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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q/A

Amendment No. 1

 

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

For the quarterly period ended June 30, 2009

 

¨	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: 0-49789

Henry County Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

Georgia		58-1485511
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

4806 N. Henry Blvd., Stockbridge, Georgia 30281

(Address of principal executive offices)

(770) 474-7293

(Issuer’s telephone number)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 (§229.405 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, or a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “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		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

State the number of shares outstanding of each of the issuer’s classes of common equity, as of August 7, 2009: 14,245,690; $2.50 par value.

 

 

 

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Explanatory Note

On November 12, 2009, management and the Audit Committee of the Board of Directors of the Company, after consultation with its independent accountants, determined that the Company had incorrectly recorded its provision for loan losses for the three and six month periods ended June 30, 2009. During the second quarter of 2009, management changed the period considered in determining its historical loss experience used for estimating the general portion of the Company’s allowance for loan losses from the most recent five years to the most recent six quarters. In making the change the Company incorrectly applied a quarterly average loss rate rather than an annual loss rate when calculating the general portion of its allowance for loan losses at June 30, 2009. The result of this error was that the provision for loan losses and the net loss of the Company for the three and six month periods ended June 30, 2009 were understated by $6.2 million along with the allowance for loan losses which was also understated by $6.2 million at June 30, 2009. The $6.2 million adjustment is reflected in the financial statements of this amended filing, and included in the associated discussions. Amendment Number 1 does not otherwise update information in the Original Filing to reflect facts or events occurring subsequent to the date of the Original filing.

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HENRY COUNTY BANCSHARES, INC AND SUBSIDIARIES

 

 

INDEX

 

 

				Page
PART I.		FINANCIAL INFORMATION
		Item 1. Financial Statements
		Consolidated Balance Sheets - June 30, 2009 and December 31, 2008		3
		Consolidated Statements of Operations and Comprehensive Income (loss) - Three and Six Months Ended June 30, 2009 and 2008		4
		Consolidated Statements of Cash Flows - Six Months Ended June 30, 2009 and 2008		5
		Notes to Consolidated Financial Statements		6-14
		Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		15-23
		Item 3. Quantitative and Qualitative Disclosures About Market Risk		23
		Item 4. Controls and Procedures		24
PART II.		OTHER INFORMATION
		Item 6 - Exhibits and Reports on Form 8-K		25
		Signatures		26

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PART I—FINANCIAL INFORMATION

FINANCIAL STATEMENTS

HENRY COUNTY BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

JUNE 30, 2009 AND DECEMBER 31, 2008

(Unaudited)

 

		Restated 2009				2008
Assets
Cash and due from banks		$	14,652,133			$	14,039,311
Interest bearing deposits in banks			56,160,313				1,499,648
Federal funds sold			—				14,300,000
Securities available for sale, at fair value			71,797,586				60,455,998
Securities held to maturity, at cost, (fair value 2009—$1,036,209; 2008—$3,349,682)			1,045,000				3,360,711
Restricted equity securities, at cost			1,265,898				1,643,251
Loans held for sale			853,036				—
Loans			496,473,079				533,608,559
Less allowance for loan losses			15,170,740				17,730,410
Loans, net			481,302,339				515,878,149
Premises and equipment			9,730,232				9,776,484
Other real estate			28,037,188				18,397,754
Other assets			8,834,192				16,526,168
Total assets		$	673,677,917			$	655,877,474
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing		$	68,359,885			$	68,210,136
Interest-bearing			559,121,321				522,266,489
Total deposits			627,481,206				590,476,625
Other borrowings			1,935,368				2,598,266
Other liabilities			3,852,520				3,459,932
Total liabilities			633,269,094				596,534,823
Stockholders’ equity
Preferred stock, no par value; 10,000,000 shares authorized; none issued
Common stock, par value $2.50; 30,000,000 shares authorized; 14,388,749.6 shares issued			35,971,874				35,971,874
Capital surplus			739,560				739,560
Retained earnings			5,433,137				24,161,264
Accumulated other comprehensive income			582,856				788,557
Treasury stock, 143,060 shares			(2,318,604	)			(2,318,604	)
Total stockholders’ equity			40,408,823				59,342,651
Total liabilities and stockholders’ equity		$	673,677,917			$	655,877,474

See Notes to Consolidated Financial Statements.

 

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HENRY COUNTY BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008

(Unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		Restated 2009				2008				Restated 2009				2008
Interest income
Loans		$	3,245,434			$	7,572,206			$	9,126,133			$	17,351,110
Taxable securities			593,989				886,473				1,192,962				2,037,107
Nontaxable securities			68,052				86,881				132,865				166,326
Deposits in banks			11,403				2,168				13,600				33,327
Federal funds sold			—				36,899				10,224				141,701
Total interest income			3,918,878				8,584,627				10,475,784				19,729,571
Interest expense
Deposits			3,790,424				4,938,220				7,626,396				10,747,138
Other borrowings			13,676				26,265				27,889				144,344
Total interest expense			3,804,100				4,964,485				7,654,285				10,891,482
Net interest income			114,778				3,620,142				2,821,499				8,838,089
Provision for loan losses			12,340,550				1,525,750				13,940,550				2,635,750
Net interest income (loss) after provision for loan losses			(12,225,772	)			2,094,392				(11,119,051	)			6,202,339
Other operating income
Service charges on deposit accounts			350,935				339,116				659,308				676,178
Other service charges and fees			221,729				277,571				453,354				532,099
Mortgage banking income			158,676				121,579				253,777				242,184
Total other income			731,340				738,266				1,366,439				1,450,461
Other expenses
Salaries and employee benefits			1,675,941				1,800,029				3,374,373				3,665,766
Occupancy and equipment expenses			386,115				485,035				861,083				966,909
Other real estate writedowns and losses			1,693,746				842,606				2,270,596				951,670
Other operating expenses			1,101,024				644,508				2,469,463				1,276,611
Total other expenses			4,856,826				3,772,178				8,975,515				6,860,956
Income (loss) before income taxes			(16,351,258	)			(939,520	)			(18,728,127	)			791,844
Income tax expense (benefit)			—				(502,360	)			—				138,340
Net income (loss)			(16,351,258	)			(437,160	)			(18,728,127	)			653,504
Other comprehensive loss:
Unrealized losses on securities available for sale, net of tax			(319,947	)			(1,015,911	)			(205,701	)			(629,170	)
Comprehensive income (loss)		$	(16,671,205	)		$	(1,453,071	)		$	(18,933,828	)		$	24,334
Earnings (loss) per share		$	(1.15	)		$	(0.03	)		$	(1.31	)		$	0.05
Weighted average shares outstanding			14,245,690				14,245,690				14,245,690				14,245,739
Cash dividends per share		$	—			$	0.06			$	—			$	0.12

See Notes to Consolidated Financial Statements.

 

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HENRY COUNTY BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2009 AND 2008

(Unaudited)

 

		2009 Restated				2008
OPERATING ACTIVITIES
Net income (loss)		$	(18,728,127	)		$	653,504
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation			273,986				347,211
Net (increase) decrease in loans held for sale			(853,036	)			67,483
Provision for loan losses			13,940,550				2,635,750
Writedowns of other real estate owned			1,731,723				951,670
Net losses on sale of other real estate			538,873				—
Decrease in interest receivable			2,311,541				2,793,382
Decrease in interest payable			(31,002	)			(837,190	)
Net other operating activities			5,909,991				(2,348,095	)
Net cash provided by operating activities			5,094,499				4,263,715
INVESTING ACTIVITIES
Purchases of securities available for sale			(35,091,946	)			(34,587,704	)
Proceeds from maturities of securities available for sale			23,438,691				47,760,190
Proceeds from maturities of securities held to maturity			2,315,711				2,111
Retirement of restricted equity securities			377,353				19,900
Net decrease in federal funds sold			14,300,000				9,500,000
Net (increase) decrease in interest-bearing deposits in banks			(54,660,665	)			2,609,626
Net decrease in loans			4,270,492				7,255,444
Proceeds from sale of other real estate			4,454,738				290,841
Purchase of premises and equipment			(227,734	)			(9,173	)
Net cash (used in) provided by investing activities			(40,823,360	)			32,841,235
FINANCING ACTIVITIES
Net increase (decrease) in deposits			37,004,581				(32,352,929	)
Net increase in federal funds purchased			—				2,000,000
Net repayments of other borrowings			(662,898	)			(6,040,686	)
Dividends paid			—				(1,709,484	)
Purchase of treasury stock			—				(60,750	)
Net cash provided by (used in) financing activities			36,341,683				(38,163,849	)
Net increase (decrease) in cash and due from banks			612,822				(1,058,899	)
Cash and due from banks, beginning of period			14,039,311				16,826,236
Cash and due from banks, end of period		$	14,652,133			$	15,767,337
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid (refunded) for:
Interest		$	7,685,287			$	11,728,672
Income taxes		$	(6,121,531	)		$	1,339,742
Noncash transactions
Other real estate acquired in settlement of loans		$	16,364,768			$	7,514,542
Financed sales of other real estate owned		$	—			$	—

See Notes to Consolidated Financial Statements.

 

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HENRY COUNTY BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1.

BASIS OF PRESENTATION

The consolidated financial information for Henry County Bancshares, Inc. (the “Company”) included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim period.

The results of operations for the three and six month periods ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year.

Recent Accounting Pronouncements

In management’s opinion, there are no recent accounting pronouncements that have had or will have a material impact on our earnings or financial position as of or for the quarter ended June 30, 2009.

 

NOTE 2.

RESTATEMENT

On November 12, 2009, management and the Audit Committee of the Board of Directors of the Company, after consultation with its independent accountants, determined that the Company had incorrectly recorded its provision for loan losses for the three and six month periods ended June 30, 2009. During the second quarter of 2009, management changed the period considered in determining its historical loss experience used for estimating the general portion of the Company’s allowance for loan losses from the most recent five years to the most recent six quarters. In making the change the Company incorrectly applied a quarterly average loss rate rather than an annual loss rate when calculating the general portion of its allowance for loan losses at June 30, 2009. The result of this error was that the provision for loan losses and the net loss of the Company for the three and six month periods ended June 30, 2009 were understated by $6.2 million along with the allowance for loan losses which was also understated by $6.2 million at June 30, 2009.

