CSB Bancorp, Inc.: Form 10-Q for the period ended Jun 30, 2009

AND RESULTS OF OPERATIONS

The following discussion focuses on the consolidated financial condition of CSB Bancorp, Inc. and its subsidiaries (the “Company”) at June 30, 2009 as compared to December 31, 2008, and the consolidated results of operations for the quarter and six-month period ended June 30, 2009 compared to the same period in 2008. The purpose of this discussion is to provide the reader with a more thorough understanding of the consolidated financial statements. This discussion should be read in conjunction with the interim consolidated financial statements and related footnotes.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report are not historical facts but rather are forward-looking statements that are subject to certain risks and uncertainties. When used herein, the terms “anticipates”, “plans”, “expects”, “believes”, and similar expressions as they relate to the Company or its management are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services.

The Company does not undertake, and specifically disclaims any obligation, to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

FINANCIAL CONDITION

Total assets were $422.6 million at June 30, 2009, compared to $424.7 million at December 31, 2008, representing a decrease of $2.1 million or 0.5%. Cash and cash equivalents increased $4.6 million, or 36.4%, during the six-month period ending June 30, 2009, due to a $5.7 million increase in Interest-earning deposits in other banks and Federal funds sold and a $1.1 million decrease in cash and due from banks. Securities decreased $9.1 million or 11.1% during the first six months of 2009 primarily due to calls within the US Agency portfolio and principal repayments within the mortgage-backed securities portfolio. Net loans increased $1.6 million, or 0.5%, while deposits decreased $4.9 million, or 1.6%, during the six-month period. Short-term borrowings of Federal funds purchased, securities sold under repurchase agreement and Federal Home Loan Bank borrowings increased $2.0 million, while other borrowings decreased $736 thousand during the period.

Net loans increased $1.6 million, or 0.5%, during the six-month period ended June 30, 2009. Loan balance increases were recognized in commercial loans of $6.6 million and home equity lines of $3.5 million during the six-month period. With low interest rates available on the mortgage secondary market , mortgages declined $5.9 million and consumer installment credit continued to decline another $770 thousand during the period. The allowance for loan losses amounted to $3,398,000, or 1.07% of total loans at June 30, 2009 compared to $3,394,000 or 1.07% of total loans at December 31, 2008.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The allowance for loan losses totaled $3.4 million at June 30, 2009 stable from March 31, 2009 and December 31, 2008. The Company provided $635 thousand to the allowance for loan losses for the six-month period ending June 30, 2009 while net loan charge-offs totaled $631 thousand for the same period. At June 30, 2009 nonperforming loans, other real estate owned and delinquent loans reflect balance decreases from March 31, 2009.

The ratio of gross loans to deposits was 104.4% at June 30, 2009, compared to 103.5% at December 31, 2008. The increase in this ratio is the result of loan growth and deposit shrinkage experienced during the six months ended June 30, 2009.

At least quarterly, the Company conducts a comprehensive security-level impairment assessment. The assessments are based on the nature of the securities, the extent and duration of the securities, the extent and duration of the loss and management’s intent to sell or if it is more likely than not that management will be required to sell a security before recovery of its amortized cost basis, which may be maturity. The Company had net unrealized gains of $1.1 million within its securities portfolio at June 30, 2009, compared to net unrealized gains of $218,000 at December 31, 2008. Gross unrealized losses of $403 thousand as of June 30, 2009 were primarily concentrated in four (4) private label CMO’s. These investments represent $2.9 million fair value, $7.5 million original par value and $251,000 gross unrealized loss. All bonds are investment grade at June 30, 2009, collateralized primarily by 1-4 family mortgage loans and borrowers in a wide geographical dispersion. Management believes the Company will fully recover the cost of these securities and it does not intend to sell these securities and likely will not be required to sell them before the anticipated recovery of the remaining amortized cost basis, which may be maturity. As a result, management concluded that these securities were not other-than-temporarily impaired at June 30, 2009 and has recognized the total amount of the impairment in other comprehensive income, net of tax. A $35,000 other-than-temporary impairment was recognized on an equity investment during the first quarter 2009.

Short-term borrowings increased $2.0 million from December 31, 2008 as new customer relationships were opened as repurchase agreements. Other borrowings decreased $736 thousand due to maturities and payments of Federal Home Loan advances.

Deposits decreased $4.9 million, or 1.6% from December 31, 2008 with non-interest bearing deposits declining $5.0 million and interest-bearing deposit accounts increasing $35 thousand reflecting normal seasonal fluctuations. By deposit type, increases were recognized in money market savings accounts of $2.1 million and time deposits under $100 thousand of $2.8 million for the six-month period ended June 30, 2009. During the period $3.2 million of brokered deposits acquired through the merger with Indian Village matured and were not renewed. Decreases were also reflected in interest-bearing demand deposits and traditional savings accounts.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total shareholders’ equity amounted to $44.7 million, or 10.6%, of total assets, at June 30, 2009, compared to $43.5 million, or 10.2% of total assets, at December 31, 2009. The increase in shareholders’ equity during the six months ended June 30, 2009 was due to net income of $1,602,000 and the increase in net unrealized gains, net of tax, on securities of $589,000. These increases were partially offset by dividends declared of $985,000. The Company and its subsidiary bank met all regulatory capital requirements at June 30, 2009.

