UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the
Quarterly Period Ended March 31, 2010
OR
o
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the
Transition Period from
___________ to __________
Commission
file number 000-30523
First National Bancshares,
Inc.
(Exact
name of registrant as specified in its charter)
South
Carolina
|
58-2466370
(I.R.S.
Employer Identification No.)
|
|
|
Spartanburg,
South Carolina
(Address
of principal executive offices)
|
29302
(Zip
Code)
|
864-948-9001
(Registrant’s
telephone number, including area code)
Not
Applicable
(Former
name, former address
and
former fiscal year,
if
changed since last report)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the 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
¨
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.
Large
accelerated filer
¨
|
Accelerated
filer
¨
|
Non-accelerated
filer
¨
|
Smaller
reporting company
x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
¨
No
x
Indicate
the number of shares outstanding of each of the issuer’s classes of common
equity, as of the latest
practicable
date: On May 6, 2010, 8,297,608 shares of the issuer’s common stock (including
106,981 treasury shares owned by the registrant)
were
issued and outstanding.
Index
PART I. FINANCIAL
INFORMATION
Item
1.
|
Financial
Statements (unaudited)
|
|
|
|
|
|
Consolidated
Balance Sheets – March 31, 2010, and December 31, 2009
|
3
|
|
|
|
|
Consolidated
Statements of Operations – For the three months ended March 31, 2010
and 2009
|
4
|
|
|
|
|
Consolidated
Statements of Changes in Shareholders’ Equity (Deficit) and Comprehensive
Income (Loss) –
|
|
|
For
the three months ended March 31, 2010 and 2009
|
5
|
|
|
|
|
Consolidated
Statements of Cash Flows – For the three months ended March 31, 2010 and
2009
|
6
|
|
|
|
|
Notes
to Unaudited Consolidated Financial Statements
|
7-23
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
24-64
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
64
|
|
|
|
Item
4.
|
Controls
and Procedures
|
64
|
|
|
|
PART II. OTHER
INFORMATION
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
65
|
|
|
|
Item
1A.
|
Risk
Factors
|
65
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
65
|
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
65
|
|
|
|
Item
4.
|
(Removed
and Reserved)
|
65
|
|
|
|
Item
5.
|
Other
Information
|
65
|
|
|
|
Item
6.
|
Exhibits
|
66
|
PART
I. FINANCIAL INFORMATION
Item 1. Financial
Statements.
FIRST
NATIONAL BANCSHARES, INC. AND SUBSIDIARY
Consolidated
Balance Sheets
(dollars
in thousands)
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
Assets
|
|
(Unaudited)
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
88,810
|
|
|
$
|
65,968
|
|
Securities
available for sale
|
|
|
59,283
|
|
|
|
99,112
|
|
Loans,
net of allowance for loan losses of $23,310 and $25,408,
respectively
|
|
|
483,875
|
|
|
|
511,753
|
|
Other
real estate
|
|
|
17,727
|
|
|
|
9,315
|
|
Premises
and equipment, net
|
|
|
7,919
|
|
|
|
8,120
|
|
Other
nonmarketable equity securities
|
|
|
6,818
|
|
|
|
6,818
|
|
Income
tax receivable
|
|
|
3,219
|
|
|
|
7,397
|
|
Bank
owned life insurance
|
|
|
3,274
|
|
|
|
3,245
|
|
Other
|
|
|
5,188
|
|
|
|
5,961
|
|
Total
assets
|
|
$
|
676,113
|
|
|
$
|
717,689
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders' Deficit
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
Noninterest-bearing
|
|
$
|
33,356
|
|
|
$
|
34,172
|
|
Interest-bearing
|
|
|
572,006
|
|
|
|
607,319
|
|
Total
deposits
|
|
|
605,362
|
|
|
|
641,491
|
|
FHLB
advances
|
|
|
52,975
|
|
|
|
54,004
|
|
Junior
subordinated debentures
|
|
|
13,403
|
|
|
|
13,403
|
|
Short-term
borrowing
|
|
|
9,641
|
|
|
|
9,641
|
|
Accrued
expenses and other liabilities
|
|
|
3,625
|
|
|
|
3,308
|
|
Total
liabilities
|
|
|
685,006
|
|
|
|
721,847
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
deficit:
|
|
|
|
|
|
|
|
|
Preferred
stock, par value $0.01 per share, 10,000,000 shares
authorized;
|
|
|
4
|
|
|
|
5
|
|
400,600
and 520,600 shares issued and outstanding, respectively
|
|
|
|
|
|
|
|
|
Common
stock, par value $0.01 per share, 100,000,000 shares
authorized;
|
|
|
82
|
|
|
|
78
|
|
8,045,340
and 7,685,340 shares issued and outstanding, respectively,
|
|
|
|
|
|
|
|
|
net
of treasury shares
|
|
|
|
|
|
|
|
|
Treasury
stock, 106,981 shares for each period, at cost
|
|
|
(1,131
|
)
|
|
|
(1,131
|
)
|
Unearned
equity compensation
|
|
|
(678
|
)
|
|
|
(678
|
)
|
Additional
paid-in capital and warrants
|
|
|
84,305
|
|
|
|
84,259
|
|
Retained
deficit
|
|
|
(90,924
|
)
|
|
|
(85,545
|
)
|
Accumulated
other comprehensive loss
|
|
|
(551
|
)
|
|
|
(1,146
|
)
|
Total
shareholders' deficit
|
|
|
(8,893
|
)
|
|
|
(4,158
|
)
|
|
|
|
|
|
|
|
|
|
Total
liabilities and shareholders' deficit
|
|
$
|
676,113
|
|
|
$
|
717,689
|
|
See
accompanying notes to unaudited consolidated financial statements.
FIRST
NATIONAL BANCSHARES, INC. AND SUBSIDIARY
Consolidated
Statements of Operations
(dollars
in thousands, except share data) (unaudited)
|
|
For
the three months
|
|
|
|
ended
March 31,
|
|
|
|
2010
|
|
|
2009
|
|
Interest
income:
|
|
|
|
|
|
|
Loans
|
|
$
|
5,681
|
|
|
$
|
8,413
|
|
Taxable
securities
|
|
|
789
|
|
|
|
797
|
|
Nontaxable
securities
|
|
|
40
|
|
|
|
202
|
|
Federal
funds sold and other
|
|
|
89
|
|
|
|
42
|
|
Total
interest income
|
|
|
6,599
|
|
|
|
9,454
|
|
|
|
|
|
|
|
|
|
|
Interest
expense:
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
3,357
|
|
|
|
4,499
|
|
FHLB
advances
|
|
|
453
|
|
|
|
517
|
|
Long-term
debt
|
|
|
-
|
|
|
|
150
|
|
Junior
subordinated debentures
|
|
|
83
|
|
|
|
131
|
|
Short-term
borrowings
|
|
|
145
|
|
|
|
15
|
|
Total
interest expense
|
|
|
4,038
|
|
|
|
5,312
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
2,561
|
|
|
|
4,142
|
|
|
|
|
|
|
|
|
|
|
Provision
for loan losses
|
|
|
3,700
|
|
|
|
2,152
|
|
|
|
|
|
|
|
|
|
|
Net
interest income (expense) after provision for loan losses
|
|
|
(1,139
|
)
|
|
|
1,990
|
|
|
|
|
|
|
|
|
|
|
Noninterest
income:
|
|
|
|
|
|
|
|
|
Service
charges and fees on deposit accounts
|
|
|
395
|
|
|
|
400
|
|
Gain
on sale of securities available for sale, net
|
|
|
149
|
|
|
|
183
|
|
Service
charges and fees on loans
|
|
|
135
|
|
|
|
151
|
|
Mortgage
banking income
|
|
|
-
|
|
|
|
712
|
|
Gain
(loss) on sale of other real estate owned
|
|
|
(38
|
)
|
|
|
45
|
|
Other
|
|
|
90
|
|
|
|
81
|
|
Total
noninterest income
|
|
|
731
|
|
|
|
1,572
|
|
|
|
|
|
|
|
|
|
|
Noninterest
expense:
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
2,054
|
|
|
|
2,544
|
|
Occupancy
and equipment expense
|
|
|
769
|
|
|
|
794
|
|
FDIC
insurance premiums
|
|
|
757
|
|
|
|
131
|
|
Professional
fees
|
|
|
295
|
|
|
|
200
|
|
Data
processing and ATM expense
|
|
|
293
|
|
|
|
297
|
|
Loan
related expenses
|
|
|
144
|
|
|
|
131
|
|
Telephone
and supplies
|
|
|
126
|
|
|
|
161
|
|
Other
real estate owned expense
|
|
|
112
|
|
|
|
52
|
|
Regulatory
fees
|
|
|
87
|
|
|
|
49
|
|
Public
relations
|
|
|
46
|
|
|
|
123
|
|
Loss
on impairment of investment in equity securities
|
|
|
-
|
|
|
|
117
|
|
Other
|
|
|
288
|
|
|
|
326
|
|
Total
noninterest expense
|
|
|
4,971
|
|
|
|
4,925
|
|
|
|
|
|
|
|
|
|
|
Net
loss before income taxes
|
|
|
(5,379
|
)
|
|
|
(1,363
|
)
|
Provision
for income taxes
|
|
|
-
|
|
|
|
-
|
|
Net
loss
|
|
|
(5,379
|
)
|
|
|
(1,363
|
)
|
Cash
dividends declared on preferred stock
|
|
|
-
|
|
|
|
-
|
|
Net
loss available to common shareholders
|
|
$
|
(5,379
|
)
|
|
$
|
(1,363
|
)
|
|
|
|
|
|
|
|
|
|
Net
loss per common share
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.68
|
)
|
|
$
|
(0.22
|
)
|
Diluted
|
|
$
|
(0.68
|
)
|
|
$
|
(0.22
|
)
|
Weighted
average common shares outstanding
|
|
|
|
|
|
|
|
|
Basic
|
|
|
7,917,340
|
|
|
|
6,296,698
|
|
Diluted
|
|
|
7,917,340
|
|
|
|
6,296,698
|
|
See
accompanying notes to unaudited consolidated financial statements.
FIRST
NATIONAL BANCSHARES, INC. AND SUBSIDIARY
Consolidated
Statements of Changes in Shareholders’ Equity (Deficit) and Comprehensive Income
(Loss)
For the
three months ended March 31, 2010 and 2009
(dollars
in thousands, unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred
Stock
|
|
|
Common
Stock
|
|
|
Treasury
Stock
|
|
|
Unearned
|
|
|
Additional
Paid-In
Capital
|
|
|
|
|
|
Accumulated
Other
|
|
|
Total
Shareholders'
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Equity
Compensation
|
|
|
and
Warrants
|
|
|
Retained
Deficit
|
|
|
Comprehensive
Income
(Loss)
|
|
|
Equity
(Deficit)
|
|
Balance,
December 31, 2008
|
|
|
720,000
|
|
|
$
|
7
|
|
|
|
6,403,679
|
|
|
$
|
64
|
|
|
|
(106,981
|
)
|
|
$
|
(1,131
|
)
|
|
$
|
(478
|
)
|
|
$
|
83,401
|
|
|
$
|
(41,807
|
)
|
|
$
|
568
|
|
|
$
|
40,624
|
|
Grant
of employee stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
19
|
|
|
|
-
|
|
|
|
-
|
|
|
|
19
|
|
Comprehensive
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,363
|
)
|
|
|
-
|
|
|
|
(1,363
|
)
|
Change
in net unrealized gain on securities available for sale,
net of
income tax of $80
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
277
|
|
|
|
277
|
|
Reclassification
adjustment for gains included in net loss,
net of income tax of
$62
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(121
|
)
|
|
|
(121
|
)
|
Total
comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,207
|
)
|
Balance,
March 31, 2009
|
|
|
720,000
|
|
|
$
|
7
|
|
|
|
6,403,679
|
|
|
$
|
64
|
|
|
|
(106,981
|
)
|
|
$
|
(1,131
|
)
|
|
$
|
(478
|
)
|
|
$
|
83,420
|
|
|
$
|
(43,170
|
)
|
|
$
|
724
|
|
|
$
|
39,436
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2009
|
|
|
520,600
|
|
|
$
|
5
|
|
|
|
7,792,321
|
|
|
$
|
78
|
|
|
|
(106,981
|
)
|
|
$
|
(1,131
|
)
|
|
$
|
(678
|
)
|
|
$
|
84,259
|
|
|
$
|
(85,545
|
)
|
|
$
|
(1,146
|
)
|
|
$
|
(4,158
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion
of preferred shares into common shares
|
|
|
(120,000
|
)
|
|
|
(1
|
)
|
|
|
360,000
|
|
|
|
4
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Grant
of employee stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
49
|
|
|
|
-
|
|
|
|
-
|
|
|
|
49
|
|
Comprehensive
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,379
|
)
|
|
|
-
|
|
|
|
(5,379
|
)
|
Change
in net unrealized gain on securities available for sale,
net of
income tax of $357
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
693
|
|
|
|
693
|
|
Reclassification
adjustment for gains included in net loss,
net of income tax of
$51
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(98
|
)
|
|
|
(98
|
)
|
Total
comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(4,784
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
March 31, 2010
|
|
|
400,600
|
|
|
$
|
4
|
|
|
|
8,152,321
|
|
|
$
|
82
|
|
|
|
(106,981
|
)
|
|
$
|
(1,131
|
)
|
|
$
|
(678
|
)
|
|
$
|
84,305
|
|
|
$
|
(90,924
|
)
|
|
$
|
(551
|
)
|
|
$
|
(8,893
|
)
|
See
accompanying notes to unaudited consolidated financial statements.
FIRST
NATIONAL BANCSHARES, INC. AND SUBSIDIARY
Consolidated
Statements of Cash Flows
(dollars
in thousands, unaudited)
|
|
For
the three months
|
|
|
|
ended
March 31,
|
|
|
|
2010
|
|
|
2009
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(5,379
|
)
|
|
$
|
(1,363
|
)
|
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Provision
for loan losses
|
|
|
3,700
|
|
|
|
2,152
|
|
Depreciation
|
|
|
191
|
|
|
|
191
|
|
Amortization
of purchase accounting adjustments
|
|
|
24
|
|
|
|
55
|
|
Amortization
(accretion) of securities discounts and premiums, net
|
|
|
109
|
|
|
|
(63
|
)
|
Gain
on sale of securities available for sale, net
|
|
|
(149
|
)
|
|
|
(183
|
)
|
Writedown
on other real estate owned
|
|
|
1,083
|
|
|
|
2
|
|
Loss
(gain) on sale of other real estate owned
|
|
|
38
|
|
|
|
(46
|
)
|
Valuation
adjustment on nonmarketable equity securities
|
|
|
-
|
|
|
|
117
|
|
Origination
of residential mortgage loans held for sale
|
|
|
(1,085
|
)
|
|
|
(85,923
|
)
|
Proceeds
from sale of residential mortgage loans held for sale
|
|
|
1,085
|
|
|
|
89,933
|
|
Compensation
expense under equity compensation programs
|
|
|
61
|
|
|
|
19
|
|
Changes
in prepaid and accrued amounts:
|
|
|
|
|
|
|
|
|
Prepaid
expenses and other assets
|
|
|
4,592
|
|
|
|
(1,483
|
)
|
Accrued
expenses and other liabilities
|
|
|
305
|
|
|
|
(426
|
)
|
Net
cash provided by operating activities
|
|
|
4,575
|
|
|
|
2,982
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from maturities/prepayment of securities available for
sale
|
|
|
1,937
|
|
|
|
7,649
|
|
Proceeds
from sales of securities available for sale
|
|
|
40,831
|
|
|
|
7,040
|
|
Purchases
of securities available for sale
|
|
|
(1,998
|
)
|
|
|
(6,588
|
)
|
Proceeds
from sale of other real estate owned
|
|
|
151
|
|
|
|
1,847
|
|
Loan
repayments, net of disbursements
|
|
|
14,494
|
|
|
|
16,399
|
|
Net
(purchases) sales of premises and equipment
|
|
|
10
|
|
|
|
(555
|
)
|
Redemption
of FHLB and other stock
|
|
|
-
|
|
|
|
741
|
|
Net
cash provided by investing activities
|
|
|
55,425
|
|
|
|
26,533
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Increase
in FHLB advances
|
|
|
-
|
|
|
|
23,725
|
|
Repayment
of FHLB advances
|
|
|
(1,029
|
)
|
|
|
(41,994
|
)
|
Net
decrease in federal funds purchased and other short-term
borrowings
|
|
|
-
|
|
|
|
(11,873
|
)
|
Net
increase (decrease) in deposits
|
|
|
(36,129
|
)
|
|
|
49,851
|
|
Net
cash provided by (used in) financing activities
|
|
|
(37,158
|
)
|
|
|
19,709
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
22,842
|
|
|
|
49,224
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of year
|
|
|
65,968
|
|
|
|
7,700
|
|
Cash
and cash equivalents, end of period
|
|
$
|
88,810
|
|
|
$
|
56,924
|
|
See
accompanying notes to unaudited consolidated financial statements.
FIRST
NATIONAL BANCSHARES, INC. AND SUBSIDIARY
Notes
to Unaudited Consolidated Financial Statements
Note 1 – Nature of Business
and Basis of Presentation
First
National Bancshares, Inc.
First National Bancshares, Inc.,
referred to herein as the “Company” or “First National,” was
organized as a South Carolina corporation in 1999 to serve as the holding
company for First National Bank of the South, a national banking association,
referred to herein as the "Bank." The Bank currently maintains its corporate
headquarters in Spartanburg, South Carolina, and a network of full-service
branches in select markets across the state. The Company has
been adversely affected by the recent collapse of the market economy, and based
on its tangible equity ratio as of March 31, 2010, the Bank was deemed to be
critically undercapitalized, primarily as a result of its increased provisions
for loan losses during 2008 and 2009 and through the first quarter of
2010. This development was also based on the Company’s maintenance of
excess liquidity on its balance sheet and the expected fluctuations of this
tangible equity ratio that occur as a result. The Company is
implementing a strategy to increase its capital levels by raising additional
capital, limiting its growth, and decreasing
assets.
Specifically, the Bank plans to reduce its balance
sheet as brokered certificates of deposits mature and are not renewed.
In addition, t
o raise additional
capital, the Company has engaged various professional advisors and is executing
a capital plan that may include issuing common stock, preferred stock, or other
financing alternatives that are treated as capital for capital adequacy ratio
purposes. The Company is in active negotiations with potential
investors and plans to raise additional capital in the next few months; however,
there are no assurances that such issuance will be completed.
The
Company’s assets consist primarily of its investment in the Bank, and its
primary activities are conducted through the Bank. As of March 31, 2010,
its consolidated total assets were $676.1 million, its consolidated total loans
were $507.2 million, and its consolidated total deposits were $605.4
million.
The
Company’s net income or loss is dependent primarily on its net interest income
or loss, which is the difference between the interest income earned on loans,
investments, and other interest-earning assets, and the interest paid on
deposits, borrowings, and other interest-bearing liabilities. The Company’s
net income or loss is also affected by its noninterest income, derived
principally from service charges and fees on deposit accounts and fees earned
upon the origination, sale and/or servicing of financial assets such as loans
and investments, as well as the level of noninterest expenses such as salaries,
employee benefits, and occupancy costs. In addition, the provision the
Company records for loan losses to maintain an adequate allowance for loan
losses significantly contributed to the losses incurred during 2008 and 2009 and
into the three-month period ended March 31, 2010.
The
Company’s operations are also significantly affected by prevailing economic
conditions, competition, and the monetary, fiscal, and regulatory policies of
governmental agencies. Lending activities are influenced by a number of factors,
including the general credit needs of individuals and small and medium-sized
businesses in its market areas, competition among lenders, the level of interest
rates, and the availability of funds. Deposit flows and costs of funds are
influenced by prevailing market interest rates (primarily the rates paid on
competing investments), account maturities, and the levels of personal income
and savings in its market areas.
As part
of the Company’s previous strategic plan for growth and expansion, it executed
the acquisition of Carolina National Corporation (“Carolina National”) effective
January 31, 2008, (the “Merger”). Through the Merger, Carolina National’s
wholly-owned bank subsidiary, Carolina National Bank and Trust Company, a
national banking association, became a subsidiary of First National, and, as of
the close of business on February 18, 2008, was merged with and into the
Bank. On May 30, 2008, the core bank data processing system was
successfully converted, bringing closure to the substantial undertaking of
blending the two banks into one cohesive statewide branch network.
First
National Bank of the South
First
National Bank of the South is a national banking association with its principal
executive offices in Spartanburg, South Carolina. The Bank is primarily engaged
in the business of accepting deposits insured by the Federal Deposit Insurance
Corporation (“FDIC”) and providing commercial, consumer, and mortgage loans to
the general public. It operates under a traditional community banking model and
offers a variety of services and products to consumers and small
businesses. It commenced banking operations in March 2000 in Spartanburg,
South Carolina, where it operates its corporate headquarters and three
full-service branches.
The Bank
relies on its statewide branch network as a vehicle to deliver products and
services to the customers in its markets throughout South Carolina. While
it offers traditional banking products and services to cater to its customers
and generate noninterest income, it also provides a variety of unique options to
complement its core business features. Combining these options with
standard features allows it to maximize its appeal to a broad customer base
while capitalizing on noninterest income potential. The Bank has offered
trust and investment management services since August 2002, through a strategic
alliance with Colonial Trust Company (“Colonial Trust”), a South
Carolina private trust company established in 1913. Through a more
recent alliance with a third party, it offers business expertise in a variety of
areas, such as human resource management, payroll administration, risk
management, and other financial services through a fee-based residual income
arrangement. In addition, it earns income through the origination and sale
of residential mortgages. Management believes that each of these
distinctive services represents not only an exceptional opportunity to build and
strengthen customer loyalty but also to enhance the Bank’s financial position
with noninterest income, as management believes they are less directly impacted
by current economic challenges.
Since
2003, the Company has expanded into four additional markets in South
Carolina. In 2004, the Bank opened its first full-service branch in South
Carolina’s coastal region. Also in 2007, it opened two full-service
branches in the Greenville market in the upstate region of South
Carolina. On February 19, 2008, the four Columbia full-service branches of
Carolina National Bank and Trust Company began to operate as First National Bank
of the South. In July 2008, First National opened its fifth full-service
branch in the Midlands region in Lexington. In May of 2009, it opened its
first full-service branch and market headquarters in the Tega Cay community of
Fort Mill, South Carolina.
Regulatory
Matters
Due to
the Bank’s financial condition, the Office of the Comptroller of the Currency
(the “OCC”) has required that the Bank’s Board of Directors sign a formal
enforcement action with the OCC which conveys specific actions needed to address
certain findings from their examination and to address the Bank’s current
financial condition. On April 27, 2009, the Bank entered into a
consent order with the OCC, which contains a list of strict requirements ranging
from a capital directive, which required it to achieve and maintain minimum
regulatory capital levels in excess of the statutory minimums to be
well-capitalized, to developing a liquidity risk management and contingency
funding plan, in connection with which the Bank will be subject to limitations
on the maximum interest rates it can pay on deposit accounts. The
consent order also contains restrictions on future extensions of credit and
requires the development of various programs and procedures to improve the
Bank’s asset quality as well as routine reporting on its progress toward
compliance with the consent order to the Board of Directors and the
OCC. As a result of the terms of the executed consent order, the Bank
is no longer deemed “well-capitalized,” regardless of its capital
levels. The Federal Reserve Bank of Richmond (the “FRB”) has also
required the Company to enter into a written agreement which contains provisions
similar to the articles in the Bank’s consent order with the OCC. The
Company and the Bank are continuing their efforts to comply with the
requirements of these two agreements in accordance with the applicable
prescribed deadlines.
The
consent order with the OCC requires the establishment of certain plans and
programs. The Bank has established a compliance committee to monitor
and coordinate compliance with the consent order. The committee
consists of five members of the Bank’s Board of Directors and meets at least
monthly to receive written progress reports from management on the results and
status of actions needed to achieve full compliance with each article of the
consent order.
In order
to comply with the consent order, the Bank:
|
•
|
revised,
by June 26, 2009, its liquidity risk management program, which assesses,
on an ongoing basis, the Bank’s current and projected funding needs, and
ensures that sufficient funds exist to meet those needs. The
plan includes specific plans for how the Bank plans to comply with
regulatory restrictions which limit the interest rates the Bank can offer
to depositors;
|
|
•
|
revised,
by June 26, 2009, its loan policy, creating a commercial real estate
concentration management program. The Bank also established a
new loan review program to ensure the timely and independent
identification of problem loans and modified its
existing program for the maintenance of an adequate allowance for loan and
lease losses;
|
|
•
|
took
immediate and continuing action to protect the Bank’s interest in certain
assets identified by the OCC or any other bank examiner by developing a
criticized assets report covering the entire credit relationship with
respect to such assets;
|
|
•
|
developed,
by July 26, 2009, an independent appraisal review and analysis process to
ensure that appraisals conform to appraisal standards and regulations, and
will order, within 30 days following any event that triggers an appraisal
analysis, a current independent appraisal or updated appraisal on loans
secured by certain properties;
|
|
•
|
developed,
by May 27, 2009, a revised other real estate owned program to ensure that
the other real estate owned properties are managed in accordance with
certain applicable banking regulations;
and
|
|
•
|
ensured
that the Bank has competent management in place on a full-time basis to
carry out the board’s policies and operate the Bank in a safe and sound
manner.
|
In
addition, the consent order required the Bank to develop by July 26, 2009, a
three-year capital plan for the Bank, which includes, among other things,
specific plans for maintaining adequate capital, a discussion of the sources and
timing of additional capital, as well as contingency plans for alternative
sources of capital. The consent order also required the Bank to
develop by July 26, 2009, a strategic plan covering at least a three-year
period, which, among other things, included a specific description of the
strategic goals and objectives to be achieved, the targeted markets, the
specific Bank personnel who are responsible and accountable for the plan, and a
description of systems to monitor the Bank’s progress.
On July 24, 2009, the Bank’s board
submitted a written strategic plan and capital plan to the OCC covering a
three-year period which included an action plan for increasing the Bank’s
capital ratios to the minimums set forth in the consent order. The
order also required the Bank to achieve and maintain Tier 1 capital at least
equal to 11% of risk-weighted assets and at least equal to 9% of adjusted total
assets by August 25, 2009. The Bank has been working on efforts to
achieve the capital levels imposed under the consent order. However,
the Bank did not achieve these minimum capital levels by August 25,
2009, the deadline specified in the consent order. On September 28,
2009, the Bank resubmitted its capital plan and strategic plan to incorporate
recent developments in its business strategy and the impact of the change in the
Bank’s president and CEO on its operations. The Bank is working with
the OCC and responding to feedback on the capital plan and strategic plan.
Once the Board of
Directors receives the OCC’s written determination of no supervisory objection,
the Board of Directors will adopt and implement the plans.
On June
15, 2009, the Company entered into a written agreement with the FRB, which
contains provisions similar to the articles in the Bank’s consent order with the
OCC. The Company has taken action to comply with each article of the
written agreement to date and has submitted all materials requested to the FRB
in a timely fashion. On July 31, 2009, under the terms of the written
agreement that it entered into with the FRB, the Bank’s board submitted a
capital plan to the FRB. On October 5, 2009, the Company resubmitted
its capital plan to the FRB to reflect the changes incorporated in the revised
capital plan submitted to the OCC on September 28, 2009. The
Company
is
working with FRB and is responding to feedback on the Capital Plan and the
Company’s Board of Directors
will adopt the written plan within 10 days
of its approval by the FRB.
On August
28, 2009, based on the Bank’s June 30, 2009, regulatory report of condition and
income, the Bank received formal notification under the OCC’s Prompt Corrective
Action (“PCA”) restrictions of the Bank’s “undercapitalized”
status. Accordingly, the Bank’s Board of Directors submitted a
Capital Restoration Plan (“CRP”) to the OCC on September 28,
2009. The CRP addresses, among other things, the steps the Bank will
take to cause its capital levels to return to the minimum level to be adequately
capitalized.
The Bank
also submitted with the CRP a written guarantee from the Company that the Bank
will comply with the terms of the CRP until it has been adequately capitalized
on average during each of four consecutive calendar quarters. As part
of the guarantee, the Company provided assurances of the Bank’s performance and
also provided assurances that the Company will fulfill any commitments to raise
capital made in the CRP. Such a guarantee would have a priority over
most of the other creditors of the Company, including the holders of the trust
preferred securities and common and preferred shareholders.
The Bank
is undertaking certain actions designed to improve its capital position and has
engaged financial advisors to assist with this effort and to evaluate its
strategic options, including capital raises and the possible sale of certain of
the Bank’s assets. As previously disclosed, in August 2009, the
Bank’s Board of Directors purchased 550,500 shares of common stock and 117,625
warrants in a private placement offering, for a collective investment of
$550,500. In addition, since December 31, 2008 and through March 31,
2010, the size of the Bank’s balance sheet has decreased, primarily due to a
reduction of loans held for investment of approximately $202.1 million, such
reduction resulting primarily from loan payoffs. There can be no
assurances as to when or whether the Bank will be successful in negotiating a
sale of any assets.
If the
Bank does not obtain additional capital or sell assets to reduce the size of its
balance sheet to a level which can be supported by its capital levels, the Bank
will not meet the capital minimums set forth in the consent
order. Failure to meet the minimum ratios set forth in the consent
order could result in regulators taking additional enforcement actions against
the Bank. The Bank’s ability to raise capital is contingent on the
current capital markets and on its financial performance. Available
capital markets are not currently favorable, and the Bank cannot be certain of
its ability to raise capital on any terms.
Basis
of Presentation and Going Concern Considerations
Basis
of Presentation
In June
2009, the Financial Accounting Standards Board (“FASB”) issued guidance which
restructured
accounting
principles generally accepted in the United States of American (‘GAAP”)
and simplified access to all authoritative literature by providing a
single source of authoritative nongovernmental GAAP in a topically organized
structure referred to as the FASB Accounting Standards Codification (“ASC”). The
new structure is effective for interim or annual periods ending after September
15, 2009. All existing accounting standards have been superseded and all other
accounting literature not included is considered nonauthoritative.
The
accompanying unaudited consolidated financial statements include all of our
accounts and the accounts of the Bank. All significant inter-company accounts
and transactions have been eliminated in consolidation. The accompanying
unaudited, consolidated financial statements, as of March 31, 2010 and for the
three-month periods ended March 31, 2010 and 2009, are prepared in accordance
with GAAP for interim financial information and with the instructions to
Form 10-Q. Accordingly, they do not include all information and footnotes
required by GAAP for complete financial statements. However, in the opinion of
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation of the financial position as of
March 31, 2010, and the results of operations and cash flows for the three-month
periods ended March 31, 2010 and 2009, have been included.
We
operate in a highly-regulated industry and must plan for the liquidity needs of
both our bank and our holding company separately. A variety of
sources of liquidity are available to us to meet our short-term and long-term
funding needs. Although a number of these sources have been limited
following execution of the consent order with the OCC, management has prepared
forecasts of these sources of funds and our projected uses of funds during 2010
and believes that the sources available are sufficient to meet our bank’s
projected short-term liquidity needs. Our holding company’s liquidity
sources have also been restricted following the execution of the written
agreement with the FRB. As a result, our forecasts of the holding
company’s projected short-term liquidity needs indicate that these sources may
be insufficient to meet these needs.
Operating
results for the three-month period ended March 31, 2010 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2010, or for any other interim period. For further information, refer to the
financial statements and footnotes thereto included in our Annual Report on Form
10-K for the year ended December 31, 2009, as filed with the Securities and
Exchange Commission
(the
“SEC”)
on March 10, 2010. The consolidated financial statements and notes
thereto are presented in accordance with the instructions for Form
10-K.
The
information included in our 2009 Annual Report on Form 10-K should be referred
to in connection with these unaudited interim financial statements. We are not
an accelerated filer as defined in Rule 12b-2 of the Exchange Act. As a result,
we qualify for the extended compliance period with respect to the accountant’s
report on management’s assessment of internal control over financial reporting
and management’s annual report on internal control over financial reporting
required by Public Company Accounting Oversight Board Auditing Standards No.
2.
In
accordance with the requirements of the FASB ASC “Subsequent Events,” issued in
May 2009 and effective for periods ending after June 15, 2009,
as
amended in February 2010,
management performed an evaluation to determine
whether or not there have been any subsequent events since the balance sheet
date.
Going
Concern
As a
result of management’s assessment of the Company’s ability to continue as a
going concern, the consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
discharge of liabilities in the normal course of business for the foreseeable
future, and does not include any adjustments to reflect the possible future
effects on the recoverability or classification of assets, and the amounts or
classification of liabilities that may result should the Company be unable to
continue as a going concern. Management continues to assess a number
of factors including liquidity, capital, and profitability that affect the
Company’s ability to continue in operation. On January 7, 2010, the Company
announced that it had reached an agreement to modify its line of credit with a
correspondent bank. The modifications to the loan agreement cured the
existing covenant violations. In addition, the Company had agreed,
subject to regulatory approval, to pay $3.5 million no later than June 15, 2010,
to its lender, which would fully satisfy its obligations under the line of
credit. Although regulatory approval has not yet been obtained and
the obligations under the line of credit have not yet been satisfied, the
Company has successfully negotiated an extension of the agreement with its
lender. Management believes that its current strategy to raise
additional capital and dispose of assets to deleverage will allow it to raise
its capital ratios to the minimums set forth in the consent order with the
OCC. In addition, management has taken a number of actions to
increase its short-term liquidity position to meet our projected liquidity needs
during this timeframe.
In its
report dated March 9, 2010, the Company’s independent registered public
accounting firm stated that the uncertainty surrounding the Company’s ability to
replenish its capital raises substantial doubt about its ability to continue as
a going concern. This uncertainty is one of the factors that has cast doubt
about its ability to continue in operation. Management continues to assess
a number of other factors including liquidity, capital, and profitability that
affect its ability to continue in operation. Although management is
committed to developing strategies to eliminate the uncertainty surrounding each
of these areas, the outcome of these developments cannot be predicted at this
time. If management is unable to identify and execute a viable strategic
alternative, the Company may be unable to continue as a going
concern.
Reclassification
Certain
prior year amounts have been reclassified to conform with the current year
presentation. These reclassifications have no effect on previously reported
shareholders’ deficit or net loss. Share and per share data reflect the 6%
stock dividend distributed on May 16, 2006, and the 7% stock dividend
distributed on March 30, 2007.
Cash
and Cash Equivalents
The
Company considers all highly-liquid investments with maturities of three months
or less to be cash equivalents.
Supplemental
Noncash Investing and Financing Data
The
following is supplemental disclosure to the statements of cash flows for the
three-month periods ended March 31, 2010 and 2009 (dollars in
thousands):
Cash
|
|
2010
|
|
|
2009
|
|
Cash
paid for interest
|
|
$
|
3,970
|
|
|
$
|
5,308
|
|
Cash
paid for income taxes
(1)
|
|
|
-
|
|
|
|
-
|
|
Non-cash
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in unrealized gain or loss on securities
available-for-sale,
|
|
$
|
595
|
|
|
|
156
|
|
net
of taxes and realized gains
|
|
|
|
|
|
|
|
|
Loans
transferred to other real estate owned, net of write downs of $1,083 and
$2
|
|
|
9,684
|
|
|
|
1,710
|
|
Loans
charged off, net
|
|
|
5,798
|
|
|
|
2,791
|
|
1
There
were no income taxes paid during the three-month periods ended March 31, 2010 or
2009, due to the net operating losses incurred during 2008 and 2009. Please see
Note 7 – Income Taxes for further discussion.
Note 2 – Net Loss per Common
Share
The
following is a reconciliation of the numerators and denominators of the basic
and diluted per share computations for net loss per common share for the
three-month periods ended March 31, 2010 and 2009 (net loss in
thousands):
|
|
2010
|
|
|
2009
|
|
|
|
Basic
|
|
|
Diluted
|
|
|
Basic
|
|
|
Diluted
|
|
Net
loss, as reported
|
|
$
|
(5,379
|
)
|
|
$
|
(5,379
|
)
|
|
$
|
(1,363
|
)
|
|
$
|
(1,363
|
)
|
Weighted
average common shares outstanding
|
|
|
7,917,340
|
|
|
|
7,917,340
|
|
|
|
6,296,698
|
|
|
|
6,296,698
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Noncumulative
convertible perpetual preferred stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Weighted
average common shares outstanding
|
|
|
7,917,340
|
|
|
|
7,917,340
|
|
|
|
6,296,698
|
|
|
|
6,296,698
|
|
Net
loss per common share
|
|
$
|
(0.68
|
)
|
|
$
|
(0.68
|
)
|
|
$
|
(0.22
|
)
|
|
$
|
(0.22
|
)
|
Note:
For the
three-month periods ended March 31, 2010 and 2009, the Company recognized a net
loss rather than net income. In this scenario, diluted loss per
common share equal basic loss per share because additional shares would be
anti-dilutive.
For the
three-month periods ended March 31, 2010 and 2009, the conversion of stock
options and warrants and of noncumulative convertible perpetual preferred stock
shares would have been anti-dilutive to net loss per diluted
share. In these scenarios, diluted loss per share equals basic loss
per share.
The
assumed exercise of stock options and warrants and the conversion of preferred
stock can create a difference between basic and diluted net income or loss per
common share. Dilutive common shares arise from the potentially dilutive
effect of outstanding stock options and warrants, as well as the potential
conversion of convertible perpetual preferred stock. In order to arrive at
net loss available to common shareholders, net loss has been reduced by the
amount of preferred stock dividends declared for that period, if any. This
approach reflects any preferred stock dividends as if they were an expense so
that the impact to the common shareholder is not obscured by its inclusion in
retained earnings. However, when a net loss is recognized rather than net
income, or when the preferred stock dividend during a period outweighs net
income for that period, resulting in a loss available to common shareholders,
diluted loss per share for that period equals basic loss per common
share. The average diluted shares have been computed utilizing the
“treasury stock” method. The weighted average shares outstanding exclude
average common shares of treasury stock purchased through the Company’s share
repurchase program of 106,981 for both of the three-month periods ended March
31, 2010 and 2009.
Note 3
–
Equity Compensation
Plans
On August
24, 2009, each member of the Board of Directors of the Company invested in a
private placement offering in which the directors collectively purchased for
$550,500 a total of (i) 550,500 shares of the Company’s common stock and (ii)
warrants to purchase 137,625 additional shares of the Company’s common stock.
Each warrant has an exercise price of $1.00 and is exercisable for a period of
three years beginning upon the date of issuance.
On August
24, 2009, the Company entered into an employment agreement with its new bank and
holding company President and Chief Executive Officer, J. Barry Mason. This
employment agreement was structured not only to retain and incentivize him as a
key officer, but also to ensure that his interests align with the interests of
the shareholders.
Pursuant
to this employment agreement and consistent with the terms outlined in the stock
award agreement with Mr. Mason executed on September 30, 2009, the Company
granted Mr. Mason 250,000 shares of restricted common stock, as well as options
to purchase one million shares of its common stock at an exercise price of $1.00
per share. The restricted shares vest ratably over five years and were
assigned a fair value of $240,250 based on the market price of the Company’s
common stock on the grant date of August 24, 2009. The recognition of the
related compensation expense for the restricted stock will be approximately
$48,000 annually and was $12,000 for the three-month period ended March 31,
2010. Total unearned equity compensation for these restricted shares as of
March 31, 2010, is $240,000 and is presented as a deduction from shareholders’
deficit as a portion of unearned equity compensation in the accompanying
Consolidated Balance Sheets and Consolidated Statements of Changes in
Shareholders’ Equity (Deficit) and Comprehensive Income (Loss) as of March 31,
2010. The stock options vest ratably over each of the next three years
ending August 24, 2012, with a ten-year expiration on August 24, 2019. The
options are not incentive stock options as defined by Section 422 of the
Internal Revenue Code. The recognition of the related compensation expense
on the options will be approximately $148,000 annually and was $37,000 for the
three-month period ended March 31, 2010.
Note 4 – Investment
Securities
The
amortized cost, fair value and gross unrealized holding gains and losses of
securities available for sale as of March 31, 2010 and December 31, 2009,
consisted of the following (dollars in thousands):
|
March
31, 2010
|
|
|
|
|
|
Gross
|
|
Gross
|
|
|
|
|
|
Amortized
|
|
Unrealized
|
|
Unrealized
|
|
Fair
|
|
|
Cost
|
|
Gains
|
|
Losses
|
|
Value
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
2,000
|
|
|
$
|
-
|
|
|
$
|
(11
|
)
|
|
$
|
1,989
|
|
Mortgage-backed
securities
|
|
|
48,669
|
|
|
|
28
|
|
|
|
(355
|
)
|
|
|
48,342
|
|
Taxable
municipal securities
|
|
|
5,803
|
|
|
|
-
|
|
|
|
(204
|
)
|
|
|
5,599
|
|
Tax-exempt
municipal securities
|
|
|
3,647
|
|
|
|
5
|
|
|
|
(299
|
)
|
|
|
3,353
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
60,119
|
|
|
$
|
33
|
|
|
$
|
(869
|
)
|
|
$
|
59,283
|
|
|
|
December
31, 2009
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
2,000
|
|
|
$
|
-
|
|
|
$
|
(54
|
)
|
|
$
|
1,946
|
|
Mortgage-backed
securities
|
|
|
83,392
|
|
|
|
4
|
|
|
|
(1,141
|
)
|
|
|
82,255
|
|
Taxable
municipal securities
|
|
|
11,353
|
|
|
|
54
|
|
|
|
(277
|
)
|
|
|
11,130
|
|
Tax-exempt
municipal securities
|
|
|
4,104
|
|
|
|
10
|
|
|
|
(333
|
)
|
|
|
3,781
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
100,849
|
|
|
$
|
68
|
|
|
$
|
(1,805
|
)
|
|
$
|
99,112
|
|
As of
March 31, 2010, and December 31, 2009, securities with a carrying value of
approximately $43.2 million and $45.2 million, respectively, were pledged to
secure public deposits, repurchase agreements and overnight borrowings with
correspondent banks, and for other purposes required or permitted by law,
including as collateral for Federal Home Loan Bank of Atlanta (“FHLB”) advances
outstanding and to satisfy the requirements related to the Bank’s clearing
account with the FRB, which was required beginning in June 2009. The FRB
requires the Bank to maintain certain collateral balances with them to secure
its daily cash clearing transactions, which began clearing directly through the
Bank’s FRB account beginning in June 2009. As of March 31, 2010, the FRB
held as collateral loans from the Bank’s loan portfolio for construction and raw
land totaling $8.5 million and securities from the Bank’s investment portfolio
totaling $9.1 million, with an FRB assigned collateral value of $8.6
million.
The
following tables show gross unrealized losses and fair value, aggregated by
investment category, and length of time that individual securities have been in
a continuous unrealized loss position as of March 31, 2010 and December 31, 2009
(dollars in thousands):
|
March
31, 2010
|
|
|
Securities
available for sale:
|
|
|
Less
than 12 months
|
|
12
months or more
|
|
Total
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,989
|
|
|
$
|
(11
|
)
|
|
$
|
1,989
|
|
|
$
|
(11
|
)
|
Mortgage-backed
securities
|
|
|
43,816
|
|
|
|
(355
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
43,816
|
|
|
|
(355
|
)
|
Taxable
municipal securities
|
|
|
5,599
|
|
|
|
(204
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
5,599
|
|
|
|
(204
|
)
|
Tax-exempt
municipal securities
|
|
|
1,447
|
|
|
|
(31
|
)
|
|
|
1,600
|
|
|
|
(268
|
)
|
|
|
3,047
|
|
|
|
(299
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
50,862
|
|
|
$
|
(590
|
)
|
|
$
|
3,589
|
|
|
$
|
(279
|
)
|
|
$
|
54,451
|
|
|
$
|
(869
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2009
|
|
|
Securities
available for sale:
|
|
|
Less
than 12 months
|
|
12
months or more
|
|
Total
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
1,946
|
|
|
$
|
(54
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,946
|
|
|
$
|
(54
|
)
|
Mortgage-backed
securities
|
|
|
76,131
|
|
|
|
(1,141
|
)
|
|
|
221
|
|
|
|
-
|
|
|
|
76,352
|
|
|
|
(1,141
|
)
|
Taxable
municipal securities
|
|
|
5,528
|
|
|
|
(277
|
)
|
|
|
1,560
|
|
|
|
-
|
|
|
|
7,088
|
|
|
|
(277
|
)
|
Tax-exempt
municipal securities
|
|
|
1,436
|
|
|
|
(39
|
)
|
|
|
-
|
|
|
|
(294
|
)
|
|
|
1,436
|
|
|
|
(333
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
85,041
|
|
|
$
|
(1,511
|
)
|
|
$
|
1,781
|
|
|
$
|
(294
|
)
|
|
$
|
86,822
|
|
|
$
|
(1,805
|
)
|
As of
March 31, 2010, and December 31, 2009, four individual securities had been in a
continuous loss position for twelve months or more. As discussed
below, management has evaluated all of the Bank’s debt securities for credit
impairment and found no evident credit losses. The unrealized losses in the
municipal securities portfolio are due to widening credit spreads caused by
concerns about the bond insurers associated with these securities. Management
believes that all contractual cash flows will be received on this
portfolio.
As of
March 31, 2010, and December 31, 2009, many investment securities had unrealized
losses that are considered temporary in nature because the decline in fair value
has been caused by the interest rate environment, widening spreads and a market
liquidity crisis brought about by a lack of investor confidence; such unrealized
losses are not caused by cash flow impairment. The Bank has the intent and
ability to hold these securities until recovery, which may be to their normal
maturity. In making this determination, management performs an analysis of
whether it intends to sell and whether it is more likely than not that the Bank
will be required to sell these securities before anticipated recovery of the
amortized cost basis. The Bank considers its expected liquidity and
capital needs, including its asset/liability management needs, forecasts,
strategies, and other relevant information. These unrealized losses are
recorded, net of tax, as accumulated other comprehensive loss on available for
sale securities in the Consolidated Statement of Changes in
Shareholders’ Equity (Deficit) and Comprehensive Income
(Loss).
The
amortized cost and estimated fair value of investment securities available for
sale as of March 31, 2010, are shown in the following table by contractual
maturity. During certain interest rate environments, some, or all of these
securities may be called for redemption by their issuers prior to the scheduled
maturities. Further, maturities within the mortgage-backed securities
portfolio may differ from scheduled and contractual maturities because the
mortgages underlying the securities may be called for redemption or repaid
without penalties. Therefore, these securities are not included in the
maturity categories in the following maturity summary.
Fair value of securities
was determined using quoted market prices (dollars in thousands).
|
|
March
31, 2010
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
Due
after one year, through five years
|
|
$
|
-
|
|
|
$
|
-
|
|
Due
after five years, through ten years
|
|
|
3,761
|
|
|
|
3,714
|
|
Due
after ten years
|
|
|
7,689
|
|
|
|
7,227
|
|
Subtotal
|
|
|
11,450
|
|
|
|
10,941
|
|
Mortgage-backed
securities
|
|
|
48,669
|
|
|
|
48,342
|
|
Total
|
|
$
|
60,119
|
|
|
$
|
59,283
|
|
As of
both March 31, 2010, and December 31, 2009, the Company owned other
nonmarketable equity securities of $6.8 million. Other nonmarketable
equity securities include investments in stock issued by the FHLB and the
FRB.
Note 5 –
Loans
A summary
of loans by classification as of March 31, 2010 and December 31, 2009, is as
follows (dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
|
Amount
|
|
|
%
of Total
(1)
|
|
|
Amount
|
|
|
%
of Total
|
|
Commercial
and industrial
|
|
$
|
24,251
|
|
|
|
4.78
|
%
|
|
$
|
31,564
|
|
|
|
5.88
|
%
|
Commercial
secured by real estate
|
|
|
312,638
|
|
|
|
61.64
|
%
|
|
|
329,897
|
|
|
|
61.42
|
%
|
Real
estate - residential mortgages
|
|
|
165,937
|
|
|
|
32.72
|
%
|
|
|
169,815
|
|
|
|
31.61
|
%
|
Installment
and other consumer loans
|
|
|
4,775
|
|
|
|
0.94
|
%
|
|
|
6,349
|
|
|
|
1.18
|
%
|
Total
loans held for investment
|
|
|
507,601
|
|
|
|
|
|
|
|
537,625
|
|
|
|
|
|
Unearned
income
|
|
|
(416
|
)
|
|
|
(0.08
|
%)
|
|
|
(464
|
)
|
|
|
(0.09
|
%)
|
Total
loans, net of unearned income
|
|
|
507,185
|
|
|
|
100.00
|
%
|
|
|
537,161
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
allowance for loan losses
|
|
|
(23,310
|
)
|
|
|
4.60
|
%
|
|
|
(25,408
|
)
|
|
|
4.73
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans, net
|
|
$
|
483,875
|
|
|
|
|
|
|
$
|
511,753
|
|
|
|
|
|
Approximately
$318.4 million and $345.1 million of the loans were variable interest rate loans
as of March 31, 2010 and December 31, 2009, respectively. The
remaining portfolio was comprised of fixed interest rate loans.
As of March 31, 2010, and December 31,
2009, nonperforming assets (nonperforming loans plus other real estate owned)
were $136.1 million and $137.3 million, respectively. In addition, as of
May 4, 2010, there were contracts in place for pending sales of loans and other
real estate owned of approximately $2.0 million, which will reduce nonperforming
assets to $134.1 million. Included in the $118.4 million balance of
loans on nonaccrual status reported as of March 31, 2010 were three related USDA
guaranteed loans with the guaranteed portion equaling $3.3
million. Net of this guaranteed portion in addition to pending sales,
total nonperforming assets were $130.8 million. Other real estate owned of $17.7
million was recorded at $20.3 million, net of reserves of $1.1 million and
estimated costs to sell of $1.5 million as of March 31,
2010. Foregone interest income during the three-month periods ended
March 31, 2010 and 2009, on these nonaccrual loans and other nonaccrual loans
charged off was approximately $1,434,000 and $331,000,
respectively. There were no performing loans contractually past due
in excess of 90 days and still accruing interest as of March 31,
2010. Included in the $128.0 million balance of loans on nonaccrual
status reported as of December 31, 2009, was one loan contractually past due for
90 days and still accruing interest. It was placed on nonaccrual
status on the following business day.
There
were nonperforming loans that were specifically reviewed for impairment,
under the criteria defined in the Receivables Topic of the FASB ASC, of $113.3
million and $119.8 million (after related chargeoffs of $18.9 million and $22.5
million), with related valuation allowances of approximately $5.5 million and
$8.6 million as of March 31, 2010, and December 31, 2009,
respectively. The remainder of the nonperforming loans were assigned a
general reserve according to their respective loan categories. The amounts
reported as nonperforming assets in these consolidated financial statements
reflect developments subsequent to March 31, 2010, and therefore may differ from
the amounts presented on the Consolidated Balance Sheets and Consolidated
Statements of Operations as of or for the three-month period ended March 31,
2010.
Significant
nonperforming loans consist primarily of loans made to residential real estate
developers. The downturn in the residential housing market is the primary
factor leading to the ongoing deterioration in these loans. Therefore,
additional reserves have been provided in the allowance for loan losses during
the three-month period ended March 31, 2010, to account for what management
believes is the increased probable credit risk associated with these
loans. These additional reserves are based on management’s evaluation of a
number of factors including the estimated real estate values of the collateral
supporting each of these loans.
As of
March 31, 2010, total residential construction and land development loans
totaled $69.5 million, or 13.6%, of the loan portfolio. These loans carry a
higher degree of risk than long-term financing of existing real estate since
repayment is dependent on the ultimate completion of the project or home and
usually on the sale of the property or permanent financing. Slow housing
conditions have affected some of these borrowers’ ability to sell the completed
projects in a timely manner. Management believes that the combination of
general reserves in the allowance for loan losses and established impairments of
these loans will be adequate to account for the current risk associated with the
residential construction loan portfolio as of March 31, 2010.
Other
real estate owned consists of property acquired through foreclosure. During
the three-month period ended March 31, 2010, gross other real estate owned
increased by $9.7 million due to the foreclosure of several properties. The
transfer of these properties represents the next logical step from their
previous classification as nonperforming loans to other real estate owned to
give the Bank the ability to control the properties. This increase was
partially offset by the disposition of several pieces of foreclosed property
totaling $0.2 million, which resulted in a net loss of $38,000. The reserve
for other real estate owned was increased by $1.1 million during the three-month
period ended March 31, 2010.
The
repossessed collateral is primarily made up of single-family residential
properties in varying stages of completion and various commercial
properties. These properties are being actively marketed and maintained
with the primary objective of liquidating the collateral at a level which most
accurately approximates fair market value and allows recovery of as much of the
unpaid principal balance as possible upon the sale of the property in a
reasonable period of time. The cost of owning the properties for the
three-month periods ended March 31, 2010 and 2009, was approximately $72,000 and
$52,000, respectively, excluding net writedowns and adjustments to reserves of
$40,000 for the three-month period ended March 31, 2010. The carrying
value of these assets is believed to be representative of their fair market
value, although there can be no assurance that the ultimate net proceeds from
the sale of these assets will be equal to or greater than the carrying
values.
As of
March 31, 2010, securities totaling $9.9 million and qualifying loans held by
the Bank and collateralized by 1-4 family residences, multi-family properties,
home equity lines of credit (“HELOC’s”) and commercial properties totaling $59.0
million were pledged as collateral for FHLB advances outstanding of $52.9
million. As of December 31, 2009, securities totaling $8.5 million
and qualifying loans held by the Bank and collateralized by 1-4 family
residences, HELOC’s and commercial properties totaling $60.5 million were
pledged as collateral for FHLB advances outstanding of $54.0 million as
of December 31, 2009. Management assesses and monitors current FHLB
guidelines to determine the eligibility of loans to qualify as collateral for an
FHLB advance. The Bank is subject to the FHLB’s revised credit risk rating,
which was effective June 27, 2008 and incorporated enhancements to the FHLB’s
credit risk rating system, which assigns member institutions a rating which is
reviewed quarterly. The rating system utilizes key factors such as loan
quality, capital, liquidity, profitability, etc. The Bank’s ability to
access its available borrowing capacity from the FHLB in the future is subject
to its rating, and any subsequent changes based on the Bank’s financial
performance considered by the FHLB in its assignment of the Bank’s credit risk
rating each quarter. In addition, residential collateral discounts recently
were applied during 2009 which further reduced the Bank’s borrowing capacity.
While the Bank is operating under its current regulatory enforcement action, the
Bank is not allowed to obtain future advances from the FHLB or renew maturing
advances with the FHLB. During the remainder of the year ending 2010,
$4.1 million in FHLB advances will mature and will need to be replaced with an
alternate source of funding. Management’s plan to replace these funds
is to utilize the securities collateralizing the advance which will be released
when the advance matures to generate the liquidity needed to repay this
advance.
Changes
in the allowance for loan losses for the three-month periods ended March 31,
2010 and 2009, were as follows (dollars in thousands):
|
|
2010
|
|
|
2009
|
|
Balance,
beginning of year
|
|
$
|
25,408
|
|
|
$
|
23,033
|
|
Provision
charged to operations
|
|
|
3,700
|
|
|
|
2,152
|
|
Loans
charged off
|
|
|
(6,546
|
)
|
|
|
(2,793
|
)
|
Recoveries
on loans previously charged off
|
|
|
748
|
|
|
|
2
|
|
Balance,
end of period
|
|
$
|
23,310
|
|
|
$
|
22,394
|
|
The
provision for loan losses has been made primarily as a result of management’s
assessment of general loan loss risk after considering historical operating
results, as well as comparable peer data. The Bank’s evaluation is
inherently subjective as it requires estimates that are susceptible to
significant change. In addition, various regulatory agencies review
the Bank’s allowance for loan losses through their periodic examinations, and
they may require the Bank to record additions to the allowance for loan losses
based on their judgment about information available to them at the time of their
examinations. The Bank’s losses will undoubtedly vary from its
estimates, and there is a possibility that chargeoffs in future periods will
exceed the allowance for loan losses as estimated at any point in
time.
Note 6 – Real Estate
Owned
Included
in nonperforming assets as of March 31, 2010, and December 31, 2009, are $17.7
million and $9.3 million in other real estate owned (net of valuation reserves
of $2.6 million and $1.5 million, respectively) or 13.0% and 7.9% of total
nonperforming assets, respectively. Other real estate owned consists of
property acquired through foreclosure and is reflected on the face of the
accompanying Consolidated Balance Sheets. The transfer of these properties
represents the next logical step from their previous classification as
nonperforming loans to other real estate owned to give the Bank the ability to
control the properties. The repossessed collateral is made up of
single-family residential properties in varying stages of completion and various
commercial properties. These properties are being actively marketed and
maintained with the primary objective of liquidating the collateral at a level
which most accurately approximates fair market value and allows recovery of as
much of the unpaid principal balance as possible upon the sale of the property
in a reasonable period of time. Management regularly evaluates the carrying
balance of the Bank’s other real estate owned and may record additional
writedowns in the future after review of a number of factors including, among
them, collateral values and general market conditions in the area surrounding
the properties. The carrying value of these assets is believe to be
representative of their fair market value, although there can be no assurance
that the ultimate net proceeds from the sale of these assets will be equal to or
greater than the carrying values. Management continues to evaluate and
assess all nonperforming assets on a regular basis as part of its well
established loan monitoring and review process.
|
|
March
31,
|
|
|
|
2010
|
|
|
2009
|
|
Balance,
beginning of the year
|
|
$
|
9,315
|
|
|
$
|
6,510
|
|
Additions
|
|
|
9,684
|
|
|
|
1,710
|
|
Sales
|
|
|
(189
|
)
|
|
|
(1,801
|
)
|
Writedowns
|
|
|
(1,083
|
)
|
|
|
(2
|
)
|
Balance,
end of the period
|
|
$
|
17,727
|
|
|
$
|
6,417
|
|
Note 7 – Income
Taxes
The
following is a summary of the items which caused recorded income taxes to differ
from taxes computed using the statutory tax rate for the three-month periods
ended March 31, 2010 and 2009 (dollars in thousands):
|
|
2010
|
|
|
2009
|
|
Income
tax benefit at federal statutory rate of 34%
|
|
$
|
(1,829
|
)
|
|
$
|
(463
|
)
|
Increase
in valuation allowance for deferred tax asset
|
|
|
1,829
|
|
|
|
478
|
|
Tax-exempt
securities income
|
|
|
(12
|
)
|
|
|
(58
|
)
|
Capital
loss on writedown of equity securities
|
|
|
-
|
|
|
|
40
|
|
Bank-owned
life insurance earnings
|
|
|
(11
|
)
|
|
|
(11
|
)
|
Other,
net
|
|
|
23
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit
|
|
$
|
-
|
|
|
$
|
-
|
|
The
components of the deferred tax assets and liabilities as of March 31, 2010, and
December 31, 2009, are as
follows
(dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
Deferred
tax liability:
|
|
|
|
|
|
|
Core
deposit intangible
|
|
$
|
348
|
|
|
$
|
365
|
|
Tax
depreciation in excess of book
|
|
|
308
|
|
|
|
308
|
|
Prepaid
expenses deducted currently for tax
|
|
|
158
|
|
|
|
158
|
|
Deferred
loss on sale/leaseback transaction
|
|
|
101
|
|
|
|
102
|
|
Loan
servicing rights
|
|
|
42
|
|
|
|
45
|
|
Other
|
|
|
80
|
|
|
|
80
|
|
Total
deferred tax liability
|
|
|
1,037
|
|
|
|
1,058
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax asset:
|
|
|
|
|
|
|
|
|
Allowance
for loan losses
|
|
$
|
7,676
|
|
|
$
|
8,366
|
|
Net
operating loss carryforward
|
|
|
12,421
|
|
|
|
9,923
|
|
Writedowns
on other real estate owned
|
|
|
754
|
|
|
|
754
|
|
Unrealized
loss on securities available for sale
|
|
|
284
|
|
|
|
590
|
|
Other
|
|
|
43
|
|
|
|
43
|
|
Total
deferred tax asset
|
|
|
21,178
|
|
|
|
19,676
|
|
Valuation
allowance
|
|
|
19,857
|
|
|
|
18,028
|
|
Deferred
tax asset after valuation allowance
|
|
|
1,321
|
|
|
|
1,648
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax asset
|
|
$
|
284
|
|
|
$
|
590
|
|
The
Company has analyzed the tax positions taken or expected to be taken in its tax
returns and concluded it has no liability related to uncertain tax positions in
accordance with FASB ASC “Income Taxes.” The change in the net deferred tax
asset of $306,000 reflects the tax effect of the change in the unrealized loss
on securities available for sale during the three-month period ended March 31,
2010.
Deferred
tax assets represent the future tax benefit of deductible differences and, if it
is more likely than not that a tax asset will not be realized, a valuation
allowance is required to reduce the recorded deferred tax assets to net
realizable value. As of March 31, 2010, the Company increased the valuation
allowance to reflect the portion of the deferred income tax asset that is not
able to be offset against reversals of net future taxable temporary differences
projected to occur in the remainder of 2010. The valuation allowance
of $19.9 million has been recorded due to the substantial doubt of the Company’s
ability to realize all of the net deferred tax assets.
Note 8 – Regulatory Capital
Requirements and Dividend Restrictions
The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure
to meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for Prompt Corrective Action (“PCA”),
the Bank must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank’s capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors. PCA provisions
are not applicable to bank holding companies.
The Company and the Bank are required to
maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital,
and Tier 1 leverage capital (as defined in the regulations). To be
considered “well-capitalized,” a bank generally must maintain total risk-based
capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of
at least 5%. However, so long as the Bank is subject to the
enforcement action executed with the OCC on April 27, 2009, it will not be
deemed to be well-capitalized even if it maintains the typical minimum capital
ratios to be well-capitalized. As of November 25, 2009, the Bank was
notified that its capital classification was significantly
undercapitalized. On April 30, 2010,
based on the Bank’s
March 31, 2010
regulatory report
of condition and income, the Bank
’s capital classification was critically
undercapitalized as its tangible equity ratio was 2.0% or less. The
Bank’s capital category is determined solely for the purpose of applying the PCA
restrictions, which may not constitute an accurate representation of the Bank’s
overall financial condition or prospects. For instance,
the
Bank’s tangible equity ratio
exceeded 2.0% for the month of
April 2010, due to further balance sheet
reductions resulting from maturation of brokered
deposits.
The
following table presents the Company’s and the Bank’s actual capital amounts and
ratios as of March 31, 2010 and December 31, 2009, as well as the minimum
calculated amounts for each regulatory-defined category presented (dollars in
thousands):
|
|
Actual
|
|
|
For
Capital Adequacy Purposes
|
|
|
Minimum
Capital Levels Set Forth in Regulatory Consent Order
(1)
|
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
As
of March 31, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital to risk-weighted assets
|
|
$
|
(8,800
|
)
|
|
|
(1.78
|
%)
|
|
$
|
39,454
|
|
|
|
8.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
Tier
1 to capital risk-weighted assets
|
|
$
|
(8,800
|
)
|
|
|
(1.78
|
%)
|
|
$
|
19,727
|
|
|
|
4.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
Tier
1 capital to average assets
|
|
$
|
(8,800
|
)
|
|
|
(1.24
|
%)
|
|
$
|
28,384
|
|
|
|
4.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Bank
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital to risk-weighted assets
|
|
$
|
19,980
|
|
|
|
4.06
|
%
|
|
$
|
39,402
|
|
|
|
8.00
|
%
|
|
$
|
|
(1)
|
|
|
|
(1)
|
Tier
1 to capital risk-weighted assets
|
|
$
|
13,613
|
|
|
|
2.76
|
%
|
|
$
|
19,701
|
|
|
|
4.00
|
%
|
|
$
|
54,178
|
|
|
|
11.00
|
%
|
Tier
1 capital to average assets
|
|
$
|
13,613
|
|
|
|
1.92
|
%
|
|
$
|
28,400
|
|
|
|
4.00
|
%
|
|
$
|
63,900
|
|
|
|
9.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital to risk-weighted assets
|
|
$
|
(3,801
|
)
|
|
|
(0.72
|
%)
|
|
$
|
52,654
|
|
|
|
8.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
Tier
1 to capital risk-weighted assets
|
|
$
|
(3,801
|
)
|
|
|
(0.72
|
%)
|
|
$
|
31,593
|
|
|
|
4.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
Tier
1 capital to average assets
|
|
$
|
(3,801
|
)
|
|
|
(0.50
|
%)
|
|
$
|
37,992
|
|
|
|
4.00
|
%
|
|
$
|
N/A
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Bank
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
capital to risk-weighted assets
|
|
$
|
24,770
|
|
|
|
4.72
|
%
|
|
$
|
41,990
|
|
|
|
8.00
|
%
|
|
$
|
|
(1)
|
|
|
|
(1)
|
Tier
1 to capital risk-weighted assets
|
|
$
|
17,976
|
|
|
|
3.42
|
%
|
|
$
|
20,995
|
|
|
|
4.00
|
%
|
|
$
|
57,736
|
|
|
|
11.00
|
%
|
Tier
1 capital to average assets
|
|
$
|
17,976
|
|
|
|
2.37
|
%
|
|
$
|
30,321
|
|
|
|
4.00
|
%
|
|
$
|
68,222
|
|
|
|
9.00
|
%
|
(1)
On April 27, 2009, the Bank became
subject to a regulatory Consent Order with the OCC.
Minimum capital amounts and ratios
presented for the Bank as of
March 31, 2010, and
December 31, 2009, are the minimum
levels set forth in the Consent Order.
No minimum total capital to
risk-weighted assets ratio was specified in the Consent Order.
Regardless of the Bank’s capital ratios,
it is unable to be classified as “well-capitalized” while it is operating under
the Consent Order with the OCC.
On June 15, 2009, the Company entered
into a written agreement with the FRB.
No minimum capital levels for the
Company were set forth in the written agreement with the
FRB.
The
ability of the Company to pay cash dividends is dependent upon receiving cash in
the form of dividends from the Bank. The dividends that may be paid by the
Bank to the Company are subject to legal limitations and regulatory capital
requirements. The approval of the OCC is required if the total of all
dividends declared by a national bank in any calendar year exceeds the total of
its net profits for that year combined with its retained net profits for the
preceding two years, less any required transfers to surplus. Further, the
Company cannot pay cash dividends on its common stock during any calendar
quarter unless full dividends on the preferred stock for the dividend period
ending during the calendar quarter have been declared and the Company has not
failed to pay a dividend in the full amount of the preferred stock with respect
to the period in which such dividend payment in respect of its common stock
would occur. However, restrictions currently exist, including within the Consent
Order the Bank signed with the OCC on April 27, 2009, that prohibit the Bank
from paying cash dividends to the Company. As of March 31, 2010, no cash
dividends have been declared or paid by the Bank or the Company. In
addition, pursuant to the terms of the written agreement that the Company
entered into with the FRB on June 15, 2009, the Company must obtain
preapproval of the FRB before paying dividends. To help preserve
liquidity, the Company’s Board of Directors did not declare a dividend on
the preferred stock for any quarter during 2009 or 2010, and the Company has
never paid cash dividends on its common stock.
Note
9
– Fair Value
Disclosures
In
September 2006, the FASB issued “Fair Value Measurements” guidance, which
defines fair value, establishes a consistent framework for measuring fair value
in generally accepted accounting principles and expands disclosures about fair
value measurements. This standard did not require any new fair value
measurements, but rather eliminated inconsistencies found in various prior
pronouncements. In February 2008, the FASB issued new guidance which delayed the
effective date for all non-financial assets and non-financial liabilities except
those that are recognized or disclosed at fair value in the financial statements
on a recurring basis. The new guidance partially deferred the effective date to
fiscal years beginning after November 15, 2008, for items within the scope of
the new guidance. The fair value guidance requires the Company, among other
things, to maximize the use of observable inputs and minimize the use of
unobservable inputs in its fair value measurement techniques. Additional
disclosures are provided as applicable. The adoption of this guidance did not
have a significant impact on the Company’s consolidated financial
statements.
Beginning
January 1, 2008, the Company was able to prospectively elect to apply the fair
value option for any of its financial assets or liabilities. Management has
evaluated this statement and has elected not to apply the fair value option,
except for those financial assets or liabilities already required to be measured
at fair value at this time.
The
guidance provided by the Fair Value Measurements and Disclosures Topic of the
FASB ASC defines fair value as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. This guidance also 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 standard describes three levels of inputs that may be used to measure fair
value:
|
•
|
Level
1 - Valuations are based on quoted prices in active markets for identical
assets and liabilities. Level 1 assets include debt and equity securities
that are traded in an active exchange market, as well as certain U.S.
Treasury securities that are highly liquid and are actively traded in
over-the-counter markets.
|
|
•
|
Level
2 - Valuations are based on 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 2 assets and liabilities
include debt securities with quoted prices that are traded less frequently
than exchange-traded instruments and derivative contracts whose value is
determined using a pricing model with inputs that are observable in the
market or can be derived principally from or corroborated by observable
market data. Valuations are obtained from third party pricing services for
similar assets or liabilities. This category generally includes U.S.
government agencies, agency mortgage-backed debt securities, private-label
mortgage-backed debt securities, state and municipal bonds, corporate
bonds, certain derivative contracts, and mortgage loans held for
sale.
|
|
•
|
Level
3 - Valuations include unobservable inputs that are supported by little or
no market activity and that are significant to the fair value of the
assets. For example, certain available for sale securities included in
this category are not readily marketable and may only be redeemed with the
issuer at par. This category includes certain derivative contracts for
which independent pricing information was not able to be obtained for a
significant portion of the underlying
assets.
|
Securities
available for sale are recorded at fair value on a recurring basis. Fair value
measurement is based upon quoted market prices. Level 2 securities include
mortgage-backed securities and bonds issued by government sponsored enterprises.
The Company recognized gains from the sale of securities available for sale as a
component of net loss reported for the three-month periods ended March 31, 2010
and 2009, of $149,000 and $183,000, respectively.
The
tables below summarize assets measured at fair value on a recurring basis. No
liabilities are recorded at fair value on a recurring basis (dollars in
thousands).
|
|
March
31, 2010
|
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Securities
available for sale
|
|
$
|
59,283
|
|
|
$
|
-
|
|
|
$
|
59,283
|
|
|
$
|
-
|
|
Other
nonmarketable equity securities
|
|
|
6,818
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
66,101
|
|
|
$
|
-
|
|
|
$
|
59,283
|
|
|
$
|
6,818
|
|
|
|
December
31, 2009
|
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Securities
available for sale
|
|
$
|
99,112
|
|
|
$
|
-
|
|
|
$
|
99,112
|
|
|
$
|
-
|
|
Other
nonmarketable equity securities
|
|
|
6,818
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
105,930
|
|
|
$
|
-
|
|
|
$
|
99,112
|
|
|
$
|
6,818
|
|
The
following table reconciles the changes in the fair value measurements using
significant observable inputs (Level 2) for securities available for sale from
December 31, 2009 to March 31, 2010 (dollars in thousands):
|
|
As
of or for the
|
|
|
|
three
months ended
|
|
|
|
March
31, 2010
|
|
Balance,
beginning of year
|
|
$
|
99,112
|
|
Proceeds
from maturities/prepayment of securities available for
sale
|
|
|
(1,937
|
)
|
Proceeds
from sales of securities available for sale
|
|
|
(40,831
|
)
|
Purchases
of securities available for sale
|
|
|
1,998
|
|
Amortization
of securities discounts and premiums, net
|
|
|
(109
|
)
|
Gain
on sale of securities available for sale, net
|
|
|
149
|
|
Change
in unrealized gain on securities available for sale
|
|
|
901
|
|
Balance,
end of year
|
|
$
|
59,283
|
|
The Company does not record loans held
for investment at fair value on a recurring basis. However, loans
considered impaired, within the definition of the guidance found in the
Receivables Topic of the FASB ASC are individually evaluated for
impairment. Under these guidelines, a loan is considered impaired, based on
current information and events, if it is probable that the Company will be
unable to collect the payments of principal and interest according to the terms
of the original loan agreement. Uncollateralized loans are measured for
impairment based on the present value of expected future cash flows discounted
at the original contractual interest rate, while all collateral-dependent loans
are measured for impairment based on the fair value of the collateral. When
the fair value of the collateral is based on an observable market price or a
current appraised value, the Company records the impaired loan as nonrecurring
Level 2. When an appraised value is not available or management determines
the fair value of the collateral is further impaired below the appraised value
and there is no observable market price, the Company records the impaired loan
as nonrecurring Level 3. The Company recognizes changes in the fair value
of impaired loans through adjustments to the allowance for loan losses or by
charging off the impaired portion of the loan if it is deemed
uncollectible.
Other
real estate owned is adjusted to fair value upon transfer of the loans to
foreclosed assets. Subsequently, foreclosed assets are carried at the lower
of carrying value or fair value. Fair value is based upon independent
market prices, appraised values of the properties or management’s estimation of
the value of the properties. When the fair value of the collateral is based
on an observable market price, the Company records the other real estate owned
as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below
the appraised value and there is no market price, the Company records the other
real estate owned as nonrecurring Level 3. Other real estate owned is
reviewed and evaluated on at least an annual basis for additional impairment and
adjusted accordingly, based on the facts discussed above. In addition,
management may discount the appraised value based on its historical knowledge,
and changes in market conditions since the time of valuation and/or its
expertise and knowledge of the asset. These discounts result in a Level 3
classification of their inputs to determine fair value.
The
tables below summarize assets measured at fair value on a nonrecurring
basis. No liabilities are recorded at fair value on a nonrecurring
basis (dollars in thousands).
|
March
31, 2010
|
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Impaired
loans
|
|
$
|
107,954
|
|
|
$
|
-
|
|
|
$
|
95,373
|
|
|
$
|
12,581
|
|
Other
real estate owned
|
|
|
17,727
|
|
|
|
-
|
|
|
|
|
|
|
|
17,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
125,681
|
|
|
$
|
-
|
|
|
$
|
95,373
|
|
|
$
|
30,308
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2009
|
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Impaired
loans
|
|
$
|
111,259
|
|
|
$
|
-
|
|
|
$
|
51,183
|
|
|
$
|
60,076
|
|
Other
real estate owned
|
|
|
9,315
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9,315
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
120,574
|
|
|
$
|
-
|
|
|
$
|
51,183
|
|
|
$
|
69,391
|
|
For the
three-month period ended March 31, 2010, the Company recognized losses related
to impaired loans and other real estate owned that are measured at fair value on
a nonrecurring basis. Approximately $5.5 million related to impaired loans
and $1.1 million in additional reserves on other real estate owned were
recognized as either chargeoffs or specific allocations within the allowance for
loan losses or the valuation reserve for other real estate owned for that
period. In addition, $38,000 of losses were recorded on the sale of other
real estate owned during the three-month period ended March 31, 2010, which were
not included in the valuation reserve at the time of the sale which were
incurred as a result of discounts taken to facilitate the sale of these
assets.
The FASB
ASC “Fair Value Measurements and Disclosures” requires disclosure of fair value
information, whether or not recognized in the statement of financial position,
when it is practical to estimate the fair value. A financial instrument is
defined as cash, evidence of an ownership interest in an entity or contractual
obligations, which require the exchange of cash, or other financial instruments.
Certain items are specifically excluded from the disclosure requirements,
including our common stock, premises and equipment, accrued interest receivable
and payable, and other assets and liabilities.
Management
uses its best judgment in estimating the fair value of the Company’s financial
instruments; however, there are inherent weaknesses in any estimation technique.
Therefore, for substantially all financial instruments, the fair value estimates
presented herein are not necessarily indicative of the amounts the Company could
realize in a sales transaction as of March 31, 2010, or December 31, 2009. The
estimated fair value amounts have been updated for purposes of these financial
statements and the estimated fair values of these financial instruments
subsequent to the reporting dates may be different than the amounts reported at
the periods noted.
The
information should not be interpreted as an estimate of the fair value of the
entire Company since a fair value calculation is only required for a limited
portion of our assets, and due to the wide range of valuation techniques and the
degree of subjectivity used in making the estimate, comparisons between our
disclosures and those of other companies or banks may not be meaningful. The
following methods and assumptions were used in estimating fair value disclosures
for financial instruments.
Fair
value approximates book value for cash and cash equivalents due to the
short-term nature of the instruments. Fair value for loans held for investment,
which are not under the scope of the guidance found in the Receivables Topic of
the FASB ASC, is based on the discounted present value of the estimated future
cash flows. Discount rates used in these computations approximate the rates
currently offered for similar loans of comparable terms and credit quality. An
overall valuation adjustment is made for specific credit risks as well as
general portfolio credit risk. Loan commitments and letters of credit, which are
off-balance-sheet financial instruments, are short-term and typically based on
current market rates; therefore, the fair values of these items are not included
in the following table.
Fair
value for demand deposit accounts and interest-bearing deposit accounts with no
fixed maturity date is equal to the carrying value. Certificate of deposit
accounts are estimated by discounting cash flows from expected maturities using
current interest rates on similar instruments. Fair value approximates book
value for federal funds purchased and other short-term borrowings including
short-term FHLB advances, due to the short-term nature of the borrowing. Fair
value for long-term FHLB advances and other long-term debt is based on
discounted cash flows using current market rates for similar instruments. Fair
value for the floating rate junior subordinated debentures is based on the
carrying value.
The
estimated fair values of our financial instruments, excluding financial
instruments measured at fair value on a recurring basis, were as follows
(dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
|
Carrying
|
|
|
Estimated
|
|
|
Carrying
|
|
|
Estimated
|
|
|
|
Amount
|
|
|
Fair
Value
|
|
|
Amount
|
|
|
Fair
Value
|
|
Financial
assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
88,810
|
|
|
$
|
88,810
|
|
|
$
|
65,968
|
|
|
$
|
65,968
|
|
Loans,
including impaired loans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
net of allowance for loan losses
|
|
|
483,875
|
|
|
|
484,099
|
|
|
|
511,753
|
|
|
|
512,547
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$
|
605,362
|
|
|
$
|
606,331
|
|
|
$
|
641,491
|
|
|
$
|
643,385
|
|
FHLB
advances
|
|
|
52,975
|
|
|
|
50,725
|
|
|
|
54,004
|
|
|
|
51,829
|
|
Short-term
borrowings
|
|
|
9,641
|
|
|
|
3,500
|
|
|
|
9,641
|
|
|
|
3,500
|
|
Junior
subordinated debentures
|
|
|
13,403
|
|
|
|
1,340
|
|
|
|
13,403
|
|
|
|
2,681
|
|
Note 10 – Recently Issued
Accounting Pronouncements
The
following is a summary of recent authoritative pronouncements that affect
accounting, reporting, and disclosure of financial information.
In
January 2010, compensation guidance was updated to reflect the SEC’s views of
when escrowed share arrangements are considered to be
compensatory. Historically, the SEC staff has expressed the view that
an escrowed share arrangement involving the release of shares to certain
shareholders based on performance-related criteria is presumed to be
compensatory. Facts and circumstances may indicate that the
arrangement is an incentive made to facilitate a transaction on behalf of the
company if the escrowed shares will be released or canceled without regard to
continued employment. In such cases, the SEC staff generally believes that the
arrangement should be recognized and measured according to its nature and
reflected as a reduction of the proceeds allocated to the newly issued
securities. The SEC staff believes that an escrowed share arrangement
in which the shares are automatically forfeited if employment terminates is
compensation. The guidance is effective upon issuance and had no impact on the
Company’s financial statements.
In
January 2010, fair value guidance was amended to require disclosures for
significant amounts transferred in and out of Levels 1 and 2 and the reasons for
such transfers and to require that gross amounts of purchases, sales, issuances
and settlements be provided in the Level 3 reconciliation. The new
disclosures are effective for the Company for the current quarter ended March
31, 2010, and have been reflected in the Fair Value footnote.
Guidance
related to subsequent events was amended in February 2010 to remove the
requirement for an SEC filer to disclose the date through which subsequent
events were evaluated. The amendments were effective upon issuance
and had no significant impact on the Company’s financial
statements.
Consolidation
guidance was amended in February 2010 to defer guidance regarding the analysis
of interests in variable interest entities issued in June 2009 for entities
having attributes of investment companies or that apply investment company
measurement principles. Disclosure requirements provided in the June
2009 guidance were not deferred. The amendments were effective
January 1, 2010 and had no effect on the Company’s financial
statements.
In March
2010, guidance related to derivatives and hedging was amended to exempt embedded
credit derivative features related to the transfer of credit risk from potential
bifurcation and separate accounting. Embedded features related to
other types of risk and other embedded credit derivative features will not be
exempt from potential bifurcation and separate accounting. The
amendments will be effective for the Company on July 1, 2010 although early
adoption is permitted. The Company does not expect these amendments
to have any impact on the financial statements.
Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s financial position, results of operations or cash flows.
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operation
The
following discussion and analysis identifies significant factors that have
affected our financial position and operating results during the periods
included in the accompanying unaudited financial statements. We
encourage you to read this discussion and analysis in conjunction with the
unaudited financial statements and the related notes and the other statistical
information also included in this report.
For
further information, refer to Management’s Discussion and Analysis of Financial
Condition and Results of Operations appearing in the Annual Report on Form 10-K
for the year ended December 31, 2009.
Special
Cautionary Notice Regarding Forward-Looking Statements
This
report, including information included or incorporated by reference in this
document, contains statements which constitute forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements relate to the financial condition, results of operations, plans,
objectives, future performance, and business of First National. Forward-looking
statements are based on many assumptions and estimates and are not guarantees of
future performance. Our actual results may differ materially from those
anticipated in any forward-looking statements, as they will depend on many
factors about which we are unsure, including many factors which are beyond our
control. The words “may,” “would,” “could,” “should,” “will,” “expect,”
“anticipate,” “predict,” “project,” “potential,” “continue,” “assume,”
“believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as
similar expressions, are meant to identify such forward-looking
statements. Potential risks and uncertainties that could cause our actual
results to differ materially from those anticipated in our forward-looking
statements include, but are not limited to the following:
|
•
|
our
efforts to raise capital or otherwise increase our regulatory capital
ratios;
|
|
•
|
the
effects of our efforts to raise capital on our balance sheet, liquidity,
capital and profitability;
|
|
•
|
whether
the regulators will approve our agreement with our lender to modify the
line of credit to our holding company, which would fully satisfy its
obligations under the line of
credit;
|
|
•
|
our
ability to retain our existing customers, including our deposit
relationships;
|
|
•
|
restrictions
and prohibitions in current or future regulatory orders, directives or
similar documents;
|
|
•
|
adequacy
of the level of our allowance for loan
losses;
|
|
•
|
reduced
earnings due to higher credit losses generally and specifically because
losses in our residential real estate loan portfolio are potentially
greater than expected due to economic factors, including, but not limited
to, declining real estate values, increasing interest rates, increasing
unemployment, or changes in payment behavior or other
factors;
|
|
•
|
reduced
earnings due to higher credit losses because our loans are concentrated by
loan type, industry segment, borrower type, or location of the borrower or
collateral;
|
|
•
|
the
rate of delinquencies and amounts of chargeoffs on
loans;
|
|
•
|
the
rate of historical loan growth and the lack of seasoning of our loan
portfolio;
|
|
•
|
the
amount of our real estate-based loans, and the weakness in the commercial
real estate market;
|
|
|
|
|
•
|
increased
funding costs due to market illiquidity, increased competition for funding
or regulatory requirements;
|
|
•
|
significant
increases in competitive pressure in the banking and financial services
industries;
|
|
•
|
changes
in the interest rate environment which could reduce anticipated or actual
margins;
|
|
•
|
changes
in political conditions or the legislative or regulatory
environment;
|
|
•
|
general
economic conditions, either nationally or regionally and especially in our
primary service areas, becoming less favorable than expected, resulting
in, among other things, a deterioration in credit
quality;
|
|
•
|
changes
occurring in business conditions and
inflation;
|
|
•
|
changes
in deposit flows;
|
|
•
|
changes
in monetary and tax policies;
|
|
•
|
changes
in accounting principles, policies or
guidelines;
|
|
•
|
our
ability to maintain effective internal control over financial
reporting;
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our
reliance on secondary funding sources to meet our liquidity
needs;
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adverse
changes in asset quality and resulting credit risk-related losses and
expenses;
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loss
of consumer confidence and economic disruptions resulting from terrorist
activities or other military
actions;
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changes
in the securities markets; and
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other
risks and uncertainties detailed from time to time in our filings with the
Securities and Exchange Commission.
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We have
based our forward-looking statements on our current expectations about future
events. Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we cannot guarantee you that these
expectations will be achieved. We undertake no obligation to publicly update or
otherwise revise any forward-looking statements, whether as a result of new
information, future events, or otherwise.
These
risks are exacerbated by ongoing developments in national and international
financial markets, and we are unable to predict what effect these uncertain
market conditions will have on us. Throughout 2008 and 2009 and so
far in 2010, the capital and credit markets continued to experience volatility
and disruption. There can be no assurance that these unprecedented
developments will not continue to materially and adversely affect our business,
financial condition and results of operations, as well as our ability to raise
capital or other funding for liquidity and business purposes.
General
We are a South Carolina corporation
organized in 1999 to serve as the holding company for First National Bank of the
South, a national banking association, referred to herein as the "bank." We
maintain our corporate headquarters in Spartanburg, South Carolina, and we
operate a network of full-service branches in select markets across the state of
South Carolina. We have been adversely affected by the recent
collapse of the market economy, and based on our tangible equity ratio as of
March 31, 2010, we were deemed to be critically undercapitalized, primarily as a
result of our increased provisions for loan losses during 2008 and 2009 and
through the first quarter of 2010. This development was also based on
our maintenance of excess liquidity on our balance sheet and the expected
fluctuations of this tangible equity ratio that occur as a result. We
are implementing a strategy to increase our capital levels by raising additional
capital, limiting our growth, and decreasing
assets.
Specifically, we plan to reduce our balance sheet as
brokered certificates of deposits mature and are not renewed.
In addition, t
o raise additional
capital, we have engaged various professional advisors and are executing a
capital plan that may include issuing common stock, preferred stock, or other
financing alternatives that are treated as capital for capital adequacy ratio
purposes. We are in active negotiations with potential investors and
plan to raise additional capital in the next few months; however, there are no
assurances that such issuance will be completed.
Our
assets consist primarily of our investment in the bank, and our primary
activities are conducted through the bank. As of March 31, 2010, our
consolidated total assets were $676.1 million, our consolidated total loans were
$507.2 million, and our consolidated total deposits were $605.4
million.
We are
implementing a strategy to raise capital to continue operations and improve our
capital ratios. We must increase our bank's minimum capital ratios to
comply with the terms of the consent order we entered into with our bank's
primary regulator, the Office of the Comptroller of the Currency (the “OCC”), on
April 27, 2009. In response to these developments, we made
significant changes to our business strategy and management team in 2009,
including hiring J. Barry Mason as our new president and chief executive
officer.
New
Executive Management and Committed Board of Directors
On August
24, 2009, we hired J. Barry Mason to serve as our new president and chief
executive officer. Mr. Mason previously served as the executive vice
president and chief lending officer of Arthur State Bank headquartered in the
upstate of South Carolina. Mr. Mason began his banking career in 1982 and
had been employed by Arthur State Bank since 1995. He also served on the
Arthur State Bank board of directors. Arthur State Bank is similar in size
to First National and operates in some of the same markets. In addition, we
believe that Mr. Mason is well known and well respected in the Spartanburg
community, having served in this market since 1982, and is familiar with First
National's employees and customers.
Our board
of directors is fully committed to restoring the health of the bank and company
and returning First National to profitability. Our board of directors
believes that First National can be revitalized with new management, aggressive
resolution of problem loans and additional capital. On August 24, 2009,
each member of the company's board of directors as a group invested $550,500 in
the company in exchange for (i) 550,500 shares of the company's common stock and
(ii) warrants to purchase 137,625 additional shares of the company's common
stock. This capital contribution by the directors was instrumental in
securing Mr. Mason's employment as our new president and chief executive
officer.
New
Business Strategy
Since the
first quarter of 2008, we have observed the deterioration in national and
regional economic indicators and declining real estate values, as well as
slowing real estate sales activity in our markets. As a result of these
worsening economic conditions, the level of our problem assets increased during
2008 and 2009. We have increased the allowance for loan losses to
reflect the related impairment in these assets, net of chargeoffs. In
response to the changing business climate, we have modified our asset growth
plan from historic levels and are implementing a new business strategy based on
the following principles:
Strengthen
our capital base.
We need
to raise additional capital, which we have already begun to accomplish through a
private placement common stock offering. On August 24, 2009, our directors
purchased 550,500 shares of common stock and 137,625 warrants at $1.00 per share
as part of this offering, which we recorded as a capital contribution to our
bank subsidiary. We are implementing a strategy to increase our capital
ratios through several actions, including:
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offering
additional equity or debt instruments to prospective investors through
public or private offerings;
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renegotiating
our holding company’s senior capital obligations (preferred stock and
senior debt);
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potentially
divesting selected branch locations, including associated loans and
deposits; and
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shrinking
our loan portfolio through loan run-off and problem asset
resolution.
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Through
these steps, we believe we can return to being well capitalized, cease being
deemed to be in troubled condition, and ultimately be released from the
restrictions imposed on us as a result of the consent order we have entered into
with the OCC (the bank’s primary federal regulator) and the written agreement we
have entered into with the Federal Reserve Bank of Richmond (the “FRB”) (our
holding company's primary federal regulator). See Exhibit 10.2 to our Form
10-K for the year ended December 31, 2008 and Exhibit 10.1 to our Form 10-Q for
the period ended June 30, 2009 for more detailed discussions regarding the
consent order and written agreement, respectively.
Improve
asset quality by reducing the amount of our nonperforming assets.
To improve our results of operations,
our primary focus is to significantly reduce the amount of our nonperforming
assets.
Nonperforming assets decrease our
profitability because they reduce the balance of earning assets, may require
additional loan loss provisions or write-downs, and require significant devotion
of our staff time and financial resources to resolve.
O
ur level of nonperforming assets (loans
not accruing interest, restructured loans, loans past due 90 days or more and
still accruing interest, and other real estate owned)
de
creased to $
136.1
million as of
March 31, 2010
, as compared to $
137.3 million as of December 31,
2009. This decrease represents an improvement in the volume of our
loans migrating from performing to nonperforming. Management’s
proactive strategy to accelerate the resolution of nonperforming assets
throughout 2008 and 2009 should result in decreases to our nonperforming assets
for future periods.
In addition, as of
May 4
, 2010, there were contracts in place
for pending sales of loans and other real estate owned of approximately
$
2.0
million, which will reduce
nonperforming assets to $
134.1
million.
Included in the $
118.4
million balance of loans on nonaccrual
status reported as of March 31, 2010 were three related USDA guaranteed
loans with the guaranteed portion equaling $3.3 million. Net of this
guaranteed portion in addition to pending sales, total nonperforming assets were
$130.8 million.
Also, as of
March
31, 20
10
, approximately $
118.4
million of our loan portfolio was
comprised of either loans not accruing interest or loans past due 90 days or
more and still accruing interest as compared to $
128.0
million of our loan p
ortfolio as of December 31,
2009
.
We believe that the
elevated
level of our nonperforming assets has
largely
resulted from
the severe housing
downturn and deterioration in the residential real estate market, as many of our
commercial loans are for residential real estate projects.
We have
moved aggressively to address this issue by increasing our reserves for losses
during 2008 and 2009 and into 2010, as well as directing the efforts of an
entire team of bankers and experienced workout specialists solely to managing
the liquidation of nonperforming assets. This team is actively pursuing
remedies with borrowers, including foreclosure, to hold the borrowers
accountable for the principal and interest owed under the terms of the personal
guarantees that were made when the loans were originated. This group allows
our credit administration team to focus on managing the performing loan
portfolio and transfers responsibility for resolving problem loans away from the
originating or managing lender. In addition, we are evaluating the
potential benefits of utilizing the services of a number of third parties with
expertise in the resolution of foreclosed property and nonperforming loans at
levels of principal recovery that we would consider reasonable and
beneficial.
During
the last six months of 2009 and in the three-month period ended March 31, 2010,
these efforts led to a significant reduction in the level of loans 30 to 89 days
past due of approximately 84.5% from $50.4 million as of June 30, 2009 to $7.8
million as of March 31, 2010. As of May 4, 2010, First National had
successfully resolved approximately $57.7 million of its problem assets since
March 31, 2009, and had approximately $2.0 million of problem assets pending
resolution as of this date. In addition to our loan loss reserves as of
March 31, 2010, we have written down the nonaccrual loans as of March 31, 2010
by approximately $18.9 million through chargeoffs to our allowance for loan
losses.
With the
assistance of a third party loan review firm, we conducted a thorough review of
our loan portfolio during the three-month period ended March 31, 2010, including
both nonperforming loans and performing loans. This review was in
addition to the multiple reviews conducted by the same firm during
2009. We believe that the reserves recorded in our allowance for loan
losses as of March 31, 2010 are adequate to cover losses inherent in the
portfolio as of that date. However, future valuation adjustments may be
necessary based on potential future events such as short sales and bulk asset
sales which typically require deeper discounts. If these potential losses
are realized, we will require additional capital to fund these
losses.
It is our
goal to remove the majority of the nonperforming assets from our balance sheet
as quickly as possible while still obtaining reasonable value for these
assets. Given the current conditions in the real estate market,
accomplishing this goal is a tremendous undertaking requiring both time and the
considerable effort of our staff, but we are committed to continue devoting
significant resources to these efforts. Additional provisions for loan
losses may be required in future periods to implement this part of our business
strategy since we will likely be required to accept discounted sales prices
below appraised value to quickly dispose of these assets.
Increase
operating earnings while maintaining adequate liquidity.
Management
is focused on increasing our operating earnings by implementing strategies to
improve the core profitability of our franchise. These strategies involve
changing the mix of our earning assets without growing our balance sheet.
Specifically, we are attempting to reduce the level of nonperforming assets,
diversify our loan and deposit mix, control our operating expenses, improve our
net interest margin and increase fee income. We are continuing to maintain
excess liquidity on our balance sheet in the form of cash and unpledged
securities to strengthen our liquidity position as we reduce our dependency on
wholesale funding. While this strategy reduced our net interest income, our net
interest margin is projected to increase later in 2010 as we fund maturing
brokered deposits with excess cash, and our liquidity returns to a more normal
level. We do not expect our balance sheet to grow over the next twelve
months as we reduce the excess liquidity on our balance sheet and dispose of
nonperforming assets, which may require us to record additional provisions for
loan losses. In fact, our balance sheet is projected to continue to shrink
during this period as we execute strategic branch divestitures, including loans
and deposits, to further reduce our asset base and improve our capital
ratios. We closed our wholesale mortgage lending division on September 2,
2009, which also lowered our asset base, improving our capital ratios. We
have also reduced the concentration of commercial real estate loans and
construction loans within our loan portfolio and have generally ceased making
new loans to homebuilders. We have tightened our loan approval policies
for new loans and continue to carefully evaluate renewing loans in our portfolio
to ensure that we are focusing our capital and resources on our best and most
profitable customer relationships.
The
benefits of this new approach to the size and composition of our balance sheet
include more disciplined loan and deposit pricing going forward on new business
as well as on current loans and deposits as they reprice and renew, which we
believe should result in subsequent net interest margin expansion. From
April 1, 2010 through December 31, 2010, we have $326.0 million of time
deposits, with a weighted average interest rate of 2.32% that will reprice at
current market rates as they mature. Included in the $326.0 million are
$101.9 million of brokered deposits which will not be
renewed. Additionally, we have $86.6 million of loans that are maturing
from April 1, 2010 through December 31, 2010. The majority of these loans
were initially made at a rate variable with the Wall Street Journal prime rate,
which is currently 3.25%. We are putting floors, or minimum interest rates,
in our variable rate loans at renewal. Furthermore, we will look to
cheaper sources of funding as they become available to us.
Continue
to aggressively manage operating costs and increase fee revenue.
We have
always focused on controlling our operating expenses and managing our overhead
to an efficient level. Given the continued challenges of the economy, we
embarked during 2009 on an even more aggressive expense reduction campaign that
we believed would save us over $5 million in annual expenditures. We
believe that we reached this level of efficiency as of December 31, 2009,
excluding expenses for elevated Federal Deposit Insurance Corporation (“FDIC”)
deposit insurance premiums, as well as professional fees paid to advisors, which
should begin to decrease in the remainder of 2010 if our financial condition
improves. In addition, management has initiated additional measures
so far in 2010 to enhance revenue and reduce expenses which are projected to
increase net income by approximately $1.0 million on an annualized
basis. To achieve these results, management has reduced salary and
benefits expense by eliminating a number of positions as a result of an analysis
of overall employee efficiency, renegotiated vendor contracts, and implemented
several other cost-saving measures to aggressively reduce noninterest
expenses. We use our centralized purchasing function to negotiate
favorable rates on purchases throughout our branch network. We make every
effort to partner with vendors who maintain a relationship with our bank as a
customer, shareholder, or both. Using a centralized purchasing function
allows us to more actively monitor and tightly control our noninterest expenses
in all areas of the bank.
We have
streamlined our cost structure to reflect our projected lower base of earning
assets and we will continue to eliminate associated unnecessary infrastructure
as our assets shrink by proactively assessing our level of overhead expense,
specifically expenses for personnel and facilities. It is our goal to
continually identify other ways to reduce costs through outsourcing when
practical and ensuring our operation is functioning as efficiently as possible.
We look at every dollar spent as an investment and require an appropriate return
on that investment to make the expenditure. We are committed to maintaining
these cost control measures and believe that this effort will play a major role
in improving our performance. We also believe that our technology allows us
to be efficient in our back-office operations. In addition, as we reduce
our level of nonperforming assets, our operating costs associated with carrying
these assets, such as maintenance, insurance and taxes, will also
decrease.
To date,
our noninterest income sources have primarily consisted of service charge income
on loan and deposit accounts, mortgage banking related fees and commissions, and
fees from joint ventures to provide financial services to our customers. We
seek to provide a broad range of products and services to our customers while
simultaneously attempting to increase our fee-based income as a percentage of
our gross income (net interest income plus noninterest
income). Additionally, we will actively pursue future opportunities to
increase fee-based income as they arise. We are seeking to increase the
amount of noninterest income from traditional sources by increasing demand
deposit accounts through expanded targeted product marketing campaigns, which,
in turn, are expected to increase deposit service charge income. We also
project that fees and service charges on loans will increase with growth in our
performing loan portfolio as nonperforming assets are removed from our balance
sheet. We are emphasizing collection of origination fees and processing
fees on new and renewing loans in our portfolio. These efforts are
projected to bring the amount of fees collected on deposit and loan accounts
more in line with the market, and we believe these efforts will not have a
negative effect on our potential for loan or deposit growth. We expect that
these efforts will help bolster our noninterest income in future
periods.
Continue
to increase local funding and core deposits.
We grew
rapidly in our initial years of operations, which we funded with a combination
of local deposits and wholesale funding, including brokered time deposits and
borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”). We are
focused on increasing the percentage of our balance sheet funded by local
depositors while we reduce the level of wholesale funding on our balance
sheet. Based on our capitalization as of March 31, 2010, we are not able to
apply for a waiver from the FDIC to accept, renew or roll over brokered
deposits. In addition, our ability to borrow funds from the FHLB has been
restricted following the FHLB’s quarterly review of our assigned credit risk
rating for the fourth quarter of 2008.
We are
focused on expanding our collection of core deposits. Core deposit
balances, generated from customers throughout our branch network, are generally
a stable source of funds similar to long-term funding, but core deposits such as
checking and savings accounts are typically much less costly than alternative
fixed rate funding. We believe that this cost advantage makes core deposits
a superior funding source, in addition to providing cross-selling opportunities
and fee income possibilities. We work to increase our level of core
deposits by actively cross-selling core deposits to our local depositors and
borrowers. We are implementing a new checking account acquisition
program to further generate core deposit accounts which is expected to be in
place during June 2010. As we grow our core deposits during 2010, we
believe that our cost of funds should decrease, thereby increasing our net
interest margin.
Our team
of experienced retail bankers is focused on strengthening our relationships with
our retail customers to grow core deposits. We also believe that the new
customer relationships generated by our new president and chief executive
officer, J. Barry Mason, have contributed significantly to our core deposit
growth. We hold our retail bankers accountable for sales production through
our targeted officer calling program which includes weekly sales calls as well
as organized tracking and reporting of these activities. Additionally, our
customer-focused sales training emphasizes product knowledge and enhanced
customer service techniques.
We
generate local deposits through a combination of competitive pricing and
extensive personal and commercial relationships in the local
market. Four of our branches are less than three years old, and we
expect those branches to increase their levels of deposits in the next twelve to
eighteen months. Our strategy is to maintain a healthy mix of deposits that
favors a larger concentration of non-time deposits, such as noninterest-bearing
checking accounts, interest-bearing checking accounts, savings accounts and
money market accounts.
Our
primary competition for core deposits in our markets is larger regional and
super-regional banks. We believe that our community banking philosophy and
emphasis on customer service give us an excellent opportunity to take market
share from our competitors. As a result, we intend to decrease our reliance
on non-core funding as our full-service branches grow and mature. While
building a core deposit base takes time, our strategy has experienced
considerable success. Since opening in 2000, the Bank has climbed to the
number two ranking for deposit market share in Spartanburg County, South
Carolina with 11.6% of the deposit market. As of the June 30, 2009 FDIC
summary of deposits report (the most recent FDIC report data available), we have
the seventh-highest deposit market share in South Carolina of the South
Carolina-based financial institutions. Our long-term goal is to be in the
top five institutions in deposit market share in each of our
markets.
Deliver
superior community banking to our customers.
We seek
to compete with our super-regional competitors by providing superior customer
service with localized decision-making capabilities. We believe that we can
continue to deliver our level of superior customer service during this
challenging period of time. We emphasize to our employees the importance of
delivering superior customer service and seeking opportunities to strengthen
relationships both with customers and in the communities we serve. Mr.
Mason, our new president and CEO, shares this approach to community banking, and
we are targeting his network of customer relationships to diversify our loan and
deposit base.
Our
organizational structure allows us to provide local decision-making consistent
with our community banking philosophy. Our regional boards are comprised of
local business and community leaders who act as ambassadors for us in their
markets and help generate referrals for new business for the bank. These
board members also provide us with valuable insight on the financial needs of
their communities, which allows us to deliver targeted financial products to
each market.
Critical
Accounting Policies
We have
adopted various accounting policies that govern the application of United States
generally accepted accounting principles that are consistent with general
practices within the banking industry in the preparation of our financial
statements. Our significant accounting policies are described in Note 1 to
our audited consolidated financial statements as of and for the year ended
December 31, 2009, “Summary of Significant Accounting Policies and Activities,”
as filed in our Annual Report on Form 10-K.
Certain
accounting policies involve significant judgments and assumptions by management
that have a material impact on the carrying value of certain assets and
liabilities. We consider these policies to be critical accounting
policies. The judgments and assumptions we use are based on historical
experience and other factors, which we believe to be reasonable under the
circumstances. Because of the nature of the judgments and assumptions we
make, actual results could differ from these judgments and estimates. These
differences could have a material impact on the carrying values of our assets
and liabilities and our results of operations. Management relies heavily on
the use of judgments, assumptions and estimates to make a number of core
decisions, including accounting for the allowance for loan losses and income
taxes. A brief discussion of each of these areas follows:
Allowance
for Loan Losses
Some of
the more critical judgments supporting the amount of our allowance for loan
losses include judgments about the creditworthiness of borrowers, the estimated
value of the underlying collateral, cash flow assumptions, the determination of
loss factors for estimating credit losses, the impact of current events, and
other factors impacting the level of probable inherent losses. Under
different conditions or using different assumptions, the actual amount of credit
losses incurred by us may be different from management’s estimates provided in
our consolidated financial statements. Please see "Allowance for Loan
Losses" under
Balance Sheet
Review
for a more complete discussion of our processes and methodology
for determining our allowance for loan losses.
Income
Taxes
Some of
the more critical judgments supporting the deferred tax asset amount include
judgments about the recovery of these accrued tax benefits. Deferred income
tax assets are recorded to reflect the tax effect of the difference between the
book and tax basis of assets and liabilities. These differences result in
future deductible amounts that are dependent on the generation of future taxable
income through operations or the execution of tax planning strategies. Due
to the doubt of our ability to utilize the portion of the deferred tax asset
that is not able to be offset against reversals of future taxable temporary
differences projected to occur in 2010, management has established a valuation
allowance for the entire net deferred tax asset.
Comparison
of Results of Operations
Income
Statement Review
Summary
Our net
loss was $5.4 million, or $0.68 per diluted share, for the three-month period
ended March 31, 2010, as compared with a net loss of $1.4 million, or $0.22 per
diluted share, for the three-month period ended March 31, 2009. Our net
loss for the three-month period ended March 31, 2010, included $3.7 million in
the provision for loan losses, as compared to $2.2 million in the provision for
loan losses for the three-month period ended March 31, 2009. Weighted
average diluted common shares outstanding for the three-month period ended March
31, 2010, increased slightly over the same period in 2009, due to the conversion
of preferred shares to common shares since March 31, 2009, and the sale of
550,500 common shares to our directors during the third quarter of
2009.
Net
interest income comprises the majority of our gross income. Net interest
income for the three-month period ended March 31, 2010, decreased by 36.6% or
$1.5 million, to $2.6 million, as compared to $4.1 million recorded during the
same period in 2009, primarily due to the negative impact of the proportionally
increased level of nonperforming loans, which was the primary cause of the
overall decrease of 96 basis points in the rates earned on our average
interest-earning assets. The net interest margin for the three-month period
ended March 31, 2010, was 1.49%, as compared to the 2.10% net interest margin
recorded for the three-month period ended March 31, 2009, or a reduction of 61
basis points during the three-month period ended March 31, 2010, primarily due
to lost interest income on the elevated level of nonperforming assets as
compared to 2009 and the excess liquidity that was held on the balance sheet,
primarily in lower-yielding interest-bearing bank balances at the Federal
Reserve.
During
2008, the Federal Reserve lowered the federal funds rate from 4.25% in January
of 2008 to near zero percent by the end of 2008, where it has stayed through
March 31, 2010. These dramatic decreases lowered the yield on our earning
assets more rapidly than our cost of funds declined, which has caused our net
interest margin and spread to compress and has caused our earnings to
suffer. In addition, while nonperforming loans continue to be treated as
interest-earning assets, for purposes of calculating the net interest margin,
the interest lost on these loans reduces net interest income, particularly in
the quarter the loans first are considered nonperforming, as any interest income
accrued on the loans is reversed at that point. In the past, we have used
lower-cost brokered deposits to help manage this margin compression, but under
our consent order with the OCC, we have not been able to renew, roll over or
increase our brokered deposits since executing the consent order on April 27,
2009.
The
provision for loan losses was recorded as part of management’s continued
proactive strategy to accelerate efforts to resolve our nonperforming assets
with the goal of removing them from the balance sheet. A portion of the
provision for loan losses was recorded to increase the general reserve included
in the allowance for loan losses to reflect probable losses in the portfolio as
of March 31, 2010. The remainder of the provision booked during the
three-month period ended March 31, 2010, was recorded to reflect valuation
adjustments on impaired loans as a result of updated appraisals as well as
negotiated discounts on impaired loans below their appraised value which are
included in contracts to dispose of nonperforming assets, which were closed or
pending as of the date of this report.
Our
return on average assets decreased from (0.7%) for the three-month period ended
March 31, 2009, to (3.07%) for the three-month period ended March 31,
2010.
Our
return on average equity decreased from (13.5%) for the three-month period ended
March 31, 2009, to (464.9%) for the three-month period ended March 31,
2010. This decrease is driven by the increased net loss recognized in the
three-month period ended March 31, 2010 as compared to the three-month period
ended March 31, 2009, in addition to a lower average equity base in 2010 due to
sustained losses since 2008.
Net
Interest Income
Our
primary source of revenue is net interest income. The level of net interest
income is determined by the balances of interest-earning assets and
interest-bearing liabilities and successful management of the net interest
margin. In addition to the growth in both interest-earning assets and
interest-bearing liabilities, and the timing of repricing of these assets and
liabilities, net interest income is also affected by the ratio of
interest-earning assets to interest-bearing liabilities and the changes in
interest rates earned on our assets and interest rates paid on our
liabilities.
Our net
interest income decreased by $1.5 million, or 36.6%, to $2.6 million for the
three-month period ended March 31, 2010, from $4.1 million as of March 31,
2009. The decrease in net interest income from 2009 to 2010 was due
primarily to the decrease in our net interest margin of 61 basis points from
2.10% to 1.49% for three-month periods ended March 31, 2009 and 2010,
respectively. Decreased loan volume was the primary contributing factor,
along with an overall decrease in the yield earned on the loan portfolio
which resulted from the elevated level of nonperforming assets during the first
quarter of 2010. Our loan yield for the three-month period ended March 31,
2010, has also been negatively impacted by the reversal of interest income on
loans reclassified to nonaccrual status. We are deliberately decreasing the
size of our loan portfolio, as we reduce the size of our balance sheet to
improve our capital ratios, while striving to improve our loan
yield.
Combined,
decreased loan yields and volume contributed $2.7 million toward our decreased
net interest income for the three-month period ended March 31, 2010. In
addition, the negative interest carry on the excess balance sheet liquidity held
in unpledged U. S. government securities and lower-yielding cash in our FRB
account contributed to the decrease in net interest income to date in
2010. The average balance of these assets for the three-month period ended
March 31, 2010 was $76.1 million and contributed $0.4 million toward our
decreased net interest income for the period. While deposit rates decreased
as well, growth in average deposits to increase liquidity partially offset the
positive impact of the reduced deposit rates.
The
following table sets forth, for the three-month periods ended March 31, 2010
and 2009, information related to our average balances, yields on average
interest-earning assets, and costs of average interest-bearing
liabilities. We derived average balances from the daily balances
throughout the periods indicated. We derived these yields by dividing
income or expense by the average balance of the corresponding interest-earning
assets or interest-bearing liabilities.
Average loans are stated
net of unearned income and include nonaccrual loans. Interest income
recognized on nonaccrual loans has been included in interest income (dollars in
thousands).
Average
Balances, Income and Expenses, and Rates for the Three-Month Periods Ended
March 31,
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2010
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2009
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Average
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Income/
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Yield/
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Average
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Income/
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|
|
Yield/
|
|
|
|
Balance
|
|
|
Expense
|
|
|
Rate*
|
|
|
Balance
|
|
|
Expense
|
|
|
Rate*
|
|
Loans,
including nonaccrual loans
(1)
|
|
$
|
526,423
|
|
|
$
|
5,681
|
|
|
|
4.38
|
%
|
|
$
|
703,546
|
|
|
$
|
8,413
|
|
|
|
4.85
|
%
|
Investment
securities - taxable
|
|
|
80,663
|
|
|
|
789
|
|
|
|
3.97
|
%
|
|
|
62,284
|
|
|
|
797
|
|
|
|
5.19
|
%
|
Investment
securities - tax-exempt
|
|
|
3,894
|
|
|
|
40
|
|
|
|
4.17
|
%
|
|
|
20,133
|
|
|
|
202
|
|
|
|
4.07
|
%
|
Federal
funds sold and other
|
|
|
87,935
|
|
|
|
89
|
|
|
|
0.41
|
%
|
|
|
15,090
|
|
|
|
42
|
|
|
|
1.13
|
%
|
Total
interest-earning assets
|
|
$
|
698,915
|
|
|
$
|
6,599
|
|
|
|
3.83
|
%
|
|
$
|
801,053
|
|
|
$
|
9,454
|
|
|
|
4.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time
deposits - retail
|
|
$
|
356,746
|
|
|
$
|
2,248
|
|
|
|
2.56
|
%
|
|
$
|
313,092
|
|
|
$
|
2,810
|
|
|
|
3.64
|
%
|
Time
deposits - wholesale
|
|
|
154,990
|
|
|
|
917
|
|
|
|
2.40
|
%
|
|
|
160,187
|
|
|
|
1,247
|
|
|
|
3.16
|
%
|
Savings
and money market
|
|
|
54,906
|
|
|
|
163
|
|
|
|
1.20
|
%
|
|
|
103,431
|
|
|
|
366
|
|
|
|
1.44
|
%
|
NOW
accounts
|
|
|
32,865
|
|
|
|
29
|
|
|
|
0.36
|
%
|
|
|
43,774
|
|
|
|
76
|
|
|
|
0.70
|
%
|
FHLB
advances
|
|
|
53,550
|
|
|
|
453
|
|
|
|
3.38
|
%
|
|
|
75,450
|
|
|
|
517
|
|
|
|
2.74
|
%
|
Long-term
debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9,500
|
|
|
|
150
|
|
|
|
6.32
|
%
|
Junior
subordinated debentures
|
|
|
13,403
|
|
|
|
83
|
|
|
|
2.48
|
%
|
|
|
13,403
|
|
|
|
131
|
|
|
|
3.91
|
%
|
Federal
funds purchased and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
borrowings
|
|
|
9,641
|
|
|
|
145
|
|
|
|
6.02
|
%
|
|
|
12,167
|
|
|
|
15
|
|
|
|
0.50
|
%
|
Total
interest-bearing liabilities
|
|
$
|
676,101
|
|
|
$
|
4,038
|
|
|
|
2.42
|
%
|
|
$
|
731,004
|
|
|
$
|
5,312
|
|
|
|
2.95
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest spread
|
|
|
|
|
|
|
|
|
|
|
1.41
|
%
|
|
|
|
|
|
|
|
|
|
|
1.84
|
%
|
Net
interest income/margin
|
|
|
|
|
|
$
|
2,561
|
|
|
|
1.49
|
%
|
|
|
|
|
|
$
|
4,142
|
|
|
|
2.10
|
%
|
Noninterest-bearing
demand deposits
|
|
$
|
34,591
|
|
|
|
|
|
|
|
|
|
|
$
|
37,625
|
|
|
|
|
|
|
|
|
|
*
Annualized for the three-month period
|
(1)
|
Includes
mortgage loans held for sale. The wholesale mortgage lending division was
closed on September 2, 2009.
|
The net
interest spread, which is the difference between the rate we earn on
interest-earning assets and the rate we pay on interest-bearing liabilities, was
1.41% for the three-month period ended March 31, 2010, as compared to 1.84% for
the three-month period ended March 31, 2009. Our consolidated net interest
margin, which is net interest income divided by average interest-earning assets
for the period, was 1.49% for the three-month period ended March 31, 2010, as
compared to 2.10% for the three-month period ended March 31, 2009.
Changes
in interest rates paid on assets and liabilities, the rate of change of the
asset and liability base, the ratio of interest-earning assets to
interest-bearing liabilities and management of the balance sheet’s interest rate
sensitivity all factor into changes in net interest income. Therefore,
improving our net interest income in the current challenging market will
continue to require deliberate and attentive management.
Our net
interest spread and our net interest margin significantly decreased from March
31, 2009 compared to the same period in 2010. This decrease occurred
principally due to the faster decrease in yields on average interest-earning
assets relative to the slower repricing of our average interest-bearing
liabilities following the 400 basis point decrease in the prime rate during
2008. Our loan yield has also been reduced due to the lost interest income
on the nonperforming assets, as well as the reversal of interest income as loans
have been reclassified to nonperforming status. In addition, our yield on
earning assets has been negatively impacted by the excess liquidity held on our
balance sheet in liquid, unpledged assets, primarily in cash balances at the
FRB, typically earning approximately 0.25%. This proactive liquidity
positioning has occurred as we increased liquid assets in 2009 to fund maturing
brokered certificates of deposit (“CDs”) and continued to strive to reduce our
historical reliance on wholesale funding, such as brokered CDs. The
decreased yield on earning assets in 2010 was partially offset by a decrease in
funding costs, as retail deposits, primarily time deposits, have begun repricing
at lower market rates.
Analysis
of Changes in Net Interest Income
Net
interest income can be analyzed in terms of the impact of changing interest
rates and changing volume. The majority of our interest-earning
assets negatively contributed to net interest income in the three-month period
ended March 31, 2010 as compared to the same period in 2009 due to declining
rates as discussed previously. Taxable investment securities, as well
as federal funds sold and other, positively contributed to net interest income
in terms of volume while the reduction in loans resulted in a reduction in net
interest income as we reduced the size of our loan portfolio during 2009, and to
date in 2010. The following tables set forth the effect that the varying
levels of interest-earning assets and interest-bearing liabilities and the
applicable rates have had on changes in net interest income for the periods
presented (dollars in thousands):
|
|
Changes
in Net Interest Income
|
|
|
|
For
the Three Months Ended
March
31, 2010 vs. 2009
Increase
(Decrease)
|
|
|
For
the Three Months Ended
March
31, 2009 vs. 2008
Increase
(Decrease)
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
|
Volume
|
|
|
Rate
|
|
|
Due
to
One-Day
Difference
(2)
|
|
|
Total
|
|
Interest-Earning
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
funds sold and other
|
|
$
|
203
|
|
|
$
|
(156
|
)
|
|
$
|
47
|
|
|
$
|
41
|
|
|
$
|
(88
|
)
|
|
$
|
(1
|
)
|
|
$
|
(48
|
)
|
Investment
securities - taxable
|
|
|
235
|
|
|
|
(243
|
)
|
|
|
(8
|
)
|
|
|
137
|
|
|
|
43
|
|
|
|
(7
|
)
|
|
|
173
|
|
Investment
securities - tax-exempt
|
|
|
(163
|
)
|
|
|
1
|
|
|
|
(162
|
)
|
|
|
28
|
|
|
|
7
|
|
|
|
(2
|
)
|
|
|
33
|
|
Loans
(1)
|
|
|
(2,118
|
)
|
|
|
(614
|
)
|
|
|
(2,732
|
)
|
|
|
1,148
|
|
|
|
(3,412
|
)
|
|
|
(119
|
)
|
|
|
(2,383
|
)
|
Total
interest-earning assets
|
|
|
(1,843
|
)
|
|
|
(1,012
|
)
|
|
|
(2,855
|
)
|
|
|
1,354
|
|
|
|
(3,450
|
)
|
|
|
(129
|
)
|
|
|
(2,225
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-Bearing
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
161
|
|
|
|
(1,303
|
)
|
|
|
(1,142
|
)
|
|
|
769
|
|
|
|
(1,966
|
)
|
|
|
(63
|
)
|
|
|
(1,260
|
)
|
FHLB
advances
|
|
|
(150
|
)
|
|
|
86
|
|
|
|
(64
|
)
|
|
|
332
|
|
|
|
(248
|
)
|
|
|
(5
|
)
|
|
|
79
|
|
Long-term
debt
|
|
|
(150
|
)
|
|
|
-
|
|
|
|
(150
|
)
|
|
|
77
|
|
|
|
71
|
|
|
|
-
|
|
|
|
148
|
|
Junior
subordinated debentures
|
|
|
-
|
|
|
|
(48
|
)
|
|
|
(48
|
)
|
|
|
-
|
|
|
|
(95
|
)
|
|
|
(3
|
)
|
|
|
(98
|
)
|
Federal
funds purchased and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
borrowings
|
|
|
(3
|
)
|
|
|
133
|
|
|
|
130
|
|
|
|
18
|
|
|
|
(96
|
)
|
|
|
(1
|
)
|
|
|
(79
|
)
|
Total
interest-bearing liabilities
|
|
|
(142
|
)
|
|
|
(1,132
|
)
|
|
|
(1,274
|
)
|
|
|
1,196
|
|
|
|
(2,334
|
)
|
|
|
(72
|
)
|
|
|
(1,210
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
$
|
(1,701
|
)
|
|
$
|
120
|
|
|
$
|
(1,581
|
)
|
|
$
|
158
|
|
|
$
|
(1,116
|
)
|
|
$
|
(57
|
)
|
|
$
|
(1,015
|
)
|
|
(1)
|
Loan
fees, which are not material for any of the periods shown, have been
included for rate calculation purposes. Totals also include mortgage loans
held for sale. The wholesale mortgage lending division was closed on
September 2, 2009.
|
|
(2)
|
Presented
to reflect the impact of February having 29 days in 2008 vs. 28 days in
2009.
|
Provision
for Loan Losses
Our
provision for loan losses was $3.7 million and $2.2 million for the three-month
periods ended March 31, 2010 and 2009, respectively, an increase of $1.5
million. The percentage of allowance for loan losses was increased during
2009 to 4.60% of gross loans outstanding as of March 31, 2010, from 3.31% as of
March 31, 2009. Approximately $3.6 million of the provision for loan losses
for the three-month period ended March 31, 2010, was recorded to reflect
impairments on loans. The actual loss on disposition of the loan and/or the
underlying collateral may be more or less than the amount expensed to the
provision for loan losses. Although the loan loss provision recorded
for the three-month period ended March 31, 2010, represents an increase over the
provision recorded for the same period in 2009, it represents a dramatic
improvement over more recent quarters. Specifically, for the
three-month period ended March 31, 2010, our loan loss provision expense of $3.7
million represented a decrease of $6.7 million, or 64.4%, as compared to the
loan loss provision recorded for the three-month period ended December 31, 2009,
of $10.4 million and a decrease of $14.3 million, or 79.4%, as compared to $18.0
million recognized as provision expense for the three-month period ended June
30, 2009. This decreased loan loss provision expense for the
three-month period ended March 31, 2010 is a direct result of the proportional
decrease in the migration of our loans from performing to nonperforming for the
three-month period ended March 31, 2010, as compared to prior
quarters. The allowance has been recorded based on management’s
ongoing evaluation of inherent risk and estimates of probable credit losses
within the loan portfolio. We believe that specific reserves related
to nonperforming assets and other nonaccrual loans have been allocated in the
allowance for loan losses as of March 31, 2010. We also believe that
these reserves will offset losses we anticipate may arise from less than full
recovery of the loans from the supporting collateral. No assurances can be
given in this regard, however, especially considering the overall weakness in
the real estate market.
At the
end of each quarter or more often, if necessary, we analyze the collectability
of our loans and adjust the loan loss allowance to an appropriate level through
an expense recorded to the provision for loan losses. Our loan loss
allowance covers estimated credit losses on individually evaluated loans that
are determined to be impaired, as well as estimated credit losses inherent in
the remainder of the loan portfolio. We strive to follow a comprehensive,
well-documented, and consistently applied analysis of our loan portfolio in
determining an appropriate level for the loan loss allowance. We consider
what we believe are all significant factors that affect the collectability of
the loans within our portfolio and support the credit losses estimated by this
process. Our loan review system and controls (including our loan grading
system) are designed to identify, monitor, and address asset quality problems in
an accurate and timely manner. We evaluate any loss estimation model before
it is employed and document inherent assumptions and adjustments. We
promptly charge off loans that we determine are uncollectible and adjust the
balance of any impaired loans downward to reflect our assessment of the
appropriate chargeoffs immediately once impairment is determined. It is
essential that we maintain an effective loan review system that works to ensure
the accuracy of our internal grading system and, thus, the quality of the
information used to assess the appropriateness of the loan loss
allowance.
Our board
of directors is responsible for overseeing management’s significant judgments
and estimates pertaining to the determination of an appropriate loan loss
allowance by reviewing and approving our written loan loss allowance policies,
procedures and model quarterly. As part of the consent order that our bank
entered into with the OCC on April 27, 2009, we implemented an updated program
for the maintenance of an adequate allowance for loan losses during
2009. This program is consistent with guidance found in the Interagency
Policy Statement on the Allowance for Loan Losses contained in OCC Bulletin
2006-47.
In
arriving at our loan loss allowance, we consider those qualitative or
environmental factors that are likely to cause credit losses, as well as our
historical loss experience. In addition, as part of our model, we consider
changes in lending policies and procedures, including changes in underwriting
standards, and collection, chargeoff, and recovery practices not considered
elsewhere in estimating credit losses, as well as changes in regional, local and
national economic and business conditions. Further, we factor in changes in
the nature and volume of the portfolio and in the terms of loans, changes in the
experience, ability, and depth of lending management and other relevant staff,
the volume of past due and nonaccrual loans, as well as adversely graded loans,
changes in the value of underlying collateral for collateral-dependent loans,
and the existence and impact of any concentrations of credit. Please see
the discussion below under
“
Allowance for Loan
Losses
”
for a
description of the factors we consider in determining the amount of the
provision we expense each period to maintain this allowance.
The
continued downturn in the real estate market has resulted in increased loan
delinquencies, defaults and foreclosures, primarily in our residential real
estate portfolio. Although we believe that these trends have slowed,
there is a possibility that they may continue. In addition to various
internal reviews of our loan portfolio over the past year, we also reviewed our
loan portfolio on numerous occasions with the assistance of a third party loan
review firm and with our bank’s regulator. The real estate collateral in
each case provides an alternate source of repayment, in the event of default by
the borrower and may deteriorate in value during the time the credit is
extended. If real estate values continue to decline, it is also more likely
that we would be required to increase our allowance for loan losses. If,
during a period of reduced real estate values, we are required to liquidate the
property collateralizing a loan to satisfy the debt or to increase the allowance
for loan losses, it could materially reduce our profitability and adversely
affect our financial condition. This downturn in the real estate market has
resulted in an increase in our nonperforming loans, and there is a risk that
this trend will continue, which could result in further loss of earnings and an
increase in our provision for loan losses and loan chargeoffs, all of which
could have a material adverse effect on our financial condition and results of
operations.
As of
March 31, 2010, and December 31, 2009, nonperforming assets (nonperforming loans
plus other real estate owned) were $136.1 million and $137.3 million,
respectively. In addition, as of May 4, 2010, there were contracts in
place for pending sales of loans and other real estate owned of approximately
$2.0 million, which will reduce nonperforming assets to $134.1
million. Included in the $118.4 million balance of loans on nonaccrual
status reported as of March 31, 2010 were three related USDA guaranteed loans
with the guaranteed portion equaling $3.3 million. Net of this
guaranteed portion in addition to pending sales, total nonperforming assets were
$130.8 million.
Foregone interest income
during the three-month periods ended March 31, 2010 and 2009, on these
nonaccrual loans and other nonaccrual loans charged off was approximately
$1,434,000 and $331,000, respectively. There were no loans
contractually past due in excess of 90 days and still accruing interest as of
March 31, 2010. Included in the $128.0 million balance reported of loans on
nonaccrual status as of December 31, 2009, was one loan contractually past due
for 90 days and still accruing interest. It was placed on nonaccrual status
the following business day. There were nonperforming loans that were
specifically reviewed for impairment of $113.3 million and $119.8 million (after
related specific chargeoffs of $18.9 million and $22.5 million), with related
valuation allowances of $5.5 million and $8.6 million as of March 31, 2010, and
December 31, 2009,
respectively.
The
remainder of the nonperforming loans were assigned a general reserve according
to their respective loan categories. The provision for loan loss recorded
in 2010 and 2009 is part of our proactive strategy to accelerate our efforts to
resolve our nonperforming assets with the goal of removing them from our balance
sheet.
Noninterest
Income
The
following table sets forth information related to the various components of our
noninterest income (dollars in thousands):
|
|
Three
Months Ended March 31,
|
|
|
|
2010
|
|
|
2009
|
|
Service
charges and fees on deposit accounts
|
|
$
|
395
|
|
|
$
|
400
|
|
Gain
on sale of securities available for sale, net
|
|
|
149
|
|
|
|
183
|
|
Service
charges and fees on loans
|
|
|
135
|
|
|
|
151
|
|
Mortgage
banking income
|
|
|
-
|
|
|
|
712
|
|
Gain
(loss) on sale of other real estate owned
|
|
|
(38
|
)
|
|
|
45
|
|
Other
|
|
|
90
|
|
|
|
81
|
|
Total
noninterest income
|
|
$
|
731
|
|
|
$
|
1,572
|
|
Noninterest
income was $0.7 million for the three-month period ended March 31, 2010, a net
decrease of approximately $0.9 million, or 56.3%, as compared to noninterest
income of $1.6 million for the three-month period ended March 31, 2009. The
decrease of $0.9 million is primarily due to the mortgage banking income of
$712,000 generated by the wholesale mortgage division in the three-month period
ended March 31, 2009, that was not recurring in the first quarter of
2010. This division was closed in the third quarter of 2009 as part
of our strategy to reduce the size of our balance sheet to improve our capital
ratios.
The gain
on the sale of securities available for sale decreased by $34,000 to
$149,000 for the three-month period ended March 31, 2010, as compared to the
same period in 2009. Please see
Investments
for more
details.
Service
charges and fees on deposit accounts of $395,000 for the three-month period
ended March 31, 2010, remained relatively flat from 2009. Pending
regulatory changes that would become effective during the third quarter of 2010
may negatively affect noninterest income in future periods earned from service
charges and fees on deposit accounts.
We
recognized losses on the sale of other real estate owned of $38,000 for the
three-month period ended March 31, 2010, as compared to gains during the
previous year. We have incurred gains and losses on disposition of other
real estate owned in following our policy of disposing of these assets in an
expeditious manner at the highest present value to the bank, pursuant to
asset-specific strategies which give consideration to holding
costs.
Service
charges and fees on loans decreased $16,000, or 10.6%, from $151,000 for the
three-month period ended March 31, 2009, to $135,000 for the three-month period
ended March 31, 2010, primarily due to decreased loan fees as a result of
lower loan volume, partially offset by increased late charges for the
three-month period ended March 31, 2010, as compared to the three-month period
ended March 31, 2009.
Noninterest
Expense
The
following table sets forth information related to the various components of our
noninterest expenses (dollars in thousands):
|
|
Three
Months Ended March 31,
|
|
|
|
2010
|
|
|
2009
|
|
Salaries
and employee benefits
|
|
$
|
2,054
|
|
|
$
|
2,544
|
|
Occupancy
and equipment expense
|
|
|
769
|
|
|
|
794
|
|
FDIC
insurance premiums
|
|
|
757
|
|
|
|
131
|
|
Professional
fees
|
|
|
295
|
|
|
|
200
|
|
Data
processing and ATM expense
|
|
|
293
|
|
|
|
297
|
|
Loan
related expenses
|
|
|
144
|
|
|
|
131
|
|
Telephone
and supplies
|
|
|
126
|
|
|
|
161
|
|
Other
real estate owned expense
|
|
|
112
|
|
|
|
52
|
|
Regulatory
fees
|
|
|
87
|
|
|
|
49
|
|
Public
relations
|
|
|
46
|
|
|
|
123
|
|
Loss
on impairment of investment in equity securities
|
|
|
-
|
|
|
|
117
|
|
Other
|
|
|
288
|
|
|
|
326
|
|
Total
noninterest expense
|
|
$
|
4,971
|
|
|
$
|
4,925
|
|
Noninterest
expense of approximately $5.0 million for the three-month period ended March 31,
2010, remained relatively flat from the same period in 2009. Although we
have always focused on controlling our operating expenses and managing our
overhead to an efficient level, given the current economic conditions, we
implemented an even more aggressive expense reduction campaign during 2009,
which we have continued in 2010. We believe that the results of this
campaign have positioned us to save over $5 million in annual expenditures
compared to our level of operating expenses in 2008. The cost
benefits of this expense reduction campaign are evident in various expense
categories that decreased for the three-month period ended March 31, 2010, as
compared to the same period of 2009, namely salaries and employee benefits,
telephone and supplies, and occupancy and equipment expenses. We were
able to reduce these expenses despite the fact that noninterest expenses for the
three-month period ended March 31, 2010, included the addition of our
full-service branch and market headquarters, which opened May 18, 2009, in the
Tega Cay community of Fort Mill, South Carolina.
We
achieved this reduction in recurring salaries and benefits expense through an
analysis of overall employee efficiency which has resulted in the streamlining
of our personnel needs through the reduction or combination of certain employee
positions. In addition, the board of directors eliminated the matching
contribution to the employee 401K plan effective May 31, 2009 in order to reduce
employee benefit expenses without further impacting personnel
levels. Furthermore, we realized the benefits of the closure of our
wholesale mortgage division on September 2, 2009, during the three-month period
ended March 31, 2010, as compared to no benefits realized during the three-month
period ended March 31, 2009, prior to the closing of the division. Our
revised strategic plan does not provide for our expansion through branching in
the near term. In fact, our balance sheet is projected to shrink over the
next twelve months, and management has taken various strategic steps to match
this shrinkage with reduced overhead.
Also
included in noninterest expenses for the three-month period ended March 31, 2010
are various amounts which reflect our current financial condition, primarily
increased FDIC insurance premiums, regulatory fees, and professional fees paid
to advisors and consultants engaged to assist us in raising capital and
complying with the regulatory enforcement actions with the OCC and the
FRB. FDIC insurance premiums increased by $626,000, or 477.9%, from
$131,000 for the three-month period ended March 31, 2009, to $757,000 for the
three-month period ended March 31, 2010. This increase includes increased
deposit insurance premiums assessed by the FDIC due to an increase in our
deposit base and the change in our financial condition since March 31, 2009, and
our heightened reliance on brokered deposits during 2009, which has since
decreased as of March 31, 2010. As our current brokered deposits
mature and our financial condition improves, our FDIC assessments should adjust
downward in future quarters, returning this insurance expense closer to its
historical levels.
Occupancy
and equipment expenses decreased by approximately $25,000, or 3.1%, from
$794,000 for the three-month period ended March 31, 2009, to $769,000 for the
three-month period ended March 31, 2010, despite incurring expenses in 2010 on
our Tega Cay branch, which opened in May 2009. During the same period in
2009, there were no expenses incurred for the Tega Cay branch. We have
streamlined our overall cost structure to reflect our projected lower base of
earning assets, and we will continue to eliminate associated unnecessary
infrastructure as our assets shrink by proactively assessing our level of
overhead expenses. The positive effects of many of our recently
renegotiated vendor contracts are also reflected in the decrease in occupancy
and equipment expenses from 2009 to 2010.
Professional
fees increased by $95,000, or 47.5%, from March 31, 2009 to the same period in
2010 due to the costs of various experienced advisors enlisted in our efforts to
comply with the requirements of the consent order with the OCC and our written
agreement with the FRB. If we make progress toward satisfying the
requirements set forth in our regulatory agreements, which we expect to result
in improvement in our financial condition, we would expect to see future
reductions in our professional fees, returning us to our historical level of
need for outside professional expertise in our ongoing operations.
Other
real estate owned expense increased by $60,000, or 115.4%, from $52,000 for the
three-month period ended March 31, 2009, to $112,000 for the three-month period
ended March 31, 2010, as writedowns on nonperforming assets were more
proactively recorded prior to the assets migrating to other real estate owned
through foreclosure for the three-month period ended March 31, 2010, as compared
to March 31, 2009. These expenses include costs incurred to maintain
properties we have foreclosed on, including property taxes and insurance,
utilities, property renovations and maintenance. These expenses also
include any writedowns to the carrying value of these foreclosed properties as
market conditions change subsequent to the foreclosure action. For the
three-month period ended March 31, 2010, there were net writedowns and
adjustments to reserves for other real estate owned of $40,000, with
approximately $72,000 and $52,000 in costs to maintain the properties for the
three-month periods ended March 31, 2010 and 2009, respectively. The
repossessed collateral is primarily made up of single-family residential
properties in varying stages of completion and various commercial
properties. These properties are being actively marketed and maintained
with the primary objective of liquidating the collateral at a level which most
accurately approximates fair market value and allows recovery of as much of the
unpaid principal balance as possible upon the sale of the property in a
reasonable period of time.
Telephone
and supplies expenses decreased by $35,000, or 21.7%, to $126,000 for the
three-month period ended March 31, 2010, as compared to $161,000 for the same
period in 2009. Although our number of branches was higher for the three-month
period ended March 31, 2010 as compared to the three-month period ended March
31, 2009, we were able to reduce these expenses due to various cost-saving
initiatives implemented during 2009.
Loan
related expenses increased by $13,000, or 9.9%, to $144,000 for the three-month
period ended March 31, 2010, as compared to $131,000 for the same period in
2009, due primarily to an increase in the number of property appraisals as a
result of regulatory requirements and proactive internal
initiatives. This increase was partially offset by the closure of the
wholesale mortgage lending division on September 2, 2009.
Public
relations expense decreased by $77,000, or 62.6%, from $123,000 for the
three-month period ended March 31, 2009, to $46,000 for the three-month period
ended March 31, 2010. While we are operating under the regulatory
consent order, we intend to limit our marketing expenditures. We
do plan to incur promotional expenditures beginning in the second quarter of
2010 to accompany a projected increase in noninterest income during 2010 from
deposits and charges on new accounts generated from the checking account
acquisition program to be implemented in June 2010.
Included
in the line item “Other,” which decreased $38,000, or 11.7%, between March 31,
2009 and 2010, are charges for fees paid to our board of directors and our
regional boards; postage, printing and stationery expenses; regulatory fees paid
to the OCC; amortization of intangibles related to the Carolina National
acquisition; and various customer-related expenses. As of February 28,
2009, board fees were suspended due to our reduced profitability. Also
included in noninterest expense for the three-month period ended March 31, 2009,
was a one-time writedown of our nonmarketable equity investment in a
correspondent bank, which we determined to be impaired.
Although
we are committed to attracting and retaining a team of seasoned and well-trained
officers and staff, maintaining highly technical operations support functions,
and further developing a professional marketing program, we are controlling our
noninterest expenses until our financial condition improves.
Balance
Sheet Review
General
As of
March 31, 2010, we had total assets of $676.1 million, a decrease of $41.6
million, or 5.8%, over total assets of $717.7 million as of December 31,
2009. Total assets on March 31, 2010, and December 31, 2009, consisted of
loans, net of unearned income, of $483.9 million and $511.8 million; cash and
cash equivalents of $88.8 million and $66.0 million; and securities available
for sale of $59.3 million and $99.1 million, all respectively. Also
included were other real estate owned of $17.7 million and $9.3 million;
premises and equipment, net of accumulated depreciation and amortization, of
$7.9 million and $8.1 million; bank owned life insurance of $3.3 million
and $3.2 million; other assets of $4.9 million and $5.4 million, income tax
receivable of $3.2 million and $7.4 million, and deferred tax assets of $0.3
million and $0.6 million, all as of March 31, 2010, and December 31, 2009,
respectively, and other nonmarketable equity securities of $6.8 million for both
periods.
Our
interest-earning assets, which include loans, net of unearned income, securities
available for sale and interest-earning bank balances, fell by $44.7 million to
$660.2 million as of March 31, 2010, or a decrease of 6.3% over the balance of
$704.9 million as of December 31, 2009. During the three-month period
ended March 31, 2010, we were negatively impacted by interest rate restrictions
on deposits imposed on our bank by the FDIC because we are not
“well-capitalized.” This rule originally became effective for us upon
signing the consent order on April 27, 2009, and limits our bank to paying 75
basis points over average deposit rates. On March 1, 2010, we began
using the national average rates, as determined by the FDIC, for each deposit
product. On April 16, 2010, we received approval from the FDIC to
continue using our market averages as we were determined to be operating in a
high-rate market area. However, as a result of the strategic sales of
approximately $40.8 million of investment securities coupled with the deliberate
reduction of our loan portfolio, which together more than outweighed the
decrease in retail and brokered deposits during the three-month period ended
March 31, 2010, our cash and cash equivalents had increased to $88.8 million, or
13.1% of total assets as of March 31, 2010, from $66.0 million, or 9.2%, of
total assets as of December 31, 2009. In April 2009, we had raised
approximately $150 million of brokered deposits laddered over a one-to two-year
time horizon. During the three-month period ended March 31, 2010, we
began to participate in an Internet-based CD placement program which allows us
to offer CDs up to $250,000 to other financial institutions at lower rates than
we typically offer our local depositors. We are incorporating this
program as a complement to our future retail deposit campaigns to partially
replace funds as our brokered CDs mature.
Our
liabilities as of March 31, 2010, decreased to $685.0 million, as compared to
liabilities as of December 31, 2009, of $721.8 million. These liabilities
consisted primarily of deposits of $605.4 million and $641.5 million; and $53.0
million and $54.0 million in Federal Home Loan Bank advances as of March 31,
2010, and December 31, 2009, all respectively, and $13.4 million in junior
subordinated debentures and $9.6 million in short-term borrowings, as of both
periods presented.
In
addition, as of March 31, 2010, our interest-bearing deposits included wholesale
funding in the form of brokered CDs of approximately $148.0 million, a decrease
of 6.3% over brokered CDs as of December 31, 2009, of $158.0 million. In the
past, we generally have obtained out-of-market time deposits of $100,000 or more
through brokers with whom we maintained ongoing relationships and who are
approved correspondents. The guidelines governing our participation in brokered
CD programs are part of our Asset Liability Management Program Policy, which is
reviewed, revised and approved annually by our Asset Liability
Committee. These guidelines allowed us to take advantage of the attractive
terms that wholesale funding can offer while mitigating the inherent related
risk.
However,
our ability to access brokered deposits through the wholesale funding market is
restricted as a result of the consent order that our bank entered into with the
OCC on April 27, 2009. Due to our bank’s capital classification, we are not
able to apply for a waiver from the FDIC to accept, renew or roll over
brokered deposits. We are using cash and unpledged liquid investment
securities, as well as retail deposits gathered from our statewide branch
network, to fund the maturity of our brokered deposits. In addition, during
the first quarter of 2010, we have begun to participate in an Internet-based CD
placement program which allows us to offer CDs up to $250,000 to other financial
institutions at lower rates than we typically offer our local
depositors.
Investments
On March
31, 2010, and December 31, 2009, our investment securities portfolio of $59.3
million and $99.1 million, respectively, represented approximately 9.0% and
14.0%, respectively, of our interest-earning assets. As of March 31, 2010,
and December 31, 2009, we were invested in U.S. Government agency securities,
mortgage-backed securities, and municipal securities with an amortized cost of
$60.1 million and $100.8 million, respectively, with a net unrealized loss of
approximately $0.8 million and $1.7 million, respectively. We did not own
any single issuer, pooled or trust preferred securities as of March 31, 2010, or
December 31, 2009.
The
mortgage-backed securities contained in the investment portfolio have primarily
been issued by the government sponsored enterprises, Fannie Mae and Freddie
Mac. In September 2008, Fannie Mae and Freddie Mac were taken into
conservatorship by the federal government and are now being managed, in part, by
their regulator, the Federal Housing Finance Agency. In management’s
opinion, the actions that led to the conservatorship include several support
initiatives by the federal government and virtually guarantee the repayment of
the underlying securities in accordance with their terms and conditions. We
do not own any preferred stock in any government sponsored enterprises. We
believe that the market for the U.S. Government and government-sponsored
enterprise securities is very liquid and that these securities could be sold
quickly to meet our liquidity needs.
The
decrease in our investment securities portfolio since December 31, 2009, has
occurred as we seek to balance an adequate level of interest income on earning
assets to support our overhead expense as our loan portfolio decreases with the
opportunity to capitalize on the unrealized gain position on several securities
in our investment portfolio. This decrease was due to the sale
of taxable securities and tax-exempt municipal securities totaling $40.6
million, which were sold for a gain of approximately $149,000, which was
recorded during the three-month period ended March 31, 2010. These
securities were sold based on an analysis of the total return on the securities
which showed a net benefit from selling the securities at a gain and investing
the proceeds at the current market yield.
Fair
values and yields on our investments (all available for sale) as of March 31,
2010, and December 31, 2009, are shown in the following table based on
contractual maturity dates. Expected maturities may differ from contractual
maturities because issuers may have the right to call or prepay obligations with
or without call or prepayment penalties. Yields on tax-exempt municipal
securities are presented on a tax equivalent basis (dollars in
thousands).
|
|
As
of March 31, 2010
|
|
|
|
Within
one year
|
|
|
After
one but within five years
|
|
|
After
five but within ten years
|
|
|
Over
ten years
|
|
|
Total
|
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
1,989
|
|
|
|
4.25
|
%
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
1,989
|
|
|
|
4.25
|
%
|
Mortgage-backed
securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
48,342
|
|
|
|
4.79
|
%
|
|
|
48,342
|
|
|
|
4.79
|
%
|
Taxable
municipal securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,117
|
|
|
|
4.65
|
%
|
|
|
4,482
|
|
|
|
5.59
|
%
|
|
|
5,599
|
|
|
|
5.40
|
%
|
Tax-exempt
municipal securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
608
|
|
|
|
3.75
|
%
|
|
|
2,745
|
|
|
|
4.03
|
%
|
|
|
3,353
|
|
|
|
3.98
|
%
|
Total
|
|
$
|
-
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
|
$
|
3,714
|
|
|
|
|
|
|
$
|
55,569
|
|
|
|
|
|
|
$
|
59,283
|
|
|
|
|
|
|
|
As
of December 31, 2009
|
|
|
|
Within
one year
|
|
|
After
one but within five years
|
|
|
After
five but within ten years
|
|
|
Over
ten years
|
|
|
Total
|
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
|
Amount
|
|
|
Yield
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
1,946
|
|
|
|
4.25
|
%
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
1,946
|
|
|
|
4.25
|
%
|
Mortgage-backed
securities
|
|
|
34
|
|
|
|
5.00
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
6,056
|
|
|
|
4.00
|
%
|
|
|
76,165
|
|
|
|
4.68
|
%
|
|
|
82,255
|
|
|
|
4.63
|
%
|
Taxable
municipal securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,511
|
|
|
|
4.10
|
%
|
|
|
9,619
|
|
|
|
5.45
|
%
|
|
|
11,130
|
|
|
|
5.26
|
%
|
Tax-exempt
municipal securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
785
|
|
|
|
3.83
|
%
|
|
|
2,996
|
|
|
|
4.04
|
%
|
|
|
3,781
|
|
|
|
3.99
|
%
|
Total
|
|
$
|
34
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
|
$
|
10,298
|
|
|
|
|
|
|
$
|
88,780
|
|
|
|
|
|
|
$
|
99,112
|
|
|
|
|
|
The
amortized cost and fair value of our investments (all available for sale) as of
March 31, 2010, and December 31, 2009, are shown in the following table
(dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
U.S.
Government/government sponsored enterprises
|
|
$
|
2,000
|
|
|
$
|
1,989
|
|
|
$
|
2,000
|
|
|
$
|
1,946
|
|
Mortgage-backed
securities
|
|
|
48,669
|
|
|
|
48,342
|
|
|
|
83,392
|
|
|
|
82,255
|
|
Taxable
municipal securities
|
|
|
5,803
|
|
|
|
5,599
|
|
|
|
11,353
|
|
|
|
11,130
|
|
Tax-exempt
municipal securities
|
|
|
3,647
|
|
|
|
3,353
|
|
|
|
4,104
|
|
|
|
3,781
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
60,119
|
|
|
$
|
59,283
|
|
|
$
|
100,849
|
|
|
$
|
99,112
|
|
We also
maintain certain nonmarketable equity investments required by law which are
reflected on the face of the consolidated balance sheets. The carrying
amounts for certain of these investments as of March 31, 2010, and
December 31, 2009, consisted of the following (dollars in
thousands):
|
|
As
of March 31,
|
|
|
As
of December 31,
|
|
|
|
2010
|
|
|
2009
|
|
Federal
Reserve Bank stock
|
|
$
|
1,821
|
|
|
$
|
1,821
|
|
Federal
Home Loan Bank stock
|
|
|
4,594
|
|
|
|
4,594
|
|
No ready
market exists for these stocks, and they have no quoted market value. However,
redemption of these stocks has historically been at par value. Accordingly, we
believe the carrying amounts are a reasonable estimate of fair
value. The level of FRB stock tied to our bank’s shareholders’ equity
and is adjusted for changes in our equity. The level of FHLB stock historically
has varied with the level of FHLB advances. However, the FHLB has
temporarily suspended the repurchase of their stock from their shareholder
banks.
We are
subject to the FHLB’s credit risk rating system which was effective September
27, 2008. This revised policy incorporated enhancements to the FHLB’s
credit risk rating system which assigns member institutions a rating which is
reviewed quarterly. The rating system utilizes key factors such as loan
quality, capital, liquidity, profitability, etc. Our ability to access our
available borrowing capacity from the FHLB in the future is subject to our
rating and any subsequent changes based on our financial performance as compared
to factors considered by the FHLB in their assignment of our credit risk rating
each quarter. In addition, residential collateral discounts were applied
during the year ended December 31, 2009, which further reduced our borrowing
capacity. We were notified by the FHLB during 2009 that it will not allow future
advances to us while we are operating under our current regulatory enforcement
action. We plan to replace the $4.1 million FHLB advances maturing in
2010 with liquidity generated by the release of the underlying securities as
these advances mature.
Other
Real Estate Owned
Other
real estate owned of $17.7 million was recorded at $20.3 million, net of
reserves of $1.1 million and estimated costs to sell of $1.5 million as of March
31, 2010. The balance in other real estate owned consists of property
acquired through foreclosure which has been recorded at its net realizable
value. The increase over the balance of $9.3 million as of December
31, 2009 represents the successful migration of several nonperforming loans
through the foreclosure process so that they now are positioned for us to take
the actions necessary to remove them from our balance sheet.
The
following table summarizes the composition of our other real estate owned as of
March 31, 2010, and December 31, 2009 (dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
Residential
housing related
|
|
$
|
13,771
|
|
|
$
|
5,380
|
|
Owner
occupied commercial
|
|
|
2,632
|
|
|
|
2,604
|
|
Other
commercial
|
|
|
1,324
|
|
|
|
1,331
|
|
Total
|
|
$
|
17,727
|
|
|
$
|
9,315
|
|
During
the three-month period ended March 31, 2010, the gross balance in other real
estate owned increased by approximately $8.4 million with the transfer to other
real estate owned of $9.7 million in properties acquired through foreclosure
during the three-month period ended March 31, 2010. The transfer of these
properties was partially offset by net sales of $0.2 million during the
three-month period ended March 31, 2010, on properties acquired through
foreclosure before or during 2010. These sales resulted in a net loss of
$38,000. In addition, the reserve for other real estate owned
was increased by $1.1 million during the three-month period ended March 31,
2010.
The
transfer of properties to other real estate owned represents the next logical
step from their previous classification as nonperforming loans to give us the
ability to control the properties in situations where the borrowers are
unwilling or unable to take the necessary steps to satisfy the debt
collateralized by the properties. However, based on our experience, each
foreclosure process is unique and can become significantly more complicated if
the borrower files bankruptcy. In general, we have found that a cooperative
transaction can be accomplished fairly quickly, sometime in as little as a few
months, with a higher recovery percentage of the loan balance as compared to a
foreclosure.
The
repossessed collateral is made up of single-family residential properties in
varying stages of completion (as well as various commercial
properties). Pursuant to the consent order that we entered into with the
OCC on April 27, 2009, we have implemented a process which requires us to
develop a written action plan for each parcel of other real estate owned to
ensure that each property is accounted for and managed in accordance with
regulatory guidance. These action plans include the following information,
at a minimum:
|
•
|
valuation
analysis and accounting for each property, including the appraisal and all
supporting documentation;
|
|
•
|
analysis
of the property, comparing the cost to carry against the financial
benefits of near term sale; and
|
|
•
|
marketing
strategy and targeted timeframes for disposing of the
property.
|
Management
follows established procedures that require periodic market valuations of each
property and outline the methodology used in the valuation. In addition,
targeted writedowns have been established at periodic intervals if marketing
strategies are unsuccessful.
These
properties are being actively marketed and maintained with the primary objective
of liquidating the collateral at a level which most accurately approximates fair
market value and allows recovery of as much of the unpaid principal balance as
possible upon the sale of the property in a reasonable period of time. An
updated appraisal from an independent appraiser is the basis for the initial
value of other real estate owned. Our appraisal review process validates
the assumptions used and conclusions formed by the appraiser with any resulting
adjustments made to the appraised value accordingly. After foreclosure,
valuations are reviewed on at least a quarterly basis by management, and any
resulting declines in the property value are recorded as part of other real
estate owned expense. The carrying value of these assets is believed to be
representative of their fair market value, although there can be no assurance
that the ultimate proceeds from the sale of these assets will be equal to or
greater than the carrying values.
Other
Assets
As of
March 31, 2010, other assets decreased to $4.9 million from $5.4 million as of
December 31, 2009. Included in other assets are interest receivable on
loans and investment securities, intangible assets and investments in
certificates of deposit at correspondent banks. From December 31, 2009, to
March 31, 2010, interest receivable decreased by approximately $436,000, or
20.3%, from $2.2 million to $1.7 million due to the reduction in the balance of
loans outstanding since December 31, 2009; intangible assets decreased by
$38,000, or 4.2%, from $908,000 to $870,000 due to scheduled amortization of
purchase accounting adjustments and mortgage servicing rights, each compared to
December 31, 2009, and investments in certificates of deposit at correspondent
banks stayed flat at $305,000 for both periods.
Loans
We offer
a variety of lending services, including real estate, commercial, and consumer
loans, including home equity lines of credit, primarily to individuals and
small- to mid-size businesses that are located in or conduct a substantial
portion of their business in the Spartanburg, Greenville, Charleston, Columbia,
Lexington or York County markets. We emphasize a strong credit culture
based on traditional credit measures and our knowledge of our markets through
experienced relationship managers. Since loans typically provide higher
interest yields than do other types of interest-earning assets, we have
historically invested a substantial percentage of our earning assets in our loan
portfolio. We are currently operating under the provisions of our consent
order with the OCC, which impacts our activities with respect to our loan
portfolio. We are deliberately reducing the size of the loan portfolio as
part of our strategy to increase our capital ratios to the minimum levels set
forth in the consent order. As a result, average loans for the three-month
period ended March 31, 2010, decreased to $526.4 million from $686.8
million for the three-month period ended March 31, 2009. In addition, total
loans outstanding as of March 31, 2010, and December 31, 2009, were $507.2
million and $537.2 million, respectively, before applying the allowance for loan
losses.
Our
underwriting standards vary for each type of loan. While we generally
underwrite the loans in our portfolio in accordance with our internal
underwriting guidelines and regulatory supervisory guidelines, in certain
circumstances we have made loans that exceed either our internal underwriting
guidelines, supervisory guidelines, or both. We generally are permitted to
hold loans that exceed supervisory guidelines up to 100% of our capital. We
have made loans that exceed our internal guidelines to a limited number of our
customers who have significant liquid assets, net worth, and amounts on deposit
with the bank. As of March 31, 2010, $75.9 million, or approximately
14.9% of our loans and 379.0% of our bank’s regulatory capital, had
loan-to-value ratios that exceeded regulatory supervisory
guidelines. We generally consider making such loans only after taking into
account the financial strength of the borrower. The number of loans in our
portfolio with loan-to-value ratios in excess of supervisory limits, our
internal guidelines, or both could increase the risk of delinquencies or
defaults in our portfolio. Any such delinquencies or defaults could have an
adverse effect on our results of operations and financial
condition.
We have
focused our lending activities primarily on small- and medium-sized business
owners, commercial real estate developers, and professionals. We maintain a
diversified loan portfolio and limit the amount of our loans to any single
customer. As of March 31, 2010, and December 31, 2009, our 10 largest
individual customer loan balances represented approximately $39.3 million and
$39.5 million, respectively, or 7.7% and 7.3% of the loan portfolio,
respectively, excluding mortgage loans held for sale.
The
following table summarizes the composition of our loan portfolio as of March 31,
2010, and December 31, 2009 (dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
|
Amount
|
|
|
%
of Total
|
|
|
Amount
|
|
|
%
of Total
|
|
Commercial
and industrial
|
|
$
|
24,251
|
|
|
|
4.78
|
%
|
|
$
|
31,564
|
|
|
|
5.88
|
%
|
Commercial
secured by real estate
|
|
|
312,638
|
|
|
|
61.64
|
%
|
|
|
329,897
|
|
|
|
61.42
|
%
|
Real
estate - residential mortgages
|
|
|
165,937
|
|
|
|
32.72
|
%
|
|
|
169,815
|
|
|
|
31.61
|
%
|
Installment
and other consumer loans
|
|
|
4,775
|
|
|
|
0.94
|
%
|
|
|
6,349
|
|
|
|
1.18
|
%
|
Total
loans
|
|
|
507,601
|
|
|
|
|
|
|
|
537,625
|
|
|
|
|
|
Unearned
income
|
|
|
(416
|
)
|
|
|
(0.08
|
%)
|
|
|
(464
|
)
|
|
|
(0.09
|
%)
|
Total
loans, net of unearned income
|
|
$
|
507,185
|
|
|
|
100.00
|
%
|
|
|
537,161
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
allowance for loan losses
|
|
|
(23,310
|
)
|
|
|
4.60
|
%
|
|
|
(25,408
|
)
|
|
|
4.73
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans, net
|
|
$
|
483,875
|
|
|
|
|
|
|
$
|
511,753
|
|
|
|
|
|
While the
largest component of our loan portfolio for all periods presented was commercial
loans secured by real estate, this category reflects a decrease from $330.0
million as of December 31, 2009, to $312.6 million as of March 31, 2010, a 5.3%
decrease. The decrease in commercial real estate loans has primarily been
driven by our disposition of problem loans and conversion of nonperforming loans
to other real estate owned upon foreclosure. This trend is primarily due
to deterioration in the residential real estate market and the economic
downturn which began during the second half of 2007 in the national, state, and
regional economies and has continued through 2009 and into 2010. In
addition, our tightened underwriting process on new and renewed credits has
resulted in a substantial net decline in our loans outstanding, and we
anticipate this trend to extend into the near future as we continue to reduce
the size of our loan portfolio as part of our strategy to shrink our balance
sheet to increase our capital ratios.
Commercial
real estate lending entails unique risks compared to residential
lending. Commercial real estate loans typically involve large loan balances
to single borrowers or groups of related borrowers. The payment experience
of such loans is typically dependent upon the successful operation of the real
estate project. These risks can be significantly affected by supply and
demand conditions in the market for office and retail space and for apartments
and, as such, may be subject to adverse conditions in the economy to a greater
extent. In dealing with these risk factors, we generally limit ourselves to
a real estate market or to borrowers with which we have experience. We
generally concentrate on originating commercial real estate loans secured by
properties located within our market areas. In addition, many of our
commercial real estate loans are secured by owner-occupied property with
personal guarantees for the debt.
