreciation of fixed assets acquired in connection with the acquisition of the
Traffix, Inc. and Ringtone.com.Impairment
of GoodwillIn
connection with its annual goodwill impairment testing for the year ended
December 31, 2008, the Company determined there was impairment and recorded a
non-cash charge of $114.8 million. The goodwill impairment, the majority of
which is not deductible for income tax purposes, is primarily due to our
declining market price and reduced valuation multiples. Such negative factors
are reflected in our stock price and market capitalization.Income
(Loss) from OperationsOperating
loss increased to approximately $117.0 million for the year ended December 31,
2008, compared to an operating loss of $5.5 million for the year ended December
31, 2007. This increase was principally attributable to the $114.8 million
charge for the impairment of goodwill taken during the fourth quarter of 2008.
Excluding the charge for impairment, the operating loss for the year ended
December 31, 2008 decreased $3.2 million to ($2.3) million compared to an
operating loss of ($5.5) million for the year ended December 31, 2007.
Management has taken action to gain approximately $4.0 million of efficiencies
resulting from the acquisition of Traffix, however the Company continues to make
appropriate and modest investments in labor, facilities, technology
infrastructure, and utilization of 3rd party
professional service providers to support its continued growth, business
development and corporate governance initiatives.Interest
income and dividendsInterest
and dividend income increased $284,000 to $748,000 for the year ended December
31, 2008, compared to $464,000 for the year ended December 31, 2007. The
increase is primarily due to interest income earned on higher cash balances
maintained throughout 2008, offset by lower rates, and interest and dividends
earned on marketable securities.Interest
expenseInterest
expense increased $125,000 to $147,000 for the year ended December 31, 2008,
compared to $22,000 for the year ended December 31, 2007. The increase is
primarily attributable to interest expense of $90,000 on the note payable
associated with the purchase of the assets of Ringtone .com.Other
Income (Expense)Other
expense increased $141,000 to $153,000 for the year ended December 31, 2008,
compared to $12,000 for the year ended December 31, 2007. The increase is
primarily attributable to loss on the sale of marketable securities of
$174,000.Income
TaxesIncome
tax benefit for the year ended December 31, 2008 was $852,000 and reflects an
effective tax rate of 0.73%, which was computed taking into consideration the
non-deductible impairment charge noted above, the effects of the merger
with Traffix, Inc. which occurred on February 4, 2008, and includes the
result of changes in the weighted average statutory rate attributable to the
addition of certain local jurisdictions resulting from the merger, and certain
adjustments realized in connection with the finalization of tax
returns.Minority
interestMinority
interest represents the income allocable to the non-controlling interests and
net income attributable to the shareholders of the Company for its interest in
MECC. Minority interest for the year ended December 31, 2008 was $24,000
compared to ($283,000) for the year ended December 31, 2007.Net
LossNet loss
increased by $111.6 million to $115.8 million for the year ended December 31,
2008 as compared to a net loss of $4.1 million for the year ended December 31,
2007. The increase is as described above.Liquidity
and Capital ResourcesThe
Company continually projects anticipated cash requirements, which may include
share repurchases, business combinations, capital expenditures, principal and
interest payments on its outstanding and future indebtedness, and working
capital requirements. Funding requirements have been financed through business
combinations, cash flow from operations, issuance of preferred stock,
option exercises and issuance of long-term debt. As of December 31, 2008, the
Company had cash and cash equivalents of approximately $20.4 million, marketable
securities of approximately $4.2
million (including Auction Rated Securities of $4.0 million that was redeemed
and converted to cash at par plus interest in January 2009) and a working
capital balance of approximately $23.7 million. The Company generated
approximately $4.4 million from operations for the year ended December 31, 2008
and expects to generate cash flows from operating activities prospectively,
which, contingent on prospective operating performance, may require reductions
in discretionary variable costs and other realignments to permanently reduce
fixed operating costs.In
conjunction with the Company’s objective of enhancing shareholder value, the
Company’s Board of Directors authorized a share repurchase program. Under this
share repurchase program, the Company purchased 1,908,926 shares of the
Company’s common stock for an aggregate price of approximately $4.05 million
during the Fiscal 2008.The
Company believes that its existing cash and cash equivalents and anticipated
cash flows from our operating activities will be sufficient to fund minimum
working capital and capital expenditure needs for at least the next twelve
months. The extent of the Company’s future capital requirements will depend on
many factors, including its results of operations. If the Company’s cash flows
from operations is less than anticipated or its working capital requirements or
capital expenditures are greater than expectations, or if the Company expands
its business by acquiring or investing in additional products or technologies,
it may need to secure additional debt or equity financing. The Company is
continually evaluating various financing strategies to be used to expand its
business and fund future growth. There can be no assurance that additional debt
or equity financing will be available on acceptable terms, it at all. The
potential inability to obtain additional debt or equity financing, if required,
could have a material adverse effect on the Company’s operations.In
connection with its investments as further described in footnote 14, the Company
is obligated to fund investments totaling approximately $1.6 million in 2009.
