Document


 
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, 2016
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 001-33003
 
 
CITIZENS COMMUNITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
 
Maryland
 
20-5120010
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
2174 EastRidge Center, Eau Claire, WI 54701
(Address of principal executive offices)
715-836-9994
(Registrant’s telephone number, including area code)
 
 
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer
 
¨
 
Accelerated filer
 
¨
Non-accelerated filer
 
¨ (do not check if a smaller reporting company)
 
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
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
At August 12, 2016 there were 5,251,998 shares of the registrant’s common stock, par value $0.01 per share, outstanding.




CITIZENS COMMUNITY BANCORP, INC.
FORM 10-Q
June 30, 2016
INDEX
 
 
 
Page Number
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 

2



PART 1 – FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

CITIZENS COMMUNITY BANCORP, INC.
Consolidated Balance Sheets
June 30, 2016 (unaudited) and September 30, 2015
(derived from audited financial statements)
(in thousands, except share data)
 
June 30, 2016
 
September 30, 2015
Assets
 
 
 
Cash and cash equivalents
$
21,345

 
$
23,872

Other interest-bearing deposits
745

 
2,992

Investment securities (available for sale securities at fair value of $84,508 and $79,921, and held to maturity securities at cost of $7,163 and $8,012 at June 30, 2016 and September 30, 2015, respectively)
91,671

 
87,933

Non-marketable equity securities, at cost
5,034

 
4,626

Loans receivable
584,046

 
450,510

Allowance for loan losses
(6,236
)
 
(6,496
)
Loans receivable, net
577,810

 
444,014

Office properties and equipment, net
5,576

 
2,669

Accrued interest receivable
1,971

 
1,574

Intangible assets
917

 
104

Goodwill
4,003

 

Foreclosed and repossessed assets, net
911

 
902

Other assets
13,026

 
11,462

TOTAL ASSETS
$
723,009

 
$
580,148

 
 
 
 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
Liabilities:
 
 
 
Deposits
$
585,224

 
$
456,298

Federal Home Loan Bank advances
58,874

 
58,891

Other borrowings
11,000

 

Other liabilities
4,316

 
4,424

Total liabilities
659,414

 
519,613

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock— $0.01 par value, authorized 30,000,000, 5,240,114 and 5,232,579 shares issued and outstanding, respectively
52

 
52

Additional paid-in capital
54,793

 
54,740

Retained earnings
8,144

 
6,245

Unearned deferred compensation
(179
)
 
(288
)
Accumulated other comprehensive income (loss)
785

 
(214
)
Total stockholders’ equity
63,595

 
60,535

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
723,009

 
$
580,148

See accompanying condensed notes to unaudited consolidated financial statements.


3




CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Operations (unaudited)
Three and Nine Months Ended June 30, 2016 and 2015
(in thousands, except per share data)
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
Interest and dividend income:
 
 
 
 
 
 
 
Interest and fees on loans
$
6,072

 
$
5,304

 
$
16,623

 
$
16,275

Interest on investments
402

 
317

 
1,267

 
998

Total interest and dividend income
6,474

 
5,621

 
17,890

 
17,273

Interest expense:
 
 
 
 
 
 
 
Interest on deposits
1,081

 
947

 
2,988

 
2,845

Interest on FHLB borrowed funds
167

 
148

 
496

 
476

Interest on other borrowed funds
47

 

 
47

 

Total interest expense
1,295

 
1,095

 
3,531

 
3,321

Net interest income before provision for loan losses
5,179

 
4,526

 
14,359

 
13,952

Provision for loan losses

 
150

 
75

 
535

Net interest income after provision for loan losses
5,179

 
4,376

 
14,284

 
13,417

Non-interest income:
 
 
 
 
 
 
 
Net gains on sale of available for sale securities
43

 
13

 
47

 
60

Service charges on deposit accounts
410

 
423

 
1,164

 
1,273

Loan fees and service charges
302

 
276

 
886

 
923

Other
258

 
219

 
676

 
633

Total non-interest income
1,013

 
931

 
2,773

 
2,889

Non-interest expense:
 
 
 
 
 
 
 
Salaries and related benefits
2,378

 
2,195

 
6,784

 
6,548

Occupancy
554

 
589

 
1,835

 
2,073

Office
350

 
317

 
864

 
825

Data processing
445

 
393

 
1,274

 
1,177

Amortization of core deposit intangible
31

 
15

 
66

 
43

Advertising, marketing and public relations
174

 
126

 
456

 
410

FDIC premium assessment
86

 
98

 
255

 
306

Professional services
182

 
251

 
574

 
840

Other
453

 
374

 
1,006

 
1,049

Total non-interest expense
4,653

 
4,358

 
13,114

 
13,271

Income before provision for income taxes
1,539

 
949

 
3,943

 
3,035

Provision for income taxes
572

 
337

 
1,415

 
1,112

Net income attributable to common stockholders
$
967

 
$
612

 
$
2,528

 
$
1,923

Per share information:
 
 
 
 
 
 
 
Basic earnings
$
0.18

 
$
0.12

 
$
0.48

 
$
0.37

Diluted earnings
$
0.18

 
$
0.12

 
$
0.48

 
$
0.37

Cash dividends paid
$

 
$

 
$
0.12

 
$
0.08

See accompanying condensed notes to unaudited consolidated financial statements.
 

4




CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Comprehensive Income (unaudited)
Nine months ended June 30, 2016 and 2015
(in thousands, except per share data)
 
Nine Months Ended
 
June 30, 2016

 
June 30, 2015

Net income attributable to common stockholders
$
2,528

 
$
1,923

Other comprehensive income (loss), net of tax:
 
 
 
Securities available for sale
 
 
 
Net unrealized gains arising during period
1,006

 
27

Reclassification adjustment for gains included in net income
28

 
36

Unrealized gains on available for sale securities
1,034

 
63

Defined benefit plans:
 
 
 
Amortization of unrecognized prior service costs and net (losses) gains
(35
)
 
1

Total other comprehensive income, net of tax
999

 
64

Comprehensive income
$
3,527

 
$
1,987


Reclassifications out of accumulated other comprehensive income for the nine months ended June 30, 2016 were as follows:

Details about Accumulated Other Comprehensive Income Components
 
Amounts Reclassified from Accumulated Other Comprehensive Income
(1)
Affected Line Item on the Statement of Operations
Unrealized gains and losses
 
 
 
 
Sale of securities
 
$
47

 
Net gain on sale of available for sale securities
 
 
(19
)
 
Provision for income taxes
Total reclassifications for the period
 
$
28

 
Net income attributable to common shareholders


(1)    Amounts in parentheses indicate decreases to profit/loss.


See accompanying condensed notes to unaudited consolidated financial statements.


5




CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statement of Changes in Stockholders’ Equity (unaudited)
Nine Months Ended June 30, 2016
(in thousands, except shares and per share data)
 
 
 
 
 
Additional Paid-In Capital
 
Retained Earnings
 
Unearned Deferred Compensation
 
Accumulated Other Comprehensive Income (Loss)
 
Total Stockholders' Equity
 
Common Stock
 
 
 
 
 
 
Shares
 
Amount
 
 
 
 
 
Balance, October 1, 2015
5,232,579

 
$
52

 
$
54,740

 
$
6,245

 
$
(288
)
 
$
(214
)
 
$
60,535

Net income
 
 
 
 
 
 
2,528

 
 
 
 
 
2,528

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
999

 
999

Forfeiture of unvested shares
(22,162
)
 
 
 
(176
)
 
 
 
176

 
 
 

Surrender of restricted shares of common stock
(5,309
)
 
 
 
(49
)
 
 
 
 
 
 
 
(49
)
Common stock awarded under the equity incentive plan
9,091

 
 
 
100

 
 
 
(100
)
 
 
 

Common stock options exercised
25,915

 
 
 
153

 
 
 
 
 
 
 
153

Stock option expense
 
 
 
 
25

 
 
 
 
 
 
 
25

Amortization of restricted stock
 
 
 
 
 
 
 
 
33

 
 
 
33

Cash dividends ($0.12 per share)
 
 
 
 
 
 
(629
)
 
 
 
 
 
(629
)
Balance, June 30, 2016
5,240,114

 
$
52

 
$
54,793

 
$
8,144

 
$
(179
)
 
$
785

 
$
63,595

See accompanying condensed notes to unaudited consolidated financial statements.
 

6




CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended June 30, 2016 and 2015
(in thousands, except per share data)
 
Nine Months Ended
 
June 30, 2016

 
June 30, 2015

Cash flows from operating activities:
 
 
 
Net income attributable to common stockholders
$
2,528

 
$
1,923

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Net amortization of premium/discount on securities
851

 
637

Depreciation
583

 
937

Provision for loan losses
75

 
535

Net realized gain on sale of securities
(47
)
 
(60
)
Amortization of core deposit intangible
66

 
43

Amortization of restricted stock
33

 
70

Stock based compensation expense
25

 
44

Loss on sale of office properties

 

Provision (benefit) for deferred income taxes
555

 
(151
)
Net gains from disposals of foreclosed properties
(77
)
 
(5
)
Provision for valuation allowance on foreclosed properties

 
34

Increase in accrued interest receivable and other assets
(1,218
)
 
(441
)
(Decrease) increase in other liabilities
(357
)
 
435

Total adjustments
489

 
2,078

Net cash provided by operating activities
3,017

 
4,001

Cash flows from investing activities:
 
 
 
Purchase of investment securities
(15,062
)
 
(36,695
)
Net decrease (increase) in interest-bearing deposits
7,241

 
(1,250
)
Proceeds from sale of securities available for sale
17,665

 
29,286

Principal payments on investment securities
11,301

 
5,703

Proceeds from sale of Federal Home Loan Bank (FHLB) stock

 
650

Purchase of Federal Reserve Bank Stock
(3
)
 

Proceeds from sale of Federal Reserve Bank (FRB) Stock

 
239

Proceeds from sale of foreclosed properties
892

 
1,049

Net (increase) decrease in loans
(5,723
)
 
11,732

Net capital expenditures
(711
)
 
(217
)
Net cash received in business combinations
20,658

 

Net cash received from sale of office properties

 
7

Net cash provided by investing activities
36,258

 
10,504

Cash flows from financing activities:
 
 
 
Net decrease in Federal Home Loan Bank advances
(3,017
)
 
(13,000
)
Increase in other borrowings
11,000

 

Net (decrease) increase in deposits
(49,225
)
 
6,686

Surrender of restricted shares of common stock
(49
)
 
(35
)
Exercise of common stock options
153

 
299

Termination of director retirement plan/supplemental executive retirement plan
(35
)
 

Cash dividends paid
(629
)
 
(419
)
Net cash used in financing activities
(41,802
)
 
(6,469
)
Net (decrease) increase in cash and cash equivalents
(2,527
)
 
8,036

Cash and cash equivalents at beginning of period
23,872

 
11,434

Cash and cash equivalents at end of period
$
21,345

 
$
19,470

Supplemental cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest on deposits
$
2,859

 
$
2,842

Interest on borrowings
$
495

 
$
484

Income taxes
$
1,211

 
$
979

Supplemental noncash disclosure:
 
 
 
Transfers from loans receivable to foreclosed and repossessed assets
$
542

 
$
947

Fair value of assets acquired, net of cash and cash equivalents
$
168,129

 
$

Fair value of liabilities assumed, net of cash and cash equivalents
$
154,250

 
$

See accompanying condensed notes to unaudited consolidated financial statements. 

7




CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
(UNAUDITED)
NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of Citizens Community Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Citizens Community Federal N.A. (the "Bank"), and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. As used in this quarterly report, the terms “we”, “us”, “our”, and “Citizens Community Bancorp, Inc.” mean the Company and its wholly owned subsidiary, the Bank, unless the context indicates other meaning.
On April 16, 2014, the U.S. Office of the Comptroller of the Currency (the "OCC"), the primary federal regulator for
the Company and the Bank, provided written notice to the Bank of the OCC's approval for the Bank to convert to a national banking association (a "National Bank") and operate under the title of Citizens Community Federal National Association ("Citizens Community Federal N.A."). The consummation of the conversion to a National Bank was effective as of May 31, 2014.
On April 18, 2014, Citizens Community Bancorp, Inc. received written notice from the Federal Reserve Bank of
Minneapolis (the "FRB") notifying the Company of the FRB's approval of the Company becoming a bank holding company as
a result of the proposed conversion of the Bank from a federally-chartered savings bank to a National Bank, which approval
was also effective as of May 31, 2014.
The consolidated income of the Company is principally derived from the income of the Bank, the Company’s wholly owned subsidiary. The Bank originates residential, commercial, agricultural, consumer and commercial and industrial (C&I) loans and accepts deposits from customers, primarily in Wisconsin, Minnesota and Michigan. The Bank operates 21 full-service offices, eight stand-alone locations and 8 branches predominantly located inside Walmart Supercenters.
The Bank is subject to competition from other financial institutions and non-financial institutions providing financial products. Additionally, the Bank is subject to the regulations of certain regulatory agencies and undergoes periodic examination by those regulatory agencies.
In preparing these consolidated financial statements, we evaluated the events and transactions that occurred subsequent to the balance sheet date as of June 30, 2016 and through the date the financial statements were available to be issued for items that should potentially be recognized or disclosed in these consolidated financial statements.

Effective May 16, 2016, Community Bank of Northern Wisconsin ("CBN") was acquired through merger (“Merger”) by the Bank. The Merger was consummated pursuant to the terms of a Plan and Agreement of Merger (“Merger Agreement”), dated February 10, 2016, as amended by the First Amendment to Agreement and Plan of Merger dated as of May 13, 2016 by and among the Bank, Old Murry Bancorp, Inc. ("Old Murry"), the controlling shareholders of Old Murry, and CBN. In accordance with the terms of the Merger Agreement, the Bank agreed to purchase all of the assets and assume all of the liabilities of CBN. The total purchase price paid in cash by the Bank was $17,447, which represented a $16,762 book value of the CBN as of April 30, 2016, less a capital dividend of $4,342 declared by CBN to Old Murry, plus a $5,000 fixed premium and daily interest through May 16, 2016 in the amount of $27. The purchase price was funded by $11,000 of debt, and the remaining $6,447 of cash.
The accompanying consolidated interim financial statements are unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Unless otherwise stated herein, and except for shares and per share amounts, all amounts are in thousands.
Principles of Consolidation – The accompanying consolidated financial statements include the accounts of the Company and the Bank. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates – Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, fair value of financial instruments, the allowance for loan losses, valuation of acquired intangible assets, useful lives for depreciation and amortization, indefinite-lived intangible assets and long-lived assets, deferred tax assets, uncertain income tax positions and contingencies. Management does not anticipate any material changes to

8




estimates made herein in the near term. Factors that may cause sensitivity to the aforementioned estimates include, but are not limited to, external market factors such as market interest rates and unemployment rates, changes to operating policies and procedures, and changes in applicable banking regulations. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period.
Investment Securities; Held to Maturity and Available for Sale – Management determines the appropriate classification of investment securities at the time of purchase and reevaluates such designation as of the date of each balance sheet. Securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. Investment securities not classified as held to maturity are classified as available for sale. Available for sale securities are stated at fair value, with unrealized holding gains and losses deemed other than temporarily impaired due to non-credit issues being reported in other comprehensive income (loss), net of tax. Unrealized losses deemed other-than-temporary due to credit issues are reported in the Company’s net income in the period in which the losses arise. Interest income includes amortization of purchase premium or accretion of purchase discount. Amortization of premiums and accretion of discounts are recognized in interest income using the interest method over the estimated lives of the underlying securities.
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuer is assessed. Significant inputs used to measure the amount of other-than-temporary impairment related to credit loss include, but are not limited to, default and delinquency rates of the underlying collateral, remaining credit support, and historical loss severities. Adjustments to market value of available for sale securities that are considered temporary are recorded as separate components of equity, net of tax. If the unrealized loss of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings, or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if credit loss exists. If there is a credit loss, it will be recorded in the Company's consolidated statement of operations. Unrealized losses on available for sale securities, other than credit, will continue to be recognized in other comprehensive income (loss), net of tax. Unrealized losses reflected in the preceding tables have not been included in results of operations because the unrealized loss was not deemed other-than-temporary. Management has determined that more likely than not, the Company neither intends to sell, nor will it be required to sell each debt security before its anticipated recovery, and therefore recovery of cost will occur.
Loans – Loans that management has the intent and ability to hold for the foreseeable future, until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, and net of deferred loan fees and costs. Interest income is accrued on the unpaid principal balance of these loans. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the interest method without anticipating prepayments. Delinquency fees are recognized into income when chargeable, assuming collection is reasonably insured.
Interest income on commercial, mortgage and consumer loans is discontinued according to the following schedules:
Commercial loans, including agricultural and C&I loans, past due 90 days or more;
Closed end consumer loans past due 120 days or more; and
Real estate loans and open ended consumer loans past due 180 days or more.
Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for a loan placed on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash basis or cost recovery method, and is generally applied against principal, until qualifying for return to accrual status. Loans are returned to accrual status when payments are made that bring the loan account current with the contractual term of the loan and a 6 month payment history has been established. Interest on impaired loans considered troubled debt restructurings (“TDRs”) or substandard, less than 90 days delinquent, is recognized as income as it accrues based on the revised terms of the loan over an established period of continued payment. Substandard loans, as defined by the OCC, our primary banking regulator, are loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.
Real estate loans and open ended consumer loans are charged off to estimated net realizable value less estimated selling costs at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 180 days or more. Closed end consumer loans are charged off to net realizable value at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 120 days or more. Commercial loans, including agricultural

9




and C&I loans, are charged off to net realizable value at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 90 days or more.
Allowance for Loan Losses – The allowance for loan losses (“ALL”) is a valuation allowance for probable and inherent credit losses in our loan portfolio. Loan losses are charged against the ALL when management believes that the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the ALL. Management estimates the required ALL balance taking into account the following factors: past loan loss experience; the nature, volume and composition of our loan portfolio; known and inherent risks in our loan portfolio; information about specific borrowers’ ability to repay; estimated collateral values; current economic conditions; and other relevant factors determined by management. The ALL consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for certain qualitative factors. The entire ALL balance is available for any loan that, in our management’s judgment, should be charged off.
A loan is impaired when full payment under the loan terms is not expected. Impaired loans consist of all TDRs, as well as individual substandard loans not considered a TDR when full payment under the loan terms is not expected. All TDRs are individually evaluated for impairment. See Note 4, “Loans, Allowance for Loan Losses and Impaired Loans” for more information on what we consider to be a TDR. If a TDR or substandard loan is deemed to be impaired, a specific ALL allocation may be established so that the loan is reported, net, at the lower of (a) outstanding principal balance, (b) the present value of estimated future cash flows using the loan’s existing rate; or (c) at the fair value of any collateral, less estimated disposal costs, if repayment is expected solely from the underlying collateral of the loan. For TDRs less than 90 days past due, and certain substandard loans that are less than 90 days delinquent, the likelihood of the loan migrating to over 90 days past due is also taken into account when determining the specific ALL allocation for these particular loans. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, as well as non-TDR commercial loans, are collectively evaluated for impairment, and accordingly, are not separately identified for impairment disclosures.

Loans Acquired through Business Combination with Deteriorated Credit Quality - Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-30, "Loan and Debt Securities Acquired with Deteriorated Credit Quality", applies to loans acquired in a business combination that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that we will be unable to collect all contractually required payments receivable. In accordance with this guidance, these loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield”, is recognized as interest income over the life of the loans using a method that approximates the level-yield method. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference”, are not recognized as a yield adjustment, a loss accrual, or a valuation allowance, Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairments. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition.
Foreclosed and Repossessed Assets, net – Assets acquired through foreclosure or repossession are initially recorded at fair value, less estimated costs to sell, which establishes a new cost basis. If the fair value declines subsequent to foreclosure or repossession, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed and are included in non-interest expense, other on our Consolidated Statements of Operations.

Goodwill - Goodwill resulting from the acquisition by merger of CBN was determined as the excess of the fair value of the consideration transferred, over the fair value of the net assets acquired, less liabilities assumed in the acquisition by merger, as of the acquisition date. Goodwill resulting from the selective purchase of loans and deposits from Central Bank in February 2016 was determined as the excess of the Premium Deposit less the Core Deposit Intangible as of the acquisition date. Goodwill is determined to have an indefinite useful life, and is not amortized. Goodwill is tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed.


10




The following table provides changes in goodwill from September 30, 2015 through June 30, 2016:

Balance at beginning of period
$

Select loans and deposit purchase from Central Bank
435

CBN acquisition
3,568

Valuation allowance

Balance at end of period
$
4,003


Income Taxes – The Company accounts for income taxes in accordance with the FASB ASC Topic 740, “Income Taxes.” Under this guidance, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. See Note 7, "Income Taxes" for details on the Company’s income taxes.
The Company regularly reviews the carrying amount of its net deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, it is more likely than not that all or a portion of the Company’s net deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets. In evaluating this available evidence, management considers, among other things, historical performance, expectations of future earnings, the ability to carry back losses to recoup taxes previously paid, the length of statutory carryforward periods, any experience with utilization of operating loss and tax credit carryforwards not expiring, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. Accordingly, the Company’s evaluation is based on current tax laws as well as management’s expectations of future performance.
Earnings Per Share – Basic earnings per common share is net income or loss divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable during the period, consisting of stock options outstanding under the Company’s stock incentive plans that have an exercise price that is less than the Company's stock price on the reporting date.

Operating Segments—While our chief decision makers monitor the revenue streams of the various banking products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the
Company’s banking operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications – Certain items previously reported were reclassified for consistency with the current presentation.
Recent Accounting Pronouncements - In June, 2016 the FASB issued Accounting Standards Update ("ASU") 2016-13, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 is intended to provide financial statement users with more decision-useful information about the excepted credit losses on financial instruments and other commitments to extend credit. For public entities, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company has not yet evaluated the potential effects of adopting ASU 2016-13 on the Company’s consolidated results of operations, financial position or cash flows.

In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606); Narrow-Scope Improvements and Practical Expedients.” ASU 2016-12 is intended to address certain specific issues identified by the FASB-IASB Joint Transition Resource Group for Revenue Recognition with respect to ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” For public entities, ASU 2016-12 is effective on a retrospective basis for the annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. The Company expects the adoption of ASU 2016-12 will have no material effect on the Company's consolidated results of operations, financial position or cash flows.
In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 is intended to simplify certain areas of share-based payment

11




transaction accounting, including the income tax consequences, equity or liability classification of certain share awards, and classification on the statement of cash flows. ASU 2016-09 is effective for the annual periods, and interim periods within those annual periods, beginning after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the effect on the consolidated results of operations, financial position and cash flows.

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)". ASU 2016-02 is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for the annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. The Company expects the adoption of ASU 2016-02 to have no material effect on the Company's consolidated results of operations, financial position or cash flows.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments-overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”. ASU 2016-01 is intended to address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. For public entities, ASU 2016-01 is effective for the annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted, except for certain provisions of ASU 2016-01, which are not applicable to the Company. The Company expects the adoption of ASU 2016-01 to have no material effect on the Company's consolidated results of operations, financial position or cash flows.
In August 2014, the FASB issued ASU 2014-14, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)". ASU 2014-14 is intended to improve accounting and disclosure consistency related to how creditors classify government-guaranteed mortgage loans, including the Federal Housing Administration ("FHA") or United States Department of Veterans Affairs ("VA") guaranteed loans, upon foreclosure. For public entities, ASU 2014-09 is effective on a prospective basis for the annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company has adopted ASU 2014-14 effective December 31, 2015. The adoption of ASU 2014-04 had no effect on the Company's consolidated results of operations, financial position or cash flows.
In January 2014, the FASB issued ASU 2014-04, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)". ASU 2014-04 is intended to improve consistency among reporting entities by clarifying when an in substance foreclosure occurs, that is, when a creditor should derecognize a loan and recognize the corresponding real estate collateral as a separate asset. For public entities, ASU 2014-04 is effective for the annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company has adopted ASU 2014-04 effective December 31, 2015. The adoption of ASU 2014-04 had no effect on the Company's consolidated results of operations, financial position or cash flows.
NOTE 2 – ACQUISITIONS

On May 16, 2016, the Company completed the acquisition through merger of CBN, with the Bank surviving the merger. The Merger was consummated pursuant to the terms of the Merger Agreement, dated February 10, 2016, and as amended on May 13, 2016. The Merger expands our presence in our Rice Lake, Wisconsin market with five additional branches.

Under the terms of the Merger Agreement, the total purchase price paid in cash by the Bank was $17,447, which represented a $16,762 book value of CBN as of April 30, 2016, less a capital dividend of $4,342 declared by CBN, plus a $5,000 fixed premium and daily interest through May 16, 2016 in the amount of $27. The Merger added $168,129 in assets, $112,327 in loans, $151,020 in deposits, $3,568 in goodwill, and $607 in a core deposit intangible. Acquisition costs consisting of accounting, legal and other professional fees were approximately $312 through June 30, 2016 and were accrued for in non-interest expense.
 
    

12




The following is a reconciliation of cash paid, net assets acquired, net of fair value adjustments, and goodwill resulting from the acquisition of CBN as of the acquisition date:

 
(Dollars in thousands)
 
Debt issued by buyer
$
11,000

 
Cash paid by buyer
6,447

 
Total consideration paid for CBN
$
17,447

 
 
 
 
CBN's net assets at fair value:
 
 
CBN net assets acquired
$
12,510

 
Adjustments to reflect assets acquired at fair value:
 
 
Investment securities discount/premium, net
(108
)
(2)
Performing loans
(164
)
(3)
Nonperforming loans
(1,168
)
(3)
Allowance for loan losses
1,832

(3)
Property and equipment, net
88

(4)
Deposits
282

(6)
Less: adjusted identifiable net assets acquired
$
13,272

 
 
 
 
Other intangibles:
 
 
Adjustment to recognize other intangibles
(607
)
(5)
 
 
 
Total goodwill
$
3,568

(7)

    

    

13




The acquisition of the net assets of CBN constitutes a business combination as defined by FASB ASC Topic 805, "Business Combinations." Accordingly, the assets acquired and liabilities assumed are presented at their fair values at acquisition date. Fair values were determined based on the requirements of FASB ASC Topic 820, Fair Value Measurements. In many cases, the determination of these fair values required management to make estimates regarding discount rates, future expected cash flows, market conditions and other future events that are highly objective in nature and subject to change. The following schedule is a breakdown of the assets acquired, liabilities assumed, related fair value adjustments, and resulting goodwill:

 
Community Bank of Northern Wisconsin
Fair Value Adjustments
 
Fair Value
Assets
(Dollars in thousands)
Cash and cash equivalents
$
28,104

$

 
$
28,104

Other interest bearing deposits
5,000

(6
)
(2)
4,994

Investment securities
16,825

(102
)
(2)
16,723

Federal Home Loan Bank stock
405


 
405

Loans receivable
113,659

(1,332
)
(3)
112,327

Allowance for loan losses
(1,832
)
1,832

(3)

Loans receivable, net
111,827

500

 
112,327

Office properties and equipment, net
2,741

88

(4)
2,829

Accrued interest receivable
540


 
540

Intangible assets

607

(5)
607

Foreclosed and repossessed assets, net
265


 
265

Other assets
1,335


 
1,335

TOTAL ASSETS
$
167,042

$
1,087

 
$
168,129

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
Liabilities:
 
 
 
 
Deposits
$
151,302

$
(282
)
(6)
$
151,020

Federal Home Loan Bank advances
3,000


 
3,000

Other liabilities
230


 
230

Total liabilities
154,532

(282
)
 
154,250

Stockholders’ equity:
 
 
 
 
Common stock


 

Additional paid-in capital
12,510

(12,510
)
(7)

Retained earnings


 

Unearned deferred compensation


 

Accumulated other comprehensive loss


 

Total stockholders’ equity
12,510

(12,510
)
 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
167,042

$
(12,792
)
 
$
154,250

Net assets acquired
 
 
 
13,879

Purchase price
 
 
 
17,447

Goodwill
 
 
 
$
3,568


The following is a description of the methods used to determine, and adjustments necessary to present, the fair values of significant assets and liabilities presented above:

Cash and cash equivalents-The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of these assets.


14




Other interest bearing deposits-Other interest bearing deposits were acquired from CBN with a $6 adjustment (2) to market value based upon quoted market prices or other observable outputs.

Investment Securities-Investment securities were acquired from CBN with a $102 adjustment (2) to market value based upon quoted market prices or other observable outputs.

Federal Home Loan Bank (FHLB) stock-Non-marketable investments in FHLB stock are carried at cost, which is their redeemable fair value since the market for each category of this stock is restricted.

Loans Receivable-Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan, related collateral, classification status, interest rate, term of the loan, whether the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns.

We evaluated $111,519 of loans purchased in conjunction with the acquisition in accordance with the provisions of FASB ASC Topic 310-20, Nonrefundable Fees and Other Costs, and those loans were recorded with a $164 discount, included in fair value adjustment (3) above. As a result, the fair value discount on these loans is being accreted into interest income over the weighted average life of the loans, using a constant yield method. The remaining $2,140 of loans evaluated were considered purchased credit impaired loans within the provisions of FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, and were recorded with a $1,168 discount, which is included in fair value adjustment (3) above. These purchased credit impaired loans will recognize interest income through accretion of the difference between the carrying amount of the loans and the expected cash flows.

Office properties and equipment-The fair values of office properties and equipment were based on the appraised value of the property. The fair value adjustment (4) of $88 will be amortized over the remaining economic life of the properties, which is estimated to be 25 years.

Accrued interest receivable-Accrued interest receivable was acquired at market value.

Intangible assets-Core deposit intangible assets represent the value of the relationships that CBN had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, and the net maintenance cost attributable to customer deposits. The Company recorded $607 of gross core deposit intangible as a result of the CBN acquisition, fair value adjustment (5) above, which will be amortized over seven years.

Foreclosed and repossessed assets-The carrying amount of these acquired assets were deemed to be a reasonable estimate of their fair value at the date of acquisition.

Other assets- The carrying amount of these acquired assets were deemed to be a reasonable estimate of their fair value at the date of acquisition.

Deposits-The fair value of deposits with no stated maturity, such as demand deposits, savings accounts, and money market accounts, is the amount payable on demand at the reporting date. The fair value of fixed rate certificate accounts is calculated by using discounted cash flows applying interest rates currently being offered on similar certificates. The Company determined that the fair value of fixed rate certificate deposits exceeded book value by $282; fair value adjustment (6) above. This fair value adjustment will be amortized over the weighted average life of these deposits, which is estimated to be 17 months.

FHLB advances and other borrowings-The fair value of long-term borrowed funds is estimated using discounted cash flows based on the Bank’s current incremental borrowing rates for similar borrowing arrangements. The carrying value of short-term borrowed funds approximates their fair value.

Other liabilities- The carrying amount of these acquired assets were deemed to be a reasonable estimate of their fair value at the date of acquisition.

Stockholders' equity-All equity of the acquired CBN entity was eliminated as a result of the acquisition; fair value adjustment (7) above.

The purchase price allocation and certain fair value measurements remain preliminary due to the timing of the acquisition. We will continue to review the estimated fair values of loans, deposits, property and equipment, intangible assets, and other assets

15




and liabilities. Our operating results for the period ended June 30, 2016, include the operating results of the acquired assets and assumed liabilities subsequent to the acquisition date.

The following unaudited pro forma condensed financial information presents our results of operations, including the effects of the purchase accounting adjustments and acquisition expenses, had the acquisition taken place at the beginning of the period presented:

 
Citizens Community Bancorp, Inc. Year Ended 09/30/2015
Community Bank of Northern Wisconsin Year Ended 12/31/2015
Pro Forma Adjustments
 
Pro Forma Combined
Interest and dividend income:
 
 
 
 
 
Interest and fees on loans
$
21,641

$
5,698

$
27

(3)
$
27,366

Interest and dividends on investments
1,363

469


 
1,832

Total interest and dividend income
23,004

6,167

27

 
29,198

Interest expense:
 
 
 
 
 
Interest on deposits
3,808

956

199

(6)
4,963

Interest on borrowed funds
630

31

367

(1)
1,028

Total interest expense
4,438

987

566

 
5,991

Net interest income before provision for loan losses
18,566

5,180

(539
)
 
23,207

Provision for loan losses
656

84


 
740

Net interest income after provision for loan losses
17,910

5,096

(539
)
 
22,467

Non-interest income
3,913

463


 
4,376

Non-interest expense
17,719

4,123

91

(4) (5)
21,933

Income before provision for income tax
4,104

1,436

(630
)
 
4,910

Provision for income taxes
1,490

18


 
1,508

Net income attributable to common stockholders
$
2,614

$
1,418

$
(630
)
 
$
3,402

 
 
 
 
 
 
Per share information:
 
 
 
 
 
Basic earnings
$
0.50

 
 
 
$
0.65

Diluted earnings
$
0.50

 
 
 
$
0.65

The following is a description of the methods used to determine the pro forma adjustments presented above:
(1) Annual interest expense of $367; represents interest on debt incurred to partially fund the acquisition of CBN. Interest expense was based on $11,000 borrowings at an annual interest rate of 3.3366%.
Pro forma adjustments to non-interest expense consist of the following:
(3) Fair value adjustment to performing loans of $164, amortized over 72 months; the weighted average remaining life of the loans, or ($27) annually.
(4) Fair value adjustment to office properties and equipment of $88, amortized over the estimated remaining life of the buildings of 25 years, or $4 annually.
(5) Core deposit intangible of $607, amortized over the estimated life of the intangible asset of seven years, or $87 annually.
(6) Fair value adjustment to deposits of $282, amortized over the weighted average life of the deposits of 17 months, or $199 annually.

Selectively purchased loans and deposits - Central Bank - In February 2016, the Bank selectively purchased loans and deposit from Central Bank in Rice Lake and Barron, Wisconsin. The fair value of the acquired assets totaled $17,323, including $10,001 in cash, $16,363 in loans and $786 in fixed and other assets. The Bank also assumed $27,131 in deposits, for which it paid a deposit premium of $707, as part of the transaction. The assets and liabilities relating to these selectively purchased loans and deposits were recorded on the Bank’s balance sheet at their preliminary fair values as of February 5, 2016 and the related results of operations for these branches have been included in the Company's consolidated statement of comprehensive income

16




since that date. Based on the preliminary purchase price allocation, the Corporation recorded $435 in goodwill and $272  in core deposit intangibles. These fair value estimates are provisional amounts based on third party valuations that are currently under review. The goodwill for this transaction is deductible for income tax purposes.


NOTE 3 – FAIR VALUE ACCOUNTING
ASC Topic 820-10, “Fair Value Measurements and Disclosures” establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The statement describes three levels of inputs that may be used to measure fair value:
Level 1- Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.
Level 2- Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3- Significant unobservable inputs that reflect the Company’s assumptions about the factors that market participants would use in pricing an asset or liability.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input within the valuation hierarchy that is significant to the fair value measurement.
The fair value of securities available for sale is determined by obtaining market price quotes from independent third parties wherever such quotes are available (Level 1 inputs); or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). Where such quotes are not available, the Company utilizes independent third party valuation analysis to support the Company’s estimates and judgments in determining fair value (Level 3 inputs).

17




Assets Measured on a Recurring Basis
The following tables present the financial instruments measured at fair value on a recurring basis as of June 30, 2016 and September 30, 2015:
 
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
June 30, 2016
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
U.S. government agency obligations
$
14,737

 
$

 
$
14,737

 
$

Obligations of states and political subdivisions
33,773

 

 
33,773

 

Mortgage-backed securities
35,559

 

 
35,559

 

Federal Agricultural Mortgage Corporation
65

 

 
65

 

Trust preferred securities
374

 

 

 
374

Total
$
84,508

 
$

 
$
84,134

 
$
374

September 30, 2015
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
U.S. government agency obligations
$
15,020

 
$

 
$
15,020

 
$

Obligations of states and political


 


 


 


subdivisions
27,407

 

 
27,407

 

Mortgage-backed securities
37,440

 

 
37,440

 

Federal Agricultural Mortgage Corporation
54

 

 
54

 

Total
$
79,921

 
$

 
$
79,921

 
$

Assets Measured on a Nonrecurring Basis
The following tables present the financial instruments measured at fair value on a nonrecurring basis as of June 30, 2016 and September 30, 2015:
 
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level  3)
June 30, 2016
 
 
 
 
 
 
 
Foreclosed and repossessed assets, net
$
911

 
$

 
$

 
$
911

Impaired loans with allocated allowances
2,352

 

 

 
2,352

Total
$
3,263

 
$

 
$

 
$
3,263

September 30, 2015
 
 
 
 
 
 
 
Foreclosed and repossessed assets, net
$
902

 
$

 
$

 
$
902

Impaired loans with allocated allowances
2,349

 

 

 
2,349

Total
$
3,251

 
$

 
$

 
$
3,251

The fair value of impaired loans referenced above was determined by obtaining independent third party appraisals and/or internally developed collateral valuations to support the Company’s estimates and judgments in determining the fair value of the underlying collateral supporting impaired loans.
The fair value of foreclosed and repossessed assets was determined by obtaining market price valuations from independent third parties wherever such quotes were available for other collateral owned. The Company utilized independent third party appraisals to support the Company’s estimates and judgments in determining fair value for other real estate owned.
The following table represents additional quantitative information about assets measured at fair value on a
recurring and nonrecurring basis and for which we have utilized Level 3 inputs to determine their fair value at
June 30, 2016.


18




 
Fair
Value
 
Valuation Techniques (1)
 
Significant Unobservable Inputs (2)
 
Range
June 30, 2016
 
 
 
 
 
 
 
Foreclosed and repossessed assets, net
$
911

 
Appraisal value
 
Estimated costs to sell
 
10 - 15%
Impaired loans with allocated allowances
$
2,352

 
Appraisal value
 
Estimated costs to sell
 
10 - 15%
September 30, 2015
 
 
 
 
 
 
 
Foreclosed and repossessed assets, net
$
902

 
Appraisal value
 
Estimated costs to sell
 
10 - 15%
Impaired loans with allocated allowances
$
2,349

 
Appraisal value
 
Estimated costs to sell
 
10 - 15%


(1)     Fair value is generally determined through independent third-party appraisals of the underlying
collateral, which generally includes various level 3 inputs which are not observable.

(2)     The fair value basis of impaired loans and real estate owned may be adjusted to reflect management
estimates of disposal costs including, but not limited to, real estate brokerage commissions, legal fees,
and delinquent property taxes.

Fair Values of Financial Instruments
ASC 825-10 and ASC 270-10, Interim Disclosures about Fair Value Financial Instruments, require disclosures about fair value financial instruments and significant assumptions used to estimate fair value. The estimated fair values of financial instruments not previously disclosed are determined as follows:
Cash and Cash Equivalents
Due to their short-term nature, the carrying amounts of cash and cash equivalents are considered to be a reasonable estimate of fair value and represents a level 1 measurement.
Other Interest-Bearing Deposits
Fair value of interest bearing deposits is estimated using a discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a level 3 measurement.
Non-marketable Equity Securities, at cost
Non-marketable equity securities are comprised of Federal Home Loan Bank stock and Federal Reserve Bank stock carried at cost, which are their redeemable fair values since the market for each category of this stock is restricted and represents a level 1 measurement.
Loans Receivable, net
Fair value is estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as real estate, C&I and consumer. The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity date using market discount rates reflecting the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Bank’s repayment schedules for each loan classification. The fair value of variable rate loans approximates carrying value. The net carrying value of the loans acquired through the CBN acquisition approximates the fair value of the loans at June 30, 2016. The fair value of loans is considered to be a level 3 measurement.
Accrued Interest Receivable and Payable
Due to their short-term nature, the carrying amounts of accrued interest receivable and payable are considered to be a reasonable estimate of fair value and represents a level 1 measurement.
Deposits

19




The fair value of deposits with no stated maturity, such as demand deposits, savings accounts, and money market accounts, is the amount payable on demand at the reporting date and represents a level 1 measurement. The fair value of fixed rate certificate accounts is calculated by using discounted cash flows applying interest rates currently being offered on similar certificates and represents a level 3 measurement. The net carrying value of fixed rate certificate accounts acquired through the CBN acquisition approximates the fair value of the loans at June 30, 2016 and represents a level 3 measurement.
Federal Home Loan Bank Advances
The fair value of long-term borrowed funds is estimated using discounted cash flows based on the Bank’s current incremental borrowing rates for similar borrowing arrangements. The carrying value of short-term borrowed funds approximates their fair value and represents a level 2 measurement.
Off-Balance Sheet Instruments
The fair value of off-balance sheet commitments would be estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the customers. Since this amount is immaterial to the Company’s consolidated financial statements, no amount for fair value is presented.
The table below represents what we would receive to sell an asset or what we would have to pay to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying amount and estimated fair value of the Company's financial instruments as of the dates indicated below were as follows:
 
June 30, 2016
 
September 30, 2015
 
Carrying
Amount
 
Estimated
Fair
Value
 
Carrying
Amount
 
Estimated
Fair
Value
Financial assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,345

 
$
21,345

 
$
23,872

 
$
23,872

Interest-bearing deposits
745

 
759

 
2,992

 
3,022

Investment securities
91,671

 
91,960

 
87,933

 
88,140

Non-marketable equity securities, at cost
5,034

 
5,034

 
4,626

 
4,626

Loans receivable, net
577,810

 
596,313

 
444,014

 
462,227

Accrued interest receivable
1,971

 
1,971

 
1,574

 
1,574

Financial liabilities:
 
 
 
 
 
 
 
Deposits
$
585,224

 
$
589,144

 
$
456,298

 
$
460,450

FHLB advances
58,874

 
59,020

 
58,891

 
59,357

Other liabilities
11,000

 
11,000

 

 

Accrued interest payable
130

 
130

 
18

 
18

NOTE 4 – LOANS, ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
Credit Quality/Risk Ratings: Management utilizes a numeric risk rating system to identify and quantify the Bank’s risk of loss within its loan portfolio. Ratings are initially assigned prior to funding the loan, and may be changed at any time as circumstances warrant.
Ratings range from the highest to lowest quality based on factors that include measurements of ability to pay, collateral type and value, borrower stability and management experience. The Bank’s loan portfolio is presented below in accordance with the risk rating framework that has been commonly adopted by the federal banking agencies. The definitions of the various risk rating categories are as follows:
1 through 4 - Pass. A "Pass" loan means that the condition of the borrower and the performance of the loan is satisfactory or better.
5 - Watch. A "Watch" loan has clearly identifiable developing weaknesses that deserve additional attention from management. Weaknesses that are not corrected or mitigated, may jeopardize the ability of the borrower to repay the loan in the future.

20




6 - Special Mention. A "Special Mention" loan has one or more potential weakness that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position in the future.
7 - Substandard. A "Substandard" loan is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Assets classified as substandard must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
8 - Doubtful. A "Doubtful" loan has all the weaknesses inherent in a Substandard loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
9 - Loss. Loans classified as "Loss" are considered uncollectible, and their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, and a partial recovery may occur in the future.


Below is a summary of originated and acquired loans by type and risk rating as of June 30, 2016:
Originated Loans:
 
1 to 5
 
6
 
7
 
8
 
9
 
TOTAL
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer
 
$
167,989

 
$

 
$
1,738

 
$

 
$

 
$
169,727

Commercial/agricultural
 
95,658

 

 

 

 

 
95,658

Total real estate loans
 
263,647

 

 
1,738

 

 

 
265,385

Consumer and other loans:
 
207,549

 
11

 
577

 

 

 
208,137

Total originated loans
 
$
471,196

 
$
11

 
$
2,315

 
$

 
$

 
$
473,522

Acquired Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer
 
$
24,089

 
$
607

 
$
892

 
$
236

 
$

 
$
25,824

Commercial/agricultural
 
57,337

 
182

 
3,444

 

 

 
60,963

Total real estate loans
 
81,426

 
789

 
4,336

 
236

 

 
86,787

Consumer and other loans:
 
22,964

 
41

 
40

 

 
1

 
23,046

Total acquired loans
 
$
104,390

 
$
830

 
$
4,376

 
$
236

 
$
1

 
$
109,833

Total Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer
 
$
192,078

 
$
607

 
$
2,630

 
$
236

 
$

 
$
195,551

Commercial/agricultural
 
152,995

 
182

 
3,444

 

 

 
156,621

Total real estate loans
 
345,073

 
789

 
6,074

 
236

 

 
352,172

Consumer and other loans:
 
230,513

 
52

 
617

 

 
1

 
231,183

Gross loans
 
$
575,586

 
$
841

 
$
6,691

 
$
236

 
$
1

 
$
583,355

Net deferred loan costs (fees) and acquisition loan discount
 
 
 
 
 
 
 
 
 
 
 
691

Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
(6,236
)
Loans receivable, net
 
 
 
 
 
 
 
 
 
 
 
$
577,810





21




Below is a summary of originated loans by type and risk rating as of September 30, 2015:
 
 
1 to 5
 
6
 
7
 
8
 
9
 
TOTAL
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer
 
$
179,946

 
$

 
$
1,260

 
$

 
$

 
$
181,206

Commercial/agricultural
 
63,266

 

 

 

 

 
63,266

Total real estate loans
 
243,212

 

 
1,260

 

 

 
244,472

Consumer and other loans:
 
203,054

 

 
547

 

 
7

 
203,608

Gross loans
 
$
446,266

 
$

 
$
1,807

 
$

 
$
7

 
$
448,080

Net deferred loan costs (fees)
 
 
 
 
 
 
 
 
 
 
 
2,430

Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
(6,496
)
Loans receivable, net
 
 
 
 
 
 
 
 
 
 
 
$
444,014

The ALL represents management’s estimate of probable and inherent credit losses in the Bank’s loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change.
There are many factors affecting the ALL; some are quantitative, while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which result in probable credit losses), includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect the Company’s earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.
As an integral part of their examination process, various regulatory agencies also review the Bank’s ALL. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of our management based on information available to the regulators at the time of their examinations.

22




Changes in the ALL by loan type for the periods presented below were as follows:
 
Consumer Real Estate
 
Commercial/Agriculture Real Estate
 
Consumer and Other
 
Unallocated
 
Total
Nine Months Ended June 30, 2016:
 
 
 
 
 
 
 
 
 
Allowance for Loan Losses:
 
 
 
 
 
 
 
 
 
Beginning balance, October 1, 2015
$
2,364

 
$
1,617

 
$
2,263

 
$
252

 
$
6,496

Charge-offs
(111
)
 

 
(394
)
 

 
(505
)
Recoveries
7

 

 
163

 

 
170

Provision
30

 
10

 
35

 

 
75

Allowance allocation adjustment
(166
)
 
249

 
128

 
(211
)
 

Total allowance on originated loans
$
2,124

 
$
1,876

 
$
2,195

 
$
41

 
$
6,236

Purchased credit-impaired loans
$

 
$

 
$

 
$

 
$

Other acquired loans

 

 

 

 

Total allowance on acquired loans
$

 
$

 
$

 
$

 
$

Ending balance, June 30, 2016
$
2,124

 
$
1,876

 
$
2,195

 
$
41

 
$
6,236

Allowance for Loan Losses at June 30, 2016:
 
 
 
 
 
 
 
 
 
Amount of allowance for loan losses arising from loans individually evaluated for impairment
$
422

 
$

 
$
189

 
$

 
$
611

Amount of allowance for loan losses arising from loans collectively evaluated for impairment
$
1,702

 
$
1,876

 
$
2,006

 
$
41

 
$
5,625

Loans Receivable as of June 30, 2016:

 

 

 
 
 
 
Ending balance of originated loans
$
124,316

 
$
128,089

 
$
221,808

 
$

 
$
474,213

Ending balance of purchased credit-impaired loans
399

 
1,762

 
1,489

 

 
3,650

Ending balance of other acquired loans
69,198

 
26,770

 
10,215

 

 
106,183

Ending balance of loans
$
193,913

 
$
156,621

 
$
233,512

 
$

 
$
584,046

Ending balance: individually evaluated for impairment
$
4,670

 
$

 
$
914

 
$

 
$
5,584

Ending balance: collectively evaluated for impairment
$
189,243

 
$
156,621

 
$
232,598

 
$

 
$
578,462


23




 
Consumer Real Estate
 
Commercial/Agriculture Real Estate
 
Consumer and Other
 
Unallocated
 
Total
Year Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
Allowance for Loan Losses:
 
 
 
 
 
 
 
 
 
Beginning balance, October 1, 2014
$
2,759

 
$

 
$
3,747

 
$

 
$
6,506

Charge-offs
(405
)
 

 
(601
)
 

 
(1,006
)
Recoveries
69

 

 
271

 

 
340

Provision
382

 
16

 
258

 

 
656

Allowance allocation adjustment
(441
)
 
1,601

 
(1,412
)
 
252

 

Ending balance, September 30, 2015
$
2,364

 
$
1,617

 
$
2,263

 
$
252

 
$
6,496

Allowance for Loan Losses at September 30, 2015:
 
 
 
 

 
 
 
 
Amount of allowance for loan losses arising from loans individually evaluated for impairment
$
463

 
$

 
$
119

 
$

 
$
582

Amount of allowance for loan losses arising from loans collectively evaluated for impairment
$
1,901

 
$
1,617

 
$
2,144

 
$
252

 
$
5,914

Loans Receivable as of September 30, 2015:
 
 
 
 

 
 
 
 
Ending balance
$
180,693

 
$
63,266

 
$
206,551

 
$

 
$
450,510

Ending balance: individually evaluated for impairment
$
4,466

 
$

 
$
848

 
$

 
$
5,314

Ending balance: collectively evaluated for impairment
$
176,227

 
$
63,266

 
$
205,703

 
$

 
$
445,196

The Bank has originated most of the loans currently recorded on the Company’s accompanying Consolidated Balance Sheet, except as noted below.
In February 2016, the Bank selectively purchased loans and deposits from Central Bank in Rice Lake and Barron, Wisconsin in the amount of $16,363 and $27,131, respectively. In May 2016, the Bank acquired loans and deposits from Community Bank of Northern Wisconsin, headquartered in Rice Lake, Wisconsin in the amount of $112,327 and $151,020, respectively.
During October 2012, the Bank entered into an agreement to purchase short term consumer loans from a third party on an ongoing basis. As part of the servicer agreement entered into in connection with this purchase agreement, the third party seller agreed to purchase or substitute performing consumer loans for all contracts that become 120 days past due. Pursuant to the ongoing loan purchase agreement, a Board of Director determinant was originally established to limit the purchase of these consumer loans under this arrangement to a maximum of $40,000 and a restricted reserve account was established at 3% of the outstanding consumer loan balances purchased up to a maximum of $1,000, with such percentage amount of the loans being deposited into a segregated reserve account. The funds in the reserve account are to be released to compensate the Bank for any purchased loans that are not purchased back by the seller or substituted with performing loans and are ultimately charged off by the Bank. During the first quarter of fiscal 2015, the Board of Directors increased the limit of these purchased consumer loans to a maximum of $50,000. As of June 30, 2016, the balance of the consumer loans purchased was $47,865. The balance in the cash reserve account has reached the maximum allowed balance of $1,000, which is included in Deposits on the accompanying Consolidated Balance Sheet. To date, the Company has not charged off or experienced losses related to the purchased loans.
The weighted average rate earned on these purchased consumer loans was 4.24% as of June 30, 2016. From March 2014 through December 2015, the rate earned for all new loan originations of these purchased consumer loans was 4.00%. As of January 2016, new loans purchased are at an interest rate of 4.25% due to the increase in the Prime Rate.

24




Loans receivable by loan type as of the end of the periods shown below were as follows:
 
Real Estate Loans
 
Commercial/Agriculture Real Estate Loans
 
Consumer and Other Loans
 
Total Loans
 
June 30, 2016
 
September 30, 2015
 
June 30, 2016
 
September 30, 2015
 
June 30, 2016
 
September 30, 2015
 
June 30, 2016
 
September 30, 2015
Performing loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Performing TDR loans
$
3,006

 
$
3,206

 
$
1,078

 
$

 
$
336

 
$
472

 
$
4,420

 
$
3,678

Performing loans other
188,315

 
176,650

 
154,675

 
63,266

 
232,431

 
205,695

 
575,421

 
445,611

Total performing loans
191,321

 
179,856

 
155,753

 
63,266

 
232,767

 
206,167

 
579,841

 
449,289

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonperforming loans (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonperforming TDR loans
483

 
273

 
482

 

 
61

 
59

 
1,026

 
332

Nonperforming loans other
2,109

 
564

 
386

 

 
684

 
325

 
3,179

 
889

Total nonperforming loans
2,592

 
837

 
868

 

 
745

 
384

 
4,205

 
1,221

Total loans
$
193,913

 
$
180,693

 
$
156,621

 
$
63,266

 
$
233,512

 
$
206,551

 
$
584,046

 
$
450,510

(1)
Nonperforming loans are either 90+ days past due or nonaccrual.
An aging analysis of the Company’s real estate, commercial/agriculture real estate, consumer and other loans and purchased third party loans as of June 30, 2016 and September 30, 2015, respectively, was as follows:
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater
Than
89 Days
 
Total
Past Due
 
Current
 
Total
Loans
 
Recorded
Investment >
89 days and
Accruing
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans
$
996

 
$
117

 
$
1,623

 
$
2,736

 
$
191,177

 
$
193,913

 
$
682

Commercial/Agriculture real estate
84

 
494

 
1,719

 
2,297

 
154,324

 
156,621

 
35

Consumer and other loans
915

 
900

 
78

 
1,893

 
183,754

 
185,647

 
36

Purchased third party loans
302

 
226

 
227

 
755

 
47,110

 
47,865

 
226

Total
$
2,297

 
$
1,737

 
$
3,647

 
$
7,681

 
$
576,365

 
$
584,046

 
$
979

September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans
$
555

 
$
500

 
$
387

 
$
1,442

 
$
179,251

 
$
180,693

 
$
244

Commercial/Agriculture real estate

 

 

 

 
63,266

 
63,266

 

Consumer and other loans
386

 
65

 
135

 
586

 
166,260

 
166,846

 
52

Purchased third party loans
238

 
189

 
177

 
604

 
39,101

 
39,705

 
177

Total
$
1,179

 
$
754

 
$
699

 
$
2,632

 
$
447,878

 
$
450,510

 
$
473

As of June 30, 2016, the balance of acquired loans that are considered past due is $4,255 and the balance of acquired loans considered current is $105,578.

25




At June 30, 2016, the Company has identified $5,446 of TDR loans and $138 of substandard loans as impaired, totaling $5,584, which includes $4,420 of performing TDR loans. A loan is identified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Performing TDRs consist of loans that have been modified and are performing in accordance with the modified terms for a sufficient length of time, generally six months, or loans that were modified on a proactive basis. A summary of the Company’s impaired loans as of June 30, 2016 and September 30, 2015 was as follows:
 
With No Related Allowance Recorded
 
With An Allowance Recorded
 
Totals
 
Consumer Real Estate
Commercial/Agricultural Real Estate
Consumer and Other
 
Total
 
Consumer Real Estate
Commercial/Agricultural Real Estate
Consumer and Other
 
Total
 
Consumer Real Estate
Commercial/Agricultural Real Estate
Consumer and Other
 
Total
Recorded investment at June 30, 2016
$
2,822

$

$
410

 
$
3,232

 
$
1,848

$

$
504

 
$
2,352

 
$
4,670

$

$
914

 
$
5,584

Unpaid balance at June 30, 2016
2,822


410

 
3,232

 
1,848


504

 
2,352

 
4,670


914

 
5,584

Recorded investment at September 30, 2015
2,494


471

 
2,965

 
1,972


377

 
2,349

 
4,466


848

 
5,314

Unpaid balance at September 30, 2015
2,494


471

 
2,965

 
1,972


377

 
2,349

 
4,466


848

 
5,314

Average recorded investment; nine months ended June 30, 2016
2,762


491

 
3,253

 
1,787


338

 
2,125

 
4,549


829

 
5,378

Average recorded investment; twelve months ended September 30, 2015
3,178


485

 
3,663

 
2,220


556

 
2,776

 
5,398


1,041

 
6,439

Interest income received; nine months ended June 30, 2016
85


31

 
116

 
33


6

 
39

 
118


37

 
155

Interest income received; twelve months ended September 30, 2015
136


35

 
171

 
61


23

 
84

 
197


58

 
255


26




Troubled Debt Restructuring – A TDR includes a loan modification where a borrower is experiencing financial difficulty and the Bank grants a concession to that borrower that the Bank would not otherwise consider except for the borrower’s financial difficulties. Concessions include an extension of loan terms, renewals of existing balloon loans, reductions in interest rates and consolidating existing Bank loans at modified terms. A TDR may be either on accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status. There were 7 delinquent TDRs greater than 59 days past due with a recorded investment of $816 at June 30, 2016, compared to 4 such loans with a recorded investment of $191 at September 30, 2015. A summary of loans by loan type modified in a troubled debt restructuring as of June 30, 2016 and June 30, 2015, and during each of the nine months then ended was as follows:
 
Consumer Real Estate
Commercial/Agricultural Real Estate
Consumer and Other
 
Total
June 30, 2016 and
 
 
 
 
 
Nine Months then Ended:
 
 
 
 
 
Accruing / Performing:
 
 
 
 
 
Beginning balance
$
3,206

$

$
472

 
$
3,678

Principal balance of acquired loans
74

1,088


 
1,162

Principal payments
(86
)
(10
)
(97
)
 
(193
)
Charge-offs



 

Advances
7


1

 
8

New restructured (1)
223


6

 
229

Class transfers out (2)



 

Transfers between accrual/non-accrual
(418
)

(46
)
 
(464
)
Ending balance
$
3,006

$
1,078

$
336

 
$
4,420

Non-accrual / Non-performing:
 
 
 
 
 
Beginning balance
$
273

$

$
59

 
$
332

Principal balance of acquired loans

267

13

 
280

Principal payments
(133
)
(19
)
(27
)
 
(179
)
Charge-offs
(77
)
(37
)
(31
)
 
(145
)
Advances
2


1

 
3

New restructured (1)



 

Class transfers out (2)

271


 
271

Transfers between accrual/non-accrual
418


46

 
464

Ending balance
$
483

$
482

$
61

 
$
1,026

Totals:
 
 
 
 
 
Beginning balance
$
3,479

$

$
531

 
$
4,010

Principal balance of acquired loans
74

1,355

13

 
1,442

Principal payments
(219
)
(29
)
(124
)
 
(372
)
Charge-offs
(77
)
(37
)
(31
)
 
(145
)
Advances
9


2

 
11

New restructured (1)
223


6

 
229

Class transfers out (2)

271


 
271

Transfers between accrual/non-accrual



 

Ending balance
$
3,489

$
1,560

$
397

 
$
5,446

(1)
“New restructured” represent loans restructured during the applicable period that met TDR criteria in accordance with the Bank’s policy at the time of the restructuring.
(2)
“Class transfers out” represent previously restructured loans that are in compliance with the modified terms for a minimum of one year, are yielding a market rate and conform to normal underwriting standards.

27




 
Consumer Real Estate
Commercial/Agricultural Real Estate
Consumer and Other
 
Total
June 30, 2015 and
 
 
 
 
 
Nine Months then Ended:
 
 
 
 
 
Accruing / Performing:
 
 
 
 
 
Beginning balance
$
4,535

$

$
797

 
$
5,332

Principal payments
(495
)

(272
)
 
(767
)
Charge-offs


(8
)
 
(8
)
Advances
10



 
10

New restructured (1)
17


42

 
59

Class transfers out (2)
(181
)


 
(181
)
Transfers between accrual/non-accrual
(232
)

(42
)
 
(274
)
Ending balance
$
3,654

$

$
517

 
$
4,171

Non-accrual / Non-performing:
 

 
 
 
Beginning balance
$
202

$

$
47

 
$
249

Principal payments
(104
)

(9
)
 
(113
)
Charge-offs
(41
)

(31
)
 
(72
)
Advances



 

New restructured (1)



 

Class transfers out (2)



 

Transfers between accrual/non-accrual
232


42

 
274

Ending balance
$
289

$

$
49

 
$
338

Totals:
 

 
 
 
Beginning balance
$
4,737

$

$
844

 
$
5,581

Principal payments
(599
)

(281
)
 
(880
)
Charge-offs
(41
)

(39
)
 
(80
)
Advances
10



 
10

New restructured (1)
17


42

 
59

Class transfers out (2)
(181
)


 
(181
)
Transfers between accrual/non-accrual



 

Ending balance
$
3,943

$

$
566

 
$
4,509

(1)
“New restructured” represent loans restructured during the applicable period that met TDR criteria in accordance with the Bank’s policy at the time of the restructuring.
(2)
“Class transfers out” represent previously restructured loans that are in compliance with the modified terms for a minimum of one year, are yielding a market rate and conform to normal underwriting standards.

Below is a breakdown of troubled debt restructurings:
 
June 30, 2016
 
September 30, 2015
 
Number of
Modifications
 
Recorded
Investment
 
Number of
Modifications
 
Recorded
Investment
Troubled debt restructurings:
 
 
 
 
 
 
 
Consumer Real Estate
34

 
$
3,489

 
34

 
$
3,479

Commercial/Agricultural Real Estate
6

 
1,560

 

 

Consumer and other
26

 
397

 
39

 
531

Total troubled debt restructurings
66

 
$
5,446

 
73

 
$
4,010



28




All acquired loans were initially recorded at fair value at the acquisition date. The outstanding balance and the carrying amount of acquired loans included in the consolidated balance sheet are as follows:
 
June 30, 2016
Accountable for under ASC 310-30 (PCI loans)
 
Outstanding balance
3,650

Carrying amount
2,530

Accountable for under ASC 310-20 (non-PCI loans)

Outstanding balance
106,183

Carrying amount
106,021

Total acquired loans
 
Outstanding balance
109,833

Carrying amount
108,551

The following table provides changes in accretable yield for all acquired loans accounted for under ASC 310-30:
 
May 16, 2016 to June 30, 2016
Balance at beginning of period
$

Acquisitions
164

Reduction due to unexpected early payoffs

Reclass from non-accretable difference

Disposals/transfers

Accretion
(2
)
Balance at end of period
$
162

The following table reflects amounts at acquisition for all purchased loans subject to ASC 310-30 (impaired and non-impaired) acquired from CBN:
 
Acquired Impaired Loans
Acquired Performing Loans
 
Total Acquired Loans
Contractually required cash flows at acquisition
$
3,698

$
109,961

 
$
113,659

Non-accretable difference (expected losses and foregone interest)
(1,168
)

 
(1,168
)
Cash flows expected to be collected at acquisition
2,530

109,961

 
112,491

Accretable yield

(164
)
 
(164
)
Basis in acquired loans at acquisition
$
2,530

109,797

 
$
112,327

Our analysis of the acquired impaired and non-impaired loan portfolio is ongoing and will be completed by September 30, 2016.


29




NOTE 5 – INVESTMENT SECURITIES
The amortized cost, estimated fair value and related unrealized gains and losses on securities available for sale and held to maturity as of June 30, 2016 and September 30, 2015, respectively, were as follows:
Available for sale securities
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
June 30, 2016
 
 
 
 
 
 
 
U.S. government agency obligations
$
14,690

 
$
79

 
$
32

 
$
14,737

Obligations of states and political subdivisions
32,941

 
851

 
19

 
33,773

Mortgage-backed securities
35,125

 
440

 
6

 
35,559

Federal Agricultural Mortgage Corporation
70

 

 
5

 
65

Trust preferred securities
374

 

 

 
374

Total available for sale securities
$
83,200

 
$
1,370

 
$
62

 
$
84,508

 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
U.S. government agency obligations
$
15,240

 
$

 
$
220

 
$
15,020

Obligations of states and political subdivisions
27,573

 
81

 
247

 
27,407

Mortgage-backed securities
37,451

 
133

 
144

 
37,440

Federal Agricultural Mortgage Corporation
71

 

 
17

 
54

Total available for sale securities
$
80,335

 
$
214

 
$
628

 
$
79,921

Held to maturity securities
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
June 30, 2016
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
5,847

 
$
271

 
$

 
$
6,118

Mortgage-backed securities
1,316

 
18

 

 
1,334

Total held to maturity securities
$
7,163

 
$
289

 
$

 
$
7,452

 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
1,319

 
$
3

 
$
4

 
$
1,318

Mortgage-backed securities
6,693

 
208

 

 
6,901

Total held to maturity securities
$
8,012

 
$
211

 
$
4

 
$
8,219

As of June 30, 2016, the Bank has pledged U.S. Government Agency securities with a carrying value of $2,857 as collateral against a borrowing line of credit with the Federal Reserve Bank. However, as of June 30, 2016, there were no borrowings outstanding on this Federal Reserve Bank line of credit. As of June 30, 2016, the Bank has pledged U.S. Government Agency securities with a carrying value of $6,164 and mortgage-backed securities with a carrying value of $21,388 as collateral against specific municipal deposits.

30




The estimated fair value of securities at June 30, 2016 and September 30, 2015, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities on mortgage-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Expected maturities may differ from contractual maturities on certain agency and municipal securities due to the call feature.
 
June 30, 2016
 
September 30, 2015
Available for sale securities
Amortized
Cost
Estimated
Fair Value
 
Amortized
Cost
Estimated
Fair Value
Due in one year or less
$
230

$
230

 
$

$

Due after one year through five years
14,126

14,258

 
6,451

6,437

Due after five years through ten years
23,664

24,253

 
22,667

22,457

Due after ten years
45,180

45,767

 
51,217

51,027

Total available for sale securities
$
83,200

$
84,508

 
$
80,335

$
79,921


 
June 30, 2016
 
September 30, 2015
Held to maturity securities
Amortized
Cost
Estimated
Fair Value
 
Amortized
Cost
Estimated
Fair Value
Due after one year through five years
$
1,316

$
1,334

 
$
1,144

$
1,143

Due after five years through ten years
1,620

1,675

 
175

175

Due after ten years
4,227

4,443

 
6,693

6,901

Total held to maturity securities
$
7,163

$
7,452

 
$
8,012

$
8,219




31




NOTE 6 – FEDERAL HOME LOAN BANK ADVANCES
A summary of Federal Home Loan Bank advances at June 30, 2016 and September 30, 2015 was as follows:
 
As of
 
Weighted Average Rate
 
As of
 
Weighted Average Rate
Maturing during the fiscal year
June 30,
 
 
September 30,
 
Ended September 30,
2016
 
 
2015
 
2016
$
23,583

 
0.52
%
 
$
33,600

 
0.67
%
2017
21,461

 
1.27
%
 
15,461

 
1.46
%
2018
10,100

 
1.74
%
 
6,100

 
2.24
%
2019
3,730

 
1.87
%
 
3,730

 
1.87
%
2020

 
%
 

 
%
Total fixed maturity
$
58,874

 
1.09
%
 
$
58,891

 
1.12
%
Advances with amortizing principal

 
%
 

 
%
Total advances
$
58,874

 
1.09
%
 
$
58,891

 
1.12
%
Irrevocable standby letters of credit
$
17,560

 
 
 
$
24,040

 
 
Total credit outstanding
$
76,434

 
 
 
$
82,931

 
 
The Bank has an irrevocable Standby Letter of Credit Master Reimbursement Agreement with the Federal Home Loan Bank. This irrevocable standby letter of credit ("LOC") is supported by loan collateral as an alternative to directly pledging investment securities on behalf of a municipal customer as collateral for their interest bearing deposit balances.
At June 30, 2016, the Bank’s available and unused portion of this borrowing arrangement was approximately $67,300. The weighted average remaining term of the borrowings at June 30, 2016 is 9.66 months compared to 14.25 months at September 30, 2015.
Maximum month-end amounts outstanding were $67,474 and $53,891 during the nine month periods ended June 30, 2016 and 2015, respectively.
Each Federal Home Loan Bank advance is payable at the maturity date, with a prepayment penalty for fixed rate advances. These advances are secured by $185,198 of real estate mortgage loans.


