SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009.
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ___________________
Commission file number 0-13153
(Exact name of registrant as specified in its charter)
Registrant's telephone number, including area code: (706) 778-1000
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $1.00 par value
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports under Section 13 or Section 15(d) of the Act.
Yes o No x
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 o
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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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Exchange Act Rule 12b-2:
(do not check if a 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 o No x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked prices of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
1,612,733 Shares of Common Stock, $1.00 par value--$5,031,727 as of June 30, 2009 (based upon market value of $3.12 /share as of that date).
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of March 22, 2010.
Common Stock, $1.00 par value--2,818,593 shares
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Company's Annual Report to Shareholders for the year ended December 31, 2009 (the “Annual Report”) are incorporated by reference into Part II.
(2) Portions of the Company's Proxy Statement relating to the 2010 Annual Meeting of Shareholders (the “Proxy Statement”) are incorporated by reference into Part III.
Item 1. BUSINESS.
History of the Company
Habersham Bancorp (the "Company"), a Georgia corporation, was organized on March 9, 1984. Effective December 31, 1984, the Company acquired all of the outstanding shares of common stock of Habersham Bank ("Habersham Bank" or the "Bank"). As a result of this transaction, the former shareholders of Habersham Bank became shareholders of the Company, and Habersham Bank became the wholly-owned subsidiary of the Company. Habersham Bank has one subsidiary, Advantage Insurers, Inc., a property, casualty and life insurance agency organized in 1997 which was sold December 30, 2009.
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Business of the Bank
Habersham Bank is a financial institution organized under the laws of the State of Georgia in 1904. Habersham Bank operates a full-service commercial banking business based in Habersham, White, Cherokee, Warren, Stephens, Forsyth and Hall Counties, Georgia, providing such customary banking services as checking and savings accounts, various types of time deposits, safe deposit facilities and individual retirement accounts. It also makes secured and unsecured loans and provides other financial services to its customers. Habersham Bank has a full-time trust officer on staff and offers a full spectrum of trust services, including trust administration, asset management services, estate and will probate and administration, and other services in the area of personal trusts.
The banking industry is highly competitive. During the past several years, legislation and regulatory changes, together with competition from unregulated entities, has resulted in the elimination of many traditional distinctions between commercial banks, thrift institutions and other providers of financial services. Consequently, competition among financial institutions of all types is virtually unlimited with respect to legal ability and authority to provide most financial services.
Habersham Bank's primary market area consists of Habersham, White, Cherokee, Warren, Stephens, Forsyth and Hall Counties, Georgia. Habersham Bank competes principally for all types of loans, deposits and other financial services with large regional banks and other community banks located in its primary market area. To a lesser extent, Habersham Bank competes for loans with insurance companies, regulated small loan companies, credit unions, and certain governmental agencies.
The Company and its non-bank subsidiary, Advantage Insurers, also competed with numerous other insurance agencies offering property, casualty and life insurance. Advantage Insurers was sold December 30, 2009.
See “Risk Factors – Competition from Other Financial Institutions May Adversely Affect our Profitability.”
As of December 31, 2009, the Company had 104 full-time equivalent employees. Neither the Company nor any of its subsidiaries is a party to any collective bargaining agreement. In the opinion of management, the Company and its subsidiaries enjoy satisfactory relations with their respective employees.
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SUPERVISION AND REGULATION
We are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of our operations. These laws generally are intended to protect depositors and not shareholders. Legislation and regulations authorized by legislation influence, among other things:
Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.
Because we own all of the capital stock of Habersham Bank, we are a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company located in Georgia, the GDBF also regulates and monitors all significant aspects of our operations.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if we are adequately capitalized and adequately managed, we or any other bank holding company located in Georgia may purchase a bank located outside of Georgia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Georgia may purchase a bank located inside of Georgia. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. Currently, Georgia law prohibits acquisitions of banks that have been chartered for less than three years. Because the Bank has been chartered for more than three years, this restriction would not limit our ability to sell.
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Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of the bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is also rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
Our common stock is registered under Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenging rebuttable presumptions of control.
Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities.
To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, the Company must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days’ written notice prior to engaging in a permitted financial activity. The Company does not meet the qualification standards applicable to financial holding companies at this time.
Support of Subsidiary Institutions. Under Federal Reserve policy, we are expected to act as a source of financial strength and commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy, we might not be inclined to provide it. In addition, any capital loans made by us to Bank will be repaid only after its deposits and various other obligations are repaid in full. In the event of our bankruptcy, any commitment we would give to a federal banking regulator to maintain the capital of the Bank would be assumed by the bankruptcy trustee and entitled to a priority of payment.
Current Restrictions on Activities. On March 10, 2010, the Federal Reserve advised the Company that prior approval would be required before the Company:
Incurs any indebtedness;
Distributes interest or principal on trust preferred securities;
Declares or pays any dividends;
Redeems any corporate stock; or
Makes any other payment representing a reduction in capital except for normal operating expenses.
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Because the Bank is a commercial bank chartered under the laws of the State of Georgia, we are primarily subject to the supervision, examination and reporting requirements of the FDIC and the Georgia Department of Banking & Finance (the “GDBF”). The FDIC and the GDBF regularly examine the Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Additionally, our deposits are insured by the FDIC to the maximum extent provided by law. We are also subject to numerous state and federal statutes and regulations that affect our business, activities and operations.
Branching. Under current Georgia law, we may open branch offices throughout Georgia with the prior approval of the GDBF. In addition, with prior regulatory approval, we may acquire branches of existing banks located in Georgia. The Bank and any other national or state-chartered bank generally may branch across state lines only if allowed by the applicable states’ laws. Georgia law, with limited exceptions, currently permits branching across state lines only through interstate mergers.
Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Currently, Georgia has not opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia. This provides a limited barrier of entry into the Georgia banking market, which protects us from an important segment of potential competition. However, because Georgia has elected not to opt-in, our ability to establish a new start-up branch in another state may be limited. Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if their home state has also elected to opt-in. Consequently, until Georgia changes its election, the only way we will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories in which all institutions are placed: Well Capitalized, Adequately Capitalized, Undercapitalized, Significantly Undercapitalized and Critically Undercapitalized.
As a bank’s capital condition deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. As of December 31, 2009, the Bank was considered significantly undercapitalized.
A “well-capitalized” bank is one that exceeds all of its required capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6% and a tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices or has not adequately corrected a prior deficiency.
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An “adequately capitalized” bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a tier 1 risk-based capital ratio of at least 4% and a tier 1 leverage ratio of at least 4%. A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the FDIC. Institutions that are not well-capitalized are also prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC. In addition, an adequately capitalized bank may be forced to comply with certain operating restrictions similar to those placed on undercapitalized banks.
An “undercapitalized” bank fails to meet the required minimum level for any relevant capital measure. A bank that reaches the undercapitalized level is likely subject to a consent order and other formal supervisory sanctions. An undercapitalized bank must submit a capital restoration plan to regulatory authorities; be closely monitored by regulatory authorities regarding its capital restoration plan, financial condition and operational restrictions; restrict asset growth in accordance with an approved capital restoration plan; and obtain prior regulatory approval for acquisitions, branching and new lines of business. In addition, an undercapitalized bank becomes subject to additional discretionary safeguards that may be imposed by its regulatory authorities, which may:
A “significantly undercapitalized” bank, in addition to being subject to the restrictions applicable to undercapitalized institutions, is subject to additional restrictions on the compensation it is able to pay to its senior executive officers. See “—Regulatory Order” for specific requirements imposed on the Bank by its regulatory authorities.
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A “critically undercapitalized” bank, in addition to being subject to the restrictions applicable to undercapitalized and significantly institutions, is further prohibited from doing any of the following without the prior written approval of the FDIC:
In addition, the FDIC may impose additional restrictions on critically undercapitalized institutions consistent with the intent of the prompt corrective action regulations. Once an institution has become critically undercapitalized, the FDIC will, subject to certain narrow exceptions such as a material capital remediation, initiate the resolution of the institution.
Regulatory Order. On June 24, 2009, the Bank entered into an Order to Cease and Desist (the “Order”) with the GDBF. The Regional Director of the FDIC acknowledged the Order, which became effective 10 days after issuance. The Order is based on the findings of the Department during an on-site examination conducted as of September 22, 2008.
Under the terms of the Order, the Bank is required to prepare and submit written plans and/or reports to the regulators that address the following items: maintaining sufficient capital at the Bank; improving the Bank’s liquidity position and funds management practices; reducing adversely classified items; reviewing and revising as necessary the Bank’s allowance for loan and lease losses policy; continuing to improve loan underwriting, loan administration, and portfolio management; reducing concentrations of credit; and revising and implementing a profitability plan and comprehensive budget to improve and sustain the Bank’s earnings. While the Order remains in place, the Bank may not pay cash dividends or bonuses without the prior written consent of its regulators. The Bank’s management team and Board of Directors have taken aggressive steps to address the requirements of the Order and the findings of the on-site examination, including but not limited to submitting a capital plan; reporting and maintaining the Bank’s liquidity position; reducing classified assets and concentrations; and reviewing and revising where appropriate the Bank’s policies and procedures in the areas identified above.
The text of the Order is incorporated herein by reference as Exhibit 10.24.
FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the amount permitted by law. The Bank is thus subject to FDIC deposit insurance premium assessments. The FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information – supervisory risk ratings for all institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have such ratings. In February 2009, the FDIC issued new risk based assessment rates that took effect April 1, 2009. For insured depository institutions in the lowest risk category, the annual assessment rate ranges from 7 to 77.5 cents for every $100 of domestic deposits. For institutions assigned to higher risk categories, the new assessment rates range from 17 to 43 cents per $100 of domestic deposits. These ranges reflect a possible downward adjustment for unsecured debt outstanding and possible upward adjustments for secured liabilities and, in the case of institutions outside the lowest risk category, brokered deposits.
The FDIC’s assessment rates are intended to result in a reserve ratio of at least 1.15%. By December 31, 2009, the ratio had fallen well below this floor. The FDIC is required to return the DIF to its statutorily mandated minimum reserve ratio of 1.15 percent within eight years, and has undertaken several initiatives to satisfy this requirement.
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On September 30, 2009, the FDIC collected a one-time special assessment of five basis points of an institution’s assets minus tier 1 capital as of June 30, 2009. The amount of the special assessment could not exceed ten basis points times the institution’s assessment base for the second quarter 2009. In addition, on November 12, 2009, the FDIC adopted a rule that required nearly all FDIC-insured depository institutions to prepay their DIF assessments for the fourth quarter of 2009 and for the next three years. The FDIC has indicated that the prepayment of DIF assessments will be in lieu of additional special assessments, although there can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (“FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2009 ranged from 1.14 cents to 1.02 cents per $100 of assessable deposits. These assessments will continue until the debt matures in 2017 through 2019.
The FDIC may, without further notice-and-comment rulemaking, adopt rates that are higher or lower than the stated base assessment rates, provided that the FDIC cannot (i) increase or decrease the total rates from one quarter to the next by more than three basis points, or (ii) deviate by more than three basis points from the stated assessment rates. The FDIC has proposed maintaining current assessment rates through December 31, 2010, followed by a uniform increase in risk-based assessment rates of three basis points effective January 1, 2011.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
FDIC Temporary Liquidity Guarantee Program. On October 14, 2008, the FDIC announced that its Board of Directors, under the authority to prevent “systemic risk” in the U.S. banking system, approved the Temporary Liquidity Guarantee Program (“TLGP”). The purpose of the TLGP is to strengthen confidence and encourage liquidity in the banking system. The TLGP is composed of two components, the Debt Guarantee Program and the Transaction Account Guarantee Program, and institutions had the opportunity, prior to December 5, 2008, to opt-out of either or both components of the TLGP.
The Debt Guarantee Program: Under the Temporary Liquidity Guarantee Program, the FDIC is permitted to guarantee certain newly issued senior unsecured debt issued by participating financial institutions. The annualized fee that the FDIC will assess to guarantee the senior unsecured debt varies by the length of maturity of the debt. For debt with a maturity of 180 days or less (excluding overnight debt), the fee is 50 basis points; for debt with a maturity between 181 days and 364 days, the fee is 75 basis points, and for debt with a maturity of 365 days or longer, the fee is 100 basis points. The Bank did not opt-out of the Debt Guarantee component of the TLGP.
The Transaction Account Guarantee Program: Under the TLGP, the FDIC is permitted to fully insure non-interest bearing deposit accounts held at participating FDIC-insured institutions, regardless of dollar amount. The temporary guarantee was originally set to expire on June 30, 2009, but was subsequently extended to June 30, 2010. For the eligible noninterest-bearing transaction deposit accounts (including accounts swept from a noninterest bearing transaction account into an noninterest bearing savings deposit account), a 10 basis point annual rate surcharge will be applied to noninterest-bearing transaction deposit amounts over $250,000. Institutions will not be assessed on amounts that are otherwise insured. The Bank chose not to opt-out of the Transaction Account Guarantee component of the TLGP.
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Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking regulators shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Bank’s financial statements and regulatory reports. Because of its significance, the Bank has developed a system by which it develops, maintains and documents a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the Bank’s stated policies and procedures, management’s best judgment and relevant supervisory guidance. Consistent with supervisory guidance, the Bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the collectability of the portfolio as of the evaluation date.
Commercial Real Estate Lending. The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans, and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:
Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. Our loan operations will be subject to federal laws applicable to credit transactions, such as the:
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The Bank’s deposit operations are subject to federal laws applicable to depository accounts, such as the:
We are required to comply with the capital adequacy standards established by the Federal Reserve. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for member banks and bank holding companies.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets, and classification as adequately capitalized, is 8%. A bank that fails to meet the required minimum guidelines is classified as undercapitalized and subject to operating and managerial restrictions. A bank, however, that exceeds its capital requirements and maintains a ratio of total capital to risk-weighted assets of 10% is classified as well capitalized.
Total capital consists of two components: Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common shareholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. To be adequately capitalized, Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and hybrid capital, and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital.
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The Bank’s ratio of total capital to risk-weighted assets and ratio of Tier 1 Capital to risk-weighted assets were 5.69% and 4.41%, respectively, as of December 31, 2009. As a result of our regulatory capital ratios, we were considered "significantly undercapitalized” by our bank regulatory authorities on December 31, 2009. As described above, an adequately capitalized bank is subject to certain restrictions on its operations and an undercapitalized, significantly undercapitalized or critically undercapitalized bank is subject to extensive operational restrictions.
The Federal Reserve has similarly established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2009, our leverage ratio was 3.08%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.
Failure to meet capital guidelines can subject a bank and a bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits and certain other restrictions on its business. As described above and elsewhere throughout this report, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements. See, “Supervision and Regulation – Habersham Bank – Prompt Corrective Action,” above, for a summary of the restrictions to which we would become subject should our capital condition deteriorate significantly.
The Company is a legal entity separate and distinct from the Bank. It is the policy of the Federal Reserve that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if the prospective earnings retention rate is consistent with the organization's expected future needs and financial condition. Additionally, a March 10, 2010 letter from the Federal Reserve states that the Company may not pay any dividends without prior Federal Reserve approval.
The principal sources of our cash flow, including cash flow to pay dividends to our shareholders, are dividends that we receive from the Bank. Statutory and regulatory limitations apply to the payment of dividends by a subsidiary bank to its bank holding company. The Bank is required to obtain prior approval of the GDBF if the total of all dividends declared by the Bank in any year will exceed 50% of the Bank’s net income for the prior year. Our payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, administrative agreements with or actions taken by our primary regulators may impose additional restrictions on our ability to pay dividends. Based on the foregoing, and under the terms of the Order, the Bank could not pay cash dividends without prior regulatory approval. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on the statutory and regulatory factors mentioned above.
If, in the opinion of the federal banking regulator, the Bank was engaged in or about to engage in unsafe or unsound practice, the federal banking regulator could require, after notice and a hearing, that we stop or refrain from engaging in the practice it considers unsafe or unsound. The federal banking regulators have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal banking regulators have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
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Restrictions on Transactions with Affiliates
The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. We must also comply with other provisions designed to avoid the taking of low-quality assets.
We are subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
We are subject to restrictions on extensions of credit to our executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Effect of Governmental Monetary Policies
The Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks, and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
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Item 1A. RISK FACTORS
An investment in the Company’s common stock involves a high degree of risk. If any of the following risks other risks, which have not been identified of which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Investors should consider carefully the risks described below and the other information in this report before deciding to invest in the Company’s common stock.
Our independent registered public accounting firm’s report discloses a going concern issue for the Company.
Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. However, due to our financial results, the substantial uncertainty throughout the U.S. banking industry and other matters discussed in this report, our independent public accountants have expressed in their opinion on our Consolidated Financial Statements included in this report that a substantial doubt exists regarding the Company’s ability to continue as a going concern. Management’s plans in addressing the issues that raise substantial doubt regarding the Bank’s ability to continue as a going concern are addressed in Note 3 of the Notes to Consolidated Financial Statements. See “—We are subject to heightened regulatory scrutiny and are currently under a regulatory order that imposes additional requirements and restrictions on our business” below and “Supervision and Regulation—Prompt Corrective Action” for a discussion of the regulatory restrictions and requirements to which we are currently subject.
We are subject to heightened regulatory scrutiny and the Bank is currently under a consent order that imposes additional requirements and restrictions on our business.
We are primarily regulated by the Federal Reserve, the FDIC and the GDBF. Our compliance with Federal Reserve, FDIC and GDBF regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements of our regulators.
Based on the results of our September 22, 2008 regulatory examination, particularly with respect to our levels of capital and classified assets, the GDBF and FDIC have required the Bank to enter into a Cease and Desist Order. The order includes provisions requiring reductions in classified assets, improvements in liquidity and funds management practices, maintenance of an appropriate allowance for loan losses and specified capital ratios, dividend and bonus restrictions, amendments to our policies and frequent progress reports to regulatory authorities, as well as other provisions to help us improve our financial condition and profitability. Under the order, the Bank must achieve and maintain total risk-based capital at or above 10% of total risk-weighted assets, and Tier 1 capital at or above 8% of total assets. If we do not comply with the terms of this order, we could face additional regulatory sanctions or civil money penalties. See “Supervision and Regulation—Regulatory Order” for a further description of the order.
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In addition, we are currently classified as "significantly undercapitalized" for regulatory capital purposes. As a result, we are subject to enhanced regulatory supervision, both under the order described above and under FDIC regulations. For example, we must obtain regulatory approval to add or replace directors or executive officers; obtain prior regulatory approval for new business lines, acquisitions, branch purchases and other significant transactions; submit a capital restoration plan for regulatory review; and comply with regulatory limitations on the amount of severance or “golden parachute” payments we are permitted to make. We are also unable to accept, renew or roll over brokered deposits absent a waiver from the FDIC. This limits our access to funding sources and could adversely affect our liquidity and net interest margin. As of December 31, 2009, we had approximately $48.9 million in out of market deposits, including brokered deposits, which represented approximately 12.53% of our total deposits. If we are unable to continue to attract deposits and maintain sufficient liquidity, our ability to meet our obligations, including the payout of deposit accounts would be adversely affected. If our liquidity becomes severely impaired and we are unable to meet our financial obligations, including the payout of deposit accounts, or if our capital levels become unacceptable to our banking regulators, the Bank could be placed into receivership and you could lose the entire amount of your investment.
Additionally, we are prohibited from paying rates in excess of 75 basis points above the local market average on deposits of comparable maturity. Effective January 1, 2010, financial institutions that are not well capitalized are prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a new national average rate for deposits of comparable maturity, as calculated by the FDIC. This national rate may be lower than the prevailing rates in our local market, and although the FDIC has permitted us to use the local market rate, the FDIC could revoke this determination in the future. If restrictions on the rates we are able to pay on deposit accounts negatively impacts our ability to compete for deposits in our market area, we may be unable to attract or maintain core deposits, and our liquidity and ability to support demand for loans could be adversely affected.
The company is also subject to regulatory restrictions on its operations. The Federal Reserve has notified the Company in a letter dated March 10, 2010 that the Company must obtain Federal Reserve approval before incurring indebtedness, paying interest or dividends on trust preferred securities, declaring or paying any dividends, redeeming corporate stock, or making other payments representing a reduction in capital outside of normal operating expenses.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks, our cost of compliance could adversely affect our ability to operate profitably.
Declines in real estate values have adversely affected our credit quality and profitability.
During 2008 and 2009, confidence in the credit market for residential housing finance significantly eroded, which resulted in a reduction in financing available to buyers of new homes and borrowers wishing to refinance existing financing terms. The tightening of credit for residential housing led to lower demand for residential housing and more foreclosures, and has reduced the absorption rate for new and existing properties. In turn, this tightening of credit has caused market prices to fall as some property owners, including lenders who acquired property by foreclosure, have accepted lower prices to reduce their exposure to these real estate assets, which has reduced the market values for comparable real estate.
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The declines in values and the increased level of marketing required to sell properties has reduced or eliminated the potential profits to many of the builders and developers of properties to whom we have extended loans. As a result, some of these borrowers have been unable to repay their loans in accordance with their terms, which has led to an increase in our past due and non-performing loans. If these housing trends continue or exacerbate, the Company expects that it will continue to experience increased delinquencies and credit losses. In addition, declining real estate and other asset values may reduce the available equity associated with these assets, which, in turn, would limit the ability of borrowers to use such equity to support borrowings.
Moreover, if the current recession continues, the Company may be required to further increase our loan loss provision, and may experience significantly higher delinquencies and credit losses. An increase in our loan loss provision or increased credit losses would reduce earnings and adversely affect the Company’s financial condition. Furthermore, to the extent that real estate collateral is obtained through foreclosure, the costs of holding and marketing the real estate collateral, as well as the ultimate values obtained from disposition, could reduce the Company’s earnings and adversely affect the Company’s financial condition. The Company’s business volume and growth is affected by the rate of growth and demand for housing in specific geographic markets, and most of its loans are secured by real estate located in northern Georgia, which is continuing to experience high rates of foreclosures and declining real estate prices and property values.
Based on the activity discussed above, the Company’s future rate of growth, if any, could be significantly less than its historical levels and its assets may in fact shrink, depending on the duration and extent of the current disruption in the housing and mortgage markets.
We make and hold in our portfolio a significant number of land acquisition and development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions.
We offer land acquisition and development, and construction loans for builders and developers. As of December 31, 2009, approximately $107.7 million, or 38.89%, of our total loan portfolio represented loans for which the related property is neither presold nor preleased. These land acquisition and development, and construction loans are considered more risky than other types of loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting, project risks, and market risks. Project risks include cost overruns, borrower credit risk, project completion risk, general contractor credit risk, and environmental and other hazard risks. Market risks are risks associated with the sale of the completed residential units. They include affordability risk, which means the risk that borrowers cannot obtain affordable financing, product design risk, and risks posed by competing projects. There can be no assurance that losses in our land acquisition and development and construction loan portfolio will not exceed our reserves, which could adversely impact our earnings. Given the current environment, the non-performing loans in our land acquisition and development and construction portfolio could increase substantially in 2010, and these non-performing loans could result in a material level of charge-offs, which will negatively impact our capital and earnings.
Ongoing deterioration in the housing market and the homebuilding industry may lead to increased losses and further worsening of delinquencies and non-performing assets in our loan portfolios. Consequently, our results of operations may be adversely impacted.
There has been substantial industry concern and publicity over asset quality among financial institutions due in large part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. As of December 31, 2009, our non-performing assets had increased significantly to $110.4 million, or 35.06%, of our loan portfolio plus other real estate owned. Furthermore, the housing and the residential mortgage markets recently have experienced a variety of difficulties and changed economic conditions. If market conditions continue to deteriorate, they may lead to additional valuation adjustments on our loan portfolios and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default, and the net realizable value of real estate owned.
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The homebuilding industry has experienced a significant and sustained decline in demand for new homes and an oversupply of new and existing homes available for sale in various markets, including some of the markets in which we lend. Our customers who are builders and developers face greater difficulty in selling their homes in markets where these trends are more pronounced. Consequently, we are facing increased delinquencies and non-performing assets as these builders and developers are forced to default on their loans with us. We do not know when the housing market will improve, and accordingly, additional downgrades, provisions for loan losses, and charge-offs related to our loan portfolio may occur.