Furthermore, management anticipates the risk adjusted return is sufficiently in
excess of the contributed capital obligations, as of this date. There
is however, no guarantee of the anticipated returns. In addition, management has
taken considerable actions to secure its interest in achieving such a
return.Significant
Estimates and Accounting PoliciesPrinciples of
ConsolidationThe
consolidated financial statements include the accounts of all majority and
wholly-owned subsidiaries and significant intercompany balances and transactions
have been eliminated.The
equity method is used to account for investments in entities in which we have an
ownership of less than 50% and have significant influence over the operating and
financial policies of the affiliate. For investments in entities for which the
company has a less than 50 percent ownership interest, but has certain
participatory rights, the investee is consolidated.Use
of EstimatesThe
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and expenses as well
as the disclosure of contingent assets and liabilities. Management continually
evaluates its estimates and judgments including those related to allowances for
doubtful accounts and the associated allowances for returns and chargebacks,
useful lives of property, plant and equipment and intangible assets, fair value
of stock options granted, forfeiture rate of equity based compensation grants,
probable losses associated with pre-acquisition contingencies, income taxes and
other contingencies. Management bases its estimates and judgments on historical
experience and other factors that are believed to be reasonable in the
circumstances. Actual results may differ from those estimates. Macroeconomic
conditions may directly, or indirectly through our business partners and
vendors, impact our financial performance and available resources. Such
conditions may, in turn, impact the aforementioned estimates and
assumptions. Accounts
Receivable and Related Allowances
The
Company maintains allowances for doubtful accounts for estimated losses which
may result from the inability of its customers to make required payments. The
Company bases its allowances on the likelihood of recoverability of
accounts receivable by customer, based on past experience, the age of the
accounts receivable balance, the credit quality of the Company’s customers, and,
taking into account current collection trends. If specific customer
circumstances change or industry trends worsen beyond the Company’s estimates,
the Company would be required to increase its allowances for doubtful accounts.
Alternatively, if trends improve beyond the Company’s estimates, the Company
would be required to decrease its allowance for doubtful accounts. The Company’s
estimates are reviewed periodically, and adjustments are reflected through bad
debt expense in the period they become known. Changes in the Company’s bad debt
experience can materially affect its results of operations.
The
Company also makes estimates for refunds, chargebacks or credits, and provides
for these probable uncollectible amounts through a deferral and reduction of
recorded revenues in the period for which the sale occurs based on analyses of
previous rates and trends.Due to
the payment terms of the carriers requiring in excess of 60 days from the date
of billing or sale, at its sole discretion, the Company can elect to use trade
discounts in order to facilitate quicker payment. This discount or fee allows
for payments of approximately 80% of the prior month’s billings 15 to 20 days
after the end of the month. The Company records revenue net of that fee, if
incurred, which is 3.5% to 5% of the associated revenue.
Goodwill
and Intangible Assets
Goodwill
represents the excess of cost over fair value of net assets of businesses
acquired. In accordance with Statement of Financial Accounting Standards
No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”, the value
assigned to goodwill and indefinite lived intangible assets is not amortized to
expense, but rather it is evaluated at least on an annual basis to determine if
there is a potential impairment. If the fair value of the reporting unit is less
than its carrying value, an impairment loss is recorded to the extent that the
implied fair value of the reporting unit goodwill is less than the carrying
value. If the fair value of an indefinite lived intangible is less than its
carrying amount, an impairment loss is recorded. Fair value is determined based
on discounted cash flows, market multiples or appraised values as appropriate.
