UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to __________
Commission file number 000-09424
FIRST M&F CORPORATION
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(Exact Name of Registrant as specified in its Charter)
MISSISSIPPI 64-0636653
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(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
134 West Washington Street, Kosciusko, Mississippi 39090
- --------------------------------------------------------------- --------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number: 662-289-5121
------------------------------------------
Securities registered under Section 12(b) of the Act:
None None
- ----------------------------------------------------------------- --------------------------------------------------
(Title of Each Class) (Name of Each Exchange on Which Registered)
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $5 par value None
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(Title of Each Class) (Name of Each Exchange on Which Registered)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter periods 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 2b-2 of the Act).
YES [X] NO [ ]
Based on closing sale price for shares on June 30, 2004, the aggregate market value of the voting stock held by
nonaffiliates of the Registrant was $102,245,699.
Based on closing sale price for shares on June 30, 2003, the aggregate market value of the voting stock held by
nonaffiliates of the Registrant was $111,851,747.
Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest
practicable date.
Title of Class Outstanding at January 31, 2005
-------------- -------------------------------
Common stock ($5.00 par value) 4,501,159 Shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement dated March 16, 2005 are incorporated by reference into Part III of the Form 10K report.
CROSS REFERENCE INDEX
Page
------
PART I
Item 1 Business 3
Item 2 Properties 11
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Security Holders 11
PART II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 11
Item 6 Selected Financial Data 13
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A Quantitative and Qualitative Disclosures About Market Risk 23
Item 8 Financial Statements and Supplementary Data 24
Item 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 52
Item 9A Controls and Procedures 52
Item 9B Other Information 52
PART III
Item 10 Directors and Executive Officers of the Registrant 53
Item 11 Executive Compensation 53
Item 12 Security Ownership of Certain Beneficial Owners and Management 53
Item 13 Certain Relationships and Related Transactions 53
Item 14 Principal Accounting Fees and Services 53
PART IV
Item 15 Exhibits, Financial Statement Schedules 53
__________
*Information called for by Part III (Items 10 through 14) is incorporated by reference to the Registrant’s Proxy Statement.
First M&F Corporation (the Company) is a one-bank holding company chartered and organized under Mississippi laws in 1979. The Company engages exclusively in the banking business through its wholly-owned subsidiary, Merchants and Farmers Bank of Kosciusko (the Bank).
The Bank was chartered and organized under the laws of the State of Mississippi in 1890, and accounts for substantially all of the total assets and revenues of the Company. The Bank is the sixth largest bank in the state, having total assets of approximately $1.139 billion at December 31, 2004. The Bank offers a complete range of commercial and consumer services at its main office and two branches in Kosciusko and its branches within central and north Mississippi, including Ackerman, Bruce, Brandon, Canton, Cleveland, Clinton, Durant, Flowood, Grenada, Jackson, Madison, Olive Branch, Oxford, Pearl, Philadelphia, Ridgeland, Southaven, Starkville, and Tupelo, Mississippi, and a loan production office in Memphis, Tennessee.
The Bank has six wholly-owned subsidiaries, M&F Financial Services, Inc., which is currently inactive, First M&F Insurance Company, Inc., a credit life insurance company, M&F Insurance Agency, Inc., a general insurance agency, M&F Insurance Group, Inc., a general insurance agency, Merchants and Farmers Bank Securities Corporation, a real estate property management company, and M&F Business Credit, Inc., an asset-based lending operation based in Memphis, Tennessee. The Bank owns 55% of MS Statewide Title, LLC, a title insurance agency. The remaining 45% ownership is held by unaffiliated parties. Since March 1, 2000 the Bank has owned 51% of a joint venture, Merchants Financial Services, 49% of which is owned by an unaffiliated company. The joint venture engages in small business accounts receivable factoring, and has been consolidated into the Company’s financial statements for reporting purposes. Merchants Financial Services sold substantially all of its receivables to its two owners as of December 31, 2004, and is planned to be dissolved by the end of 2005.
The banking system offers a variety of deposit, investment and credit products to customers. The Bank provides these services to middle market and professional businesses, ranging from business checking, treasury management services and secured and unsecured lines of credit. Additional services include ach origination, sweep accounts and letters of credit. The Bank also offers a variety of checking accounts to its customers and other services, which include debit cards and automated teller machine access through several networks, and an overdraft protection plan. Trust services are offered through the Kosciusko main office and discount brokerage services are offered through the Madison and Tupelo offices.
As of December 31, 2004, the Company and its subsidiary employed 459 full-time equivalent employees.
Forward Looking StatementsCertain of the information included in these discussions contains forward looking financial data and information that is based upon management’s belief as well as certain assumptions made by, and information currently available to management. Specifically, these discussions include statements with respect to the adequacy of the allowance for loan losses, the effect of legal proceedings against the Company’s financial condition, results of operations and liquidity, and market risk disclosures. Should one or more of these risks materialize or the assumptions prove to be significantly different, actual results may vary from those estimated, anticipated, projected or expected. For instance, if the economy deteriorated and real estate values became depressed, the approximately 77% of the Company’s loan portfolio that is secured by real estate could come under stress, thus possibly requiring additional loan loss accruals. The Company may not be able to dispose of its foreclosed real estate at prices above the properties’ carrying values, thus causing additional losses. Unfavorable judgments in excess of accrued liabilities related to ongoing litigation may result in additional expenses. Unanticipated catastrophic loss claims could occur that would reduce or eliminate the profit sharing revenues of the insurance agencies. Such claims may also affect the availability of insurance products for certain classes of customers, thereby reducing commission revenues available to the agencies. A severe slowing of the economy may affect the ability of the Company’s customers to make timely loan payments, or may cause customers to use up deposit balances, thereby causing a strain on the Company’s liquidity. A much steeper than anticipated increase in interest rates could cause the Company’s net interest margins to decrease, thereby decreasing net interest revenues. Mortgage originations, and therefore mortgage revenues, would be hurt by steeply rising interest rates. A poor stock market could reduce brokerage transactions, therefore reducing investment brokerage revenues. An unanticipated increase in inflation could cause the Company’s operating costs related to salaries, technology, supplies and property taxes to increase. Unforeseen new competition from outside the traditional financial services industry could constrain the Company’s ability to price its products profitably. Investments in the portfolio of the Company’s pension plan may not provide adequate returns to fund the accumulated and projected plan obligations, thus causing higher annual plan expenses and requiring additional contributions by the Company. These examples are not intended to be exhaustive, and describe events, circumstances and contingencies that may never materialize. Nevertheless, the reader is cautioned that such types of occurrences, usually outside of the control of the Company, may cause financial results to be different than the reader or the Company’s management had originally estimated.
In the opinion of First M&F Corporation’s management, the Company’s most significant accomplishments during 2004 were as follows:
Facilities
o In February, completed construction and opened a full service branch in Flowood in Rankin County
o In September, opened a full service branch at a rented location in Jackson
o In November, completed construction of a full service branch in Olive Branch, in DeSoto County,
replacing rented office space
o In December, opened a loan production office in Memphis, Tennessee with an initial staff of three
banking professionals
Revenues
o Strong debit card revenue growth was an encouraging component of deposit revenues
o Commissions from annuity sales increased significantly
o Retail investment brokerage revenues increased by 60.3%
o Trust revenues increased by 28.8%
o Treasury services revenues continued to improve
o Property, casualty, life and health insurance commissions increased by 4.7% to $3.4 million
o The Company made progress toward achieving its strategic objectives related to fee revenue growth and
building diverse revenue sources
Products and Services
o In November, began promoting the new eRate Plus account, designed to accommodate only electronic
transactions and paying a higher rate of interest
o Promoted a multi-featured, low cost deposit product, Priority Checking, designed for customers over 50
years old
o Completed the most successful Gridiron loan campaign, an annual loan promotion offering college season
football tickets to qualifying loan customers, in Company history
o Focusing on consumer loans, promoted home equity lines with an introductory rate and removed the
interest rate floor provisions, providing an attractive and competitive product
o Closed out 2004 with an internal deposit campaign targeting non-interest bearing deposit growth and
cross-selling of other products and services
In the opinion of Management, the challenges and opportunities facing the Company going forward from December 31,
2004 are as follows:
o Continue branch expansion in economically viable markets
o Continue to increase the volumes and improve the products and services delivered through the insurance
agencies
o Focus on small businesses, building deposit and treasury services relationships onto the small business
loan relationships
o Use core deposit growth as the primary funding source for lending activities
o Build the retail investment brokerage business with plans to increase balances in brokered accounts
o Focus on consumer lending primarily through home equity loan promotions
o Continue to seek out commercial lending opportunities in economic and industry sectors where we have
expertise
o Contain expenses in current operations while also focusing on expansion into new locations and markets
o Promote low-cost delivery channels such as debit cards and electronic banking that are convenient to the
customers
o Grow the Company's geographic footprint into contiguous states when the opportunity provides for
enhanced shareholder returns
The Company competes generally with other banking institutions, savings associations, credit unions, mortgage banking firms, consumer finance companies, mutual funds, insurance companies, securities brokerage firms, and other finance related institutions; many of which have greater resources than those available to the Company. The competition is primarily related to areas of interest rates, the availability and quality of services and products, and the pricing of those services and products.
