SOUTHERN MISSOURI BANCORP, INC. - Quarter Report: 2008 September (Form 10-Q)

• changes in consumer spending and saving habits; and
• our success at managing the risks involved in the foregoing.

(1) Calculated net of deferred loan fees, loan discounts and loans-in-process. Non-accrual loans are included in average loans.
(2) Includes FHLB stock and related cash dividends.
(3) Includes average balances for fixed assets and BOLI of $8.2 million and $7.3 million, respectively, for the three-month period ending September 30, 2008, as compared to $8.6 million and $7.0 million for the same period of the prior year.
(4) Interest rate spread represents the difference between the average rate on interest-earning assets and the average cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average interest-earning assets

Results of Operations - Comparison of the three-month periods ended September 30, 2008 and 2007

General. Net income for the three-month period ended September 30, 2008, was $927,000, an increase of $114,000, or 14.0%, as compared to net income of $813,000 earned during the same period of the prior year. Basic and diluted earnings per share were $0.42, for the first quarter of fiscal 2009, compared to $0.37 basic and $0.36 diluted earnings per share for the first quarter of fiscal 2008. Our annualized return on average assets for the three-month period ended September 30, 2008, was ..88%, compared to .86% for the same period of the prior year. Our return on average stockholders' equity for the three-month period ended September 30, 2008, was 12.0%, compared to 11.2% for the same period of the prior year.

Net Interest Income. Net interest income for the three-month period ended September 30, 2008, increased $822,000, or 31.2%, as compared to the same period of the prior year. The increase reflected an expansion of our net interest rate spread, and our growth initiatives, which resulted in increases in the average balances of both interest-earning assets and interest-bearing liabilities. Our interest rate spread was 3.19% for the three-month period ended September 30, 2008, as compared to 2.59% for the same period of the prior year. For the three-month period ended September 30, 2008, our net interest margin, determined by dividing the annualized net interest income by total average interest-earning assets, was 3.45%, compared to 2.94% for the same period of the prior year. The increase in interest rate spread for the three-month period resulted from a 135 basis point decrease in the average cost of interest-bearing liabilities, partially offset by a 75 basis point decrease in the average yield on interest-earning assets. Expansion of our interest rate spread was attributed primarily to the faster re-pricing of liabilities (compared to assets) on the Company's balance sheet, combined with the improved slope of the yield curve.

Interest Income. Total interest income for the three-month period ended September 30, 2008, was $6.3 million, up $10,000, or 0.2%, from the roughly equivalent amount earned in the same period of the prior year. The increases was due to the increase of $42.6 million, or 11.9%, in the average balance of interest-earning assets during the first quarter of fiscal 2009, partially offset by a 75 basis point decrease in the average yield on those assets. For the three-month period ended September 30, 2008, the average interest rate on interest-earning assets was 6.33%, as compared to 7.08% for the same period of the prior year.

Interest Expense. Total interest expense for the three-month period ended September 30, 2008, was $2.9 million, a decrease of $812,000, or 21.9%, compared to the same period of the prior fiscal year. The decrease was due to a 135 basis point decrease in the average cost of interest-bearing liabilities, partially offset by a $37.7 million increase in the average balance of interest-bearing liabilities. For the three-month period ended September 30, 2008, the average interest rate on interest-bearing liabilities was 3.14%, as compared to 4.49% for the same period of the prior year. The increase in the average balance of interest-bearing liabilities was primarily due to funding needed for asset growth.

Provision for Loan Losses. The provision for loan losses for the three-month period ended September 30, 2008, was $400,000, as compared to $110,000 for the same period of the prior year. The increased provision was primarily due to management's belief that it is appropriate to maintain larger reserves in light of continuing deterioration of the credit and housing markets. In addition, the Company's growth, over the last several years, in its commercial and commercial real estate loan portfolios has required increased provisions for loan losses, as those loan types generally carry additional risk. In general, however, the Company does not anticipate that it will realize the level of credit problems that have been experienced by financial institutions more heavily involved in either subprime or Alt-A residential lending, or construction and development lending. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, additions may be necessary as the loan portfolio grows, as economic conditions change, and as other conditions differ from the current operating environment. Even though we use the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change. (See "Critical Accounting Policies", "Allowance for Loan Loss Activity" and "Nonperforming Assets").

Non-interest Income. Non-interest income for the three-month period ended September 30, 2008, decreased $255,000, or 43.1%, to $336,000, as compared to $590,000 for the same period of the prior year. The decrease was primarily due to the charge incurred to recognize the other-than-temporary impairment of the bank's investment in Freddie Mac preferred stock. Outside that charge, non-interest income would have increased 8.3%, due to increased non-sufficient funds activity and debit card activity.

Non-interest Expense. Non-interest expense for the three-month period ended September 30, 2008, increased $138,000, or 7.3%, to $2.0 million, as compared to $1.9 million, for the same period of the prior year. The increase in non-interest expense was primarily in the categories of compensation and benefits and charges for debit card activity, combined with a reduction in the prior period's gain on the sale of foreclosed real estate assets, partially offset by lower occupancy and advertising charges. As the Company continues to grow its balance sheet, non-interest expense will continue to increase due to compensation, expenses related to expansion, and inflation. Our efficiency ratio, determined by dividing total non-interest expense by the sum of net interest income and non-interest income, was 53.8% for the three-month period ended September 30, 2008, as compared to 58.9% for the same period of the prior year.

Income Taxes. Provisions for income taxes for the three-month period ended September 30, 2008, increased $26,000, or 6.4%, to $425,000, as compared to $399,000 for the same period of the prior year. Our effective tax rate for the three-month period ended September 30, 2008, was 31.4%, as compared to 32.9% for the same period of the prior year. The decrease in the effective tax rate was attributable to the Company's investment in tax-exempt securities and purchases of tax credits; the increase in tax provisions was due to increased pre-tax income, partially offset by the lower effective tax rate.

Allowance for Loan Loss Activity

The Company regularly reviews its allowance for loan losses and makes adjustments to its balance based on management's analysis of the loan portfolio, the amount of non-performing and classified assets, as well as general economic conditions. Although the Company maintains its allowance for loan losses at a level that it considers sufficient to provide for losses, there can be no assurance that future losses will not exceed internal estimates. In addition, the amount of the allowance for loan losses is subject to review by regulatory agencies, which can order the establishment of additional loss provisions. The following table summarizes changes in the allowance for loan losses over the three months ended September 30, 2008 and 2007:

The allowance for loan losses has been calculated based upon an evaluation of pertinent factors underlying the various types and quality of the Company's loans. Management considers such factors as the repayment status of a loan, the estimated net fair value of the underlying collateral, the borrower's intent and ability to repay the loan, local economic conditions, and the Company's historical loss ratios. We maintain the allowance for loan losses through the provisions for loan losses that we charge to income. We charge losses on loans against the allowance for loan losses when we believe the collection of loan principal is unlikely. The allowance for loan losses increased $183,000 to $3.8 million at September 30, 2008, from $3.6 million at June 30, 2008. During the three-month period ended September 30, 2008, the Company's net charge-offs increased, compared to the same period of the prior year, due primarily to the default of a single commercial relationship. At September 30, 2008, the Bank had $4.1 million, or 0.97% of total assets adversely classified ($4.1 million classified "substandard" none classified "doubtful" or "loss"), as compared to adversely classified assets of $4.5 million, or 1.07% of total assets at June 30, 2008, and $4.4 million, or 1.13% of total assets, adversely classified at September 30, 2007. Adversely classified loans were generally comprised of loans secured by commercial real estate, agricultural real estate, or inventory and equipment, and all were performing in accordance with terms at September 30, 2008. All were classified due to concerns as to the borrowers' ability to generate sufficient cash flows to service the debt.

While management believes that our asset quality remains strong, it recognizes that, due to the continued growth in the loan portfolio and potential changes in market conditions, our level of nonperforming assets and resulting charge offs may fluctuate. Higher levels of net charge offs requiring additional provisions for loan losses could result. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change.

Nonperforming Assets

The ratio of nonperforming assets to total assets and non-performing loans to net loans receivable is another measure of asset quality. Nonperforming assets of the Company include nonaccruing loans, accruing loans delinquent/past maturity 90 days or more, and assets which have been acquired as a result of foreclosure or deed-in-lieu of foreclosure. The table on the following page summarizes changes in the Company's level of nonperforming assets over selected time periods:

At September 30, 2008, non-performing assets totaled $522,000, up from $68,000 at June 30, 2008, and $147,000 at September 30, 2007. The increase in loans past maturity or delinquent by 90 days or more was attributable to three loans to one borrower. Most of the increase in other repossessed assets was due to collateral repossessed from one commercial borrower, to which most of the increase in charge-offs for the three-month period ended September 30, 2008, was attributed (see Allowance for Loan Loss Activity).

Liquidity Resources

The term "liquidity" refers to our ability to generate adequate amounts of cash to fund loan originations, loans purchases, deposit withdrawals and operating expenses. Our primary sources of funds include deposit growth, securities sold under agreements to repurchase, FHLB advances, brokered deposits, amortization and prepayment of loan principal and interest, investment maturities and sales, and funds provided by our operations. While the scheduled loan repayments and maturing investments are relatively predictable, deposit flows, FHLB advance redemptions, and loan and security prepayment rates are significantly influenced by factors outside of the Bank's control, including interest rates, general and local economic conditions and competition in the marketplace. The Bank relies on FHLB advances and brokered deposits as additional sources for funding cash or liquidity needs.