Discounted cash flow analysis requires assumptions about the timing and amount
of future cash inflows and outflows, risk, the cost of capital, and terminal
values. Each of these factors can significantly affect the value of the
intangible asset. The estimates of future cash flows, based on reasonable and
supportable assumptions and projections, require management’s judgment. Any
changes in key assumptions about the Company’s businesses and their prospects,
or changes in market conditions, could result in an impairment charge. Some of
the more significant estimates and assumptions inherent in the intangible asset
valuation process include: the timing and amount of projected future cash flows;
the discount rate selected to measure the risks inherent in the future cash
flows; and the assessment of the asset’s life cycle and the competitive trends
impacting the asset, including consideration of any technical, legal or
regulatory trends.The
Company has determined that there was an impairment of goodwill as a result of
completing its annual impairment analysis as of December 31, 2008. In
performing the related valuation analysis the company used various valuation
methodologies including probability weighted discounted cash flows, comparable
transaction analysis, and market capitalization and comparable company multiple
comparison. The results of this review and impact of the impairment are more
fully described in Note 6 - “Goodwill and Intangible
Assets”.Intangible
assets subject to amortization primarily consist of customer lists, trade names
and trademarks, and restrictive covenants that were acquired. The
intangible asset values assigned to the identified assets for each acquisition
were generally determined based upon the expected discounted aggregate cash
flows to be derived over the estimated useful life. The method of amortizing the
intangible asset values reflects, based upon the Company’s historical
experience, an accelerated rate of attrition in the subscriber database based
over the expected life of the underlying subscriber database after considering
turnover. Accordingly, the Company amortizes the value assigned to
subscriber database based on the actual depletion of the acquired subscriber
database. The Company reviews the recoverability of its finite-lived intangible
assets for recoverability whenever events or circumstances indicated that the
carrying amount of an asset may not be recoverable. Recoverability is assessed
by comparison to associated undiscounted cash flows.Stock-Based
Compensation
The
Company records stock based compensation in accordance with Financial Accounting
Standard Board Statement of Financial Accounting Standards No. 123 (revised
2004). In estimating the grant date fair value at stock option awards, we use
certain assumptions and estimates to derive fair value, such as expected term,
rate of risk free returns and volatility. If different assumptions and estimates
were used, the amounts charged to compensation expense would be
different.
Revenue
RecognitionThe
Company monetizes a portion of its user activities through subscription based
sources by providing on-going monthly access to and usage of premium products
and services. In general, customers are billed at standard rates, at
the beginning of the month, and revenues are recognized upon receipt of
information confirming an arrangement. The Company estimates a provision for
refunds and credits which is recorded as a reduction to revenues. In determining
the estimate for refunds and credits, the Company relies upon historical data,
contract information and other factors. The estimated provision for refunds can
vary from actual results.The
Company effectuates this type of revenues through a carrier or distributors who
are paid a transaction fee for their services. In accordance with
Emerging Issues Task Force (“EITF” No 99-19) “Reporting Revenues Gross as
Principal Versus Net as an Agent”, the Company recognizes as revenues the net
amount received from the carrier or distributor, net of their
fee. Revenues are deferred if the probability of collection is not
reasonably assured.The
Company monetizes a portion of its user activities through transactional based
services generated primarily from (a) fees earned, primarily on a CPC basis,
from search syndication services; (b) commission fees earned for the Company's
search engine marketing ("SEM") services; (c) commission fees earned from
marketing service arrangements associated with our affiliate marketing partners;
and (d) other fees for marketing services including data and list management
services, which can be either periodic or transactional. Commission fee revenue
is recognized in the period that the Company's advertiser customer generates a
sale or other agreed-upon action on the Company's affiliate marketing networks
or as a result of the Company's SEM services, provided that no significant
Company obligations remain, collection of the resulting receivable is reasonably
assured, and the fees are fixed or determinable. All transaction services
revenues are recognized on a gross basis in accordance with the provisions of
EITF 99-19, due to the fact that the Company is the primary obligor to its
customer, and publisher expenses that are directly related to a
revenue-generating event are recorded as a component of 3rd part Media
Cost.Income
TaxesThe
Company uses the asset and liability method of financial accounting and
reporting for income taxes required by Statement of Financial Accounting
Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”. Under SFAS
109, deferred income taxes reflect the tax impact of temporary differences
between the amount of assets and liabilities recognized for financial reporting
purposes and the amounts recognized for tax purposes.Effective
January 1, 2007, the Company adopted FIN No. 48, “Accounting for
Uncertainty in Income Taxes” which resulted in no material adjustment in the
liability for unrecognized tax benefits. The Company classifies interest expense
and penalties related to unrecognized tax benefits as income tax expense. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS No. 109 and
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. The evaluation of a tax position in accordance with this
Interpretation is a two-step process. The first step is recognition, in which
the enterprise determines whether it is more likely than not that a tax position
will be sustained upon examination, including resolution of any related appeals
or litigation processes, based on the technical merits of the position. The
second step is measurement. A tax position that meets the more-likely-than-not
