MidWestOne Financial Group - 10-Q quarterly report FY

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

OR

For the transition period from _______ to _______

Commission file number 000-24630

102 South Clinton Street

Iowa City, IA 52240

Registrant’s telephone number: 319-356-5800

 

Indicate by check mark whether the registrant (1) has filed all reports required 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 such reports), and (2) has been subject to such filing requirements for the past 90 days.

YesxNoo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

As of August 8, 2008, there were 8,656,110 shares of common stock $1 par value outstanding.

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

(Unaudited)

The accompanying consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U. S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Management believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of June 30, 2008, and the results of operations and cash flows for the three months and the six months ended June 30, 2008 and 2007.

The results for the three months or the six months ended June 30, 2008 may not be indicative of results for the year ending December 31, 2008, or for any other period.

In the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in banks, and federal funds sold.

Basic earnings per common share computations are based on the weighted average number of shares of common stock actually outstanding during the period. The weighted average number of shares outstanding for the three months ended June 30, 2008 and 2007 was 8,680,792 and 5,160,868, respectively. The weighted average number of shares outstanding for the six-month periods ended June 30, 2008 and 2007 was 7,251,827 and 5,167,510, respectively. Diluted earnings per share amounts are computed by dividing net income by the weighted average number of shares outstanding and all dilutive potential shares outstanding during the period. The computation of diluted earnings per share used a weighted average number of shares outstanding of 8,680,792 and 5,160,868 for the three months ended June 30, 2008 and 2007, respectively. For the six months ended June 30, 2008 and 2007, weighted average diluted shares outstanding were 7,251,827 and 5,167,510, respectively. The following table presents the computation of earnings per common share for the respective periods:

 

 

Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” for financial assets and liabilities. In accordance with Financial Accounting Standards Board Staff Positions (FSP) No. 157-2, “Effective Date of FASB Statement No. 157,” the Company will delay application of SFAS 157 for non-financial assets and non-financial liabilities until January 1, 2009. These include foreclosed real estate, long-lived assets, goodwill and core deposit premium; which are recorded at fair value only upon impairment. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and liabilities carried at fair value effective January 1, 2008.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2008, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

 

The following table summarizes financial assets and financial liabilities measured at fair value on a non recurring basis as of June 30, 2008, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value.

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. A significant estimate that is particularly sensitive to change is the allowance for loan losses.

PART I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

On July 9, 2008, the Company announced that it had entered into an agreement to divest itself of its branch location in Wapello, Iowa. Community Bank of Muscatine, Iowa, will assume approximately $9.5 million in deposits of the Wapello branch and will retain the existing employees. The Company will retain the loans associated with the branch. Subject to purchaser’s regulatory approval, the transaction is expected to close early in fourth quarter of 2008. The sale agreement provides that the Company will receive upon closing a premium of 6% of the deposits assumed by the purchaser.

RESULTS OF OPERATIONS

Quarter Ended June 30, 2008

 

Summary

The Company earned net income of $3.0 million for the quarter ended June 30, 2008, compared with $1.6 million for the quarter ended June 30, 2007, an increase of 88%. Net income for the quarter ended June 30, 2008 was reduced by an “other than temporary impairment” loss on equity securities held by the Company. The amount of the loss was $567,000, which net of tax effect, resulted in a reduction in net income of $374,000 or $0.04 per share. Basic and diluted earnings per share for the second quarter of 2008 were $.34 versus $.31 for the second quarter of 2007. The Company’s return on average assets for the second quarter of 2008 was 0.79% compared with a return of 0.95% for the same period in 2007. The Company’s return on average equity was 7.65% for the quarter ended June 30, 2008 versus 8.77% for the quarter ended June 30, 2007. Return on average tangible equity was 9.79% for the second quarter of 2008 compared with 9.36% for the same period in 2007.

 

Second quarter results were affected by a write-down of equity securities held in the Company’s investment portfolio that were determined to be an “other than temporary impairment” loss. This write-down was attributable to the decline in the market prices of these stocks, which were below their historical cost. They were adjusted to reflect the June 30, 2008, market values in accordance with generally accepted accounting principles.

The following table presents selected financial results and measures for the second quarter of 2008 and 2007.

Net Interest Income

Net interest income is computed by subtracting total interest expense from total interest income. Fluctuations in net interest income can result from the changes in the volumes of assets and liabilities as well as changes in interest rates. The Company’s net interest income for the quarter ended June 30, 2008 increased $6.5 million, or 134%, to $11.4 million from $4.9 million from the quarter ended June 30, 2007. Total interest income was $10.5 million greater in the second quarter of 2008 compared with the same period in 2007. Most of the increase in interest income was due to increased interest on loans, which was mainly attributable to increased volumes attributable to the merger. The increase in interest income was offset by increased interest expense on deposits and borrowed funds. Total interest expense for the second quarter of 2008 increased $4.0 million, or 84%, compared with the same period in 2007 due primarily to increased volumes. The Company’s net interest margin on a federal tax-equivalent basis for the second quarter of 2008 increased to 3.45% compared with 3.09% in the second quarter of 2007. Net interest margin is a measure of the net return on interest-earning assets and is computed by dividing annualized net interest income by the average of total interest-earning assets for the period. The Company’s overall yield on earning assets declined to 5.96% for the second quarter of 2008 compared with 6.08% for the second quarter of 2007. The rate on interest-bearing liabilities decreased in the second quarter of 2008 to 2.84% compared to 3.43% for the second quarter of 2007.

The following table presents a comparison of the average balance of earning assets, interest-bearing liabilities, interest income and expense, and average yields and costs for the quarter ended June 30, 2008 and 2007. Interest income on tax-exempt securities and loans is reported on a fully tax-equivalent basis assuming a 34% tax rate. Dividing annualized income or expense by the average balances of assets or liabilities results in average yields or costs.

 

 

Provision for Loan Losses

The Company recorded a provision for loan losses of $758,000 in the second quarter of 2008 compared with a $150,000 provision in the second quarter of 2007. Net loans charged off in the second quarter of 2008 totaled $90,000 compared with net loans charged off of $15,000 in the second quarter of 2007. Management determines an appropriate provision based on its evaluation of the adequacy of the allowance for loan losses in relationship to a continuing review of problem loans, the current economic conditions, actual loss experience and industry trends. Management believes that the allowance for loan losses was adequate based on the inherent risk in the portfolio as of June 30, 2008; however, there is no assurance losses will not exceed the allowance and any growth in the loan portfolio and the uncertainty of the general economy require that management continue to evaluate the adequacy of the allowance for loan losses and make additional provisions in future periods as deemed necessary.

Noninterest Income

Noninterest income results from the charges and fees collected by the Company from its customers for various services performed, miscellaneous other income, and gains (or losses) from the sale of investment securities held in the available for sale category. Total noninterest income was $1.1 million, or 50%, greater in the second quarter of 2008 compared with the same period in 2007. Most of the change between the periods is due to the merger. During the second quarter of 2008, the Company recognized an “other than temporary impairment” write-down of $567,000 on equity securities held as available for sale investments. This write-down was attributable to the decline in market prices of these stocks, which were below their historical cost. They were adjusted to reflect their June 30, 2008, market values in accordance with generally accepted accounting principles. Security losses totaled $499,000 in the second quarter of 2008 compared with no gain or loss recognized in the second quarter of 2007.

Noninterest Expense

 

Income Tax Expense

The Company incurred income tax expense of $949,000 for the second quarter ended June 30, 2008 compared with $554,000 for the same period of 2007. The effective income tax rates for the three months ended June 30, 2008 and 2007 was 24.2% and 25.7%, respectively. The effective tax rate varies from the statutory rate due to state taxes and the amount of tax-exempt income on municipal bonds earned during the period. Tax-exempt income on municipal bonds is greater in comparison to previous periods as the market yields on recently purchased bonds has increased and the Company has a higher volume of municipal bonds.

 

Six Months Ended June 30, 2008

 

Summary

The Company earned net income of $5.2 million for the six months ended June 30, 2008, compared with $3.2 million for the six months ended June 30, 2007, an increase of 64%. The increase in net income was primarily due to the merger. Basic and diluted earnings per share for the first half of 2008 were $0.72 versus $0.62 for the first half of 2007. The Company’s return on average assets for the first half of 2008 was 0.90% compared with a return of 0.96% for the first half of 2007. The Company’s return on average equity was 8.71% for the six months ended June 30, 2008 versus 8.85% for the six months ended June 30, 2007. Return on tangible equity was 10.62% for the first half of 2008 compared with 9.45% for the same period in 2007.

The following table presents selected financial results and measures for the first half of 2008 and 2007.

Net Interest Income

The Company’s net interest income for the six months ended June 30, 2008 increased $8.0 million, or 84%, to $17.5 million from $9.5 million from the six months ended June 30, 2007. Total interest income was $12.8 million greater in the first six months of 2008 compared with the same period in 2007. Most of the increase in interest income was due to increased interest on loans and loan pools, which was mainly attributable to increased volumes of loans and loan pools reflecting the merger. The increase in interest income was offset by increased interest expense on deposits and borrowed funds related to the merger. Total interest expense for the first half of 2008 increased $4.9 million, or 53%, compared with the same period in 2007 due primarily to increased volumes. The Company’s net interest margin on a federal tax-equivalent basis for the first six months of 2008 increased to 3.42% compared with 3.21% for the six months ended June 30, 2007. The Company’s overall yield on earning assets declined to 6.18% for the first six months of 2008 compared with 6.24% for the six months ended June 30, 2007. The rate on interest-bearing liabilities decreased in the first half of 2008 to 2.33% compared to 3.53% for the first half of 2007.

 

The following table presents a comparison of the average balance of earning assets, interest-bearing liabilities, interest income and expense, and average yields and costs for the six months ended June 30, 2008 and 2007. Interest income on tax-exempt securities and loans is reported on a fully tax-equivalent basis assuming a 34% tax rate. Dividing annualized income or expense by the average balances of assets or liabilities results in average yields or costs. Average balances for the six months ended June 30, 2008 reflect the additional assets and liabilities of the acquired subsidiaries from March 15, 2008 through June 30, 2008.

 

 

Provision for Loan Losses

The Company recorded a provision for loan losses of $828,000 in the first half of 2008 compared with a $300,000 provision in the first half of 2007. Net loans charged off in the first half of 2008 totaled $393,000 compared with net recoveries of loans previously charged off of $15,000 in the first half of 2007. Management determines an appropriate provision based on its evaluation of the adequacy of the allowance for loan losses in relationship to a continuing review of problem loans, the current economic conditions, actual loss experience and industry trends. Management believes that the allowance for loan losses was adequate based on the inherent risk in the portfolio as of June 30, 2008; however, there is no assurance losses will not exceed the allowance and any growth in the loan portfolio and the uncertainty of the general economy require that management continue to evaluate the adequacy of the allowance for loan losses and make additional provisions in future periods as deemed necessary.

Noninterest Income

Noninterest income results from the charges and fees collected by the Company from its customers for various services performed, miscellaneous other income, and gains (or losses) from the sale of investment securities held in the available for sale category. Total noninterest income was $1.45 million, or 33%, greater in the first six months of 2008 compared with the same period in 2007. Most of the increase between the first six months of 2008 in comparison to the same period of 2007 was due to the merger.

 

Noninterest Expense

Income Tax Expense

FINANCIAL CONDITION

Investment Securities

Investment securities available for sale totaled $281.2 million as of June 30, 2008. This was an increase of $49.1 million from December 31, 2007. The increase in the balance was due primarily to the Merger. Investment securities classified as held to maturity increased to $8.7 million as of June 30, 2008, also as a result of the merger. The investment portfolio consisted mainly of U.S. Government Agency securities, mortgage-backed securities and obligations of states and political subdivisions.

During the second quarter of 2008, the Company recognized an “other than temporary impairment” write-down of $567,000 on equity securities held in the available for sale investments category. This write-down was attributable to the decline in the market prices of these stocks, which were below their historical cost. These equity securities are all publicly-traded stocks of companies in the financial services industy. The value of these holdings declined in concert with the market decline in financial services stocks during the past nine months.

 

 

Loans

Loan Pool Participations

As of June 30, 2008, the Company had loan pool participations of $89.1 million. Loan pools are participation interest in performing, sub-performing and non-performing loans that have been purchased from various non-affiliated banking organizations. Former MidWestOne has engaged in this activity since 1988. The loan pool investment balance shown as an asset on the Company’s Statement of Condition represented the discounted purchase cost of the loan pool participations. The Company acquired new loan pool participations totaling $9.6 million during the second quarter of 2008. As of June 30, 2008, the categories of loans by collateral type in the loan pools were commercial real estate - 51%, commercial loans - 12%, agricultural and agricultural real estate - 9%, single-family residential real estate - 14% and other loans - 14%. The Company has minimal exposure in loan pools to consumer real estate subprime credit or to construction and real estate development loans.

Goodwill and Other Intangible Assets

Goodwill totaled $20.8 million as of June 30, 2008 and $4.4 million as of December 31, 2007. The increase in goodwill was due to the Merger. As of June 30, 2008 the Company has not finalized the valuation of certain tangible and intangible assets given the timing of the transaction. The Company is in the process of obtaining third-party valuations of certain tangible assets and liabilities, and intangible assets; thus the allocation of the purchase price is subject to refinement.

Goodwill is subject to impairment testing annually under the provisions of Financial Accounting Standards Board Statement No. 142 (“SFAS 142”). The Company has historically tested goodwill for impairment at the end on the third quarter. SFAS 142 does provide that goodwill should be tested more frequently upon the occurrence of certain defined events or a change in circumstances. A significant change in the business climate is one of these defined events. Due to the decline in the Company’s stock price to a level below its book value, the Company evaluated its goodwill for impairment at the end of the second quarter of 2008. Goodwill was determined to not be impaired at that time and no impairment write-down of goodwill was recorded. Management will continue to evaluate goodwill for potential impairment given the uncertain business climate and the level of the Company’s stock price relative to book value.

 

Other intangible assets increased to $13.8 million as of June 30, 2008 as a result of the Merger. The Company has not finalized the valuation of the intangible assets given the timing of the transaction. The Company is in the process of finalizing its third-party valuation of the intangibles assets; thus the allocation of purchase price is subject to refinement. Amortization of intangible assets is recorded using an accelerated method based on the estimated life of the respective intangible. Projections of amortization expense are based on existing asset balances and the remaining useful lives. The following table summarizes the amounts and carrying values of intangible assets as of June 30, 2008 and December 31, 2007.