Attached files

file filename
EX-32 - FIRST FINANCIAL SERVICE CORPv165194_ex32.htm
EX-31.1 - FIRST FINANCIAL SERVICE CORPv165194_ex31-1.htm
EX-31.2 - FIRST FINANCIAL SERVICE CORPv165194_ex31-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2009

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission File Number 0-18832

First Financial Service Corporation
(Exact Name of Registrant as specified in its charter)

Kentucky
 
61-1168311
(State or other jurisdiction
 
(IRS Employer Identification No.)
of incorporation or organization)
   

2323 Ring Road
 
(270) 765-2131
Elizabethown, Kentucky 42701
 
(Registrant's telephone number,
(Address of principal executive offices)
 
including area code)
(Zip Code)
   

(270) 765-2131
(Registrant's telephone number, including area code)

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 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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer¨
Accelerated Filer x
Non-Accelerated Filer¨
Smaller Reporting Company¨
   
(Do not check if a smaller reporting company)
 

Indicate by a 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 stock, as of the latest practicable date.

Class
 
Outstanding as of October 31, 2009
     
Common Stock
 
4,707,898 shares
 
 
 

 

FIRST FINANCIAL SERVICE CORPORATION
FORM 10-Q
TABLE OF CONTENTS

PART IFINANCIAL INFORMATION
 
     
Preliminary Note Regarding Forward-Looking Statements
 
     
Item 1.
Consolidated Financial Statements and Notes to Consolidated Financial Statements
4
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
27
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
43
     
Item 4.
Controls and Procedures
45
     
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
45
     
Item 1A.
Risk Factors
45
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
45
     
Item 3.
Defaults upon Senior Securities
45
     
Item 4.
Submission of Matters to a Vote of Security Holders
45
     
Item 5.
Other Information
45
     
Item 6.
Exhibits
45
     
SIGNATURES
46
 
 
2

 

PRELIMINARY NOTE REGARDING
FORWARD-LOOKING STATEMENTS

Statements in this report that are not statements of historical fact are forward-looking statements. First Financial Service Corporation (the “Corporation”) may make forward-looking statements in future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by or with the approval of the Corporation.  Forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, capital structure and other financial items; (2) plans and objectives of the Corporation or its management or Board of Directors; (3) statements regarding future events, actions or economic performance; and (4) statements of assumptions underlying such statements.  Words such as “estimate,” “strategy,” “believes,” “anticipates,” “expects,” “intends,” “plans,” “targeted,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.

Various risks and uncertainties may cause actual results to differ materially from those indicated by our forward-looking statements.  In addition to those risks described under “Item 1A Risk Factors,” of this report and our Annual Report on Form 10-K, the following factors could cause such differences: changes in general economic conditions and economic conditions in Kentucky and the markets we serve, any of which may affect, among other things, our level of non-performing assets, charge-offs, and provision for loan loss expense; changes in interest rates that may reduce interest margins and impact funding sources; changes in market rates and prices which may adversely impact the value of financial products including securities, loans and deposits; changes in tax laws, rules and regulations; various monetary and fiscal policies and regulations, including those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Office of Financial Institutions (“KOFI”); competition with other local and regional commercial banks, savings banks, credit unions and other non-bank financial institutions; our ability to grow core businesses; our ability to develop and introduce new banking-related products, services and enhancements and gain market acceptance of such products; and management’s ability to manage these and other risks.

Our forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date of the statement to reflect the occurrence of unanticipated events.

 
3

 

Item 1.
FIRST FINANCIAL SERVICE CORPORATION
 
 
Consolidated Balance Sheets
 
 
(Unaudited)
 

   
September 30,
   
December 31,
 
(Dollars in thousands, except share data)
 
2009
   
2008
 
             
ASSETS:
           
Cash and due from banks
  $ 17,535     $ 17,310  
Interest bearing deposits
    2,566       3,595  
Total cash and cash equivalents
    20,101       20,905  
                 
Securities available-for-sale
    35,144       15,775  
Securities held-to-maturity, fair value of $1,359 Sept (2009) and $6,846 Dec (2008)
     1,346        7,022  
Total securities
    36,490       22,797  
Loans held for sale
    7,729       9,567  
Loans, net of unearned fees
    980,121       903,434  
Allowance for loan losses
    (16,173 )     (13,565 )
Net loans
    971,677       899,436  
                 
Federal Home Loan Bank stock
    8,515       8,515  
Cash surrender value of life insurance
    8,923       8,654  
Premises and equipment, net
    32,345       30,068  
Real estate owned:
               
Acquired through foreclosure
    8,184       5,925  
Held for development
    45       45  
Other repossessed assets
    40       91  
Goodwill
    11,931       11,931  
Core deposit intangible
    1,401       1,703  
Accrued interest receivable
    5,064       4,379  
Deferred income taxes
    468       1,147  
Other assets
    2,382       1,451  
                 
TOTAL ASSETS
  $ 1,107,566     $ 1,017,047  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
LIABILITIES:
               
Deposits:
               
Non-interest bearing
  $ 59,499     $ 55,668  
Interest bearing
    878,219       719,731  
Total deposits
    937,718       775,399  
                 
Short-term borrowings
    2,200       94,869  
Advances from Federal Home Loan Bank
    52,777       52,947  
Subordinated debentures
    18,000       18,000  
Accrued interest payable
    340       288  
Accounts payable and other liabilities
    2,366       2,592  
                 
TOTAL LIABILITIES
    1,013,401       944,095  
Commitments and contingent liabilities
    -       -  
                 
STOCKHOLDERS' EQUITY:
               
Serial preferred stock, $1 par value per share; authorized 5,000,000 shares; issued and outstanding, 20,000 shares with a liquidation preference of $1,000/share Sept (2009)
         19,768          -  
Common stock, $1 par value per share; authorized 10,000,000 shares; issued and outstanding, 4,707,898 shares Sept (2009), and 4,668,030 shares Dec (2008)
       4,708          4,668  
Additional paid-in capital
    34,965       34,145  
Retained earnings
    35,744       36,476  
Accumulated other comprehensive loss
    (1,020 )     (2,337 )
                 
TOTAL STOCKHOLDERS' EQUITY
    94,165       72,952  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 1,107,566     $ 1,017,047  

See notes to the unaudited consolidated financial statements.

 
4

 

FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statements of Income
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
(Dollars in thousands, except per share data)
 
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Interest and Dividend Income:
                       
Loans, including fees
  $ 14,410     $ 14,337     $ 42,509     $ 41,718  
Taxable securities
    312       403       925       1,095  
Tax exempt securities
    137       90       361       297  
Total interest income
    14,859       14,830       43,795       43,110  
                                 
Interest Expense:
                               
Deposits
    4,513       5,325       13,359       15,815  
Short-term borrowings
    27       156       117       661  
Federal Home Loan Bank advances
    601       610       1,798       1,808  
Subordinated debentures
    331       315       989       649  
Total interest expense
    5,472       6,406       16,263       18,933  
                                 
Net interest income
    9,387       8,424       27,532       24,177  
Provision for loan losses
    2,482       1,720       6,441       2,819  
Net interest income after provision for loan losses
    6,905       6,704       21,091       21,358  
                                 
Non-interest Income:
                               
Customer service fees on deposit accounts
    1,750       1,817       4,872       4,865  
Gain on sale of mortgage loans
    300       179       832       566  
Gain on sale of investments
    -       52       -       52  
Total other-than-temporary impairment losses
    (1,352 )     -       (2,915 )     (216 )
Portion of loss recognized in other comprehensive income (before taxes)
    1,048        -       2,212        -  
Net impairment losses recognized in earnings
    (304 )     -       (703 )     (216 )
Write down on real estate acquired through foreclosure
    (305 )     (151 )     (555 )     (160 )
Brokerage commissions
    89       109       281       352  
Other income
    365       361       1,263       1,001  
Total non-interest income
    1,895       2,367       5,990       6,460  
                                 
Non-interest Expense:
                               
Employee compensation and benefits
    4,042       3,867       12,193       10,765  
Office occupancy expense and equipment
    832       779       2,488       2,112  
Marketing and advertising
    225       215       735       638  
Outside services and data processing
    793       882       2,381       2,365  
Bank franchise tax
    257       258       778       761  
FDIC insurance premiums
    414       102       1,381       286  
Amortization of core deposit intangible
    100       56       302       59  
Other expense
    1,365       1,478       3,998       3,505  
Total non-interest expense
    8,028       7,637       24,256       20,491  
                                 
Income before income taxes
    772       1,434       2,825       7,327  
Income taxes
    196       443       773       2,354  
Net Income
    576       991       2,052       4,973  
Less:
                               
Dividends on preferred stock
    (250 )     -       (730 )     -  
Accretion on preferred stock
    (14 )     -       (39 )     -  
Net income available to common shareholders
  $ 312     $ 991     $ 1,283     $ 4,973  
                                 
Shares applicable to basic income per common share
    4,704,289       4,667,081       4,689,917       4,665,058  
Basic income per common share
  $ 0.07     $ 0.21     $ 0.27     $ 1.07  
                                 
Shares applicable to diluted income per common share
    4,734,037       4,683,978       4,703,432       4,689,458  
Diluted income per common share
  $ 0.07     $ 0.21     $ 0.27     $ 1.06  
                                 
Cash dividends declared per common share
  $ 0.050     $ 0.190     $ 0.430     $ 0.570  

See notes to the unaudited consolidated financial statements.

 
5

 

FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statements of Comprehensive Income/(Loss)
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(Dollars in thousands)
 
2009
   
2008
   
2009
   
2008
 
                         
Net Income
  $ 576     $ 991     $ 2,052     $ 4,973  
Other comprehensive income (loss):
                               
Change in unrealized gain (loss) on securities available-for-sale
    915       (2,131 )     1,526       (2,518 )
Reclassification of realized amount on securities available-for-sale
    304       (52 )     679       164  
Non-credit component of other-than- temporary impairment on held-to-maturity securities
       -          -          (215 )        -  
Accretion of non-credit component of other- than-temporary impairment on held-to-maturity securities
       3          -          5          -  
Net unrealized gain (loss) recognized in comprehensive income
    1,222       (2,183 )     1,995       (2,354 )
Tax effect
    (415 )     742       (678 )     800  
Total other comphrehensive income (loss)
    807       (1,441 )     1,317       (1,554 )
                                 
Comprehensive Income/(Loss)
  $ 1,383     $ (450 )   $ 3,369     $ 3,419  

See notes to the unaudited consolidated financial statements.

 
6

 

FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statement of Changes in Stockholders' Equity
Nine Months Ended September 30, 2009
(Dollars In Thousands, Except Per Share Amounts)
(Unaudited)
 
   
Shares
   
Amount
   
 Additional
   
 
   
 Accumulated Other Comprehensive
       
   
Preferred
   
Common
   
Preferred
   
Common
   
Paid-in Capital
   
Retained Earnings
   
 (Loss), Net of Tax
 
 
Total
 
                                                 
Balance, January 1, 2009
    -       4,668     $ -     $ 4,668     $ 34,145     $ 36,476     $ (2,337 )   $ 72,952  
Net income
                                            2,052               2,052  
Issuance of preferred stock and a
                                                               
  common stock warrant
    20,000               19,729               271                       20,000  
Shares issued under dividend
                                                               
  reinvestment program
            1               1       2                       3  
Stock issued for stock options exercised
            12               12       89                       101  
Stock issued for employee benefit
                                                               
  plans
            27               27       380                       407  
Stock-based compensation expense
                                    78                       78  
Net change in unrealized gains (losses)
                                                               
  on securities available-for-sale,
                                                               
  net of tax
                                                    1,317       1,317  
Dividends on preferred stock
                                            (730 )             (730 )
Accretion of preferred stock discount
                    39                       (39 )             -  
Cash dividends declared
                                                               
  ($.43 per share)
    -       -       -       -       -       (2,015 )     -       (2,015 )
Balance, September 30, 2009
    20,000       4,708     $ 19,768     $ 4,708     $ 34,965     $ 35,744     $ (1,020 )   $ 94,165  
 
See notes to the unaudited consolidated financial statements.

 
7

 

FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statements of Cash Flows
(Dollars In Thousands)
(Unaudited)

   
Nine Months Ended
 
   
September 30,
 
   
2009
   
2008
 
Operating Activities:
           
Net income
  $ 2,052     $ 4,973  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    6,441       2,819  
Depreciation on premises and equipment
    1,264       1,178  
Federal Home Loan Bank stock dividends
    -       (309 )
Core deposit intangible amortization
    302       59  
Net amortization (accretion) available-for-sale
    131       (3 )
Net amortization (accretion) held-to-maturity
    8       18  
Impairment loss on securities available-for-sale
    679       216  
Impairment loss on securities held-to-maturity
    24       -  
Gain on sale of investments available-for-sale
    -       (52 )
Gain on sale of mortgage loans
    (832 )     (566 )
Origination of loans held for sale
    (101,364 )     (47,277 )
Proceeds on sale of loans held for sale
    104,034       46,432  
Stock-based compensation expense
    78       92  
Changes in:
               
Cash surrender value of life insurance
    (269 )     (271 )
Interest receivable
    (685 )     155  
Other assets
    (931 )     (17 )
Interest payable
    52       (763 )
Accounts payable and other liabilities
    (226 )     (589 )
Net cash from operating activities
    10,758       6,095  
                 
Investing Activities:
               
Cash paid for acquisition of Farmers State Bank, net of cash acquired
    -       (1,466 )
Sales of securities available-for-sale
    -       679  
Purchases of securities available-for-sale
    (19,565 )     (524 )
Maturities of securities available-for-sale
    1,592       2,208  
Maturities of securities held-to-maturity
    5,434       12,517  
Net change in loans
    (82,728 )     (58,518 )
Net purchases of premises and equipment
    (3,541 )     (4,070 )
Net cash from investing activities
    (98,808 )     (49,174 )
                 
Financing Activities
               
Net change in deposits
    162,319       31,927  
Change in short-term borrowings
    (92,669 )     22,500  
Repayments to Federal Home Loan Bank
    (170 )     (102 )
Proceeds from issuance of subordinated debentures
    -       8,000  
Issuance of preferred stock, net
    20,000       -  
Issuance of common stock
    3       -  
Issuance of common stock for stock options exercised
    101       -  
Issuance of common stock for employee benefit plans
    407       144  
Dividends paid on common stock
    (2,015 )     (2,659 )
Dividends paid on preferred stock
    (730 )     -  
Net cash from financing activities
    87,246       59,810  
                 
(Decrease) Increase in cash and cash equivalents
    (804 )     16,731  
Cash and cash equivalents, beginning of period
    20,905       14,948  
Cash and cash equivalents, end of period
  $ 20,101     $ 31,679  

See notes to the unaudited consolidated financial statements.

 
8

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation – The accompanying unaudited consolidated financial statements include the accounts of First Financial Service Corporation and its wholly owned subsidiary, First Federal Savings Bank.  First Federal Savings Bank has three wholly owned subsidiaries, First Service Corporation of Elizabethtown, Heritage Properties, LLC and First Federal Office Park, LLC.  Unless the text clearly suggests otherwise, references to "us," "we," or "our" include First Financial Service Corporation and its wholly-owned subsidiary.  All significant intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the nine-month period ending September 30, 2009 are not necessarily indicative of the results that may occur for the year ending December 31, 2009.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the period ended December 31, 2008.

Adoption of New Accounting Standards In June 2009, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 168 – “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted AccountingPrinciples – areplacement of FASB Statement No. 162,” (“SFAS 168”).  SFAS 168 establishes the FASB Accounting Standards Codification (“Codification”) as the source of authoritative generally accepted accounting principles (“GAAP”) for nongovernmental entities.  The Codification does not change GAAP.  Instead, it takes the thousands of individual pronouncements that currently comprise GAAP and reorganizes them into approximately 90 accounting Topics, and displays all Topics using a consistent structure.  Contents in each Topic are further organized first by Subtopic, then Section and finally Paragraph.  The Paragraph level is the only level that contains substantive content.  Citing particular content in the Codification involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.  FASB suggests that all citations begin with “FASB ASC,” where ASC stands for Accounting Standards Codification.  SFAS 168, (FASB ASC 105-10-05, 10, 15, 65, 70) is effective for interim and annual periods ending after September 15, 2009 and will not have an impact on our financial position but will change the referencing system for accounting standards.  The following pronouncements provide citations to the applicable Codification by Topic, Subtopic and Section.

