Attached files

file filename
EX-32 - FIRST FINANCIAL SERVICE CORPv201412_ex32.htm
EX-31.1 - FIRST FINANCIAL SERVICE CORPv201412_ex31-1.htm
EX-31.2 - FIRST FINANCIAL SERVICE CORPv201412_ex31-2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended September 30, 2010

OR

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

Commission File Number 0-18832

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

Kentucky
61-1168311
(State or other jurisdiction
(IRS Employer Identification No.)
of incorporation or organization)
 
   
2323 Ring Road
(270) 765-2131
Elizabethown, Kentucky 42701
(Registrant's telephone number,
(Address of principal executive offices)
including area code)
(Zip Code)
 
 
(270) 765-2131
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
Outstanding as of October 31, 2010
Common Stock
4,726,168 shares


 
FIRST FINANCIAL SERVICE CORPORATION
FORM 10-Q
TABLE OF CONTENTS

PART IFINANCIAL INFORMATION
 
     
Preliminary Note Regarding Forward-Looking Statements
3
     
Item 1.
Consolidated Financial Statements and Notes to Consolidated Financial Statements
4
 
   
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
24
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
40
     
Item 4.
Controls and Procedures
42
     
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
42
     
Item 1A.
Risk Factors
42
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
43
     
Item 3.
Defaults upon Senior Securities
43
     
Item 4.
Reserved
43
     
Item 5.
Other Information
43
     
Item 6.
Exhibits
43
     
SIGNATURES
44

2

 
PRELIMINARY NOTE REGARDING
FORWARD-LOOKING STATEMENTS

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

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

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

3

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

   
September 30,
   
December 31,
 
(Dollars in thousands, except per share data)
 
2010
   
2009
 
             
ASSETS:
           
Cash and due from banks
  $ 12,591     $ 21,253  
Interest bearing deposits
    76,407       77,280  
Total cash and cash equivalents
    88,998       98,533  
                 
Securities available-for-sale
    164,750       45,764  
Securities held-to-maturity, fair value of $131 Sept 2010 and $1,176 Dec 2009
    128       1,167  
Total securities
    164,878       46,931  
                 
Loans held for sale
    13,213       8,183  
Loans, net of unearned fees
    920,095       994,926  
Allowance for loan losses
    (20,091 )     (17,719 )
Net loans
    913,217       985,390  
                 
Federal Home Loan Bank stock
    5,015       8,515  
Cash surrender value of life insurance
    9,266       9,008  
Premises and equipment, net
    32,317       31,965  
Real estate owned:
               
Acquired through foreclosure
    12,781       8,428  
Held for development
    45       45  
Other repossessed assets
    48       103  
Core deposit intangible
    1,071       1,300  
Accrued interest receivable
    6,248       5,658  
Accrued income taxes
    3,754       -  
Deferred income taxes
    3,377       4,515  
Prepaid FDIC premium
    5,163       7,022  
Other assets
    2,651       2,091  
                 
TOTAL ASSETS
  $ 1,248,829     $ 1,209,504  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
LIABILITIES:
               
Deposits:
               
Non-interest bearing
  $ 70,288     $ 63,950  
Interest bearing
    1,018,438       985,865  
Total deposits
    1,088,726       1,049,815  
                 
Short-term borrowings
    345       1,500  
Advances from Federal Home Loan Bank
    52,564       52,745  
Subordinated debentures
    18,000       18,000  
Accrued interest payable
    246       360  
Accounts payable and other liabilities
    3,956       1,952  
                 
TOTAL LIABILITIES
    1,163,837       1,124,372  
Commitments and contingent liabilities
    -       -  
                 
STOCKHOLDERS' EQUITY:
               
Serial preferred stock, $1 par value per share;
               
authorized 5,000,000 shares; issued and outstanding, 20,000 shares with a liquidation preference of $20,000
    19,822       19,781  
Common stock, $1 par value per share;
               
authorized 10,000,000 shares; issued and outstanding, 4,726,075 shares Sept 2010, and 4,709,839 shares Dec 2009
    4,726       4,710  
Additional paid-in capital
    35,171       34,984  
Retained earnings
    24,128       26,720  
Accumulated other comprehensive income/(loss)
    1,145       (1,063 )
                 
TOTAL STOCKHOLDERS' EQUITY
    84,992       85,132  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 1,248,829     $ 1,209,504  
 
See notes to the unaudited consolidated financial statements.
 
