Attached files
Table of Contents
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 AND EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2010
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the transition period from to .
COMMISSION FILE NO. 000-49747
FIRST SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
Tennessee | 58-2461486 | |
(State of Incorporation) | (I.R.S. Employer Identification No.) |
531 Broad Street, Chattanooga, TN | 37402 | |
(Address of principal executive offices) | (Zip Code) |
(423) 266-2000
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its 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 ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:
Common Stock, $0.01 par value:
16,418,327 shares outstanding and issued as of November 9, 2010
Table of Contents
First Security Group, Inc. and Subsidiary
Form 10-Q
INDEX
Page No. | ||||||
PART I. | FINANCIAL INFORMATION | |||||
Item 1. | Financial Statements | |||||
Consolidated Balance Sheets - September 30, 2010, December 31, 2009 and September 30, 2009 |
1 | |||||
Consolidated Income Statements - Three months and nine months ended September 30, 2010 and 2009 |
3 | |||||
Consolidated Statement of Stockholders Equity - Nine months ended September 30, 2010 |
4 | |||||
Consolidated Statements of Cash Flows - Nine months ended September 30, 2010 and 2009 |
5 | |||||
7 | ||||||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 27 | ||||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 61 | ||||
Item 4. | Controls and Procedures | 62 | ||||
PART II. | OTHER INFORMATION | |||||
Item 1. | Legal Proceedings | 63 | ||||
Item 1A. | Risk Factors | 63 | ||||
Item 3. | Defaults Upon Senior Securities | 64 | ||||
Item 6. | Exhibits | 65 | ||||
SIGNATURES | 66 |
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1. | Financial Statements |
First Security Group, Inc. and Subsidiary
Consolidated Balance Sheets
(in thousands) |
September 30, 2010 (unaudited) |
December 31, 2009 (restated) |
September 30, 2009 (unaudited) |
|||||||||
ASSETS |
||||||||||||
Cash and Due from Banks |
$ | 8,545 | $ | 23,220 | $ | 14,711 | ||||||
Federal Funds Sold and Securities Purchased under Agreements to Resell |
| | | |||||||||
Cash and Cash Equivalents |
8,545 | 23,220 | 14,711 | |||||||||
Interest Bearing Deposits in Banks |
224,111 | 152,616 | 5,394 | |||||||||
Securities Available-for-Sale |
155,108 | 143,045 | 147,175 | |||||||||
Loans Held for Sale |
3,386 | 1,225 | 1,001 | |||||||||
Loans |
774,032 | 950,793 | 963,294 | |||||||||
Total Loans |
777,418 | 952,018 | 964,295 | |||||||||
Less: Allowance for Loan and Lease Losses |
25,320 | 26,492 | 25,686 | |||||||||
752,098 | 925,526 | 938,609 | ||||||||||
Premises and Equipment, net |
31,891 | 33,157 | 33,587 | |||||||||
Intangible Assets |
1,570 | 1,918 | 2,012 | |||||||||
Other Assets |
73,068 | 73,917 | 61,420 | |||||||||
TOTAL ASSETS |
$ | 1,246,391 | $ | 1,353,399 | $ | 1,202,908 | ||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Balance Sheets
(in thousands, except share data) |
September 30, 2010 (unaudited) |
December 31, 2009 (restated) |
September 30, 2009 (unaudited) |
|||||||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||
LIABILITIES |
||||||||||||
Deposits |
||||||||||||
Noninterest Bearing Demand |
$ | 166,723 | $ | 151,174 | $ | 146,820 | ||||||
Interest Bearing Demand |
65,047 | 62,429 | 61,502 | |||||||||
Savings and Money Market Accounts |
170,426 | 177,543 | 164,490 | |||||||||
Certificates of Deposit less than $100 thousand |
215,811 | 244,312 | 244,127 | |||||||||
Certificates of Deposit of $100 thousand or more |
164,466 | 207,465 | 203,533 | |||||||||
Brokered Deposits |
329,731 | 339,750 | 198,815 | |||||||||
Total Deposits |
1,112,204 | 1,182,673 | 1,019,287 | |||||||||
Federal Funds Purchased and Securities Sold under Agreements to Repurchase |
17,676 | 17,911 | 20,463 | |||||||||
Security Deposits |
939 | 1,376 | 1,444 | |||||||||
Other Borrowings |
81 | 94 | 7,724 | |||||||||
Other Liabilities |
8,645 | 10,181 | 8,801 | |||||||||
Total Liabilities |
1,139,545 | 1,212,235 | 1,057,719 | |||||||||
STOCKHOLDERS EQUITY |
||||||||||||
Preferred Stock no par value 10,000,000 shares authorized; 33,000 issued as of September 30, 2010, December 31, 2009 and September 30, 2009 |
31,620 | 31,339 | 31,248 | |||||||||
Common Stock - $.01 par value - 150,000,000 shares authorized as of September 30, 2010, 50,000,000 shares authorized as of December 31, 2009 and September 30, 2009; 16,418,327 issued as of September 30, 2010, December 31, 2009 and September 30, 2009 |
114 | 114 | 114 | |||||||||
Paid-In Surplus |
111,550 | 111,964 | 111,999 | |||||||||
Common Stock Warrants |
2,006 | 2,006 | 2,006 | |||||||||
Unallocated ESOP Shares |
(5,396 | ) | (6,193 | ) | (6,446 | ) | ||||||
Accumulated Deficit |
(38,789 | ) | (4,258 | ) | (524 | ) | ||||||
Accumulated Other Comprehensive Income |
5,741 | 6,192 | 6,792 | |||||||||
Total Stockholders Equity |
106,846 | 141,164 | 145,189 | |||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 1,246,391 | $ | 1,353,399 | $ | 1,202,908 | ||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Income Statements
(unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
(in thousands, except per share data) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
INTEREST INCOME |
||||||||||||||||
Loans, including fees |
$ | 11,909 | $ | 14,462 | $ | 38,090 | $ | 43,859 | ||||||||
Debt Securities taxable |
926 | 1,097 | 3,010 | 3,435 | ||||||||||||
Debt Securities non-taxable |
335 | 396 | 1,062 | 1,200 | ||||||||||||
Other |
32 | 3 | 371 | 38 | ||||||||||||
Total Interest Income |
13,202 | 15,958 | 42,533 | 48,532 | ||||||||||||
INTEREST EXPENSE |
||||||||||||||||
Interest Bearing Demand Deposits |
47 | 45 | 142 | 146 | ||||||||||||
Savings Deposits and Money Market Accounts |
341 | 384 | 1,105 | 1,255 | ||||||||||||
Certificates of Deposit of less than $100 thousand |
1,131 | 1,738 | 3,722 | 5,687 | ||||||||||||
Certificates of Deposit of $100 thousand or more |
970 | 1,530 | 3,261 | 4,934 | ||||||||||||
Brokered Deposits |
2,459 | 1,225 | 7,169 | 4,478 | ||||||||||||
Other |
119 | 136 | 363 | 395 | ||||||||||||
Total Interest Expense |
5,067 | 5,058 | 15,762 | 16,895 | ||||||||||||
NET INTEREST INCOME |
8,135 | 10,900 | 26,771 | 31,637 | ||||||||||||
Provision for Loan and Lease Losses |
18,415 | 9,280 | 26,424 | 20,469 | ||||||||||||
NET INTEREST (LOSS) INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES |
(10,280 | ) | 1,620 | 347 | 11,168 | |||||||||||
NONINTEREST INCOME |
||||||||||||||||
Service Charges on Deposit Accounts |
951 | 1,184 | 2,999 | 3,501 | ||||||||||||
Gain on Sales of Available for Sale Securities, net |
| | 57 | | ||||||||||||
Other |
1,453 | 1,553 | 4,210 | 4,331 | ||||||||||||
Total Noninterest Income |
2,404 | 2,737 | 7,266 | 7,832 | ||||||||||||
NONINTEREST EXPENSES |
||||||||||||||||
Salaries and Employee Benefits |
4,787 | 4,903 | 14,438 | 15,303 | ||||||||||||
Expense on Premises and Fixed Assets, net of rental income |
1,431 | 1,493 | 4,187 | 4,525 | ||||||||||||
Impairment of Goodwill |
| 27,156 | | 27,156 | ||||||||||||
Other |
6,294 | 3,811 | 15,539 | 9,731 | ||||||||||||
Total Noninterest Expenses |
12,512 | 37,363 | 34,164 | 56,715 | ||||||||||||
LOSS BEFORE INCOME TAX PROVISION |
(20,388 | ) | (33,006 | ) | (26,551 | ) | (37,715 | ) | ||||||||
Income Tax Provision (Benefit) |
9,384 | (4,877 | ) | 6,461 | (7,326 | ) | ||||||||||
NET LOSS |
(29,772 | ) | (28,129 | ) | (33,012 | ) | (30,389 | ) | ||||||||
Preferred Stock Dividends |
413 | 412 | 1,238 | 1,196 | ||||||||||||
Accretion on Preferred Stock Discount |
95 | 90 | 281 | 254 | ||||||||||||
NET LOSS TO COMMON STOCKHOLDERS |
$ | (30,280 | ) | $ | (28,631 | ) | $ | (34,531 | ) | $ | (31,839 | ) | ||||
NET LOSS PER SHARE: |
||||||||||||||||
Net Loss Per Share - Basic |
$ | (1.92 | ) | $ | (1.84 | ) | $ | (2.20 | ) | $ | (2.05 | ) | ||||
Net Loss Per Share - Diluted |
$ | (1.92 | ) | $ | (1.84 | ) | $ | (2.20 | ) | $ | (2.05 | ) | ||||
Dividends Declared Per Common Share |
$ | | $ | 0.01 | $ | | $ | 0.07 |
(See Accompanying Notes to Consolidated Financial Statements)
3
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First Security Group, Inc. and Subsidiary
Consolidated Statement of Stockholders Equity
Common Stock | Accumulated | |||||||||||||||||||||||||||||||||||
(in thousands) |
Preferred Stock |
Shares | Amount | Paid-In Surplus |
Common Stock Warrants |
Accumulated Deficit |
Other Comprehensive Income |
Unallocated ESOP Shares |
Total | |||||||||||||||||||||||||||
Balance December 31, 2009 (restated) |
$ | 31,339 | 16,418 | $ | 114 | $ | 111,964 | $ | 2,006 | $ | (4,258 | ) | $ | 6,192 | $ | (6,193 | ) | $ | 141,164 | |||||||||||||||||
Comprehensive Income: |
||||||||||||||||||||||||||||||||||||
Net Loss (unaudited) |
(33,012 | ) | (33,012 | ) | ||||||||||||||||||||||||||||||||
Change Unrealized Gain: |
||||||||||||||||||||||||||||||||||||
Securities Available-for-Sale, net of tax and reclassification adjustments (unaudited) |
563 | 563 | ||||||||||||||||||||||||||||||||||
Fair Value of Derivatives, net of tax and reclassification adjustments (unaudited) |
(1,014 | ) | (1,014 | ) | ||||||||||||||||||||||||||||||||
Total Comprehensive Loss |
(33,463 | ) | ||||||||||||||||||||||||||||||||||
Accretion of Discount Associated with Preferred Stock (unaudited) |
281 | (281 | ) | | ||||||||||||||||||||||||||||||||
Preferred Stock Dividend (unaudited) |
(1,238 | ) | (1,238 | ) | ||||||||||||||||||||||||||||||||
Stock-based Compensation, net of forfeitures (unaudited) |
73 | 73 | ||||||||||||||||||||||||||||||||||
ESOP Allocation (unaudited) |
(487 | ) | 797 | 310 | ||||||||||||||||||||||||||||||||
Balance September 30, 2010 (unaudited) |
$ | 31,620 | 16,418 | $ | 114 | $ | 111,550 | $ | 2,006 | $ | (38,789 | ) | $ | 5,741 | $ | (5,396 | ) | $ | 106,846 | |||||||||||||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(unaudited)
Nine Months Ended September 30, | ||||||||
(in thousands) |
2010 | 2009 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net Loss |
$ | (33,012 | ) | $ | (30,389 | ) | ||
Adjustments to Reconcile Net Loss to Net Cash (Used in) Provided by Operating Activities - |
||||||||
Provision for Loan and Lease Losses |
26,424 | 20,469 | ||||||
Amortization, net |
751 | 513 | ||||||
Impairment of Goodwill |
| 27,156 | ||||||
Deferred Tax Asset Valuation Allowance |
17,432 | | ||||||
Stock-Based Compensation |
73 | 274 | ||||||
ESOP Compensation |
310 | 469 | ||||||
Depreciation |
1,372 | 1,582 | ||||||
Net Gain on Sale of Premises and Equipment |
(17 | ) | (2 | ) | ||||
Loss on Sale of Other Real Estate and Repossessions, net |
550 | 71 | ||||||
Write-down of Other Real Estate and Repossessions |
2,715 | 507 | ||||||
Gain on Sale of Available-for-Sale Securities, net |
(57 | ) | | |||||
Accretion of Fair Value Adjustment, net |
(79 | ) | (140 | ) | ||||
Accretion of Cash Flow Swaps |
| (528 | ) | |||||
Accretion of Terminated Cash Flow Swaps |
(1,532 | ) | (1,252 | ) | ||||
Changes in Operating Assets and Liabilities - |
||||||||
Loans Held for Sale |
(2,164 | ) | 608 | |||||
Interest Receivable |
584 | 142 | ||||||
Other Assets |
(12,243 | ) | (4,318 | ) | ||||
Interest Payable |
(1,291 | ) | (2,463 | ) | ||||
Other Liabilities |
(1,639 | ) | (715 | ) | ||||
Net Cash (Used in) Provided by Operating Activities |
(1,823 | ) | 11,984 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Net Change in Interest Bearing Deposits in Banks |
(71,495 | ) | (4,476 | ) | ||||
Activity in Available-for-Sale-Securities - |
||||||||
Maturities, Prepayments, and Calls |
46,685 | 21,624 | ||||||
Sales |
14,762 | | ||||||
Purchases |
(73,002 | ) | (26,826 | ) | ||||
Loan Originations and Principal Collections, net |
134,191 | 19,205 | ||||||
Proceeds for Interim Settlements of Cash Flow Swaps, net |
| 938 | ||||||
Proceeds for Termination of Cash Flow Swaps |
| 5,778 | ||||||
Proceeds from Sale of Premises and Equipment |
17 | 16 | ||||||
Proceeds from Sales of Other Real Estate and Repossessions |
8,086 | 6,720 | ||||||
Additions to Premises and Equipment |
(106 | ) | (1,406 | ) | ||||
Capital Improvements to Repossessions and Other Real Estate |
(1,273 | ) | (355 | ) | ||||
Net Cash Provided by Investing Activities |
57,865 | 21,218 | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net Decrease in Deposits |
(70,469 | ) | (57,002 | ) | ||||
Net Decrease in Federal Funds Purchased and Securities Sold Under Agreements to Repurchase |
(235 | ) | (19,573 | ) | ||||
Net (Decrease) Increase of Other Borrowings |
(13 | ) | 4,947 | |||||
Proceeds from Issuance of Preferred Stock and Common Stock Warrants |
| 33,000 | ||||||
Repurchase of Common Stock for 401(k) and ESOP Plan |
| (1,023 | ) | |||||
Dividends Paid on Preferred Stock |
| (990 | ) | |||||
Dividends Paid on Common Stock |
| (1,072 | ) | |||||
Net Cash Used in Financing Activities |
(70,717 | ) | (41,713 | ) | ||||
NET CHANGE IN CASH AND CASH EQUIVALENTS |
(14,675 | ) | (8,511 | ) | ||||
CASH AND CASH EQUIVALENTS - beginning of period |
23,220 | 23,222 | ||||||
CASH AND CASH EQUIVALENTS - end of period |
$ | 8,545 | $ | 14,711 | ||||
(See Accompanying Notes to Consolidated Financial Statements)
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Nine Months Ended September 30, | ||||||||
(in thousands) |
2010 | 2009 | ||||||
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES |
||||||||
Transfers to Foreclosed Properties and Repossessions |
$ | 18,781 | $ | 17,103 | ||||
SUPPLEMENTAL SCHEDULE OF CASH FLOWS |
||||||||
Interest Paid |
$ | 17,053 | $ | 19,358 | ||||
Income Taxes Paid |
$ | 128 | $ | 539 |
(See Accompanying Notes to Consolidated Financial Statements)
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature, except for the deferred tax valuation allowance as discussed in Note 11.
The consolidated financial statements include the accounts of First Security Group, Inc. and its subsidiary bank, which is wholly-owned. All significant intercompany balances and transactions have been eliminated.
Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010 or any other period. These interim financial statements should be read in conjunction with the Companys latest annual consolidated financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009.
NOTE 2 RESTATEMENT
Subsequent to filing the June 30, 2010 Quarterly Report on Form 10-Q and a change in personnel responsible for the Companys other real estate owned, the Company determined that certain write-downs associated with other real estate owned (OREO) were not recorded in the appropriate accounting periods. Upon completion of the Companys internal review, the primary regulator of the Companys wholly-owned subsidiary bank, FSGBank, N.A. (Bank), verified the findings as part of its ongoing annual safety and soundness examination. The Bank has been requested to file amended Call Reports with the FDIC and the Company to file amended FR Y-9C and FR Y-9LP reports with the Federal Reserve, for December 31, 2009, March 31, 2010 and June 30, 2010 to reflect the findings.
On October 28, 2010, the Companys Audit/Corporate Governance Committee determined that the previously issued audited consolidated financial statements for the year ended December 31, 2009 (contained in the Companys Annual Report on Form 10-K filed March 16, 2010, and subsequently amended by that certain Amendment No. 1 to the Annual Report on Form 10-K filed on April 30, 2010) and the previously issued unaudited consolidated financial statements for the quarters ended March 31, 2010 and June 30, 2010 (contained in the Companys Quarterly Reports on Form 10-Q filed, respectively, on May 10, 2010 and August 8, 2010) should no longer be relied upon. The restatements to these consolidated financial statements reflect the appropriate timing and recognition of charge-offs and write-downs associated with other real estate owned. While the changes were not quantitatively material, the restatements ensure consistency with the Companys publicly available financial information.
For the period ended December 31, 2009, the Company determined that additional OREO write-downs totaling $616 thousand and additional OREO charge-offs totaling $89 thousand were improperly reflected in future periods. The December 31, 2009 Form 10-K/A (Amendment No. 2) will properly reflect these items as well as an increase in the provision for loan and lease losses of $89 thousand to return the allowance for loan and lease losses to the previously reported balance. The tax benefit associated with the additional expenses totaled $270 thousand. The net impact on these items increased the net loss available to common stockholders by $435 thousand from the previously reported net loss of $34,974 thousand to $35,409 thousand.
For the three-month period ended March 31, 2010, the Company previously reported no OREO write-downs. The Companys policies require an appraisal to determine the initial fair value of the property at the time of foreclosure. An updated appraisal is required on at least an annual basis. The Companys internal review determined that 15 properties were subject to new appraisals during the first quarter of 2010; however, all 15 appraisals were received subsequent to March 31, 2010. These findings were consistent with the properties due for a new appraisal during the fourth quarter of 2009; ten of the twelve appraisals due in the fourth quarter were received in the second quarter of 2010. The other two appraisals were received during the fourth quarter but the associated write-downs were not recorded. Accordingly, March 31, 2010 Form 10-Q/A will only reflect changes to the December 31, 2009 and March 31, 2010 consolidated balance sheets.
For the three-month period ended June 30, 2010, the Company previously reported $1,337 thousand in write-downs to OREO/repossessions. Of this amount, $292 thousand were inappropriately accounted for in this reporting period. These write-downs have been included in the above restatements. Additionally, the Companys internal review determined that a charge-off of $89 thousand and a write-down of $24 thousand were not properly reported in the three months ended June 30, 2010. The June 30, 2010 Form 10-Q/A will reflect the changes described above, including the tax effects thereof, as well as an additional $89 thousand in provision for loan and lease losses to return the allowance to the previously reported balance.
For the three months ended September 30, 2010, the Companys internal review identified $526 thousand of write-downs that were associated with prior periods. These have been reclassified in the above restatements. As the Companys internal review was completed prior to filing the September 30, 2010 quarterly report on Form 10-Q, no restatement is required for this period.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The following table provides the previously reported and the restated amounts included in the restatements:
Previously Reported as of December 31, 2009 |
Anticipated Restatement Adjustments |
Restated as of December 31, 2009 |
||||||||||
(in thousands) | ||||||||||||
Changes to the Consolidated Balance Sheet |
||||||||||||
Other Assets |
$ | 74,352 | $ | (435 | ) | $ | 73,917 | |||||
Accumulated Deficit |
$ | (3,823 | ) | $ | (435 | ) | $ | (4,258 | ) | |||
Changes to the Consolidated Income Statements |
||||||||||||
Provision for Loan and Lease Losses |
$ | 25,315 | $ | 89 | $ | 25,404 | ||||||
Other Non-Interest Expense |
$ | 14,938 | $ | 617 | $ | 15,555 | ||||||
Income Tax (Benefit) Provision |
$ | (7,982 | ) | $ | (271 | ) | $ | (8,253 | ) | |||
Net (Loss) Income Available to Common Shareholders |
$ | (34,974 | ) | $ | (435 | ) | $ | (35,409 | ) | |||
Previously Reported as of March 31, 2010 |
Anticipated Restatement Adjustments |
Restated as of March 31, 2010 |
||||||||||
(in thousands) | ||||||||||||
Changes to the Consolidated Balance Sheet |
||||||||||||
Other Assets |
$ | 80,539 | $ | (435 | ) | $ | 80,104 | |||||
Accumulated Deficit |
$ | (5,442 | ) | $ | (435 | ) | $ | (5,877 | ) | |||
Previously Reported as of June 30, 2010 |
Anticipated Restatement Adjustments |
Restated as of June 30, 2010 |
||||||||||
(in thousands) | ||||||||||||
Changes to the Consolidated Balance Sheet |
||||||||||||
Other Assets |
$ | 80,313 | $ | (365 | ) | $ | 79,948 | |||||
Accumulated Deficit |
$ | (8,144 | ) | $ | (365 | ) | $ | (8,509 | ) | |||
Changes to the Consolidated Income Statements for the three months ended June 30, 2010 |
||||||||||||
Provision for Loan and Lease Losses |
$ | 3,544 | $ | 90 | $ | 3,634 | ||||||
Other Non-Interest Expense |
$ | 5,907 | $ | (203 | ) | $ | 5,704 | |||||
Income Tax Benefit |
$ | (1,812 | ) | $ | 43 | $ | (1,769 | ) | ||||
Net Loss Available to Common Shareholders |
$ | (2,702 | ) | $ | 70 | $ | (2,632 | ) |
NOTE 3. OPERATIONAL AND REGULATORY MATTERS
The Company continues to operate in a difficult environment and has been significantly impacted by the unprecedented credit and economic market turmoil, as well as the recessionary economy. Deterioration in the Tennessee and Georgia commercial and residential real estate markets and related declines in property values in those markets has had a negative impact on our operating results since the latter half of 2008.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Operational Matters
The Companys financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has experienced losses from operations during the last two years that raise possible doubt as to its ability to continue as a going concern. The Companys ability to continue as a going concern is contingent upon its ability to devise and successfully execute a management plan to develop profitable operations, satisfy the requirements of the regulatory actions detailed below, and lower the level of problem assets to an acceptable level.