 
9

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1. 
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

FASB ASC 855-10, Subsequent Events, was issued in May 2009 and establishes the period after thebalance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements and the circumstances under which an entity shall recognize events or transactions that occur after the balance sheet date. The standard also requires disclosure of the date through which subsequent events have been evaluated. The new standard becomes effective for interim and annual periods ending after June 15, 2009. We adopted this standard for the interim reporting period ending June 30, 2009. The adoption of this statement did not have a material impact on our consolidated financial position or results of operations. We evaluated subsequent events through November 9, 2009, the date the financial statements were issued, and believe that no events have occurred requiring further disclosure or adjustment to the consolidated financial statements.

In early April 2009, the FASB issued three staff positions related to fair value which are discussed below:

 
§
FASB ASC 825-10, Interim Disclosures about Fair Value of Financial Instruments, requires disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements and also requires those disclosure in summarized financial information at interim reporting periods.  A publicly traded company includes any company whose securities trade in a public market on either a stock exchange or in the over-the-counter market, or any company that is a conduit bond obligor.  Additionally, when a company makes a filing with a regulatory agency in preparation for sale of its securities in a public market it is considered a publicly traded company for this purpose.  This guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  Adoption of this standard did not have a material impact.
 
 
§
FASB ASC 820-10, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not Orderly, provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This topic also includes guidance on identifying circumstances that indicate a transaction is not orderly. This standard emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This standard requires a reporting entity: (1) disclose in interim and annual periods the inputs and valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period, and (2) define major category for equity securities and debt securities to be major security types. This guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  We early adopted this standard for our first quarter ended March 31, 2009, but its adoption did not have a material impact.

 
§
FASB ASC 320-10-65, Recognition and Presentation of Other-Than-Temporary Impairments, categorizes losses on debt securities available-for-sale or held-to-maturity determined by management to be other-than-temporarily impaired into losses due to credit issues and losses related to all other factors.  Other-than-temporary impairment (OTTI) exists when it is more likely than not that the security will mature or be sold before its amortized cost basis can be recovered.  An OTTI related to credit losses should be recognized through earnings.  An OTTI related to other factors should be recognized in other comprehensive income.  The standard does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.  This guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We early adopted this standard for our first quarter ended March 31, 2009.  Previous other-than-temporary impairment charges were recorded on equity securities so there is no cumulative effect adjustment upon adoption.

 
10

 
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. 
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
FASB ASC 805-20, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, was issued in April 2009. This standard addresses concerns raised by constituents about assets and liabilities arising from contingencies in a business combination.  The standard requires an acquirer to recognize at fair value “an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period.” The guidance is effective for business combinations whose acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  This standard is expected to have an impact on our accounting for any business combinations closing on or after January 1, 2009.

FASB ASC 815-10, Disclosures about Derivative Instruments and Hedging Activities, was issued in March 2008. This statement requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related items are accounted for and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The new standard is effective for us on January 1, 2009. Adoption of this standard did not have a material impact.

FASB ASC 350-30, 275-10, Determination of the Useful Life of Intangible Assets, was issued in April 2008. This standard amends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible asset.  The guidance provides that in addition to considering the entity specific factors in paragraph 11 of Statement No. 142, an entity must consider its own historical experience in renewing or extending similar arrangements.  Alternatively, if an entity lacks historical experience, it must consider the assumptions a market participant would use consistent with the highest and best use of the asset, adjusted for the entity specific factors in paragraph 11 of Statement No. 142. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Early adoption is prohibited.  Adoption of this standard did not have a material impact.

FASB ASC 260-10, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities, was issued in June 2008.  This guidance concluded that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders and therefore are considered participating securities for purposes of computing earnings per share. Entities that have participating securities that are not convertible into common stock are required to use the “two-class” method of computing earnings per share. The two- class method is an earnings allocation formula that dividends declared (or accumulated) and participation rights in undistributed earnings. This standard is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. This standard became effective for us on January 1, 2009. Adoption of this standard did not have a material impact.

FASB ASC 805, Business Combinations, was issued in December 2007.   This statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. It also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This standard is effective for business combinations where the acquisition date is on or after fiscal years beginning after December 15, 2008. This standard is expected to have an impact on our accounting for any business combinations closing on or after January 1, 2009.

 
11

 


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. 
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
FASB ASC 810-10-65-1, Non-controlling Interests in Consolidated Financial Statements, was issued in December 2007. This statement establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of this standard shall be applied prospectively. This standard is effective for fiscal years beginning after December 15, 2008.  Adoption of this standard did not have a material impact.

Effect of Newly Issued But Not Yet Effective Accounting StandardsIn August 2009, the Financial Accounting Standards Board(“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-05, Measuring Liabilities at FairValue, which is codified as ASC 820, Fair Value Measurements and Disclosures. This update provides amendments to Topic 820-10, Fair Value Measurements and Disclosures. This update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or that is consistent with the principles of Topic 820. The amendments in this update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents transfer of the liability. The amendments in this update also clarify that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. This update is effective for periods beginning after October 1, 2009 and we do not expect the adoption of this update will have a significant impact to our financial condition, results of operations or cash flows.
 
FASB ASC 715-20-65-2, Employers’ Disclosures about Postretirement Benefit Plan Assets, was issued in December 2008. This staff position provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This standard requires disclosure of the fair value of each major category of plan assets for pension plans and other postretirement benefit plans. This standard becomes effective for us on January 1, 2010.  Adoption of this standard is not expected to have a material impact.

SFAS 166, Accounting for Transfers of Financial Assets (not yet integrated into the ASC), was issued in June 2009.  This statement amends and removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The new standard will become effective for us on January 1, 2010. We are currently evaluating the impact of adopting this standard but do not expect the impact of adoption to be material to our results of operation or financial position.

SFAS 167, Amendments to FASB Interpretation No. 46(R) (not yet integrated into the ASC), was also issued in June 2009 and amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. This standard requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This statement requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The new standard will become effective for us on January 1, 2010. We are currently evaluating the impact of adopting the standard but do not expect the impact of adoption to be material to our results of operation or financial position.

 
12

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
2. 
SECURITIES

The amortized cost basis and fair values of securities are as follows:

         
Gross
   
Gross
       
(Dollars in thousands)
 
Amortized
   
Unrealized
   
Unrealized
       
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available-for-sale:
                       
September 30, 2009:
                       
U.S. Treasury and agencies
  $ 15,000     $ 122     $ -     $ 15,122  
Government-sponsored mortgage-backed securities
    4,834       180       -       5,014  
Equity
    933       43       -       976  
State and municipal
    13,591       467       (78 )     13,980  
Trust preferred securities
    2,108       -       (2,056 )     52  
                                 
Total
  $ 36,466     $ 812     $ (2,134 )   $ 35,144  
                                 
December 31, 2008:
                               
Government-sponsored mortgage-backed securities
  $ 6,079     $ 70     $ (10 )   $ 6,139  
Equity
    933       17       (2 )     948  
State and municipal
    9,558       3       (946 )     8,615  
Trust preferred securities
    2,732       -       (2,659 )     73  
                                 
Total
  $ 19,302     $ 90     $ (3,617 )   $ 15,775  

         
Gross
   
Gross
       
   
Amortized
   
Unrecognized
   
Unrecognized
       
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities held-to-maturity:
                       
September 30, 2009:
                       
Government-sponsored mortgage-backed securities
  $ 1,077     $ 8     $ -     $ 1,085  
State and municipal
    245       5       -       250  
Trust preferred securities
    24       -       -       24  
                                 
Total
  $ 1,346     $ 13     $ -     $ 1,359  
                                 
December 31, 2008:
                               
U.S. Treasury and agencies
  $ 4,503     $ 54     $ -     $ 4,557  
Government-sponsored mortgage-backed securities
    1,780       -       (7 )     1,773  
State and municipal
    481       2       -       483  
Trust preferred securities
    258       -       (225 )     33  
                                 
Total
  $ 7,022     $ 56     $ (232 )   $ 6,846  
 
 
13

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

The amortized cost and fair value of securities at September 30, 2009, by contractual maturity, are shown below.  Securities not due at a single maturity date, primarily mortgage-backed and equity securities, are shown separately.

   
Amortized
   
Fair
 
(Dollars in thousands)
 
Cost
   
Value
 
Securities available-for-sale:
           
Due after one year through five years
  $ 15,115     $ 15,240  
Due after five years through ten years
    373       371  
Due after ten years
    15,211       13,543  
Government-sponsored mortgage-backed securities
    4,834       5,014  
Equity
    933       976  
Total
  $ 36,466     $ 35,144  
                 
   
Amortized
   
Fair
 
(Dollars in thousands)
 
Cost
   
Value
 
Securities held-to-maturity:
               
Due in one year or less
  $ 245     $ 250  
Due after ten years
    24       24  
Government-sponsored mortgage-backed securities
     1,077        1,085  
Total
  $ 1,346     $ 1,359  

There were not any sales of available-for-sale securities for the September 30, 2009 period.  For the quarter and nine month periods ended September 30, 2008, proceeds from sales of available-for-sale securities were $679,000 and gross realized gains recognized in income were $52,000.

Investment securities pledged to secure public deposits and FHLB advances had an amortized cost of $31.8 million and fair value of $32.5 million at September 30, 2009 and a $19.6 million amortized cost and fair value of $18.8 million at December 31, 2008.

 
14

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

The following table summarizes the investment securities with unrealized losses at September 30, 2009 and December 31, 2008 by aggregated major security type and length of time in a continuous unrealized loss position:

September 30, 2009
 
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
   
Unrealized
 
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Description of Securities
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
  
                                   
State and municipal
  $ 371     $ (1 )   $ 2,517     $ (77 )   $ 2,888     $ (78 )
Trust preferred securities
    -       -       52       (2,056 )     52       (2,056 )
  
                                               
Total temporarily impaired
  $ 371     $ (1 )   $ 2,569     $ (2,133 )   $ 2,940     $ (2,134 )
                                                 
December 31, 2008
 
Less than 12 Months
   
12 Months or More
   
Total
 
  
 
Fair
   
Unrealized
 
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Description of Securities
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
  
                                               
Government-sponsored  mortgage-backed securities
  $ 3,944     $ (15 )   $ 526     $ (2 )   $ 4,470     $ (17 )
Equity
    6       (2 )     -       -       6       (2 )
State and municipal
    938       (99 )     7,450       (847 )     8,388       (946 )
Trust preferred securities
    106       (2,884 )     -       -       106       (2,884 )
  
                                               
Total temporarily impaired
  $ 4,994     $ (3,000 )   $ 7,976     $ (849 )   $ 12,970     $ (3,849 )
 
We evaluate investment securities with significant declines in fair value on a quarterly basis to determinewhether they should be considered other-than-temporarily impaired under current accounting guidance,which generally provides that if a security is in an unrealized loss position, whether due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the impairment is other-than-temporary.

As discussed in Note 1, in early April 2009, the FASB issued FASB ASC 320-10-65, Recognition and Presentation of Other-Than-Temporary Impairments.  Among other provisions, the guidance requires entities to split other than temporary impairment charges between credit losses (i.e., the loss based on the entity’s estimate of the decrease in cash flows, including those that result from expected voluntary prepayments), which are charged to earnings, and the remainder of the impairment charge (non-credit component) to accumulated other comprehensive income. This requirement pertains to both securities held to maturity and securities available for sale.

The unrealized losses on the state and municipal securities were caused primarily by interest rate decreases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment.  Because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do not consider these investments to be other-than-temporarily impaired at September 30, 2009.  We also considered the financial condition and near term prospects of the issuer and identified no matters that would indicate less than full recovery.

As discussed in Note 6 - Fair Value, the fair value of our portfolio of trust preferred securities, has decreased significantly as a result of the current credit crisis and lack of liquidity in the financial markets.  There are limited trades in trust preferred securities and the majority of holders of such instruments have elected not to participate in the market unless they are required to sell as a result of liquidation, bankruptcy, or other forced or distressed conditions.

 
15

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)
 
To determine if the five trust preferred securities were other than temporarily impaired as of September 30, 2009, we used a discounted cash flow analysis.  The cash flow models used were used to determine if the current present value of the cash flows expected on each security were still equivalent to the original cash flows projected on the security when purchased.   The cash flow analysis takes into consideration assumptions for prepayments, defaults and deferrals for the underlying pool of banks, insurance companies and REITs.

Management works with independent third parties to identify its best estimate of the cash flow estimatedto be collected. If this estimate results in a present value of expected cash flows that is less than theamortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following general assumptions:

 
·
We assume default rates on individual entities behind the pools based on Fitch ratings for financial institutions and A.M. Best ratings for insurance companies.  These ratings are used to predict the default rates for the next seven quarters.
 
·
We assume that annual defaults for the remaining life of each security will be 37.5 basis points.
 
·
We assume a recovery rate of 15% on deferrals after two years.
 
·
We assume 2% prepayments through the five year par call and then 2% per annum for the remaining life of the security.
 
·
Our securities have been modeled using the above assumptions by FTN Financial using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

Additionally, in making our determination, we considered all available market information that could be obtained without undue cost and effort, and considered the unique characteristics of each trust preferred security individually by assessing the available market information and the various risks associated with that security including:

 
·
Valuation estimates provided by our investment broker;
 
·
The amount of fair value decline;
 
·
How long the decline in fair value has existed;
 
·
Significant rating agency changes on the issuer;
 
·
Level of interest rates and any movement in pricing for credit and other risks;
 
·
Information about the performance of the underlying institutions that issued the debt instruments, such as net income, return on equity, capital adequacy, non-performing assets, Texas ratios, etc;
 
·
Our intent to sell the security or whether it is more likely than not that we will be required to sell the security before its anticipated recovery; and
 
·
Other relevant observable inputs.

 
16

 
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

       
Moody's
                             
% of Current
 
       
Credit
 
Current
                   
Current
   
Deferrals and
 
(Dollars in thousands)
     
Ratings
 
Moody's
             
Estimated
   
Deferrals
   
Defaults
 
       
When
 
Credit
 
Par
   
Book
   
Fair
   
and
   
to Current
 
Security
 
Tranche
 
Purchased
 
Ratings
 
Value
   
Value
   
Value
   
Defaults
   
Collateral
 
                                           
Preferred Term Securities IV
 
Mezzanine
   
A3
 
 Ca
  $ 244     $ 200     $ 24     $ 18,000       27 %
Preferred Term Securities VI
 
Mezzanine
   
A1
 
 Caa1
    259       24       24       25,000       61 %
Preferred Term Securities XV B1
 
Mezzanine
   
A2
 
 Ca
    1,004       829       15       131,550       22 %
Preferred Term Securities XXI C2
 
Mezzanine
   
A3
 
 Ca
    1,018       641       8       177,500       24 %
Preferred Term Securities XXII C1
 
Mezzanine
   
A3
 
 Ca
    503       438       5       317,500       23 %
                                                       
Total
                $ 3,028     $ 2,132     $ 76                  
 
The following table details the five debt securities with other-than-temporary impairment at September 30, 2009 and the related credit losses recognized in earnings:

 (Dollars in thousands)
 
PreTSL XXI
   
PreTSL XXII
   
PreTSL VI
   
PreTSL IV
   
PreTSL XV
   
Total
 
     
                                   
Amount of other-than-temporary impairment related to credit loss at January 1, 2009
  $ -     $ -     $ -     $ -     $ -     $ -  
Addition    
    393       66       25       44       175       703  
Amount of other-than-temporary impairment related to credit loss at September 30, 2009
  $ 393     $ 66     $ 25     $ 44     $ 175     $ 703  
 
 
17

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
3. 
LOANS

Loans are summarized as follows:

     
 
September 30,
   
December 31,
 
(Dollars in thousands)
 
2009
   
2008
 
     
           
Commercial  
  $ 56,546     $ 56,863  
Real estate commercial
    623,473       563,314  
Real estate construction
    12,635       17,387  
Residential mortgage  
    177,898       165,337  
Consumer and home equity
    73,249