32




NOTE 7 – INCOME TAXES
Income tax expense (benefit) for each of the periods shown below consisted of the following:
 
Nine months ended June 30, 2016
 
Nine months ended June 30, 2015
Current tax provision
 
 
 
Federal
$
647

 
$
1,094

State
190

 
169


837

 
1,263

Deferred tax (benefit) provision
 
 
 
Federal
496

 
(159
)
State
82

 
8


578

 
(151
)
Total
$
1,415

 
$
1,112

The provision for income taxes differs from the amount of income tax determined by applying statutory federal income tax rates to pretax income as result of the following differences:
 
Nine months ended June 30, 2016
 
Nine months ended June 30, 2015
 
Amount
 
Rate
 
Amount
 
Rate
Tax expense at statutory rate
$
1,370

 
34.0
 %
 
$
1,032

 
34.0
 %
State income taxes net of federal taxes
207

 
5.1

 
177

 
5.8

Tax exempt interest
(118
)
 
(2.9
)
 
(47
)
 
(1.6
)
Other
(44
)
 
(1.1
)
 
(50
)
 
(1.5
)
Total
$
1,415

 
35.1
 %
 
$
1,112

 
36.7
 %
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following is a summary of the significant components of the Company’s deferred tax assets and liabilities as of June 30, 2016 and September 30, 2015, respectively:
 
June 30, 2016
 
September 30, 2015
Deferred tax assets:
 
 
 
Allowance for loan losses
$
2,443

 
$
2,544

Deferred loan costs/fees
93

 
145

Director/officer compensation plans
535

 
536

Net unrealized loss on securities available for sale

 
166

Economic performance accruals
189

 
388

Other
109

 
132

Deferred tax assets
3,369

 
3,911

Deferred tax liabilities:
 
 
 
Office properties and equipment
(286
)
 
(114
)
Net unrealized gain on securities available for sale
(524
)
 

Other
(117
)
 
(110
)
Deferred tax liabilities
(927
)
 
(224
)
Net deferred tax assets
$
2,442

 
$
3,687


33




The Company regularly reviews the carrying amount of its deferred tax assets to determine if the establishment of a valuation allowance is necessary, as further discussed in Note 1 “Nature of Business and Summary of Significant Accounting Policies,” above. At June 30, 2016 and September 30, 2015, respectively, management determined that no valuation allowance was necessary for any of the deferred tax assets.
The Company’s income tax returns are subject to review and examination by federal, state and local government authorities. As of June 30, 2016, years open to examination by the U.S. Internal Revenue Service include taxable years ended September 30, 2012 to present. The years open to examination by state and local government authorities varies by jurisdiction.
The tax effects from uncertain tax positions can be recognized in the consolidated financial statements, provided the position is more likely than not to be sustained on audit, based on the technical merits of the position. The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company applied the foregoing accounting standard to all of its tax positions for which the statute of limitations remained open as of the date of the accompanying consolidated financial statements.
The Company’s policy is to recognize interest and penalties related to income tax issues as components of other noninterest expense. During the nine month periods ended June 30, 2016 and 2015, the Company did not recognize any interest or penalties related to income tax issues in its consolidated statements of operations. The Company had no recorded accrual or liability for the payment of interest and penalties related to income tax issues as of June 30, 2016 or September 30, 2015 respectively.
NOTE 8 – STOCK-BASED COMPENSATION
In February 2005, the Company’s stockholders approved the Company’s 2004 Recognition and Retention Plan. This plan provides for the grant of up to 113,910 shares of the Company’s common stock to eligible participants under this plan. As of June 30, 2016, 113,910 restricted shares under this plan were granted. In February 2005, the Company’s stockholders also approved the Company’s 2004 Stock Option and Incentive Plan. This plan provides for the grant of nonqualified and incentive stock options and stock appreciation rights to eligible participants under the plan. The plan provides for the grant of awards for up to 284,778 shares of the Company’s common stock. At June 30, 2016, 284,778 options had been granted under this plan to eligible participants.
In February 2008, the Company’s stockholders approved the Company’s 2008 Equity Incentive Plan. The aggregate number of shares of common stock reserved and available for issuance under the 2008 Equity Incentive Plan is 597,605 shares. Under this Plan, the Compensation Committee may grant stock options and stock appreciation rights that, upon exercise, result in the issuance of 426,860 shares of the Company’s common stock. The Committee may also grant shares of restricted stock and restricted stock units for an aggregate of 170,745 shares of Company common stock under this plan. As of June 30, 2016, 41,591 restricted shares under this plan were granted. As of June 30, 2016, 150,000 options had been granted to eligible participants.
Restricted shares granted to date under these plans were awarded at no cost to the employee and vest pro rata over a five-year period from the grant date. Options granted to date under these plans vest pro rata over a five-year period from the grant date. Unexercised, nonqualified stock options expire within 15 years of the grant date and unexercised incentive stock options expire within 10 years of the grant date.
Compensation expense related to restricted stock awards from both the 2004 Recognition and Retention Plan and the 2008 Equity Incentive Plan was $(20) and $33 for the three and nine months ended June 30, 2016, respectively. Compensation expense related to restricted stock awards from both the 2004 Recognition and Retention Plan and the 2008 Equity Incentive Plan was $26 and $70 for the three and nine months ended June 30, 2015, respectively.

34




Restricted Common Stock Award
 
 
June 30, 2016
 
September 30, 2015
 
 
Number of Shares
 
Weighted
Average
Grant Price
 
Number of Shares
 
Weighted
Average
Grant Price
Restricted Shares
 
 
 
 
 
 
 
 
Unvested and outstanding at beginning of fiscal year
 
46,857

 
$
7.59

 
41,014

 
$
6.51

Granted
 
9,091

 
11.00

 
17,500

 
9.20

Vested
 
(12,627
)
 
7.23

 
(11,657
)
 
6.18

Forfeited
 
(22,162
)
 
7.54

 

 

Unvested and outstanding fiscal to date
 
21,159

 
$
9.33

 
46,857

 
$
7.59

The Company accounts for stock-based employee compensation related to the Company’s 2004 Stock Option and Incentive Plan and the 2008 Equity Incentive Plan using the fair-value-based method. Accordingly, management records compensation expense based on the value of the award as measured on the grant date and then the Company recognizes that cost over the vesting period for the award. The compensation cost recognized for stock-based employee compensation related to both plans for the three and nine month periods ended June 30, 2016 was $(7) and $25, respectively. The compensation cost recognized for stock-based employee compensation related to both plans for the three and nine month periods ended June 30, 2015 was $16 and $44, respectively.
Common Stock Option Awards

 
 
Option Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
2016
 
 
 
 
 
 
 
 
Outstanding at September 30, 2015
 
171,737

 
$
7.46

 
 
 

Granted
 
55,000

 
10.00

 
 
 
 
Exercised
 
(25,915
)
 
 
 
 
 
 
Forfeited or expired
 
(42,516
)
 
 
 
 
 
 
Outstanding at June 30, 2016
 
158,306

 
$
8.57

 
6.94
 


Exercisable at June 30, 2016
 
65,120

 
$
7.46

 
3.80
 
$
189

Fully vested and expected to vest
 
158,306

 
$
8.57

 
6.94
 
$
297

2015
 
 
 
 
 
 
 
 
Outstanding at September 30, 2014
 
179,192

 
$
6.52

 
 
 
 
Granted
 
50,000

 
9.20

 
 
 
 
Exercised
 
(51,955
)
 
 
 
 
 
 
Forfeited or expired
 
(5,500
)
 
 
 
 
 
 
Outstanding at September 30, 2015
 
171,737

 
$
7.46

 
7.58
 


Exercisable at September 30, 2015
 
63,764

 
$
6.79

 
5.33
 
 
Fully vested and expected to vest
 
171,737

 
$
7.46

 
7.58
 
 
Information related to the 2004 Stock Option and Incentive Plan and 2008 Equity Incentive Plan during each year follows:
 
 
2016
 
2015
Intrinsic value of options exercised
 
$
86

 
$
180

Cash received from options exercised
 
$
153

 
$
299

Tax benefit realized from options exercised
 
$

 
$
9


35




Set forth below is a table showing relevant assumptions used in calculating stock option expense related to the Company’s 2004 Stock Option and Incentive Plan and 2008 Equity Incentive Plan:
 
 
2016
 
2015
Dividend yield
 
1.02
%
 
0.88
%
Risk-free interest rate
 
1.7
%
 
2.1
%
Weighted average expected life (years)
 
10

 
10

Expected volatility
 
5
%
 
2
%

NOTE 9 – OTHER COMPREHENSIVE INCOME (LOSS)
The following table shows the tax effects allocated to each component of other comprehensive income for the nine months ended June 30, 2016:
 
Before-Tax
Amount
 
Tax
Expense
 
Net-of-Tax
Amount
Unrealized gains (losses) on securities:
 
 
 
 
 
Net unrealized gains arising during the period
$
1,677

 
(671
)
 
$
1,006

Less: reclassification adjustment for gains included in net income
47

 
(19
)
 
28

Defined benefit plans:

 

 
 
Amortization of unrecognized prior service costs and net gains
(58
)
 
23

 
(35
)
Other comprehensive income
$
1,666

 
$
(667
)
 
$
999


The following table shows the tax effects allocated to each component of other comprehensive income for the nine months ended June 30, 2015:
 
Before-Tax
Amount
 
Tax
Expense
 
Net-of-Tax
Amount
Unrealized gains (losses) on securities:
 
 
 
 
 
Net unrealized gains arising during the period
$
45

 
(18
)
 
$
27

Less: reclassification adjustment for gains included in net income
60

 
(24
)
 
36

Defined benefit plans:
 
 
 
 
 
Amortization of unrecognized prior service costs and net gains
1

 

 
1

Other comprehensive income
$
106

 
$
(42
)
 
$
64

The changes in the accumulated balances for each component of other comprehensive income (loss) for the nine months ended June 30, 2016 were as follows:
 
Unrealized
Gains  (Losses)
on
Securities
 
Defined
Benefit
Plans
 
Other Accumulated
Comprehensive
Income (Loss)
Balance, October 1, 2015
$
(249
)
 
$
35

 
$
(214
)
Current year-to-date other comprehensive income, net of tax
1,666

 
(667
)
 
999

Ending balance, June 30, 2016
$
1,417

 
$
(632
)
 
$
785


36




NOTE 10 – TERMINATION OF CERTAIN RETIREMENT PLANS
The Company maintained a Supplemental Benefit Plan For Key Employees ("SERP") which was an unfunded, unsecured, non-contributory defined benefit plan, providing retirement benefits for certain former key employees previously designated by the Company’s Board of Directors. Benefits under the SERP generally were based on such former employees’ years of service and compensation during the years preceding their retirement. In May 2009, any additional accrual of benefits under the SERP was suspended.

The Company also maintained a Directors’ Retirement Plan ("DRP"), which was an unfunded, unsecured, non-contributory defined benefit plan, providing for supplemental pension benefits for its directors following their termination of service as a director of the Company. Benefits were based on a formula that included each participant’s past and future earnings and years of service with Citizens. Moreover, the benefit amounts owed by the Company under the DRP were determined by individual director agreements entered into by the Company with such participants. The remaining DRP liability related to current and former Directors of the Company.

The Company's Board of Directors voted to terminate each of the SERP and the DRP at its regularly scheduled Board meeting on November 19, 2015, with such termination being effective as of the same date. In connection with the termination of each plan, the Board of Directors, in accordance with applicable law and each applicable participant’s plan participation agreement, negotiated lump sum payments to the participants in satisfaction of the Company’s total liability to each participant under the SERP and DRP. In accordance with the final settlement of the Company’s obligations under such plans, the Company will make two payments (each for 50% of the total liability owed) to each plan participant. The first payment will occur in December 2016 and the second and final payment will occur in January 2017.

In connection with the settlement of all obligations owed by the Company to the participants in the SERP and the DRP, the Company retained an independent consultant during the three months ended March 31, 2016 to perform an actuarial calculation of the final amount of the accumulated benefit owed by the Company to each plan participant. In making this calculation, the consultant made certain assumptions regarding the applicable discount rate to be used and regarding certain other relevant factors to determine the amount of the benefit obligation due each participant, in each case taking into account the terms of each participant’s negotiated plan benefit agreement and the terms of each plan. Differences between the amount of the projected accrued benefit obligation previously recorded by the Company in its consolidated financial statements in connection with these plans and the actual amount of the benefit obligation to be paid to the participants, based upon the calculations of the independent consultant, is recorded in the aggregate as a gain of $41 during the nine months ended June 30, 2016 on the accompanying Consolidated Statements of Operations line item "Salaries and related benefits" as a reduction to the expense. Moreover, as of June 30, 2016, the Company recorded a liability on the accompanying Consolidated Balance Sheet of $1,065 for the aggregate amount of the benefit obligation due plan participants currently receiving monthly and quarterly payments and the final lump sum payment amounts due in December 2016 and January 2017.

The components of the SERP and Directors' Retirement plans' cost at June 30, 2016 are summarized below.
 
 
2016
Beginning accrued benefit cost
 
$
1,120

Service cost
 

Interest cost
 
44

Amortization of prior service costs
 
1

Net plan termination Credit
 
(41
)
Net periodic benefit cost
 
4

Benefits paid
 
(59
)
Ending accrued benefit cost
 
$
1,065


Amounts recognized in consolidated balance sheets:
 
 
June 30, 2016

Pension obligation
 
$
1,065

 
 
 
Prior service cost
 

Net loss (gain)
 

Total accumulated other comprehensive income, before tax
 


37






ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as “anticipate,” “believe,” “could,” “expect,” “intend,” “may,” “planned,” “potential,” “should,” “will,” “would,” or the negative of those terms or other words of similar meaning.  Such forward-looking statements in this report are inherently subject to many uncertainties arising in the Company’s operations and business environment. These uncertainties include general economic conditions, in particular, relating to consumer demand for the Bank’s products and services; the Bank’s ability to maintain current deposit and loan levels at current interest rates; competitive and technological developments; deteriorating credit quality, including changes in the interest rate environment reducing interest margins; prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; the Bank’s ability to maintain required capital levels and adequate sources of funding and liquidity; maintaining capital requirements may limit the Bank’s operations and potential growth; changes and trends in capital markets; competitive pressures among depository institutions; effects of critical accounting estimates and judgments; changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies overseeing the Bank; the Bank’s ability to implement its cost-savings and revenue enhancement initiatives including managing costs associated with its branch consolidation and new market branch growth initiatives; legislative or regulatory changes or actions, or significant litigation, adversely affecting the Bank or the Company; fluctuation of the Company’s stock price; the Bank's ability to attract and retain key personnel; the Bank's ability to secure confidential information through the use of computer systems and telecommunications networks; and the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity. Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. Such uncertainties and other risks that may affect the Company’s performance are discussed further in Part I, Item 1A, “Risk Factors,” in the Company’s Form 10-K, for the year ended September 30, 2015 filed with the Securities and Exchange Commission on December 7, 2015. The Company undertakes no obligation to make any revisions to the forward-looking statements contained in this report or to update them to reflect events or circumstances occurring after the date of this report.
GENERAL
The following discussion sets forth management’s discussion and analysis of our consolidated financial condition as of June 30, 2016, and our consolidated results of operations for the nine months ended June 30, 2016, compared to the same period in the prior fiscal year for the nine months ended June 30, 2015. This discussion should be read in conjunction with the interim consolidated financial statements and the condensed notes thereto included with this report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes related thereto included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission on December 7, 2015. Unless otherwise stated, all monetary amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, other than share, per share and capital ratio amounts, are stated in thousands.
ACQUISITION
On May 16, 2016, we successfully completed the acquisition of CBN. The acquisition expands our branch network in northern Wisconsin. The acquisition resulted in the following increases to our balance sheet as of the acquisition date: approximately $112,000 in loans, $151,000 in deposits, $3,568 of goodwill, $11,000 of debt, and net assets of $12,510. The acquisition also reduced cash and other liquid assets by approximately $6,447, which funded a portion of the acquisition, as discussed further in Note 2-Acquisition. The discussion of our results below reflect the acquired net assets of CBN, the financing transactions to fund the purchase price, and goodwill arising from accounting for the acquisition as of June 30, 2016.