Weakness in the economy and in the real estate market, including specific weakness within our geographic footprint, has adversely affected us and may continue to adversely affect us.
Declines in the U.S. economy and our local real estate markets contributed to our significant provisions for loan losses during 2009, and may result in additional loan losses and loss provisions for 2010. These factors could result in further increases in loan loss provisions, and additional delinquencies, charge-offs, or both in future periods, any of which may adversely affect our financial condition and results of operations. If the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations continue to decline, this could result in, among other things, further deterioration in credit quality or a reduced demand for credit, including a resultant adverse effect on our loan portfolio and additional increases to our allowance for loan and lease losses.
In addition, deterioration of the U.S. economy may adversely impact our banking business more generally. Economic declines may be accompanied by a decrease in demand for consumer or commercial credit and declining real estate and other asset values. Declining real estate and other asset values may reduce the ability of borrowers to use such equity to support borrowings. Delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Additionally, our servicing costs, collection costs, and credit losses may also increase in periods of economic slowdown or recessions. Effects of the current real estate slowdown have not been limited to those directly involved in the real estate construction industry (such as builders and developers). Rather, it has impacted a number of related businesses such as building materials suppliers, equipment leasing firms, and real estate attorneys, among others, and the current recession has negatively impacted businesses of all types. All of these affected businesses have banking relationships, and when their businesses suffer from an economic slowdown or recession, the banking relationship suffers as well.
The amount of “other real estate owned” (“OREO”) increased significantly in 2008 and 2009 and may continue to increase, resulting in additional losses and expenses that will negatively affect our operations.
At December 31, 2009, we had a total of $37.8 million of OREO, and at December 31, 2008, we had a total of $27.3 million of OREO, reflecting a $10.5 million increase, or 38.40% from 2008 to 2009. This increase in OREO is due, among other things, to the continued deterioration of the residential real estate market and the tightening of the credit market. As the amount of OREO increases, our losses, and the costs and expenses to maintain the real estate likewise increase. Due to the on-going economic crisis, the amount of OREO may continue to increase throughout 2010. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and reduce our ultimate realization from any OREO sales.
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We could suffer loan losses from a decline in credit quality.
We could sustain losses if borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for credit losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we may experience significant loan losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.
If our assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease our net income. In view of the difficult real estate market, we maintained our allowance at $12.2 million at December 31, 2008 and $12.1 million at December 31, 2009. Although charge-off activity may periodically decrease our allowance, we may also make additions to our allowance in 2010 in response to continued credit deterioration. However, given current and future market conditions, we can make no assurance that our allowance will be adequate to cover future loan losses.
In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs as required by these regulators could have a negative effect on our operating results.
The deterioration in the residential mortgage market may continue to spread to commercial credits, which may result in greater losses and non-performing assets, adversely affecting our business operations.
The losses that were initially associated with subprime residential mortgages rapidly spread into the residential mortgage market generally. If the losses in the residential mortgage market continue to spread to commercial credits, then we may be forced to take greater losses or retain more non-performing assets. Our business operations and financial results could be adversely affected if we continue to experience losses from our commercial loan portfolio.
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We will realize additional future losses if the proceeds we receive upon liquidation of non-performing assets are less than the fair value of such assets.
Non-performing assets are recorded on our financial statements at fair value, as required under GAAP, unless these assets have been specifically identified for liquidation, in which case they are recorded at the lower of cost or estimated net realizable value. In current market conditions, we are likely to realize additional future losses if the proceeds we receive upon dispositions of non-performing assets are less than the recorded fair value of such assets.
Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition.
Our profitability is vulnerable to interest rate fluctuations.
Our profitability depends substantially upon our net interest income. Net interest income is the difference between the interest earned on assets, such as loans and investment securities, and the interest paid for liabilities, such as savings and time deposits and out-of-market certificates of deposit. Market interest rates for loans, investments, and deposits are highly sensitive to many factors beyond our control. Recently, interest rate spreads have generally narrowed due to changing market conditions, policies of various government and regulatory authorities, and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow even further. This narrowing of interest rate spreads could adversely affect our financial condition and results of operations.
At December 31, 2009 we were in a liability sensitive position, which generally means that changes in interest rates affect our interest paid on liabilities more quickly than our interest earned on assets because the rates paid on our liabilities reset sooner than rates earned on our assets. Accordingly, we anticipate that any interest rate increases by the Federal Reserve throughout 2010 will have a negative effect on our net interest income over the short term until the interest rates earned on our assets reset.
In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.
We may be required to pay significantly higher FDIC premiums or remit special assessments that could adversely affect our earnings.
Market developments have significantly depleted the FDIC’s Deposit Insurance Fund (“DIF”) and reduced its ratio of reserves to insured deposits. The FDIC’s assessment rates are intended to result in a reserve ratio of at least 1.15%. By December 31, 2009, the ratio had fallen well below this floor. The FDIC is required to return the DIF to its statutorily mandated minimum reserve ratio of 1.15 percent within eight years, and has undertaken several initiatives to satisfy this requirement.
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On September 30, 2009, the FDIC collected a one-time special assessment of five basis points of an institution’s assets minus tier 1 capital as of June 30, 2009. The amount of the special assessment could not exceed ten basis points times the institution’s assessment base for the second quarter 2009. In addition, on November 12, 2009, the FDIC adopted a final rule that required nearly all FDIC-insured depository institutions to prepay their DIF assessments for the fourth quarter of 2009 and for the next three years. There can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future. If we are required to pay significantly higher premiums or additional special assessments in the future, our earnings could be adversely affected. A further downgrade in our regulatory condition could also cause our assessment to materially increase.
We have suspended dividends on our common stock and may be unable to pay future dividends.
We have suspended dividend payment on our common stock and make no assurances that we will pay any dividends in the future. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our Board of Directors may deem relevant. In addition, our ability to pay dividends is restricted by federal policies and regulations. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if the prospective earnings retention is consistent with the organization’s expected future needs and financial condition. We are also precluded from declaring or paying any dividends without prior Federal Reserve approval under the terms of a March 12, 2010 letter from the Federal Reserve. Further, our principal source of funds to pay dividends is cash dividends that we receive from the Bank, and GDBF regulations and the terms of the order prohibit the Bank from paying dividends without prior regulatory approval. See Item 5—”Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities.”
Competition from other financial institutions may adversely affect our profitability.
The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions, which operate in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well established and much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our markets, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification, as well as restrictions on the deposit interest rates we can pay.
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
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The impact of the current economic downturn on the performance of other financial institutions in our geographic area, actions taken by our competitors to address the current economic downturn, and the public perception of and confidence in the economy generally, and the banking industry specifically, could negatively impact our performance and operations.
All financial institutions are subject to the same risks resulting from a weakening economy such as increased charge-offs and levels of past due loans and nonperforming assets. As troubled institutions in our market area continue to dispose of problem assets, the already excess inventory of residential homes and land lots will continue to negatively affect home values and increase the time it takes us or our borrowers to sell existing inventory. Additionally, the perception that smaller, community banking institutions are risky institutions for purposes of regulatory compliance or safeguarding deposits may cause depositors, nonetheless to move their funds to larger institutions. If our depositors should move their funds based on events happening at other financial institutions, our operating results would suffer.
In addition, reputation risk, or the risk to our business from negative publicity, is inherent in our business. Negative publicity can result from the actual or alleged conduct of financial institutions, generally, or the Company or Bank, specifically, in any number of activities, including leasing practices, corporate governance, and actions taken by government regulators in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action, any of which could negatively affect our business operations or financial results.
We are subject to liquidity risk in our operations.
Liquidity risk is the possibility of being unable, at a reasonable cost and within acceptable risk tolerances, to pay obligations as they come due, to capitalize on growth opportunities as they arise, or to pay regular dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis. Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses, and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding sources. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption in the financial markets or negative views and expectations about the prospects for the financial services industry as a whole, given the recent turmoil faced by banking organizations in the domestic and worldwide credit markets. As a result of our present regulatory capital status, our access to additional borrowed funds is currently limited, and, to the extent such funds may be available to us, we may be required to pay above market rates for additional borrowed funds, which may adversely affect our results of operations.
In the past, we have relied to some extent on the use of brokered deposits to provide liquidity and support our lending activities. As of December 31, 2009, we had approximately $10.1 million in brokered deposits, which represented approximately 2.58% of our total deposits. We intend to continue to utilize our core, in-market deposits as our primary source of liquidity and to reduce or even eliminate our use of brokered deposits over time. However, should we require additional liquidity in the future while we are prohibited from renewing, rolling over, or funding additional brokered deposits as a result of regulatory restrictions, we may become subject to acute liquidity stress unless we are able to improve our regulatory status to remove this restriction and regain access to brokered funds, replace maturing brokered deposits with core deposits or other non-brokered funding or otherwise reduce our liquidity needs.
If we are unable to meet our liquidity needs as a result of competition in the marketplace, regulatory restrictions to which we are subject, or for any other reason, our operations could be materially adversely affected. If our liquidity position should become critically inadequate, our ability to continue as a going concern could be threatened.
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Adverse market conditions and future losses may require us to raise additional capital to support our operations, but that capital may not be available when it is needed, which could adversely affect our financial condition and results of operations.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us or at all. If we cannot raise additional capital when needed, our financial performance could be materially impaired and we could become subject to further regulatory restriction on our operations, which could in turn decrease significantly or eliminate the value of our securities.
If we fail to retain our key employees, our growth and profitability could be adversely affected.
Our success is, and is expected to remain, highly dependent on our executive management team, consisting of our Chief Executive Officer, David D. Stovall, and our Chief Operating Officer, Bonnie Bowling. This is particularly true because, as a community bank, we depend on our management team’s ties to the community to generate business for us. Our growth will continue to place significant demands on our management, and the loss of any such person’s services may have an adverse effect upon our financial condition and results of operations.
Our directors and executive officers own a significant portion of our common stock and can influence stockholder decisions.
Our directors and executive officers, as a group, beneficially owned approximately 44.9% of our fully diluted outstanding common stock as of December 31, 2009. As a result of their ownership, the directors and executive officers will have the ability, if they voted their shares in concert, to influence significantly the outcome of all matters submitted to our shareholders for approval, including the election of directors.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value, or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
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Confidential customer information transmitted through the Bank’s online banking service is vulnerable to security breaches and computer viruses, which could expose the Bank to litigation and adversely affect its reputation and ability to generate deposits.
The Bank provides its customers with the ability to bank online. The secure transmission of confidential information over the Internet is a critical element of online banking. The Bank’s network could be vulnerable to unauthorized access, computer viruses, phishing schemes, and other security problems. The Bank may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that the Bank’s activities or the activities of its clients involve the storage and transmission of confidential information, security breaches and viruses could expose the Bank to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in the Bank’s systems and could adversely affect its reputation and its ability to generate deposits.
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.
As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve. Our subsidiary bank is primarily regulated by the FDIC and the GDBF. Our compliance with Federal Reserve Board, FDIC, and GDBF regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements of our regulators.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
The rules and regulations promulgated by the SEC that currently apply to us, together with related exchange rules and regulations, have increased the scope, complexity and cost of our corporate governance, reporting, and disclosure practices. Additional legislation or regulations, or amendments to current legislation or regulations, related to corporate governance, reporting, and disclosure may cause us to experience greater compliance costs.
Natural disasters or other adverse weather events could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business or results of operations.
Georgia’s economy is affected, from time to time, by tornadoes and other natural disasters. We cannot predict whether, or to what extent, damage caused by these events will affect our operations, our customers, or the economies in our banking markets. However, weather events could cause a decline in loan originations, destruction or decline in the value of properties securing our loans, or an increase in the risks of delinquencies, foreclosures, and loan losses.
Item 1B. UNRESOLVED STAFF COMMENTS
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Item 2. PROPERTIES
The Company's principal office is located at Habersham Bank's Central Habersham office, 282 Historic Highway 441, Cornelia, Georgia. The telephone number of that office is (706) 778-1000.
Habersham Bank's North Habersham (main) office is located at 1151 Washington Street, Clarkesville, Georgia. The telephone number of that office is (706) 778-1000. Habersham Bank also has nine full-service branch offices. Its Central Habersham office is located at 282 Historic Highway 441, Cornelia, Georgia; its South Habersham office is located at 186 441 By-Pass, Baldwin, Georgia; its Cleveland Office is located at 575 South Main Street, Cleveland, Georgia; its Canton Office is located at 1925 Marietta Highway, Canton, Georgia; its Warrenton Office is located at 189 Legion Drive, Warrenton, Georgia; its Toccoa Office is located at 27 North Big A Road; its Cumming Office is located at 2740 Nuckolls Road, Cumming, Georgia and its Flowery Branch Office is located at 5977 Sprout Springs Road, Flowery Branch, Georgia. Each office has a 24-hour teller machine, with the exception of the Warrenton Office. Habersham Bank owns its office properties without encumbrance.
Item 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of its property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to its business, and no such proceedings are known to be contemplated by governmental authorities.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of Habersham Bancorp is traded on the Over-the-Counter Bulletin Board under the symbol HABC. Prior to December 24, 2009, it was traded on the Nasdaq Stock Market under the same symbol. At December 31, 2009 Habersham Bancorp had approximately 486 shareholders of record. The following table sets forth the high and low sale prices and the cash dividends paid on the Company's common stock on a quarterly basis for the past two fiscal years and a portion of the first quarter of 2010.
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The Company suspended dividends on its common stock on November 19, 2008. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our Board of Directors may deem relevant. In addition, our ability to pay dividends is restricted by federal policies and regulations. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and if prospective earning retention is consistent with the organization’s expected future needs and financial condition. We are also precluded from declaring or paying dividends without prior Federal Reserve approval under the terms of a March 10, 2010 letter from the Federal Reserve.
Cash dividends on Habersham Bank’s common stock, which would be paid to the Company and could serve as a source of funds for cash dividends to the Company's shareholders, may be declared and paid only out of its retained earnings, and dividends may not be distributed at any time when the Bank’s paid-in capital and appropriated earnings do not, in combinations, equal at least 20% of its capital stock account. In addition, the GDBF’s rules and regulations require prior approval before cash dividends may be declared and paid if: (i) the Bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the Bank’s net earnings, after taxes but before dividends, for the previous calendar year, or (iii) the percentage of the Bank’s loans classified as adverse as to repayment or recovery by the GDBF at the most recent examination of the Bank exceeds 80% of the Bank’s equity as reflected at such examination. As of December 31, 2009, the Bank could not declare dividends without regulatory approval. See “Risk Factors – The Company has suspended dividends on the common stock and may be unable to pay future dividends” and “Supervision and Regulation – Payment of Dividends.”
See Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for a table presenting information on equity securities subject to future issuance under the Company’s equity compensation plans.
Item 6. SELECTED FINANCIAL DATA
(In thousands, except share and per share data)
NM – not meaningful in a loss year
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The Company owns all of the outstanding stock of Habersham Bank and The Advantage Group, Inc. Habersham Bank owned all of the outstanding stock of Advantage Insurers, Inc. (“Advantage Insurers”), which was sold on December 30, 2009. Advantage Insurers offered a full line of property, casualty and life insurance products. The Advantage Group, Inc. and Advantage Insurers do not comprise a significant portion of the financial position, results of operations, or cash flows of the Company and as a result management’s discussion and analysis, which follows, relates primarily to Habersham Bank.
The Company’s continuing primary business is the operation of banks in rural and suburban communities in Habersham, White, Cherokee, Warren, Stephens, Forsyth and Hall counties in Georgia. Habersham Bank’s main office is located in Cornelia, Georgia, and it has 9 branch offices, with its most recent branch office having been opened in Flowery Branch (Hall County), Georgia in the fourth quarter of 2008. The Company’s primary source of revenue is interest income on loans to businesses and individuals in its market area.
Year Ended December 31, 2009
The Company’s primary source of income is interest income from loans and investment securities. Its profitability depends largely on net interest income, which is the difference between the interest received on interest-earning assets and the interest paid on deposits, borrowings, and other interest-bearing liabilities.