4

 
FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statements of Income
(Unaudited)
 
   
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
(Dollars in thousands, except per share data)
 
2010
   
2009
   
2010
   
2009
 
Interest and Dividend Income:
                       
Loans, including fees
  $ 13,543     $ 14,410     $ 41,857     $ 42,509  
Taxable securities
    1,117       312       2,488       925  
Tax exempt securities
    255       137       628       361  
Total interest income
    14,915       14,859       44,973       43,795  
                                 
Interest Expense:
                               
Deposits
    4,883       4,513       14,642       13,359  
Short-term borrowings
    6       27       38       117  
Federal Home Loan Bank advances
    599       601       1,788       1,798  
Subordinated debentures
    331       331       989       989  
Total interest expense
    5,819       5,472       17,457       16,263  
                                 
Net interest income
    9,096       9,387       27,516       27,532  
Provision for loan losses
    6,327       2,482       11,353       6,441  
Net interest income after provision for loan losses
    2,769       6,905       16,163       21,091  
                                 
Non-interest Income:
                               
Customer service fees on deposit accounts
    1,671       1,750       4,935       4,872  
Gain on sale of mortgage loans
    513       300       1,227       832  
Gain/(loss) on sale of investments
    7       -       (16 )     -  
Other than temporary impairment loss:
                               
Total other-than-temporary impairment losses
    (649 )     (304 )     (832 )     (918 )
Portion of loss recognized in other comprehensive income(before taxes)
    -       -       -       (215 )
Net impairment losses recognized in earnings
    (649 )     (304 )     (832 )     (703 )
Loss on sale and write downs of real estate acquired through foreclosure
    (374 )     (305 )     (838 )     (555 )
Brokerage commissions
    109       89       309       281  
Other income
    703       365       1,514       1,263  
Total non-interest income
    1,980       1,895       6,299       5,990  
                                 
Non-interest Expense:
                               
Employee compensation and benefits
    4,176       4,042       12,171       12,193  
Office occupancy expense and equipment
    779       832       2,351       2,488  
Marketing and advertising
    225       225       675       735  
Outside services and data processing
    622       793       2,020       2,381  
Bank franchise tax
    566       257       1,482       778  
FDIC insurance premiums
    615       414       1,969       1,381  
Amortization of core deposit intangible
    77       100       229       302  
Real estate acquired through foreclosure expense
    302       124       916       366  
Other expense
    1,352       1,241       3,809       3,632  
Total non-interest expense
    8,714       8,028       25,622       24,256  
                                 
Income/(loss) before income taxes
    (3,965 )     772       (3,160 )     2,825  
Income taxes/(benefits)
    (1,472 )     196       (1,359 )     773  
Net Income/(loss)
    (2,493 )     576       (1,801 )     2,052  
Less:
                               
Dividends on preferred stock
    (250 )     (250 )     (750 )     (730 )
Accretion on preferred stock
    (14 )     (14 )     (41 )     (39 )
Net income/(loss) available to common shareholders
  $ (2,757 )   $ 312     $ (2,592 )   $ 1,283  
                                 
Shares applicable to basic income per common share
    4,724,043       4,704,289       4,719,513       4,689,917  
Basic income/(loss) per common share
  $ (0.58 )   $ 0.07     $ (0.55 )   $ 0.27  
                                 
Shares applicable to diluted income per common share
    4,724,043       4,734,037       4,719,513       4,703,432  
Diluted income/(loss) per common share
  $ (0.58 )   $ 0.07     $ (0.55 )   $ 0.27  
                                 
Cash dividends declared per common share
  $ -     $ 0.05     $ -     $ 0.43  
 
See notes to the unaudited consolidated financial statements.
 
5

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

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(Dollars in thousands)
 
2010
   
2009
   
2010
   
2009
 
                         
Net Income/(Loss)
  $ (2,493 )   $ 576     $ (1,801 )   $ 2,052  
Other comprehensive income (loss):
                               
Change in unrealized gain (loss) on securities available-for-sale
    1,103       1,128       2,551       1,401  
Change in unrealized gain (loss) on securities available-for-sale for which a portion of other-than-temporary impairment has been recognized into earnings
    (6 )     (213 )     (53 )     101  
Reclassification of realized amount on securities available-for-sale losses (gains)
    641       304       798       679  
Non-credit component of other-than-temporary impairment on held-to-maturity securities
    -       -       -       (215 )
Reclassification of unrealized loss on held-to-maturity security recognized in income
    1       -       50       24  
Accretion (amortization) of non-credit component of other-than- temorary impairment on held-to-maturity securities
    -       3       (1 )     5  
Net unrealized gain (loss) recognized in comprehensive income
    1,739       1,222       3,345       1,995  
Tax effect
    (591 )     (415 )     (1,137 )     (678 )
Total other comphrehensive income
    1,148       807       2,208       1,317  
                                 
