10-Q 1 a5756601.txt EMCLAIRE FINANCIAL CORP. 10-Q -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2008 ------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission File Number: 000-18464 --------- EMCLAIRE FINANCIAL CORP. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 25-1606091 -------------------------------------------------------------------------------- (State or other jurisdiction (IRS Employer Identification No.) of incorporation or organization) 612 Main Street, Emlenton, Pennsylvania 16373 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (724) 867-2311 -------------------------------------------------------------------------------- (Registrant's telephone number) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| 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. Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |_| Smaller reporting company |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The number of shares outstanding of the Registrant's common stock was 1,267,835 at August 14, 2008. -------------------------------------------------------------------------------- EMCLAIRE FINANCIAL CORP. INDEX TO QUARTERLY REPORT ON FORM 10-Q PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Interim Financial Statements (Unaudited) Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007.................................1 Consolidated Statements of Income for the three and six months ended June 30, 2008 and 2007.................................2 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007.................................3 Consolidated Statements of Changes in Stockholders' Equity for the three and six months ended June 30, 2008 and 2007....4 Notes to Consolidated Financial Statements..........................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................12 Item 3. Quantitative and Qualitative Disclosures About Market Risk.........23 Item 4T. Controls and Procedures............................................24 PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings..................................................24 Item 1A. Risk Factors.......................................................25 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........25 Item 3. Defaults Upon Senior Securities....................................25 Item 4. Submission of Matters to a Vote of Security Holders................25 Item 5. Other Information..................................................25 Item 6. Exhibits...........................................................25 Signatures ...................................................................26 PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Interim Financial Statements ------------------------------------- Emclaire Financial Corp. and Subsidiary Consolidated Balance Sheets As of June 30, 2008 (Unaudited) and December 31, 2007 (Dollar amounts in thousands, except share data)
June 30, December 31, 2008 2007 ------------ ------------ Assets ------ Cash and due from banks $ 7,654 $ 10,288 Interest earning deposits with banks 3,463 195 ------------ ------------ Cash and cash equivalents 11,117 10,483 Securities available for sale, at fair value 61,942 51,919 Loans receivable, net of allowance for loan losses of $2,301 and $2,157 241,855 229,819 Federal bank stocks, at cost 2,849 2,662 Bank-owned life insurance 5,086 4,987 Accrued interest receivable 1,291 1,365 Premises and equipment, net 8,016 7,904 Goodwill 1,422 1,422 Prepaid expenses and other assets 1,152 1,159 ------------ ------------ Total Assets $ 334,730 $ 311,720 ============ ============ Liabilities and Stockholders' Equity ------------------------------------ Liabilities: Deposits: Non-interest bearing $ 51,427 $ 47,111 Interest bearing 207,606 197,151 ------------ ------------ Total deposits 259,033 244,262 Short-term borrowed funds 13,651 5,400 Long-term borrowed funds 35,000 35,000 Accrued interest payable 753 771 Accrued expenses and other liabilities 1,288 1,584 ------------ ------------ Total Liabilities 309,725 287,017 ------------ ------------ Commitments and Contingencies -- -- Stockholders' Equity: Preferred stock, $1.00 par value, 3,000,000 shares authorized; none issued -- -- Common stock, $1.25 par value, 12,000,000 shares authorized; 1,395,852 shares issued; 1,267,835 shares outstanding 1,745 1,745 Additional paid-in capital 10,954 10,902 Treasury stock, at cost; 128,017 shares (2,653) (2,653) Retained earnings 15,403 15,114 Accumulated other comprehensive loss (444) (405) ------------ ------------ Total Stockholders' Equity 25,005 24,703 ------------ ------------ Total Liabilities and Stockholders' Equity $ 334,730 $ 311,720 ============ ============
See accompanying notes to consolidated financial statements. 1 Emclaire Financial Corp. and Subsidiary Consolidated Statements of Income For the three and six months ended June 30, 2008 and 2007 (Unaudited) (Dollar amounts in thousands, except per share data)
For the three months ended For the six months ended June 30, June 30, ------------------------------ ------------------------------ 2008 2007 2008 2007 ------------- ------------- ------------- ------------- Interest and dividend income: Loans receivable, including fees $ 3,929 $ 3,788 $ 7,858 $ 7,392 Securities: Taxable 412 419 789 783 Exempt from federal income tax 161 172 323 345 Federal bank stocks 25 21 55 71 Deposits with banks 36 16 59 137 ------------- ------------- ------------- ------------- Total interest and dividend income 4,563 4,416 9,084 8,728 ------------- ------------- ------------- ------------- Interest expense: Deposits 1,554 1,568 3,126 3,235 Borrowed funds 445 350 851 686 ------------- ------------- ------------- ------------- Total interest expense 1,999 1,918 3,977 3,921 ------------- ------------- ------------- ------------- Net interest income 2,564 2,498 5,107 4,807 Provision for loan losses 85 30 145 75 ------------- ------------- ------------- ------------- Net interest income after provision for loan losses 2,479 2,468 4,962 4,732 ------------- ------------- ------------- ------------- Noninterest income: Fees and service charges 407 391 765 716 Commissions on financial services 127 81 245 243 Net gain (loss) on available for sale securities (275) 118 (275) 176 Net gain (loss) on sales of loans (6) 7 8 7 Earnings on bank-owned life insurance 57 54 113 108 Other 186 121 301 253 ------------- ------------- ------------- ------------- Total noninterest income 496 772 1,157 1,503 ------------- ------------- ------------- ------------- Noninterest expense: Compensation and employee benefits 1,283 1,245 2,700 2,550 Premises and equipment 418 401 839 801 Other 592 690 1,169 1,295 ------------- ------------- ------------- ------------- Total noninterest expense 2,293 2,336 4,708 4,646 ------------- ------------- ------------- ------------- Income before provision for income taxes 682 904 1,411 1,589 Provision for income taxes 141 197 311 331 ------------- ------------- ------------- ------------- Net income $ 541 $ 707 $ 1,100 $ 1,258 ============= ============= ============= ============= Basic and diluted earnings per share $ 0.43 $ 0.56 $ 0.87 $ 0.99 Average common shares outstanding 1,267,835 1,267,835 1,267,835 1,267,835
See accompanying notes to consolidated financial statements. 2
Emclaire Financial Corp. and Subsidiary Condensed Consolidated Statements of Cash Flows For the six months ended June 30, 2008 and 2007 (Unaudited) (Dollar amounts in thousands) For the six months ended June 30, ------------------------ 2008 2007 ---------- ---------- Cash flows from operating activities Net income $ 1,100 $ 1,258 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of premises and equipment 342 332 Provision for loan losses 145 75 Amortization of premiums and accretion of discounts, net (84) 6 Amortization of intangible assets and mortgage servicing rights 5 8 Amortization of deferred loan costs 156 126 Realized (gains) losses on sales of available for sale securities, net 275 (176) Net gains on sales of loans (8) (7) Originations of loans sold (1,263) (603) Proceeds from the sale of loans 1,261 605 Stock compensation expense 52 1 Earnings on bank owned life insurance, net (99) (95) Decrease (increase) in accrued interest receivable 74 (5) Decrease (increase) in prepaid expenses and other assets 22 (237) Decrease in accrued interest payable (18) (104) Increase (decrease) in accrued expenses and other liabilities (297) 643 ---------- ---------- Net cash provided by operating activities 1,663 1,827 ---------- ---------- Cash flows from investing activities Loan originations and principal collections, net (12,331) (7,005) Available for sale securities: Sales -- 989 Maturities, repayments and calls 45,440 9,256 Purchases (55,708) (11,693) Purchase of federal bank stocks (187) (176) Purchases of premises and equipment (454) (186) ---------- ---------- Net cash used in investing activities (23,240) (8,815) ---------- ---------- Cash flows from financing activities Net increase (decrease) in deposits 14,771 (4,524) Net increase in short-term borrowed funds 8,251 1,700 Dividends paid on common stock (811) (735) ---------- ---------- Net cash provided by (used in) financing activities 22,211 (3,559) ---------- ---------- Net increase (decrease) in cash and cash equivalents 634 (10,547) Cash and cash equivalents at beginning of period 10,483 16,717 ---------- ---------- Cash and cash equivalents at end of period $ 11,117 $ 6,170 ========== ========== Supplemental information: Interest paid $ 3,995 $ 4,025 Income taxes paid 180 126 Supplemental noncash disclosure: Transfers from loans to foreclosed real estate 44 -- See accompanying notes to consolidated financial statements.