Supervision and RegulationAs a bank holding company, First M&F Corporation is subject to regulation under the Bank Holding Company Act of 1956, as amended, (the “BHCA”) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. The BHCA also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity which is determined to be so closely related to banking or managing or controlling banks that an exception is allowed for those activities.
As a state-chartered commercial bank, Merchants and Farmers Bank, First M&F Corporation’s banking subsidiary, is subject to regulation, supervision and examination by the Mississippi Department of Banking and Consumer Finance. Merchants and Farmers Bank (the “Bank”) is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”). State and Federal law also govern the activities in which the Bank engages, the investments it makes and the aggregate amount of loans that may be granted to one borrower. The insurance company subsidiary of the Bank is also regulated and examined by the Insurance Department of the State of Mississippi.
The earnings of the Bank and its subsidiaries are affected by general economic conditions, management policies, changes in state and Federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant state and Federal laws to which the Company, the Bank and subsidiaries are subject.
CapitalThe Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve Board and the FDIC. There are two basic measures of capital adequacy for bank holding companies and their banking subsidiaries; a risk-based measure and a leverage measure.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among depository institutions and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The minimum guideline for the total capital to risk-weighted assets, including certain off-balance sheet items such as standby letters of credit (“total capital ratio”) is 8.0 percent. At least half of total capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (“Tier 1 capital”). The remainder may consist of subordinated debt, other preferred stock, a limited amount of loan loss reserves, and unrealized gains on equity securities subject to limitations (“Tier 2 capital”). At December 31, 2004, the Company and the Bank were in compliance with the total capital ratio and the Tier 1 capital ratio requirements. Note 17 of the Notes to Consolidated Financial Statements presents the Company’s and the Bank’s capital ratios.
Deposit Insurance AssessmentsThe deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law. A majority of the deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund (“BIF”) of the FDIC. However, a portion of the Bank’s deposits, relating to a savings association acquisition, are subject to assessments imposed by the Savings Association Insurance Fund (“SAIF”) of the FDIC. The FDIC equalized the assessment rates for BIF-insured and SAIF-insured deposits effective January 1, 1997. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of insured deposits, depending on the institution’s capital position and other supervisory factors. Legislation was enacted in 1996 requiring both SAIF-insured and BIF-insured deposits to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”). The FDIC is currently assessing, effective for the first quarter of 2005, BIF- and SAIF-insured deposits totaling an additional 1.44 basis points per $100 of deposits.
The Company maintains an internet website at www.mfbank.com. The Company makes available free of charge on the website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with the Securities and Exchange Commission. These reports are made available on the Company’s website as soon as reasonably practical after the reports are filed with the Commission. Information on the Company’s website is not incorporated into this Form 10-K or the Company’s other securities filings and is not a part of them.
STATISTICAL DISCLOSURE
The statistical disclosures for the Company are contained in Tables 1 through 12.
Table 1
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AVERAGE BALANCE SHEETS/YIELDS
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2004 2003 2002
(Dollars in thousands) Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------------ ---------- -------- ----------- ---------- ------- ----------- ---------- -------
Interest-bearing bank balances $ 5,747 $ 98 1.71% $ 7,451 $ 108 1.45% $ 7,387 $ 124 1.68%
Federal funds sold 11,449 113 .99 16,690 192 1.15 10,241 163 1.59
Taxable investments 131,105 5,439 4.15 152,447 6,653 4.37 194,120 9,998 5.15
Tax-exempt investments 53,500 3,528 6.59 54,980 3,793 6.90 56,567 4,104 7.26
Loans 803,968 50,403 6.27 730,133 48,685 6.67 660,529 49,125 7.44
------------ ---------- -------- ----------- ---------- ------- ----------- ---------- -------
Total earning assets 1,005,769 59,581 5.92 961,701 59,431 6.18 928,844 63,514 6.84
Nonearning assets 104,420 100,236 94,202
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Total average assets $1,110,189 $1,061,937 $1,023,046
============ =========== ===========
NOW & MMDA 280,291 1,913 .68 291,723 2,786 .96 264,193 4,954 1.88
Savings deposits 86,758 1,180 1.36 90,305 1,435 1.59 97,020 2,162 2.23
Certificates of deposit 359,318 8,643 2.41 345,849 9,178 2.65 355,745 12,683 3.57
Short-term borrowings 20,839 664 3.19 18,757 608 3.24 20,512 695 3.39
Other borrowings 118,597 4,650 3.92 87,579 3,850 4.40 72,010 3,208 4.45
------------ ---------- -------- ----------- ---------- ------- ----------- ---------- -------
Total interest-bearing 865,803 17,050 1.97 834,213 17,857 2.14 809,480 23,702 2.93
liabilities
Noninterest-bearing deposits 123,773 107,493 99,672
Noninterest-bearing 8,618 9,323 8,940
liabilities
Capital 111,995 110,908 104,954
------------ ----------- -----------
Total avg. liabilities & $1,110,189 $1,061,937 $1,023,046
equity ============ ---------- -------- =========== ---------- ------- =========== ---------- -------
Net interest margin 42,531 4.23 41,574 4.32 39,812 4.29
Less tax equivalent adjustment
Investments 1,316 .13 1,415 .14 1,531 .16
Loans 88 .01 98 .01 110 .02
---------- -------- ---------- ------- ---------- -------
Reported book net interest $41,127 4.09% $40,061 4.17% $38,171 4.11%
margin ========== ======== ========== ======= ========== =======
Tax equivalent adjustments were made using a blended Federal/State rate of 37.3%.
Table 2
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RATE/VOLUME VARIANCES
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2004 Compared To 2003 2003 Compared To 2002
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(Dollars in thousands) Increase (Decrease) Due To Increase (Decrease) Due To
------------------------------------------- --------------------------------------------
Yield/ Yield/
Volume Cost Net Volume Cost Net
------------ ------------- ---------- ----------- ------------- ------------
Interest earned on:
Interest-bearing bank balances $ (27) $ 17 $ (10) $ 1 $ (17) $ (16)
Federal funds sold (56) (23) (79) 88 (59) 29
Taxable investments (908) (306) (1,214) (1,983) (1,362) (3,345)
Tax-exempt investments (100) (165) (265) (112) (199) (311)
Loans 4,776 (3,058) 1,718 4,909 (5,349) (440)
------------ ------------- ---------- ----------- ------------- ------------
Total earning assets 2,667 (2,517) 150 2,139 (6,222) (4,083)
Interest paid on:
NOW & MMDA (94) (779) (873) 390 (2,558) (2,168)
Savings deposits (52) (203) (255) (128) (599) (727)
Certificates of deposit 341 (876) (535) (308) (3,197) (3,505)
Short-term borrowings 67 (11) 56 (58) (29) (87)
Other borrowings 1,290 (490) 800 689 (47) 642
------------ ------------- ---------- ----------- ------------- ------------
Total interest-bearing liabilities 649 (1,456) (807) 627 (6,472) (5,845)
------------ ------------- ---------- ----------- ------------- ------------
Change in net interest income
on a tax-equivalent basis $ 2,018 $ (1,061) $ 957 $ 1,512 $ 250 $ 1,762
============ ============= ========== =========== ============= ============
The rate/volume variances are computed for each line item and are therefore non-additive.