The following presents the amounts originally reported in the Company’s June 30, 2009 Quarterly Report on Form 10Q that are affected by the restatement.

 

		Impact to Consolidated Balance Sheet (unaudited)
(in thousands)		As Previously Reported			As Restated
Loans		$	496,473		$	496,473
Less allowance for loan losses			9,006			15,171
Loans, net			487,467			481,302
Total assets			679,843			673,678
Total stockholders’ equity			46,574			40,409
Total liabilities and stockholders’ equity			679,843			673,678

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2.

RESTATEMENT (Continued)

 

		Impact to Consolidated Statements of Operations (unaudited)
		Three Months Ended June 30, 2009								Six Months Ended June 30, 2009
(in thousands)		As Previously Reported				As Restated				As Previously Reported				As Restated
Provision for loan losses		$	6,175			$	12,340			$	7,775			$	13,940
Net interest income (loss) after provision for loan losses			(6,061	)			(12,226	)			(4,954	)			(11,119	)
Loss before income taxes			(10,186	)			(16,351	)			(12,563	)			(18,728	)
Net loss			(10,186	)			(16,351	)			(12,563	)			(18,728	)
Loss per share		$	(0.72	)		$	(1.15	)		$	(0.88	)		$	(1.31	)

 

NOTE 3.

SECURITIES

The amortized cost and fair value of securities are summarized as follows:

 

		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses				Fair Value
Securities Available for Sale
June 30, 2009:
Government-sponsored agencies		$	36,933,933		$	178,392		$	(231,211	)		$	36,881,114
State and municipal securities			7,665,494			121,297			(20,936	)			7,765,855
Mortgage-backed securities			26,315,044			871,824			(36,251	)			27,150,617
		$	70,914,471		$	1,171,513		$	(288,398	)		$	71,797,586
December 31, 2008:
Government-sponsored agencies		$	25,719,945		$	342,801		$	—			$	26,062,746
State and municipal securities			6,035,312			94,578			(8,203	)			6,121,687
Mortgage-backed securities			27,505,958			848,033			(82,426	)			28,271,565
		$	59,261,215		$	1,285,412		$	(90,629	)		$	60,455,998
Securities Held to Maturity
June 30, 2009:
State and municipal securities		$	1,045,000		$	9,383		$	(18,174	)		$	1,036,209
Mortgage-backed securities			—			—			—				—
		$	1,045,000		$	9,383		$	(18,174	)		$	1,036,209
December 31, 2008:
State and municipal securities		$	3,360,000		$	14,612		$	(25,644	)		$	3,348,968
Mortgage-backed securities			711			3			—				714
		$	3,360,711		$	14,615		$	(25,644	)		$	3,349,682

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 3.

SECURITIES (Continued)

 

Restricted equity securities are summarized as follows:

 

		June 30			December 31
		2009			2008
Federal Home Loan Bank stock		$	1,265,898		$	1,367,900
Correspondent bank stock			—			275,351
		$	1,265,898		$	1,643,251

Securities with a carrying value of $20,056,000 at June 30, 2009 and $31,500,000 at December 31, 2008, were pledged to secure public deposits and for other purposes required or permitted by law.

There were no sales of securities available for sale for the periods ended June 30, 2009 or December 31, 2008.

The amortized cost and fair value of debt securities as of June 30, 2009 by contractual maturity are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without penalty. Therefore, these securities are not included in the maturity categories in the following summary.

 

		Securities Available for Sale						Securities Held to Maturity
		Amortized Cost			Fair Value			Amortized Cost			Fair Value
Due in one year or less		$	3,318,509		$	3,369,664		$	—		$	—
Due from one to five years			26,618,784			26,729,120			1,045,000			1,036,209
Due from five to ten years			14,156,770			14,022,727			—			—
Due after ten years			505,364			525,458			—			—
Mortgage-backed securities			26,315,044			27,150,617			—			—
		$	70,914,471		$	71,797,586		$	1,045,000		$	1,036,209

In 2003, the FASB Emerging Issues Task Force released Issue 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The issue requires disclosure of certain information about other than temporary impairments in the market value of securities. The market value of securities is based on quoted market values and is significantly affected by the interest rate environment.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3.

SECURITIES (Continued)

 

Information pertaining to securities with gross unrealized losses at June 30, 2009 and at December 31, 2008 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

		Less Than Twelve Months						Over Twelve Months
		Gross Unrealized Losses			Fair Value			Gross Unrealized Losses			Fair Value
June 30, 2009
Government-sponsored agencies		$	231,211		$	16,343,742		$	—		$	—
State and municipal securities			20,936			2,334,762			18,174			581,826
Mortgage-backed securities			946			1,048,879			35,305			1,436,877
		$	253,093		$	19,727,383		$	53,479		$	2,018,703
December 31, 2008
Government-sponsored agencies		$	—		$	—		$	—		$	—
State and municipal securities			8,203			197,790			25,644			574,356
Mortgage-backed securities			36,898			2,995,680			45,528			842,900
		$	45,101		$	3,193,470		$	71,172		$	1,417,256

The unrealized losses on the Company’s investment in State and municipal securities are caused by changes in interest rates. The Company’s investments in State and municipal securities consist primarily of general obligations of municipalities located in the state of Georgia. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2009 and at December 31, 2008.

The unrealized losses on the Company’s investment in federal agency mortgage-backed securities were also caused by changes in interest rates. The Company purchased those investments at a discount relative to their face amount, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2009 and at December 31, 2008.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4.

FAIR VALUE OF FINANCIAL INSTRUMENTS

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques the Company is required to provide the following information according to fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following categories:

Level 1 Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities traded in an active market, as well as certain U.S. Treasury and U.S. Government-sponsored enterprise debt securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4.

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Assets Measured at Fair Value on a Recurring Basis

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available for Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U. S. agency securities, mortgage-backed agency securities, obligations of state and political subdivisions and certain corporate, asset backed and other securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

    The following table presents financial assets measured at fair value on a recurring basis:

 

					Fair Value Measurements at June 30, 2009
		Assets/Liabilities Measured at Fair Value June 30, 2009			Quoted Prices In Active Markets for Identical assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Available for sale securities		$	71,797,586		$	3,881,066		$	67,916,520		$	—

Assets Measured at Fair Value on a Nonrecurring Basis

Following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Once a loan is identified as individually impaired, management measures the impairment in accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS 114’). The fair value of impaired loans is estimated using one of several methods, including the present value of future cash flows discounted at the loan’s effective interest rate or a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. In accordance with SFAS 114, impaired loans where an allowance is established based on fair value of collateral require classification in the fair value hierarchy.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4.

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Impaired Loans (Continued)

The Company measures the fair value of collateral dependent loans based on the fair value of collateral securing these loans. These measurements are classified as Level 3 within the valuation hierarchy. All impaired loans are secured by real estate. The fair value of these real estate properties is generally determined based upon appraisals performed by a certified or licensed appraiser using inputs such as absorption rates, capitalization rates, and comparables. Management also considers other factors or recent developments which could result in adjustments to the valuation. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. For the three and six months ended June 30, 2009, a nonrecurring change in fair value of $7.3 million and $9.1 million, respectively, has been recorded on those loans considered impaired at June 30, 2009.

Other Real Estate Owned

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Subsequently, other real estate owned is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the other real estate owned as nonrecurring Level 2. When an appraisal is not available or management determines the fair value is further impaired below the appraised value and there is no observable market price, the Company records the other real estate owned as nonrecurring Level 3. As a result of continued deterioration in the appraised values of our other real estate owned as evidenced by current market conditions, the Company recorded loss on sales and additional write-downs of $1.7 million and $2.3 million, respectively, through a charge to earnings during the three and six months ending June 30, 2009.

The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the FAS No. 157 valuation hierarchy (as described above) as of June 30, 2009, for which a nonrecurring change in fair value has been recorded during the six months ended June 30, 2009:

 

					Fair Value Measurements at June 30, 2009
		Assets/Liabilities Measured at Fair Value June 30, 2009			Quoted Prices In Active Markets for Identical assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Impaired loans		$	85,530,304		$	—		$	—		$	85,530,304
Other real estate owned		$	28,037,188		$	—		$	—		$	28,037,188

Fair Value Option

In February, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. SFAS No. 159 allows companies to report selected financial assets and liabilities at fair value. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. While SFAS No. 159 became effective for the Company beginning January 1, 2008, the Company has not elected the fair value option that is offered by this statement.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4.

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair value is based on discounted cash flows or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash, Due From Banks, Interest-bearing Deposits in Banks and Federal Funds Sold: The carrying amount of cash, due from banks, interest-bearing deposits in banks and federal funds sold approximates fair values.

Securities: Fair values of securities are based on available quoted market prices. The carrying values of equity securities with no readily determinable fair value approximate fair values.

Loans and Loans Held For Sale: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable. The carrying amounts of loans held for sale approximate fair value.

Deposits: The carrying amount of demand deposits, savings deposits, and variable-rate certificates of deposit approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities.

Repurchase Agreements and Other Borrowings: The carrying amount of variable rate borrowings and securities sold under repurchase agreements approximate fair value. The fair value of fixed rate other borrowings are estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.

Accrued Interest: The carrying amounts of accrued interest approximates their fair value.

Off-Balance Sheet Instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value and are not significant. The carrying amount of the off-balance sheet financial instruments is based on fees charged to enter into such agreements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4.

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

The carrying amount and estimated fair value of the Company’s financial instruments were as follows:

 

 

NOTE 5.

SUBSEQUENT EVENTS

Management has evaluated all significant events and transactions that occurred after June 30, 2009, but prior to November 12, 2009, the date these financial statements were available to be issued, for potential recognition or disclosure in these financial statements. Loans past due 90+ days and still accruing include a loan relationship totaling $7.8 million with which the bank negotiated a plan to cure the default and begin a structured paydown of the debt. Subsequent to the end of the second quarter, it became unlikely this transaction will be consummated. In the event the transaction does not occur, the loan relationship will become non-performing in the third quarter.