RESULTS OF OPERATIONS

Three months ended June 30, 2009 and 2008

For the quarter ended June 30, 2009, the Company recorded net income of $706,000, or $0.26 per share, as compared to net income of $878,000, or $0.36 per share for the quarter ended June 30, 2008. The $172,000 decrease in net income for the quarter was principally due to a $346,000 increase in the provision for loan losses and a $593,000 increase in other expenses. The declines were partially offset by net increases in other income of $100,000 and a decline in federal income tax provision of $121,000.

Interest income for the quarter ended June 30, 2009, was $5,466,000, representing a $573,000 increase, or 11.7%, compared to the same period in 2008. This increase was primarily due to an increase in average loan volume of $70 million for the second quarter in 2009 compared to the quarter ended June 30, 2008. Securities posted an additional net interest increase due to an increase in average volume of $5 million. These interest increases were partially offset by a rate decline of 1.78% on approximately $10 million in overnight fed funds sold and interest bearing deposit accounts.

Interest expense for the quarter ended June 30, 2009 was $1,634,000, an increase of $26,000, or 1.6%, from the same period in 2008. The increase in interest expense occurred due to volume increases from the deposits and Federal Home Loan Bank advances acquired in the Indian Village transactions, which were mostly offset by decreases in interest rates across the board for the quarter ended June 30, 2009. During second quarter 2009, maturing time deposits renewed at interest rates that were lower than the previous period.

The provision for loan losses for the quarter ended June 30, 2009, was $394,000, compared to a $48,000 provision for the same quarter in 2008. The provision for loan losses is determined based on management’s calculation of the adequacy of the allowance for loan losses, which includes provisions for classified loans as well as for the remainder of the portfolio based on historical data including past charge-offs and current economic trends.

Non-interest income for the quarter ended June 30, 2009, was $780,000, an increase of $100,000, or 14.7%, compared to the same quarter in 2008. This increase occurred due to the gain on sale of mortgage loans into the secondary market of $117,000 for the quarter as compared to the prior year quarter of $7,000 attributable to refinancings in the current low rate mortgage market environment. Additional increases were made in debit card interchange fees of $16,000 and all other income of $33,000. Trust and brokerage fees declined $43,000 on a quarter over quarter basis as the market value of assets under management declined. Service charges on deposit accounts also declined by $15,000 or 4.4% as customer use of overdraft privilege products declined.

Non-interest expenses for the quarter ended June 30, 2009, increased $593,000, or 22.7%, compared to the second quarter of 2008. FDIC assessments increased $211,000 due to increased rates and a special assessment while a previous credit balance was exhausted. Increases in all other expenses occurred primarily as a result of the Indian Village acquisition; salaries and employee benefits increased $169,000, occupancy and equipment expenses increased $65,000 and other expenses increased $69,000 or 13.0%.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Federal income tax expense decreased $121,000, or 28.7% for the quarter ended June 30, 2009 as compared to the second quarter of 2008. The provision for income taxes was $302,000 (effective rate of 29.9%) for the quarter ended June 30, 2009, compared to $423,000 (effective rate of 32.5%) for the quarter ended June 30, 2008. The decrease in the effective tax rate resulted from an increase in tax-exempt interest income and decreased income generated by the company.

Six months ended June 30, 2009 and 2008

Net income for the six months ending June 30, 2009, was $1,602,000, or $0.59 per share, as compared to $1,880,000 or $0.77 per share during the same period in 2008. Return on average assets and return on average equity were 0.76% and 7.24%, respectively, for the six-month period of 2009, compared to 1.10% and 10.14%, respectively for 2008.

Net interest income was $7,726,000 for the six months ended June 30, 2009, an increase of $1,060,000 or 15.9% from the same period last year. Comparative net income decreased primarily due to the increase in the provision for loan losses of $480,000 and the increase in FDIC premiums and assessments of $377,000 compared to the same period in 2008.

Interest income on loans increased $773,000, or 9.2%, for the six months ended June 30, 2009, as compared to the same period in 2008. This increase was primarily due to an average volume increase of $67 million partially offset by an interest rate decrease of 91 basis points for the comparable six-month periods. Interest income on securities increased $156,000, or 9.3%, as the yield on taxable securities increased 8 basis points, while average investment balances increased by $3.4 million. Interest income on fed funds sold and interest bearing deposits decreased $61,000 for the six months ended June 30, 2009 as the average fed funds sold rate decreased 184 basis points to 0.23%, compared to the same period in 2008.

Interest expense decreased $192,000 to $3,320,000 for the six months ended June 30, 2009, compared to the six months ended June 30, 2008. Interest expense on deposits decreased $296,000, or 11.4%, from the same period as last year, while interest expense on other borrowings increased $104,000 or 11.4%. The decrease in interest expense has been caused by lower interest rates being paid across the board on interest-bearing deposit accounts and borrowings. Time deposits continue to renew at lower interest rates, and some depositors have moved monies to saving instruments anticipating higher rate time deposits. Competition for deposits appears to be decreasing from a year ago with larger money center banks reducing the premium paid for term deposits. The net interest margin declined by 21 basis points for the six-month period ended June 30, 2009, to 3.93%, from 4.14% for the same period in 2008.

The provision for loan losses was $635,000 during the first six months of 2009, compared to $155,000 in the same six-month period of 2008. The provision or credit for loan losses is determined based on management’s calculation of the adequacy of the allowance for loan losses, which includes provisions for classified loans as well as for the remainder of the portfolio based on historical data including past charge-offs and current economic trends.

Non-interest income decreased $59,000, or 3.6%, during the six months ended June 30, 2009, as compared to the same period in 2008. The decrease in non-interest income was primarily due to the sale of credit cards resulting in a gain of $261,000 during first quarter 2008. Trust and Brokerage fees declined $117,000 due to declines in market values and reductions in brokerage revenues. Service charges on deposits decreased $9,000 from the same period in 2008 as deposit customers curtailed their use of overdraft privilege products in 2009. These decreases were partially offset by a $184,000 increase in gains on mortgage loans sold in the secondary market for the first half of 2009, a $31,000 increase in debit card interchange fees and a $116,000 gain on securities sold during the first quarter of 2009.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Non-interest expenses increased $993,000, or 18.6%, for the six months ended June 30, 2009, compared to the same period in 2008. The bank’s FDIC deposit premium rose $377,000 from $15,000 for the six months ended 2008 reflecting the rising assessment rate, the exhaustion of the bank’s credit in 2009 and the effect of the special assessment payable on September 30, 2009. Salaries and employee benefits increased $341,000, or 11.1%, primarily the result of increased number of employees following the merger of Indian Village as well as increased cost of benefit programs. Professional and directors fees a result of increased legal and legal collection fees due to an increased number of nonperforming loans. Occupancy expense has increased during the first six-months of 2009 as compared with 2008 due to increased rents, maintenance and utilities on three additional offices. Other expenses increased $55,000 or 4.8% primarily the result of increased operating costs of a larger company.

The provision for income taxes was $726,000 (effective rate of 31.1%) for the six months ended June 30, 2009, compared to $921,000 (effective rate of 32.9%) for the six months ended June 30, 2008. The decrease in the effective tax rate resulted from an increase in tax-exempt interest income as a portion of total income before income taxes.

CAPITAL RESOURCES

The Federal Reserve Board (FRB) has established risk-based capital guidelines that must be observed by financial holding companies and banks. Failure to meet specified minimum capital requirements could result in regulatory actions by the Federal Reserve or Ohio Division of Financial Institutions that could have a material effect on the Company’s financial condition or results of operations. Management believes there were no material changes to Capital Resources as presented in CSB Bancorp’s annual report on Form 10-K for the year ended December 31, 2008, and as of June 30, 2009 the holding company and its bank meet all capital adequacy requirements to which they are subject.

LIQUIDITY

Liquidity refers to the Company’s ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, pay operating expenses and meet other obligations. The Company’s primary sources of liquidity are cash and cash equivalents, which totaled $17.4 million at June 30, 2009, an increase of $4.6 million from $12.7 million at December 31, 2008. Net income, securities available-for-sale, and loan repayments also serve as sources of liquidity. Cash and cash equivalents and estimated principal cash flow and maturities on investments maturing within one year represent 7.5% of total assets as of June 30, 2009 compared to 6.6% of total assets at year-end 2008. Other sources of liquidity include, but are not limited to, purchase of federal funds, advances from the FHLB, adjustments of interest rates to attract deposits, and borrowing at the Federal Reserve discount window. Management believes that its sources of liquidity are adequate to meet cash flow obligations for the foreseeable future.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements (as such term is defined in applicable Securities and Exchange Commission rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the quantitative and qualitative disclosures about market risks as of June 30, 2009, from that presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008. Management performs a quarterly analysis of the Company’s interest rate risk. All positions are currently within the Company’s board-approved policy.

The following table presents an analysis of the estimated sensitivity of the Company’s annual net interest income to sudden and sustained 100 and 200 basis point changes in market interest rates at June 30, 2009 and December 31, 2008:

June 30 2009

(Dollars in Thousands)

December 31, 2008

(Dollars in Thousands)

With the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that:

(a) information required to be disclosed by the Company in this Quarterly Report on Form 10-Q would be accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure;

(b) information required to be disclosed by the Company in this Quarterly Report on Form 10-Q would be recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and

(c) the Company’s disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that material information relating to the Company and its consolidated subsidiary is made known to them, particularly during the period for which our periodic reports, including this Quarterly Report on Form 10-Q, are being prepared.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no changes during the period covered by this Quarterly Report on Form 10-Q in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

FORM 10-Q

Quarter ended June 30, 2009

There were no material changes to the Risk Factors described in Item 1A in the Company’s Annual Report on Form 10-K for the period ended December 31, 2008.