Table 3
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SECURITIES AVAILABLE FOR SALE
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Carrying Value of Securities
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(Dollars in thousands) December 31
--------------------
2004 2003 2002
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Securities Available For Sale
U. S. Treasury $ 550 $ 560 $ 1,082
Government agencies 61,796 69,794 60,806
Mortgage-backed securities 47,397 51,526 107,868
Obligations of states and political subdivisions 56,089 60,071 59,642
Other securities 9,822 5,626 6,712
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Total securities available for sale $175,654 $187,577 $236,110
============= ==================== =============
Amortized Cost of Securities
------------------------------------------------------------
December 31
--------------------
2004 2003 2002
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Securities Available For Sale
U. S. Treasury $ 528 $ 532 $ 1,037
Government agencies 61,564 67,954 58,125
Mortgage-backed securities 46,718 49,986 104,122
Obligations of states and political subdivisions 54,274 57,503 56,954
Other securities 9,724 5,400 6,379
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Total securities available for sale $172,808 $181,375 $226,617
============= ==================== =============
Table 4
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MATURITY DISTRIBUTION AND YIELDS OF SECURITIES AVAILABLE FOR SALE
- ----------------------------------------------------------------------------------------------------------------------------------
After One
But
Within Within After Five
(Dollars in thousands) One Five But Within Over
Year Yield Years Yield Ten Years Yield Ten Years Yield Total Yield
----------------- ----------------- ------------------ ----------------- -----------------
Securities Available For
Sale
U.S. Treasury $ - -% $ - -% $ 528 4.60% $ - -% $ 528 4.60%
Government agencies 46,498 3.76 14,555 3.59 511 5.38 - - 61,564 3.74
Mortgage-backed securities 13,754 5.08 27,398 4.60 3,322 4.06 2,244 4.33 46,718 4.69
Obligations of states and
political subdivisions 8,600 7.29 40,192 6.61 5,252 5.79 230 6.08 54,274 6.64
Other debt securities - - 7,079 4.49 607 4.13 1,000 3.51 8,686 4.35
----------------- ----------------- ------------------ ----------------- -----------------
Total securities available
for sale $68,852 4.47% $89,224 5.33% $10,220 5.05% $ 3,474 4.21% $171,770 4.95%
Equity securities 1,038
----------
$172,808
==========
Tax equivalent adjustments were made using a blended Federal rate of 34.0% and a State rate of 5.0%. The amounts
shown represent the investment portfolio as stated at amortized cost.
Non mortgage-backed securities are categorized in the earlier of their maturity dates or call dates.
Mortgage-backed securities are distributed based upon their estimated average lives.
Table 5
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COMPOSITION OF THE LOAN PORTFOLIO
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(Dollars in thousand) 2004 2003 2002 2001 2000
--------- ---------- --------- --------- ----------
% Of % Of % Of % Of % Of
Held For Investment Amount Total Amount Total Amount Total Amount Total Amount Total
--------- --------- ---------- --------- --------- ---------- --------- --------- ---------- ---------
Commercial,
financial and
agricultural $131,886 15.63% $ 112,443 14.43% $ 94,169 13.92% $ 86,040 13.11% $ 76,834 12.15%
Non-residential real
Estate 369,100 43.75 339,547 43.58 262,141 38.74 234,950 35.81 202,619 32.05
Residential real
Estate 284,823 33.75 263,450 33.81 241,861 35.75 242,288 36.92 248,830 39.35
Consumer loans 57,990 6.87 63,740 8.18 78,395 11.59 92,875 14.15 103,960 16.44
Lease financing - - - - 9 0.00 33 0.01 51 0.01
--------- --------- ---------- --------- --------- ---------- --------- --------- ---------- ---------
Total loans $843,799 100.00% $ 779,180 100.00% $676,575 100.00% $656,186 100.00% $632,294 100.00%
========= ========= ========== ========= ========= ========== ========= ========= ========== =========
Mortgages held
for sale $ 923 $ 2,141 $ 2,171 $ 5,096 $ 915
========= ========= ========== ========= ========= ========== ========= ========= ========== =========
Table 6
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LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES
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Maturity distribution of loans at December 31, 2004
(Dollars in thousands) Within One to Five After Five
One Year Years Years Total
------------- --------------- ------------- -------------
Commercial, financial and agricultural $ 70,611 $ 56,853 $ 4,422 $131,886
Non-residential real estate 97,264 233,114 38,722 369,100
Residential real estate 38,437 181,668 64,718 284,823
Consumer loans 15,455 42,122 413 57,990
------------- --------------- ------------- -------------
Total loans $221,767 $513,757 $108,275 $843,799
============= =============== ============= =============
Rate sensitivity of loans at December 31, 2004
One to Five After Five
Years Years Total
------------- --------------- -------------
Fixed rate loans $438,755 $ 82,459 $521,214
Floating rate loans 75,002 25,816 100,818
------------- --------------- -------------
$513,757 $108,275 $622,032
============= =============== =============
Table 7
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NONPERFORMING ASSETS AND PAST DUE LOANS
- -----------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
2004 2003 2002 2001 2000
---------- ----------- ------------ ------------ ------------
Nonaccrual loans $3,302 $4,517 $1,582 $1,825 $1,385
Restructured loans - - - - -
---------- ----------- ------------ ------------ ------------
Total nonperforming loans 3,302 4,517 1,582 1,825 1,385
Other real estate owned 2,816 802 950 1,077 965
---------- ----------- ------------ ------------ ------------
Total nonperforming assets 6,118 5,319 2,532 2,902 2,350
Accruing loans past due 90 days or more 645 1,531 2,169 1,958 1,806
---------- ----------- ------------ ------------ ------------
Total nonperforming assets and loans $6,763 $6,850 $4,701 $4,860 $4,156
========== =========== ============ ============ ============
Table 8
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ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
2004 2003 2002 2001 2000
------------- ------------ ----------- ----------- -----------
Balance at beginning of year $10,891 $10,258 $ 8,426 $8,510 $7,629
Charge offs:
Commercial, financial and agricultural (3,832) (721) (650) (2,313) (1,897)
Real estate - nonresidential (312) (318) (332) (301) (176)
Real estate - residential (289) (1,120) (474) (507) (164)
Consumer (1,193) (1,516) (1,849) (2,167) (1,989)
------------- ------------ ----------- ----------- -----------
Total (5,626) (3,675) (3,305) (5,288) (4,226)
Recoveries:
Commercial, financial and agricultural 190 85 82 74 70
Real estate - nonresidential 24 56 37 20 37
Real estate - residential 445 27 6 50 46
Consumer 344 338 517 645 655
------------- ------------ ----------- ----------- -----------
Total 1,003 506 642 789 808
------------- ------------ ----------- ----------- -----------
Net charge-offs (4,623) (3,169) (2,663) (4,499) (3,418)
Provision for loan losses 5,351 3,802 4,495 4,415 4,299
------------- ------------ ----------- ----------- -----------
Balance at end of year $11,619 $10,891 $10,258 $8,426 $8,510
============= ============ =========== =========== ===========
Net Charge-Offs To Average Loans 0.57% 0.43% 0.40% 0.69% 0.54%
============= ============ =========== =========== ===========
Table 9
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ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
- -------------------------------------------------------------------------------------------------------------------
December 31
--------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
------------ ------------ ----------- ----------- -----------
Commercial, financial and agricultural $ 5,224 $ 4,833 $ 3,804 $2,380 $1,291
Non-residential real estate 574 317 322 411 487
Residential real estate 1,241 330 1,048 1,102 1,596
Consumer loans 4,581 5,411 5,084 4,532 5,135
------------ ------------ ----------- ----------- -----------
Total loans $11,619 $10,891 $10,258 $8,426 $8,510
============ ============ =========== =========== ===========
Allowance As A Percentage Of Loan Type
December 31
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ----------- ----------- -----------
Commercial, financial and agricultural 3.96% 4.30% 4.04% 2.77% 1.68%
Non-residential real estate 0.16 0.09 0.12 0.18 0.24
Residential real estate 0.44 0.13 0.43 0.45 0.64
Consumer loans 7.90 8.49 6.48 4.88 4.94
------------ ------------ ----------- ----------- -----------
Total loans 1.38% 1.40% 1.52% 1.28% 1.35%
============ ============ =========== =========== ===========
Net Charge-Offs As A Percent Of Year End Loans Outstanding, By Type
December 31
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ----------- ----------- -----------
Commercial, financial and agricultural 2.76% 0.57% 0.60% 2.60% 2.38%
Non-residential real estate 0.08 0.08 0.11 0.12 0.07
Residential real estate (0.05) 0.41 0.19 0.19 0.05
Consumer loans 1.46 1.85 1.70 1.64 1.28
------------ ------------ ----------- ----------- -----------
Total loans 0.55% 0.41% 0.39% 0.69% 0.54%
============ ============ =========== =========== ===========
Table 10
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TIME DEPOSITS OF $100,000 OR MORE
- -------------------------------------------------------------------------------------------------------------------
The table below shows maturities of outstanding time deposits of $100,000 or more at December 31, 2004 (in
thousands):
Three months or less $ 48,902
Over three months through six months 32,023
Over six months through twelve months 27,435
Over one year 58,107
-----------------
Total $166,467
=================
Table 11
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SELECTED RATIOS
- -------------------------------------------------------------------------------------------------------------------
The following table reflects ratios for the Company for the last three years:
2004 2003 2002
----------------- ------------------ ------------------
Return on average assets 0.97% 1.03% 1.00%
Return on average equity 9.62 9.82 9.75
Dividend payout ratio 42.19 42.37 45.05
Average equity to assets ratio 10.09 10.44 10.26
Table 12
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SHORT-TERM BORROWINGS
- -------------------------------------------------------------------------------------------------------------------
The table below presents certain information regarding the Company's short-term borrowings for each of the last
three years (in thousands):
2004 2003 2002
------------- ------------- --------------
Securities sold under agreements to repurchase
Outstanding at end of period $16,808 $15,205 $23,599
Maximum outstanding at any month-end during the period 18,872 22,859 23,599
Average outstanding during the period 15,428 16,984 20,411
Interest paid 557 584 693
Weighted average rate during each period 3.61% 3.44% 3.40%
Federal funds purchased
Outstanding at end of period $ - $ - $ -
Maximum outstanding at any month-end during the period 31,900 8,600 -
Average outstanding during the period 5,411 1,773 102
Interest paid 107 24 2
Weighted average rate during each period 1.97% 1.36% 2.09%
The Bank’s legal headquarters is a 21,000 square foot, three story, brick building located at 134 West Washington Street. This building houses the primary administrative offices of the Bank and Company.