The Company uses its liquid resources principally to satisfy its ongoing cash requirements, which include funding loan commitments, funding maturing certificates of deposit and deposit withdrawals, maintaining liquidity, funding maturing or called FHLB advances, purchasing investments, and meeting operating expenses. At September 30, 2008, the Company had outstanding commitments to fund approximately $40.8 million in mortgage and non-mortgage loans. These commitments are expected to be funded through existing cash balances, cash flow from normal operations and, if needed, FHLB advances. At September 30, 2008, the Bank had pledged its residential real estate loan portfolio and a significant portion of its commercial real estate portfolio with the FHLB for available credit of approximately $128.6 million, of which $89.9 million had been advanced (additionally, letters of credit totaling $3.5 million had been issued on the Bank's behalf in order to secure public unit funding). The Bank has the ability to pledge several of its other loan portfolios, including home equity and commercial business loans, which could provide additional collateral for additional borrowings; in total, FHLB borrowings are generally limited to 40% of Bank assets, or $170.5 million, which means $77.1 million in borrowings remain available. Along with the ability to borrow from the FHLB, management believes its liquid resources will be sufficient to meet the Company's liquidity needs.

Regulatory Capital

The Bank is subject to minimum regulatory capital requirements pursuant to regulations adopted by the federal banking agencies. The requirements address both risk-based capital and leverage capital. As of September 30, 2008, and June 30, 2008, the Bank met all applicable adequacy requirements.

The FDIC has in place qualifications for banks to be classified as "well-capitalized." As of September 30, 2008, the most recent notification from the FDIC categorized the Bank as "well-capitalized." There were no conditions or events since the FDIC notification that has changed the Bank's classification.

The Bank's actual capital amounts and ratios are also presented in the following tables.

PART I: Item 3: Quantitative and Qualitative Disclosures About Market Risk
SOUTHERN MISSOURI BANCORP, INC.

Asset and Liability Management and Market Risk

The goal of the Company's asset/liability management strategy is to manage the interest rate sensitivity of both interest-earning assets and interest-bearing liabilities in order to maximize net interest income without exposing the Bank to an excessive level of interest rate risk. The Company employs various strategies intended to manage the potential effect that changing interest rates may have on future operating results. The primary asset/liability management strategy has been to focus on matching the anticipated re-pricing intervals of interest-earning assets and interest-bearing liabilities. At times, however, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Company may determine to increase its interest rate risk position somewhat in order to maintain its net interest margin.

In an effort to manage the interest rate risk resulting from fixed rate lending, the Bank has utilized longer term FHLB advances (with maturities up to ten years), subject to early redemptions and fixed terms. Other elements of the Company's current asset/liability strategy include (i) increasing originations of commercial business, commercial real estate, agricultural operating lines, and agricultural real estate loans, which typically provide higher yields and shorter repricing periods, but inherently increase credit risk; (ii) limiting the price volatility of the investment portfolio by maintaining a weighted average maturity of five years or less, (iii) actively soliciting less rate-sensitive deposits, and (iv) offering competitively-priced money market accounts and CDs with maturities of up to five years. The degree to which each segment of the strategy is achieved will affect profitability and exposure to interest rate risk.

The Company continues to originate long-term, fixed-rate residential loans. During the first three months of fiscal year 2009, fixed rate residential loan production totaled $3.7 million, as compared to $6.4 million during the same period of the prior year. At September 30, 2008, the fixed rate residential loan portfolio was $97.4 million with a weighted average maturity of 207 months, as compared to $95.1 million at September 30, 2007, with a weighted average maturity of 206 months. The Company originated $4.5 million in adjustable-rate residential loans during the three-month period ended September 30, 2008, as compared to $2.4 million during the same period of the prior year. At September 30, 2008, fixed rate loans with remaining maturities in excess of 10 years totaled $86.2 million, or 24.6% of net loans receivable, as compared to $80.4 million, or 25.2% of net loans receivable at September 30, 2007. The Company originated $18.9 million of fixed rate commercial and commercial real estate loans during the three-month period ended September 30, 2008, as compared to $14.1 million during the same period of the prior year. At September 30, 2008, the fixed rate commercial and commercial real estate loan portfolio was $115.3 million with a weighted average maturity of 38.5 months, compared to $100.7 million at September 30, 2007, with a weighted average maturity of 28 months. The Company originated $16.2 million in adjustable rate commercial and commercial real estate loans during the three-month period ended September 30, 2008, as compared to $8.1 million during the same period of the prior year. At September 30, 2008, adjustable-rate home equity lines of credit totaled $8.7 million, as compared to $6.5 million at September 30, 2007. Over the last several years, the Company had maintained a relatively short weighted average life of its investment portfolio; however, in anticipation of the current declining rate environment, management began to expand the portfolio's duration during the prior fiscal year. At September 30, 2008, the portfolio's weighted-average life stands at 5.3 years, compared to 3.2 years at September 30, 2007. Management continues to focus on customer retention, customer satisfaction, and offering new products to customers in order to increase the Company's amount of less rate-sensitive deposit accounts. The company remains "liability-sensitive," in that our liabilities generally re-price more quickly than our assets. As we reach what we expect to be the bottom of the current interest rate cycle, it is anticipated that management will seek to reduce the amount of sensitivity, but management does expect to achieve the ability to maintain its net interest margin in a rising rate environment.