38




PERFORMANCE SUMMARY
The following table sets forth our results of operations and related summary information for the three and nine month periods ended June 30, 2016 and 2015, respectively:
 
Three Months Ended June 30,
 
Nine Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Net income as reported
$
967

 
$
612

 
$
2,528

 
$
1,923

EPS - basic, as reported
$
0.18

 
$
0.12

 
$
0.48

 
$
0.37

EPS - diluted, as reported
$
0.18

 
$
0.12

 
$
0.48

 
$
0.37

Cash dividends paid
$

 
$

 
$
0.12

 
$
0.08

Return on average assets (annualized)
0.59
%
 
0.43
%
 
0.52
%
 
0.45
%
Return on average equity (annualized)
6.17
%
 
4.15
%
 
5.43
%
 
4.41
%
Efficiency ratio, as reported (1)
75.15
%
 
79.16
%
 
75.11
%
 
76.61
%
(1)
The efficiency ratio is calculated as non-interest expense minus branch closure costs divided by the sum of net interest income plus non-interest income, excluding net impairment losses recognized in net income. A lower ratio indicates greater efficiency.
Key factors behind these results were:
Net interest income was $5,179 and $14,359 for the three and nine month periods ended June 30, 2016, an increase of $653 or 14.43% from the prior three month period and an increase of $407 or 2.92% from the prior year period. The three and nine month increase was primarily due to the increase in loan balances due to the CBN acquisition on May 17, 2016.
The net interest margin of 3.27% for the three months ended June 30, 2016 represents a 4 bp decrease from a net interest margin of 3.31% for the three months ended June 30, 2015. The net interest margin of 3.24% for the nine months ended June 30, 2016 represents a 14 bp decrease from a net interest margin of 3.38% for the nine months ended June 30, 2015.
Total loans were $584,046 at June 30, 2016, an increase of $133,536, or 29.64%, from their balances at September 30, 2015, due primarily to $112,327 of additional loans resulting from the acquisition of CBN, along with continued commercial loan growth and the Central Bank Rice Lake and Barron, Wisconsin selective loans purchase. Total deposits were $585,224 at June 30, 2016, an increase of $128,926, or 28.25%, from their balances at September 30, 2015, mainly due to deposits received from the CBN acquisition of $151,020 and the Central Bank Rice Lake and Barron, Wisconsin deposit purchase , offset by decreases in balances of accounts in closed branches of $12,433.
Net loan charge-offs decreased from $479 for the nine months ended June 30, 2015 to $335 for the nine months ended June 30, 2016, as a result of overall credit quality improvement within our loan portfolio. Continued lower levels of net loan charge-offs in recent periods led to a decreased provision for loan losses of $75 for the nine month period ended June 30, 2016, compared to $535 for the nine months ended June 30, 2015. Annualized net loan charge-offs as a percentage of average loans were 0.09% for the nine months ended June 30, 2016, compared to 0.14% for the nine months ended June 30, 2015.
Non-interest income increased from $931 for the three months ended June 30, 2015 to $1,013 for the three months ended June 30, 2016, because of an increase in interchange income received due to additional card usage. Non-interest income decreased from $2,889 for the nine months ended June 30, 2015 to $2,773 for the nine months ended June 30, 2016, mainly due to a decrease in overdraft fee income. As a result of our branch rationalization, our deposit mix is changing which has led to a decrease in overdraft fee income.
Non-interest expense increased $295 for the three months ended June 30, 2016 from $4,358 to $4,653 compared to the three months ended June 30, 2015. Non-interest expense decreased $157 for the nine months ended June 30, 2016 from $13,271 to $13,114, compared to the nine month period ended June 30, 2015. During the current three month period, salaries and related benefits costs increased $183, mainly due to the addition of new employees related to the CBN acquisition. During the current nine month period, similar personnel cost increases were offset by decreases in occupancy expenses due to efficiencies and cost savings realized over recent periods through management initiatives including branch closures and technology improvements. Occupancy costs consist primarily of office rental and depreciation expenses. Other non-interest expense reductions, including professional services, reflected reduced expenses as part of our branch rationalization plan.
CRITICAL ACCOUNTING ESTIMATES

39




    
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amount of assets, liabilities, revenue, expenses and their related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that our management believes to be relevant at the time our consolidated financial statements are prepared. Some of these estimates are more critical than others. In addition to the policies included in Note 1, “Nature of Business and Summary of Significant Accounting Policies,” to the Consolidated Financial Statements included as an exhibit to our Form 10-K annual report for the fiscal year ending September 30, 2015, our critical accounting estimates are as follows:
Allowance for Loan Losses.
We maintain an allowance for loan losses to absorb probable incurred losses in our loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated probable and inherent losses in our loan portfolio. In evaluating the level of the allowance for loan loss, we consider the types of loans and the amount of loans in our loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying loan collateral and prevailing economic conditions. We follow all applicable regulatory guidance, including the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued by the Federal Financial Institutions Examination Council ("FFIEC"). We believe that the Bank’s Allowance for Loan Losses Policy conforms to all applicable regulatory requirements. However, based on periodic examinations by regulators, the amount of the allowance for loan losses recorded during a particular period may be adjusted.
Our determination of the allowance for loan losses is based on (1) specific allowances for specifically identified and evaluated impaired loans and their corresponding estimated loss based on likelihood of default, payment history, and net realizable value of underlying collateral; and (2) a general allowance on loans not specifically identified in (1) above, based on historical loss ratios which are adjusted for qualitative and general economic factors. We continue to refine our allowance for loan losses methodology, with an increased emphasis on historical performance adjusted for applicable economic and qualitative factors.
Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including estimating the amount and timing of future cash flows expected to be received on impaired loans, any of which estimates may be susceptible to significant change. In our opinion, the allowance for loan losses, when taken as a whole, reflects estimated probable and inherent loan losses in our loan portfolio.
Income Taxes.
The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be material to our consolidated results of our operations and reported earnings. We believe that the tax assets and liabilities are adequate and properly recorded in the accompanying consolidated financial statements. As of June 30, 2016, management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.

40




STATEMENT OF OPERATIONS ANALYSIS
Net Interest Income. Net interest income represents the difference between the dollar amount of interest earned on interest-bearing assets and the dollar amount of interest paid on interest-bearing liabilities. The interest income and expense of financial institutions (including those of the Bank) are significantly affected by general economic conditions, competition, policies of regulatory authorities and other factors.
Interest rate spread and net interest margin are used to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest earning assets and the rate paid for interest-bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest earning assets. Net interest margin currently exceeds interest rate spread because non-interest bearing sources of funds (“net free funds”), principally demand deposits and stockholders’ equity, also support interest earning assets. The narrative below discusses net interest income, interest rate spread, and net interest margin for the nine month periods ended June 30, 2016 and 2015, respectively.
Tax equivalent net interest income was $5,248 and $14,554 for the three and nine months ended June 30, 2016, compared to $4,567 and $14,032 for the three and nine months ended June 30, 2015. The net interest margin for the three and nine month periods ended June 30, 2016 was 3.27% and 3.24% compared to 3.31% and 3.38% for the three and nine month periods ended June 30, 2015.
As shown in the rate/volume analysis in the following pages, volume changes resulted in an increase of $714 and $857 in net interest income for the three and nine month periods ended June 30, 2016 compared to the comparable prior year period. The increase and changes in the composition of interest earning assets resulted in an increase of $929 and $1,133 for the three and nine month periods ended June 30, 2016, compared to the same period in the prior year. Rate changes on interest earning assets decreased net interest income by $48 and $401 for the three and nine month periods ended June 30, 2016. Rate changes on interest-bearing liabilities decreased interest expense by $15 and $66 over the same period in the prior year, resulting in a net decrease of $33 and $335 in net interest income as a result of changes in interest rates due to competitive pricing during the three and nine month periods ended June 30, 2016. Rate decreases on loans are reflective of the overall lower market interest rate environment versus historic levels.
Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following Net Interest Income Analysis table presents interest income from average interest earning assets, expressed in dollars and yields, and interest expense on average interest-bearing liabilities, expressed in dollars and rates on a tax equivalent basis. Shown below is the weighted average yield on interest earning assets, rates paid on interest-bearing liabilities and the resultant spread at or during the nine month period ended June 30, 2016, and for the comparable prior year nine month periods. Non-accruing loans have been included in the table as loans carrying a zero yield.
Average interest earning assets were $646,388 and $600,434 for the three and nine month periods ended June 30, 2016, respectively, compared to $553,258 and $555,225 for the comparable prior year periods. Interest income on interest earning assets was $6,543 and $18,085 for the three and nine month periods ended June 30, 2016, respectively, compared to $5,662 and $17,353 for the same periods in the prior year. Interest income is comprised primarily of interest income on loans and interest income on investment securities adjusted for the tax benefit of tax-exempt securities. Interest income on loans was $6,072 and $16,623 for the three and nine month periods ended June 30, 2016, respectively, compared to $5,304 and $16,275 for the comparable prior year periods. The increase in loan interest income in the current year three and nine month periods was primarily due to an increased level of commercial loans in the current year periods over the comparable periods in the prior year. Interest income on investment securities was $397 and $1,250 for the three and nine month periods ended June 30, 2016, compared to $308 and $938 for the similar prior year periods. The increase is due to an increase in our investment portfolio from funds received from the Central Bank selective loans and deposits purchase and the CBN acquisition.
Average interest-bearing liabilities were $566,575 and $525,139 for the three and nine month periods ended June 30, 2016, respectively, compared to $483,181 and $486,620 for the similar prior year periods. Interest expense on interest-bearing liabilities was $1,295 and $3,531 for the three and nine month periods ended June 30, 2016, respectively, compared to $1,095 and $3,321 for the same periods in the prior year. Interest expense increased during the current three and nine month periods compared to the comparable prior year periods, due to increases in deposit balances from the recent acquisition.
For the three and nine months ended June 30, 2016, interest expense on interest-bearing deposits increased $150 and $175, respectively, from volume and mix changes and decreased $16 and $32 from the impact of the rate environment, resulting in an aggregate increase of $134 and $143 in interest expense on interest-bearing deposits during such periods. Interest expense on FHLB advances and other borrowings increased $65 and $101 from volume and mix changes and increased $1 and decreased $34 from the impact of the rate environment during the three and nine month periods ended June 30, 2016 for an aggregate increase of $66 and $67 for the three and nine month periods.

41





NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
(Dollar amounts in thousands)
Three months ended June 30, 2016 compared to the three months ended June 30, 2015:
 
Three months ended June 30, 2016
 
Three months ended June 30, 2015
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
Average interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,118

 
$
18

 
0.34
%
 
$
24,006

 
$
17

 
0.28
%
Loans
525,780

 
6,072

 
4.64
%
 
454,255

 
5,304

 
4.68
%
Interest-bearing deposits
2,557

 
10

 
1.57
%
 
1,495

 
7

 
1.88
%
Investment securities (1)
92,102

 
397

 
1.73
%
 
68,713

 
308

 
1.80
%
Non-marketable equity securities, at cost
4,831

 
46

 
3.83
%
 
4,789

 
26

 
2.18
%
Total interest earning assets
$
646,388

 
$
6,543

 
4.07
%
 
$
553,258

 
$
5,662

 
4.10
%
Average interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Savings accounts
$
35,825

 
$
11

 
0.12
%
 
$
28,113

 
$
8

 
0.11
%
Demand deposits
42,898

 
65

 
0.61
%
 
21,883

 
42

 
0.77
%
Money market
141,162

 
141

 
0.40
%
 
145,575

 
156

 
0.43
%
CD’s
251,534

 
787

 
1.26
%
 
218,287

 
675

 
1.24
%
IRA’s
27,332

 
77

 
1.13
%
 
22,182

 
66

 
1.19
%
Total deposits
498,751

 
1,081

 
0.87
%
 
436,040

 
947

 
0.88
%
FHLB Advances and other borrowings
67,824

 
214

 
1.27
%
 
47,141

 
148

 
1.26
%
Total interest-bearing liabilities
$
566,575

 
$
1,295

 
0.92
%
 
$
483,181

 
$
1,095

 
0.91
%
Net interest income
 
 
$
5,248

 
 
 
 
 
$
4,567

 
 
Interest rate spread
 
 
 
 
3.15
%
 
 
 
 
 
3.19
%
Net interest margin
 
 
 
 
3.27
%
 
 
 
 
 
3.31
%
Average interest earning assets to average interest-bearing liabilities
 
 
 
 
1.14

 
 
 
 
 
1.15

(1) For the three months ended June 30, 2016 and 2015, the average balances of the tax exempt investment securities, included in investment securities, were $30,190 and $17,248, respectively. The interest income on tax exempt securities is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.



42




Nine months ended June 30, 2016 compared to the nine months ended June 30, 2015:
 
Nine months ended June 30, 2016
 
Nine months ended June 30, 2015
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
Average interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
18,630

 
$
51

 
0.37
%
 
$
19,765

 
$
37

 
0.25
%
Loans
482,808

 
16,623

 
4.60
%
 
459,104

 
16,275

 
4.74
%
Interest-bearing deposits
2,868

 
43

 
2.00
%
 
1,195

 
18

 
2.01
%
Investment securities (1)
91,420

 
1,250

 
1.83
%
 
70,052

 
938

 
1.79
%
Non-marketable equity securities, at cost
4,708

 
118

 
3.35
%
 
5,109

 
85

 
2.22
%
Total interest earning assets
$
600,434

 
$
18,085

 
4.02
%
 
$
555,225

 
$
17,353

 
4.18
%
Average interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Savings accounts
$
30,755

 
$
26

 
0.11
%
 
$
27,840

 
$
22

 
0.11
%
Demand deposits
32,008

 
155

 
0.65
%
 
20,343

 
114

 
0.75
%
Money market
142,003

 
436

 
0.41
%
 
142,062

 
467

 
0.44
%
CD’s
232,558

 
2,159

 
1.24
%
 
222,416

 
2,045

 
1.23
%
IRA’s
24,584

 
212

 
1.15
%
 
22,268

 
197

 
1.18
%
Total deposits
461,908

 
2,988

 
0.86
%
 
434,929

 
2,845

 
0.87
%
FHLB Advance and other borrowings
63,231

 
543

 
1.15
%
 
51,691

 
476

 
1.23
%
Total interest-bearing liabilities
$
525,139

 
$
3,531

 
0.90
%
 
$
486,620

 
$
3,321

 
0.91
%
Net interest income
 
 
$
14,554

 
 
 
 
 
$
14,032

 
 
Interest rate spread
 
 
 
 
3.12
%
 
 
 
 
 
3.27
%
Net interest margin
 
 
 
 
3.24
%
 
 
 
 
 
3.38
%
Average interest earning assets to average interest-bearing liabilities
 
 
 
 
1.14

 
 
 
 
 
1.14

(1) For the nine months ended ended June 30, 2016 and 2015, the average balances of the tax exempt investment securities, included in investment securities, were $28,433 and $12,494, respectively. The interest income on tax exempt securities is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.
Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for the components of interest earning assets and interest-bearing liabilities that are presented in the preceding table. For each category of interest earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in volume, which are changes in the average outstanding balances multiplied by the prior period rate (i.e. holding the initial rate constant); and (2) changes in rate, which are changes in average interest rates multiplied by the prior period volume (i.e. holding the initial balance constant). Changes due to both rate and volume which cannot be segregated have been allocated in proportion to the relationship of the dollar amounts of the change in each category.

43




RATE / VOLUME ANALYSIS
(Dollar amounts in thousands)
Three months ended June 30, 2016 compared to the three months ended June 30, 2015:
 
Increase (decrease) due to
 
Volume
 
Rate
 
Net
Interest income:
 
 
 
 
 
Cash and cash equivalents
$
(2
)
 
$
3

 
$
1

Loans
826

 
(58
)
 
768

Interest-bearing deposits
4

 
(1
)
 
3

Investment securities
101

 
(12
)
 
89

Non-marketable equity securities, at cost

 
20

 
20

Total interest earning assets
929

 
(48
)
 
881

Interest expense:
 
 
 
 
 
Savings accounts
2

 
1

 
3

Demand deposits
34

 
(11
)
 
23

Money market accounts
(5
)
 
(10
)
 
(15
)
CD’s
104

 
8

 
112

IRA’s
15

 
(4
)
 
11

Total deposits
150

 
(16
)
 
134

FHLB Advances
65

 
1

 
66

Total interest bearing liabilities
215

 
(15
)
 
200

Net interest income
$
714

 
$
(33
)
 
$
681

Nine months ended June 30, 2016 compared to the nine months ended June 30, 2015.
 
Increase (decrease) due to
 
Volume
 
Rate
 
Net
Interest income:
 
 
 
 
 
Cash and cash equivalents
$
(2
)
 
$
16

 
$
14

Loans
825

 
(477
)
 
348

Interest-bearing deposits
25

 

 
25

Investment securities
292

 
20

 
312

Non-marketable equity securities, at cost
(7
)
 
40

 
33

Total interest earning assets
1,133

 
(401
)
 
732

Interest expense:
 
 
 
 
 
Savings accounts
2

 
2

 
4

Demand deposits
59

 
(18
)
 
41

Money market accounts

 
(31
)
 
(31
)
CD’s
94

 
20

 
114

IRA’s
20

 
(5
)
 
15

Total deposits
175

 
(32
)
 
143

FHLB Advance and other borrowings
101

 
(34
)
 
67

Total interest bearing liabilities
276

 
(66
)
 
210

Net interest income (loss)
$
857

 
$
(335
)
 
$
522




44




Provision for Loan Losses. We determine our provision for loan losses (“provision”, or “PLL”) based on our desire to provide an adequate allowance for loan losses (“ALL”) to reflect probable and inherent credit losses in our loan portfolio. Prior to the past 3 years, higher charge off levels and the negative influence of certain qualitative and general economic factors discussed above under “Critical Accounting EstimatesAllowance for Loan Losses”, made it necessary to increase our provision to ensure an adequate ALL. Within the last year, we have experienced lower levels of charge-offs and nonperforming loans. With both local and national unemployment rates improving slightly in recent quarters and improved asset quality due to our stricter underwriting standards, we anticipate our actual charge-off experience to remain stable throughout the remainder of the fiscal year ending September 30, 2016.
Net loan charge-offs for the nine month period ended June 30, 2016 were $335, compared to $479, for the comparable prior year period. Annualized net charge-offs to average loans were 0.09% for the nine months ended June 30, 2016, compared to 0.14% for the comparable period in the prior year. Non-accrual loans were $3,226 at June 30, 2016, compared to $748 at September 30, 2015. Of the $2,478 increase in non-accrual loans, $1,832 is attributable to the CBN acquisition. Even though we are experiencing a slight increase in our nonperforming loans, we believe our credit and underwriting policies have supported more effective lending decisions by the Bank. Long term, we believe our loan servicing procedures will be able to manage delinquency efficiently and effectively. Refer to the “Allowance for Loan Losses” and “Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections below for more information related to non-performing loans.
We recorded a provision for loan losses of $0 and $75 for the three and nine month periods ended June 30, 2016, compared to $150 and $535 for the comparable prior year periods. Management believes that the provision taken for the current year three and nine month periods is adequate in view of the present condition of our loan portfolio and the sufficiency of collateral supporting our non-performing loans. We continually monitor non-performing loan relationships and will make adjustments to our provision, as necessary, if changing facts and circumstances require a change in the ALL. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market areas, or otherwise, could all affect the adequacy of our ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate, we will need to record an additional PLL in the future. See the section below captioned “Allowance for Loan Losses” in this discussion for further analysis of our provision for loan losses.
Non-interest Income (Loss). The following table reflects the various components of non-interest income for the three and nine month periods ended June 30, 2016 and 2015, respectively.
 
Three months ended June 30,
 
%
 
Nine months ended June 30,
 
%
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Non-interest Income:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on available for sale securities
$
43

 
$
13

 
230.77
 %
 
$
47

 
$
60

 
(21.67
)%
Service charges on deposit accounts
410

 
423

 
(3.07
)
 
1,164

 
1,273

 
(8.56
)%
Loan fees and service charges
302

 
276

 
9.42

 
886

 
923

 
(4.01
)%
Other
258

 
219

 
17.81

 
676

 
633

 
6.79
 %
Total non-interest income
$
1,013

 
$
931

 
8.81
 %
 
$
2,773

 
$
2,889

 
(4.02
)%
The decrease of $13 and $109 in service charges on deposit accounts for the three and nine month periods ended June 30, 2016, respectively, was primarily due to a decrease in overdraft fee income. As a result of our branch rationalization, our deposit mix is changing and has caused the decrease in overdraft fee income during the current three and nine month periods ended June 30, 2016. The increase of $82 in total non-interest income during the current year three month period ended June 30, 2016, compared to the same period in the prior year, was attributable to increased Visa interchange income due to additional usage of our Visa Debit cards. Total non-interest income decreased $116 during the current nine month period ended June 30, 2016 over the prior year period, primarily due to a decrease in overdraft fee income, secondary market loan origination fees and a loan sale premium received in the first quarter of the previous year in the amount of $89 recorded in loan fees and service charges.

45




Non-interest Expense. The following table reflects the various components of non-interest expense for the three and nine month periods ended June 30, 2016 and 2015, respectively.
 
Three months ended June 30,
 
%
 
Nine months ended June 30,
 
%
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Non-interest Expense:
 
 
 
 
 
 
 
 
 
 
 
Salaries and related benefits
$
2,378

 
$
2,195

 
8.34
 %
 
$
6,784

 
$
6,548

 
3.60
 %
Occupancy - net
554

 
589

 
(5.94
)
 
1,835

 
2,073

 
(11.48
)
Office
350

 
317

 
10.41

 
864

 
825

 
4.73

Data processing
445

 
393

 
13.23

 
1,274

 
1,177

 
8.24

Amortization of core deposit intangible
31

 
14

 
121.43

 
66

 
42

 
57.14

Advertising, marketing and public relations
174

 
126

 
38.10

 
456

 
410

 
11.22

FDIC premium assessment
86

 
98

 
(12.24
)
 
255

 
306

 
(16.67
)
Professional services
182

 
251

 
(27.49
)
 
574

 
840

 
(31.67
)
Other
453

 
375

 
20.80

 
1,006

 
1,050

 
(4.19
)
Total non-interest expense
$
4,653

 
$
4,358

 
6.77
 %
 
$
13,114

 
$
13,271

 
(1.18
)%
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest expense (annualized) / Average assets
2.82
%
 
3.08
%
 
(8.44
)%
 
2.68
%
 
3.12
%
 
(14.10
)%
During the three months ended June 30, 2016, salaries and related benefits costs increased $183, primarily due to the addition of new employees related to the CBN acquisition. During the current three and nine month periods, occupancy expense decreased due to efficiencies and cost savings realized over recent periods through management initiatives including branch closures and technology improvements. Occupancy costs consist primarily of office rental and depreciation expenses. Data processing expenses increased during the three and nine month periods ended June 30, 2016, due to conversion costs related to the CBN acquisition, and the Central Bank selective deposits and loans purchase. We are continuing to focus on technology to provide progressive, online and mobile banking services that complement friendly, knowledgeable bankers in convenient community bank locations. As we redefine and expand our footprint, we expect these costs to continue to remain higher. Amortization of core deposit intangible expense increased due to the premium paid for the Central Bank selective deposits purchase and the CBN acquisition for the current three and nine month periods ended June 30, 2016, compared to the same periods in the prior year. Professional services expense decreased in the current year three month period primarily due to higher professional services costs and related accruals in the comparable prior period related to branch closures. Other expense increased during the three and nine month periods ended June 30, 2016, due to increased insurance costs and loan related legal and collection expenses. Total non-interest expense increased $295 and decreased $157, respectively, for the three and nine month periods ended June 30, 2016, compared to the same periods in the prior year.
Income Taxes. Income tax expense was $572 and $1,415 for the three and nine months ended June 30, 2016, respectively, compared to $337 and $1,112 for the same period in the prior year. The effective tax rate decreased from 36.7% to 35.1% for the nine month periods ended June 30, 2015 and 2016, respectively.

46




BALANCE SHEET ANALYSIS
Loans. Gross Loan balances increased by $133,536, or 29.64%, to $584,046 as of June 30, 2016 from $450,510 at September 30, 2015 mainly due to the acquisition of CBN loans in the amount of $113,659. At June 30, 2016, the loan portfolio was comprised of $350,534 of loans secured by real estate, or 60.0% of total loans including $156,621 in commercial and agricultural real estate loans, and $233,512 of consumer and other loans, or 40.0% of total loans. Consumer and other loans include secured consumer indirect loans of $123,413 secured primarily by boats and travel trailers, $47,865 of third party purchased indirect loans secured primarily by household goods, $13,331 of automobile loans and C&I loans totaling $38,725. At September 30, 2015, the loan portfolio mix included real estate loans of $243,959, or 54.1% of total loans including $63,266 in commercial and agricultural real estate loans, and consumer and other loans of $207,301, or 45.9% of total loans. Consumer and other loans include secured consumer loans of $130,880 in indirect loans, $39,705 of third party purchased indirect loans, $14,113 of automobile loans and C&I loans totaling $10,010.
During the quarter ended March 31, 2016, we entered into an agreement to originate and sell longer term secured consumer indirect paper loans. Our expectation is that this will reduce our secured consumer indirect loan portfolio growth, while increasing our non-interest loan fee income due to the origination fee income generated with each loan sold. Through, June 30, 2016, we have sold $11,039 in loans and generated $134 in origination loan fee income due to the sale of these secured consumer indirect paper loans.
Allowance for Loan Losses. The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we maintain an ALL for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our consolidated statements of operations as PLL. See “Provision for Loan Losses” earlier in this quarterly report. We attempt to control, monitor and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner, as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and that are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest.
At least quarterly, we review the adequacy of the ALL. Based on an estimate computed pursuant to the requirements of ASC 450-10, “Accounting for Contingencies and ASC 310-10, “Accounting by Creditors for Impairment of a Loan, the analysis of the ALL consists of three components: (i) specific credit allocation established for expected losses relating to specific impaired loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for significant loan categories; and (iii) general portfolio allocation based on qualitative factors such as economic conditions and other relevant factors specific to the markets in which we operate. We continue to refine our ALL methodology by introducing a greater level of granularity to our loan portfolio. We currently segregate loans into pools based on common risk characteristics for purposes of determining the ALL. The additional segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting our ALL. In addition, management continually evaluates our ALL methodology to assess whether modifications in our methodology are appropriate in light of underwriting practices, market conditions, identifiable trends, regulatory pronouncements or other factors. We believe that any modifications or changes to the ALL methodology would be to enhance the ALL. However, any such modifications could result in materially different ALL levels in future periods.
The specific credit allocation for the ALL is based on a regular analysis of all loans that are considered impaired. In compliance with ASC 310-10, the fair value of the loan is determined based on either the present value of expected cash flows discounted at the loan’s effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less the expected cost of sale for such collateral. At June 30, 2016, we had 108 such impaired loans, all secured by real estate or personal property with an aggregate recorded investment of $5,584. Of the 108 impaired loans, there were 36 such individual loans where estimated fair value was less than their book value (i.e. we deemed impairment to exist) totaling $2,352 for which $611 in specific ALL was recorded as of June 30, 2016.
At June 30, 2016, the ALL was $6,236, or 1.07% of our total loan portfolio, compared to ALL of $6,496, or 1.44% of the total loan portfolio at September 30, 2015. This level was based on our analysis of the loan portfolio risk at June 30, 2016, taking into account the factors discussed above. At June 30, 2016, the ALL was 1.16% of our total loan portfolio, excluding the third party purchased consumer loans referenced elsewhere herein, compared to 1.58% of the total loan portfolio excluding these third party purchased consumer loans at September 30, 2015. We have established a separate restricted reserve account for these third party purchased consumer loans. The funds in the reserve account are to be released to compensate the Bank for any nonperforming purchased loans that are not purchased back by the seller or substituted with performing loans and are ultimately charged off.

47




All of the nine factors identified in the FFIEC's Interagency Policy Statement on the Allowance for Loan and Lease Losses are taken into account in determining the ALL. The impact of the factors in general categories are subject to change; thus the allocations are management’s estimate of the loan loss categories in which the probable and inherent loss has occurred as of the date of our assessment. Of the nine factors, we believe the following have the greatest impact on our customers’ ability to repay loans and our ability to recover potential losses through collateral sales: (1) lending policies and procedures; (2) economic and business conditions; and (3) the value of the underlying collateral. As loan balances and estimated losses in a particular loan type decrease or increase and as the factors and resulting allocations are monitored by management, changes in the risk profile of the various parts of the loan portfolio may be reflected in the allocated allowance. The general component covers non-impaired loans and is based on historical loss experience adjusted for these and other qualitative factors. In addition, management continues to refine the ALL estimation process as new information becomes available. These refinements could also cause increases or decreases in the ALL. The unallocated portion of the ALL is intended to account for imprecision in the estimation process or relevant current information that may not have been considered in the process.
Nonperforming Loans, Potential Problem Loans and Foreclosed Properties. We practice early identification of non-accrual and problem loans in order to minimize the Bank's risk of loss. Non-performing loans are defined as non-accrual loans and restructured loans that were 90 days or more past due at the time of their restructure, or when management determines that such classification is warranted. The accrual of interest income is discontinued on our loans according to the following schedule:
Commercial loans, including agricultural and C&I loans, past due 90 days or more;
Closed end consumer loans past due 120 days or more; and
Real estate loans and open ended consumer loans past due 180 days or more.
When interest accruals are discontinued, interest credited to income is reversed. If collection is in doubt, cash receipts on non-accrual loans are used to reduce principal rather than being recorded as interest income. A TDR typically involves the granting of some concession to the borrower involving a loan modification, such as modifying the payment schedule or making interest rate changes. TDR loans may involve loans that have had a charge-off taken against the loan to reduce the carrying amount of the loan to fair market value as determined pursuant to ASC 310-10.

48




The following table identifies the various components of non-performing assets and other balance sheet information as of the dates indicated below and changes in the ALL for the periods then ended:
 
June 30, 2016
and Nine Months
Then Ended
 
September 30, 2015
and Twelve Months
Then Ended
Nonperforming assets:
 
 
 
Nonaccrual loans (1)
$
3,226

 
$
748

Accruing loans past due 90 days or more (1)
979

 
473

Total nonperforming loans (“NPLs”)
4,205

 
1,221

Other real estate owned (1)
835

 
838

Other collateral owned
76

 
64

Total nonperforming assets (“NPAs”)
$
5,116

 
$
2,123

Troubled Debt Restructurings (“TDRs”) (1)
$
5,446

 
$
4,010

Nonaccrual TDRs (1)
1,026

 
332

Average outstanding loan balance
517,278

 
460,438

Loans, end of period (1) (2)
584,046

 
450,510

Total assets, end of period
723,009

 
580,148

ALL, at beginning of period
$
6,496

 
$
6,506

Loans charged off:
 
 
 
Real estate loans
(111
)
 
(405
)
Consumer and other loans
(394
)
 
(601
)
Total loans charged off
(505
)
 
(1,006
)
Recoveries of loans previously charged off:
 
 
 
Real estate loans
7

 
69

Consumer and other loans
163

 
271

Total recoveries of loans previously charged off:
170

 
340

Net loans charged off (“NCOs”)
(335
)
 
(666
)
Additions to ALL via provision for loan losses charged to operations
75

 
656

ALL, at end of period
$
6,236

 
$
6,496

Ratios:
 
 
 
ALL to NCOs (annualized)
1,396.12
%
 
975.38
%
NCOs (annualized) to average loans
0.09
%
 
0.14
%
ALL to total loans
1.07
%
 
1.44
%
NPLs to total loans
0.72
%
 
0.27
%
NPAs to total assets
0.71
%
 
0.37
%
(1)
The captions in the table above include the following amounts attributable to the CBN acquisition: Nonaccrual loans; $1,832, Accruing loans past due 90 days or more; $269, Other real estate owned; $283, TDRs; $1,648, Nonaccrual TDRs; $495, Total loans; $112,327, ALL/Charge offs/Recoveries/Provision; all $0, as loans were recorded at fair value at date of acquisition, with no adjustments during the period subsequent thereto.
(2)    Total loans at June 30, 2016, include $47,865 in consumer and other loans purchased from a third party. See Note 3 in the accompanying Condensed Consolidated Financial Statements regarding the separate restricted reserve account established for these purchased consumer loans.





49




An aging analysis of the Company’s originated and acquired loans as of June 30, 2016 and September 30, 2015, respectively, was as follows
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater
Than
89 Days
 
Total
Past Due
June 30, 2016
 
 
 
 
 
 
 
Originated loans
$
1,376

 
$
275

 
$
1,775

 
$
3,426

Acquired loans
921

 
1,462

 
1,872

 
4,255

Total
$
2,297

 
$
1,737

 
$
3,647

 
$
7,681

September 30, 2015
 
 
 
 
 
 
 
Originated loans
$
1,179

 
$
754

 
$
699

 
$
2,632

Acquired loans

 

 

 

Total
$
1,179

 
$
754

 
$
699

 
$
2,632

We believe our credit and underwriting policies continue to support more effective lending decisions by the Bank, which increases the likelihood of maintaining loan quality going forward. Moreover, we believe the favorable trends noted in previous quarters regarding our nonperforming loans and nonperforming assets reflect our continued adherence to improved underwriting criteria and practices along with improvements in macroeconomic factors in our credit markets. We believe our current ALL is adequate to cover probable losses in our current loan portfolio.
Non-performing loans of $4,205 at June 30, 2016, which included $1,026 of non-accrual troubled debt restructured loans, reflected an increase of $2,984 from the non-performing loans balance of $1,221 at September 30, 2015. These non-performing loan relationships are secured primarily by collateral including residential real estate or the consumer assets financed by the loans.
Our non-performing assets were $5,116 at June 30, 2016, or 0.71% of total assets, compared to $2,123, or 0.37% of total assets at September 30, 2015. The increase in non-performing assets since September 30, 2015 was primarily a result of an increase in nonperforming loans acquired through the merger of CBN.
Other real estate owned ("OREO") decreased by $3, from $838 at September 30, 2015 to $835 at June 30, 2016. Other collateral owned increased $12 during the nine months ended June 30, 2016 to $76 from the September 30, 2015 balance of $64. We continue to aggressively liquidate OREO and other collateral owned as part of our overall credit risk strategy.
Net charge offs for the nine month period ended June 30, 2016 were $335, compared to $479 for the same prior year period. The ratio of annualized net charge-offs to average loans receivable was 0.09% for the nine month period ended June 30, 2016, compared to 0.14% for the twelve months ended September 30, 2015. Improved net charge-offs during the current year to date period were primarily a result of the overall credit quality improvement within our loan portfolio.
Investment Securities. We manage our securities portfolio in an effort to enhance income and provide liquidity. Our investment portfolio is comprised of securities available for sale and securities held to maturity. The weighted average life of the investment portfolio was 4.1 years at June 30, 2016, compared with 4.6 years at September 30, 2015. The modified duration of the investment portfolio was 3.8 years at June 30, 2016, compared with 4.2 years at September 30, 2015.
Securities held to maturity were $7,163 at June 30, 2016, compared with $8,012 at September 30, 2015. Securities available for sale, which represent the majority of our investment portfolio, were $84,508 at June 30, 2016, compared with $79,921 at September 30, 2015. We increased our investment portfolio with funds received from the Central Bank selective loans and deposit purchase and the CBN acquisition.