recognition threshold is measured to determine the amount of benefit to
recognize in the financial statements.The
Company and its subsidiaries file income tax returns in the U.S and Canada. The
Company is subject to U.S., Australian (prior years filing) and Canadian federal
and state examinations. The statute of limitations for 2007 and 2008 in all
jurisdictions remains open and are subject to examination by tax
authorities.Contractual
Obligations and Off-Balance Sheet ArrangementsAt
December 31, 2008, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, the Company is not
exposed to any financing, liquidity, market or credit risk that could arise if
it had engaged in such relationships.The
following table shows the Company’s future commitments for future minimum lease
payments required under operating leases that have remaining non cancellable
lease terms in excess of one year, future commitments under investment and
marketing agreements, future commitments under employment agreements, and note
and interest payable as of December 31, 2008: |
| | | For the Year December 31, | | | | | | | | Change Inc.(Dec.) | | | | Change Inc.(Dec.) | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2008 | | | | 2007 | | | | $ | | | | % | | |
| | | | | | | | | | | | | | | | | |
| Operating Expenses | | | | | | | | | | | | | | | | |
| Cost of Media – 3rd party | | $ | 74,541 | | | $ | 29,054 | | | | 45,487 | | | | 157 | % |
| Product and distribution | | | 9,749 | | | | 3,149 | | | | 6,600 | | | | 210 | % |
| Selling and marketing | | | 9,974 | | | | 1,521 | | | | 8,453 | | | | 556 | % |
| General and administrative and other operating | | | 16,060 | | | | 7,408 | | | | 8,652 | | | | 117 | % |
| Depreciation and Amortization | | | 5,867 | | | | 1,349 | | | | 4,518 | | | | 335 | % |
| Impairment of goodwill | | | 114,783 | | | | - | | | | 114,783 | | | | 100 | % |
| | | | | | | | | | | | | | | | | |
| Total Operating Expenses | | $ | 230,974 | | | $ | 42,481 | | | $ | 188,493 | | | | 444 | % |
| PTIX/10-K/0001144204-09-016416 |
STRATEGIC
INITIATIVES | In
certain situations, the Company does have minimum fee obligations assuming the
counterparty performs the required level of services. We feel that the level of
business activity under normal and ordinary circumstances exceeds the minimum
thresholds. Therefore, the amounts are not included in the table
above.Recent
Accounting PronouncementsIn
June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities.” EITF 03-6-1 gives guidance as to the circumstances
when unvested share-based payment awards should be included in the computation
of EPS. EITF 03-6-1 is effective for fiscal years beginning after
December 15, 2008. We are currently assessing the impact of EITF 03-6-1 on
our consolidated financial statements.In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162
("SFAS 162"), The Hierarchy of Generally Accepted Accounting
Principles. This
statement identifies the sources of accounting principles and the framework for
selecting the principles used in preparation of financial statements of
nongovernmental entities that are presented in conformity with U.S. GAAP.
This statement is effective November 15, 2008. The Company will adopt
SFAS 162 as required, and its adoption is not expected to have an impact on
the consolidated financial statements.In
April 2008, the FASB issued FASB Staff Position No. FSP 142-3,
“Determining the Useful Life of Intangible Assets” FSP 142-3 amends the factors
to be considered in determining the useful life of intangible assets. Its intent
is to improve the consistency between the useful life of an intangible asset and
the period of expected cash flows used to measure its fair value. FSP 142-3 is
effective for fiscal years beginning after December 15, 2008. We are
currently assessing the impact of FSP 142-3 on our consolidated financial
statements.In March
2008, the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments and
Hedging Activities,” an amendment of FASB Statement No. 133. SFAS No. 161
changes the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a) how
and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement No. 133 and its
related interpretations and (c) how derivative instruments and related hedged
items affect an entity’s financial position, financial performance and cash
flows. SFAS No. 161 is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the impact SFAS No.
161 may have its consolidated financial statements.In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which we refer to as SFAS No. 160. SFAS No.
160 establishes requirements for ownership interests in subsidiaries held by
parties other than us (minority interests) be clearly identified and disclosed
in the consolidated statement of financial position within equity, but separate
from the parent's equity. Any changes in the parent's ownership interests are
required to be accounted for in a consistent manner as equity transactions and
any noncontrolling equity investments in deconsolidated subsidiaries must be
measured initially at fair value. SFAS No. 160 is effective, on a prospective
basis, for fiscal years beginning after December 15, 2008; however, presentation
and disclosure requirements must be retrospectively applied to comparative
financial statements. The Company will adopt SFAS No. 160 in our fiscal year
ending December 31, 2009. However, the Company is currently evaluating the
impact of SFAS No. 160 may have its consolidated financial
statements.On
February 12, 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-2,
“Effective Date of SFAS No. 157,” which defers the effective date of SFAS 157
for nonfinancial assets and liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis. This
FSP delayed the implementation of SFAS 157 for the Company’s accounting of
goodwill, acquired intangibles, and other nonfinancial assets and liabilities
that are measured at the lower of cost or market until January 1,
2009.In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”). SFAS 141R establishes the principles and requirements for how an
acquirer: (i) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed and any non-controlling
interest in the acquiree; (ii) recognizes and measures the goodwill acquired in
the business combination or a gain from a bargain purchase; and (iii) determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. SFAS 141R
is to be applied prospectively to business combinations consummated on or after
the beginning of the first annual reporting period on or after December 15,
2008, with early adoption prohibited. We are currently evaluating the impact
SFAS 141R will have on adoption on our accounting for future acquisitions.
Previously, any release of valuation allowances for certain deferred tax assets
would serve to reduce goodwill, whereas under the new standard any release of
the valuation allowance related to acquisitions currently or in prior periods
will serve to reduce our income tax provision in the period in which the reserve
is released. Additionally, under SFAS 141R transaction-related expenses, which
were previously capitalized, will be expensed as incurred.In
February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS 159”), which gives companies the option
to measure eligible financial assets, financial liabilities and firm commitments
at fair value (i.e., the fair value option), on an instrument-by-instrument
basis, that are otherwise not permitted to be accounted for at fair value under
other accounting standards. The election to use the fair value option is
available when an entity first recognizes a financial asset or liability or upon
entering into a firm commitment. Subsequent changes in fair value must be
recorded in earnings. SFAS 159 is effective for financial statements issued for
fiscal year beginning after November 15, 2007. The Company elected not to adopt
the provisions of SFAS 159 for its financial instruments that are not required
to be measured at fair value.AcquisitionsOn
February 4, 2008, New Motion completed its merger with Traffix, Inc.
(“Traffix”); a performance based online marketing company, pursuant to a merger
agreement entered into by the companies on September 26, 2007. As a result of
the closing of the transaction, Traffix became a wholly owned subsidiary of New
Motion. Immediately following the consummation of the merger, Traffix
stockholders owned approximately 45% of the capital stock of New Motion, on a
fully-diluted basis. Each issued and outstanding share of Traffix common stock
was converted into the right to receive approximately 0.676 shares of New Motion
common stock based on the capitalization of both companies on the closing date
of the merger. Effective the date of the close of the merger, New Motion
commenced trading on The NASDAQ Global Market under the symbol
“NWMO.”On June
30, 2008, New Motion entered into an Asset Purchase Agreement with Ringtone.com,
LLC, a Minnesota limited liability company and W3i Holdings LLC, a Minnesota
limited liability company and the sole member of Ringtone.com. In consideration
for the assets, the Company at the closing paid to Ringtone.com $7 million in
cash. In addition, the Company delivered to Ringtone.com a convertible
promissory note (the “Note”) in the aggregate principal amount of $1.75 million,
which accrues interest at a rate of 10% per annum (provided that from and after
an event of default, the Note will bear interest at a rate of 15% per
annum).See Note
4 to the consolidated financial statements for a more detailed description
of the Traffix and Ringtone.com acquisitions.Pro Forma Financial
DataAs more
fully described in Note 4 to the consolidated financial statements, New Motion
acquired all of the outstanding common shares of Traffix in accordance with the
merger agreement as well as certain assets and liabilities of Ringtone.com, LLC
in accordance with the asset purchase agreement. The following unaudited pro
forma results of operations are based on the historical statements of operations
of New Motion, Traffix and Ringtone.com, LLC, after giving effect to
the acquisition of Traffix by New Motion, using the purchase method of
accounting and applying the assumptions and adjustments described in the related
discussion below.The pro
forma combined statement of operations for the year ended December 31, 2008 is
presented as if the acquisitions of Traffix and Ringtone.com had occurred on
January 1, 2008. You should read this information in conjunction with the
accompanying notes to the consolidated financial statements included
herewith.The pro
forma information presented is for illustrative purposes only and is not
necessarily indicative of the financial position or results of operations that
would have been realized if the acquisitions had been completed on the dates
indicated, nor is it indicative of future operating results or financial
position.Financial
statements of New Motion issued after the acquisitions reflects only the
operations of Traffix and Ringtone.com after the acquisitions and have not been
restated retroactively to reflect the historical financial position or results
of operations of Traffix and Ringtone.com.
