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EX-23.1 - EXHIBIT 23.1 - Southeastern Bank Financial CORPc13195exv23w1.htm
EX-31.2 - EXHIBIT 31.2 - Southeastern Bank Financial CORPc13195exv31w2.htm
EX-31.1 - EXHIBIT 31.1 - Southeastern Bank Financial CORPc13195exv31w1.htm
EX-32.1 - EXHIBIT 32.1 - Southeastern Bank Financial CORPc13195exv32w1.htm
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 0-24172
SOUTHEASTERN BANK FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
     
GEORGIA   58-2005097
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
3530 Wheeler Road    
Augusta, Georgia   30909
(Address of principal executive offices)   (Zip Code)
(706) 738-6990
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $3.00 par value per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller Reporting Company þ
        (do not check if smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of June 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $34,099,725 based on the closing sale price of $11.00 per share as reported on the Over the Counter Bulletin Board.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class   Outstanding at February 17, 2011
Common Stock, $3 par value per share   6,675,851 shares
DOCUMENTS INCORPORATED BY REFERENCE
     
Document   Parts Into Which Incorporated
 
 
Proxy Statement for the Annual Meeting of Shareholders to be held
  Part III
April 27, 2011
   
 
 

 

 


 

Introductory Note: Although the Company is classified as a “smaller reporting company” as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended, it has elected to file a report and attestation as to its internal controls over financial reporting in addition to management’s report on internal controls in this Annual Report on Form 10-K.
Item 1.  
Description of Business
General
Southeastern Bank Financial Corporation (the “Company”) is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company had total consolidated assets of $1,607,105, total deposits of $1,410,737 and total stockholders’ equity of $99,958 at December 31, 2010. The Company has two wholly-owned subsidiaries that primarily do business in the Augusta-Richmond County, GA-SC metropolitan area-Georgia Bank & Trust Company of Augusta (“GB&T”) and Southern Bank & Trust (“SB&T”), a South Carolina State Bank (collectively, the “Banks”). The Company’s operations campus is located in Martinez, Georgia and services both subsidiaries.
GB&T, a Georgia state bank, operates its main office and eight full service branches in Augusta, Martinez, and Evans, Georgia, with mortgage origination offices located in Augusta and Savannah Georgia. During the third quarter of 2010, the Company made the decision to exit the Athens, Georgia market, and GB&T closed its Athens branch on November 30, 2010. No material exit costs were incurred as a result of the decision. SB&T, originally a federally chartered thrift, operates three full service branches in North Augusta and Aiken, South Carolina. During the third quarter of 2010, SB&T filed an application with the South Carolina State Board of Financial Institutions (the “SCSBFI”) to convert from a thrift charter to a commercial bank charter under the laws of the State of South Carolina (the “Charter Conversion”). It also filed notifications with the Office of Thrift Supervision, the Federal Deposit Insurance Corporation (the “FDIC”), the Georgia Department of Banking and Finance and with the Federal Reserve Bank of Atlanta. The Charter Conversion was approved by the appropriate regulatory agencies and became effective October 1, 2010.
The Company is community oriented and focuses primarily on offering real estate, commercial and consumer loans and various deposit and other services to individuals, small to medium sized businesses and professionals in its market area. The Company is the largest locally owned and operated financial institution headquartered in Richmond and Columbia Counties. Each member of the Company’s management team is a banking professional with many years of experience in the Augusta or Aiken market with this and other banking organizations. A large percentage of Company management has worked together for many years. The Company competes against the larger regional and super-regional banks operating in its market by emphasizing the stability and accessibility of its management, management’s long-term familiarity with the market, immediate local decision making and the pride of local ownership.
The Company’s internet address is www.georgiabankandtrust.com. It makes available free of charge through its website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission (“SEC”).

 

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The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The Internet address of the SEC website is www.sec.gov.
History
GB&T was organized by a group of local citizens from Richmond and Columbia Counties and commenced business from the main office location at 3530 Wheeler Road in Augusta on August 28, 1989. In December 1992 GB&T acquired FCS Financial Corporation (“FCS”) and First Columbia Bank (“First Columbia”). GB&T also operates eight full service branches in Augusta, Martinez and Evans, Georgia and a loan production office in Savannah, Georgia. SB&T was organized by the Company during 2005 and 2006, opening its main office in Aiken, South Carolina on September 12, 2006. SB&T opened its first North Augusta branch at 336 Georgia Avenue in August 2007 and opened its second Aiken branch at 149 Laurens Street on January 10, 2008.
Employees
The Company had approximately 349 full-time equivalent employees at December 31, 2010. The Company maintains training, educational and affirmative action programs designed to prepare employees for positions of increasing responsibility in both management and operations, and provides a variety of benefit programs, including group life, health, accident and other insurance and retirement plans. None of the Company’s employees are covered by a collective bargaining agreement, and the Company believes its employee relations are generally good.
Management Team
GB&T was founded with an experienced management team, and that team has continued to expand with the growth of the bank. GB&T’s President and Chief Executive Officer, R. Daniel Blanton, was involved in the organization of GB&T beginning in 1988 and previously served with a predecessor to Wells Fargo Bank, N.A. (“Wells Fargo”), Georgia State Bank, for over 13 years. With the acquisition of FCS and First Columbia, GB&T obtained its Executive Vice President and Chief Operating Officer, Ronald L. Thigpen, who had served as Chief Executive Officer of FCS and First Columbia since 1991, and before that served in various capacities with Wells Fargo and its predecessors. GB&T’s senior loan officer and Group Vice President, Jay Forrester, has been associated with GB&T since 1995. He previously served as Vice President, Commercial Lending for C & S National Bank and NationsBank, predecessors of Bank of America. Regina W. Mobley, Group Vice President, Bank Operations, has been with GB&T since the acquisition of First Columbia Bank. With over 33 years of bank operations experience, she previously served First Columbia Bank and C & S National Bank, as predecessor of Bank of America. GB&T’s Senior Credit Officer and Group Vice President, James R. Riordan, Jr., joined the team in 2002. For the prior ten years, he served in various capacities with SunTrust Bank, Augusta, N. A., most recently as senior lending officer. He has 24 years of bank lending and credit administration experience. Paula Tankersley, Group Vice President, Retail Banking, has been associated with GB&T since 1992. Prior to joining GB&T, she was associated with the Bank of Columbia County and its successor, Allied Bank of Georgia. In September 2004, Robert C. Osborne, Jr., joined GB&T as Executive Vice President and head of Wealth Management. For the prior 28 years, he was associated with Wachovia Corporation in Atlanta and Augusta, most recently as head of their Wealth Management unit in Augusta.

 

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The Company opened SB&T with a management team that has extensive experience in the Aiken, South Carolina market. In 2005, both Frank Townsend and Darrell Rains joined GB&T with the responsibility of organizing SB&T. Frank Townsend became President and Chief Executive Officer of SB&T upon its opening in September 2006. Prior to joining GB&T, Mr. Townsend spent 11 years with Regions Bank and was the Commercial Sales Manager in Aiken. He has 25 years experience in both banking and insurance. Darrell Rains, Group Vice President and Chief Financial Officer, has over 29 years of financial experience, including service at Regions Bank as Regional Financial Officer for the Mid-Atlantic Region and at Palmetto Federal, a predecessor to Regions Bank in Aiken, S.C., as Chief Financial Officer. He serves as Chief Financial Officer for the Company, GB&T and SB&T. Mark Wills, Executive Vice President and Senior Credit Officer, first joined GB&T in 2005 and was one of the original employees of SB&T upon its opening in 2006. With over 29 years of banking experience, he previously served Bank of America and Regions Bank. In September 2007, Susan Yarborough joined SB&T as Executive Vice President and Business Development Officer. Prior to joining SB&T, she spent 13 years with Carolina First Bank in Aiken as Senior Vice President and City Executive and served in various capacities with Bank of America and its predecessors for 15 years.
Market Area
The Company’s primary market area includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA). The 2009 population of the Augusta-Richmond County, GA-SC MSA was 539,154, the second largest in Georgia and fourth largest in South Carolina. The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast. Significant medical facilities include the Medical College of Georgia, University Hospital, Veteran’s Administration Hospital, Dwight D. Eisenhower Hospital, Gracewood State School and Hospital, Doctors’ Hospital and Trinity Hospital. Other major employers in the Augusta market area include U.S. Department of Energy Savannah River Site, the Fort Gordon military installation, E-Z Go/Textron (golf car manufacturer), the Richmond County school system and the Columbia County school system. Major employers in the Aiken market include Savannah River Site, Aiken County Board of Education, Bechtel Savannah River Company (engineering construction firm), Wal-Mart Associates Inc., Kimberly Clark Corporation, and BFS North American Tire, LLC. The area is served by Interstate 20, which connects it to Atlanta, 140 miles to the west and Columbia, South Carolina, 70 miles to the east. Augusta is also served by a major commercial airport (Bush Field) and a commuter airport (Daniel Field). The average unemployment rate for the Augusta-Richmond County MSA was 9.2% in 2009. Between June 2009 and June 2010 (the latest date for which FDIC information is available), total commercial bank and thrift deposits in the Augusta-Richmond County, GA-SC MSA increased 2.53% from $7,056,431 to $7,235,246. Based on data reported as of June 30, 2010, the Company has 18.62% of all deposits in the Augusta-Richmond County, GA-SC MSA and is the second largest depository institution. The demographic information as presented above is based upon information and estimates provided by the U.S. Census Bureau, U.S. Department of Labor, the FDIC, Augusta Metro Chamber of Commerce, and the South Carolina Employment Security Commission.
Competition
The banking business generally is highly competitive, and sources of competition are varied. The Company competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions, mortgage banking companies, consumer finance companies, securities brokerages, insurance companies, and money market mutual funds operating in Richmond and Columbia Counties in Georgia, Aiken County in South Carolina and elsewhere. In addition, customers conduct banking activities without regard to geographic barriers through computer-based banking and similar services.

 

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Many of the financial organizations in competition with the Company have much greater financial resources, more diversified markets and larger branch networks than the Company and are able to offer similar services at varying costs with higher lending limits. In addition, with the enactment of federal and state laws affecting interstate and bank holding company expansion, there have been major interstate acquisitions involving financial institutions which have offices in the Company’s market area but are headquartered in other states. The effect of such acquisitions (and the possible increase in size of the financial institutions in the Company’s market areas) may further increase the competition faced by the Company. The Company believes, however, that it will be able to use its local independent image to its advantage in competing for retail and commercial business.
Lending Activities
Through its bank subsidiaries, the Company offers a wide range of lending services, including real estate, commercial and consumer loans, to individuals, small to medium-sized businesses and professionals that are located in, or conduct a substantial portion of their business in, the Company’s market area. The Company’s total loans at December 31, 2010, were $874,095, or 58.69% of total interest-earning assets. An analysis of the composition of the Company’s loan portfolio is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Composition of the Loan Portfolio.”
Real Estate Loans. Loans secured by real estate are the primary component of the Company’s loan portfolio, constituting $667,550, or 76.37% of the Company’s total loans, at December 31, 2010. These loans consist of commercial real estate loans, construction and development loans, residential real estate loans, and home equity loans.
Commercial Real Estate Loans. At December 31, 2010, the Company held $327,458 of commercial real estate loans of various sizes secured by office buildings, retail establishments, and other types of property. These commercial real estate loans represented 37.46% of the Company’s total loans at December 31, 2010. Loan terms are generally limited to five years and often do not exceed three years, although the installment payments may be structured on a 20-year amortization basis with a balloon payment at maturity. Interest rates may be fixed or adjustable. The Company generally charges an origination fee. Management attempts to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. In addition, the Company requires personal guarantees from the principal owners of the property supported with an analysis by the Company of the guarantors’ personal financial statements in connection with a substantial majority of such loans. The Company experienced $1,035 in net charge-offs on commercial real estate loans during 2010. A number of the loans classified as commercial real estate loans are, in fact, commercial loans for which a security interest in real estate has been taken as additional collateral. These loans are subject to underwriting as commercial loans as described below.

 

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Acquisition Development and Construction Loans (“ADC loans”). ADC real estate loans comprise $182,412, or 20.87% of the Company’s total loans at December 31, 2010. A construction and development loan portfolio presents special problems and risks, requiring additional administration and monitoring. This is necessary since most loans are originated as lines of credit and draws under the line require specific activities which add value to the asset, such as progress on the completion of a building or the placement of utilities and roads in a development. This requires specialized knowledge on the part of our personnel to appraise and evaluate that progress, hence the higher level of administration and monitoring. The level of construction and development loans are representative of the character of the Company’s market. The Company subjects this type of loan to underwriting criteria that include: certified appraisal and valuation of collateral; loan-to-value margins (typically not exceeding 75%); cash equity requirements; evaluations of borrowers’ cash flows and alternative sources of repayment; and a determination that the market is able to absorb the project on schedule.
To further reduce the risk related to construction and development loans, the Company generally relies upon the long-standing relationships between its loan officers and the developer/contractor borrowers. In most cases, these relationships exceed ten years. The Company targets seasoned developers and contractors who have experience in the local market. Various members of the Company’s Board of Directors have close contacts with the construction industry: Robert W. Pollard, Jr. owns and operates a lumber manufacturing company; E. G. Meybohm owns the largest local real estate brokerage firm; William J. Badger owns and operates a building supply company; Larry S. Prather owns a utility and grading company; and Patrick D. Cunning, an experienced real estate developer. Through these connections to the industry, the Company attempts to monitor current economic conditions in the marketplace for residential real estate, and the financial standing and ongoing reputation of its construction and development borrowers.
Infrastructure development loans are generally made with an initial maturity of one year, although the Company may renew the loan for up to two additional one-year terms to allow the developer to complete the sale of the lots comprising the property before requiring the payment of the related loan. These loans typically bear interest at a floating rate and the Company typically charges an origination fee. These loans are repaid, interest only, on a monthly or quarterly basis until sales of lots begin, and then principal payments are made as each lot is sold at a rate allowing the Company to be repaid in full by the time 75% of the lots have been sold. In order to reduce the credit risk associated with these loans, the Company requires the project’s loan to value ratio (on an as completed basis) to be not more than 75%. The Company experienced $8,113 in net loan charge-offs on construction and development loans during 2010.
Residential construction loans are typically made for homes with a completed value in the range of $100 to $500 thousand. Loans are typically made for a term of six months to twelve months. Typically, these loans bear interest at a floating rate and the Company collects an origination fee. The Company may renew these loans for an additional term (up to 24 months total) to allow the contractor time to market the home. In order to reduce the credit risk with respect to these loans, the Company restricts the number and dollar amount of loans that are made for homes being built on a speculative basis and carefully manages its aggregate lending relationship with each borrower. The Company experienced $1,811 in net loan charge-offs on residential construction loans during 2010.

 

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Interest reserves are established for certain ADC (acquisition, development and construction) loans based on the feasibility of the project, the timeframe for completion, the creditworthiness of the borrower and guarantors, and collateral. An interest reserve allows the borrower’s interest cost to be capitalized and added to the loan balance. As a matter of practice the Banks do not generally establish loan funded interest reserves on ADC loans; however, the Company’s loan portfolio includes six loans with interest reserves at December 31, 2010. The following table details the loans and accompanying interest reserves as of December 31, 2010 and 2009.
                                 
    December 31, 2010  
            Reserves  
    Balance     Original     Advanced     Remaining  
    (Dollars in thousands)  
 
                               
Loan 1
  $ 4,166       179       179        
Loan 2
    10,135       300       300        
Loan 3
    2,234       255       255        
Loan 4
    452       30       30        
Loan 5
    162       10       10        
Loan 6
    1,114       81       81        
                                 
    December 31, 2009  
            Reserves  
    Balance     Original     Advanced     Remaining  
    (Dollars in thousands)  
 
                               
Loan 1
  $ 4,278       179       179        
Loan 2
    9,666       300       77       223  
Loan 3
    2,598       255       255        
Loan 4
    455       30       30        
Loan 5
    166       10       10        
Loan 6
    1,133       81       81        
Underwriting for ADC loans with interest reserves follows the same process as those loans without reserves. In order for the Banks to establish a loan funded interest reserve, the borrower must have the ability to repay without the use of a reserve and a history of developing and stabilizing similar properties. All ADC loans, including those with interest reserves, are carefully monitored through periodic construction site inspections by bank employees or third party inspectors to ensure projects are moving along as planned. Management assesses the appropriateness of the use of interest reserves during the entire term of the loan as well as the adequacy of the reserve. Collateral inspections are completed before approval of advances. Two of these loans have been renewed; one due to delays and time needed to obtain current financial information on the guarantors and another to allow for completion of the final punch list and negotiation of the permanent loan. None of these loans have been restructured or are currently on nonaccrual.
Residential Loans. The Company originates, on a selective basis, residential loans for its portfolio on single and multi-family properties, both owner-occupied and non-owner-occupied. At December 31, 2010, the Company held $157,680 of such loans representing 18.04% of the Company’s loan portfolio. This portfolio typically includes 15 or 30-year adjustable rate mortgage loans whose terms mirror those prevalent in the secondary market for mortgage loans or, less typically, floating rate non-amortized term loans for purposes other than acquisition of the underlying residential property. A limited number of fixed rate loans are maintained in the portfolio when there are compelling market reasons to do so. Generally, all fixed rate residential loans are sold into the secondary market. In the case of home equity loans and lines of credit, the underwriting criteria are the same as applied by the Company when making a first mortgage loan, as described above. Home equity lines of credit typically mature ten years after their origination. The Company experienced net loan charge-offs on residential loans of $1,248 during 2010.

 

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The Company also originates both fixed and variable rate residential loans for sale into the secondary market, servicing released. Loans originated for sale into the secondary market are approved for purchase by an investor prior to closing. The Company generates loan origination fees, typically ranging from 1.00% to 1.50% of the loan balance, and servicing release fees, generally ranging from 0.25% to 0.75% of the loan balance. The Company bears minimal interest rate risk on these loans and only holds the loans temporarily until documentation can be completed to finalize the sale to the investor. Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in the fair values of these derivatives are included in net gains on sales of loans. Fair values of these derivatives were $2 and $182 as of December 31, 2010 and 2009, respectively. The Company had $12,775 of such loans at December 31, 2010.
Commercial Loans. The Company makes loans for commercial purposes to various types of businesses. At December 31, 2010, the Company held $189,128 of these loans, representing 21.64% of the total loan portfolio, excluding for these purposes commercial loans secured by real estate. See “Real Estate Loans.” Equipment loans are made for a term of up to five years (more typically three years) at fixed or variable rates, with the loan being fully amortized over the term and secured by the financed equipment with a loan-to-value ratio based on the overall relationship and creditworthiness of the customer. Working capital loans are made for a term typically not exceeding one year. These loans are usually secured by accounts receivable or inventory, and principal is either repaid as the assets securing the loan are converted into cash, or principal is due at maturity. The Company experienced net loan charge-offs on commercial loans of $905 during 2010.
Consumer Loans. The Company makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, and revolving lines of credit such as overdraft protection. At December 31, 2010, the Company held $17,412 of consumer loans, representing 1.99% of total loans. These loans typically carry balances of less than $25,000 and earn interest at a fixed rate. Non-revolving loans are either amortized over a period generally not exceeding 60 months or are ninety-day term loans. Revolving loans require monthly payments of interest and a portion of the principal balance (typically 2 to 3% of the outstanding balance). The Company experienced net charge-offs on consumer loans of $181 during 2010.
Loan Approval and Review. The Company’s loan approval policies provide for various levels of officer lending authority. When the aggregate amount of outstanding loans to a single borrower exceeds that individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit or by the Directors’ Loan Committee. Individual officers’ lending limits range from $15 to $2,000 for GB&T and $5 to $300 for SB&T depending on seniority and the type of loan. Any loan in excess of the lending limit of senior bank officers must be approved by the Directors’ Loan Committee.
The Company maintains a loan review and classification process which involves multiple officers of the Company and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1 — 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful and rating 8 Loss.

 

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When a loan officer originates a new loan, he or she documents the credit file with an offering sheet summary, supplemental underwriting analyses, relevant financial information and collateral evaluations. All of this information is used in the determination of the initial loan risk rating. Then, the Company’s Credit Administration department undertakes an independent credit review of that relationship in order to validate the lending officer’s rating. Lending relationships with total related exposure of $500 or greater are also placed into a tracking database and reviewed by Credit Administration personnel on an annual basis in conjunction with the receipt of updated borrower and guarantor financial information. The individual loan reviews analyze such items as: loan type; nature, type and estimated value of collateral; borrower and/or guarantor estimated financial strength; most recently available financial information; related loans and total borrower exposure; and current/anticipated performance of the loan. The results of such reviews are presented to Executive Management.
Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (loan grade 5) or classified (loan grade 6 through 8) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (5 or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for his criticized credit relationships.
Depending upon the individual facts, circumstances and the result of the Classified/Watch review process, Executive Management may categorize the loan relationship as impaired. Once that determination has occurred, Executive Management in conjunction with Credit Administration personnel, will complete an evaluation of the collateral (for collateral-dependent loans) based upon appraisals on file adjusting for current market conditions and other local factors that may affect collateral value. This judgmental evaluation may produce an initial specific allowance for placement in the Company’s Allowance for Loan & Lease Losses calculation. As soon as practical, updated appraisals on the collateral backing that impaired loan relationship are ordered. When the updated appraisals are received, Executive Management with assistance from Credit Administration department personnel reviews the appraisal, and updates the specific allowance analysis for each loan relationship accordingly. The Director’s Loan Committee reviews on a quarterly basis the Classified/Watch reports including changes in credit grades of 5 or higher as well as all impaired loans, the related allowances and OREO.
In general, once the specific allowance has been finalized, Executive Management will authorize a charge-off prior to the following calendar quarter-end in which that reserve calculation is finalized.
The review process also provides for the upgrade of loans that show improvement since the last review.

 

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Deposits
The Company offers a variety of deposit programs to individuals and to small to medium-sized businesses and other organizations at interest rates generally consistent with local market conditions. The following table sets forth the mix of depository accounts for the Company as a percentage of total deposits at December 31, 2010.
Deposit Mix
                 
    (Dollars in thousands)  
 
               
Noninterest-bearing
  $ 120,139       8.51 %
NOW accounts
    356,267       25.26 %
Money management accounts
    36,937       2.62 %
Savings
    409,584       29.03 %
Time deposits
               
Under $100
    141,089       10.00 %
$100 and over
    346,721       24.58 %
 
           
 
               
 
  $ 1,410,737       100.00 %
 
           
The Company accepts deposits at both main office locations and ten branch banking offices, eleven of which maintain an automated teller machine. The Company is a member of Mastercard’s Maestro and Cirrus networks, VISA Plus, as well as the “STAR” network of automated teller machines, which permits customers to perform certain transactions in many cities throughout Georgia, South Carolina and other regions. The Company controls deposit volumes primarily through the pricing of deposits and to a certain extent through promotional activities such as “free checking”. The Company also utilizes other sources of funding, specifically repurchase agreements, Federal Home Loan Bank borrowings, Insured Network Deposits and brokered certificates of deposit. Deposit rates are set weekly by executive management of the Company. Management believes that the rates it offers are competitive with, or in some cases, slightly above those offered by other institutions in its market area. The Company does not actively solicit deposits outside of its market area.
Supervision and Regulation
The Company, GB&T and SB&T are subject to extensive state and federal banking laws and regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws and regulations generally are intended to protect depositors and not shareholders.
   
Legislation and regulations authorized by legislation influences, among other things:
   
how, when and where the Company may expand geographically;
   
into what product or service markets it may enter;
   
how it must manage its assets; and
   
under what circumstances money may or must flow between the Company and its subsidiaries.
Set forth below is a summary of the major pieces of legislation affecting the Company’s industry and how that legislation affects its actions. The following summary is qualified by references to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on the Company’s business and prospects, and legislative changes and the policies of various regulatory authorities may significantly affect its operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on the Company’s business and earnings in the future.

 

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The Company owns all of the capital stock of GB&T and SB&T and is a multi-bank holding company under the federal Bank Holding Company Act of 1956. As a result, the Company is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System. Because the Company is a bank holding company located in Georgia, the Georgia Department of Banking and Finance (“GDBF”) also regulates and monitors all significant aspects of the Company’s operations.
GB&T is a commercial bank regulated by the GDBF, while SB&T is a commercial bank regulated by the South Carolina State Board of Financial Institutions (the “SCSBFI”). Both subsidiaries are regulated by the FDIC.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve Board’s prior approval before:
   
acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
   
acquiring all or substantially all of the assets of any bank; or
   
merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly or, substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve Board’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if adequately capitalized and adequately managed, a bank holding company located in a given state may purchase a bank located outside that state, although restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. Georgia law prohibits acquisitions of Georgia banks that have been incorporated for less than three years, and South Carolina law prohibits the acquisition of South Carolina banks that have been incorporated for less than five years.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
   
the bank holding company has registered securities under Section 12 of the Securities Act of 1934; or
   
no other person owns a greater percentage of that class of voting securities immediately after the transaction.
The Company’s common stock is registered under the Securities Exchange Act of 1934. The regulations provide a procedure for challenging the rebuttable presumption of control.

 

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Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities.
To qualify to become a financial holding company, any depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, the Company must file an election with the Federal Reserve Board to become a financial holding company and must provide the Federal Reserve Board with 30 days’ written notice prior to engaging in a permitted financial activity. While the Company meets the qualification standards applicable to financial holding companies, the Company has not elected to become a financial holding company at this time.
Capital Adequacy. The Company, GB&T and SB&T are required to comply with the capital adequacy standards established by the Federal Reserve Board, in the case of the Company, and the FDIC, in the case of GB&T and SB&T. The Federal Reserve Board has established a risk-based and a leverage measure of capital adequacy for bank holding companies. GB&T and SB&T are also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve Board for bank holding companies.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets, and classification as “adequately capitalized,” is 8%. A bank that fails to meet the required minimum guidelines is classified as “undercapitalized” and subject to operating and management restrictions. However, a bank that exceeds its capital requirements and maintains a ratio of total capital to risk-weighted assets of 10% is classified as “well capitalized.” As of December 31, 2010, both GB&T and SB&T were “well capitalized.”
Total capital consists of two components: Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stockholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock, and notes payable to unconsolidated special purpose entities that issue trust preferred securities, net of investment in the entity, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and hybrid capital, and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. The Company’s ratio of total capital to risk-weighted assets was 13.59% and the ratio of Tier 1 Capital to risk-weighted assets was 12.14% at December 31, 2010.

 

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In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve Board’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2010, our leverage ratio was 7.39%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.
Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described in “Prompt Corrective Action” below, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.
Generally, the regulatory capital framework under which the Company and its subsidiaries operate is in a period of change with likely legislation or regulation that will continue to revise the current standards and very likely increase capital requirements for the entire banking industry. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), bank regulators are required to establish new minimum leverage and risk-based capital requirements for certain bank holding companies and systematically important non-bank financial companies. The new minimum thresholds will not be lower than existing regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher once established.
Payment of Dividends. The Company is a legal entity separate and distinct from its subsidiaries. The principal sources of the Company’s cash flow, including cash flow to pay dividends to its shareholders, are dividends paid by the subsidiaries to the Company. Statutory and regulatory limitations apply to GB&T’s and SB&T’s payment of dividends. If, in the opinion of the FDIC , such subsidiaries were engaged in or about to engage in an unsafe or unsound practice, the FDIC could require, after notice and a hearing, that they stop or refrain from engaging in the questioned practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. See “Prompt Corrective Action.”
GB&T and SB&T have additional restrictions for dividends imposed by their respective regulatory agencies. Cash dividends on GB&T’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time when GB&T’s paid-in capital and appropriated earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the GDBF’s current rules and regulations require prior approval before cash dividends may be declared and paid if: (1) the bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the bank’s loans classified as adverse as to repayment or recovery by the GDBF at the most recent examination of the bank exceeds 80% of the bank’s equity as reflected at such examination. The SCSBFI permits a bank to pay cash dividends of up to 100% of net income in any given calendar year without prior regulatory approval if the bank received a composite “1” or “2” rating in its last state or federal examination.

 

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GB&T declared cash dividends payable to the Company of $0 in 2010 and 2009 and $1,450 in 2008. The Company suspended the payment of quarterly cash dividends on its common stock effective April 22, 2009. The Board of Directors considered the action prudent in order to maintain its capital position in the current state of the economy. The Board plans to reinstate the dividend payment at an appropriate time once economic conditions improve and stabilize. Any future determination relating to dividend policy will be made at the discretion of the Board and will depend on many of the statutory and regulatory factors mentioned above.
Restrictions on Transactions with Affiliates. The Company, GB&T and SB&T are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
   
a bank’s loans or extensions of credit to affiliates;
   
a bank’s investment in affiliates;
   
assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve Board;
   
loans or extensions of credit made by a bank to third parties collateralized by the securities or obligations of affiliates; and
   
a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. GB&T and SB&T must also comply with other provisions designed to avoid taking low-quality assets.
The Company, GB&T and SB&T are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
GB&T and SB&T are also subject to restrictions on extensions of credit to their respective executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Effective July 21, 2011, an insured depository institution will be prohibited from engaging in asset purchases or sales transactions with its officers, directors or principal shareholders unless on market terms and, if the transaction represents greater than 10% of the capital and surplus of the bank, it has been approved by a majority of the disinterested directors.

 

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Support of Subsidiary Institutions. Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength for its subsidiaries and to commit resources to support them. In addition, pursuant to the Dodd-Frank Act, the federal banking regulators are required to issue, within two years of enactment, rules that require a bank holding company to serve as a source of financial strength for any depository institution subsidiary. This support may be required at times when, without this Federal Reserve Board policy, the Company might not be inclined to provide it. In addition, any capital loans made by the Company to its subsidiaries will be repaid only after the applicable subsidiary’s deposits and various other obligations are repaid in full. In the unlikely event of the Company’s bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of GB&T and SB&T will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Prompt Corrective Action. The FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each of the other categories.
Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
As of December 31, 2010, GB&T and SB&T qualified for the well capitalized category. A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure pursuant to any written agreement, order, capital directive, or other remediation, and significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6%, and a tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital if the federal regulator determines that a bank is in an unsafe or unsound condition or is engaged in unsafe or unsound practices requiring certain remedial action.
FDIC Insurance Assessments. GB&T’s and SB&T’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the maximum amount permitted by law, which was permanently increased to $250,000 by the Dodd-Frank Act. The FDIC uses the DIF to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. Pursuant to the Dodd-Frank Act, the FDIC must take steps, as necessary, for the DIF reserve ratio to reach 1.35% of estimated insured deposits by September 30, 2020. GB&T and SB&T are thus subject to FDIC deposit premium assessments.

 

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Currently, the FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information — supervisory risk ratings for all institutions, financial ratios for most institutions, including GB&T and SB&T, and long-term debt issuer ratings for large institutions that have such ratings. For institutions assigned to the lowest risk category, the annual assessment rate ranges between 7 and 16 cents per $100 of domestic deposits. For institutions assigned to higher risk categories, assessment rates range from 17 to 77.5 cents per $100 of domestic deposits. These ranges reflect a possible downward adjustment for unsecured debt outstanding and possible upward adjustments for secured liabilities and, in the case of institutions outside the lowest risk category, brokered deposits.
On September 29, 2009, the FDIC announced a uniform three basis point-increase effective January 1, 2011, and on November 12, 2009, adopted a rule requiring nearly all FDIC-insured depository institutions, including GB&T and SB&T, to prepay their DIF assessments for the fourth quarter of 2009 and for the following three years on December 30, 2009. At that time, the FDIC indicated that the prepayment of DIF assessments was in lieu of additional special assessments; however, there can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future.
On October 19, 2010, the FDIC adopted a new DIF Restoration Plan that foregoes the uniform three basis point-increase scheduled to take effect on January 1, 2011. The FDIC indicated that this change was based on revised projections calling for lower than previously expected DIF losses for the period 2010 through 2014, continued stresses on the earnings of insured depository institutions, and the additional time afforded to reach the DIF reserve ratio required by the Dodd-Frank Act. The FDIC will pursue further rulemaking in 2011 regarding the method that will be used to reach the required 1.35% reserve ratio by September 30, 2020 and plans to offset the effect of this statutory requirement on insured depository institutions with total consolidated assets of less than $10 billion.
On February 7, 2011, pursuant to another element of the Dodd-Frank Act, the FDIC adopted regulations anticipated to become effective April 1, 2011 that amend current regulations to redefine the “assessment base” used for calculating deposit insurance assessments. Rather than the current system, whereby the assessment base is calculated by using an insured depository institution’s domestic deposits less a few allowable exclusions, the new assessment base will be calculated using the average consolidated total assets of an insured depository institution less the average tangible equity of such institution. Under the new rules, the FDIC defines tangible equity as Tier 1 capital. The FDIC will continue to utilize a risk-based assessment system in which institutions will be subject to assessment rates ranging from 2.5 to 45 basis points, subject to adjustments for unsecured debt and, in the case of small institutions outside the lowest risk category and certain large and highly complex institutions, brokered deposits. The final rules eliminate adjustments for secured liabilities.
The new rules retain the FDIC Board’s flexibility to, without further notice-and-comment rulemaking, adopt rates that are higher or lower than the stated base assessment rates, provided that the FDIC cannot (i) increase or decrease the total rates from one quarter to the next by more than two basis points, or (ii) deviate by more than two basis points from the stated base assessment rates. Although the Dodd-Frank Act requires that the FDIC eliminate its requirement to pay dividends to depository institutions when the reserve ratio exceeds a certain threshold, the FDIC’s new rule establishes a decreasing schedule of assessment rates that would take effect when the DIF reserve ratio first meets or exceeds 1.15%. If the DIF reserve ratio meets or exceeds 1.15%, base assessment rates would range from 1.5 to 40 basis points; if the DIF reserve ratio meets or exceeds 2%, base assessment rates would range from 1 to 38 basis points; and if the DIF reserve ratio meets or exceeds 2.5%, base assessment rates would range from 0.5 to 35 basis points. All base assessment rates would continue to be subject to adjustments for unsecured debt and brokered deposits.

 

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The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (“FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2010 ranged from 1.06 cents to 1.04 cents per $100 of assessable deposits. These assessments will continue until the debt matures between 2017 and 2019.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
Branching. Under current Georgia law, GB&T may open or acquire branch offices throughout Georgia with the prior approval of the GDBF. Similarly, SB&T may open or acquire branch offices in South Carolina with the prior approval of the SCSBFI. Prior to the enactment of the Dodd-Frank Act, national and state-chartered banks were generally permitted to branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. However, interstate branching is now permitted for all national and state-chartered banks as a result of the Dodd-Frank Act, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve or the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our operations. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Company’s financial statements and regulatory reports. Because of its significance, the Company has developed a system by which it develops, maintains and documents a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with generally accepted accounting principles, the bank’s stated policies and procedures, management’s best judgment and relevant supervisory guidance. Consistent with supervisory guidance, GB&T and SB&T each maintain a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. Management’s estimate of credit losses reflects consideration of all significant factors that affect the collectability of the portfolio as of the evaluation date. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies.”

 

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Commercial Real Estate Lending. Our lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:
   
total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or
   
total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,100,000 per day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties.
Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue regulatory orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.
The Consumer Financial Protection Bureau. The Dodd-Frank Act creates the Consumer Financial Protection Bureau (the “Bureau”) within the Federal Reserve Board. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions.

 

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Limitations on Senior Executive Compensation. In June of 2010, federal banking regulators issued guidance designed to help ensure that incentive compensation policies at banking organizations do not encourage excessive risk-taking or undermined the safety and soundness of the organization. In connection with this guidance, the regulatory agencies announced that they will review incentive compensation arrangements as part of the regular, risk-focused supervisory process. Regulatory authorities may also take enforcement action against a banking organization if its incentive compensation arrangement or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and the organization is not taking prompt and effective measures to correct the deficiencies. To ensure that incentive compensation arrangements do not undermine safety and soundness at insured depository institutions, the incentive compensation guidance sets forth the following key principles:
   
Incentive compensation arrangements should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose the organization to imprudent risk;
   
Incentive compensation arrangements should be compatible with effective controls and risk management; and
   
Incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the board of directors.
The Dodd-Frank Act. The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes previously discussed and including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased regulatory examination fees; and (iii) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the Office of the Comptroller of the Currency and the FDIC.
Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Other Regulations. Interest and other charges collected or contracted for are subject to state usury laws and federal laws concerning interest rates.
Our loan operations are also subject to federal laws applicable to credit transactions, such as the:
   
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
   
Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
   
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
   
Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;
   
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

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National Flood Insurance Act and Flood Disaster Protection Act, requiring flood insurance to extend or renew certain loans in flood plains;
 
   
Real Estate Settlement Procedures Act, requiring certain disclosures concerning loan closing costs and escrows, and governing transfers of loan servicing and the amounts of escrows in connection with loans secured by one-to-four family residential properties;
   
Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), imposing requirements and limitations on specific financial transactions and account relationships, intended to guard against money laundering and terrorism financing;
   
sections 22(g) and 22(h) of the Federal Reserve Act which set lending restrictions and limitations regarding loans and other extensions of credit made to executive officers, directors, principal shareholders and other insiders;
   
Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the U.S. military;
   
Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for certain types of consumer loans to military service members and their dependents; and
   
rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
Our deposit operations are subject to federal laws applicable to depository accounts, such as the following:
   
Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;
   
Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
   
Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and,
   
rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
Additionally, as part of their overall conduct of their business, the Company, GB&T and SB&T must comply with:
   
privacy and data security laws and regulations at both the federal and state level; and
   
anti-money laundering laws, including the USA Patriot Act.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating or doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

 

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Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks and thrifts through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Item 1A.  
Risk Factors
An investment in our common stock involves risks. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors could lose all or part of their investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Risks Associated with our Business
The amount of “other real estate owned” (“OREO”) may increase significantly, resulting in additional losses, and costs and expenses that will negatively affect our operations
At December 31, 2010, we had a total of $7,751 of OREO as compared to $7,974 at December 31, 2009 and $5,734 at December 31, 2008. This increase in OREO is due, among other things, to the continued deterioration of the residential real estate market and the tightening of the credit market. As the amount of OREO increases, our losses and the costs and expenses of maintaining the real estate will likewise increase. Due to the on-going economic crisis, the amount of OREO may continue to increase throughout 2011. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and reduce our ultimate realization from any OREO sales.
The deterioration in the residential mortgage market may continue to spread to commercial credits, which may result in greater losses and non-performing assets, adversely affecting our business operations.
The losses that were initially associated with subprime residential mortgages rapidly spread into the residential mortgage market generally. If the losses in the residential mortgage market continue to spread to commercial credits, then we may be forced to take greater losses or to hold more non-performing assets. Our business operations and financial results could be adversely affected if we continue to experience losses from our commercial loan portfolio.

 

21


 

Future impairment losses could be required on various investment securities, which may materially reduce the Company’s and the Banks’ regulatory capital levels.
The Company establishes fair value estimates of securities available-for-sale in accordance with generally accepted accounting principles. The Company’s estimates can change from reporting period to reporting period, and we cannot provide any assurance that the fair value estimates of our investment securities would be the realizable value in the event of a sale of the securities.
A number of factors could cause the Company to conclude in one or more future reporting periods that any difference between the fair value and the amortized cost of one or more of the securities that we own constitutes an other-than-temporary impairment. These factors include, but are not limited to, an increase in the severity of the unrealized loss on a particular security, an increase in the length of time unrealized losses continue without an improvement in value, a change in our intent or whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery, or changes in market conditions or industry or issuer specific factors that would render us unable to forecast a full recovery in value, including adverse developments concerning the financial condition of the companies in which we have invested.
The Company may be required to take other-than-temporary impairment charges on various securities in its investment portfolio. In addition, depending on various factors, including the fair values of other securities that we hold, we may be required to take additional other-than-temporary impairment charges on other investment securities. Any other-than-temporary impairment charges would negatively affect our regulatory capital levels, and may result in a change to our capitalization category, which could limit certain corporate practices and could compel us to take specific actions.
The Company recognized other-than-temporary impairment charges of $96 and $975 for the years ended December 31, 2010 and 2009, respectively.
We could suffer loan losses from a decline in credit quality.
We could sustain losses if borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for credit losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations. In particular, we face credit quality risks presented by past, current and potential economic and real estate market conditions as more fully described in the risk factors appearing below.
Our results of operations and financial condition would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses.
Experience in the banking industry indicates that a portion of our loans in all categories of our lending business will become delinquent, and some may only be partially repaid or may never be repaid at all. Our methodology for establishing the adequacy of the allowance for loan losses depends on subjective application of risk grades as indicators of borrowers’ ability to repay. Deterioration in general economic conditions and unforeseen risks affecting customers may have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions. In times of improving credit quality, with growth in our loan portfolio, the allowance for loan losses may decrease as a percent of total loans. Changes in economic and market conditions may increase the risk that the allowance would become inadequate if borrowers experience economic and other conditions adverse to their businesses. Maintaining the adequacy of our allowance for loan losses may require that we make significant and unanticipated increases in our provisions for loan losses, which would materially affect our results of operations and capital adequacy. Recognizing that many of our loans individually represent a significant percentage of our total allowance for loan losses, adverse collection experience in a relatively small number of loans could require an increase in our allowance. Federal regulators, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with large provisions for loan losses and to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition.

 

22


 

If the value of real estate in our core market were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our business, financial condition and results of operations.
With most of our loans concentrated in Richmond, Columbia and Clarke counties in the state of Georgia and Aiken County in the state of South Carolina, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.
In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2010, approximately 76.37% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. Our markets and the U.S. generally are experiencing a period of reduced real estate values, and if we are required to liquidate the collateral securing a significant loan or collection of loans to satisfy the debt during such a period, our earnings and capital could be adversely affected. See the disclosure below under “An economic downturn, especially one affecting our market areas, could adversely affect our financial condition, results of operations, or cash flows.”
Our profitability is vulnerable to interest rate fluctuations.
Our profitability depends substantially upon our net interest income. Net interest income is the difference between the interest earned on assets, such as loans and investment securities, and the interest paid for liabilities, such as savings and time deposits and out-of-market certificates of deposit. Market interest rates for loans, investments and deposits are highly sensitive to many factors beyond our control. Recently, interest rate spreads (the difference between interest rates earned on assets and interest rates paid on liabilities) have generally narrowed as a result of changing market conditions, policies of various government and regulatory authorities and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow even further. This narrowing of interest rate spreads could adversely affect our financial condition and results of operations. In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Asset/Liability Management, Interest Rate Sensitivity and Liquidity.”

 

23


 

An economic downturn, especially one affecting our market areas, could adversely affect our financial condition, results of operations or cash flows.
Our success depends upon the growth in population, income levels, deposits and housing starts in our primary market areas which principally include Richmond, Columbia and Clarke counties in the state of Georgia and Aiken County in the state of South Carolina. If the communities in which we operate do not grow, or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Unpredictable economic conditions may have an adverse effect on the quality of our loan portfolio and our financial performance. Economic recession over a prolonged period or other economic problems in our market areas could have a material adverse impact on the quality of the loan portfolio and the demand for our products and services. We experienced a higher percentage of non-performing loans to total loans in 2010 and 2009 than in prior years based in part on general economic conditions in our market areas. Future adverse changes in the economies in our market areas may have a material adverse effect on our financial condition, results of operations or cash flows. Further, the banking industry in Georgia and South Carolina is affected by general economic conditions such as inflation, recession, unemployment and other factors beyond our control. As community financial institutions, we are less able to spread the risk of unfavorable local economic conditions than larger or more regional banks. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas even if they do occur.
We will realize additional future losses if the proceeds we receive upon liquidation of non-performing assets are less than the fair value of such assets.
Non-performing assets are recorded on our financial statements at our best estimate of fair value, as required under GAAP. If the proceeds we receive upon dispositions of non-performing assets are less than the recorded fair value of such assets then additional losses will be recognized.
Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition.
Confidential customer information transmitted through our online banking service is vulnerable to security breaches and computer viruses, which could expose us to litigation and adversely affect our reputation and ability to generate deposits.
We provide our customers with the ability to bank online. The secure transmission of confidential information over the Internet is a critical element of online banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes, and other security problems. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our clients involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in our systems and could adversely affect our reputation and ability to generate deposits.

 

24


 

Our controls and procedures may fail or be circumvented.
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.
As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Our subsidiary banks are primarily regulated by the FDIC, the GDBF, and the SCSBFI. Our compliance with regulations promulgated by these agencies is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements of our regulators.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
See the section of this report entitled “Supervision and Regulation” for additional information on the statutory and regulatory issues that affect our business.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.

 

25


 

Risks Associated with our Common Stock
We are not currently paying dividends on our common stock and we may be unable to pay future dividends. As a result, capital appreciation, if any, of our common stock may represent the sole opportunity for gains on an investment for the foreseeable future.
We are not currently paying dividends on our common stock, and we make no assurances that we will pay any dividends in the future. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that our Board of Directors may deem relevant. The holders of our common stock are entitled to receive dividends when, and if declared by our Board of Directors out of funds legally available for that purpose. As part of our consideration of potential cash dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business. In addition, our ability to pay dividends is restricted by federal policies and regulations and by the terms of our existing indebtedness. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. Further, our principal source of funds to pay dividends are cash dividends that we receive from our subsidiaries, and they are subject to statutory and regulatory limitations on the amount of dividends they can pay without prior regulatory approval. See “Business — Supervision and Regulation — Payment of Dividends.”
Our stock price can be volatile.
Stock price volatility may make it more difficult for investors to resell their common stock when they want to and at prices they find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
   
actual or anticipated variations in quarterly results of operations;
 
   
recommendations by securities analysts;
 
   
the operating and stock price performance of other companies that investors deem comparable to the Company;
 
   
perceptions in the marketplace regarding the Company and/or its competitors;
 
   
new technology used, or services offered, by competitors;
 
   
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company or its competitors;
 
   
failure to integrate acquisitions or realize anticipated benefits from acquisitions;
 
   
changes in government regulations; and
 
   
geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results as evidenced by the current volatility and disruption of capital and credit markets.

 

26


 

The trading volume in our common stock is less than that of other larger financial services companies.
Although the Company’s common stock is traded on the Over-the-Counter Bulletin Board, the trading volume in our common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.
Holders of our subordinated debentures have rights that are senior to those of our common shareholders.
We have supported our continued growth by issuing trust preferred securities from special purpose trusts and accompanying subordinated debentures. We have also issued a subordinated debenture to an entity affiliated with one of our directors, as is further described in Note 11 to our Consolidated Financial Statements included elsewhere in this report. At December 31, 2010, we had outstanding subordinated debentures totaling $22,947 and may issue additional trust preferred securities or incur further indebtedness in the future. We unconditionally guarantee the payment of principal and interest on the trust preferred securities. The debentures described above are senior to our common stock. As a result, we must make payments on the subordinated debentures before we can pay any dividends on our common stock. In the event of our bankruptcy, dissolution or liquidation, holders of our subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on the subordinated debentures relating to our trust preferred securities (and dividend payments on the related trust preferred securities) for up to five years, but during that time we would not be able to pay dividends on our common stock.
Our directors and executive officers own a significant portion of our common stock and can influence shareholder decisions.
Our directors, executive officers and relatives of directors, as a group, beneficially owned approximately 53.66% of our fully diluted outstanding common stock as of February 17, 2011. As a result of their ownership, the directors and executive officers will have the ability, if they voted their shares in concert, to control the outcome of all matters submitted to our shareholders for approval, including the election of directors.
Item 1B.  
Unresolved Staff Comments
   
None

 

27


 

Item 2.  
Properties
The Company currently operates two main offices, ten branches and an operations center. The principal administrative offices of the Company are located at 3530 Wheeler Road, Augusta, Georgia. Locations in Georgia include the main office, four branch offices in Augusta, Georgia, two branches in Martinez, Georgia and two branches in Evans, Georgia. SB&T locations include the main office and one additional branch in Aiken, South Carolina, and one leased facility in North Augusta, South Carolina. All banking offices except the leased facility are owned by the Company, are not subject to mortgage, and are covered by appropriate insurance for replacement value.
Each banking office in metro Augusta is a brick building with a teller line, customer service area, offices for the Company’s lenders, drive-in teller lanes, a vault with safe deposit boxes, and a walk-up or drive-up automated teller machine. The banking offices are generally 3,000 to 5,000 square foot buildings. Exceptions are the main office with approximately 14,000 square feet, the Washington Road branch with 1,800 square feet, and the Cotton Exchange branch with 7,500 square feet of space.
The Pine Log Road office, located in Aiken, South Carolina, opened in September 2006, and consists of a 4,000 square foot banking office with all the facilities of the metro Augusta offices. In July 2007, a 1,600 square foot drive-thru facility was opened in Evans, Georgia, and in August 2007, a 4,600 square foot full-service branch was opened in North Augusta, South Carolina. On January 10, 2008, SB&T opened its second branch in Aiken, South Carolina and relocated its main office to a 3,168 square foot wood frame historic home on Laurens Street.
In 1997, the Company acquired 24,000 square feet of commercial office space located at 3515 Wheeler Road, across the street from the main office. This office space is partially leased but mainly occupied by the Company’s mortgage operations, wealth management and construction lending departments.
Due to continued growth, the Company purchased a commercial building with approximately 45,000 square feet of office space on Columbia Road in Martinez in May 2006. This office space was renovated during 2006 and 2007, and operational functions including data processing, deposit operations, human resources, loan operations, credit administration and accounting were relocated to this facility in October 2007.
The Company’s automated teller machine network includes three drive-up machines located in major retail shopping areas as well as machines located at eleven of the twelve branch offices.
See Note 7 to the Consolidated Financial Statements for additional information concerning the Company’s premises and equipment and Note 8 to the Consolidated Financial Statements for additional information concerning the Company’s commitments under various equipment leases.
Item 3.  
Legal Proceedings
In the ordinary course of business, the Company and its subsidiaries are parties to various legal proceedings. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, there is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision would result in a material adverse change to the consolidated results of operations or financial condition of the Company or its subsidiaries.

 

28


 

Item 4.  
[Removed and Reserved]

 

29


 

PART II
Item 5.  
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of February 17, 2011, there were approximately 997 holders of record of the Company’s common stock. As of February 17, 2011, there were 6,675,851 shares of the Company’s common stock outstanding. The Company’s common stock is traded via the Over-the-Counter Bulletin Board under the trading symbol “SBFC”. The following table reflects the range of high and low bid quotations, adjusted for stock dividends and splits, in the Company’s common stock for the past two years:
Southeastern Bank Financial Corporation Stock Price
                 
    Low     High  
Quarter ended
               
March 31, 2009
    12.00       19.50  
June 30, 2009
    13.05       18.00  
September 30, 2009
    11.00       15.50  
December 31, 2009
    10.00       13.00  
 
               
Quarter ended
               
March 31, 2010
    9.17       11.75  
June 30, 2010
    10.50       14.50  
September 30, 2010
    9.50       13.00  
December 31, 2010
    8.00       10.50  
 
               
Period ended
               
February 17, 2011
    8.77       13.50  
The Company declared cash dividends of $0.13 per share on January 21, 2009, but suspended cash dividends as of April 22, 2009. The Company’s primary sources of income are dividends and other payments received from its subsidiaries. The amount of dividends that may be paid by GB&T and SB&T to the Company depends upon the subsidiaries’ earnings and capital position and is limited by federal and state law, regulations and policies.
Cash dividends on GB&T’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time when GB&T’s paid-in capital and appropriated earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the GDBF’s current rules and regulations require prior approval before cash dividends may be declared and paid if: (i) the bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the bank’s loans classified as adverse as to repayment or recovery by the GDBF at the most recent examination of the bank exceeds 80% of the bank’s equity as reflected at such examination. The SCSBFI permits a bank to pay cash dividends of up to 100% of net income in any given calendar year without prior regulatory approval if the bank received a composite “1” or “2” rating in its last state or federal examination.

 

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The Company’s ability to pay cash dividends is further subject to continued payment of interest that is owed on subordinated debentures issued in connection with the Southeastern Bank Financial Statutory Trust I issuance in December 2005 of $10,000 of trust preferred securities, the Southeastern Bank Financial Trust II issuance in March 2006 of $10,000 of trust preferred securities, and the issuance in May 2009 of $2,947 of subordinated debentures to R.W. Pollard Enterprises, LLLP. As of December 31, 2010, the Company had approximately $22,947 of subordinated debentures outstanding. On $20,000 of the subordinated debt, the Company has the right to defer payment of interest for a period not exceeding 20 consecutive quarters. If the Company defers, or fails to make, interest payments on the subordinated debentures, the Company will be prohibited, subject to certain exceptions, from paying cash dividends on common stock until all deferred interest is paid and interest payments on the subordinated debentures resumes.
There were no shares repurchased under an existing stock repurchase plan or otherwise during the fourth quarter of 2010.
The Company did not sell any of its equity securities without registration under the Securities Act of 1933, as amended, during the fourth quarter of 2010.
See “Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for a table presenting information on equity securities subject to future issuance under the Company’s equity compensation plans.

 

31


 

Item 6.  
Selected Financial Data
The selected consolidated financial data presented on the following page as of December 31, 2010 and 2009 and for each of the years in the three-year period ended December 31, 2010 is derived from the audited consolidated financial statements and related notes included in this report and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data as of December 31, 2007 and 2006 is derived from audited consolidated financial statements that are not included in this report but that are included in the Annual Reports on Form 10-K filed with the Securities and Exchange Commission for those years. The per share data presented on the following page has been adjusted accordingly for the 10% stock dividend paid June 2, 2008.

 

32


 

                                         
Selected Consolidated Financial Data   2010     2009     2008     2007     2006  
    (Dollars in thousands, except per share data)  
Earnings
                                       
Total interest income
  $ 69,874     $ 70,760     $ 75,675     $ 79,181     $ 65,626  
Total interest expense
    23,998       28,483       35,489       40,932       31,423  
Net interest income
    45,876       42,277       40,186       38,249       34,203  
Provision for loan losses
    15,801       30,904       9,055       3,823       2,478  
Noninterest income
    21,086       20,739       16,705       16,168       14,040  
Noninterest expense
    41,815       46,511       36,752       32,508       28,932  
Net income (loss)
    6,856       (7,985 )     7,578       11,765       11,160  
Per Share Data
                                       
Net income (loss)- Diluted
  $ 1.03     $ (1.24 )   $ 1.26     $ 1.95     $ 1.89  
Book value
    14.97       14.05       15.81       15.04       13.21  
Cash dividends declared per common share
    0.00       0.13       0.52       0.52       0.52  
Weighted average common and common equivalent shares outstanding
    6,674,224       6,422,867       6,011,689       6,044,871       5,908,659  
Selected Average Balances
                                       
Assets
  $ 1,575,360     $ 1,476,887     $ 1,318,384     $ 1,133,064     $ 951,115  
Total loans (net of unearned income)
    902,346       965,111       934,512       800,852       647,421  
Deposits
    1,367,416       1,221,100       1,057,198       893,959       735,128  
Stockholders’ equity
    100,719       100,760       89,337       83,850       69,317  
Selected Year-End Balances
                                       
Assets
  $ 1,607,105     $ 1,491,119     $ 1,411,039     $ 1,212,980     $ 1,041,202  
Loans (net of unearned income)
    874,095       937,489       986,831       871,440       735,112  
Allowance for loan losses
    26,657       22,338       14,742       11,800       9,777  
Deposits
    1,410,737       1,280,534       1,139,552       952,166       801,763  
Short-term borrowings
    8,818       20,788       62,553       81,666       76,020  
Long-term borrowings
    74,947       82,947       104,000       79,000       75,000  
Stockholders’ equity
    99,958       93,744       94,651       89,758       78,924  
Selected Ratios
                                       
Return on average total assets
    0.44 %     (0.54 %)     0.57 %     1.04 %     1.17 %
Return on average equity
    6.81 %     (7.92 %)     8.48 %     14.03 %     16.10 %
Average earning assets to average total assets
    91.73 %     91.54 %     94.11 %     93.66 %     93.67 %
Average loans to average deposits
    65.99 %     79.04 %     88.40 %     89.58 %     88.07 %
Average equity to average total assets
    6.39 %     6.82 %     6.78 %     7.40 %     7.29 %
Net interest margin
    3.18 %     3.12 %     3.24 %     3.60 %     3.84 %
Operating efficiency
    63.59 %     75.66 %     64.52 %     60.64 %     60.20 %
Net charge-offs to average loans
    1.27 %     2.42 %     0.65 %     0.22 %     0.17 %
Allowance for loan losses to net loans (year-end)
    3.05 %     2.38 %     1.49 %     1.35 %     1.33 %
Risk-based capital
                                       
Tier 1 capital
    12.14 %     11.06 %     10.45 %     11.38 %     12.09 %
Total capital
    13.59 %     12.55 %     11.70 %     12.61 %     13.29 %
Tier 1 leverage ratio
    7.39 %     7.51 %     8.14 %     9.08 %     9.78 %

 

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Item 7.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollar amounts are expressed in thousands unless otherwise noted)
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and its subsidiaries, Georgia Bank & Trust Company of Augusta (“GB&T”) and Southern Bank & Trust (“SB&T”), during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and related notes to the consolidated financial statements.
Overview
The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the Augusta-Richmond County, GA-SC metropolitan statistical area, the Company had 18.62% of all deposits and was the second largest depository institution and the largest locally based institution at June 30, 2010 based on deposit levels, as cited from the FDIC’s website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services, by adding locations, and by focusing on the customer relationship management philosophy. The Company is committed to building lifelong relationships with its customers, employees, shareholders, and the communities it serves.
Net income in 2010 was $6,856 compared to a net loss of $7,985 in 2009. Although economic conditions continued to contribute to problems with loan quality, earnings were positively impacted by a decrease in the provision for loan loss expense of $15,103 primarily due to decreased losses on nonperforming assets.
The Company’s primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans decreased primarily due to decreased volumes and elevated levels of nonaccrual loans. Service charges and fees on deposits decreased due to decreases in NSF income on retail checking accounts, as a result of decreased economic activity, somewhat offset by increases in debit/ATM card income. Gain on sales of mortgage loans for 2010 increased slightly over 2009 due to higher production levels resulting from declining interest rates. Retail investment income experienced an increase due to increased activity and bond trading. Trust service fees increased due to improving market conditions. As portfolio balances increased, the level of fee based assets under management increased which resulted in higher income. Salary and benefit expenses have increased $928 from 2009 primarily due to increased incentive accruals, retail investment and trust commissions and expenses related to group insurance costs. Occupancy expense decreased $110 from 2009 primarily due to decreased depreciation expense, as a result of several assets which became fully depreciated in the first half of the year. Other operating expenses decreased $795 from 2009 primarily due to decreased maintenance agreement expense and decreased FDIC insurance expense.

 

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The Company continues to maintain a defensive posture as uncertainty remains about the sustainability of economic recovery and has continued to focus on the net interest margin, capital preservation, liquidity management and risk mitigation. Balance sheet management, including rate changes on deposits, investment purchases and liability mix including wholesale funds levels have been key areas of focus in 2010.
Over the past four years, assets grew from $1,041,202 at December 31, 2006 to $1,607,105 at December 31, 2010. From year end 2006 to year end 2010, loans increased $138,983, and deposits increased $608,974. Net interest income for the year ended 2006 was $34,203 compared to net interest income of $45,876 in 2010. The Company has paid cash dividends of $0.13 per share each quarter since 2004 but elected to suspend dividends effective April 22, 2009 to conserve capital.
The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments received from mortgage backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net interest income in a ramp up and down annually 300 basis points (3.00%) scenario and as it applies to economic value of equity in a shock up and down 300 basis points (3.00%) scenario. The Company monitors operating expenses through responsibility center budgeting. See “Interest Rate Sensitivity” below.
Critical Accounting Estimates
The accounting and financial reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels; (4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management’s assessment of economic conditions. The Company’s Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.

 

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The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.
Please see “Allowance for Loan Losses” and “Non-Performing Assets” for a further discussion of the Company’s loans, loss experience, and methodology in determining the allowance.
Fair Value of Financial Instruments
A significant portion of the Company’s assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, tax credits, mortgage banking derivatives and other real estate owned. At December 31, 2010 and December 31, 2009 the percentage of total assets measured at fair value was 38.58% and 23.89% respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At December 31, 2010, 5.59% of assets measured at fair value were based on significant unobservable inputs. This consisted primarily of available-for-sale securities, impaired loans and other real estate. This represents approximately 2.16% of the Company’s total assets. See Note 6 “Fair Value Measurements” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.
Other Real Estate Owned
Assets acquired through or instead of loan foreclosure are initially recorded at lower of cost or fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of property are capitalized.
Investment Securities
The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. As of December 31, 2010, the Company had approximately $13,657 of available-for-sale securities, which is approximately 0.85% of total assets, valued using unobservable inputs (Level 3). These securities were primarily non-agency mortgage-backed securities and single issuer subordinated debentures issued by financial institutions.

 

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Results of Operations
Total assets increased $115,986, or 7.78% in 2010 compared to year end 2009 due primarily to an increase in deposits of $130,203 offset partially by repayment of other borrowings. Loans declined $63,394 or 6.76% due primarily to economic conditions and lack of demand. Management responded to the growth in deposits, the reduction in loans and a high level of liquidity at the end of 2009 by increasing investment securities. Investments increased $279,906 or 91.26% in 2010 compared to year end 2009. The Company recorded net income of $6,856 in 2010 compared to a net loss of $7,985 in 2009. The increase in net income is primarily attributable to a $15,103 decrease in provision for loan losses associated with a somewhat improved level of nonperforming assets and loan charge-offs. Loan charge-offs decreased from $24,133 in 2009 to $12,588 in 2010 and resulted primarily from lower losses in segments of the Company’s acquisition, development and construction loan portfolio (“ADC”) outside of its primary market. Loans participated with other banks on properties in the metro Atlanta market as well as ADC loans in the Athens and Savannah, Georgia markets experienced a lower level of charge offs in 2010. During 2010 losses increased somewhat in the Company’s primary market area of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA).
Interest income decreased $886 or 1.25% to $69,874 in 2010. Interest income on loans decreased $2,489 from 2009 and was primarily the result of a decline in volume as average loans decreased $60,382. Partially offsetting this was an increase in average yield from 5.70% in 2009 to 5.80% in 2010. Interest income on investment securities increased $1,499 in 2010 primarily as a result of a $152,373 increase in the average balance of the investment portfolio in 2010. The yield on the taxable investment portfolio declined from 4.88% in 2009 to 3.49% in 2010.
Interest expense decreased $4,485 to $23,998 in 2010. Interest expense on deposits decreased $3,784 to $20,465 primarily due to continuing declines in cost of funds somewhat offset by the growth of deposits. Average interest bearing deposits grew $142,225, or 12.86% in 2010. The most significant increases were in average balances of NOW and savings and money market accounts which increased $120,570 and $84,754, respectively. Average time deposits decreased $63,099 due in part to customers transferring to NOW and savings accounts as well as balances of brokered CDs which decreased from $255,876 at year end 2009 to $183,732 at year end 2010.
Noninterest income increased $347 in 2010 and was due to several factors including reduced impairment losses recognized in earnings of $879, increased retail investment income of $487, increased gain on sale of loans of $131 and increased trust service fees of $88. Offsetting these were decreased investment securities gains of $1,261 and decreased service charges and fees on deposit accounts of $125.
Noninterest expense decreased $4,696 or 10.10% in 2010 due primarily to decreased losses on sale of other real estate. Increased salaries and other personnel expense were offset by decreases in occupancy and other operating expenses. The operating efficiency ratio improved from 75.66% in 2009 to 63.59% in 2010.

 

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The earnings performance of the Company is reflected in its return on average assets and average equity of 0.44% and 6.81%, respectively, during 2010 compared to (0.54%) and (7.92%), respectively, during 2009. Basic net income (loss) per share on weighted average common shares outstanding increased to $1.03 in 2010 compared to ($1.24) in 2009 and $1.27 in 2008. Diluted net income (loss) per share on weighted average common and common equivalent shares outstanding increased to $1.03 in 2010 compared to ($1.24) in 2009 and $1.26 in 2008.
Net Interest Income
The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, average yields earned and rates paid on those respective balances, and the resulting interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.
Average Balances, Income and Expenses, Yields and Rates
                                                                         
    Year Ended Dec. 31, 2010     Year Ended Dec. 31, 2009     Year Ended Dec. 31, 2008  
            Average     Amount             Average     Amount             Average     Amount  
    Average     Yield or     Paid or     Average     Yield or     Paid or     Average     Yield or     Paid or  
    Amount     Rate     Earned     Amount     Rate     Earned     Amount     Rate     Earned  
    (Dollars in thousands)  
ASSETS
                                                                       
Interest-earning assets:
                                                                       
Loans
  $ 925,923       5.80 %   $ 53,707     $ 986,305       5.70 %   $ 56,196     $ 952,800       6.46 %   $ 61,568  
Investments
                                                                       
Taxable
    420,774       3.49 %     14,680       273,834       4.88 %     13,376       239,253       5.38 %     12,875  
Tax-exempt
    26,402       4.17 %     1,101       20,969       4.32 %     906       16,266       4.40 %     716  
Federal funds sold
    4,847       0.19 %     9       22,322       0.13 %     29       29,916       1.57 %     470  
Interest-bearing deposits in other banks
    67,121       0.56 %     377       48,509       0.52 %     253       2,557       1.80 %     46  
 
                                                           
Total interest-earning assets
    1,445,067       4.84 %   $ 69,874       1,351,939       5.23 %   $ 70,760       1,240,792       6.10 %   $ 75,675  
 
                                                           
Cash and due from banks
    59,370                       49,848                       22,846                  
Premises and equipment
    30,473                       32,894                       33,584                  
Other
    65,110                       58,036                       34,581                  
Allowance for loan losses
    (24,660 )                     (15,830 )                     (13,419 )                
 
                                                                 
Total assets
  $ 1,575,360                     $ 1,476,887                     $ 1,318,384                  
 
                                                                 
 
                                                                       
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                       
Interest-bearing liabilities:
                                                                       
NOW accounts
  $ 307,820       0.99 %   $ 3,058     $ 187,250       0.95 %   $ 1,777     $ 147,227       1.46 %   $ 2,149  
Savings and money management accounts
    425,872       1.43 %     6,077       341,118       1.71 %     5,842       353,719       2.52 %     8,912  
Time deposits
    514,798       2.20 %     11,330       577,897       2.88 %     16,630       446,434       4.25 %     18,956  
Federal funds purchased / securities sold under repurchase agreements
    1,468       1.36 %     20       40,823       0.80 %     327       60,629       2.17 %     1,317  
Other borrowings
    93,951       3.74 %     3,513       103,238       3.78 %     3,907       98,741       4.21 %     4,155  
 
                                                           
Total interest-bearing liabilities
    1,343,909       1.79 %     23,998       1,250,326       2.28 %     28,483       1,106,750       3.21 %     35,489  
 
                                                           
Noninterest-bearing demand deposits
    118,926                       114,835                       109,818                  
Other liabilities
    11,806                       10,966                       12,479                  
Stockholders’ equity
    100,719                       100,760                       89,337                  
 
                                                                 
Total liabilities and stockholders’ equity
  $ 1,575,360                     $ 1,476,887                     $ 1,318,384                  
 
                                                                 
 
                                                                       
Net interest spread
            3.05 %                     2.95 %                     2.89 %        
Benefit of noninterest sources
            0.13 %                     0.17 %                     0.35 %        
Net interest margin/income
            3.18 %   $ 45,876               3.12 %   $ 42,277               3.24 %   $ 40,186  
 
                                                                 

 

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2010 compared with 2009:
Interest earning asset yields declined 39 basis points while interest bearing liability rates declined 49 basis points. As a result the Company’s average interest rate spread improved to 3.05% in 2010 as compared to 2.95% in 2009. The year over year decline in asset yields and liability costs were a result of lower market interest rates. These factors contributed to a small improvement in the net interest margin from 3.12% in 2009 to 3.18% in 2010.
The increase in average investments of $152,373 and average interest bearing deposits in other banks of $18,612 were funded primarily by increases in average interest bearing deposits of $142,225 and decreases in average loans of $60,382. For 2010, average total assets were $1,575,360, a 6.67% increase over 2009. Average interest-earning assets for 2010 were $1,445,067, or 91.73% of average total assets.
Interest income is the largest contributor to income. Interest income on loans, including loan fees, decreased $2,489 from 2009 to $53,707 in 2010. The decline was driven principally by lower average balances of loans offset in part by a 10bp increase in average yield. The average yield increased in part due to lower levels of interest reversals on non accruing loans. Average non-accrual loans decreased $7,426 from $38,651 in 2009 to $31,225 in 2010. Also, the reversal of interest income on loans placed on non-accrual declined from $1,302 in 2009 to $686 for the year ended 2010. If these non-accrual loans had been accruing interest under their original terms, approximately $1,204 in 2010 and $2,377 in 2009 would have been recognized in earnings. Interest income on investments increased $1,499 or 10.50% to $15,781 in 2010. Average investment balances increased $152,373 or 51.69% but the effect on income was substantially reduced due to a decline in the average portfolio yield. The average yield on the taxable investment portfolio declined from 4.88% in 2009 to 3.49% in 2010. Market yields available on high quality investments made during the year were lower in 2010 and were impacted by the investment of funds from increased deposits, maturities of investments coupled with funds reinvested from the liquidation of certain securities based on asset liability strategies. Average yields on interest-earning assets were 4.84% in 2010, compared to 5.23% in 2009.
Interest expense on deposits decreased $3,784 from 2009 to $20,465 in 2010. Declining interest rates paid on deposits more than offset the additional interest due to growth. The mix of interest bearing deposits also affects the interest rate spread. During 2010 the proportion of higher cost time deposits as a percent of interest bearing liabilities decreased from 46.22% to 38.31% while lower cost money management, savings and checking accounts increased from 42.26% to 54.59%. The overall result was an increase in net interest income of $3,599 or 8.51% in 2010 over 2009.
A key performance measure for net interest income is the “net interest margin”, or net interest income divided by average interest-earning assets. Unlike the “net interest spread” (the difference between interest rates earned on assets and interest rates paid on liabilities), the net interest margin is affected by the level of non-interest sources of funding used to support interest-earning assets. The Company’s net interest spread increased 10bp to 3.05% in 2010 while the net interest margin increased 6bp from 3.12% in 2009 to 3.18% in 2010. The net interest margin increase was slightly smaller than the increase in spread in 2010 due to the benefit of noninterest sources decreasing from 0.17% in 2009 to 0.13% in 2010 reflecting the reduced benefit of such balances in the net interest margin. The high level of competition in the local market for both loans and particularly deposits continues to influence the net interest margin. The net interest margin continues to be supported by demand deposits which provide a noninterest-bearing source of funds. The Company continues to focus on demand deposits and NOW accounts to help prevent further deterioration in the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing sources of funds. The net interest spread eliminates the impact of noninterest-bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in interest rates in 2010, the net interest spread increased 10 basis points to 3.05% in 2010.

 

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2009 compared with 2008:
Interest earning asset yields declined sharply in 2009 compared to 2008, decreasing 87 basis points while interest bearing liability rates declined 93 basis points. As a result the Company’s average interest rate spread improved slightly to 2.95% in 2009 as compared to 2.89% in 2008. The year over year decline in asset yields and liability costs were a result of decreased market interest rates coupled with an increased level of liquidity. The Federal Reserve Board decreased its target Federal Funds rate seven times totaling 400 basis points during 2008. As a result, the prime interest rate dropped from 7.25% at year end 2007 to 3.25% at year end 2008. A significant portion of the Company’s loan portfolio adjusts immediately to these changes in rates while deposit liabilities typically lag. In addition, the yield on federal funds sold declined 144 basis points and negatively impacted overall asset yields. These factors contributed to the net interest margin declining from 3.24% in 2008 to 3.12% in 2009.
The increase in average loans of $33,505, average investments of $39,284, average interest bearing deposits in other banks of $45,952 and average cash and due from banks of $27,002 were funded by increases in average interest bearing deposits of $158,885 and other borrowings of $4,497, offset in part by decreases in federal funds purchased and securities sold under repurchase agreements of $19,806. For 2009, average total assets were $1,476,887, a 12.02% increase over 2008. Average interest-earning assets for 2009 were $1,351,939, or 91.54% of average total assets.
Interest income is the largest contributor to income. Interest income on loans, including loan fees, decreased $5,372 from 2008 to $56,196 in 2009. Declining interest rates accounted for approximately $7,264 reduction in interest but was offset by approximately $2,164 due to increased average balances of loans. Also affecting the overall yield on loans was an increase in average non-accrual loans of approximately $15,951 in 2009. Loans placed on non-accrual resulted in the reversal of interest income of $1,302 for the year ended 2009 and $1,003 in 2008. If these non-accrual loans had been accruing interest under their original terms, approximately $2,377 in 2009 and $1,561 in 2008 would have been recognized in earnings. Interest income on investments increased $691 to $14,282 primarily as a result of higher average balances partially offset by lower investment yields in 2009. The average yield on the taxable investment portfolio declined from 5.38% in 2008 to 4.88% in 2009 and accounted for $1,185 in decreased interest in 2009. Market yields available on high quality investments made during the year were lower in 2009 and were impacted by the investment of funds from increased deposits, maturities of investments coupled with funds reinvested from the liquidation of certain securities based on asset liability strategies. Interest income on federal funds sold decreased as the average yield declined from 1.57% in 2008 to 0.13% in 2009. Average yields on interest-earning assets were 5.23% in 2009, compared to 6.10% in 2008.
Interest expense on deposits decreased $5,768 from 2008 to $24,249 in 2009. Declining interest rates paid on deposits more than offset the additional interest due to growth. The mix of interest bearing deposits also affects the interest rate spread. During 2009 the proportion of higher cost time deposits as a percent of interest bearing liabilities increased from 40.34% to 46.22% while lower cost money management and savings accounts decreased from 31.96% to 27.28%. The overall result was an increase in net interest income of $2,091 or 5.20% in 2009 from 2008.

 

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In 2009, the Company’s net interest margin decreased to 3.12% from 3.24% in 2008. The net interest margin deteriorated in 2009 as the benefit of noninterest sources decreased from 0.35% in 2008 to 0.17% in 2009 reflecting the reduced benefit of such balances in the net interest margin. The 2009 net interest spread of 2.95% increased 6 basis points from 2008 as a result of changes in interest rates.
Changes in the 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 rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits. The following table: “Analysis of Changes in Net Interest Income” indicates the changes in the Company’s net interest income as a result of changes in volume and rate from 2010 to 2009, and 2009 to 2008. The analysis of changes in net interest income included in the following table indicates that on an overall basis in 2010 to 2009, the increase in the balances or volumes of interest-earning assets created a positive impact in net income. This was somewhat offset by the impact of increased volumes of interest-bearing liabilities. The rate environment of 2010 resulted in significant rate decreases on interest-earning assets and interest-bearing liabilities. In 2009 to 2008, the increase in the balances or volumes of interest-earning assets created a positive impact in net income which was partially offset by the impact of increased volumes of interest-bearing liabilities. Declining rates in 2009 resulted in rate decreases on interest-earning assets and interest-bearing liabilities.
Analysis of Changes in Net Interest Income
                                                                 
    2010 vs. 2009     2009 vs. 2008  
    Increase (Decrease)     Increase (Decrease)  
    Average     Average                     Average     Average              
    Volume     Rate     Combined     Total     Volume     Rate     Combined     Total  
    (Dollars in thousands)     (Dollars in thousands)  
Interest-earning assets:
                                                               
 
                                                               
Loans
  $ (3,440 )   $ 1,013     $ (62 )   $ (2,489 )   $ 2,164     $ (7,264 )   $ (272 )   $ (5,372 )
Investments, taxable
  $ 7,177     $ (3,822 )   $ (2,051 )     1,304       1,860       (1,185 )     (174 )     501  
Investments, tax-exempt
  $ 235     $ (32 )   $ (8 )     195       207       (13 )     (4 )     190  
Federal funds sold
  $ (23 )   $ 13     $ (10 )     (20 )     (119 )     (342 )     86       (375 )
Interest-bearing deposits in other banks
  $ 97     $ 19     $ 8       124       827       (36 )     (650 )     141  
 
                                               
Total
  $ 4,046     $ (2,809 )   $ (2,123 )   $ (886 )   $ 4,939     $ (8,840 )   $ (1,014 )   $ (4,915 )
 
                                               
 
                                                               
Interest-bearing liabilities:
                                                               
 
                                                               
NOW accounts
  $ 1,144     $ 83     $ 54     $ 1,281     $ 584     $ (752 )   $ (204 )   $ (372 )
Savings and money management accounts
  $ 1,451     $ (974 )   $ (242 )     235       (318 )     (2,857 )     104       (3,071 )
Time deposits
  $ (1,816 )   $ (3,911 )   $ 427       (5,300 )     5,587       (6,127 )     (1,785 )     (2,325 )
Federal funds purchased / securities sold under repurchase agreements
  $ (315 )   $ 229     $ (221 )     (307 )     (430 )     (829 )     269       (990 )
Other borrowings
  $ (351 )   $ (47 )   $ 4       (394 )     189       (420 )     (17 )     (248 )
 
                                               
Total
  $ 113     $ (4,620 )   $ 22     $ (4,485 )   $ 5,612     $ (10,985 )   $ (1,633 )   $ (7,006 )
 
                                               
 
                                                               
Change in net interest income
                          $ 3,599                             $ 2,091  
 
                                                           
The variances for each major category of interest-earning assets and interest-bearing liabilities are attributable to (a) changes in volume (changes in volume times prior year rate), (b) changes in rate (changes in rate times prior year volume) and (c) combined (changes in rate times the change in volume).

 

41


 

Provision for Loan Losses
The provision for loan losses is the charge to operating earnings necessary to maintain the allowance for loan losses at a level which, in management’s estimate, is adequate to cover the estimated amount of probable incurred losses in the loan portfolio. The provision for loan losses totaled $15,801 for the year ended December 31, 2010 compared to $30,904 for the year ended December 31, 2009. See “Allowance for Loan Losses” for further analysis of the provision for loan losses.
Noninterest Income
Noninterest income consists of revenues generated from a broad range of financial services and activities, including service charges on deposit accounts, gain on sales of loans, fee-based services, and products where commissions are earned through sales of products such as real estate mortgages, retail investment services, trust services, and other activities. In addition, increases in cash surrender value of bank-owned life insurance, gain on sale of fixed assets, other-than-temporary losses and gains or losses realized from the sale of investment securities are included in noninterest income.
2010 compared with 2009:
Noninterest income for 2010 was $21,086, an increase of $347 or 1.67% from 2009. The net increase was the result of several offsetting factors. Net investment securities gains declined $1,261 or 49.80% primarily due to reduced sales activity in 2010. Net impairment losses declined $879 or 90.15% due primarily to large impairments recognized in 2009. Retail investment income increased $487 or 41.45% due to increased brokerage activity in 2010. Gain on sales of loans increased $131 or 1.54% and trust service fees increased $88 or 8.46% both due to increased volume. Service charges and fees on deposits declined $125 or 1.77%. The reduced level of service charges was primarily due to decreases in NSF income on retail checking accounts resulting from decreased economic activity.
2009 compared with 2008:
Noninterest income for 2009 was $20,739, an increase of $4,034 or 24.15% from 2008. Gain on sales of loans increased $2,746 as falling rates caused an increase in mortgage refinance activity coupled with improved pricing. Investment securities gains increased $2,609 due to increased sales of investments which occurred in part to asset liability strategies during the year. These increases were partially offset by other-than-temporary impairment losses of $975 and reduced service charges and fees on deposits of $240. The reduced level of service charges was primarily due to lower returned check fees resulting from decreased economic activity.

 

42


 

The following table presents the principal components of noninterest income for the last three years:
Noninterest Income
                         
    Year Ended December 31,  
    2010     2009     2008  
    (Dollars in thousands)  
Service charges and fees on deposits
  $ 6,926     $ 7,051     $ 7,291  
Gain on sales of loans
    8,624       8,493       5,747  
Gain (loss) on sale of fixed assets, net
    26       (15 )     8  
Investment securities gains (losses), net of OTTI
    1,175       1,557       (77 )
Retail investment income
    1,662       1,175       1,096  
Trust service fees
    1,128       1,040       1,134  
Increase in cash surrender value of bank-owned life insurance
    931       880       708  
Miscellaneous income
    614       558       798  
 
                 
Total noninterest income
  $ 21,086     $ 20,739     $ 16,705  
 
                 
 
                       
Noninterest income as a percentage of total average assets
    1.34 %     1.40 %     1.27 %
 
                       
Noninterest income as a percentage of total income
    23.18 %     22.67 %     18.08 %
Noninterest Expense
2010 compared with 2009:
Noninterest expense totaled $41,815 in 2010, a decrease of $4,696 or 10.10% over 2009.
The significant decrease in noninterest expense in 2010 primarily resulted from decreased losses on sales of other real estate which decreased $4,719. The higher levels in 2009 were due to a bulk sale of ORE assets. During the fourth quarter of 2009, management became concerned with declining real estate values on foreclosed properties and concluded that liquidation of a significant portion of such assets was necessary to avoid further value declines
Salaries and other personnel expense increased $928 or 4.12% due primarily to increased incentive compensation accruals of $493, a $177 increase in commissions paid due to higher retail investment and trust commissions, an increase in group insurance costs of $204 offset in part by a $212 decrease in salaries expense due to a small decline in average full time equivalent employees. In addition, no merit increases were granted for officer level and above in 2010.
FDIC insurance expense decreased $455 or 16.71% due primarily to a special assessment of $670 levied in 2009. Occupancy expense decreased $110 in 2010 due primarily to reduced maintenance and lease contracts as a result of cost control initiatives. Loan costs remained elevated at $954 an increase of $37 over the prior year due primarily to continued expense associated with problem asset resolution and foreclosed properties.
2009 compared with 2008:
Noninterest expense totaled $46,511 in 2009, an increase of $9,759 or 26.55% over 2008.

 

43


 

The significant increase in noninterest expense in 2009 was from losses on sales of other real estate which increased $5,804 and a $588 valuation allowance established based on recent appraisals. The increase was due primarily to aggressive liquidation of such assets in the fourth quarter. Proceeds from sales of other real estate totaled $5,753 and a loss of $5,225 was recorded on those sales.
Salaries and other personnel expense increased $1,682 or 8.06% due primarily to a $795 increase in accruals to the Company’s non-qualified defined benefit plan, due to a reduction in the discount rate and newly added participants, and a $787 increase in retail investment and trust commissions.
FDIC insurance expense increased $1,825 or 203.14% due primarily to a special assessment of $670 and increased assessment rates. Occupancy expense increased $317 in 2009 due primarily to depreciation expense on purchases of upgraded computer systems and software. Loan costs increased $322 primarily related to the increase in expense from foreclosed properties.
The Company continues to monitor expenditures in all organizational units by utilizing specific cost-accounting and reporting methods as well as responsibility center budgeting. The following table presents the principal components of noninterest expense for the years ended December 31, 2010, 2009 and 2008.
Noninterest Expense
                         
    Year Ended December 31,  
    2010     2009     2008  
    (Dollars in thousands)  
 
                       
Salaries and other personnel expense
  $ 23,462     $ 22,534     $ 20,852  
Occupancy expense
    4,581       4,691       4,373  
Marketing & business development
    1,237       1,451       1,668  
Processing expense
    1,540       1,733       1,917  
Legal and professional fees
    1,657       1,552       1,763  
Data processing expense
    1,401       1,265       1,203  
FDIC insurance
    2,268       2,723       898  
(Gain) loss on sale of other real estate
    (299 )     5,741       (63 )
Other real estate valuation allowance
    1,909       588        
Loan costs
    954       917       658  
Supplies expense
    660       604       763  
Other expense
    2,445       2,712       2,720  
 
                 
Total noninterest expense
  $ 41,815     $ 46,511     $ 36,752  
 
                 
 
                       
Noninterest expense as a percentage of total average assets
    2.65 %     3.15 %     2.79 %
 
                       
Operating efficiency ratio
    63.59 %     75.66 %     64.52 %
The Company’s efficiency ratio (noninterest expense as a percentage of net interest income and noninterest income, excluding gains and losses on the sale of investments) decreased to 63.59% in 2010 compared to 75.66% in 2009, and 64.52% in 2008.

 

44


 

Income Taxes
Income tax expense totaled $2,490 in 2010 compared to a benefit of $6,414 in 2009. The effective tax rate as a percentage of pre-tax income was 26.64% in 2010, 44.54% in 2009, and 31.63% in 2008.
At December 31, 2010, the Company maintains net deferred tax assets of $14,595. ASC 740-30-25 provides accounting guidance for determining when a company is required to record a valuation allowance on it deferred tax assets. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset. In making this assessment, all sources of taxable income available to realize the deferred tax asset are considered including taxable income in prior carry-back years, future reversals of existing temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards. Based on management’s assessment, no valuation allowance was deemed necessary at December 31, 2010.
The Company has no net operating loss carryforwards. The Company was able to carryback both the federal and state net operating losses (NOLs) sustained in 2009. These carrybacks generated a federal tax refund of $2,755 that was received in the first quarter of 2010 and a state tax refund of $495 that had not been received as of year end.
The Company was also able to carryback a capital loss sustained in 2009. This carryback generated a tax refund of $226, which was received in the second quarter of 2010.
Financial Condition
Composition of the Loan Portfolio
Loans are the primary component of the Company’s interest-earning assets and generally are expected to provide higher yields than the other categories of earning assets. Those higher yields reflect the inherent credit risks associated with the loan portfolio. Management attempts to control and balance those risks with the rewards associated with higher returns.
Loans outstanding averaged $902,346 in 2010 compared to $965,111 in 2009 and $934,512 in 2008. At December 31, 2010, loans totaled $874,095 compared to $937,489 at December 31, 2009, a decrease of $63,394 or 6.76%.
The Company experienced significant decreases in loan volumes and balances during 2009 and 2010 as the economy continued to worsen and as the Company worked through problem acquisition development and construction loans (“ADC loans”). ADC loans declined $87,650 or 32.46% in 2010. Partially offsetting this decline was an increase in commercial and residential real estate loans which increased $4,594 and $10,277 or 1.42% and 6.97% respectively in 2010.

 

45


 

The following table sets forth the composition of the Company’s loan portfolio as of December 31st for the past five years. The Company’s loan portfolio does not contain any concentrations of loans exceeding 10% of total loans which are not otherwise disclosed as a category of loans in this table. The Company has not invested in loans to finance highly-leveraged transactions (“HLT”), such as leveraged buy-out transactions, as defined by the Federal Reserve and other regulatory agencies. Loans made by a bank for recapitalization or acquisitions (including acquisitions by management or employees) which result in a material change in the borrower’s financial structure to a highly-leveraged condition are considered HLT loans. The Company had no foreign loans or loans to lesser-developed countries as of December 31st of any of the years presented.
Loan Portfolio Composition
                                                                                 
    December 31,  
    2010     2009     2008     2007     2006  
    Amount     %     Amount     %     Amount     %     Amount     %     Amount     %  
    (Dollars in thousands)  
Commercial financial and agricultural
  $ 189,128       21.64 %   $ 173,974       18.56 %     171,883       17.42 %   $ 144,167       16.54 %   $ 128,661       17.50 %
 
                                                           
Real estate
                                                                               
Commercial
    327,458       37.46 %     322,864       34.44 %     266,362       26.99 %     236,358       27.12 %     198,453       27.00 %
Residential
    157,680       18.04 %     147,403       15.72 %     150,724       15.27 %     139,764       16.05 %     110,705       15.06 %
Acquisition, development and construction
    182,412       20.87 %     270,062       28.81 %     369,731       37.47 %     318,438       36.54 %     266,875       36.30 %
 
                                                           
Total real estate
    667,550       76.37 %     740,329       78.97 %     786,817       79.73 %     694,560       79.71 %     576,033       78.36 %
 
                                                           
Lease financing
    0       0.00 %     0       0.00 %     33       0.00 %     37       0.00 %     116       0.02 %
Consumer
                                                                               
Direct
    15,643       1.79 %     20,507       2.19 %     24,272       2.46 %     25,569       2.93 %     24,146       3.28 %
Indirect
    899       0.10 %     1,898       0.20 %     3,319       0.34 %     4,237       0.49 %     6,232       0.85 %
Revolving
    870       0.10 %     836       0.09 %     905       0.09 %     3,819       0.44 %     843       0.12 %
 
                                                           
Total consumer
    17,412       1.99 %     23,241       2.48 %     28,496       2.89 %     33,625       3.86 %     31,221       4.25 %
 
                                                           
Deferred loan origination costs (fees)
    5       0.00 %     (55 )     (0.01 %)     (398 )     (0.04 %)     (949 )     (0.11 %)     (919 )     (0.13 %)
 
                                                           
Total
  $ 874,095       100.00 %   $ 937,489       100.00 %   $ 986,831       100.00 %   $ 871,440       100.00 %   $ 735,112       100.00 %
 
                                                           
Loans may be periodically renewed with principal reductions and appropriate interest rate adjustments. Loan maturities as of December 31, 2010 are set forth in the following table based upon contractual terms. Actual cash flows may differ as borrowers generally have the right to prepay without prepayment penalties.
Loan Maturity Schedule
At December 31, 2010
                                 
    Within     One to Five     After Five        
    One Year     Years     Years     Total  
    (Dollars in thousands)  
Commercial, financial and agricultural
  $ 113,399     $ 69,087     $ 6,642     $ 189,128  
Real Estate
                               
Commercial
    125,022       195,278       7,158       327,458  
Residential
    61,914       77,728       18,038       157,680  
Acquisition, development and construction
    146,052       35,256       1,104       182,412  
Consumer
    8,964       8,227       221       17,412  
Deferred loan origination fees
    5                   5  
 
                       
Total loans
  $ 455,356     $ 385,576     $ 33,163     $ 874,095  
 
                       
The following table presents an interest rate sensitivity analysis of the Company’s loan portfolio as of December 31, 2010. The loans outstanding are shown in the time period where they are first subject to repricing.

 

46


 

Sensitivity of Loans to Changes in Interest Rates
At December 31, 2010
                                 
    Within     One to Five     After Five        
    One year     Years     Years     Total  
    (Dollars in thousands)  
Loans maturing or repricing with:
                               
Predetermined interest rates
  $ 224,090     $ 304,679     $ 12,339     $ 541,108  
Floating or adjustable interest rates
    322,126       9,916       945       332,987  
 
                       
Total loans
  $ 546,216     $ 314,595     $ 13,284     $ 874,095  
 
                       
Non-Performing Assets
As a result of management’s ongoing review of the loan portfolio, loans are classified as nonaccrual when it is not reasonable to expect collections of interest and principal under the original terms, generally when a loan becomes 90 days or more past due. These loans are classified as nonaccrual, even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. When a loan is placed on nonaccrual, the interest which has been accrued but remains unpaid is reversed and deducted from current period interest income. No additional interest is accrued and recognized as income on the loan balance until the collection of both principal and interest becomes reasonably certain. Also, there may be write downs, and ultimately, the total charge-off of the principal balance of the loan, which could necessitate additional charges to earnings through the provision for loan losses.
If non accruing loans had been accruing interest under their original terms, approximately $1,204 in 2010, $2,377 in 2009 and $1,561 in 2008 would have been recognized as earnings.
The Company is required to identify impaired loans and evaluate the collectability of both contractual interest and principal of loans when assessing the need for a loss allowance. Large pools of smaller balance homogeneous loans are collectively evaluated for impairment. A loan is considered impaired, when based upon 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 note agreement. The amount of the impairment is measured based on the present value of future cash flows discounted at the loan’s effective interest rate or, if the loan is collateral dependent or foreclosure is probable, the fair value of collateral, less estimated selling expenses. Regulatory guidance is also considered. At December 31, 2010 and 2009, the Company had impaired loans of $25,048 and $34,667, respectively. Allowances for losses on impaired loans totaled $1,474 on balances of $14,369 and $1,979 on balances of $24,276, respectively at December 31, 2010 and 2009. Charge-offs of $6,155 were taken on these impaired loans during 2010. The amount of impaired loans, for which there is no related allowance for credit losses, totaled $10,679 and $10,391 at December 31, 2010 and 2009, respectively. Impaired loans for which there is no related allowance for credit losses are secured by collateral with fair value less estimated selling expenses in excess of the carrying amount of the loan.
Non-performing assets include nonaccrual loans, loans past due 90 days or more, restructured loans and other real estate owned. The following table, “Non-Performing Assets”, presents information on these assets as of December 31st, for the past five years. Non-performing assets were $34,000 at December 31, 2010 or 3.86% of period end loans and other real estate owned. This compares to $40,231 or 4.26% of total loans and other real estate owned at December 31, 2009.

 

47


 

At December 31, 2010 and 2008 there were $69 and $7,298, respectively of loans past due 90 days or more and still accruing. There were no loans past due 90 days or more and still accruing at December 31, 2009, 2007 and 2006. All loans past due 90 days or more are classified as nonaccrual loans unless the loan officer believes that both principal and interest are collectible, in which case the loan continues to accrue interest.
Troubled debt Restructurings (TDRs) are troubled loans on which the original terms have been modified in favor of the borrower or either principal or interest has been forgiven due to deterioration in the borrower’s financial condition. There were $3,514 in TDRs at December 31, 2010, of which $970 were on nonaccrual status. TDRs totaled $1,656 at December 31, 2009 and are included under nonaccrual loans in the table below
Non-Performing Assets
                                         
    Year Ended December 31,  
    2010     2009     2008     2007     2006  
    (Dollars in thousands)  
Nonaccrual loans:
                                       
Commercial, financial and agricultural
  $ 2,924     $ 962     $ 449     $ 359     $ 112  
Real Estate:
                                       
Commercial
    3,793       2,932       3,491       1,440       1,028  
Residential
    4,734       4,277       2,627       887       776  
Acquisition, development and construction
    11,953       23,755       27,908       2,261       205  
Consumer
    301       331       306       548       230  
 
                             
Total Nonaccrual loans
  $ 23,705     $ 32,257     $ 34,781     $ 5,495     $ 2,351  
 
                             
Restructured loans (1)
  $ 2,544     $     $     $     $  
Other real estate owned
    7,751       7,974       5,734              
 
                             
Total Nonperforming assets
  $ 34,000     $ 40,231     $ 40,515     $ 5,495     $ 2,351  
 
                             
 
                                       
Loans past due 90 days or more and still accruing interest
  $ 69     $     $ 7,298     $     $  
 
                             
 
                                       
Allowance for loan losses to period end total loans
    3.05 %     2.38 %     1.49 %     1.35 %     1.33 %
Allowance for loan losses to period end nonaccrual loans
    112.45 %     69.25 %     42.39 %     214.74 %     415.87 %
Net charge-offs to average loans
    1.27 %     2.42 %     0.65 %     0.22 %     0.17 %
Nonperforming assets to period end loans
    3.89 %     4.29 %     4.11 %     0.63 %     0.32 %
Nonperforming assets to period end loans and other real estate owned
    3.86 %     4.26 %     4.08 %     0.63 %     0.32 %
     
(1)  
Restructured loans on nonaccrual status at year end are included under nonaccrual loans in the table.

 

48


 

The net decrease in nonaccrual loans reflects decreased levels of acquisition, development and construction loans offset in part by an increase in nonaccrual commercial and commercial real estate loans. The table below provides additional detail on loans greater than $800 at December 31, 2010.
                                                 
                Nonaccrual                       Appraisal   Appraised  
    Balance     Originated   Date   Trigger   Collateral   Allowance     Method   Date   Value  
    (Dollars in thousands)  
 
 
Commercial Real Estate
  $ 1,268     04/08/08   03/30/10   delinquency   equipment, land & stock   $ 175     collateral value   05/10   $ 1,277  
1-4 Family Residential
    1,086     05/08-06/08   12/14/10   financial condition   houses & land         collateral value   In Process     1,828  
ADC Loan — Savannah, Georgia
    1,568     09/30/08   05/06/10   delinquency   lots & land     175     collateral value   06/10     1,650  
ADC Loan — CSRA
    1,009     03/07-04/08   11/30/09   delinquency   lots & land         collateral value   03/10     1,201  
1-4 Family Residential
    982     01/08-09/08   11/09-09/10   delinquency   houses         collateral value   03/10     2,348  
Farmland & Equity lines
    1,158     09/18/08   11/10-12/10   financial condition   house & land         collateral value   11/10 - 12/10     2,328  
1-4 Family Residential
    805     04/19/07   06/21/10   financial condition   house         collateral value   08/10     895  
ADC Loan — CSRA
    3,157     8/06 - 11/07   08/17/09   delinquency   lots & land         collateral value   09/09 - 09/10     5,586  
ADC Loan — Athens, Georgia
    1,130     09/07/07   12/16/10   financial condition   lots & land         collateral value   03/10     2,079  
ADC Loan — Athens, Georgia
    1,940     08/06-01/07   01/28/09   delinquency   land & townhomes         collateral value   02/09 - 09/10     2,415  
 
                                             
 
  $ 14,103                                          
Other, net
    9,602                                          
 
                                             
 
                                               
Nonaccrual loans at December 31, 2010
  $ 23,705                                          
 
                                             
The table below presents a roll forward of other real estate owned for the twelve month period ended December 31, 2010 and 2009, respectively.
Other Real Estate Owned
                 
    2010     2009  
    (Dollars in thousands)  
 
               
Beginning balance, January 1
  $ 7,974     $ 5,734  
Additions
    9,395       20,752  
Increase in valuation allowance
    (1,909 )     (588 )
Sales
    (8,008 )     (12,183 )
Gain (loss) on sale of OREO
    299       (5,741 )
 
           
Ending balance, December 31
  $ 7,751     $ 7,974  
 
           
The following table provides details of other real estate owned as of December 31, 2010 and 2009, respectively.
                 
    2010     2009  
    (Dollars in thousands)  
Other Real Estate:
               
Single family developed lots
  $ 2,109     $ 724  
Residential land
    196        
1-4 Family residential
    1,608       484  
Commercial real estate
    3,126       4,468  
Condominums
    2,827       2,886  
 
           
 
    9,866       8,562  
 
               
Valuation allowance
    (2,115 )     (588 )
 
           
 
               
 
  $ 7,751     $ 7,974  
 
           
The net decrease in other real estate owned is due to the continuing process of resolving problem loans.

 

49


 

Potential Problem Loans
In addition to loans disclosed above as past due, nonaccrual and restructured as of December 31, 2010, management also identified further weaknesses in $28,829 of already classified loans. These loans, principally classified for regulatory purposes as substandard, are principally commercial real estate and ADC loans in the company’s primary market area. Estimated potential losses from these potential credit weaknesses have been provided for in determining the allowance for loan losses at December 31, 2010.
Allowance for Loan Losses
The allowance for loan losses represents an allocation for the estimated amount of probable incurred losses in the loan portfolio. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
The Company’s Board of Directors, with the recommendation of management, approves the appropriate level for the allowance for loan losses based upon internal policies and procedures, historical loan loss ratios, loan volume, size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, value of the collateral underlying the loans, specific problem loans and present or anticipated economic conditions and trends. The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics.
For significant problem loans, management’s review consists of the evaluation of the financial condition and strengths of the borrower, cash flows available for debt repayment, related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual problem loan, management classifies the loan accordingly and allocates a portion of the allowance for loan losses for that loan based on the results of the evaluations described above.
Additions to the allowance for loan losses, which are expensed on the Company’s income statement as the “provision for loan losses”, are made periodically to maintain the allowance for loan losses at an appropriate level based upon management’s analysis of risk in loan portfolio. The Company’s provision for loan losses in 2010 was $15,801, a decrease of $15,103, or 48.87% from the 2009 provision of $30,904.
The Company’s approach to ALLL reserve calculation uses two distinct perspectives, the guidelines of using Financial Accounting Standards ASC 450 (Accounting for Contingencies) and ASC 310 (Accounting by Creditors for Impairment of a Loan, for individual loans). The process is generally as follows:
   
Loans are grouped accordingly in categories of similar risk characteristics (Portfolio segments).

 

50


 

   
For each loan category, a four year average rolling historical net loss rate is calculated, with the loss rate more heavily weighted to the most recent two years loss history. An emergence factor is then applied to the average historical net loss rate.
   
The historical loss ratios are adjusted for internal and external qualitative factors within each loan category. The qualitative factor adjustment may be further increased for loan classifications of watch rated and substandard within each category. Factors include:
   
levels and trends in delinquencies and impaired/classified/graded loans;
 
   
changes in the quality of the loan review system;
 
   
trends in volume and terms of loans;
 
   
effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;
 
   
experience, ability, and depth of lending management and other relevant staff;
 
   
national and local economic trends and conditions;
 
   
changes in the value of underlying collateral;
 
   
other external factors-competition, legal and regulatory requirements;
 
   
effects of changes in credit concentrations
   
The resultant loss factor is applied to each loan pool to calculate the ALLL for each loan pool.
The table below indicates the allocated allowance for all loans according to loan type determined through the Company’s comprehensive allowance methodology for the years indicated. Because these allocations are based upon estimates and subjective judgment, it is not necessarily indicative of the specific amounts or loan categories in which loan losses may occur.
Allocation of the Allowance for Loan Loss
                                                                                 
    December 31,  
    2010     2009     2008     2007     2006  
    Amount     Percent(1)     Amount     Percent(1)     Amount     Percent(1)     Amount     Percent(1)     Amount     Percent(1)  
    (Dollars in thousands)  
Balance at end of year Applicable to:
                                                                               
Commercial, financial, and agricultural
  $ 3,463       21.73 %   $ 1,442       18.21 %   $ 1,964       18.93 %   $ 1,760       17.73 %   $ 1,713       18.91 %
Real estate
                                                                               
Commercial
    8,698       37.50 %     5,709       33.10 %     2,565       26.92 %     2,483       28.67 %     2,547       25.04 %
Residential
    5,372       18.00 %     5,322       16.68 %     2,048       14.11 %     2,198       15.37 %     1,382       16.42 %
Acquisition, development and construction
    8,493       20.87 %     8,876       29.51 %     7,050       37.13 %     4,344       34.38 %     3,191       36.33 %
Consumer loans to individuals
    631       1.90 %     989       2.50 %     1,115       2.91 %     1,015       3.85 %     944       3.30 %
 
                                                           
Balance at end of year
  $ 26,657       100.00 %   $ 22,338       100.00 %   $ 14,742       100.00 %   $ 11,800       100.00 %   $ 9,777       100.00 %
     
(1)  
Percent of gross loans in each category to total loans adjusted for loans recorded at fair value
The allocation of the allowance for loan losses on commercial real estate loans increased $2,989 and was due in part to an increased level of classified/watch rated loans coupled with an increase in balances. The allocation of the allowance for loan losses for commercial, financial and agricultural loans increased $2,021 and was due in part to an increased level of classified/watch rated loans coupled with an increase in balances and charge offs during 2010.

 

51


 

In response to the economic environment, management ceased originating and participating in new out of market ADC lending opportunities, has curtailed ADC lending in its primary market and is allowing the portfolio segment to contract to reduce the Company’s near term exposure. Accordingly, in 2010, the total ADC portfolio declined $87,650 or 32.46%. In the CSRA, demand for origination of ADC loans was slow during 2010, and new loans were granted generally in pre-sold situations, or with those borrowers with longstanding superior credit relationships with the bank, having a limited number of speculative houses in inventory. The CSRA ADC portfolio declined $46,823 or 23.96%.
In 2010 charge offs declined for problem ADC loans in the Atlanta (ADC participations — Georgia), Savannah, Georgia and Athens, Georgia markets to $3,305 or 28.78% of net charge-offs. In 2009 these loans accounted for $16,427 or 70.48% of net charge-offs. Athens, GA ADC loans declined $8,853 or 44.20% to $11,178. Savannah, GA ADC loans declined $8,681 or 44.14% to $10,985. ADC participations — Georgia declined $3,393 or 34.30% to $6,500.
ADC loans in Greenville, SC experienced $1,344 in charge-offs in 2010. The charge offs related to a single borrower with upper end residential construction loans and land. The total loans in this category declined $18,911 or 91.87% to $1,673. Approximately $9,666 of the decrease was due to completed construction of an apartment complex which was reclassified to non-owner occupied commercial real estate. The loan is performing and is currently expected to be repaid upon the borrower obtaining permanent financing, or held in the portfolio. Approximately $2,625 of the decrease related to townhouses which were sold. Approximately $2,979 of the decrease related to land which was reclassified to OREO in the third quarter. In addition, approximately $1,375 of the decrease was due to completion of an office building which was reclassified to owner occupied commercial real estate. The loan is performing and currently expected to remain in the portfolio.
ADC loans in the CSRA experienced a higher level of charge-offs in 2010. Charge-offs totaled $3,270 or 28.48% of net charge-offs in 2010 compared to $725 of charge-offs or 3.11% of net charge-offs in 2009. Although the CSRA market has not experienced the same level of property value declines and delinquency as the previously identified markets it has been affected by the national recession. Management believes the local market has performed better due to several factors, including: (1) the level of military spending due to the ongoing expansion of the Army’s Fort Gordon and its missions, (2) the ongoing expansion and economic opportunities provided by the medical community around the state’s Medical College of Georgia, and (3) the reduced level of volatility shown in the Augusta/CSRA residential housing market. However, the CSRA has experienced a much higher than historical level of classified/watch rated loans as well as loans considered impaired. In addition, slow absorption on certain real estate developments has impacted property valuations. These factors, in addition to higher loss experience have contributed to an increase in the allowance.

 

52


 

The following table provides selected asset quality information related to the acquisition, development and construction loan portfolio as of December 31, 2010, 2009 and 2008.
Acquisition Development and Construction Loans
                         
    2010     2009     2008  
    (Dollars in thousands)  
CSRA — primary market area
                       
Period-end loans
    148,570       195,394       247,053  
Impaired loans
    4,492       11,278       5,187  
Classified/watch rated loans
    27,719       27,237       9,879  
Charge-offs % (annual)
    2.20 %     0.44 %     0.19 %
Specific reserve allowance / Impaired loans
    3.47 %     10.29 %     0.00 %
General reserve allowance / Loans not impaired %
    3.43 %     2.10 %     0.67 %
Allowance / Charge-offs
    1.56       6.94       4.78  
 
                       
Savannah, Georgia
                       
Period-end loans
    10,985       19,666       28,300  
Impaired loans
    2,066       1,300       2,645  
Classified/watch rated loans
    638       4,064       5,060  
Charge-offs % (annual)
    13.32 %     11.21 %     3.18 %
Specific reserve allowance / Impaired loans
    8.47 %     8.62 %     6.62 %
General reserve allowance / Loans not impaired %
    3.12 %     3.42 %     4.20 %
Allowance / Charge-offs
    0.31       0.34       1.39  
 
                       
Athens, Georgia
                       
Period-end loans
    11,178       20,031       31,806  
Impaired loans
    4,193       8,457       8,772  
Classified/watch rated loans
    1,439       2,742       13,667  
Charge-offs % (annual)
    3.38 %     47.59 %     1.78 %
Specific reserve allowance / Impaired loans
    0.00 %     0.00 %     12.04 %
General reserve allowance / Loans not impaired %
    11.40 %     10.68 %     3.97 %
Allowance / Charge-offs
    2.11       0.13       2.55  
 
                       
ADC Participations — Georgia
                       
Period-end loans
    6,500       9,893       21,676  
Impaired loans
          3,393       10,637  
Classified/watch rated loans
    6,500       6,500       48  
Charge-offs % (annual)
    22.52 %     47.41 %     8.88 %
Specific reserve allowance / Impaired loans
    0.00 %     20.81 %     4.09 %
General reserve allowance / Loans not impaired %
    15.00 %     9.50 %     9.55 %
Allowance / Charge-offs
    0.67       0.28       0.77  
 
                       
ADC Loans — Greenville
                       
Period-end loans
    1,673       20,584       19,103  
Impaired loans
    150              
Classified/watch rated loans
    821       2,351        
Charge-offs % (annual)
    17.33 %     0.00 %     0.00 %
Specific reserve allowance / Impaired loans
    0.00 %     0.00 %     0.00 %
General reserve allowance / Loans not impaired %
    18.65 %     1.18 %     0.65 %
Allowance / Charge-offs
    0.21              
 
                       
ADC Participations — Florida
                       
Period-end loans
    3,506       4,034       8,005  
Impaired loans
    3,506       1,034       3,650  
Classified/watch rated loans
                704  
Charge-offs % (annual)
    5.56 %     10.26 %     0.19 %
Specific reserve allowance / Impaired loans
    25.33 %     0.00 %     11.34 %
General reserve allowance / Loans not impaired %
    0.00 %     10.00 %     4.27 %
Allowance / Charge-offs
    4.55       0.72       2.00  

 

53


 

The following table provides details regarding charge-offs and recoveries by loan category during the most recent five year period, as well as supplemental information relating to both net loan losses, the provision and the allowance for loan losses during each of the past five years. Net charge-offs for 2010 represented 1.27% of average loans outstanding, compared to 2.42% for 2009 and 0.65% for 2008.
Allowances for Loan Losses
                                         
    At December 31,  
    2010     2009     2008     2007     2006  
    (Dollars in thousands)  
 
                                       
Total loans outstanding at end of period, net of unearned income
  $ 874,095     $ 937,489     $ 986,831     $ 871,440     $ 735,112  
 
                             
 
                                       
Average loans outstanding, net of unearned income
  $ 902,346     $ 965,111     $ 934,512     $ 800,852     $ 647,421  
 
                             
 
                                       
Balance of allowance for loan losses at beginning of year
  $ 22,338     $ 14,742     $ 11,800     $ 9,777     $ 8,431 (1)
 
                                       
Charge-offs:
                                       
Commercial, financial and agricultural
    1,139       1,120       885       146       652  
Real estate — commercial
    1,048       1,082       279       219       130  
Real estate — residential mortgage
    1,306       3,742       596       210       672  
Real estate — acquisition, development and construction
    8,656       17,573       4,265       915       100  
Consumer
    439       616       711       1,086       386  
 
                             
Total charge-offs
    12,588       24,133       6,736       2,576       1,940  
 
                             
 
                                       
Recoveries of previous loan losses:
                                       
Commercial, financial and agricultural
    234       363       348       23       292  
Real estate — commercial
    13       15             32       20  
Real estate — residential mortgage
    58       169       41       91       6  
Real estate — acquisition, development and construction
    543       6       2       12       6  
Consumer
    258       272       232       618       484  
 
                             
Total recoveries
    1,106       825       623       776       808  
 
                             
 
                                       
Net loan losses
    11,482       23,308       6,113       1,800       1,132  
Provision for loan losses
    15,801       30,904       9,055       3,823       2,478  
 
                             
Balance of allowance for loan losses at end of period
  $ 26,657     $ 22,338     $ 14,742     $ 11,800       9,777  
 
                             
 
                                       
Allowance for loan losses to period end loans
    3.05 %     2.38 %     1.49 %     1.35 %     1.33 %
Net charge-offs to average loans
    1.27 %     2.42 %     0.65 %     0.22 %     0.17 %
     
(1)  
Includes adjustment of $694 for estimated overstatement of allowance for loan loss as of 12/31/05 as required by SAB 108.
At December 31, 2010, the allowance for loan losses was 3.05% of outstanding loans, up from 2.38% at December 31, 2009 and 1.49% at December 31, 2008. Although net charge-offs decreased, the Company has continued to experience elevated levels of net charge-offs in the real estate construction and real estate mortgage categories in 2010. Impaired loans are evaluated based on recent appraisals of the collateral. Collateral values are monitored and further charge-offs are taken if it is determined that collateral values have continued to decline.

 

54


 

Management considers the allowance appropriate based upon its analysis of risk in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct. While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans. Because management evaluates such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required. See “Critical Accounting Estimates.”
Investment Securities
The Company’s investment securities portfolio increased $279,906 to $586,612 at year-end 2010 from 2009. The Company maintains an investment strategy of seeking portfolio yields within acceptable risk levels, as well as providing liquidity. The Company maintains two classifications of investments: “Held to Maturity” and “Available for Sale.” “Available for Sale” securities are carried at fair market value with related unrealized gains or losses included in stockholders’ equity as accumulated other comprehensive income, whereas the “Held to Maturity” securities are carried at amortized cost. As a consequence, with a higher percentage of securities being placed in the “Available for Sale” category, the Company’s stockholders’ equity is more volatile than it would be if a larger percentage of investment securities were placed in the “Held to Maturity” category. Although equity is more volatile, management has discretion, with respect to the “Available for Sale” securities, to proactively adjust to favorable market conditions in order to provide liquidity and realize gains on the sales of securities. The changes in values in the investment securities portfolio are not taken into account in determining regulatory capital requirements. As of December 31, 2010, except for the U.S. Government agencies and government sponsored entities, there was no issuer who represented 10% or more of stockholders’ equity within the investment portfolio. As of December 31, 2010 and 2009, the estimated fair value of investment securities as a percentage of their amortized cost was 99.38% and 99.30%, respectively. At December 31, 2010, the investment securities portfolio had gross unrealized gains of $4,998 and gross unrealized losses of $8,653, for a net unrealized loss of $3,655. As of December 31, 2009 and 2008, the investment securities portfolio had a net unrealized loss of $2,171 and a net unrealized gain of $81, respectively. The following table presents the amortized cost of investment securities held by the Company at December 31, 2010, 2009 and 2008.

 

55


 

Investment Securities
                         
    December 31,  
    2010     2009     2008  
    (Dollars in thousands)  
Available for sale:
                       
U.S. Government Agencies
  $ 202,153     $ 67,290     $ 109,256  
Obligations of states and political subdivisions
    67,137       26,402       17,384  
Mortgage-backed securities
                       
U.S. GSE’s MBS — residential
    141,524       87,113       117,373  
U.S. GSE’s CMO
    139,208       107,153       28,179  
Other CMO
    3,382       7,834       11,997  
Corporate bonds
    36,551       12,591       15,032  
Equity securities
    2       4       46  
 
                 
Total
  $ 589,957     $ 308,387     $ 299,267  
 
                 
                         
    December 31,  
    2010     2009     2008  
Held to maturity:
                       
Obligations of states and political subdivisions
  $ 310     $ 490     $ 689  
 
                 
Total
  $ 310     $ 490     $ 689  
 
                 
The following table represents maturities and weighted average yields of debt securities at December 31, 2010. Yields are based on the amortized cost of securities. Maturities are based on the contractual maturities. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

56


 

Maturity Distribution and Yields of Investment Securities
                 
    December 31, 2010  
    Amortized Cost     Yield  
    (Dollars in thousands)  
Available for Sale
               
Obligations of U.S. Government agencies
               
Over one through five years
    8,000       0.81 %
Over five through ten years
    64,081       2.14 %
Over ten years
    130,072       2.69 %
 
           
Total
  $ 202,153       2.44 %
 
           
 
               
Obligations of states and political subdivisions(1)
               
Over one through five years
  $ 2,258       3.99 %
Over five through ten years
    7,860       5.11 %
Over ten years
    57,019       5.34 %
 
           
Total
  $ 67,137       5.27 %
 
           
 
               
Corporate bonds
               
Over one through five years
  $ 8,454       4.08 %
Over five through ten years
  $ 12,478       3.43 %
Over ten years
    15,619       5.18 %
 
           
Total
  $ 36,551       4.32 %
 
           
 
               
U.S. GSE’s MBS — residential
               
Over five through ten years
  $ 4,855       4.45 %
Over ten years
    136,669       2.84 %
 
           
Total
  $ 141,524       2.90 %
 
           
 
               
U.S. GSE’s CMO
               
Over one through five years
  $ 1,054       5.26 %
Over five through ten years
  $ 3,933       4.80 %
Over ten years
    134,221       2.56 %
 
           
Total
  $ 139,208       2.64 %
 
           
 
               
Other CMO
               
Over five through ten years
  $ 516       4.90 %
Over ten years
    2,866       12.60 %
 
           
Total
  $ 3,382       11.73 %
 
           
 
               
Equity securities
  $ 2       0.00 %
 
           
 
               
Total Available for Sale
  $ 589,957       3.09 %
 
           
 
               
Held to Maturity
               
Obligations of states and political subdivisions(1)
               
Over one through five years
  $ 310       7.87 %
Total
  $ 310       7.87 %
 
           
 
               
Total Held to Maturity
  $ 310       7.87 %
 
           
 
               
Total Investment Securities
  $ 590,267       3.09 %
 
           
     
(1)  
Tax-equivalent yield

 

57


 

Deposits
The Company’s average interest bearing liabilities increased $93,583 or 7.48% from 2009 to 2010. Average noninterest-bearing deposits increased $4,091 or 3.56%. Average deposits increased $146,316 or 11.98% over 2009 and were net of a reduction of $72,144 in brokered deposits. Average borrowings decreased $48,642 or 33.76% from 2009 to 2010. The majority of the growth in deposits reflects the Company’s strategy of consistently emphasizing deposit growth, as deposits are the primary source of funding for balance sheet growth. Borrowed funds consist of short-term borrowings, securities sold under agreements to repurchase with the Company’s commercial customers and reverse repurchase agreements with SunTrust Robinson Humphrey and Center State Bank, federal funds purchased, subordinated debentures and borrowings from the Federal Home Loan Bank.
Average interest-bearing liabilities increased $143,576 or 12.97% from 2008 to 2009, while average noninterest-bearing deposits increased $5,017 or 4.57% during the same period.
The following table presents the average amount outstanding and the average rate paid on deposits and borrowings by the Company for the years 2010, 2009 and 2008:
Average Deposit and Borrowing Balances and Rates
                                                 
    Year ended December 31,  
    2010     2009     2008  
    Average     Average     Average     Average     Average     Average  
    Amount     Rate     Amount     Rate     Amount     Rate  
    (Dollars in thousands)  
Noninterest-bearing demand deposits
  $ 118,926       0.00 %   $ 114,835       0.00 %   $ 109,818       0.00 %
Interest-bearing liabilities:
                                               
NOW accounts
    307,820       0.99 %     187,250       0.95 %     147,227       1.46 %
Savings, money management accounts
    425,872       1.43 %     341,118       1.71 %     353,719       2.52 %
Time deposits
    514,798       2.20 %     577,897       2.88 %     446,434       4.25 %
Federal funds purchased / securities sold under repurchase agreements
    1,468       1.36 %     40,823       0.80 %     60,629       2.17 %
Other borrowings
    93,951       3.74 %     103,238       3.78 %     98,741       4.21 %
 
                                   
Total interest-bearing liabilities
  $ 1,343,909       1.79 %   $ 1,250,326       2.28 %   $ 1,106,750       3.21 %
 
                                   
 
                                               
Total noninterest & interest-bearing liabilities
  $ 1,462,835             $ 1,365,161             $ 1,216,568          
 
                                         
The following table presents the maturities of the Company’s time deposits over $100 at December 31, 2010:
Maturities of Time Deposits
         
    Time Certificates  
    of Deposit of  
    $100 or More  
    (Dollars in thousands)  
Months to Maturity
       
Within 3 months
  $ 79,527  
After 3 through 6 months
    59,674  
After 6 through 12 months
    75,391  
 
     
Within one year
    214,592  
After 12 months
    132,129  
 
     
 
       
Total
  $ 346,721  
 
     

 

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This table indicates that the majority of time deposits of $100 or more have a maturity of less than twelve months. This is reflective of both the Company’s market and recent interest rate environments. Large time deposit customers tend to be extremely rate sensitive, making these deposits a volatile source of funding for liquidity planning purposes. However, dependent upon pricing, these deposits are virtually always available in the Company’s market. At December 31, 2010, the Company had $93,901 of brokered certificates of deposit that mature after 12 months. The Company does not have any time deposits of $100 or more that are not certificates of deposit.
Off-Balance Sheet Arrangements
The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company follows the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Unfunded commitments to extend credit where contractual amounts represent potential credit risk totaled $136,194 and $174,894 at December 31, 2010 and 2009, respectively. These commitments are primarily at variable interest rates.
The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available for sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.
The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’ contractual obligations, consisting of deposits, FHLB advances and borrowed funds by contractual maturity date.
Commitments and Contractual Obligations
                                 
    Less than     1 - 3     3 - 5     More than  
    1 Year     Years     Years     5 Years  
    (Dollars in thousands)  
Lines of credit
  $ 136,194                    
Lease agreements
    310       233       86       26  
Deposits
    1,238,875       144,777       25,566       1,519  
Securities sold under repurchase agreements
    818                    
FHLB advances
    8,000       13,000             39,000  
Other borrowings
                       
Subordinated debentures
                2,947       20,000  
 
                       
Total commitments and contractual obligations
  $ 1,384,197       158,010       28,599       60,545  
 
                       

 

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Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.
Asset/Liability Management, Interest Rate Sensitivity and Liquidity
General. It is the objective of the Company to manage assets and liabilities to preserve the integrity and safety of the deposit and capital base of the Company by protecting the Company from undue exposure to poor asset quality and interest rate risk. Additionally, the Company pursues a consistent level of earnings as further protection for the depositors and to provide an appropriate return to stockholders on their investment.
These objectives are achieved through compliance with an established framework of asset/liability, interest rate risk, loan, investment, and capital policies. Management is responsible for monitoring policies and procedures that result in proper management of the components of the asset/liability function to achieve stated objectives. The Company’s philosophy is to support quality asset growth primarily through growth of core deposits, which include non-volatile deposits of individuals, partnerships and corporations. Management seeks to invest the largest portion of the Company’s assets in loans that meet the Company’s quality standards. Alternative investments are made in the investment portfolio. The Company’s asset/liability function and related components of liquidity and interest rate risk are monitored on a continuous basis by management. The Board of Directors reviews and monitors these functions on a monthly basis.
Interest Rate Sensitivity. The process of asset/liability management involves monitoring the Company’s balance sheet in order to determine the potential impact that changes in the interest rate environment would have on net interest income so that the appropriate strategies to minimize any negative impact can be implemented. The primary objective of asset/liability management is to continue the steady growth of net interest income, the Company’s primary earnings component within a context of liquidity requirements.
In theory, interest rate risk can be minimized by maintaining a nominal level of interest rate sensitivity. In practice, however, this is made difficult because of uncontrollable influences on the Company’s balance sheet, including variations in both loan demand and the availability of funding sources.
The measurement of the Company’s interest rate sensitivity is one of the primary techniques employed by the Company in asset/liability management. The dollar difference between assets and liabilities which are subject to interest rate repricing within a given time period, including both floating rate or adjustable instruments and instruments which are approaching maturity, determine the interest sensitivity gap.
The Company manages its sensitivity to interest rate movements by adjusting the maturity of, and establishing rates on, the interest-earning asset portfolio and interest-bearing liabilities in line with management’s expectations relative to market interest rates. The Company would generally benefit from increasing market interest rates when the balance sheet is asset sensitive and would benefit from decreasing market rates when it is liability sensitive. At December 31, 2010, the Company’s interest rate sensitivity position was liability sensitive within the one-year horizon.

 

60


 

The following table “Interest Sensitivity Analysis” details the interest rate sensitivity of the Company at December 31, 2010. The principal balances of the various interest-earning and interest-bearing balance sheet instruments are shown in the time period where they are first subject to repricing, whether as a result of floating or adjustable rate contracts. At December 31, 2008 the Company instituted floors on various categories of its variable rate loan portfolio. In most cases the floors are between 5.50% and 6.00% and based upon the prime interest rate plus a margin. The prime interest rate at December 31, 2010 was 3.25%. At this level the prime based variable rate loans will essentially have the characteristics of fixed rate loans until the prime rate increases above 5.50% to 6.00%. Fixed rate time deposits are presented according to their contractual maturity while variable rate time deposits reprice with the prime rate and are presented in the within three months time frame. Prime savings accounts reprice at management’s discretion when prime is below 5.00% and at 50% of the prime rate when prime is greater than 5.00%. In the table presented below, prime savings reprices in the within three months time frame. Regular savings, money management and NOW accounts do not have a contractual maturity date and are presented as repricing at the earliest date in which the deposit holder could withdraw the funds. All other borrowings are shown in the first period in which they could reprice. In the one-year time period, the pricing mismatch on a cumulative basis was liability sensitive $397,720 or 26.71% of total interest-earning assets. Management has procedures in place to carefully monitor the Company’s interest rate sensitivity as the rate environment changes. It should also be noted that all interest rates do not adjust at the same velocity. As an example, the majority of the savings category listed below is priced on an adjustable basis. When prime is greater than 5.00%, it is fifty percent of the prime rate. Therefore, as the prime rate adjusts 100 basis points, the rate on this liability only adjusts 50 basis points. Moreover, varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities. Investments prepayments are reflected at their current prepayment speeds in the interest sensitivity analysis report. No other prepayments are reflected in the following interest sensitivity analysis report. Prepayments may have significant effects on the Company’s net interest margin. Hence, gap is only a general indicator of interest rate sensitivity and cannot be interpreted as an absolute measurement of the Company’s interest rate risk.

 

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Interest Sensitivity Analysis
At December 31, 2010
                                                         
                    After Six                            
    Within     After Three     Through             One Year              
    Three     Through     Twelve     Within     Through     Over Five        
    Months     Six Months     Months     One Year     Five Years     Years     Total  
    (Dollars in thousands)  
Interest-earning assets:
                                                       
Loans
  $ 392,756       49,871       103,589       546,216       314,595       13,284       874,095  
Investment securities (including restricted equity securities)
    159,737       11,763       16,206       187,706       160,570       244,043       592,319  
Federal funds sold
                                         
Interest-bearing deposits in other banks
    22,810                   22,810                   22,810  
 
                                         
Total interest-earning assets
  $ 575,303     $ 61,634     $ 119,795     $ 756,732     $ 475,165     $ 257,327     $ 1,489,224  
 
                                         
 
                                                       
Interest-bearing liabilities:
                                                       
Money management accounts
  $ 36,937                   36,937                   36,937  
Savings accounts
    409,584                   409,584                   409,584  
NOW accounts
    356,267                   356,267                   356,267  
Time deposits
    119,555       98,467       104,824       322,846       164,963       1       487,810  
Securities sold under repurchase ageements
    818                   818                   818  
Federal Home Loan Bank advances
          8,000             8,000       13,000       39,000       60,000  
Notes and bonds payable
                                         
Subordinated debentures
    20,000                   20,000       2,947             22,947  
 
                                         
Total interest-bearing liabilities
  $ 943,161     $ 106,467     $ 104,824     $ 1,154,452     $ 180,910     $ 39,001     $ 1,374,363  
 
                                         
 
                                                       
Period gap
  $ (367,858 )   $ (44,833 )   $ 14,971     $ (397,720 )   $ 294,255     $ 218,326          
Cumulative gap
  $ (367,858 )   $ (412,691 )   $ (397,720 )   $ (397,720 )   $ (103,465 )   $ 114,861          
Ratio of cumulative gap to total interest-earning assets
    (24.70 %)     (27.71 %)     (26.71 %)     (26.71 %)     (6.95 %)     7.71 %        
Liquidity
Management of the Company’s liquidity position is closely related to the process of asset/liability management. Liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to provide sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. The Company intends to meet its liquidity needs by managing cash and due from banks, federal funds sold and purchased, maturity of investment securities, principal repayments received from mortgage-backed securities and lines of credit as necessary. GB&T and SB&T each maintain a line of credit with the Federal Home Loan Bank approximating 10% of their total assets. Federal Home Loan Bank advances are collateralized by eligible first mortgages, commercial real estate loans and investment securities. GB&T maintains repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $20,000 of which no amounts were outstanding at December 31, 2010. GB&T has a federal funds purchased accommodation with SunTrust Bank, Atlanta, Georgia, for advances up to $10,000 and a $10,000 repurchase line of credit with Center State Bank, Orlando, Florida. Additionally, liquidity needs can be supplemented by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers. The Company also uses retail securities sold under repurchase agreements to fund operations. Retail securities sold under repurchase agreements were $818 at December 31, 2010.

 

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Capital
Total stockholders’ equity was $99,958 at December 31, 2010, an increase of $6,214 or 6.63% from the previous year. The Company purchased no shares of treasury stock in 2010, and 302 shares in 2009 at a cost of $0 and $5, respectively, which is shown as a reduction of stockholders’ equity. The Company issued no shares of treasury stock in 2010 and 302 shares in 2009 at a price of $0 and $5, respectively, for the Director Stock Purchase Plan.
The Company’s average equity to average total assets was 6.39% in 2010 compared to 6.82% in 2009 and 6.78% in 2008. Capital is considered to be adequate to meet present operating needs and anticipated future operating requirements.
Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on the Company’s capital resources or operations. The following table presents the return on equity and assets for the years 2010, 2009 and 2008.
Return on Equity and Assets
                         
    Years ended December 31,  
    2010     2009     2008  
 
                       
Return on average total assets
    0.44 %     (0.54 %)     0.57 %
 
                       
Return on average equity
    6.81 %     (7.92 %)     8.48 %
 
                       
Average equity to average assets ratio
    6.39 %     6.82 %     6.78 %
At December 31, 2010, the Company was well above the minimum capital ratios required under the regulatory risk-based capital guidelines and was considered well capitalized. The following table presents the capital ratios for the Company and its subsidiaries.

 

63


 

ANALYSIS OF CAPITAL
                                                 
    Required     Actual     Excess  
    Amount     %     Amount     %     Amount     %  
    (Dollars in thousands)  
Southeastern Bank Financial Corporation
                                               
12/31/2010
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 40,224       4.00 %   $ 122,052       12.14 %   $ 81,828       8.14 %
Total capital
    80,448       8.00 %     136,564       13.59 %     56,116       5.59 %
Tier 1 leverage ratio
    66,092       4.00 %     122,052       7.39 %     55,960       3.39 %
12/31/2009
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 41,573       4.00 %   $ 114,930       11.06 %   $ 73,357       7.06 %
Total capital
    83,146       8.00 %     130,395       12.55 %     47,249       4.55 %
Tier 1 leverage ratio
    61,177       4.00 %     114,930       7.51 %     53,753       3.51 %
 
                                               
Georgia Bank & Trust Company
                                               
12/31/2010
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 35,363       4.00 %   $ 106,962       12.10 %   $ 71,599       8.10 %
Total capital
    70,726       8.00 %     118,175       13.37 %     47,449       5.37 %
Tier 1 leverage ratio
    66,500       4.50 %     106,962       7.24 %     40,462       2.74 %
12/31/2009
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 36,391       4.00 %   $ 99,984       10.99 %   $ 63,593       6.99 %
Total capital
    72,782       8.00 %     111,465       12.25 %     38,683       4.25 %
Tier 1 leverage ratio
    61,301       4.50 %     99,984       7.34 %     38,683       2.84 %
 
                                               
Southern Bank & Trust
                                               
12/31/2010
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 4,889       4.00 %   $ 14,475       11.84 %   $ 9,586       7.84 %
Total capital
    9,779       8.00 %     16,015       13.10 %     6,236       5.10 %
Tier 1 leverage ratio
    7,381       4.00 %     14,475       7.84 %     7,094       3.84 %
12/31/2009
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 5,091       4.00 %   $ 14,136       11.11 %   $ 9,045       7.11 %
Total capital
    10,183       8.00 %     15,734       12.36 %     5,551       4.36 %
Tier 1 leverage ratio
    6,640       4.00 %     14,136       8.52 %     7,496       4.52 %
Cash Flows from Operating, Investing and Financing Activities
Net cash provided by operating activities was $38,351 in 2010, an increase of $19,041 from 2009. Net cash provided by operating activities was $19,310 in 2009, an increase of $11,529 from 2008. An increase in net proceeds from sales of real estate loans over real estate loans originated for sale of $6,387 contributed to the increase.
Net cash provided by investing activities decreased $235,979 in 2010 to a net cash used of $231,487. The decrease was principally due to growth in the investment securities portfolio in 2010. Loans decreased $42,517 in 2010 compared to a decrease in loans of $5,281 in 2009. In addition, the Company received proceeds from sale of other real estate of $8,008. Net cash provided by investing activities increased $189,926 in 2009 to $4,492. Loans decreased $5,281 in 2009 compared to an increase in loans of $127,889 in 2008.

 

64


 

Net cash provided by financing activities in 2010 was $110,257, an increase of $23,833 from 2009. The primary reason was the decrease in federal funds purchased and securities sold under repurchase agreements which was offset by a $10,779 decline in deposit growth compared to 2009. Cash was used to repay $17,000 in advances from Federal Home Loan Bank. Net cash provided by financing activities in 2009 was $86,424, a decrease of $103,939 from 2008. The primary reason for the decrease was slower deposit growth of $46,404 compared to 2008 coupled with a decrease in federal funds purchased and securities sold under repurchase agreements. In addition cash from financing activities included the issuance of common stock of $9,010 and proceeds of issuance of subordinated debt of $2,947. Deposit accounts provided cash flows of $140,982 in 2009, a decrease of $46,404 over 2008. Cash provided by federal funds purchased and securities sold under repurchase agreements decreased $40,752 in 2009. Cash was used to repay $7,000 in advances from Federal Home Loan Bank.
Forward-Looking Statements
The Company may from time to time make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economy, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including regulations relating to branching and acquisitions; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.
Adoption of New Accounting Standards
In July 2010, the FASB amended existing guidance related to financing receivables and the allowance for credit losses, which requires further disaggregated disclosures that improve financial statement users’ understanding of 1) the nature of an entity’s credit risk associated with its financing receivables and 2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this standard is not expected to have a material effect on the Company’s result of operations or financial position but it does require expansion of the Company’s disclosures.
In January 2010, the FASB amended previous guidance related to fair value measurements and disclosures, which requires new disclosures for transfers in and out of Levels 1 and 2 and requires a reconciliation to be provided for the activity in Level 3 fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Levels 1 and 2 and provide an explanation for the transfers. This guidance is effective for interim periods beginning after December 15, 2009, and did not have a material effect on the Company’s results of operations or financial position.

 

65


 

In the reconciliation for fair value measurements using unobservable inputs (Level 3) a reporting entity should present separately information about purchases, sales, issuances, and settlements on a gross basis rather than a net basis. Disclosures relating to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurement will become effective beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position but it will require expansion of the Company’s future disclosures about fair value measurements.
Effects of Inflation and Changing Prices
Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation can increase a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.
Various information shown elsewhere herein will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions and compositions of the loan and security portfolios and the data on the interest sensitivity of loans and deposits should be considered.
Item 7A.  
Quantitative and Qualitative Disclosures About Market Risk
Market risk reflects the risk of loss due to changes in the market prices and interest rates. This loss could be reflected in diminished current market values or reduced net interest income in future periods.
The Company’s market risk arises primarily from the interest rate risk inherent in its lending and deposit activities. This risk is managed primarily by careful periodic analysis and modeling of the various components of the entire balance sheet. The investment portfolio is utilized to assist in minimizing interest rate risk in both loans and deposits due to the flexibility afforded in structuring the investment portfolio with regards to various maturities, cash flows and fixed or variable rates.

 

66


 

The following table presents the Company’s projected changes in net interest income for the various rate shock levels as of December 31, 2010 and 2009.
                         
    Amount     Dollar Change     Percent Change  
    (Dollars in thousands)  
December 31, 2010
                       
-300 basis points
  $ 44,178     $ (6,858 )     (13.44 %)
-200 basis points
    44,967       (6,069 )     (11.89 %)
-100 basis points
    47,533       (3,503 )     (6.86 %)
Base
    51,036                  
+100 basis points
    50,824       (212 )     (0.42 %)
+200 basis points
    50,465       (571 )     (1.12 %)
+300 basis points
    51,357       321       0.63 %
 
                       
December 31, 2009
                       
-200 basis points
  $ 43,426     $ 957       2.25 %
-100 basis points
    42,862       393       0.93 %
Base
    42,469                  
+100 basis points
    42,372       (97 )     (0.23 %)
+200 basis points
    43,701       1,232       2.90 %

 

67


 

Item 8.  
Financial Statements and Supplementary Data

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Table of Contents
         
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Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Southeastern Bank Financial Corporation
Augusta, Georgia
We have audited the accompanying consolidated balance sheets of Southeastern Bank Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income (loss), stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Southeastern Bank Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Southeastern Bank Financial Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2011 expressed an unqualified opinion thereon.
/s/ Crowe Horwath LLP
Oak Brook, Illinois
February 25, 2011

 

70


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2010 and 2009
                 
    2010     2009  
    (Dollars in thousands)  
Assets
               
Cash and due from banks
  $ 42,305       123,661  
Federal funds sold
          7,300  
Interest-bearing deposits in other banks
    22,810       17,033  
 
           
 
               
Cash and cash equivalents
    65,115       147,994  
 
           
 
               
Investment securities:
               
Available-for-sale
    586,302       306,216  
Held-to-maturity, at cost (fair values of $311 and $492 at December 31, 2010 and 2009, respectively)
    310       490  
 
               
Loans held for sale
    12,775       19,157  
 
               
Loans
    874,095       937,489  
Less allowance for loan losses
    26,657       22,338  
 
           
 
               
Loans, net
    847,438       915,151  
 
           
 
               
Premises and equipment, net
    29,416       31,702  
Accrued interest receivable
    6,382       6,091  
Goodwill, net
    140       140  
Bank-owned life insurance
    24,178       23,248  
Restricted equity securities
    5,707       6,338  
Other real estate owned
    7,751       7,974  
Prepaid FDIC assessment
    4,784       6,886  
Deferred tax asset
    14,595       11,160  
Other assets
    2,212       8,572  
 
           
 
               
 
  $ 1,607,105       1,491,119  
 
           
(continued)

 

71


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2010 and 2009
                 
    2010     2009  
Liabilities and Stockholders’ Equity
               
Deposits:
               
Noninterest-bearing
  $ 120,139       114,780  
Interest-bearing:
               
NOW accounts
    356,267       210,438  
Savings
    409,584       343,740  
Money management accounts
    36,937       44,781  
Time deposits of $100 or more
    346,721       418,751  
Other time deposits
    141,089       148,044  
 
           
 
               
 
    1,410,737       1,280,534  
 
               
Securities sold under repurchase agreements
    818       3,188  
Advances from Federal Home Loan Bank
    60,000       77,000  
Other borrowed funds
          600  
Accrued interest payable and other liabilities
    12,645       13,106  
Subordinated debentures
    22,947       22,947  
 
           
 
               
Total liabilities
    1,507,147       1,397,375  
 
           
 
               
Stockholders’ equity:
               
Preferred stock, no par value; 10,000,000 shares authorized; 0 shares outstanding in 2010 and 2009, respectively
           
Common stock, $3.00 par value; 10,000,000 shares authorized; 6,675,147 and 6,672,826 shares issued and outstanding in 2010 and 2009, respectively
    20,025       20,018  
Additional paid-in capital
    62,618       62,360  
Retained earnings
    19,548       12,692  
Accumulated other comprehensive loss, net
    (2,233 )     (1,326 )
 
           
 
               
Total stockholders’ equity
    99,958       93,744  
 
           
 
               
 
  $ 1,607,105       1,491,119  
 
           
See accompanying notes to consolidated financial statements.

 

72


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Loss)
Years ended December 31, 2010, 2009 and 2008
                         
    2010     2009     2008  
    (Dollars in thousands, except per share data)  
Interest income:
                       
Loans, including fees
  $ 53,707       56,196       61,568  
Investment securities:
                       
Taxable
    14,680       13,376       12,875  
Tax-exempt
    1,101       906       716  
Federal funds sold
    9       29       470  
Interest-bearing deposits in other banks
    377       253       46  
 
                 
 
                       
Total interest income
    69,874       70,760       75,675  
 
                 
 
                       
Interest expense:
                       
Deposits
    20,465       24,249       30,017  
Federal funds purchased and securities sold under repurchase agreements
    20       327       1,317  
Other borrowings
    3,513       3,907       4,155  
 
                 
Total interest expense
    23,998       28,483       35,489  
 
                 
Net interest income
    45,876       42,277       40,186  
Provision for loan losses
    15,801       30,904       9,055  
 
                 
Net interest income after provision for loan losses
    30,075       11,373       31,131  
 
                 
Noninterest income:
                       
Service charges and fees on deposits
    6,926       7,051       7,291  
Gain on sales of loans
    8,624       8,493       5,747  
Gain (loss) on sale of fixed assets, net
    26       (15 )     8  
Investment securities gains (losses), net
    1,271       2,532       (77 )
Other-than-temporary loss
                       
Total impairment loss
    (96 )     (991 )      
Loss recognized in other comprehensive loss
          16        
 
                 
Net impairment loss recognized in earnings
    (96 )     (975 )      
Retail investment income
    1,662       1,175       1,096  
Trust services fees
    1,128       1,040       1,134  
Increase in cash surrender value of bank-owned life insurance
    931       880       708  
Miscellaneous income
    614       558       798  
 
                 
 
                       
Total noninterest income
    21,086       20,739       16,705  
 
                 
 
                       
Noninterest expense:
                       
Salaries and other personnel expense
    23,462       22,534       20,852  
Occupancy expenses
    4,581       4,691       4,373  
Other real estate losses (gains)
    1,610       6,329       (63 )
Other operating expenses
    12,162       12,957       11,590  
 
                 
 
                       
Total noninterest expense
    41,815       46,511       36,752  
 
                 
Income (loss) before income taxes
    9,346       (14,399 )     11,084  
Income tax expense (benefit)
    2,490       (6,414 )     3,506  
 
                 
Net income (loss)
  $ 6,856       (7,985 )     7,578  
 
                 
(continued)

 

73


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Loss)
Years ended December 31, 2010, 2009 and 2008
                         
    2010     2009     2008  
 
 
Basic net income (loss) per share
  $ 1.03       (1.24 )     1.27  
Diluted net income (loss) per share
    1.03       (1.24 )     1.26  
Weighted average common shares outstanding
    6,674,224       6,422,867       5,972,429  
Weighted average number of common and common equivalent shares outstanding
    6,674,224       6,422,867       6,011,689  
See accompanying notes to consolidated financial statements.

 

74


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)
Years ended December 31, 2010, 2009 and 2008
(Dollars in thousands, except per share data)
                                                                 
                                                    Accumulated        
            Common stock     Additional                     other     Total  
    Comprehensive     Number             paid-in     Retained     Treasury     comprehensive     stockholders’  
    income (loss)     of shares     Amount     capital     earnings     stock     income (loss), net     equity  
Balance, December 31, 2007
            5,434     $ 16,301       39,518       34,228       (317 )     28       89,758  
Comprehensive income:
                                                               
Net income
  $ 7,578                         7,578                   7,578  
Other comprehensive income — unrealized gain on investment securities available for sale, net of income tax effect of $13
    16                                     16       16  
 
                                                             
Total comprehensive income
  $ 7,594                                                          
 
                                                             
Cash dividends ($0.52 per common share)
                              (2,968 )                 (2,968 )
Stock options exercised
            11       32       (291 )           726             467  
Stock options compensation cost
                        209                         209  
Stock dividend
            543       1,630       15,753       (17,383 )                  
Directors’ stock purchase plan
                                    36             36  
Purchase of treasury stock
                                    (445 )           (445 )
 
                                                 
Balance, December 31, 2008
            5,988     $ 17,963       55,189       21,455             44       94,651  
 
                                                 
Comprehensive income (loss):
                                                               
Net loss
  $ (7,985 )                       (7,985 )                 (7,985 )
Other comprehensive loss — unrealized loss on investment securities available for sale, net of income tax effect of $873
    (1,370 )                                   (1,370 )     (1,370 )
 
                                                             
Total comprehensive loss
  $ (9,355 )                                                        
 
                                                             
Cash dividends ($0.13 per common share)
                              (778 )                 (778 )
Stock options compensation cost
                        188                         188  
Issuance of common stock
            683       2,049       6,961                         9,010  
Directors’ stock purchase plan
            2       6       22             5             33  
Purchase of treasury stock
                                    (5 )           (5 )
 
                                                 
Balance, December 31, 2009
            6,673     $ 20,018       62,360       12,692             (1,326 )     93,744  
 
                                                 
Comprehensive income:
                                                               
Net income
  $ 6,856                         6,856                   6,856  
Other comprehensive loss — unrealized loss on investment securities available for sale, net of income tax effect of $577
    (907 )                                   (907 )     (907 )
 
                                                             
Total comprehensive income
  $ 5,949                                                          
 
                                                             
Stock options compensation cost
                        241                         241  
Directors’ stock purchase plan
            2       7       17                         24  
 
                                                 
Balance, December 31, 2010
            6,675     $ 20,025       62,618       19,548             (2,233 )     99,958  
 
                                                 
(continued)

 

75


 

(continued)
                         
    Disclosure of reclassification amount  
    2010     2009     2008  
Unrealized holding losses arising during period, net of taxes
  $ (309 )     (686 )     (48 )
Reclassification adjustment for (gains) losses included in net income (loss)
    (1,175 )     (1,557 )     77  
Tax effect
    577       873       (13 )
 
                 
Net unrealized (losses) gains in securities
  $ (907 )     (1,370 )     16  
 
                 
See accompanying notes to consolidated financial statements.

 

76


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
                         
    2010     2009     2008  
    (Dollars in thousands)  
Cash flows from operating activities:
                       
Net income (loss)
  $ 6,856       (7,985 )     7,578  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Depreciation
    2,651       2,718       2,343  
Deferred income tax benefit
    (2,857 )     (3,945 )     (929 )
Provision for loan losses
    15,801       30,904       9,055  
Investment securities (gains) losses, net
    (1,271 )     (2,532 )     77  
Other-than-temporary impairment losses
    96       975        
Net amortization of premium (accretion of discount) on investment securities
    2,090       366       (147 )
Increase in cash surrender value of bank-owned life insurance
    (931 )     (880 )     (708 )
Stock options compensation cost
    241       188       209  
(Gain) loss on disposal of premises and equipment
    (26 )     15       (8 )
(Gain) loss on the sale of other real estate
    (299 )     5,741       (63 )
Provision for other real estate valuation allowance
    1,909       588        
Gain on sales of loans
    (8,624 )     (8,493 )     (5,747 )
Real estate loans originated for sale
    (328,098 )     (367,532 )     (258,946 )
Proceeds from sales of real estate loans
    343,104       375,823       257,042  
(Increase) decrease in accrued interest receivable
    (291 )     994       331  
Decrease (increase) in other assets
    8,461       (10,458 )     (2,199 )
(Decrease) increase in accrued interest payable and other liabilities
    (461 )     2,823       (107 )
 
                 
 
                       
Net cash provided by operating activities
    38,351       19,310       7,781  
 
                 
 
                       
Cash flows from investing activities:
                       
Proceeds from sales of available for sale securities
    72,296       127,524       27,285  
Proceeds from maturities of available for sale securities
    198,747       128,193       68,665  
Proceeds from maturities of held to maturity securities
    180       203       765  
Purchase of available for sale securities
    (553,527 )     (263,117 )     (149,781 )
Purchase of restricted equity securities
          (322 )     (1,511 )
Proceeds from redemption of FHLB stock
    631       23        
Purchase of loans
          (1,809 )      
Net decrease (increase) in loans
    42,517       7,090       (127,889 )
Purchase of Bank-owned life insurance
          (5,000 )      
Additions to premises and equipment
    (368 )     (747 )     (5,196 )
Proceeds from sale of other real estate
    8,008       12,183       715  
Proceeds from sale of premises and equipment
    29       271       1,513  
 
                 
 
                       
Net cash (used in) provided by investing activities
    (231,487 )     4,492       (185,434 )
 
                 
(continued)

 

77


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
                         
    2010     2009     2008  
Cash flows from financing activities:
                       
Net increase in deposits
    130,203       140,982       187,386  
Net decrease in federal funds purchased and securities sold under repurchase agreements
    (2,370 )     (59,365 )     (18,613 )
Advances from Federal Home Loan Bank
                25,000  
Payments of Federal Home Loan Bank advances
    (17,000 )     (7,000 )      
Proceeds from subordinated debentures
          2,947        
Proceeds from other borrowed funds
          600        
Principal payments on other borrowed funds
    (600 )           (500 )
Proceeds from issuance of common stock
          9,010        
Proceeds from directors’ stock purchase plan
    24       33       36  
Purchase of treasury stock
          (5 )     (445 )
Payment of cash dividends
          (778 )     (2,968 )
Proceeds from stock options exercised, net of stock redeemed
                467  
 
                 
 
                       
Net cash provided by financing activities
    110,257       86,424       190,363  
 
                 
 
                       
Net (decrease) increase in cash and cash equivalents
    (82,879 )     110,226       12,710  
 
 
Cash and cash equivalents at beginning of year
    147,994       37,768       25,058  
 
                 
 
                       
Cash and cash equivalents at end of year
  $ 65,115       147,994       37,768  
 
                 
 
                       
Supplemental disclosures of cash paid during the year for:
                       
Interest
  $ 24,190       29,620       35,729  
Income taxes, net of refunds
    822       628       4,092  
 
                       
Supplemental information on noncash investing activities:
                       
Loans transferred to other real estate
  $ 9,395       20,752       6,386  
See accompanying notes to consolidated financial statements.

 

78


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(1)  
Summary of Significant Accounting Policies
   
Southeastern Bank Financial Corporation and its wholly owned subsidiaries (collectively the “Company”), consisting of Southeastern Bank Financial Corporation (the “Parent”), Georgia Bank & Trust Company of Augusta, Georgia (“GB&T”), and Southern Bank and Trust Company of Aiken, South Carolina (“SB&T”), offer a wide range of lending services, including real estate, commercial, and consumer loans to individuals and small to medium-sized businesses and professionals that are located in, or conduct a substantial portion of their business in, the Richmond and Columbia Counties of Georgia, and Aiken County, South Carolina.
 
   
The Company is subject to competition from other financial institutions and is also subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by those regulatory authorities. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a description of the more significant of those policies the Company follows in preparing and presenting its consolidated financial statements.
  (a)  
Basis of Presentation
 
     
The consolidated financial statements include the accounts of Southeastern Bank Financial Corporation and its wholly owned subsidiaries, Georgia Bank & Trust Company of Augusta, Georgia and Southern Bank and Trust Company of Aiken, South Carolina. Significant intercompany transactions and accounts are eliminated in consolidation.
 
     
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates.
 
     
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, other real estate owned and other than temporary impairment of debt securities.
 
  (b)  
Cash and Cash Equivalents
 
     
Cash and cash equivalents include cash and due from banks, Federal funds sold, and short-term interest-bearing deposits in other banks. Generally, Federal funds are sold for one-day periods. Net cash flows are reported for loan and deposit transactions and for short term borrowings with an original maturity of 90 days or less.

 

79


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (c)  
Investment Securities
 
     
The Company classifies its investment securities into one of two categories: available-for-sale and held-to-maturity. Held-to-maturity securities are those debt securities for which the Company has the ability and intent to hold the security until maturity. All other securities are classified as available-for-sale.
 
     
Held-to-maturity securities are recorded at cost adjusted for the amortization or accretion of premiums or discounts. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of related tax effects, on securities available-for-sale are excluded from net income and are reported within stockholders’ equity as a component of other comprehensive income (loss) until realized.
 
     
A decline in the fair value of securities below their cost that are other than temporary are reflected as realized losses. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. In estimating other-than-temporary impairment, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, whether the market decline was affected by macroeconomic conditions, and whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. If either of the criteria regarding intent or requirement to sell is met, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. For debt securities that do not meet the aforementioned criteria, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. For equity securities, the entire amount of impairment is recognized through earnings.
 
     
Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using a method which approximates the effective interest method and takes into consideration prepayment assumptions. Dividends and interest income are recognized when earned. Realized gains and losses for investment securities available-for-sale which are sold are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

 

80


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (d)  
Loans and Allowance for Loan Losses
 
     
Loans are stated at the amount of unpaid principal outstanding less unearned loan fees, reduced by an allowance for loan losses. Interest on loans is calculated using the simple interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the straight line method without anticipating prepayments. Accrual of interest is generally discontinued on loans that become past due 90 days or more. These loans are classified as nonaccrual, even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. When a loan is placed on nonaccrual status, all interest accrued but not received is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
      Concentration of Credit Risk:
 
     
Most of the Company’s business activity is with customers located within the Augusta-Richmond County, GA-SC metropolitan statistical area. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in this area. The Company also has a significant concentration of loans with real estate developers.
 
      Certain Purchased Loans:
 
     
The Company purchases individual loans; some of which have shown evidence of credit deterioration since origination. These purchased loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.
 
     
Such purchased loans are accounted for individually based on common risk characteristics such as, credit score, loan type, and date of origination. The Company estimates the amount and timing of expected cash flows for each purchased loan, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
 
     
Over the life of the loan, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

 

81


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
      Allowance for Loan Losses:
 
     
The allowance for loan losses is a valuation allowance for probable incurred credit losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.
 
     
A loan is 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. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
 
     
Commercial and commercial real estate loans over $500 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

 

82


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
     
The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 4 years. The following portfolio segments have been identified:
   
Acquisition Development and Construction (“ADC”) — CSRA
 
   
ADC — Savannah, Georgia
 
   
ADC — Greenville, South Carolina
 
   
ADC-Athens, Georgia
 
   
ADC Participations — Florida
 
   
ADC Participations — Georgia
 
   
Commercial Real Estate — Non owner occupied
 
   
Commercial Real Estate — Owner occupied
 
   
1-4 Family
 
   
Consumer
 
   
All other
     
The following is a discussion of the risks characteristics of these portfolio segments.
 
      Acquisition, Development & Construction (ADC) — CSRA (Primary Market) — ADC lending carries all of the normal risks involved in lending including the changing nature of borrower and guarantor financial conditions and the knowledge that the sale of the completed lots and/or structures is likely the sole source of repayment as opposed to other forms of borrower cash flow. In addition, this type of lending carries several additional risk factors including: (1) timely project completion (contractor financial condition, commodity prices, weather delays, prospective tenant financial condition); (2) market factors (changing economic conditions, unemployment rates, end-user financing availability, interest rates); (3) competition (similar product availability, bank foreclosed properties); (4) end-product price stability.
 
      ADC — Savannah, Georgia — ADC lending in the Savannah market carries all of the ADC risks outlined for the CSRA plus the additional risk of lending outside of the Company’s traditional market area where our knowledge of that market is not as well developed. Additionally, the Savannah market has additional economic factors at play including the impacts of the port, tourism and secondary (vacation) properties.

 

83


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
      ADC — Greenville, South Carolina — ADC lending in the Greenville market carries all of the risks outlined for the CSRA plus the additional risk of lending outside the Company’s traditional market area. However, since the Company has made the strategic decision to cease operations in this market, the risk remaining in this segment should diminish.
 
      ADC — Athens, Georgia — ADC lending in the Athens market carries all of the risks outlined for the CSRA. Also, Athens continues to operate as a suburb of the greater Atlanta market. As such, it has been more susceptible to the recent significant price declines and project slowdowns caused by the recent recessions. However, since the Company has made the strategic decision to cease operations in this market, the risk remaining in this segment should diminish.
 
      ADC Participations — Florida — ADC participation lending on projects located in Florida carries the ADC CSRA risks outlined above. Additionally, these loans also have the risk of lending out of state (market, legal, etc.) and the risk of loss of control as a junior participant subject to the direction/financial condition of the lead lender. The bank has made the strategic decision to exit this portfolio segment and is not actively seeking or originating new participations in the Florida geography. At December 31, 2010, this portfolio segment has been reduced to two participation loans, both of which have been individually analyzed for impairment and reserved accordingly.
 
      ADC Participations — Georgia - ADC participation lending on projects located in Georgia outside the CSRA carries the ADC CSRA risks outlined above. Additionally, these loans also have the risk of lending out of market and the risk of loss of control as a junior participant subject to the direction/financial condition of the lead lender. The bank has made the strategic decision to exit this portfolio segment and is not actively seeking or originating new participations in the Georgia geography outside of our normal market area. At December 31, 2010, this portfolio segment has been reduced to one participation loan in the FAS 5 category.

 

84


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
      Commercial Real Estate — Non Owner Occupied — This lending category includes loans for multi-family, office, warehouse, retail, hotel/motel and other non-owner occupied properties. Loans in this category carry more risk than owner-occupied properties because the property’s cash flow is not derived from the owner of the property’s business, but from unrelated tenants. These outside tenants are each subject to their own set of business risks depending upon their own financial situation, competitors, industry segment and general economic conditions. Therefore, the cash flow from the property in the form of rent may not be as stable as a one-user, owner-occupied property.
 
     
The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans that become uncollectible, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to pay. The allowance is evaluated on a regular basis utilizing estimated loss factors for specific types of loans. Such loss factors are periodically reviewed and adjusted as necessary based on actual losses.
 
     
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may advise the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
 
     
The process of assessing the adequacy of the allowance is necessarily subjective. Further, and particularly in terms of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management’s current estimates of probable incurred credit losses inherent within the loan portfolio. As such, there can be no assurance that future loan charge-offs will not exceed management’s current estimate of the allowance for loan losses.
 
     
ALLL Methodology
 
     
The Company’s approach to ALLL reserve calculation uses two distinct perspectives, the guidelines of using Financial Accounting Standards ASC 450 (Accounting for Contingencies) and ASC 310 (Accounting by Creditors for Impairment of a Loan, for individual loans). The process is generally as follows:
   
Loans are grouped according in categories of similar risk characteristics.(Portfolio segments)
 
   
For each loan category, a four year average rolling historical net loss rate is calculated, with the loss rate more heavily weighted to the most recent two years loss history. An emergence factor is then applied to the average historical net loss rate.

 

85


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
The historical loss ratios are adjusted for internal and external qualitative factors within each loan category. The qualitative factor adjustment may be further increased for loan classifications of watch rated and substandard within each category. Factors include:
   
levels and trends in delinquencies and impaired/classified/graded loans;
 
   
changes in the quality of the loan review system;
 
   
trends in volume and terms of loans;
 
   
effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;
 
   
experience, ability, and depth of lending management and other relevant staff;
 
   
national and local economic trends and conditions;
 
   
changes in the value of underlying collateral;
 
   
other external factors-competition, legal and regulatory requirements;
 
   
effects of changes in credit concentrations
   
The resultant loss factor is applied to each loan pool to calculate the ALLL for each loan pool.
 
   
The total of each loan pool is then added to the ALLL determined for individual loans evaluated for impairment in accordance with ASC 310.
      Loans Held for Sale:
 
     
Mortgage loans held for sale are generally sold with servicing rights released. The Company originates mortgages to be held for sale only for loans that have been individually pre-approved by the investor. Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors.
 
     
Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
 
     
The Company bears minimal interest rate risk on these loans and only holds the loans temporarily until documentation can be completed to finalize the sale to the investor. Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in the fair values of these derivatives are included in net gains on sales of loans. Fair values of these derivatives were $2 and $182 as of December 31, 2010 and 2009, respectively.

 

86


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (e)  
Premises and Equipment
 
     
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is provided on the straight-line basis over the estimated useful lives of the related assets, which range from three to forty years. Premises and equipment and other long term assets are reviewed for impairment when events indicate their carrying amounts may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
 
  (f)  
Other Real Estate
 
     
Assets acquired through or instead of loan foreclosure are initially recorded at lower of cost or fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of property are capitalized.
 
  (g)  
Goodwill
 
     
Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. The Company’s goodwill is not considered impaired at December 31, 2010.
 
  (h)  
Stock-Based Compensation
 
     
Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black- Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

87


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (i)  
Income Taxes
 
     
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
 
     
The Company recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense.
 
  (j)  
Income (Loss) Per Share
 
     
Basic net income (loss) per share is net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share includes the dilutive effect of additional potential common shares issuable under stock options. The calculation of diluted earnings (loss) per share for 2010 and 2009 excludes the dilutive effect of stock options outstanding as the effect is anti-dilutive. Income per share is restated for all stock dividends through the date of issuance of the financial statements.
                         
    December 31,  
    2010     2009     2008  
Weighted average common shares outstanding for basic earnings per common share
    6,674,224       6,422,867       5,972,429  
Add: Dilutive effects of assumed exercises of stock options
                39,260  
 
                 
Weighted average number of common and common equivalent shares outstanding
    6,674,224       6,422,867       6,011,689  
 
                 
  (k)  
Other Comprehensive Income (Loss)
 
     
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
 
  (l)  
Segment Disclosures
 
     
While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company wide basis. Discrete financial information is not available other than on a Company wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

 

88


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (m)  
Adoption of New Accounting Standards
 
     
In July 2010, the FASB amended existing guidance related to financing receivables and the allowance for credit losses, which requires further disaggregated disclosures that improve financial statement users’ understanding of 1) the nature of an entity’s credit risk associated with its financing receivables and 2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this standard is not expected to have a material effect on the Company’s result of operations or financial position but it does require expansion of the Company’s disclosures.
 
     
In January 2010, the FASB amended previous guidance related to fair value measurements and disclosures, which requires new disclosures for transfers in and out of Levels 1 and 2 and requires a reconciliation to be provided for the activity in Level 3 fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Levels 1 and 2 and provide an explanation for the transfers. This guidance is effective for interim periods beginning after December 15, 2009, and did not have a material effect on the Company’s results of operations or financial position.
 
     
In the reconciliation for fair value measurements using unobservable inputs (Level 3) a reporting entity should present separately information about purchases, sales, issuances, and settlements on a gross basis rather than a net basis. Disclosures relating to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurement will become effective beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position but it will require expansion of the Company’s future disclosures about fair value measurements.

 

89


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
  (n)  
Bank Owned Life Insurance
 
     
The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
 
  (o)  
Loss Contingencies
 
     
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are reported as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the consolidated financial statements.
 
  (p)  
Reclassifications
 
     
Some items in the prior period financial statements were reclassified to conform to the current presentation.
 
  (q)  
Rounding
 
     
Dollar amounts are rounded to thousands except share and per share data unless otherwise noted.
(2)  
Cash and Due From Banks
   
The Company’s subsidiaries are required by the Federal Reserve Bank to maintain average daily cash balances. These required balances were $3,519 at December 31, 2010 and $5,199 at December 31, 2009.
(3)  
Investment Securities
   
The following tables summarize the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio at December 31, 2010 and 2009 and the corresponding amounts of unrealized gains and losses therein:

 

90


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
                                 
    2010  
            Gross     Gross        
    Amortized     unrealized     unrealized     Estimated  
    cost     gains     losses     fair value  
    (Dollars in thousands)  
Available-for-sale:
                               
Obligations of U.S. Government agencies
  $ 202,153       527       (1,763 )     200,917  
Obligations of states and political subdivisions
    67,137       318       (3,337 )     64,118  
Mortgage-backed securities
                               
U.S. GSE’s* MBS - residential
    141,524       1,880       (1,679 )     141,725  
U.S. GSE’s CMO
    139,208       1,756       (630 )     140,334  
Other CMO
    3,382       50       (359 )     3,073  
Corporate bonds
    36,551       467       (885 )     36,133  
Equity securities
    2                   2  
 
                       
 
  $ 589,957       4,998       (8,653 )     586,302  
 
                       
Held-to-maturity:
                               
Obligations of states and political subdivisions
  $ 310       1             311  
 
                       
 
  $ 310       1             311  
 
                       
     
*  
Government sponsored entities
                                 
    2009  
            Gross     Gross        
    Amortized     unrealized     unrealized     Estimated  
    cost     gains     losses     fair value  
    (Dollars in thousands)  
Available-for-sale:
                               
Obligations of U.S. Government agencies
  $ 67,290       43       (1,003 )     66,330  
Obligations of states and political subdivisions
    26,402       299       (521 )     26,180  
Mortgage-backed securities
                               
U.S. GSE’s MBS - residential
    87,113       2,245       (205 )     89,153  
U.S. GSE’s CMO
    107,153       1,116       (1,427 )     106,842  
Other CMO
    7,834       142       (301 )     7,675  
Corporate bonds
    12,591       35       (2,594 )     10,032  
Equity securities
    4                   4  
 
                       
 
  $ 308,387       3,880       (6,051 )     306,216  
 
                       
Held-to-maturity:
                               
Obligations of states and political subdivisions
  $ 490       2             492  
 
                       
 
  $ 490       2             492  
 
                       

 

91


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
As of December 31, 2010, except for the U.S. Government agencies and government sponsored entities, there was no issuer who represented 10% or more of stockholders’ equity within the investment portfolio.
 
   
Proceeds from sales of securities available-for-sale and the associated gains (losses) during 2010, 2009 and 2008 were as follows:
                         
    December 31,  
    2010     2009     2008  
    (Dollars in thousands)  
 
       
Proceeds
  $ 72,296     $ 127,524     $ 27,285  
Gross Gains
    1,610       3,132       211  
Gross Losses
    339       603       288  
   
Investment securities with a carrying amount of approximately $298,254 and $161,449 at December 31, 2010 and 2009, respectively, were pledged to secure public and trust deposits, and for other purposes required or permitted by law.
 
   
The amortized cost and fair value of the investment securities portfolio excluding equity securities are shown below by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
                 
    Amorized     Estimated  
    cost     fair value  
    (Dollars in thousands)  
Available-for-sale:
               
After one year through five years
  $ 19,766       19,758  
After five years through ten years
    93,723       93,806  
After ten years
    476,466       472,736  
 
           
 
  $ 589,955       586,300  
 
           
Held-to-maturity:
               
After one year through five years
  $ 310       311  
 
           
 
  $ 310       311  
 
           

 

92


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
The following tables summarize the investment securities with unrealized losses at year-end 2010 and 2009, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.
                                                 
    December 31, 2010  
    Less than 12 months     12 months or longer     Total  
    Estimated     Unrealized     Estimated     Unrealized     Estimated     Unrealized  
    fair value     loss     fair value     loss     fair value     loss  
    (Dollars in thousands)  
Temporarily impaired
                                               
Obligations of U.S. Government agencies
  $ 99,306       1,763                   99,306       1,763  
Obligations of states and political subdivisions
    45,906       3,245       2,309       92       48,215       3,337  
Mortgage-backed securities
                                               
U.S. GSE’s MBS - residential
    81,783       1,538       509       141       82,292       1,679  
U.S. GSE’s CMO
    46,776       630                   46,776       630  
Other CMO
                2,085       359       2,085       359  
Corporate bonds
    22,385       481       3,880       404       26,265       885  
 
                                   
 
 
  $ 296,156       7,657       8,783       996       304,939       8,653  
 
                                   
                                                 
    December 31, 2009  
    Less than 12 months     12 months or longer     Total  
    Estimated     Unrealized     Estimated     Unrealized     Estimated     Unrealized  
    fair value     loss     fair value     loss     fair value     loss  
    (Dollars in thousands)  
Temporarily impaired
                                               
Obligations of U.S. Government agencies
  $ 43,528       1,003                   43,528       1,003  
Obligations of states and political subdivisions
    8,644       220       4,457       301       13,101       521  
Mortgage-backed securities
                                               
U.S. GSE’s MBS - residential
    21,996       205                   21,996       205  
U.S. GSE’s CMO
    61,373       1,408       665       19       62,038       1,427  
Other CMO
                4,243       285       4,243       285  
Corporate bonds
    733       267       6,291       2,327       7,024       2,594  
 
                                   
 
  $ 136,274       3,103       15,656       2,932       151,930       6,035  
 
                                   
Other-than-temporarily impaired
                                               
Mortgage-backed securities
                                               
Other CMO
  $             748       16       748       16  
 
                                   
 
 
  $ 136,274       3,103       16,404       2,948       152,678       6,051  
 
                                   
   
Other-Than-Temporary Impairment — December 31, 2010
 
   
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under the provisions of ASC 320-10, Investments — Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

93


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
 
   
As of December 31, 2010, the Company’s security portfolio consisted of 329 securities, 160 of which were in an unrealized loss position. Of these securities with unrealized losses, 41.06% were related to the Company’s mortgage backed and corporate securities as discussed below.
 
   
Mortgage-backed Securities
 
   
At December 31, 2010, $282,059 or approximately 98.92% of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.
 
   
The Company’s mortgage-backed securities portfolio also includes five non-agency collateralized mortgage obligations with a market value of $3,073, of which four had unrealized losses of approximately $359 at December 31, 2010. These non-agency securities were rated AAA at purchase.

 

94


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
At December 31, 2010, four of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions, the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition, the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. During 2009, two of these securities were considered to be other-than-temporarily impaired. Upon completion of the December 31, 2010 analysis, our model indicated that none of these securities had additional other-than-temporary impairment. During the third quarter of 2010, one of these securities was considered other-than-temporarily impaired and an OTTI loss of $96 was recorded. At December 31, 2010 this security is now in an unrealized gain position and it remains classified as available-for-sale, based on an improvement in underlying assumptions during the fourth quarter.
 
   
At December 31, 2010, the fair values of three collateralized mortgage obligations totaling $2,410 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on a yield of 10% over 1 month libor that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.
 
   
Corporate Securities
 
   
The Company holds twenty corporate securities totaling $36,133, of which thirteen had an unrealized loss of $885 at December 31, 2010. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At December 31, 2010, two of the corporate securities were rated below Investment grade and five securities to two issuers were not rated. None of the issuers were in default at December 31, 2010 but in January of 2011 the Company was notified that two trust preferred securities to the two issuers not rated had elected to defer interest payments. The issuers are both bank holding companies with operations in the Southeast. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Although these issuers have indicated they will defer payments going forward, the Company has considered the capital position of the subsidiary banks, the liquidity of the holding company, the existence and severity of publicly available regulatory agreements, and the fact that these deferrals are coming after the most severe impact of the national and regional recession. The prospect of capital formation in the current market, improving operating results of the industry overall have caused the Company to conclude that a return to normal subsidiary dividends and thus interest payments on the debt for these issuers is reasonably assured at this time. Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.

 

95


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
At December 31, 2010, the fair values of twelve corporate securities totaling $10,741 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
 
   
The table below presents a rollforward of the credit losses recognized in earnings for the twelve month period ended December 31, 2010:
         
Beginning balance, January 1, 2010
  $ 475  
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized
    96  
Additions/Subtractions
       
Amounts realized for securities sold during the period
     
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis
     
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security
     
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized
     
 
     
 
       
Ending balance, December 31, 2010
  $ 571  
 
     

 

96


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
Total other-than-temporary impairment recognized in accumulated other comprehensive loss at December 31, 2010 was not material.
 
   
Other-Than-Temporary Impairment — December 31, 2009
 
   
As of December 31, 2009, the Company’s security portfolio consisted of 247 securities, 100 of which were in an unrealized loss position. The majority of unrealized losses were related to the Company’s mortgage-backed and corporate securities, as discussed below.
 
   
Mortgage-backed Securities
 
   
At December 31, 2009, $195,995 or approximately 96.23% of the Company’s mortgage-backed securities totaling $203,670 were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2009.
 
   
The Company’s mortgage-backed securities portfolio also includes eleven non-agency collateralized mortgage obligations with a market value of $7,675, seven of which had unrealized losses of approximately $301 at December 31, 2009. These non-agency securities were rated AAA at purchase.
 
   
At December 31, 2009, five of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions, the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition, the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. In 2009 two of these securities had OTTI losses of $491, of which $475 was recorded as expense and $16 was recorded in other comprehensive income or loss. These two securities remained classified as available-for-sale at December 31, 2009.
 
   
At December 31, 2009, the fair values of three collateralized mortgage obligations totaling $3,780 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. These securities were previously measured using Level 2 inputs. The discount rates used in the valuation model were based on a yield that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.

 

97


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
Corporate Securities
 
   
The Company held thirteen corporate securities to eight issuers totaling $10,032, of which ten had an unrealized loss of $2,594 at December 31, 2009. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At December 31, 2009, three of the corporate securities were rated Speculative and three were rated Investment grade by at least one of the major rating agencies, (Moody’s, S&P and Fitch). Seven of the securities to three issuers were not rated. None of the issuers were in default and to date all interest payments have been made as contracted. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and an increase in credit spreads for financial institution debt issuers due to the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2009.
 
   
At December 31, 2009, the fair values of all thirteen corporate securities were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. These securities, eight of which totaled $4,307 were previously measured using Level 2 inputs. The discount rates used in the valuation model were based on current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
 
   
In addition to the securities discussed above, the Company had an investment in the senior debt of Silverton Financial Services, Inc. of $500 for which an other-than-temporary impairment charge was taken in the first half of 2009.

 

98


 

SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
   
The table below presents a rollforward of the credit losses recognized in earnings for the twelve month period ended December 31, 2009:
         
Beginning balance, January 1, 2009
  $  
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized
    975  
Additions/Subtractions
       
Amounts realized for securities sold during the period
     
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis
     
Reductions for previous credit losses on securities charged off
    (500 )
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security
     
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized
     
 
     
 
       
Ending balance, December 31, 2009
  $ 475  
 
     
   
The following details the two mortgage-backed securities and one single issuer corporate debt security with OTTI at December 31, 2009 and the related credit losses recognized in earnings:
                                 
    Silverton                    
    Financial                    
    Services, Inc     CMO 1     CMO 2     Total  
    (Dollars in thousands)  
Amount of other-than temporary-impairment related to credit losses at January 1, 2009
  $     $     $     $  
 
                               
Addition for credit losses recognized in earnings
    500       155       320       975  
 
                       
 
       
Amount of other-than temporary-impairment related to credit losses at December 31, 2009
  $ 500     $ 155     $ 320     $ 975