50




The amortized cost and market values of our available for sale securities by asset categories as of the dates indicated below were as follows:
Securities available for sale
Amortized
Cost
 
Fair
Value
June 30, 2016
 
 
 
U.S. government agency obligations
$
14,690

 
$
14,737

Obligations of states and political subdivisions
32,941

 
33,773

Mortgage-backed securities
35,125

 
35,559

Federal Agricultural Mortgage Corporation
70

 
65

Trust preferred securities
$
374

 
$
374

Totals
$
83,200

 
$
84,508

September 30, 2015
 
 
 
U.S. government agency obligations
$
15,240

 
$
15,020

Obligations of states and political subdivisions
27,573

 
27,407

Mortgage-backed securities
37,451

 
37,440

Federal Agricultural Mortgage Corporation
71

 
54

Totals
$
80,335

 
$
79,921

The amortized cost and fair value of our held to maturity securities by asset categories as of the dates noted below were as follows:
Securities held to maturity
Amortized
Cost
 
Fair
Value
June 30, 2016
 
 
 
Obligations of states and political subdivisions
$
5,847

 
$
6,118

Mortgage-backed securities
1,316

 
1,334

Totals
$
7,163

 
$
7,452

September 30, 2015
 
 
 
Obligations of states and political subdivisions
$
1,319

 
$
1,318

Mortgage-backed securities
6,693

 
6,901

Totals
$
8,012

 
$
8,219

The composition of our available for sale portfolios by credit rating as of the dates indicated below was as follows:
 
June 30, 2016
 
September 30, 2015
Securities available for sale
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
U.S. government agency
$
49,815

 
$
50,297

 
$
52,692

 
$
52,460

AAA
1,519

 
1,585

 
734

 
735

AA
24,666

 
25,226

 
22,228

 
22,057

A
5,066

 
5,241

 
2,970

 
2,959

BBB

 

 

 

Below investment grade

 

 

 

Non-rated
2,134

 
2,159

 
1,711

 
1,710

Total
$
83,200

 
$
84,508

 
$
80,335

 
$
79,921

The composition of our held to maturity portfolio by credit rating as of the dates indicated was as follows:

51




 
June 30, 2016
 
September 30, 2015
Securities held to maturity
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
U.S. government agency
$
5,847

 
$
6,118

 
$
6,693

 
$
6,901

AAA

 

 

 

AA

 

 

 

A
966

 
978

 
969

 
968

BBB

 

 

 

Below investment grade

 

 

 

Non-rated
350

 
356

 
350

 
350

Total
$
7,163

 
$
7,452

 
$
8,012

 
$
8,219


At June 30, 2016, securities with a carrying value of $2,857 were pledged against a line of credit with the Federal Reserve Bank of Minneapolis. As of June 30, 2016, this line of credit had a zero balance. The Bank has pledged U.S. Government Agency securities with a carrying value of $6,164 and mortgage-backed securities with a carrying value of $21,388 as collateral against specific municipal deposits.
Deposits. Deposits increased to $585,224 at June 30, 2016, from $456,298 at September 30, 2015, largely due to deposits purchased from Central Bank in Rice Lake and Barron, Wisconsin in the amount of $27,131, and deposits acquired through the CBN acquisition in the amount of $151,020, partially offset by deposit runoff in the markets where branch closures took place and a reduction in checking balances from Insider accounts related to the CBN acquisition.
The following is a summary of deposits by type at June 30, 2016 and September 30, 2015, respectively:
 
 
June 30, 2016
 
September 30, 2015
Non-interest bearing demand deposits
 
$
37,555

 
$
19,354

Interest bearing demand deposits
 
52,138

 
22,547

Savings accounts
 
49,906

 
29,395

Money market accounts
 
148,810

 
146,201

Certificate accounts
 
296,815

 
238,801

Total deposits
 
$
585,224

 
$
456,298

Since December 2012, we have closed eleven branches and sold the deposits and loans in one retail branch, resulting in nine markets we have exited. As of September 30, 2015, the deposit account balances remaining in these nine exited markets totaled $56,915. As of June 30, 2016, these deposit account balances have declined to $44,482. We expect these deposit balances to continue to decline as certificates mature and accounts are closed.
Our objective is to grow core deposits and build customer relationships in our core markets by expanding our branch network, deposit product offerings, including Treasury Management, and providing excellent customer service. Management expects to continue to place emphasis on both retaining and generating additional core deposits in 2016 through competitive pricing of deposit products, our branch delivery systems that have already been established and electronic banking.
Institutional certificates of deposit as a funding source decreased to $27,682 at June 30, 2016 from $32,099 as of September 30, 2015. Institutional certificates of deposit remain an important part of our deposit mix as we continue to pursue funding sources to lower the Bank's cost of funds.
The Bank had $11,959 and $22,773 in brokered deposits at June 30, 2016 and September 30, 2015, respectively. Brokered deposit levels are within all regulatory directives thereon.
Federal Home Loan Bank (FHLB) advances (borrowings). FHLB advances were $58,874 as of June 30, 2016 and $58,891 as of September 30, 2015.
Stockholders’ Equity. Total stockholders’ equity was $63,595 at June 30, 2016, compared to $60,535 at September 30, 2015. Total stockholders’ equity increased by $3,060, primarily as a result of an increase in retained earnings and accumulated other comprehensive income during the nine months ended June 30, 2016.

52




Liquidity and Asset / Liability Management. Liquidity management refers to our ability to ensure cash is available in a timely manner to meet loan demand and depositors’ needs, and meet other financial obligations as they become due without undue cost, risk or disruption to normal operating activities. Asset / liability management refers to our ability to efficiently and effectively utilize customer deposits and other funding sources to generate sufficient risk-weighted yields on interest earning assets. We manage and monitor our short-term and long-term liquidity positions and needs through a regular review of maturity profiles, funding sources, and loan and deposit forecasts to minimize funding risk. A key metric we monitor is our liquidity ratio, calculated as cash and investments with maturities less than one-year divided by deposits with maturities less than one-year. At June 30, 2016, our liquidity ratio was 9.01%, which is slightly below our targeted liquidity ratio of 10.0%.
Our primary sources of funds are deposits; amortization, prepayments and maturities of outstanding loans; other short-term investments; and funds provided from operations. We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, and to fund loan commitments. While scheduled payments from the amortization of loans and maturing short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Although $149,760 of our $297,081 (50.41%) CD portfolio as of June 30, 2016 will mature within the next 12 months, we have historically retained a majority of our maturing CD’s. However, $20,670, or 13.80%, of the CD maturities within the next 12 months are from deposits located within the nine markets we have exited and we don't expect to retain a majority of these CD's. Through new deposit product offerings to our consumer and commercial loan customers, we are currently attempting to strengthen customer relationships by building core deposit relationships. In the present interest rate environment, and based on maturing yields, this should also improve our cost of funds. While we believe that our branch network attracts core deposits and enhances the Bank's long-term liquidity, a key component to our broader liquidity management strategy, we continue to analyze the profitability of our branch network.
We maintain access to additional sources of funds including FHLB borrowings and lines of credit with the Federal Reserve Bank, US Bank, Bankers’ Bank and First Tennessee Bank. We utilize FHLB borrowings to leverage our capital base, to provide funds for our lending and investment activities, and to manage our interest rate risk. Our borrowing arrangement with the FHLB calls for pledging certain qualified real estate loans, and borrowing up to 75% of the value of those loans, not to exceed 35% of the Bank’s total assets. Currently, we have approximately $67,300 available under this arrangement. We also maintain lines of credit of $3,290 with the Federal Reserve Bank, $5,000 with US Bank, $13,500 with Bankers’ Bank and $11,000 with First Tennessee Bank as part of our contingency funding plan. The Federal Reserve Bank line of credit is based on 80% of the collateral value of the agency securities being held at the Federal Reserve Bank. The Bankers’ Bank and First Tennessee line of credit is a discretionary line of credit. As of June 30, 2016, our line of credit balance with the Federal Home Loan Bank was $58,874. As of the same date, our line of credit balance with the Federal Reserve Bank, US Bank, Bankers' Bank and First Tennessee Bank was $0.
Off-Balance Sheet Liabilities. Some of our financial instruments have off-balance sheet risk. These instruments include unused commitments for lines of credit, overdraft protection lines of credit and home equity lines of credit, as well as commitments to extend credit. As of June 30, 2016, the Company had $24,849 in unused commitments, compared to $24,097 in unused commitments as of September 30, 2015.
Capital Resources. As of June 30, 2016, as shown in the table below, our Tier 1 and Risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions.

53




 
Actual
 
For Capital Adequacy
Purposes
 
To Be Well Capitalized
Under Prompt Corrective
Action Provisions
 
Amount
 
Ratio
 
Amount
 
 
 
Ratio
 
Amount
 
 
 
Ratio
As of June 30, 2016 (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
74,137,000

 
14.2
%
 
$
41,694,000

 
>=
 
8.0
%
 
$
52,117,000

 
>=
 
10.0
%
Tier 1 capital (to risk weighted assets)
67,901,000

 
13.0
%
 
31,270,000

 
>=
 
6.0
%
 
41,694,000

 
>=
 
8.0
%
Common equity tier 1 capital (to risk weighted assets)
67,901,000

 
13.0
%
 
23,453,000

 
>=
 
4.5
%
 
33,876,000

 
>=
 
6.5
%
Tier 1 leverage ratio (to adjusted total assets)
67,901,000

 
9.2
%
 
29,546,000

 
>=
 
4.0
%
 
36,933,000

 
>=
 
5.0
%
As of September 30, 2015 (Audited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
64,930,000

 
16.5
%
 
$
31,443,000

 
>=
 
8.0
%
 
$
39,304,000

 
>=
 
10.0
%
Tier 1 capital (to risk weighted assets)
59,997,000

 
15.3
%
 
23,583,000

 
>=
 
6.0
%
 
31,443,000

 
>=
 
8.0
%
Common equity tier 1 capital (to risk weighted assets)
59,997,000

 
15.3
%
 
17,687,000

 
>=
 
4.5
%
 
25,548,000

 
>=
 
6.5
%
Tier 1 leverage ratio (to adjusted total assets)
59,997,000

 
10.4
%
 
23,031,000

 
>=
 
4.0
%
 
28,788,000

 
>=
 
5.0
%

At June 30, 2016, the Bank was categorized as "Well Capitalized" under Prompt Corrective Action Provisions, as determined by the OCC, our primary regulator.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time and are not predictable or controllable. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. Like other financial institutions, our interest income and interest expense are affected by general economic conditions and policies of regulatory authorities, including the monetary policies of the Federal Reserve. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk through several means including through the use of third party reporting software. In monitoring interest rate risk we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates.
In order to manage the potential for adverse effects of material and prolonged increases in interest rates on our results of operations, we adopted asset and liability management policies to better align the maturities and re-pricing terms of our interest-earning assets and interest-bearing liabilities. These policies are implemented by our Asset and Liability Management Committee ("ALCO"). The ALCO is comprised of members of senior management and the Board of Directors. The ALCO establishes guidelines for and monitors the volume and mix of our assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The Committee’s objectives are to manage assets and funding sources to produce results that are consistent with liquidity, cash flow, capital adequacy, growth, risk and profitability goals for the Bank. The ALCO meets on a regularly scheduled basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to net present value of portfolio equity analysis. At each meeting, the Committee recommends strategy changes, as appropriate, based on this review. The Committee

54




is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Bank’s Board of Directors on a regularly scheduled basis.
In order to manage our assets and liabilities and achieve desired levels of liquidity, credit quality, cash flow, interest rate risk, profitability and capital targets, we have focused our strategies on:
originating shorter-term secured consumer, commercial and agricultural loan maturities;
managing our funding needs by utilizing core deposits, institutional certificates of deposits and borrowings as appropriate to extend terms and lock in fixed interest rates;
reducing non-interest expense and managing our efficiency ratio by implementing technologies to enhance customer service and increase employee productivity;
realigning supervision and control of our branch network by modifying their configuration, staffing, locations and reporting structure to focus resources on our most productive markets;
managing our exposure to changes in interest rates, including but not limited to the sale of longer term fixed rate consumer loans. In fiscal 2015, the Bank sold approximately $15.7 million in fixed rate longer term consumer real estate loans to lessen our exposure to changes in interest rates. Additional loan sales may occur in the future if the analysis proves advantageous to the Bank; and
originating balloon mortgage loans with a term of 7 years or less to minimize the impact of sudden rate changes.
Selling longer term secured consumer Indirect Paper loans.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the ALCO may determine to increase or decrease the Bank’s interest rate risk position somewhat in order to manage net interest margin.
The following table sets forth, at March 31, 2016 (the most recent date available), an analysis of our interest rate risk as measured by the estimated changes in Economic Value of Equity ("EVE") resulting from an immediate and permanent shift in the yield curve (up 300 basis points and down 100 basis points). As of June 30, 2016, due to the current level of interest rates, EVE estimates for decreases in interest rates greater than 100 basis points are not meaningful.
Change in Interest Rates in Basis Points (“bp”)
Rate Shock in Rates (1)
Economic Value of Equity (EVE)
 
EVE Ratio (EVE as a % of Assets)
 
 
 
Amount
 
Change
 
% Change
 
EVE Ratio
 
Change
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 +300 bp
$
37,644

 
$
(41,436
)
 
(52
)%
 
6.95
%
 
(606
)
 
 bp 
 +200 bp
55,246

 
(23,834
)
 
(30
)%
 
9.77
%
 
(324
)
 
 
 +100 bp
69,524

 
(9,556
)
 
(12
)%
 
11.82
%
 
(119
)
 
 
0 bp
79,080

 

 

 
13.01
%
 

 
  
 -100 bp
81,019

 
1,939

 
2
 %
 
13.03
%
 
2

 
  
(1)
Assumes an immediate and parallel shift in the yield curve at all maturities.

The following table sets forth, at September 30, 2015, an analysis of our interest rate risk as measured by the estimated changes in EVE resulting from an immediate and permanent shift in the yield curve (up 300 basis points and down 100 basis points).
Change in Interest Rates in Basis Points (“bp”)
Rate Shock in Rates (1)
Economic Value of Equity (EVE)
 
EVE Ratio (EVE as a % of Assets)
 
 
 
Amount
 
Change
 
% Change
 
EVE Ratio
 
Change
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 +300 bp
$
36,916

 
$
(41,454
)
 
(53
)%
 
7.10
%
 
(505
)
 
 bp 
 +200 bp
54,752

 
(23,618
)
 
(30
)%
 
10.06
%
 
(209
)
 
 
 +100 bp
68,836

 
(9,534
)
 
(12
)%
 
12.15
%
 
(121
)
 
 
0 bp
78,370

 

 

 
13.36
%
 

 
  
 -100 bp
80,768

 
2,398

 
3
 %
 
13.45
%
 
9

 
  
(1)    Assumes an immediate and parallel shift in the yield curve at all maturities.

55




Our overall interest rate sensitivity is demonstrated by net interest income shock analysis which measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in our net interest income over the next 12 months in the event of an immediate and parallel shift in the yield curve (up 300 basis points and down 100 basis points). The table below presents our projected change in net interest income for the various rate shock levels at March 31, 2016 (the most recent date available) and September 30, 2015.
 
Change in Net Interest Income Over One Year Horizon
 
At March 31, 2016
 
At September 30, 2015
Change in Interest Rates in Basis Points (“bp”)
Rate Shock in Rates (1)
Dollar Change in Net Interest Income (in thousands)
 
Percentage Change
 
Dollar Change in Net Interest Income (in thousands)
 
Percentage Change
 
 
 
 
 
 
 +300 bp
$
(3,000
)
 
(14.40
)%
 
$
(1,921
)
 
(9.53
)%
 +200 bp
(1,676
)
 
(8.05
)%
 
(909
)
 
(4.50
)%
 +100 bp
(805
)
 
(3.87
)%
 
(368
)
 
(1.83
)%
0 bp
(357
)
 
(1.71
)%
 
(221
)
 
(1.09
)%
 -100 bp
(85
)
 
(0.41
)%
 
(309
)
 
(1.53
)%
(1)
Assumes an immediate and parallel shift in the yield curve at all maturities.
Note: The table above may not be indicative of future results.
The assumptions used to measure and assess interest rate risk include interest rates, loan prepayment rates, deposit decay (runoff) rates, and the market values of certain assets under differing interest rate scenarios. Actual values may differ from those projections set forth above should market conditions vary from the assumptions used in preparing the analysis. Further, the computations do not contemplate any actions we may undertake in response to changes in interest rates.
ITEM 4.
CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that the information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures. We have designed our disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives. We carried out an evaluation as of June 30, 2016, under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2016 at reaching a level of reasonable assurance.
There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1.
LEGAL PROCEEDINGS
In the normal course of business, the Company occasionally becomes involved in various legal proceedings. In our opinion, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

56





Item 1A.
RISK FACTORS
There are no material changes from the risk factors disclosed in Part I, Item 1A, “Risk Factors,” of the Company’s Form 10-K, for the fiscal year ended September 30, 2015. Please refer to that section for disclosures regarding the risks and uncertainties relating to our business.
Item 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a)
Not applicable.
(b)
Not applicable.
(c)
Not applicable.
Item 3.
DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4.
MINE SAFETY DISCLOSURES
Not applicable.
Item 5.
OTHER INFORMATION
Not applicable.
Item 6.
EXHIBITS
(a) Exhibits
2.1*
 
Plan and Agreement of Merger dated February 10, 2016, by and among Old Murry Bancorp, Inc., the Control Shareholders, Community Bank of Northern Wisconsin and Citizens Community Federal, N.A.
31.1
 
Rule 13a-14(a) Certification of the Company’s Chief Executive Officer
31.2
 
Rule 13a-14(a) Certification of the Company’s Chief Financial Officer
32.1**
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
101
 
The following materials from Citizens Community Bancorp, Inc.’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2016 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Income (Loss); (iv) Consolidated Statement of Changes in Stockholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Condensed Notes to Consolidated Financial Statements.
*
Schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule or exhibit will be furnished supplementally to the Securities and Exchange Commission upon request; provided, however that Citizens Community Bancorp, Inc. may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, for any schedules or exhibits so furnished.
**
This certification is not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

57





SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
CITIZENS COMMUNITY BANCORP, INC.
 
 
 
Date: August 12, 2016
 
By:
 
/s/ Stephen M. Bianchi
 
 
 
 
Stephen M. Bianchi
 
 
 
 
Chief Executive Officer
 
 
 
Date: August 12, 2016
 
By:
 
/s/ Mark C. Oldenberg
 
 
 
 
Mark C. Oldenberg
 
 
 
 
Chief Financial Officer

58