UNITED STATES

SECURIT1ES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

APPLICABLE ONLY TO CORPORATE ISSUERS

CITIZENS COMMUNITY BANCORP, INC.

FORM 10-Q

MARCH 31,JUNE 30, 2010

INDEX

See accompanying notes to unaudited, consolidated financial statements.

CITIZENS COMMUNITY BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 –ORGANIZATION

The financial statements of Citizens Community Federal (the “Bank”) included herein have been included by its parent company, Citizens Community Bancorp, Inc. (the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Citizens Community Bancorp (CCB) was a successor to Citizens Community Federal as a result of a regulatory restructuring into the mutual holding company form, which was effective on March 29, 2004.  Historically,Originally, Citizens Community Federal was a credit union that accepted deposits and made loans to members, who lived, worked or worshiped in the Wisconsin counties of Chippewa and Eau Claire, and parts of the Wisconsin counties of Pepin, Buffalo and Trempealeau.union. In December 2001, Citizens Community Federal converted to a federal mutual s avings bank in order to better serve its customers and the local community through the broader lending ability of a federal savings bank, and to expand its customer base beyond the limited field of membership permitted for credit unions.bank. In 2004, Citizens Community Federal reorganized into the mutual holding company form of organization. In 2006, Citizens Community Bancorp completed its second-step mutual to stock conversion.

The consolidated income of the Company is principally derived from the Bank’s income.  The Bank originates residential and consumer loans and accepts deposits from customers, primarily in Wisconsin, Minnesota and Michigan.  The Bank operates 26 full-service offices; nine stand-alone locations and 17 branches located inside Walmart Supercenters.

In preparing these financial statements, we evaluated the events and transactions that occurred through MayAugust 12, 2010, the date on which the financial statements were available to be issued.  As of MayAugust 12, 2010, there were no subsequent events which required recognition or disclosure.

NOTE 2 – PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Citizens Community Federal.  All significant inter-company accounts and transactions have been eliminated.

NOTE 3 – USE OF ESTIMATES

Preparation of 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, future cash flows associated with impairment testing for goodwill, indefinite-lived intangible assets and long-lived assets, deferred tax assets, uncertain income tax positions and contingencies. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the financial statements in any individual reporting period.

NOTE 4 – ADOPTION OF NEW ACCOUNTING STANDARDS

In January 2010, the FASB issued ASU 2010-06, which provided updated guidance on fair value measurements and disclosures as set forth in ASC 820-10.  The guidance requires companies to disclose transfers in and out of levels 1 and 2, and to expand the reconciliation of level 3 fair value measurements by presenting separately information about purchases, sales, issuances and settlements.  The updated guidance also clarifies existing disclosure requirements on the level of disaggregation (provide fair value measurement disclosures for each class of assets and liabilities) and inputs and valuation techniques (disclose for fair value measurements that fall in either level 2 or level 3).  This guidance was effective for interim and annual reporting periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances and settlements in the reconciliation of level 3 fair value measurements.  Those disclosures regarding the reconciliation of level 3 fair value measurements are effective for periods beginning after December 15, 2010.  We adopted this guidance effective January 1, 2010, except with respect to the level 3 reconciliation requirements. The expanded level 3 reconciliation requirement will be adopted for our fiscal year ending September 30, 2011.

In June 2009, the FASB issued FASB ASC 810-10, Consolidation. The amendments adopted by this codification topic include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. FASB ASC 810-10 is effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. The Company adopted FASB ASC 810-10 starting in fiscal 2010. The adoption of FASB ASC 810-10 did not have any impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued FASB ASC 860-10, Transfers and Servicing. FASB ASC 860-10 eliminates the concept of a "qualifying special-purpose entity," changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity's continuing involvement in and exposure to the risks related to transferred financial assets. FASB ASC 860-10 is effective for fiscal years beginning after November 15, 2009. The Company has adopted FASB ASC 860-10 starting in fiscal 2010. The adoption of FASB ASC 860-10 did not have any impact on the Company’s consolidated financial statements.

Level 3 assets measured on a recurring basis are certain investments for the grant of up to 113,910 shareswhich little or no market activity exists or whose value of the Company's common stockunderlying collateral is not market observable.  With respect to eligible participants underresidential mortgage-backed securities held as investments by the Company, the credit markets continue to be disrupted resulting in a continued dislocation and lack of trading activity.  Management’s valuation uses both observable as well as unobservable inputs to assist in the Level 3 valuation of mortgage-backed securities held by the Company, employing a methodology that considers future cash flows along with risk-adjusted returns.  The inputs in this plan.  Asmethodology are as follows: ability and intent to hold to maturities, mortgage underwriting rates, market prices/conditions, loan type, loan-to-value, s trength of March 31, 2010, 70,615 restricted shares were issuedborrower, loan age, delinquencies, prepayment/cash flows, liquidity, expected future cash flows, rating agency actions, and outstanding under this plan. During the quarter ended March 31, 2010 no shares were granteda discount rate, which is assumed to eligible participants under this plan; and 9,338 of previously awarded shares were forfeited.  Restricted shares are awarded at no costbe approximately equal to the employee and have a five-year vesting period.  coupon rate for each security. We had an independent valuation of all Level 3 securities in the current quarter.  Based on this valuation, we recorded pre-tax other than temporary impairment of $125 in the current quarter.

The fair value of foreclosed assets is determined by obtaining market price quotes from independent third parties wherever such quotes are available. Where such quotes are not available, we utilize independent third party appraisals to support our own estimates and judgments in determining fair value.

The following table presents a reconciliation of residential mortgage-backed securities held by the restricted sharesCompany measured at fair value on the date of award was $7.04 per share for 63,783 shares and $6.18 for 6,832 shares.  Compensation expense related to these awards was $31 and $18a recurring basis using significant unobservable inputs (Level 3) for the three and six monthsnine month periods ended March 31,June 30, 2010 respectively.and 2009:

Fair Values of nonqualified and incentive stock options and stock appreciation rights to eligible participants under this plan.  The plan provides for the grant of awards for up to 284,778 shares of the Company's common stock.  At March 31, 2010, 202,197 options had been granted under this plan to eligible participants at a weighted-average exercise price of $7.04 per share.  Options granted vest over a five-year period.  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.  At March 31, 2010, since the plan’s inception, options for 113,915 sha res of the Company's common stock were vested, options for 83,724 shares were forfeited and options for 4,558 shares were exercised.  Of the 202,197 options granted, 113,915 remained outstanding as of March 31, 2010.Financial Instruments

Fair value is estimated for stock-based employee compensation related to our 2004 Stock Optionportfolios of loans with similar financial characteristics. Loans are segregated by type such as residential mortgage and Incentive Planconsumer. The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity date using market discount rates reflecting the fair-value-based method. Accordingly, we record compensation expensecredit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s repayment schedules for each loan classification.

Impaired loans with a valuation allowance based upon the fair value of the award as measuredunderlying collateral had a carrying amount of $2,596 at June 30, 2010 compared to $0 at September 30, 2009. The valuation allowance on the grant date and recognize that cost over the vesting period.  The compensation cost recognized for stock-based employee compensation for the three months ended March 31,impaired loans was $300 at June 30, 2010, was $12.compared to $0 at September 30, 2009.

NOTE 67 – FAIR VALUE ACCOUNTING

In estimatingFebruary 2005, our stockholders approved the Company's 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, 2010, 70,615 restricted shares were issued and outstanding under this plan. During the quarter ended June 30, 2010 no shares were granted to eligible participants under this plan; and 9,338 of previously awarded shares were forfeited.  Restricted shares are awarded at no cost to the employee and have a five-year vesting period.  The fair valuesvalue of the restricted shares on the date of award was $7.04 per share for investment securities available63,783 shares and $6.18 for sale, we believe that independent third-party market prices are6,832 shares.  Compensation expense related to these awards was $2 and $20 for the best evidence of exit pricethree and where available, we base our estimates on such prices.  If such third-party market prices are not available, we obtain independent third-party valuations.  Where market observable data is not available due to market conditions in an illiquid market, the valuation of financial instruments becomes more subjective and involves substantial judgment. Additionally, there may be inherent risk in the valuation calculation and changes in underlying assumptions, including estimates of future cash flow and discount rates that could significantly affect future values.nine months ended June 30, 2010, respectively.

 

 

CashIn February 2005, our stockholders also approved the Company's 2004 Stock Option and Cash Equivalents

NOTE 78 – FEDERAL HOME LOAN BANK STOCK

The Company is required to be a member of and maintain a certain amount of capital stock of the FHLB of Chicago ("FHLB") to obtain an advance from the FHLB.  As of March 31,June 30, 2010, the carrying amount of the Company’s investment in FHLB stock was $6.0 million.  There is no ready market for the FHLB stock nor are there any quoted market values for the FHLB stock because shares can only be purchased or sold between members of the FHLB at the stock's $100 par value.  As a result, we account for this investment as a long-term asset and carry it at cost. Whenever an event or change in circumstances has occurred that may have significant adverse effect on the fair value of the investmentFHLB stock the Company reviews this investment for impairment. 

On October 10, 2007, the FHLB entered into a consensual cease and desist order with its regulator, the Federal Housing Finance Board ("Finance Board"). Under this order, the FHLB must maintain certain minimum capital ratios; therefore, restricting capital stock repurchases and redemptions, including redemptions upon membership withdrawal, without approval of the Director of the Office of Supervision of the Finance Board.   As a result of this order, coupled with net losses over several periods, and the restrictions placed on stock redemptions, the Company considers the following in order to determine whether the FHLB stock should be classified as other-than-temporarily impaired:

Available for Sale Securities.

Securities are classified as available for sale and are carried at fair value, with unrealized gains and losses reported in other comprehensive income (loss).  Amortization of premiums and accretion of discounts are recognized in interest income using the interest method over the estimated lives of the securities.

We evaluate all investment securities on a quarterly basis, and more frequently when economic conditions warrant determining if other-than-temporary impairment exists.  A debt security is considered impaired if the fair value is less than its amortized cost at the report date.  If impaired, we then assess whether the impairment is other-than-temporary.

Current authoritative guidance provides that an unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security.  The credit loss component is recorded in earnings as a component of other-than-temporary impairment in the consolidated statements of operations, while the loss component related to other market factors is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery of the unrealized loss.

We consider the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

Interest income on securities for which other-than-temporary impairment has been recognized in earnings is recognized at a rate commensurate with the expected future cash flows and amortized cost basis of the securities after the impairment.

Gains and losses on the sale of securities are recorded on the trade date and determined using the specific-identification method.

To determine if other-than-temporary impairment exists on a debt security, the Bank first determines if (1) it intends to sell the security or (2) it is more likely than not that it will be required to sell the security before its anticipated recovery.  If either of the conditions is met, the Bank will recognize other-than-temporary impairment in earnings equal to the difference between the security’s fair value and its adjusted cost basis.  If neither of the conditions is met, the Bank determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors.  The difference between the present values of the cash flows expected to be collected and the amortized cost basis is the credit loss.  The credit loss is the amount of the other-th an-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security.  The amount of the total impairment related to all other factors (excluding credit loss) is included in other comprehensive loss.

We monitor our portfolio investments on an on-going basis and we obtain an independent valuation of our non-agency residential mortgage-backed securities.  This analysis is utilized to ascertain whether any decline in market value is other-than-temporary. In determining whether an impairment is other-than-temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer including investment downgrades by rating agencies and economic conditions within the issuer's industry, whether it is more likely than not that we will be required to sell the security before there would be a recovery in value, and credit performance of the underlying collateral backing the securities, including delinquency rates, cumulative losses to date, and prepayment speed.

The independent valuation process included:

For non-agency residential mortgage-backed securities that are considered other-than-temporarily impaired and for which we have the ability and intent to hold these securities until the recovery of our amortized cost basis, we recognize other-than-temporary impairment in accordance with accounting principles generally accepted in the United States.  Under these principles, we separate the amount of the other-than-temporary impairment into the amount that is credit related and the amount due to all other factors.  The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of expected future cash flows.  The amount due to other factors is recognized in other comprehensive income (loss).

Goodwill.

Goodwill represents the difference between the cost of the acquisition and the fair value of the acquired net assets and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, and are classified separately under the appropriate balance sheet captions.  Goodwill is considered to have an indefinite useful life and is stated at cost less any accumulated impairment losses. Tests for impairment are conducted annually.

RESULTS OF OPERATIONS

 

We continue to see income from our core operations increase as our core business model continues to generate increased loans and deposits, and as we continue to identify cost-cutting and operating efficiency opportunities.  However, the needcontinuing to continue increasing our provisionprovide for loan losses based on current and historical loan charge offat higher levels and current adverse general economic factors has offset some of the income growth from core operations.  Also offsetting this growth, were additional other-than-temporary impairment (OTTI) charges incurred during the quarter and nine month period on our remaining non-agency mortgage-backed securities portfolio. In addition, the Bank had significant improvement in net interest margin and interest spread during both the quarter and nine months ended March 31,June 30, 2010 as compared to the quartersame periods in the prior fiscal year.

Net interest margin increased from 3.43 percent during the three-month period ended March 31,June 30, 2009 to 4.01 percent during the three-month period ended June 30, 2010.  Net interest margin increased from 3.22 percent to 3.88 percent for the nine month period ended June 30, 2010, compared to the prior year nine month period. Interest spread increased to 3.74 percent at June 30, 2010, compared to 2.89 percent at June 30, 2009.  The increases in net interest margin and interest spread during the current year resulted from costs of interest-bearing liabilities decreasing at a faster rate than the corresponding yields on interest-earning assets.

Efficiency levels continuecontinued to improve as indicated by the Bank efficiency measurement improving to 70.570.4 percent net of OTTI for the sixnine months ended March 31,June 30, 2010 compared to 80.483.3 percent for the sixnine months ended March 31,June 30, 2009 and 81.3 percent for the year ended September 30, 2009.  Efficiency is calculated net of OTTI, by dividing the Bank’s fiscal year to date non-interest expense for the period by fiscal year to date non-interest income minus OTTI plus net interest margin.margin for the period.  Additionally, as of June 30, 2010 all of the Bank’s regulatory capital levels arewere in the well-capitalized category by all regulatory measurements (see the discussion below under the heading “Capital Ratios”). We believe our cost cutting initiatives have not inhibited our ability to maintain sound business practices and responsive internal controls.

As we move forward withWe continue to evaluate our existing branch distribution strategy, we anticipate continued loan and deposit growth. We believe our existing branch locations willfor opportunities to increase their profitability. We are evaluating opportunities to improve accessibility and increase customer traffic to our branch locations. We are looking for ways to expand our in-store branch model. We continue to offer excellent potential for additional coreseek deposit and loan growth,cross-selling opportunities to our indirect paper lending customers.  All of these initiatives are intended to strengthen our customer base and are consistent with our growth strategy. Seventeen of our 26improve branch locations were opened during 2008 and 2009.overall Bank profitability.

 

 

The average cost of interest-bearing liabilities decreased from 3.563.41 percent for the prior year’s sixnine month period ended March 31,June 30, 2009, to 2.332.26 percent for the current year’s six-monthnine month period.  The decrease was primarily a result of lower deposit costs due to declining CD yields, the growth of lower costing core deposits via our new branches and the decline in the cost of FHLB advances.