3
Emclaire Financial Corp. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity For the three and six months ended June 30, 2008 and 2007 (Unaudited) (Dollar amounts in thousands, except per share data) For the three months ended For the six months ended June 30, June 30, ------------ ------------ ------------ ------------ 2008 2007 2008 2007 ------------ ------------ ------------ ------------ Balance at beginning of period $ 25,086 $ 24,069 $ 24,703 $ 23,917 Net income 541 707 1,100 1,258 Other comprehensive income (loss): Change in net unrealized gains (losses) on available for sale securities, net of taxes (429) (341) (221) (335) Less reclassification adjustment for (gains) losses included in net income, net of taxes 182 (78) 182 (116) ------------ ------------ ------------ ------------ Other comprehensive loss (247) (419) (39) (451) ------------ ------------ ------------ ------------ Total comprehensive income 294 288 1,061 807 Stock compensation expense 31 1 52 1 Dividends declared (406) (368) (811) (735) ------------------------------------------------------------ Balance at end of period $ 25,005 $ 23,990 $ 25,005 $ 23,990 ============ ============ ============ ============ Common cash dividend per share $ 0.32 $ 0.29 $ 0.64 $ 0.58 ============ ============ ============ ============
See accompanying notes to consolidated financial statements. 4 Emclaire Financial Corp. and Subsidiary Notes to Consolidated Financial Statements (Unaudited) 1. Nature of Operations and Basis of Presentation. Emclaire Financial Corp. (the "Corporation") is a Pennsylvania company organized as the holding company of Farmers National Bank of Emlenton (the "Bank"). The Corporation provides a variety of financial services to individuals and businesses through its offices in western Pennsylvania. Its primary deposit products are checking, savings and certificate of deposit accounts and its primary lending products are residential and commercial mortgages, commercial business and consumer loans. The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiary, the Bank. All intercompany transactions and balances have been eliminated in preparing the consolidated financial statements. The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Corporation's consolidated financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission's Form 10-Q and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2007, as contained in the Corporation's 2007 Annual Report of Form 10-K filed with the Securities and Exchange Commission. The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses. The results of operations for interim quarterly or year to date periods are not necessarily indicative of the results that may be expected for the entire year or any other period. Certain amounts previously reported may have been reclassified to conform to the current year's financial statement presentation. 2. Earnings per Common Share. Basic earnings per common share (EPS) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation. Options on 85,000 shares of common stock were not included in computing diluted earnings per share because their effects were not dilutive for the three and six months periods ended June 30, 2008 and 2007. 5 3. Securities. The Corporation's securities as of the respective dates are summarized as follows:
------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) Amortized Unrealized Unrealized Fair cost gains losses value ------------------------------------------------------------------------------------------------------- Available for sale: ------------------- June 30, 2008: U.S. Government agencies and related entities $ 20,987 $ 114 $ (44) $ 21,057 Mortgage-backed securities 20,485 52 (53) 20,484 Municipal securities 13,686 430 -- 14,116 Corporate securities 3,001 -- (4) 2,997 Equity securities 3,990 -- (702) 3,288 ---------- ---------- ---------- ---------- $ 62,149 $ 596 $ (803) $ 61,942 ========== ========== ========== ========== December 31, 2007: U.S. Government agencies and related entities $ 29,356 $ 37 $ (59) $ 29,334 Mortgage-backed securities 1,932 -- (48) 1,884 Municipal securities 13,685 566 -- 14,251 Corporate securities 2,939 -- -- 2,939 Equity securities 4,156 -- (645) 3,511 ---------- ---------- ---------- ---------- $ 52,068 $ 603 $ (752) $ 51,919 ========== ========== ========== ========== -------------------------------------------------------------------------------------------------------
Management evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Effective June 30, 2008, management evaluated the Corporation's investment portfolio and determined that a $275,000 other than temporary impairment existed on two financial industry investments. The impairment of these securities were considered to be other than temporary due to recent developments in the financial condition and near-term prospects of the issuers, a downturn in the economic conditions affecting the financial services industry and declining book values of these securities. These securities were written down to their fair market value as of June 30, 2008 and the resulting impairment losses were recognized in earnings during the second quarter of 2008. Management will continue to evaluate the value of these investments and make any necessary adjustments as conditions dictate. There were no other unrealized losses that were considered other than temporary at June 30, 2008. 4. Loans Receivable. The Corporation's loans receivable as of the respective dates are summarized as follows:
------------------------------------------------------------------------------- (Dollar amounts in thousands) June 30, December 31, 2008 2007 ------------------------------------------------------------------------------- Mortgage loans on real estate: Residential first mortgages $ 65,659 $ 65,706 Home equity loans and lines of credit 53,081 49,426 Commercial real estate 76,637 71,599 ------------ ------------ 195,377 186,731 Other loans: Commercial business 39,997 35,566 Consumer 8,782 9,679 ------------ ------------ 48,779 45,245 ------------ ------------ Total loans, gross 244,156 231,976 Less allowance for loan losses 2,301 2,157 ------------ ------------ Total loans, net $ 241,855 $ 229,819 ============ ============ -------------------------------------------------------------------------------
6 5. Deposits. The Corporation's deposits as of the respective dates are summarized as follows:
----------------------------------------------------------------------------------------- (Dollar amounts in thousands) June 30, 2008 December 31, 2007 ----------------------------------------------------------------------------------------- Type of accounts Amount % Amount % --------------------------------------------------------------- ---------------------- Non-interest bearing deposits $ 51,427 19.8% $ 47,111 19.3% Interest bearing demand deposits 91,340 35.3% 77,614 31.8% Time deposits 116,266 44.9% 119,537 48.9% --------- --------- --------- --------- $ 259,033 100.0% $ 244,262 100.0% ========= ========= ========= ========= -----------------------------------------------------------------------------------------
6. Guarantees. The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Of these letters of credit at June 30, 2008, $85,000 will expire within the next fourteen months, $798,000 will automatically renew within the next twelve months and $216,000 will automatically renew within thirteen to twenty months. The Corporation, generally, holds collateral and/or personal guarantees supporting these commitments. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The current amount of the liability as of June 30, 2008 for guarantees under standby letters of credit issued is not material. 7. Employee Benefit Plans. The Corporation maintains a defined contribution 401(k) Plan. Eligible employees participate by providing tax-deferred contributions up to 20% of qualified compensation. Employee contributions are vested at all times. The Corporation provides a matching contribution of up to 4% of the participant's salary. Matching contributions for the six months ended June 30, 2008 and 2007 amounted to $76,000 and $67,000, respectively. The Corporation provides pension benefits for eligible employees through a defined benefit pension plan. Substantially all full-time employees participate in the retirement plan on a non-contributing basis and are fully vested after three years of service. The Corporation uses December 31 as the measurement date for its plans. 7 7. Employee Benefit Plans (continued). The components of the periodic pension cost are as follows:
-------------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) For the three months ended For the six months ended Year ended June 30, June 30, December 31, -------------------------- -------------------------- ----------- 2008 2007 2008 2007 2007 -------------------------------------------------- ----------- ----------- ----------- ----------- Service cost $ 63 $ 57 $ 126 $ 114 $ 238 Interest cost 71 65 142 130 262 Expected return on plan assets (79) (77) (158) (154) (303) Transition asset -- (2) -- (4) -- Prior service costs (8) (8) (16) (16) (31) Recognized net actuarial (gain) loss 4 7 8 14 31 ----------- ----------- ----------- ----------- ----------- Net periodic pension cost $ 51 $ 42 $ 102 $ 84 $ 197 =========== =========== =========== =========== =========== --------------------------------------------------------------------------------------------------------------
The expected rate of return on plan assets was 8.50% for the periods ended June 30, 2008 and 2007. The Corporation previously disclosed in its financial statements for the year ended December 31, 2007 that it expected to contribute $335,000 to its pension plan in 2008. As of June 30, 2008, there have been no contributions. The Corporation presently anticipates contributing $335,000 to its pension plan in 2008. 8. Stock Compensation Plans. In May 2007, the Corporation adopted the 2007 Stock Incentive Plan and Trust. Under the Plan, the Corporation may grant options to its directors, officers and employees for up to 177,496 shares of common stock. Incentive stock options, non-incentive or compensatory stock options and share awards may be granted under the Plan. The exercise price of each option shall at least equal the market price of a share of common stock on the date of grant and have a contractual term of ten years. Options shall vest and become exercisable at the rate, to the extent and subject to such limitations as may be specified by the Corporation. Effective May 2007, the Corporation adopted SFAS No. 123(R), Share-Based Payment, which requires that compensation cost related to share-based payment transactions be recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued. For the six-month period ended June 30, 2008, the Corporation recognized $52,000 in compensation expense for stock options. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: ---------------------------------------------------------------------- For the six months ended June 30, 2008 ---------------------------------------------------------------------- Dividend yield 4.46% Expected life 10 years Expected volatility 14.09% Risk-free interest rate 5.10% ---------------------------------------------------------------------- The expected volatility is based on historical stock price fluctuations. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on the maximum term of the options. The dividend yield assumption is based on the Corporation's history and expectation of dividend payouts. 8 8. Stock Compensation Plans (continued). A summary of option activity under the Plan as of June 30, 2008, and changes during the period then ended is presented below:
----------------------------------------------------------------------------------------------------------------------- Weighted-Average Weighted-Average Aggregate Remaining Term Options Exercise Price Intrinsic Value (in years) ----------------------------------------------------------------------------------------------------------------------- Outstanding at the beginning of the year 84,000 $ 26.00 9.0 Granted 5,500 25.90 9.8 Exercised -- -- -- Forfeited 4,500 26.00 -- ---------------- ---------------- ---------------- ---------------- Outstanding as of June 30, 2008 85,000 $ 25.99 $ -- 9.0 ================ ================ ================ ================ Exercisable as of June 30, 2008 -- $ -- $ -- -- ================ ================ ================ ================ -----------------------------------------------------------------------------------------------------------------------
A summary of the status of the Corporation's nonvested shares as of June 30, 2008, and changes during the period then ended is presented below:
------------------------------------------------------------------------------------- Weighted-Average Options Grant-date Fair Value ------------------------------------------------------------------------------------- Nonvested at the beginning of the year 84,000 $ 3.39 Granted 5,500 2.90 Vested -- -- Forfeited 4,500 -- --------------------- --------------------- Nonvested as of June 30, 2008 85,000 $ 3.36 ===================== ===================== -------------------------------------------------------------------------------------
As of June 30, 2008, there was $203,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over an average period of 2.0 years. 9. Fair Values of Financial Instruments. In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Corporation adopted SFAS 157 effective January 1, 2008 for financial assets and liabilities that are measured and reported at fair value. There was no impact from the adoption of SFAS 157 on the amounts reported in the consolidated financial statements. The primary effect of SFAS 157 on the Corporation was to expand the required disclosures pertaining to the methods used to determine fair values. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are as follows: Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. 9 9. Fair Values of Financial Instruments (continued). Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity). An asset or liability's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2008 are as follows:
---------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) (Level 1) (Level 2) Quoted Prices in Significant (Level 3) Active Markets Other Significant for Identical Observable Unobservable Description June 30, 2008 Assets Inputs Inputs ---------------------------------------------------------------------------------------------------------- Securities available for sale $ 61,942 $ 3,288 $ 58,654 $ -- ---------------- ---------------- ---------------- ---------------- $ 61,942 $ 3,288 $ 58,654 $ -- ================ ================ ================ ================ ----------------------------------------------------------------------------------------------------------
The Corporation's adoption of SFAS 157 applies only to its financial instruments required to be reported at fair value. The adoption does not apply to non-financial assets and non-financial liabilities until January 1, 2009 in accordance with FSP FAS 157-2. The following valuation technique was used to measure fair value of assets in the table above on a recurring basis as of June 30, 2008: Available for sale securities - Fair value on available for sale securities were based upon a market approach. Prices for securities that are fixed income instruments that are not quoted on an exchange, but are traded in active markets, are obtained through third party data service providers or dealer market participants which the Corporation has historically transacted both purchases and sales of investment securities. As of June 30, 2008, all fair values on available for sale securities were based on prices obtained from these sources and were based on actual market quotations for each specific security. 10. Adoption of New Accounting Standards. The Corporation adopted the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157) effective January 1, 2008 for financial assets and liabilities that are measured and reported at fair value. There was no impact from the adoption of SFAS 157 on the amounts reported in the consolidated financial statements. The primary effect of SFAS 157 on the Corporation was to expand required disclosures pertaining to the methods used to determine fair values. See note 9 for further detail. 11. Proposed Merger Conversion Effective May 22, 2008, the Corporation entered into a definitive agreement with Elk County Savings and Loan Association (ECSLA), headquartered in Ridgway, Pennsylvania, to acquire ECSLA in a conversion merger transaction. At June 30, 2008, ECSLA had total assets, loans, deposits and equity of $9.4 million, $7.6 million, $7.0 million and $2.4 million, respectively. In connection with this transaction, the Corporation will offer shares of its common stock to certain members of ECSLA in a subscription offering. Any stock not purchased by eligible members of ECSLA in the subscription offering will then be offered to certain members of the community and to the general public. Following the closing of the offering of the Corporation's common stock, ECSLA will merge with and into Farmers National Bank, with Farmers National Bank as the surviving institution. The Corporation expects this transaction to be finalized during the fourth quarter of 2008. 10 12. Effect of Recently Issued Accounting Standards. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for the Corporation January 1, 2008. This new accounting pronouncement had no effect on the Corporation's consolidated financial statements as the Corporation elected not to adopt SFAS 159. In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141R). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance will become effective for fiscal years beginning after December 15, 2008. This new pronouncement will impact the Corporation's accounting for business combinations completed beginning January 1, 2009. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements - An Amendment of ARB No. 51 (SFAS 160). SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance will become effective for fiscal years beginning after December 15, 2008, which for the Corporation will be January 1, 2009. The Corporation believes that this new pronouncement will have an immaterial impact on its consolidated financial statements. In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R and other GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Corporation is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements. In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. This Statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Corporation is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements. In June 2008, the FASB ratified EITF Issue No. 07-5, Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity's Own Stock (EITF 07-5). EITF 07-5 provides that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. It also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. EITF is effective for fiscal years beginning after December 15, 2008. The Corporation is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results -------------------------------------------------------------------------------- of Operations ------------- This section discusses the consolidated financial condition and results of operations of Emclaire Financial Corp. (the "Corporation") and its wholly owned subsidiary bank, the Farmers National Bank of Emlenton (the "Bank"), for the three and six months ended June 30, 2008 compared to the same periods in 2007 and should be read in conjunction with the Corporation's December 31, 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission and with the accompanying consolidated financial statements and notes presented on pages 1 through 11 of this Form 10-Q. The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words "believes," "anticipates," "contemplates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses and general economic conditions. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. CHANGES IN FINANCIAL CONDITION Total assets increased $23.0 million to $334.7 million at June 30, 2008 from $311.7 million at December 31, 2007. This 7.4% increase resulted from increases in securities and loans receivable, net of allowance for loan losses, of $10.0 million and $12.0 million, respectively. The increase in the Corporation's assets was primarily funded by increases in customer deposits and borrowed funds. Non-performing assets to total assets decreased to 0.31% at June 30, 2008 compared to 0.35% at December 31, 2007. The Bank has a $2.3 million personal loan that was not included as a non-performing asset for purposes of the June 30, 2008 calculation that has exhibited credit weaknesses and has been classified as substandard. This loan is secured by local real property pledged by an associate of the borrower as well as proceeds from a life insurance policy. Although the Bank is in negotiations with the borrower, the Bank believes that it may be required to initiate foreclosure proceedings. However, due to the low loan to value ratio at the time of the loan origination in March 2006, the Bank does not believe it will incur any material losses on this loan. Total liabilities increased $22.7 million to $309.7 million at June 30, 2008 from $287.0 million at December 31, 2007, while total stockholders' equity increased $302,000 to $25.0 million at June 30, 2008 from $24.7 million at December 31, 2007. The increase in total liabilities resulted primarily from increases in customer deposits of $14.8 million and borrowed funds of $8.3 million. RESULTS OF OPERATIONS Comparison of Results for the Three Month Periods Ended June 30, 2008 and 2007 General. Net income decreased $166,000 or 23.5% to $541,000 for the three months ended June 30, 2008 from $707,000 for the same period in 2007. This decrease was the result of an increase in the provision of loan losses of $55,000 and a decrease in noninterest income of $276,000, partially offset by an increase in net interest income of $66,000 and decreases in noninterest expense and the provision for income taxes of $43,000 and $56,000, respectively. Net interest income. Net interest income on a tax equivalent basis increased $57,000 or 2.2% to $2.7 million for the three months ended June 30, 2008 from $2.6 million for the same period in 2007. This net increase can be attributed to an increase in tax equivalent interest income of $138,000, partially offset by an increase in interest expense of $81,000. 12 Interest income. Interest income on a tax equivalent basis increased $138,000 or 3.0% to $4.7 million for the three months ended June 30, 2008, compared to $4.5 million for the same period in the prior year. This increase can be attributed to increases in interest on loans and interest-earning deposits with banks and dividends on federal bank stocks of $137,000, $20,000 and $4,000, respectively, partially offset by a decrease in interest on securities of $23,000. Tax equivalent interest earned on loans receivable increased $137,000 or 3.6% to $4.0 million for the three months ended June 30, 2008, compared to $3.8 million for the same period in 2007. This increase resulted primarily from average loans increasing $21.2 million or 9.7%, accounting for $357,000 in additional loan interest income. This increase can be primarily attributed to growth in the Corporation's commercial loan portfolios. Offsetting this volume increase, the yield on loans receivable decreased 37 basis points to 6.61% for the three months ended June 30, 2008, versus 6.98% for the same period in 2007, accounting for a $220,000 decrease in interest income. Contributing to this decrease in yields on loans receivable was recent decreases in short-term market interest rates. In addition, the Corporation collected $54,000 of interest due associated with the payoff of a previously non-performing commercial loan in April 2007 that had been on non-accrual status. In connection with the loan payoff, the Corporation received all principal and interest due under the contractual terms of the loan agreement and interest collected was recorded as loan interest income during the three months ended June 30, 2007. Interest earned on interest-earning deposit accounts increased $20,000 or 125.0% to $36,000 for the three months ended June 30, 2008 from $16,000 for the same period in 2007. The average volume of these assets increased $6.4 million or 183.2%, primarily as a result of an increase in customer deposits, increasing interest income by $36,000. Offsetting this volume increase, the average yield on interest-earning deposit accounts decreased 344 basis points to 2.03% for the three months ended June 30, 2008, compared to 5.47% for the same period in the prior year, accounting for a $16,000 decrease in interest income. The decrease in the average yield reflects the recent decreases in short-term market interest rates. Dividends on federal bank stocks increased $4,000 or 19.0% to $25,000 for the three month period ended June 30, 2008 from $21,000 for the same period in 2007. The average volume of these assets increased $430,000 or 18.5%, accounting for the increase in income. Tax equivalent interest earned on securities decreased $23,000 to $645,000 for the three months ended June 30, 2008, compared to $668,000 for the same period in 2007. The average yield on securities decreased 14 basis points to 4.78% for the three months ended June 30, 2008, versus 4.92% for the same period in 2007, as a result of certain higher yielding securities maturing. This unfavorable yield variance accounted for a $21,000 decrease in interest income. In addition, the average volume of securities decreased $192,000, accounting for a $2,000 decrease in interest income. Interest expense. Interest expense increased $81,000 or 4.2% to $2.0 million for the three months ended June 30, 2008, compared to $1.9 million for the same period in 2007. This increase in interest expense can be attributed to an increase in interest incurred on borrowed funds of $95,000, partially offset by a decrease in interest incurred on deposits of $14,000. Interest expense incurred on borrowed funds increased $95,000 or 27.1% to $445,000 for the three months ended June 30, 2008, compared to $350,000 for the same period in the prior year. This increase in interest expense can be attributed to the increase in the average balance of borrowed funds of $12.5 million or 39.3% to $44.3 million for the three months ended June 30, 2008, compared to $31.8 million for the same period in the prior year contributing $128,000 in additional expense. This volume increase was the result of $5.0 million of FHLB long-term borrowings placed in the fourth quarter of 2007 used primarily to fund loan growth and an average of $9.3 million in short-term borrowings used to fund security purchases. Partially offsetting this volume increase, the cost of borrowed funds decreased 38 basis points to 4.04% for the three months ended June 30, 2008, compared to 4.42% for the same period in 2007 causing a $33,000 decrease in interest expense. 13 Interest expense incurred on deposits decreased $14,000 or 1.0% to $1.6 million for the three months ended June 30, 2008 compared to the same period in 2007. The cost of interest-bearing deposits decreased 18 basis points to 3.06% for the three months ended June 30, 2008, compared to 3.24% for the same period in 2007 causing a $96,000 decrease in interest expense. Partially offsetting this yield decrease, the average volume of interest-bearing deposits increased $10.4 million to $204.4 million for the three months ended June 30, 2008, compared to $194.0 million for the same period in 2007 causing an $82,000 increase in interest expense. 14 Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include non-accrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.
-------------------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) Three months ended June 30, -------------------------------------------------------------------------------------------------------------------- 2008 2007 ------------------------------ -------------------------------- Average Yield / Average Yield / Balance Interest Rate Balance Interest Rate -------------------------------------------------------------------------------------------------------------------- Interest-earning assets: ------------------------ Loans, taxable $ 234,664 $ 3,865 6.62% $ 213,162 $ 3,718 7.00% Loans, tax exempt 6,072 92 6.12% 6,325 102 6.49% ---------- -------- --------- --------- Total loans receivable 240,736 3,957 6.61% 219,487 3,820 6.98% ---------- -------- --------- --------- Securities, taxable 39,934 412 4.15% 39,587 419 4.25% Securities, tax exempt 14,332 233 6.54% 14,871 249 6.71% ---------- -------- --------- --------- Total securities 54,266 645 4.78% 54,458 668 4.92% ---------- -------- --------- --------- Interest-earning deposits with banks 7,148 36 2.03% 1,174 16 5.47% Federal bank stocks 2,751 25 3.66% 2,321 21 3.68% ---------- -------- --------- --------- Total interest-earning cash equivalents 9,899 61 2.48% 3,495 37 4.28% ---------- -------- --------- --------- Total interest-earning assets 304,901 4,663 6.15% 277,440 4,525 6.54% Cash and due from banks 5,569 5,668 Other noninterest-earning assets 14,590 14,668 ---------- --------- Total Assets $ 325,060 $ 297,776 ========== ========= Interest-bearing liabilities: ----------------------------- Interest-bearing demand deposits $ 87,112 311 1.44% $ 72,859 224 1.23% Time deposits 117,290 1,243 4.26% 121,095 1,344 4.45% ---------- -------- --------- --------- Total interest-bearing deposits 204,402 1,554 3.06% 193,954 1,568 3.24% ---------- -------- --------- --------- Borrowed funds, short-term 9,291 53 2.29% 1,791 25 5.60% Borrowed funds, long-term 35,000 392 4.50% 30,000 325 4.35% ---------- -------- --------- --------- Total borrowed funds 44,291 445 4.04% 31,791 350 4.42% ---------- -------- --------- --------- Total interest-bearing liabilities 248,693 1,999 3.23% 225,745 1,918 3.41% ---------- -------- --------- --------- Noninterest-bearing demand deposits 48,878 - - 45,088 - - ---------- -------- --------- --------- Funding and cost of funds 297,571 1,999 2.70% 270,833 1,918 2.84% Other noninterest-bearing liabilities 2,466 2,851 ---------- --------- Total Liabilities 300,037 273,684 Stockholders' Equity 25,023 24,092 ---------- --------- Total Liabilities and Stockholders' Equity $ 325,060 $ 297,776 ========== -------- ========= --------- Net interest income $ 2,664 $ 2,607 ======== ========= Interest rate spread (difference between 2.92% 3.13% ========= ======== weighted average rate on interest-earning assets and interest-bearing liabilities) Net interest margin (net interest 3.51% 3.77% ========= ======== income as a percentage of average interest-earning assets) --------------------------------------------------------------------------------------------------------------------
15 Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis. ------------------------------------------------------------------------------ (Dollar amounts in thousands) Three months ended June 30, 2008 versus 2007 Increase (Decrease) due to ------------------------------------------------------------------------------ Volume Rate Total ------------------------------------------------------------------------------ Interest income: Loans $ 357 $ (220) $ 137 Securities (2) (21) (23) Interest-earning deposits with banks 36 (16) 20 Federal bank stocks 4 -- 4 -------- -------- -------- Total interest-earning assets 395 (257) 138 -------- -------- -------- Interest expense: Deposits 82 (96) (14) Borrowed funds 128 (33) 95 -------- -------- -------- Total interest-bearing liabilities 210 (129) 81 -------- -------- -------- Net interest income $ 185 $ (128) $ 57 ======== ======== ======== ------------------------------------------------------------------------------ Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of non-performing assets, the estimated underlying value of the collateral and other factors related to the collectibility of the loan portfolio. Information pertaining to the allowance for loan losses and non-performing assets for the quarters ended June 30, 2008 and 2007 is as follows:
--------------------------------------------------------------------------------------- (Dollar amounts in thousands) At or for the three months ended June 30, ----------------------------------- 2008 2007 --------------------------------------------------------------------------------------- Balance at the beginning of the period $ 2,218 $ 2,078 Provision for loan losses 85 30 Charge-offs (17) (32) Recoveries 15 10 --------------- --------------- Balance at the end of the period $ 2,301 $ 2,086 =============== =============== Non-performing loans $ 986 $ 1,176 Non-performing assets 1,030 1,176 Non-performing loans to total loans 0.40% 0.53% Non-performing assets to total assets 0.31% 0.39% Allowance for loan losses to total loans 0.94% 0.94% Allowance for loan losses to non-performing loans 233.37% 177.36% ---------------------------------------------------------------------------------------
16 The provision for loan losses increased $55,000 or 183.3% to $85,000 for the three month period ended June 30, 2008 from $30,000 for the same period in the prior year. Management's evaluation of the loan portfolio, including the changing composition of the portfolio as well as economic trends, regulatory considerations and other factors contributed to the recognition of $85,000 in the provision for loan losses during the three months ended June 30, 2008. Noninterest income. Noninterest income decreased $276,000 or 35.8% to $496,000 during the three months ended June 30, 2008, compared to $772,000 during the same period in the prior year. This decrease can be attributed to the negative variance in gains and losses on securities and decreases in gains on the sale of loans of $393,000 and $13,000, respectively. Partially offsetting this decrease in noninterest income were increases in fees and service charges, commissions on financial services, earnings on bank-owned life insurance and other noninterest income of $16,000, $46,000, $3,000 and $65,000, respectively. The Corporation realized security losses of $275,000 in the second quarter of 2008 compared to gains of $118,000 for the same period in 2007. Management determined that two marketable equity securities were impaired. The impairment of these financial industry securities were considered to be other than temporary due to recent developments in the financial condition and near-term prospects of the issuers, a downturn in the economic conditions affecting the industry and declining book values of the securities. At June 30, 2008, these securities were written down to their current fair value. The gain during the three month periods ended June 30, 2007, was primarily due to the realization of a gain from the sale of a community bank stock investment as a result of that bank's merger with a larger financial institution. Noninterest expense. Noninterest expense decreased $43,000 or 1.8% to $2.3 million during the three months ended June 30, 2008 compared to the same period in 2007. This decrease in noninterest expense can be attributed to a decrease in other noninterest expense of $98,000, partially offset by increases in compensation and employee benefits and premises and equipment of $38,000 and $17,000, respectively. Compensation and employee benefits increased $38,000 or 3.1% to $1.3 million for the three months ended June 30, 2008, compared to $1.2 million for the same period in the prior year. This increase can be attributed primarily to normal salary and wage increases and the addition of staff at a new branch location. Premises and equipment increased $17,000 or 4.2% to $418,000 for the three months ended June 30, 2008, compared to $401,000 for the same period in the prior year. This increase can be attributed primarily to costs associated with an additional branch office which was opened in April 2008. Other noninterest expense decreased $98,000 or 14.2% to $592,000 during the three months ended June 30, 2008, compared to $690,000 for the same period in the prior year. This decrease can be attributed primarily to a decrease in professional fees relating to Sarbanes-Oxley Section 404 compliance. Provision for income taxes. The provision for income taxes decreased $56,000 or 28.4% to $141,000 for the three months ended June 30, 2008, compared to $197,000 for the same period in the prior year. This was due to a decrease in pre-tax earnings of $222,000 or 24.6% to $682,000 for the three months ended June 30, 2008, compared to $904,000 for the same period in the prior year and a decrease in the effective tax rate to 20.7% for the three months ended June 30, 2008, compared to 21.8% for the same period in 2007. The difference between the statutory rate of 34% and the Corporation's effective tax rate is due to tax-exempt income earned on certain tax-free loans and securities and bank-owned life insurance. 17 Comparison of Results for the Six Month Periods Ended June 30, 2008 and 2007 General. Net income decreased $158,000 or 12.6% to $1.1 million for the six months ended June 30, 2008 from $1.3 million for the same period in 2007. This decrease was a result of increases in the provision for loans losses and noninterest expense of $70,000 and $62,000, respectively, and a decrease in noninterest income of $346,000. Partially offsetting this decrease was an increase in net interest income of $300,000 and a decrease in the provision for income taxes of $20,000. Net interest income. Net interest income on a tax equivalent basis increased $285,000 or 5.7% to $5.3 million for the six months ended June 30, 2008 from $5.0 million for the same period in 2007. This net increase can be attributed to an increase in tax equivalent interest income of $341,000, partially offset by a $56,000 increase in interest expense. Interest income. Interest income on a tax equivalent basis increased $341,000 or 3.8% to $9.3 million for the six months ended June 30, 2008, compared to $8.9 million for the same period in the prior year. This increase can be attributed to an increase in interest earned on loans of $461,000, partially offset by decreases in interest earned on securities, federal bank stocks, and interest-earning deposits with banks of $26,000, $16,000 and $78,000, respectively. Tax equivalent interest earned on loans receivable increased $461,000 or 6.2% to $7.9 million for the six months ended June 30, 2008, compared to $7.5 million for the same period in 2007. During that time, average loans increased $19.8 million or 9.1%, accounting for $666,000 in additional loan interest income. This increase can be primarily attributed to growth in the Corporation's commercial loan portfolios. Partially offsetting this volume increase, the yield on loans decreased 21 basis points to 6.71% for the six months ended June 30, 2008, versus 6.92% for the same period in 2007, accounting for a $205,000 decrease in interest income. Contributing to this unfavorable yield variance was the recent decrease in short-term market interest rates. In addition, the Corporation collected $54,000 of interest due as a result of the payoff of a previously commercial loan in April 2007 that had been on non-accrual status. In connection with the loan payoff, the Corporation received all principal and interest due under the contractual terms of the loan agreement and interest collected was recorded as loan interest income during the three months ended June 30, 2007. Tax equivalent interest earned on securities decreased $26,000 or 2.0% to $1.3 million for the six months ended June 30, 2008. The average volume of securities decreased $2.6 million to $50.6 million for the six months ended June 30, 2008, compared to $53.2 million for the six months ended June 30, 2007, primarily as a result of the utilization of these funds for loan growth. This resulted in a $63,000 decline in interest income. Partially offsetting this unfavorable volume variance, the average yield on securities increased 13 basis points to 4.99% for the six months ended June 30, 2008, versus 4.86% for the same period in 2007, as a result of certain lower yielding securities maturing. This favorable yield variance contributed an additional $37,000 to interest income. Interest earned on interest-earning deposit accounts decreased $78,000 to $59,000 for the six months ended June 30, 2008 from $137,000 for the same period in 2007. The average yield on interest-earning deposit accounts decreased 301 basis points to 2.26% for the six months ended June 30, 2008, compared to 5.27% for the same period in the prior year, accounting for the decline in interest income. The decrease in the average yield reflects the recent decreases in short-term market interest rates. Interest earned on federal bank stocks decreased $16,000 to $55,000 for the six month period ended June 30, 2008 from $71,000 for the same period in the prior year as a result of a lower yield. The lower yield resulted from the recognition of a special dividend on FHLB capital stock during the six months ended June 30, 2007. Interest expense. Interest expense increased $56,000 or 1.4% to $4.0 million for the six months ended June 30, 2008, compared to $3.9 million for the same period in the prior year. This increase in interest expense can be attributed to an increase in interest incurred on borrowed funds of $165,000, partially offset by a decrease in interest incurred on deposits of $109,000. 18 Interest expense incurred on borrowed funds increased $165,000 or 24.1% to $851,000 for the six months ended June 30, 2008, compared to $686,000 for the same period in the prior year. This increase in interest expense can be attributed to the increase in the average balance of borrowed funds of $10.4 million to $41.3 million for the six months ended June 30, 2008, compared to $30.9 million for the same period in the prior year. This volume increase was the result of $5.0 million of FHLB long-term borrowings placed in the fourth quarter of 2007 used primarily to fund loan growth and an average of $6.3 million in short-term borrowings used primarily to fund security purchases. This volume variance contributed $217,000 in additional expense. Partially offsetting this volume increase, the cost of borrowed funds decreased 34 basis points to 4.14% for the six months ended June 30, 2008, compared to 4.48% for the same period in 2007 causing a $52,000 decrease in interest expense. Interest expense incurred on deposits decreased $109,000 or 3.4% to $3.1 million for the six months ended June 30, 2008, compared to $3.2 million for the same period in the prior year. This decrease can be attributed to the cost of interest-bearing deposits decreasing 17 basis points to 3.14% for the six months ended June 30, 2008, compared to 3.31% for the same period in 2007 accounting for a $162,000 decline in interest expense. The decrease in the rate paid on deposits reflects the recent decreases in short-term market interest rates. Partially offsetting this favorable yield variance, the average volume of deposits increased $3.2 million or 1.7% to $200.0 million for the six months ended June 30, 2008, compared to $196.8 million for the same period in 2007 contributing $53,000 in additional expense. 19 Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include non-accrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.
------------------------------------------------------------------------------------------------------------ Six months ended June 30, ------------------------------------------------------------- 2008 2007 ------------------------------- ----------------------------- Average Yield / Average Yield / (Dollar amounts in thousands) Balance Interest Rate Balance Interest Rate --------- ----------- --------- -------- --------- ---------- ------------------------------------------------------------------------------------------------------------ Interest-earning assets: ------------------------ Loans, taxable $ 231,135 $ 7,727 6.72% $210,977 $ 7,250 6.93% Loans, tax exempt 6,078 190 6.29% 6,419 206 6.48% --------- ----------- --------- -------- --------- ---------- Total loans receivable 237,213 7,917 6.71% 217,396 7,456 6.92% --------- ----------- --------- -------- --------- ---------- Securities, taxable 36,296 789 4.37% 38,176 783 4.14% Securities, tax exempt 14,346 468 6.56% 15,046 500 6.70% --------- ----------- --------- -------- --------- ---------- Total securities 50,642 1,257 4.99% 53,222 1,283 4.86% --------- ----------- --------- -------- --------- ---------- Interest-earning deposits with banks 5,249 59 2.26% 5,247 137 5.27% Federal bank stocks 2,635 55 4.20% 2,265 71 6.32% --------- ----------- --------- -------- --------- ---------- Total interest-earning cash equivalents 7,884 114 2.91% 7,512 208 5.58% --------- ----------- --------- -------- --------- ---------- Total interest-earning assets 295,739 9,288 6.32% 278,130 8,947 6.49% Cash and due from banks 5,399 5,913 Other noninterest-earning assets 14,601 14,601 --------- -------- Total assets $ 315,739 $298,644 ========= ======== Interest-bearing liabilities: ----------------------------- Interest-bearing demand deposits $ 83,035 594 1.44% $ 72,513 457 1.27% Time deposits 117,014 2,532 4.35% 124,291 2,778 4.51% --------- ----------- --------- -------- --------- ---------- Total interest-bearing deposits 200,049 3,126 3.14% 196,804 3,235 3.31% --------- ----------- --------- -------- --------- ---------- Borrowed funds, long-term 35,000 782 4.49% 30,000 661 4.44% Borrowed funds, short-term 6,319 69 2.20% 908 25 5.55% --------- ----------- --------- -------- --------- ---------- Total borrowed funds 41,319 851 4.14% 30,908 686 4.48% --------- ----------- --------- -------- --------- ---------- Total interest-bearing liabilities 241,368 3,977 3.31% 227,712 3,921 3.47% Noninterest-bearing demand deposits 47,018 - - 44,230 - - --------- ----------- --------- -------- --------- ---------- Funding and cost of funds 288,386 3,977 2.77% 271,942 3,921 2.91% Other noninterest-bearing liabilities 2,428 2,712 --------- -------- Total liabilities 290,814 274,654 Stockholders' equity 24,925 23,990 --------- -------- Total liabilities and stockholders' equity $ 315,739 $298,644 ========= ----------- ======== --------- Net interest income $ 5,311 $ 5,026 =========== ========= Interest rate spread (difference between 3.00% 3.01% ========= ========== weighted average rate on interest-earning assets and interest-bearing liabilities) Net interest margin (net interest 3.61% 3.64% ========= ========== income as a percentage of average interest-earning assets)
20 Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.
----------------------------------------------------------------------------------------- (Dollar amounts in thousands) Six months ended June 30, 2008 versus 2007 Increase (Decrease) due to ------------------------------------------ Volume Rate Total ----------------------------------------------------------------------------------------- Interest income: Loans $ 666 $ (205) $ 461 Securities (63) 37 (26) Interest-earning deposits with banks - (78) (78) Federal bank stocks 10 (26) (16) ---------- ---------- ---------- Total interest-earning assets 613 (272) 341 ---------- ---------- ---------- Interest expense: Deposits 53 (162) (109) Borrowed funds 217 (52) 165 ---------- ---------- ---------- Total interest-bearing liabilities 270 (214) 56 ---------- ---------- ---------- Net interest income $ 343 $ (58) $ 285 ========== ========== ========== -----------------------------------------------------------------------------------------
Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of non-performing assets, the estimated underlying value of the collateral and other factors related to the collectibility of the loan portfolio. Information pertaining to the allowance for loan losses and non-performing assets for the six months ended June 30, 2008 and 2007 is as follows: ----------------------------------------------------------------------------- At or for the year For the six months ended: ended June 30, December 31, --------------------------- ------------ (Dollar amounts in thousands) 2008 2007 2007 ----------------------------------------------------------------------------- Balance at the beginning of the period $ 2,157 $ 2,035 2,035 Provision for loan losses 145 75 256 Charge-offs (27) (47) (164) Recoveries 26 23 30 ------------ ------------ ------------ Balance at the end of the period $ 2,301 $ 2,086 $ 2,157 ============ ============ ============ Non-performing loans $ 986 $ 1,176 952 Non-performing assets 1,030 1,176 1,081 Non-performing loans to total loans 0.40% 0.53% 0.41% Non-performing assets to total assets 0.31% 0.39% 0.35% Allowance for loan losses to total loans 0.94% 0.94% 0.93% Allowance for loan losses to non- performing loans 233.37% 177.36% 226.58% ----------------------------------------------------------------------------- 21 The provision for loan losses increased $70,000 or 93.3% to $145,000 for the six month period ended June 30, 2008 from $75,000 for the same period in the prior year. Management's evaluation of the loan portfolio, including the changing composition of the portfolio as well as economic trends, regulatory considerations and other factors contributed to the recognition of $145,000 in the provision for loan losses during the six months ended June 30, 2008. Noninterest income. Noninterest income decreased $346,000 to $1.2 million for the six months ended June 30, 2008, compared to $1.5 million for the same period in the prior year. This decrease can be attributed to a decrease in gains on securities of $451,000, partially offset by increases in fees and service charges, commissions earned on financial services, gains on the sale of loans, earnings on bank-owned life insurance and other noninterest income of $49,000, $2,000, $1,000, $5,000 and $48,000, respectively. The Corporation realized security losses of $275,000 during the six months ended June 30, 2008 compared to gains of $176,000 for the same period in 2007. During the second quarter of 2008, management determined that two marketable equity securities were impaired. The impairment of these financial industry securities were considered to be other than temporary due to recent developments in the financial condition and near-term prospects of the issuers, a downturn in the economic conditions affecting the industry and declining book values of the securities. At June 30, 2008, these securities were written down to their current fair value. The gain during the six month period ended June 30, 2007, was primarily due to the realization of a $166,000 gain from the sale of a community bank stock investment as a result of that bank's merger with a larger financial institution. Noninterest expense. Noninterest expense increased $62,000 or 1.3% to $4.7 million during the six months ended June 30, 2008, compared to $4.6 million during the same period in the prior year. This increase in noninterest expense can be attributed to increases in compensation and benefits and premises and equipment of $150,000 and $38,000, respectively, partially offset by a decrease in other noninterest expense of $126,000. Compensation and benefits increased $150,000 or 5.9% to $2.7 million during the six months ended June 30, 2008, compared to $2.6 million for the same period in the prior year. This increase can be attributed primarily to normal salary and wage increases and the addition of staff at a new branch location. Premises and equipment increased $38,000 or 4.7% to $839,000 during the six months ended June 30, 2008, compared to $801,000 for the same period in the prior year. This increase can be attributed primarily to costs associated with an additional branch office which was opened in April 2008. Other noninterest expense decreased $126,000 or 9.7% to $1.2 million during the six months ended June 30, 2008, compared to $1.3 million for the same period in the prior year. This decrease can be attributed primarily to a decrease in professional fees relating to Sarbanes-Oxley Section 404 compliance. Provision for income taxes. The provision for income taxes decreased $20,000 or 6.0% to $311,000 for the six months ended June 30, 2008, compared to $331,000 for the same period in the prior year due primarily to the decrease in pre-tax earnings of $178,000 or 11.2% to $1.4 million for the six months ended June 30, 2008, compared to $1.6 million for the same period in the prior year. Partially offsetting this favorable variance, the effective tax rate was 22.0% for the six months ended June 30, 2008, compared to 20.8% for the same period in 2007. The difference between the statutory rate of 34% and the Corporation's effective tax rate is due to tax-exempt income earned on loans, securities and bank-owned life insurance. LIQUIDITY The Corporation's primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB and amortization and prepayments of outstanding loans and maturing securities. During the six months ended June 30, 2008, the Corporation used its sources of funds primarily to fund loan originations and security purchases. As of such date, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $28.1 million, and standby letters of credit totaling $1.1 million. 22 At June 30, 2008, time deposits amounted to $116.3 million or 44.9% of the Corporation's total consolidated deposits, including approximately $47.7 million of which are scheduled to mature within the next year. Management of the Corporation believes that it has adequate resources to fund all of its commitments, that all of its commitments will be funded as required by related maturity dates and that, based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities. Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation has alternative sources of funds such as a term borrowing capacity from the FHLB and, to a limited and rare extent, the sale of loans. At June 30, 2008, the Corporation's borrowing capacity with the FHLB, net of funds borrowed, was $116.1 million. Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business. CRITICAL ACCOUNTING POLICIES Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the determination of the allowance for loan losses and the evaluation of securities for other than temporary impairment as a critical accounting policies. The allowance for loan losses provides for an estimate of probable losses in the loan portfolio. In determining the appropriate level of the allowance for loan loss, the loan portfolio is separated into risk-rated and homogeneous pools. Migration analysis/historical loss rates, adjusted for relevant trends, have been applied to these pools. Qualitative adjustments are then applied to the portfolio to allow for quality of lending policies and procedures, national and local economic and business conditions, changes in the nature and volume of the portfolio, experience, ability and depth of lending management, changes in the trends, volumes and severity of past due, non-accrual and classified loans and loss and recovery trends, quality of the Corporation's loan review system, concentrations of credit, and external factors. The methodology used to determine the adequacy of the Corporation's allowance for loan losses is comprehensive and meets regulatory and accounting industry standards for assessing the allowance, however, it is still an estimate. Loan losses are charged against the allowance while recoveries of amounts previously charged-off are credited to the allowance. Loan loss provisions are charged against current earnings based on management's periodic evaluation and review of the factors indicated above. Management evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Item 3. Quantitative and Qualitative Disclosures About Market Risk ------------------------------------------------------------------- Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and interest-bearing liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Bank does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses depend upon the local economic conditions in the immediate trade area. 23 One of the primary functions of the Corporation's asset/liability management committee is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability committee is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates. Interest rate sensitivity is the result of differences in the amounts and repricing dates of the Bank's rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing "gap", provide an indication of the extent that the Corporation's net interest income is affected by future changes in interest rates. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income. Based on certain assumptions provided by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation's assets and liabilities to interest rate changes, at June 30, 2008, the Corporation's interest-earning assets maturing or repricing within one year totaled $86.3 million while the Corporation's interest-bearing liabilities maturing or repricing within one-year totaled $99.2 million, providing an excess of interest-bearing liabilities over interest-earning assets of $12.9 million or 3.9% of total assets. At June 30, 2008, the percentage of the Corporation's assets to liabilities maturing or repricing within one year was 114.9%. For more information, see "Market Risk Management" in Exhibit 13 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 2007. Item 4T. Controls and Procedures --------------------------------- The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Corporation's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of "disclosure controls and procedures" in Rule 13a-15(e). There has been no change made in the Corporation's internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting. As of June 30, 2008, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation's management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures. Based on the foregoing, the Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective. There have been no significant changes in the Corporation's internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Corporation completed its evaluation. PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings -------------------------- The Corporation is involved in various legal proceedings occurring in the ordinary course of business. It is the opinion of management, after consultation with legal counsel, that these matters will not materially effect the Corporation's consolidated financial position or results of operations. 24 Item 1A. Risk Factors ---------------------- There have been no material changes in the Corporation's risk factors from those previously disclosed in the 2007 Form 10-K. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds -------------------------------------------------------------------- None. Item 3. Defaults Upon Senior Securities ---------------------------------------- None. Item 4. Submission of Matters to a Vote of Security Holders ------------------------------------------------------------ (a) The annual meeting of stockholders of the Corporation was held April 23, 2008. Of 1,267,835 common shares eligible to vote, 937,632 or 74.0% were voted in person or by proxy. (b) The following Class B directors were elected for a three year term expiring in 2011: Name Shares For Shares Withheld ---- ---------- --------------- James M. Crooks 899,862 37,770 Robert L. Hunter 929,184 8,448 John B. Mason 922,406 15,226 In addition to the above listed individuals, the following persons continue to serve as directors: Ronald L. Ashbaugh, David L. Cox, George W. Freeman, Mark A. Freemer, J. Michael King, William C. Marsh and Brian C. McCarrier. The recommendation of the Board of Directors to ratify the appointment of Beard Miller Company LLP as the Corporation's independent auditors, as described in the proxy statement for the annual meeting was approved with 930,172 shares in favor, 2,258 shares against and 5,202 shares abstained. Item 5. Other Information -------------------------- (a) Not applicable. (b) Not applicable. Item 6. Exhibits ----------------- Exhibit 31.1 Rule 13a-14(a) Certification of Chief Executive Officer Exhibit 31.2 Rule 13a-14(a) Certification of Chief Financial Officer Exhibit 32.1 CEO Certification Pursuant to 18 U.S.C. Section 1350 Exhibit 32.2 CFO Certification Pursuant to 18 U.S.C. Section 1350 25 Signatures ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EMCLAIRE FINANCIAL CORP. AND SUBSIDIARY Date: August 14, 2008 By: /s/ David L. Cox ------------------------------------- David L. Cox Chairman of the Board, President and Chief Executive Officer Date: August 14, 2008 By: /s/ William C. Marsh ------------------------------------- William C. Marsh Treasurer and Chief Financial Officer 26