As of
March 31, 2010, and December 31, 2009, our commercial real estate loans ranged
in size from less than $1,000 to $4.5 million and from less than $1,000 to $4.5
million, respectively. The average commercial real estate loan size
as of
March 31, 2010 and December 31, 2009, w
as approximately $284,000 and
$303,000, respectively. These loans generally have terms of five years or less,
although payments may be structured on a longer amortization basis. We
evaluate each borrower on an individual basis and attempt to determine the
business risks and credit profile of each borrower. We have reduced credit
risk in the commercial real estate portfolio by emphasizing loans on
owner-occupied properties where the loan-to-value ratio, established by
independent appraisals, does not exceed 80%. We prepare a credit analysis
in addition to a cash flow analysis to support the loan. In order to ensure
secondary sources of payment and to support a loan request, we typically review
all of the personal financial statements of the principal owners and require
their personal guarantees. These commercial real estate loans include
various types of business purpose loans secured by commercial real
estate.
Commercial
real estate loans make up the majority of our nonaccrual loans due to the
downturn in the residential housing industry. The following tables show the
spread of the nonaccrual loans geographically and by product type for the
periods ended March 31, 2010, and December 31, 2009 (dollars in
thousands):
|
|
March
31, 2010 CRE Nonaccrual Loans by Geography
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
of Total Nonaccrual
|
|
|
|
Upstate
|
|
|
Midlands
|
|
|
Coastal
|
|
|
Northern
|
|
|
Other
|
|
|
Total
|
|
|
Loans
|
|
CRE
Nonaccrual Loans by Product Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
construction
|
|
$
|
1,444
|
|
|
$
|
1,799
|
|
|
$
|
4,627
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
7,870
|
|
|
|
6.6
|
%
|
Residential
other
|
|
|
12,106
|
|
|
|
2,455
|
|
|
|
10,790
|
|
|
|
105
|
|
|
|
1,621
|
|
|
|
27,077
|
|
|
|
22.9
|
%
|
Residential
land
|
|
|
9,563
|
|
|
|
3,674
|
|
|
|
18,726
|
|
|
|
3,510
|
|
|
|
743
|
|
|
|
36,216
|
|
|
|
30.6
|
%
|
Multifamily
|
|
|
1,691
|
|
|
|
141
|
|
|
|
1,319
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,151
|
|
|
|
2.7
|
%
|
Commercial
owner-occupied
|
|
|
2,627
|
|
|
|
322
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,949
|
|
|
|
2.5
|
%
|
Commercial
nonresidential
|
|
|
14,528
|
|
|
|
4,272
|
|
|
|
11,460
|
|
|
|
3,204
|
|
|
|
1,271
|
|
|
|
34,735
|
|
|
|
29.3
|
%
|
Total
|
|
$
|
41,959
|
|
|
$
|
12,663
|
|
|
$
|
46,922
|
|
|
$
|
6,819
|
|
|
$
|
3,635
|
|
|
$
|
111,998
|
|
|
|
94.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CRE
Nonaccrual Loans as % of Total Nonaccrual
|
|
|
35.4
|
%
|
|
|
10.7
|
%
|
|
|
39.6
|
%
|
|
|
5.8
|
%
|
|
|
3.1
|
%
|
|
|
94.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Nonaccrual Loans March 31, 2010
|
|
$
|
118,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2009 CRE Nonaccrual Loans by Geography
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
of Total Nonaccrual
|
|
|
|
Upstate
|
|
|
Midlands
|
|
|
Coastal
|
|
|
Northern
|
|
|
Other
|
|
|
Total
|
|
|
Loans
|
|
CRE
Nonaccrual Loans by Product Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
construction
|
|
$
|
1,504
|
|
|
$
|
2,033
|
|
|
$
|
6,023
|
|
|
$
|
506
|
|
|
$
|
-
|
|
|
$
|
10,066
|
|
|
|
7.9
|
%
|
Residential
other
|
|
|
12,094
|
|
|
|
2,956
|
|
|
|
13,308
|
|
|
|
1,678
|
|
|
|
221
|
|
|
|
30,257
|
|
|
|
23.6
|
%
|
Residential
land
|
|
|
10,730
|
|
|
|
3,685
|
|
|
|
19,261
|
|
|
|
6,205
|
|
|
|
-
|
|
|
|
39,881
|
|
|
|
31.1
|
%
|
Multifamily
|
|
|
2,155
|
|
|
|
-
|
|
|
|
1,496
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,651
|
|
|
|
2.9
|
%
|
Commercial
owner-occupied
|
|
|
2,642
|
|
|
|
322
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,964
|
|
|
|
2.3
|
%
|
Commercial
nonresidential
|
|
|
8,134
|
|
|
|
4,697
|
|
|
|
14,579
|
|
|
|
3,196
|
|
|
|
2,847
|
|
|
|
33,453
|
|
|
|
26.1
|
%
|
Total
|
|
$
|
37,259
|
|
|
$
|
13,693
|
|
|
$
|
54,667
|
|
|
$
|
11,585
|
|
|
$
|
3,068
|
|
|
$
|
120,272
|
|
|
|
93.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CRE
Nonaccrual Loans as % of Total Nonaccrual
|
|
|
29.1
|
%
|
|
|
10.7
|
%
|
|
|
42.7
|
%
|
|
|
9.0
|
%
|
|
|
2.4
|
%
|
|
|
93.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Nonaccrual Loans December 31, 2009
|
|
$
|
128,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Although
we are deliberately reducing the size of our loan portfolio, we are continuing
to originate loans which meet our loan underwriting criteria and are priced
appropriately for the credit risk. However, we are consistently decreasing
the concentration of commercial real estate and construction loans in our
portfolio. Our dedication to strong credit quality is reinforced by our
internal credit review process and performance and development benchmarks in the
areas of past dues and loan documentation. We currently engage an outside
firm to perform our credit review function and to evaluate our loan portfolio on
a quarterly basis for credit quality and a second outside firm for compliance
issues on an annual basis. Pursuant to the executed consent order with the
OCC, our bank’s loan review is required to deliver quarterly written reports to
the board of directors on the content of the results of the loan reviews
performed.
We also
make some commercial business loans that are not secured by real estate. We
make loans for commercial purposes in various lines of business, including
retail, service industry, and professional services. As of March 31, 2010,
and December 31, 2009, our individual commercial business loans ranged in size
from less than $1,000 to $1.2 million and from less than $1,000 to $1.2 million,
respectively, with an average loan size of approximately $63,000 and $69,000,
respectively. As with other categories of loans, the principal economic
risk associated with commercial loans is the creditworthiness of the
borrower. The risks associated with commercial loans vary with many
economic factors, including the economy in our market areas. Commercial
loans are generally considered to have greater risk than first or second
mortgages on real estate because commercial loans may be unsecured, or if they
are secured, the value of the collateral may be difficult to assess and more
likely to decrease than real estate.
We do not
generally originate traditional long-term residential mortgages, but we do issue
traditional first and second mortgage residential real estate loans and home
equity lines of credit. Both fixed and variable rate home equity lines are
offered with terms typically ranging between 5 and 15 years. We obtain a
security interest in real estate whenever possible, in addition to any other
available collateral. This collateral is taken to increase the likelihood
of the ultimate repayment of the loan. Historically, we have generally
limited the loan-to-value ratio on loans we make to 80%. We do not offer
option arm, or “pick-a-payment,” mortgages which may carry increased credit risk
during times of declining home values.
Our
lending activities are subject to a variety of lending limits imposed by federal
law. In general, our bank is subject to a legal limit on loans to a single
borrower equal to 15% of the bank’s capital and unimpaired surplus. This
limit will increase or decrease as the bank’s capital increases or
decreases. Based upon the capitalization of the bank as of March 31, 2010,
our legal lending limit was approximately $5.5 million. We may sell
participations in our larger loans to other financial institutions, which allows
us to manage the risk involved in these loans and to meet the lending needs of
our customers requiring extensions of credit in excess of this
limit.
The
continued downturn in the real estate market could continue to increase loan
delinquencies, defaults and foreclosures, and could significantly impair the
value of our collateral and our ability to sell the collateral upon
foreclosure. The real estate collateral in each case provides alternate
sources of repayment in the event of default by the borrower and may deteriorate
in value during the time the credit is extended. As real estate values have
declined, we have been required to increase our allowance for loan
losses. If, during a period of reduced real estate values, we are required
to liquidate the property collateralizing a loan to satisfy the debt or to
increase the allowance for loan losses, it could materially reduce our
profitability and adversely affect our financial condition.
Maturities
and Sensitivity of Loans to Changes in Interest Rates
The
information in the following tables is based on the contractual maturities of
individual loans, including loans that may be subject to renewal at their
contractual maturity. Renewal of such loans is subject to review and credit
approval, as well as modification of terms upon their maturity. Actual
repayments of loans may differ from the maturities reflected below because
borrowers have the right to prepay obligations with or without prepayment
penalties.
The
following tables summarize the loan maturity distribution by type and related
interest rate characteristics as of March 31, 2010, and December 31, 2009
(dollars in thousands):
|
|
As
of March 31, 2010
|
|
|
|
One
year or less
|
|
|
After
one but within five years
|
|
|
After
five years
|
|
|
Total
|
|
Commercial
|
|
$
|
7,588
|
|
|
$
|
9,543
|
|
|
$
|
398
|
|
|
$
|
17,529
|
|
Real
estate - construction
|
|
|
28,605
|
|
|
|
24,904
|
|
|
|
207
|
|
|
|
53,716
|
|
Real
estate - mortgage
|
|
|
137,388
|
|
|
|
243,309
|
|
|
|
51,225
|
|
|
|
431,922
|
|
Consumer
and other
|
|
|
2,516
|
|
|
|
1,512
|
|
|
|
406
|
|
|
|
4,434
|
|
Total
|
|
$
|
176,097
|
|
|
$
|
279,268
|
|
|
$
|
52,236
|
|
|
$
|
507,601
|
|
Unearned
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(416
|
)
|
Total
loans, net of unearned income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
507,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
maturing after one year with:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
interest rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
139,639
|
|
Floating
interest rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
191,865
|
|
|
|
As
of December 31, 2009
|
|
|
|
One
year or less
|
|
|
After
one but within five years
|
|
|
After
five years
|
|
|
Total
|
|
Commercial
|
|
$
|
7,147
|
|
|
$
|
10,263
|
|
|
$
|
428
|
|
|
$
|
17,838
|
|
Real
estate - construction
|
|
|
39,173
|
|
|
|
22,890
|
|
|
|
93
|
|
|
|
62,156
|
|
Real
estate - mortgage
|
|
|
142,334
|
|
|
|
258,432
|
|
|
|
51,300
|
|
|
|
452,066
|
|
Consumer
and other
|
|
|
3,324
|
|
|
|
1,799
|
|
|
|
442
|
|
|
|
5,565
|
|
Total
|
|
$
|
191,978
|
|
|
$
|
293,384
|
|
|
$
|
52,263
|
|
|
$
|
537,625
|
|
Unearned
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(464
|
)
|
Total
loans, net of unearned income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
537,161
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
maturing after one year with:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
interest rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
148,073
|
|
Floating
interest rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
197,574
|
|
As
previously discussed, our loan portfolio has decreased in part due to the
migration of nonperforming loans to other real estate owned through disposition
or otherwise, and we are strategically shrinking our loan portfolio to support
the projected decrease in our balance sheet as part of our strategy to improve
our capital ratios. This strategy involves our tightened underwriting
process on new and renewing loans as well as increased interest rates on new and
renewing loans in order to further reduce our balance sheet and improve our
capital ratios.
Our
strategy also includes reducing the size of our real estate construction
portfolio as these loans carry a higher degree of risk than long-term financing
of existing real estate since repayment is dependent on the ultimate completion
of the project or home and usually on the sale of the property or permanent
financing. This category of loans experienced a decrease from $62.2
million as of December 31, 2009, or 11.6% of total loans to $53.7 million, or
10.6% of total loans, as of March 31, 2010.
In prior
years, we originated adjustable and fixed rate residential and commercial
construction loans to builders and developers. As of March 31, 2010 and
December 31, 2009, our commercial construction and development real estate loans
ranged in size from approximately $6,700 to $3.9 million and approximately
$6,700 to $3.9 million, respectively, with an average loan size of approximately
$321,000 and $342,000 respectively. As of March 31, 2010, our individual
residential construction and development real estate loans ranged in size from
approximately $7,800 to $832,000, with an average loan size of approximately
$112,000. The duration of our construction and development loans generally
is limited to 12 months, although payments may be structured on a longer
amortization basis. We reduced the risk associated with construction and
development loans by obtaining personal guarantees and by keeping the
loan-to-value ratio of the completed project at or below 80%. Specific
risks of construction and development loans include:
|
•
|
mismanaged
construction;
|
|
•
|
inferior
or improper construction
techniques;
|
|
•
|
economic
changes or downturns during
construction;
|
|
•
|
rising
interest rates that may prevent sale of the property;
and
|
|
•
|
failure
to sell completed projects in a timely
manner.
|
We have
reduced the concentration of real estate construction and land development loans
in our portfolio and have generally ceased making new loans to
homebuilders.
Allowance
for Loan Losses
The
allowance for loan losses represents an amount that we believe will be adequate
to absorb probable losses on existing loans that may become uncollectible, based
on our continuous review of a variety of factors. Assessing the adequacy
of the allowance for loan losses is a process that requires considerable
judgment. Our judgment in determining the adequacy of the allowance is
based on evaluations of the collectability of loans, including consideration of
factors such as the balance of impaired loans; the quality, mix and size of our
overall loan portfolio; economic conditions that may affect the borrower’s
ability to repay; the amount and quality of collateral securing the loans; our
historical loan loss experience; and a review of specific problem
loans. Our judgment as to the adequacy of the allowance for loan losses is
based on a number of assumptions, which we believe to be reasonable, but which
may or may not prove to be accurate. In assessing adequacy, management
relies predominantly on its ongoing review of the loan portfolio, which is
undertaken both to determine whether there are probable losses that must be
charged off and to assess the risk characteristics of the aggregate
portfolio. We adjust the amount of the allowance periodically based on
changing circumstances as a component of the provision for loan losses. We
charge recognized losses against the allowance and add subsequent recoveries
back to the allowance.
Our
allowance for loan losses is also subject to regulatory examinations and
determinations as to adequacy, which may take into account such factors as the
methodology used to calculate the allowance for loan losses and the size of the
allowance for loan losses compared to a group of peer banks identified by our
regulators. During routine examinations of our bank, the OCC may require us
to make additional provisions to our allowance for loan losses when, in the
OCC’s opinion, their credit evaluations and allowance for loan loss methodology
differ materially from ours. As part of the consent order that our bank
entered into with the OCC on April 27, 2009, we implemented an updated allowance
for loan losses program. This program is consistent with the guidance found
in the Interagency Policy Statement on the Allowance for Loan Losses contained
in OCC Bulletin 2006-47. The program includes the following
elements: internal risk ratings of our loans; results of our independent
loan review; criteria to determine which loans will be reviewed, how impairment
will be determined, and procedures to ensure that the analysis of loans complies
with the criteria defined in the Receivables Topic of the FASB ASC; criteria for
determining loan pools found in the FASB ASC “Contingencies,” and an analysis of
those loan pools; recognition of nonaccrual loans in conformance with GAAP and
regulatory guidance; loan loss expense; trends of delinquent and nonaccrual
loans; concentrations of credit; and present and projected economic and market
conditions. The program provides for a review of the allowance for loan
losses by our board of directors at least once each calendar
quarter.
We
calculate the allowance for loan losses for specific types of loans and evaluate
the adequacy on an overall portfolio basis utilizing our credit grading system
which we apply to each loan. We combine our estimates of the reserves
needed for each component of the portfolio, including loans analyzed on a pool
basis and loans analyzed individually. Certain nonperforming loans are
individually assessed for impairment and assigned a specific reserve. All
other loans are evaluated based on quantitative and qualitative risk factors and
are assigned a general reserve. As of March 31, 2010, management felt that
the allowance for loan losses compared to our loan portfolio was adequate, but
should further analysis require a future increase to our allowance for loan
losses, we will provide additional provisions as appropriate.
The
following table sets forth the changes in the allowance for loan losses for the
year ended December 31, 2009, and the three-month periods ended March 31, 2010
and 2009 (dollars in thousands):
|
|
As
of or For the Three Months Ended
|
|
|
As
of or For the Year Ended
|
|
|
As
of or For the Three Months Ended
|
|
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
March
31, 2009
|
|
Balance,
beginning of year
|
|
$
|
25,408
|
|
|
$
|
23,033
|
|
|
$
|
23,033
|
|
Provision
charged to operations
|
|
|
3,700
|
|
|
|
39,712
|
|
|
|
2,152
|
|
Loans
charged off
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
housing related
|
|
|
(2,170
|
)
|
|
|
(16,879
|
)
|
|
|
(1,463
|
)
|
Owner
occupied commercial
|
|
|
-
|
|
|
|
(887
|
)
|
|
|
-
|
|
Other
commercial
|
|
|
(4,192
|
)
|
|
|
(19,222
|
)
|
|
|
(1,285
|
)
|
Other
|
|
|
(184
|
)
|
|
|
(499
|
)
|
|
|
(45
|
)
|
Total
chargeoffs
|
|
|
(6,546
|
)
|
|
|
(37,487
|
)
|
|
|
(2,793
|
)
|
Recoveries
of loans previously charged off
|
|
|
748
|
|
|
|
150
|
|
|
|
2
|
|
Balance,
end of period
|
|
$
|
23,310
|
|
|
$
|
25,408
|
|
|
$
|
22,394
|
|
Allowance
to loans, year end
|
|
|
4.60
|
%
|
|
|
4.73
|
%
|
|
|
3.31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
chargeoffs to average loans
|
|
|
4.41
|
%
|
|
|
5.90
|
%
|
|
|
1.63
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonaccrual
loans
|
|
$
|
118,425
|
|
|
$
|
128,019
|
|
|
$
|
68,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Past
due loans in excess of 90 days on accrual status
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
real estate owned
|
|
|
17,727
|
|
|
|
9,315
|
|
|
|
6,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
nonperforming assets
|
|
$
|
136,152
|
|
|
$
|
137,334
|
|
|
$
|
74,667
|
|
Generally,
a loan is placed on nonaccrual status when it becomes 90 days past due as to
principal or interest, or when management believes, after considering economic
and business conditions and collection efforts, that the borrower’s financial
condition is such that collection of the loan is doubtful. A payment of
interest on a loan that is classified as nonaccrual is recognized as income when
received. Historically, we have had low levels of nonperforming assets, but
the economic downturn which began during the second half of 2007 in the
national, state, and regional economies and has continued through 2009 and so
far in 2010, combined with continued deterioration in real estate market
conditions, has increased those levels to $136.1 million in nonperforming
assets as of March 31, 2010. In addition, as of May 4, 2010, there were
contracts in place for pending sales of loans and other real estate owned of
approximately $2.0 million, which will reduce nonperforming assets to $134.1
million. Included in the $118.4 million balance of loans on nonaccrual
status reported as of March 31, 2010 were three related USDA guaranteed loans
with the guaranteed portion equaling $3.3 million. Net of this
guaranteed portion in addition to pending sales, total nonperforming assets were
$130.8 million. The net chargeoffs to average loans ratio for the
three-month period ended March 31, 2010, was 4.41% as compared to 1.63% for the
three-month period ended March 31, 2009 and 5.90% for the year ended
December 31, 2009. For the three-month period ended March 31, 2010, total
net chargeoffs were $5.8 million compared to $2.8 million for the same period in
2009 and $37.3 million for the year ended December 31, 2009. The actual
loss on disposition of the loan and/or the underlying collateral may be more or
less than the amount charged off.
The
following table sets forth the breakdown of the allowance for loan losses by
loan category and the percentage of loans in each category to
gross loans for each of the periods represented (dollars in
thousands).
|
|
As
of or For the Three Months Ended
|
|
|
As
of or For the Year Ended
|
|
|
As
of or For the Three Months Ended
|
|
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
March
31, 2009
|
|
Commercial
|
|
$
|
10,634
|
|
|
|
3.4
|
%
|
|
$
|
9,990
|
|
|
|
3.3
|
%
|
|
$
|
6,235
|
|
|
|
3.6
|
%
|
Real
estate - construction
|
|
|
4,371
|
|
|
|
10.6
|
%
|
|
|
7,620
|
|
|
|
11.6
|
%
|
|
|
9,746
|
|
|
|
28.6
|
%
|
Real
estate - mortgage
|
|
|
8,209
|
|
|
|
85.0
|
%
|
|
|
7,721
|
|
|
|
84.1
|
%
|
|
|
6,352
|
|
|
|
66.7
|
%
|
Consumer
|
|
|
96
|
|
|
|
1.0
|
%
|
|
|
77
|
|
|
|
1.0
|
%
|
|
|
61
|
|
|
|
1.1
|
%
|
Unallocated
|
|
|
-
|
|
|
|
N/A
|
|
|
|
-
|
|
|
|
N/A
|
|
|
|
-
|
|
|
|
N/A
|
|
Total
allowance for loan losses
|
|
$
|
23,310
|
|
|
|
100.0
|
%
|
|
$
|
25,408
|
|
|
|
100.0
|
%
|
|
$
|
22,394
|
|
|
|
100.0
|
%
|
We
believe that the allowance can be allocated by category only on an approximate
basis. The allocation of the allowance to each category is not
necessarily indicative of further losses and does not restrict the use of the
allowance to absorb losses in any other category.
The
provision for loan losses has been made primarily as a result of management’s
assessment of probable losses on specific loans, as well as general loan loss
risk after considering historical operating results. Our evaluation is
inherently subjective as it requires estimates that are susceptible to
significant change. In addition, various regulatory agencies review our
allowance for loan losses through their periodic examinations, and they may
require us to record additions to the allowance for loan losses based on their
judgment about information available to them at the time of their
examinations. Our losses will undoubtedly vary from our estimates, and
there is a possibility that chargeoffs in future periods will exceed the
allowance for loan losses as estimated at any point in time. Any such
excess would adversely affect our results of operations. Please see Note 5
- Loans in the Notes to Consolidated Financial Statements included in this
report for additional information.
Specific
Reserve
We
analyze individual loans within the portfolio and make allocations to the
allowance based on each individual loan’s specific factors and other
circumstances that affect the collectability of the credit in accordance with
the criteria defined in the Receivables Topic of the FASB ASC. As of March
31, 2010, our allowance for loan losses included specific reserves of $5.5
million, net of $18.9 million in specific chargeoffs, as compared to $8.6
million, net of $22.5 million in specific chargeoffs, as of December 31,
2009.
Significant
individual credits classified as doubtful or substandard/special mention within
our credit grading system that are determined to be impaired require both
individual analysis and specific allocation. Loans in the substandard
category are characterized by deterioration in quality exhibited by any number
of well-defined weaknesses requiring corrective action, such as declining or
negative earnings trends and declining or inadequate liquidity. Loans in
the doubtful category exhibit the same weaknesses found in the substandard
loans; however, the weaknesses are more pronounced. These loans, however,
are not yet rated as loss because certain events may occur which could salvage
the debt, such as injection of capital, alternative financing, or liquidation of
assets.
In these
situations where a loan is determined to be impaired (primarily because it is
probable that all principal and interest due according to the terms of the loan
agreement will not be collected as scheduled), the loan is excluded from the
general reserve calculations described below and is assigned a specific
reserve. We calculate specific reserves on those impaired loans exceeding
$250,000. These reserves are based on a thorough analysis of the most
probable source of repayment which is usually the liquidation of the underlying
collateral, but may also include discounted future cash flows, borrower
guarantees or, in rare cases, the market value of the loan itself. The
loans with specific reserves are typically identified through our process of
reviewing and assessing the ratings on loans, which is performed by personnel in
our credit administration area and special assets management group. The
accuracy of the loan ratings is validated by a third-party review which is
performed quarterly and annually covers a substantial amount of the loan
portfolio.
Generally,
for larger collateral-dependent loans, current market appraisals are ordered to
estimate the current fair value of the collateral. As set forth in the
consent order with the OCC, we had appraisals prepared during 2009 and reviewed
on a large number of our residential and commercial collateral-dependent
loans. However, in situations where a current market appraisal is not
available, management uses the best available information (including recent
appraisals for similar properties, communications with qualified real estate
professionals, information contained in reputable trade publications and other
observable market data) to estimate the current fair value. In these
situations, valuations based on our internal calculations have generally been
consistent with the valuations determined by appraisals on similar properties
and, as such, management believes the internal valuations can be reasonably
relied upon for valuation purposes. The estimated costs to sell the subject
property, if any, are then deducted from the estimated fair value to arrive at
the “net realizable value” of the loan and to determine the specific reserve on
each impaired loan reviewed. The credit risk management group periodically
reviews the fair value assigned to each impaired loan and adjusts the specific
reserve accordingly. We recorded charge-offs for projected losses on
impaired loans of $6.5 million during the three-month period ended March 31,
2010, excluding reserves for estimated costs to liquidate the
collateral.
As a
result of the identification of adverse developments with respect to certain
loans in our loan portfolio, the amount of nonperforming loans that were
specifically reviewed for impairment decreased during the three-month period
ended March 31, 2010, to $113.3 million (after related chargeoffs of $18.9
million) from $119.8 million (after related chargeoffs of $22.5 million) as of
December 31, 2009, with related valuation allowances of $5.5 million and $8.6
million, respectively. The remainder of the nonperforming loans were
assigned a general reserve according to their respective loan
categories. The provision for loan losses generally, and the loans impaired
under the criteria defined in the Receivables Topic of the FASB ASC
specifically, reflect the negative impact of the continued deterioration in the
residential real estate market, specifically along the South Carolina coast, and
the economy in general in our market areas. Although we believe the
negative impact of these trends on our loan portfolio is decreasing, our loan
portfolio may continue to be negatively affected in the
future. Reviews by the credit department typically have included
several of our residential real estate development and construction
borrowers.
Our
analysis of impaired loans and their underlying collateral values has revealed
the continued deterioration in the level of property values, as well as reduced
borrower ability to make regularly scheduled payments. Loans in our
residential land development and construction portfolios are secured by
unimproved and improved land, residential lots, and single-family and
multi-family homes. Generally, current lot sales by the developers and/or
borrowers are taking place at a greatly reduced pace and at reduced
prices. As home sales volumes have declined, income of residential
developers, contractors and other real estate-dependent borrowers has also been
reduced. This difficult operating environment, along with the additional
loan carrying time, has caused some borrowers to exhaust payment
sources.
Approximately
$5.5 million of the net chargeoffs in the first three months of 2010 were
recorded to reflect impairments on nonperforming loans as of March 31, 2010 as
required by the Receivables Topic of the FASB ASC. The actual loss on
future disposition of the loan and/or the underlying collateral may be more or
less than the amount recorded to expense. The $3.7 million provision for
loan loss for the three-month period ended March 31, 2010, is part of our
ongoing strategy to resolve our nonperforming assets with the goal of removing
them from our balance sheet.
As of
March 31, 2010, and December 31, 2009, nonperforming assets (nonperforming loans
plus other real estate owned) were $136.1 million and $137.3 million,
respectively. In addition, as of May 4, 2010, there were contracts in
place for pending sales of loans and other real estate owned of approximately
$2.0 million, which would reduce nonperforming assets to $134.1
million. Included in the $118.4 million balance of loans on nonaccrual
status reported as of March 31, 2010 were three related USDA guaranteed
loans with the guaranteed portion equaling $3.3 million. Net of this
guaranteed portion in addition to pending sales, total nonperforming assets were
$130.8 million. Foregone interest income on these nonaccrual loans and
other nonaccrual loans charged off during the three-month periods ended March
31, 2010, and December 31, 2009, was approximately $1,434,000 and $331,000,
respectively. There were no performing loans contractually past due
in excess of 90 days and still accruing interest as of March 31,
2010. Included in the $128.0 million balance reported of loans on
nonaccrual status as of December 31, 2009, was one loan contractually past due
for 90 days and still accruing interest. It was placed on nonaccrual status
the following business day. There were nonperforming loans, under the
criteria defined in the Receivables Topic of the FASB ASC, of $113.3 million,
(after related specific chargeoffs of $18.9 million) and $119.8 million (after
related specific chargeoffs of $22.5 million), with related valuation allowances
of $5.5 million and $8.6 million as of March 31, 2010, and December 31,
2009.
General
Reserve
Our
general reserve was $17.8 million as of March 31, 2010, as compared to $16.8
million as of December 31, 2009. We calculate our general reserve based on
a percentage allocation for each of the categories of the following unclassified
loan types: real estate, commercial, SBA, consumer, A&D/construction,
and residential mortgage. A percentage allocation is also assigned to the
loans classified as special mention, substandard and doubtful that are not
impaired or are under $250,000 and impaired. We apply our historical trend
loss factors to each category and adjust these percentages for qualitative or
environmental factors, as discussed below. The general estimate is then
added to the specific allocations made to determine the amount of the total
allowance for loan losses.
We
maintain the general reserve in accordance with December 2006 regulatory
interagency guidance in our assessment of the loan loss allowance. This
general reserve considers qualitative or environmental factors that are likely
to cause estimated credit losses including, but not limited to: changes in
delinquent loan trends, trends in risk grades and net chargeoffs, concentrations
of credit, trends in the nature and volume of the loan portfolio, general and
local economic trends, collateral valuations, the experience and depth of
lending management and staff, lending policies and procedures, the quality of
loan review systems, and other external factors.
Our
general reserve has increased in recent quarters due to the significant increase
in chargeoffs, which are used as a factor to calculate the general reserve
component of the allowance for loan losses. Because of the deterioration in
the economy and real estate markets over the past several years, we use an
internal trending analysis in calculating our general reserve, versus the
five-year peer-based averages we had relied on in the past. Although we
have observed consistent improvement in the totals of our loans with past due
balances in the 30 to 89 day category
over the past three
quarters, with March 31, 2010 reflecting a decrease to $7.8 million from $50.4
million as of June 30, 2009, we have determined that due to the elevated level
of chargeoffs during 2009, a higher general reserve level is necessary to
reflect probable losses in the portfolio as of March 31, 2010.
Credit Risk
Management
Through
our third party loan review firm, we continuously review our loan portfolio for
credit risk. During 2009, this third party review firm performed reviews on
65% of the loans in our loan portfolio, and this review firm performs reviews on
approximately 15% of our loan portfolio on a quarterly basis, with no loans
being reviewed in consecutive quarters. Our senior credit officer reports
directly to our chief executive officer and provides regular reports
to the board of directors and its committees on the relevant loan portfolio
statistics. Adherence to underwriting standards is managed through a
documented credit approval process, including independent loan underwriting of
new loans and renewing loans by our credit administration group for
relationships where total credit exposure will exceed
$500,000. Post-funding review is managed by a separate department, ensuring
adherence to our approval and underwriting documentation
requirements. Based on the volume and complexity of the problem loans in
our portfolio, we adjust the resources allocated to the process of monitoring
and resolution of these assets.
Compliance
with our underwriting standards is closely supervised through a number of
procedures including reviews of exception reports. Pursuant to the consent
order that we entered into with the OCC on April 27, 2009, we implemented
enhanced procedures to monitor and correct credit and collateral
exceptions. We believe that reducing the number of credit and collateral
exceptions is essential to maintaining excellent asset quality. Excessive
credit and collateral exceptions contribute to asset quality issues by limiting
our ability to monitor the loan portfolio and increasing the risk of loss on
secured transactions. Since implementing the new procedures in this area
during 2009, we have reduced the number of credit exceptions to well below 10%
of the dollar amount of the outstanding loan balances. Our strategic
plan includes maintaining a low level of credit and collateral exceptions as
part of our goal of improving the quality of the loan portfolio.
We
emphasize centralized policies and uniform underwriting criteria for all
loans. We maintain an internal rating system that provides a mechanism to
regularly monitor the credit quality of our loan portfolio. The rating
system is designed to identify and measure the credit quality of lending
relationships. We believe we have identified problem loans early, placed loans
on nonaccrual status promptly and maintained adequate reserve levels. Once
problem loans are identified, policies require written plans for resolution and
periodic reporting to credit risk management to review and document
progress.
During
2009, we implemented monthly loan review meetings, whereby loan officers present
a written review of selected loan relationships over $250,000 to senior officers
from the credit risk management and lending functions. This review assesses
the overall status of the relationship, the proper risk rating for the
relationship, and the appropriate relationship strategy (increase, maintain,
reduce, or exit).
In
addition, the terms of the consent order that we entered into with the OCC on
April 27, 2009 required us to implement a revised general loan policy including
a commercial real estate and construction and development concentration
management program. The consent order also required us to obtain updated
independent appraisals on loans secured by real property that met certain
criteria in the consent order. We have implemented an enhanced independent
appraisal review and analysis process for these appraisals and all future
appraisals obtained to ensure that appraisals conform to applicable appraisal
standards and regulations. We also established a new loan review program,
and we have increased the scope and frequency of our external loan
reviews.
Special Assets Management
Group
In order
to concentrate our efforts on the timely resolution and disposition of
nonperforming and foreclosed assets, we formed a special assets management group
during 2009. This group’s objective is the expedient workout/resolution of
assigned loans and assets at the highest present value recovery. As
of May 4, 2010, First National had successfully resolved approximately $57.7
million of its problem assets since March 31, 2009, and had approximately $2.0
million of problem assets pending resolution as of this date. This
separate operating unit consists of experienced workout specialists and loan
officers with extensive experience in resolving problem assets dedicated solely
to the resolution of the assigned special assets. When loans are scheduled
to be moved to the special assets management group, they are assessed and
assigned to the special assets officer best suited to manage that
loan/asset. The assigned special assets officer then begins the takeover
and review process to determine the recommended action plan. These plans
are reviewed and approved by the senior credit officer and submitted for final
approval. In cases where the plan involves a loan restructure or
modification, appropriate risk controls such as improved requirements for
borrower/guarantor financial information, principal reductions or additional
collateral or loan covenants specific to the project or borrower may be utilized
to preserve or strengthen our position. The group also manages the
disposition of foreclosed properties from the pre-foreclosure deed steps to the
management, maintenance and marketing efforts, with the objective of disposing
of these assets in an expeditious manner at the highest present value to the
bank, pursuant to asset-specific strategies which give consideration to holding
costs.
Deposits
Our
primary source of funds for loans and investments is our deposits. National
and local market trends over the past several years suggest that consumers have
moved an increasing percentage of discretionary savings funds into investments
such as annuities, stocks, and fixed income mutual funds. Accordingly, it
has become more difficult in recent years to attract retail
deposits.
The
following table shows the average balance amounts and the average rates paid on
deposits held by us for the three-month periods ended March 31, 2010 and 2009,
and for the year ended December 31, 2009 (dollars in thousands):
|
|
March
31, 2010
|
|
|
December
31, 2009
|
|
|
March
31, 2009
|
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
Demand
deposit accounts
|
|
$
|
34,591
|
|
|
|
-
|
|
|
$
|
38,370
|
|
|
|
-
|
|
|
$
|
37,625
|
|
|
|
-
|
|
NOW
accounts
|
|
|
32,865
|
|
|
|
0.35
|
%
|
|
|
38,377
|
|
|
|
0.48
|
%
|
|
|
43,774
|
|
|
|
0.71
|
%
|
Savings
and money market
|
|
|
54,906
|
|
|
|
1.20
|
%
|
|
|
74,438
|
|
|
|
1.29
|
%
|
|
|
103,431
|
|
|
|
1.43
|
%
|
Time
deposits - retail
|
|
|
356,746
|
|
|
|
2.56
|
%
|
|
|
343,510
|
|
|
|
3.12
|
%
|
|
|
313,092
|
|
|
|
3.64
|
%
|
Time
deposits - wholesale
|
|
|
154,990
|
|
|
|
2.40
|
%
|
|
|
200,015
|
|
|
|
2.61
|
%
|
|
|
160,187
|
|
|
|
3.16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deposits
|
|
$
|
634,098
|
|
|
|
|
|
|
$
|
694,710
|
|
|
|
|
|
|
$
|
658,109
|
|
|
|
|
|
Core
deposits, which exclude time deposits of $100,000 or more, brokered deposits and
municipal deposits, provide a relatively stable funding source for our loan
portfolio and other interest-earning assets. Our core deposits were $281.7
million and $323.3 million as of March 31, 2010, and December 31, 2009, or 46.5%
and 50.4% of total deposits, respectively.
The
maturity distribution of our time deposits of $100,000 or more as of March 31,
2010, is as follows (dollars in thousands):
|
|
As
of March 31,
|
|
|
|
2010
|
|
Three
months or less
|
|
$
|
76,076
|
|
Over
three through six months
|
|
|
65,861
|
|
Over
six through twelve months
|
|
|
92,381
|
|
Over
twelve months
|
|
|
71,951
|
|
Total
|
|
$
|
306,269
|
|
On April
27, 2009, our bank entered into a consent order with the OCC.
Additionally, on June 15, 2009, our holding company entered into a written
agreement with the FRB which contains provisions similar to the articles in the
bank’s consent order with the OCC. Our ability to access brokered deposits
through the wholesale funding market is now restricted as a result of the
consent order. Due to our capital classification, our bank may not apply
for a waiver from the FDIC to accept, renew or roll over brokered
deposits. During the twelve-month period ending December 31, 2010, $101.9
million of brokered deposits are scheduled to mature. We are using cash and
unpledged liquid investment securities as well as retail deposits gathered from
our statewide branch network to fund the maturity of our brokered deposits due
to limitations imposed on other nontraditional funding sources as a result of
the deterioration in our financial condition. In addition, during the first
quarter of 2010, we have begun to participate in an Internet-based CD placement
program which allows us to offer CDs up to $250,000 to other financial
institutions at lower rates than we typically offer our local
depositors.
To combat
the restrictions described above, we are focused on expanding our collection of
core deposits. Core deposit balances, generated from customers throughout
our branch network, are generally a stable source of funds similar to long-term
funding, but core deposits such as checking and savings accounts are typically
much less costly than alternative fixed rate funding. We believe that this
cost advantage makes core deposits a superior funding source, in addition to
providing cross-selling opportunities and fee income possibilities. We work
to increase our level of core deposits by actively cross-selling core deposits
to our local depositors and borrowers. As we grow our core deposits, we
believe that our cost of funds should decrease, thereby increasing our net
interest margin.
Other
Interest-Bearing Liabilities
The
following tables outline our various sources of borrowed funds as of or for the
three-month period ended March 31, 2010, and the year ended December 31, 2009,
the amounts outstanding and their corresponding interest rates as of the end of
each period, the maximum point for each component during the periods and the
average balance and average interest rate that we paid for each borrowing
source. The maximum balance represents the highest indebtedness for each
component of borrowed funds at any time during each of the periods
shown (dollars in thousands):
|
|
Ending
|
|
|
Period-End
|
|
|
Maximum
|
|
|
Average
for the Period
|
|
|
|
Balance
|
|
|
Rate
|
|
|
Balance
|
|
|
Balance
|
|
|
Rate
|
|
As
of or for the Three Months Ended March 31, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLB
advances
|
|
$
|
52,975
|
|
|
|
3.39
|
%
|
|
$
|
54,004
|
|
|
$
|
53,550
|
|
|
|
3.38
|
%
|
Federal
funds purchased and other borrowings
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Junior
subordinated debentures
|
|
$
|
13,403
|
|
|
|
2.33
|
%
|
|
$
|
13,403
|
|
|
$
|
13,403
|
|
|
|
2.47
|
%
|
Line
of credit
|
|
$
|
9,641
|
|
|
|
6.00
|
%
|
|
$
|
9,641
|
|
|
$
|
9,641
|
|
|
|
6.03
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of or for the Year Ended December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLB
advances
|
|
$
|
54,004
|
|
|
|
3.39
|
%
|
|
$
|
88,309
|
|
|
$
|
67,463
|
|
|
|
3.03
|
%
|
Federal
funds purchased and other borrowings
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
4,000
|
|
|
$
|
3,042
|
|
|
|
0.48
|
%
|
Junior
subordinated debentures
|
|
$
|
13,403
|
|
|
|
2.34
|
%
|
|
$
|
13,403
|
|
|
$
|
13,403
|
|
|
|
3.12
|
%
|
Line
of credit
|
|
$
|
9,641
|
|
|
|
6.00
|
%
|
|
$
|
9,641
|
|
|
$
|
9,605
|
|
|
|
6.10
|
%
|
We
utilized these sources of borrowed funds in prior years to fund the growth of
earning assets in excess of deposit growth. However, due to the terms of
the consent order that our bank entered into with the OCC on April 27, 2009, the
majority of these sources are no longer available to us. Our FHLB advance
line of credit has been reduced to the outstanding balance with no further
advances or renewals of maturing advances allowed. During the twelve-month
period ending December 31, 2010, $4.1 million of these advances will mature and
we will need to replace these maturing advances with an alternate source of
funding.
As of
March 31, 2010, and December 31, 2009, we had short-term lines of credit with
correspondent banks to purchase federal funds totaling $9.0 million and $13.0
million, respectively. During the three-month period ended March 31,
2010, we reduced our short-term lines of credit with correspondent banks to
purchase federal funds and were able to release pledges on securities with a
carrying value of $5.2 million. As of March 31, 2010, and December 31,
2009, securities with a carrying value of approximately $6.1 million and $11.4
million, respectively, were pledged to secure the available lines of credit for
overnight borrowings with correspondent banks.
As of
March 31, 2010, we had $13.4 million in floating rate junior subordinated
debentures which were issued to unconsolidated subsidiary trusts. Each
trust’s sole purpose is to issue trust preferred securities and then use the
proceeds to purchase debentures with terms essentially identical to the trust
preferred securities from our holding company. Interest payments on the
debentures are payable quarterly. So long as an event of default has not
occurred, we may defer interest payments for up to 20 consecutive
quarters. We elected to defer the second quarter 2009 interest payments on
the debentures to conserve cash at the holding company level. Pursuant to
the terms of the written agreement that our holding company executed with the
FRB on June 15, 2009, we must obtain pre-approval from the FRB before paying any
principal or interest payments, including payments on the
debentures. Therefore, we also elected to defer the interest payments
through the first quarter of 2010 and have provided appropriate notices of our
election to defer interest payments to the trustee of each trust as required by
the respective debentures. We continue to accrue interest expense and,
under the terms of the debentures, are required to bring the interest payments
current in the first quarter of 2014. While no interest payments are
required until 2014, the restrictions contained in our written agreement with
the FRB could ultimately result in a default under the provisions of the
debentures.
As part
of our strategic plan to renegotiate our senior capital obligations,
we have engaged a third party to solicit offers to purchase, and consent
solicitations relating to securities at a discount to face value of the trust
preferred securities. Each of these offers may be amended, extended or
terminated by us in our sole discretion. The terms and conditions
of the offers for the trust preferred securities are described in the offers to
purchase the trust preferred for cash and consent solicitations statement and
the related letter of transmittal and consent, sent to holders of each of the
trust preferred securities. Each of the offers is conditioned on the
receipt of (i) the approval of the applicable banking regulators and (ii)
proceeds from a stock offering or other transaction in an amount sufficient to
consummate the offers and to increase our subsidiary bank’s capital ratios to
levels acceptable to our regulators. There are no assurances that either of
these conditions will be satisfied, and we reserve the right to waive any
condition of the offers.
As of
March 31, 2010, and December 31, 2009, short-term borrowings of $9.6 million for
each period consisted of the balance due on our holding company’s line of credit
with a correspondent bank. During the fourth quarter of 2007, our holding
company established this line of credit which is secured by the stock of our
bank. The line of credit, in an amount up to $15,000,000, had an original
twelve-year final maturity with interest payable quarterly at a floating rate
tied to the Wall Street Journal Prime Rate. The original terms of the line
included two years of quarterly interest payments followed by ten years of
annual principal payments plus quarterly interest payments on the outstanding
principal balance as of December 31, 2009. The line of credit was secured
in connection with the terms of the merger agreement, dated August 26, 2007,
between First National and Carolina National, to support the cash consideration
of the merger and to fund general operating expenses for the holding company for
2008 and 2009.
On
January 7, 2010, the company announced that it had reached an agreement to
modify this loan agreement. The modifications to the loan agreement cure
the existing covenant violations. In addition, the company had agreed,
subject to regulatory approval, to pay $3.5 million no later than June 15, 2010
to its lender, which would fully satisfy its obligations under the line of
credit. Although regulatory approval has not yet been obtained and the
obligations under the line of credit have not yet been satisfied, the company
has successfully negotiated an extension of the agreement with its
lender.
Going
Concern
As a
result of management’s assessment of our ability to continue as a going concern,
the consolidated financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the discharge of
liabilities in the normal course of business for the foreseeable future, and
does not include any adjustments to reflect the possible future effects on the
recoverability or classification of assets, and the amounts or classification of
liabilities that may result should we be unable to continue as a going
concern. Management continues to assess a number of factors including
liquidity, capital, and profitability that affect our ability to continue in
operation. We believe that our current strategy to raise additional capital and
dispose of assets to deleverage will allow us to raise our capital ratios to the
minimums set forth in the consent order with the OCC. In addition,
management has taken a number of actions to increase our short-term liquidity
position to meet our projected liquidity needs during this
timeframe.
In its
report dated March 9, 2010, our independent registered public accounting firm
stated that the uncertainty surrounding our ability to replenish our capital
raises substantial doubt about our ability to continue as a going
concern. This uncertainty is one of the factors that has cast doubt about
our ability to continue in operation. Management continues to assess a
number of other factors including liquidity, capital, and profitability that
affect our ability to continue in operation. Although we are committed to
developing strategies to eliminate the uncertainty surrounding each of these
areas, the outcome of these developments cannot be predicted at this
time. If we are unable to identify and execute a viable strategic
alternative, we may be unable to continue as a going concern.
Capital
Resources
General
Shareholders’
deficit on March 31, 2010, was $8.9 million, as compared to shareholders’
deficit on December 31, 2009, of $4.2 million. The increase reflects the
loss recognized for the three-month period ended March 31, 2010, which consisted
primarily of the provision for loan losses of $3.7 million, mainly due to
chargeoffs on nonperforming loans recognized during the three-month period ended
March 31, 2010.
Unrealized Gain/Loss on
Securities Available for
Sale
The
unrealized loss on securities available for sale as of March 31, 2010, reflects
the change in the market value of these securities since December 31,
2009. We believe that the unrealized loss position as of March 31, 2010,
was attributable to changes in market interest rates as compared to December 31,
2009. Our securities portfolio includes U.S. Government agency securities,
mortgage-backed securities, and municipal securities as prescribed by our bank’s
investment policy. We use securities available for sale to pledge as collateral
to secure public deposits and for other purposes required or permitted by law,
including as collateral for FHLB advances outstanding and to satisfy the
requirements related to our clearing account with the FRB. The FRB requires
us to maintain certain collateral balances with them to secure our daily cash
clearing transactions, which began clearing directly through our FRB account in
June 2009. Due to our current elevated level of cash and cash equivalents
and the availability of various liquidity sources, we intend to hold these
securities to maturity.
We
believe that our existing liquidity sources are sufficient to meet our
short-term liquidity needs. To ensure that our long-term funding needs are
met, we continue to evaluate other sources of liquidity that may also qualify as
regulatory capital, such as common stock, subordinated debt and trust preferred
securities. However, further market disruption may reduce the cost
effectiveness and availability of our funding sources for a prolonged period of
time, which may require management to more aggressively pursue other funding
alternatives. We meet our bank’s daily liquidity needs primarily through
changes in deposit levels, in addition to borrowings under our federal funds
purchased facilities and other short-term funding sources, when
necessary.
Regulatory
Capital
The
Federal Reserve and bank regulatory agencies require bank holding companies and
financial institutions to maintain capital at adequate levels based on a
percentage of assets and off-balance sheet exposures, adjusted for risk weights
ranging from 0% to 100%. Under the capital adequacy guidelines, capital is
classified into two tiers. These guidelines require an institution to
maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted
assets. Tier 1 capital consists of common shareholders’ equity, excluding
the unrealized gain or loss on securities available for sale, minus certain
intangible assets, plus qualifying preferred stock and trust preferred
securities (limited to 25% of Tier 1 capital, with the excess being treated as
Tier 2 capital). In determining the amount of risk-weighted assets, all
assets, including certain off-balance sheet assets, are multiplied by a
risk-weight factor of 0% to 100% based on the risks believed to be inherent in
the type of asset, as prescribed by the Federal Reserve and bank regulatory
agencies’ risk-based capital guidelines. Tier 2 capital consists of Tier 1
capital plus the reserve for loan losses subject to certain limitations.
As of March 31, 2010, the amount of our reserve for loan losses that was not
included due to these limitations was approximately $16.9 million. The bank
is also required to maintain capital at a minimum level based on total average
assets, which is known as the Tier 1 leverage ratio.
In the
past, we have utilized trust preferred securities to meet our holding company’s
capital requirements up to regulatory limits. While our equity is in a
deficit position, we are not able to recognize trust preferred securities as
part of our regulatory capital at the holding company. As of March 31,
2010, we had formed three statutory trust subsidiaries for the purpose of
raising capital via this avenue. We contributed to our bank subsidiary the
$13.0 million in cash proceeds from the sale of these securities. On
December 19, 2003, FNSC Capital Trust I, a subsidiary of our holding
company, was formed to issue $3 million in floating rate trust preferred
securities. On April 30, 2004, FNSC Capital Trust II was formed to
issue an additional $3 million in floating rate trust preferred
securities. On March 30, 2006, FNSC Statutory Trust III was formed to
issue an additional $7 million in floating rate trust preferred
securities. These entities are not included in our consolidated financial
statements. The trust preferred securities qualify as Tier 1 capital up to
25% or less of Tier 1 capital, with the excess includable as Tier 2
capital. As of March 31, 2010, because of our deficit equity position, none
of the trust preferred securities qualified as Tier 1 or Tier 2
capital. As part of our strategic plan, we currently are
negotiating to restructure our senior capital obligations to progress toward our
goal of strengthening our capital structure to support our current and future
operations. The payoff of our trust preferred securities at a discount is
currently being pursued as part of our action steps to achieve this
objective.
Our
holding company and our bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Under these
capital guidelines, to be considered “adequately capitalized,” we must maintain
a minimum total risk-based capital ratio of 8%, with at least 4% being Tier 1
capital. In addition, we must maintain a minimum Tier 1 leverage ratio of
at least 4%. To be considered “well-capitalized,” a bank generally must
maintain total risk-based capital of at least 10%, Tier 1 capital of at least
6%, and a leverage ratio of at least 5%. However, so long as our bank is
subject to the enforcement action executed with the OCC on April 27, 2009, it
will not be deemed to be well-capitalized even if it maintains these minimum
capital ratios. The enforcement action also required the bank to achieve
and maintain Tier 1 capital equal to at least 11% of risk-weighted assets and
equal to at least 9% of adjusted total assets by August 25, 2009. However,
we did not achieve these minimum capital levels by the deadline specified in the
consent order. On September 28, 2009, we resubmitted our capital plan
and strategic plan to incorporate recent developments in our business strategy
and the impact of the change in our president and CEO on
operations. We are working with the OCC and responding to feedback on
the capital plan and strategic plan. Once we receive the OCC’s
written determination of no supervisory objection, our board of directors will
adopt and implement the plans.
The
following table sets forth the holding company’s and the bank’s various capital
ratios as of March 31, 2010, and December 31, 2009. We continue to
evaluate various options, such as issuing common or preferred stock, to increase
the bank’s capital and related capital ratios in order to maintain adequate
capital levels.
|
|
As
of March 31,
|
|
|
As
of December 31,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Holding
|
|
|
|
|
|
Holding
|
|
|
|
|
|
|
Co.
|
|
|
Bank
|
|
|
Co.
|
|
|
Bank
|
|
Total
risk-based capital
|
|
|
(1.78
|
%)
|
|
|
4.06
|
%
|
|
|
(0.72
|
%)
|
|
|
4.72
|
%
|
Tier
1 risk-based capital
|
|
|
(1.78
|
%)
|
|
|
2.76
|
%
|
|
|
(0.72
|
%)
|
|
|
3.43
|
%
|
Leverage
capital
|
|
|
(1.24
|
%)
|
|
|
1.92
|
%
|
|
|
(0.50
|
%)
|
|
|
2.37
|
%
|
The
decrease in our capital ratios from December 31, 2009, to March 31, 2010, is
primarily due to the net loss recorded for the period ended March 31,
2010. As a result of the terms of the executed consent order, we are
no longer deemed “well-capitalized,” regardless of our capital
levels. The FRB also has required our bank holding company to enter
into a written agreement which contains provisions similar to the articles in
the bank’s consent order with the OCC. Please see Regulatory Matters
under Note 1 – Nature of Business and Basis of Presentation for further
discussion of our capital requirements under the consent order with the OCC and
the written agreement with the FRB. Under the FDIC’s “Prompt
Corrective Action” (“PCA”) restrictions, our bank’s capital was classified as
critically undercapitalized due to the level of the bank’s tangible equity
ratios as of the March 31, 2010 regulatory report of condition and
income. As of the date of the filing of this report, there are no
events or conditions that have occurred that would change our capital
classification as of our March 31, 2010 regulatory report, which was consistent
with our capital classification based on our December 31, 2009 regulatory
reports. However, the bank’s tangible equity ratio exceeded 2.0% for
the month of April 2010, due to further balance sheet reductions resulting from
maturities of brokered deposits.
Strategic Capital
Plan
We have
an active program for managing our shareholders’ equity. Historically, we
have used capital to fund organic growth, pay dividends on our preferred stock,
and repurchase shares of our common stock. Our management team is focused
on carefully managing the size of our loan portfolio to maintain an asset base
that can be supported by our capital resources. Our objective is to produce
above-market, long-term returns by opportunistically using capital when expected
future returns are determined to be high and issuing or accumulating capital
when such costs are perceived to be low.
As a
result of ongoing market disruptions, the availability of capital (principally
to financial services companies like ours) has become significantly
restricted. Those companies wishing to survive the current economic
environment and prosper will need a strong capital base that supports the asset
size of the company. While some companies have been successful at raising
capital, the cost of that capital has been substantially higher than the
prevailing market rates prior to the volatility of the current market. The
consent order that we entered into with the OCC on April 27, 2009, contains a
requirement that our bank maintain minimum capital requirements that exceed the
minimum regulatory capital ratios for “well-capitalized” banks. As a result
of the consent order, our bank is no longer deemed “well-capitalized,”
regardless of its capital levels. In addition, as of March 31, 2010, as a
result of losses during 2008, 2009 and the first three months of 2010, our bank
was significantly undercapitalized. We are implementing a strategy to reach
the capital levels imposed under the consent order by raising additional
capital, limiting our growth, and selling assets. We were not able to reach
this capital goal by August 25, 2009, the deadline specified in the consent
order. However, we are continuing to work diligently with our financial and
professional advisors to secure qualified sources of outside capital and achieve
compliance with minimum capital requirements in the consent order.
Upon the
execution of the bank's consent order with the OCC on April 27, 2009, we had 90
days to submit a strategic plan and capital plan which would increase the bank’s
capital ratios to the minimum levels specified in the order within 120 days from
the date of the order. On July 24, 2009, our board submitted a written
strategic plan and capital plan to the OCC covering the three-year period ending
December 31, 2012. Based on discussions with the OCC regarding these plans and
their correspondence to us dated August 28, 2009, we resubmitted our capital
plan and strategic plan to the OCC on September 28, 2009 to incorporate recent
developments in our business strategy and the impact of the change in our
president and CEO on our operations. Management and our board of directors
are working with the OCC and responding to feedback on the capital plan and
strategic plan. Our board of directors will adopt and implement these plans
upon receiving a written determination of no supervisory objection from the
OCC.
On June
15, 2009, our holding company entered into a written agreement with the FRB,
which contains provisions similar to the articles in the bank’s consent order
with the OCC. On July 30, 2009, under the terms of the written agreement
that we entered into with the FRB, we submitted a capital plan to the FRB.
This plan is designed to maintain sufficient capital on a consolidated basis and
at the bank as a separate stand-alone entity. While the plan is not
required to contain a provision to obtain specific target capital ratios or
specific timelines, the plan is required to address our current and future
capital requirements, the bank’s current and future capital requirements, the
adequacy of the bank’s capital, taking into account its risk profile, and the
source and timing of additional funds to satisfy each entity’s future capital
requirements. We resubmitted our capital plan to the FRB on October 5,
2009, to be consistent with the revised capital and strategic plans submitted to
the OCC. We are working with the regulators and responding to feedback on
the capital plan and strategic plan and will adopt the written capital plan
within 10 days of its approval by the FRB.
Losses
for the years ended December 31, 2008 and 2009, and the three-month period ended
March 31, 2010, have eroded our capital cushion. Therefore, it is critical
that we raise additional capital, which we have already begun to accomplish
through a private placement common stock offering. We may also need
additional capital to absorb the probable future losses we will encounter as we
continue removing the nonperforming assets from our balance sheet, given the
particularly challenging real estate market. As a result, we have begun
implementing a plan to increase our capital in order to strengthen our balance
sheet and support our operations, satisfy the commitments we have made to our
bank regulator in this area, and position our holding company and our bank for
future success.
Our
board’s executive committee consists of five members of our board of
directors. This committee meets frequently and has been authorized by the
board of directors to monitor and make recommendations regarding the capital,
liquidity and asset quality of our bank.
Preferred
Stock
On July
9, 2007, we closed an underwritten public offering of 720,000 shares of Series A
Noncumulative Perpetual Preferred Stock at $25.00 per share. Our net
proceeds after payment of underwriting discounts and other expenses of the
offering were approximately $16.5 million. We used the net proceeds of the
preferred stock offering to provide additional capital to support asset growth
and the expansion of our bank’s branch network, to pay off the balance of $5
million on a revolving line of credit, and to partially fund the cash portion of
the consideration to close the acquisition of Carolina National.
The terms
of the preferred stock include the payment of quarterly dividends at an annual
interest rate of 7.25%. Under the terms of the preferred stock, dividends
are declared each quarter at the discretion of our board of directors. The
first quarterly dividend was paid in October 2007, as prescribed in the
Certificate of Designation of Series A Preferred Stock, and prior to the first
quarter of 2009, we had paid dividends of $326,250 each quarter. Our board
of directors did not declare any dividends during 2009 or during the first
quarter of 2010. Under the terms of the written agreement entered into with
the FRB on June 15, 2009, we must seek prior written approval of the FRB before
declaring or paying any dividends to our preferred shareholders.
As of
March 31, 2010, and December 31, 2009, 400,600 and 520,600 shares of preferred
stock were outstanding, respectively. During the three-month period ended
March 31, 2010, 360,000 shares of common stock were issued to convert 120,000
preferred shares, resulting in a reduction of preferred shares
outstanding. Since March 31, 2010, an additional 100,800 shares
of preferred stock have been converted to common stock. As part of
our strategic plan, we currently are negotiating to restructure our senior
capital obligations to progress toward our goal of strengthening our capital
structure to support our current and future operations. As part of
our action steps to achieve this objective, we currently are pursuing this
conversion of our preferred stock to common stock with our preferred
shareholders which will continue to increase our common shares outstanding as
additional preferred shares are converted.
Dividends
Since our
inception, we have not paid cash dividends on our common stock. Our ability
to pay cash dividends is dependent on receiving cash in the form of dividends
from our bank.
Additionally,
pursuant to the terms of the written agreement that the company entered into
with the FRB on June 15, 2009, we must obtain preapproval of the FRB before
paying dividends.
In
addition, restrictions currently exist within the consent order we signed with
the OCC that prohibit our bank from paying cash dividends to the holding
company. Regardless of the restrictions imposed by the consent order, all
dividends from our bank subsidiary to our holding company are subject to prior
approval of the OCC and are payable only from the undivided profits of our
bank.
We
distributed 3-for-2 stock splits on March 1, 2004, and January 18,
2006. We also have distributed shares of our common stock through stock
dividends. On May 16, 2006, we issued a stock dividend of 6% to
shareholders of record as of May 1, 2006. On March 30, 2007, we
issued a stock dividend of 7% to shareholders of record as of March 16,
2007. We may distribute future stock splits and dividends based on our
evaluation of a number of factors, including our financial performance and
projected capital and earnings levels.
Employee Share Ownership
Programs
We enable
employee share ownership through various programs, including the First National
Bancshares, Inc. 2000 Stock Incentive Plan, which absorbed the Carolina National
Corporation 2003 Stock Option Plan (together the “Stock Option Plan”) as part of
the Carolina National acquisition, our Employee Stock Ownership Plan (“ESOP”),
and the First National Bancshares, Inc. 2008 Restricted Stock Plan (the
“Restricted Stock Plan”). The Stock Option Plan provides for the issuance
of stock options in order to reward the recipients and to promote our growth and
profitability through additional employee motivation toward our
success. Under the Stock Option Plan, options for 600,697 shares of common
stock were authorized for issuance including 141,346 stock options from the
Carolina National merger. As of March 31, 2010, 90,966 options were
outstanding, with no shares granted under the Stock Option Plan in the
three-month period ended March 31, 2010.
On August
24, 2009, we entered into an employment agreement with our new bank and holding
company president and chief executive officer, J. Barry Mason. This
employment agreement was structured not only to retain and incentivize him as a
key officer, but also to ensure that his interests align with the interests of
the shareholders. Pursuant to this employment agreement and consistent with
the terms outlined in the stock award agreement with Mr. Mason executed on
September 30, 2009, we granted Mr. Mason 250,000 shares of restricted common
stock and options to purchase one million shares of our common stock at an
exercise price of $1.00 per share. The restricted shares vest ratably over
five years and were assigned a fair value of $240,250 based on the market price
of our common stock on the date of the grant (August 24, 2009). The
recognition of the related compensation expense for the restricted stock will be
approximately $48,000 annually and was $12,000 for the three-month period ended
March 31, 2010 and $17,000 for the year ended December 31, 2009. Total
remaining compensation expense for these shares will be approximately $211,000,
based on the remaining vesting period for these shares. Total unearned
equity compensation for these shares as of March 31, 2010, is $240,250 and is
included in unearned equity compensation in the accompanying consolidated
balance sheets as of March 31, 2010. The options are not incentive stock
options as defined by Section 422 of the Internal Revenue Code and vest ratably
over each of the next three years ending August 24, 2012, with a ten-year
expiration on August 24, 2019. The recognition of the related compensation
expense on the options will be approximately $148,000 annually and was $37,000
for the three-month period ended March 31, 2010, and $49,000 for the year ended
December 31, 2009.
On
November 30, 2005, we loaned our ESOP $600,000 which was used to purchase
42,532 shares of our common stock. As of March 31, 2010, the ESOP owned
44,912 shares of our stock, of which approximately 31,000 shares with a book
value of $438,000 were pledged to secure the loan. The remainder of the
shares is being allocated on an annual basis to individual accounts of
participants as the debt is repaid. We presented the book value of the shares
that were pledged as collateral as a component of shareholders’
deficit, which is included in unearned equity compensation in the
accompanying consolidated balance sheets as of March 31, 2010,
and December 31, 2009.
The
Restricted Stock Plan permits the grant of stock awards to our employees,
officers and directors at the discretion of the board compensation
committee. A total of 320,000 shares of common stock have been reserved for
issuance under this plan.
Share Repurchase
Program
From time
to time in prior years, our board of directors authorized us to repurchase
shares of our common stock pursuant to a formal share repurchase program which
expired on November 30, 2008. As of March 31, 2010, we held 106,981 common
shares as treasury stock. Currently, under the terms of the written
agreement that our holding company entered into with the FRB on June 15, 2009,
we must seek prior written approval of the FRB before repurchasing shares of our
common stock.
Return
on Equity and Assets
The
following table shows the return on average assets (net income divided by
average total assets), return on average equity (net income divided by average
equity), and equity to assets ratio (average equity divided by average total
assets) for the three-month periods ended March 31, 2010 and 2009, and for the
year ended December 31, 2009:
|
|
Three
Months Ended
March
31, 2010
|
|
|
Year
Ended
December
31, 2009
|
|
|
Three
Months Ended
March
31, 2009
|
|
Return
on average assets
|
|
|
(3.07
|
%)
|
|
|
(5.35
|
%)
|
|
|
(0.68
|
%)
|
Return
on average equity
|
|
|
(464.90
|
%)
|
|
|
(170.63
|
%)
|
|
|
(13.53
|
%)
|
Equity
to assets ratio
|
|
|
(0.66
|
%)
|
|
|
3.13
|
%
|
|
|
5.01
|
%
|
The
ratios shown above reflect a net loss for each period presented. In
addition, our return on average equity and equity to assets ratios for the
three-month period ended March 31, 2010, and the year ended December 31, 2009,
reflect the impact of the continued erosion of our consolidated shareholders’
equity to a deficit as of December 31, 2009, and March 31, 2010.
Effect
of Inflation and Changing Prices
The
effect of relative purchasing power over time due to inflation has not been
taken into effect in our financial statements. Rather, the statements
have been prepared on an historical cost basis in accordance with accounting
principles generally accepted in the United States of America.
Unlike
most industrial companies, the assets and liabilities of financial institutions
such as our holding company and bank are primarily monetary in
nature. Therefore, the effect of changes in interest rates will have
a more significant impact on our performance than will the effect of changing
prices and inflation in general. In addition, interest rates may generally
increase as the rate of inflation increases, although not necessarily in the
same magnitude. As discussed previously, we seek to manage the
relationships between interest-sensitive assets and liabilities in order to
protect against wide rate fluctuations, including those resulting from
inflation.
Off-Balance
Sheet Arrangements
Through
the operations of our bank, we have made contractual commitments to extend
credit in the ordinary course of our business activities to meet the financing
needs of customers. Such commitments involve, to varying degrees,
elements of credit risk and interest rate risk in excess of the amount
recognized in the balance sheets. These commitments are legally
binding agreements to lend money at predetermined interest rates for a specified
period of time and generally have fixed expiration dates or other termination
clauses. We use the same credit and collateral policies in making
these commitments as we do for on-balance sheet instruments.
We
evaluate each customer’s creditworthiness on a case-by-case basis and obtain
collateral, if necessary, based on our credit evaluation of the
borrower. In addition to commitments to extend credit, we also issue
standby letters of credit that are assurances to a third party that they will
not suffer a loss if our customer fails to meet its contractual obligation to
the third party. The credit risk involved in the underwriting of
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
As of
March 31, 2010 and December 31, 2009, we had issued commitments to extend credit
of $53.2 million and $59.1 million, respectively, through various types of
commercial and consumer lending arrangements, the majority of which are at
variable rates of interest. Standby letters of credit totaled
$131,000 and $891,000, as of March 31, 2010, and December 31, 2009,
respectively. Past experience indicates that many of these
commitments to extend credit will expire unused. The effect of
these commitments to provide credit on our revenues, expenses, cash flows,
liquidity, and capital resources cannot be reasonably predicted because there is
no guarantee that the commitments will ever be used. However, we
believe that we have adequate sources of liquidity to fund commitments that may
be drawn upon by borrowers.
Except as
disclosed in this report, we are not involved in off-balance sheet contractual
relationships, unconsolidated related entities that have off-balance sheet
arrangements or transactions that could result in liquidity needs or other
commitments that could significantly impact earnings.
Liquidity
General
Liquidity
represents the ability of a company to convert assets into cash or cash
equivalents without significant loss and to raise additional funds at a
reasonable cost by increasing liabilities in a timely manner and without adverse
consequences. Liquidity management involves maintaining and monitoring our
sufficient and diverse sources and uses of funds in order to meet our day-to-day
and long-term cash flow requirements while maximizing profits and maintaining an
acceptable level of risk under both normal and adverse conditions. These
requirements arise primarily from the withdrawal of deposits, funding of loan
disbursements and payment of operating expenses. Liquidity management is
made more complicated because different balance sheet components are subject to
varying degrees of management control. For example, the timing of
maturities of the investment portfolio is fairly predictable and subject to a
high degree of control at the time the investment decisions are made.
However, net deposit inflows and outflows are far less predictable, as they are
greatly influenced by general interest rates, economic conditions and
competition, and are not subject to nearly the same degree of
control. Management has policies and procedures in place governing the
length of time to maturity on its earning assets, such as loans and investments,
which state that these assets are not typically utilized for day-to-day
liquidity needs. Therefore, our liabilities have generally provided our
day-to-day liquidity in the past.
We
operate in a highly-regulated industry and must plan for the liquidity needs of
both our bank and our holding company separately. Through this
approach, we consider the unique funding sources available to each entity, as
well as each entity’s capacity to manage adverse conditions. This
approach also recognizes that adverse market conditions or other events could
negatively affect the availability or cost of liquidity for either
entity. A number of our short-term and long-term liquidity sources
have been restricted or eliminated following execution of the regulatory
enforcement actions with the OCC on April 27, 2009, and the FRB on June 15,
2009.
Management’s forecasts of the sources of
funds available to the bank, which are primarily retail deposits and liquid
unpledged assets on our balance sheet, and our projected uses of funds indicate
that the sources available are sufficient to meet the bank’s projected
short-term liquidity needs. The holding company relies on dividends
from the bank as its primary source of liquidity. As a result, the
holding company has deferred payment of interest and dividends on its trust
preferred securities and noncumulative preferred stock for the past five
quarters. Various legal limitations restrict the bank from lending or
otherwise supplying funds to the holding company to meet its
obligations. In addition, restrictions continued in the terms of the
bank’s consent order with the OCC limit the bank’s ability to pay dividends to
the holding company to satisfy its liquidity needs. As a result,
management’s forecasts of the holding company’s available sources of liquidity
indicate that these sources may be insufficient to meet its projected liquidity
needs.
Deposit
Strategy
Prior to
2009, our liquidity had decreased over the past several years, primarily as a
result of funds needed to support the growth of our branch network and loan
production offices. In addition, the demand for retail deposits increased
during 2009 due to the tightness of liquidity in financial markets, which also
creates more liquidity risk. These conditions have challenged us to
maximize the various funding options available to us. Throughout
2009, our liquid, unpledged assets increased substantially as we executed our
strategy to improve our short-term liquidity position. In April 2009, we
raised approximately $150 million of brokered deposits laddered over a one- to
two-year time horizon. In recent months, we have worked aggressively
to reduce our dependency on brokered deposits. Since April 30, 2009, our
brokered deposits have decreased by $134.5 million and were $148.0 million and
$158.0 million as of March 31, 2010, and December 31, 2009. During the nine
months from March 31, 2010 to December 31, 2010, $101.9 million of our brokered
deposits are scheduled to mature.
In
addition to our overnight and short-term borrowing options, we emphasize deposit
growth and retention throughout our retail branch network to enhance our
liquidity position. In pricing our retail deposits, we must comply with
federal restrictions, which are potentially significant to us due to our
historical practice of paying above average rates on deposits, particularly
CDs.
On May
29, 2009, the FDIC approved a final rule effective January 1, 2010, that amended
its existing rules which impose interest rate restrictions on deposits that can
be paid by depository institutions that are not “well-capitalized.” Under
this rule, banks that are not “well-capitalized,” such as our bank, are limited
to paying 75 basis points over the national average rates set by the FDIC for
each deposit product. To compute the national rate, the FDIC uses data from
the branches of approximately 8,300 banks and thrifts to determine a national
average rate for each deposit product. On December 4, 2009, the FDIC
announced that institutions that are less than “well-capitalized” that believe
they are operating in an area where rates paid on deposits are higher than the
“national rate” could submit a letter to the FDIC to request a determination to
that effect on a quarterly basis. We requested this determination before
December 31, 2009, received a response from the FDIC that we were not operating
in a high-rate area and have been using the FDIC’s national rates since March 1,
2010. Prior to March 31, 2010, we submitted a second letter to the
FDIC, again requesting a determination that we are operating in an area where
deposit rates are higher than the “national rate.” Subsequent to
March 31, 2010, we received notice of the FDIC’s determination that we are
indeed operating in an area where deposit rates exceed the “national rates” and,
therefore, are no longer limited to paying 75 basis points over the national
average rates. Instead, beginning April 16, 2010, we used averages
rates paid by our competitors locally based on deposit rate surveys conducted by
our bank personnel instead of the national rates. This beneficial
exception to the “national rate” limitation will remain in effect for a period
of one year.
During
the short period that the FDIC’s national rate limitations were applicable to
us, we were negatively affected by the restrictions they imposed on the rates we
were allowed to offer on our deposit products. As we have
historically paid above-average rates locally, these new restrictions limited
our ability to attract new deposits and to retain existing
deposits. However, using the high-rate market area exception has
reduced the negative impact of the national rate limitations. Our
retail staff trains extensively on an ongoing basis with a recent focus on
combating the challenges presented by these rate limitations with creative and
attentive customer service. This positive, proactive strategy
somewhat mitigated the negative impact of the restrictions while the harsher
rate limitations were in place.
The
market for retail deposits in the South Carolina markets, where our branches are
located, is very competitive and includes a high proportion of community
financial institutions, in addition to larger, money center banks. As our
needs for additional funding have grown over the past several years, we have
implemented several different deposit gathering strategies to reduce our
reliance on brokered deposits, including building new branches. Four
of our branches have been open for less than three years, and we believe these
branches have potential for future retail deposit growth. We have
historically paid above-average rates in building the base of deposits for these
branches. This strategy may make us vulnerable to the federal restrictions
on the level of interest rates that we offer. We believe that our ability
to attract deposits is somewhat a function of our ability to offer rates above
the average rates in our markets.
As a
result of the strategic sales of approximately $40.8 million of investment
securities coupled with the deliberate reduction of our loan portfolio, which
together more than outweighed the decrease in retail and brokered deposits
during the three-month period ended March 31, 2010, our cash and cash
equivalents increased to $88.8 million, or 13.1% of total assets as of March 31,
2010, from $66.0 million, or 9.2% of total assets as of December 31,
2009. From April 1, 2010 through December 31, 2010, we have $326.0 million
of maturing time deposits that, if renewed, will reprice at current market
rates. Included in the $326.0 million are $101.9 million of brokered
deposits which will not be renewed.
We
participate in the FDIC’s Transaction Account Guarantee Program (“TAGP”) which
fully insures noninterest bearing deposit transaction accounts, regardless of
dollar amount, which is a useful tool in attracting and retaining demand deposit
accounts. A 10-basis point surcharge is added to a participating
institution’s current FDIC insurance assessment in order to fully cover the
noninterest bearing transaction account. On April 13, 2010, the FDIC
approved an interim rule that extends the TAGP to December 31,
2010. We have elected to continue our voluntary participation in the
program to further enhance our existing deposit base and to assist us in
attracting new deposits.
Investment
securities may provide a secondary source of liquidity, net of amounts pledged
for deposits and FHLB advances; however, the primary objective for investment
securities is to serve as collateral for public deposits, which limits their
availability as a liquidity source.
Wholesale
Funding
Our
ability to maintain and expand borrowing capabilities also has served as a
source of liquidity in the past. We have utilized certain nontraditional
funding sources as they have been available to us to compensate for the
increased liquidity risk associated with the increased market demand for retail
deposits. The sources listed below have been deemed acceptable by the
bank’s board of directors and are monitored regularly by management and reported
on at each formal board Asset Liability Management Committee (“ALCO”)
meeting
:
|
•
|
Federal
Funds Purchased – funds are purchased from up-stream correspondent
financial institutions when the need for overnight funds
exists. These lines are available for short-term funding needs
only. In the past, these lines required no collateral. However,
as a result of our weakened financial condition, we have been required to
pledge investment securities as collateral for our available federal funds
purchased lines of credit. These lines of credit are generally
somewhat less expensive than longer-term funding
options.
|
|
•
|
FHLB
Advances – this source of borrowing offers both long-term fixed and
adjustable borrowings, typically at very competitive rates, as well as
overnight borrowing capacity, all subject to available
collateral. This source of borrowing requires us to be a member of
the FHLB, and as such, to purchase and hold FHLB stock as a percentage of
the funds borrowed. Our participation in the FHLB advance program has
been restricted by our credit rating with the
FHLB.
|
|
•
|
CD
Programs – these programs have historically been known as brokered
deposits. Various terms are available, and in considering the various
CD program options, management balances our current interest rate risk
profile with our liquidity demands. Because of the agreements
currently in place with our regulators, our ability to access brokered
deposits through the wholesale funding market is restricted at this
time. During the first quarter of 2010, we began participating
in an Internet-based CD placement program which allows us to offer CDs up
to $250,000 to other financial institutions at lower rates than we
typically offer our local
depositors.
|
|
•
|
Reverse
Repurchase Agreements – this source of funds relies on our investment
portfolio as collateral in borrowing from an up-stream
correspondent. Reverse repurchase agreements involve overnight
borrowings with daily rate changes. This funding source has become
restricted due to tightened liquidity in the financial
markets.
|
We have
been notified by the FHLB that it will not allow future advances to us or allow
us to renew maturing advances while we are operating under our current
regulatory enforcement action. As of March 31, 2010, securities totaling
$9.9 million and qualifying loans held by the bank and collateralized by 1-4
family residences, home equity lines of credit (“HELOC’s”) and commercial
properties totaling $59.0 million were pledged as collateral for FHLB advances
outstanding of $52.9 million. A key component in borrowing funds from the
FHLB is maintaining high quality collateral to pledge against our
advances. We primarily rely on our existing loan portfolio for this
collateral. We access and monitor current FHLB guidelines to determine the
eligibility of loans to qualify as collateral for an FHLB advance. We are
subject to the FHLB’s credit risk rating system which was revised June 27, 2008,
to incorporated enhancements and which assigns member institutions a rating
which is reviewed quarterly. The rating system incorporates key factors
such as loan quality, capital, liquidity, profitability, etc. Our ability
to access our available borrowing capacity from the FHLB in the future is
subject to any subsequent changes based on our financial performance considered
by the FHLB in their assignment of our credit risk rating each quarter. In
addition, residential collateral discounts were applied during 2009 which have
further reduced our borrowing capacity.
Due to
the consent order the bank executed with the OCC on April 27, 2009,
our ability to access brokered deposits through the wholesale funding market is
restricted. Due to our capital classification as of March 31, 2010, we are
not eligible to apply for a waiver from the FDIC to accept, renew or rollover
brokered deposits. We are working aggressively to reduce our dependency on
brokered deposits. Since April 30, 2009, our brokered deposits have
decreased by $134.5 million and were $148.0 million as of March 31,
2010. During the nine months from March 31 to December 31, 2010, $101.9
million of brokered deposits are scheduled to mature.
Historically,
we had planned to meet our future cash needs through the generation of deposits
from retail and wholesale sources, the liquidation of temporary investments, and
the maturities of investment securities as well as nontraditional funding
sources. However, the ongoing effects of the credit crisis have impacted
liquidity for the banking industry. As a result, most of the sources of
liquidity that we rely on have been significantly disrupted. We have
reduced our reliance on the wholesale funding market for deposits by
capitalizing on existing and new retail deposit opportunities through our
statewide network of full-service branches. In addition, the bank maintains
secured federal funds lines of credit with correspondent banks that
totaled $9.0 million and $13.0 million as of March 31, 2010, and December
31, 2009, respectively. Proactive and well-advised daily cash management
ensures that these lines are accessed and repaid with careful consideration of
all of our available funding options, as well as the associated costs. Our
overnight lines historically have been tested at least once each quarter to
ensure ease of access, continued availability and that we consistently maintain
healthy working relationships with each correspondent bank. In
addition, during the first quarter of 2010, we have begun to participate in an
Internet-based CD placement program which allows us to offer CDs up to $250,000
to other financial institutions at lower rates than we typically offer our local
depositors.
Liquidity Risk
Management
Liquidity
risk is the possibility that our cash flows may not be adequate to fund our
ongoing operations and allow us to meet our commitments in a timely and
cost-effective manner. Since liquidity risk is closely linked to both
credit risk and market risk, many of the risk control mechanisms used to manage
these risks also apply to the monitoring and management of liquidity
risk. We measure and monitor liquidity on a regular basis, allowing us to
better understand, predict and respond to balance sheet trends.
Comprehensive
daily and weekly liquidity analyses serve management as vital decision-making
tools by providing summaries of anticipated changes in loans, investments, core
deposits, wholesale funds and construction commitments for capital
expenditures. These internal funding reports provide management with the
details critical to anticipate immediate and long-term cash requirements, such
as expected deposit runoff, loan paydowns and amount and cost of available
borrowing sources, including secured overnight federal funds lines with our
various correspondent banks. These liquidity analyses act as cash
forecasting tools and are subject to certain assumptions based on past market
and customer trends, as well as other information currently available regarding
current and future funding options and various indicators of future market and
customer behaviors. Through consideration of the information provided in
these reports, management is better able to maximize our earning opportunities
by wisely and purposefully choosing our immediate, and more critically, our
long-term funding sources.
We
revised our comprehensive liquidity risk management program during 2009 as
required by the consent order with the OCC. This program assesses our
current and projected funding needs to ensure that sufficient funds or access to
funds exist to meet those needs. The program also includes effective
methods to achieve and maintain sufficient liquidity and to measure and monitor
liquidity risk, including the preparation and submission of liquidity reports on
a regular basis to the board of directors and the OCC. The program also contains
a contingency funding plan that forecasts funding needs and funding sources
under different stress scenarios. This plan details how the bank will comply
with the restrictions in the order, including the restriction against brokered
deposits, as well as requires reports detailing all funding sources and
obligations under best case and worse case scenarios.
Our
liquidity contingency plan is designed to successfully respond to an overall
decline in the economic environment, the banking industry or a problem specific
to our liquidity, outlined in a formal Contingency Funding Policy approved by
the ALCO of our board of directors. This policy contains requirements
for contingency funding planning and analysis, including reporting under a
number of different contingency funding conditions. The three conditions
are described as follows:
|
•
|
Stage
One Condition – During this stage, core deposits are not affected and the
institution remains “well-capitalized,” but additional loan loss
provisions may result in weak or negative quarterly earnings. The
ability to quickly open new full-service branches may be limited by our
internal evaluations of our ability to successfully expand
further. In addition, external funding lines could be
reduced.
|
|
•
|
Stage
Two Condition – At this level, the institution has become
“adequately capitalized,” with serious asset-quality deterioration
and reduced deposits overall. At Stage Two, a meaningful level of
uncertainty and vulnerability exists. External funding lines would
likely be reduced. External factors, such as adverse general industry
or market conditions and reputation risk, may also impact
liquidity.
|
|
•
|
Stage
Three Condition - At this point, the institution has significant earnings
deterioration, in part due to significantly increased provisions for loan
losses, and impaired residual assets. External funding lines would be
greatly reduced, and the institution has become
“undercapitalized.”
|
In
addition, a liquidity crisis action plan is in place, which may be followed in
reaction to or in anticipation of a financial shock to the banking industry,
generally, or us, specifically, which results in strains or expectations of
strains on the bank’s normal funding activities.
Interest
Rate Risk
Interest
rate risk is one of the most significant risks to which we are regularly
exposed. Interest rate risk is defined as the potential for loss
resulting from adverse changes in the level of interest rates on our net
interest income. Asset liability management is the process by which
we manage our interest rate risk, specifically by monitoring and controlling the
mix and maturities of our assets and liabilities. The essential
purposes of asset liability management are to ensure adequate liquidity and to
maintain an appropriate balance between interest-sensitive assets and
liabilities to minimize the potentially adverse impact on earnings and capital
from changes in market interest rates. Our ALCO monitors and manages
our exposure to interest rate risk through the review of reports prepared by
management using a simulation model that projects the impact of rate shocks,
rate cycles, and rate forecast estimates on the net interest income and economic
value of equity (the net present value of expected cash flows from assets and
liabilities). These simulations provide a test for embedded interest
rate risk and take into consideration factors such as maturities, reinvestment
rates, prepayment speeds, repricing limits, decay rates and other
factors. We give careful attention to our assumptions and have
implemented a detailed model that interfaces with our core processing system to
model the impact of changes in assumptions on individual assets and
liabilities.
The
results are compared to risk tolerance limits set by ALCO policy. Our
policy specifies that if interest rates were to shift gradually up or down 100
or 200 basis points, estimated net interest income for the subsequent 12 months
should change by less than 7% and 15%, respectively. As of January
31, 2010 and December 31, 2009, our estimated net interest income changes were
within these guidelines. The ALCO meets quarterly and consists of
members of the board of directors and senior management of the
bank. The ALCO is charged with the responsibility of managing our
exposure to interest rate risk by maintaining the level of interest rate
sensitivity of the bank’s interest-sensitive assets and liabilities within
board-approved limits. The ALCO also reviews and approves interest
rate risk and liquidity management programs.
Interest
rate risk can be measured by analyzing the extent to which the repricing of
assets and liabilities are mismatched to create an interest sensitivity
“gap.” An asset or liability is considered to be interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. The interest rate sensitivity gap is defined as the
difference between the amount of interest earning assets maturing or repricing
within a specific time period and the amount of interest bearing liabilities
maturing or repricing within that same time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. During a period
of rising interest rates, therefore, a negative gap would tend to adversely
affect net interest income. Conversely, during a period of falling
interest rates a negative gap position would tend to result in an increase in
net interest income.
We
adopted a revised interest rate risk management program during 2009 to comply
with the consent order with the OCC. The program establishes adequate management
reports on which to base sound interest rate risk management decisions as well
as sets the strategic direction and tolerance for interest rate risk. The
program also requires tools to measure and monitor performance and the overall
interest rate risk profile to be implemented while utilizing competent personnel
and setting prudent limits on interest rate risk.
The
following table sets forth information regarding our interest rate sensitivity
as of March 31, 2010, for each of the time intervals indicated using a static
gap analysis. It is important to note that certain shortcomings are
inherent in static gap analysis. Although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market interest rates (dollars in
thousands).
|
|
Within
three months
|
|
|
After
three but within twelve months
|
|
|
After
one but within four years
|
|
|
After
four years
|
|
|
Total
|
|
Interest-earning
assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
funds sold and other
|
|
$
|
93,739
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
93,739
|
|
Investment
securities
|
|
|
18,027
|
|
|
|
33,532
|
|
|
|
7,401
|
|
|
|
1,160
|
|
|
|
60,120
|
|
Loans
|
|
|
357,122
|
|
|
|
34,323
|
|
|
|
109,876
|
|
|
|
8,986
|
|
|
|
510,307
|
|
Total
interest-earning assets
|
|
$
|
468,888
|
|
|
$
|
67,855
|
|
|
$
|
117,277
|
|
|
$
|
10,146
|
|
|
$
|
664,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
accounts
|
|
$
|
31,282
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
31,282
|
|
Money
market and savings
|
|
|
55,887
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
55,887
|
|
Time
deposits
|
|
|
223,745
|
|
|
|
189,560
|
|
|
|
76,413
|
|
|
|
5,219
|
|
|
|
494,937
|
|
FHLB
advances
|
|
|
942
|
|
|
|
11,778
|
|
|
|
20,155
|
|
|
|
20,100
|
|
|
|
52,975
|
|
Junior
subordinated debentures
|
|
|
13,403
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
13,403
|
|
Total
interest-bearing liabilities
|
|
$
|
325,259
|
|
|
$
|
201,338
|
|
|
$
|
96,568
|
|
|
$
|
25,319
|
|
|
$
|
648,484
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period
gap
|
|
$
|
143,629
|
|
|
$
|
(133,483
|
)
|
|
$
|
20,709
|
|
|
$
|
(15,173
|
)
|
|
|
|
|
Cumulative
gap
|
|
$
|
143,629
|
|
|
$
|
10,146
|
|
|
$
|
30,855
|
|
|
$
|
15,682
|
|
|
|
|
|
Ratio
of cumulative gap to total interest-earning assets
|
|
|
21.6
|
%
|
|
|
1.5
|
%
|
|
|
4.6
|
%
|
|
|
2.4
|
%
|
|
|
|
|
The
information in the table may not be indicative of our interest rate sensitivity
position at other points in time. In addition, the maturity
distribution indicated in the table may differ from the contractual maturities
of the interest-earning assets and interest-bearing liabilities presented due to
consideration of prepayment speeds under various interest rate change scenarios
in the application of the interest rate sensitivity methods described
above.
Quantitative
and Qualitative Disclosures about Market Risk
Market
risk is the potential loss arising from adverse changes in market prices and
rates that principally arises from interest rate risk inherent in our lending,
investing, deposit gathering, and borrowing activities. It is our
policy to maintain an acceptable level of interest rate risk over a range of
possible changes in interest rates while remaining responsive to market demand
for loan and deposit products. Interest rate risk may directly impact the
earnings generated by our interest-earning assets or the cost of our
interest-bearing liabilities, thus directly impacting our overall level of net
interest income. We are also exposed to market risk through changes
in fair value and other than temporary impairment of investment securities
available for sale. Changes in fair value of investment securities
available for sale are recorded through other comprehensive income each
quarter. Other types of market risks, such as foreign currency
exchange rate risk and commodity price risk, do not normally arise in the normal
course of our business.
Our
primary market risk is interest rate risk. Interest rate risk arises
from differing maturities or repricing intervals of interest-earning assets or
interest-bearing liabilities and the fact that rates on these financial
instruments do not change uniformly. We actively monitor and manage
our interest rate risk exposure. The principal interest rate risk monitoring
technique we employ is the measurement of our interest sensitivity “gap,” which
is the positive or negative dollar difference between assets and liabilities
that are subject to interest rate repricing within a given time
period. Interest rate sensitivity can be managed by repricing assets
or liabilities, selling securities available for sale, replacing an asset or
liability at maturity, or adjusting the interest rate during the life of an
asset or liability. Managing the amount of assets and liabilities
repricing in this same time interval helps to hedge the risk and minimize the
impact of rising or falling interest rates on net interest income. We
generally would benefit from increasing market rates of interest when we have an
asset-sensitive gap position and generally would benefit from decreasing market
rates of interest when we are liability-sensitive.
As of
March 31, 2010, we were asset sensitive over a one-year time
frame. Our goal is to have the net interest margin increase slightly
in a rising interest rate environment. However, our gap analysis is
not a precise indicator of our interest sensitivity position. The
analysis presents only a static view of the timing of maturities and repricing
opportunities, without taking into consideration that changes in interest rates
do not affect all assets and liabilities equally. For example, rates
paid on a substantial portion of core deposits may change contractually within a
relatively short time frame, but those rates are viewed by management as
significantly less interest-sensitive than market-based rates such as those paid
on non-core deposits. Net interest income may be impacted by other
significant factors in a given interest rate environment, including changes in
the volume and mix of interest-earning assets and interest-bearing
liabilities. Therefore, we also utilize the income simulation method
to analyze the expected changes in income in response to changes in interest
rates.
Recently
Issued Accounting Pronouncements
The
following is a summary of recent authoritative pronouncements that affect
accounting, reporting, and disclosure of financial information.
In
January 2010, compensation guidance was updated to reflect the SEC’s views of
when escrowed share arrangements are considered to be
compensatory. Historically, the SEC staff has expressed the view that
an escrowed share arrangement involving the release of shares to certain
shareholders based on performance-related criteria is presumed to be
compensatory. Facts and circumstances may indicate that the
arrangement is an incentive made to facilitate a transaction on behalf of the
company if the escrowed shares will be released or canceled without regard to
continued employment. In such cases, the SEC staff generally believes that the
arrangement should be recognized and measured according to its nature and
reflected as a reduction of the proceeds allocated to the newly issued
securities. The SEC staff believes that an escrowed share arrangement
in which the shares are automatically forfeited if employment terminates is
compensation. The guidance is effective upon issuance and had no impact on our
financial statements.
In
January 2010, fair value guidance was amended to require disclosures for
significant amounts transferred in and out of Levels 1 and 2 and the reasons for
such transfers and to require that gross amounts of purchases, sales, issuances
and settlements be provided in the Level 3 reconciliation. The new
disclosures are effective for us for the current quarter ended March 31, 2010,
and have been reflected in Note 9 – Fair Value Disclosures.
Guidance
related to subsequent events was amended in February 2010 to remove the
requirement for an SEC filer to disclose the date through which subsequent
events were evaluated. The amendments were effective upon issuance
and had no significant impact on our financial statements.
Consolidation
guidance was amended in February 2010 to defer guidance regarding the analysis
of interests in variable interest entities issued in June 2009 for entities
having attributes of investment companies or that apply investment company
measurement principles. Disclosure requirements provided in the June
2009 guidance were not deferred. The amendments were effective
January 1, 2010 and had no effect on our financial statements.
In March
2010, guidance related to derivatives and hedging was amended to exempt embedded
credit derivative features related to the transfer of credit risk from potential
bifurcation and separate accounting. Embedded features related to
other types of risk and other embedded credit derivative features will not be
exempt from potential bifurcation and separate accounting. The
amendments will be effective for us on July 1, 2010 although early adoption is
permitted. We do not expect these amendments to have any impact
on the financial statements.
Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s financial position, results of operations or cash flows.
Item 3.
Quantitative and Qualitative
Disclosures about Market Risk.
See
“Market Risk” in Item 2, Management’s Discussion and Analysis of Financial
Condition and Results of Operations, for quantitative and qualitative
disclosures about market risk, which information is incorporated herein by
reference.
Item 4.
Controls and
Procedures.
Evaluation
of Disclosure Controls and Procedures
As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision and with the participation of our management, including our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as defined in Exchange Act Rule
13a-15(e). Based upon that evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that our current disclosure controls
and procedures are effective as of March 31, 2010. There have been no
significant changes in our internal controls over financial reporting during the
fiscal quarter ended March 31, 2010, that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
The
design of any system of controls and procedures is based in part upon certain
assumptions about the likelihood of future events. There can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote.
PART
II. OTHER INFORMATION
Item
1.
Legal
Proceedings.
There are
no material pending legal proceedings to which the company or any of its
subsidiaries is a party or of which any of their property is the
subject.
Not
applicable.
Item
2.
Unregistered Sales of Equity
Securities and Use of Proceeds.
None
Item
3.
Defaults Upon Senior
Securities.
None
Item
4.
(Removed and
Reserved).
Item
5.
Other
Information.
None
|
|
10.1
|
First
Amendment to Loan Modification and Settlement Agreement by and among First
National Bancshares, Inc.
and
Nexity Bank dated March 26, 2010
|
|
|
31.1
|
Rule
13a-14(a) Certification of the Chief Executive Officer.
|
|
|
31.2
|
Rule
13a-14(a) Certification of the Chief Financial Officer.
|
|
|
32
|
Section
1350 Certifications.
|
SIGNATURES
Pursuant to the requirements of the
Exchange Act, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
|
FIRST
NATIONAL BANCSHARES, INC.
|
|
|
|
|
|
|
|
|
|
Date:
May 10, 2010
|
By:
|
/
s/ J. Barry
Mason
|
|
|
|
J.
Barry Mason
|
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
Date:
May 10, 2010
|
By:
|
/s/
Kitty B. Payne
|
|
|
|
Kitty
B. Payne
|
|
|
|
Executive
Vice President/Chief Financial Officer
|
|
INDEX
TO EXHIBITS
|
|
10.1
|
First
Amendment to Loan Modification and Settlement Agreement by and among First
National Bancshares, Inc.
and
Nexity Bank dated March 26, 2010
|
|
|
31.1
|
Rule
13a-14(a) Certification of the Chief Executive Officer.
|
|
|
31.2
|
Rule
13a-14(a) Certification of the Chief Financial Officer.
|
|
|
32
|
Section
1350 Certifications.
|
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