The Bank owns its main office building and 30 of its branch facilities and leases five of its locations. The Bank’s insurance agency subsidiary owns four of its locations and leases one. The Bank’s asset-based lending subsidiary leases one office. The facilities occupied under lease agreements have terms which range from month to month to five years. It is anticipated that all leases will be renewed.
There has been a trend toward increased litigation against financial services companies arising out of consumer lending and other consumer financial transactions, especially in Mississippi. Some of these actions have resulted in large settlements or substantial damage awards.
The Bank and one of its subsidiaries are subject to similar cases that seek substantial damages for claims arising out of transactions that involve relatively small amounts of money. While the allegations vary from case to case, in general they allege that loans were originated or renewed in a way that the borrowers were improperly sold insurance products, such as credit life insurance. The Company has denied these allegations and will vigorously defend the claims.
In total, there are cases involving over 200 plaintiffs that have been filed over a three year period. Some suits have been filed in Holmes County. A suit involving 36 plaintiffs was settled out of court in the third quarter of 2004. It is not possible at this time to determine the potential exposure related to possible damages in connection with the remaining suits. Future legislation and court decisions may limit the amount of damages that can be recovered in legal proceedings such as these. However, management cannot predict at this time the effect that legislation or court decisions may have on these cases.
Additionally, the Company and its subsidiaries are defendants in various other lawsuits arising out of the normal course of business. In the opinion of management, the ultimate resolution of this category of claims should not have a material adverse effect on the Company’s consolidated financial position or results of operations.
No matters were submitted to a shareholder vote during the fourth quarter of 2004.
Effective September 1, 1996, the Company’s common stock was listed with the National Association of Securities Dealers, Inc. Automated Quotation National Market System (NASDAQ) and became subject to trading and reporting over the counter with most securities dealers.
At December 31, 2004, there were 1,254 shareholders of record of the Company’s common stock. On December 31, 2004, the Company’s stock closed at $33.85 per share.
The following table summarizes the trading ranges and dividend payouts for the two years ended December 31, 2004.
Quarterly Closing Common Stock
Price Ranges and Dividends Paid
First Second Third Fourth
- ---------------------------------------------------------------------------------------------------------------
2004:
High $39.10 $36.00 $34.00 $34.55
Low 30.50 30.65 31.01 32.65
Close 33.51 31.14 33.35 33.85
Dividend .25 .25 .25 .25
- ---------------------------------------------------------------------------------------------------------------
2003:
High $35.80 $39.30 $37.00 $39.11
Low 27.75 30.50 31.75 34.59
Close 35.80 32.71 35.65 37.90
Dividend .25 .25 .25 .25
The following table summarizes stock and dividend performance ratios for the five years ended December 31, 2004.
2004 2003 2002 2001 2000
-------------- -------------- -------------- -------------- --------------
Price/earnings ratio 14.28x 16.06x 12.50x 13.23x 11.03x
Price/book value ratio 1.36x 1.56x 1.18x .95x .80x
Book value/share $24.96 $24.24 $23.59 $21.68 $21.01
Dividend payout ratio 42.19% 42.37% 45.05% 64.52% 65.36%
Historical dividend yield 2.64% 3.60% 4.88% 5.93% 3.33%
The following table summarizes repurchases of common stock for the program in place during the fourth quarter of
2004:
Maximum Number
Total Number (or Approximate
of Shares Dollar Value)
(or Units) Purchased of Shares (or Units)
Total Number As Part of That May Yet Be
of Shares (or Average Price Paid Publicly Announced Purchased Under the
Period Units) Purchased Per Share (or Unit) Plans or Programs Plans or Programs
------ ---------------- ------------------- --------------------- -------------------
10/01/04 - 10/31/04 (1) - $ - - 60,000
11/01/04 - 11/30/04 8,100 33.73 5,000 50,000
12/01/04 - 12/31/04 10,000 33.94 10,000 40,000
(1) On April 14, 2004, the Board authorized a program to repurchase up to 120,000 shares of common stock in
the open market over a twelve month period beginning on May 1, 2004 and ending on April 30, 2005. The
authorization limits the number of shares that may be repurchased in any calendar month to no more than
10,000.
SELECTED FINANCIAL DATA
(Thousands, except per share data) 2004 2003 2002 2001 2000
- ------------------------------------------- ---------------- ---------------- ---------------- ---------------- ----------------
EARNINGS
Interest income $ 58,177 $ 57,918 $ 61,873 $ 70,320 $ 73,340
Interest expense 17,050 17,857 23,702 37,355 41,227
Net interest income 41,127 40,061 38,171 32,965 32,113
Provision for loan losses 5,351 3,802 4,495 4,415 4,299
Noninterest income 15,281 14,357 14,088 13,783 10,590
Noninterest expense 35,738 35,121 33,394 32,118 29,803
Income taxes 4,544 4,603 4,135 3,062 1,522
Net income $ 10,775 $ 10,892 $ 10,235 $ 7,153 $ 7,079
Net interest income, taxable equivalent $ 42,531 $ 41,574 $ 39,812 $ 34,753 $ 33,967
Cash dividends paid $ 4,535 $ 4,604 $ 4,610 $ 4,615 $ 4,626
PER COMMON SHARE
Net income (basic) $ 2.37 $ 2.36 $ 2.22 $ 1.55 $ 1.53
Cash dividends paid 1.00 1.00 1.00 1.00 1.00
Book value 24.96 24.24 23.59 21.68 21.01
Closing stock price 33.85 37.90 27.75 20.50 16.88
SELECTED AVERAGE BALANCES
Assets $ 1,110,189 $ 1,061,937 $ 1,023,046 $ 1,010,122 $ 1,009,619
Earning assets, amortized cost 1,005,769 961,701 928,844 920,423 927,212
Loans held for investment 803,968 730,133 660,529 645,541 630,485
Investments, amortized cost 184,605 207,427 250,687 249,677 279,364
Total deposits 850,140 835,370 816,630 800,665 791,797
Equity 111,995 110,908 104,954 100,197 91,986
SELECTED YEAR-END BALANCES
Assets $ 1,142,712 $ 1,078,298 $ 1,037,134 $ 1,018,309 $ 1,020,416
Earning assets, carrying value 1,028,108 970,261 932,995 912,232 925,500
Loans held for investment 843,799 779,180 676,575 656,186 632,294
Investments, carrying value 175,654 187,577 236,110 250,358 264,280
Total deposits 877,264 820,226 824,024 816,617 787,554
Equity 112,468 110,678 108,210 100,063 96,942
SELECTED RATIOS
Return on average assets .97% 1.03% 1.00% .71% .70%
Return on average equity 9.62 9.82 9.75 7.14 7.70
Average equity to average assets 10.09 10.44 10.26 9.92 9.11
Dividend payout ratio 42.19 42.37 45.05 64.52 65.36
Price to earnings (x) 14.28x 16.06x 12.50x 13.23x 11.03x
Price to book (x) 1.36 1.56 1.18 .95 .80
Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of the financial statements requires management to make certain judgments and assumptions in determining accounting estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and obligations. Management evaluates these judgments and estimates on an ongoing basis to determine if changes are needed. Management believes that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.
(1) Allowance for loan losses (2) Goodwill, intangible assets and related impairment (3) Contingent liabilitiesAllowance for loan losses
The Company’s policy is to maintain the allowance for loan losses at a level that is sufficient to absorb estimated probable losses in the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Management’s estimate is reflected in the balance of the allowance for loan losses. Changes in this estimate can materially affect the provision for loan losses, and thus net income.
Management of the Company evaluates many factors in determining the estimate for the allowance for loan losses. Historical loan losses by loan type and loan grade are a significant factor in estimating future losses. Management reviews loan quality on an ongoing basis to determine the collectibility of individual loans and reflects that collectibility by assigning loan grades to individual credits. The grades will generally determine how closely a loan will be monitored on an ongoing basis. A customer’s payment history, financial statements, cash flow patterns and collateral, among other factors, are reviewed to determine if the loan has potential losses. Concentrations of credit by loan type and collateral type are reviewed to determine exposures and risks of loss. General economic factors as well as economic factors for individual industries or factors that would affect certain types of loan collateral are reviewed to determine the exposure of loans to economic fluctuations. The Company also has a loan review department that audits types of loans as well as geographical segments to determine credit problems and loan policy violations that require the attention of management. All of these factors are used to determine the adequacy of the allowance for loan losses and adjust its balance accordingly.
The allowance for loan losses in increased by the amount of the provision for loan losses and by recoveries of previously charged-off loans. It is decreased by loan charge-offs as they occur when principal is deemed to be uncollectible.
Goodwill, intangible assets and related impairmentThe policy of First M&F Corporation is to assess goodwill for impairment at the reporting unit level on an annual basis. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Accounting standards require management to estimate the fair value of each reporting unit in making an annual assessment of impairment. Management performs this assessment as of January 1 of each year.
Impairment of goodwill is recognized by a charge against earnings and is to be shown as a separate line item in the noninterest expense section of the consolidated statement of income.
The estimate of fair value is dependent on such assumptions as: (1) future cash flows determined from the budget, strategic plan, and forecasts of growth, and (2) discount rates and earnings multiples used to determine the present value of those cash flows. Management uses a model similar to those used to evaluate potential mergers and acquisitions. The original valuations performed in 2002 resulted in no impairment being recognized. Subsequent updates in 2003 and 2004 resulted in no impairment charges.
Identifiable intangible assets are amortized over their estimated lives. Identifiable intangible assets that have indefinite lives are not amortized until such time that their estimated lives are determinable. Intangible assets with indefinite lives must be assessed for impairment annually.
Accounting standards require that a liability be recorded if management determines that it is probable that a loss has occurred and the loss can be reasonably estimated. Management must estimate the probability of occurrence and estimate the potential exposure of a variety of contingencies such as health claims, legal claims, tax liabilities and other potential claims against the Company’s assets or requirements to perform services in the future.
Management’s estimates are based upon their judgment concerning future events and their potential exposures. However, there can be no assurance that future events, such as changes in a regulator’s position or court cases will not differ from management’s assessments. When management, based upon current facts and expert advice, believes that an event is probable and reasonably estimable, it accrues a liability in the consolidated financial statements. That liability is adjusted as facts and circumstances change and subsequent assessments produce a different estimate.
The purpose of this discussion is to focus on significant changes in financial condition and results of operations of the Company and its banking subsidiary during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and selected financial data presented elsewhere in this report.
SUMMARYNet income for 2004 was $10.775 million, or $2.37 basic and $2.36 diluted per share as compared to $10.892 million, or $2.36 basic and $2.35 diluted per share in 2003 and $10.235 million, or $2.22 basic and diluted per share in 2002. Income tax expense was flat from 2003 to 2004, but increased by $.468 million in 2003 as compared to 2002 due to lower tax-exempt earnings as a percent of total earnings in 2003.
In the first quarter of 2004 the Company completed construction of a branch facility in Flowood in Rankin County and commenced full-service operations. In the third quarter of 2004 the Company rented a location in Jackson and opened a full-service banking office. In the fourth quarter of 2004, the Company closed two small, limited-service branches. The Company also completed construction of a bank building in Olive Branch in DeSoto County, and moved its operations over from a rented office location. In the fourth quarter the Company also opened a loan production office in Memphis, Tennessee with a three-person staff.
In the first quarter of 2003 the Company opened a loan production office in Olive Branch, which eventually was moved into a newly constructed facility in the fourth quarter of 2004. In the second quarter of 2003 the Company opened a new business, M&F Business Credit, Inc., in Memphis Tennessee. The business is a wholly owned subsidiary of M&F Bank and is an asset-based lending operation with a target market area of the southeastern United States. In the third quarter of 2003 the Company opened an additional branch in Tupelo, giving it four (4) locations in the Tupelo market. The location is a former bank building purchased in 2002 and remodeled in 2003.
In 2002 the Company closed a small drive-in branch in Grenada and acquired an insurance agency in Brandon. The Company also acquired land adjacent to a shopping center in Rankin County in the third quarter of 2002, anticipating building a full-service branch in the third or fourth quarter of 2003. Construction was begun in the late summer of 2003, and the branch eventually opened in the first quarter of 2004.
In the second quarter of 2004 the internet banking product was converted to a new system to accommodate corporate customer needs and enhance the availability of information to customers. The core information processing system underwent a significant upgrade that further streamlined the branch platform processes and enhanced the information available to customer service representatives for meeting customer needs. Technology that allows for e-mailing of account statements to customers was also implemented in the third quarter of 2004.
In November and December of 2003 the mainframe processing system was enhanced with faster equipment as well as the addition of a storage area network. These additions were made with expectations for lower ongoing combined lease, maintenance and depreciation costs.
The Company added automated platform technology in June of 2002 and an automated teller transaction processing system in December of 2002 to enhance the efficiency and accuracy of the customer service representatives and tellers.
Total assets increased by 5.97% in 2004, ending the year at $1.143 billion. Total assets increased by 3.97% in 2003 to end the year at $1.078 billion. Total assets increased by 1.85% in 2002 to end the year at $1.037 billion. The compounded annual growth rate for total assets for the last five (5) years was 2.24%, while the compounded growth rate for deposits was 2.12%.
The average earning asset mix for 2004 was 79.94% in loans, 18.35% in investments and 1.71% in short-term funds. The average earning asset mix for 2003 was 75.92% in loans, 21.57% in investments, and 2.51% in short-term funds. The average earning asset mix for 2002 was 71.11% in loans, 26.99% in investments, and 1.90% in short-term funds. Loans grew by 8.29% in 2004 while deposits grew by 6.95%. Loans grew by 15.17% in 2003 while deposits decreased. Loans grew by 3.11% in 2002 while deposits grew by .91%. Noninterest-bearing deposits grew by 11.80% in 2004, grew by 20.88% in 2003 and fell by 6.30% in 2002. Average noninterest- bearing deposits grew by 15.15% in 2004, grew by 7.85% in 2003 and by 7.26% in 2002. The following table shows the volume changes in loans and deposits over the last three years.
2004 2003 2002
------------- ------------ -------------
Net increase in loans $ 64,619 $ 102,605 $ 20,389
Net increase in deposits 57,038 (3,798) 7,407
Ratio of loan growth to deposit growth 113.29% - 275.27%
Loan growth for 2004 occurred mainly in the second half of the year, while it was strong throughout 2003 after being weak in 2002. Consumer loans decreased by $5.750 million in 2004 after decreasing by approximately $14 million per year from 2001 through 2003. A consumer loan campaign during the fourth quarter of 2004 helped to stem the decreases. Residential loan balances increased by $21.373 million in 2004 after increasing by $21.589 million from 2002 to 2003 and decreasing from 2001 to 2002. Commercial real estate-secured loans grew by 8.11% in 2004, by 29.53% in 2003 and by 11.57% in 2002. Commercial loans not secured by real estate increased by 17.29% in 2004, by 19.41% in 2003 and by 9.45% in 2002. Much of the commercial real estate related loan growth in 2004 came in the Lee and DeSoto County markets as well as in the newly opened Jackson office. The commercial real estate loan growth in 2003 came in the Madison, Lee and DeSoto county markets as the company expanded the commercial lending staff in those areas. The new asset-based lending operation in Memphis, M&F Business Credit, Inc., accounted for 48.96% of the increase in non-real estate related commercial loans in 2004 and 37.29% of that increase in 2003. The Company’s strategy is to continue to grow the loan portfolio in markets that have expanding economies. As a secondary source of loan growth, the Company may purchase participations in loans that are within the loan policies and the Company’s credit expertise. The Company has plans for additional full-service branch expansion in 2005 in DeSoto County and Madison County. Although the short-term effect of de novo expansion on earnings can be negative, management believes that this strategy creates long-term shareholder value.
INVESTMENT SECURITIESThe Company’s investment portfolio decreased by 6.36% in 2004, by 20.56% in 2003, and by 5.69% in 2002. The Company sold approximately $6.6 million in mortgage-backed securities in a restructuring transaction during the first quarter of 2004 and reallocated the proceeds to corporate debt and debt collateralized by trust preferred securities. The Company purchased approximately $20.5 million of mortgage-backed securities during 2004, offsetting the effect of the year’s monthly principal pay-downs. The 2004 decrease in securities was used primarily for lending purposes, and was provided equally by calls and maturities of Government agency securities and securities of municipalities. The 2003 decrease was used to provide funding for the loan portfolio as well. Most of the cash flows diverted to the 2003 lending effort were generated from mortgage-backed securities. In 2002 and 2003 the Company increased its investments in U.S. Government agency securities to provide a high-quality liquidity portfolio, 21.60% of which matured within 2004. The 2002 decrease in investments was primarily attributable to the prepayment activity of investments in a leverage portfolio from a 1999 bank acquisition. As of December 31, 2004, municipal securities represented 31.41% of total debt securities as compared to 31.70% at December 31, 2003 and 25.13% at December 31, 2002. The increase in the percentage allocated to municipals in 2003 and 2004 was more a result of the decreased size of the portfolio than it was a result of a change in strategy.
DEPOSITS AND BORROWINGSDeposits increased by 6.95% in 2004 and decreased by .46% in 2003 after growing by .91% in 2002. The increases in noninterest-bearing deposits in 2004 and 2003 were primarily in consumer and business accounts. NOW and MMDA deposits increased by $5.484 million in 2004 after decreasing by $19.128 million in 2003. Consumer and business NOW and MMDA balances decreased in 2003 and 2004, while balances of municipalities increased by $18.821 million in 2004 after decreasing by $14.017 million in 2003. NOW and MMDA deposits increased by 25.38% while certificates of deposit decreased by 9.92% in 2002, primarily due to the low interest rate environment. Certificates of deposit increased by $38.469 million in 2004 after remaining relatively flat in 2003. For 2004, 32.36% of the certificate of deposit growth occurred in consumer and business accounts while 41.27% occurred in municipal deposits and 25.87% consisted of brokered certificates of deposit. The Company offered various bonus-rate certificate of deposit products for maturities ranging from 7 to 60 months between 2002 and 2004 to try to extend the average maturity life of the deposit base, reduce interest rate sensitivity, and meet liquidity needs as the circumstances required.
Short-term Treasury rates increased by 131 basis points in 2004 after decreasing by 30 basis points in 2003 and by 51 basis points in 2002. The poor stock market in 2001 and 2002 influenced the movement of funds out of equity securities and time deposits into more liquid deposit accounts. In 2003, a stronger stock market, combined with decreasing market interest rates made it difficult to retain deposits. Special certificate of deposit campaigns were used in 2003 and again in 2004 to attract funds. A rising interest rate environment should make deposits more attractive although the cost of funding will also increase. Core deposit growth is expected to be a primary component of the Company’s funding in the foreseeable future. The Company’s business development strategy includes the acquisition of noninterest-bearing and interest-bearing demand deposits held by customers who primarily use the Company as a source of credit.
The following table shows the deposit mix for the latest three year ends.
December 31, 2004 December 31, 2003 December 31, 2002
------------------------ ----------------------- ----------------------
Noninterest-bearing demand $137,728 $123,191 $101,915
NOW deposits 149,572 131,430 138,916
Money market deposits 122,409 135,067 146,709
Savings deposits 85,342 86,794 92,305
Certificates of deposit 382,213 343,744 344,179
------------------------ ----------------------- ----------------------
Total $877,264 $820,226 $824,024
======================== ======================= ======================
The following table shows the mix of public funds deposits as of the last three year ends.
December 31, 2004 December 31, 2003 December 31, 2002
------------------------ ----------------------- ----------------------
Noninterest-bearing demand $ 5,101 $ 4,594 $ 3,636
NOW deposits 59,241 41,665 54,585
Money market deposits 21,394 20,149 21,246
Savings deposits 299 557 1,476
Certificates of deposit 74,536 58,467 34,764
------------------------ ----------------------- ----------------------
Total $160,571 $125,432 $115,707
======================== ======================= ======================
The Company made a decision to price less aggressively during 2002 and 2003 for certificates of deposit. This influenced the certificate of deposit decreases in 2002 and 2003. The Company used certain longer-term specially priced certificate of deposit promotions to offset some of the decreases in 2002 and 2003 and also to extend the average maturity of the certificate of deposit portfolio. This strategy was maintained during 2004 while the Company also began to price more aggressively in pricing its time deposits. The Company also began to increase the interest rates paid on certain large money market deposits during 2004. Management monitors liquidity on a weekly and monthly basis to determine if pricing strategies need to be adjusted or other sources of liquidity need to be accessed.
Long-term debt increased by $6.805 million in 2004 and by $50.891million in 2003 after decreasing by $2.493 million in 2002. The Company used short-term borrowings as a source of liquidity during 2004. Borrowing increases that occurred during 2004 were generally paid off with deposit growth that occurred during the third and fourth quarters. The increase in 2003 was used along with investment maturities to fund loan portfolio growth. Decreases during 2002 were due to reductions in debt related to an investment leverage program that was reduced as investments matured. Borrowings were also used in 2002 as an alternative to deposits to fund loan production. The Company uses wholesale funding sources such as the Federal Home Loan Bank to provide the liquidity needed for loan growth. However, the long-term strategy of the Company is to primarily fund loan growth through deposit growth first, with borrowings used when deposit funding is uneconomical. During 2002 and 2003 the Company took advantage of occasions when borrowing rates were lower than comparable certificate of deposit rates.
LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENTLiquidity is the ability of a bank to convert assets into cash and cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet day-to-day cash flow requirements of customers, whether they wish to withdraw funds or to borrow funds to meet their capital needs. Historically, deposit growth has been sufficient to provide for the Company’s liquidity needs. In 2002 the Company used borrowings as well as deposits due to lower demand by customers for time deposit products and to the availability of low-cost funds in the Federal Home Loan Bank lines. In 2003 the Company continued to use low-cost Federal Home Loan Bank borrowings to fund loan growth. This trend continued to a much lesser extent during 2004. The Company has sufficient lines available through the Federal Home Loan Bank and correspondent banks to meet all anticipated liquidity needs. However, it is the Company’s strategy to balance the use of deposits and debt as funding sources for asset growth.
The Company announced a general purpose stock repurchase plan in August of 2002. The Company terminated the 2002 plan in March of 2003 and replaced it with a 12-month plan to repurchase up to 240,000 shares through February, 2004. The 2003 plan was completed on schedule in February, 2004. In April of 2004 the Company announced a 12-month plan to repurchase up to 120,000 shares through April of 2005. The 2004 plan stipulated that no more than 10,000 shares may be repurchased in a single calendar month. The 2003 and 2004 plans were authorized to offset the dilutive effect that stock option issuances were having, and would have, on reported earnings per share. During 2003, 147,846 shares were issued related to stock option exercises, at an average price of $26.99 per share. During 2004, 40,721 shares were issued related to stock option exercises, at an average price of $26.53 per share.
The resulting debt from the repurchase programs will be paid off through dividends received by the Company from Merchants and Farmers Bank. The repurchase programs have not had any negative effect on liquidity.
The following table shows the stock repurchase activity for 2002 through 2004.
2002 Plan 2003 Plan 2004 Plan
Target of 184,590 Target of 240,000 Target of 120,000 Totals
--------------------------- --------------------------- --------------------------- ----------------------
Year Shares Average Shares Average Shares Average Shares Average
Purchased Purchased Price Purchased Price Purchased Price Purchased Price
------------ ----------- ------------ ----------- ------------ ----------- ------------ ---------
2002 27,738 $ 27.21 - $- - $- 27,738 $ 27.21
2003 30,000 30.25 135,000 33.29 - - 165,000 33.83
2004 - - 36,500 35.70 60,000 33.41 96,500 34.27
--------- ----------- ------------ ----------- ------------ ----------- ------------ ----------
Plan Total 57,738 $ 28.79 171,500 $ 33.81 60,000 $ 33.41 289,238 $ 33.34
========= =========== ============ =========== ============ =========== ============ ==========
Purchases of stock outside of the formally announced plans amounted to 4,854 shares at an average price of $31.70 during 2003 and 3,100 shares at an average price of $33.83 during 2004.
Interest rate sensitivity is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities. Interest rate sensitivity management focuses on repricing relationships of these assets and liabilities during periods of changing market interest rates. Management seeks to minimize the effect of interest rate movements on net interest income. The asset-liability management committee monitors the interest-sensitivity gap on a monthly basis. The Company embarked on a strategy in 2002 through 2004 to increase the rate sensitivity of assets while reducing the sensitivity of liabilities. This was done by reducing the maturity terms of loans made, match funding certain other long-term loans originated, as well as by purchasing shorter-maturity securities. The Company also has used long-term CD promotions and FHLB borrowings to increase the average maturity of the liability portfolio. Beginning in 2002 these initiatives were taken with the anticipation of a rising interest rate environment at the end of the current soft economic cycle. At the end of 2004 the one-year repricing gap stood at + 20.57% as compared to + 3.85% at the end of 2003 and + 1.72% at the end of 2002. The increase in the one-year repricing gap from 2003 to 2004 was due primarily to shorter investment maturities, the reduction of loan maturities and an increase in short-term, floating-rate loans. The Company targets its one year repricing gap at between + 7.5% and - 7.5%.
CAPITAL RESOURCESCapital adequacy is continuously monitored by the Company to promote depositor and investor confidence and provide a solid foundation for future growth of the organization. The Company has kept the dividend payout ratio above 40%, ending 2004 with a 42.19% ratio, ending 2003 with a ratio of 42.37% and ending 2002 with a ratio of 45.05%. The high payout percentage has been due to the lower than historical earnings per share, as the five-year compounded growth rate for earnings per share through 2004 was 1.87%. The Company has maintained a $1.00 annual dividend rate for 1999 through 2004. The ratio of capital to assets stood at 9.84% at December 31, 2004, 10.26% at December 31, 2003 and 10.43% at December 31, 2002, with risk-based capital ratios well in excess of the regulatory requirements. The Company has sufficient lines of credit at commercial banks to raise additional funds if needed. The Company’s stock is publicly traded on NASDAQ, also providing an avenue for additional capital if it is needed.
The Company’s regulatory capital ratios for 2003 and 2004 are summarized in Note 17 of the audited financial statements included in Item 8, Financial Statements and Supplementary Data, in this Form 10-K.
The following table shows performance ratios for the last three years:
2004 2003 2002
----------------------- ----------------------- ----------------------
Net interest margin 4.23% 4.32% 4.29%
Efficiency ratio 61.82 62.79 61.96
Return on assets .97 1.03 1.00
Return on equity 9.62 9.82 9.75
Noninterest income to avg. assets 1.38 1.35 1.38
Noninterest income
to revenues (1) 26.43 25.67 26.14
Noninterest expense to avg. assets 3.22 3.31 3.26
Salaries and benefits to total
noninterest expense 57.89 52.60 53.33
Contribution margin (2) 64.22 66.97 66.96
Nonperforming loans to loans .47 .77 .55
Net charge-offs as a percent of average loans .57 .43 .40
(1) Revenues equal tax-equivalent net interest income before loan loss expense, plus noninterest income.
(2) Contribution margin equals revenues minus salaries & benefits, divided by revenues.
The following table shows revenue related performance statistics for the last three years:
(Amounts in thousands) 2004 2003 2002
----------------------- ------------------------ ----------------------
Mortgage originations $61,632 $75,051 $64,341
Commissions from annuity sales 401 228 257
Trust and retail investment revenues 433 310 187
Revenues per FTE employee 128 132 133
Agency commissions per agency
FTE employee (1) 76 76 72
(1) Agency commissions are property, casualty, life and health commissions produced by the insurance agency personnel.
Net Interest Income
Net interest income is the largest component of the Company's net income and represents income from interest-earning assets less the cost of interest-bearing liabilities. Net interest income was $41.127 million in 2004 as compared to $40.061 million in 2003 and $38.171 million in 2002. The 2004 improvement was the result of decreases due to the decrease in net interest spreads from 4.04% in 2003 to 3.95% in 2004, offset by increases due to a 10.11% increase in average loan balances from 2003 to 2004. Loans made up a larger proportion of earning assets during 2004 than in previous years. Another factor that reduced the negative impact of falling asset yields from 2002 to 2004 was the growth in noninterest-bearing deposits. Average noninterest-bearing deposits represented 12.51% of total funding during 2004 as compared to 11.41% during 2003 and 10.96% during 2002. Earning asset yields decreased by 26 basis points from 2003 to 2004 while funding costs decreased by 17 basis points. The margin improvement in 2003 was due to increased loan volumes and decreased costs of deposits and borrowings. Average loans outstanding increased from $660.529 million in 2002 to $730.133 million in 2003. Interest and fees on loans decreased from 2002 to 2003 due to decreasing rates, as loan yields fell from 7.44% in 2002 to 6.67% in 2003. Interest expense decreased by $5.845 million from 2002 to 2003 as liability costs decreased to 2.14% in 2003 from 2.93% in 2002. Another improvement in 2003 came from noninterest-bearing funding sources such as demand deposits and capital. Average earning assets grew by $32.857 million in 2003 while average interest-bearing liabilities increased by $24.733 million. The difference was made up through retained earnings and noninterest-bearing deposits. The improvement in 2002 was due to the ability of the Company to take advantage of the trend of decreasing interest rates. Earning asset yields decreased by 100 basis points in 2002 while liability costs decreased by 170 basis points. Therefore, while interest and fees on loans decreased by $5.994 million in 2002, interest on deposits decreased by $11.985 million. Competition for loans kept new loan yields from increasing as quickly as general interest rates did in 2004. There was also a delayed reaction of floating rate loan repricing as compared to changes in the prime rate due to the volume of loans that had contractual floor rates that were above the 2004 prime rates, and therefore did not reprice.
During 2004 the Company's provision increased to $5.351 million after decreasing to $3.802 million in 2003 from $4.495 million in 2002. Approximately $3.131 million of the 2004 loan loss accruals related to Merchants Financial Services Group (MFS), of which the Company is a 51% owner. MFS, an accounts receivable factoring company, incurred the losses primarily in one account. MFS sold substantially all of its accounts receivable to its two owners at the end of 2004. The Company received approximately $2.020 million in receivables in the transfer. Loans past due for over 90 days received in the transfer amounted to $311 thousand. Net charge-offs for 2004 were $4.623 million, which included $3.283 million of losses at MFS. Net charge-offs were $3.169 million in 2003 as compared to $2.663 million in 2002. Net charge-offs as a percentage of average loans were .57% in 2004, ..43% in 2003, and .40% in 2002. The strategy of the Company is to maintain credit quality at levels that produce net charge-off percentages in the .30% to .35% range. The net charge-off percentage would have been .17%, excluding the loss at MFS. The net charge-off percentage for 2003 would have been .36%, excluding one large write-down on some rental properties in Lee County. Nonaccrual loans as a percentage of total loans were .39% at the end of 2004, .58% at the end of 2003, and .23% at the end of 2002. The nonaccrual loan totals were typical except for the 2003 totals which included non-accruing loans on rental properties mentioned above of approximately $1.890 million. Management maintains a conservative approach to classifying loans internally for purposes of determining needed loan loss allowances. The percentage of allowance for loan loss to total loans was 1.38% at December 31, 2004, 1.40% at December 31, 2003, and 1.52% at December 31, 2002.
Noninterest IncomeNoninterest income increased by 6.44% in 2004, by 1.91% in 2003 and by 2.21% in 2002. Deposit income decreased by 1.80% after increasing by 2.25% in 2003, and increasing by 6.08% in 2002. The lack of growth in deposit revenues in 2003 and 2004 was due mainly to lower insufficient check volumes than in 2002. The number of checking accounts with balances of less than $100 thousand increased by 2.84% in 2004 after increasing by 1.10% in 2003, contributing to the lack of growth in deposit account service charges from 2002 to 2004. Debit card revenues more than doubled in 2004, partially offsetting the decrease in other deposit revenues. Mortgage banking income decreased by 21.21% in 2004 after increasing by 8.11% in 2003 and having no growth in 2002. Rising interest rates during 2004 significantly reduced the activity resulting from mortgage refinancings. The low interest rate environment in 2002 and much of 2003 was the main contributing factor to the increased originations in 2003. However, the presence of mortgage originators in economically strong markets such as Madison, DeSoto, Rankin and Lee counties helped to spur growth in 2003 and contributed most of the origination volumes in 2004. Agency commissions continued to grow in 2003 and 2004 as the Company continued its efforts to place insurance agents in branch locations and to build relationships with the Bank's retail and commercial sales associates. Annuity commissions grew by 75.97% in 2004 after falling by 11.41% in 2003. Property, casualty, life and health commissions increased by 4.65% in 2004 and by 7.88% in 2003. Pricing in the property and casualty industry became more competitive in 2004 after having been high in 2003 and 2002. The insurance revenue increases in 2002 were driven by the increased pricing throughout the industry that began in late 2001. Commissions on annuity sales increased by approximately $100 thousand in 2002 as customers sought alternatives to deposit products to achieve better returns. Trust and brokerage income increased by 39.68% in 2004 and by 65.78% in 2003. The Company has committed to building the Trust and retail investment businesses and added an additional licensed broker to the retail investment staff in 2004. These and other areas such as treasury management services and electronic banking are not yet significant contributors to the Company's overall revenues. However, management continues to focus on building these businesses and revenue streams as an important strategic objective for the future. Increases in other income for 2004 over 2003 were the result of insurance agency contingency revenue increases of $162 thousand, revenues from the sale of timber on undeveloped properties of $123 thousand, rental revenues on foreclosed property of $89 thousand, fees on letters of credit of $91 thousand, and fees collected in the asset-based lending operation for specific services performed of $132 thousand.
Noninterest ExpenseSalary and benefit expenses increased by 11.99% in 2004 after increasing by 3.73% in 2003 and increasing by 5.73% in 2002. The number of full-time equivalent employees was 458.5 at the end of 2004, 436.0 at the end of 2003 and 415.5 at the end of 2002. The following table shows increases in employment throughout the Company for 2003 and 2004.
2004 2003
Activity Change in FTE Change in FTE
- ------------------------------------------------------ ------------------- --------------------
New branches 17.0 3.0
New services and new businesses 2.0 6.0
Mortgage production 1.0 6.5
Other retail and commercial positions 4.5 4.5
Administrative positions (2.0) .5
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Change from prior year 22.5 20.5
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The Company expects to add producers as it expands in current markets and moves into future new markets and businesses. However, the Company also expects that the contributions, as can be measured by the contribution margins, will increase as the new associates produce earning assets and fee revenues.
Marketing and business development expenses were up in 2004 as compared to 2003 due to several factors. During the first quarter of 2004, expenses were up due to spending on a deposit campaign as well as an image campaign. Spending was also up due to grand opening and other branch promotion expenses in the first half of 2004. The Bank paid for several sponsorships in 2004 that offered advertising opportunities related to community events and programs. Finally, spending related to the Gridiron lending campaign for 2004 was higher than in 2003 due to a 30% increase in loan originations for the 2004 program, resulting in higher costs related to the promotional tickets given to customers.
Legal expenses increased by $345 thousand in 2003 and by approximately $400 thousand in 2002 due to litigation expenses on various cases as well as continuing expenses related to prior-year loan losses. Telecommunication expenses decreased in 2004 after increasing by $133 thousand in 2003 as the Company upgraded its data communications network. ATM and debit card network and processing expenses leveled off in 2004 after increasing by $358 thousand in 2003 as the Company switched debit card providers and upgraded its debit card offering.
Amortization of intangible assets decreased by $1.248 million in 2002 as goodwill amortization was discontinued following the implementation of a new accounting standard. Under the new standard, goodwill is tested for impairment annually. The Company performed its impairment tests in the first quarters of 2002, 2003 and 2004, with no impairment charge required.
The $1.256 million negative balance in noncontrolling joint venture losses is the amount of losses, primarily the result of a $3.283 million loan loss, attributable to the other minority owner in the MFS accounts receivable factoring venture. The factoring venture reported a net loss of $2.522 million, one half of which was absorbed by the Company. Since the Company is a majority owner of MFS, it consolidates the financial condition and results of operations of MFS into its financial statements. Therefore, the $2.522 million reported net loss of MFS in 2004 and the net income in 2002 and 2003 is included in the interest and noninterest revenue and expense accounts and loan loss accruals of the Company, offset by a negative (positive) noncontrolling interest’s expense for their share of the net loss (net income).
As the Company continues to expand in strong economic markets, higher personnel costs will result. However, the Company will expand in those areas and into businesses that will provide a return in excess of its hurdle rate of return on capital.
Income TaxesThe Company’s effective tax rate was 29.66% in 2004, 29.71% in 2003, and 28.78% in 2002. The main factor in the increase over historical rates has been an increased percentage of pre-tax earnings being derived from taxable sources. The Company primarily uses tax-exempt securities and loans to provide tax benefits and does not use any exotic tax-shelter vehicles. The Company paid $130 thousand in Federal tax assessments and $11 thousand in Mississippi tax assessments in 2004. The Federal assessment was related to the audit of the final 1999 returns of Community Federal Bancorp, which was acquired by the Company in November, 1999.
Quarterly Financial TrendsThe following table summarizes components of the Company’s statements of income by quarter for 2004 and 2003.
2004
-------------------------------------------------------- 4th Qtr 04
First Second Third Fourth Vs
(Dollars in Thousands) Quarter Quarter Quarter Quarter 4th Qtr 03
- -------------------------------------------------------------------------------------------------------------
Interest income $ 14,277 $ 14,085 $ 14,533 $ 15,282 3.08%
Interest expense 4,036 4,106 4,258 4,650 5.56
Net interest income 10,241 9,979 10,275 10,632 2.02
Provision for loan losses 2,460 999 620 1,272 32.50
Noninterest income 4,006 3,721 3,873 3,681 3.60
Noninterest expense 8,084 8,736 9,533 9,385 4.63
Income taxes 1,102 1,212 1,214 1,016 (17.73)
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Net income $ 2,601 $ 2,753 $ 2,781 $ 2,640 (6.02%)
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Per common share:
Net income (basic) $ .57 $ .60 $ .62 $ .58 (4.92%)
Net income (diluted) $ .57 $ .60 $ .61 $ .58 (4.92%)
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Cash dividends .25 .25 .25 .25 -
- -------------------------------------------------------------------------------------------------------------
2003 4th Qtr 03
--------------------------------------------------------
First Second Third Fourth Vs
Quarter Quarter Quarter Quarter 4th Qtr 02
- -------------------------------------------------------------------------------------------------------------
Interest income $ 14,386 $ 14,290 $ 14,416 $ 14,826 (1.15%)
Interest expense 4,862 4,513 4,077 4,405 (16.71)
Net interest income 9,524 9,777 10,339 10,421 7.32
Provision for loan losses 920 962 960 960 (5.04)
Noninterest income 3,376 3,619 3,809 3,553 (4.21)
Noninterest expense 8,256 8,681 9,214 8,970 5.01
Income taxes 1,070 1,115 1,183 1,235 8.71
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Net income $ 2,654 $ 2,638 $ 2,791 $ 2,809 2.89%
- -------------------------------------------------------------------------------------------------------------
Per common share:
Net income (basic) $ .57 $ .57 $ .61 $ .61 3.39%
Net income (diluted) $ .57 $ .57 $ .60 $ .61 3.39%
- -------------------------------------------------------------------------------------------------------------
Cash dividends .25 .25 .25 .25 -
- -------------------------------------------------------------------------------------------------------------
The Company measures and monitors credit quality on an ongoing basis through credit committees and the loan review process. Management reviews loan quality on a monthly basis. Classified and past due loans are monitored to determine if deterioration is occurring and if corrective actions need to be taken. Credit standards are approved by the Board with their adherence monitored during the lending process as well as through subsequent loan reviews. The Company has an internal Officer’s Loan Committee which reviews certain proposed large extensions and renewals of credit. Those credits that are approved within the Committee’s limits may be funded. Larger credit requests that the Committee approves are forwarded to the Board Loan Committee for a final approval or denial. The Board has authorized a Loan Committee which meets weekly to review potential large extensions and renewals of credit. The Loan Committee must approve those credits before they can be funded. The Company strives to minimize risk through the diversification of the portfolio geographically within Mississippi as well as by loan purpose and collateral.
The Bank’s credit standards are enforced within the Bank as well as within all of its wholly-owned subsidiaries. As of March, 2004, management began to enforce the Bank’s credit standards on the Bank’s partially-owned joint venture as well. Management will enforce its credit standards as well as other quality and internal control standards on future business ventures in which it is a partner.
The adequacy of the allowance for loan losses is monitored quarterly with provision accruals approved by the Board. Allowance adequacy is dependent on loan classifications by external examiners as well as by internal loan review personnel, past due loans, loan growth and loss history. The allowance as a percentage of loans at December 31, 2004 is comparable to other peer banks.
The following table shows nonperforming loans and other assets of the Company:
(Amounts in thousands)
December 31
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2004 2003 2002
----------------- --------------------- ------------------
Nonaccrual loans $3,302 $4,517 $1,582
Past due 90 days or more and still
accruing interest 645 1,531 2,169
----------------- --------------------- ------------------
Total nonperforming loans 3,947 6,048 3,751
Other real estate 2,816 802 950
----------------- --------------------- ------------------
Total nonperforming assets $6,763 $6,850 $4,701
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Ratios:
Nonperforming loans to loans .47% .77% .55%
Nonperforming assets to assets .59% .64% .45%
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The Company’s primary off-balance sheet arrangements are in the form of loan commitments and operating lease commitments. At December 31, 2004 the Company had $139.277 million in unused loan commitments outstanding. Of these commitments, $73.589 million mature in one year or less. Lines of credit are established using the credit policy of the Company concerning the lending of money.
Letters of credit are issued to facilitate the borrowers’ business and are usually related to the acquisition of inventory or of assets to be used in the customers’ business. Letters of credit are generally secured and are underwritten using the same standards as traditional commercial loans. Most standby letters of credit expire without being presented for payment. However, the presentment of a standby letter of credit would create a loan receivable from the Bank’s loan customer. The Bank’s asset-based lending subsidiary uses commercial letters of credit to facilitate the purchase of inventory items by its customers. There were $105 thousand in commercial letters of credit outstanding at December 31, 2004. At December 31, 200