Management has developed strategic and capital plans, which include, but are not limited to: (1) reorganizing management into a line of business structure, (2) restructuring credit and lending functions with new policies and centralized processes, (3) reducing adversely classified assets, (4) maintaining a Tier 1 leverage capital ratio of not less than 9%, (5) maintaining a total risk-based capital ratio of not less than 13%, (6) maintaining an adequate allowance for loan losses and (7) actively working to maintain appropriate liquidity while reducing reliance on non-core sources of funding.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
Regulatory Matters
First Security Group, Inc.
On September 7, 2010, the Company entered into a Written Agreement (Agreement) with the Federal Reserve Bank of Atlanta (Federal Reserve), the Companys primary regulator. The Agreement is designed to enhance the Companys ability to act as a source of strength to the Bank.
The Agreement prohibits the Company from declaring or paying dividends without prior written consent of the Federal Reserve. The Company is also prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank without prior written consent.
Within 60 days of the Agreement, the Company is required to submit to the Federal Reserve a written plan designed to maintain sufficient capital at the Company and the Bank.
On September 14, 2010, the Company filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides the final, executed Agreement.
9
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
FSGBank, N.A.
On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order (Order), FSGBank, the Companys wholly-owned subsidiary, consented and agreed to the issuance of a Consent Order by the Office of the Comptroller of the Currency (OCC), the Banks primary regulator.
The Bank and the OCC agreed as to the areas of the Banks operations that warrant improvement and a plan for making those improvements. The Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Bank is required to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan and lease losses, liquidity management, criticized asset, loan review and credit.
Within 120 days of the effective date of the Order, the Bank is required to achieve and thereafter maintain total capital at least equal to 13 percent of risk-weighted assets and Tier 1 capital at least equal to 9 percent of adjusted total assets. As of September 30, 2010, the first financial reporting period subsequent to the 120 day requirement, the Banks total capital to risk-weighted assets was 12.93 percent and the Tier 1 capital to adjusted total assets was 7.43 percent. The Bank has notified the OCC of the non-compliance.
During the third quarter of 2010, the OCC requested additional information and clarifications to the Banks submitted strategic and capital plans. The Bank is currently preparing the response and anticipates submitting the response during the fourth quarter of 2010.
Because the Order established specific capital amounts to be maintained by the Bank, the Bank may not be considered better than adequately capitalized for capital adequacy purposes, even if the Bank exceeds the levels of capital set forth in the Order. As an adequately capitalized institution, the Bank may not pay interest on deposits that are more than 75 basis points above the rate applicable to the applicable market of the Bank as determined by the FDIC. Additionally, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC.
On April 29, 2010, the Company filed a current report on Form 8-K describing the Order and the Banks actions to date. The Form 8-K also provides the final, executed Order.
10
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 4 COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in equity, not only reflecting net income but certain other changes as well. The following table presents the comprehensive income for the three and nine month periods ended September 30, 2010 and 2009, respectively.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in thousands) | ||||||||||||||||
Net loss |
$ | (29,772 | ) | $ | (28,129 | ) | $ | (33,012 | ) | $ | (30,389 | ) | ||||
Other comprehensive income (loss) |
||||||||||||||||
Available-for-sale securities |
||||||||||||||||
Unrealized net gain on securities arising during the period |
794 | 2,432 | 911 | 2,789 | ||||||||||||
Tax expense related to unrealized net gain |
(270 | ) | (827 | ) | (310 | ) | (948 | ) | ||||||||
Reclassification adjustments for realized gain included in net income |
| | (57 | ) | | |||||||||||
Tax expense related to gain realized in net income |
| | 19 | | ||||||||||||
Unrealized gain on securities, net of tax |
524 | 1,605 | 563 | 1,841 | ||||||||||||
Derivative cash flow hedges |
||||||||||||||||
Unrealized gain on derivatives arising during the period |
41 | | | 312 | ||||||||||||
Tax expense related to unrealized gain |
(14 | ) | | | (106 | ) | ||||||||||
Reclassification adjustments for realized gain included in net income |
(485 | ) | (614 | ) | (1,537 | ) | (1,765 | ) | ||||||||
Tax expense related to gain realized in net income |
165 | 209 | 523 | 600 | ||||||||||||
Unrealized loss on derivatives, net of tax |
(293 | ) | (405 | ) | (1,014 | ) | (959 | ) | ||||||||
Other comprehensive income (loss), net of tax |
231 | 1,200 | (451 | ) | 882 | |||||||||||
Comprehensive loss, net of tax |
$ | (29,541 | ) | $ | (26,929 | ) | $ | (33,463 | ) | $ | (29,507 | ) | ||||
NOTE 5 EARNINGS PER SHARE
The difference in basic and diluted weighted average shares is due to the assumed conversion of outstanding options using the treasury stock method. The following table presents the computation of basic and diluted earnings per share.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in thousands, except per share data) | ||||||||||||||||
Net loss available to common stockholders |
$ | (30,280 | ) | $ | (28,631 | ) | $ | (34,531 | ) | $ | (31,839 | ) | ||||
Denominator: |
||||||||||||||||
Weighted average common shares outstanding |
15,785 | 15,543 | 15,717 | 15,539 | ||||||||||||
Equivalent shares issuable upon exercise of stock options |
| | | | ||||||||||||
Weighted average diluted shares outstanding |
15,785 | 15,543 | 15,717 | 15,539 | ||||||||||||
Net loss per share: |
||||||||||||||||
Basic |
$ | (1.92 | ) | $ | (1.84 | ) | $ | (2.20 | ) | $ | (2.05 | ) | ||||
Diluted |
$ | (1.92 | ) | $ | (1.84 | ) | $ | (2.20 | ) | $ | (2.05 | ) | ||||
For the three and nine months ended September 30, 2010, the weighted average stock options, stock warrants and restricted stock awards that were anti-dilutive totaled 1,892 thousand and 1,930 thousand, respectively, compared to 1,311 thousand and 1,361 thousand for the same periods in 2009. Anti-dilutive options and awards are not included in the computation of diluted earnings per share under the treasury stock method.
11
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 6 SECURITIES
Investment Securities by Type
The following table presents the amortized cost and fair value of securities, with gross unrealized gains and losses.
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Securities available-for-sale |
||||||||||||||||
September 30, 2010 |
||||||||||||||||
Debt securities |
||||||||||||||||
Federal agencies |
$ | 27,787 | $ | 386 | $ | | $ | 28,173 | ||||||||
Mortgage-backed |
86,876 | 2,978 | | 89,854 | ||||||||||||
Municipals |
35,326 | 1,690 | 10 | 37,006 | ||||||||||||
Other |
127 | | 52 | 75 | ||||||||||||
Total |
$ | 150,116 | $ | 5,054 | $ | 62 | $ | 155,108 | ||||||||
Securities available-for-sale |
||||||||||||||||
December 31, 2009 |
||||||||||||||||
Debt securities |
||||||||||||||||
Federal agencies |
$ | 17,226 | $ | 144 | $ | 16 | $ | 17,354 | ||||||||
Mortgage-backed |
80,338 | 3,225 | 477 | 83,086 | ||||||||||||
Municipals |
41,216 | 1,373 | 66 | 42,523 | ||||||||||||
Other |
126 | | 44 | 82 | ||||||||||||
Total |
$ | 138,906 | $ | 4,742 | $ | 603 | $ | 143,045 | ||||||||
Securities available-for-sale |
||||||||||||||||
September 30, 2009 |
||||||||||||||||
Debt securities |
||||||||||||||||
Federal agencies |
$ | 20,262 | $ | 138 | $ | 1 | $ | 20,399 | ||||||||
Mortgage-backed |
80,765 | 3,202 | 559 | 83,408 | ||||||||||||
Municipals |
41,479 | 1,801 | 3 | 43,277 | ||||||||||||
Other |
126 | | 35 | 91 | ||||||||||||
Total |
$ | 142,632 | $ | 5,141 | $ | 598 | $ | 147,175 | ||||||||
Proceeds from sales of securities available-for-sale totaled $14,762 thousand for the nine months ended September 30, 2010. Gross realized gains from sales of securities were $368 thousand for the nine months ended September 30, 2010. Gross realized losses were $311 thousand for the nine months ended September 30, 2010. There were no sales of securities during the nine months ended September 30, 2009.
At September 30, 2010, December 31, 2009 and September 30, 2009, federal agencies, municipals and mortgage-backed securities with a carrying value of $28,949 thousand, $12,600 thousand and $14,973 thousand, respectively, were pledged to secure public deposits. At September 30, 2010, December 31, 2009 and September 30, 2009, the carrying amount of securities pledged to secure repurchase agreements was $20,095 thousand, $26,472 thousand and $33,596 thousand, respectively. At September 30, 2010, securities of $5,899 thousand were pledged to the Federal Reserve Bank of Atlanta to secure the Companys daytime correspondent transactions.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Maturity of Securities
The following table presents the amortized cost and fair value of debt securities by contractual maturity at September 30, 2010.
Amortized Cost |
Fair Value |
|||||||
(in thousands) | ||||||||
Within 1 year |
$ | 1,865 | $ | 1,890 | ||||
Over 1 year through 5 years |
33,734 | 34,574 | ||||||
5 years to 10 years |
23,060 | 24,082 | ||||||
Over 10 years |
4,581 | 4,708 | ||||||
63,240 | 65,254 | |||||||
Mortgage-backed securities |
86,876 | 89,854 | ||||||
Total |
$ | 150,116 | $ | 155,108 | ||||
Impairment Analysis
The following table shows the gross unrealized losses and fair value of the Companys investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010, December 31, 2009 and September 30, 2009.
Less than 12 months | 12 months or greater | Totals | ||||||||||||||||||||||
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
|||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
September 30, 2010 |
||||||||||||||||||||||||
Federal agencies |
$ | | $ | | $ | | $ | | $ | | $ | | ||||||||||||
Mortgage-backed |
| | | | | | ||||||||||||||||||
Municipals |
| | 392 | 10 | 392 | 10 | ||||||||||||||||||
Other |
| | 75 | 52 | 75 | 52 | ||||||||||||||||||
Totals |
$ | | $ | | $ | 467 | $ | 62 | $ | 467 | $ | 62 | ||||||||||||
December 31, 2009 |
||||||||||||||||||||||||
Federal agencies |
$ | 1,982 | $ | 16 | $ | | $ | | $ | 1,982 | $ | 16 | ||||||||||||
Mortgage-backed |
2,375 | 6 | 3,086 | 471 | 5,461 | 477 | ||||||||||||||||||
Municipals |
1,404 | 31 | 617 | 35 | 2,021 | 66 | ||||||||||||||||||
Other |
| | 82 | 44 | 82 | 44 | ||||||||||||||||||
Totals |
$ | 5,761 | $ | 53 | $ | 3,785 | $ | 550 | $ | 9,546 | $ | 603 | ||||||||||||
September 30, 2009 |
||||||||||||||||||||||||
Federal agencies |
$ | 1,370 | $ | 1 | $ | | $ | | $ | 1,370 | $ | 1 | ||||||||||||
Mortgage-backed |
| | 4,574 | 559 | 4,574 | 559 | ||||||||||||||||||
Municipals |
| | 650 | 3 | 650 | 3 | ||||||||||||||||||
Other |
| | 91 | 35 | 91 | 35 | ||||||||||||||||||
Totals |
$ | 1,370 | $ | 1 | $ | 5,315 | $ | 597 | $ | 6,685 | $ | 598 | ||||||||||||
As of September 30, 2010, the Company performed an impairment assessment of the securities in its portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) the Company intends to sell the security, (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized costs basis or (3) the Company does not expect to recover the securitys entire amortized cost basis, even if the Company does not intend to sell. Additionally, accounting guidance requires that for impaired securities that the Company does not intend to sell and/or that it is not more-likely-than-not that the Company will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses,
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, the Company considers factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
As of September 30, 2010, gross unrealized losses in the Companys portfolio totaled $62 thousand, compared to $603 thousand as of December 31, 2009 and $598 thousand as of September 30, 2009. The unrealized losses in municipal securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. Based on results of the Companys impairment assessment, the unrealized losses at September 30, 2010 are considered temporary.
NOTE 7 LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
The following table presents loans by type.
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
(in thousands) | ||||||||||||
Loans secured by real estate- |
||||||||||||
Residential 1-4 family |
$ | 258,579 | $ | 281,354 | $ | 284,811 | ||||||
Commercial |
236,991 | 259,819 | 233,692 | |||||||||
Construction |
101,870 | 153,144 | 176,570 | |||||||||
Multi-family and farmland |
37,816 | 37,960 | 37,461 | |||||||||
635,256 | 732,277 | 732,534 | ||||||||||
Commercial loans |
91,637 | 146,016 | 148,473 | |||||||||
Consumer installment loans |
37,884 | 48,927 | 51,866 | |||||||||
Leases, net of unearned income |
10,139 | 19,730 | 24,679 | |||||||||
Other |
2,502 | 5,068 | 6,743 | |||||||||
Total loans |
777,418 | 952,018 | 964,295 | |||||||||
Allowance for loan and lease losses |
(25,320 | ) | (26,492 | ) | (25,686 | ) | ||||||
Net loans |
$ | 752,098 | $ | 925,526 | $ | 938,609 | ||||||
14
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The following table presents an analysis of the allowance for loan and lease losses. The provision expense for loan and lease losses in the table does not include the Companys provision accrual for unfunded commitments of $18 thousand and $18 thousand for the nine months ended September 30, 2010 and 2009, respectively. The reserve for unfunded commitments totaled $223 thousand and $199 thousand as of September 30, 2010 and 2009, respectively, and is included in other liabilities in the consolidated balance sheets.
September 30, 2010 | September 30, 2009 | |||||||
(in thousands) | ||||||||
Allowance for loan and lease losses-beginning of period |
$ | 26,492 | $ | 17,385 | ||||
Provision expense for loan and lease losses |
26,406 | 20,451 | ||||||
Loans charged-off |
(28,130 | ) | (12,443 | ) | ||||
Loan loss recoveries |
552 | 293 | ||||||
Allowance for loan and lease losses-end of period |
$ | 25,320 | $ | 25,686 | ||||
The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans were $45,395 thousand, $40,118 thousand and $23,608 thousand at September 30, 2010, December 31, 2009 and September 30, 2009, respectively. Nonaccrual loans were $55,083 thousand, $45,454 thousand and $31,463 thousand at September 30, 2010, December 31, 2009 and September 30, 2009, respectively. Loans past due 90 days or more and still accruing interest were $6,025 thousand, $4,524 thousand and $3,377 thousand as of September 30, 2010, December 31, 2009 and September 30, 2009, respectively. The Company had no significant outstanding commitments to lend additional funds to customers whose loans have been placed on nonaccrual status.
Because of uncertainties inherent in the estimation process, managements estimate of credit losses in the loan portfolio and the related allowance may change in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
NOTE 8 GOODWILL
The changes in the carrying amounts of goodwill are as follows:
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
(in thousands) | ||||||||||||
Goodwill beginning of period |
$ | | $ | | $ | 27,156 | ||||||
Goodwill acquired |
| | | |||||||||
Goodwill impairment |
| | (27,156 | ) | ||||||||
Goodwill end of period |
$ | | $ | | $ | | ||||||
The Companys policy to assess goodwill for impairment was on an annual basis or between annual assessments if an event occurred or circumstances changed that would more likely than not reduce the fair value of goodwill below its carrying amount as required by authoritative accounting guidance. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The impairment testing is a two-step process. Step 1 compares the fair value of the reporting unit to the carrying value. If the fair value is below the carrying value, Step 2 is performed. Step 2 involves a process similar to business combination accounting in which fair values are assigned to all assets, liabilities and other (non-goodwill) intangibles. The result of Step 2 is the implied fair value of goodwill. If the implied fair value of goodwill is below the recorded goodwill amount, an impairment charge is recorded for the difference.
The Company engaged an independent valuation firm to assist in computing the fair value estimate for the goodwill impairment assessment as of September 30, 2009. The firm utilized two separate valuation methodologies for Step 1 and compared the results of each to determine the fair value of the
15
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
goodwill associated with the Companys prior bank acquisitions. The valuation methodologies utilized included a discounted cash flow valuation technique and a comparison of the average price to book value of comparable bank acquisitions. Both methods indicated a valuation below the book value of the Company. The firm conducted Step 2, which assigned fair values to all assets, liabilities and other (non-goodwill) intangibles. The results of Step 2 indicated a full goodwill impairment of $27,156 thousand that was recorded in non-interest expense in the Consolidated Income Statements during the nine months ended September 30, 2009. The impairment was primarily a result of the continuing economic downturn and its implications on bank valuations.
The goodwill was associated with six prior acquisitions. Three acquisitions were taxable asset purchases and three were non-taxable stock purchases. The goodwill impairment that is deductible for tax is $6,953 thousand, which added $2,394 thousand to the tax benefit recognized in the third quarter of 2009. The remaining $20,203 thousand goodwill impairment is not deductible for taxes and thus no tax benefit was recognized in 2009.
NOTE 9 GUARANTEES
The Company, as part of its ongoing business operations, issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by the Company to guarantee the performance of a customer to a third-party. A financial standby letter of credit is a commitment to guarantee a customers repayment of an outstanding loan or debt instrument. In a performance standby letter of credit, the Company guarantees a customers performance under a contractual nonfinancial obligation for which it receives a fee. The maximum potential amount of future payments the Company could be required to make under its standby letters of credit at September 30, 2010, December 31, 2009, and September 30, 2009 was $14,625 thousand, $16,077 thousand, and $15,972 thousand, respectively. The Companys outstanding standby letters of credit generally have a term of one year and some may have renewal options. The amount of collateral, if any, we obtain on an extension of credit is based on our credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.
NOTE 10 STOCKHOLDERS EQUITY
Common Stock and ESOP Activity
On January 27, 2010, the Companys Board of Directors elected to suspend the dividend on the Companys common stock. The Company may not pay dividends on common stock unless all Preferred Stock dividends have been paid.
On July 22, 2010, the Company filed with the State of Tennessee, Articles of Amendment to the Charter of Incorporation to increase the number of authorizes shares of common stock from 50 million to 150 million, in accordance with shareholder approval obtained on June 30, 2010.
On September 30, 2010, June 30, 2010 and March 31, 2010, the Company released 22,189, 70,701 and 65,655 shares, respectively, from the Employee Stock Ownership Plan (ESOP) for the employer matching contribution. Prior to July 1, 2010, the employer match was 100% of the employees contribution up to 6% of the employees compensation for the first six months of 2010. Effective July 1, 2010, the 6% employer match was reduced to 1% of the employees compensation for the remainder of the Plan year. The number of unallocated, committed to be released, and allocated shares for the ESOP are presented in the following table.
Unallocated Shares | Committed to be released shares |
Allocated Shares |
Compensation Expense (in thousands) |
|||||||||||||
Shares as of December 31, 2009 |
768,787 | | 431,889 | |||||||||||||
Shares allocated during 2010 |
(158,545 | ) | | 158,545 | $ | 310 | ||||||||||
Shares as of September 30, 2010 |
610,242 | | 590,434 | |||||||||||||
Preferred Stock
The Companys Board of Directors elected to defer payment on the February 15, 2010, May 15, 2010 and August 16, 2010 dividends on the Series A Preferred Stock (Preferred Stock). Dividends for the
16
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Preferred Stock are cumulative. The Company recognized $413 thousand and $1,238 thousand for the three and nine months ended September 30, 2010. As of September 30, 2010, the unpaid, accrued dividend is $1,444 thousand. For the three and nine months ended September 30, 2010, the Company recognized $95 thousand and $281 thousand, respectively, in Preferred Stock discount accretion.
The Preferred Stock was issued under the Capital Purchase Program (CPP) administered by the U.S. Department of the Treasury (Treasury) under the Troubled Asset Relief Program (TARP). If the Company misses six quarterly Preferred Stock dividend payments, whether or not consecutive, the Treasury will have the right to appoint two directors to the Companys Board of Directors until all accrued but unpaid dividends have been paid on the Preferred Stock. As of September 30, 2010, the Company has deferred three dividend payments.
On September 7, 2010, the Company entered into a Written Agreement with the Federal Reserve Bank of Atlanta. As part of the Written Agreement, the Company is prohibited from declaring or paying dividends without prior written consent from the Federal Reserve. Note 3 provides additional information on the Written Agreement.
NOTE 11 TAXES
The Company accounts for income taxes in accordance with ASC 740, which requires an asset and liability approach for the financial accounting and reporting of income taxes. Under this method, deferred income taxes are recognized for the expected future tax consequences of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. These balances are measured using the enacted tax rates expected to apply in the year(s) in which these temporary differences are expected to reverse. The effect on deferred income taxes of a change in tax rates is recognized in income in the period when the change is enacted.
In accordance with ASC 740, the Company is required to establish a valuation allowance for deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions.
As of September 30, 2010, the Company established a $17,432 thousand deferred tax asset valuation allowance after evaluating all available positive and negative evidence. Positive evidence included the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years and general business and economic trends. As business and economic conditions change, the Company will re-evaluate the valuation allowance.
17
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
For the three and nine months ended September 30, 2010, the Company recognized an income tax provision of $9,384 thousand and $6,461 thousand, respectively. For the three and nine months ended September 30, 2009, the Company recognized income tax benefit of $4,877 thousand and $7,326 thousand, respectively. The following reconciles the income tax provision (benefit) to statutory rates:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in thousands) | ||||||||||||||||
Federal taxes at statutory tax rate |
$ | (6,932 | ) | $ | (11,222 | ) | $ | (9,027 | ) | $ | (12,823 | ) | ||||
Tax exempt loss on non-deductible goodwill impairment |
| 6,869 | | 6,869 | ||||||||||||
Tax exempt earnings on loans and securities |
(115 | ) | (137 | ) | (366 | ) | (414 | ) | ||||||||
Tax exempt earnings on bank owned life insurance |
(84 | ) | (85 | ) | (256 | ) | (256 | ) | ||||||||
Low-income housing tax credits |
(103 | ) | | (310 | ) | | ||||||||||
Other, net |
20 | (93 | ) | 123 | (174 | ) | ||||||||||
State tax provision, net of federal effect |
(834 | ) | (209 | ) | (1,135 | ) | (528 | ) | ||||||||
Changes in the deferred tax asset valuation allowance |
17,432 | | 17,432 | | ||||||||||||
Income tax provision (benefit) |
$ | 9,384 | $ | (4,877 | ) | $ | 6,461 | $ | (7,326 | ) | ||||||
The deferred tax asset valuation allowance of $17,432 thousand fully offset the income tax benefits recognized for the three and nine months ended September 30, 2010. The benefit recognized before the valuation allowance primarily related to increases in deferred tax assets, including the allowance for loan and lease losses and the year-to-date operating loss. The benefit recognized during the three and nine months ended September 30, 2009, primarily relates to increases in deferred tax assets including the increase associated with the temporary difference of the allowance for loan and lease losses, the tax-deductible portion of the goodwill impairment and the year-to-date net operating loss.
The Company recognized a goodwill impairment of $27,156 thousand in the third quarter of 2009. Approximately $6,953 thousand of the impairment was deductible for taxes, which represents $2,394 thousand of the total 2009 income tax benefit. The remaining $20,203 thousand of the impairment was not deductible for taxes. As shown above, this non-deductible portion significantly impacts the effective tax rate for 2009.
The Company evaluated its material tax positions as of September 30, 2010. Under the more-likely-than-not threshold guidelines, the Company believes it has identified all significant uncertain tax benefits. The Company evaluates, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a component of income tax expense in the Companys consolidated financial statements. The roll-forward of unrecognized tax benefits is as follows:
Amount | ||||
(in thousands) | ||||
Balance at January 1, 2010 |
$ | 1,146 | ||
Increases related to prior year tax positions |
| |||
Increases related to current year tax positions |
148 | |||
Lapse of statute |
| |||
Balance at September 30, 2010 |
$ | 1,294 | ||
18
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 12 FAIR VALUE MEASUREMENTS
The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
The following tables present information about the Companys assets and liabilities measured at fair value on a recurring basis as of September 30, 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The following table presents the Companys assets and liabilities measured at fair value on a recurring basis as of September 30, 2010.
Balance as of September 30, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||||
(in thousands) | ||||||||||||||||
Financial assets |
||||||||||||||||
Securities available-for-sale |
$ | 155,108 | $ | | $ | 154,858 | $ | 250 | ||||||||
Loans held for sale |
3,386 | | 3,386 | | ||||||||||||
Forward loan sales contracts |
35 | | 35 | | ||||||||||||
Financial liabilities |
||||||||||||||||
None |
| | | |
The following table presents additional information about changes in assets and liabilities measured at fair value on a recurring basis and for which the Company utilized Level 3 inputs to determine fair value as of September 30, 2010.
Beginning Balance |
Total Realized and Unrealized Gains or Losses |
Purchases, Sales, Other Settlements and Issuances, net |
Net Transfers In and/or Out of Level 3 |
Ending Balance |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Financial assets |
||||||||||||||||||||
Securities available-for-sale |
$ | 250 | $ | | $ | | $ | | $ | 250 |
The Company did not recognize any unrealized gains or losses on Level 3 fair value assets or liabilities.
At September 30, 2010, the Company also had assets and liabilities measured at fair value on a non-recurring basis. Items measured at fair value on a non-recurring basis include other real estate owned (OREO), repossessions and collateral-dependent impaired loans. Such measurements were determined utilizing Level 2 and Level 3 inputs.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Upon recognition, OREO and repossessions are measured at fair value, which becomes the cost basis. The cost basis is subsequently re-measured at fair value when events or circumstances occur that indicate the initial fair value has declined. Collateral-dependent impaired loans are measured at fair value based on the appraised value of the collateral. A loan is collateral-dependent when repayment of the loan is expected solely by the underlying collateral and there are no other available and reliable sources of repayment. If the recorded investment in the impaired loan exceeds the measure of fair value, the shortfall is recognized as a charge-off. The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis, for which impairment was recognized during the nine months ended September 30, 2010.
Carrying Value as of September 30, 2010 |
Level 1 Fair Value Measurement |
Level 2 Fair Value Measurement |
Level 3 Fair Value Measurement |
Valuation Allowance as of September 30, 2010 |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Other real estate owned |
$ | 14,425 | $ | | $ | 14,425 | $ | | $ | 5,387 | ||||||||||
Repossessions |
491 | | 491 | | 230 | |||||||||||||||
Collateral-dependent loans |
28,084 | | 28,084 | | 14,867 |
The following table presents the estimated fair values of the Companys financial instruments.
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||||||||||||||
Carrying Amount |
Fair Value | Carrying Amount |
Fair Value | Carrying Amount |
Fair Value | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Financial assets |
||||||||||||||||||||||||
Cash and cash equivalents |
$ | 8,545 | $ | 8,545 | $ | 23,220 | $ | 23,220 | $ | 14,711 | $ | 14,711 | ||||||||||||
Interest bearing deposits in banks |
$ | 224,111 | $ | 224,111 | $ | 152,616 | $ | 152,616 | $ | 5,394 | $ | 5,394 | ||||||||||||
Securities available-for-sale |
$ | 155,108 | $ | 155,108 | $ | 143,045 | $ | 143,045 | $ | 147,175 | $ | 147,175 | ||||||||||||
Loans held for sale |
$ | 3,386 | $ | 3,386 | $ | 1,225 | $ | 1,225 | $ | 1,001 | $ | 1,001 | ||||||||||||
Loans |
$ | 774,032 | $ | 793,061 | $ | 950,793 | $ | 959,689 | $ | 963,294 | $ | 983,185 | ||||||||||||
Allowance for loan and lease losses |
$ | (25,320 | ) | $ | (25,320 | ) | $ | (26,492 | ) | $ | (26,492 | ) | $ | (25,686 | ) | $ | (25,686 | ) | ||||||
Financial liabilities |
||||||||||||||||||||||||
Deposits |
$ | 1,112,204 | $ | 1,118,438 | $ | 1,182,673 | $ | 1,187,263 | $ | 1,019,287 | $ | 1,025,567 | ||||||||||||
Federal funds purchased and securities sold under agreements to repurchase |
$ | 17,676 | $ | 17,676 | $ | 17,911 | $ | 17,911 | $ | 20,463 | $ | 20,463 | ||||||||||||
Other borrowings |
$ | 81 | $ | 81 | $ | 94 | $ | 94 | $ | 7,724 | $ | 7,724 |
The following methods and assumptions were used by the Company in estimating fair value of each class of financial instruments for which it is practicable to estimate that value:
| Cash and cash equivalents The carrying value of cash and cash equivalents approximates fair value. |
| Interest bearing deposits in banks The carrying amounts of interest bearing deposits in banks approximate fair value. |
| Securities The Companys securities are valued utilizing Level 2 inputs with the exception of one $250 thousand bond. Level 2 inputs are based on quoted prices for similar assets in active markets. |
| Loans held for sale Fair value for loans held for sale are based on quoted prices for similar assets in active markets. |
| Loans For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans and other consumer loans are estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans and |
20
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
leases is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit ratings quality. Fair value for impaired loans and leases are estimated using discounted cash flow analysis or underlying collateral values, where applicable. |
| Deposit liabilities The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value for fixed-rate certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected maturities on time deposits. |
| Federal funds purchased and securities sold under agreements to repurchase These borrowings generally mature in 90 days or less and, accordingly, the carrying amount reported in the balance sheet approximates fair value. |
| Other borrowings Other borrowings carrying amount reported in the consolidated balance sheets approximates fair value. |
NOTE 13 FAIR VALUE OPTION
Authoritative accounting guidance provides a fair value option election (FVO) that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. The guidance permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The Company records all newly-originated loans held for sale under the fair value option. Origination fees and costs are recognized in earnings at the time of origination. The servicing value is included in the fair value of the loan and recognized at origination of the loan. The Company uses derivatives to hedge changes in servicing value as a result of including the servicing value in the fair value of the loan. The estimated impact from recognizing servicing value, net of related hedging costs, as part of the fair value of the loan is captured in the mortgage loan and related fees component of noninterest income.
As of September 30, 2010, December 31, 2009 and September 30, 2009, there was $3,386 thousand, $1,225 thousand and $1,001 thousand in loans held for sale recorded at fair value, respectively. For the three and nine months ended September 30, 2010, approximately $319 thousand and $704 thousand in loan origination and related fee income was recognized in noninterest income, respectively, and an insignificant amount of origination and related fee expense, respectively, was recognized in noninterest expense utilizing the fair value option.
For the nine months ended September 30, 2010, the Company recognized a gain of $45 thousand due to changes in fair value for loans held for sale in which the fair value option was elected. This amount does not reflect the change in fair value attributable to the related hedges the Company used to mitigate the interest rate risk associated with loans held for sale. The changes in the fair value of the hedges were also recorded in the mortgage loan and related fee component of noninterest income, and reduced income by $39 thousand.
The following table provides the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale for which the fair value option has been elected.
Aggregate fair value |
Aggregate unpaid principal balance under FVO |
Fair value carrying amount over (under) unpaid principal |
||||||||||
(in thousands) | ||||||||||||
Loans held for sale |
$ | 3,386 | $ | 3,421 | $ | (35 | ) |
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 14 DERIVATIVE FINANCIAL INSTRUMENTS
The Company records all derivative financial instruments at fair value in the financial statements. It is the policy of the Company to enter into various derivatives both as a risk management tool and in a dealer capacity, as necessary, to facilitate client transactions. Derivatives are used as a risk management tool to hedge the exposure to changes in interest rates or other identified market risks. As of September 30, 2010, the Company has not entered into a transaction in a dealer capacity.
When a derivative is intended to be a qualifying hedged instrument, the Company prepares written hedge documentation that designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or (2) a hedge of a forecasted transaction, such as, the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).
The written documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item, and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for managements assertion that the hedge will be highly effective. Methodologies related to hedge effectiveness and ineffectiveness include (1) statistical regression analysis of changes in the cash flows of the actual derivative and a perfectly effective hypothetical derivative, (2) statistical regression analysis of changes in fair values of the actual derivative and the hedged item and (3) comparison of the critical terms of the hedged item and the hedging derivative. Changes in fair value of a derivative that is highly effective and that has been designated and qualifies as a fair value hedge are recorded in current period earnings, along with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Changes in the fair value of a derivative that is highly effective and that has been designed and qualifies as a cash flow hedge are initially recorded in other comprehensive income and reclassified to earnings in conjunction with the recognition of the earnings impacts of the hedged item; any ineffective portion is recorded in current period earnings. Designated hedge transactions are reviewed at least quarterly for ongoing effectiveness. Transactions that are no longer deemed to be effective are removed from hedge accounting classification and the recorded impacts of the hedge are recognized in current period income or expense in conjunction with the recognition of the income or expense on the originally hedged item.
The Companys derivatives are based on underlying risks, primarily interest rates. The Company has utilized swaps to reduce the risks associated with interest rates. Swaps are contracts in which a series of net cash flows, based on a specific notional amount that is related to an underlying risk, are exchanged over a prescribed period. The Company also utilizes forward contracts on the held for sale loan portfolio. The forward contracts hedge against changes in fair value of the held for sale loans.
Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk is equal to the fair value gain of the derivative. The credit exposure for swaps is the replacement cost of contracts that have become favorable. Credit risk is minimized by entering into transactions with high quality counterparties that are initially approved by the Board of Directors and reviewed periodically by the Asset Liability Committee. It is the Companys policy of requiring that all derivatives be governed by an International Swap and Derivatives Associations Master Agreement (ISDA). Bilateral collateral agreements may also be required.
On August 28, 2007 and March 26, 2009, the Company elected to terminate a series of interest rate swaps with a total notional value of $150 million and $50 million, respectively. At termination, the swaps had a market value of $2,010 thousand and $5,778 thousand, respectively. These gains are being accreted into interest income over the remaining life of the originally hedged items. The Company recognized a total of $1,532 thousand for the nine months ended September 30, 2010.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The following table presents the accretion of the remaining gain for the terminated swaps.
20101 | 2011 | 2012 | Total | |||||||||||||
(in thousands) | ||||||||||||||||
Accretion of gain from 2007 terminated swaps |
$ | 80 | $ | 219 | $ | 62 | $ | 361 | ||||||||
Accretion of gain from 2009 terminated swaps |
$ | 410 | $ | 1,628 | $ | 1,272 | $ | 3,310 |
1 | Represents the gain accretion for October 1, 2010 to December 31, 2010. Excludes the amounts recognized in the first nine months of 2010. |
The following table presents the cash flow hedges as of September 30, 2010.
Notional Amount |
Gross Unrealized Gains |
Gross Unrealized Losses |
Accumulated Other Comprehensive Income |
Maturity Date |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Asset hedges |
||||||||||||||||||||
Cash flow hedges: |
||||||||||||||||||||
Forward contracts |
$ | 3,386 | $ | 38 | $ | 3 | $ | 23 | Various | |||||||||||
$ | 3,386 | $ | 38 | $ | 3 | $ | 23 | |||||||||||||
Terminated asset hedges |
||||||||||||||||||||
Cash flow hedges: 1 |
||||||||||||||||||||
Interest rate swap |
$ | 25,000 | $ | | $ | | $ | 53 | June 28, 2011 | |||||||||||
Interest rate swap |
20,000 | | | 40 | June 28, 2011 | |||||||||||||||
Interest rate swap |
35,000 | | | 145 | June 28, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 1,092 | October 15, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 1,092 | October 15, 2012 | |||||||||||||||
$ | 130,000 | $ | | $ | | $ | 2,422 | |||||||||||||
1 | The $2.4 million of gains, net of taxes, recorded in accumulated other comprehensive income as of September 30, 2010, will be reclassified into earnings as interest income over the remaining life of the respective hedged items. |
The following table presents additional information on the active derivative positions as of September 30, 2010.
Consolidated Balance Sheet Presentation |
Consolidated Income Statement Presentation |
|||||||||||||||||||||||||||
Assets | Liabilities | Gains | ||||||||||||||||||||||||||
Notional | Classification | Amount | Classification | Amount | Classification | Amount Recognized |
||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||
Hedging Instrument: |
||||||||||||||||||||||||||||
Forward contracts |
$ | 3,386 | Other assets | $ | 35 | Other liabilities | N/A | |
Noninterest income other |
|
$ | (35 | ) | |||||||||||||||
Hedged Items: |
||||||||||||||||||||||||||||
Loans held for sale |
N/A | |
Loans held for sale |
|
$ | 3,386 | N/A | N/A | |
Noninterest income other |
|
N/A |
For the three and nine months ended September 30, 2010, no significant amounts were recognized for hedge ineffectiveness.
NOTE 15 ACCOUNTING POLICIES RECENTLY ADOPTED AND PENDING ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2010, the Company adopted the provisions of the FASB Accounting Standards Update 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06), which updates ASC 820 to require disclosure of significant transfers into and out of Level 1 and Level 2 of the fair value hierarchy, as well as disclosure of an entitys policy for determining when transfers between all levels of the hierarchy are recognized. ASC 820, as amended, also provides enhanced disclosure requirements regarding purchases, sales, issuances, and settlements related to recurring Level 3 measurements, and requires separate disclosure in the Level 3 reconciliation of total gains and losses
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
recognized in other comprehensive income. The updated provisions of ASC 820 require that fair value measurement disclosures be provided by each class of assets and liabilities, and that disclosures providing a description of the valuation techniques and inputs used to measure fair value be included for both recurring and nonrecurring fair value measurements classified as either Level 2 or Level 3. The provisions of ASU 2010-06 are effective for periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales, issuances, and settlements on a gross basis which will be effective for periods beginning after December 15, 2010. Comparative disclosures are required only for periods ending subsequent to initial adoption. The Company revised its disclosures accordingly.
Effective January 1, 2010, the Company adopted the provisions of the FASB Accounting Standards Update 2009-16, Accounting for Transfers of Financial Assets (ASU 2009-16). ASU 2009-16 updates ASC 860 to provide for the removal of the qualifying special purpose entity (QSPE) concept from GAAP, resulting in the evaluation of all former QSPEs for consolidation on and after January 1, 2010 in accordance with ASC 810. The amendments to ASC 860 modify the criteria for achieving sale accounting for transfers of financial assets and define the term participating interest to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. The updated provisions of ASC 860 also provide that a transferor should recognize and initially measure at fair value all assets obtained (including a transferors beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. ASC 860, as amended, requires enhanced disclosures which are generally consistent with, and supersede, the disclosures previously required by the Codification update to ASC 810 and ASC 860 which was effective for periods ending after December 15, 2008. The provisions of ASU 2009-16 are effective prospectively for new transfers of financial assets occurring in fiscal years beginning after November 15, 2009, and in interim periods within those fiscal years. ASC 860s amended disclosure requirements should be applied to transfers that occurred both before and after the effective date of the Codification update, with comparative disclosures required only for periods subsequent to initial adoption for those disclosures not previously required under the Codification update to ASC 810 and ASC 860 which was effective for periods ending after December 15, 2008. The adoptions did not impact the Companys consolidated financial statements.
Effective December 31, 2009, the Company adopted the provisions of FASB Accounting Standards Update (ASU) 2009-05, Measuring Liabilities at Fair Value (ASU 2009-05) to the FASB Accounting Standards Codification (ASC or Codification). ASU 2009-05 updates ASC 820 to clarify that a quoted price for the identical liability, when traded as an asset in an active market, is a Level 1 measurement for that liability when no adjustment to the quoted price is required. ASU 2009-05 further amends ASC 820 to provide that if a quoted price for an identical liability does not exist in an active market, the fair value of the liability should be measured using an approach that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. Under the updated provisions of ASC 820, for such liabilities fair value will be measured using either a valuation technique that uses the quoted price of the identical liability when traded as an asset, a valuation technique that uses the quoted price for similar liabilities or similar liabilities when traded as an asset, or another valuation technique that is consistent with the principles of ASC 820. The adoption had no significant impact on the Companys consolidated financial statements.
Effective September 30, 2009, the Company adopted the provisions of the FASB Accounting Standard Codification 105-10, Generally Accepted Accounting Principles. This standard establishes the FASB Accounting Standards Codification as the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP, other than guidance issued by the SEC. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority, with this Statement superseding all then-existing non-SEC accounting and reporting standards as of its effective date. Following this Statement, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standard Updates that will serve only to update the Codification. In conjunction with the adoption of this Statement, all references to pre-Codification Statements have either been removed or updated to reflect the new Codification reference. The adoption of this Statement did not have a significant impact on the Companys consolidated financial statements.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Effective June 30, 2009, the Company adopted the FASB ASC 855, Subsequent Events. ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.
Effective June 30, 2009, the Company adopted ASC 825-10, Financial Instruments. This update requires disclosures about the fair value of financial instruments in interim financial statements. The guidance requires that disclosures be included in both interim and annual financial statements of the methods and significant assumptions used to estimate the fair value of financial instruments. Comparative disclosures are required only for periods ending subsequent to initial adoption. The additional required disclosures are presented in Note 12 of the Companys consolidated financial statements.
Effective March 31, 2009, the Company adopted the FASB Codification update ASC 320-10-35 which replaces the intent and ability to hold to recovery indicator of other-than-temporary impairment in ASC 320-10-35 for debt securities. The guidance, issued in April 2009, establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities as well as requiring additional disclosures related to debt and equity securities. Under the new guidance, an impairment is other-than-temporary if any of the following conditions exist: (1) the entity intends to sell the security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the securitys entire amortized cost basis, even if the entity does not intend to sell. Additionally, the guidance requires that for impaired securities that an entity does not intend to sell that it is not more-likely-than-not that it will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. The guidance discusses the proper interaction with other authoritative guidance, including the additional factors that must be considered in an other-than-temporary impairment analysis. The additional disclosure requirements include a roll-forward of amounts recognized in earnings for debt securities for which an other-than-temporary impairment has been recognized and the noncredit portion of the other-than-temporary impairment that has been recognized in other comprehensive income. The adoption did not impact the Companys consolidated financial statements.
Effective March 31, 2009, the Company first applied the provisions of the FASB ASC 820-10, Fair Value Measurements and Disclosures, that was issued in April 2009. The update provides factors that an entity should consider when determining whether a market for an asset is not active. If, after evaluating the relevant factors, the evidence indicates that a market is not active, the guidance provides an additional list of factors that an entity must consider when determining whether events and circumstances indicate that a transaction which occurred in an inactive market is orderly. The guidance requires that entities place more weight on observable transactions determined to be orderly and less weight on transactions for which there is insufficient information to determine whether the transaction is orderly when determining the fair value of an asset or liability under applicable authoritative guidance. The guidance also requires enhanced disclosures, including disclosure of a change in valuation technique that results from its application and disclosure of fair value measurements for debt and equity securities by major security types. The adoption did not impact the Companys consolidated financial statements.
Effective January 1, 2009, the Company adopted the provisions of the Codification update to ASC 815-10-50 which requires expanded disclosures about an entitys derivative instruments and hedging activities, but does not change previous authoritative guidance on scope or accounting. This updated guidance requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under GAAP and its related interpretations, and how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows. To meet those objectives, this guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures in a tabular format about fair value amounts and gains and losses on derivative instruments including specific disclosures
25
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
regarding the location and amounts of derivative instruments in the financial statements, and disclosures about credit-risk-related contingent features in derivative agreements. The guidance also clarifies derivative instruments that are subject to the concentration of credit-risk disclosures. The adoption did not impact the Companys consolidated financial statements.
Effective January 1, 2009, the Company adopted the provisions of a Codification update to ASC 805. This update establishes principles and requirements for how an acquirer in a business combination: recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and discloses information to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption did not impact the Companys consolidated financial statements.
Effective January 1, 2009, the Company adopted the provisions of a Codification update to ASC 805, which requires that an acquirer recognize at fair value as of the acquisition date an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of the asset or liability can be determined during the measurement period. The guidance provides that if the acquisition-date fair value of an asset acquired or liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, the asset or liability should be recognized at the acquisition date if information available before the end of the measurement period indicates that it is probable that an asset existed or a liability had been incurred at the acquisition date and the amount of the asset or liability can be reasonably estimated. Additionally, the guidance requires enhanced disclosures regarding assets and liabilities arising from contingencies which are recognized at the acquisition date of a business combination, including the nature of the contingencies, the amounts recognized at the acquisition date and the measurement basis applied. The adoption did not impact the Companys consolidated financial statements.
Effective January 1, 2009, the Company adopted the provisions of a Codification update to ASC 810, as amended. The update establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be clearly reported as equity in the consolidated financial statements. Additionally, the guidance requires that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated income statement. The adoptions did not impact the Companys consolidated financial statements.
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Table of Contents
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
In this Form 10-Q, First Security, we, us, the Company and our refer to First Security Group, Inc.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of our statements contained in this Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to future events or our future financial performance and include statements about the competitiveness of the banking industry, potential regulatory obligations, our entrance and expansion into other markets, our other business strategies and other statements that are not historical facts. Forward-looking statements are not guarantees of performance or results. When we use words like may, plan, contemplate, anticipate, believe, intend, continue, expect, project, predict, estimate, could, should, would, will, and similar expressions, you should consider them as identifying forward-looking statements, although we may use other phrasing. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared.
These forward-looking statements involve risks and uncertainties and may not be realized due to a variety of factors, including, but not limited to the following: deterioration in the financial condition of borrowers; changes in loan underwriting, credit review or loss reserve policies; the failure of assumptions underlying the establishment of reserves for possible loan losses; changes in political and economic conditions; changes in financial market conditions; fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability, market liquidity levels, and pricing; governmental monetary and fiscal policies, as well as legislative and regulatory changes; First Securitys participation or lack of participation in governmental programs; First Securitys lack of participation in a stress test under the Federal Reserves Supervisory Capital Assessment Program; the effects of competition from other commercial banks, thrifts, and other financial institutions; and the effect of any mergers, acquisitions or other transactions, to which we or our subsidiary may from time to time be a party.
Many of these risks are beyond our ability to control or predict, and you are cautioned not to put undue reliance on such forward-looking statements. First Security does not intend to update or reissue any forward-looking statements contained in this Form 10-Q as a result of new information or other circumstances that may become known to First Security.
All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by this Cautionary Note. Our actual results may differ significantly from those we discuss in these forward-looking statements.
THIRD QUARTER 2010 AND RECENT EVENTS
The following discussion and analysis sets forth the major factors that affected results of operations and financial condition reflected in the unaudited consolidated financial statements for the three and nine month periods ended September 30, 2010 and 2009. Such discussion and analysis should be read in conjunction with the Companys Consolidated Financial Statements and the notes attached thereto.
Company Overview
First Security Group, Inc. is a bank holding company headquartered in Chattanooga, Tennessee, with $1.2 billion in assets as of September 30, 2010. Founded in 1999, First Securitys community bank subsidiary, FSGBank, N.A. has 37 full-service banking offices, including the headquarters, along the interstate corridors of eastern and middle Tennessee and northern Georgia and 325 full-time equivalent employees. In Dalton, Georgia, FSGBank operates under the name of Dalton Whitfield Bank; along the Interstate 40 corridor in Tennessee, FSGBank operates under the name of Jackson Bank & Trust. FSGBank provides retail and commercial banking services, trust and investment management, mortgage banking, financial planning and internet banking (www.FSGBank.com) services.
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Recent Regulatory Events
Effective September 7, 2010, First Security entered into a Written Agreement (Agreement) with the Federal Reserve Bank of Atlanta (Federal Reserve). The Agreement is designed to ensure First Security is a source of strength to FSGBank. Substantially all of the requirements of the Agreement are similar to those already in effect for FSGBank pursuant to the Consent Order that is described below. On September 14, 2010, we filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides a copy of the fully executed Agreement.
Effective April 28, 2010, FSGBank reached an agreement with its primary regulator, the Office of the Controller of the Currency (OCC), regarding the issuance of a Consent Order (Order). The Order is a result of the OCCs regular examination of the FSGBank in the fall of 2009 and directs FSGBank to take actions intended to strengthen its overall condition. All customer deposits remain fully insured by the FDIC to the maximum extent allowed by law; the Order does not impact this coverage in any manner. On April 29, 2010, First Security filed a current report on Form 8-K describing the Order and the related actions taken by the Bank to date. The Form 8-K also provides a copy of the fully executed Order.
Prior to and following the OCCs regularly scheduled exam in the fall of 2009, we developed and began implementing a number of strategic initiatives designed to improve both the operations and the financial performance of First Security. The Order establishes a framework and timeline for fully implementing certain of our strategic initiatives. We believe the successful execution of our initiatives will result in full compliance with the Order and position us for long-term growth and a return to profitability.
The OCC is currently conducting its regularly scheduled safety and soundness examination and is working with the Board and management to address certain items within the previously submitted strategic and capital plans. The Order required FSGBank to maintain certain capital ratios within 120 days of it execution. The September 30, 2010 Call Report was the first public financial statement related to a period subsequent to the 120 day requirement. As of September 30, 2010, the Banks total capital to risk-weighted assets was 12.93 percent and the Tier 1 capital to adjusted total assets was 7.43 percent. The Bank has notified the OCC of the non-compliance. The Bank anticipates submitting revised earnings and capital plans to the OCC during the fourth quarter of 2010.
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Strategic Initiatives
During 2009 and 2010, we initiated a set of strategic initiatives to position us appropriately for both short-term stability and long-term success. The following are the primary initiatives with associated target dates for implementation:
Strategic Initiative |
Current and/or Potential Impact |
Actual/Expected | ||
Capital |
||||
CPP participation |
Received $33 million in Preferred Stock capital |
1st quarter 2009 | ||
Capital stress test |
Outsourced a SCAP capital stress test to assist in capital planning |
4th quarter 2009 | ||
Liquidity |
||||
Liquidity enhancement |
Increased longer term brokered deposits and excess cash to fund future contractual obligations and prudent investments |
1st quarter 2010 | ||
Asset Quality |
||||
Loan review department expansion |
Added resources to increase frequency and coverage of the review of our portfolio |
4th quarter 2009 | ||
Extensive loan review |
Outsourced an extensive loan review prior to year-end 2009 |
4th quarter 2009 | ||
OREO management |
Transferred OREO management to the special assets department |
3rd quarter 2010 | ||
OREO sales |
Outsourced the marketing and sales function for most foreclosed residential properties to market leading real estate firms |
4th quarter 2010 | ||
Credit Administration |
||||
Lines of business |
Credit functions aligned by retail and commercial lines of business with dedicated credit officers and staff supporting each portfolio |
4th quarter 2009 | ||
Loan underwriting centralization |
Ensures consistency in underwriting, pricing, loan structure and policy compliance |
2nd quarter 2010 | ||
Collections centralization |
Dedicated collections department created to focus on collection of past due loans and recovery of prior charge-offs |
2nd quarter 2010 | ||
Loan document preparation centralization |
Operational efficiencies and reduction of loan policy exceptions |
2nd quarter 2010 | ||
Loan policy |
Amended existing loan policy to provide the framework and guidelines for current and future loans |
2nd quarter 2010 | ||
Management |
||||
Chief risk officer |
Elevated risk manager to executive level with expanded responsibilities |
1st quarter 2010 | ||
Chief credit officer |
Hired experienced executive credit officer to oversee credit administration |
2nd quarter 2010 | ||
Retail banking president |
Created new executive level position responsible for consumer and small-business loan and deposit relationships and associated retail lenders |
3rd quarter 2010 | ||
Commercial banking president |
Created new executive level position responsible for commercial loan and deposit relationships and associated commercial lenders |
3rd quarter 2010 | ||
Chief operating officer and president |
Hired experienced bank executive to manage and oversee banking operations, including the credit, financial, retail banking and commercial banking functions |
3rd quarter 2010 |
The above initiatives are discussed in additional detail throughout MD&A.
Overview
Market Conditions
Most indicators point toward the overall U.S. economy transitioning to a gradual recovery period over the balance of 2010 and 2011. Some economists have indicated that the future recovery may bring with it few new jobs. As our financial results can be a reflection of our regional economy, we closely monitor and evaluate local and regional economic trends.
Announced in 2008, the $1 billion Volkswagen automotive production facility is preparing for the launch of vehicle production in 2011. The Volkswagen plant will bring about 2,000 direct jobs, including
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approximately 400 white-collar jobs, and up to 9,500 supplier-related jobs to the region. We believe the positive economic impact on Chattanooga and the surrounding region from Volkswagen and other recently announced large economic investments will be significant and it may stabilize and possibly increase real estate values and enhance economic activity within our market area.
While the economic recession has resulted in higher unemployment across the country, our larger market areas benefit from more stable rates of employment. Our major market areas of Chattanooga and Knoxville have a lower unemployment rate of 8.3% and 7.3%, respectively (as of September 2010, the most recent available data), than the Tennessee rate of 9.4%. The economy of the Dalton, Georgia MSA is primarily centered on the carpet and floor-covering industries. With the decline in housing starts and the overall economy, Dalton has been the most negatively impacted region in our footprint. The unemployment rate in the Dalton MSA is 11.8% (as of September 2010) compared to the Georgia rate of 10.0%. For the Chattanooga and Knoxville MSAs, the number of unemployed workers is decreasing and, as of September 2010, has declined by 17.6% in Chattanooga and 21.9% in Knoxville since the peak in June 2009. We believe these positive employment trends will continue throughout 2010 and into 2011.
Our market area has also benefited from a relatively stable housing environment. According to the National Association of REALTORS, the year-over-year median sales prices of existing single-family homes was unchanged for the Chattanooga MSA and declined by 0.8% for the Knoxville MSA compared to 1.6% increase for the nation and a 2.0% decline for the census region identified as the South as of June 30, 2010 (the most recent available data). While residential real estate values may continue to decline, we are hopeful that the stabilization in housing prices will continue.
Financial Results
As of September 30, 2010, we had total consolidated assets of $1.2 billion, total loans of $777.4 million, total deposits of $1.1 billion and stockholders equity of $106.8 million. For the three and nine months ended September 30, 2010, our net loss available to common stockholders was $30.2 million and $34.5 million, respectively, resulting in basic and diluted net loss of $1.92 per share for the quarter and $2.20 per share for the year-to-date period. During the third quarter of 2010, we recorded a $17.4 million valuation allowance on our deferred taxes.
As of September 30, 2009, we had total consolidated assets of $1.2 billion, total loans of $964.3 million, total deposits of $1.0 billion and stockholders equity of $145.2 million. For the three and nine months ended September 30, 2009, our net loss available to common stockholders was $28.6 million and $31.8 million, respectively, resulting in basic and diluted net loss of $1.84 per share for the quarter and $2.05 per share for the year-to-date period. During the third quarter of 2009, we recorded a $27.2 million goodwill impairment.
For the three and nine month periods ended September 30, 2010, net interest income decreased by $2.8 million and $4.9 million, respectively, and noninterest income decreased by $333 thousand and $566 thousand, respectively, compared to the same periods in 2009. For the three and nine months ended September 30, 2010, noninterest expense increased by $2.3 million and $4.6 million, respectively, compared to the same periods in 2009 excluding the $27.2 million goodwill impairment in 2009. The decline in interest income is primarily attributable to the shift in earning assets from loans to interest bearing cash partially offset by reductions in rates on interest bearing liabilities. Noninterest income decreased primarily due to lower deposit fees while noninterest expense, excluding the goodwill impairment, increased primarily due to higher expenses associated with nonperforming assets, including write-downs, losses and holding costs. These increases were partially offset by reductions in salary and benefit expense. Full-time equivalent employees were 325 at September 30, 2010, compared to 348 at September 30, 2009.
The provision for loan and lease losses increased $9.1 million and $6.0 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009.
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Our efficiency ratio increased in the third quarter of 2010 to 118.7% compared to 74.9% in the same period of 2009 primarily due to reductions in net interest income and noninterest income and increases to noninterest expense. We anticipate our efficiency ratio to begin to improve during 2011 as we focus on enhancing revenue while reducing certain overhead expenses. The stabilization and possible improvement of our efficiency ratio in the fourth quarter of 2010 and into 2011 is contingent on both macro-economic factors, such as potential changes to the federal funds target rate and micro-economic factors, such as local unemployment and real estate values.
Net interest margin in the third quarter of 2010 was 2.72%, or 124 basis points lower than the prior year period of 3.96%. We believe that our net interest margin will continue to be under pressure until loan balances stabilize. The projected stabilization of our net interest margin is dependent on multiple factors including our ability to raise core deposits, our growth or contraction in loans, our deposit and loan pricing, maturities of brokered deposits, and any possible further action by the Federal Reserve Board.
For the third quarter of 2010, our Board of Directors elected to defer payment on the Series A Preferred Stock (Preferred Stock). To date, the Company has deferred three consecutive Preferred Stock dividend payments. If we miss six quarterly Preferred Stock dividend payments, whether or not consecutive, the U.S. Treasury (Treasury) will have the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid on the Preferred Stock. Pursuant to the Written Agreement between First Security and the Federal Reserve, we may not declare or pay dividends without prior written consent from the Federal Reserve.
RESULTS OF OPERATIONS
We reported a net loss to common stockholders for the three and nine month periods ended September 30, 2010 of $30.3 million and $34.5 million, respectively. During the third quarter of 2010, we established a deferred tax asset valuation allowance of $17.4 million. For the three and nine months ended September 30, 2009, we reported a net loss to common stockholders of $28.6 million and $31.8 million, respectively. During the third quarter of 2009, we recorded a one-time, non-cash goodwill impairment of $27.2 million. In the third quarter of 2010, the basic and diluted net loss per share was $1.92 compared to $1.84 for the same period in 2009. On a year-to-date period, the basic and diluted net loss per share was $2.20 for 2010 compared to $2.05 for 2009.
Excluding the 2009 goodwill impairment, the net loss on a quarterly and year-to-date basis in 2010 was above the comparable amounts in 2009 primarily as a result of the deferred tax valuation allowance as well as higher provision for loan and lease loss expense and the contraction in the net interest margin.
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The following table summarizes the components of income and expense and the changes in those components for the three and nine month periods ended September 30, 2010 compared to the same periods in 2009.
CONDENSED CONSOLIDATED INCOME STATEMENT
For the Three Months Ended September 30, 2010 |
Change from Prior Year |
For the Nine Months Ended September 30, 2010 |
Change from Prior Year |
|||||||||||||||||||||
Amount | Percentage | Amount | Percentage | |||||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Interest income |
$ | 13,202 | $ | (2,756 | ) | -17.3 | % | $ | 42,533 | $ | (5,999 | ) | -12.4 | % | ||||||||||
Interest expense |
5,067 | 9 | 0.2 | % | 15,762 | (1,133 | ) | -6.7 | % | |||||||||||||||
Net interest income |
8,135 | (2,765 | ) | -25.4 | % | 26,771 | (4,866 | ) | -15.4 | % | ||||||||||||||
Provision for loan and lease losses |
18,415 | 9,135 | 98.4 | % | 26,424 | 5,955 | 29.1 | % | ||||||||||||||||
Net interest income after provision for loan and lease losses |
(10,280 | ) | (11,900 | ) | -734.6 | % | 347 | (10,821 | ) | -96.9 | % | |||||||||||||
Noninterest income |
2,404 | (333 | ) | -12.2 | % | 7,266 | (566 | ) | -7.2 | % | ||||||||||||||
Noninterest expense |
12,512 | (24,851 | ) | -66.5 | % | 34,164 | (22,551 | ) | -39.8 | % | ||||||||||||||
Net loss before income taxes |
(20,388 | ) | 12,618 | 38.2 | % | (26,551 | ) | 11,164 | 29.6 | % | ||||||||||||||
Income tax provision |
9,384 | 14,261 | 292.4 | % | 6,461 | 13,787 | 188.2 | % | ||||||||||||||||
Net loss |
(29,772 | ) | (1,643 | ) | -5.8 | % | (33,012 | ) | (2,623 | ) | -8.6 | % | ||||||||||||
Preferred stock dividends and discount accretion |
508 | 6 | 1.2 | % | 1,519 | 69 | 4.8 | % | ||||||||||||||||
Net loss available to common stockholders |
$ | (30,280 | ) | $ | (1,649 | ) | -5.8 | % | $ | (34,531 | ) | $ | (2,692 | ) | -8.5 | % | ||||||||
Net Interest Income
Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. For the three months ended September 30, 2010, net interest income decreased by $2.8 million, or 25.4%, to $8.1 million compared to $10.9 million for the same period in 2009. For the nine months ended September 30, 2010, net interest income decreased by $4.9 million, or 15.4%, to $26.8 million for the period ended September 30, 2010 compared to $31.6 million for the same period in 2009.
We monitor and evaluate the effects of certain risks on our earnings and seek balance between the risks assumed and returns sought. Some of these risks include interest rate risk, credit risk and liquidity risk.
The level of net interest income is determined primarily by the average balances (volume) of interest earning assets and the various rate spreads between our interest earning assets and our funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest earning assets and interest bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, our ability to manage the interest earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.
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The following tables summarize net interest income and average yields and rates paid for the quarters ended September 30, 2010 and 2009.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
FULLY TAX EQUIVALENT BASIS
For the Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average Balance |
Income/ Expense |
Yield/ Rate |
Average Balance |
Income/ Expense |
Yield/ Rate |
|||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
ASSETS |
||||||||||||||||||||||||
Earning Assets: |
||||||||||||||||||||||||
Loans, net of unearned income (1) (2) |
$ | 823,753 | $ | 11,911 | 5.74 | % | $ | 966,677 | $ | 14,465 | 5.94 | % | ||||||||||||
Debt securities taxable |
115,557 | 938 | 3.22 | % | 98,500 | 1,111 | 4.47 | % | ||||||||||||||||
Debt securities non-taxable (2) |
37,033 | 512 | 5.49 | % | 42,702 | 605 | 5.62 | % | ||||||||||||||||
Other earning assets |
236,651 | 32 | 0.05 | % | 7,663 | 3 | 0.16 | % | ||||||||||||||||
Total earning assets |
1,212,994 | 13,393 | 4.38 | % | 1,115,542 | 16,184 | 5.76 | % | ||||||||||||||||
Allowance for loan and lease losses |
(27,626 | ) | (19,201 | ) | ||||||||||||||||||||
Intangible assets |
1,634 | 28,941 | ||||||||||||||||||||||
Cash & due from banks |
7,836 | 16,379 | ||||||||||||||||||||||
Premises & equipment |
32,125 | 33,842 | ||||||||||||||||||||||
Other assets |
81,653 | 56,423 | ||||||||||||||||||||||
TOTAL ASSETS |
$ | 1,308,616 | $ | 1,231,926 | ||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||||||||||||||
Interest bearing liabilities: |
||||||||||||||||||||||||
Interest bearing demand deposits |
$ | 65,547 | 47 | 0.28 | % | $ | 60,756 | 45 | 0.29 | % | ||||||||||||||
Money market accounts |
132,945 | 314 | 0.94 | % | 123,839 | 357 | 1.14 | % | ||||||||||||||||
Savings deposits |
39,211 | 27 | 0.27 | % | 36,770 | 27 | 0.29 | % | ||||||||||||||||
Time deposits of less than $100 thousand |
226,002 | 1,131 | 1.99 | % | 245,611 | 1,738 | 2.81 | % | ||||||||||||||||
Time deposits of $100 thousand or more |
178,410 | 970 | 2.16 | % | 204,664 | 1,530 | 2.97 | % | ||||||||||||||||
Brokered CDs and CDARS® |
346,197 | 2,459 | 2.82 | % | 124,644 | 1,062 | 3.38 | % | ||||||||||||||||
Brokered money markets and NOWs |
| | | % | 77,250 | 163 | 0.84 | % | ||||||||||||||||
Federal funds purchased |
| | | % | 92 | | 0.54 | % | ||||||||||||||||
Repurchase agreements |
17,523 | 117 | 2.65 | % | 18,347 | 130 | 2.81 | % | ||||||||||||||||
Other borrowings |
83 | 2 | 9.56 | % | 4,747 | 6 | 0.50 | % | ||||||||||||||||
Total interest bearing liabilities |
1,005,918 | 5,067 | 2.00 | % | 896,720 | 5,058 | 2.24 | % | ||||||||||||||||
Net interest spread |
$ | 8,326 | 2.38 | % | $ | 11,126 | 3.52 | % | ||||||||||||||||
Noninterest bearing demand deposits |
155,889 | 150,571 | ||||||||||||||||||||||
Accrued expenses and other liabilities |
10,521 | 11,856 | ||||||||||||||||||||||
Stockholders equity |
130,502 | 166,775 | ||||||||||||||||||||||
Accumulated other comprehensive income |
5,786 | 6,004 | ||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 1,308,616 | $ | 1,231,926 | ||||||||||||||||||||
Impact of noninterest bearing sources and other changes in balance sheet composition |
0.34 | % | 0.44 | % | ||||||||||||||||||||
Net interest margin |
2.72 | % | 3.96 | % | ||||||||||||||||||||
(1) | Nonaccrual loans have been included in the average balance. Only the interest collected on such loans has been included as income. |
(2) | Interest income from securities and loans includes the effects of taxable-equivalent adjustments using a federal income tax rate of approximately 34% for both years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable equivalent adjustment amounts included in the above table were $191 thousand and $226 thousand for the three months ended September 30, 2010 and 2009, respectively. |
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The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.
CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO 2009
Increase (Decrease) in Interest Income and Expense Due to Changes in: |
||||||||||||
Volume | Rate | Total | ||||||||||
(in thousands) | ||||||||||||
Interest earning assets: |
||||||||||||
Loans, net of unearned income |
$ | (2,139 | ) | $ | (415 | ) | $ | (2,554 | ) | |||
Debt securities taxable |
192 | (365 | ) | (173 | ) | |||||||
Debt securities non-taxable |
(80 | ) | (13 | ) | (93 | ) | ||||||
Other earning assets |
90 | (61 | ) | 29 | ||||||||
Total earning assets |
(1,937 | ) | (854 | ) | (2,791 | ) | ||||||
Interest bearing liabilities: |
||||||||||||
Interest bearing demand deposits |
4 | (2 | ) | 2 | ||||||||
Money market accounts |
26 | (69 | ) | (43 | ) | |||||||
Savings deposits |
2 | (2 | ) | | ||||||||
Time deposits of less than $100 thousand |
(139 | ) | (468 | ) | (607 | ) | ||||||
Time deposits of $100 thousand or more |
(196 | ) | (364 | ) | (560 | ) | ||||||
Brokered CDs and CDARS® |
1,888 | (491 | ) | 1,397 | ||||||||
Brokered money markets and NOWs |
(163 | ) | | (163 | ) | |||||||
Federal funds purchased |
| | | |||||||||
Repurchase agreements |
(6 | ) | (7 | ) | (13 | ) | ||||||
Other borrowings |
(6 | ) | 2 | (4 | ) | |||||||
Total interest bearing liabilities |
1,410 | (1,401 | ) | 9 | ||||||||
Increase (decrease) in net interest income |
$ | (3,347 | ) | $ | 547 | $ | (2,800 | ) | ||||
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The following tables summarize net interest income and average yields and rates paid for the year-to-date periods ended September 30, 2010 and 2009.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
FULLY TAX EQUIVALENT BASIS
For the Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average Balance |
Income/ Expense |
Yield/ Rate |
Average Balance |
Income/ Expense |
Yield/ Rate |
|||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
ASSETS |
||||||||||||||||||||||||
Earning Assets: |
||||||||||||||||||||||||
Loans, net of unearned income (1) (2) |
$ | 875,851 | $ | 38,097 | 5.82 | % | $ | 983,492 | $ | 43,869 | 5.96 | % | ||||||||||||
Debt securities taxable |
110,036 | 3,048 | 3.70 | % | 96,827 | 3,479 | 4.80 | % | ||||||||||||||||
Debt securities non-taxable (2) |
38,823 | 1,623 | 5.59 | % | 43,282 | 1,834 | 5.67 | % | ||||||||||||||||
Other earning assets |
219,126 | 371 | 0.23 | % | 20,653 | 38 | 0.25 | % | ||||||||||||||||
Total earning assets |
1,243,836 | 43,139 | 4.64 | % | 1,144,254 | 49,220 | 5.75 | % | ||||||||||||||||
Allowance for loan and lease losses |
(26,917 | ) | (18,930 | ) | ||||||||||||||||||||
Intangible assets |
1,748 | 29,266 | ||||||||||||||||||||||
Cash & due from banks |
8,157 | 14,760 | ||||||||||||||||||||||
Premises & equipment |
32,553 | 33,864 | ||||||||||||||||||||||
Other assets |
79,963 | 55,473 | ||||||||||||||||||||||
TOTAL ASSETS |
$ | 1,339,340 | $ | 1,258,687 | ||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||||||||||||||
Interest bearing liabilities: |
||||||||||||||||||||||||
Interest bearing demand deposits |
$ | 65,751 | 142 | 0.29 | % | $ | 61,834 | 146 | 0.32 | % | ||||||||||||||
Money market accounts |
134,892 | 1,028 | 1.02 | % | 124,625 | 1,178 | 1.26 | % | ||||||||||||||||
Savings deposits |
38,536 | 77 | 0.27 | % | 35,757 | 77 | 0.29 | % | ||||||||||||||||
Time deposits of less than $100 thousand |
235,175 | 3,722 | 2.12 | % | 245,154 | 5,687 | 3.10 | % | ||||||||||||||||
Time deposits of $100 thousand or more |
192,980 | 3,261 | 2.26 | % | 202,518 | 4,934 | 3.26 | % | ||||||||||||||||
Brokered CDs and CDARS® |
341,003 | 7,112 | 2.79 | % | 151,892 | 3,988 | 3.51 | % | ||||||||||||||||
Brokered money markets and NOWs |
8,772 | 57 | 0.87 | % | 77,828 | 490 | 0.84 | % | ||||||||||||||||
Federal funds purchased |
| | | % | 448 | 4 | 1.19 | % | ||||||||||||||||
Repurchase agreements |
18,790 | 358 | 2.55 | % | 20,884 | 373 | 2.39 | % | ||||||||||||||||
Other borrowings |
87 | 5 | 7.68 | % | 2,192 | 18 | 1.10 | % | ||||||||||||||||
Total interest bearing liabilities |
1,035,986 | 15,762 | 2.03 | % | 923,132 | 16,895 | 2.45 | % | ||||||||||||||||
Net interest spread |
$ | 27,377 | 2.61 | % | $ | 32,325 | 3.30 | % | ||||||||||||||||
Noninterest bearing demand deposits |
154,312 | 149,300 | ||||||||||||||||||||||
Accrued expenses and other liabilities |
10,090 | 12,535 | ||||||||||||||||||||||
Stockholders equity |
133,093 | 167,325 | ||||||||||||||||||||||
Accumulated other comprehensive income |
5,859 | 6,395 | ||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 1,339,340 | $ | 1,258,687 | ||||||||||||||||||||
Impact of noninterest bearing sources and other changes in balance sheet composition |
0.33 | % | 0.48 | % | ||||||||||||||||||||
Net interest margin |
2.94 | % | 3.78 | % | ||||||||||||||||||||
(1) | Nonaccrual loans have been included in the average balance. Only the interest collected on such loans has been included as income. |
(2) | Interest income from securities and loans includes the effects of taxable-equivalent adjustments using a federal income tax rate of approximately 34% for both years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable equivalent adjustment amounts included in the above table were $606 thousand and $688 thousand for the nine months ended September 30, 2010 and 2009, respectively. |
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The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.
CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO 2009
Increase (Decrease) in Interest Income and Expense Due to Changes in: |
||||||||||||
Volume | Rate | Total | ||||||||||
(in thousands) | ||||||||||||
Interest earning assets: |
||||||||||||
Loans, net of unearned income |
$ | (4,908 | ) | $ | (864 | ) | $ | (5,772 | ) | |||
Debt securities taxable |
464 | (895 | ) | (431 | ) | |||||||
Debt securities non-taxable |
(193 | ) | (18 | ) | (211 | ) | ||||||
Other earning assets |
364 | (31 | ) | 333 | ||||||||
Total earning assets |
(4,273 | ) | (1,808 | ) | (6,081 | ) | ||||||
Interest bearing liabilities: |
||||||||||||
Interest bearing demand deposits |
9 | (13 | ) | (4 | ) | |||||||
Money market accounts |
94 | (244 | ) | (150 | ) | |||||||
Savings deposits |
6 | (6 | ) | | ||||||||
Time deposits of less than $100 thousand |
(246 | ) | (1,719 | ) | (1,965 | ) | ||||||
Time deposits of $100 thousand or more |
(245 | ) | (1,428 | ) | (1,673 | ) | ||||||
Brokered CDs and CDARS® |
4,941 | (1,817 | ) | 3,124 | ||||||||
Brokered money markets and NOWs |
(435 | ) | 2 | (433 | ) | |||||||
Federal funds purchased |
(4 | ) | | (4 | ) | |||||||
Repurchase agreements |
(38 | ) | 23 | (15 | ) | |||||||
Other borrowings |
(17 | ) | 4 | (13 | ) | |||||||
Total interest bearing liabilities |
4,065 | (5,198 | ) | (1,133 | ) | |||||||
Increase (decrease) in net interest income |
$ | (8,338 | ) | $ | 3,390 | $ | (4,948 | ) | ||||
Net Interest Income Volume and Rate Changes
Interest income for the third quarter of 2010 was $13.2 million, a 17.3% decrease compared to the same period in 2009. Average earning assets increased $97.5 million, or 8.7%, in the third quarter of 2010 compared to the same period in 2009. The increase in average earning assets was led by average other earning assets, which increased $229.0 million, and investment securities, which increased $11.4 million. These increases were offset by declines in the loan portfolio, which decreased $142.9 million. Average loans declined primarily due to current economic conditions while other earning assets increased as we maintained over $234 million in an interest bearing account at the Federal Reserve Bank of Atlanta. The yield on this account is approximately 25 basis points. The increase in this account was primarily funded by an increase in brokered deposits, as well as reductions in our loan portfolio. The purpose of the increase in liquid assets was to reduce liquidity risk, which we describe more fully below in the Liquidity section, resulting from deteriorating asset quality and the Consent Order. Investment securities increased as we reinvested the cash flow from the investment securities portfolio into new securities. The change in mix of earning assets reduced interest income by $1.9 million (on a tax equivalent basis) for the third quarter of 2010 compared to 2009, while the decline in yields on earning assets, as discussed further below, reduced interest income by an additional $854 thousand.
Interest income for the nine months ended September 30, 2010 was $42.5 million, a 12.4% decrease compared to the same period in 2009. Average earning assets increased $99.6 million, or 8.7%, in 2010 compared to 2009. On a year-to-date basis, average other earning assets increased $198.5 million, average loans decreased $107.6 million and investment securities increased $8.8 million. The change in mix of earning assets reduced interest income by $4.3 million (on a tax equivalent basis) for 2010 compared to 2009. The reduction in rates earned resulted in a $1.8 million (on a tax equivalent basis) decline in interest income, as discussed below.
The reductions in interest income due to changes in volume for both the three and nine months ended September 30, 2010 were further impacted by the decline in the yield on earning assets. The tax
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equivalent yield on earning assets decreased by 138 basis points and 111 basis points for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009. Comparing the third quarter of 2010 to 2009, the yield on loans declined 20 basis points from 5.94% to 5.74%. We anticipate the yield on loans to stabilize or improve over time as we have instituted higher loan pricing floors on new and renewing loans; however, reversed interest caused by loans downgraded to nonaccrual may continue to put additional pressure on the loan yield. Our loan portfolio is approximately 59% fixed rate, 36% variable rate and 5% adjustable rate. The variable rate loans reprice simultaneously with changes in the associated index, such as Prime, LIBOR or Treasury bond rates, while the repricing of adjustable rate loans is based on a time component in addition to changes in the associated index. Accordingly, changes in the target federal funds rate (and the implied correlation to the Prime lending rate) have an immediate impact on the yield of our earning assets.
Total interest expense was $5.1 million in the third quarter of 2010, or $9 thousand higher than the same period in 2009. On a year-to-date basis, total interest expense was $15.8 million, or 6.7% lower than the same period in 2009. Average interest bearing liabilities increased for the three and nine month periods ending September 30, 2010 by $109.2 million, or 12.2%, and $112.9 million, or 12.2%, compared to the same periods in 2009. Average brokered deposits increased $144.3 million and $120.1 million for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009. The increases in brokered deposits were partially offset by reductions in retail and jumbo CDs. The $1.4 million increase in interest expense due to increases in volume was nearly fully offset by reductions in rates. On a year-to-date basis, increases in volume added $4.1 million, fully offset by a reduction in interest expense of $5.2 million due to reductions in deposit rates. The decrease in rates is due primarily to term deposits maturing and repricing at lower current market rates.
We expect average loans to continue to decline before beginning to stabilize in the next six months as the regional economy begins to enter into some measure of recovery. Investment securities will continue to grow as earnings are reinvested into new securities. We expect other earning assets to begin to decline during the fourth quarter of 2010 and into 2011 as brokered deposits mature without being replaced. Rates paid on deposits for the fourth quarter are expected to be consistent with third quarter results.
Net Interest Income Net Interest Spread and Net Interest Margin
The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The net interest rate spread does not consider the impact of noninterest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing noninterest bearing deposits in earning assets.
Our net interest rate spread (on a tax equivalent basis) was 2.38% and 2.61% for the three and nine months ended September 30, 2010, respectively, compared to 3.52% and 3.30% for the same periods in 2009, respectively. Our net interest margin (on a tax equivalent basis) was 2.72% and 2.94% for the three and nine months ended September 30, 2010, respectively, compared to 3.96% and 3.78% for the same periods in 2009, respectively. The decreased net interest spread and margin are the result of the combination of lower loan volumes and higher brokered deposit volumes partially offset by deposits rates reducing faster than asset yields. During December of 2009 and first quarter of 2010, we issued over $180.0 million in brokered deposits to improve our contingent funding capacity. A portion of these funds were utilized to payoff our variable-rate brokered money market account during the first quarter of 2010. The remaining funds were placed in our interest bearing account at the Federal Reserve. As of September 30, 2010, our balance at the Federal Reserve was approximately $223 million. The negative spread associated between the interest bearing cash and the brokered deposits will continue to negatively impact our net interest spread and margin. Average interest bearing liabilities as a percentage of average earning assets was 82.9% for the three-month period ended September 30, 2010 compared to 80.4% for the same period in 2009. Noninterest bearing funding sources contributed 34 basis points to the net interest margin during the third quarter of 2010 compared to 44 basis points in the same period in 2009.
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In prior years, we terminated two sets of interest rate swaps. The combined gains at termination were $7.8 million, which are being accreted into interest income over the remaining life of the originally hedged items. For the three and nine months ended September 30, 2010, the accretion of the swaps added approximately $490 thousand and $1.5 million, respectively, to interest income compared to $530 thousand and $1.8 million for the same periods in 2009.
We anticipate our net interest margin will stabilize and improve over the next six months. However, improvement is dependent on multiple factors including our ability to raise core deposits, our growth or contraction in loans, our deposit and loan pricing, maturities of brokered deposits, and any possible further action by the Federal Reserve Board.
Provision for Loan and Lease Losses
The provision for loan and lease losses charged to operations during the three months ended September 30, 2010 was $18.4 million compared to $9.3 million in the same period of 2009. Net charge-offs for the third quarter of 2010 were $19.9 million compared to net charge-offs of $2.9 million for the same period in 2009. The provision for the nine months ended September 30, 2010 and 2009 was $26.4 million and $20.5 million, respectively. Annualized net charge-offs as a percentage of average loans were 9.67% for the three months ended September 30, 2010 compared to 1.18% for the same period in 2009. Our peer groups average (as reported in the June 30, 2010 Uniform Bank Performance Report) was 1.23%.
The increase in our provision for loan and lease losses on a quarterly and year-to-date basis in 2010 compared to the same periods in 2009 resulted from our analysis of inherent risks in the loan portfolio in relation to the portfolios growth, the level of impaired, past due, charged-off, classified and non-performing loans, as well as increased environmental risk factors due to the general economic conditions. As of September 30, 2010, we determined our allowance of $25.3 million was adequate to provide for credit losses, which we describe more fully below in the Allowance for Loan and Lease Losses section. We will reanalyze the allowance for loan and lease losses on at least a quarterly basis, and the next review will be at December 31, 2010, or sooner if needed, and the provision expense will be adjusted accordingly, if necessary.
We will continue to provide provision expense to maintain an allowance level adequate to absorb known and estimated losses inherent in our loan portfolio. As the determination of provision expense is a function of calculations made to determine our allowance for loan and lease losses, these quarterly credit quality assessments will also determine our provision expense. As these credit quality assessments are currently in process for the fourth quarter of 2010, we cannot accurately estimate our provision expense for the quarter-ended December 31, 2010.
Noninterest Income
Noninterest income totaled $2.4 million for the third quarter of 2010, a decrease of $333 thousand, or 12.2%, from the same period in 2009. On a year-to-date basis, noninterest income totaled $7.3 million, a decrease of $566 thousand, or 7.2%, from the 2009 level. The quarterly and year-to-date declines are primarily a result of lower deposit fees.
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The following table presents the components of noninterest income for the periods ended September 30, 2010 and 2009.
NONINTEREST INCOME
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2010 | Percent Change |
2009 | 2010 | Percent Change |
2009 | |||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Non-sufficient funds (NSF) fees |
$ | 719 | -21.2 | % | $ | 913 | $ | 2,277 | -14.6 | % | $ | 2,666 | ||||||||||||
Service charges on deposit accounts |
232 | -14.4 | % | 271 | 722 | -13.5 | % | 835 | ||||||||||||||||
Point-of-sale (POS) fees |
322 | 10.7 | % | 291 | 948 | 14.8 | % | 825 | ||||||||||||||||
Bank-owned life insurance income |
251 | | % | 251 | 754 | | % | 754 | ||||||||||||||||
Mortgage loan and related fees |
319 | -17.1 | % | 385 | 704 | -14.7 | % | 826 | ||||||||||||||||
Trust fees |
190 | -0.5 | % | 191 | 567 | 5.6 | % | 537 | ||||||||||||||||
Gain on sale of available for sale securities |
| | % | | 57 | 100.0 | % | | ||||||||||||||||
Other income |
371 | -14.7 | % | 435 | 1,237 | -10.9 | % | 1,389 | ||||||||||||||||
Total noninterest income |
$ | 2,404 | -12.2 | % | $ | 2,737 | $ | 7,266 | -7.2 | % | $ | 7,832 | ||||||||||||
Our largest sources of noninterest income are service charges and fees on deposit accounts. Total service charges, including non-sufficient funds fees, were $951 thousand for the third quarter of 2010, a decrease of $233 thousand, or 19.7%, from the same period in 2009. While service charges and fees on deposit accounts typically correspond to the level and mix of our customer deposits, the implementation of the Dodd-Frank financial reform legislation may directly or indirectly impact the fee structure of our deposit products; therefore, we cannot reasonably estimate deposit fees for future periods.
Point-of-sale fees increased 10.7% and 14.8% to $322 thousand and $948 thousand for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009. POS fees are primarily generated when our customers use their debit cards for retail purchases. We anticipate POS fees to continue to grow as customer trends show increased use of debit cards, although it is unclear if certain provisions affecting interchange fees for card issuers included in the Dodd-Frank financial reform legislation will have a future material impact on this product and its revenue.
Bank-owned life insurance income was $251 thousand and $754 thousand for the three and nine months ended September 30, 2010, respectively. The Company is the owner and beneficiary of these contracts. The income generated by the cash value of the insurance policies accumulates on a tax-deferred basis and is tax free to maturity. In addition, the insurance death benefit will be a tax-free payment to the Company. This tax-advantaged asset enables us to provide benefits to our employees. On a fully tax-equivalent basis, the weighted average interest rate earned on the policies was 5.88% through September 30, 2010.
Mortgage loan and related fees for the third quarter of 2010 decreased $66 thousand, or 17.1%, to $319 thousand compared to $385 thousand in the third quarter of 2009. For the nine months ended September 30, 2010, mortgage income decreased $122 thousand, or 14.7%, compared to the same period in 2009. As discussed in Note 13 to our consolidated financial statements, we elect the fair value option for all held for sale loan originations. This election impacts the timing and recognition of origination fees and costs, as well as the value of servicing rights. The recognition of the income and fees is concurrent with the origination of the loan.
Our process to originate and sell a conforming mortgage in the secondary market typically takes 30 to 60 days from the date of mortgage origination to the date the mortgage is sold to an investor in the secondary market. Due to the normal processing time, we will have a certain amount of held for sale loans at any time. Mortgages originated in the secondary market totaled $15.6 million and $33.4 million for the
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three and nine months ended September 30, 2010, respectively. Mortgages sold in the secondary market for the three and nine months ended September 30, 2010 totaled $14.9 million and $31.2 million, respectively. Mortgages originated in the secondary market totaled $15.0 million and $51.0 million for the three and nine months ended September 30, 2009, respectively. Mortgages sold in the secondary market for the three and nine months ended September 30, 2009 totaled $17.9 million and $51.6 million, respectively. We sold these loans with the right to service the loan being released to the purchaser for a fee. Mortgage income for the remainder of the year is dependent on mortgage rates as well as our ability to generate higher levels of held for sale loans.
Trust fees were consistent for the three months ended September 30, 2010 compared to the same period in 2009 and increased $30 thousand for the nine months ended September 30, 2010 compared to the same period in 2009. As of September 30, 2010, our trust and wealth management department had 471 accounts with assets held under management of $204.9 million compared to 427 accounts with assets held under management of $182.8 million as of September 30, 2009. For the fourth quarter of 2010 and into 2011, we anticipate higher trust fees as marketing campaigns are underway to increase the number of trust accounts.
Other income for the third quarter of 2010 was $371 thousand compared to $435 thousand for the same period in 2009. For the nine months ended September 30, 2010, other income decreased $152 thousand to $1.2 million compared to the same period in 2009. The components of other income primarily consist of ATM fee income, gains on sales of other real estate owned (OREO) and repossessions, underwriting revenue, and safe deposit box fee income.
Noninterest Expense
Noninterest expense for the three and nine months ended September 30, 2010 totaled $12.5 million and $34.2 million, respectively, compared to $37.4 million and $56.7 million for the respective periods in 2009. Both periods in 2009 included a goodwill impairment of $27.2 million. Excluding the 2009 goodwill impairment, noninterest expense increased $2.3 million, or 22.6%, for the three months ended September 30, 2010. On a year-to-date basis, noninterest expense, excluding the 2009 goodwill impairment, increased $4.6 million in 2010 compared to 2009. The quarterly and year-to-date increases are primarily due to higher levels of write-downs on OREO properties and repossessions as well as higher FDIC insurance assessments and professional fees.
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The following table represents the components of noninterest expense for the three and nine month periods ended September 30, 2010 and 2009.
NONINTEREST EXPENSE
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2010 | Percent Change |
2009 | 2010 | Percent Change |
2009 | |||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Salaries & benefits |
$ | 4,787 | -2.4 | % | $ | 4,903 | $ | 14,438 | -5.7 | % | $ | 15,303 | ||||||||||||
Occupancy |
908 | 6.0 | % | 857 | 2,633 | 1.0 | % | 2,606 | ||||||||||||||||
Furniture and equipment |
522 | -17.9 | % | 636 | 1,554 | -19.0 | % | 1,919 | ||||||||||||||||
FDIC insurance |
1,044 | 137.8 | % | 439 | 2,581 | 86.1 | % | 1,387 | ||||||||||||||||
Professional fees |
936 | 66.5 | % | 562 | 2,344 | 79.3 | % | 1,307 | ||||||||||||||||
Write-downs on other real estate owned and repossessions |
1,575 | 1,212.5 | % | 120 | 2,715 | 435.5 | % | 507 | ||||||||||||||||
Losses on other real estate owned and repossessions |
88 | -40.9 | % | 149 | 763 | 163.1 | % | 290 | ||||||||||||||||
OREO and repossession holding costs |
356 | 7.6 | % | 331 | 1,269 | 97.0 | % | 644 | ||||||||||||||||
Data processing |
354 | -8.5 | % | 387 | 1,089 | 0.7 | % | 1,081 | ||||||||||||||||
Communications |
184 | 9.5 | % | 168 | 476 | -5.0 | % | 501 | ||||||||||||||||
Impairment of goodwill |
| -100.0 | % | 27,156 | | -100.0 | % | 27,156 | ||||||||||||||||
Intangible asset amortization |
116 | -8.7 | % | 127 | 349 | -10.7 | % | 391 | ||||||||||||||||
Printing & supplies |
91 | -12.5 | % | 104 | 267 | -11.6 | % | 302 | ||||||||||||||||
Advertising |
35 | -53.3 | % | 75 | 121 | -41.0 | % | 205 | ||||||||||||||||
Other expense |
1,516 | 12.4 | % | 1,349 | 3,565 | 14.4 | % | 3,116 | ||||||||||||||||
Total noninterest expense |
$ | 12,512 | -66.5 | % | $ | 37,363 | $ | 34,164 | -39.8 | % | $ | 56,715 | ||||||||||||
Salaries and benefits for the third quarter of 2010 decreased $116 thousand, or 2.4%, compared to the same period in 2009 and $865 thousand, or 5.7%, on a year-to-date basis. The decrease in salaries and benefits is primarily related to reductions in staffing. As of September 30, 2010, we had 325 full time equivalent employees compared to 348 as of September 30, 2009. We currently operate 37 full-service banking offices.
Occupancy expense for the third quarter and year-to-date period of 2010 was comparable to the same periods in 2009. As of September 30, 2010, we leased nine facilities and the land for five branches. As a result, current period occupancy expense is higher than if we owned these facilities, including the real estate, but due to market conditions, property availability and favorable lease terms, we leased these locations to execute our growth strategy. Furthermore, we have been able to deploy the capital into earning assets rather than capital expenditures for facilities.
Furniture and equipment expense decreased on a quarterly and year-to-date basis $114 thousand, or 17.9%, and $365 thousand, or 19.0%, respectively, primarily due to lower equipment depreciation expense.
FDIC deposit premium insurance increased $605 thousand and $1.2 million to $1.0 million and $2.6 million for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009. For the fourth quarter of 2010 and into 2011, we anticipate FDIC insurance to be comparable to the third quarter expense.
Professional fees increased $374 thousand for the third quarter of 2010 compared to the same period in 2009 and $1.0 million on a year-to-date basis. The increase is primarily due to consulting costs related to complying with the Consent Order, as well as additional legal costs associated with higher levels of non-performing assets. Professional fees include fees related to investor relations, outsourcing compliance and internal audit to Professional Bank Services, as well as external audit, tax services and legal and accounting advice related to, among other things, foreclosures, lending activities, employee benefit programs, prospective capital offerings and regulatory matters.
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Write-downs on OREO and repossessions increased $1.5 million and $2.2 million for the three and nine month periods ended September 30, 2010 compared to the same periods in 2009. At foreclosure or repossession, the fair value of the property is determined and a charge-off to the allowance is recorded, if applicable. Any decreases in value subsequent to the initial determination of fair value are recorded as a write-down. As a general policy, we re-assess the fair value of OREO and repossessions on at least an annual basis or sooner if indications exist that deterioration in value has occurred. Write-downs are based on property-specific appraisals or valuations. Write-downs for the remainder of 2010 and 2011 are dependent on real estate market conditions and our ability to liquidate properties.
Losses on OREO and repossessions totaled $88 thousand and $763 thousand for the three and nine months ending September 30, 2010, respectively, compared to $149 thousand and $290 thousand for the same periods in 2009. We anticipate increases in losses as nonperforming assets continue to increase as we seek to liquidate existing properties and repossessions in a timely manner.
OREO and repossession holding costs include, among other items, maintenance, repairs, utilities, taxes and storage costs. Holding costs increased $25 thousand and $625 thousand for the three and nine months ended September 30, 2010 compared to the same periods in 2009. We anticipate the level of holding costs to remain elevated for the remainder of 2010 and into 2011.
Data processing fees decreased 8.5% for the third quarter of 2010 compared to the same period in 2009 and were comparable on a year-to-date basis. The monthly fees associated with data processing are typically based on transaction volume.
We anticipate communications, printing and supplies and advertising expenses to remain stable or decline for the remainder of 2010 and 2011 as we continue to reduce discretionary expenses.
Intangible asset amortization expense decreased $11 thousand, or 8.7%, in the third quarter of 2010 compared to the same period in 2009 and decreased 10.7% on a year-to-date basis. Our core deposit intangible assets amortize on an accelerated basis in which the expense recognized declines over an estimated useful life of ten years. We anticipate further decreases in amortization expense for the fourth quarter of 2010 and into 2011.
Our policy was to assess goodwill for impairment on an annual basis or between annual assessments if an event occurred or circumstances changed that would more likely than not reduce the fair value of goodwill below its carrying amount. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Accounting guidance required us to estimate the fair value in making the assessment of impairment at least annually. We engaged an independent valuation firm to assist in computing the fair value estimate for the goodwill as of September 30, 2009. The firm utilized two separate valuation methodologies and compared the results of each methodology in order to determine the fair value of the goodwill associated with our prior acquisitions. The impairment testing is a two-step process. Step 1 compares the fair value of the reporting unit to the carrying value. If the fair value is below the carrying value, Step 2 is performed. Step 2 involves a process similar to business combination accounting in which fair values are assigned to all assets, liabilities and other (non-goodwill) intangibles. The result of Step 2 is the implied fair value of goodwill. If the implied fair value of goodwill is below the recorded goodwill amount, an impairment charge is recorded for the difference.
The results of the third-party goodwill assessment for 2009 indicated a full impairment and therefore we recorded a $27.2 million goodwill impairment as of September 30, 2009. The impairment was primarily a result of the continuing economic downtown and its implication on bank valuations. The one-time, non-cash accounting adjustment had no impact on cash flows, liquidity, tangible capital or our ability to conduct business. Additionally, as goodwill is excluded from regulatory capital, the impairment had no impact on the regulatory capital ratios of First Security or FSGBank.
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Income Taxes
As of September 30, 2010, we recorded a $17.4 million deferred tax valuation allowance to reduce our net deferred tax assets to an amount that we consider realizable. The remaining net deferred tax asset is anticipated to be realized through available carryback tax periods. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions. We identified as positive evidence the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years as well as current business trends. As conditions change, we will evaluate the need to increase or decrease the valuation allowance. Currently, we anticipate increasing the valuation allowance to offset any future recorded tax benefit to result in minimal, if any, income tax expense or benefit.
For the three and nine months ended September 30, 2010, recording the valuation allowance resulted in income tax expense of $9.4 million and $6.5 million, respectively. For the three and nine months ended September 30, 2009, we recorded income tax benefits of $4.9 million and $7.3 million, respectively.
STATEMENT OF FINANCIAL CONDITION
Our total assets were $1.2 billion at September 30, 2010, $1.4 billion at December 31, 2009 and $1.2 billion at September 30, 2009. For the fourth quarter of 2010 and into 2011, we anticipate that our total assets will continue to decline as brokered deposits mature and are funded with our current interest bearing cash. Due to the economic recession, we anticipate loan demand to continue to remain low.
Loans
Our active efforts to reduce certain credit exposures and their related balance sheet risk, as well as the effects of the economic recession, have resulted in declining loan balances. Year-to-date, loans contracted by $174.6 million, or 18.3%. From September 30, 2009 to September 30, 2010, our loans declined by $186.9 million, or 19.4%.
The following table presents our loan portfolio by type.
LOAN PORTFOLIO
Percent change from | ||||||||||||||||||||
September 30, 2010 |
December 31, 2009 |
September 30, 2009 |
December 31, 2009 |
September 30, 2009 |
||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Loans secured by real estate- |
||||||||||||||||||||
Residential 1-4 family |
$ | 258,579 | $ | 281,354 | $ | 284,811 | -8.1 | % | -9.2 | % | ||||||||||
Commercial |
236,991 | 259,819 | 233,692 | -8.8 | % | 1.4 | % | |||||||||||||
Construction |
101,870 | 153,144 | 176,570 | -33.5 | % | -42.3 | % | |||||||||||||
Multi-family and farmland |
37,816 | 37,960 | 37,461 | -0.4 | % | 0.9 | % | |||||||||||||
635,256 | 732,277 | 732,534 | -13.2 | % | -13.3 | % | ||||||||||||||
Commercial loans |
91,637 | 146,016 | 148,473 | -37.2 | % | -38.3 | % | |||||||||||||
Consumer installment loans |
37,884 | 48,927 | 51,866 | -22.6 | % | -27.0 | % | |||||||||||||
Leases, net of unearned income |
10,139 | 19,730 | 24,679 | -48.6 | % | -58.9 | % | |||||||||||||
Other |
2,502 | 5,068 | 6,743 | -50.6 | % | -62.9 | % | |||||||||||||
Total loans |
777,418 | 952,018 | 964,295 | -18.3 | % | -19.4 | % | |||||||||||||
Allowance for loan and lease losses |
(25,320 | ) | (26,492 | ) | (25,686 | ) | -4.4 | % | -1.4 | % | ||||||||||
Net loans |
$ | 752,098 | $ | 925,526 | $ | 938,609 | -18.7 | % | -19.9 | % | ||||||||||
Year-to-date, the largest declining loan balances were commercial loans of $54.4 million, or 37.2%, construction and land development loans of $51.3 million, or 33.5%, commercial real estate loans of $22.8 million, or 8.8%, and residential 1-4 family loans of $22.8 million, or 8.1%. Comparing September 30, 2010 to September 30, 2009, the largest declining loan balances were construction and land development loans of $74.7 million, or 42.3%, commercial loans of $56.8 million, or 38.3%, and residential 1-4 family loans of $26.2 million, or 9.2%.
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We will continue to extend prudent loans to credit-worthy consumers and businesses. However, due to the current economic environment, we anticipate our loans may remain stable or possibly decline in the near term. Funding of future loans may be restricted by our ability to raise core deposits, although we may use alternative funding sources, if available, necessary and cost effective. Loan growth may also be restricted by the necessity for us to maintain appropriate capital and liquidity levels.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses reflects our assessment and estimate of the risks associated with extending credit and our evaluation of the quality of the loan portfolio. We regularly analyze our loan portfolio in an effort to establish an allowance that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:
| our loan loss experience; |
| specific known risks; |
| the status and amount of past due and non-performing assets; |
| underlying estimated values of collateral secured loans; |
| current and anticipated economic conditions; and |
| other factors which we believe affect the allowance for potential credit losses. |
The allowance is composed of three primary components: (1) specific impairments for substandard/nonaccrual loans and leases, (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, and (3) general allocations for the remaining pools of loans. Specific impairments are commonly referred to as SFAS 114 impairments and general allocations are commonly referred to as SFAS 5 allocations. We accumulate pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions.
An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan and lease losses is prepared jointly by our accounting and credit administration departments and presented to our Board of Directors or the Directors Loan Committee on at least a quarterly basis. Based on our analysis, we may determine that our provision expense needs to increase or decrease in order for us to remain adequately reserved for probable loan losses. As stated earlier, we make this determination after considering both quantitative and qualitative factors under appropriate regulatory and accounting guidelines.
Our allowance for loan and lease losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance compared to a group of peer banks. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance methodology differ materially from the banks methodology. We believe our allowance methodology is in compliance with regulatory interagency guidance as well as applicable GAAP guidance.
For specifically impaired loans, one of three methods may be used to determine the impairment: (1) the present value of future cash flow, (2) the fair value of collateral or (3) an observable market price for the loan. For loans that are determined to be collateral-dependent, the fair value of the collateral is the required impairment method. Additionally, an impairment on a collateral-dependent loan is required to be charged-off in the period the impairment is determined. During the third quarter of 2010, management, in consultation with bank regulators, identified various loan relationships that had previously been evaluated utilizing the present value of future cash flow that were more appropriately evaluated as collateral-dependent
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relationships as of September 30, 2010. Changing the impairment method on these relationships resulted in a significant number of charge-offs during the third quarter of 2010. Additionally, the third quarter 2010 impairment analysis of one commercial loan relationship resulted in a $9.5 million charge-off. The underlying financial condition of the borrower was unable to support the unsecured portion of this relationship and therefore, the entire unsecured portion was charged-off. For the three months ended September 30, 2010, we recorded $20.2 million in charge-offs.
While it is our policy to charge-off all or a portion of certain loans in the current period when a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because the assessment of these risks includes assumptions regarding local and national economic conditions, our judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
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The following table presents an analysis of the changes in the allowance for loan and lease losses for the nine months ended September 30, 2010 and 2009. The provision for loan and lease losses of $26.4 million in the table below does not include our provision accrual for unfunded commitments of $18 thousand as of September 30, 2010. The reserve for unfunded commitments totals $223 thousand and $199 thousand as of September 30, 2010 and 2009, respectively, and is included in other liabilities in the accompanying consolidated balance sheets.
ANALYSIS OF CHANGES IN ALLOWANCE FOR LOAN AND LEASE LOSSES
For the nine months ended September 30, | ||||||||
2010 | 2009 | |||||||
(in thousands, except percentages) | ||||||||
Allowance for loan and lease losses |
||||||||
Beginning of period |
$ | 26,492 | $ | 17,385 | ||||
Provision for loan and lease losses |
26,406 | 20,451 | ||||||
Sub-total |
52,898 | 37,836 | ||||||
Charged-off loans: |
||||||||
Real estate Residential 1-4 family |
1,736 | 1,090 | ||||||
Real estate Commercial |
1,972 | 1,505 | ||||||
Real estate Construction |
5,574 | 1,337 | ||||||
Real estate Multi-family and farmland |
924 | 58 | ||||||
Commercial loans |
15,421 | 6,985 | ||||||
Consumer installment loans and Other |
862 | 777 | ||||||
Leases, net of unearned income |
1,641 | 691 | ||||||
Total charged-off |
28,130 | 12,443 | ||||||
Recoveries of charged-off loans: |
||||||||
Real estate Residential 1-4 family |
37 | 25 | ||||||
Real estate Commercial |
153 | | ||||||
Real estate Construction |
5 | 10 | ||||||
Real estate Multi-family and farmland |
| 3 | ||||||
Commercial loans |
242 | 142 | ||||||
Consumer installment loans and Other |
115 | 107 | ||||||
Leases, net of unearned income |
| 6 | ||||||
Total recoveries |
552 | 293 | ||||||
Net charged-off loans |
27,578 | 12,150 | ||||||
Allowance for loan and lease losses end of period |
$ | 25,320 | $ | 25,686 | ||||
Total loans end of period |
$ | 777,418 | $ | 964,295 | ||||
Average loans |
$ | 875,851 | $ | 983,492 | ||||
Net loans charged-off to average loans, annualized |
4.20 | % | 1.65 | % | ||||
Provision for loan and lease losses to average loans, annualized |
4.02 | % | 2.77 | % | ||||
Allowance for loan and lease losses as a percentage of: |
||||||||
Period end loans |
3.26 | % | 2.66 | % | ||||
Non-performing assets |
31.97 | % | 53.83 | % |
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The following table presents the allocation of the allowance for loan and lease losses for each respective loan category with the corresponding percentage of loans in each category to total loans. The comprehensive allowance analysis developed by our credit administration and accounting group enables us to allocate the allowance based on risk elements within the portfolio.
ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES
As of September 30, 2010 | As of December 31, 2009 | As of September 30, 2009 | ||||||||||||||||||||||
Amount | Percent
of Portfolio1 |
Amount | Percent
of Portfolio1 |
Amount | Percent
of Portfolio1 |
|||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Real estate Residential 1-4 family |
$ | 6,278 | 33.3 | % | $ | 5,037 | 29.6 | % | $ | 4,751 | 29.6 | % | ||||||||||||
Real estate Commercial |
6,295 | 30.5 | % | 4,525 | 27.3 | % | 4,232 | 24.2 | % | |||||||||||||||
Real estate Construction |
4,289 | 13.0 | % | 6,706 | 16.0 | % | 4,994 | 18.3 | % | |||||||||||||||
Real estate Multi-family and farmland |
550 | 4.9 | % | 766 | 4.0 | % | 510 | 3.9 | % | |||||||||||||||
Commercial loans |
6,089 | 11.8 | % | 6,953 | 15.4 | % | 6,946 | 15.4 | % | |||||||||||||||
Consumer installment loans |
688 | 4.9 | % | 1,107 | 5.1 | % | 1,131 | 5.4 | % | |||||||||||||||
Leases, net of unearned income |
1,100 | 1.3 | % | 1,386 | 2.1 | % | 3,053 | 2.5 | % | |||||||||||||||
Other |
31 | 0.3 | % | 12 | 0.5 | % | 69 | 0.7 | % | |||||||||||||||
Total |
$ | 25,320 | 100.0 | % | $ | 26,492 | 100.0 | % | $ | 25,686 | 100.0 | % | ||||||||||||
1 | Represents the percentage of loans in each category to total loans. |
Over the last twelve to eighteen months, our asset quality deteriorated and the allowance as a percentage of total loans significantly increased as a result of the economic downturn and the associated decline in real estate values. Over the last twelve months, the allowance as a percentage of total loans increased from 2.66% to 3.26% as of September 30, 2010.
From September 30, 2009 to September 30, 2010, the allowance declined by $366 thousand. Specific impairments declined by $4.1 million and the decline in loans reduced the allowance by an additional $3.3 million. Offsetting these declines was an increase in the loss factors for the FAS 5 pools. The increased loss factors contributed a net increase of $7.0 million. The considerable charge-offs recorded in the third quarter of 2010 caused the loss factor applied to the FAS 5 pools to significantly increase.
The percentage of classified loans to total loans increased from 14% to 17% from September 30, 2009 to September 30, 2010 as loans secured by real estate continue to migrate through our risk ratings. The decline in real estate values combined with the slowdown in real estate sales has contributed to higher levels of classified real estate secured loans. We consider the following factors in the decision to downgrade a real estate construction loans, including, but not limited to, the decline in the associated collateral value, the length of time the finished home has been on the market, and the borrowers ability to begin amortizing the loan. In many cases, a downgraded loan may not be past due or involve a borrower missing scheduled payments; a downgraded loan instead indicates a risk of future non-performance, rather than a measure of actual non-performing loans.
We believe that the allowance for loan and lease losses as of September 30, 2010 is sufficient to absorb losses inherent in the loan portfolio based on our assessment of the information available, including the results of extensive internal and independent reviews of our loan portfolio, as discussed in the Asset Quality and Non-Performing Asset section below. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant.
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Asset Quality and Non-performing Assets
Asset Quality Strategic Initiatives for 2009 and 2010
Our ability to return to profitability is largely dependent on properly addressing and improving our asset quality. At September 30, 2010, our loan portfolio was 60.1% of total assets. Over the past twelve months, we implemented several significant strategies to further address our asset quality, including:
| Hired a new Chief Credit Officer |
| Restructured and expanded our credit department, including special assets |
| Developed centralized underwriting, document preparation and collections processes |
| Conducted a third-party loan review |
| Hired an experienced special assets officer |
| Outsourced the marketing and sales of residential OREO to market-leading real estate firms, and |
| Expanded our loan review department |
During the fourth quarter of 2009, we began the process of restructuring our credit administration department to add additional depth and expertise. Specifically, the credit department is now aligned by line of business for commercial and retail credit with dedicated credit officers and staff supporting each of these portfolios. The chief credit officer serves to support both senior credit officers. As of September 30, 2010, we have successfully hired a chief credit officer, three experienced senior credit officers and two seasoned special assets officers. We anticipate additions to the credit department, including special assets, during the fourth quarter of 2010 through hiring and/or reallocation of existing resources.
With the additional depth and expertise of the restructured credit department, we have centralized our loan underwriting, document preparation and collections processes. This centralization will improve consistency, increase quality and provide higher levels of operational efficiencies. Collectively, we believe these changes will assist in reducing current and future non-performing assets.
During the fourth quarter of 2009, we engaged an independent consulting firm to conduct an extensive loan review. The primary purpose of the loan review was to evaluate individual credits for compliance with credit and underwriting standards, and to assess the potential impairment of certain credits in which we might experience additional risks of loss.
Our internal loan review department performs risk-based reviews and historically targets 60% to 70% of our portfolio over an 18-month cycle. In the last twelve months, we have added two additional employees to our internal loan review department. For 2010, we are combining the additional internal resources with external assistance to condense the normal 18-month cycle to a 12-month cycle, focusing on a risk-based approach for the 2010 loan reviews.
We believe the above loan review and credit initiatives will enable us to improve our asset quality over time through a more timely recognition of problem relationships. Additionally, we believe the expanded special assets department will allow us to manage the problem relationships in a more efficient and effective manner to ultimately reduce future loan losses.
Asset Quality and Non-Performing Assets Analysis and Discussion
Our asset quality ratios weakened in the third quarter of 2010 compared to year-end and the same period in 2009. As of September 30, 2010, our allowance for loan and lease losses as a percentage of total loans was 3.26%, which is an increase from the 2.78% as of December 31, 2009 and 2.66% as of September 30, 2009. Net charge-offs as a percentage of average loans (annualized) increased to 4.20% from 1.65% for the nine month periods ended September 30, 2010 and 2009, respectively. Non-performing assets as a percentage of total assets was 6.35% as of September 30, 2010, compared to 3.97% for the same period in 2009. As of September 30, 2010, non-performing assets plus loans 90 days past due, increased to $85.2 million, or 6.84% of total assets, from $69.9 million, or 5.16% as of December 31, 2009, and $51.1 million, or 4.25% of total assets as of September 30, 2009.
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We believe that overall asset quality may stabilize in 2011. Our special assets department actively collects past due loans and develops action plans for classified and criticized loans and leases. As for managing and marketing repossession and OREO, we are focused on achieving the proper level of balance between maximizing the realized value upon sale and minimizing the holding period and carrying costs with a bias towards liquidation.
Nonperforming assets include nonaccrual loans, OREO and repossessed assets. We place loans on non-accrual status when we have concerns relating to our ability to collect the loan principal and interest, and generally when such loans are 90 days or more past due. The following table presents our non-performing assets and related ratios.
NON-PERFORMING ASSETS BY TYPE
September 30, 2010 |
December 31, 2009 |
September 30, 2009 |
||||||||||
(restated) | ||||||||||||
(in thousands, except percentages) | ||||||||||||
Nonaccrual loans |
$ | 55,083 | $ | 45,454 | $ | 31,463 | ||||||
Loans past due 90 days and still accruing |
6,025 | 4,524 | 3,377 | |||||||||
Total nonperforming loans |
$ | 61,108 | $ | 49,978 | $ | 34,840 | ||||||
Other real estate owned |
$ | 22,888 | $ | 16,017 | $ | 14,206 | ||||||
Repossessed assets |
1,229 | 3,881 | 2,050 | |||||||||
Nonaccrual loans |
55,083 | 45,454 | 31,463 | |||||||||
Total nonperforming assets |
$ | 79,200 | $ | 65,352 | $ | 47,719 | ||||||
Nonperforming loans as a percentage of total loans |
7.86 | % | 5.25 | % | 3.61 | % | ||||||
Nonperforming assets as a percentage of total assets |
6.35 | % | 4.83 | % | 3.97 | % | ||||||
Nonperforming assets plus loans 90 days past due to total assets |
6.84 | % | 5.16 | % | 4.25 | % |
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The following table provides the activity in our nonperforming assets for the last five quarters. Additions may include transfer into the category or additions to previously existing loans/properties. Reductions for nonaccrual loans may include (1) a transfer to other real estate owned, (2) a charge-off, (3) a principal payment and/or (4) transfers to accrual status. Reductions in other real estate owned may include (1) a charge-off or write-down or (2) a sale of the property.
NONPERFORMING ASSETS ACTIVITY
3rd
Quarter 2010 |
2nd
Quarter 2010 |
1st
Quarter 2010 |
4th
Quarter 2009 |
3rd
Quarter 2009 |
||||||||||||||||
(restated) | (restated) | (restated) | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Nonaccrual loans |
||||||||||||||||||||
Beginning balance |
$ | 58,339 | $ | 50,305 | $ | 45,454 | $ | 31,463 | $ | 26,782 | ||||||||||
Additions |
26,583 | 15,525 | 16,701 | 20,378 | 11,837 | |||||||||||||||
Reductions |
(29,839 | ) | (7,491 | ) | (11,850 | ) | (6,387 | ) | (7,156 | ) | ||||||||||
Ending balance |
$ | 55,083 | $ | 58,339 | $ | 50,305 | $ | 45,454 | $ | 31,463 | ||||||||||
Other real estate owned |
||||||||||||||||||||
Beginning balance |
$ | 18,387 | $ | 18,933 | $ | 16,017 | $ | 14,206 | $ | 12,930 | ||||||||||
Additions |
7,096 | 6,274 | 3,866 | 4,415 | 5,599 | |||||||||||||||
Reductions |
(2,595 | ) | (6,820 | ) | (950 | ) | (2,604 | ) | (4,323 | ) | ||||||||||
Ending balance |
$ | 22,888 | $ | 18,387 | $ | 18,933 | $ | 16,017 | $ | 14,206 | ||||||||||
Repossessions |
||||||||||||||||||||
Beginning balance |
$ | 1,921 | $ | 3,466 | $ | 3,881 | $ | 2,050 | $ | 1,473 | ||||||||||
Additions |
727 | 709 | 1,383 | 3,588 | 1,978 | |||||||||||||||
Reductions |
(1,419 | ) | (2,254 | ) | (1,798 | ) | (1,757 | ) | (1,401 | ) | ||||||||||
Ending balance |
$ | 1,229 | $ | 1,921 | $ | 3,466 | $ | 3,881 | $ | 2,050 | ||||||||||
The following table provides the classifications for nonaccrual loans and other real estate owned as of September 30, 2010, December 31, 2009 and September 30, 2009.
NONPERFORMING ASSETS CLASSIFICATION AND NUMBER OF UNITS
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||||||||||||||
Amount | Units | Amount | Units | Amount | Units | |||||||||||||||||||
(restated) | ||||||||||||||||||||||||
(dollar amounts in thousands) | ||||||||||||||||||||||||
Nonaccrual loans |
||||||||||||||||||||||||
Construction/development loans |
$ | 30,225 | 60 | $ | 13,706 | 36 | $ | 10,583 | 15 | |||||||||||||||
Residential real estate loans |
7,113 | 58 | 6,059 | 52 | 3,758 | 32 | ||||||||||||||||||
Commercial real estate loans |
7,327 | 25 | 6,156 | 26 | 2,162 | 11 | ||||||||||||||||||
Commercial and industrial loans |
4,886 | 31 | 15,397 | 38 | 8,432 | 25 | ||||||||||||||||||
Commercial leases |
3,541 | 59 | 2,389 | 20 | 5,064 | 21 | ||||||||||||||||||
Consumer and other loans |
1,991 | 26 | 1,747 | 15 | 1,464 | 2 | ||||||||||||||||||
Total |
$ | 55,083 | 259 | $ | 45,454 | 187 | $ | 31,463 | 106 | |||||||||||||||
Other real estate owned |
||||||||||||||||||||||||
Construction/development loans |
10,510 | 64 | $ | 6,243 | 37 | $ | 6,339 | 31 | ||||||||||||||||
Residential real estate loans |
7,789 | 60 | 5,132 | 34 | 3,688 | 25 | ||||||||||||||||||
Commercial real estate loans |
4,589 | 18 | 4,642 | 14 | 4,179 | 12 | ||||||||||||||||||
Total |
$ | 22,888 | 142 | $ | 16,017 | 85 | $ | 14,206 | 68 | |||||||||||||||
Nonaccrual loans totaled $55.1 million, $45.5 million and $31.5 million as of September 30, 2010, December 31, 2009 and September 30, 2009, respectively. We place loans on nonaccrual when we have concerns related to our ability to collect the loan principal and interest, and generally when loans are 90 or more days past due. As of September 30, 2010, we are not aware of any additional material loans that we have doubts as to the collectability of principal and interest that are not classified as nonaccrual. As previously described, we have individually reviewed each nonaccrual loan in excess of $500 thousand for possible impairment. We measure impairment by adjusting loans to either the present value of expected cash flows, the fair value of the collateral or observable market prices.
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As of September 30, 2010, nonaccruals increased by $9.6 million, or 21.2%, compared to year-end 2009. During the third quarter of 2010, we recorded charge-offs of $20.2 million on predominantly non-accrual loans. The reduction in nonaccruals during the third quarter of 2010 through the charge-offs were partially offset by new nonaccrual loans. Construction and development nonaccruals increased from $18.1 million as of June 30, 2010 to $30.2 million as of September 30, 2010. The new construction and development nonaccrual loans were predominantly in our Knoxville, TN region. We are actively pursuing the appropriate strategies to reduce the current level of nonaccruals either through longer-term reworks of the credits, charge-offs and/or foreclosure.
Other real estate increased $6.9 million from December 31, 2009 to September 30, 2010, as additions continued to outpace dispositions. During the nine months ended September 30, 2010, we sold twenty-four properties with total proceeds of $4.7 million, resulting in a 100% realization of the carrying value prior to sale and an 84% realization of the original loan balance. We anticipate taking a more aggressive sales approach during the remainder of 2010 to dispose of our current properties, which may lead to a lower realization rate.
Loans 90 days past due and still accruing increased to $6.0 million from $4.5 million at year-end 2009. As of September 30, 2010, two relationships accounted for $3.9 million, or 65%, of the total.
Total nonperforming assets at the end of the third quarter of 2010 were $79.2 million compared to $65.4 million at December 31, 2009 and $47.7 million at September 30, 2009.
Our asset quality ratios were less favorable compared to our peer group. Our peer group, as defined by the Uniform Bank Performance Report (UBPR), is all commercial banks between $1 billion and $3 billion in total assets. The following table provides our asset quality ratios as of September 30, 2010 and our UBPR peer group ratios as of September 30, 2010.
NONPERFORMING ASSET RATIOS
First Security Group, Inc |
UBPR Peer Group |
|||||||
Nonperforming loans1 as a percentage of gross loans |
7.86 | % | 3.91 | % | ||||
Nonperforming loans1 as a percentage of the allowance |
241.34 | % | 163.11 | % | ||||
Nonperforming loans1 as a percentage of equity capital |
57.2 | % | 26.64 | % | ||||
Nonperforming loans1 plus OREO as a percentage of gross loans plus OREO |
10.50 | % | 5.14 | % |
1 | Nonperforming loans are: Nonaccrual loans plus loans 90 days past due and still accruing |
Investment Securities and Other Earning Assets
The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the consolidated balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. Currently, all of our investments are classified as available-for-sale. While we have no plans to liquidate a significant amount of any available-for-sale securities, the securities classified as available-for-sale may be used for liquidity purposes should we deem it to be in our best interest.
Available-for-sale securities totaled $155.1 million at September 30, 2010, $143.0 million at December 31, 2009 and $147.2 million at September 30, 2009. At September 30, 2010, the available-for-sale securities portfolio had unrealized net gains of approximately $3.3 million, net of tax. Our securities portfolio at September 30, 2010 consisted of tax-exempt municipal securities, federal agency mortgage bonds, federal agency issued Real Estate Mortgage Investment Conduits (REMICs) and federal agency issued pools.
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The following table provides the amortized cost of our available-for-sale securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the tax equivalent yields for each maturity range.
MATURITY OF AFS INVESTMENT SECURITIES AMORTIZED COST
Less than One Year |
One to Five Years |
Five to Ten Years |
More than Ten Years |
Totals | ||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Municipal-tax exempt |
$ | 1,865 | $ | 14,440 | $ | 14,567 | $ | 4,454 | $ | 35,326 | ||||||||||
Agency bonds |
| 19,294 | 8,493 | | 27,787 | |||||||||||||||
Agency issued REMICs |
16,158 | 29,999 | 2,902 | | 49,059 | |||||||||||||||
Agency issued mortgage pools |
233 | 29,602 | 7,136 | 846 | 37,817 | |||||||||||||||
Other |
| | | 127 | 127 | |||||||||||||||
Total |
$ | 18,256 | $ | 93,335 | $ | 33,098 | $ | 5,427 | $ | 150,116 | ||||||||||
Tax Equivalent Yield |
5.11 | % | 3.51 | % | 4.39 | % | 6.07 | % | 3.99 | % |
We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. All securities held are historically traded in liquid markets, except for one bond. This $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by The Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee.
As of September 30, 2010, we performed an impairment assessment of the securities in our portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) we intend to sell the security, (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (3) we do not expect to recover the securitys entire amortized cost basis, even if we do not intend to sell. Additionally, accounting guidance requires that for impaired securities that we do not intend to sell and/or that it is not more-likely-than-not that we will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, we consider factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
As of September 30, 2010, gross unrealized losses in our portfolio totaled $62 thousand, compared to $603 thousand and $598 thousand as of December 31, 2009 and September 30, 2009, respectively. The unrealized losses in municipal securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. Based on results of our impairment assessment, the unrealized losses at September 30, 2010 are considered temporary.
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As of September 30, 2010, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders equity. The following table presents the amortized cost and market value of the securities from each such issuer as of September 30, 2010.
Book Value | Market Value | |||||||
(in thousands) | ||||||||
FHLMC* |
$ | 44,306 | $ | 45,968 | ||||
Fannie Mae |
$ | 35,594 | $ | 32,265 | ||||
Ginnie Mae |
$ | 26,946 | $ | 23,211 |
* | Federal Home Loan Mortgage Corporation |
We held no federal funds sold as of September 30, 2010, December 31, 2009 or September 30, 2009. As of September 30, 2010, we held $224.1 million in interest bearing deposits, primarily at the Federal Reserve Bank of Atlanta, compared to $152.6 million at December 31, 2009 and $5.4 million as of September 30, 2009. The yield on our account at the Federal Reserve Bank is approximately 25 basis points.
As of September 30, 2010, we held $100 thousand in certificates of deposit at other FDIC insured financial institution. At September 30, 2010, we held $25.6 million in bank-owned life insurance, compared to $24.9 million at December 31, 2009 and $24.7 million at September 30, 2009.
Deposits and Other Borrowings
As of September 30, 2010, deposits decreased by 6.0% from December 31, 2009 while increasing by 9.1% from September 30, 2009. Excluding the changes in brokered deposits, our deposits decreased by 7.2% from December 31, 2009 and 4.6% from September 30, 2009. Jumbo CDs decreased by $39.1 million, or 19.2%, from September 30, 2009 and $43.0 million, or 20.7%, from December 31, 2009. Retail CDs decreased by $28.3 million and $28.5 million in the same time periods. The decline in our CD portfolio is partly due to the Consent Orders rate caps for deposit products. Offsetting the declines was growth in noninterest bearing demand deposits and interest bearing demand deposits which increased 10.3% and 4.2%, respectively. We define our core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposit with denominations less than $100,000. Core deposit growth is an important tenet to our business strategy.
Brokered deposits increased $130.9 million from September 30, 2009 to September 30, 2010 with the majority of the increase in the fourth quarter of 2009 and first quarter of 2010. We issued approximately $86 million of brokered certificates of deposit in December 2009. The issuance enhanced our liquidity position. During January 2010, we issued an additional $94.5 million in brokered certificates of deposit. Approximately $77 million of the January 2010 funds were used to eliminate our brokered money market account. In addition to brokered certificates of deposits, we are a member bank of the Certificate of Deposit Account Registry Service® (CDARS®) network. CDARS® is a network of banks that allows customers CDs to receive full FDIC insurance of up to $50 million. Additionally, members have the opportunity to purchase or sell one-way time deposits. As of September 30, 2010, our CDARS® balance consists of $18.4 million in purchased time deposits and $8.8 million in our customers reciprocal accounts.
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Brokered deposits at September 30, 2010, December 31, 2009 and September 30, 2009 were as follows:
BROKERED DEPOSITS
September 30, 2010 |
December 31, 2009 |
September 30, 2009 |
||||||||||
(in thousands) | ||||||||||||
Brokered deposits |
||||||||||||
Brokered certificates of deposits |
$ | 302,584 | $ | 239,283 | $ | 98,932 | ||||||
Brokered money market accounts |
| 76,749 | 75,616 | |||||||||
Brokered NOW accounts |
| 514 | 1,646 | |||||||||
CDARS® |
27,147 | 23,204 | 22,621 | |||||||||
Total |
$ | 329,731 | $ | 339,750 | $ | 198,815 | ||||||
As discussed in Note 3 to our consolidated financial statements, the presence of a capital requirement in our Consent Order restricts our ability to accept, renew or roll over brokered deposits without prior approval of the FDIC. The liquidity enhancement over the last twelve months was in part to ensure we have adequate funding to meet our short-term contractual obligations. We believe that our current liquidity, along with maintaining or increasing core deposits, will provide for our short-term contractual obligations, including maturing brokered deposits. The table below is a maturity schedule for our brokered deposits.
BROKERED DEPOSITS BY MATURITY
Less than 3 months |
Three months to six months |
Six months to twelve months |
One to two years |
Greater than two years |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Brokered certificates of deposit |
$ | | $ | 32,025 | $ | 12,414 | $ | 42,847 | $ | 215,298 | ||||||||||
CDARS® |
14,892 | 5,006 | | 5,781 | 1,468 | |||||||||||||||
Total |
$ | 14,892 | $ | 37,031 | $ | 12,414 | $ | 48,628 | $ | 216,766 | ||||||||||
As of September 30, 2010, December 31, 2009 and September 30, 2009, we had no Federal funds purchased.
Securities sold under agreements to repurchase with commercial checking customers were $7.7 million as of September 30, 2010, compared to $7.9 million and $10.5 million as of December 31, 2009 and September 30, 2009, respectively. In November 2007, we entered into a five-year structured repurchase agreement with another financial institution for $10.0 million, with a stated maturity in November 2012. For the nine months ended September 30, 2010 and 2009, we paid a fixed rate of 3.93% for the structured repurchase agreement. The agreement in callable on a quarterly basis.
As a member of the Federal Home Loan Bank of Cincinnati (FHLB), we have the ability to acquire short and long-term advances through a blanket agreement secured by our unencumbered qualifying 1-4 family first mortgage loans equal to at least 315% of outstanding advances. We also use FSGBanks borrowing capacity at the FHLB to purchase a letter of credit that we pledged to the State of Tennessee Bank Collateral Pool. The letter of credit allows us to release investment securities from the Collateral Pool and thus improve our liquidity ratio. As of September 30, 2010 and December 31, 2009, we had no significant advances from the FHLB. As of September 30, 2009, we had a $7.6 million short-term advance from FHLB.
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Liquidity
Liquidity refers to our ability to adjust future cash flows to meet the needs of our daily operations. We rely primarily on management fees and cash dividends from FSGBank to fund the liquidity needs of our daily operations. Our cash balance on deposit with FSGBank, which totaled approximately $956 thousand as of September 30, 2010, is available for funding activities for which FSGBank would not receive direct benefit, such as acquisition due diligence, stockholder relations and holding company operations. As discussed in Note 3 to our consolidated financial statements, the Written Agreement with the Federal Reserve requires prior written authorization for any payment to First Security that reduces the equity of FSGBank, including management fees. Subsequent to September 30, 2010, we received authorization to pay management fees for the months of September and October 2010.
The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate securities available-for-sale.
As of September 30, 2010, our interest bearing account at the Federal Reserve Bank of Atlanta totaled approximately $223.4 million. This excess liquidity is available to fund our contractual obligations and prudent investment opportunities.
As of September 30, 2010, the unused borrowing capacity (using 1-4 family residential mortgage) for FSGBank at FHLB was $25.6 million. FHLB maintains standards for loan collateral files. Therefore, our borrowing capacity may be restricted if our collateral files have exceptions.
Another source of funding is loan participations sold to other commercial banks (in which we retain the service rights). As of quarter-end, we had $10.2 million in loan participations sold. FSGBank may continue to sell loan participations as a source of liquidity. An additional source of short-term funding would be to pledge investment securities against a line of credit at a commercial bank. As of quarter-end, FSGBank had no borrowings against our investment securities, except for repurchase agreements, treasury tax and loan deposits, and public-fund deposits attained in the ordinary course of business.
Historically, we have utilized brokered deposits to provide an additional source of funding. As of September 30, 2010, we had $302.6 million in brokered certificates of deposit outstanding with a weighted average remaining life of approximately 31 months, a weighted average coupon rate of 2.60% and a weighted average all-in cost (which includes fees paid to deposit brokers) of 2.85%. Our CDARS® product had $27.1 million at September 30, 2010, with a weighted average coupon rate of 2.15% and a weighted average life of approximately 6 months. Our certificates of deposit greater than $100 thousand were generated in FSGBanks communities and are considered relatively stable. As discussed in Note 3 to our consolidated financial statements, the presence of a capital requirement in our Consent Order restricts our ability to accept, renew or roll over brokered deposits without prior approval of the FDIC.
We believe that our liquidity sources are adequate to meet our current operating needs. We continue to study our contingency funding plans and update them as needed paying particular attention to the sensitivity of our liquidity and deposit base to positive and negative changes in our asset quality.
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We also have contractual cash obligations and commitments, which include certificates of deposit, other borrowings, operating leases and loan commitments. Unfunded loan commitments and standby letters of credit totaled $142.6 million and $14.6 million, respectively, at September 30, 2010. The following table illustrates our significant contractual obligations at September 30, 2010 by future payment period.
CONTRACTUAL OBLIGATIONS
Less than One Year |
One to Three Years |
Three to Five Years |
More than Five Years |
Total | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Certificates of deposit |
(1 | ) | $ | 302,886 | $ | 72,888 | $ | 4,503 | $ | | $ | 380,277 | ||||||||||||
Brokered certificates of deposit |
(1 | ) | 44,439 | 146,137 | 105,241 | 6,767 | 302,584 | |||||||||||||||||
CDARS® |
(1 | ) | 19,898 | 6,792 | 457 | | 27,147 | |||||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase |
(2 | ) | 7,676 | 10,000 | | | 17,676 | |||||||||||||||||
FHLB borrowings |
(3 | ) | | 3 | | | 3 | |||||||||||||||||
Operating lease obligations |
(4 | ) | 904 | 1,207 | 927 | 4,595 | 7,633 | |||||||||||||||||
Commitments to fund affordable housing investments |
(5 | ) | 1,340 | | | | 1,340 | |||||||||||||||||
Note payable |
(6 | ) | 16 | 35 | 27 | | 78 | |||||||||||||||||
Total |
$ | 377,159 | $ | 237,062 | $ | 111,155 | $ | 11,362 | $ | 736,738 | ||||||||||||||
1 | Certificates of deposit give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. For more information regarding certificates of deposit, see Deposits and Other Borrowings. |
2 | We expect securities repurchase agreements to be re-issued and, as such, do not necessarily represent an immediate need for cash. |
3 | For more information regarding FHLB borrowings, see Deposits and Other Borrowings. |
4 | Operating lease obligations include existing and future property and equipment non-cancelable lease commitments. |
5 | We have commitments to certain investments in affordable housing and historic building rehabilitation projects within our market area. The investments entitle us to receive historic tax credits and low-income housing tax credits. |
6 | This note payable is a mortgage on the land of our branch facility located at 2905 Maynardville Highway, Maynardville, Tennessee. |
Net cash from operations declined by $13.8 million comparing the nine months ended September 30, 2010 to the same period in 2009. The decline is primarily related to less net earnings after adjusting for the significant non-cash items, including the deferred tax valuation allowance, the provision expense and the goodwill impairment. Net cash from investing activities increased from $21.2 million for the nine months ended September 30, 2009 to $57.9 million for the same period in 2010. The decline in loans is the primary reason for the increased cash from investment activities. Net cash used in financing activities increased $29.0 million from $41.7 million to $70.7 million comparing the nine months ended September 30, 2009 to the same period in 2010. The preferred stock issuance of $33.0 million in 2009 is the primary difference between the two periods.
Derivative Financial Instruments
Derivatives are used as a risk management tool and to facilitate client transactions. We utilize derivatives to hedge the exposure to changes in interest rates or other identified market risks. Derivatives may also be used in a dealer capacity to facilitate client transactions by creating by customized loan products for our larger customers. These products allow us to meet the needs of our customers, while minimizing our interest rate risk. We currently have not entered into any transactions in a dealer capacity.
The Asset/Liability Committee of the Board of Directors (ALCO) provides oversight by ensuring that policies and procedures are in place to monitor our significant derivative positions. We believe the use of derivatives will reduce our interest rate risk and potential earnings volatility caused by changes in interest rates.
Our derivatives are based on underlying risks, primarily interest rates. Historically, we have utilized cash flow swaps to reduce the risks associated with interest rates. On August 28, 2007 and March 26, 2009,
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we elected to terminate a series of interest rate swaps with a total notional value of $150 million and $50 million, respectively. At termination, the swaps had a market value of $2.0 million and $5.8 million, respectively. These gains are being accreted into interest income over the remaining life of the originally hedged items. We recognized a total of $1.5 million in interest income for the nine months ended September 30, 2010.
The following table presents the accretion of the remaining gain for the terminated swaps.
20101 | 2011 | 2012 | Total | |||||||||||||
(in thousands) | ||||||||||||||||
Accretion of gain from 2007 terminated swaps |
$ | 80 | $ | 219 | $ | 62 | $ | 361 | ||||||||
Accretion of gain from 2009 terminated swaps |
$ | 410 | $ | 1,628 | $ | 1,272 | $ | 3,310 |
1 | Represents the gain accretion for October 1, 2010 to December 31, 2010. Excludes the amounts recognized in the first nine months of 2010. |
We also use forward contracts to hedge against changes in interest rates on our held for sale loan portfolio. Our practice is to enter into a best efforts contract with the investor simultaneous to providing an interest rate lock to a customer. The use of the fair value option on the closed held for sale loans and the forward contracts minimize the volatility in earnings from changes in interest rates.
The following table presents the cash flow hedges as of September 30, 2010.
Notional Amount |
Gross Unrealized Gains |
Gross Unrealized Losses |
Accumulated Other Comprehensive Income |
Maturity Date | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Asset hedges |
||||||||||||||||||||
Cash flow hedges: |
||||||||||||||||||||
Forward contracts |
$ | 3,386 | $ | 38 | $ | 3 | $ | 23 | Various | |||||||||||
$ | 3,386 | $ | 38 | $ | 3 | $ | 23 | |||||||||||||
Terminated asset hedges |
||||||||||||||||||||
Cash flow hedges: 1 |
||||||||||||||||||||
Interest rate swap |
$ | 25,000 | $ | | $ | | $ | 53 | June 28, 2011 | |||||||||||
Interest rate swap |
20,000 | | | 40 | June 28, 2011 | |||||||||||||||
Interest rate swap |
35,000 | | | 145 | June 28, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 1,092 | October 15, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 1,092 | October 15, 2012 | |||||||||||||||
$ | 130,000 | $ | | $ | | $ | 2,422 | |||||||||||||
1 | The $2.4 million of gains, net of taxes, recorded in accumulated other comprehensive income as of September 30, 2010, will be reclassified into earnings as interest income over the remaining life of the respective hedged items. |
The following table presents additional information on the active derivative positions as of September 30, 2010.
Consolidated Balance Sheet Presentation | Consolidated Income Statement Presentation | |||||||||||||||||||||||||||
Assets | Liabilities | Gains | ||||||||||||||||||||||||||
Notional | Classification | Amount | Classification | Amount | Classification | Amount Recognized | ||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||
Hedging Instrument: |
||||||||||||||||||||||||||||
Forward contracts |
$ | 3,386 | Other assets | $ | 35 | Other liabilities | N/A | |
Noninterest income other |
|
$ | (35 | ) | |||||||||||||||
Hedged Items: |
||||||||||||||||||||||||||||
Loans held for sale |
N/A | |
Loans held for sale |
|
$ | 3,386 | N/A | N/A | |
Noninterest income other |
|
N/A |
Derivatives expose us to credit risk from the counterparty when the derivatives are in an unrealized gain position. All counterparties must be approved by the board of directors and are monitored by ALCO on an ongoing basis. We minimize the credit risk exposure by requiring collateral when certain conditions are met. When the derivatives are at an unrealized loss position, our counterparty may require us to pledge collateral.
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Off-Balance Sheet Arrangements
We are party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making commitments as we do for on-balance sheet instruments.
The following table discloses our maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at September 30, 2010 and 2009.
As of September 30, | ||||||||
2010 | 2009 | |||||||
(in thousands) | ||||||||
Commitments to extend credit |
$ | 142,588 | $ | 236,692 | ||||
Standby letters of credit |
$ | 14,625 | $ | 15,972 |
Commitments to extend credit are agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customers credit worthiness on a case-by-case basis. The amount of collateral, if any, we obtain on an extension of credit is based on our credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.
Capital Resources
Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Comptroller of the Currency and the Federal Reserve, the primary federal regulators for FSGBank and First Security, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. The Consent Order, as described in Note 3 to our consolidated financial statements, requires FSGBank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Order provided 120 days from the effective date of April 28, 2010 to achieve these ratios. As shown below, FSGBank was not in compliance with the capital requirements. We anticipate both ratios increasing over time as brokered deposits mature and are funded by available cash.
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The following table compares the required capital ratios maintained by First Security and FSGBank:
CAPITAL RATIOS
September 30, 2010 |
FSGBank Consent Order1 |
Well Capitalized |
Adequately Capitalized |
First Security |
FSGBank | |||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 11.92 | % | 11.65 | %3 | |||||||||||
Total capital to risk adjusted assets |
13.0 | % | 10.0 | % | 8.0 | % | 13.19 | % | 12.93 | %3 | ||||||||||
Leverage ratio |
9.0 | % | 5.0 | %2 | 4.0 | % | 7.62 | % | 7.43 | %3 | ||||||||||
December 31, 2009 |
||||||||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 12.7 | % | 11.6 | % | |||||||||||
Total capital to risk adjusted assets |
n/a | 10.0 | % | 8.0 | % | 14.0 | % | 12.8 | % | |||||||||||
Leverage ratio |
n/a | 5.0 | %2 | 4.0 | % | 10.6 | % | 9.6 | % | |||||||||||
September 30, 2009 |
||||||||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 13.0 | % | 9.4 | % | |||||||||||
Total capital to risk adjusted assets |
n/a | 10.0 | % | 8.0 | % | 14.3 | % | 10.7 | % | |||||||||||
Leverage ratio |
n/a | 5.0 | %2 | 4.0 | % | 11.1 | % | 8.0 | % |
1 | FSGBank must achieve and maintain the above capital ratios within 120 days from April 28, 2010. |
2 | The Federal Reserve Board definition of well capitalized for bank holding companies does not include a leverage ratio component; accordingly, the leverage ratio requirement for well capitalized status only applies to FSGBank. |
3 | Due to the capital requirement within FSGBanks Consent Order, FSGBank is considered to be adequately capitalized. |
During 2010, to further preserve our capital resources, our Board of Directors elected to suspend our common stock dividend and defer the dividend on the Series A Preferred Stock for the first, second and third quarters of 2010. As described in Note 3 to our consolidated financial statements, the Written Agreement between First Security and the Federal Reserve prohibits declaring or paying dividends without prior written consent. Under applicable banking regulations, we do not anticipate declaring or paying a dividend until we return to sustained profitability.
EFFECTS OF GOVERNMENTAL POLICIES
We are affected by the policies of regulatory authorities, including the Federal Reserve Board and the OCC. An important function of the Federal Reserve Board is to regulate the national money supply.
Among the instruments of monetary policy used by the Federal Reserve Board are: purchases and sales of U.S. Government securities in the marketplace; changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve Board; and changes in the reserve requirements of depository institutions. These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation.
The monetary policies of the Federal Reserve Board and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the national and international economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels or loan demand or whether the changing economic conditions will have a positive or negative effect on operations and earnings.
Legislation from time to time is introduced in the United States Congress and the Tennessee General Assembly and other state legislatures, and regulations are proposed by the regulatory agencies that could affect our business. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which our business may be affected thereby.
The Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) which, among other things, alters the oversight and supervision of financial institutions by federal and state regulators, introduces minimum capital requirements, creates a new federal agency to supervise consumer
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financial products and services, and implements changes to corporate governance and compensation practices. Although the Act is particularly focused on large bank holding companies with consolidated assets of $50 billion or more, it does contain a number of provisions that may affect us, including:
| Minimum Leverage and Risk-Based Capital Requirements. Under the Act, the appropriate Federal banking agencies are required to establish minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and bank holding companies, which can be no less than the currently applicable leverage and risk-based capital requirements for depository institutions. |
| Deposit Insurance Modifications. The Act modifies the FDICs assessment base upon which deposit insurance premiums are calculated. The new assessment base will equal our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The Act also makes permanent the increase in maximum federal deposit insurance limits from $100,000 to $250,000. |
| Creation of New Consumer Protection Bureau. The Act creates a new Bureau of Consumer Financial Protection within the Federal Reserve with broad powers to supervise and enforce consumer protection laws. The Bureau of Consumer Financial Protection will have broad rule-making authority for a wide range of consumer protection laws that apply to all insured depository institutions. The Bureau of Consumer Financial Protection has examination and enforcement authority over all depository institutions with more than $10 billion in assets. Depository institutions with $10 billion or less in assets, such as FSGBank, will be examined by their applicable bank regulators. |
| Executive Compensation and Corporate Governance Requirements. The Act includes provisions that may impact our corporate governance, including a grant of authority to the SEC to issue rules that allow shareholders to nominate directors by using the companys proxy solicitation materials. The Act further requires the SEC to adopt rules that prohibit the listing of any equity security of a company that does not have an independent compensation committee and require all exchange-traded companies to adopt clawback policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements. |
Many provisions of the Act will require our regulators to adopt additional rules in order to implement the mandates included in the Act. In addition, the Act requires multiple studies which could result in additional legislative action. Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2010, the FASB issued Accounting Standards Update 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). ASU 2010-20 requires disclosures regarding loans and the allowance for loan losses that are disaggregated by portfolio segment and class of financing receivable. Existing disclosures were amended to require a rollforward of the allowance for loan losses by portfolio segment, with the ending balance broken out by basis of impairment method, as well as the recorded investment in the respective loans. Nonaccrual and impaired loans by class must also be shown. ASU 2010-20 also requires disclosures regarding: (1) credit quality indicators by class, (2) aging of past due loans by class, (3) troubled debt restructurings (TDRs) by class and their effect on the allowance for loan losses, (4) defaults on TDRs by class and their effect on the allowance for loan losses, and (5) significant purchases and sales of loans disaggregated by portfolio segment. This guidance is effective for interim and annual reporting periods ending on or after December 15, 2010, for end of period type disclosures. Activity related disclosures are effective for interim and annual reporting periods beginning on or after December 15, 2010. ASU 2010-20 will have an impact on our disclosures, but not our financial position or results of operations.
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ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk, with respect to us, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. We do not deal in international instruments, and therefore are not exposed to risk inherent to foreign currency.
Our interest rate risk management is the responsibility of the Asset/Liability Committee (ALCO). ALCO has established policies and limits to monitor, measure and coordinate our sources, uses and pricing of funds.
Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with our interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both static gap and income simulation reports to quantify the estimated exposure of net interest income to a sustained change in interest rates.
Our income simulation analysis projected net interest income based on both a rise and fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month period. Given this scenario, we had, as of September 30, 2010, an exposure to falling rates and a benefit from rising rates. More specifically, our model forecasts a decline in net interest income of $6.9 million, or 19.4%, as a result of a 200 basis point decline in rates based on annualizing our financial results through September 30, 2010. The model also predicts a $7.4 million increase in net interest income, or 20.7%, as a result of a 200 basis point increase in rates. The forecasted results of the model are within the limits specified by ALCO. The following chart reflects our sensitivity to changes in interest rates as of September 30, 2010. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvested in like instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.
INTEREST RATE RISK
INCOME SENSITIVITY SUMMARY
AS OF SEPTEMBER 30, 2010
Down 200 BP | Current | Up 200 BP | ||||||||||
(in thousands, except percentages) | ||||||||||||
Annualized net interest income1 |
$ | 28,787 | $ | 35,695 | $ | 43,075 | ||||||
Dollar change net interest income |
(6,908 | ) | | 7,380 | ||||||||
Percentage change net interest income |
(19.35 | )% | 0.00 | % | 20.68 | % |
1 | Annualized net interest income is a twelve month projection based on year-to-date results. |
The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that we might take in responding to or anticipating changes in interest rates.
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We use the Sendero Vision Asset/Liability system, which is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration and income simulations using a wide range of scenarios including interest rate shocks and rate ramps. The system also models derivative instruments.
ITEM 4. | CONTROLS AND PROCEDURES |
As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have evaluated the effectiveness of our disclosure controls and procedures (Disclosure Controls). Disclosure Controls, as defined in Rule 13a-15(e) of the Exchange Act, are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief executive officer (CEO) and chief financial officer (CFO) (hereinafter in Item 4 management, including the CEO and CFO, are referred to collectively as management), as appropriate to allow timely decisions regarding required disclosure.
Our management does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective.
As previously disclosed in First Securitys Current Report on Form 8-K, filed with the Securities and Exchange Commission (SEC) on October 29, 2010, subsequent to filing the June 30, 2010 Quarterly Report on Form 10-Q and a change in personnel responsible for First Securitys other real estate owned, First Security determined that certain write-downs associated with other real estate owned were not recorded in the appropriate accounting periods. Upon completion of First Securitys internal review, the primary regulator of First Securitys wholly-owned subsidiary bank verified the findings as part of its ongoing annual safety and soundness examination. First Security has been requested to file amended Call Reports with the FDIC and amended FR Y-9C and FR Y-9LP reports with the Federal Reserve, for December 31, 2009, March 31, 2010 and June 30, 2010 to reflect the findings.
In connection with these regulatory restatements, First Securitys Audit/Corporate Governance Committee determined that the impacted SEC filings should not be relied upon. Accordingly, First Security is amending the December 31, 2009 Form 10-K, the March 31, 2010 Form 10-Q and the June 30, 2010 Form 10-Q. The Audit/Corporate Governance Committee also determined that a material weakness existed in the Companys internal control over financial reporting during the relevant periods. First Security identified certain control deficiencies in its administration of other real estate owned, including the timely identification of charge-offs and write-downs. These control deficiencies were related to the lack of separation of duties and violations of First Security policy.
In response to these control deficiencies, First Security has implemented certain changes to its internal control over financial reporting which include: broadened segregation of duties; intensified management oversight and analysis of other real estate owned accounts; and expanded documentation and approval procedures for other real estate owned appraisals. In addition, management has instituted a program to require periodic testing of these changes. First Security believes that these measures will appropriately address the material weakness related to the issues described above.
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First Security made no other changes in its internal controls or in other factors that has materially affected, or is reasonably likely to materially affect these controls subsequent to the date of the evaluation of the controls by the Chief Executive and Chief Financial Officers.
PART II. OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
In the normal course of business, we are at times subject to pending and threatened legal actions. Although we are not able to predict the outcome of such actions, after reviewing pending and threatened actions with counsel, we believe that the outcome of any or all such actions will not have a material adverse effect on our business, financial condition and/or operating results.
ITEM 1A. | RISK FACTORS |
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009 and in Part II, item 1A. Risk Factors in our Quarterly Reports on Form 10-Q for the periods ended March 31, 2010 and June 30, 2010, which could materially affect our business, financial condition or future results. The risks described in our prior filings are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
The following risks supplement the risk factors previously identified in our prior filings. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
We are not currently in compliance with the capital requirements contained in our Order and may need to raise capital to comply, but that capital may not be available when it is needed or it could be dilutive to our existing stockholders, which could adversely affect our financial condition and our results of operations.
The Order required the Bank to, within 120 days of the effective date of the Order, achieve and thereafter maintain total capital at least equal to 13 percent of risk-weighted assets and Tier 1 capital at least equal to 9 percent of adjusted total assets. As of September 30, 2010, the Banks total risk-based capital ratio was approximately 12.93 percent and its leverage ratio was approximately 7.43 percent. The Company is considering a variety of strategic alternatives intended to achieve and maintain the prescribed capital ratios.
Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. If we need to raise additional capital, there is no guarantee that we will be able to borrow funds or successfully raise capital at all or on terms that are favorable or otherwise not dilutive to existing stockholders. If we cannot raise additional capital when needed, our ability to operate or expand our business could be materially impaired.
The failure to satisfy the capital requirements of the Order could result in further enforcement actions by the OCC. In addition, the OCC may require that the Bank develop a plan to sell, merge or liquidate the Bank. While the Company intends to take such actions as may be necessary to enable the Bank to comply with the requirements of the Order, there can be no assurance that the Bank will be able to comply fully with the provisions of the Order, or that efforts to comply with the Order will not have adverse effects on the operations and financial condition of the Company and the Bank.
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We are subject to an Agreement that could have a material negative effect on our business, operating flexibility, financial condition and the value of our common stock.
On September 7, 2010, First Security entered into a Written Agreement with the Federal Reserve Bank of Atlanta. The Agreement is designed to enhance the Companys ability to act as a source of strength to the Bank. Pursuant to the Agreement, the Company will be prohibited from declaring or paying dividends without prior written consent from the Federal Reserve. In addition, pursuant to the Agreement, without the prior written consent of regulators, the Company is prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank; incurring, increasing or guaranteeing any debt; redeeming any shares of the Companys common stock. The Company will also provide quarterly written progress reports to the Federal Reserve. Within 60 days of the Agreement, the Company will submit to the Federal Reserve a written plan designed to maintain sufficient capital at the Company, on a consolidated basis, and at the Bank.
Any material failure to comply with the provisions of the Agreement could result in further enforcement actions by the Federal Reserve. While the Company intends to take such actions as may be necessary to comply with the requirements of the Agreement, there can be no assurance that the Company will be able to comply fully with the provisions of the Agreement, or that efforts to comply with the Agreements, particularly the limitations on dividend payments, will not have adverse effects on the operations and financial condition of the Company and the value of our common stock.
ITEM 3. | Defaults Upon Senior Securities |
As previously disclosed, First Security has decided to defer quarterly cash dividend payments on its Series A Preferred Stock. Cash dividends on the Series A Preferred Stock are cumulative and accrue and compound on each subsequent payment date. At September 30, 2010, First Security had unpaid preferred stock dividends in arrears of $1.4 million. If First Security misses six quarterly dividend payments on the Series A Preferred Stock, whether or not consecutive, the Treasury will have the right to appoint two directors to First Securitys board of directors until all accrued but unpaid dividends have been paid. First Security has deferred the February, May and August 2010 dividend payments as of September 30, 2010.
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ITEM 6. | EXHIBITS |
Exhibits:
EXHIBIT |
DESCRIPTION | |
10.1 | Written Agreement between First Security Group, Inc. and the Federal Reserve Bank of Atlanta, dated September 7, 20101 | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 |
1 | Incorporated by reference to the Exhibit 10.1 to the Current Report on Form 8-K filed on September 14, 2010. |
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Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST SECURITY GROUP, INC. | ||
(Registrant) | ||
November 9, 2010 | /S/ RODGER B. HOLLEY | |
Rodger B. Holley | ||
Chairman & Chief Executive Officer | ||
November 9, 2010 | /S/ WILLIAM L. LUSK, JR. | |
William L. Lusk, Jr. | ||
Secretary, Chief Financial Officer & Executive Vice President |
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