Net loss for the year ended December 31, 2009 was $26.1 million or $9.34 per diluted share, a decrease of $11.3 million or 75.96% when compared to net loss of $14.8 million or $5.27 per diluted share for the year ended December 31, 2008. The decrease resulted primarily from an income tax expense related to the establishment of a deferred tax asset valuation allowance totaling approximately $12.0 million and a decrease in net interest income of approximately $3.2 million offset by decreases in provisions for loan losses of approximately $2.5 million and in other noninterest expense of approximately $927,000. Noninterest income also increased approximately $29,000.
The decrease in net interest income was attributable to increases in the number and balances of loans on nonaccrual status and the number and balances of variable rate loans repricing at lower rates and a smaller net interest margin. Interest income for the year ended December 31, 2009 was approximately $20.4 million, representing a decrease of approximately 21.99%, when compared to 2008. The decrease resulted from: 1) the effect of the fallen prime interest rate on outstanding variable rate loans totaling approximately $214.3 million, 2) average loan balances decreasing approximately $30.4 million when compared to 2008, and 3) nonaccrual loans increasing approximately $15.8 million. Interest expense for the year ended December 31, 2009 was approximately $11.7 million, representing a decrease of approximately $2.6 million when compared to 2008. This decrease resulted from declining rates paid on deposit and borrowing balances during 2009. The net interest margin for the year ended December 31, 2009 was 2.16%, a decrease from 2.79% for the year ended December 31, 2008. In addition, increases in interest costs outpaced increases in interest earned as variable rate interest loans repriced at lower interest rates more quickly than the rates paid on deposit balances as each responded to decreases in the interest rates set by the Federal Reserve Bank.
Net interest income before provision for loan loss for the year ended December 31, 2009, decreased approximately $3.2 million or 26.79% when compared to 2008 as a result of the items discussed above. Declines in the U.S. economy and our local real estate markets contributed to our continuing expense of the provision for loan losses. As delinquencies and foreclosures continued during 2009, Habersham Bank recorded provisions to its allowance for loan losses of approximately $13.5 million for 2009.
For the fourth quarter ended December 31, 2009, the Company recognized a net loss of $16.9 million, including a provision for loan losses of $3.0 million and expenses, losses on sales and write downs of other real estate of $3.0 million. The provision and other real estate expenses related to the continued deterioration in real estate values in our market area. Additionally, during the fourth quarter of 2009, the Company performed an assessment of the Company’s deferred income tax asset accounts. As a result of this assessment, the Company established a valuation allowance of $12.7 million to be recorded against all of the Company’s deferred tax assets, which was recorded as a tax expense.
At December 31, 2009, Habersham Bank’s other real estate portfolio totaled approximately $37.8 million, an increase of approximately $10.5 million when compared to December 31, 2008. This increase resulted in higher legal and professional services expenses for 2009 in foreclosure and maintenance costs. The other real estate properties are primarily located in the metro Atlanta area and the surrounding counties.
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The Company’s total assets decreased $38.8 million, or 7.85%, to $456.0 million at December 31, 2009 when compared to $494.9 million at December 31, 2008. Decreases in loans, investment securities, other assets and premises and equipment of approximately $45.7 million, $23.7 million, $6.3 million and $1.8 million, respectively, were offset by increases in cash and cash equivalents of approximately $28.2 million and other real estate of approximately $10.5 million.
The Company’s total liabilities (deposits, borrowings and other liabilities) at December 31, 2009 decreased approximately $13.9 million or 3.08% to $438.9 at December 31, 2009 from $452.9 million at December 31, 2008. Decreases in other borrowings, total deposit account balances and in other liabilities totaled approximately $10.3 million, $2.7 million and $900,000, respectively. A decrease in total stockholders’ equity of approximately $24.9 million resulted from the year-to-date loss of approximately $26.1 million and dividend payments of approximately $211,000, offset by the sale of preferred stock and an increase in accumulated other comprehensive income of approximately $1.0 million and $432,000, respectively.
The following discussion sets forth the major factors that affect the Company’s results of operations and financial condition. These comments should be read in conjunction with the consolidated financial statements and related notes. As described elsewhere in this Report, the Bank is currently operating under heightened regulatory scrutiny and has entered into a Cease and Desist Order with the GDBF.
This discussion contains forward-looking statements involving risks and uncertainties. Results may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, risks involving the potential adverse effect of changes in U.S., state and local economic and real estate market conditions, unexpected changes in interest rates and the current interest rate environment, difficulties in expanding into new market areas, loan losses and the adequacy of the Company’s loan loss allowance, changes in regulation and legislation, competition and other risks identified in this Annual Report on Form 10-K for the year ended December 31, 2009 and its other filings with the Securities and Exchange Commission.
CRITICAL ACCOUNTING ESTIMATES
In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies which are used in preparing the consolidated financial statements of the Company. These policies are described in Note 2 to the consolidated financial statements which are presented elsewhere in this annual report. Of these policies, management believes that the accounting for the allowance for loan losses is the most critical. This is because of the subjective nature of the estimates used in establishing the allowance and the effect these estimates have on the Company’s earnings. Because the allowance is replenished by means of a provision for loan losses that is charged as an expense against net earnings, the estimation of the allowance affects the Company’s earnings directly. Losses on loans result from a broad range of causes, from borrower-specific problems to industry issues to the impact of the economic environment. The identification of the factors that lead to default or non-performance under a loan agreement and the estimation of loss in these situations is very subjective. In addition, a dramatic change in the performance of one or a small number of borrowers can have a significant impact on the estimate of losses. As described further below, under “Allowance for Loan Losses,” management has implemented a process that has been applied consistently to systematically consider the many variables that impact the estimation of the allowance for loan losses.
Certain economic factors could have a material impact on the loan loss allowance determination and its adequacy. The depth and duration of any economic recession would have an impact on the credit risk associated with the loan portfolio. Another factor that can impact the determination is a consideration of concentrations in collateral which secure the loan portfolio. The Company’s loan portfolio is secured primarily by commercial and residential real estate, with such loans comprising approximately 90.61% of the total loan portfolio at December 31, 2009.
The commercial and residential real estate loan portfolio is segregated into construction and land development, loans secured by 1-4 family residential properties, and commercial properties and other land loans totaling approximately $107.7 million, $71.5 million, $71.1 million and $736,000, respectively. The construction, land development and other land loan portfolios have been the hardest hit by the downturn in the economy resulting in increases in nonperforming assets. Habersham Bank held concentrations of loans totaling 100% or more of Tier 1 Capital to borrowers in land and subdivision development , real estate lessors (amortized non-owner occupied), raw land and non-residential building construction (non-owner occupied) at December 31, 2009 and 2008. See “Loans.”
The Bank will, from time to time, make unsecured loans. The risk to the Bank is greater for unsecured loans as the ultimate repayment of the loan is only dependent on the borrower’s ability to pay. The balance of unsecured loans at December 31, 2009 and 2008 was $12.6 million and $14.2 million, respectively.
Refer to the section entitled “Allowance for Loan Losses” for an additional discussion of the key assumptions and methods used in determining the allowance for loan losses, as well as inherent risks in estimating the allowance.
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Refer to Note12 to the consolidated financial statements for further discussion of the assumptions and methods used in determining the carrying values for other real estate, estimated disposal costs and quick sale concessions.
Refer to Note 17 to the consolidated financial statements for further discussion of the assumptions and methods used in determining the valuation of the deferred tax asset, as well as inherent risks in estimating the valuation account.
RESULTS OF OPERATIONS
Habersham Bancorp experienced a net loss of $26.1 million for the year ended December 31, 2009, or diluted loss of $9.34 per share, representing a decrease of 75.96% from 2008. Habersham Bancorp experienced a net loss of $14.8 million for the year ended December 31, 2008, or diluted loss of $5.27 per share, representing a decrease of 605.19% from 2007. For the year ended December 31, 2007, net earnings were $2.9 million, with related diluted earnings per common and common equivalent share of $1.00.
For the year ended December 31, 2009, the net loss represented a loss on average equity of 72.87%. For the year ended December 31, 2008, the net loss represented a loss on average equity of 31.21%. For the year ended December 31, 2007, net earnings represented a return on average equity of 5.23%.
The increase in net loss for the year ended December 31, 2009, when compared to the year ended December 31, 2008, was primarily due to an income tax expense related to the establishment of a deferred tax asset valuation allowance totaling approximately $12.7 million and a decrease in net interest income of approximately $3.2 million offset by a decrease in provision for loan losses expense and in other noninterest expenses of approximately $2.5 million and $927,000, respectively. The provision for loan losses decreased as a result of adjustments to the allowance for loan loss calculation. The decrease in interest income includes the loss of interest income of approximately $3.7 million on nonaccrual loans during 2009, a decrease in loan balances of approximately $45.8 million and a smaller net interest margin.
The decrease in net earnings for the year ended December 31, 2008, when compared to the year ended December 31, 2007, was primarily due to a decrease in net interest income of approximately $7.7 million or 39.5% and in increases in noninterest expense of approximately $4.0 million or 21.20% and in the provision for loan losses of $15.3 million or 2272.6% when compared to 2007. The provision for loan loss was increased in order to maintain an adequate allowance for loan losses. The decrease in interest income includes the loss of interest income of approximately $2.4 million on nonaccrual loans during 2008. The increase in noninterest expense is primarily attributable to a $3.5 million goodwill impairment expense. Additional factors include: increases in other real estate expenses, occupancy expense, telephone and leased equipment expense totaling approximately $1.2 million, $251,000, $40,000 and $47,000, respectively, when compared to 2007 expenses.
NET INTEREST INCOME
Net interest income is the largest single source of income for the Company. Management strives to attain a level of earning asset growth while providing a net yield on earning assets that will cover overhead and other costs and provide a reasonable return to our stockholders.
Net interest income for 2009 decreased approximately $3.2 million or 26.79% when compared to 2008 and decreased approximately $7.7 million or 39.3% when compared to 2007. Net interest income is affected by interest income from loans, investment securities and federal funds sold offset by interest paid on deposits and borrowings. The following table compares the weighted average tax equivalent yields for loans, investment securities and federal funds sold and the weighted average rates for deposits and borrowings for 2009, 2008 and 2007.
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Yields and rates reflect adjustments in pricing as the Federal Reserve moves the prime interest rate.
During 2009, average balances in interest earning assets decreased approximately $28.9 million or 6.55% when compared to 2008. During the same period, average balances in interest bearing liabilities increased approximately $10.3 million or 2.51%, when compared to 2008. During 2008, average balances in interest earning assets decreased approximately $14.1 million or 3.08%, when compared to 2007. During the same time period, average balances in interest bearing liabilities increased approximately $16.9 million or 4.29%.
During 2009, interest income decreased approximately $5.7 million when compared to 2008. Decreases in loan interest income, in investment security income and in federal funds sold income were approximately $5.2 million, $434,000, and $68,000, respectively. Loss of interest income on nonaccrual loans totaled approximately $3.7 million during 2009. Loan yields decreased by 107 basis points when comparing yields for 2009 to yields for 2008, as variable rate loans repriced in response to the decreasing prime rate.
During 2008, interest income decreased approximately $10.2 million when compared to 2007. Decreases in loan interest income and federal funds sold of approximately $10.3 million and $176,000, respectively, were offset by increases in investment securities income of approximately $190,000. Loss of interest income on nonaccrual loans totaled approximately $2.4 million during 2008. Loan yields decreased by 259 basis points when comparing yields for 2008 to yields for 2007, as variable rate loans repriced in response to the decreasing prime rate.
Interest expense for 2009 decreased approximately $2.6 million, or 18.05%, when compared to 2008. Interest expense for deposits and borrowings decreased approximately $1.8 million and $788,000, respectively. Average interest rate paid on deposit balances was 2.69% for 2009 compared to 3.40% for 2008. Increases in average certificate of deposit balances totaling approximately $42.0 million were offset by decreases in average savings, money market and NOW accounts of approximately $16.5 million, as depositors moved into higher yielding accounts. Average borrowing balances for 2009 decreased approximately $15.2 million when compared to 2008, primarily in securities sold under repurchase agreements.
Interest expense for 2008 decreased approximately $2.5 million, or 15.06%, when compared to 2007. Interest expense for deposits and borrowings decreased approximately $2.3 million and $202,000, respectively. Average interest rate paid on deposit balances was 3.40% for 2008 compared to 4.15% for 2007. Increases in average certificate of deposit balances totaling approximately $16.9 million were offset by decreases in average savings, money market and NOW accounts of approximately $10.0 million, as depositors moved into higher yielding accounts. Average borrowing balances for 2008 increased approximately $10.0 million when compared to 2007, primarily in securities sold under repurchase agreements.
The tax equivalent net interest margin was 2.16% in 2009, 2.79% in 2008 and 4.41% in 2007. The net interest margin decreased due to decreases in loan yields and the loss of interest on nonaccrual loans.
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME AND EXPENSE, AND AVERAGE YIELDS EARNED AND RATES PAID
Average balances in the total loan portfolio decreased approximately $30.4 million, or 9.0% at December 31, 2009 from 2008 average balances. Decreases in the average balances in real estate construction and land development loans, commercial real estate loans, commercial loans, consumer loans and 1-4 family residential loans totaled approximately $45.8 million, $5.1 million, $2.5 million, $2.2 million and $1.1 million, respectively, and were offset by an increase in the nonaccrual loan portfolio of approximately $26.6 million. The decrease in the real estate construction and land development portfolios is net of approximately $22.3 million of foreclosures of loans as result of the decline in the real estate market for both construction lending and acquisition and development of residential properties.
Average balances in the total loan portfolio decreased approximately $16.2 million, or 4.59% at December 31, 2008 from 2007 average balances. The total loan portfolio decreased approximately $27.6 million during 2008. Decreases in the real estate construction and land development portfolios, commercial loans, commercial real estate portfolios and consumer lending totaling approximately $27.8 million, $3.7 million, $1.3 million and $581,000, respectively, were offset by an increase in the residential mortgage portfolio of approximately $5.6 million. The decrease in the real estate construction and land development portfolios is net of approximately $17.8 million of foreclosures of loans as result of the decline in the real estate market for both construction lending and acquisition and development of residential properties.
Average balances of investment securities decreased approximately $4.8 million, or 4.87%, from year-end 2008 to 2009. Purchases of investment securities totaled approximately $33.5 million during 2009, offset by sales and calls and maturities of investment securities of approximately $42.9 million and $14.2 million, respectively. Purchases of U.S. government-sponsored enterprises and mortgage back securities totaled approximately $8.8 million and $24.7 million, respectively.
Average balances of investment securities increased approximately $4.2 million, or 4.43%, from year-end 2007 to 2008. Purchases of investment securities totaled approximately $62 million during 2008, offset by sales and calls and maturities of investment securities of approximately $47.6 million and $9.7 million, respectively. Purchases of U.S. government-sponsored enterprises and tax-exempt state and political subdivisions securities totaled approximately $60.2 million and $1.8 million, respectively.
Average balances in the total interest bearing deposit portfolio increased approximately $25.5 million, or 7.33% during 2009. Increases in average account balances in time deposits of approximately $42.0 million were offset by decreases in average account balances in savings and money market and in interest bearing demand accounts totaling approximately $5.3 million and $11.2 million, respectively. Deposit balances moved from lower interest rates in money market and savings accounts to higher yields in time deposit accounts.
Average balances in the total deposit portfolio increased approximately $3.2 million, or .84% during 2008. Average account balances in time deposits increased approximately $17.0 million. Decreases in average account balances in noninterest bearing accounts, savings and interest bearing demand deposits totaled approximately $3.8 million, $8.6 million and $1.4 million, respectively. Deposit balances moved from lower interest rates in money market and savings accounts to higher yields in time deposit accounts.
The following table sets forth the consolidated average balance sheets for the Company, average rates earned on interest-earning assets, average rates paid on interest-bearing liabilities, interest income and interest expense for each category of interest-earning assets and interest-bearing liabilities, and net interest margin. Yields on non-taxable instruments are reported on a tax-equivalent basis. This information is presented for the years ended December 31, 2009, 2008 and 2007.
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME AND EXPENSE, AND AVERAGE YIELDS EARNED AND RATES PAID
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME AND EXPENSE, AND AVERAGE YIELDS EARNED AND RATES PAID, continued
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The following table sets forth a summary of the changes in interest income and interest expense resulting from changes in volume and rates for the periods indicated:
NONINTEREST INCOME AND NONINTEREST EXPENSE
In 2009, noninterest income increased approximately $29,000 or .70% when compared to 2008.