Interest Rate Sensitivity Analysis

The following table sets forth as of September 30, 2008, management's estimates of the projected changes in net portfolio value ("NPV") in the event of 100, 200, and 300 basis point ("bp") instantaneous and permanent increases, and 100, 200, and 300 basis point instantaneous and permanent decreases in market interest rates. Dollar amounts are expressed in thousands.

Computations of prospective effects of hypothetical interest rate changes are based on an internally generated model using actual maturity and repricing schedules for the Bank's loans and deposits, and are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit run-offs, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates.

Management cannot predict future interest rates or their effect on the Bank's NPV in the future. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have an initial fixed rate period typically from one to five years, and over the remaining life of the asset changes in the interest rate are restricted. In addition, the proportion of adjustable-rate loans in the Bank's portfolio could decrease in future periods due to refinancing activity if market interest rates remain steady in the future. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the table. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

The Bank's Board of Directors (the "Board") is responsible for reviewing the Bank's asset and liability policies. The Board's Asset/Liability Committee meets monthly to review interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Bank's management is responsible for administering the policies and determinations of the Board with respect to the Bank's asset and liability goals and strategies.

PART I: Item 4: Controls and Procedures
SOUTHERN MISSOURI BANCORP, INC.

An evaluation of Southern Missouri Bancorp's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended, (the "Act")) as of September 30, 2008, was carried out under the supervision and with the participation of our Chief Executive and Financial Officer, and several other members of our senior management. The Chief Executive and Financial Officer concluded that, as of September 30, 2008, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to management (including the Chief Executive and Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended September 30, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company does not expect that its disclosures and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

PART II: Other Information
SOUTHERN MISSOURI BANCORP, INC.

Item 1: Legal Proceedings

In the opinion of management, the Bank is not a party to any pending claims or lawsuits that are expected to have a material effect on the Bank's financial condition or operations. Periodically, there have been various claims and lawsuits involving the Bank mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. Aside from such pending claims and lawsuits, which are incident to the conduct of the Bank's ordinary business, the Bank is not a party to any material pending legal proceedings that would have a material effect on the financial condition or operations of the Bank.

Item 1a: Risk Factors

The following risk factors represent changes or additions to, and should be read in conjunction with, the risk factors set forth in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended June 30, 2008:

Difficult global market conditions and economic trends have adversely affected our industry and, to a lesser extent, our business.

             Dramatic declines in the US housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans, and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility, and widespread reduction in general business activity. Financial institutions have experienced decreased access to deposits or borrowings.

             The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations, and stock price.

             Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. We also expect to face increased regulation and government oversight as a result of these downward trends. This increased government action may increase our costs and limit our ability to pursue certain business opportunities. We expect to pay higher Federal Deposit Insurance Corporation (FDIC) premiums than we have over recent periods, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.

             We do not believe these difficult conditions are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers, and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies, and customer bankruptcies, as well as more restricted access to funds.

Recent legislative and regulator initiatives to address these difficult market and economic conditions may not stability the US banking system.

             The recently-enacted Emergency Economic Stabilization Act of 2008 ("EESA") authorizes the United States Department of Treasury ("Treasury") to purchase from financial institutions and their holding companies up to $750 billion in mortgage loans, mortgage-related securities, and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a Troubled Asset Relief Program ("TARP"). The purpose of the TARP is to restore confidence and stability to the US banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury has allocated $250 billion under the TARP for a Capital Purchase Program ("CPP"). Under the CPP, the Treasury will purchase debt or equity securities from participating institutions. The TARP is also expected to include direct purchases or guarantees of troubled assets of financial institutions.

             The EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry. In addition, the FDIC has implemented two temporary programs to provide deposit insurance for the full amount of most non-interest bearing transaction accounts through the end of 2009 and to guarantee certain unsecured debt of financial institutions and their holding companies

             The EESA, the TARP, and the FDIC's recent regulatory initiative may not stabilize the US banking system or financial markets. If the volatility in the market and the economy continue or worsen, our business, financial condition, results of operations, access to funds, and the price of our stock could all be materially and adversely impacted.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

Item 3: Defaults upon Senior Securities

Not applicable

Item 4: Submission of Matters to a Vote of Security Holders

Item 5 - Other Information

None

Item 6 - Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.