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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the transition period from to .
COMMISSION FILE NO. 000-49747
FIRST SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
Tennessee | 58-2461486 | |
(State of Incorporation) | (I.R.S. Employer Identification No.) | |
531 Broad Street, Chattanooga, TN | 37402 | |
(Address of principal executive offices) | (Zip Code) |
(423) 266-2000
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ | Smaller reporting company | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:
Common Stock, $0.01 par value:
16,418,140 shares outstanding and issued as of May 16, 2011
Table of Contents
First Security Group, Inc. and Subsidiary
Form 10-Q
Page No. | ||||||
PART I. | FINANCIAL INFORMATION | 1 | ||||
Item 1. | Financial Statements | 1 | ||||
Consolidated Balance Sheets - March 31, 2011, December 31, 2010 and March 31, 2010 |
2 | |||||
Consolidated Income Statements - Three months ended March 31, 2011 and 2010 |
3 | |||||
Consolidated Statement of Stockholders Equity - Three months ended March 31, 2011 |
4 | |||||
Consolidated Statements of Cash Flows - Three months ended March 31, 2011 and 2010 |
5 | |||||
7 | ||||||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 26 | ||||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 51 | ||||
Item 4. | Controls and Procedures | 52 | ||||
PART II. | OTHER INFORMATION | |||||
Item 1. | Legal Proceedings | 52 | ||||
Item 1A. | Risk Factors | 52 | ||||
Item 3. | Defaults Upon Senior Securities | 52 | ||||
Item 6. | Exhibits | 53 | ||||
SIGNATURES | 54 |
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
First Security Group, Inc. and Subsidiary
Consolidated Balance Sheets
(in thousands) |
March 31, 2011 (unaudited) |
December 31, 2010 |
March 31, 2010 (unaudited) |
|||||||||
ASSETS |
||||||||||||
Cash and Due from Banks |
$ | 12,139 | $ | 8,298 | $ | 17,974 | ||||||
Federal Funds Sold and Securities Purchased under Agreements to Resell |
| | | |||||||||
Cash and Cash Equivalents |
12,139 | 8,298 | 17,974 | |||||||||
Interest Bearing Deposits in Banks |
185,603 | 200,621 | 210,961 | |||||||||
Securities Available-for-Sale |
154,317 | 154,165 | 145,568 | |||||||||
Loans Held for Sale |
1,145 | 2,556 | 2,138 | |||||||||
Loans |
681,503 | 724,535 | 903,374 | |||||||||
Total Loans |
682,648 | 727,091 | 905,512 | |||||||||
Less: Allowance for Loan and Lease Losses |
22,500 | 24,000 | 26,101 | |||||||||
660,148 | 703,091 | 879,411 | ||||||||||
Premises and Equipment, net |
30,519 | 30,814 | 32,717 | |||||||||
Intangible Assets |
1,348 | 1,461 | 1,800 | |||||||||
Other Assets |
72,630 | 70,098 | 80,104 | |||||||||
TOTAL ASSETS |
$ | 1,116,704 | $ | 1,168,548 | $ | 1,368,535 | ||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Balance Sheets
(in thousands, except share data) |
March 31, 2011 (unaudited) |
December 31, 2010 |
March 31, 2010 (unaudited) |
|||||||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||
LIABILITIES |
||||||||||||
Deposits |
||||||||||||
Noninterest Bearing Demand |
$ | 161,658 | $ | 149,323 | $ | 156,736 | ||||||
Interest Bearing Demand |
63,735 | 63,838 | 70,729 | |||||||||
Savings and Money Market Accounts |
155,178 | 161,873 | 177,998 | |||||||||
Certificates of Deposit less than $100 thousand |
197,077 | 205,675 | 239,446 | |||||||||
Certificates of Deposit of $100 thousand or more |
145,740 | 153,138 | 203,340 | |||||||||
Brokered Deposits |
277,852 | 314,876 | 353,396 | |||||||||
Total Deposits |
1,001,240 | 1,048,723 | 1,201,645 | |||||||||
Federal Funds Purchased and Securities Sold under Agreements to Repurchase |
14,951 | 15,933 | 18,371 | |||||||||
Security Deposits |
658 | 732 | 1,188 | |||||||||
Other Borrowings |
72 | 77 | 90 | |||||||||
Other Liabilities |
9,636 | 9,709 | 7,671 | |||||||||
Total Liabilities |
1,026,557 | 1,075,174 | 1,228,965 | |||||||||
STOCKHOLDERS EQUITY |
||||||||||||
Preferred Stock no par value 10,000,000 shares authorized; 33,000 issued as of March 31, 2011, December 31, 2010 and March 31, 2010 |
31,816 | 31,718 | 31,431 | |||||||||
Common Stock $.01 par value 150,000,000 shares authorized as of March 31, 2011 and December 31, 2010; 50,000,000 shares authorized as of March 31, 2010; 16,418,140 issued as of March 31, 2011; 16,418,327 issued as of December 31, 2010 and March 31, 2010 |
114 | 114 | 114 | |||||||||
Paid-In Surplus |
111,198 | 111,344 | 111,852 | |||||||||
Common Stock Warrants |
2,006 | 2,006 | 2,006 | |||||||||
Unallocated ESOP Shares |
(5,039 | ) | (5,218 | ) | (5,907 | ) | ||||||
Accumulated Deficit |
(53,798 | ) | (50,629 | ) | (5,877 | ) | ||||||
Accumulated Other Comprehensive Income |
3,850 | 4,039 | 5,951 | |||||||||
Total Stockholders Equity |
90,147 | 93,374 | 139,570 | |||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 1,116,704 | $ | 1,168,548 | $ | 1,368,535 | ||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Income Statements
(unaudited)
Three Months Ended March 31, |
||||||||
(in thousands, except per share data) |
2011 | 2010 | ||||||
INTEREST INCOME |
||||||||
Loans, including fees |
$ | 10,186 | $ | 13,450 | ||||
Debt Securities taxable |
864 | 1,090 | ||||||
Debt Securities non-taxable |
328 | 378 | ||||||
Other |
124 | 123 | ||||||
Total Interest Income |
11,502 | 15,041 | ||||||
INTEREST EXPENSE |
||||||||
Interest Bearing Demand Deposits |
41 | 45 | ||||||
Savings Deposits and Money Market Accounts |
278 | 408 | ||||||
Certificates of Deposit of less than $100 thousand |
812 | 1,343 | ||||||
Certificates of Deposit of $100 thousand or more |
669 | 1,194 | ||||||
Brokered Deposits |
2,063 | 2,254 | ||||||
Other |
113 | 122 | ||||||
Total Interest Expense |
3,976 | 5,366 | ||||||
NET INTEREST INCOME |
7,526 | 9,675 | ||||||
Provision for Loan and Lease Losses |
890 | 4,375 | ||||||
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES |
6,636 | 5,300 | ||||||
NONINTEREST INCOME |
||||||||
Service Charges on Deposit Accounts |
782 | 1,000 | ||||||
Gain on Sales of Available-for-Sale Securities |
| 57 | ||||||
Other |
1,482 | 1,247 | ||||||
Total Noninterest Income |
2,264 | 2,304 | ||||||
NONINTEREST EXPENSES |
||||||||
Salaries and Employee Benefits |
4,476 | 4,948 | ||||||
Expense on Premises and Fixed Assets, net of rental income |
1,333 | 1,383 | ||||||
Other |
5,558 | 3,541 | ||||||
Total Noninterest Expenses |
11,367 | 9,872 | ||||||
LOSS BEFORE INCOME TAX EXPENSE (BENEFIT) |
(2,467 | ) | (2,268 | ) | ||||
Income Tax Expense (Benefit ) |
191 | (1,154 | ) | |||||
NET LOSS |
(2,658 | ) | (1,114 | ) | ||||
Preferred Stock Dividends |
413 | 413 | ||||||
Accretion on Preferred Stock Discount |
98 | 92 | ||||||
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS |
$ | (3,169 | ) | $ | (1,619 | ) | ||
NET LOSS PER COMMON SHARE: |
||||||||
Net Loss Per Share - Basic |
$ | (0.20 | ) | $ | (0.10 | ) | ||
Net Loss Per Share - Diluted |
$ | (0.20 | ) | $ | (0.10 | ) | ||
Dividend Declared Per Common Share |
$ | | $ | |
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Statement of Stockholders Equity
Common Stock | Accumulated Other Comprehensive Income |
|||||||||||||||||||||||||||||||||||
(in thousands) |
Preferred Stock |
Shares | Amount | Paid-In Surplus |
Common Stock Warrants |
Accumulated Deficit |
Unallocated ESOP Shares |
Total | ||||||||||||||||||||||||||||
Balance December 31, 2010 |
$ | 31,718 | 16,418 | $ | 114 | $ | 111,344 | $ | 2,006 | $ | (50,629 | ) | $ | 4,039 | $ | (5,218 | ) | $ | 93,374 | |||||||||||||||||
Comprehensive Income: |
||||||||||||||||||||||||||||||||||||
Net Loss (unaudited) |
(2,658 | ) | (2,658 | ) | ||||||||||||||||||||||||||||||||
Change in Unrealized Gain: |
||||||||||||||||||||||||||||||||||||
Securities Available-for-Sale, net of tax adjustments (unaudited) |
182 | 182 | ||||||||||||||||||||||||||||||||||
Fair Value of Derivatives, net of tax and reclassification adjustments (unaudited) |
(371 | ) | (371 | ) | ||||||||||||||||||||||||||||||||
Total Comprehensive Loss |
(2,847 | ) | ||||||||||||||||||||||||||||||||||
Accretion of Discount Associated with Preferred Stock (unaudited) |
98 | (98 | ) | | ||||||||||||||||||||||||||||||||
Preferred Stock Dividend (unaudited) |
(413 | ) | (413 | ) | ||||||||||||||||||||||||||||||||
Stock-based Compensation (unaudited) |
5 | 5 | ||||||||||||||||||||||||||||||||||
ESOP Allocation (unaudited) |
(151 | ) | 179 | 28 | ||||||||||||||||||||||||||||||||
Balance March 31, 2011 (unaudited) |
$ | 31,816 | 16,418 | $ | 114 | $ | 111,198 | $ | 2,006 | $ | (53,798 | ) | $ | 3,850 | $ | (5,039 | ) | $ | 90,147 | |||||||||||||||||
(See Accompanying Notes to Consolidated Financial Statements)
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First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(unaudited)
Three Months Ended March 31, | ||||||||
(in thousands) |
2011 | 2010 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net Loss |
$ | (2,658 | ) | $ | (1,114 | ) | ||
Adjustments to Reconcile Net Loss to Net Cash (Used in) Provided by Operating Activities - |
||||||||
Provision for Loan and Lease Losses |
890 | 4,375 | ||||||
Amortization, net |
314 | 182 | ||||||
Stock-Based Compensation |
5 | 25 | ||||||
ESOP Compensation |
28 | 149 | ||||||
Depreciation |
386 | 473 | ||||||
Gain on Sale of Premises and Equipment |
(5 | ) | (8 | ) | ||||
Loss on Sale of Other Real Estate and Repossessions, net |
176 | 240 | ||||||
Write-down of Other Real Estate and Repossessions |
797 | 6 | ||||||
Gain on the Sale of Available-for-Sale Securities |
| (57 | ) | |||||
Accretion of Fair Value Adjustment, net |
(8 | ) | (15 | ) | ||||
Accretion of Terminated Cash Flow Swaps |
(481 | ) | (519 | ) | ||||
Changes in Operating Assets and Liabilities - |
||||||||
Loans Held for Sale |
1,411 | (897 | ) | |||||
Interest Receivable |
172 | 237 | ||||||
Other Assets |
510 | (3,923 | ) | |||||
Interest Payable |
(840 | ) | (753 | ) | ||||
Other Liabilities |
345 | (2,209 | ) | |||||
Net Cash Provided by (Used in) Operating Activities |
1,042 | (3,808 | ) | |||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Net Change in Interest Bearing Deposits in Banks |
15,018 | (58,345 | ) | |||||
Activity in Available-for-Sale-Securities |
||||||||
Maturities, Prepayments, and Calls |
13,317 | 16,541 | ||||||
Sales |
| 14,762 | ||||||
Purchases |
(13,395 | ) | (33,704 | ) | ||||
Loan Originations and Principal Collections, net |
34,295 | 38,459 | ||||||
Proceeds from Sale of Premises and Equipment |
5 | 8 | ||||||
Proceeds from Sales of Other Real Estate and Repossessions |
2,132 | 1,837 | ||||||
Additions to Premises and Equipment |
(91 | ) | (33 | ) | ||||
Capital Improvements to Other Real Estate and Repossessions |
(12 | ) | (391 | ) | ||||
Net Cash Provided by (Used in) Investing Activities |
51,269 | (20,866 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net (Decrease) Increase in Deposits |
(47,483 | ) | 18,972 | |||||
Net (Decrease) Increase in Federal Funds Purchased and Securities Sold Under Agreements to Repurchase |
(982 | ) | 460 | |||||
Net Decrease of Other Borrowings |
(5 | ) | (4 | ) | ||||
Net Cash (Used in) Provided by Financing Activities |
(48,470 | ) | 19,428 | |||||
NET CHANGE IN CASH AND CASH EQUIVALENTS |
3,841 | (5,246 | ) | |||||
CASH AND CASH EQUIVALENTS - beginning of period |
8,298 | 23,220 | ||||||
CASH AND CASH EQUIVALENTS - end of period |
$ | 12,139 | $ | 17,974 | ||||
(See Accompanying Notes to Consolidated Financial Statements)
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Three Months Ended March 31, | ||||||||
(in thousands) |
2011 | 2010 | ||||||
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES |
||||||||
Foreclosed Properties and Repossessions |
$ | 6,555 | $ | 5,248 | ||||
SUPPLEMENTAL SCHEDULE OF CASH FLOWS |
||||||||
Interest Paid |
$ | 4,816 | $ | 6,119 | ||||
Income Taxes Paid |
$ | 167 | $ | 38 |
(See Accompanying Notes to Consolidated Financial Statements)
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Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature.
The consolidated financial statements include the accounts of First Security Group, Inc. and its subsidiary, which is wholly-owned. All significant intercompany balances and transactions have been eliminated.
Operating results for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 or any other period. These interim financial statements should be read in conjunction with the Companys latest annual consolidated financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010.
NOTE 2 OPERATIONAL AND REGULATORY MATTERS
The Company continues to operate in a difficult environment and has been significantly impacted by the unprecedented credit and economic turmoil, as well as the recessionary economy. Deterioration in the Tennessee and Georgia commercial and residential real estate markets and related declines in property values in those markets has had a negative impact on our operating results since the latter half of 2008.
Operational Matters
The Companys financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has experienced losses from operations during the last two years that raise substantial doubt as to its ability to continue as a going concern. The Companys ability to continue as a going concern is contingent upon its ability to devise and successfully execute a management plan to develop profitable operations, satisfy the requirements of the regulatory actions detailed below, and lower the level of problem assets to an acceptable level.
Management has developed strategic and capital plans, which include, but are not limited to: (1) reorganizing management into a line of business structure, (2) restructuring credit and lending functions with new policies and centralized processes, (3) reducing adversely classified assets, (4) maintaining a Tier 1 leverage capital ratio of not less than 9%, (5) maintaining a total risk-based capital ratio of not less than 13%, (6) maintaining an adequate allowance for loan losses and (7) actively working to maintain appropriate liquidity while reducing reliance on non-core sources of funding.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
Regulatory Matters
First Security Group, Inc.
On September 7, 2010, the Company entered into a Written Agreement (Agreement) with the Federal Reserve Bank of Atlanta (Federal Reserve), the Companys primary regulator. The Agreement is designed to enhance the Companys ability to act as a source of strength to the Bank.
The Agreement prohibits the Company from declaring or paying dividends without prior written consent of the Federal Reserve. The Company is also prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank without prior written consent.
Within 60 days of the Agreement, the Company was required to submit to the Federal Reserve Bank a written plan designed to maintain sufficient capital at the Company and the Bank. The Company submitted a copy of the Banks capital plan that had previously been submitted to the OCC. Neither the Federal Reserve Bank nor the OCC have accepted that capital plan.
The Company is currently deemed not in compliance with several provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve Bank. Management believes the successful execution of the strategic initiatives discussed above will ultimately result in full compliance with the Agreement and position the Company for long-term growth and a return to profitability.
On September 14, 2010, the Company filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides the final, executed Agreement.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
FSGBank, N.A.
On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order (Order), FSGBank, the Companys wholly-owned subsidiary, consented and agreed to the issuance of a Consent Order by the Office of the Comptroller of the Currency (OCC), the Banks primary regulator.
The Bank and the OCC agreed as to the areas of the Banks operations that warrant improvement and a plan for making those improvements. The Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Bank is required to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan and lease losses, liquidity management, criticized asset, loan review and credit.
Within 120 days of the effective date of the Order, the Bank was required to achieve and thereafter maintain total capital at least equal to 13 percent of risk-weighted assets and Tier 1 capital at least equal to 9 percent of adjusted total assets. As of March 31, 2011, the third financial reporting period subsequent to the 120 day requirement, the Banks total capital to risk-weighted assets was 12.3 percent and the Tier 1 capital to adjusted total assets was 7.3 percent. The Bank has notified the OCC of the non-compliance.
During the third quarter of 2010, the OCC requested additional information and clarifications to the Banks submitted strategic and capital plans as well as the management assessments. At this time, the Bank has not submitted updated strategic and capital plans. However, as discussed further in Note 15, the Company engaged Triumph Investment Managers, LLC (Triumph), to assist management with the refinement of a comprehensive business plan. The Company anticipates this business plan will incorporate strategic and capital plans that will be submitted to the OCC.
Because the Order established specific capital amounts to be maintained by the Bank, the Bank may not be considered better than adequately capitalized for capital adequacy purposes, even if the Bank exceeds the levels of capital set forth in the Order. As an adequately capitalized institution, the Bank may not pay interest on deposits that are more than 75 basis points above the rate applicable to the applicable market of the Bank as determined by the FDIC. Additionally, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC.
The Bank is currently deemed not in compliance with the provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. Management believes the successful execution of the strategic initiatives discussed above will ultimately result in full compliance with the Order and position the Bank for long-term growth and a return to profitability.
On April 29, 2010, the Company filed a current report on Form 8-K describing the Order and the Banks actions to date. The Form 8-K also provides the final, executed Order.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 3 COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in equity, not only reflecting net income but certain other changes as well. The following table presents the comprehensive income for the three-month period ended March 31, 2011 and 2010, respectively.
Three months ended March 31, |
||||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
Net loss |
$ | (2,658 | ) | $ | (1,114 | ) | ||
Other comprehensive loss |
||||||||
Available-for-sale securities |
||||||||
Unrealized net gain on securities arising during the period |
275 | 186 | ||||||
Tax expense related to unrealized net gain |
(93 | ) | (63 | ) | ||||
Reclassification adjustments for realized gain included in net income |
| (57 | ) | |||||
Tax effect related to gain realized in net income |
| 19 | ||||||
Unrealized gain on securities, net of tax |
182 | 85 | ||||||
Derivative cash flow hedges |
||||||||
Unrealized (loss) gain on derivatives arising during the period |
(81 | ) | 25 | |||||
Tax expense related to unrealized gain |
27 | (8 | ) | |||||
Reclassification adjustments for realized gain included in net income |
(480 | ) | (519 | ) | ||||
Tax effect related to gain realized in net income |
163 | 176 | ||||||
Unrealized loss on derivatives, net of tax |
(371 | ) | (326 | ) | ||||
Other comprehensive (loss) income, net of tax |
(189 | ) | (241 | ) | ||||
Comprehensive loss |
$ | (2,847 | ) | $ | (1,355 | ) | ||
NOTE 4 EARNINGS PER SHARE
The difference in basic and diluted weighted average shares is due to the assumed conversion of outstanding options using the treasury stock method. The computation of basic and diluted earnings per share is as follows:
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in thousands, except per share data) |
||||||||
Net loss available to common shareholders |
$ | (3,169 | ) | $ | (1,619 | ) | ||
Denominator: |
||||||||
Weighted average common shares outstanding |
15,840 | 15,649 | ||||||
Equivalent shares issuable upon exercise of stock options, stock warrants and restricted stock awards |
1 | | ||||||
Diluted shares |
15,841 | 15,649 | ||||||
Net loss per common share: |
||||||||
Basic |
$ | (0.20 | ) | $ | (0.10 | ) | ||
Diluted |
$ | (0.20 | ) | $ | (0.10 | ) | ||
For the three months ended March 31, 2011 and 2010, there were 1,617 thousand and 2,006 thousand stock options, stock warrants and restricted stock awards that were not included in the computation of diluted earnings per share because the options were anti-dilutive under the treasury stock method, respectively. The anti-dilutive options expire between 2011 and 2019.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 5 SECURITIES
Investment Securities by Type
The following table presents the amortized cost and fair value of securities, with gross unrealized gains and losses.
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Securities available-for-sale |
||||||||||||||||
March 31, 2011 |
||||||||||||||||
Debt securities |
||||||||||||||||
Federal agencies |
$ | 29,969 | $ | 237 | $ | 169 | $ | 30,037 | ||||||||
Mortgage-backed |
86,713 | 2,278 | 110 | 88,881 | ||||||||||||
Municipals |
34,377 | 1,062 | 73 | 35,366 | ||||||||||||
Other |
127 | | 94 | 33 | ||||||||||||
Total |
$ | 151,186 | $ | 3,577 | $ | 446 | $ | 154,317 | ||||||||
Securities available-for-sale |
||||||||||||||||
December 31, 2010 |
||||||||||||||||
Debt securities |
||||||||||||||||
Federal agencies |
$ | 31,967 | $ | 199 | $ | 339 | $ | 31,827 | ||||||||
Mortgage-backed |
84,515 | 2,366 | 73 | 86,808 | ||||||||||||
Municipals |
34,700 | 947 | 147 | 35,500 | ||||||||||||
Other |
127 | | 97 | 30 | ||||||||||||
Total |
$ | 151,309 | $ | 3,512 | $ | 656 | $ | 154,165 | ||||||||
There were no sales of securities for the three months ended March 31, 2011. Proceeds from sales of securities available-for-sale totaled $14,762 thousand for the three months ended March 31, 2010. Gross realized gains from sales of securities were $368 thousand for the three months ended March 31, 2010. Gross losses were $311 thousand for the three months ended March 31, 2010.
At March 31, 2011, December 31, 2010 and March 31, 2010, federal agencies, municipals and mortgage-backed securities with a carrying value of $22,823 thousand, $21,572 thousand and $31,666 thousand, respectively, were pledged to secure public deposits. At March 31, 2011, December 31, 2010 and March 31, 2010, the carrying amount of securities pledged to secure repurchase agreements was $18,581 thousand, $30,254 thousand and $25,577 thousand, respectively. At March 31, 2011, December 31, 2010 and March 31, 2010, securities of $5,762 thousand, $5,756 thousand and $6,195 thousand were pledged to the Federal Reserve Bank of Atlanta to secure the Companys daytime correspondent transactions. At March 31, 2011, the carrying amount of securities pledged to secure lines of credit with the FHLB totaled $10,985 thousand.
Maturity of Securities
The following table presents the amortized cost and fair value of debt securities by contractual maturity at March 31, 2011.
Amortized Cost |
Fair Value |
|||||||
(in thousands) | ||||||||
Within 1 year |
$ | 2,542 | $ | 2,576 | ||||
Over 1 year through 5 years |
30,154 | 30,824 | ||||||
5 years to 10 years |
27,448 | 27,784 | ||||||
Over 10 years |
4,329 | 4,252 | ||||||
64,473 | 65,436 | |||||||
Mortgage-backed securities |
86,713 | 88,881 | ||||||
Total |
$ | 151,186 | $ | 154,317 | ||||
10
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
Impairment Analysis
The following table shows the gross unrealized losses and fair value of the Companys investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010.
Less than 12 months | 12 months or greater | Totals | ||||||||||||||||||||||
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
|||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
March 31, 2011 |
||||||||||||||||||||||||
Federal agencies |
$ | 6,823 | $ | 169 | $ | | $ | | $ | 6,823 | $ | 169 | ||||||||||||
Mortgage-backed |
13,409 | 110 | | | 13,409 | 110 | ||||||||||||||||||
Municipals |
1,808 | 46 | 375 | 27 | 2,183 | 73 | ||||||||||||||||||
Other |
| | 33 | 94 | 33 | 94 | ||||||||||||||||||
Totals |
$ | 22,040 | $ | 325 | $ | 408 | $ | 121 | $ | 22,448 | $ | 446 | ||||||||||||
December 31, 2010 |
||||||||||||||||||||||||
Federal agencies |
$ | 15,147 | $ | 339 | $ | | $ | | $ | 15,147 | $ | 339 | ||||||||||||
Mortgage-backed |
8,466 | 73 | | | 8,466 | 73 | ||||||||||||||||||
Municipals |
4,030 | 110 | 364 | 37 | 4,394 | 147 | ||||||||||||||||||
Other |
| | 30 | 97 | 30 | 97 | ||||||||||||||||||
Totals |
$ | 27,643 | $ | 522 | $ | 394 | $ | 134 | $ | 28,037 | $ | 656 | ||||||||||||
As of March 31, 2011, the Company performed an impairment assessment of the securities in its portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) the Company intends to sell the security, (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized costs basis or (3) the Company does not expect to recover the securitys entire amortized cost basis, even if the Company does not intend to sell. Additionally, accounting guidance requires that for impaired securities that the Company does not intend to sell and/or that it is not more-likely-than-not that the Company will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, the Company considers factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
As of March 31, 2011, gross unrealized losses in the Companys portfolio totaled $446 thousand, compared to $656 thousand as of December 31, 2010. The unrealized losses in federal agencies (consisting of three securities), mortgage-backed (consisting of five securities) and municipal (consisting of six securities) securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. The Company does not intend to sell the investments with unrealized losses and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. Based on results of the Companys impairment assessment, the unrealized losses at March 31, 2011 are considered temporary.
11
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 6 LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Loans by type are summarized as follows:
March 31, 2011 |
December 31, 2010 |
March 31, 2010 |
||||||||||
Loans secured by real estate |
||||||||||||
Residential 1-4 family |
$ | 240,906 | $ | 252,026 | $ | 278,695 | ||||||
Commercial |
215,831 | 226,357 | 255,174 | |||||||||
Construction |
74,672 | 84,232 | 125,603 | |||||||||
Multi-family and farmland |
35,556 | 36,393 | 41,314 | |||||||||
566,965 | 599,008 | 700,786 | ||||||||||
Commercial loans |
77,087 | 82,807 | 138,156 | |||||||||
Consumer installment loans |
29,468 | 33,860 | 45,564 | |||||||||
Leases, net of unearned income |
5,467 | 7,916 | 17,405 | |||||||||
Other |
3,661 | 3,500 | 3,601 | |||||||||
Total loans |
682,648 | 727,091 | 905,512 | |||||||||
Allowance for loan and lease losses |
(22,500 | ) | (24,000 | ) | (26,101 | ) | ||||||
Net loans |
$ | 660,148 | $ | 703,091 | $ | 879,411 | ||||||
The allowance for loan and lease losses is composed of three primary components: (1) specific impairments for substandard/nonaccrual loans and leases, (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, and (3) general allocations for the remaining pools of loans. The Company accumulates pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions. Because of uncertainties inherent in the estimation process, managements estimate of credit losses in the loan portfolio and the related allowance may materially change in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
The following table presents an analysis of the activity in the allowance for loan and lease losses for the periods ended March 31, 2011 and March 31, 2010. The provisions for loan and lease losses in the table below do not include the Companys provision accrual for unfunded commitments of $6 thousand and $6 thousand for the three month periods ended March 31, 2011 and March 31, 2010, respectively. The reserve for unfunded commitments is included in other liabilities in the consolidated balance sheets and totaled $235 thousand and $211 thousand at March 31, 2011 and 2010, respectively.
Allowance for Loan and Lease Losses
For the Three Months Ended March 31, 2011
Real estate: Residential 1-4 family |
Real estate: Commercial |
Real estate: Construction |
Real estate: Multi- family and farmland |
Commercial | Consumer | Leases | Other | Unallocated | Total | |||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Allowance for loan and lease losses: |
||||||||||||||||||||||||||||||||||||||||
Beginning balance, December 31, 2010 |
$ | 7,346 | $ | 5,550 | $ | 2,905 | $ | 761 | $ | 5,692 | $ | 813 | $ | 917 | $ | 16 | $ | | $ | 24,000 | ||||||||||||||||||||
Charge-offs |
(270 | ) | (662 | ) | (700 | ) | ( | ) | (352 | ) | (122 | ) | (919 | ) | ( | ) | | (3,025 | ) | |||||||||||||||||||||
Recoveries |
6 | 1 | 38 | 6 | 253 | 36 | 301 | | | 641 | ||||||||||||||||||||||||||||||
Provision |
(402 | ) | 492 | 1,136 | (82 | ) | (908 | ) | (129 | ) | 783 | (6 | ) | | 884 | |||||||||||||||||||||||||
Ending balance, March 31, 2011 |
$ | 6,680 | $ | 5,381 | $ | 3,379 | $ | 685 | $ | 4,685 | $ | 598 | $ | 1,082 | $ | 10 | $ | | $ | 22,500 | ||||||||||||||||||||
12
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
For the Three Months Ended March 31, 2010
Real estate: Residential 1-4 family |
Real estate: Commercial |
Real estate: Construction |
Real estate: Multi- family and farmland |
Commercial | Consumer | Leases | Other | Unallocated | Total | |||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Allowance for loan and lease losses: |
||||||||||||||||||||||||||||||||||||||||
Beginning balance, December 31, 2009 |
$ | 5,037 | $ | 4,525 | $ | 6,706 | $ | 766 | $ | 6,953 | $ | 1,107 | $ | 1,386 | $ | 12 | $ | | $ | 26,492 | ||||||||||||||||||||
Charge-offs |
(429 | ) | ( | ) | (2,413 | ) | (130 | ) | (1,232 | ) | (358 | ) | (494 | ) | ( | ) | | (5,056 | ) | |||||||||||||||||||||
Recoveries |
3 | 145 | 1 | | 109 | 37 | | 1 | | 296 | ||||||||||||||||||||||||||||||
Provision |
742 | 729 | 315 | (69 | ) | 1,691 | 532 | 425 | 4 | | 4,369 | |||||||||||||||||||||||||||||
Ending balance, March 31, 2010 |
$ | 5,353 | $ | 5,399 | $ | 4,609 | $ | 567 | $ | 7,521 | $ | 1,318 | $ | 1,317 | $ | 17 | $ | | $ | 26,101 | ||||||||||||||||||||
The following table presents an analysis of the end of period balance of the allowance for loan and lease losses as of March 31, 2011.
As of March 31, 2011
Real estate: Residential 1-4 family |
Real estate: Commercial |
Real estate: Construction |
Real estate: Multi-family and farmland |
Total Real Estate Loans | ||||||||||||||||||||||||||||||||||||
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
|||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Individually evaluated |
$ | 2,366 | $ | | $ | 13,774 | $ | | $ | 19,221 | $ | 900 | $ | 1,069 | $ | | $ | 36,430 | $ | 900 | ||||||||||||||||||||
Collectively evaluated |
238,540 | 6,680 | 202,057 | 5,381 | 55,451 | 2,479 | 34,487 | 685 | 530,535 | 15,225 | ||||||||||||||||||||||||||||||
Total evaluated |
$ | 240,906 | $ | 6,680 | $ | 215,831 | $ | 5,381 | $ | 74,672 | $ | 3,379 | $ | 35,556 | $ | 685 | $ | 566,965 | $ | 16,125 | ||||||||||||||||||||
(continued from above) | Commercial | Consumer | Leases | Other | Grand Total | |||||||||||||||||||||||||||||||||||
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
|||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Individually evaluated |
$ | 3,948 | $ | 304 | $ | 1,673 | $ | | $ | 1,089 | $ | | $ | | $ | | $ | 43,140 | $ | 1,204 | ||||||||||||||||||||
Collectively evaluated |
73,139 | 4,381 | 27,795 | 598 | 4,378 | 1,082 | 3,661 | 10 | 639,508 | 21,296 | ||||||||||||||||||||||||||||||
Total evaluated |
$ | 77,087 | $ | 4,685 | $ | 29,468 | $ | 598 | $ | 5,467 | $ | 1,082 | $ | 3,661 | $ | 10 | $ | 682,648 | $ | 22,500 | ||||||||||||||||||||
The following table presents an analysis of the end of period balance of the allowance for loan and lease losses as of December 31, 2010.
As of December 31, 2010
Real estate: Residential 1-4 family |
Real estate: Commercial |
Real estate: Construction |
Real estate: Multi-family and farmland |
Total Real Estate Loans | ||||||||||||||||||||||||||||||||||||
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
|||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Individually evaluated |
$ | 1,944 | $ | | $ | 8,232 | $ | | $ | 23,909 | $ | 148 | $ | 415 | $ | | $ | 34,500 | $ | 148 | ||||||||||||||||||||
Collectively evaluated |
250,082 | 7,346 | 218,125 | 5,550 | 60,323 | 2,757 | 35,978 | 761 | 564,508 | 16,414 | ||||||||||||||||||||||||||||||
Total evaluated |
$ | 252,026 | $ | 7,346 | $ | 226,357 | $ | 5,550 | $ | 84,232 | $ | 2,905 | $ | 36,393 | $ | 761 | $ | 599,008 | $ | 16,562 | ||||||||||||||||||||
(continued from above) | Commercial | Consumer | Leases | Other | Grand Total | |||||||||||||||||||||||||||||||||||
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
Carrying Value |
Associated Allowance |
|||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||
Individually evaluated |
$ | 3,600 | $ | 309 | $ | 1,423 | $ | | $ | 2,083 | $ | | $ | | $ | | $ | 41,606 | $ | 457 | ||||||||||||||||||||
Collectively evaluated |
79,207 | 5,383 | 32,437 | 813 | 5,833 | 917 | 3,500 | 16 | 685,485 | 23,543 | ||||||||||||||||||||||||||||||
Total evaluated |
$ | 82,807 | $ | 5,692 | $ | 33,860 | $ | 813 | $ | 7,916 | $ | 917 | $ | 3,500 | $ | 16 | $ | 727,091 | $ | 24,000 | ||||||||||||||||||||
13
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The Company utilizes a risk rating system to evaluate the credit risk of its loan portfolio. The Company classifies loans as: pass, special mention, substandard, doubtful or loss. The Company assigns a pass rating to loans that are performing as contractually agreed and do not exhibit the characteristics of heightened credit risk. The Company assigns a special mention risk rating to loans that are criticized but not considered as severe as a classified loan. Special mention loans generally contain one or more potential weaknesses, which if not corrected, could result in an unacceptable increase in the credit risk at some future date. The Company assigns a substandard risk rating to loans that have specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic or managerial nature and may require nonaccrual status. Substandard loans have a greater likelihood of loss.
The Company segregates substandard loans into two classifications based on the Companys allowance methodology for impaired loans. The Company defines an impaired loan as a substandard loan relationship in excess of $500 thousand that is also on nonaccrual status. The Company individually reviews these relationships on a quarterly basis to determine the required allowance or loss, as applicable.
For the allowance analysis, the Companys primary categories are: pass, special mention, substandard non-impaired, and substandard impaired. Loans in the substandard and doubtful loan categories are combined and impaired loans are segregated from non-impaired loans. The following table presents the Companys internal risk rating by loan classification as utilized in the allowance analysis as of March 31, 2011:
As of March 31, 2011
Pass | Special Mention |
Substandard Non-impaired |
Substandard Impaired |
Total | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Loans by Classification |
||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 207,493 | $ | 6,865 | $ | 24,182 | $ | 2,366 | $ | 240,906 | ||||||||||
Real estate: Commercial |
169,946 | 14,111 | 18,000 | 13,774 | 215,831 | |||||||||||||||
Real estate: Construction |
41,442 | 3,458 | 10,551 | 19,221 | 74,672 | |||||||||||||||
Real estate: Multi-family and farmland |
30,624 | 1,936 | 1,927 | 1,069 | 35,556 | |||||||||||||||
Commercial |
51,121 | 3,893 | 18,125 | 3,948 | 77,087 | |||||||||||||||
Consumer |
27,298 | 26 | 471 | 1,673 | 29,468 | |||||||||||||||
Leases |
| 1,864 | 2,514 | 1,089 | 5,467 | |||||||||||||||
Other |
3,641 | | 20 | | 3,661 | |||||||||||||||
Total Loans |
$ | 531,565 | $ | 32,153 | $ | 75,790 | $ | 43,140 | $ | 682,648 | ||||||||||
The following table presents the Companys internal risk rating by loan classification as utilized in the allowance analysis as of December 31, 2010:
As of December 31, 2010
Pass | Special Mention |
Substandard Non-impaired |
Substandard Impaired |
Total | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Loans by Classification |
||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 217,470 | $ | 7,378 | $ | 25,234 | $ | 1,944 | $ | 252,026 | ||||||||||
Real estate: Commercial |
182,584 | 18,030 | 17,511 | 8,232 | 226,357 | |||||||||||||||
Real estate: Construction |
46,305 | 3,970 | 10,048 | 23,909 | 84,232 | |||||||||||||||
Real estate: Multi-family and farmland |
30,835 | 3,238 | 1,905 | 415 | 36,393 | |||||||||||||||
Commercial |
54,553 | 4,338 | 20,316 | 3,600 | 82,807 | |||||||||||||||
Consumer |
31,238 | 43 | 1,156 | 1,423 | 33,860 | |||||||||||||||
Leases |
| 2,036 | 3,797 | 2,083 | 7,916 | |||||||||||||||
Other |
3,464 | | 36 | | 3,500 | |||||||||||||||
Total Loans |
$ | 566,449 | $ | 39,033 | $ | 80,003 | $ | 41,606 | $ | 727,091 | ||||||||||
The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans were $43,140 thousand
14
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
and $41,606 thousand at March 31, 2011 and December 31, 2010, respectively. For impaired loans, the Company generally applies all payments directly to principal. Accordingly, the Company did not recognize any significant amount of interest for impaired loans during the three months ended March 31, 2011. The following table presents additional information on the Companys impaired loans as of March 31, 2011 and December 31, 2010:
As of March 31, 2011 | As of December 31, 2010 | |||||||||||||||||||||||
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
|||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Impaired loans with no related allowance recorded: |
||||||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 2,366 | $ | 2,700 | $ | | $ | 1,944 | $ | 2,265 | $ | | ||||||||||||
Real estate: Commercial |
13,774 | 15,167 | | 8,232 | 9,210 | | ||||||||||||||||||
Real estate: Construction |
13,985 | 18,130 | | 18,644 | 24,886 | | ||||||||||||||||||
Real estate: Multi-family and farmland |
1,069 | 1,350 | | 415 | 415 | | ||||||||||||||||||
Commercial |
3,020 | 13,100 | | 2,658 | 12,634 | | ||||||||||||||||||
Consumer |
1,673 | 1,673 | | 1,423 | 1,423 | | ||||||||||||||||||
Leases |
1,089 | 2,898 | | 2,083 | 2,198 | | ||||||||||||||||||
Other |
| | | | | | ||||||||||||||||||
Total |
$ | 36,976 | $ | 55,018 | $ | | $ | 35,399 | $ | 53,031 | $ | | ||||||||||||
Impaired loans with an allowance recorded: |
||||||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | | $ | | $ | | $ | | $ | | $ | | ||||||||||||
Real estate: Commercial |
| | | | | | ||||||||||||||||||
Real estate: Construction |
5,236 | 5,400 | 900 | 5,265 | 5,400 | 148 | ||||||||||||||||||
Real estate: Multi-family and farmland |
| | | | | | ||||||||||||||||||
Commercial |
928 | 977 | 304 | 942 | 977 | 309 | ||||||||||||||||||
Consumer |
| | | | | | ||||||||||||||||||
Leases |
| | | | | | ||||||||||||||||||
Other |
| | | | | | ||||||||||||||||||
Total |
$ | 6,164 | $ | 6,377 | $ | 1,204 | $ | 6,207 | $ | 6,377 | $ | 457 | ||||||||||||
Nonaccrual loans were $52,539 thousand, $54,082 thousand and $50,305 thousand at March 31, 2011, December 31, 2010 and March 31, 2010, respectively. The following table provides nonaccrual loans by type:
As of March 31, 2011 |
As of December 31, 2010 |
As of March 31, 2010 |
||||||||||
Nonaccrual Loans by Classification |
||||||||||||
Real estate: Residential 1-4 family |
$ | 7,648 | $ | 8,906 | 7,392 | |||||||
Real estate: Commercial |
14,705 | 9,181 | 5,622 | |||||||||
Real estate: Construction |
19,944 | 25,586 | 13,950 | |||||||||
Real estate: Multi-family and farmland |
1,320 | 826 | 1,281 | |||||||||
Commercial |
4,818 | 4,228 | 16,234 | |||||||||
Consumer and other |
1,862 | 1,896 | 1,883 | |||||||||
Leases |
2,242 | 3,459 | 3,943 | |||||||||
Total Loans |
$ | 52,539 | $ | 54,082 | $ | 50,305 | ||||||
15
Table of Contents
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The Company monitors loans by past due status. The following table provides the past due status for all loans. Nonaccrual loans are included in the applicable classification.
As of March 31, 2011
30-89 Days Past Due |
Greater than 90 Days Past Due |
Total Past Due |
Current | Total | Greater than 90 Days Past Due and Accruing |
|||||||||||||||||||
Loans by Classification |
||||||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 6,030 | $ | 3,187 | $ | 9,217 | $ | 231,689 | $ | 240,906 | $ | 137 | ||||||||||||
Real estate: Commercial |
6,236 | 6,326 | 12,562 | 203,269 | 215,831 | 863 | ||||||||||||||||||
Real estate: Construction |
1,958 | 14,098 | 16,056 | 58,616 | 74,672 | 2,109 | ||||||||||||||||||
Real estate: Multi-family and farmland |
715 | 766 | 1,481 | 34,075 | 35,556 | | ||||||||||||||||||
Subtotal of real estate secured loans |
14,939 | 24,377 | 39,316 | 527,649 | 566,965 | 3,109 | ||||||||||||||||||
Commercial |
4,311 | 3,628 | 7,939 | 69,148 | 77,087 | 1,075 | ||||||||||||||||||
Consumer |
314 | 1,734 | 2,048 | 27,420 | 29,468 | 30 | ||||||||||||||||||
Leases |
1,615 | 1,792 | 3,407 | 2,060 | 5,467 | 48 | ||||||||||||||||||
Other |
56 | 17 | 73 | 3,588 | 3,661 | 17 | ||||||||||||||||||
Total Loans |
$ | 21,235 | $ | 31,548 | $ | 52,783 | $ | 629,865 | $ | 682,648 | $ | 4,279 | ||||||||||||
As of December 31, 2010
30-89 Days Past Due |
Greater than 90 Days Past Due |
Total Past Due |
Current | Total | Greater than 90 Days Past Due and Accruing |
|||||||||||||||||||
Loans by Classification |
||||||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 3,629 | $ | 5,855 | $ | 9,484 | $ | 242,542 | $ | 252,026 | $ | 403 | ||||||||||||
Real estate: Commercial |
5,185 | 5,905 | 11,090 | 215,267 | 226,357 | 2,271 | ||||||||||||||||||
Real estate: Construction |
3,732 | 15,371 | 19,103 | 65,129 | 84,232 | 3 | ||||||||||||||||||
Real estate: Multi-family and farmland |
53 | 1,757 | 1,810 | 34,583 | 36,393 | 985 | ||||||||||||||||||
Subtotal of real estate secured loans |
12,599 | 28,888 | 41,487 | 557,521 | 599,008 | 3,662 | ||||||||||||||||||
Commercial |
1,726 | 2,955 | 4,681 | 78,126 | 82,807 | 409 | ||||||||||||||||||
Consumer |
384 | 2,430 | 2,814 | 31,046 | 33,860 | 679 | ||||||||||||||||||
Leases |
2,725 | 3,055 | 5,780 | 2,136 | 7,916 | 82 | ||||||||||||||||||
Other |
80 | 6 | 86 | 3,414 | 3,500 | 6 | ||||||||||||||||||
Total Loans |
$ | 17,514 | $ | 37,334 | $ | 54,848 | $ | 672,243 | $ | 727,091 | $ | 4,838 | ||||||||||||
NOTE 7 COMMITMENTS AND CONTINGENCIES
The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and the issuance of financial guarantees in the form of financial and performance standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The Companys exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as they do for on-balance-sheet instruments. The Companys maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at March 31, 2011, December 31, 2010 and March 31, 2010, was as follows:
March 31, 2011 |
December 31, 2010 |
March 31, 2010 |
||||||||||
(in thousands) | ||||||||||||
Commitments to extend credit |
$ | 120,464 | $ | 127,377 | $ | 157,755 | ||||||
Standby letters of credit |
$ | 13,798 | $ | 14,090 | $ | 15,394 |
Commitments to extend credit are agreements to lend to customers. Standby letters of credit are contingent commitments issued by the Company to guarantee performance of a customer to a third party under a contractual non-financial obligation for which it receives a fee. Financial standby letters of credit represent a commitment to guarantee customer repayment of an outstanding loan or debt instrument. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company on extension of credit, is based on managements credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Additionally, in the ordinary course of business, the Company is subject to regulatory examinations, information gathering requests, inquiries, and investigations. The Company establishes accruals for litigation and regulatory matters when those matters present loss contingencies that the Company determines to be both probable and reasonably estimable. Based on current knowledge, advice of counsel and available insurance coverage, management does not believe that liabilities arising from legal claims, if any, will have a material adverse effect on the Companys consolidated financial condition, results of operations, or cash flows. However, in light of the significant uncertainties involved in these matters, the early stage of various legal proceedings, and the indeterminate amount of damages sought in some of these matters, it is possible that the ultimate resolution of these matters, if unfavorable, could be material to the Companys results of operations for any particular period.
The Company intends to vigorously pursue all available defenses to these claims. There are significant uncertainties involved in any litigation. Although the ultimate outcome of these lawsuits cannot be ascertained at this time, based upon information that presently is available to it, management is unable to predict the outcome of these cases and cannot determine the probability of an adverse result or reasonably estimate a range of potential loss, if any. In addition, management is unable to estimate a range of reasonably possible losses with respect to these claims.
NOTE 8 STOCKHOLDERS EQUITY
Preferred Stock
Beginning with the February 15, 2010 dividend on the Preferred Stock, the Companys Board of Directors elected to defer payments on the dividend on the Preferred Stock. Dividends for the Series A Preferred Stock are cumulative. If the Company misses six quarterly Preferred Stock dividend payments, whether or not consecutive, the Treasury will have the right to appoint two directors to the Companys Board of Directors until all accrued but unpaid dividends have been paid on the Preferred Stock. The Treasury has requested, and the Company agreed, to permit an observer employed by the Treasury to attend meetings of the Companys Board of Directors.
On September 7, 2010, the Company entered into a Written Agreement with the Federal Reserve Bank of Atlanta. As part of the Agreement, the Company is prohibited from declaring or paying dividends without prior written consent from the Federal Reserve. Note 2 provides additional information on the Agreement.
The Company recognized $413 thousand and $413 thousand in expense for Preferred Stock dividends for the three months ended March 31, 2011 and 2010, respectively. As of March 31, 2011, the unpaid, accrued dividend is $2,269 thousand and is included in other liabilities in the Companys consolidated balance sheet. As of March 31, 2011 and 2010, the Company recognized $98 thousand and $92 thousand, respectively, in Preferred Stock discount accretion.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
ESOP Activity
On March 31, 2011, the Company released shares from the Employee Stock Ownership Plan (ESOP) for the matching contribution of 100% of the employees contribution up to 1% of the employees compensation for the Plan year. The number of unallocated, committed to be released, and allocated shares for the ESOP are as follows:
Unallocated Shares |
Committed to be released shares |
Allocated Shares |
Compensation Expense (in thousands) |
|||||||||||||
Shares as of December 31, 2010 |
577,723 | | 622,953 | |||||||||||||
Shares allocated for first quarter 2011 match |
(27,669 | ) | | 27,669 | $ | 28 | ||||||||||
Shares as of March 31, 2011 |
550,054 | | 650,622 | |||||||||||||
NOTE 9 TAXES
The Company accounts for income taxes in accordance with ASC 740, which requires an asset and liability approach for the financial accounting and reporting of income taxes. Under this method, deferred income taxes are recognized for the expected future tax consequences of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. These balances are measured using the enacted tax rates expected to apply in the year(s) in which these temporary differences are expected to reverse. The effect on deferred income taxes of a change in tax rates is recognized in income in the period when the change is enacted.
In accordance with ASC 740, the Company is required to establish a valuation allowance for deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions.
During 2010, the Company established a deferred tax asset valuation allowance after evaluating all available positive and negative evidence. Positive evidence included the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years and general business and economic trends. As business and economic conditions change, the Company will re-evaluate the valuation allowance. As of March 31, 2011, the valuation allowance totals $25,971 thousand.
For the three months ended March 31, 2011 and 2010, the Company recognized an income tax provision of $191 thousand and an income tax benefit of $1,154 thousand, respectively. The following reconciles the income tax provision (benefit) to statutory rates:
For the Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
Federal taxes at statutory tax rate |
$ | (839 | ) | $ | (771 | ) | ||
Tax exempt earnings on loans and securities |
(113 | ) | (131 | ) | ||||
Tax exempt earnings on bank owned life insurance |
(87 | ) | (86 | ) | ||||
Low-income housing tax credits |
(97 | ) | (103 | ) | ||||
Other, net |
29 | 52 | ||||||
State tax provision, net of federal effect |
(123 | ) | (115 | ) | ||||
Changes in the deferred tax asset valuation allowance |
1,421 | | ||||||
Income tax provision (benefit) |
$ | 191 | $ | (1,154 | ) | |||
The increase in the deferred tax valuation allowance offset the income tax benefits recognized for the three months ended March 31, 2011. The benefit recognized before the valuation allowance primarily related to the year-to-date operating loss.
The Company evaluated its material tax positions as of March 31, 2011. Under the more-likely-than-not threshold guidelines, the Company believes it has identified all significant uncertain tax benefits. The Company evaluates, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
component of income tax expense in the Companys consolidated financial statements. The roll-forward of unrecognized tax benefits is as follows:
Amount | ||||
(in thousands) | ||||
Balance at January 1, 2011 |
$ | 1,338 | ||
Increases related to prior year tax positions |
| |||
Increases related to current year tax positions |
27 | |||
Lapse of statute |
| |||
Balance at March 31, 2011 |
$ | 1,365 | ||
NOTE 10 FAIR VALUE MEASUREMENTS
The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
The following tables present information about the Companys assets and liabilities measured at fair value on a recurring basis as of March 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The following table presents the Companys assets and liabilities measured at fair value on a recurring basis as of March 31, 2011.
Balance as of March 31, 2011 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||||
(in thousands) | ||||||||||||||||
Financial assets |
||||||||||||||||
Securities available-for-sale |
$ | 154,317 | $ | | $ | 154,067 | $ | 250 | ||||||||
Loans held for sale |
1,145 | | 1,145 | | ||||||||||||
Forward loan sales contracts |
1 | | 1 | | ||||||||||||
Financial liabilities |
||||||||||||||||
None |
| | | |
The following table presents additional information about changes in assets and liabilities measured at fair value on a recurring basis and for which the Company utilized Level 3 inputs to determine fair value as of March 31, 2011.
Beginning Balance |
Total Realized and Unrealized Gains or Losses |
Purchases, Sales, Other Settlements and Issuances, net |
Net Transfers In and/or Out of Level 3 |
Ending Balance |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Financial Assets |
||||||||||||||||||||
Securities available-for-sale |
$ | 250 | $ | | $ | | $ | | $ | 250 |
The Company did not recognize any unrealized gains or losses on Level 3 fair value assets or liabilities.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
At March 31, 2011, the Company also had assets and liabilities measured at fair value on a non-recurring basis. Items measured at fair value on a non-recurring basis include other real estate owned (OREO), repossessions, and collateral-dependent impaired loans. Such measurements were determined utilizing Level 2 and Level 3 inputs.
Upon initial recognition, OREO and repossessions are measured at fair value, which becomes the cost basis. The cost basis is subsequently re-measured at fair value when events or circumstances occur that indicate the initial fair value has declined. The fair value is generally determined using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. Fair value adjustments for OREO and repossessions have generally been classified as Level 2.
The Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of these loans. Nonrecurring adjustments also include certain impairment amounts for collateral-dependent loans when establishing the allowance for loan and lease losses. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance may be established as a component of the allowance for loan and lease losses or the expense is recognized as a partial charge-off. The fair value of collateral-dependent loans is generally determined using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally available in the marketplace. These measurements have generally been classified as Level 2.
The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis for which impairment was recognized for during the three months ended March 31, 2011.
Carrying Value as of March 31, 2011 |
Level 1 Fair Value Measurement |
Level 2 Fair Value Measurement |
Level 3 Fair Value Measurement |
Valuation Allowance as of March 31, 2011 |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Other real estate owned |
$ | 3,123 | $ | | $ | 3,123 | $ | | $ | (1,111 | ) | |||||||||
Repossessions |
8 | | 8 | | (13 | ) | ||||||||||||||
Collateral-dependent impaired loans |
4,120 | | 4,120 | | (2,163 | ) |
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The following table presents the estimated fair values of the Companys financial instruments.
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying Amount |
Fair Value | Carrying Amount |
Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Financial assets |
||||||||||||||||
Cash and cash equivalents |
$ | 12,139 | $ | 12,139 | $ | 8,298 | $ | 8,298 | ||||||||
Interest bearing deposits in banks |
$ | 185,603 | $ | 185,603 | $ | 200,621 | $ | 200,621 | ||||||||
Securities available-for-sale |
$ | 154,317 | $ | 154,317 | $ | 154,165 | $ | 154,165 | ||||||||
Loans held for sale |
$ | 1,145 | $ | 1,145 | $ | 2,556 | $ | 2,556 | ||||||||
Loans |
$ | 681,503 | $ | 692,035 | $ | 724,535 | $ | 736,232 | ||||||||
Allowance for loan and lease losses |
$ | (22,500 | ) | $ | (22,500 | ) | $ | 24,000 | $ | 24,000 | ||||||
Financial liabilities |
||||||||||||||||
Deposits |
$ | 1,001,240 | $ | 993,938 | $ | 1,048,723 | $ | 1,052,784 | ||||||||
Federal funds purchased and securities sold under agreements to repurchase |
$ | 14,951 | $ | 14,951 | $ | 15,933 | $ | 15,933 | ||||||||
Other borrowings |
$ | 72 | $ | 72 | $ | 77 | $ | 77 |
The following methods and assumptions were used by the Company in estimating fair value of each class of financial instruments for which it is practicable to estimate that value:
| Cash and cash equivalents The carrying value of cash and cash equivalents approximates fair value. |
| Interest bearing deposits in banks The carrying amounts of interest bearing deposits in banks approximate fair value. |
| Securities The Companys securities are valued utilizing Level 2 inputs with the exception of one $250 thousand bond. Level 2 inputs are based on quoted prices for similar assets in active markets. |
| Loans held for sale Fair value for loans held for sale are based on quoted prices for similar assets in active markets. |
| Loans For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans and other consumer loans are estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans and leases are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit ratings quality. Fair value for impaired loans and leases is estimated using discounted cash flow analysis or underlying collateral values, where applicable. |
| Deposit liabilities The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value for fixed-rate certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected maturities on time deposits. |
| Federal funds purchased and securities sold under agreements to repurchase These borrowings generally mature in 90 days or less and, accordingly, the carrying amount reported in the balance sheet approximates fair value. |
| Other borrowings Other borrowings carrying amount reported in the consolidated balance sheets approximates fair value. |
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 11 FAIR VALUE OPTION
Authoritative accounting guidance provides a fair value option election (FVO) that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. The guidance permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The Company records all newly-originated loans held for sale under the fair value option. Origination fees and costs are recognized in earnings at the time of origination. The servicing value is included in the fair value of the loan and recognized at origination of the loan. The Company uses derivatives to hedge changes in servicing value as a result of including the servicing value in the fair value of the loan. The estimated impact from recognizing servicing value, net of related hedging costs, as part of the fair value of the loan is captured in the mortgage loan and related fees component of noninterest income.
As of March 31, 2011, December 31, 2010 and March 31, 2010, there was $1,145 thousand, $2,556 thousand and $2,138 thousand in loans held for sale recorded at fair value, respectively. For the three months ended March 31, 2011 and 2010, $205 thousand and $149 thousand, respectively, in loan origination and related fee income was recognized in non-interest income and an insignificant amount of origination and related fee expense was recognized in non-interest expense utilizing the fair value option.
For the three months ended March 31, 2011 and 2010, the Company recognized losses of $213 thousand and $122 thousand, respectively, due to changes in fair value for loans held for sale in which the fair value option was elected. This amount does not reflect the change in fair value attributable to the related hedges the Company used to mitigate the interest rate risk associated with loans held for sale. The changes in the fair value of the hedges were also recorded in the mortgage loan and related fee component of noninterest income, and offset $295 thousand and $58 thousand of the change in fair value of loans held for sale, respectively.
The following table provides the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale for which the fair value option has been elected.
Aggregate fair value |
Aggregate unpaid principal balance under FVO |
Fair value carrying amount over (under) unpaid principal |
||||||||||
(in thousands) | ||||||||||||
Loans held for sale |
$ | 1,145 | $ | 1,146 | $ | (1 | ) |
NOTE 12 DERIVATIVE FINANCIAL INSTRUMENTS
The Company accounts for derivatives in accordance with ASC 815. The Company records all derivative financial instruments at fair value in the financial statements. It is the policy of the Company to enter into various derivatives both as a risk management tool and in a dealer capacity, as necessary, to facilitate client transactions. Derivatives are used as a risk management tool to hedge the exposure to changes in interest rates or other identified market risks. As of March 31, 2011, the Company has not entered into a transaction in a dealer capacity.
When a derivative is intended to be a qualifying hedged instrument, the Company prepares written hedge documentation that designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or (2) a hedge of a forecasted transaction, such as the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).
The written documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item, and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for managements assertion that the hedge will be highly effective. Methodologies related to hedge effectiveness and ineffectiveness include (1) statistical regression analysis of changes in the cash flows of the actual derivative and a perfectly effective hypothetical derivative, (2) statistical regression analysis of changes in fair values of the actual derivative and the hedged item and (3) comparison of the critical terms of the hedged item and the hedging derivative. Changes in fair value of a derivative that is highly effective and that has been designated and qualifies as a fair value hedge are recorded in current period earnings, along with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Changes in the fair value of a derivative that is highly effective and that has been designed and qualifies as a cash flow hedge are initially recorded in other comprehensive income and reclassified to earnings in conjunction with the recognition of the earnings impacts of the hedged item; any ineffective portion is recorded in current period earnings. Designated hedge transactions are reviewed at least quarterly for ongoing effectiveness. Transactions that are no longer deemed to be effective are removed from hedge accounting classification and the recorded impacts of the hedge are recognized in current period income or expense in conjunction with the recognition of the income or expense on the originally hedged item.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The Companys derivatives are based on underlying risks, primarily interest rates. The Company has utilized swaps to reduce the risks associated with interest rates. Swaps are contracts in which a series of net cash flows, based on a specific notional amount that is related to an underlying risk, are exchanged over a prescribed period. The Company also utilizes forward contracts on the held for sale loan portfolio. The forward contracts hedge against changes in fair value of the held for sale loans.
Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk is equal to the fair value gain of the derivative. The credit exposure for swaps is the replacement cost of contracts that have become favorable. Credit risk is minimized by entering into transactions with high quality counterparties that are initially approved by the Board of Directors and reviewed periodically by the Asset Liability Committee. It is the Companys policy of requiring that all derivatives be governed by an International Swap and Derivatives Associations Master Agreement (ISDA). Bilateral collateral agreements may also be required.
On August 28, 2007 and March 26, 2009, the Company elected to terminate a series of interest rate swaps with a total notional value of $150 million and $50 million, respectively. At termination, the swaps had a market value of $2.0 million and $5.8 million, respectively. These gains are being accreted into interest income over the remaining life of the originally hedged items. The Company recognized a total of $480 thousand and $519 thousand in interest income for the three months ended March 31, 2011 and 2010, respectively.
The following table presents the accretion of the remaining gain for the terminated swaps.
20111 | 2012 | Total | ||||||||||
(in thousands) | ||||||||||||
Accretion of gain from 2007 terminated swaps |
$ | 141 | $ | 62 | $ | 203 | ||||||
Accretion of gain from 2009 terminated swaps |
$ | 1,227 | $ | 1,272 | $ | 2,499 |
1 | Represents the gain accretion for April 1, 2011 to December 31, 2011. Excludes the amounts recognized in the first three months of 2011. |
The following table presents the cash flow hedges as of March 31, 2011.
Notional Amount |
Gross Unrealized Gains |
Gross Unrealized Losses |
Accumulated Other Comprehensive Income |
Maturity Date |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Asset hedges |
||||||||||||||||||||
Cash flow hedges: |
||||||||||||||||||||
Forward contracts |
$ | 1,145 | $ | 1 | $ | | $ | 1 | Various | |||||||||||
$ | 1,145 | $ | 1 | $ | | $ | 1 | |||||||||||||
Terminated asset hedges |
||||||||||||||||||||
Cash flow hedges: 1 |
||||||||||||||||||||
Interest rate swap |
$ | 25,000 | $ | | $ | | $ | 17 | June 28, 2011 | |||||||||||
Interest rate swap |
20,000 | | | 13 | June 28, 2011 | |||||||||||||||
Interest rate swap |
35,000 | | | 104 | June 28, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 825 | October 15, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 825 | October 15, 2012 | |||||||||||||||
$ | 130,000 | $ | | $ | | $ | 1,784 | |||||||||||||
1 | The $1.8 million of gains, net of taxes, recorded in accumulated other comprehensive income as of March 31, 2011, will be reclassified into earnings as interest income over the remaining life of the respective hedged items. |
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
The following table presents additional information on the active derivative positions as of March 31, 2011.
Consolidated Balance Sheet Presentation |
Consolidated Income
Statement |
|||||||||||||||||||||||
Assets |
Liabilities | Gains |
||||||||||||||||||||||
Notional | Classification |
Amount | Classification | Amount | Classification |
Amount Recognized |
||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Hedging Instrument: |
||||||||||||||||||||||||
Forward contracts |
$ | 1,145 | Other assets | $ | 1 | Other liabilities | N/A | Noninterest income other |
$ | 296 | ||||||||||||||
Hedged Items: |
||||||||||||||||||||||||
Loans held for sale |
N/A | Loans held for sale | $ | 1,145 | N/A | N/A | Noninterest income other |
N/A |
For the three months ended March 31, 2011, no significant amounts were recognized for hedge ineffectiveness.
NOTE 13 DEPOSITS
Deposits decreased by $47,483 thousand, or 4.5% (18.1% annualized) from December 31, 2010 and decreased by $200,406 thousand, or 16.7%, from March 31, 2010. Excluding the changes in brokered deposits, the Companys year-over-year deposits decreased by $124,862 thousand, or 14.7%, and by $10,459 thousand, or 1.4% (5.7% annualized) from December 31, 2010. From March 31, 2010 to March 31, 2011, the Companys fastest growing sector of core deposits was noninterest bearing demand accounts that grow $4,921 thousand, or 3.1%. The Company defines core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposits with denominations less than $100,000.
NOTE 14 RECENT ACCOUNTING PRONOUNCEMENTS
In April 2011, the FASB issued Accounting Standards Update 2011-02, Receivables (Topic 301): A Creditors Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance in determining what is considered a troubled debt restructuring (TDR). The update clarifies the two criteria that are required in determining a TDR. The update is effective for interim or annual periods beginning after June 15, 2011. The Company is currently evaluating the impact of this update to its consolidated financial statements.
Effective December 31, 2010, the Company adopted the provisions of the FASB Accounting Standards Update 2010-20, Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). The update requires additional disclosures about the credit quality of financing receivables, which include loans, lease receivables, and other long-term receivables, and the associated credit allowances. The disclosure requirements as of March 31, 2011 are included in Note 6, Loans and Allowance for Loan and Lease Losses, to the consolidated financial statements.
Effective January 1, 2010, the Company adopted the provisions of the FASB Accounting Standards Update 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06), which updates ASC 820 to require disclosure of significant transfers into and out of Level 1 and Level 2 of the fair value hierarchy, as well as disclosure of an entitys policy for determining when transfers between all levels of the hierarchy are recognized. ASC 820, as amended, also provides enhanced disclosure requirements regarding purchases, sales, issuances, and settlements related to recurring Level 3 measurements, and requires separate disclosure in the Level 3 reconciliation of total gains and losses recognized in other comprehensive income. The updated provisions of ASC 820 require that fair value measurement disclosures be provided by each class of assets and liabilities, and that disclosures providing a description of the valuation techniques and inputs used to measure fair value be included for both recurring and nonrecurring fair value measurements classified as either Level 2 or Level 3. The provisions of ASU 2010-06 are effective for periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales, issuances, and settlements on a gross basis which will be effective for periods beginning after December 15, 2010. Comparative disclosures are required only for periods ending subsequent to initial adoption. The Company revised its disclosures accordingly.
Effective January 1, 2010, the Company adopted the provisions of the FASB Accounting Standards Update 2009-16, Accounting for Transfers of Financial Assets (ASU 2009-16). ASU 2009-16 updates ASC 860 to provide for the removal of the qualifying special purpose entity (QSPE) concept from GAAP, resulting in the evaluation of all former QSPEs for consolidation on and after January 1, 2010 in accordance with ASC 810. The amendments to ASC 860 modify the criteria for achieving sale accounting for transfers of financial assets and define the term participating interest to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. The updated provisions of ASC 860 also provide that a transferor should recognize and initially measure at fair value all assets obtained (including a transferors beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. ASC 860, as amended, requires enhanced disclosures which are generally consistent with, and supersede, the disclosures previously required by the Codification update to ASC 810 and ASC 860 which was effective for periods ending after December 15, 2008. The provisions of ASU 2009-16 are effective prospectively for new transfers of financial assets occurring in fiscal years beginning after November 15, 2009, and in interim periods within those fiscal years. ASC 860s amended disclosure requirements should be applied to transfers that occurred both before and after the effective date of the Codification update, with comparative disclosures required only for periods subsequent to initial adoption for those disclosures not previously required under the Codification update to ASC 810 and ASC 860 which was effective for periods ending after December 15, 2008. The adoptions did not impact the Companys consolidated financial statements.
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FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(unaudited)
NOTE 15 SUBSEQUENT EVENTS
On April 4, 2011, the Company received a notice from the NASDAQ Stock Market (Nasdaq) that its stock had closed below $1.00 per share for 30 consecutive business days, and was therefore not in compliance with Nasdaq Marketplace Rule 5450(a)(1) (the Bid Price Rule). In accordance with Marketplace Rule 5810(c)(3)(A), the Company may regain compliance with the Bid Price Rule if its stock closes at or above $1.00 for 10 consecutive business days by October 3, 2011. The notification has no effect on the listing of the Companys stock at this time. The Company filed a Current Report on Form 8-K on April 8, 2011 that provides additional information.
On April 11, 2011, the Company increased the size of its Board of Directors and elected Kelly P. Kirkland to serve on the Board of First Security Group, Inc. Ms. Kirkland was in private practice with a Chattanooga law firm for 27 and a half years prior to retiring at the end of 2010. The Company filed a Current Report on Form 8-K on April 15, 2011 that provides additional information.
On April 27, 2011, the Company announced that Ralph E. Gene Coffman, Jr. was appointed acting interim Chairman and Chief Executive Officer, pending regulatory non-objection, following the resignation of Rodger B. Holley as Chairman and Chief Executive Officer of the Company. In connection with his resignation, Mr. Holley and the Company entered into a severance agreement (Agreement). Pursuant to the Agreement, Mr. Holley will retain certain benefits provided by the terms of a salary continuation agreement, dated December 21, 2005, but limited to the amount accrued and vested as of December 31, 2010, which was approximately $2.0 million. The Company filed a Current Report on Form 8-K on April 27, 2011 that provides additional information.
During April 2011, the Companys Board of Directors elected to defer the May 15, 2011 Preferred Stock dividend.
On April 29, 2011, the Company announced that Ralph E. Mathews, Jr. resigned from the Board of Directors. In connection with his resignation, the Company appointed Carol H. Jackson as lead independent director. The Company filed a Current Report on Form 8-K on April 29, 2011 that provides additional information.
On May 4, 2011, the Company announced the engagement of Triumph Investment Managers, LLC. (Triumph) to provide strategic advisory services. Additionally, the Company invited Triumphs managing directors, Robert P. Bob Keller and John J. Jack Clarke to serve on the Companys Board of Directors, pending regulatory non-objection. The Company filed a Current Report on Form 8-K on May 4, 2011 that provides additional information.
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ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
In this Form 10-Q, First Security, we, us, the Company and our refer to First Security Group, Inc.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements made under the caption Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and elsewhere throughout this Form 10-Q are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking statements relate to future events or our future financial performance and may involve known or unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of First Security to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Forward-looking statements include statements using the words such as may, will, anticipate, should, would, believe, contemplate, expect, estimate, continue, intend, seeks, or other similar words and expressions of the future.
These forward-looking statements involve risks and uncertainties, and may not be realized due to a variety of factors, including, without limitation: the effects of future economic conditions, governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; the costs of evaluating possible acquisitions and the risks inherent in integrating acquisitions; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in First Securitys market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and, the failure of assumptions underlying the establishment of reserves for possible loan losses. All written or oral forward-looking statements attributable to First Security are expressly qualified in their entirety by this Special Note.
FIRST QUARTER 2011 AND RECENT EVENTS
The following discussion and analysis sets forth the major factors that affected results of operations and financial condition reflected in the unaudited financial statements for the three-month periods ended March 31, 2011 and 2010. Such discussion and analysis should be read in conjunction with the Companys Consolidated Financial Statements and the notes attached thereto.
Company Overview
First Security Group, Inc. is a bank holding company headquartered in Chattanooga, Tennessee, with $1.1 billion in assets as of March 31, 2011. Founded in 1999, First Securitys community bank subsidiary, FSGBank, N.A. (Bank) has 36 full-service banking offices, including the headquarters, along the interstate corridors of eastern and middle Tennessee and northern Georgia and 314 full-time equivalent employees. In Dalton, Georgia, FSGBank operates under the name of Dalton Whitfield Bank; along the Interstate 40 corridor in Tennessee, FSGBank operates under the name of Jackson Bank & Trust. FSGBank provides retail and commercial banking services, trust and investment management, mortgage banking, financial planning and internet banking (www.FSGBank.com) services.
Strategic Initiatives and Triumph Investment Managers
During 2009 and 2010, we implemented a number of strategic initiatives to position us appropriately for both short-term stability and long-term success. Initiatives included centralizing loan underwriting and approval, deepening senior management, improving our liquidity position and outsourcing the marketing and sales function for most of our foreclosed properties. Throughout 2011, we anticipate continuing to execute these prior initiatives.
As announced on May 4, 2011, we engaged Triumph Investment Managers, LLC (Triumph) to provide strategic advisory services and invited the managing directors of Triumph, Mr. Robert P. Keller and John J. Clarke, to serve on our Board of Directors. The mutual goal of this engagement is to create and restore shareholder value through the realignment of the organizational structure and the installation of a philosophy that provides for greater accountability. Triumph and management will evaluate, monitor, and, as appropriate, refine, these existing initiatives, while also considering others.
Going Concern Discussion
In connection with our audited financial statements for the year ended December 31, 2010, our independent registered public accounting firm included language in its audit opinion related to our ability to continue as a going concern. As discussed in Note 2 to our consolidated financial statements for the year ended December 31, 2010, we recognized that the losses recorded during 2009 and
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2010 had significantly impacted our operating results for those two years. Our ability to continue as a going concern is contingent upon our ability to devise and successfully execute a management plan to develop profitable operations, satisfy the requirements of the regulatory actions detailed above, and lower the level of problem assets to an acceptable level.
As discussed above, we are developing strategic and capital plans, which include, but are not limited to: (1) reorganizing management into a line of business structure, (2) restructuring credit and lending functions with new policies and centralized processes, (3) reducing adversely classified assets, (4) maintaining an adequate allowance for loan losses, (5) actively working to maintain appropriate liquidity while reducing reliance on non-core sources of funding and (6) evaluating strategic and capital opportunities.
We believe that the successful execution of the strategic initiatives will ultimately result in full compliance with the regulatory requirements and position us for long-term growth and a return to profitability. Although we recognized a loss for the first quarter of 2011, our strategic initiatives appear to have made a positive change as we significantly narrowed our loss in the first quarter of 2011 compared to the last two quarters of 2010.
Material Weakness in Internal Controls over Financial Reporting
As reported in the December 31, 2010 Annual Report on Form 10-K, management determined that a material weakness in internal controls over financial reporting existed as of December 31, 2010. Specifically, First Security did not maintain an effective control environment. The control environment sets the tone of the organization, influences the control consciousness of its people, and is the foundation for all other components of internal control over financial reporting.
Subsequent to year-end, various changes have occurred that may have subsequently affected First Securitys control environment:
| On February 23, 2011, John R. Haddock was appointed acting interim Chief Financial Officer following the resignation of William L. Lusk, Jr. Mr. Haddock has served as the Corporate Controller since 2006. |
| On April 11, 2011, Kelly P. Kirkland joined the Board of Directors. Ms. Kirkland brings over 27 years of legal experience in private practice, including the representation of numerous complex public companies. |
| On April 21, 2011, Ralph E. Coffman, Jr. was appointed acting interim Chairman and Chief Executive Officer following the resignation of Rodger B. Holley. Mr. Coffman has more than 20 years of executive management experience in financial organizations, including serving in the CEO or President role at three different financial institutions. |
| On May 4, 2011, we engaged Triumph to assist the Board and management with strategic advisory services. Pursuant to our agreement, our Board invited, subject to regulatory non-objections, Robert P. Keller and John J. Clarke, the managing directors of Triumph, to serve on our Board. Mr. Keller and Mr. Clarke provide over 60 years of experience in investment and bank activity, including leadership experience as directors to three other financial institutions. |
Overall, management believes that First Securitys control environment has improved as of the filing of this Quarterly Report on Form 10-Q. However, we are continuing to evaluate various additional changes, included but not limited to, revisions to policies, additional training and education. We are committed to establishing and maintaining an appropriate control environment and we anticipate that these actions and measures combined with future actions will appropriately address the material weakness related to the issues described above.
Recent Regulatory Events
Effective September 7, 2010, First Security entered into an Agreement with the Federal Reserve Bank. The Agreement is designed to ensure First Security is a source of strength to FSGBank. Substantially all of the requirements of the Agreement are similar to those already in effect for FSGBank pursuant to the Consent Order that is described below. On September 14, 2010, we filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides a copy of the fully executed Agreement.
We are currently deemed not in compliance with several provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve Bank. We can provide no assurances that we will be able to comply fully with the Agreement, that efforts to comply with the Agreement will not have a material adverse effect on the operations and financial condition of First Security, or that further enforcement actions wont be imposed on First Security.
Effective April 28, 2010, FSGBank reached an agreement with its primary regulator, the OCC, regarding the issuance of a Consent Order. The Order is a result of the OCCs regular examination of FSGBank in the fall of 2009 and directs FSGBank to take actions intended to strengthen its overall condition. All customer deposits remain fully insured by the FDIC to the maximum extent allowed by law; the Order does not impact this coverage in any manner. On April 29, 2010, First Security filed a current report on Form 8-K describing the Order and the related actions taken by the Bank to date. The Form 8-K also provides a copy of the fully executed Order.
We are currently deemed not in compliance with the provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC. We can provide no assurances that we will be able to comply fully with the Order, that efforts to comply with the Order will not have a material adverse effect on the operations and financial condition of FSGBank, or that further enforcement actions wont be imposed on FSGBank.
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Management has maintained open communication with the OCC and the Federal Reserve Bank regarding the changes within the First Security as well as the First Security financial condition. We do not currently expect any immediate negative action by the regulators against the First Security.
Overview
Market Conditions
The economic recovery continued during the first three months of 2011, with positive trends in employment data. As of April 2011, nonfarm payroll employment increased for the seventh consecutive month. However, the housing market continues to be weak due to the elevated inventory of foreclosed and distressed properties. As our financial results can be a reflection of our regional economy, we monitor and evaluate local and regional economic trends. At this time, we anticipate our regional economy will recover at a faster rate than the national average due to the economic developments occurring in our region.
Announced in 2008, the $1 billion Volkswagen automotive production facility has launched vehicle production. The Volkswagen plant has added about 2,000 direct jobs, including approximately 400 white-collar jobs, and up to 9,500 indirect jobs to the region. We believe the positive economic impact on Chattanooga and the surrounding region from Volkswagen and other recently announced large economic investments will be significant and it may stabilize and possibly increase real estate values and enhance economic activity within our market area.
While the economic recession has resulted in higher unemployment across the country, our market areas benefit from more stable rates of employment. Our major market areas of Chattanooga and Knoxville have a lower unemployment rate of 8.2% and 7.5%, respectively (as of March 2011, the most recent available data), than the Tennessee rate of 9.5%. The economy of the Dalton, Georgia MSA is primarily centered on the carpet and floor-covering industries. With the decline in housing starts and the overall economy, Dalton has been the most negatively impacted region in our footprint. The unemployment rate in the Dalton MSA is 11.5% (as of March 2011) compared to the Georgia rate of 9.8%. For the Chattanooga and Knoxville MSAs, the number of unemployed workers is decreasing and, as of March 2011, has declined by 18% in Chattanooga and 20% in Knoxville since the peak in June 2009. We believe these positive employment trends will continue throughout 2011.
Our market area has also benefited from a relatively stable housing market. According to the National Association of REALTORS, the median sales prices of existing single-family homes increased 3.9% and 3.4% for the Chattanooga and Knoxville MSAs, respectively, comparing the first quarter of 2011 to the same period in 2010 compared to a decline of 4.6% for the nation and 0.6% for the census region identified as the South. While our region continues to have elevated inventory of housing, we are hopeful that housing prices will continue to increase and remain above the regional and national levels due to the significant economic investments being made in our market.
Financial Results
As of March 2011, we had total consolidated assets of $1.1 billion, total loans of $682.6 million, total deposits of $1.0 billion and stockholders equity of $90.1 million. For the three months ended March 31, 2011, our net loss available to common shareholders was $3.2 million, resulting in basic and diluted net loss of $0.20 per share.
As of March 31, 2010, we had total consolidated assets of $1.4 billion, total loans of $905.5 million, total deposits of $1.2 billion and stockholders equity of $139.6 million. For the three months ended March 31, 2010, our net loss available to common shareholders was $1.6 million, resulting in basic and diluted net loss of $0.10 per share.
Net interest income decreased by $2.1 million primarily due to a reduction in our loan portfolio. The provision for loan and lease losses decreased by $3.5 million based on our analysis of inherent risks in the loan portfolio in relation to the portfolios growth, trends in non-performing and classified loans and general economic conditions. Noninterest income decreased by $40 thousand, while noninterest expense increased by $1.5 million. The decrease in noninterest income is attributable to a reduction in revenue from deposit fees, partially offset by an increase in mortgage loan and related fee income. Noninterest expense increased primarily due to higher costs associated with nonperforming assets, FDIC insurance expense and professional fees. There were 314 full-time equivalent employees as of March 31, 2011, compared to 345 as of March 31, 2010.
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Our efficiency ratio increased in the first quarter of 2011 to 116.1% compared to 82.4% in the same period of 2010 primarily due to reductions in net interest income and noninterest income and increases to noninterest expense. We anticipate our efficiency ratio to stabilize and begin to improve during the second half of 2011 as we focus on enhancing revenue while reducing certain overhead expenses. The stabilization and possible improvement of our efficiency ratio in 2011 is contingent on both macro-economic factors, such as changes to the federal funds target rate, and micro-economic factors, such as local unemployment and real estate value.
Net interest margin in the first quarter of 2011 was 2.99%, or 18 basis points lower than the prior year period of 3.17%. We believe that our net interest margin will remain consistent or continue to improve throughout 2011 as we fund maturing higher cost deposits with existing cash reserves and therefore eliminating negative spread on our elevated cash position. The projected continued increase of our net interest margin is dependent on our loan and deposit pricing, our ability to raise core deposits and any possible actions to the target federal funds rate by the Federal Reserve Board.
For the first quarter of 2011, our Board of Directors elected to defer payment of the Series A Preferred Stock (Preferred Stock). To date, the Company has deferred five consecutive Preferred Stock dividend payments. If we miss six quarterly Preferred Stock dividend payments, whether or not consecutive, the U.S. Treasury (Treasury) will have the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid on the Preferred Stock. Pursuant to the Written Agreement between First Security and the Federal Reserve, we may not declare or pay dividends without prior written consent from the Federal Reserve. During 2011, the Treasury requested an observer be allowed to attend our Board meetings, and we anticipate the observer will begin attending Board meetings in May 2011.
RESULTS OF OPERATIONS
We reported a net loss available to common shareholders for the first quarter of 2011 of $3.2 million versus net loss for the same period in 2010 of $1.6 million. In 2011, our net loss per share (basic and diluted) was $0.20, on approximately 15,840 thousand basic and 15,841 diluted weighted average shares outstanding compared to a net loss per share (basic and diluted) of $0.10 for the same period in 2010.
Net income available to common shareholders in the first quarter of 2011 was below the 2010 level as a result of the reduction in our loan portfolio and higher operating expenses associated with elevated levels of non-performing assets. The 2011 loss before taxes was $199 thousand, or 8.8%, higher than the loss in 2010. Noninterest expense increased by $1.5 million, while noninterest income declined by $40 thousand. As of March 31, 2011, we had 36 banking offices, including the headquarters, and 314 full-time equivalent employees.
The following table summarizes the components of income and expense and the changes in those components for the period ended March 31, 2011 compared to the same period in 2010.
CONDENSED CONSOLIDATED INCOME STATEMENT
Change from Prior Year | ||||||||||||
2011 | Amount | Percentage | ||||||||||
(in thousands, except percentages) | ||||||||||||
Interest income |
$ | 11,502 | $ | (3,539 | ) | (23.5 | )% | |||||
Interest expense |
3,976 | (1,390 | ) | (25.9 | )% | |||||||
Net interest income |
7,526 | (2,149 | ) | (22.2 | )% | |||||||
Provision for loan and lease losses |
890 | (3,485 | ) | (79.7 | )% | |||||||
Net interest income after provision for loan and lease losses |
6,636 | 1,336 | 25.2 | % | ||||||||
Noninterest income |
2,264 | (40 | ) | (1.7 | )% | |||||||
Noninterest expense |
11,367 | 1,495 | 15.1 | % | ||||||||
Net loss before income taxes |
(2,467 | ) | (199 | ) | 8.8 | % | ||||||
Income tax expense |
191 | 1,345 | 116.6 | % | ||||||||
Net loss |
(2,658 | ) | (1,544 | ) | 138.6 | % | ||||||
Preferred stock dividends and discount accretion |
511 | 6 | 1.2 | % | ||||||||
Net loss available to common shareholders |
$ | (3,169 | ) | $ | (1,550 | ) | 95.7 | % | ||||
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Net Interest Income
Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. For the three months ended March 31, 2011, net interest income decreased by $2.1 million, or 22.2%, to $7.5 million compared to $9.7 million for the same period in 2010.
We monitor and evaluate the effects of certain risks on our earnings and seek balance between the risks assumed and returns sought. Some of these risks include interest rate risk, credit risk and liquidity risk.
The level of net interest income is determined primarily by the average balances (volume) of interest earning assets and the various rate spreads between our interest earning assets and our funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest earning assets and interest bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest earning asset portfolio (which includes loans), and the availability of particular sources of funding, such as noninterest bearing deposits.
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The following table summarizes net interest income and average yields and rates paid for the quarters ended March 31, 2011 and 2010.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
FULLY TAX EQUIVALENT BASIS
For the Three Months Ended March 31, | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
Average Balance |
Income / Expense |
Yield / Rate |
Average Balance |
Income / Expense |
Yield / Rate |
|||||||||||||||||||
(restated) | ||||||||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Earning assets: |
||||||||||||||||||||||||
Loans, net of unearned income |
$ | 707,034 | $ | 10,188 | 5.84 | % | $ | 931,566 | $ | 13,453 | 5.86 | % | ||||||||||||
Investment securities taxable |
118,100 | 875 | 3.00 | % | 105,361 | 1,104 | 4.25 | % | ||||||||||||||||
Investment securities non-taxable |
35,340 | 502 | 5.76 | % | 41,289 | 578 | 5.68 | % | ||||||||||||||||
Other earning assets |
184,986 | 124 | 0.27 | % | 188,491 | 123 | 0.26 | % | ||||||||||||||||
Total earning assets |
1,045,460 | 11,689 | 4.53 | % | 1,266,707 | 15,258 | 4.89 | % | ||||||||||||||||
Allowance for loan and lease losses |
(24,891 | ) | (26,776 | ) | ||||||||||||||||||||
Intangible assets |
1,417 | 1,864 | ||||||||||||||||||||||
Cash & due from banks |
10,938 | 8,920 | ||||||||||||||||||||||
Premises & equipment |
30,706 | 33,003 | ||||||||||||||||||||||
Other assets |
72,365 | 78,051 | ||||||||||||||||||||||
TOTAL ASSETS |
$ | 1,135,995 | $ | 1,361,769 | ||||||||||||||||||||
Liabilities and Stockholders Equity |
||||||||||||||||||||||||
Interest bearing liabilities: |
||||||||||||||||||||||||
NOW accounts |
$ | 62,606 | 41 | 0.27 | % | $ | 62,935 | 45 | 0.29 | % | ||||||||||||||
Money market accounts |
118,256 | 255 | 0.87 | % | 138,264 | 384 | 1.13 | % | ||||||||||||||||
Savings deposits |
38,525 | 23 | 0.24 | % | 37,195 | 24 | 0.26 | % | ||||||||||||||||
Time deposits less than $100 thousand |
201,535 | 812 | 1.63 | % | 243,953 | 1,343 | 2.23 | % | ||||||||||||||||
Time deposits of $100 thousand, or more |
149,742 | 669 | 1.81 | % | 206,429 | 1,194 | 2.35 | % | ||||||||||||||||
Brokered CDs and CDARS® |
295,137 | 2,063 | 2.83 | % | 323,650 | 2,197 | 2.75 | % | ||||||||||||||||
Brokered money markets and NOWs |
| | | % | 26,609 | 57 | 0.87 | % | ||||||||||||||||
Repurchase agreements |
16,041 | 112 | 2.83 | % | 19,882 | 121 | 2.47 | % | ||||||||||||||||
Other borrowings |
74 | 1 | 5.48 | % | 91 | 1 | 4.46 | % | ||||||||||||||||
Total interest bearing liabilities |
881,916 | 3,976 | 1.83 | % | 1,059,008 | 5,366 | 2.05 | % | ||||||||||||||||
Net interest spread |
$ | 7,713 | 2.70 | % | $ | 9,892 | 2.84 | % | ||||||||||||||||
Noninterest bearing demand deposits |
152,054 | 150,447 | ||||||||||||||||||||||
Accrued expenses and other liabilities |
10,239 | 10,597 | ||||||||||||||||||||||
Stockholders equity |
88,049 | 135,619 | ||||||||||||||||||||||
Accumulated other comprehensive income |
3,737 | 6,098 | ||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 1,135,995 | $ | 1,361,769 | ||||||||||||||||||||
Impact of noninterest bearing sources and other changes in balance sheet composition |
0.29 | % | 0.33 | % | ||||||||||||||||||||
Net interest margin |
2.99 | % | 3.17 | % | ||||||||||||||||||||
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The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.
CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS
FOR THE THREE MONTHS ENDED MARCH 31, 2011 COMPARED TO 2010
Increase (Decrease) in Interest Income and Expense Due to Changes in: |
||||||||||||
Volume | Rate | Total | ||||||||||
(in thousands) | ||||||||||||
Interest earning assets: |
||||||||||||
Loans, net of unearned income |
$ | (3,243 | ) | $ | (22 | ) | $ | (3,265 | ) | |||
Investment securities taxable |
133 | (362 | ) | (229 | ) | |||||||
Investment securities non-taxable |
(83 | ) | 7 | (76 | ) | |||||||
Other earning assets |
(2 | ) | 3 | 1 | ||||||||
Total earning assets |
(3,195 | ) | (374 | ) | (3,569 | ) | ||||||
Interest bearing liabilities: |
||||||||||||
NOW accounts |
| (4 | ) | (4 | ) | |||||||
Money market accounts |
(56 | ) | (73 | ) | (129 | ) | ||||||
Savings deposits |
1 | (2 | ) | (1 | ) | |||||||
Time deposits less than $100 thousand |
(234 | ) | (297 | ) | (531 | ) | ||||||
Time deposits of $100 thousand, or more |
(328 | ) | (197 | ) | (525 | ) | ||||||
Brokered CDs and CDARS® |
(194 | ) | 60 | (134 | ) | |||||||
Brokered money markets accounts and NOWs |
(57 | ) | | (57 | ) | |||||||
Repurchase agreements |
(23 | ) | 14 | (9 | ) | |||||||
Other borrowings |
| | | |||||||||
Total interest bearing liabilities |
(891 | ) | (499 | ) | (1,390 | ) | ||||||
Increase (decrease) in net interest income |
$ | (2,304 | ) | $ | 125 | $ | (2,179 | ) | ||||
Net Interest Income Volume and Rate Changes
Interest income for the first quarter of 2011 was $11.5 million, which is a 23.5% decrease compared to the same period in 2010. Average earnings assets for the first quarter of 2011 decreased $221.2 million, or 17.5%, compared to the same period in 2010. Average loans in 2011 declined by $224.5 million, or 24.1%. The change in mix and volume of earning assets reduced interest income by $3.2 million comparing 2011 to 2010. For other earning assets, we maintained an elevated balance at the Federal Reserve Bank of Atlanta, which averaged over $180 million for the first quarter of 2011. The yield on this account is approximately 25 basis points. The purpose of maintaining an elevated balance in liquid assets is to reduce liquidity risk, which we describe more fully below in the Liquidity Section, resulting from deteriorating asset quality and the Consent Order. We anticipate average loans to continue to decline as loan reductions continue to exceed new loan demand. In addition, we anticipate average earning assets to decline as brokered deposits mature and are funded with existing cash reserves.
The yield on average earning assets declined 36 basis points from 4.89% to 4.53% comparing the three months ended March 31, 2011 to the same period in 2010. The decline in yield further reduced interest income by an additional $374 thousand. Comparing 2011 to 2010, the yield on loans was consistent at 5.84% compared to 5.86% for 2010. We anticipate the yield on loans to improve in 2011 as we have instituted higher loan pricing floors on new and renewing loans. The yield on taxable investment securities declined from 4.25% to 3.00%. A portion of this decline is a result of a bond swap conducted in the first quarter of 2010 in which we sold approximately $14.7 million of investment securities with an average tax-equivalent yield of 5.20% and replaced with $14.6 million of bonds with an average tax-equivalent yield of 3.17%. The transaction eliminated the credit risk associated with our private-label CMO securities, as well as certain municipal securities. We anticipate the yield on investment securities to remain consistent for the remainder of 2011. We are maintaining an asset-sensitive balance sheet and will benefit from the eventual increase in the federal funds rate. As of March 31, 2011, our loan portfolio is approximately 60% fixed rate, 34% variable rate and 6% adjustable rate. The variable rate loans reprice simultaneously with changes in the associated index, such as the Prime, LIBOR or Treasury bond rates, while the repricing of adjustable rate loans are based on a time component in addition to changes in the associated index. Accordingly, changes in the target federal funds rate have an immediate impact on the yield of our earning assets.
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Total interest expense was $4.0 million in the first quarter of 2011, or 25.9% lower than the comparable period in 2010. Interest expense decreased due to a decline in average balances of retail, jumbo and brokered certificates of deposit as new and maturing deposits as well as significant reductions in the rates paid on retail and jumbo certificates of deposit. Average interest bearing liabilities decreased $177.1 million, or 16.7%, for the three months ended March 31, 2011 compared to the same period in 2010. The reduction in interest bearing liabilities was primarily a result of decreases in retail, jumbo and brokered certificates of deposit. The deposit gathering activities at the branch level maintained the level of saving and NOW accounts. The average rate paid on interest bearing liabilities decreased 22 basis points to 1.83% from 2.05% for the period ended March 31, 2011 and 2010, respectively. The decrease is due primarily to term deposits maturing and repricing at lower current market rates.
We expect average loans to stabilize during the remainder of 2011 while other earning assets begin to decline as brokered deposits mature and are funded with existing cash reserves. The average yield on loans in 2011 should be comparable to the first quarter 2011 as we do not currently anticipate significant changes to interest rates. We expect average brokered deposits to decline during the second half of 2011 while all other interest bearing liabilities to stabilize. Rates paid on deposits are expected to be consistent with the current rates.
Net Interest Income Net Interest Spread and Net Interest Margin
The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The net interest rate spread does not consider the impact of noninterest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing noninterest bearing deposits in earning assets.
Our net interest rate spread (on a tax equivalent basis) was 2.70% for the period ended March 31, 2011 compared to 2.84% for the same period in 2010. Net interest margin (on a tax equivalent basis) was 2.99% for the period ended March 31, 2011 compared to 3.17% for the same period in 2010. The decreased net interest spread and margin are the result of the combination of lower loan volumes and higher other earning asset volumes partially offset by deposit rates reducing faster than asset yields. As of March 31, 2011, our balance at the Federal Reserve Bank was approximately $183 million. The negative spread associated between the interest-bearing cash and the brokered deposits will continue to negatively impact our net interest spread and margin. Average interest bearing liabilities as a percentage of average earning assets was 84.4% for the period ended March 31, 2011 compared to 83.6% for the same period in 2010. Noninterest bearing funding sources contributed 29 basis points to the net interest margin during the first quarter of 2011 compared to 33 basis points in the same period in 2010.
In prior years, we terminated two sets of interest rate swaps. The combined gains at termination were $7.8 million, which are being accreted into interest income over the remaining life of the originally hedged items. For the three months ended March 31, 2011, the accretion of the swaps added approximately $480 thousand to interest income. The accretion for the remainder of 2011 will be approximately $450 thousand per quarter.
We anticipate our net interest margin will remain consistent or continue to improve during the remainder of 2011. Increasing our margin is dependent on multiple factors, including our ability to raise core deposits, anticipated maturities of brokered deposits, our growth or contraction in loans, our deposit and loan pricing, and any possible action by the Federal Reserve Board to adjust the target federal funds rate.
Provision for Loan and Lease Losses
The provision for loan and lease losses charged to operations during the three months ended March 31, 2011 was $890 thousand compared to $4.4 million in the same period of 2010. Net charge-offs for the first quarter of 2011 were $2.4 million compared to net charge-offs of $4.8 million for the same period in 2010. Annualized net charge-offs as a percentage of average loans were 1.35% for the three months ended March 31, 2011 compared to 2.04% for the same period in 2010. Our peer groups average annualized net charge-offs (as reported in the March 31, 2011 Uniform Bank Performance Report) were 0.82%.
The decrease in our provision for loan and lease losses for the first quarter of 2011 compared to the same period in 2010 resulted from our analysis of inherent risks in the loan portfolio in relation to the reduction of our portfolio, the level of past due, charged-off, classified and nonperforming loans, as well as general economic conditions. As of March 31, 2011, management determined our allowance of $22.5 million was adequate to provide for credit losses, which we describe more fully below in the Allowance for Loan and Lease Losses section. We will reanalyze the allowance on at least a quarterly basis, and the next review will be at June 30, 2011, or sooner if needed, and the provision expense will be adjusted accordingly, if necessary.
We will continue to provide provision expense to maintain an allowance level adequate to absorb known and estimated losses inherent in our loan portfolio. As the determination of provision expense is a function of the adequacy of the allowance for loan and
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lease losses, we cannot reasonably estimate the provision expense for the remainder of 2011. Furthermore, the provision expense could materially increase or decrease in 2011 depending on a number of factors, including, among others, the level of net charge-offs, the amount of classified loans and the value of collateral associated with impaired loans.
Noninterest Income
Noninterest income totaled $2.3 million for the first quarter of this year, a decrease of $40 thousand, or 1.7%, from the same period in 2010. The decrease is a result of lower deposit fees and a reduction in gains on sales of repossessions.
The following table presents the components of noninterest income for the periods ended March 31, 2011 and 2010.
NONINTEREST INCOME
Three Months Ended March 31, | ||||||||||||
2011 | Percent Change |
2010 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Non-sufficient funds (NSF) fees |
$ | 585 | (22.9 | )% | $ | 759 | ||||||
Service charges on deposit accounts |
197 | (18.3 | )% | 241 | ||||||||
Point-of-sale (POS) fees |
317 | 10.8 | % | 286 | ||||||||
Bank-owned life insurance income |
257 | 2.0 | % | 252 | ||||||||
Trust fees |
228 | 23.2 | % | 185 | ||||||||
Mortgage loan and related fees |
205 | 37.6 | % | 149 | ||||||||
Net gain on sale of available-for-sale securities |
| (100.0 | )% | 57 | ||||||||
Other income |
475 | 2.67 | % | 375 | ||||||||
Total noninterest income |
$ | 2,264 | (1.7 | )% | $ | 2,304 | ||||||
Our largest sources of noninterest income are service charges and fees on deposit accounts. Total service charges, including non-sufficient funds (NSF) fees, were $782 million for the first quarter of 2011, a decrease of $218 thousand, or 21.8%, from the same period in 2010. While service charges and fees on deposit accounts typically correspond to the level and mix of our customer deposits, the implementation of the Dodd-Frank financial reform legislation may directly or indirectly impact the fee structure of our deposit products; therefore, we cannot reasonably estimate deposit fees for future periods.
Point-of-sale fees increased 10.8% to $317 thousand for the first quarter of 2011 compared to the same period in 2010. POS fees are primarily generated when our customers use their debit cards for retail purchases. We anticipate POS fees to continue to grow as customer trends show increased use of debit cards, although it is unclear if provisions affecting interchange fees for card issuers included in the Dodd-Frank financial reform legislation will have a future material impact on this product and its revenue.
Bank-owned life insurance income increased 2.0% to $257 thousand for the three months ended March 31, 2011 compared to the same period in 2010. FSGBank is the owner and beneficiary of these contracts. The income generated by the cash value of the insurance policies accumulates on a tax-deferred basis and is tax-free to maturity. In addition, the insurance death benefit will be a tax-free payment to FSGBank. This tax-advantaged asset enables us to provide benefits to our employees. On a fully tax equivalent basis, the weighted average interest rate earned on the policies was 6.04% for the three months ended March 31, 2011.
Trust fees increased by 23.2% to $228 thousand for the three months ended March 31, 2011 compared to the same period in 2010. As of March 31, 2011, our trust and wealth management department managed 459 accounts with assets held under management of approximately $210.9 million compared to 460 accounts with assets held under management of approximately $190.0 million as of March 31, 2010. For the remainder of 2011, we anticipate trust fees to be higher than the comparable 2010 periods due to the increase in the stock market over the last 12 months. A decline in the stock market may negatively impact trust fees.
Mortgage loan and related fees for the first quarter of 2011 increased $56 thousand, or 37.6%, to $205 thousand compared to $149 thousand in the first quarter of 2010. As discussed in Note 11 of our consolidated financial statements, we elect the fair value option for all held for sale loan originations. This election impacts the timing and recognition of origination fees and costs, as well as the value of the servicing rights. The recognition of the income and fees is concurrent with the origination of the loan.
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Our process to originate and sell a conforming mortgage in the secondary market typically takes 30 to 60 days from the date of mortgage origination to the date the mortgage is sold to an investor in the secondary market. Due to the normal processing time, we will have a certain amount of held for sale loans at any time. Mortgages originated for sale in the secondary markets totaled $6.6 million for the first three months of 2011. Mortgages sold in the secondary market totaled $8.1 million for the first three months of 2011. Mortgages originated and sold in the secondary market totaled $9.8 million and $8.9 million, respectively, for the first three months of 2010. We sold these loans with the right to service the loan being released to the purchaser for a fee. While the real estate market is showing signs of improvement, the risk of rising interest rates may negatively impact the volume of refinancing activity. The impact of these two factors will largely determine the level of mortgage income for the remainder of 2011.
Other income for the first quarter of 2011 was $475 thousand, compared to $375 thousand for the same period in 2010. The components of other income primarily consist of ATM fee income, gains on sales of other real estate, repossessions, leased equipment and premises and equipment, underwriting revenue and safe deposit box fee income.
Noninterest Expense
Noninterest expense for the first quarter of 2011 increased $1.5 million, or 15.1%, to $11.4 million compared to $9.9 million for the same period in 2010. The increase in noninterest expense primarily reflects higher costs associated with nonperforming assets and increased FDIC insurance, partially offset by reductions in salary and benefits as well as expenses from furniture and equipment.
The following table represents the components of noninterest expense for the three month periods ended March 31, 2011 and 2010.
NONINTEREST EXPENSE
Three Months Ended March 31, | ||||||||||||
2011 | Percent Change |
2010 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Salaries & benefits |
$ | 4,476 | (9.5 | )% | $ | 4,948 | ||||||
Occupancy |
889 | 4.2 | % | 853 | ||||||||
Furniture and equipment |
444 | (16.2 | )% | 530 | ||||||||
Professional fees |
1,065 | 116.5 | % | 492 | ||||||||
FDIC insurance |
1,047 | 134.2 | % | 447 | ||||||||
Data processing |
396 | 6.5 | % | 372 | ||||||||
Write-downs on other real estate owned and repossessions |
797 | nm | 6 | |||||||||
Losses on other real estate owned, repossessions and fixed assets |
192 | (34.2 | )% | 292 | ||||||||
OREO and repossession holding costs |
370 | 5.1 | % | 352 | ||||||||
Communications |
163 | 1.9 | % | 160 | ||||||||
Intangible asset amortization |
116 | (1.7 | )% | 118 | ||||||||
Printing & supplies |
95 | 6.7 | % | 89 | ||||||||
Advertising |
61 | 15.1 | % | 53 | ||||||||
Other expense |
1,256 | 8.28 | % | 1,160 | ||||||||
Total noninterest expense |
$ | 11,367 | 15.1 | % | $ | 9,872 | ||||||
Salaries and benefits for the first quarter of 2011 decreased $472 thousand, or 9.5%, compared to the same period in 2010. The decrease in salaries and benefits is primarily related to a reduction of 31 full-time equivalent employees. As of March 31, 2011, we had 314 full-time equivalent employees. We currently operate 36 full service banking offices.
Occupancy expense increased $36 thousand, or 4.2%, for the first quarter of 2011 compared to the same period in 2010. As of March 31, 2011, we leased six facilities and the land for five branches. As a result, current period occupancy expense is higher than if we owned these facilities, including the real estate, but due to market conditions, property availability and favorable lease terms, we leased these locations to execute our growth strategy. Furthermore, we have been able to deploy the capital into earning assets rather than capital expenditures for facilities.
Furniture and equipment expense decreased $86 thousand for the first quarter of 2011 compared to the same period in 2010 due to a reduction in depreciation expense and equipment maintenance costs.
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Professional fees increased 116.5% for the first quarter of 2011 compared to the same period in 2010. The increase is primarily due to additional legal costs associated with higher levels of non-performing assets. Professional fees include fees related to investor relations, outsourcing compliance and a portion of internal audit to Professional Bank Services, as well as external audit, tax services and legal and accounting advice related to, among other things, foreclosures, lending activities, employee benefit programs, prospective capital offerings and regulatory matters.
The premium paid for FDIC deposit insurance increased $600 thousand to $1.0 million for the first quarter of 2011 compared to the same period in 2010. The increase is an indirect result of the items described in the Consent Order, including the deterioration of our asset quality and its impact on our financial results. FDIC insurance premiums are likely to remain elevated for so long as the Consent Order remains in place.
Data processing fees increased $24 thousand for the first quarter of 2011 compared to the same period in 2010. The monthly fees associated with data processing are typically based on transaction volume.
Write-downs on other real estate owned and repossessions increased $791 thousand to $797 thousand for the first quarter of 2011 compared to the same period in 2010. The increase is primarily related to larger write-downs on other real estate owned. At foreclosure or repossession, the fair value of the property is determined and a charge-off to the allowance is recorded, if applicable. Any decreases in value subsequent to the initial determination of fair value are recorded as a write-down. As a general policy, we re-assess the fair value of OREO and repossessions on at least an annual basis or sooner if indications exist that deterioration in value has occurred. Write-downs are based on property-specific appraisals or valuations. Write-downs for the remainder of 2011 are dependent on real estate market conditions and our ability to liquidate properties.
Losses on OREO, repossessions and fixed assets decreased $100 thousand, or 34.2%, for the first quarter of 2011 compared to the same period of 2010. The decrease primarily related to less sales of repossessions through the liquidation of equipment at our leasing subsidiaries and was partially offset by an increase in losses on sales of other real estate properties. We anticipate increases in losses as we seek to liquidate existing properties and repossessions in a timely manner. As we seek to liquidate existing properties and repossessions in a timely manner, we may continue to experience elevated losses, depending on real estate market conditions and our ability to liquidate properties.
OREO and repossession holding costs include, among other items, maintenance, repairs, utilities, taxes and storage costs. Holding costs increased $18 thousand to $370 thousand for the first quarter of 2011 compared to the same period in 2010. We anticipate the level of holding costs will remain elevated for 2011.
Intangible asset amortization expense decreased $2 thousand, or 1.7%, in the first quarter of 2011 compared to the same period in 2010. Our core deposit intangible assets amortize on an accelerated basis in which the expense recognized declines over the estimated useful life of ten years. We anticipate further decreases in amortization expense throughout the remainder of 2011.
Other expense increased $96 thousand during the first quarter of 2011 compared to the same period in 2010.
Income Taxes
We recorded an income tax expense of $191 thousand for the first quarter of 2011 compared to a benefit of $1.2 million for the same period in 2010. During 2010, we established a deferred tax asset valuation allowance. For the three months ended March 31, 2011, we recorded $1.4 million in additional deferred tax valuation allowance to offset the tax benefits generated during the first quarter. For the three months ended March 31, 2011, our tax-exempt income from municipal securities and loans as well as bank-owned life insurance was approximately $589 thousand. We also recorded low-income housing tax credits of $97 thousand. Adjusting for these items and the deferred tax valuation expense, our effective tax rate approximates 37%.
At March 31, 2011, we evaluated our significant uncertain tax positions. Under the more-likely-than-not threshold guidelines, we believe we have identified all significant uncertain tax benefits. We evaluate, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a component of income tax expense in our consolidated financial statements. During the fourth quarter of 2009, we accrued $1.1 million for an uncertain tax position and approximately $155 thousand in associated interest and penalties. During 2010, certain tax refunds were withheld and applied to the disputed uncertain tax position. As of March 31, 2011, our total accrual for uncertain tax positions is $1.0 million.
The remaining deferred tax asset is anticipated to be realized through available carryback tax periods. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies
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and assessments of the current and future economic and business conditions. We identified as positive evidence the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years as well as current business trends. As conditions change, we will evaluate the need to increase or decrease the valuation allowance. Currently, we anticipate increasing the valuation allowance to offset any future recorded tax benefit to result in minimal, if any, income tax expense or benefit.
STATEMENT OF FINANCIAL CONDITION
Our total assets were $1.1 billion at March 31, 2011, $1.2 billion at December 31, 2010, and $1.4 billion at March 31, 2010. The decline from March 31, 2010 to March 31, 2011 is primarily due to the reductions in our loan portfolio. For the remainder of 2011, we anticipate funding prudent investment opportunities through our existing cash reserves or with growth in core deposits.
Loans
The effects of the economic recession, as well as our active efforts to reduce certain credit exposures and their related balance sheet risk, resulted in declining loan balances during 2010 and the first quarter of 2011. As of March 31, 2011, total loans declined by $44.4 million, or 6.1% (24.4% annualized), from December 31, 2010 and by $222.9 million, or 24.6%, from March 31, 2010.
The following table presents our loan portfolio by type.
LOAN PORTFOLIO
Percent change from | ||||||||||||||||||||
March 31, 2011 |
December 31, 2010 |
March 31, 2010 |
December 31, 2010 |
March 31, 2010 |
||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Loans secured by real estate- |
||||||||||||||||||||
Residential 1-4 family |
$ | 240,906 | $ | 252,026 | $ | 278,695 | (4.4 | )% | (13.6 | )% | ||||||||||
Commercial |
215,831 | 226,357 | 255,174 | (4.7 | )% | (15.4 | )% | |||||||||||||
Construction |
74,672 | 84,232 | 125,603 | (11.3 | )% | (40.5 | )% | |||||||||||||
Multi-family and farmland |
35,556 | 36,393 | 41,314 | (2.3 | )% | (13.9 | )% | |||||||||||||
566,965 | 599,008 | 700,786 | (5.3 | )% | (19.1 | )% | ||||||||||||||
Commercial loans |
77,087 | 82,807 | 138,156 | (6.9 | )% | (44.2 | )% | |||||||||||||
Consumer installment loans |
29,468 | 33,860 | 45,564 | (13.0 | )% | (35.3 | )% | |||||||||||||
Leases, net of unearned income |
5,467 | 7,916 | 17,405 | (30.9 | )% | (68.6 | )% | |||||||||||||
Other |
3,661 | 3,500 | 3,601 | 4.6 | % | 1.7 | % | |||||||||||||
Total loans |
682,648 | 727,091 | 905,512 | (6.1 | )% | (24.6 | )% | |||||||||||||
Allowance for loan and lease losses |
(22,500 | ) | (24,000 | ) | (26,101 | ) | (6.3 | )% | (13.8 | )% | ||||||||||
Net loans |
$ | 660,148 | $ | 703,091 | $ | 879,411 | (6.1 | )% | (24.9 | )% | ||||||||||
Year-to-date, the largest declining loan balances were residential 1-4 family loans of $11.1 million, or 4.4%, commercial real estate loans of $10.5 million, or 4.7%, and construction and land development (C&D) loans of $9.6 million, or 11.3%. From March 31, 2010 to March 31, 2011, the largest declining loan balances were commercial and industrial loans of $61.1 million, or 44.2%, C&D loans of $50.9 million, or 40.5%, commercial real estate loans of $39.3 million, or 15.4% and residential 1-4 family loans of $37.8 million, or 13.6%.
We will continue to extend prudent loans to credit-worthy consumers and businesses during 2011. However, due to the current economic environment and the corresponding decline in loan demand, we anticipate our loans may remain stable or possibly continue to decline in the near term. Funding for future loans may be restricted by our ability to raise core deposits, although we may use our current cash reserves, as necessary and appropriate. Loan growth may also be restricted by the necessity for us to maintain appropriate capital levels, as well as adequate liquidity.
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Allowance for Loan and Lease Losses
The allowance for loan and lease losses reflects our assessment and estimate of the risks associated with extending credit and our evaluation of the quality of the loan portfolio. We regularly analyze our loan portfolio in an effort to establish an allowance that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:
| our loan loss experience; |
| specific known risks; |
| the status and amount of past due and non-performing assets; |
| underlying estimated values of collateral secured loans; |
| current and anticipated economic conditions; and |
| other factors which we believe affect the allowance for potential credit losses. |
The allowance is composed of three primary components: (1) specific impairments for substandard/nonaccrual loans and leases, (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, and (3) general allocations for the remaining pools of loans. We accumulate pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions.
An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan and lease losses is prepared by our accounting and credit administration department and presented to our Board of Directors on at least a quarterly basis. Based on our analysis, we may determine that our provision expense needs to increase or decrease in order for us to remain adequately reserved for probable loan losses. As stated earlier, we make this determination after considering both quantitative and qualitative factors under appropriate regulatory and accounting guidelines.
Our allowance for loan and lease losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance compared to a group of peer banks. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance methodology differ materially from the banks methodology. We believe our allowance methodology is in compliance with regulatory interagency guidance as well as applicable GAAP guidance.
While it is our policy to charge-off all or a portion of certain loans in the current period when a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because the assessment of these risks includes assumptions regarding local and national economic conditions, our judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
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The following table presents an analysis of the changes in the allowance for loan and lease losses for the three months ended March 31, 2011 and 2010. The provision for loan and lease losses of $890 thousand and $4.4 million for March 31, 2011 and 2010, respectively, in the table below does not include our provision accrual for unfunded commitments of $6 thousand and $6 thousand for the first quarter of 2011 and 2010, respectively. The reserve for unfunded commitments is included in other liabilities in the accompanying consolidated balance sheets and totaled $235 thousand and $211 thousand as of March 31, 2011 and 2010, respectively.
ANALYSIS OF CHANGES IN ALLOWANCE FOR LOAN AND LEASE LOSSES
For the three months ended March 31, | ||||||||
2011 | 2010 | |||||||
(in thousands, except percentages) | ||||||||
Allowance for loan and lease losses |
||||||||
Beginning of period |
$ | 24,000 | $ | 26,492 | ||||
Provision for loan and lease losses |
884 | 4,369 | ||||||
Sub-total |
24,884 | 30,861 | ||||||
Charged-off loans: |
||||||||
Real estate Residential 1-4 family |
270 | 429 | ||||||
Real estate Commercial |
662 | | ||||||
Real estate Construction |
700 | 2,413 | ||||||
Real estate Multi-family and farmland |
| 130 | ||||||
Commercial loans |
352 | 1,232 | ||||||
Consumer installment loans and Other |
122 | 358 | ||||||
Leases, net of unearned income |
919 | 494 | ||||||
Total charged-off |
3,025 | 5,056 | ||||||
Recoveries of charged-off loans: |
||||||||
Real estate Residential 1-4 family |
6 | 3 | ||||||
Real estate Commercial |
1 | 145 | ||||||
Real estate Construction |
38 | 1 | ||||||
Real estate Multi-family and farmland |
6 | | ||||||
Commercial loans |
253 | 109 | ||||||
Consumer installment loans and Other |
36 | 38 | ||||||
Leases, net of unearned income |
301 | | ||||||
Total recoveries |
641 | 296 | ||||||
Net charged-off loans |
2,384 | 4,760 | ||||||
Allowance for loan and lease losses end of period |
$ | 22,500 | $ | 26,101 | ||||
Total loans end of period |
$ | 682,648 | $ | 905,512 | ||||
Average loans |
$ | 707,034 | $ | 931,566 | ||||
Net loans charged-off to average loans, annualized |
1.35 | % | 2.04 | % | ||||
Provision for loan and lease losses to average loans, annualized |
0.50 | % | 1.88 | % | ||||
Allowance for loan and lease losses as a percentage of: |
||||||||
Period end loans |
3.30 | % | 2.88 | % | ||||
Non-performing loans |
39.60 | % | 48.07 | % |
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The following table presents the allocation of the allowance for loan and lease losses for each respective loan category with the corresponding percentage of loans in each category to total loans. The comprehensive allowance analysis developed by our credit administration and financial reporting group enables us to allocate the allowance based on risk elements within the portfolio.
ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES
As of March 31, 2011 | As of December 31, 2010 | As of March 31, 2010 | ||||||||||||||||||||||
Amount | Percent
of Portfolio1 |
Amount | Percent
of Portfolio1 |
Amount | Percent
of Portfolio1 |
|||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||||||
Real estate residential 1-4 family |
$ | 6,680 | 35.3 | % | $ | 7,346 | 34.7 | % | $ | 5,353 | 30.8 | % | ||||||||||||
Real estate commercial |
5,381 | 31.6 | % | 5,550 | 31.1 | % | 5,399 | 28.2 | % | |||||||||||||||
Real estate construction |
3,379 | 10.9 | % | 2,905 | 11.6 | % | 4,609 | 13.8 | % | |||||||||||||||
Real estate multi-family and farmland |
685 | 5.3 | % | 761 | 5.0 | % | 567 | 4.6 | % | |||||||||||||||
Commercial loans |
4,685 | 11.3 | % | 5,692 | 11.4 | % | 7,521 | 15.3 | % | |||||||||||||||
Consumer installment loans |
598 | 4.3 | % | 813 | 4.7 | % | 1,318 | 5.0 | % | |||||||||||||||
Leases, net of unearned income |
1,082 | 0.8 | % | 917 | 1.1 | % | 1,317 | 1.9 | % | |||||||||||||||
Other |
10 | 0.5 | % | 16 | 0.4 | % | 17 | 0.4 | % | |||||||||||||||
Total |
$ | 22,500 | 100.0 | % | $ | 24,000 | 100.0 | % | $ | 26,101 | 100.0 | % | ||||||||||||
1 | Represents the percentage of loans in each category to total loans. |
Over the last twelve to eighteen months, the ratio of the allowance to total loans significantly increased largely because of the economic downturn and the associated decline in real estate values. These two factors have contributed to a significant increase in classified loans, which is a driving component of the allowance.
We utilize a risk rating system to evaluate the credit risk of our loan portfolio. We classify loans as: pass, special mention, substandard, doubtful or loss. We assign a pass rating to loans that are performing as contractually agreed and do not exhibit the characteristics of heightened credit risk. A special mention risk rating is assigned to loans that are criticized but not considered as severe as a classified loan. Special mention loans generally contain one or more potential weaknesses, which if not corrected, could result in an unacceptable increase in the credit risk at some future date. A substandard risk rating is assigned to loans that have specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic or managerial nature and may require nonaccrual status. Substandard loans have a greater likelihood of loss.
We segregate substandard loans into two classifications based on our allowance methodology for impaired loans. An impaired loan is defined as a substandard loan relationship in excess of $500 thousand that is also on nonaccrual status. These relationships are individually reviewed on a quarterly basis to determine the required allowance or loss, as applicable.
For the allowance analysis, the primary categories are: pass, special mention, substandard non-impaired, and substandard impaired. Loans in the substandard and doubtful loan categories are combined and impaired loans are segregated from non-impaired loans. The following table presents our internal risk rating by loan classification as utilized in the allowance analysis as of March 31, 2011 and December 31, 2010:
As of March 31, 2011
Pass | Special Mention |
Substandard Non-impaired |
Substandard Impaired |
Total | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Loans by Classification |
||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 207,493 | $ | 6,865 | $ | 24,182 | $ | 2,366 | $ | 240,906 | ||||||||||
Real estate: Commercial |
169,946 | 14,111 | 18,000 | 13,774 | 215,831 | |||||||||||||||
Real estate: Construction |
41,442 | 3,458 | 10,551 | 19,221 | 74,672 | |||||||||||||||
Real estate: Multi-family and farmland |
30,624 | 1,936 | 1,927 | 1,069 | 35,556 | |||||||||||||||
Commercial |
51,121 | 3,893 | 18,125 | 3,948 | 77,087 | |||||||||||||||
Consumer |
27,298 | 26 | 471 | 1,673 | 29,468 | |||||||||||||||
Leases |
| 1,864 | 2,514 | 1,089 | 5,467 | |||||||||||||||
Other |
3,641 | | 20 | | 3,661 | |||||||||||||||
Total Loans |
$ | 531,565 | $ | 32,153 | $ | 75,790 | $ | 43,140 | $ | 682,648 | ||||||||||
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As of December 31, 2010
Pass | Special Mention |
Substandard Non-impaired |
Substandard Impaired |
Total | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Loans by Classification |
||||||||||||||||||||
Real estate: Residential 1-4 family |
$ | 217,470 | $ | 7,378 | $ | 25,234 | $ | 1,944 | $ | 252,026 | ||||||||||
Real estate: Commercial |
182,584 | 18,030 | 17,511 | 8,232 | 226,357 | |||||||||||||||
Real estate: Construction |
46,305 | 3,970 | 10,048 | 23,909 | 84,232 | |||||||||||||||
Real estate: Multi-family and farmland |
30,835 | 3,238 | 1,905 | 415 | 36,393 | |||||||||||||||
Commercial |
54,553 | 4,338 | 20,316 | 3,600 | 82,807 | |||||||||||||||
Consumer |
31,238 | 43 | 1,156 | 1,423 | 33,860 | |||||||||||||||
Leases |
| 2,036 | 3,797 | 2,083 | 7,916 | |||||||||||||||
Other |
3,464 | | 36 | | 3,500 | |||||||||||||||
Total Loans |
$ | 566,449 | $ | 39,033 | $ | 80,003 | $ | 41,606 | $ | 727,091 | ||||||||||
We classify a loan as impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans were $43,140 thousand and $41,606 thousand at March 31, 2011 and December 31, 2010, respectively. For impaired loans, payments are generally applies directly to principal.
We believe that the allowance for loan and lease losses as of March 31, 2011 is sufficient to absorb losses inherent in the loan portfolio based on our assessment of the information available, including the results of ongoing internal reviews of our loan portfolio, as discussed in the Asset Quality and Non-Performing Asset section below. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant.
Asset Quality and Non-Performing Assets
Asset Quality Strategic Initiatives
Our ability to return to profitability is largely dependent on properly addressing and improving asset quality. As of March 31, 2011, our loan portfolio was 61.1% of total assets. Over the past twelve to eighteen months, we implemented several significant strategies to further address our asset quality, including:
| Restructured and expanded our credit department, including special assets |
| Developed centralized underwriting, document preparation and collections processes |
| Conducted a third-party loan review |
| Hired an experienced special assets and credit officers |
| Expanded our loan review department, and |
| Outsourced the marketing and sales of residential OREO to market-leading real estate firms |
During the fourth quarter of 2009, we began the process of restructuring our credit administration department to add additional depth and expertise. Specifically, the credit department is now aligned by line of business for commercial and retail credit with dedicated credit officers and staff supporting each of these portfolios. The chief credit officer will serve to support both senior credit officers.
With the additional depth and expertise of the restructured credit department, we have centralized our loan underwriting, document preparation and collections processes. This centralization will improve consistency, increase quality and provide higher levels of operational efficiencies. Collectively, we believe these changes will assist in reducing current and future non-performing assets.
During the fourth quarter of 2009, we engaged an independent consulting firm to conduct an extensive loan review. The primary purpose of the loan review was to evaluate individual credits for compliance with credit and underwriting standards, and to assess the potential impairment of certain credits in which we might experience additional risks of loss.
Our internal loan review department performs risk-based reviews and historically targets 60% to 70% of our portfolio over an 18-month cycle. In the last twelve months, we have added two experienced loan review employees to our loan review department. During 2010, we achieved the 60% to 70% review of our portfolio over a 12-month cycle, focusing on a risk-based approach. We anticipate similar coverage during 2011.
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During the second half of 2010, we outsourced the marketing and sales process over our OREO properties to market leading real estate companies. We anticipate higher volumes of OREO sales in 2011.
We believe the above loan review and credit initiatives will enable us to improve our asset quality over time through a more timely recognition of problem relationships. Additionally, we believe the expanded special assets department will allow us to manage the problem relationships in a more efficient and effective manner to ultimately reduce future loan losses.
Asset Quality and Non-Performing Assets Analysis and Discussion
Our asset quality ratios weakened in the first quarter of 2011 compared to year-end and the same period in 2010. As of March 31, 2011, our allowance for loan and lease losses as a percentage of total loans was 3.30%, which is consistent with year-end and an increase from the 2.88% as of March 31, 2010. Net charge-offs as a percentage of average loans (annualized) decreased to 1.35% for the three months ended March 31, 2011 compared to 4.49% for the fourth quarter of 2010 and 2.04% for the first quarter of 2010. Non-performing assets as a percentage of total assets was 7.25% at March 31, 2011, compared to 5.26% for the same period in 2010. As of March 31, 2011, non-performing assets, including loans that are 90 days past due, increased to $85.2 million, or 7.63% of total assets, from $84.1 million, or 7.20% of total assets as of December 31, 2010 and from $76.0 million, or 5.55% as of March 31, 2010.
We believe that overall asset quality will stabilize and begin to improve during 2011. Our special assets department actively collects past due loans and develops action plans for classified and criticized loans and leases. For OREO properties, we are focused on achieving the proper level of balance between maximizing the realized value upon sale and minimizing the holding period and carrying costs with a bias towards liquidation.
Nonperforming assets include nonaccrual loans, restructured loans, OREO and repossessed assets. We place loans on non-accrual status when we have concerns relating to our ability to collect the loan principal and interest, and generally when such loans are 90 days or more past due. The following table presents our non-performing assets and related ratios.
NON-PERFORMING ASSETS BY TYPE
March 31, 2011 |
December 31, 2010 |
March 31, 2010 |
||||||||||
(in thousands, except percentages) | ||||||||||||
Nonaccrual loans |
$ | 52,539 | $ | 54,082 | $ | 50,305 | ||||||
Loans past due 90 days and still accruing |
4,279 | 4,838 | 3,993 | |||||||||
Total nonperforming loans |
$ | 56,818 | $ | 58,920 | $ | 54,298 | ||||||
Other real estate owned |
$ | 28,065 | $ | 24,399 | $ | 18,228 | ||||||
Repossessed assets |
311 | 763 | 3,466 | |||||||||
Nonaccrual loans |
52,539 | 54,082 | 50,305 | |||||||||
Total nonperforming assets |
$ | 80,915 | $ | 79,244 | $ | 71,999 | ||||||
Nonperforming loans as a percentage of total loans |
8.32 | % | 8.10 | % | 6.00 | % | ||||||
Nonperforming assets as a percentage of total assets |
7.25 | % | 6.78 | % | 5.26 | % | ||||||
Nonperforming assets plus loans 90 days past due to total assets |
7.63 | % | 7.20 | % | 5.55 | % |
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The following table provides the classifications for nonaccrual loans and other real estate owned as of March 31, 2011, December 31, 2010 and March 31, 2010.
NON-PERFORMING ASSETS CLASSIFICATION AND NUMBER OF UNITS
March 31, 2011 | December 31, 2010 | March 31, 2010 | ||||||||||||||||||||||
Amount | Units | Amount | Units | Amount | Units | |||||||||||||||||||
(dollar amounts in thousands) | ||||||||||||||||||||||||
Nonaccrual loans |
||||||||||||||||||||||||
Construction/development loans |
$ | 19,944 | 35 | $ | 25,586 | 56 | $ | 13,950 | 33 | |||||||||||||||
Residential real estate loans |
7,648 | 77 | 8,906 | 84 | 7,392 | 53 | ||||||||||||||||||
Commercial real estate loans |
16,025 | 36 | 10,007 | 30 | 6,903 | 26 | ||||||||||||||||||
Commercial and industrial loans |
4,818 | 34 | 4,228 | 26 | 16,234 | 39 | ||||||||||||||||||
Commercial leases |
2,242 | 63 | 3,459 | 59 | 3,943 | 37 | ||||||||||||||||||
Consumer and other loans |
1,862 | 21 | 1,896 | 18 | 1,883 | 15 | ||||||||||||||||||
Total |
$ | 52,539 | 266 | $ | 54,082 | 273 | $ | 50,305 | 203 | |||||||||||||||
Other real estate owned |
||||||||||||||||||||||||
Construction/development loans |
$ | 13,604 | 77 | $ | 10,821 | 67 | $ | 7,505 | 50 | |||||||||||||||
Residential real estate loans |
9,414 | 76 | 8,266 | 63 | 5,153 | 41 | ||||||||||||||||||
Commercial real estate loans |
5,047 | 20 | 5,312 | 20 | 5,570 | 18 | ||||||||||||||||||
Total |
$ | 28,065 | 173 | $ | 24,399 | 150 | $ | 18,228 | 109 | |||||||||||||||
Nonaccrual loans totaled $52.5 million, $54.1 million and $50.3 million as of March 31, 2011, December 31, 2010 and March 31, 2010, respectively. We place loans on nonaccrual when we have concerns related to our ability to collect the loan principal and interest, and generally when loans are 90 or more days past due. As of March 31, 2011, we are not aware of any additional material loans that we have doubts as to the collectability of principal and interest that are not classified as nonaccrual. As previously described, we have individually reviewed each nonaccrual loan in excess of $500 thousand for possible impairment. We measure impairment by adjusting loans to either the present value of expected cash flows, the fair value of the collateral or observable market prices.
As of March 31, 2011, nonaccruals decreased by $1.5 million, or 2.9%, compared to year-end 2010. Comparing March 31, 2011 to December 31, 2010, nonaccrual construction and development loans declined by $5.6 million while nonaccrual commercial real estate loans increased by $6.0 million. During the first quarter of 2011, there were two commercial real estate properties placed on nonaccrual that totaled $4.1 million, or nearly 70% of the increase in nonaccrual commercial real estate loans. Both of these relationships were evaluated for impairment with no loss currently estimated. The decline in construction and development loans was a result of certain relationships migrating to OREO. We continue to actively pursue the appropriate strategies to reduce the current level of nonaccrual loans.
Other real estate increased $3.7 million from December 31, 2010 to March 31, 2011, as additions continued to outpace dispositions. During the first quarter of 2011, we sold eleven properties with total proceeds of $1.4 million, resulting in a 92% realization of the carrying value prior to sale compared to four properties sold during the first quarter of 2010. As previously mentioned, we have outsourced the marketing and sales process of our OREO properties to market-leading real estate firms. We anticipate increased sales volume during 2011 as a result of this outsourcing. Additionally, we are taking a more aggressive sales approach to dispose of our current properties, which may lead to a lower realization rate.
Loans 90 days past due and still accruing declined by $559 thousand from year-end 2010 in a positive trend. As of March 31, 2011, the $4.3 million in past due loans was composed of $2.1 million in C&D loans, $1.1 million in commercial and industrial loans, $863 thousand in commercial real estate loans and the remainder in other categories.
Total non-performing assets for the first quarter of 2011 were $80.9 million compared to $79.2 million at December 31, 2010 and $72.0 million at March 31, 2010.
Our asset ratios were generally less favorable as compared to our peer group. Our peer group, as defined by the Uniform Bank Performance Report (UBPR), is all commercial banks between $1 billion and $3 billion in total assets. The following table provides our asset quality ratios as of March 31, 2011 and our UBPR peer group ratios as of March 31, 2011, which is the latest available information.
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NONPERFORMING ASSET RATIOS
First Security Group, Inc. |
UBPR Peer Group |
|||||||
Nonperforming loans1 as a percentage of gross loans |
8.32 | % | 3.58 | % | ||||
Nonperforming loans1 as a percentage of the allowance |
252.5 | % | 160.15 | % | ||||
Nonperforming loans1 as a percentage of equity capital |
63.03 | % | 23.41 | % | ||||
Nonperforming loans1 plus OREO as a percentage of gross loans plus OREO |
11.94 | % | 4.84 | % |
1 | Nonperforming loans are: Nonaccrual loans plus loans 90 days past due and still accruing |
Investment Securities and Other Earning Assets
The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. Currently, all of our investments are classified as available-for-sale. As of March 31, 2011, we have no plans to liquidate a significant amount of any available-for-sale securities. However, the securities classified as available-for-sale may be used for liquidity purposes should we deem it to be in our best interest.
Available-for-sale securities totaled $154.3 million at March 31, 2011, $154.2 million at December 31, 2010 and $145.6 million at March 31, 2010. We believe our current securities portfolio provides an appropriate level of liquidity and provides a proper balance to our interest rate and credit risk in our loan portfolio. At March 31, 2011, the available-for-sale securities portfolio had unrealized net gains of approximately $2.1 million, net of tax.
All investment securities purchased to date have been classified as available-for-sale. Our securities portfolio at March 31, 2011 consisted of tax-exempt municipal securities, federal agency bonds, federal agency issued Real Estate Mortgage Investment Conduits (REMICs) and federal agency issued pools.
The following table provides the amortized cost of our available-for-sale securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the tax equivalent yields for each maturity range.
MATURITY OF AFS INVESTMENT SECURITIES AMORTIZED COST
Less than One Year |
One to Five Years |
Five to Ten Years |
More than Ten Years |
Totals | ||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Municipal-tax exempt |
$ | 2,542 | $ | 16,173 | $ | 11,460 | $ | 4,202 | $ | 34,377 | ||||||||||
Agency bonds |
| 13,982 | 15,987 | | 29,969 | |||||||||||||||
Agency issued REMICs |
5,703 | 38,726 | | | 44,429 | |||||||||||||||
Agency issued pools |
302 | 31,695 | 9,472 | 815 | 42,284 | |||||||||||||||
Other |
| | | 127 | 127 | |||||||||||||||
Total |
$ | 8,547 | $ | 100,576 | $ | 36,919 | $ | 5,144 | $ | 151,186 | ||||||||||
Tax Equivalent Yield |
5.18 | % | 3.64 | % | 3.81 | % | 6.06 | % | 3.85 | % |
We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. All securities held are historically traded in liquid markets, except for one bond. This $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by the Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee.
As of March 31, 2011, we performed an impairment assessment of the securities in our portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) we intend to sell the security, (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (3) we do not expect to recover the securitys entire amortized cost basis, even if we do not intend to sell. Additionally, accounting guidance requires that for impaired securities that we do not intend to sell and/or that it is not more-likely-than-not that we will have to sell prior
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to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, we consider factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
As of March 31, 2011, gross unrealized losses in our portfolio totaled $446 thousand, compared to $656 thousand as of December 31, 2010. The unrealized losses in federal agencies (consisting of three securities), mortgage-backed (consisting of five securities) and municipal (consisting of six securities) securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. We do not intend to sell the investments with unrealized losses and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. Based on the results of the impairment assessment, the unrealized losses at March 31, 2011 are considered temporary.
As of March 31, 2011, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders equity. As of the first quarter ended 2011, the amortized cost and market value of the securities from each such issuer are as follows:
Book Value | Market Value | |||||||
(in thousands) | ||||||||
Fannie Mae |
$ | 44,400 | $ | 39,228 | ||||
Ginnie Mae |
$ | 27,233 | $ | 27,466 | ||||
FHLMC* |
$ | 39,048 | $ | 40,196 |
* | Federal Home Loan Mortgage Corporation |
As of March 31, 2011, we held $185.6 million in interest bearing deposits, primarily at the Federal Reserve Bank of Atlanta, compared to $200.6 million at December 31, 2010 and $211.0 million as of March 31, 2010. The yield on our account at the Federal Reserve Bank is approximately 25 basis points.
As of March 31, 2011, we held $100 thousand in certificates of deposit at other FDIC insured financial institutions. At March 31, 2011, we held $26.0 million in bank-owned life insurance, compared to $25.8 million at December 31, 2010 and $25.1 million at March 31, 2010.
Deposits and Other Borrowings
As of March 31, 2011, deposits decreased by 4.5% (18.1% annualized) from December 31, 2010 and decreased by 16.7% from March 31, 2010. Excluding the changes in brokered deposits, our year-over-year deposits decreased 14.7%. From March 31, 2010 to March 31, 2011, the fastest growing sector of our core deposit base was noninterest bearing demand deposit accounts that grew $4.9 million, or 3.1%. We define our core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposits with denominations less than $100,000. We consider our retail CDs to be a stable source of funding because they are in-market, relationship-oriented deposits. Core deposit growth is an important tenet of our business strategy.
Brokered deposits decreased $75.5 million from March 31, 2010 to March 31, 2011 due to maturities in the absence of brokered deposit issuances. During January 2010, we issued $94.5 million in brokered certificates of deposit. Approximately $77 million of the January funds were used to eliminate our brokered money market account. In addition to brokered certificates of deposits, we are a member bank of the Certificate of Deposit Account Registry Service® (CDARS®) network. CDARS® is a network of banks that allows customers CDs to receive full FDIC insurance of up to $50 million. Additionally, members have the opportunity to purchase or sell one-way time deposits. As of March 31, 2011, our CDARS balance consists of $6.6 million in purchased time deposits and $702 thousand in our customers reciprocal accounts.
Brokered deposits at March 31, 2011, December 31, 2010 and March 31, 2010 were as follows:
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BROKERED DEPOSITS
March 31, 2011 |
December 31, 2010 |
March 31, 2010 |
||||||||||
(in thousands) | ||||||||||||
Brokered deposits |
||||||||||||
Brokered certificates of deposits |
$ | 270,559 | $ | 302,584 | $ | 322,944 | ||||||
CDARS® |
7,293 | 12,292 | 30,452 | |||||||||
Total |
$ | 277,852 | $ | 314,876 | $ | 353,396 | ||||||
As discussed in Note 2 of our consolidated financial statements, the presence of a capital requirement in our Consent Order restricts our ability to accept, renew, or roll over brokered deposits without prior approval of the FDIC. We believe that our current liquidity, along with maintaining or increasing core deposits, will provide for our short-term contractual obligations, including maturing brokered deposits. The table below is a maturity schedule for our brokered deposits.
BROKERED DEPOSITS BY MATURITY
Less than 3 months |
Three months to six months |
Six months to twelve months |
One to two years |
Greater than two years |
||||||||||||||||
(in thousands) | ||||||||||||||||||||
Brokered certificates of deposit |
$ | | $ | 12,414 | $ | 22,447 | $ | 72,961 | $ | 162,737 | ||||||||||
CDARS® |
| | 5,815 | 1,021 | 457 | |||||||||||||||
Total |
$ | | $ | 12,414 | $ | 28,262 | $ | 73,982 | $ | 163,194 | ||||||||||
As of March 31, 2011, December 31, 2010 and March 31, 2010, we had no federal funds purchased.
Securities sold under agreements to repurchase with commercial checking customers were $5.0 million as of March 31, 2011, compared to $5.9 million and $8.4 million as of December 31, 2010 and March 31, 2010, respectively. In November 2007, we entered into a five-year structured repurchase agreement with another financial institution for $10.0 million, with a stated maturity in November 2012. For the three months ended March 31, 2011 and 2010, we paid a fixed rate of 3.93%. The agreement is callable on a quarterly basis.
Liquidity
Liquidity refers to our ability to adjust future cash flows to meet the needs of our daily operations. We rely primarily on management fees from FSGBank to fund our daily operations liquidity needs. Our cash balance on deposit with FSGBank, which totaled approximately $1.4 million as of March 31, 2011, is available for funding activities for which FSGBank would not receive direct benefit, such as acquisition due diligence, shareholder relations and holding company operations. These funds should adequately meet our cash flow needs. If we determine that our cash flow needs will be satisfactorily met, we may deploy a portion of the funds into FSGBank or use them to support the growth of our franchise.
Since January 2010, to further preserve our capital resources and liquidity, our Board of Directors elected to defer the dividend payment on our Series A Preferred Stock. As the payment of future dividends requires prior written consent by the Federal Reserve, we anticipate continuing to defer the dividend payments on the Preferred Stock until conditions improve.
The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate securities available-for-sale.
As of March 31, 2011, our interest bearing account at the Federal Reserve Bank of Atlanta totaled approximately $182.9 million. This excess liquidity is available to fund our contractual obligations and prudent investment opportunities.
As of March 31, 2011, the unused borrowing capacity (using 1-4 family residential mortgages) for FSGBank at the FHLB required the individual pledging of loans. We are currently preparing the necessary documentation to increase the available funding and anticipate securing additional funding capacity during 2011.
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Another source of funding is loan participations sold to other commercial banks (in which we retain the service rights). As of quarter-end, we had $9.8 million in loan participations sold. FSGBank may continue to sell loan participations as a source of liquidity. An additional source of short-term funding would be to pledge investment securities against a line of credit at a commercial bank. As of quarter-end, FSGBank had no borrowings against our investment securities, except for repurchase agreements and public-fund deposits attained in the ordinary course of business.
Historically, we have utilized brokered deposits to provide an additional source of funding. As of March 31, 2011, we had $270.6 million in brokered CDs outstanding with a weighted average remaining life of approximately 29 months, a weighted average coupon rate of 2.60% and a weighted average all-in cost (which includes fees paid to deposit brokers) of 2.83%. Our CDARS® product had $7.3 million at March 31, 2011, with a weighted average coupon rate of 1.95% and a weighted average remaining life of approximately 27 months. Our certificates of deposit greater than $100 thousand were generated in our communities and are considered relatively stable. During 2009, we were approved to use the Federal Reserve discount window. We applied to utilize the Federal Reserve window as an abundance of caution due to the economic climate. As discussed in Note 2 of our consolidated financial statements, the presence of a capital requirement in our Consent Order restricts our ability to accept, renew or roll over brokered deposits without prior approval of the FDIC.
Management believes that our liquidity sources are adequate to meet our current operating needs. We continue to study our contingency funding plans and update them as needed paying particular attention to the sensitivity of our liquidity and deposit base to positive and negative changes in our asset quality.
We also have contractual cash obligations and commitments, which include certificates of deposit, other borrowings, operating leases and loan commitments. Unfunded loan commitments totaled $120.5 million at March 31, 2011. The following table illustrates our significant contractual obligations at March 31, 2011 by future payment period.
CONTRACTUAL OBLIGATIONS
Less than One Year |
One to Three Years |
Three to Five Years |
More than Five Years |
Total | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Certificates of deposit |
(1 | ) | $ | 283,950 | $ | 54,274 | $ | 4,593 | $ | | $ | 342,817 | ||||||||||||
Brokered certificates of deposit |
(1 | ) | 34,861 | 148,019 | 85,703 | 1,976 | 270,559 | |||||||||||||||||
CDARS® |
(1 | ) | 5,815 | 1,021 | 457 | | 7,293 | |||||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase |
(2 | ) | 4,951 | 10,000 | | | 14,951 | |||||||||||||||||
FHLB borrowings |
(3 | ) | 1 | 1 | | | 2 | |||||||||||||||||
Operating lease obligations |
(4 | ) | 840 | 1,048 | 900 | 4,323 | 7,111 | |||||||||||||||||
Commitments to fund affordable housing investments |
(5 | ) | 158 | | | | 158 | |||||||||||||||||
Note payable |
(6 | ) | 16 | 37 | 17 | | 70 | |||||||||||||||||
Total |
$ | 330,592 | $ | 214,400 | $ | 91,670 | $ | 6,299 | $ | 642,961 | ||||||||||||||
1 | Certificates of deposit give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. For more information regarding certificates of deposit, see Deposits and Other Borrowings. |
2 | We expect securities repurchase agreements to be re-issued and, as such, do not necessarily represent an immediate need for cash. |
3 | For more information regarding FHLB borrowings, see Deposits and Other Borrowings. |
4 | Operating lease obligations include existing and future property and equipment non-cancelable lease commitments. |
5 | We have commitments to certain investments in affordable housing and historic building rehabilitation projects within our market area. The investments entitle us to receive historic tax credits and low-income housing tax credits. |
6 | This note payable is a mortgage on the land of our branch facility located at 2905 Maynardville Highway, Maynardville, Tennessee. |
Net cash provided by operations during the first quarter of 2011 totaled $1.0 million compared to net cash used in operations of $3.8 million for the same period in 2010. The increase in cash provided by operations is primarily due to changes in other assets and other liabilities. Net cash provided by investing activities in 2011 totaled $51.3 million compared to net cash used in investing activities of $20.9 million in 2010. The change in interest bearing cash is the primary reason for the year-over-year change as we significantly increased our cash position during the first quarter of 2010. Net cash used in financing activities totaled $48.5 million in 2011 compared to net cash provided by financing activities of $19.4 million in 2010. The year-over-year change is primarily due to the decline in deposits during 2011.
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Derivative Financial Instruments
Derivatives are used as a risk management tool and to facilitate client transactions. We utilize derivatives to hedge the exposure to changes in interest rates or other identified market risks. Derivatives may also be used in a dealer capacity to facilitate client transactions by creating customized loan products for our larger customers. These products allow us to meet the needs of our customers, while minimizing our interest rate risk. We currently have not entered into any transactions in a dealer capacity.
The Asset/Liability Committee of the Board of Directors (ALCO) provides oversight through ensuring policies and procedures are in place to monitor our derivative positions. We believe the use of derivatives will reduce our interest rate risk and potential earnings volatility caused by changes in interest rates.
Our derivatives are based on underlying risks, primarily interest rates. Historically, we have utilized cash flow swaps to reduce the risks associated with interest rates. On August 28, 2007 and March 26, 2009, we elected to terminate a series of interest rate swaps with a total notional value of $150 million and $50 million, respectively. At termination, the swaps had a market value of $2.0 million and $5.8 million, respectively. These gains are being accreted into interest income over the remaining life of the originally hedged items. We recognized a total of $480 thousand in interest income for the three months ended March 31, 2011.
The following table presents the remaining accretion of the gain for the terminated swaps.
20111 | 2012 | Total | ||||||||||
(in thousands) | ||||||||||||
Accretion of gain from 2007 terminated swaps |
$ | 141 | $ | 62 | $ | 203 | ||||||
Accretion of gain from 2009 terminated swaps |
$ | 1,227 | $ | 1,272 | $ | 2,499 |
1 | Represents the gain accretion for April 1, 2011 to December 31, 2011. Excludes the amounts recognized in the first three months of 2011. |
We also use forward contracts to hedge against changes in interest rates on our held for sale loan portfolio. Our practice is to enter into a best efforts contract with the investor concurrently with providing an interest rate lock to a customer. The use of the fair value option on the closed held for sale loans and the forward contracts minimize the volatility in earnings from changes in interest rates.
The following are the cash flow hedges as of March 31, 2011:
Notional Amount |
Gross Unrealized Gains |
Gross Unrealized Losses |
Accumulated Other Comprehensive Income |
Maturity Date | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Asset hedges |
||||||||||||||||||||
Cash flow hedges: |
||||||||||||||||||||
Forward contracts |
$ | 1,145 | $ | 1 | $ | | $ | 1 | Various | |||||||||||
$ | 1,145 | $ | 1 | $ | | $ | 1 | |||||||||||||
Terminated asset hedges |
||||||||||||||||||||
Cash flow hedges: 1 |
||||||||||||||||||||
Interest rate swap |
$ | 25,000 | $ | | $ | | $ | 17 | June 28, 2011 | |||||||||||
Interest rate swap |
20,000 | | | 13 | June 28, 2011 | |||||||||||||||
Interest rate swap |
35,000 | | | 104 | June 28, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 825 | October 15, 2012 | |||||||||||||||
Interest rate swap |
25,000 | | | 825 | October 15, 2012 | |||||||||||||||
$ | 130,000 | $ | | $ | | $ | 1,784 | |||||||||||||
1 | The $1.8 million of gains, net of taxes, recorded in accumulated other comprehensive income as of March 31, 2011, will be reclassified into earnings as interest income over the remaining life of the respective hedged items. |
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The following table presents additional information on the active derivative positions as of March 31, 2011:
Consolidated Balance Sheet Presentation |
Consolidated Income Statement Presentation | |||||||||||||||||||||||
Assets |
Liabilities |
Gains | ||||||||||||||||||||||
Notional | Classification |
Amount | Classification |
Amount | Classification | Amount Recognized | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Hedging Instrument: |
||||||||||||||||||||||||
Forward contracts |
$ | 1,145 | Other assets | $ | 1 | Other liabilities | N/A | |
Noninterest income other |
|
$ | 296 | ||||||||||||
Hedged Items: |
||||||||||||||||||||||||
Loans held for sale |
N/A | Loans held for sale | $ | 1,145 | N/A | N/A | |
Noninterest income other |
|
N/A |
Derivatives expose us to credit risk from the counterparty when the derivatives are in an unrealized gain position. All counterparties must be approved by the Board of Directors and are monitored by the ALCO on an ongoing basis. We minimize the credit risk exposure by requiring collateral when certain conditions are met. When the derivatives are at an unrealized loss position, our counterparty may require us to pledge collateral.
Off-Balance Sheet Arrangements
We are party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making commitments as we do for on-balance-sheet instruments.
Our maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at March 31, 2010 and 2009 was as follows:
As of March 31, | ||||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
Commitments to extend credit |
$ | 120,464 | $ | 157,755 | ||||
Standby letters of credit |
$ | 13,798 | $ | 15,394 |
Commitments to extend credit are agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customers credit worthiness on a case-by-case basis. The amount of collateral, if any, we obtain on an extension of credit is based on our credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties. Through this economic recession, we have intentionally reduced our potential credit exposure by reducing our unfunded loan commitments and standby letters of credit.
Capital Resources
Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Comptroller of the Currency and the Federal Reserve, the primary federal regulators for FSGBank and First Security, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. As described in Note 2 to our consolidated financial statements, the Consent Order requires FSGBank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Order provides 120 days from April 28, 2010, the effective date of the Order, to achieve these ratios.
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The following table compares the required capital ratios maintained by First Security and FSGBank:
March 31, 2011 |
FSGBank Consent Order1 |
Well Capitalized |
Adequately Capitalized |
First Security |
FSGBank | |||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 11.3 | % | 11.1 | %3 | |||||||||||
Total capital to risk adjusted assets |
13.0 | % | 10.0 | % | 8.0 | % | 12.6 | % | 12.3 | %3 | ||||||||||
Leverage ratio |
9.0 | % | 5.0 | %2 | 4.0 | % | 7.5 | % | 7.3 | %3 | ||||||||||
December 31, 2010 |
||||||||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 11.2 | % | 10.9 | %3 | |||||||||||
Total capital to risk adjusted assets |
13.0 | % | 10.0 | % | 8.0 | % | 12.5 | % | 12.2 | %3 | ||||||||||
Leverage ratio |
9.0 | % | 5.0 | %2 | 4.0 | % | 7.3 | % | 7.1 | %3 | ||||||||||
March 31, 2010 |
||||||||||||||||||||
Tier I capital to risk adjusted assets |
n/a | 6.0 | % | 4.0 | % | 12.9 | % | 12.5 | %3 | |||||||||||
Total capital to risk adjusted assets |
13.0 | % | 10.0 | % | 8.0 | % | 14.2 | % | 13.7 | %3 | ||||||||||
Leverage ratio |
9.0 | % | 5.0 | %2 | 4.0 | % | 9.2 | % | 8.9 | %3 |
1 | FSGBank was required to achieve and maintain the above capital ratios within 120 days from April 28, 2010. |
2 | The Federal Reserve Board definition of well capitalized for bank holding companies does not include a leverage ratio component; accordingly, the leverage ratio requirement for well capitalized status only applies to FSGBank. |
3 | Due to the capital requirement within FSGBanks Consent Order, FSGBank is considered to be adequately capitalized. |
To further preserve our capital resources, our Board of Directors elected to suspend our common stock dividend and defer the dividend on the Series A Preferred Stock for all four quarters of 2010 and the first quarter of 2011. As described in Note 2 to our consolidated financial statements, the Written Agreement between First Security and the Federal Reserve prohibits declaring or paying dividends without prior written consent. Under applicable banking regulations, we do not anticipate declaring or paying a dividend until we return to sustained profitability.
EFFECTS OF GOVERNMENTAL POLICIES
We are affected by the policies of regulatory authorities, including the Federal Reserve Board and the OCC. An important function of the Federal Reserve Board is to regulate the national money supply.
Among the instruments of monetary policy used by the Federal Reserve Board are: purchases and sales of U.S. Government securities in the marketplace; changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve Board; and changes in the reserve requirements of depository institutions. These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation.
The monetary policies of the Federal Reserve Board and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the national and international economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels or loan demand or whether the changing economic conditions will have a positive or negative effect on operations and earnings.
Legislation from time to time is introduced in the United States Congress and the Tennessee General Assembly and other state legislatures, and regulations are proposed by the regulatory agencies that could affect our business. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which our business may be affected thereby.
The Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) which, among other things, alters the oversight and supervision of financial institutions by federal and state regulators, introduces minimum capital requirements, creates a new federal agency to supervise consumer financial products and services, and implements changes to corporate governance and compensation practices. Although the Act is particularly focused on large bank holding companies with consolidated assets of $50 billion or more, it does contain a number of provisions that may affect us, including:
| Minimum Leverage and Risk-Based Capital Requirements. Under the Act, the appropriate Federal banking agencies are required to establish minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and bank holding companies, which can be no less than the currently applicable leverage and risk-based capital requirements for depository institutions. |
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| Deposit Insurance Modifications. The Act modifies the FDICs assessment base upon which deposit insurance premiums are calculated. The new assessment base will equal our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The Act also makes permanent the increase in maximum federal deposit insurance limits from $100,000 to $250,000. |
| Creation of New Consumer Protection Bureau. The Act creates a new Bureau of Consumer Financial Protection within the Federal Reserve with broad powers to supervise and enforce consumer protection laws. The Bureau of Consumer Financial Protection will have broad rule-making authority for a wide range of consumer protection laws that apply to all insured depository institutions. The Bureau of Consumer Financial Protection has examination and enforcement authority over all depository institutions with more than $10 billion in assets. Depository institutions with $10 billion or less in assets, such as FSGBank, will be examined by their applicable bank regulators. |
| Executive Compensation and Corporate Governance Requirements. The Act includes provisions that may impact our corporate governance, including a grant of authority to the SEC to issue rules that allow shareholders to nominate directors by using the companys proxy solicitation materials. The Act further requires the SEC to adopt rules that prohibit the listing of any equity security of a company that does not have an independent compensation committee and require all exchange-traded companies to adopt clawback policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements. |
Many provisions of the Act will require our regulators to adopt additional rules in order to implement the mandates included in the Act. In addition, the Act requires multiple studies which could result in additional legislative action. Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2011, the FASB issued Accounting Standards Update 2011-02, Receivables (Topic 301): A Creditors Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance in determining what is considered a troubled debt restructuring (TDR). The update clarifies the two criteria that are required in determining a TDR. The update is effective for interim or annual periods beginning after June 15, 2011. We are currently evaluating the impact of this update to its consolidated financial statements.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk, with respect to us, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. We do not deal in international instruments, and therefore are not exposed to risk inherent to foreign currency.
Our interest rate risk management is the responsibility of the ALCO. This committee has established policies and limits to monitor, measure and coordinate our sources, uses and pricing of funds.
Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with our interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both static gap and income simulation reports to quantify the estimated exposure of net interest income to a sustained change in interest rates.
Our income simulation analysis projected net interest income based on both a rise and fall in interest rates of 200 basis points (i.e., 2.00%) over a twelve-month period. Given this scenario, we had, as of March 31, 2011, an exposure to falling rates and a benefit from rising rates. More specifically, our model forecasts a decline in net interest income of $7.6 million, or 25.1%, as a result of a 200 basis point decline in rates. The model also predicts a $3.2 million increase in net interest income, or 10.5%, as a result of a 200 basis point increase in rates. The following chart reflects our sensitivity to changes in interest rates as of March 31, 2011. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvested in like instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.
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INTEREST RATE RISK
INCOME SENSITIVITY SUMMARY
Down 200 BP | Current | Up 200 BP | ||||||||||
(in thousands, except percentages) | ||||||||||||
Annualized net interest income1 |
$ | 22,873 | $ | 30,522 | $ | 33,727 | ||||||
Dollar change net interest income |
(7,649 | ) | | 3,205 | ||||||||
Percentage change net interest income |
(25.06 | )% | 0.00 | % | 10.50 | % |
1 | Annualized net interest income is a twelve month projection based on year-to-date results. |
The preceding sensitivity summary is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that we might take in responding to or anticipating changes in interest rates.
We use the Sendero Vision Asset/Liability system which is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration and income simulations using a wide range of scenarios including interest rate shocks and rate ramps. The system also has the capability to model derivative instruments, such as interest rate swap contracts.
ITEM 4. | CONTROLS AND PROCEDURES |
As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have evaluated the effectiveness of our disclosure controls and procedures (Disclosure Controls). Disclosure Controls, as defined in Rule 13a-15(e) of the Exchange Act, are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief executive officer (CEO) and chief financial officer (CFO) (hereinafter in Item 4 management, including the CEO and CFO, are referred to collectively as management), as appropriate to allow timely decisions regarding required disclosure.
Our management does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective.
As previously disclosed in First Securitys Annual Report on Form 10-K, filed with the Securities and Exchange Commission (SEC) on April 15, 2011, management identified a material weakness in the Companys entity level controls and therefore concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2010. Subsequent to December 31, 2010, various changes have occurred that may have impacted our control environment. Management believes that its control environment has improved as of the filing of this Quarterly Report on Form 10-Q, however, we are continuing to evaluate additional changes, including but not limited to, revisions to policies, additional training and education.
Additionally, on February 23, 2011, William L. Lusk, Jr. resigned as Chief Financial Officer. The Board of Directors appointed John R. Haddock, the Companys Controller, as acting interim Chief Financial Officer on February 23, 2011. The Company is currently conducting a search for a new Controller. In the interim, the Company has taken steps to ensure the internal controls over financial reporting have not been impacted by one person serving in both the Chief Financial Officer and Controller roles.
PART II. OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
In the normal course of business, we are at times subject to pending and threatened legal actions. Although we are not able to predict the outcome of such actions, after reviewing pending and threatened actions with counsel, we believe that the outcome of any or all such actions will not have a material adverse effect on our business, financial condition and/or operating results.
ITEM 1A. | RISK FACTORS |
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2010, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
As previously disclosed, First Security has decided to defer quarterly cash dividend payments on its Series A Preferred Stock. Cash dividends on the Series A Preferred Stock are cumulative and accrue and compound on each subsequent payment date. At March 31, 2011, First Security had unpaid preferred stock dividends in arrears of $2.3 million, which is included in other liabilities in First Securitys consolidated balance sheet. If First Security misses six quarterly dividend payments on the Series A Preferred Stock, whether or not consecutive, the Treasury will have the right to appoint two directors to First Securitys board of directors until all accrued but unpaid dividends have been paid. First Security has deferred all five dividend payments as of March 31, 2011. The Treasury has requested, and First Security has agreed, to permit an observer employed by the Treasury to attend meetings of First Securitys Board of Directors.
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ITEM 6. | EXHIBITS |
Exhibits:
EXHIBIT |
DESCRIPTION | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 |
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Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed by the undersigned, thereunto duly authorized.
FIRST SECURITY GROUP, INC. | ||||
(Registrant) | ||||
May 16, 2011 | By: | /S/ RALPH E. COFFMAN, JR. | ||
Ralph E. Coffman, Jr. | ||||
Acting Interim Chairman & CEO | ||||
May 16, 2011 | By: | /S/ JOHN R. HADDOCK | ||
John R. Haddock | ||||
Secretary, Chief Financial Officer & Executive Vice President |
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