Traffix
and Ringtone results of operations are derived from the unaudited management
accounts of Traffix and Ringtone for the period from January 1, 2008 to February
3, 2008 and the period from January 1, 2008 to June 30, 2008,
respectively. |
| | | Operating Leases | | | | Employment Agreements | | | | Investments & Marketing Advances | | | | Note and Interest payable | | | | Total Obligations | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| 2009 | | $ | 1,502 | | | $ | 1,333 | | | $ | 1,570 | | | $ | 1,925 | | | $ | 6,330 | |
| 2010 | | | 1,246 | | | | 1,250 | | | | - | | | | - | | | $ | 2,496 | |
| 2011 | | | 1,184 | | | | 271 | | | | - | | | | - | | | $ | 1,455 | |
| 2012 and thereafter | | | 5,912 | | | | - | | | | - | | | | - | | | $ | 5,912 | |
| | | $ | 9,844 | | | $ | 2,854 | | | $ | 1,570 | | | $ | 1,925 | | | $ | 16,193 | |
| PTIX/10-K/0001144204-09-016416 |
UNAUDITED
PRO FORMA RESULTS OF OPERATIONS | Pro
Forma AdjustmentsThe
following pro forma adjustments are included in the unaudited pro forma
consolidated statement of operations: |
| | | New Motion | | | | Traffix | | | | Acquisition Adjustments | | | | Total Traffix | | | | Ringtone | | | | Acquisition Adjustments | | | | Total Ringtone | | | | Combined Pro Forma | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net revenue-Subscription | | $ | 44,196 | | | | | | | | | | | | | | | $ | 7,278 | | | $ | (310 | )(g) | | $ | 6,968 | | | $ | 51,164 | |
| Net revenue-Transactional | | | 69,688 | | | | 10,637 | | | | (3,068 | )(a) | | | 7,569 | | | | | | | | - | | | | - | | | | 77,257 | |
| TOTAL REVENUE | | | 113,884 | | | | 10,637 | | | | (3,068 | ) | | | 7,569 | | | | 7,278 | | | | (310 | ) | | | 6,968 | | | | 128,421 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| EXPENSES | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cost of revenues-third party | | | 74,541 | | | | 7,441 | | | | (310 | )(b) | | | 7,131 | | | | 5,675 | | | | (1,107 | )(h) | | | 4,568 | | | | 86,240 | |
| Product and distribution | | | 9,749 | | | | | | | | - | | | | - | | | | | | | | - | | | | - | | | | 9,749 | |
| Selling and marketing | | | 9,974 | | | | 266 | | | | (1,961 | )(c) | | | (1,695 | ) | | | | | | | - | | | | - | | | | 8,279 | |
| General and administrative | | | 16,060 | | | | 1,596 | | | | (560 | )(d) | | | 1,036 | | | | 669 | | | | - | | | | 669 | | | | 17,765 | |
| Depreciation and amortization | | | 5,867 | | | | 96 | | | | 275 | (e) | | | 371 | | | | 54 | | | | 14 | (e) | | | 68 | | | | 6,306 | |
| Impairment of goodwill | | | 114,783 | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 114,783 | |
| | | | 230,974 | | | | 9,399 | | | | (2,556 | ) | | | 6,843 | | | | 6,398 | | | | (1,093 | ) | | | 5,305 | | | | 243,122 | |
| (LOSS) FROM OPERATIONS | | | (117,090 | ) | | | 1,238 | | | | (512 | ) | | | 726 | | | | 880 | | | | 783 | | | | 1,663 | | | | (114,701 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| OTHER EXPENSE (INCOME) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest income and dividends | | | (748 | ) | | | | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (748 | ) |
| Interest expense | | | 147 | | | | | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 147 | |
| Other income/expenses | | | 153 | | | | | | | | 28 | | | | 28 | | | | - | | | | - | | | | - | | | | 181 | |
| (LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES | | $ | (116,642 | ) | | $ | 1,238 | | | $ | (540 | ) | | $ | 698 | | | $ | 880 | | | $ | 783 | | | $ | 1,663 | | | $ | (114,281 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| INCOME TAXES | | | (852 | ) | | | 551 | | | | (551 | )(f) | | | - | | | | - | | | | - | | | | - | | | | (852 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | - | |
| (LOSS) INCOME BEFORE MINORITY INTEREST | | | (115,790 | ) | | | 687 | | | | 11 | | | | 698 | | | | 880 | | | | 783 | | | | 1,663 | | | | (113,429 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| MINORITY INTEREST, NET OF PROVISION FOR INCOME | | | (24 | ) | | | | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (24 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | - | |
| NET INCOME | | $ | (115,766 | ) | | $ | 687 | | | $ | 11 | | | $ | 698 | | | $ | 880 | | | $ | 783 | | | $ | 1,663 | | | $ | (113,405 | ) |
| PTIX/10-K/0001144204-09-016416 |
44 | Plan
of OperationsBusiness
OverviewThe
Company is in its developmental stage, with encouraging but not conclusive evidence that its lead drug candidate, PT00014, may
be effective as an anti-anxiety and/or anti-depression drug. It is focused on confirming the efficacy of this drug candidate,
along with performing the other preclinical steps needed to progress along the pathway to bring this drug candidate into human
clinical trials and eventually, to the global market to provide a new pharmaceutical for patients suffering from anxiety or treatment-resistant
depression.We
anticipate $4,225,000 in capital expenditures in FY 2021 to implement our current plan of operations in connection with the development
of PT00114.If
we are able to successfully develop our drug, PT00114, and obtain FDA approval, we could then begin marketing and selling it in
the United States and generate revenue. FDA approval to begin commercial sales is the singular gating item that will allow us
to begin generating sales revenue in the U.S., so it will have an enormous impact on our business plan and our financial condition.
It is anticipated that the sale of our drug will allow the Company to generate enough sales revenue to support all of our operations
and to generate a profit. However, given the stage of development, even if FDA Approval is obtained, we do not anticipate generating
any revenue from sales prior to 2024.Development
Milestones (upcoming developmental milestones)Upcoming
development milestones include confirming efficacy of our lead drug candidate in an animal model in a CRO, conducting toxicology
testing in two animal species, and filing an IND application to begin human clinical trials. |
| | | Payments due by period | | | | | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Contractual obligations | | Total | | | | Less than 1 year | | | | 1-3 years | | | | 3-5 years | | | | More than 5 years | | |
| Long-Term PIK convertible notes payable | | $ | 1,597,500 | | | $ | - | | | $ | - | | | $ | 1,597,500 | | | $ | - | |
| Long-Term PIK convertible notes payable– Related Party | | $ | 400,000 | | | $ | - | | | $ | - | | | $ | 400,000 | | | $ | - | |
| Total | | $ | 1,997,500 | | | $ | - | | | $ | - | | | $ | 1,997,500 | | | $ | - | |
| PTIX/10-K/0001493152-21-006756 |
23 | *This
expenditure may depend on a successful capital raising event. We do not currently have any commitments for such a capital raising
event.If
we are able to successfully develop our drug, PT00114, and obtain FDA approval, we could then begin marketing and selling it in
the United States and generate revenue. FDA approval to begin commercial sales is the singular gating item that will allow us
to begin generating sales revenue in the U.S., so it will have an enormous impact on our business plan and our financial condition.
It is anticipated that the sale of our drug will allow the Company to generate enough sales revenue to support all of our operations
and to generate a profit. However, given the stage of development, even if FDA Approval is obtained, it is not anticipated prior
to 2023.Development
Milestones (upcoming developmental milestones)Upcoming
development milestones include confirming efficacy of our lead drug candidate in an animal model in a clinical research organization
(CRO), conducting toxicology testing in two animal species, and filing an Investigational New Drug (IND) application to begin
human clinical trials. |
| | | Estimated Cost | | |
| --- | --- | --- | --- | --- |
| 2Q 2019 | | | | |
| Final Dosing work for Phase I | | $ | 55,000 | |
| Final Safety and Toxicology Animal studies | | $ | 850,000 | \* |
| | | | | |
| 3Q 2019 | | | | |
| Complete Stability and Formulation | | $ | 85,000 | |
| IND application write-up and filing | | $ | 120,000 | |
| | | | | |
| 4Q 2019 | | | | |
| Site selection, patient enrollment | | $ | 850,000 | \* |
| | | | | |
| 1H 2020 | | | | |
| Human Safety Data generated from Phase I trial | | $ | 450,000 | |
| | | | | |
| 2H 2020 | | | | |
| Human Efficacy Data generated from Phase II trial | | $ | 600,000 | |
| PTIX/10-K/0001493152-19-004288 |
24 | Off
Balance Sheet ArrangementsWe
have no material off-balance sheet arrangements that are likely to have a current or future effect on our financial condition,
changes in financial condition, revenues or expenses, results of operations, liquidity, capital resources, or capital expenditures.Critical
accounting policies and estimatesOur
discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
The notes to the consolidated financial statements contained in this Annual Report describe our significant accounting policies
used in the preparation of the consolidated financial statements. The preparation of these financial statements requires us 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
periods. Actual results could differ from those estimates. We continually evaluate our critical accounting policies and estimates.We
believe the critical accounting policies listed below reflect significant judgments, estimates and assumptions used in the preparation
of our consolidated financial statements.Foreign
Currency Translation and Transactions. The assets and liabilities of our foreign subsidiary PTI Canada are translated into
U.S. dollars from the functional currency using the exchange rate in effect at the balance sheets date. Additionally, the accounts
on the statements of operations are translated using exchange rates approximating average rates prevailing during the years. Equity
accounts are translated at historical exchange rates. Translation adjustments that arise from translating its financial statements
from the local currency to the U.S. dollar are accumulated and reflected as a separate component of stockholders’ equity
(deficit). The current year effects of the transaction adjustments are included on the statement of operations as a realized gain
(loss) on foreign transaction exchange. |
| Basic Science of TCAP-1 | | $ | 60,000 | |
| --- | --- | --- | --- | --- |
| Efficacy Studies | | $ | 1,050,000 | |
| Toxicology Studies | | $ | 850,000 | |
| Stability and Formulation | | $ | 85,000 | |
| Custom antibodies as an alternative to ELISA | | $ | None | |
| Tagged antibodies | | $ | 104,000 | |
| Antibody purification | | $ | 24,000 | |
| Clinical consultants | | $ | 30,000 | |
| Medical Writing and IND application compilation | | $ | 79,000 | |
| Technical Infrastructure | | $ | 11,000 | |
| Total R&D not including personnel | | $ | 2,293,000 | |
| PTIX/10-K/0001493152-19-004288 |
Comparison of Fiscal Years Ended December 31, 2018 and 2017 | The $14.5 million decrease in research and development expense during the year ended December 31, 2018 as compared to the year ended December 31, 2017 principally reflects a $7.2 million decrease in costs related to the VTL-308 clinical trial due to completion of enrollment in the first quarter of 2018. There were 97 subjects enrolled in the VTL-308 clinical trial in the twelve months ended December 31, 2017, while there were 19 subjects enrolled in the twelve months ended December 31, 2018 due to the completion of enrollment. In addition, upon the release of results from the VTL-308 clinical trial in September 2018, we ceased substantially all development efforts related to the ELAD System. As a result, research and development expense also reflects a $1.7 million reduction in salaries and wages, $1.4 million reduction in estimated incentive compensation costs and a $1.3 million net reversal of stock-based compensation in the 2018 period, all reflecting that our VTL-308 clinical trial did not successfully reach its primary or secondary survival endpoints and a related reduction in staff. Manufacturing supplies, travel and entertainment, outside marketing efforts and consulting also all decreased primarily as a result of the completion of the VTL-308 clinical trial by $918,000, $697,000, $498,000 and $225,000, respectively. Depreciation expense also decreased by $279,000 in 2018 as compared to 2017, in part due to the impairment loss recorded in 2018.The $0.3 million increase in general and administrative expense during the year ended December 31, 2018 as compared to the year ended December 31, 2017 reflects an increase of $786,000 in outside services, primarily due to strategic marketing efforts in anticipation of the potential commercialization of ELAD, and increases in patent and other legal and securities-related costs of $882,000 including costs for the filing of a shelf registration statement on Form S-3 in the second quarter of 2018 and the subsequent write-off of deferred offering costs as a result of our inability to complete a follow-on offering considering the VTL-308 clinical trial results. These increased costs were largely offset by a $1.5 million decrease in compensation-related costs driven by a $862,000 reduction in stock-based compensation for the reversal of previously recognized expense related to performance-based stock options and a $502,000 reduction in estimated incentive compensation costs both reflecting that our VTL-308 clinical trial did not successfully reach its primary or secondary survival endpoints.As previously reported, we ceased substantially all of our development efforts related to the ELAD System in September 2018. This resulted in a substantial change in the expected use of our long-lived assets and a significant decrease in the benefits expected to be realized from these assets. Accordingly, we recognized an impairment charge of $1.2 million on our property and equipment reflecting the difference in the carrying value of such property and equipment and its estimated fair value, and severance costs of $2.4 million for the related reduction in staff, in the consolidated statement of operations for the year ended December 31, 2018.In conjunction with our review of strategic alternatives and our decision to cease the further development of ELAD, we have significantly reduced our projected monthly cash usage entering into 2019. In addition, we are exploring options to reduce the amount of space we lease to further reduce expenses. The reduction in staff in September 2018 and the cancellation of stock options in January 2019 has also reduced and should reduce reported stock-based compensation in 2019. However, we expect our expenditures will change materially to the extent we enter into any strategic transactions, such as the Transaction with Immunic. For example, the Transaction would be expected to trigger the accelerated vesting of restricted stock unit awards and payments to our officers under severance and control agreements increasing costs. The timing and amount of our actual expenditures will be based on many factors, including, but not limited to, future research and development efforts including such costs incurred by Immunic assuming completion of the Transaction, and any other strategic options that we pursue. |
| | | | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | | | | | Change | | | | | |
| | 2018 | | | | 2017 | | | | $ | | | | % | |
| Operating expenses: | | | | | | | | | | | | | | |
| Research and development | $ | 24,825 | | | $ | 39,341 | | | $ | (14,516 | ) | | (37 | )% |
| General and administrative | 13,585 | | | | 13,314 | | | | 271 | | | | 2 | % |
| Severance Costs | 2,395 | | | | — | | | | 2,395 | | | | 100 | % |
| Impairment Loss | 1,219 | | | | — | | | | 1,219 | | | | 100 | % |
| Total operating expenses | $ | 42,024 | | | $ | 52,655 | | | $ | (10,631 | ) | | (20 | )% |
| IMUX/10-K/0001280776-19-000025 |