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management’s discussion and analysis of certain significant factors which have affected the financial position and operating results of Henry County Bancshares, Inc. and its subsidiaries, The First State Bank ( the “Bank”) and First Metro Mortgage Co., during the periods included in the accompanying consolidated financial statements.

SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the statements made herein under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) are forward-looking statements for purposes of the Securities Act of 1933, as amended, (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Henry County Bancshares, Inc. to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such forward looking statements include statements using the words such as “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “intend,” or other similar words and expressions of the future. Our actual results may differ significantly from the results we discuss in these forward-looking statements.

These forward-looking statements involve risks and uncertainties and may not be realized due to a variety of factors, including, without limitation: the effects of future economic conditions; governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and other interest-sensitive assets and liabilities; interest rate risks; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating regionally, nationally, and internationally, together with such competitors offering banking products and services by mail, telephone, computer, and the Internet.

Critical Accounting Policies

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2008 as filed in our annual report on Form 10-K.

Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

Determination of the Bank’s allowance for loan losses as well as allowance for other real estate owned have been identified as critical accounting policies. Please see the portion of the discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses. The allowance for other real estate owned is determined primarily using external appraisals and adjusting such appraised values for estimated disposal costs and other factors that management believes will impact appraised values.

 

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Liquidity and Capital Resources

We manage our liquidity to ensure adequate cash flow for deposit withdrawals, credit commitments and repayments of borrowed funds. Liquidity needs are met through loan repayments, cash flows received from pay downs on mortgage backed securities, net interest and fee income as well as continuously provided through the acquisition of new deposits, the renewal of maturing deposits and external borrowings. Management regularly monitors deposit flow and evaluates alternate pricing structures to retain and grow deposits as needed. Traditional local deposit funding sources are supplemented by the use of FHLB borrowings as well as brokered deposits.

At the end of the period, the bank held approximately $50 million in excess interest bearing deposits at the Federal Reserve Bank that previously would have been held as federal funds. In addition, the bank holds approximately $55 million in unpledged securities available for liquidity needs. The bank ended the period with a liquidity ratio of 21.39%, which the bank feels is adequate to meet foreseeable cash flow needs.

The regulatory minimum capital requirements to be classified as well-capitalized and our actual capital ratios on a consolidated and bank-only basis are as follows:

 

		Actual
		Restated Consolidated			Restated Bank			Minimum Regulatory Requirement
Leverage capital ratios		5.92	%		5.89	%		5.00	%
Risk-based capital ratios:
Core capital		7.40			7.45			6.00
Total capital		8.67			7.82			10.00

The bank fell below the Minimum Regulatory Requirement for Total Risk-based capital during the second quarter. Under the terms of an informal agreement with its primary regulators, the company has an obligation to restore the bank to a minimum Leverage Capital ratio of 8.00% and a minimum Risk-based total capital of 10.00%. The company has a Capital Policy and the Capital Committee of the Board of Directors is developing a plan to return the company to the required levels. However, there is no assurance that any such plan will be successfully executed or approved by applicable regulatory authorities.

Off-Balance Sheet Risk

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. A summary of our commitments is as follows:

 

		June 30, 2009
Commitments to extend credit		$	49,386,000
Letters of credit			4,367,000
		$	53,753,000

 

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer.

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral is required in instances which we deem necessary.

Financial Condition

Following is a summary of our balance sheets for the periods indicated:

 

		Restated June 30, 2009			December 31, 2008
		(Dollars in Thousands)
Cash and due from banks		$	14,652		$	14,039
Interest-bearing deposits in banks			56,160			1,500
Federal funds sold			—			14,300
Securities			74,109			65,460
Loans, net			481,302			515,878
Loans held for sale			853			—
Premises and equipment			9,730			9,776
Other real estate			28,037			18,398
Other assets			8,835			16,526
		$	673,678		$	655,877
Total deposits		$	627,481		$	590,477
Other borrowings			1,935			2,598
Other liabilities			3,853			3,460
Stockholders’ equity			40,409			59,342
		$	673,678		$	655,877

 

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Our assets increased by 2.71% for the first six months of 2009. Net loans decreased by $34.6 million, primarily due to the transfer of approximately $14 million to other real estate owned, net of writedowns, as a result of foreclosures during the first six months of 2009 as well as the charge-off of $16.5 million in loans. Total deposits increased $37 million during the first six months of 2009. The increase was $15.2 million in the first quarter and $21.7 million in the second quarter. The second quarter increase in deposit accounts were primarily a result of an increase in brokered certificates of deposit of approximately $22.2 million, coupled with decreases in retail certificates of deposit, interest bearing checking, savings and demand deposits of $.5 million. Our total equity has decreased by $18.9 million year to date as a result of a year to date loss in the amount of $18.7 million which includes a provision for loan losses in the amount of $13.9 million and the writedown and loss on sales of bank owned real estate in the amount of $2.3 million as well as the reversal of interest income on non-performing loans in the amount of $2.8 million.

Results of Operations For The Three and Six Months Ended June 30, 2009 and 2008

Following is a summary of our operations for the periods indicated.

 

		Three Months Ended June 30,
		Restated 2009				2008
		(Dollars in Thousands)
Interest income		$	3,919			$	8,584
Interest expense			3,804				4,964
Net interest income			115				3,620
Provision for loan losses			12,340				1,526
Other income			731				738
Other expense			4,857				3,772
Pretax loss			(16,351	)			(940	)
Income taxes (benefit)			—				(503	)
Net loss		$	(16,351	)		$	(437	)

 

		Six Months Ended June 30,
		Restated 2009				2008
		(Dollars in Thousands)
Interest income		$	10,476			$	19,729
Interest expense			7,654				10,891
Net interest income			2,822				8,838
Provision for loan losses			13,940				2,636
Other income			1,366				1,450
Other expense			8,976				6,861
Pretax income (loss)			(18,728	)			791
Income taxes			—				138
Net income (loss)		$	(18,728	)		$	653

Our second quarter results were highlighted by increased provisions for loan losses and compressed net interest margins, which together contributed to a net loss of $16.4 million, or $(1.15) per share. These factors have also contributed to the net loss for the first 6 months of 2009. Net loss for the six months ending June 30, 2009 was $18.7 million, or $(1.31) per share compared to earnings of $653,504 or $0.05 per share for the same period in 2008.

 

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Our net interest income decreased by $3.505 million and $6.016 million in the second quarter and first six months of 2009 respectively compared to the same periods in 2008. Our net yield on average interest-earning assets decreased to 0.92% in the first six months of 2009 as compared to 2.67% in the first six months of 2008. Our increasing levels of nonperforming loans have negatively affected our net interest margin. We have reversed approximately $3.3 million in interest income on loans placed on nonaccrual during the first six months of 2009, effectively lowering our net yield on average earning assets by 33 basis points. An additional impact to interest income is a result of reversal of previously recorded income required by regulatory authorities of approximately $2.3 million in interest income that had been paid by certain borrowers using fully secured lines of credit to support interest payments due on other loans. We have been informed that the current regulatory policy disallows the recording of interest income if advances on the borrower’s credit lines are used to make scheduled interest payments on other or related indebtedness. Interest income recognition is disallowed even if the credit line has independent collateral with no collateral deficiency and is serviced separately from other debt of the borrower. As a result of the regulatory requirement, in the first six months the bank reversed $2.3 million in interest income, including some prior period income that was attributed to borrowers’ use of available credit lines for interest payments. Net cost on interest-bearing liabilities decreased to 2.70% during the first six months of 2009 compared to 3.99% for the same period in 2008. The decrease in interest expense is largely the result of a lower cost of funds during the first six months of 2009.

The provision for loan losses amounted to $12,340,000 and $13,940,000 for the second quarter and first six months of 2009, respectively. The amounts provided are indicative of our assessment of the inherent risk in the loan portfolio at June 30, 2009. The allowance for loan losses as a percentage of total loans was 3.06% at June 30, 2009 as compared to 3.32% at December 31, 2008. The allowance for loan losses is maintained at a level that is deemed appropriate by management to adequately cover all known and inherent risks in the loan portfolio. Our evaluation of the loan portfolio includes a continuing review of loan loss experience, current economic conditions which may affect the borrower’s ability to repay and the underlying collateral value. Please see the information in the following sections for a further discussion of our allowance for loan losses methodology.

The following table shows our nonperforming assets for the periods ended June 30, 2009, December 31, 2008, and June 30, 2008:

 

		June 30, 2009			December 31, 2008			June 30, 2008
		(Dollars in Thousands)
Nonaccrual loans		$	98,461		$	77,804		$	50,045
Loans contractually past due ninety days or more as to interest or principal payments and still accruing			8,873			20,066			4,682
Restructured loans			0			0			0
Total nonperforming loans		$	107,334		$	97,870		$	54,727
Other real estate			28,037			18,398			16,666
Total nonperforming assets		$	135,371		$	116,268		$	71,393

Nonperforming assets consist of nonaccrual loans, loans restructured due to the debtors’ financial difficulties, loans past due 90 days or more as to interest or principal and still accruing, and other real estate owned, which is real estate acquired through foreclosure. Nonaccrual loans are those loans on which recognition of interest income has been discontinued. Restructured loans generally allow for an extension of the original repayment period or a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower.

 

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When management believes there is sufficient doubt to the collectability of principal or interest on any loan, or generally when loans are 90 days or more past due, the accrual of interest is discontinued and the loan is designated as nonaccrual, unless the loan is well secured and in the process of collection. Interest payments received on nonaccrual loans are either applied against principal or reported as income according to management’s judgment as to the collectability of principal. Loans are returned to an accrual status when those factors that indicated doubtful collectability on a timely basis no longer exist. Other real estate owned is initially recorded at the lower of cost or estimated market value at the date of acquisition. A provision for estimated losses is recorded when a subsequent decline in value occurs.

Nonperforming assets at June 30, 2009 amounted to approximately $135.4 million, or 25.77% of total loans and other real estate. This compares to approximately $116.3 million or 20.53% of total loans and other real estate at December 31, 2008. The increase in nonperforming assets is attributable to the significant slowdown in residential real estate sales that began in the summer of 2007 and has continued through the first half of 2009. With the significant slowing of home and land sales, the prices of homes and land have declined. Therefore, many of our customers who develop and sell residential real estate cannot service their loans because they are not generating sufficient revenue, resulting in the significant increase in nonaccrual loans. In addition, due to regulatory policy with regard to the use of credit lines used for funding interest payments, the company placed an additional $29.5 million of its loan portfolio into non-accrual status at June 30, 2009

Nonaccrual loans increased by $20.65 million or 26% during the six month period ended June 30, 2009. There was significant movement within these loans during the quarter as $49.7 million went on nonaccrual status, $13.9 million went into foreclosure, and $15.2 million were charged off. The ten largest nonaccrual loan relationships comprise $58.2 million or 59% of the total and all are collateralized primarily by residential real estate. During the first six months of 2009, regulatory policy on use of credit lines for payment of interest on loans caused the bank to place approximately $29.5 million additional loans in a non-performing status. A number of these borrowers may well have other ability to service their debt and as credit lines are replaced by cash reserves or other independent means of servicing their debt the bank expects some of these loans to be returned to performing status.

Other real estate owned increased by $9.6 million, or 52% during the six month period ended June 30, 2009. During the first six months of 2009, we foreclosed on $16.4 million of real estate, net of write downs of $1.7 million, and sold $5.1 million of real estate. The total balance of $28.03 million at June 30, 2009 is distributed as follows; residential development (70%), homes and lots (21%) and commercial real estate (9%). While the bank has used what it believes are appropriate value methodologies for evaluating the risk of loss in the portfolio, the current real estate environment in the bank’s market is very illiquid, primarily with regard to land and vacant developed lots. This type of property is the underlying collateral for 91% of the bank’s non-performing assets and there is no certainty that these properties can be liquidated for the carrying cost.

Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been included in the table above do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. These classified loans do not represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

 

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Information regarding certain loans and allowance for loan loss data through June 30, 2009 and 2008 is as follows:

 

		Six Months Ended June 30,
		Restated 2009				2008
		(Dollars in Thousands)
Average amount of loans outstanding		$	513,541			$	564,527
Balance of allowance for loan losses at beginning of period		$	17,730			$	7,657
Loans charged off
Real estate			(16,544	)			(60	)
Commercial			(18	)			—
Consumer installment			—				(16	)
			(16,562	)			(76	)
Loans recovered
Real estate			51				—
Commercial			—				—
Consumer installment			11				2
			62				2
Net (charge-offs)/ recoveries			(16,500	)			(74	)
Additions to allowance charged to operating expense during period			13,940				2,636
Balance of allowance for loan losses at end of period		$	15,170			$	10,219
Ratio of net loans charged off during the period to average loans outstanding			3.23	%			.01	%

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The provision for loan losses is based on management’s evaluation and assessment of the allowance for loan losses. This assessment includes procedures to estimate probable losses and determine the adequacy and appropriateness of the resulting allowance balance. The allowance for loan losses consists of two components: (1) a specific amount representative of identified credit exposures for each impaired loan based on an evaluation of the borrower and the underlying collateral (SFAS 114 component); and (2) a general amount based upon historical losses that have been adjusted to estimate current probable losses based on the use of eight specific risk factors representative of various economic conditions and characteristics of the loan portfolio, as well as additional general qualitative factors (SFAS 5 component).

 

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We establish the specific amount by examining all impaired loans. Under generally accepted accounting principles, we may measure the loss either by (1) the observable market price of the loan; or (2) the present value of expected future cash flows discounted at the loan’s effective interest rate; or (3) the fair value of the collateral if the loan is collateral dependent. Because the significant majority of our impaired loans are collateral dependent, nearly all of our specific allowances are calculated on the fair value of the collateral. As of June 30, 2009, our impaired loans totaled $165 million of which $50.95 million have specific loss allocations of $5.1 million recorded. As of December 31, 2008, our impaired loans totaled $94.4 million of which $46.8 million had specific loss allocations of $12.5 million. The increase in impaired loans over the prior period is primarily attributable to regulatory policy with regard to credit lines used to fund interest and the bank’s inclusion of currently performing loans in the amount of $20.8 million, which the bank carries as collateral dependent impaired loans until the loans meet certain performance standards, typically for at least a six month period. None of these performing loans have allocated reserves due to a collateral deficiency. Changes in nonperforming loans contributed to the increases in the loan loss provision for the six month period ended June 30, 2009. During the six month period ended June 30, 2009, the impaired loan allowances were reduced by $7.4 million. This reduction is primarily a result of impaired loans being foreclosed upon and loans charged off. The remaining changes in the impaired loan allowances were the result of changes in loans considered to be impaired. As previously discussed, nonperforming loans are concentrated in our residential construction and land development portfolio.

The general amount of the allowance is based upon historical losses that are adjusted to estimate current probable losses using eight specific risk factors. The risk factors consist of: (1) economic factors including such matters as changes in the general economic conditions; (2) changes in local economic conditions; (3) concentrations of credit; (4) deterioration in asset values; (5) slowing pace of housing sales; (6) deterioration in lot values; (7) higher loan to values given risk; and (8) level of loans secured by real estate. These factors are evaluated and assigned percentages to be allocated to the portfolio, exclusive of the SFAS 114 component, on a quarterly basis. During the second quarter of 2009 the company changed the historical component of the reserve calculation to use only the most recent 6 quarters loss experience in calculating probable future losses. The company also added a qualitative factor to adjust the pools against which the historical component was applied. This qualitative factor considers loans that were specifically evaluated for risk of loss due to the adequacy of their collateral protection. The historical loss component had previously been based on the most recent 5 year loss history. The weighting of these risk factors varies from period to period and will impact the allowance for loan losses as changes in the risk factors increase or decrease from quarter to quarter. During the quarter ended June 30, 2009, changes in risk factors did not result in a significant change in the general amount of the allowance.

The Company has originated construction and land development loans where a component of the cost of the project was the interest required to service the debt during the construction period of the loan, sometimes known as interest reserves. The Company allows disbursements of this interest component as long as the project is progressing as originally projected and if there has been no deterioration of the financial standing of the borrower or the underlying project. If the Company makes a determination that there is such deterioration, or if the loan becomes non performing, the Company halts any disbursement of those funds identified for use in paying interest. In some cases, additional interest reserves may be taken by use of deposited funds.

Noninterest income

Other income was $731,340 and $1,366,439 for the second quarter and first six months of 2009, respectively, as compared to $738,266 and $1,450,461 for the same periods in 2008. The first quarter decreased by $77,096 from the prior period while the second quarter decreased by only $6,926. The change in this trend is primarily attributable to the introduction of a courtesy overdraft privilege program in the second quarter which has increased insufficient funds charges.

 

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Noninterest expense

Other expenses have increased by $2.1 million in the first six months of 2009 as compared to the first six months of 2008. Other expenses have increased as a result of increases in other real estate writedowns of $1.3 million; increased cost to hold owned real estate and increased FDIC insurance costs of $1 million. Other components of the change in other expenses was a decrease in salaries and other benefits of $290 thousand, primarily due to reductions in incentive and profit sharing accruals, and reduced occupancy expense of $100 thousand

Income Taxes

The company has operated at a loss during 2009 with no income tax benefits being recorded due to uncertainty as to the realizability of such benefits.

We are not aware of any known trends, events or uncertainties, other than the effect of events as described above that will have or are reasonably likely to have a material effect on our liquidity, capital resources or operations. We are also not aware of any current recommendations by the regulatory authorities which, if they were implemented, would have such an effect.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed only to U.S. dollar interest rate changes and accordingly, we manage exposure by considering the possible changes in the net interest margin. We do not have any trading instruments nor do we classify any portion of the investment portfolio as held for trading. We do not engage in any hedging activities or enter into any derivative instruments with a higher degree of risk than mortgage-backed securities that are commonly pass through securities. Finally, we have no exposure to foreign currency exchange rate risk, commodity price risk, and other market risks. Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as “interest rate risk.” The repricing of interest earning assets and interest-bearing liabilities can influence the changes in net interest income. As part of our asset/liability management program, the timing of repriced assets and liabilities is referred to as Gap management. It is our policy to maintain a Gap ratio in the one-year time horizon of .80 to 1.20.

GAP management alone is not enough to properly manage interest rate sensitivity, because interest rates do not respond at the same speed or at the same level to market rate changes. For example, savings and money market rates are more stable than loans tied to a “Prime” rate and thus respond with less volatility to a market rate change.

We use a third party simulation model to monitor changes in net interest income due to changes in market rates. The model of rising, falling and stable interest rate scenarios allow management to monitor and adjust interest rate sensitivity to minimize the impact of market rate swings. The analysis of impact on net interest margins as well as market value of equity over a twelve-month period is subjected to a 200 basis point increase and decrease in rates. Our investment committee monitors changes on a quarterly basis, measures the changing values based on the model’s performance and determines an appropriate interest rate policy for management to follow in order to minimize the impact on earnings and market value equity in the projected rate environment.

 

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ITEM 4.

CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer also acting as the Principal Financial and Accounting Officer, of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures are effective. In connection with the new rules, we are in the process of further reviewing and documenting our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes designed to enhance their effectiveness and to ensure that our systems evolve with our business.

There have been no changes in our internal controls or in other factors that could affect internal controls subsequent to the date of this evaluation, and there have been no corrective actions with respect to significant deficiencies or material weaknesses.

Subsequent to the date of this evaluation, we determined that the validation testing, including frequency thereof, performed on the financial models used in the preparation and analysis of our allowance for loan losses was ineffective, and this material weakness resulted in an error in the calculation of the general portion of our allowance not being detected in a timely manner.

 

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II—OTHER INFORMATION

 

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K.

 

(a)

Exhibits.

 

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32		Certification of the Chief Executive Officer and Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

				HENRY COUNTY BANCSHARES, INC.
				(Registrant)
DATE: November 17, 2009				BY:		/s/ David H. Gill
						David H. Gill, President and CEO
						(Principal Executive Officer)
DATE: November 17, 2009				BY:		/s/ David H. Gill
						David H. Gill, Acting CFO
						(Principal Financial and Accounting Officer)

 

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