Noninterest income increased primarily due to increases occurring in a gain from the sale of an insurance subsidiary (Advantage Insurers, Inc.), net security gains and a gain on the sale and impairment of other investments totaling approximately $297,000, $151,000 and $20,000, respectively, offset by decreases in mortgage origination income and in service charges on deposit accounts of approximately $279,000 and $21,000, respectively. The security gains were a result of sales and calls of investment securities as the securities market reacted to the lower interest rate environment. Mortgage origination activity was down in 2009 as a result of the decline in the 1-4 family residential market, which reduced income for 2009 when compared to 2008.
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In 2008, noninterest income increased approximately $353,000, or 9.37% when compared to 2007.
Noninterest income increased primarily due to increases occurring in net security gains, income from company-owned life insurance and service charges on deposit accounts, offset by decreases in mortgage origination income. The security gains were a result of sales and calls of investment securities as the securities market reacted to the lower interest rate environment. Mortgage origination activity was down in 2008 as a result of the decline in the 1-4 family residential market, which reduced income for 2008 when compared to 2007.
In 2009, noninterest expense decreased approximately $927,000 or 4.10% when compared to 2008.
Exclusive of the goodwill impairment charge of $3.5 million taken in 2008, noninterest expense increased approximately $1 million for the period ending December 31, 2009. Other real estate expense (legal fees, write downs and losses on sales of ORE) increased due to the increasing number of properties held in other real estate. Additional expenses in occupancy, loss on disposal of premises, telephone and leased equipment resulted from the closing of one branch office (Eastanollee) and the sale of another branch office (Hickory Flat). Increases occurring in other expense include FDIC insurance, legal and professional expenses and insurance (bond and property). These increases were offset by a reduction in salaries and employee benefits resulting from the elimination of any bonus or incentive programs, the reduction of personnel, the elimination of overtime and the reduction in office hours.
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In 2008, noninterest expense increased approximately $4.0 million or 21.24% when compared to 2007.
Noninterest expense increased primarily from a goodwill impairment expense and increased expenses associated with other real estate as the number of these properties increased. These increases were offset by a reduction in salaries and employee benefits resulting from a decision not to provide for any bonus or incentive programs, the reduction of personnel when possible, the elimination of overtime and the reduction in office hours.
INCOME TAX EXPENSE
Income tax expense for the period ended December 31, 2009 was approximately $3.8 million and income tax benefit for the period ended December 31, 2008 was approximately $7.8 million, and income tax expense for the period ended December 31, 2007 was approximately $1.0 million. The effective tax rate is not meaningful for the year ended December 31, 2009 due to the valuation allowance recorded on the Company’s deferred tax assets. The effective tax rate for the periods ended December 31, 2008 and 2007 were (34.5%) and 25.77%, respectively. Tax-exempt income on municipal bonds and loans for the periods ended December 31, 2009, 2008 and 2007 was 4.50%, 3.99% and 28.03% of pre-tax income, respectively. Income tax for the years ended December 31, 2009, 2008 and 2007 is more fully explained in Note 17 to the consolidated financial statements.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents a reserve for probable losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated monthly based on a review of all significant loans, with particular emphasis on impaired, nonaccruing, past due and other loans that management believes require special attention. The determination of the allowance for loan losses is subjective and is based on the consideration of a number of factors and assumptions. As such, the accounting policy followed in the determination of the allowance is considered a critical accounting policy. See “Critical Accounting Estimates.”
The allowance for loan losses methodology is partially based on a loan classification system. For purposes of determining the required allowance for loan losses and resulting periodic provisions, the Company identifies problem loans in its portfolio and segregates the remainder of the loan portfolio into broad segments, such as commercial, commercial real estate, residential mortgage and consumer. The Company provides for a general allowance for losses inherent in the portfolio for each of the above categories. The general allowance is calculated based on estimates of inherent losses which are likely to exist as of the evaluation date. Loss percentages used for non-problem loans in the portfolio are based on historical loss factors and supplemented by various qualitative factors. Specific allowance allocations for losses on problem loans are based on a review and evaluation of these loans, taking into consideration the financial condition and strengths of the borrower, related collateral, cash flows available for debt repayment, and known and expected economic conditions.
For loans considered impaired, specific allowances are provided in the event that the specific collateral analysis on each problem loan indicates that the liquidation of the collateral would not result in repayment of these loans if the loan is collateral dependent or if the present value of expected future cash flows on the loan is less than the balance. In addition to these allocated allowances, at any point in time, the Company may have an unallocated component of the allowance. Unallocated portions of the allowance are due to a number of quantitative and qualitative factors, such as improvement in the condition of impaired loans and credit concentrations. The level of the unallocated portion of the allowance serves as a prime indicator to management for the need of additional provisions for loan loss as management prospectively accounts for this critical accounting estimate.
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The allowance for loan losses allocation is based on subjective judgment and estimates and, therefore, is not necessarily indicative of the specific amounts or loan categories in which charge-offs may ultimately occur. The allocation of the allowance for loan losses by loan category at December 31, 2009, 2008, 2007, 2006 and 2005 is as follows:
The Company’s provision for loan losses is intended to create an adequate allowance for losses in the loan portfolio at the end of each reporting period.
The following table summarizes, for each of the years in the five year period ended December 31, 2009, selected information related to the allowance for loan losses.
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The number and the average balance of charge-offs during 2009, 2008 and 2007 by category follow:
The risk associated with loans varies with the creditworthiness of the borrower, the type of loan (consumer, commercial or real estate) and its maturity. Cash flow adequate to support a repayment schedule is an element considered for all types of loans. Real estate loans are impacted by market conditions regarding the value of the underlying property used as collateral. Commercial loans are impacted by the management of the business as well as economic conditions also.
Management believes the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, the financial condition of borrowers and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The total loan portfolio for 2009 decreased approximately $45.8 million when compared to 2008. During 2009, decreases occurred in the real estate secured lending, commercial lending and consumer lending portfolios totaling approximately $40 million, $3.1 million and $2.8, respectively. The average yields on the total loan portfolio for 2009 and 2008 were 5.25% and 6.32%, respectively.
The total loan portfolio for 2008 decreased approximately $27.6 million when compared to 2007. During 2008, decreases occurred in the real estate secured lending, commercial lending and consumer lending portfolios totaling approximately $23.3 million, $3.7 million and $581,000, respectively. The average yields on the total loan portfolio for 2008 and 2007 were 6.32% and 8.91%, respectively.
The amount of loans (net of unearned loan origination fees) outstanding at December 31 for each of the last five years is set forth in the following table according to type of loan. The Company had no foreign loans at December 31 in any of the last five years.
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The following table sets forth the maturities and sensitivities to changes in interest rates of loans at December 31, 2009.
NONPERFORMING ASSETS AND PAST DUE LOANS
Nonperforming assets consist of nonaccrual loans, accruing loans 90 days past due, restructured loans, and other real estate owned. Accrual of interest is discontinued when either principal or interest becomes 90 days past due, unless the loan is both well secured and in the process of collection, or when in management’s opinion, reasonable doubt exists as to the full collection of interest or principal. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable.
The following table sets forth the totals of nonperforming assets, selected ratios, and accruing loans past due 90 days or more at December 31 for each of the last five years.
Nonperforming assets increased approximately $26.2 million or 31.11% from December 31, 2008 to December 31, 2009. Increases occurred as the decline in the 1-4 family real estate market in both construction lending and new mortgages continued during 2008. The result of this activity is reflected in the increases in nonaccrual loans, other real estate and restructured loans totaling approximately $15.8 million, $10.5 million and $728,000, respectively, offset by decreases in accruing loans 90 days past due of approximately $802,000. The effects of the real estate market decline are visible in the loan portfolio as loans move from 90 days past due, to nonaccrual status, to foreclosure and finally to other real estate. See the discussion that follows within this section for a description of the assets that comprised this increase.
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Loans classified as 90 days past due decreased $802,000 from December 31, 2008 to December 31, 2009. The increase is the net result of the following changes: