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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Fiscal Year Ended June 30, 2012
For the transition period from to
Commission File Number: 001-34593
OBA Financial Services, Inc.
(Name of Registrant as Specified in its Charter)
(Registrants Telephone Number including area code)
Securities Registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
The NASDAQ Stock Market LLC
(Name of exchange on which registered)
Securities Registered Under Section 12(g) of the Exchange Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file reports), and (2) has been subject to such requirements for the past 90 days.
(1) YES x NO ¨
(2) YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) ¨ YES x NO
The aggregate value of the voting common equity held by non-affiliates of the Registrant, computed by reference to the closing price of the Registrants shares of common stock as of December 31, 2011 ($14.34) was $60.3 million.
As of September 19, 2012, there were 4,135,666 shares outstanding of the Registrants common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Proxy Statement for the 2012 Annual Meeting of Stockholders (Part II and III)
OBA FINANCIAL SERVICES, INC.
This report, as well as other written communications made from time to time by OBA Financial Services, Inc., and its subsidiary, OBA Bank, (collectively, the Company) and oral communications made from time to time by authorized officers of the Company, may contain statements relating to the future results of the Company (including certain projections and business trends) that are considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 (the PSLRA). Such forward-looking statements can be identified by the use of words such as estimate, project, believe, intend, anticipate, plan, seek, expect, will, may, potential, and words of similar meaning. These forward-looking statements include, but are not limited to:
The Company cautions that a number of important factors could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Such factors include, but are not limited to:
These forward-looking statements are based on the Companys current beliefs and expectations and are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond the Companys control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Readers are cautioned not to place undue reliance on these forward-looking statements which are made as of the date of this report, and except as may be required by applicable law or regulation, the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the PSLRA.
OBA Financial Services, Inc.
OBA Financial Services, Inc. is a Maryland corporation that owns 100% of the common stock of OBA Bank (Bank). On January 21, 2010, the Company completed its initial public offering of common stock in connection with the mutual-to-stock conversion of OBA Bancorp, MHC, selling 4,628,750 shares of common stock at $10.00 per share and raising $46.3 million of gross proceeds. Since the completion of the initial public offering, the Company has not engaged in any significant business activity other than owning the common stock of and having deposits in the Bank. At June 30, 2012, the Company had consolidated assets of $392.1 million, consolidated deposits of $269.6 million, and consolidated stockholders equity of $75.7 million.
The Companys executive offices are located at 20300 Seneca Meadows Parkway, Germantown, Maryland 20876. The Companys telephone number at this address is (301) 916-0742.
The Bank is a federally chartered savings bank headquartered in Germantown, Maryland. The Bank was organized in 1861, and reorganized into the mutual holding company structure in 2007. The Bank is a wholly-owned subsidiary of OBA Financial Services, Inc. The Bank provides financial services to individuals, families, and businesses through six banking offices located in the Maryland counties of Montgomery, Anne Arundel, and Howard.
The Banks executive offices are located at 20300 Seneca Meadows Parkway, Germantown, Maryland 20876. The Banks telephone number at this address is (301) 916-0742.
OBA Financial Services, Inc. is a public company and files interim, quarterly, and annual reports with the SEC. These respective reports are on file and a matter of public record with the SEC and may be read and copied at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).
The Companys and Banks website address is www.obabank.com. Information on this website should not be considered a part of this annual report.
The Banks business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in commercial real estate, commercial business, and residential mortgage loans, home equity loans and lines of credit, and investment securities. To a lesser extent, the Bank also originates construction loans and other consumer loans. The Bank offers a variety of deposit accounts, including commercial and consumer checking, money market, savings, individual retirement accounts, and certificates of deposit.
The Banks operations are conducted from four full-service branch offices located in Montgomery County, Maryland, which is on the northwest border of Washington, D.C., a full-service branch office located in Howard County, Maryland, and a full-service branch office in Anne Arundel County, Maryland. Government,
professional and business services, and education and health services are the leading industries. Maryland has a larger share of professional, technical, and government jobs and a smaller share of manufacturing jobs than the United States.
The national unemployment rate has dropped from 9.3% to 8.2% from July 2011 to July 2012. The state of Maryland unemployment rate had no significant changes the past 12 months and was at 7.1% for July 2012, down from 7.4% in July 2011. Maryland has a civilian labor force of approximately three million. Unemployment rates for Montgomery and Howard Counties were both at 5.3% for July 2012, showing little variation for the past several quarters. Anne Arundel County was down slightly from 6.8% in July 2011 to 6.6% for July 2012.
Total housing starts in the United States have slowly started to rise and mortgage interest rates continue to be at an all-time low. The average sales price of Maryland homes reported for July 2012 was approximately $307 thousand, showing little change from July 2011. The average sales price of homes in Howard County, Maryland increased to approximately $439 thousand. In Montgomery County, Maryland, the average sales price fell slightly, to approximately $499 thousand. Anne Arundel County, Maryland also showed a slight decrease to approximately $369 thousand.
The Bank faces intense competition in making loans and attracting deposits in the market areas served by the Bank. The Bank competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and investment banking firms. Some competitors have greater name recognition and market presence that benefit them in attracting business and offer certain services that the Bank does not or cannot provide.
The Banks primary lending activities are the origination of commercial real estate, commercial business, and residential mortgage loans, and home equity loans and lines of credit. To a lesser extent, the Bank also originates construction loans and other consumer loans.
Commercial Real Estate Loans. Properties securing the Banks commercial real estate loans primarily include small office buildings, office suites, and churches. The Bank is seeking to originate more loans for business owner-occupied properties. The Bank typically seeks to originate commercial real estate loans with initial principal balances of $2.5 million or less. All of the Banks commercial real estate loans are secured by properties located in the Banks primary market area.
In the underwriting of commercial real estate loans, the Bank generally lends up to the lesser of 80% of the propertys appraised value or purchase price. The credit decision is based primarily on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, the ratio of the propertys projected net cash flow to the loans debt service requirement, generally requiring a minimum ratio of 125%, is emphasized and is computed after deductions for a vacancy factor and property expenses, as deemed appropriate. Personal guarantees are usually obtained from commercial real estate borrowers. The Bank requires title insurance, fire and extended coverage casualty insurance, and, if appropriate, flood insurance, in order to protect the Banks security interest in the underlying property. Almost all of the Banks commercial real estate loans are generated internally by the Banks loan officers.
Commercial Business Loans. The Bank makes secured and unsecured commercial business loans primarily to small and medium sized businesses primarily located in Montgomery, Anne Arundel, and Howard Counties, Maryland. The Bank is well diversified from an industry perspective with no major concentrations in any industry. Commercial business loans, both fixed and adjustable rate, consist of term loans, as well as, closed and open-end lines of credit for the purpose of current asset financing, equipment purchase, working capital, and
other general business purposes. The adjustable-rate is generally indexed to a short-term market rate. The Bank seeks to originate loans with principal balances between $100 thousand and $2.5 million. Generally, the maximum term of a commercial business loan is ten years.
Construction Loans. The Bank makes construction loans for rental properties, commercial buildings, and homes built by developers on speculative, undeveloped property. The terms of commercial construction loans are made in accordance with the Banks commercial loan policy. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction, but are generally limited to an 80% loan-to-completed-appraised-value ratio. Generally, before making a commitment to fund a construction loan, the Bank requires an appraisal of the property by a state-certified or state-licensed appraiser. The Bank reviews and inspects all properties before disbursement of funds during the term of the construction loan. Repayment of construction loans on residential properties is normally expected from the propertys eventual rental income, income from the borrowers operating entity, or the sale of the subject property. In the case of income-producing property, repayment is usually expected from permanent financing upon completion of construction. Construction loans are interest-only loans during the construction period, which generally will not exceed twelve months, and convert to permanent, fully amortizing financing following the completion of construction. The Bank typically provides the permanent mortgage financing on the Banks construction loans on income-producing property.
Residential Mortgage Loans. The Bank offers fixed-rate and adjustable-rate residential mortgage loans with maturities generally up to 30 years. Residential mortgage loans are generally underwritten according to Freddie Mac guidelines. The Bank refers to loans that conform to such guidelines as Conforming Loans. The Bank generally originates both fixed and adjustable rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Federal Housing Finance Agency, which is generally $417 thousand for single-family homes, but is $626 thousand for single-family homes located in the Washington, DC metropolitan area. The Bank also originates loans above the amounts for Conforming Loans, which are referred to as Jumbo Loans. The Banks maximum loan amount for Jumbo Loans is generally $1.0 million. The Bank generally underwrites Jumbo Loans in a manner similar to Conforming Loans. Jumbo Loans are not uncommon in the Banks market area. Loans in excess of $417 thousand are generally originated for retention in the Banks loan portfolio.
The Bank originates loans with loan-to-value ratios up to 95%. The Bank generally requires private mortgage insurance for loans with loan-to-value ratios in excess of 80%. During the year ended June 30, 2012, the Bank did not originate any residential mortgage loans with loan-to-value ratios in excess of 80%. The Bank currently retains the servicing rights on loans sold to generate servicing fee income and cross selling opportunities.
The Bank offers special programs for first-time home buyers and low and moderate-income home buyers. Through the Banks first-time home buyer program, the borrowers could potentially qualify for grant funds which could be applied as a credit towards closing costs. Under the Banks affordable housing program, the Bank waives certain processing and underwriting fees and reduces the appraisal fee for those buyers that meet the programs qualifications, which for calendar year 2012 are: (i) a maximum sales price of $364,650; (ii) a maximum loan amount of $346,418; and (iii) maximum combined income of $89,300.
Other than the Banks loans for the construction of residential mortgage loans and home equity lines of credit, the Bank does not offer interest only mortgage loans on residential properties. An interest only loan is defined as the borrower paying interest only for an initial period, after which the loan converts to a fully amortizing loan. Additionally, the Bank does not offer loans that provide for negative amortization of principal, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. The Bank does not offer subprime loans, loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios, or Alt-A loans, traditionally defined as loans having less than full documentation.
Home Equity Loans and Lines of Credit. Home equity loans and home equity lines of credit are, generally, secured by the borrowers primary residence or secondary residence. The Banks home equity loans are originated with fixed rates of interest and with terms of up to 15 years. Home equity lines of credit have a maximum term of 25 years. The borrower is permitted to draw against the line during the first ten years of the line of credit. During this draw period, repayments are made on an interest-only basis. After this initial ten-year draw period, the borrower is required to make payments to principal based on a 15-year amortization.
The home equity lines of credit are currently originated with adjustable rates of interest. Home equity loans and lines of credit are generally underwritten with the same criteria that are used to underwrite residential mortgage loans. For a borrowers primary residence, home equity loans and lines of credit may be underwritten with a maximum loan-to-value ratio of 75% when combined with the principal balance of the existing mortgage loan, while the maximum loan-to-value ratio on secondary residences and investment properties is 70% when combined with the principal balance of the existing mortgage loan.
The Bank requires appraisals on home equity loans and lines of credit. At the time of closing a home equity loan or line of credit, the Bank records the mortgage to perfect the security interest in the underlying collateral. At June 30, 2012 the Banks self-imposed maximum limit for a home equity loan or a line of credit was generally $200 thousand.
Loan Originations, Purchases, Sales, Participations and Servicing. All loans originated are underwritten pursuant to the Banks policies and procedures, which incorporate standard underwriting guidelines, including those of Freddie Mac, to the extent applicable. The Bank originates both adjustable-rate and fixed-rate loans. Most of the Banks residential mortgage loan originations are generated by the Banks employees located in the Banks branch offices and corporate headquarters.
Historically, the Bank has retained, in portfolio, a majority of originated loans. Going forward, the Bank intends to sell most of the residential mortgage loans it originates, but will retain many of the jumbo residential mortgage loans it originates. Loans sold by the Bank are sold without recourse, except for normal representations and warranties provided in sale transactions. Historically, the Bank has retained the servicing rights on sold residential mortgage loans. The Bank intends to continue this practice, subject to the pricing of retaining servicing rights. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of un-remedied defaults, making certain insurance and tax payments on behalf of the borrowers, and generally administering the loans. The Bank retains a portion of the interest paid by the borrower on the loans serviced as consideration for the servicing activities.
During the fiscal years ended 2012 and 2011, the Bank did not have to repurchase any loans or provide loss reimbursement on loans sold.
From time to time, the Bank enters into participations in commercial loans with other banks. In these circumstances, the Bank will generally follow the Banks customary loan underwriting and approval policies.
Loan Approval Procedures and Authority. The Banks lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the Banks Board of Directors. The loan approval process is intended to assess the borrowers ability to repay the loan and value of the property that will secure the loan. To assess the borrowers ability to repay, the Bank reviews the borrowers employment and credit history and information on the historical and projected income and expenses of the borrower. The Bank requires full documentation on all loan applications.
Management establishes the Banks policies and loan approval limits; which are approved by the Board of Directors. Consumer loans in amounts up to $100 thousand, residential real estate loans up to the Freddie Mac conforming loan limit, and commercial loans up to $2.0 million can be approved by designated individual officers or officers acting together with specific lending approval authority. Relationships in excess of these amounts require the approval of the Board of Directors or its loan committee.
The Bank requires appraisals for all real property securing residential mortgage and commercial real estate loans and home equity loans and lines of credit. All appraisals are performed by state-licensed or state-certified appraisers. The Banks practice is to have local appraisers approved annually by the Board of Directors.
The Banks securities portfolio consists primarily of mortgage-backed securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises that are backed by the full faith and credit of the U.S. government.
The Banks Investment Committee, which is comprised of the Boards Executive Committee and the Banks Chief Financial Officer, has primary responsibility for establishing and overseeing the investment policy. The general investment strategies are developed and authorized by the Investment Committee. The Banks President and the Chief Financial Officer are responsible for the execution of specific investment actions. These officers are authorized to execute investment transactions of up to $1.0 million per transaction without the Investment Committees prior approval provided the transactions are within the scope of the established investment policy. The investment policy is reviewed annually by the Investment Committee and changes to the policy are subject to approval by the full Board of Directors. Investment policy objectives include providing liquidity necessary to conduct business activities of the Bank, collateral for pledging, a portfolio of high credit quality assets, and enhancing profitability within the overall asset/liability management objectives of the Bank. All gains and losses on securities transactions are reported to the Board of Directors on a monthly basis.
The Banks current investment policy permits, among other securities, investments in securities issued by the U.S. Government as well as mortgage-backed securities and direct obligations of Fannie Mae, Freddie Mac and Ginnie Mae. In September 2008, the Federal Housing Finance Agency placed Freddie Mac and Fannie Mae into conservatorship. The U.S. Treasury Department has established financing agreements to ensure that Freddie Mac and Fannie Mae meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed. These actions have not affected the markets for mortgage-backed securities issued by Freddie Mac or Fannie Mae. The Banks current investment policy does not permit investment in stripped mortgage-backed securities or derivatives as defined in federal banking regulations, or in other high-risk securities. The investment policy permits, with certain limitations, investments in certificates of deposit, collateralized mortgage obligations, auction rate/money market preferred securities, and mutual funds, limited to adjustable rate mortgage funds. The policy also permits investments in equity securities, generally limited to agency and Federal Home Loan Bank of Atlanta (FHLBA) common and preferred stock. The Banks investment in equity securities outside the policys general limitation totaled $50 thousand at June 30, 2012 and is not considered material.
The Banks investment policy expressly prohibits the use of the investment portfolio for market-oriented trading activities or speculative purposes unless otherwise approved by the Board of Directors. The Bank does not intend to profit in the investment account from short-term securities price movements. Accordingly, the Bank does not currently have a trading account for investment securities.
Accounting guidance requires that, at the time of purchase, the Bank designate a security as either held to maturity, available-for-sale, or trading, based upon the Banks ability and intent to hold the security. Securities available-for-sale and trading securities are reported at fair value and securities held to maturity are reported at amortized cost. A periodic review and evaluation of the available-for-sale and held-to-maturity securities portfolios is conducted to determine if the fair value of any security has declined below its carrying value and whether such decline is other-than-temporary. The fair values of mortgage-backed securities, which, at June 30, 2012, comprised the significant majority of the investment portfolio, are based on quoted market prices or, when quoted prices in active markets for identical assets are not available, are based on matrix pricing, which is a mathematical technique that relies on the securities relationship to other benchmark quoted prices.
Mortgage-backed securities are securities issued in the secondary market that are collateralized by pools of mortgages. Certain types of mortgage-backed securities are commonly referred to as pass-through certificates because the principal and interest of the underlying loans are passed through to investors, net of certain costs, including servicing and guarantee fees. Mortgage-backed securities typically are collateralized by pools of one- to four-family or multifamily residential mortgages. The Bank invests primarily in mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities pool the loans and resell the participation interests in the form of securities to investors. The interest rate on the security is lower than the interest rates on the underlying loans to allow for payment of servicing and guaranty fees. Ginnie Mae, a U.S. Government agency, and Fannie Mae and Freddie Mac, either guarantee the payments or guarantee the timely payment of principal and interest to investors. Mortgage-backed securities are more liquid than individual mortgage loans since there is an active trading market for such securities. In addition, mortgage-backed securities may be used to collateralize borrowings. Investments in mortgage-backed securities include a risk that actual principal payments will be greater or less than the prepayment rate estimated at the time of purchase, or prepayment risk. The difference in expected cash flow may require adjustments to the amortization of premium or accretion of discount relating to the security, thereby affecting the net yield on the security.
Sources of Funds
General. Deposits traditionally have been the primary source of funds for investment and lending activities. The Bank also borrows from the Federal Home Loan Bank of Atlanta and from securities dealers to supplement cash flow needs, change the maturity of liabilities for interest rate risk management purposes, and manage the Banks cost of funds. Additional sources of funds are scheduled loan payments, maturing investments, loan repayments, customer repurchase agreements, retained earnings, income on other earning assets, and the proceeds of loan sales.
Deposits. The Bank accepts deposits primarily from the areas in which the Banks offices are located. The Bank relies on competitive pricing and products, convenient locations, and quality customer service to attract and retain deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The deposit accounts consist of commercial and consumer checking, money market, savings, individual retirement accounts, and certificates of deposit. The Bank accepts deposits through the Certificate of Deposit Account Registry Service (CDARS) program, which are classified as brokered deposits for regulatory purposes and can accept brokered deposits.
Interest rates paid, maturity terms, service fees, and withdrawal penalties are reviewed and adjusted on a periodic basis by Management and approved by the Banks Asset Liability Committee. Deposit rates and terms are based primarily on current operating strategies, market interest rates, liquidity requirements, and the Banks deposit growth goals.
Borrowings. The Banks borrowings consist of advances from the Federal Home Loan Bank of Atlanta and funds borrowed from securities dealers and customers under repurchase agreements. Advances from the Federal Home Loan Bank of Atlanta are secured by pledged mortgage-backed securities, as well as, a blanket pledge on various categories of assets. Repurchase agreements are generally secured by mortgage-backed securities.
As of June 30, 2012, the Company had 65 full-time employees and four part-time employees. The Companys employees are not represented by any collective bargaining group. Management believes that there is a good working relationship with the Companys employees.
FEDERAL AND STATE TAXATION
General. OBA Financial Services, Inc. and OBA Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to OBA Financial Services, Inc. and OBA Bank.
Method of Accounting. For federal income tax purposes, the Bank files a consolidated tax return with OBA Financial Services, Inc., reports its income and expenses on the accrual method of accounting, and uses a tax year ending June 30th for filing their consolidated federal income tax returns.
Corporate Dividends. OBA Financial Services, Inc. can exclude from its income 100.0% of dividends received from OBA Bank as a member of the same affiliated group of corporations.
Audit of Tax Returns. The Companys federal income tax returns, as applicable, have not been audited in the most recent five-year period.
The State of Maryland imposes an income tax of approximately 8.25% on income measured substantially the same as federally taxable income, except that U.S. Government interest is not fully taxable. The Companys state income tax returns, as applicable, have not been audited in the most recent five-year period.
SUPERVISION AND REGULATION
The Bank is supervised and examined by the Office of the Comptroller of the Currency (OCC) and is subject to examination by the Federal Deposit Insurance Corporation (FDIC). This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDICs deposit insurance funds and depositors, and not for the protection of security holders. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and, sensitivity to market interest rates. The OCC examines the Bank and prepares reports on any operating deficiencies for the consideration of its Board of Directors. The Bank also is a member of and owns stock in the Federal Home Loan Bank of Atlanta, which is one of the twelve regional banks in the Federal Home Loan Bank System. The Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System (the FRB), governing reserves to be maintained against deposits and other matters. The Banks relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a much lesser extent, state law, especially in matters concerning the ownership of deposit accounts and the form and content of the Banks loan documents.
Any change in these laws or regulations, whether by the FDIC, the OCC, or Congress, could have a material adverse impact on the Company, and its operations.
OBA Financial Services, Inc., as a savings and loan holding company, is required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the Federal Reserve Board. The Company is also subject to the rules and regulations of the SEC under the federal securities laws.
Certain of the regulatory requirements that are applicable to OBA Bank and OBA Financial Services, Inc. are described below. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on OBA Bank and OBA Financial Services, Inc., and is qualified in its entirety by reference to the actual statutes and regulations.
The Dodd-Frank Act has changed bank regulatory structure and affected the lending, investment, trading, and operating activities of financial institutions and their holding companies. The Dodd-Frank Act eliminated the Companys former primary federal regulator, the Office of Thrift Supervision (OTS) and required the Bank to be regulated by the OCC, the primary federal regulator for national banks, as of July 21, 2011. The Dodd-Frank Act also authorizes the FRB to supervise and regulate all savings and loan holding companies in addition to the bank holding companies that it previously regulated. The Dodd-Frank Act also requires the FRB to set minimum capital levels for depository institution holding companies that are as stringent as those required for the insured depository subsidiaries. Additionally, the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. Bank holding companies with assets of less than $500 million are exempt from these capital requirements. The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect when the statute was enacted, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act also created the Consumer Financial Protection Bureau (CFPB) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit unfair, deceptive or abusive acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will continue to be examined for compliance by their applicable bank regulators. The legislation also weakened the federal preemption available for national banks and federal savings associations, and gave state attorneys general the ability to enforce applicable federal consumer protection laws.
The legislation also broadened the base for FDIC insurance assessments. Assessments are now based on an institutions average consolidated total assets less tangible equity capital. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250 thousand per depositor, retroactive to January 1, 2009, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called golden parachute payments and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a companys proxy materials. The legislation directed the FRB to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. The Dodd-Frank Act provided for originators of certain securitized loans to retain a percentage of the risk for transferred loans, directed the FRB to regulate pricing of certain debit card interchange fees and contained a number of reforms related to mortgage origination.
Federal Banking Regulation
Business Activities. A federal savings bank derives its lending and investment powers from the Home Owners Loan Act, as amended and federal regulations. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities, and certain other assets, subject to applicable limits. The Bank also may establish subsidiaries that may engage in activities not otherwise permissible for the Bank, including real estate investment and securities and insurance brokerage.
Capital Requirements. Federal regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio.
The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a savings bank that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the purchasers recourse against the savings bank. In assessing an institutions capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary.
On June 6, 2012, the OCC and the other federal bank regulatory agencies issued a series of proposed rules to revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to make them consistent with the agreements that were reached by the Basel Committee on Banking Supervision in Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (Basel III). The proposed rules would apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (banking organizations). Among other things, the proposed rules establish a new common equity tier 1 minimum capital requirement and a higher minimum tier 1 capital requirement, and assign higher risk weightings (150%) to exposures that are more than 90 days past due or are on nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or construction of real property. The proposed rules also limit a banking organizations capital distributions and certain discretionary bonus payments if the banking organization does not hold a capital conservation buffer consisting of a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rules will become effective on January 1, 2013, and the changes set forth in the final rules will be phased in from January 1, 2013 through January 1, 2019.
At June 30, 2012, the Banks capital exceeded all applicable requirements.
Loans-to-One Borrower. Generally, a federal savings bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate.
Qualified Thrift Lender Test. As a federal savings bank, the Bank must satisfy the qualified thrift lender test (QTL). Under the QTL, the Bank must maintain at least 65% of its portfolio assets in qualified thrift investments, primarily residential mortgages and related investments, including mortgage-backed securities, in at least nine months of the most recent 12-month period. Portfolio assets generally mean total assets of a savings bank, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the Banks business. The Bank also may satisfy the QTL by
qualifying as a domestic building and loan association as defined in the Internal Revenue Code. A savings bank that fails the QTL is subject to certain operating restrictions. In addition, the Dodd-Frank Act made noncompliance with the QTL potentially subject to agency enforcement action for violation of laws.
Capital Distributions. Federal regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the savings banks capital account. A savings bank must file an application for approval of a capital distribution if:
Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a regulatory notice at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
Such a notice or application may be disapproved if:
In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution, if after making such distribution the institution would be undercapitalized.
Liquidity. A federal savings bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. The Banks primary source of liquidity to meet short- and long-term funding needs are cash balances at the Federal Reserve Bank, deposits, loan repayments, repurchase agreements with security dealers, and borrowing lines at the Federal Home Loan Bank of Atlanta.
Community Reinvestment Act and Fair Lending Laws. All federal savings banks have a responsibility under the Community Reinvestment Act and related federal regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a federal savings bank, the OCC is required to assess the savings banks record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A savings banks failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by regulators and the Department of Justice. The Bank received an outstanding Community Reinvestment Act rating in its most recent federal examination. The Community Reinvestment Act requires all Federal Deposit Insurance-insured institutions to publicly disclose their rating.
Transactions with Related Parties. A federal savings banks authority to engage in transactions with its affiliates is limited by federal regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementation of Regulation W promulgated by the Board of Governors of the Federal Reserve System. An affiliate is generally a company that controls, is controlled by, or is under common control with an insured
depository institution such as the Bank. OBA Financial Services, Inc. is an affiliate of OBA Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative and collateral requirements. In addition, federal regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates. Federal regulations require savings banks to maintain detailed records of all transactions with affiliates.
The Banks authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders:
In addition, extensions of credit in excess of certain limits must be approved by the Banks Board of Directors.
Enforcement. The OCC has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all institution-affiliated parties, including directors, officers, stockholders, attorneys, appraisers, and/or accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on a federal savings bank. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution, and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25 thousand per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Prompt Corrective Action Regulations. Under prompt corrective action regulations, the OCC is authorized and, under certain circumstances, required to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the savings banks capital:
Generally, the OCC is required to appoint a receiver or conservator for a savings bank that is critically undercapitalized within specific time frames. The regulations also provide that a capital restoration plan must be filed with the OCC within 45 days of the date a savings bank receives notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. Any holding company of the savings bank that is required to submit a capital restoration plan must guarantee the lesser of an amount equal to 5% of the savings banks assets at the time it was notified or deemed to be undercapitalized by the OCC, or the amount necessary to restore the savings bank to adequately capitalized status. This guarantee remains in place until the OCC notifies the savings bank that it has maintained adequately capitalized status for each of four consecutive calendar quarters. Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the savings bank, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized savings banks, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At June 30, 2012, the Bank met the criteria for being considered well-capitalized.
Insurance of Deposit Accounts. The Deposit Insurance Fund (DIF) of the FDIC insures deposits at FDIC-insured depository institutions, such as the Bank. Deposit accounts in the Bank are insured by the FDIC; generally up to a maximum of $250 thousand per separately insured depositor and up to a maximum of $250 thousand for self-directed retirement accounts. The Dodd-Frank Act also extended unlimited deposit insurance on noninterest bearing transaction accounts through December 31, 2012.
The FDIC charges insured depository institutions premiums to maintain the DIF. Under the FDICs risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels, and certain other risk factors. Rates are based on each institutions risk category and certain specified risk adjustments. Stronger institutions pay lower rates while riskier institutions pay higher rates. Assessment rates range from 2.5 to 45 basis points of an institutions total assets less tangible capital.
The Dodd-Frank Act increased the minimum target ratio for the Deposit Insurance Fund from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The Federal Deposit Insurance Corporation must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the Federal Deposit Insurance Corporation and the Federal Deposit Insurance Corporation has exercised that discretion by establishing a long-term fund ratio of 2%.
In addition to the FDIC assessments, the Financing Corporation (FICO) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs, and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2012, the annualized FICO assessment was equal to 66 basis points of an institutions total assets less tangible capital.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order, or condition imposed by the FDIC. The Bank does not know of any practice, condition, or violation that could lead to termination of its deposit insurance.
Prohibitions Against Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank.
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Banks operations are also subject to federal laws applicable to credit transactions, such as the:
The operations of the Bank also are subject to the:
Holding Company Regulation
General. OBA Financial Services, Inc. is a non-diversified savings and loan holding company within the meaning of the Home Owners Loan Act. As such, the Company is registered with the FRB and subject to FRB regulations, examinations, supervision, and reporting requirements. In addition, the FRB has enforcement authority over the Company and its subsidiaries. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
The functions of the OTS relating to savings and loan holding companies and their subsidiaries, as well as rulemaking and supervision authority over savings and holding companies, were transferred to the FRB on July 21, 2011, as required by the Dodd-Frank Act.
Permissible Activities. The business activities of the Company are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to prior regulatory approval and certain additional activities authorized by federal regulations.
Federal law prohibits a savings and loan holding company, including the Company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a non-subsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the FRB must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The FRB is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital, which is currently permitted for bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.
Source of Strength. The Dodd-Frank Act extended the source of strength doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
Dividends and Repurchases. The FRB has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organizations capital needs, asset quality, and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the Companys net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the Companys overall rate of earnings retention is inconsistent with the Companys capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The policy statement also provides for regulatory review prior to a holding Company redeeming or repurchasing regulatory capital instruments when the holding company is experiencing financial weaknesses or redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of a quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies could affect the ability of the Company to pay dividends, repurchase shares of common stock, or otherwise engage in capital distributions.
Acquisition. Under the Federal Change in Control Act, a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire direct or indirect control of a savings and loan holding company. Under certain circumstances, such as where the company involved has securities registered with the SEC under the Securities Exchange Act of 1934, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the companys outstanding voting stock, unless the FRB has found that the acquisition will not result in control of the company. That rebuttable presumption applies to the Company. A change in control is defined under federal law to occur upon the acquisition of 25% or more of the companys outstanding voting stock. Under the Change in Control Act, the FRB generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.
Federal Securities Laws
The Companys common stock is registered with the SEC under the Securities Exchange Act of 1934. The Company is subject to the information, proxy solicitation, insider trading restrictions and, other requirements under the Securities Exchange Act of 1934.
OBA Financial Services, Inc. common stock held by persons who are affiliates (generally officers, directors and principal shareholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, the Companys Chief Executive Officer and Chief Financial Officer are required to certify that the Companys quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the SEC under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Companys internal control over financial reporting; they have made certain disclosures to the Companys auditors and the audit committee of the Board of Directors about the Companys internal control over financial reporting; and they have included information in the Companys quarterly and annual reports about their evaluation and whether there have been changes in the Companys internal control over financial reporting or in other factors that could materially affect internal control over financial reporting. The Company was subject to further reporting requirements beginning with the fiscal year ended June 30, 2011 under the requirements of the Sarbanes-Oxley Act. The Company has prepared policies, procedures and systems designed to ensure compliance with these regulations.
Readers should carefully consider the following risks prior to making an investment decision regarding OBA Financial Services, Inc. The following risk factors may cause future earnings to be lower or the financial condition less favorable than Management expects. In addition, other risks of which Management is not currently aware or which Management does not believe to be material, may cause earnings to be lower or may cause the financial condition to be worse than expected. Please consider all information contained within this Annual Report on Form 10-K, as well as, the documents incorporated by reference.
The Company intends to continue its emphasis on commercial real estate and commercial business loan originations. Credit risk will increase and a continued downturn in the local real estate market or the local or national economy could adversely affect earnings.
The Company intends to continue its recent emphasis on originating commercial real estate and commercial business loans. Commercial real estate and commercial business loans generally have more risk than residential mortgage loans that the Bank originates. Because the repayment of commercial real estate and commercial business loans depends on the successful management and operation of the borrowers properties or related businesses, repayment of such loans can be affected by adverse conditions in the local real estate market or economy. Commercial real estate and commercial business loans may also involve relatively large loan balances to individual borrowers or groups of related borrowers. A downturn in the real estate market or the local economy could adversely affect the value of properties securing the loan or the revenues from the borrowers business, thereby increasing the risk of nonperforming loans. As the Companys commercial real estate and commercial business loan portfolios increase, the corresponding risks and potential for losses from these loans may also increase. This increasing risk has contributed to the Companys need to increase the allowance for loan losses through charges to earnings. Future increases in commercial real estate loans and commercial loans may require additional increases in the Companys allowance for loan losses through charges to earnings.
The Company continues to originate and retain in its portfolio some residential mortgage loans. A continued downturn in the local real estate market and economy could adversely affect earnings.
The Company has continued its origination and retention of some of those loans in the residential mortgage loan portfolio. Although the local real estate market and economy have performed better than many other markets, a continued downturn could cause higher unemployment, more delinquencies, and could adversely affect the value of properties securing loans. In addition, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on the Companys financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
A portion of the commercial business loan portfolio is unseasoned.
The Company has grown its commercial business loan portfolio to $32.0 million, or 10.8%, of the total loan portfolio, at June 30, 2012 from $5.7 million, or 1.9% of the total loan portfolio, at June 30, 2008. The future performance of this portion of the loan portfolio is difficult to assess due to the general unseasoned nature of the portfolio. These loans may have delinquency or charge-off levels above the Companys historical experience, which could adversely affect future performance.
If the Companys allowance for loan losses is not sufficient to cover actual loan losses, earnings could be adversely affected.
The Company makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of the Companys borrowers and the value of the real estate and other assets serving as collateral for the repayment of the Companys loans. In determining the amount of the allowance for loan losses, Management reviews the loans and the loss and delinquency experience, and evaluates economic conditions. If the assumptions are incorrect, the allowance for loan losses may not be sufficient to cover probable incurred losses in the Companys loan portfolio, resulting in additions to the allowance through charges to earnings. Material additions to the allowance could materially decrease the Companys net income. In addition, bank regulators periodically review the Companys allowance for loan losses and may require the Company to increase the allowance for loan losses or recognize further loan charge-offs. Any increase in the allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on the Companys financial condition and results of operations.
The Companys branch network expansion strategy may negatively affect the Companys financial performance.
The Company intends to expand its branch network over the next five years. This strategy may not generate earnings, or may not generate earnings within a reasonable period of time. Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel, and an effective marketing strategy. Additionally, a new branch takes time to originate sufficient loans and generate sufficient deposits to produce enough income to offset expenses, some of which, like salaries and occupancy expense, are relatively fixed costs.
Concentration of loans in the Companys primary market area, which has recently experienced an economic downturn, may increase risk.
The Companys success depends primarily on the general economic conditions in Howard and Montgomery Counties, Maryland as nearly all of the Companys loans are to customers in these markets. Accordingly, the local economic conditions in these markets have a significant impact on the ability of borrowers to repay loans as well as the Companys ability to originate new loans. As such, a further decline in real estate values in these markets would also lower the value of the collateral securing loans on properties in these markets. In addition, a continued weakening in general economic conditions, such as; inflation, recession, unemployment, or other factors beyond the Companys control could negatively affect financial results.
The Companys 2011 Equity Incentive Plan will increase expenses and reduce income.
In May 2011, the Companys stockholders approved the OBA Financial Services, Inc. 2011 Equity Incentive Plan. Stockholders approved the issuance of a total of 648,025 shares under the plan. Grants under the plan were issued on July 21, 2011 as described in the Companys Current Report on Form 8-K as filed with the SEC on May 17, 2011. Subsequent periods included expenses for the 2011 equity incentive plan which reduced income.
The implementation of the 2011 Equity Incentive Plan may dilute stockholders ownership interest.
The Companys 2011 Equity Incentive Plan will be funded through either open market purchases of shares of common stock or from the issuance of authorized but unissued shares of common stock. The ability to repurchase shares of common stock to fund the plan will be subject to many factors, including, but not limited to, applicable regulatory restrictions on stock repurchases, the availability of stock in the market, the trading price of the stock, alternative uses for the capital, and the Companys capital levels and financial performance. Although the Companys current intention is to fund the plan with stock repurchases, the Company may not be able to conduct such repurchases. If the Company does not repurchase shares of common stock to fund the plan, then stockholders would experience a reduction in their ownership interest, which would total 12.3% in the event newly issued shares are used to fund stock options or awards of shares of common stock under the plan.
If the Companys investment in the common stock of the Federal Home Loan Bank of Atlanta is classified as other-than-temporarily impaired, the Companys earnings and stockholders equity could decrease.
The Company owns stock of the Federal Home Loan Bank of Atlanta (FHLBA), which is part of the Federal Home Loan Bank system. The FHLBA common stock is held to qualify for membership in the FHLBA and to be eligible to borrow funds under the FHLBAs advance programs. There is no market for FHLBA common stock.
Although the FHLBA is not reporting current operating difficulties, it is possible that the capital of the Federal Home Loan Bank system, including the FHLBA, could be substantially diminished. This could occur with respect to an individual Federal Home Loan Bank due to the requirement that each Federal Home Loan Bank is jointly and severally liable along with the other Federal Home Loan Banks for the consolidated obligations issued through the Office of Finance, a joint office of the Federal Home Loan Banks, or due to the merger of a Federal Home Loan Bank experiencing operating difficulties into a stronger Federal Home Loan Bank. Consequently, there continues to be a risk that the Companys investment in FHLBA common stock could be deemed other-than-temporarily impaired at some time in the future, and if this occurs, it would cause the Companys earnings and stockholders equity to decrease by the impairment charge.
Strong competition within the Companys market areas may limit the Companys growth and profitability.
Competition in the banking and financial services industry is intense. In the Companys market areas, the Company competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that the Company does not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively, which could affect the Companys ability to grow and remain profitable on a long-term basis. The Companys profitability depends upon the continued ability to successfully compete in the Companys market areas. If interest rates paid on deposits increase or interest rates charged on loans decrease, net interest margin and profitability could be adversely affected. For additional information see Item 1. BusinessCompetition.
The expiration of unlimited Federal Deposit Insurance Corporation insurance on certain non-interest-bearing transaction accounts may increase the Companys costs and reduce the Companys liquidity levels.
On December 31, 2012, unlimited FDIC insurance on certain non-interest bearing transaction accounts is scheduled to expire. Unlimited insurance coverage does not apply to money market deposit accounts or negotiable order of withdrawal accounts. The reduction in FDIC insurance on other types of accounts to the standard $250,000 maximum amount may cause depositors to place such funds in fully insured interest bearing accounts, which would increase the Companys costs of funds and negatively affect the Companys results of
operations, or may cause depositors to withdraw their deposits and invest uninsured funds in investments perceived as being more secure. This may reduce the Companys liquidity, or require the Company to pay higher interest rates to maintain its liquidity by retaining deposits.
Future changes in interest rates could reduce profits.
The Companys ability to make a profit largely depends on net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
Net interest income is affected by changes in market interest rates because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. In a period of rising interest rates, the interest income earned on assets, such as loans and investments, may not increase as rapidly as the interest paid on liabilities, such as deposits causing a reduction in net interest income. In a period of declining interest rates, the interest income earned on assets may decrease more rapidly than the interest paid on liabilities causing a reduction in net interest income.
Changes in market interest rates create reinvestment or prepayment risk, which is the risk that the Bank receives an amount of cashflows inconsistent with original estimates. In a declining rate environment, the risk is that Management may not be able to reinvest additional prepayments at interest rates that are comparable to the interest rates earned on the prepaid loans or securities. In an increasing rate environment, loan demand may decrease, the repayment of adjustable-rate loans may be more difficult for borrowers, and a decrease in prepayments may result in a lost opportunity to reinvest those additional cash flows at higher yields.
Changes in interest rates also affect the current fair value of interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates.
See Managements Discussion and Analysis of Financial Condition and Results of OperationsManagement of Market Risk.
Government responses to economic conditions may adversely affect operations, financial condition and earnings.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has changed the bank regulatory framework, created an independent consumer protection bureau that has assumed the consumer protection responsibilities of the various federal banking agencies, and established more stringent capital standards for banks and bank holding companies. Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations. Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of the Dodd-Frank Act and regulatory actions, may adversely affect the Companys operations by restricting its business activities, including the ability to originate or sell loans, modify loan terms, or foreclose on property securing loans. These risks could affect the performance and value of the Banks loan and investment securities portfolios, which also would negatively affect financial performance. In addition, the Dodd-Frank Act and implementing regulations are likely to have a significant effect on the financial services industry, which are likely to increase operating costs and reduce profitability. Regulatory or legislative changes could make regulatory compliance more difficult or expensive, and could cause changes to or limits on some products and services, or the way business is operated.
If the Board of Governors of the Federal Reserve System increases the federal funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering the Banks operating costs, could have a significant negative effect on the Banks borrowers, especially business borrowers, and the values of underlying collateral securing loans, which could negatively affect the Banks financial performance.
The Company is subject to extensive regulatory oversight.
The Company is subject to extensive regulation and supervision. Regulators have intensified their focus on bank lending criteria and controls, and on the USA PATRIOT Acts anti-money laundering and Bank Secrecy Act compliance requirements. There also is increased scrutiny of compliance practices generally and particularly with the rules enforced by the Office of Foreign Assets Control. The Companys failure to comply with these and other regulatory requirements could lead to, among other remedies, administrative enforcement actions and legal proceedings.
The Companys stock value may be negatively affected by federal regulations that restrict takeovers.
For three years following the Companys stock offering, federal regulations prohibit any person from acquiring or offering to acquire more than 10% of the Companys common stock without prior written regulatory approval.
The corporate governance provisions in the Companys articles of incorporation and bylaws, the Banks Charter, and the corporate governance provisions under Maryland law, may prevent or impede the holders of the Companys common stock from obtaining representation on the Companys Board of Directors and may impede takeovers of the company that the board might conclude are not in the best interest of the Company or its stockholders.
Provisions in the Companys articles of incorporation and bylaws may prevent or impede holders of the Companys common stock from obtaining representation on the Companys Board of Directors and may make takeovers of the Company more difficult. For example, the Companys Board of Directors is divided into three staggered classes. A classified board makes it more difficult for stockholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. The Companys articles of incorporation include a provision that no person will be entitled to vote any shares of the Companys common stock in excess of 10% of the Companys outstanding shares of common stock. This limitation does not apply to the purchase of shares by a tax-qualified employee stock benefit plan established by the Company. In addition, the Companys articles of incorporation and bylaws restrict who may call special meetings of stockholders and how directors may be removed from office. The charter of the Bank generally provides that for a period of five years from the closing of the stock offering, no person other than the Company may directly or indirectly acquire or offer to acquire the beneficial ownership of more than 10% of any class of equity security of the Bank. In addition, during this five-year period, all shares owned over the 10% limit may not be voted on any matter submitted to stockholders for a vote. Additionally, in certain instances, the Maryland General Corporation Law requires a supermajority vote of stockholders to approve a merger or other business combination with a large stockholder, if the proposed transaction is not approved by a majority of the Companys Board of Directors.
The requirement to account for certain assets at estimated fair value may adversely affect results of operations.
The Company reports certain assets, including securities, at fair value. Generally, for securities that are reported at fair value, the Company uses quoted market prices or valuation models that utilize observable market inputs to estimate fair value. Because these assets are carried on the Companys books at their estimated fair value, the Company may record losses even if the asset in question presents minimal credit risk.
Because the nature of the financial services business involves a high volume of transactions, the Bank may face significant operational risks.
The Company operates in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from the Companys operations, including but not limited to, the risk of fraud by employees or persons outside the company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action, and suffer damage to the Companys reputation.
Risks associated with system failures, interruptions, or breaches of security could negatively affect the Companys earnings.
Information technology systems are critical to the Companys business. The Bank uses various technology systems to manage customer relationships, the general ledger, securities, deposits, and loans. The Bank has established policies and procedures to prevent or limit the impact of system failures, interruptions, and security breaches, but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of the Banks systems could deter customers from using the Banks products and services. Although the Bank relies on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect the Banks systems from compromises or breaches of security.
In addition, the Bank outsources a majority of the data processing to certain third-party providers. If these third-party providers encounter difficulties, or if the Bank has difficulty communicating with them, the Banks ability to adequately process and account for transactions could be affected, and the Banks business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption, or breach of security could damage the Banks reputation and result in a loss of customers and business thereby subjecting the Bank to additional regulatory scrutiny, or could expose the Bank to litigation and possible financial liability. Any of these events could have a material adverse effect on the Banks financial condition and results of operations.
The ratings downgrade of the United States Government may adversely affect the Company.
In July 2011, certain rating agencies placed the United States governments long-term sovereign debt rating on their equivalent of negative watch and announced the possibility of a credit rating downgrade. In August 2011, one rating agency deceased their rating of the United States Government to AA+. The rating agencies, due to constraints related to the rating of the United States, also placed government-sponsored enterprises on negative watch. A downgrade of the United States credit rating would trigger a similar downgrade in the credit rating of these government-sponsored enterprises. Furthermore, the credit rating of other entities, such as state and local governments, may be downgraded if the United States credit rating is downgraded. The impact that these credit rating downgrades may have on the national and local economy and the Companys financial condition and results of operations is uncertain.
Historically low interest rates may adversely affect the Companys net interest income and profitability.
The Federal Reserve Board has recently maintained interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a general matter, the Companys interest-bearing liabilities reprice or mature more quickly than its interest-earning assets. This has resulted in increases in net interest income in the short term. The Companys ability to lower its interest expense is limited at these interest rate levels while the average yield on its interest-earning assets may continue to decrease. The FRB has indicated its intention to maintain low interest rates through late 2014. Accordingly, the Companys net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may decrease, which may have an adverse affect on its profitability.
The Bank operates from a main office and three full-service branches located in Montgomery County, a full-service branch located in Howard County, Maryland, and a full-service branch located in Anne Arundel County, Maryland. The following table sets forth information with respect to the Companys full-service banking offices, including the expiration date of leases with respect to leased facilities.
At June 30, 2012, the Company was not involved in any legal proceedings the outcome of which the Company believes would be material to its financial condition or results of operations.
(a) Market, Holder and Dividend Information. The Companys common stock is traded on the NASDAQ Capital Market under the symbol OBAF. The approximate number of holders of record of OBA Financial Services, Inc.s common stock as of September 25, 2012 was 837. Certain shares of OBA Financial Services, Inc. are held in nominee or street name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for OBA Financial Services, Inc.s common stock for the past two fiscal years. The following information with respect to trading prices was provided by the NASDAQ Capital Market.
Dividend payments by OBA Financial Services, Inc. are dependent on dividends it receives from OBA Bank, because OBA Financial Services, Inc. has no source of income other than dividends from OBA Bank, earnings from the investment of proceeds from the sale of shares of common stock retained by OBA Financial Services, Inc. and interest payments with respect to OBA Financial Services, Inc.s loan to the Employee Stock Ownership Plan. See Item 1. BusinessSupervision and RegulationFederal Banking RegulationCapital Distributions.
(d) Securities Authorized for Issuance Under Equity Compensation Plans. The following table sets forth the information as of June 30, 2012 with respect to compensation plans (other than the Companys employee stock ownership plan) under which equity securities of the registrant are authorized for issuance.
(e) Stock Repurchases. The following table sets forth information in connection with repurchases of the Companys shares of common stock during the periods listed. On March 16, 2012, the Board of Directors authorized the repurchase of up to 208,294 shares, or 5% of the Companys common stock outstanding at the completion of the Companys initial repurchase program approved on May 19, 2011. For that initial program, the Board of Directors previously authorized the repurchase of 462,875 shares, or 10% Companys common stock. The repurchase authorization has no expiration date.
(f) Stock Performance Graph. Not applicable.
The following selected consolidated financial and other data has been derived, in part, from the consolidated financial statements and notes appearing elsewhere in this annual report.
The principal objective of this financial review is to provide an overview of the consolidated financial condition and results of operations of OBA Financial Services, Inc. and its subsidiary, OBA Bank. This discussion and tabular presentations should be read in conjunction with the accompanying Consolidated Financial Statements and Notes, as well as, other information contained herein.
Overview of Income and Expenses
The Company has two primary sources of pre-tax income. Net interest income is the difference between interest income, which is the income the Company earns on its loans and investments, and interest expense, which is the interest the Company pays on its deposits and borrowings.
Non-interest income is the compensation received from providing products and services and from other income. Non-interest income is primarily earned from service charges on deposit accounts, loan servicing fees, and bank owned life insurance income. The Company also earns income from the sale of residential mortgage loans and other fees and charges.
The Company recognizes gains or losses as a result of the sale of investment securities, foreclosed property, and premises and equipment. In addition, the Company recognizes losses on its investment securities that are considered other-than-temporarily impaired. Gains and losses are not a regular part of the Companys primary sources of income.
The expenses the Company incurs in operating its business consist of salaries and employee benefits, occupancy and equipment expense, external processing fees, FDIC assessments, Director fees, and other non-interest expenses.
Salaries and employee benefits expense consists primarily of the salaries and wages paid to employees, stock based compensation, payroll taxes, and expenses for health care, retirement, and other employee benefits.
Occupancy expenses, which are fixed or variable costs associated with premises and equipment, consist primarily of lease payments, real estate taxes, depreciation charges, maintenance, and cost of utilities.
Equipment expense includes expenses and depreciation charges related to office and banking equipment.
External processing fees are paid to third parties primarily for data processing services.
Other expenses include expenses for professional services, including, but not limited to, legal, accounting and consulting services, advertising and marketing, charitable contributions, insurance, office supplies, postage, telephone, and other miscellaneous operating expenses.
Critical Accounting Policies and Estimates
The Notes to the Consolidated Financial Statements contain a summary of the Companys significant accounting policies, including a discussion of recently issued accounting pronouncements. These policies, as well as, estimates made by Management, are integral to the presentation of the Companys operations and financial condition. These accounting policies require that Management make highly difficult, complex, or subjective judgments and estimates at times regarding matters that are inherently uncertain or susceptible to change. Management has discussed these significant accounting policies, the related estimates, and its judgments with the Audit Committee of the Board of Directors. Additional information regarding these policies can be found in the Notes to the Consolidated Financial Statements.
Discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements of the Company, which are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of any contingent assets and liabilities for the reporting periods. Management evaluates estimates on an on-going basis and bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.
Management believes the following critical accounting policies require the most significant judgments and estimates used in preparation of the financial statements:
Allowance for Loan Losses. Management maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the statement of condition date. Managements determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss rates for each loan group and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, or an estimate of the value of collateral. Based on the estimate of the level of allowance for loan losses required, Management records a provision for loan losses to maintain the allowance for loan losses at an appropriate level.
The determination of the allowance for loan losses is based on Managements current judgments about the loan portfolio credit quality and Managements consideration of all known relevant internal and external factors that affect loan collectability, as of the reporting date. Management cannot predict with certainty the amount of loan charge-offs that will be incurred. Management does not currently determine a range of loss with respect to the allowance for loan losses. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Companys allowance for loan losses. Such agencies may require that Management recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Accordingly, actual results could differ from those estimates.
Deferred Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be used. The recoverability of deferred tax assets is dependent upon future taxable income.
Other-Than-Temporary Impairment. In estimating other-than-temporary impairment of investment securities, securities are evaluated periodically, and at least quarterly, to determine whether a decline in their value is other than temporary.
Management considers numerous factors when determining whether potential other-than-temporary impairment exists and the period over which a debt security is expected to recover. The principal factors considered are the length of time and the extent to which the fair value has been less than the amortized cost basis, the financial condition of the issuer (and guarantor, if any), any adverse conditions specifically related to the security, industry, or geographic area, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of a security by a rating agency, and the presence of credit enhancements, if any, including the guarantee of the federal government or any of its agencies.
For debt securities, other-than-temporary impairment is considered to have occurred if Management intends to sell the security, Management will, more likely than not, be required to sell the security before recovery of its amortized cost basis, or the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. In determining the present value of expected cash flows, Management discounts the expected cash flows at the effective interest rate implicit in the security at the date of acquisition or, for debt securities that are
beneficial interests in securitized financial assets, at the current rate used to accrete the beneficial interest. In estimating cash flows expected to be collected, Management uses available information with respect to security prepayment speeds, expected deferral rates and severity, whether subordinated interests, if any, are capable of absorbing estimated losses and the value of any underlying collateral.
Total assets increased $5.6 million, or 1.5%, to $392.1 million at June 30, 2012 from $386.4 million at June 30, 2011. For the fiscal year ended June 30, 2012, the Company had net income of $268 thousand, or $0.07 basic and diluted earnings per share, compared to net income of $857 thousand, or $0.20 basic and diluted earnings per share, for the fiscal year ended June 30, 2011. Net interest margin, the percentage of net interest income to average interest-earning assets, decreased to 3.59% for the fiscal year ended June 30, 2012 from 3.70% for the fiscal year ended June 30, 2011. Net interest income, the difference between interest income and interest expense, increased $262 thousand to $12.3 million for the fiscal year ended June 30, 2012 from $12.0 million for the fiscal year ended June 30, 2011.
Non-performing assets totaled $6.1 million or 1.55% of total assets at June 30, 2012, compared to $5.4 million or 1.40% of total assets at June 30, 2011. The Bank had $6.1 million of loans delinquent 30 days or greater at June 30, 2012, compared to $2.7 million of such delinquencies at June 30, 2011. In addition, the Bank provided $1.1 million for loan losses during the fiscal year ended June 30, 2012 compared to a provision for loan losses of $739 thousand during the fiscal year ended June 30, 2011, or an increase of $346 thousand.
Balance Sheet Analysis
Cash and Cash Equivalents. At June 30, 2012 and 2011, the Company had $31.5 million and $38.0 million of cash and cash equivalents, respectively. The reduction in cash and cash equivalents was primarily due to an increase in loans and a decrease in borrowings partially offset by an increase in total deposits and a decrease in the securities portfolio.
Loans. At June 30, 2012, total loans were $296.2 million, or 75.6% of total assets. During the year ended June 30, 2012, the loan portfolio increased $14.4 million, or 5.1%, as compared to $281.9 million, or 72.9% of total assets at June 30, 2011. The increase in loans was primarily due to an increase in commercial real estate loans partially offset by decreases in residential mortgage loans and home equity loans and lines of credit.
Loan Portfolio Composition. The following table sets forth the composition of the Companys loan portfolio at the dates indicated.
Loan Portfolio Maturities. The following table summarizes the scheduled repayments of the June 30, 2012 loan portfolio at the dates indicated. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at the date indicated:
Securities. The following table sets forth the amortized cost and estimated fair value of the available for sale and held to maturity securities portfolios, excluding Federal Home Loan Bank of Atlanta common stock, at the dates indicated.
All of the Banks mortgage-backed securities are backed by United States Government Agencies with the full faith and credit of the United States Government including Federal National Mortgage Association, Federal Home Loan Mortgage Corporation or Government National Mortgage Association. Total mortgaged-backed securities decreased $2.6 million, or 6.6%, to $36.9 million, or 9.4% of total assets, at June 30, 2012 from $39.5 million, or 10.2% of total assets, at June 30, 2011. The decrease in the investment portfolio is primarily due to the prepayments on securities within the portfolio and using those cash flows to partially fund the increase in the loan portfolio and reduction in the Banks borrowings. The net unrealized gains on individual residential mortgage-backed securities as of June 30, 2012 and 2011 were the result of changes to current market interest rates as compared to the original purchase yield of the securities. At June 30, 2012 and 2011, the Bank had no mortgage-backed securities with unrealized losses.
The Bank currently owns one immaterial position in an insurance company-backed pooled trust preferred security that is performing as contractually obligated.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at June 30, 2012 are summarized in the following table. Maturities are based on the final contractual maturity dates and do not reflect the impact of repayments or early redemptions that may occur. No tax-equivalent adjustments have been made, as the Bank did not hold any tax-advantaged investment securities at June 30, 2012.
Deposits. The Bank accepts deposits primarily from the areas in which the Banks offices are located. Managements focus is building broader customer relationships and targeting small business customers to increase core deposits. The Bank also relies on enhanced technology and customer service to attract and retain deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Banks deposit accounts consist of commercial and retail checking accounts, money market deposit accounts, savings accounts, certificates of deposit, and individual retirement accounts. The Bank accepts deposits through the CDARS program, which are classified as brokered deposits for regulatory purposes, and can accept other brokered deposits.
Interest rates paid, maturity terms, service fees, and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies, market interest rates, liquidity requirements, and the Banks deposit growth goals.
During the fiscal year ended June 30, 2012, deposits increased $12.5 million, or 4.9%, to $269.6 million from $257.0 million at June 30, 2011. The increase primarily resulted from a 35.8% increase in non-interest bearing demand accounts to $40.0 million from $29.5 million and a 25.9% increase in interest bearing demand accounts to $72.2 million from $57.3 million at June 30, 2012 as compared to June 30, 2011. This increase was offset by decreases in certificates of deposit of $6.2 million and money market deposits of $7.1 million. The Bank currently has no brokered certificates of deposit, exclusive of the CDARS program.
The following tables set forth the distribution of the average total deposit accounts by account type, for the years indicated.
The following table sets forth the maturities of certificates of deposit in amounts greater than or equal to $100 thousand as of the date indicated.
Borrowings. The Companys borrowings consist primarily of advances from the Federal Home Loan Bank of Atlanta and funds borrowed from securities dealers and depositors; primarily small business customers under repurchase agreements. During the fiscal year ended June 30, 2012, borrowings decreased $1.8 million, or 3.9%, to $43.4 million. At June 30, 2012, Federal Home Loan Bank advances totaled $27.0 million, or 8.5% of total liabilities, and repurchase agreements totaled $16.4 million, or 5.2% of total liabilities. At June 30, 2012, the Company had access to additional Federal Home Loan Bank advances of up to $44.0 million. As of June 30, 2012, the Companys available credit lines and other sources of liquidity had not been reduced compared to levels from June 30, 2011.
The following table sets forth information concerning balances and interest rates on Federal Home Loan Bank advances at the dates and for the fiscal years indicated.
The following table sets forth information concerning balances and interest rates on securities dealer repurchase agreements at the dates and for the years indicated.
The following table sets forth information concerning balances and interest rates on customer repurchase agreements at the dates and for the years indicated.
Stockholders Equity. At June 30, 2012, stockholders equity was $75.7 million, a decrease of $5.1 million, or 6.4%, from $80.9 million at June 30, 2011 primarily due to the Companys share repurchase program.
Average Balances and Yields
The following tables set forth average balance sheets, average yields and rates, and certain other information for the years indicated. No tax-equivalent yield adjustments were made, as the Company did not hold any tax-advantaged interest-earning assets during the fiscal years indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.
The following table presents the effects of changing rates and volumes on the Companys net interest income for the years indicated. The rate column shows the effects attributable to changes in rate, which are changes in rate multiplied by prior volume. The volume column shows the effects attributable to changes in volume, which are changes in volume multiplied by prior rate. The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume.
Comparison of Operating Results for the Fiscal Years Ended June 30, 2012 and 2011
General. For the fiscal year ended June 30, 2012, the Company had net income of $268 thousand, or $0.07 basic and diluted earnings per share, compared to net income of $857 thousand, or $0.20 basic and diluted earnings per share, for the fiscal year ended June 30, 2011. Net income was impacted by an increase in non-interest expense and provision for loan losses and a decrease in non-interest income offset by increases in net interest income. Non-interest expense increased $470 thousand to $11.5 million for the fiscal year ended June 30, 2012. The provision for loan losses increased $346 thousand to $1.1 million for the year ended June 30, 2012. Non-interest income decreased $233 thousand to $734 thousand for the fiscal year ended June 30, 2012. Net interest income increased $262 thousand to $12.3 million for the fiscal year ended June 30, 2012.
Net Interest Income. Net interest income increased $262 thousand, or 2.2%, to $12.3 million for the fiscal year ended June 30, 2012 compared to $12.0 million for the fiscal year ended June 30, 2011. Interest expense decreased $602 thousand as continued low market interest rates allowed the Company to reduce deposit rates while maintaining a competitive position in its local market. Non-interest bearing deposits increased 35.8%, or $10.5 million, to $40.0 million for the fiscal year ended June 30, 2012. The inflow of these lower costing deposits allowed the Bank to reduce higher costing borrowings and brokered certificates of deposit. The Bank currently has zero brokered certificates of deposit exclusive of the CDARS product. Interest and dividend income decreased $340 thousand, or 2.1%, as interest income on loans decreased $366 thousand. Net interest margin was 3.59% for the fiscal year ended June 30, 2012 as compared to 3.70% for fiscal year ended June 30, 2011.
Interest and Dividend Income. Interest and dividend income decreased $340 thousand, or 2.1%, to $15.9 million for the fiscal year ended June 30, 2012 from $16.2 million for the fiscal year ended June 30, 2011. Interest income on loans decreased $366 thousand, or 2.4%, to $14.7 million for the fiscal year ended June 30, 2012 from $15.1 million for the fiscal year ended June 30, 2011, as the average yield on loans decreased 15 basis points, to 5.21% for the fiscal year ended June 30, 2012 from 5.36% for the fiscal year ended June 30, 2011.
Average loans increased $1.1 million, or 0.4%. Average commercial loans increased $19.1 million offset by a decrease in average residential mortgage loans of $13.5 million during the fiscal year ended June 30, 2012. The average balance of commercial loans increased 14.4% to $151.5 million for the fiscal year ended June 30, 2012 from $132.4 million for the fiscal year ended June 30, 2011. The reduction in the residential mortgage portfolio resulted from selling newly-originated longer term, primarily 30 year, residential mortgage loans, as well as, prepayments exceeding other originations that were held in portfolio.
Interest income on total investments and interest bearing deposits at other banks remained relatively unchanged at $1.1 million for the fiscal year ended June 30, 2012 as compared to the fiscal year ended June 30, 2011. The average yield on securities decreased 80 basis points to 2.24% for the fiscal year ended June 30, 2012 from 3.04% for the fiscal year ended June 30, 2011. The decrease in yield reflects the purchase of U.S. Government mortgage-backed securities at lower yields as market rates declined over the period. Additionally, as market rates declined, prepayment speeds on mortgage-backed securities increased causing the yield to decrease on bonds purchased at a premium.
Interest Expense. Interest expense decreased $602 thousand, or 14.3%, to $3.6 million for the fiscal year ended June 30, 2012 from $4.2 million for the fiscal year ended June 30, 2011. Declining market interest rates and a decrease in higher cost certificates of deposit allowed for the reduction of deposit expense by $361 thousand or 13.8%. The average rate paid on deposits decreased 29 basis points to 0.99% for the fiscal year ended June 30, 2012 from 1.28% for the fiscal year ended June 30, 2011. The average balance of interest bearing deposits increased $22.7 million, or 11.1%, during the fiscal year ended June 30, 2012. Average money market deposits increased $20.2 million, or 29.7%, and average interest bearing checking deposits increased by $3.8 million, or 6.3%, for the fiscal year ended June 30, 2012. Average non-interest bearing demand checking accounts increased $7.0 million, or 27.1%, for the fiscal year ended June 30, 2012.
Interest expense on Federal Home Loan Bank borrowings decreased $207 thousand to $1.1 million for the fiscal year ended June 30, 2012 from $1.3 million for the fiscal year ended June 30, 2011. This change resulted from a $1.8 million, or 4.9%, decrease in average outstanding borrowings for the fiscal year ended June 30, 2012. Additionally, average repurchase agreements decreased $2.1 million, or 12.2% for the fiscal year ended June 30, 2012. The average yield on repurchase agreements decreased three basis points to 1.39% for the fiscal year ended June 30, 2012 from 1.42% for the fiscal year ended June 30, 2011. The decrease in FHLBA borrowings reflects managements strategy to reduce high cost borrowings and brokered certificates of deposit facilitated primarily by the inflow of core deposits.
Provision for Loan Losses. Based on an analysis of the factors described in Allowance for Loan Losses, the Company recorded a provision for loan losses of $1.1 million for the fiscal year ended June 30, 2012 and a provision for loan losses of $739 thousand for fiscal year ended June 30, 2011. During the fiscal years ended June 30, 2012 and 2011, the Company had net loan charge-offs of $296 thousand and $230 thousand, respectively. Net charge-offs for the fiscal year ended June 30, 2012 include a recovery of $15 thousand in commercial loans. The remaining charge-offs include one residential mortgage, two commercial, and two consumer loans. Total loans increased by $14.4 million, or 5.1%, to $296.2 million at June 30, 2012 from $281.9 million at June 30, 2011. Commercial real estate loans increased by $27.3 million, or 25.1%, to $136.0 million at June 30, 2012 as compared to June 30, 2011. This increase was offset partially by decreases in commercial business loans of $3.9 million, or 10.8%, to $32.0 million, home equity loans and lines of credit of $5.7 million, or 14.6%, to $33.1 million, and residential mortgage loans of $4.0 million, or 4.1%, to $93.3 million at June 30, 2012.
Non-performing loans totaled $6.0 million at June 30, 2012 and $5.3 million at June 30, 2011. The increase was a result of two residential loans. The Banks non-performing loans to total loans ratio increased to 2.04% from 1.88% at June 30, 2012 and 2011, respectively.
Non-performing assets totaled $6.1 million at June 30, 2012 and $5.4 million at June 30, 2011. In addition to the abovementioned loans, the Bank has one real estate owned property that is included in total non-performing assets. The Companys non-performing assets to total assets ratio increased to 1.55% from 1.40% at June 30, 2012 and 2011, respectively.
There were $1.7 million in loans delinquent less than 90 days and $4.4 million in loans delinquent 90 days or more with total delinquencies of $6.1 million at June 30, 2012. This represents an increase in total delinquent loans of $3.4 million from June 30, 2011. Total delinquent loans were $2.7 million at June 30, 2011. Loans delinquent less than 90 days were $600 thousand and loans delinquent 90 days or more were $2.1 million at June 30, 2011.
The allowance for loan losses to total loans was 1.02% and 0.80% at June 30, 2012 and 2011, respectively. The Company has provided for all losses that are both probable and reasonably estimable at June 30, 2012 and 2011.
Non-Interest Income. The following table summarizes changes in non-interest income for the fiscal years indicated.
The Companys non-interest income decreased $233 thousand for the fiscal year ended June 30, 2012 to $734 thousand from $967 thousand for fiscal year end June 30, 2011. Net gains and losses decreased $176 thousand during the year ended June 30, 2012. The Company wrote down the sole property in Other Real Estate Owned to $40 thousand from $105 thousand contributing to the $85 thousand net losses for the fiscal year ended June 30, 2012. The Company charged-off $26 thousand for two ATMs, which were deemed non-compliant under new regulations contained within the recently amended Americans with Disability Act, during the fiscal year ended June 30, 2012. The Company saw a reduction in net gains on sale of loans of $93 thousand for the fiscal year ended June 30, 2012 as many of the loans originated during the year were retained in the residential mortgage portfolio. Non-interest income before net gains decreased $57 thousand, or 6.5% to $819 thousand for the year ended June 30, 2012 as compared to $876 thousand for the year ended June 30, 2011. Customer service fees decreased $37 thousand, or 9.0%, for the fiscal year ended June 30, 2012.
Non-Interest Expense. The following table summarizes changes in non-interest expense at the date and years indicated.
The Companys non-interest expense increased to $11.5 million for the fiscal year ended June 30, 2012 from $11.0 million for the fiscal year ended June 30, 2011, or 4.3%. Salaries and employee benefits increased 12.9%, or $771 thousand, to $6.7 million in the period ended June 30, 2012 primarily due to the inception of the Companys equity compensation plan during the fiscal year ended June 30, 2012 and additions to staff. These increases were offset by a decrease in other non-interest expenses of $281 thousand, or 13.7%, to $1.8 million and a decrease in occupancy and equipment of $131 thousand for the period ended June 30, 2012. The decrease in other non-interest expense was primarily due to a decrease of $200 thousand in legal, regulatory, and accounting costs due to the Companys initial public offering that were necessary to operate as a public company and a decrease of $51 thousand due to a reduction in advertising expenses as a result of the completion of the Companys previously disclosed money market promotion. The decrease in occupancy and equipment was primarily due to the sale of the Companys Washington D.C. branch in the third fiscal quarter of 2011.
Income Tax Expense. The Bank recorded income tax expense of $185 thousand for the fiscal year ended June 30, 2012, compared to an income tax benefit of $383 thousand for the fiscal year ended June 30, 2011. The effective tax rate for fiscal 2012 was 40.8%, while the effective tax rate for fiscal 2011 was 30.9%. The increase in rate for fiscal year 2012 is the result of amounts associated with stock options and the ESOP plan.
Non-performing and Problem Assets
When a residential mortgage loan or home equity line of credit is 15 calendar days past due, a notice is mailed informing the borrower that the loan is past due. When the loan is 20 days past due, an additional notice is mailed and Bank personnel attempt to achieve direct contact with the borrower as an additional reminder of the delinquency. When a loan is 30 days or more past due, a default notice is mailed and additional attempts at direct contact with the borrower are made. Bank personnel attempt to determine the reason(s) for the delinquency and establish a course of action by which the borrower will bring the loan current. When the loan is 45 days past due, Bank personnel investigate the issues surrounding the delinquency and repayment options and issue an additional demand letter. In addition, Management determines whether to initiate foreclosure proceedings and obtains Board approval. Foreclosure proceedings are initiated by counsel if the loan is not brought current by the end of the calendar month. Procedures for avoiding foreclosure can include restructuring the loan in a manner that provides concessions to the borrower to facilitate repayment.
Commercial business loans, commercial real estate loans, and consumer loans are generally handled in the same manner as residential mortgage loans or home equity lines of credit.
A loan is placed on non-accrual status when payment of principal or interest is 90 days or more delinquent. If a loan is well secured and in the process of collection, exceptions to the non-accrual policy may be made. Loans may also be placed on non-accrual status if collection of principal or interest, in full, is in doubt. When loans are placed on a non-accrual status, unpaid accrued interest is fully reversed and further income is recognized only when full repayment of the loan is complete or the loan returns to accrual status, at which point income is recognized to the extent received. The loan may be returned to accrual status if both principal and interest payments are brought current, there has been a period of sustained performance (generally six months), and full payment of principal and interest is expected.
Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets at the dates indicated.
For the year ended June 30, 2012, gross interest income that would have been recorded had non-accruing loans been current in accordance with their original terms was $321 thousand. The Bank recognized $338 thousand of interest income on such non-accruing loans on a cash basis during the fiscal year including interest recovered from prior periods.
Troubled Debt Restructurings. Loans are periodically modified to make concessions to help a borrower remain current on the loan and to avoid foreclosure. Generally, the Bank does not forgive principal or interest on loans or modify the interest rate on loans to rates that are below market rates. At June 30, 2012 and 2011, the Bank had $5.8 million and $2.8 million of these modified loans, respectively. At June 30, 2012, the Bank had $1.1 million in residential mortgage loans and home equity loans and lines of credit that were considered troubled debt restructures. At June 30, 2012, the Bank had $4.7 million commercial real estate loans that were considered troubled debt restructures. At June 30, 2011, the Bank had $731 thousand in residential mortgage loans and home equity loans and lines of credit and $2.0 million in commercial real estate loans that were considered troubled debt restructures. At June 30, 2010, the Bank had $1.9 million in residential mortgage loans and home equity loans and lines of credit and $1.5 million in commercial real estate loans that were considered troubled debt restructures. At June 30, 2009, the Bank had $1.0 million in residential mortgage loans that were considered trouble debt restructures. The Bank had no such modified loans at June 30, 2008.
Delinquent Loans. The following table sets forth loan delinquencies by type and by amount at the dates indicated.
Real Estate Owned. Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned. When property is acquired it is recorded at estimated fair value at the date of foreclosure less the cost to sell, establishing a new cost basis. Estimated fair value generally represents the sale price a buyer would be willing to pay on the basis of current market conditions, including normal terms from other financial institutions. Holding costs and declines in estimated fair value result in charges to expense after acquisition. At June 30, 2012 and June 30, 2011 the Bank had $40 thousand and $105 thousand respectively, of real estate owned. At June 30, 2010 and 2009, the same property was held at $193 thousand in real estate owned. The Bank had no real estate owned at June 30, 2008.
Classification of Assets. Various Bank policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets, or portions of assets, classified as loss are those considered uncollectible and of such little value that their continuance as an asset is not warranted. Assets that do not expose the Bank to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve close attention, are required to be designated as Special Mention.
The Bank maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the statement of condition date. The Banks determination as to the classification of assets is subject to review by the Banks principal federal regulator, the OCC. The Bank regularly reviews the asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The following table details classified assets, assets designated as special mention, and criticized assets at the dates indicated.
The Bank had $11.8 million in loans classified as substandard at June 30, 2012 as compared to $8.7 million at June 30, 2011. At June 30, 2012, $6.9 million of the loans classified as substandard were residential mortgage or commercial real estate loans that were collateral-dependent. Management reviewed these loans for impairment on an individual loan or relationship basis.
At June 30, 2012, Management determined that eight of the loans listed as substandard, for a total of $5.4 million, were both considered impaired and troubled debt restructures. Accordingly, a specific allowance for loan losses for these loans was provided or the loans were written down to current market value. An analysis was completed for each of the loans listed as substandard according to the methodology described in Allowance for Loan Losses. Based on this analysis, the Bank provided specific reserves of $150 thousand for these loans.
Allowance for Loan Losses
The Bank provides for loan losses based upon the consistent application of the documented allowance for loan loss methodology. All loan losses are charged to the allowance for loan losses and all recoveries are credited to the same. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in Managements judgment, deserve current recognition in estimating probable losses. Management regularly reviews the loan portfolio and makes provisions for loan losses in order to maintain the allowance for loan losses in accordance with U.S. GAAP. The Bank considers residential mortgage loans and home equity loans and lines of credit as small, homogeneous loans, which are evaluated for impairment collectively based on historical loss experience. Commercial real estate and commercial business loans are viewed individually and considered impaired if the probability exists that the Bank will be unable to collect contractually obligated principal and interest cash flows. The allowance for loan losses consists primarily of three components:
Actual loan losses may be significantly more than the allowance for loan losses established, which could have a material negative effect on financial results.
The adjustments to historical loss experience are based on Managements evaluation of several qualitative and environmental factors, including:
Historically, the Bank experienced limited loan losses. More recently, as the Bank has experienced increased loan losses, Management utilized the Banks historical loss experience in determining applicable portions of the allowance for loan losses. Periodically, the Bank adjusts its historical loss experience to reflect current economic conditions, as well as increases in commercial real estate and commercial business loans.
Management evaluates the allowance for loan losses based upon the combined total of the specific, general, and unallocated components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
Generally, the Bank underwrites commercial real estate and residential real estate loans at a loan-to-value ratio of 75% or less. Accordingly, in the event that a loan becomes past due, Management will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. The Bank may request a formal third party appraisal for various reasons including, but not limited to, age of previous appraisal, changes in market condition, and changes in borrowers condition. For loans initially determined to be impaired loans, the Bank utilizes the ascertained or appraised property value in determining the appropriate specific allowance for loan losses attributable to a loan as described above. In addition, changes in the appraised value of properties securing loans can result in an increase or decrease in the general allowance for loan losses as an adjustment to the historical loss experience due to qualitative and environmental factors, as described above.
The loan portfolio is evaluated on a quarterly basis and the allowance is adjusted accordingly. While the best information available is used to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the OCC will periodically review the allowance for loan losses. The OCC may require the Bank to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
The following table sets forth activity in the Companys allowance for loan losses for the fiscal years indicated.