Comprehensive Income/(Loss)
  $ (1,345 )   $ 1,383     $ 407     $ 3,369  
 
The following is a summary of the accumulated other comprehensive income balances, net of tax:
 
           
 
Balance at 12/31/2009
   
Current Period Change
   
Balance at 9/30/2010
 
Unrealized gains (losses) on securities available-for-sale  
  $ (925 )   $ 2,176     $ 1,251  
Unrealized gains (losses) on held-to-maturity securities for which   OTTI has been recorded, net of accretion
       (138 )        32          (106 )
   
                       
       Total  
  $ (1,063 )   $ 2,208     $ 1,145  
 
See notes to the unaudited consolidated financial statements.
 
6

 
FIRST FINANCIAL SERVICE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 2010
(Dollars In Thousands, Except Per Share Amounts)
(Unaudited)
 
   
Shares
   
Amount
   
Additional Paid-in
   
Retained
   
Accumulated Other Comprehensive (Loss), Net of
       
   
Preferred
   
Common
   
Preferred
   
Common
   
Capital
   
Earnings
   
Tax
   
Total
 
Balance, January 1, 2010
    20,000       4,710     $ 19,781     $ 4,710     $ 34,984     $ 26,720     $ (1,063 )   $ 85,132  
Net loss
                                            (1,801 )             (1,801 )
Shares issued under dividend reinvestment program
            2               2       14                       16  
Stock issued for employee benefit plans
            14               14       102                       116  
Stock-based compensation expense
                                    71                       71  
Net change in unrealized gains (losses) on securities available-for-sale, net of tax
                                                    1,695       1,695  
Change in unrealized gains (losses) on held-to-maturity  securities for which an other-than-temporary impairment charge has been recorded, net of tax
                                                    32       32  
Change in unrealized gains (losses) on securities available-for-sale for which a portion of an other-than-temporary impairment charge has been recognized into earnings, net of reclassification and taxes
                                                    481       481  
Dividends on preferred stock
                                            (750 )             (750 )
Accretion of preferred stock discount
    -       -       41       -       -       (41 )     -       -  
Balance, September 30, 2010
    20,000       4,726     $ 19,822     $ 4,726     $ 35,171     $ 24,128     $ 1,145     $ 84,992  

See notes to the unaudited consolidated financial statements.

7


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

   
Nine Months Ended
 
   
September 30,
 
   
2010
   
2009
 
Operating Activities:
           
Net income/(loss)
  $ (1,801 )   $ 2,052  
Adjustments to reconcile net income / (loss) to net cash provided by operating activities:
               
Provision for loan losses
    11,353       6,441  
Depreciation on premises and equipment
    1,320       1,264  
Core deposit intangible amortization
    229       302  
Net amortization (accretion) available-for-sale
    (1,554 )     131  
Net amortization (accretion) held-to-maturity
    -       8  
Impairment loss on securities available-for-sale
    782       679  
Impairment loss on securities held-to-maturity
    50       24  
Gain on sale of investments available-for-sale
    (7 )     -  
Loss on sale of investments available-for-sale
    23       -  
Gain on sale of mortgage loans
    (1,227 )     (832 )
Origination of loans held for sale
    (96,445 )     (101,364 )
Proceeds on sale of loans held for sale
    92,642       104,034  
Stock-based compensation expense
    71       78  
Prepaid FDIC premium
    1,859       -  
Changes in:
               
Cash surrender value of life insurance
    (258 )     (269 )
Interest receivable
    (590 )     (685 )
Other assets
    (560 )     (931 )
Interest payable
    (114 )     52  
Accrued income tax
    (3,754 )     (1,013 )
Accounts payable and other liabilities
    2,004       787  
Net cash from operating activities
    4,023       10,758  
                 
Investing Activities:
               
Sales of securities available-for-sale
    665       -  
Purchases of securities available-for-sale
    (179,022 )     (19,565 )
Maturities of securities available-for-sale
    63,424       1,592  
Maturities of securities held-to-maturity
    1,038       5,434  
Net change in loans
    61,552       (82,728 )
Redemption of Federal Home Loan Bank stock
    3,500       -  
Net purchases of premises and equipment
    (1,672 )     (3,541 )
Net cash from investing activities
    (50,515 )     (98,808 )
                 
Financing Activities
               
Net change in deposits
    38,911       162,319  
Change in short-term borrowings
    (1,155 )     (92,669 )
Repayments to Federal Home Loan Bank
    (181 )     (170 )
Issuance of preferred stock, net
    -       20,000  
Issuance of common stock under dividend reinvestment program
    16       3  
Issuance of common stock for stock options exercised
    -       101  
Issuance of common stock for employee benefit plans
    116       407  
Dividends paid on common stock
    -       (2,015 )
Dividends paid on preferred stock
    (750 )     (730 )
Net cash from financing activities
    36,957       87,246  
                 
(Decrease) Increase in cash and cash equivalents
    (9,535 )     (804 )
Cash and cash equivalents, beginning of period
    98,533       20,905  
Cash and cash equivalents, end of period
  $ 88,998     $ 20,101  
                 
Supplemental noncash disclosures:
               
Transfers from loans to real estate owned
  $ 10,434     $ 6,652  

See notes to the unaudited consolidated financial statements.
 
8

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three and nine month periods ending September 30, 2010 are not necessarily indicative of the results that may occur for the year ending December 31, 2010.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the period ended December 31, 2009.

Reclassifications Some items in the prior year financial statements were reclassified to conform to the current presentation.

Adoption of New Accounting Standards FASB ASC 860, Transfers and Servicing, was issued in June 2009.  This statement amends and removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The new standard became effective for us on January 1, 2010 and did not have a material impact.

FASB ASC 810, Consolidations, was also issued in June 2009 and amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. This standard requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This statement requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The new standard became effective for us on January 1, 2010 and did not have a material impact.

Newly Issued But Not Yet Effective Accounting StandardsFASB ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, was issued in July 2010.  The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements.  The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010.  Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance roll-forward and modification disclosures, will be required for periods beginning after December 15, 2010.  The Company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.

9

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES

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

(Dollars in thousands)
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
Securities available-for-sale:
                       
September 30, 2010:
                       
U.S. Treasury and agencies
  $ 80,859     $ 408     $ (15 )   $ 81,252  
Government-sponsored mortgage-backed residential
    57,853       1,112       (56 )     58,909  
Equity
    309       8       (5 )     312  
State and municipal
    22,613       1,627       (24 )     24,216  
Trust preferred securities
    1,265       -       (1,204 )     61  
                                 
Total
  $ 162,899     $ 3,155     $ (1,304 )   $ 164,750  

December 31, 2009:
                       
U.S. Treasury and agencies
  $ 20,000     $ 80     $ -     $ 20,080  
Government-sponsored mortgage-backed residential
    9,632       171       (51 )     9,752  
Equity
    933       60       (3 )     990  
State and municipal
    14,604       399       (110 )     14,893  
Trust preferred securities
    1,983       -       (1,934 )     49  
                                 
Total
  $ 47,152     $ 710     $ (2,098 )   $ 45,764  
 
   
Amortized Cost
   
Gross Unrecognized Gains
   
Gross Unrecognized Losses
   
Fair Value
 
Securities held-to-maturity:
                       
September 30, 2010:
                       
Government-sponsored mortgage-backed residential
  $ 107     $ 3     $ -     $ 110  
Trust preferred securities
    21       -       -       21  
                                 
Total
  $ 128     $ 3     $ -     $ 131  
                                 
December 31, 2009:
                               
Government-sponsored mortgage-backed residential
  $ 902     $ 6     $ -     $ 908  
State and municipal
    245       3       -       248  
Trust preferred securities
    20       -       -       20  
                                 
Total
  $ 1,167     $ 9     $ -     $ 1,176  
 
10

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

The amortized cost and fair value of securities at September 30, 2010, by contractual maturity, are shown below.  Securities not due at a single maturity date, primarily mortgage-backed and equity securities, are shown separately.

   
Available for Sale
   
Held-to-Maturity
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
(Dollars in thousands)
 
Cost
   
Value
   
Cost
   
Value
 
                         
Due in one year or less
  $ -     $ -     $ -     $ -  
Due after one year through five years
    10,514       10,588       -       -  
Due after five years through ten years
    41,894       42,159       -       -  
Due after ten years
    52,329       52,782       21       21  
Government-sponsored mortgage-backed residential
    57,853       58,909       107       110  
Equity
    309       312       -       -  
    $ 162,899     $ 164,750     $ 128     $ 131  
 
For the September 30, 2010 nine month period, proceeds from sales of available-for-sale equity securities were $665,000 and net realized losses recognized in income were $16,000.  There were no sales of available-for-sale securities for the September 30, 2009 period.

Investment securities pledged to secure public deposits and FHLB advances had an amortized cost of $44.8 million and fair value of $45.6 million at September 30, 2010 and a $28.6 million amortized cost and fair value of $28.8 million at December 31, 2009.

Securities with unrealized losses at September 30, 2010 and December 31, 2009 aggregated by major security type and length of time in a continuous unrealized loss position are as follows:

September 30, 2010
 
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Description of Securities
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
                                     
U.S. Treasury and agencies
  $ 4,980     $ (15 )   $ -     $ -     $ 4,980     $ (15 )
Government-sponsored mortgage-backed residential
    10,178       (56 )     -       -       10,178       (56 )
Equity
    3       (5 )     -       -       3       (5 )
State and municipal
    -       -       581       (24 )     581       (24 )
Trust preferred securities
    -       -       61       (1,204 )     61       (1,204 )
                                                 
Total temporarily impaired
  $ 15,161     $ (76 )   $ 642     $ (1,228 )   $ 15,803     $ (1,304 )

December 31, 2009
 
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Description of Securities
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
                                     
Government-sponsored mortgage-backed residential
  $ 5,141     $ (51 )   $ -     $ -     $ 5,141     $ (51 )
Equity
    75       (3 )     -       -       75       (3 )
State and municipal
    1,161       (22 )     2,456       (88 )     3,617       (110 )
Trust preferred securities
    -       -       49       (1,934 )     49       (1,934 )
                                                 
Total temporarily impaired
  $ 6,377     $ (76 )   $ 2,505     $ (2,022 )   $ 8,882     $ (2,098 )

11

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

We evaluate investment securities with significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under current accounting guidance, which generally provides that if a security is in an unrealized loss position, whether due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the impairment is other-than-temporary.

Accounting guidance requires entities to split other than temporary impairment charges between credit losses (i.e., the loss based on the entity’s estimate of the decrease in cash flows, including those that result from expected voluntary prepayments), which are charged to earnings, and the remainder of the impairment charge (non-credit component) to accumulated other comprehensive income. This requirement pertains to both securities held to maturity and securities available for sale.

The unrealized losses on the state and municipal securities were caused primarily by interest rate decreases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment.  Because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do not consider these investments to be other-than-temporarily impaired at September 30, 2010.  We also considered the financial condition and near term prospects of the issuers and identified no matters that would indicate less than full recovery.

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

To determine if the five trust preferred securities were other than temporarily impaired as of September 30, 2010, we used a discounted cash flow analysis.  The cash flow models were used to determine if the current present value of the cash flows expected on each security were still equivalent to the original cash flows projected on the security when purchased.   The cash flow analysis takes into consideration assumptions for prepayments, defaults and deferrals for the underlying pool of banks, insurance companies and REITs.

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

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

12

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. 
SECURITIES – (Continued)

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

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

The following table details the five debt securities with other-than-temporary impairment at September 30, 2010 and the related credit losses recognized in earnings during the nine months ended September 30 2010:

(Dollars in thousands)
     
Moody's Credit Ratings When
 
Current Moody's Credit
 
Par
   
Amortized
   
Estimated Fair
   
Current Deferrals and
   
% of Current Deferrals and Defaults to Current
   
OTTI
 
Security
 
Tranche
 
Purchased
 
Ratings
 
Value
   
Cost
   
Value
   
Defaults
   
Collateral
   
Recognized
 
                                                 
Preferred Term Securities IV
 
Mezzanine
    A3  
Ca
  $ 244     $ 187     $ 24     $ 18,000       27 %   $ 12  
Preferred Term Securities VI
 
Mezzanine
    A1  
Caa1
    259       21       21       33,000       81 %     50  
Preferred Term Securities XV B1
 
Mezzanine
    A2  
Ca
    1,004       475       19       209,450       35 %     357  
Preferred Term Securities XXI C2
 
Mezzanine
    A3  
Ca
    1,018       440       13       215,890       29 %     191  
Preferred Term Securities XXII C1
 
Mezzanine
    A3  
Ca
    503       163       5       396,500       29 %     222  
                                                               
Total
                $ 3,028     $ 1,286     $ 82                     $ 832  
 
The table below presents a roll-forward of the credit losses recognized in earnings for the period ended September 30, 2010:

(Dollars in thousands)
     
       
Beginning balance January 1, 2010
  $ 862  
Increases to the amount related to the credit loss for which
       
other-than-temporary impairment was previously recognized
    832  
Ending balance September 30, 2010
  $ 1,694  
 
13


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
3. 
LOANS

Loans are summarized as follows:

   
September 30,
   
December 31,
 
(Dollars in thousands)
 
2010
   
2009
 
             
Commercial
  $ 44,265     $ 62,940  
Real estate commercial
    587,767       627,788  
Real estate construction
    10,402       14,567  
Residential mortgage
    169,763       178,985  
Consumer and home equity
    77,080       74,844  
Indirect consumer
    31,325       36,628  
Loans held for sale
    13,213       8,183  
      933,815       1,003,935  
Less:
               
Net deferred loan origination fees
    (507 )     (826 )
Allowance for loan losses
    (20,091 )     (17,719 )
                 
      (20,598 )     (18,545 )
                 
Loans Receivable
  $ 913,217     $ 985,390  
 
The allowance for loan loss is summarized as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(Dollars in thousands)
 
2010
   
2009
   
2010
   
2009
 
                         
Balance, beginning of period
  $ 20,953     $ 14,236     $ 17,719     $ 13,565  
Provision for loan losses
    6,327       2,482       11,353       6,441  
Charge-offs
    (7,276 )     (656 )     (9,180 )     (4,063 )
Recoveries
    87       111       199       230  
Balance, end of period
  $ 20,091     $ 16,173     $ 20,091     $ 16,173  
 
Impaired loans are summarized below.  There were no impaired loans for the periods presented without an allowance allocation.

   
As of the
Nine Months Ended
   
As of the Year Ended
 
   
September 30,
   
December 31,
 
(Dollars in thousands)
 
2010
   
2009
 
             
End of period impaired loans
  $ 100,093     $ 66,956  
Amount of allowance for loan loss allocated
    10,086       6,398  
 
14


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3. 
LOANS– (Continued)

We report non-performing loans as impaired.  Our non-performing loans were as follows:

   
September 30,
   
December 31,
 
(Dollars in thousands)
 
2010
   
2009
 
             
Restructured
  $ 2,008     $ 9,812  
Loans past due over 90 days still on accrual
    -       -  
Non accrual loans
    58,054       28,186  
Total
  $ 60,062     $ 37,998  
 
We have allocated $358,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2010.  We are not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring.

4. 
REAL ESTATE ACQUIRED THROUGH FORECLOSURE

A summary of the real estate acquired through foreclosure activity is as follows:

   
September 30,
   
December 31,
 
(Dollars in thousands)
 
2010
   
2009
 
             
Beginning balance
  $ 8,428     $ 5,925  
Additions
    9,471       5,979  
Sales
    (4,367 )     (2,930 )
Writedowns
    (751 )     (546 )
Ending balance
  $ 12,781     $ 8,428  
 
5. 
EARNINGS (LOSS) PER SHARE

The reconciliation of the numerators and denominators of the basic and diluted EPS is as follows:

   
Three Months Ended
   
Nine Months Ended
 
(Dollars in thousands,
 
September 30,
   
September 30,
 
except per share data)
 
2010
   
2009
   
2010
   
2009
 
                         
Basic:
                       
Net income/(loss)
  $ (2,493 )   $ 576     $ (1,801 )   $ 2,052  
Less:
                               
Preferred stock dividends
    (250 )     (250 )     (750 )     (730 )
Accretion on preferred stock discount
    (14 )     (14 )     (41 )     (39 )
Net income/(loss) available to common shareholders
  $ (2,757 )   $ 312     $ (2,592 )   $ 1,283  
Weighted average common shares
    4,724       4,704       4,720       4,690  
                                 
Diluted:
                               
Weighted average common shares
    4,724       4,704       4,720       4,690  
Dilutive effect of stock options and warrants
    -       30       -       13  
Weighted average common and incremental shares
    4,724       4,734       4,720       4,703  
                                 
Earnings/(Loss) Per Common Share: