Attached files
file | filename |
---|---|
EX-32.1 - EXHIBIT 32.1 - MOUNTAIN NATIONAL BANCSHARES INC | c17358exv32w1.htm |
EX-32.2 - EXHIBIT 32.2 - MOUNTAIN NATIONAL BANCSHARES INC | c17358exv32w2.htm |
EX-31.1 - EXHIBIT 31.1 - MOUNTAIN NATIONAL BANCSHARES INC | c17358exv31w1.htm |
EX-31.2 - EXHIBIT 31.2 - MOUNTAIN NATIONAL BANCSHARES INC | c17358exv31w2.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-49912
MOUNTAIN NATIONAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Tennessee | 75-3036312 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) |
300 East Main Street | ||
Sevierville, Tennessee | 37862 | |
(Address of principal executive offices) | (Zip Code) |
(865) 428-7990
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
(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 Exchange Act of 1934 during the preceding 12 months
(or such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date. Common stock outstanding: 2,631,611 shares as of May 1, 2011.
MOUNTAIN NATIONAL BANCSHARES, INC.
Quarterly Report on Form 10-Q
For the quarter ended March 31, 2011
Quarterly Report on Form 10-Q
For the quarter ended March 31, 2011
Table of Contents
Item | Page | |||||||
Number | Number | |||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
25 | ||||||||
48 | ||||||||
50 | ||||||||
50 | ||||||||
51 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32.1 | ||||||||
Exhibit 32.2 |
2
Table of Contents
PART I FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 9,645,502 | $ | 30,039,647 | ||||
Federal funds sold |
6,249,007 | 2,536,173 | ||||||
Total cash and cash equivalents |
15,894,509 | 32,575,820 | ||||||
Securities available for sale |
89,765,600 | 86,316,591 | ||||||
Securities held to maturity, fair value $1,350,730 at March 31, 2011 and
$1,303,080 at December 31, 2010 |
1,333,297 | 1,317,951 | ||||||
Restricted investments, at cost |
3,843,150 | 3,843,150 | ||||||
Loans, net of allowance for loan losses of $10,037,471 at March 31, 2011 and
$10,942,414 at December 31, 2010 |
355,090,981 | 363,413,050 | ||||||
Investment in partnership |
4,306,002 | 4,303,600 | ||||||
Premises and equipment |
32,276,720 | 32,600,673 | ||||||
Accrued interest receivable |
1,661,787 | 1,495,869 | ||||||
Cash surrender value of company owned life insurance |
11,871,917 | 11,774,605 | ||||||
Other real estate owned |
12,936,232 | 13,140,698 | ||||||
Other assets |
4,505,183 | 6,424,504 | ||||||
Total assets |
$ | 533,485,378 | $ | 557,206,511 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Deposits: |
||||||||
Noninterest-bearing demand deposits |
$ | 48,492,160 | $ | 47,638,792 | ||||
NOW accounts |
54,389,421 | 57,344,798 | ||||||
Money market accounts |
48,809,424 | 49,701,122 | ||||||
Savings accounts |
23,608,702 | 23,733,795 | ||||||
Time deposits |
254,098,323 | 271,172,901 | ||||||
Total deposits |
429,398,030 | 449,591,408 | ||||||
Securities sold under agreements to repurchase |
866,045 | 432,016 | ||||||
Accrued interest payable |
658,391 | 719,133 | ||||||
Subordinated debentures |
13,403,000 | 13,403,000 | ||||||
Federal Home Loan Bank advances |
55,200,000 | 55,200,000 | ||||||
Other liabilities |
1,116,903 | 2,186,784 | ||||||
Total liabilities |
500,642,369 | 521,532,341 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity: |
||||||||
Preferred stock, no par value; 1,000,000 shares authorized;
0 shares issued and outstanding |
| | ||||||
Common stock, $1.00 par value; 10,000,000 shares authorized; 2,631,611
issued and outstanding |
2,631,611 | 2,631,611 | ||||||
Additional paid-in capital |
42,255,363 | 42,229,713 | ||||||
Retained earnings (deficit) |
(11,501,513 | ) | (8,122,476 | ) | ||||
Accumulated other comprehensive income (loss) |
(542,452 | ) | (1,064,678 | ) | ||||
Total shareholders equity |
32,843,009 | 35,674,170 | ||||||
Total liabilities and
shareholders equity |
$ | 533,485,378 | $ | 557,206,511 | ||||
See accompanying Notes to Consolidated Financial Statements
3
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three months ended March 31, | ||||||||
2011 | 2010 | |||||||
INTEREST INCOME |
||||||||
Loans |
$ | 4,609,498 | $ | 5,148,435 | ||||
Taxable securities |
553,167 | 768,934 | ||||||
Tax-exempt securities |
57,914 | 102,757 | ||||||
Federal funds sold and deposits in other banks |
5,884 | 10,698 | ||||||
Total interest income |
5,226,463 | 6,030,824 | ||||||
INTEREST EXPENSE |
||||||||
Deposits |
1,453,299 | 2,179,182 | ||||||
Repurchase agreements |
2,690 | 5,919 | ||||||
Federal Reserve and Federal Home Loan Bank
advances |
554,574 | 638,156 | ||||||
Subordinated debentures |
76,749 | 80,051 | ||||||
Total interest expense |
2,087,312 | 2,903,308 | ||||||
Net interest income |
3,139,151 | 3,127,516 | ||||||
Provision for loan losses |
3,000,000 | 212,300 | ||||||
Net interest income after provision for loan losses |
139,151 | 2,915,216 | ||||||
NONINTEREST INCOME |
||||||||
Service charges on deposit accounts |
378,072 | 398,212 | ||||||
Other fees and commissions |
330,599 | 326,444 | ||||||
Gain on sale of mortgage loans |
22,655 | 45,713 | ||||||
Investment gains and losses, net |
| 953,609 | ||||||
Other real estate gains and losses, net |
13,673 | 59,029 | ||||||
Other noninterest income |
141,860 | 192,459 | ||||||
Total noninterest income |
886,859 | 1,975,466 | ||||||
NONINTEREST EXPENSE |
||||||||
Salaries and employee benefits |
1,995,418 | 2,342,353 | ||||||
Occupancy expenses |
454,008 | 448,700 | ||||||
FDIC assessment expense |
351,832 | 312,312 | ||||||
Other operating expenses |
1,504,554 | 1,479,988 | ||||||
Total noninterest expense |
4,305,812 | 4,583,353 | ||||||
Income (loss) before income tax expense (benefit) |
(3,279,802 | ) | 307,329 | |||||
Income tax expense (benefit) |
99,235 | (21,785 | ) | |||||
Net income (loss) |
$ | (3,379,037 | ) | $ | 329,114 | |||
EARNINGS (LOSS) PER SHARE |
||||||||
Basic |
$ | (1.28 | ) | $ | 0.13 | |||
Diluted |
$ | (1.28 | ) | $ | 0.13 |
See accompanying Notes to Consolidated Financial Statements
4
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
For the Three Months Ended March 31, 2011 and 2010
(unaudited)
Accumulated | ||||||||||||||||||||||||
Additional | Retained | Other | Total | |||||||||||||||||||||
Comprehensive | Common | Paid-in | Earnings | Comprehensive | Shareholders | |||||||||||||||||||
Income (Loss) | Stock | Capital | (Deficit) | Income/(Loss) | Equity | |||||||||||||||||||
BALANCE, January 1, 2010 |
$ | 2,631,611 | $ | 42,125,828 | $ | 2,328,702 | $ | 283,014 | $ | 47,369,155 | ||||||||||||||
Share-based compensation |
2,110 | 2,110 | ||||||||||||||||||||||
Comprehensive income (loss): |
||||||||||||||||||||||||
Net income |
$ | 329,114 | 329,114 | 329,114 | ||||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||
Change in unrealized gains (losses) on
securities available-for-sale |
(273,412 | ) | (273,412 | ) | (273,412 | ) | ||||||||||||||||||
Total comprehensive income |
55,702 | |||||||||||||||||||||||
BALANCE, March 31, 2010 |
2,631,611 | 42,127,938 | 2,657,816 | 9,602 | 47,426,967 | |||||||||||||||||||
BALANCE, January 1, 2011 |
$ | 2,631,611 | $ | 42,229,713 | $ | (8,122,476 | ) | $ | (1,064,678 | ) | $ | 35,674,170 | ||||||||||||
Share-based compensation |
25,650 | 25,650 | ||||||||||||||||||||||
Comprehensive income (loss): |
||||||||||||||||||||||||
Net loss |
(3,379,037 | ) | (3,379,037 | ) | (3,379,037 | ) | ||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||
Change in unrealized gains (losses) on
securities available-for-sale |
522,226 | 522,226 | 522,226 | |||||||||||||||||||||
Total comprehensive loss |
$ | (2,856,811 | ) | |||||||||||||||||||||
BALANCE, March 31, 2011 |
$ | 2,631,611 | $ | 42,255,363 | $ | (11,501,513 | ) | $ | (542,452 | ) | $ | 32,843,009 | ||||||||||||
See accompanying Notes to Consolidated Financial Statements
5
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three months ended March 31, | ||||||||
2011 | 2010 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net income (loss) |
$ | (3,379,037 | ) | $ | 329,114 | |||
Adjustments to reconcile net income (loss) to net cash
provided by operating activities: |
||||||||
Depreciation |
378,983 | 406,869 | ||||||
Net realized gains on securities available for sale |
| (942,085 | ) | |||||
Net realized gains on securities held to maturity |
| (11,524 | ) | |||||
Net amortization on available for sale securities |
312,997 | 184,137 | ||||||
Increase in held to maturity due to accretion |
(15,347 | ) | (16,232 | ) | ||||
Provision for loan losses |
3,000,000 | 212,300 | ||||||
Net gain on other real estate |
(13,673 | ) | (59,029 | ) | ||||
Gross mortgage loans originated for sale |
(1,516,801 | ) | (4,352,282 | ) | ||||
Gross proceeds from sale of mortgage loans |
1,602,956 | 3,527,245 | ||||||
Gain on sale of mortgage loans |
(22,655 | ) | (45,713 | ) | ||||
Increase in cash surrender value of life insurance |
(97,312 | ) | (102,000 | ) | ||||
Investment in partnership |
(2,402 | ) | (71,650 | ) | ||||
Share-based compensation |
25,650 | 2,110 | ||||||
Change in operating assets and liabilities: |
||||||||
Accrued interest receivable |
(165,918 | ) | 549,473 | |||||
Accrued interest payable |
(60,742 | ) | 50,315 | |||||
Other assets and liabilities |
849,441 | 86,005 | ||||||
Net cash provided
by (used in)
operating
activities |
896,140 | (252,947 | ) | |||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Activity in available-for-sale securities: |
||||||||
Proceeds from sales |
| 80,373,113 | ||||||
Proceeds from maturities, prepayments and calls |
7,034,461 | 29,269,199 | ||||||
Purchases |
(10,274,241 | ) | (121,850,168 | ) | ||||
Activity in held-to-maturity securities: |
||||||||
Proceeds from sales |
| 520,000 | ||||||
Purchases of restricted investments |
| (26,100 | ) | |||||
Loan originations and principal collections, net |
5,068,569 | 3,198,491 | ||||||
Purchase of premises and equipment |
(55 | ) | (90,611 | ) | ||||
Proceeds from sale of other real estate |
353,164 | 851,762 | ||||||
Net cash provided
by (used in)
investing
activities |
2,181,898 | (7,754,314 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net (decrease) increase in deposits |
(20,193,378 | ) | 7,022,708 | |||||
Net decrease in securities sold under agreements to repurchase |
434,029 | 398,924 | ||||||
Net cash (used in)
provided by
financing
activities |
(19,759,349 | ) | 7,421,632 | |||||
NET DECREASE IN CASH AND CASH EQUIVALENTS |
(16,681,311 | ) | (585,629 | ) | ||||
CASH AND CASH EQUIVALENTS, beginning of period |
32,575,820 | 14,104,636 | ||||||
CASH AND CASH EQUIVALENTS, end of period |
$ | 15,894,509 | $ | 13,519,007 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
||||||||
Cash paid for: |
||||||||
Interest |
$ | 2,148,054 | $ | 2,852,993 | ||||
Income taxes |
| | ||||||
Non-cash investing and financing activities: |
||||||||
Transfers from loans to other real estate owned |
190,000 | 760,692 | ||||||
Loans advanced for sales of other real estate |
| 109,350 | ||||||
Transfers from held-to-maturity to available-for-sale securities |
| 439,097 |
See accompanying Notes to Consolidated Financial Statements
6
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation and Accounting Policies
The unaudited consolidated financial statements in this report have been prepared in
conformity with U.S. generally accepted accounting principles (GAAP) for interim financial
information and with the instructions of Form 10-Q and Rule 10-01 of Regulation S-X. The
consolidated financial statements include the accounts of Mountain National Bancshares, Inc., a
Tennessee corporation (the Company), and its subsidiaries. The Companys principal subsidiary is
Mountain National Bank, a national association (the Bank). All material intercompany accounts and
transactions have been eliminated in consolidation.
Loss contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable and
an amount or range of loss can be reasonably estimated. Management does not believe there are
now such matters that will have a material effect on the financial statements.
Certain information and note disclosures normally included in the Companys annual audited
financial statements prepared in accordance with generally accepted accounting principles have been
condensed or omitted from the unaudited financial statements in this report. Consequently, the
quarterly financial statements should be read in conjunction with the notes included herein and the
notes to the audited financial statements presented in the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2010. The unaudited quarterly financial statements reflect all
adjustments that are, in the opinion of management, necessary for a fair presentation of the
results of operations for interim periods presented. All such adjustments were of a normal,
recurring nature. The results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the complete fiscal year.
Reclassifications: Some items in prior year financial statements were reclassified to conform
to current presentation.
Note 2. New Accounting Standards
In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, Receivables
(Topic 310) Disclosures about the Credit Quality of Financing Receivables and the Allowance for
Credit Losses. ASU No. 2010-20 expands the disclosures about the credit quality of financing
receivables and the related allowance for credit losses. The ASU also requires disaggregation of
existing disclosures by portfolio segment. The amendments that require disclosures as of the end of
a reporting period were effective for periods ending on or after December 15, 2010. The amendments
that require disclosures about activity that occurs during a reporting period are effective for
periods beginning on or after December 15, 2010. The adoption of this guidance expanded the
Companys disclosures surrounding credit quality of financing receivables and the related allowance
for credit losses.
In April, 2011, the FASB issued ASU No. 2011-02, A Creditors Determination of Whether a
Restructuring Is a Troubled Debt Restructuring. ASU No. 2011-02 intended to provide additional
guidance to assist creditors in determining whether a restructuring of a receivable meets the
criteria to be considered a Troubled Debt Restructuring (TDR). The amendments in this ASU are
effective for the first interim or annual period beginning on or after June 15, 2011, and are to be
applied retrospectively to the beginning of the annual period of adoption. As a result of applying
these amendments, an entity may identify receivables that are newly considered TDRs. The Company is
continuing to evaluate the impact of adoption of this ASU.
7
Table of Contents
Note 3. Investment Securities
The following table summarizes the amortized cost and fair value of the available-for-sale and
held-to-maturity investment securities portfolio at March 31, 2011 and December 31, 2010 and the
corresponding amounts of unrealized gains and losses therein.
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
March 31, 2011 |
||||||||||||||||
Available-for-sale |
||||||||||||||||
U. S. Government securities |
$ | 249,967 | $ | 22 | $ | | $ | 249,989 | ||||||||
Obligations of states and political
subdivisions |
5,210,513 | 38,041 | (259,571 | ) | 4,988,983 | |||||||||||
Mortgage-backed securities-residential |
84,671,859 | 287,144 | (432,375 | ) | 84,526,628 | |||||||||||
Total available-for-sale securities |
$ | 90,132,339 | $ | 325,207 | $ | (691,946 | ) | $ | 89,765,600 | |||||||
Held-to-maturity |
||||||||||||||||
Obligations of states and political
subdivisions |
$ | 1,333,297 | $ | 17,433 | $ | | $ | 1,350,730 | ||||||||
December 31, 2010 |
||||||||||||||||
Available-for-sale |
||||||||||||||||
U. S. Government securities |
$ | 249,879 | $ | | $ | (13 | ) | $ | 249,866 | |||||||
Obligations of states and political
subdivisions |
5,201,492 | 17,407 | (296,786 | ) | 4,922,113 | |||||||||||
Mortgage-backed securities-residential |
81,754,184 | 134,557 | (744,129 | ) | 81,144,612 | |||||||||||
Total available-for-sale securities |
$ | 87,205,555 | $ | 151,964 | $ | (1,040,928 | ) | $ | 86,316,591 | |||||||
Held-to-maturity |
||||||||||||||||
Obligations of states and political
subdivisions |
$ | 1,317,951 | $ | | $ | (14,871 | ) | $ | 1,303,080 | |||||||
8
Table of Contents
The amortized cost and fair value of the investment securities portfolio are shown below by
expected maturity. Expected maturities may differ from contractual maturities if borrowers have the
right to call or prepay obligations with or without call or prepayment penalties.
March 31, 2011 | ||||||||
Amortized | Fair | |||||||
Cost | Value | |||||||
Maturity |
||||||||
Available-for-sale |
||||||||
Within one year |
$ | 249,967 | $ | 249,989 | ||||
One to five years |
267,402 | 265,050 | ||||||
Five to ten years |
1,190,455 | 1,206,613 | ||||||
Beyond ten years |
3,752,656 | 3,517,320 | ||||||
Mortgage-backed securities-residential |
84,671,859 | 84,526,628 | ||||||
Total |
$ | 90,132,339 | $ | 89,765,600 | ||||
Held-to-maturity |
||||||||
Five to ten years |
730,360 | 733,190 | ||||||
Beyond ten years |
602,937 | 617,540 | ||||||
Total |
$ | 1,333,297 | $ | 1,350,730 | ||||
The following table summarizes the investment securities with unrealized losses at March 31,
2011 and December 31, 2010 aggregated by major security type and length of time in a continuous
unrealized loss position.
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Loss | Value | Loss | Value | Loss | |||||||||||||||||||
March 31, 2011 |
||||||||||||||||||||||||
Available-for-sale |
||||||||||||||||||||||||
Obligations of states and
political subdivisions |
$ | 1,735,275 | $ | (72,520 | ) | $ | 1,589,233 | $ | (187,051 | ) | $ | 3,324,508 | $ | (259,571 | ) | |||||||||
Mortgage-backed
securities-residential |
47,584,756 | (432,375 | ) | | | 47,584,756 | (432,375 | ) | ||||||||||||||||
Total available-for-sale |
$ | 49,320,031 | $ | (504,895 | ) | $ | 1,589,233 | $ | (187,051 | ) | $ | 50,909,264 | $ | (691,946 | ) | |||||||||
December 31, 2010 |
||||||||||||||||||||||||
Available-for-sale |
||||||||||||||||||||||||
U. S. Government
securities |
$ | 249,866 | $ | (13 | ) | $ | | $ | | $ | 249,866 | $ | (13 | ) | ||||||||||
Obligations of states and
political subdivisions |
3,632,820 | (112,755 | ) | 1,571,970 | (198,902 | ) | 5,204,790 | (311,657 | ) | |||||||||||||||
Mortgage-backed
securities-residential |
57,369,268 | (744,129 | ) | | | 57,369,268 | (744,129 | ) | ||||||||||||||||
Total available-for-sale |
$ | 61,251,954 | $ | (856,897 | ) | $ | 1,571,970 | $ | (198,902 | ) | $ | 62,823,924 | $ | (1,055,799 | ) | |||||||||
Proceeds from sales of securities were approximately $80 million for the three months ended
March 31, 2010. No securities were sold during the first quarter of 2011. Gross gains of $1,012,979
and gross losses of $59,370 were realized on these sales during the first three months of 2010.
During the first quarter of 2010, the Bank sold one security classified as held-to-maturity.
The remaining held-to-maturity security in the Banks portfolio was reclassified as available for
sale. The approximately $1.3 million residual balance in held-to-maturity securities at March 31,
2011 represents securities held in the portfolio of MNB Investments, Inc., a consolidated
subsidiary of the Bank. MNB Investments, Inc. does not intend and it is not more likely than not
that it would be required to sell these
securities prior to maturity.
9
Table of Contents
Other-Than-Temporary-Impairment
Management evaluates securities for other-than-temporary impairment (OTTI) at least on a
quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
In determining OTTI, management considers many factors, including: (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic
conditions, and (4) whether the entity has the intent to sell the debt security or more likely than
not will be required to sell the debt security before its anticipated recovery. The assessment
of whether an other-than-temporary decline exists involves a high degree of subjectivity and
judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity
intends to sell the security or it is more likely than not it will be required to sell the
security before recovery of its amortized cost basis, less any current-period credit loss. If
an entity intends to sell or it is more likely than not it will be required to sell the security
before recovery of its amortized cost basis, less any current-period credit loss, the OTTI
shall be recognized in earnings equal to the entire difference between the investments amortized
cost basis and its fair value at the balance sheet date. Otherwise, the OTTI shall be separated
into the amount representing the credit loss and the amount related to all other factors. The
amount of the total OTTI related to the credit loss is determined based on the present
value of cash flows expected to be collected and is recognized in earnings. The amount of
the total OTTI related to other factors is recognized in other comprehensive income (loss), net of
applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings
becomes the new amortized cost basis of the investment.
As of March 31, 2011, the Companys securities portfolio consisted of 83 securities, 41 of
which were in an unrealized loss position. The majority of unrealized losses are related to the
Companys mortgage-backed securities and obligations of states and political subdivisions, as
discussed below.
Unrealized losses on mortgage-backed securities and obligations of states and political
subdivisions have not been recognized into income because the issuer(s) bonds are of high credit
quality, the decline in fair value is largely due to changes in interest rates and other market
conditions, and because the Company does not have the intent to sell these securities and it is
likely that it will not be required to sell the securities before their anticipated recovery. The
Company does not consider these securities to be other-than-temporarily impaired at March 31, 2011.
Note 4. Net Earnings (Loss) Per Common Share
Net earnings (loss) per common share are based on the weighted average number of common shares
outstanding during the period. Diluted earnings per common share include the effects of potential
common shares outstanding, including shares issuable upon the exercise of options for which the
exercise price is lower than the market price of the common stock, during the period.
10
Table of Contents
The following is a summary of the basic and diluted earnings (loss) per share calculation for
the three months ended March 31, 2011 and 2010:
Three-Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Basic earnings (loss) per share calculation: |
||||||||
Numerator Net income (loss) |
$ | (3,379,037 | ) | $ | 329,114 | |||
Denominator Average common shares outstanding |
2,631,611 | 2,631,611 | ||||||
Basic net income (loss) per share |
$ | (1.28 | ) | $ | 0.13 | |||
Diluted earnings (loss) per share calculation: |
||||||||
Numerator Net income (loss) |
(3,379,037 | ) | 329,114 | |||||
Denominator Average common shares outstanding |
2,631,611 | 2,631,611 | ||||||
Dilutive shares contingently issuable |
| | ||||||
Average dilutive common shares outstanding |
2,631,611 | 2,631,611 | ||||||
Diluted net income (loss) per share |
$ | (1.28 | ) | $ | 0.13 |
During the three months ended March 31, 2011 and 2010, there were options for the
purchase of 122,133 and 125,086 shares, respectively, outstanding during each time period that were
antidilutive. These shares were accordingly excluded from the calculations above.
Note 5. Loans and Allowance for Loan Losses
At March 31, 2011 and December 31, 2010, the Banks loans consisted of the following (in
thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Mortgage loans on real estate: |
||||||||
Residential 1-4 family |
$ | 82,661 | $ | 86,403 | ||||
Residential multifamily |
6,106 | 6,147 | ||||||
Commercial real estate |
133,339 | 133,917 | ||||||
Construction and land development |
78,784 | 83,543 | ||||||
Second mortgages |
8,616 | 8,880 | ||||||
Equity lines of credit |
24,808 | 25,391 | ||||||
334,314 | 344,281 | |||||||
Commercial loans |
25,911 | 24,944 | ||||||
Consumer installment loans: |
||||||||
Personal |
2,607 | 2,855 | ||||||
Credit cards |
2,296 | 2,275 | ||||||
4,903 | 5,130 | |||||||
Total Loans |
365,128 | 374,355 | ||||||
Less: Allowance for loan losses |
(10,037 | ) | (10,942 | ) | ||||
Loans, net |
$ | 355,091 | $ | 363,413 | ||||
11
Table of Contents
Loans held for sale at March 31, 2011 and December 31, 2010 were $153,000 and $216,500,
respectively. These loans are included in residential 1-4 family loans in the table above.
The following table presents the recorded investment in loans and the balance in the allowance
for loan losses (ALLL) by portfolio segment and based on impairment method as of March 31, 2011
and December 31, 2010 (in thousands):
Collectively Evaluated | Individually Evaluated | |||||||||||||||||||||||
for Impairment | for Impairment | Total | ||||||||||||||||||||||
March 31, | December 31, | March 31, | December 31, | March 31, | December 31, | |||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Loans: |
||||||||||||||||||||||||
Construction and development |
$ | 39,041 | $ | 42,026 | $ | 39,743 | $ | 41,517 | $ | 78,784 | $ | 83,543 | ||||||||||||
Residential real estate |
92,550 | 97,639 | 29,641 | 29,182 | 122,191 | 126,821 | ||||||||||||||||||
Commercial real estate |
111,552 | 112,389 | 21,787 | 21,529 | 133,339 | 133,918 | ||||||||||||||||||
Commercial |
25,798 | 24,831 | 113 | 113 | 25,911 | 24,944 | ||||||||||||||||||
Consumer/other |
2,592 | 2,839 | 15 | 15 | 2,607 | 2,854 | ||||||||||||||||||
Credit cards |
2,296 | 2,275 | | | 2,296 | 2,275 | ||||||||||||||||||
Total ending loan balance |
$ | 273,829 | $ | 281,999 | $ | 91,299 | $ | 92,356 | $ | 365,128 | $ | 374,355 | ||||||||||||
Allowance for loan losses: |
||||||||||||||||||||||||
Construction and development |
$ | 2,228 | $ | 1,445 | $ | 1,731 | $ | 1,647 | $ | 3,959 | $ | 3,092 | ||||||||||||
Residential real estate |
2,784 | 1,653 | 1,085 | 2,444 | 3,869 | 4,097 | ||||||||||||||||||
Commercial real estate |
1,160 | 1,444 | 272 | 617 | 1,432 | 2,061 | ||||||||||||||||||
Commercial |
605 | 395 | 5 | 1 | 610 | 396 | ||||||||||||||||||
Consumer/other |
46 | 97 | | 1 | 46 | 98 | ||||||||||||||||||
Credit cards |
121 | 121 | | | 121 | 121 | ||||||||||||||||||
Unallocated |
| 1,077 | | | | 1,077 | ||||||||||||||||||
Total ending allowance
balance |
$ | 6,944 | $ | 6,232 | $ | 3,093 | $ | 4,710 | $ | 10,037 | $ | 10,942 | ||||||||||||
The following table details the changes in the allowance for loan losses from December
31, 2010 to March 31, 2011 by portfolio segment (in thousands):
For the quarter ended March 31, 2011 | ||||||||||||||||||||||||||||||||
Construction and | Residential | Commercial | Consumer / | Credit | ||||||||||||||||||||||||||||
Development | Real Estate | Real Estate | Commercial | Other | Cards | Unallocated | Total | |||||||||||||||||||||||||
Beginning balance |
$ | 3,092 | $ | 4,097 | $ | 2,061 | $ | 396 | $ | 98 | $ | 121 | $ | 1,077 | $ | 10,942 | ||||||||||||||||
Charged-off loans |
(839 | ) | (2,827 | ) | (225 | ) | | (13 | ) | (56 | ) | | (3,960 | ) | ||||||||||||||||||
Recovery of previously
charged-off loans |
| 1 | 48 | | 5 | 1 | 55 | |||||||||||||||||||||||||
Provision for loan losses |
1,706 | 2,598 | (452 | ) | 214 | (44 | ) | 55 | (1,077 | ) | 3,000 | |||||||||||||||||||||
Ending balance |
$ | 3,959 | $ | 3,869 | $ | 1,432 | $ | 610 | $ | 46 | $ | 121 | $ | | $ | 10,037 | ||||||||||||||||
12
Table of Contents
A summary of transactions in the ALLL for the three months ended March 31, 2010 is as follows
(in thousands):
Three Months Ended | ||||
March 31, 2010 | ||||
Balance, beginning of year |
$ | 11,353 | ||
Loans charged-off |
(609 | ) | ||
Recoveries of loans previously charged-off |
19 | |||
Provision for loan losses |
212 | |||
Balance, end of year |
$ | 10,975 | ||
Credit Quality Indicators:
The Company uses several credit quality indicators, which are updated at least annually, to
manage credit risk in an ongoing manner. The Company categorizes loans into risk categories based
on relevant information about the ability of borrowers to service their debt such as: current
financial information, historical payment experience, credit documentation, public information and
current economic trends, among other factors. The Company uses an internal credit risk rating
system that categorizes loans into pass, special mention or classified categories. Credit risk
ratings are applied to all loans individually with the exception of credit cards.
The following are the definitions of the Companys risk ratings:
Pass:
|
Loans that are not adversely rated, are contractually current
as to principal and interest and are otherwise in compliance with the
contractual terms of the loan or lease agreement. Management believes that
there is a low likelihood of loss related to those loans that are considered
pass. |
|
Special Mention:
|
Loans classified as special mention have a potential weakness that
deserves managements close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the loan
or of the institutions credit position at some future date. |
|
Substandard/ Accruing: |
Loans classified as substandard are inadequately protected by the current
net worth and paying capacity of the obligor or of the collateral pledged, if
any. Loans so classified have a well-defined weakness or weaknesses that
jeopardize the liquidation of the debt. They are characterized by the distinct
possibility that the institution will sustain some loss if the deficiencies are
not corrected. |
|
Substandard/ Nonaccrual: |
A loan classified as nonaccrual has all the deficiencies of a loan
graded substandard but collection of the full amount of principal and interest
owed is uncertain or unlikely and collateral support, if any, may be weak. |
|
Doubtful:
|
Loans classified as doubtful have all the weaknesses inherent in those
classified as substandard, with the added characteristic that the weaknesses
make collection or liquidation in full, on the basis of currently existing
estimations, facts, conditions and values, highly questionable and improbable.
Doubtful loans include only the portion of each specific loan deemed
uncollectible and the classification can change as certain current information
and facts are ascertained. |
13
Table of Contents
The following table presents by class and by risk category, the recorded investment in the
Companys loans as of March 31, 2011 and December 31, 2010 (in thousands):
As of March 31, 2011 | ||||||||||||||||||||||||
Not | Special | Substandard | Substandard | |||||||||||||||||||||
Rated | Pass | Mention | Accruing | Nonaccrual | Doubtful | |||||||||||||||||||
Construction and development |
$ | | $ | 43,403 | $ | 419 | $ | 4,930 | $ | 29,081 | $ | 951 | ||||||||||||
Commercial real estate mortgage |
| 110,770 | 3,357 | 11,868 | 7,344 | | ||||||||||||||||||
Commercial and industrial |
| 25,279 | 156 | 476 | | | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
| 62,459 | 2,879 | 1,761 | 15,562 | | ||||||||||||||||||
Home equity and junior liens |
| 30,222 | 509 | 1,257 | 1,436 | | ||||||||||||||||||
Multi-family |
| 4,409 | | 1,697 | | | ||||||||||||||||||
Total residential real estate |
| 97,090 | 3,388 | 4,715 | 16,998 | | ||||||||||||||||||
Consumer and other |
| 2,493 | 68 | 38 | 8 | | ||||||||||||||||||
Credit cards |
2,296 | | | | | | ||||||||||||||||||
Total |
$ | 2,296 | $ | 279,035 | $ | 7,388 | $ | 22,027 | $ | 53,431 | $ | 951 | ||||||||||||
As of December 31, 2010 | ||||||||||||||||||||||||
Not | Special | Substandard | Substandard | |||||||||||||||||||||
Rated | Pass | Mention | Accruing | Nonaccrual | Doubtful | |||||||||||||||||||
Construction and development |
$ | | $ | 36,086 | $ | 284 | $ | 19,244 | $ | 26,977 | $ | 952 | ||||||||||||
Commercial real estate mortgage |
| 99,649 | 1,044 | 26,863 | 6,362 | | ||||||||||||||||||
Commercial and industrial |
| 24,274 | 207 | 395 | 67 | | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
| 54,332 | 2,905 | 11,720 | 17,446 | | ||||||||||||||||||
Home equity and junior liens |
| 30,841 | 669 | 1,561 | 1,201 | | ||||||||||||||||||
Multi-family |
| 4,454 | | 1,692 | | | ||||||||||||||||||
Total residential real estate |
| 89,627 | 3,574 | 14,973 | 18,647 | | ||||||||||||||||||
Consumer and other |
| 2,755 | 41 | 59 | | | ||||||||||||||||||
Credit cards |
2,275 | | | | | | ||||||||||||||||||
Total |
$ | 2,275 | $ | 252,391 | $ | 5,150 | $ | 61,534 | $ | 52,053 | $ | 952 | ||||||||||||
14
Table of Contents
The following table presents the aging of the recorded investment in past due loans,
including the payment status of loans on non-accrual which have been incorporated into the table,
as of March 31, 2011 and December 31, 2010 by class of loans (in thousands):
As of March 31, 2011 | ||||||||||||||||||||||||
30-59 | 60-89 | Greater Than | ||||||||||||||||||||||
Days | Days | 90 Days | Total | Total | ||||||||||||||||||||
Past Due | Past Due | Past Due | Past Due | Current | Loans | |||||||||||||||||||
Construction and development |
$ | 5,317 | $ | 1,680 | $ | 2,073 | $ | 9,070 | $ | 69,714 | $ | 78,784 | ||||||||||||
Commercial real estate mortgage |
1,903 | | 1,034 | 2,937 | 130,402 | 133,339 | ||||||||||||||||||
Commercial and industrial |
560 | | | 560 | 25,351 | 25,911 | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
5,015 | 1,827 | 409 | 7,251 | 75,410 | 82,661 | ||||||||||||||||||
Home equity and junior liens |
144 | 175 | 1,092 | 1,411 | 32,013 | 33,424 | ||||||||||||||||||
Multi-family |
| | | | 6,106 | 6,106 | ||||||||||||||||||
Total residential real estate |
5,159 | 2,002 | 1,501 | 8,662 | 113,529 | 122,191 | ||||||||||||||||||
Consumer and other |
8 | | | 8 | 2,599 | 2,607 | ||||||||||||||||||
Credit cards |
3 | 44 | | 47 | 2,249 | 2,296 | ||||||||||||||||||
Total |
$ | 12,950 | $ | 3,726 | $ | 4,608 | $ | 21,284 | $ | 343,844 | $ | 365,128 | ||||||||||||
As of December 31, 2010 | ||||||||||||||||||||||||
30-59 | 60-89 | Greater Than | ||||||||||||||||||||||
Days | Days | 90 Days | Total | Total | ||||||||||||||||||||
Past Due | Past Due | Past Due | Past Due | Current | Loans | |||||||||||||||||||
Construction and development |
$ | 265 | $ | 49 | $ | 394 | $ | 708 | $ | 82,835 | $ | 83,543 | ||||||||||||
Commercial real estate mortgage |
214 | 326 | 2,573 | 3,113 | 130,805 | 133,918 | ||||||||||||||||||
Commercial and industrial |
| | | | 24,944 | 24,944 | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
948 | 2,580 | | 3,528 | 82,875 | 86,403 | ||||||||||||||||||
Home equity and junior liens |
| 409 | 62 | 471 | 33,800 | 34,271 | ||||||||||||||||||
Multi-family |
| | | | 6,146 | 6,146 | ||||||||||||||||||
Total residential real estate |
948 | 2,989 | 62 | 3,999 | 122,821 | 126,820 | ||||||||||||||||||
Consumer and other |
14 | 10 | | 24 | 2,831 | 2,855 | ||||||||||||||||||
Credit cards |
43 | 1 | 19 | 63 | 2,212 | 2,275 | ||||||||||||||||||
Total |
$ | 1,484 | $ | 3,375 | $ | 3,048 | $ | 7,907 | $ | 366,448 | $ | 374,355 | ||||||||||||
All interest accrued but not collected for loans that are placed on nonaccrual or charged
off is reversed against interest income. The interest on these loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual. Generally, loans are
returned to accrual status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured, which usually requires a minimum of six
months sustained repayment performance.
Nonperforming loans include both smaller balance homogeneous loans that are collectively
evaluated for impairment and individually classified as impaired loans.
15
Table of Contents
The following table presents the recorded investment in nonperforming loans by class of loans
as of March 31, 2011 and December 31, 2010 (in thousands):
As of March 31, 2011 | ||||||||
Loans Past Due Over | ||||||||
Nonaccrual | 90 Days Still Accruing | |||||||
Construction and development |
$ | 30,032 | $ | 110 | ||||
Commercial real estate mortgage |
7,344 | | ||||||
Residential real estate |
||||||||
Residential mortgage |
15,562 | | ||||||
Home equity and junior liens |
1,436 | | ||||||
Total residential real estate |
16,998 | | ||||||
Consumer and other |
8 | | ||||||
Total nonperforming loans |
$ | 54,382 | $ | 110 | ||||
As of December 31, 2010 | ||||||||
Loans Past Due Over | ||||||||
Nonaccrual | 90 Days Still Accruing | |||||||
Construction and development |
$ | 27,929 | $ | | ||||
Commercial real estate mortgage |
6,362 | 413 | ||||||
Commercial and industrial |
67 | | ||||||
Residential real estate |
||||||||
Residential mortgage |
17,446 | | ||||||
Home equity and junior liens |
1,201 | | ||||||
Total residential real estate |
18,647 | | ||||||
Credit cards |
| 19 | ||||||
Total nonperforming loans |
$ | 53,005 | $ | 432 | ||||
16
Table of Contents
The following table presents loans individually evaluated for impairment by class of
loans as of March 31, 2011 and December 31, 2010 (in thousands):
As of March 31, 2011 | ||||||||||||
Unpaid | Allowance for | |||||||||||
Principal | Recorded | Loan Losses | ||||||||||
Balance | Investment | Allocated | ||||||||||
With no related allowance recorded: |
||||||||||||
Construction and development |
$ | 16,921 | $ | 11,808 | $ | | ||||||
Commercial real estate mortgage |
6,374 | 5,446 | | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
10,473 | 7,882 | | |||||||||
Home equity and junior liens |
1,705 | 1,261 | | |||||||||
Total residential real estate |
12,178 | 9,143 | | |||||||||
Total with no related allowance recorded |
$ | 35,473 | $ | 26,397 | $ | | ||||||
With an allowance recorded: |
||||||||||||
Construction and development |
$ | 28,184 | $ | 27,936 | $ | 1,731 | ||||||
Commercial real estate mortgage |
16,390 | 16,341 | 272 | |||||||||
Commercial and industrial |
113 | 113 | 5 | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
17,533 | 17,485 | 898 | |||||||||
Home equity and junior liens |
1,321 | 1,321 | 95 | |||||||||
Multi-family |
1,692 | 1,692 | 92 | |||||||||
Total residential real estate |
20,546 | 20,498 | 1,085 | |||||||||
Consumer and other |
14 | 14 | | |||||||||
Total with an allowance recorded |
$ | 65,247 | $ | 64,902 | $ | 3,093 | ||||||
Total impaired loans |
$ | 100,720 | $ | 91,299 | $ | 3,093 | ||||||
As of December 31, 2010 | ||||||||||||
Unpaid | Allowance for | |||||||||||
Principal | Recorded | Loan Losses | ||||||||||
Balance | Investment | Allocated | ||||||||||
With no related allowance recorded: |
||||||||||||
Construction and development |
$ | 18,005 | $ | 13,216 | $ | | ||||||
Commercial real estate mortgage |
5,559 | 4,834 | | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
4,358 | 4,336 | | |||||||||
Home equity and junior liens |
468 | 468 | | |||||||||
Total residential real estate |
4,826 | 4,804 | | |||||||||
Total with no related allowance recorded |
$ | 28,390 | $ | 22,854 | $ | | ||||||
With an allowance recorded: |
||||||||||||
Construction and development |
$ | 28,505 | $ | 28,301 | $ | 1,647 | ||||||
Commercial real estate mortgage |
16,743 | 16,695 | 617 | |||||||||
Commercial and industrial |
113 | 113 | 1 | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
22,349 | 22,298 | 2,335 | |||||||||
Home equity and junior liens |
388 | 388 | 17 | |||||||||
Multi-family |
1,692 | 1,692 | 92 | |||||||||
Total residential real estate |
24,429 | 24,378 | 2,444 | |||||||||
Consumer and other |
15 | 15 | 1 | |||||||||
Total with an allowance recorded |
$ | 69,805 | $ | 69,502 | $ | 4,710 | ||||||
Total impaired loans |
$ | 98,195 | $ | 92,356 | $ | 4,710 | ||||||
17
Table of Contents
The following table presents by class, information related to the average recorded
investment and interest income recognized on impaired loans for the three months ended March 31,
2011 (in thousands):
As of March 31, 2011 | ||||||||
Average Recorded | Interest Income | |||||||
Investment | Recognized | |||||||
With no related allowance recorded: |
||||||||
Construction and development |
$ | 12,512 | $ | 1 | ||||
Commercial real estate mortgage |
5,140 | | ||||||
Residential real estate |
||||||||
Residential mortgage |
6,109 | 4 | ||||||
Home equity and junior liens |
865 | | ||||||
Total residential real estate |
6,974 | 4 | ||||||
Total with no related allowance recorded |
$ | 24,626 | $ | 5 | ||||
With an allowance recorded: |
||||||||
Construction and development |
$ | 28,119 | $ | 106 | ||||
Commercial real estate mortgage |
16,518 | 142 | ||||||
Commercial and industrial |
113 | 1 | ||||||
Residential real estate |
||||||||
Residential mortgage |
19,892 | 105 | ||||||
Home equity and junior liens |
855 | 12 | ||||||
Multi-family |
1,692 | | ||||||
Total residential real estate |
22,439 | 117 | ||||||
Consumer and other |
15 | | ||||||
Total with an allowance recorded |
$ | 67,204 | $ | 366 | ||||
Total impaired loans |
$ | 91,830 | $ | 371 | ||||
For the three months ended March 31, 2011, the amount of interest income recognized by
the Company within the period that the loans were impaired was primarily related to loans modified
in a troubled debt restructuring that remained on accrual status. For the three months ended March
31, 2011, the amount of interest income recognized using a cash-basis method of accounting during
the period that the loans were impaired was not material.
Troubled Debt Restructurings:
Impaired loans also include loans that the Bank may elect to formally restructure due to the
weakening credit status of a borrower such that the restructuring may facilitate a repayment plan
that minimizes the potential losses, if any, that the Bank may have to otherwise incur. These loans
are
classified as impaired loans and, if on nonaccruing status as of the date of the restructuring, the
loans are included in the nonperforming loan balances noted above. Not included in nonperforming
loans are loans that have been restructured that were performing as of the restructure date.
18
Table of Contents
The Company had allocated approximately $2,628,000 and $3,700,000 of specific reserves to
customers whose loan terms have been modified in TDRs as of March 31, 2011 and December 31, 2010,
respectively. The decrease in specific reserves allocated to TDRs during the first quarter of 2011
of approximately $1,072,000 was primarily attributable to partial chargeoffs of collateral
dependent loans that are also TDRs. The Company had approximately $82,222,000 outstanding to
customers whose loans were classified as TDRs at March 31, 2011 as compared to approximately
$82,443,000 at December 31, 2010. Currently, the Company has committed to lend additional amounts
totaling approximately $1,550,000 related to loans classified as TDRs. At March 31, 2011 and
December 31, 2010, there were approximately $35,898,000 and $35,752,000, respectively, of accruing
restructured loans that remain in a performing status; however, these loans are included in
impaired loan totals.
Loans are stated at unpaid principal balances, less the allowance for loan losses. The
recorded investment in loans presented throughout the Notes to the Consolidated Financial
Statements is defined as the outstanding principal balance of loans. Interest income is accrued on
the unpaid principal balance.
Note 6. Comprehensive Income (Loss)
Comprehensive income (loss) is made up of net income (loss) and other comprehensive income
(loss). Other comprehensive income (loss) is made up of changes in the unrealized gain (loss) on
securities available for sale. Comprehensive income (loss) for the three months ended March 31,
2011 was ($2,856,811) as compared to $55,702 for the three months ended March 31, 2010.
Note 7. Fair Value
Fair value is the exchange price that would be received for an asset or paid to transfer a
liability (exit price) in the principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the measurement date. There are three levels
of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices
for similar assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions
about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value
of each type of financial instrument:
Investment Securities Available for Sale Securities classified as available for sale are
reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair
value measurements from an independent service provider. The fair value measurements consider
observable data that may include dealer quotes, market spreads, cash flows, the U. S. Treasury
yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit
information and the securities terms and conditions, among other things.
Impaired Loans The fair value of impaired loans with specific allocations of the allowance
for loan losses may be based on recent real estate appraisals. These appraisals may utilize a
single valuation approach or a combination of approaches including comparable sales and the income
approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for
differences between the comparable sales and income data available. Such adjustments are usually
significant and typically result in a Level 3 classification of the inputs for determining fair
value. If the recorded investment in an impaired loan exceeds the measure of fair value, a
valuation allowance may be established as a component of the allowance for loan losses or the
expense is recognized as a charge-off. As a result of partial charge-offs, certain impaired loans
are carried at fair value with no allocation. Certain impaired loans are not measured at fair
value, which generally includes troubled debt restructurings that are measured for impairment based
upon the present value of expected cash flows discounted at the loans original effective interest
rate, and are excluded from the assets measured on a nonrecurring basis.
19
Table of Contents
Other Real Estate The fair value of other real estate (ORE) is generally based on current
appraisals, comparable sales, and other estimates of value obtained principally from independent
sources, adjusted for estimated selling costs. At the time of foreclosure, any excess of the loan
balance over the fair value of the real estate held as collateral is treated as a charge against
the AFLL. Gains or losses on sale and any subsequent adjustments to the value are recorded as a
gain or loss on ORE. ORE is classified within Level 3 of the hierarchy.
Assets and Liabilities Measured on a Recurring Basis
The following table summarizes assets and liabilities measured at fair value on a recurring
basis as of March 31, 2011 and December 31, 2010, segregated by the level of the valuation inputs
within the fair value hierarchy utilized to measure fair value:
Fair Value Measurements at | ||||||||
March 31, 2011 Using: | ||||||||
Significant Other | ||||||||
Observable Inputs | ||||||||
Carrying Value | (Level 2) | |||||||
Assets: |
||||||||
Available for sale securities: |
||||||||
U. S. Government securities |
$ | 249,989 | $ | 249,989 | ||||
Obligations of states and political
subdivisions |
4,988,983 | 4,988,983 | ||||||
Mortgage-backed securities-residential |
84,526,628 | 84,526,628 | ||||||
Total available for sale securities |
$ | 89,765,600 | $ | 89,765,600 | ||||
Fair Value Measurements at | ||||||||
December 31, 2010 Using: | ||||||||
Significant Other | ||||||||
Observable Inputs | ||||||||
Carrying Value | (Level 2) | |||||||
Assets: |
||||||||
Available for sale securities: |
||||||||
U. S. Government securities |
$ | 249,866 | $ | 249,866 | ||||
Obligations of states and
political subdivisions |
4,922,113 | 4,922,113 | ||||||
Mortgage-backed securities-residential |
81,144,612 | 81,144,612 | ||||||
Total available for sale securities |
$ | 86,316,591 | $ | 86,316,591 | ||||
For the quarter ended March 31, 2011, there were no transfers between Level 1 and Level 2.
20
Table of Contents
Assets and Liabilities Measured on a Non-Recurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis, that is,
the instruments are not measured at fair value on an ongoing basis but are subject to fair value
adjustments in certain circumstances (for example, when there is evidence of impairment). The
following table summarizes assets and liabilities measured at fair value on a non-recurring basis
as of March 31, 2011 and December 31, 2010, segregated by the level of the valuation inputs within
the fair value hierarchy utilized to measure fair value:
Fair Value Measurements at | ||||||||
March 31, 2011 Using: | ||||||||
Significant | ||||||||
Unobservable Inputs | ||||||||
Carrying Value | (Level 3) | |||||||
Assets: |
||||||||
Impaired loans: |
||||||||
Construction and development |
$ | 8,467,964 | $ | 8,467,964 | ||||
Commercial real estate |
5,855,123 | 5,855,123 | ||||||
Residential real estate |
4,073,359 | 4,073,359 | ||||||
Total impaired loans |
18,396,446 | 18,396,446 | ||||||
Other real estate: |
||||||||
Construction and development |
2,257,161 | 2,257,161 | ||||||
Commercial real estate |
1,404,833 | 1,404,833 | ||||||
Residential real estate |
7,284,704 | 7,284,704 | ||||||
Total other real estate |
10,946,698 | 10,946,698 | ||||||
Total Assets Measured at Fair |
||||||||
Value on a Non-Recurring Basis |
$ | 29,343,144 | $ | 29,343,144 | ||||
Fair Value Measurements at | ||||||||
December 31, 2010 Using: | ||||||||
Significant | ||||||||
Unobservable Inputs | ||||||||
Carrying Value | (Level 3) | |||||||
Assets: |
||||||||
Impaired loans: |
||||||||
Construction and development |
$ | 8,826,040 | $ | 8,826,040 | ||||
Commercial real estate |
3,378,152 | 3,378,152 | ||||||
Residential real estate |
4,045,756 | 4,045,756 | ||||||
Total impaired loans |
16,249,948 | 16,249,948 | ||||||
Other real estate: |
||||||||
Construction and development |
2,229,161 | 2,229,161 | ||||||
Commercial real estate |
1,404,833 | 1,404,833 | ||||||
Residential real estate |
7,518,670 | 7,518,670 | ||||||
Total other real estate |
11,152,664 | 11,152,664 | ||||||
Total Assets Measured at Fair |
||||||||
Value on a Non-Recurring Basis |
$ | 27,402,612 | $ | 27,402,612 | ||||
21
Table of Contents
At March 31, 2011, impaired loans measured at fair value, which are evaluated for impairment
using the fair value of collateral, had a carrying amount of $18,703,642, with a valuation
allowance of $307,196 resulting in an additional provision for loan losses of $2,024,413 for the
three-month period ended March 31, 2011. At December 31, 2010, impaired loans measured at fair
value had a carrying amount of $17,718,189, with a valuation allowance of $1,468,241 resulting in
an additional provision for loan losses of $4,514,585 for the year ended December 31, 2010.
Impaired loans carried at fair value include loans that have been written down to fair value
through the partial charge-off of principal balance. Accordingly, these loans do not have a
specific valuation allowance as their balances represent fair value.
The March 31, 2011 carrying amount of ORE includes net valuation adjustments of approximately
$33,000 for the three months ended March 31, 2011. The December 31, 2010 carrying amount of ORE
includes net valuation adjustments of approximately $1,211,000. Valuation adjustments include both
charge offs and holding gains and losses. The fair value of ORE is based upon appraisals performed
by qualified, licensed appraisers. Appraisals are obtained at the time of foreclosure and at least
annually thereafter or more often if management determines property values have significantly
declined.
Fair Value of Financial Instruments
Fair value estimates are made at a specific point in time, based on relevant market
information about the financial instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the Companys entire holdings of a particular
financial instrument. Because no market exists for a significant portion of the Companys
financial instruments, fair value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various financial instruments, and
other factors. These estimates are subjective in nature; involve uncertainties and matters of
judgment; and, therefore, cannot be determined with precision. Changes in assumptions could
significantly affect the estimates. Accordingly, the aggregate fair value amounts presented are not
intended to represent the underlying value of the Company.
Fair value estimates are based on existing financial instruments without attempting to
estimate the value of anticipated future business and the value of assets and liabilities that are
not considered financial instruments. The following methods and assumptions were used to estimate
the fair value of each class of financial instruments:
Cash and cash equivalents:
For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
Investment Securities:
The fair value of securities is estimated as previously described for securities available for
sale, and in a similar manner for securities held to maturity.
Restricted investments:
Restricted investments consist of Federal Home Loan Bank (FHLB) and Federal Reserve Bank
stock. It is not practicable to determine the fair value due to restrictions placed on the
transferability of the stock.
Loans:
The fair value of loans is calculated by discounting scheduled cash flows through the
estimated maturity using estimated market discount rates, adjusted for credit risk and servicing
costs. The estimate of maturity is based on historical experience with repayments for each loan
classification, modified, as required, by an estimate of the effect of current economic and lending
conditions. The allowance for loan losses is considered a reasonable discount for credit risk.
22
Table of Contents
Deposits:
The fair value of deposits with no stated maturity, such as demand deposits, money market
accounts, and savings deposits, is equal to the amount payable on demand. The fair value of time
deposits is based on the discounted value of contractual cash flows. The discount rate is
estimated using the rates currently offered for deposits of similar remaining maturities.
Federal funds purchased, Federal Reserve Bank advances and securities sold under agreements to
repurchase:
The estimated value of these liabilities, which are extremely short term, approximates their
carrying value.
Subordinated debentures:
For the subordinated debentures with a floating interest rate tied to LIBOR, the fair value is
based on the discounted value of contractual cash flows. The discount rate is estimated using the
most recent offering rates available for subordinated debentures of similar amounts and remaining
maturities.
Federal Home Loan Bank advances:
For FHLB advances the fair value is based on the discounted value of contractual cash flows.
The discount rate is estimated using the rates currently offered for FHLB advances of similar
amounts and remaining maturities.
Accrued interest receivable and payable:
The carrying amounts of accrued interest receivable and payable approximate their fair value.
Commitments to extend credit, letters of credit and lines of credit:
The fair value of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers
the difference between
current levels of interest rates and the committed rates. The fair values of these
commitments are insignificant and are not included in the table below.
23
Table of Contents
The carrying amounts and estimated fair values of the Companys financial instruments at March
31, 2011 and December 31, 2010, not previously presented, are as follows (in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Amount | Fair Value | Amount | Fair Value | |||||||||||||
Assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 15,895 | $ | 15,895 | $ | 32,576 | $ | 32,576 | ||||||||
Investment securities held to maturity |
1,333 | 1,351 | 1,318 | 1,303 | ||||||||||||
Restricted investments |
3,843 | N/A | 3,843 | N/A | ||||||||||||
Loans, net |
355,091 | 347,116 | 363,413 | 358,587 | ||||||||||||
Accrued interest receivable |
1,662 | 1,662 | 1,496 | 1,496 | ||||||||||||
Liabilities: |
||||||||||||||||
Noninterest-bearing demand deposits |
$ | 48,492 | $ | 48,492 | $ | 47,639 | $ | 47,639 | ||||||||
NOW accounts |
54,389 | 54,389 | 57,345 | 57,345 | ||||||||||||
Savings and money market accounts |
72,418 | 72,418 | 73,435 | 73,435 | ||||||||||||
Time deposits |
254,098 | 255,160 | 271,173 | 272,304 | ||||||||||||
Subordinated debentures |
13,403 | 7,333 | 13,403 | 7,276 | ||||||||||||
Federal funds purchased and securities
sold under agreements to repurchase |
866 | 866 | 432 | 432 | ||||||||||||
Federal Reserve/Federal Home Loan Bank advances |
55,200 | 60,447 | 55,200 | 61,136 | ||||||||||||
Accrued interest payable |
658 | 658 | 719 | 719 |
Note 8. Regulatory Matters
The Bank and Company are subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action applicable to the Bank, the Bank and Company
must meet specific capital guidelines that involve quantitative measures of assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank
and Company to maintain minimum amounts and ratios of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). In addition, the Companys and the Banks regulators may impose additional
capital requirements on financial institutions and their bank subsidiaries, like the Company and
the Bank, beyond those provided for statutorily, which standards may be in addition to, and require
higher levels of capital, than the general capital adequacy guidelines. As discussed below, the
Bank has agreed to maintain certain of its capital ratios above statutory levels. As of March 31,
2011 and discussed below, the Bank failed to meet all capital adequacy requirements to which it is
subject.
As a result of a regulatory examination conducted during the first quarter of 2009, the Bank
has entered into a formal written agreement in which it made certain commitments to the OCC,
including
commitments to, among other things, implement a written program to reduce the high level of
credit risk in the Bank including strengthening credit underwriting and problem loan workouts and
collections, reduce its level of criticized assets, implement a concentration risk management
program related to commercial real estate lending, improve procedures related to the maintenance of
the Banks ALLL, strengthen the Banks internal loan review program, strengthen the Banks loan
workout department, and develop a liquidity plan that improves the Banks reliance on wholesale
funding sources.
24
Table of Contents
In February 2010, the Bank agreed to an OCC requirement to maintain a minimum Tier 1 capital
to average assets ratio of 9% and a minimum total capital to risk-weighted assets ratio of 13%. The
OCC imposed this requirement to maintain capital at higher levels than those required by applicable
federal regulations because the OCC believed that the Banks capital levels were less than
satisfactory given the level of credit risk in the Bank, specifically the high level of
nonperforming assets and provision for loan losses. As noted below under Item 2. Managements
Discussion and Analysis of Financial Condition and Results of Operations Funding Resources,
Capital Adequacy and Liquidity, the Bank had 8.62% of Tier 1 capital to average assets and 12.74%
of total capital to risk-weighted assets ratio at March 31, 2011, and was therefore not in
compliance with the minimum levels required by the OCC. As a result, the OCC may bring additional
enforcement actions, including a consent order, against the Bank.
In the fourth quarter of 2010, the OCC informed the Bank that, because the OCC does not
believe that the Bank has fully satisfied the requirements of the formal written agreement, it will
be requested to replace the formal written agreement with a consent order (the Consent Order)
containing commitments for further improvements in the Banks operations. While the requirements of
the Consent Order are not currently known to the Bank, the OCC has informed the Banks management
that the Consent Order will likely contain provisions similar to those currently contained in the
existing minimum capital commitment that the Bank made to the OCC in connection with the Banks
entering into the formal written agreement, requiring the Bank to maintain a minimum Tier 1
leverage capital ratio of 9% and a minimum total risk-based capital ratio of 13%. If the Bank fails
to comply with the requirements of the Consent Order, the OCC may impose additional limitations,
restraints, commitments or conditions on the Bank. Once the Consent Order is effective, the Bank
will be deemed to be adequately capitalized even if the Banks capital ratios exceed those
minimum amounts necessary to be considered well capitalized under federal banking regulations as
well as the minimum ratios set forth in the Consent Order.
Since the Bank agreed to the capital requirement, certain actions have been taken, and are
ongoing, that are designed to improve the Banks capital ratios by influencing the underlying
metrics. The reduction of total assets of the Bank can have a significant impact on the Tier 1
capital ratio. Since December 31, 2009 the Bank has reduced total assets approximately $107,000,000
from approximately $640,000,000 to approximately $533,000,000 at March 31, 2011. This reduction in
assets was accomplished by reducing wholesale funding including brokered deposits and Federal Home
Loan Bank advances as well as the reduction of public funds deposits. Additionally, loans
outstanding and the bond investment portfolio were reduced subsequent to the capital requirement.
Expense reduction measures were put in place during the first and second quarter of 2010 which
included a significant reduction of salaries and benefits. In addition, the Company is actively
exploring other potential transactions to raise capital at the holding company that could provide
additional capital for the Bank.
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS |
The following discussion and analysis is designed to provide a better understanding of various
factors related to the financial condition and results of operations of the Company and its
subsidiaries, including the Bank. This section should be read in conjunction with the financial
statements and notes thereto which are contained in Item 1 above and the Companys Annual Report on
Form 10-K for the year ended December 31, 2010, including Managements Discussion and Analysis of
Financial Condition and Results of Operations.
25
Table of Contents
To better understand financial trends and performance, the Companys management analyzes
certain key financial data in the following pages. This analysis and discussion reviews the
Companys results of operations and financial condition for the three months ended March 31, 2011.
This discussion is intended to supplement and highlight information contained in the accompanying
unaudited consolidated financial statements as of and for the three-month period ended March 31,
2011. The Company has also provided some comparisons of the financial data for the three-month
period ended March 31, 2011, against the same period in 2010, as well as the Companys year-end
results as of and for the year ended December 31, 2010, to illustrate significant changes in
performance and the possible results of trends revealed by that historical financial data. This
discussion should be read in conjunction with our financial statements and notes thereto, which are
included under Item 1 above.
Special Cautionary Notice Regarding Forward-Looking Statements
Certain of the statements made herein are forward-looking statements within the meaning of,
and subject to the protections of Section 27A of the Securities Act of 1933, as amended, (the
Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange
Act).
Forward-looking statements include statements with respect to our beliefs, plans, objectives,
goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and
involve known and unknown risks, uncertainties and other factors, which may be beyond our control,
and which may cause our actual results, performance or achievements to be materially different from
future results, performance or achievements expressed or implied by such forward-looking
statements.
All statements other than statements of historical fact are statements that could be
forward-looking statements. You can identify these forward-looking statements through our use of
words such as may, will, anticipate, assume, should, indicate, attempt, would,
believe, contemplate, expect, seek, estimate, continue, plan, point to, project,
predict, could, intend, target, potential, and other similar words and expressions of the
future. These forward-looking statements may not be realized due to a variety of factors,
including those risk factors set forth in the Companys Annual Report on Form 10-K for the year
ended December 31, 2010 and below under Part II, Item 1A. Risk Factors and, without limitation:
| the effects of greater than anticipated deterioration in economic and business
conditions (including in the residential and commercial real estate construction and
development segment of the economy) nationally and in our local market; |
||
| deterioration in the financial condition of borrowers resulting in significant
increases in loan losses and provisions for those losses; |
||
| increased levels of non-performing and repossessed assets; |
||
| lack of sustained growth in the economy in the Sevier County and Blount County,
Tennessee area; |
||
| government monetary and fiscal policies as well as legislative and regulatory
changes, including changes in banking, securities and tax laws and regulations; |
||
| the risks of changes in interest rates on the levels, composition and costs of
deposits, loan demand, and the values of loan collateral, securities, and interest
sensitive assets and liabilities; |
||
| the effects of competition from a wide variety of local, regional, national and
other providers of financial, and investment services; |
||
| the failure of assumptions underlying the establishment of reserves for possible
loan losses and other estimates; |
||
| the risks of mergers, acquisitions and divestitures, including, without limitation,
the related time and costs of implementing such transactions, integrating operations as
part of these
transactions and the possible failure to achieve expected gains, revenue growth and/or
expense savings from such transactions; |
||
| the effects of failing to comply with our regulatory commitments; |
||
| changes in accounting policies, rules and practices; |
26
Table of Contents
| changes in technology or products that may be more difficult, or costly, or less
effective, than anticipated; |
||
| the effects of war or other conflicts, acts of terrorism or other catastrophic
events that may affect general economic conditions; |
||
| results of regulatory examinations; |
||
| the remediation efforts related to the Companys material weakness in internal
control over financial reporting; |
||
| the ability to raise additional capital; |
||
| the prepayment of FDIC insurance premiums and higher FDIC assessment rates; |
||
| the effects of negative publicity; |
||
| the effectiveness of the Companys activities in improving, resolving or liquidating
lower quality assets; |
||
| the Companys recording of a further allowance related to its deferred tax asset;
and |
||
| other factors and information described in this report and in any of our other
reports that we make with the Securities and Exchange Commission (the Commission)
under the Exchange Act. |
All written or oral forward-looking statements that are made by or attributable to us are
expressly qualified in their entirety by this cautionary notice. Except as required by the Federal
securities laws, we have no obligation and do not undertake to update, revise or correct any of the
forward-looking statements after the date of this report, or after the respective dates on which
such statements otherwise are made.
Recent Regulatory Developments
In the first quarter of 2009, the OCC conducted an examination of the Bank and found that the
Banks condition had significantly deteriorated since the OCCs most recent examination of the
Bank. The Banks asset quality and earnings had both significantly declined since the OCCs last
examination of the Bank and the Banks dependence on brokered deposits and other sources of
non-core funding was too high.
Despite the Banks efforts to comply with the requirements of the examination report, the OCC
concluded that the Bank had not satisfactorily responded to the matters requiring attention
identified in the examination report and requested that the Bank consent to the issuance of a
formal written agreement with the OCC in order to improve its asset quality and reduce losses and
to correct weaknesses that were the subject of examination criticism. Following discussions with
the OCC, the Banks board of directors entered into a formal written agreement requiring that the
Bank take a number of actions to improve the Banks operations including the following:
| reduce the high level of credit risk and strengthen the Banks credit underwriting,
particularly in the commercial real estate portfolio, including improving its management
and training of commercial real estate lending personnel; |
||
| strengthen its problem loan workouts and collection department; |
||
| improve its loan review program, including its internal loan review staffing; |
||
| reduce the level of criticized assets and the concentrations of commercial real estate
loans; |
||
| improve its credit underwriting standards for commercial real estate; |
27
Table of Contents
| engage in portfolio stress testing and sensitivity analysis of the Banks commercial
real estate concentrations; |
||
| improve its methodology of calculating the allowance for loan and lease losses; and |
||
| reduce its levels of brokered deposits and other wholesale funding. |
Since its issuance, the board of directors and members of the Banks management have sought to
comply with the terms of the formal written agreement and have taken a number of actions in an
effort to so comply, including:
| the hiring of a new Chief Credit Officer, a new Loan Review Officer and other credit
personnel; |
||
| the retention of a third party loan reviewer to review over 80 percent of the total
outstanding loans in the loan portfolio; |
||
| the adoption of action plans for all criticized assets, along with revised procedures
for eliminating the basis for criticism of problem credit and disposing of nonperforming
assets; |
||
| the adoption of a revised credit risk management program and enhanced credit risk review
process; |
||
| improvements to the Banks allowance methodology; |
||
| implementation of a full-time special assets department with improvised policies; and |
||
| adoption of revised liquidity plans. |
Following its most recent examination by the OCC in the first quarter of 2010, the Bank has
sought to further improve its strategic, capital and liquidity planning, reviewed the results of a
management study, further improved its policies on recognition of non-accrual loans, incorporated a
historical loss rates migration analysis into its quarterly determination of the allowance for loan
losses and further refined its credit policies and credit review process.
Although the Bank has instituted a number of improvements to its practices in an effort to
comply with the terms of the formal written agreement, the OCC has informed the Bank that, because
the OCC does not believe that the Bank has fully satisfied the requirements of the formal written
agreement, it will be requested to replace the formal written agreement with a consent order (the
Consent Order) containing commitments for further improvements in the Banks operations. While
the requirements of the Consent Order are not currently known to the Bank, the OCC has informed the
Banks management that the Consent Order will likely contain provisions similar to those currently
contained in the existing minimum capital commitment that the Bank made to the OCC in connection
with the Banks entering into the formal written agreement, requiring the Bank to achieve and
maintain a minimum Tier 1 leverage capital ratio of 9% and a minimum total risk-based capital ratio
of 13%. As a result of losses in the year ended December 31, 2010 and continued losses in the three
months ended March 31, 2011, the Bank is not currently in compliance with these requirements. As a
result of such requirements being included in the Consent Order, the Bank will be deemed not to be
well capitalized under the applicable federal banking regulations even if the Banks actual
capital ratios exceed those required to be considered well capitalized under the prompt
corrective action provisions of the Federal Deposit Insurance Corporation
Improvements Act (FDICIA) or those that it is required to maintain under the Consent Order.
As a result, the Bank will be required to seek approval of the FDIC before it can accept, renew or
roll over brokered deposits or pay interest on deposits above certain federally established rates.
28
Table of Contents
Overview
We conduct our operations, which consist primarily of traditional commercial banking
operations, through the Bank. Through the Bank we offer a broad range of traditional banking
services from our corporate headquarters in Sevierville, Tennessee, our Blount County regional
headquarters in Maryville, Tennessee, through eight additional branches in Sevier County,
Tennessee, and two additional branches in Blount County, Tennessee. Our banking operations
primarily target individuals and small businesses in Sevier and Blount Counties and the surrounding
area. The retail nature of the Banks commercial banking operations allows for diversification of
depositors and borrowers, and we believe that the Bank is not dependent upon a single or a few
customers. But, due to the predominance of the tourism industry in Sevier County, a significant
portion of the Banks commercial loan portfolio is concentrated within that industry, including the
residential real estate and commercial real estate segments of that industry. The predominance of
the tourism industry also makes our business more seasonal in nature, particularly with respect to
deposit levels, than may be the case with banks in other market areas. The tourism industry in
Sevier County has remained relatively strong during recent years and we anticipate that this trend
will continue during the remainder of 2011. Additionally, we have a significant concentration of
commercial and residential real estate construction and development loans. Economic downturns
relating to sales of these types of properties have adversely affected the Banks operations
creating risk independent of the tourism industry.
In addition to our twelve existing locations, we own one property in Knox County for use in
future branch expansion. This property is not currently under development. Management does not
anticipate construction of any additional branches during 2011.
The net loss for the three-month period ended March 31, 2011 as compared to net income for the
same period during 2010 was as follows:
3/31/2011 | 3/31/2010 | $ change | % change | |||||||||||||
Three months ended |
||||||||||||||||
Net Income |
(3,379,037 | ) | 329,114 | (3,708,151 | ) | -1126.71 | % |
The net loss for the first three months of 2011 was primarily attributable to the Companys
provision for loan losses as discussed in more detail below under Provision for Loan Losses. The
decrease from net income for the first quarter of 2010 to a net loss for the first quarter of 2011
was also the result of a reduction in net investment gains, included in noninterest income, as
discussed in more detail below under Investment Securities. The net loss was positively impacted
during the first three months of 2011 by a decrease in noninterest expense that was primarily
attributable to the decrease in salary and employee benefit expense. Noninterest expense is
discussed in more detail under the heading Noninterest Expense below.
Basic and diluted earnings per share decreased from basic and diluted earnings per share of
$0.13 and $0.13, respectively, in the first three months of 2010 to basic and diluted loss per
share of ($1.28) and ($1.28), respectively, in the first three months of 2011. The change in net
loss per share for the three months ended March 31, 2011, as compared to net earnings per share for
the same period in 2010, was due primarily to the change from net income in the first quarter of
2010 to a net loss in the first quarter of 2011.
29
Table of Contents
The change in total assets, total liabilities and shareholders equity for the three months
ended March 31, 2011, was as follows:
3/31/11 | 12/31/10 | $ change | % change | |||||||||||||
Total Assets |
$ | 533,485,378 | $ | 557,206,511 | $ | (23,721,133 | ) | -4.26 | % | |||||||
Total Liabilities |
500,642,369 | 521,532,341 | (20,889,972 | ) | -4.01 | % | ||||||||||
Shareholders Equity |
32,843,009 | 35,674,170 | (2,831,161 | ) | -7.94 | % |
The net decrease in total liabilities was primarily attributable to a decrease in time
deposits of approximately $17 million and a decrease in NOW accounts of approximately $3 million,
as discussed in more detail below under Deposits. The net decrease in total assets was primarily
the result of a decrease in cash and cash equivalents of approximately $17 million and a decrease
in net loans of approximately $8 million, as discussed in more detail below under Loans.
The decrease in shareholders equity was primarily attributable to the net loss for the three
months ended March 31, 2011. The decrease in shareholders equity was partially offset by a
decrease in accumulated other comprehensive loss which represents the net unrealized gains (losses)
on securities available-for-sale.
Balance Sheet Analysis
The following table presents an overview of selected period-end balances at March 31, 2011 and
December 31, 2010, as well as the dollar and percentage change for each:
3/31/11 | 12/31/10 | $ change | % change | |||||||||||||
Cash and equivalents |
$ | 15,894,509 | $ | 32,575,820 | $ | (16,681,311 | ) | -51.21 | % | |||||||
Loans |
365,128,452 | 374,355,464 | (9,227,012 | ) | -2.46 | % | ||||||||||
Allowance for loan losses |
10,037,471 | 10,942,414 | (904,943 | ) | -8.27 | % | ||||||||||
Investment securities |
91,098,897 | 87,634,542 | 3,464,355 | 3.95 | % | |||||||||||
Premises and equipment |
32,276,720 | 32,600,673 | (323,953 | ) | -0.99 | % | ||||||||||
Other real estate owned |
12,936,232 | 13,140,698 | (204,466 | ) | -1.56 | % | ||||||||||
Noninterest-bearing deposits |
48,492,160 | 47,638,792 | 853,368 | 1.79 | % | |||||||||||
Interest-bearing deposits |
380,905,870 | 401,952,616 | (21,046,746 | ) | -5.24 | % | ||||||||||
Total deposits |
429,398,030 | 449,591,408 | (20,193,378 | ) | -4.49 | % | ||||||||||
Federal Reserve/Federal Home
Loan Bank advances |
$ | 55,200,000 | $ | 55,200,000 | $ | | 0.00 | % |
Loans
At March 31, 2011, loans comprised 76.3% of the Banks earning assets. The decrease in our
loan portfolio was primarily attributable to the decrease in construction and land development
loans and 1-4 family residential loans, which was primarily the result of the general pay down of
loan balances pursuant to managements strategy to reduce loans during this period of economic
stress. Additionally, net charge-offs of approximately $3.9 million were recorded during the first
three months of 2011 as discussed in more detail under Provision for Loan Losses. Total earning
assets, as a percentage of total assets, were 89.7% at March 31, 2011, compared to 86.8% at
December 31, 2010, and 87.7% at March 31, 2010. Total earning assets relative to total assets
increased for the three-month period ended March 31, 2011 due to the increase in federal funds sold
and investment securities and the decrease in total assets. The percentage increased when compared
to March 31, 2010 due to the increase in federal funds sold and the decrease in total assets. The
average yield on loans, including loan fees, during the first three months of 2011 was 5.03%
compared to 5.13% for the first three months of 2010. The decrease in the average yield on loans
was the result of several factors including the increase in TDRs involving interest rate
concessions and the increase in average non-accrual loans.
30
Table of Contents
The decrease in the Banks ORE balance during the three month period ended March 31,
2011 was the net result of the foreclosure of additional properties offset by the sale of certain
properties previously held as ORE. One property, an operating nightly condo rental operation
located in Pigeon Forge, Tennessee, which previously secured a loan for approximately $5,116,000,
represents approximately $4,585,000, or 35%, of the ORE balance at March 31, 2011 (included in
multifamily residential properties in the table below). The condos are currently under management
contract with an experienced nightly rental management company as we seek to market the sale of the
properties.
The following table presents the Companys total ORE balance by property type:
March 31, 2011 | December 31, 2010 | |||||||
(in thousands) | ||||||||
Construction, land development and other land |
$ | 2,623 | $ | 2,595 | ||||
1-4 family residential properties |
3,621 | 3,799 | ||||||
Multifamily residential properties |
4,585 | 4,640 | ||||||
Nonfarm nonresidential properties |
2,107 | 2,107 | ||||||
Total |
$ | 12,936 | $ | 13,141 | ||||
Allowance for Loan Losses
The allowance for loan losses represents managements assessment and estimates of the risks
associated with extending credit and its evaluation of the quality of our loan portfolio.
Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses
and the appropriate provision required to maintain the allowance for loan losses at a level
believed to be adequate to absorb probable incurred loan losses. In assessing the adequacy of the
allowance, management reviews the size, quality and risk of loans in the portfolio. Management also
considers such factors as the Banks loan loss experience, the amount of past due and nonperforming
loans, impairment of loans, specific known risks, the status, amounts and values of nonperforming
assets (including loans), underlying collateral values securing loans, current and anticipated
economic conditions and other factors which affect the allowance for potential credit losses. Based
on an analysis of the credit quality of the loan portfolio prepared by the Banks risk officer, the
CFO presents a quarterly analysis of the adequacy of the allowance for loan losses for review by
our board of directors.
Our allowance for loan 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 level of risk in the loan portfolio. During their routine examinations of banks,
regulatory agencies may advise a bank to make additional provisions to its allowance for loan
losses, which would negatively impact a banks results of operations, when the opinion of the
regulators regarding credit evaluations and allowance for loan loss methodology differ materially
from those of the banks management. During the regular safety and soundness examination conducted
by the Banks regulatory agency during the first quarter of 2011, significant changes were incurred
due to required provisions to the allowance based on loans determined to be collateral dependent by
the OCC. These changes have been recognized and incorporated into the results of operations as of
both December 31, 2010 and March 31, 2011.
Concentrations of credit risk typically involve loans to one borrower, an affiliated
group of borrowers, borrowers engaged in or dependent upon the same industry, or a group of
borrowers whose loans are secured by the same type of collateral. Our most significant
concentration of credit risks lies in the high proportion of our loans to businesses and
individuals dependent on the tourism industry and loans to subdividers and developers of land. The
Bank assesses loan risk by primary concentrations of credit by industry and loans directly related
to the tourism industry are monitored carefully. At March 31, 2011, approximately $171 million in
loans, or 47% of total loans, were to businesses and individuals whose ability to repay depends to
a significant extent on the tourism industry in the markets we serve as compared to approximately
$192 million in loans, or 51% of total loans, at December 31, 2010. The most significant decreases
in this category were loans to overnight rentals by agency and loans to subdividers and developers
which decreased approximately $14 million and $5 million, respectively.
31
Table of Contents
While it is the Banks policy to charge off in the current period loans for which a loss
is considered confirmed, there are additional risks of losses which cannot be quantified precisely
or attributed to particular loans or classes of loans. Because the risk of loss includes
unpredictable factors, such as the state of the economy and conditions affecting individual
borrowers, managements judgments regarding the appropriate size of the allowance for loan losses
is necessarily approximate and imprecise, and involves numerous estimates and judgments that may
result in an allowance that is insufficient to absorb all incurred loan losses.
Management is not aware of any loans classified for regulatory purposes as loss, doubtful,
substandard, or special mention that have not been identified and sufficiently provided for in the
allowance for loan losses which (1) represent or result from trends or uncertainties which
management reasonably expects will materially impact future operating results, liquidity, or
capital resources, or (2) represent material credits about which management is aware of any
information which causes management to have serious doubts as to the ability of such borrowers to
comply with the loan repayment terms.
Individually impaired loans are loans that the Bank does not expect to collect all amounts due
according to the contractual terms of the loan agreement and include any loans that meet the
definition of a TDR, as discussed in more detail below. In some cases, collection of amounts due
becomes dependent on liquidating the collateral securing the impaired loan. Collateral dependent
loans do not necessarily result in the loss of principal or interest amounts due; rather the cash
flow is disrupted until the underlying collateral can be liquidated. As a result, the Banks
impaired loans may exceed nonaccrual loans which are placed on nonaccrual status when questions
arise about the future collectability of interest due on these loans. The status of impaired loans
is subject to change based on the borrowers financial position.
Problem loans are identified and monitored by the Banks watch list report which is generated
during the loan review process. This process includes review and analysis of the borrowers
financial statements and cash flows, delinquency reports and collateral valuations. The watch list
includes all loans determined to be impaired. Management determines the proper course of action
relating to these loans and receives monthly updates as to the status of the loans.
The following table presents impaired loans as of March 31, 2011 and December 31, 2010:
March 31, 2011 | December 31, 2010 | |||||||||||||||
Impaired | % of total | Impaired | % of total | |||||||||||||
Loans | loans | Loans | loans | |||||||||||||
($ in thousands) | ||||||||||||||||
Construction, land development
and other land loans |
$ | 39,743 | 10.88 | % | $ | 41,517 | 11.09 | % | ||||||||
Commercial real estate |
21,787 | 5.97 | % | 21,529 | 5.75 | % | ||||||||||
Consumer real estate |
29,641 | 8.12 | % | 29,182 | 7.80 | % | ||||||||||
Other loans |
128 | 0.04 | % | 128 | 0.03 | % | ||||||||||
Total |
$ | 91,299 | 25.00 | % | $ | 92,356 | 24.67 | % | ||||||||
32
Table of Contents
The slight decrease in impaired loans from December 31, 2010 to March 31, 2011 was primarily
the result of the partial charge-off of collateral dependent loans during the first quarter of
2011. Otherwise, the sustained, high level of impaired loans continues to relate to the weak
residential and commercial real estate market in the Banks market areas. Within this segment of
the portfolio, the Bank has traditionally made loans to, among other borrowers, home builders and
developers of land. These borrowers have continued to experience stress during the current real
estate recession due to a combination of declining demand for residential real estate, excessive
volume of properties available and the resulting price and collateral value declines. In addition,
housing starts in the Banks market areas continue to be at historically low levels. An extended
recessionary period in real estate will likely cause the Banks real estate mortgage loans, which
include construction and land development loans, to continue to underperform and may result in
increased levels of impaired loans and non-performing assets, which may negatively impact the
Companys results of operations.
Forty-two impaired loans with a total balance of approximately $24,974,000 were considered to
be collateral dependent at March 31, 2011, and of this amount approximately $19,873,000 are
troubled debt restructurings discussed in more detail below. Collateral dependent loans are
recorded at the lower of cost or the appraised value net of estimated selling costs. Repayment of
these loans is anticipated to be from the sale or liquidation of the collateral securing the loans.
Management obtains independent appraisals of the collateral securing collateral dependent loans at
least annually from independent licensed real estate appraisers and the carrying amount of the
loans that exceed the appraised value net of estimated selling costs is taken as a charge against
the allowance for loan losses and may result in additional charges to the provision expense. All
loans considered collateral dependent are nonaccrual loans and included in the nonperforming loan
balances. Management has recorded partial charge offs on these collateral dependent loans totaling
approximately $9,047,000 as of March 31, 2011.
Due to the weakening credit status of a borrower, we may elect to formally restructure certain
loans to facilitate a repayment plan that minimizes the potential losses, if any, that we might
incur. All restructured loans are classified as impaired loans and, if on nonaccruing status as of
the date of restructuring, the loans are included in the nonperforming loan balances. Not included
in nonperforming loans are loans that have been restructured that were performing as of the
restructure date. At March 31, 2011 and December 31, 2010, there were $35.9 million and $36.0
million, respectively, of accruing restructured loans that remain in a performing status.
TDRs are restructured loans due to a borrower experiencing financial difficulty and the Bank
granting concessions it would not normally otherwise grant. These concessions generally include a
reduced interest rate for a limited period of time to allow the borrower to improve their economic
position, especially during this period of economic downturn. Management has made an attempt to
identify all loans where, by granting certain concessions, borrowers have additional time to
recover from the economic downturn, and in certain instances, have been able to significantly
reduce or repay their loans. During 2011, Management intends to identify problem loans that have
not improved sufficiently to warrant further concessions and take appropriate actions to liquidate
these loans.
TDRs at March 31, 2011 totaled approximately $82,222,000 which is 90.1% of total impaired
loans. The TDRs related primarily to construction and development loans totaling approximately
$37,084,000, or 40.6% of impaired loans, 1-4 family residential loans totaling approximately
$24,789,000, or 27.2% of impaired loans and commercial real estate loans totaling approximately
$20,222,000, or 22.1% of impaired loans. The Banks TDRs are due to lack of real estate sales and
weak or insufficient cash flows of the guarantors of the loans due to the current economic climate.
The majority of the TDRs are for a limited term, in most instances, of one to two years.
33
Table of Contents
The Banks allowance for loan losses as a percentage of total loans at March 31, 2011 and December
31, 2010 was as follows:
Allowance for | Total | % of total | ||||||||||
loan losses | loans | loans | ||||||||||
($ in thousands) | ||||||||||||
As of: |
||||||||||||
March 31, 2011 |
$ | 10,037 | $ | 365,128 | 2.75 | % | ||||||
December 31, 2010 |
10,942 | 374,355 | 2.92 | % |
Our allowance for loan losses decreased approximately $905,000 during the first quarter of
2011 since provision for loan losses was exceeded by net chargeoffs. The allowance for loan losses
as a percentage of total loans and non-accrual loans at March 31, 2011 was 2.75% and 18.46%,
respectively, compared to 2.92% and 20.64%, respectively, at December 31, 2010. The allowance for
loan losses attributable to loans collectively evaluated for impairment, also identified as the
general component and described in more detail in the following paragraph, increased 33 basis
points during the first quarter of 2011 from 2.21% at December 31, 2010, to 2.54% at March 31,
2011. Management continues to evaluate and adjust our allowance for loan losses, and presently
believes the allowance for loan losses is adequate to provide for probable losses inherent in the
loan portfolio. Management believes the loans, including those loans that were delinquent at March
31, 2011, that will result in additional charge-offs have been identified and adequate provision
has been made in the allowance for loan loss balance. No assurance can be given, however, that
adverse economic circumstances, declines in real estate values or other events or changes in
borrowers financial conditions, particularly borrowers in the real estate construction and
development business, will not result in increased losses in the Banks loan portfolio or in the
need for increases in the allowance for loan losses through additional provision expense in future
periods.
Within the allowance, there are specific and general loss components as disclosed in more
detail under Note 5. Loans and Allowance for Loan Losses. The specific loss component is assessed
for non-homogeneous loans that management believes to be impaired. Loans are considered to be
impaired when it is determined that the obligor will not pay all contractual principal and interest
due. For loans determined to be impaired, the loans carrying value is compared to its fair value
using one of the following fair value measurement techniques: present value of expected future cash
flows, observable market price, or fair value of the associated collateral less costs to sell. An
allowance is established when the fair value is lower than the carrying value of that loan. The
general component covers non-classified and classified non-impaired loans and is based on a
three-year historical average loss experience adjusted for current factors. These loans are
segregated by major product type and/or risk grade with an estimated loss ratio applied against
each product type and/or risk grade. The loss ratio is generally based upon historic loss
experience for each loan type as adjusted for certain environmental factors management believes to
be relevant.
34
Table of Contents
Past Due Loans
The following table presents the Banks delinquent and nonaccrual loans for the periods
indicated:
Past due 30 to | Past due 90 days | |||||||||||||||||||||||
89 days and still | % of total | or more and | % of total | % of total | ||||||||||||||||||||
accruing | loans | still accruing | loans | Nonaccrual | loans | |||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||
As of March 31, 2011 |
||||||||||||||||||||||||
Construction, land development
and other land loans |
$ | 2,592 | 0.71 | % | $ | 110 | 0.03 | % | $ | 30,032 | 8.23 | % | ||||||||||||
Commercial real estate |
| 0.00 | % | | 0.00 | % | 7,344 | 2.01 | % | |||||||||||||||
Consumer real estate |
2,098 | 0.57 | % | | 0.00 | % | 16,998 | 4.66 | % | |||||||||||||||
Commercial loans |
560 | 0.15 | % | | 0.00 | % | | 0.00 | % | |||||||||||||||
Consumer loans |
56 | 0.02 | % | | 0.00 | % | 8 | 0.00 | % | |||||||||||||||
Total |
$ | 5,306 | 1.45 | % | $ | 110 | 0.03 | % | $ | 54,382 | 14.89 | % | ||||||||||||
As of December 31, 2010 |
||||||||||||||||||||||||
Construction, land development
and other land loans |
$ | 265 | 0.07 | % | $ | | 0.00 | % | $ | 27,929 | 7.46 | % | ||||||||||||
Commercial real estate |
541 | 0.14 | % | 413 | 0.11 | % | 6,362 | 1.70 | % | |||||||||||||||
Consumer real estate |
1,130 | 0.30 | % | | 0.00 | % | 18,647 | 4.98 | % | |||||||||||||||
Commercial loans |
| 0.00 | % | | 0.00 | % | 67 | 0.02 | % | |||||||||||||||
Consumer loans |
68 | 0.02 | % | 19 | 0.01 | % | | 0.00 | % | |||||||||||||||
Total |
$ | 2,004 | 0.54 | % | $ | 432 | 0.12 | % | $ | 53,005 | 14.16 | % | ||||||||||||
Delinquent and nonaccrual loans at both March 31, 2011 and December 31, 2010 consisted
primarily of construction and land development loans and commercial and consumer real estate loans.
The majority of the increase in loans delinquent 30 to 89 days, which was largely isolated to
construction and land development and consumer real estate loans, was attributable to one
relationship in each category, approximately $2.4 million and $1.5 million, respectively, rather
than a further deterioration of the portfolio generally. The increase in nonaccrual loans was the
result of continued stress in the local real estate market as discussed in more detail below.
Certain nonaccrual loans are carried on a cash basis nonaccrual status until an acceptable payment
history can be established to support placing the loan back on accrual. During this time, the loans
continue to be reported as non-performing assets while payments are being collected.
Notwithstanding the general favorable trends in tourism in Sevier County, residential and
commercial real estate sales continued to be weak during first three month of 2011, following the
same pattern that began during the second half of 2008 and continued throughout 2010. The reduced
sales have negatively impacted past due, nonaccrual and charged-off loans. Price declines during
2009 and 2010 have had an adverse impact on overall real estate values. These trends have had the
greatest effect on the construction and development and commercial real estate portfolios resulting
in the significant increase in nonaccrual loans beginning in 2009 and continuing through the first
quarter of 2011. Many of the borrowers in these categories are dependent upon real estate sales to
generate the cash flows used to service their debt. Since real estate sales have been depressed,
many of these borrowers have experienced greater difficulty meeting their obligations, and to the
extent that sales remain depressed, these borrowers may continue to have difficulty meeting their
obligations.
35
Table of Contents
Investment Securities
Our investment portfolio consists of U.S. Treasury securities, securities of U.S. government
agencies, mortgage-backed securities and municipal securities. The investment securities portfolio
is the second largest component of our earning assets and represented 17.1% of total assets at
quarter-end, down from 15.7% at December 31, 2010, reflecting an increase in investment securities
and a decrease in total assets during the first three months of 2011. The approximately $3 million
increase in investment securities during the three months ended March 31, 2011 was primarily
attributable to increased pledging requirements related to municipal deposits. As an integral
component of our asset/liability management strategy, we manage our investment securities portfolio
to maintain liquidity, balance interest rate risk and augment interest income. In addition to
securing public deposits, we also use our investment securities portfolio to meet pledging
requirements for borrowings. The average yield on our investment securities portfolio during the
first three months of 2011 was 2.67% versus 2.32% for the first three months of 2010. Net
unrealized losses on securities available for sale, included in accumulated other comprehensive
income (loss), decreased by approximately $522,000, net of income taxes, during the first three
months of 2011 from approximately $1,064,000 at December 31, 2010, to approximately $542,000 at
March 31, 2011.
Deposits
The table below sets forth the total balances of deposits by type as of March 31, 2011 and
December 31, 2010, and the dollar and percentage change in balances over the intervening period:
March 31, | December 31, | $ | % | |||||||||||||
2011 | 2010 | change | change | |||||||||||||
(in thousands) | ||||||||||||||||
Non-interest bearing accounts |
$ | 48,492 | $ | 47,638 | $ | 854 | 1.79 | % | ||||||||
NOW accounts |
54,389 | 57,345 | (2,956 | ) | -5.15 | % | ||||||||||
Money market accounts |
48,809 | 49,701 | (892 | ) | -1.79 | % | ||||||||||
Savings accounts |
23,609 | 23,734 | (125 | ) | -0.53 | % | ||||||||||
Certificates of deposit |
213,289 | 222,550 | (9,261 | ) | -4.16 | % | ||||||||||
Brokered deposits |
19,947 | 27,019 | (7,072 | ) | -26.17 | % | ||||||||||
Individual retirement accounts |
20,863 | 21,604 | (741 | ) | -3.43 | % | ||||||||||
TOTAL DEPOSITS |
$ | 429,398 | $ | 449,591 | $ | (20,193 | ) | -4.49 | % |
The balance in NOW accounts primarily consists of public funds deposits that are
generally obtained through a bidding process under varying terms.
The decrease in certificates of deposit was the result of seasonal reductions. At March 31,
2011, brokered deposits represented approximately 4.6% of total deposits and management intends to
seek to further reduce the level of brokered deposits approximately $3 million during the remainder
of 2011 based on scheduled maturities. Because we anticipate that the Consent Order will establish
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 Consent Order. As an adequately capitalized institution, the Bank may not
accept, renew or roll over brokered deposits without prior approval of the FDIC. As of March 31,
2011, brokered deposits maturing in the next 24 months totaled approximately $16.7 million. Funding
sources for the maturing brokered deposits include, among other sources: our cash account at the
Federal Reserve Bank of Atlanta; growth, if any, of core deposits from current and new retail and
commercial customers; scheduled repayments on existing loans; and the possible pledge or sale of
investment securities.
Because the Bank will not be considered well capitalized following issuance of the Consent
Order, it will also not be permitted to pay interest on deposits at rates that are more than 75
basis points above the rate applicable to the applicable market of the Bank as determined by the
FDIC. These interest rate limitations may limit the ability of the Bank to increase or maintain
core deposits from current and new deposit customers.
36
Table of Contents
The total average cost of interest-bearing deposits (including demand, savings and
certificate of deposit accounts) for the three-month period ended March 31, 2011 was 1.52%, down
from 1.82% for the same period a year ago primarily reflecting the continued downward repricing of
the Banks time deposits as they mature and are renewed at current market rates. Competitive
pressures in our markets, however, have limited, and are likely to continue to limit, our ability
to realize the full effect of the ongoing low interest rate environment.
Funding Resources, Capital Adequacy and Liquidity
Our funding sources primarily include deposits and repurchase accounts. The Bank, being
situated in a market area that relies on tourism as its principal industry, can be subject to
periods of reduced deposit funding because tourism in Sevier County and Blount County is seasonably
slower in the winter months. The Bank manages seasonal deposit outflows through its secured and
unsecured Federal Funds lines of credit at several correspondent banks. Available lines totaled $33
million with $10 million secured and accessible as of March 31, 2011, and are available on one
days notice. The Bank also has a cash management line of credit in the amount of $100 million from
the FHLB as well as a line of credit from the Federal Reserve Discount Window that totaled
approximately $13 million at March 31, 2011, none of which was borrowed as of that date. The
borrowing capacity can be increased based on the amount of collateral pledged.
Capital adequacy is important to the Banks continued financial safety and soundness and
growth. Our banking regulators have adopted risk-based capital and leverage guidelines to measure
the capital adequacy of national banks. In addition, the Companys and the Banks regulators may
impose additional capital requirements on financial institutions and their bank subsidiaries, like
the Company and the Bank, beyond those provided for statutorily, which standards may be in addition
to, and require higher levels of capital, than the general capital adequacy guidelines. As
discussed below, the Bank has agreed to maintain certain of its capital ratios above statutory
levels and expects that the Consent Order will contain a provision requiring the Bank to maintain a
minimum Tier 1 leverage capital ratio of 9% and a total risk-based capital ratio of 13%.
Following passage of the Dodd Frank Wall Street Reform and Consumer Protection Act (the
Reform Act), bank holding companies like the Company must be subject to capital requirements that
are at least as severe as those imposed on banks under current federal regulations. Trust preferred
and cumulative preferred securities will no longer be deemed Tier 1 capital for bank holding
companies with over $10 billion in total assets at December 31, 2009 following passage of the
Reform Act, but trust preferred securities issued by bank holding companies with under $10 billion
in total assets at December 31, 2009 will be grandfathered in and continue to count as Tier 1
capital. Accordingly, the Companys trust preferred securities will continue to count as Tier 1
capital.
37
Table of Contents
The table below sets forth the Companys capital ratios as of the periods indicated.
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Tier 1 Risk-Based Capital |
11.02 | % | 11.87 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Total Risk-Based Capital |
12.75 | % | 13.27 | % | ||||
Regulatory Minimum |
8.00 | % | 8.00 | % | ||||
Tier 1 Leverage |
8.28 | % | 8.34 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % |
The table below sets forth the Banks capital ratios as of the periods indicated.
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Tier 1 Risk-Based Capital |
11.47 | % | 11.97 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Well-capitalized minimum |
6.00 | % | 6.00 | % | ||||
Total Risk-Based Capital |
12.74 | % | 13.23 | % | ||||
Regulatory Minimum |
8.00 | % | 8.00 | % | ||||
Well-capitalized minimum |
10.00 | % | 10.00 | % | ||||
Level required by OCC (see below) |
13.00 | % | 13.00 | % | ||||
Tier 1 Leverage |
8.62 | % | 8.41 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Well-capitalized minimum |
5.00 | % | 5.00 | % | ||||
Level required by OCC (see below) |
9.00 | % | 9.00 | % |
In February 2010, the Bank agreed to an OCC requirement to maintain a minimum Tier 1 capital
to average assets ratio of 9% and a minimum total capital to risk-weighted assets ratio of 13%. As
noted above, the Bank had 8.62% of Tier 1 capital to average assets and 12.74% of total capital to
risk-weighted assets at March 31, 2011 and thus was not in compliance with such requirements. The
Banks Tier 1 capital at March 31, 2011 was approximately $2,052,000 below the amount needed to
meet the agreed-upon Tier 1 capital to average assets ratio of 9%. The Banks total risk-based
capital at March 31, 2011 was approximately $1,050,000 below the amount needed to meet the
agreed-upon total capital to risk-weighted assets ratio of 13%. As a result of its non-compliance
with these requirements, the OCC may bring further enforcement actions, including a consent order,
against the Bank. Managements strategy to reduce total assets described above in Note 8.
Regulatory Matters positively affected the Companys and the Banks Tier 1 capital to average
assets ratio during the first quarter of 2011 and should continue to positively impact the ratio
during the remainder of the year. However, as noted above, these measures were not significant
enough for the Bank to maintain its Tier 1 capital to average assets and total capital to
risk-weighted assets ratios above the levels agreed upon with the OCC. The Company is actively
exploring other potential transactions to raise capital at the holding company that could provide
additional capital for the Bank.
38
Table of Contents
As described above, the Company anticipates that the Bank will be requested to replace the
formal written agreement that the Bank is currently subject to with the Consent Order containing,
among other provisions, capital maintenance ratio requirements similar to those currently contained
in the informal commitment described in the immediately preceding paragraph requiring the Bank to
achieve and maintain a minimum Tier 1 to average assets ratio of 9% and a minimum total capital to
risk-weighted assets ratio of 13%. Once the Consent Order is effective, the Bank will be deemed to
be adequately capitalized even if the Banks capital ratios exceed those minimum amounts
necessary to be considered well capitalized under federal banking regulations as well as the
minimum ratios set forth in the Consent Order.
Liquidity is the ability of a company to convert assets into cash or cash equivalents without
significant loss. Our liquidity management involves maintaining our ability to meet the day-to-day
cash flow requirements of our customers, whether they are depositors wishing to withdraw funds or
borrowers requiring funds to meet their credit needs. Without proper liquidity management, we would
not be able to perform the primary function of a financial intermediary and would, therefore, not
be able to meet the production and growth needs of the communities we serve.
The Companys primary source of liquidity is dividends paid to it by the Bank and cash that
has not been injected into the Bank. The Bank is required by federal law to obtain the prior
approval of the OCC for payments of dividends if the total of all dividends declared by its board
of directors in any year will exceed (1) the total of its net profits for that year, plus (2) its
retained net profits of the preceding two years, less any required transfers to surplus. Given the
losses experienced by the Bank during 2009 and 2010, the Bank may not, without the prior approval
of the OCC, pay any dividends to the Company until such time that current year profits exceed the
net losses and dividends of the prior two years. Generally, federal regulatory policy discourages
payment of holding company or bank dividends if the holding company or its subsidiaries are
experiencing losses. Accordingly, until such time as it may receive dividends from the Bank, the
Company must service its interest payment on its subordinated indebtedness from its available cash
balances, if any.
On December 14, 2010, the Company exercised its rights to defer regularly scheduled interest
payments on all of its issues of junior subordinated debentures relating to outstanding trust
preferred securities. Management cannot currently project the length of time it will be necessary
to extend the deferral of these payments and therefore anticipates deferring payment indefinitely.
The regular scheduled interest payments will continue to be accrued for payment in the future and
reported as an expense for financial statement purposes. At March 31, 2011, total interest accrued
for these deferred payments was approximately $170,000.
Supervisory guidance from the Federal Reserve Board indicates that bank holding companies that
are experiencing financial difficulties generally should eliminate, reduce or defer dividends on
Tier 1 capital instruments including trust preferred securities, preferred stock or common stock,
if the holding company needs to conserve capital for safe and sound operation and to serve as a
source of strength to its subsidiaries. The Company has informally committed to the Federal Reserve
Board that it will not (1) declare or pay dividends on the Companys common or preferred stock, or
(2) incur any additional indebtedness without in each case, the prior written approval of the
Federal Reserve Board.
The primary function of asset and liability management is not only to assure adequate
liquidity in order for us to meet the needs of our customer base, but also to maintain an
appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that we
can also meet the investment objectives of our shareholders. Daily monitoring of the sources and
uses of funds is necessary to maintain an acceptable cash position that meets both the needs of our
customers and the objectives of our shareholders. In a banking environment, both assets and
liabilities are considered sources of liquidity funding and both are therefore monitored on a daily
basis.
39
Table of Contents
Off-Balance Sheet Arrangements
Our only material off-balance sheet arrangements consist of commitments to extend credit and
standby letters of credit issued in the ordinary course of business to facilitate customers
funding needs or risk management objectives.
Commitments and Lines of Credit
In the ordinary course of business, the Bank has granted commitments to extend
credit and standby letters of credit to approved customers. Generally, these commitments to extend
credit have been granted on a temporary basis for seasonal or inventory requirements and have been
approved by the loan committee. These commitments are recorded in the financial statements as they
are funded. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitment amounts expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash requirements.
Following is a summary of the commitments outstanding at March 31, 2011 and December 31, 2010.
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
Commitments to extend credit |
$ | 35,847 | $ | 41,155 | ||||
Standby letters of credit |
4,271 | 5,288 | ||||||
TOTALS |
$ | 40,118 | $ | 46,443 |
Commitments to extend credit include unused commitments for open-end lines secured
by 1-4 family residential properties, commitments to fund loans secured by commercial real estate,
construction loans, land development loans, and other unused commitments. Reflecting current
economic conditions in our market, commitments to fund commercial real estate, construction, and
land development loans decreased by approximately $2,424,000 to approximately $5,280,000 at March
31, 2011, compared to commitments of approximately $7,704,000 at December 31, 2010.
40
Table of Contents
Income Statement Analysis
The following tables set forth the amount of our average balances, interest income or interest
expense for each category of interest-earning assets and interest-bearing liabilities and the
average interest rate for total interest-earning assets and total interest-bearing liabilities, net
interest spread and net interest margin for the three months ended March 31, 2011 and 2010 (dollars
in thousands):
Net Interest Income Analysis
For the Three Months Ended March 31, 2011 and 2010
(in thousands, except rates)
For the Three Months Ended March 31, 2011 and 2010
(in thousands, except rates)
Average Balance | Income/Expense | Yield/Rate | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||
Loans |
$ | 371,429 | $ | 406,902 | $ | 4,609 | $ | 5,148 | 5.03 | % | 5.13 | % | ||||||||||||
Investment Securities: |
||||||||||||||||||||||||
Available for sale |
87,509 | 147,227 | 548 | 808 | 2.54 | % | 2.23 | % | ||||||||||||||||
Held to maturity |
1,323 | 1,571 | 15 | 16 | 4.60 | % | 4.13 | % | ||||||||||||||||
Equity securities |
3,843 | 3,818 | 48 | 48 | 5.07 | % | 5.10 | % | ||||||||||||||||
Total securities |
92,675 | 152,616 | 611 | 872 | 2.67 | % | 2.32 | % | ||||||||||||||||
Federal funds sold and other |
7,209 | 23,265 | 6 | 11 | 0.34 | % | 0.19 | % | ||||||||||||||||
Total interest-earning
assets |
471,313 | 582,783 | 5,226 | 6,031 | 4.50 | % | 4.20 | % | ||||||||||||||||
Nonearning assets |
66,596 | 72,878 | ||||||||||||||||||||||
Total Assets |
$ | 537,909 | $ | 655,661 | ||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||
Interest bearing deposits: |
||||||||||||||||||||||||
Interest bearing
demand deposits |
105,513 | 155,728 | 262 | 446 | 1.01 | % | 1.16 | % | ||||||||||||||||
Savings deposits |
23,154 | 22,001 | 42 | 73 | 0.74 | % | 1.35 | % | ||||||||||||||||
Time deposits |
258,007 | 308,452 | 1,149 | 1,660 | 1.81 | % | 2.18 | % | ||||||||||||||||
Total interest bearing deposits |
386,674 | 486,181 | 1,453 | 2,179 | 1.52 | % | 1.82 | % | ||||||||||||||||
Securities sold under agreements
to repurchase |
622 | 1,570 | 3 | 6 | 1.96 | % | 1.55 | % | ||||||||||||||||
Federal Home Loan Bank advances
and other borrowings |
55,200 | 62,900 | 554 | 638 | 4.07 | % | 4.11 | % | ||||||||||||||||
Subordinated debt |
13,403 | 13,403 | 77 | 80 | 2.33 | % | 2.42 | % | ||||||||||||||||
Total interest-bearing liabilities |
455,899 | 564,054 | 2,087 | 2,903 | 1.86 | % | 2.09 | % | ||||||||||||||||
Noninterest-bearing deposits |
44,700 | 42,454 | | | ||||||||||||||||||||
Total deposits and interest-bearings liabilities |
500,599 | 606,508 | 2,087 | 2,903 | 1.69 | % | 1.94 | % | ||||||||||||||||
Other liabilities |
2,416 | 1,651 | ||||||||||||||||||||||
Shareholders equity |
34,894 | 47,502 | ||||||||||||||||||||||
$ | 537,909 | $ | 655,661 | |||||||||||||||||||||
Net interest income |
$ | 3,139 | $ | 3,128 | ||||||||||||||||||||
Net interest spread (1) |
2.64 | % | 2.11 | % | ||||||||||||||||||||
Net interest margin (2) |
2.70 | % | 2.18 | % |
(1) | Yields realized on interest-earning assets less the rates paid on interest-bearing liabilities. |
|
(2) | Net interest margin is the result of annualized net interest income divided by average
interest-earning assets for the period. |
41
Table of Contents
The following tables set forth the extent to which changes in interest rates and changes in
volume of interest-earning assets and interest-bearing liabilities have affected our interest
income and interest expense during the periods indicated. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes attributable to (1)
change in volume (change in volume multiplied by previous year rate); (2) change in rate (change in
rate multiplied by current year volume); and (3) a combination of change in rate and change in
volume. The changes in interest income and interest expense attributable to both volume and rate
have been allocated proportionately to the change due to volume and the change due to rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
2011 Compared to 2010 | ||||||||||||
Increase (decrease) | ||||||||||||
due to change in | ||||||||||||
Rate | Volume | Total | ||||||||||
(dollars in thousands) | ||||||||||||
Three months ended March 31, 2011 and 2010 |
||||||||||||
Income from interest-earning assets: |
||||||||||||
Interest and fees on loans |
$ | (92 | ) | $ | (447 | ) | $ | (539 | ) | |||
Interest on securities |
80 | (341 | ) | (261 | ) | |||||||
Interest on Federal funds sold and other |
3 | (8 | ) | (5 | ) | |||||||
Total interest income |
(9 | ) | (796 | ) | (805 | ) | ||||||
Expense from interest-bearing liabilities: |
||||||||||||
Interest on interest-bearing deposits |
(72 | ) | (143 | ) | (215 | ) | ||||||
Interest on time deposits |
(237 | ) | (274 | ) | (511 | ) | ||||||
Interest on other borrowings |
(10 | ) | (80 | ) | (90 | ) | ||||||
Total interest expense |
(319 | ) | (497 | ) | (816 | ) | ||||||
Net interest income |
$ | 310 | $ | (299 | ) | $ | 11 |
42
Table of Contents
The following is a summary of our results of operations (dollars in thousands except per share
amounts):
Three months ended | ||||||||||||||||
3/31/11 | 3/31/10 | $ change | % change | |||||||||||||
Interest income: |
||||||||||||||||
Loans |
$ | 4,609 | $ | 5,148 | (539 | ) | -10.47 | % | ||||||||
Securities |
611 | 872 | (261 | ) | -29.93 | % | ||||||||||
Fed funds sold/other |
6 | 11 | (5 | ) | -45.45 | % | ||||||||||
Total Interest income |
5,226 | 6,031 | (805 | ) | -13.35 | % | ||||||||||
Interest Expense: |
||||||||||||||||
Deposits |
1,453 | 2,179 | (726 | ) | -33.32 | % | ||||||||||
Other borrowed funds |
634 | 724 | (90 | ) | -12.43 | % | ||||||||||
Total interest expense |
2,087 | 2,903 | (816 | ) | -28.11 | % | ||||||||||
Net interest income |
3,139 | 3,128 | 11 | 0.35 | % | |||||||||||
Provision for loan losses |
3,000 | 212 | 2,788 | 1315.09 | % | |||||||||||
Net interest income after
provision for loan losses |
139 | 2,916 | (2,777 | ) | -95.23 | % | ||||||||||
Noninterest income |
887 | 1,975 | (1,088 | ) | -55.09 | % | ||||||||||
Noninterest expense |
4,306 | 4,584 | (278 | ) | -6.06 | % | ||||||||||
Net income (loss) before
income tax benefit |
(3,280 | ) | 307 | (3,587 | ) | -1168.40 | % | |||||||||
Income tax benefit |
99 | (22 | ) | 121 | 550.00 | % | ||||||||||
Net income (loss) |
$ | (3,379 | ) | $ | 329 | $ | (3,708 | ) | -1127.05 | % | ||||||
Net Interest Income and Net Interest Margin
Interest Income
The interest income and fees earned on loans are the largest contributing element of interest
income. The decrease in this component of interest income for the three months ended March 31, 2011
as compared to the same period in 2010 was primarily the result of a decrease in the volume of
average loans as well as a decrease in the average rate earned on loans. Average loans outstanding
decreased approximately $35,473,000, or 8.7%, from March 31, 2010 to March 31, 2011. The decrease
in the average yield on loans was the result of several factors including the increase in TDRs
involving interest rate concessions and the increase in average non-accrual loans. Interest income
on securities decreased during the three-month period ended March 31, 2011 as compared to the same
period in 2010 due to the approximately $59,941,000, or 39.3%, decrease in the volume of average
securities from March 31, 2010 to March 31, 2011. Partially offsetting the reduction in volume, the
yield earned on securities increased 35 basis points during the first quarter of 2011 as compared
to the same period in 2010 reflecting a redistribution of the portfolio from lower to higher
yielding investments at March 31, 2011 when compared to March 31, 2010. Additionally, interest
income on federal funds sold/other decreased due to a decrease in the average balance outstanding.
43
Table of Contents
Interest Expense
The decrease in interest expense for the three months ended March 31, 2011 as compared to the
same period in 2010 was attributable to the reduction in both the volume and the average cost of
the Banks interest-bearing liabilities, predominantly the volume and cost of time and interest
bearing demand deposits. The average balance of total interest bearing deposits, the largest
component of interest-bearing liabilities, decreased approximately $99,507,000, or 20.5%, for the
first three months of 2011 compared to the first three months of 2010. Additionally, the average
rate paid on total interest bearing deposits decreased 30 basis points between the two periods
contributing to the net decrease in deposit interest expense. Interest expense on FHLB advances and
other borrowings decreased during the three-month period ended March 31, 2011 compared to the same
period in 2010 due to a decrease in the average borrowed funds balance of approximately $7,700,000,
or 12.2%, during the periods compared. The average rate paid on these liabilities decreased 4 basis
points, contributing to the reduction in interest expense. The average balance of subordinated
debentures did not change from March 31, 2010 to March 31, 2011. Therefore, the 9 basis point
decrease in the rate paid on this debt for the three-month period ended March 31, 2011 compared to
the same period in 2010 resulted in an overall decrease in the related interest expense.
Interest bearing deposits consist of interest bearing demand deposits, savings and time
deposits. As stated above, the cost of our interest bearing deposits decreased for the first three
months of 2011 compared to the first three months of 2010. The largest factor contributing to the
overall reduction in expense was a reduction in the average balance of time deposits from the first
quarter of 2010 to the first quarter of 2011 of approximately $50,445,000, or 16.4%, followed by a
reduction in the average rate paid on these time deposits of 37 basis points between the periods
compared. Additionally, the average balance of interest bearing demand deposits decreased
approximately $50,215,000, or 32.3%, during the first three months of 2011 when compared to the
first three months of 2010, primarily due to a decrease in average public funds deposits resulting
from Managements 2009 strategic initiative that involved not bidding to retain the deposits of
certain municipal entities. The rate paid on these deposits decreased 15 basis points during the
same time period.
Net Interest Income
The increase in net interest income before the provision for loan losses for the three-month
period ended March 31, 2011 when compared to the same period in 2010 was primarily the result of
the decrease in interest expense on deposits and FHLB advances. Decreases in interest income,
mostly related to loans and investment securities, largely offset the decreased interest expenses.
Net interest income for the two periods was also influenced by decreases in the volume of
interest-earning assets and interest-bearing liabilities as well as decreases in rates earned and
paid on these interest-sensitive balances.
Net Interest Margin
Our net interest margin, the difference between the yield on earning assets, including loan
fees, and the rate paid on funds to support those assets, increased 52 basis points for the first
three months of 2011 compared to the same period in 2010. The increase in our net interest margin
reflects an increase in the average spread during the first three months of 2011 between the rates
we earned on our interest-earning assets, which had an increase in overall yield of 30 basis points
to 4.50% at March 31, 2011, as compared to 4.20% at March 31, 2010, and the rates we paid on
interest-bearing liabilities, which had a decrease of 23 basis points in the overall rate to 1.86%
at March 31, 2011, versus 2.09% at March 31, 2010. Our net interest margin continues to be
negatively impacted by the high level of nonaccrual loans as well as TDRs involving interest rate
concessions. For the three-month period ended March 31, 2011, when compared to the same period in
2010, average nonaccrual loans increased approximately $2,469,000, or 4.8%, from approximately
$51,609,000 at March 31, 2010 to $54,078,000 at March 31, 2011. The average balance of TDRs,
certain of which involve interest rate concessions that cause the effective interest rate to be
below the current market rate for similar debt, increased approximately $40,074,000, or 95.6%, from
the first three months of 2010 to the first three months of 2011. Additionally, the net interest
margin was positively affected by an increase in the average balance of noninterest-bearing
deposits of approximately $2,246,000, or 5.29%, from the first quarter of 2010 to the first quarter
of 2011. The effects of these changes will continue as long as and to the extent that the average
balances of nonaccrual loans, TDRs and noninterest-bearing deposits remains elevated.
44
Table of Contents
Provision For Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an
allowance for loan losses and is based on managements evaluation of economic conditions, volume
and composition of the loan portfolio, historical charge-off experience, the level of
non-performing and past due loans, and other indicators derived from reviewing the loan portfolio.
Management performs such reviews quarterly and makes appropriate adjustments to the level of the
allowance for loan losses as a result of these reviews.
As mentioned above in the section titled Allowance for Loan Losses, management determines the
necessary amount, if any, to increase the allowance account through the provision for loan losses.
Although total loans decreased approximately $9 million during the first three months of 2011, the
continuing increased level of provision for loan loss expense during the first quarter of 2011 was
due to increased charge-offs and delinquencies, related primarily to deterioration in the real
estate segment of the Companys loan portfolio, particularly construction and land development, as
well as increased probable losses as the result of the slowdown in economic conditions. Continuing
reductions in property values and the reduced volume of sales of developed and undeveloped land has
led to an increase of impaired loans determined to be collateral dependent. As the collateral value
for these land loans has declined significantly during 2010 and into 2011, related charge-offs and
provision expense have been incurred. Management has continued its ongoing review of the loan
portfolio with particular emphasis on construction and land development loans and while we believe
we have identified and adequately provided for losses present in the loan portfolio, due to the
necessarily approximate and imprecise nature of the allowance for loan loss estimate, certain
projected scenarios may not occur as anticipated. Additionally, further deterioration of factors
relating to the loan portfolio, such as conditions in the local and national economy and the local
real estate market, could have an added adverse impact and require additional provision expense and
higher allowance levels.
45
Table of Contents
The following table summarizes our loan loss experience and provision for loan losses for the
three months ended March 31, 2011 and 2010.
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
(dollars in thousands) | ||||||||
Charge-offs: |
||||||||
Construction and land development |
$ | 839 | $ | 290 | ||||
Equity Lines of Credit |
9 | 54 | ||||||
Residential 1-4 family |
2,789 | 113 | ||||||
Second mortgages |
26 | | ||||||
Residential multifamily |
2 | | ||||||
Commercial real estate |
225 | 48 | ||||||
Consumer loans |
70 | 104 | ||||||
Recoveries: |
||||||||
Equity Lines of Credit |
(1 | ) | (1 | ) | ||||
Commercial real estate |
(48 | ) | | |||||
Consumer loans |
(6 | ) | (18 | ) | ||||
Net charge-offs |
3,905 | 590 | ||||||
Average balance of loans outstanding |
371,429 | 406,902 | ||||||
Annualized net charge-offs as % of
average loans |
4.26 | % | 0.59 | % | ||||
Provision for loan losses |
3,000 | 212 |
As noted in the table above, the majority of net charge-offs during the first quarter of 2011
were related to residential 1-4 family real estate loans followed by construction and land
development loans. Six relationships involving charge-offs of approximately $3.4 million represent
87.5% of net charge-offs during the first quarter of 2011. Of this total, approximately $2.5
million, $741,000 and $189,000 were related to the residential 1-4 family, construction and land
development and commercial real estate categories, respectively.
Non-Interest Income
Non-interest income represents the total of all sources of income, other than interest-related
income, which are derived from various service charges, fees and commissions charged for bank
services.
The decrease in non-interest income for the three months ended March 31, 2011, was primarily
attributable to the decrease in gain on investment securities. The gains recognized during the
first quarter of 2010 were related to managements strategy to manage liquidity and pledging
requirements discussed in more detail above under Investment Securities. The decrease in
non-interest income was also affected by a reduction in net ORE gains as well as a decrease in
other noninterest income which was largely the result of a decrease in income generated by the
Banks investment in Appalachian Fund for Growth II, LLC. Additionally, there was a decrease in
gain on sale of mortgage loans and deposit service charges during the first three months of 2011,
primarily non-sufficient fee income from overdrafts of demand deposit accounts.
46
Table of Contents
The following table presents the main components that make up the changes in non-interest
income:
Three months ended | ||||||||||||||||
3/31/11 | 3/31/10 | $ change | % change | |||||||||||||
(dollars in thousands) | ||||||||||||||||
Investment gains and losses, net |
$ | | $ | 954 | (954 | ) | -100.00 | % | ||||||||
Other noninterest income |
142 | 192 | (50 | ) | -26.04 | % | ||||||||||
Net gain (loss) on other real estate |
14 | 59 | (45 | ) | -76.27 | % | ||||||||||
Gain on sale of mortgage loans |
23 | 45 | (22 | ) | -48.89 | % | ||||||||||
Service charges on deposit accounts |
378 | 398 | (20 | ) | -5.03 | % | ||||||||||
Other fees and commissions |
331 | 326 | 5 | 1.53 | % |
Non-Interest Expense
The Companys net loss during the three months ended March 31, 2011, as compared to the same
period in 2010, was positively impacted by the decrease in non-interest expense. Total non-interest
expense represents the total costs of operating overhead, such as salaries, employee benefits,
building and equipment costs, telephone costs and marketing costs. The decrease in non-interest
expense from the first quarter 2010 to the first quarter of 2011 relates primarily to a decrease in
salary and employee benefit expenses which is the result of several cost cutting measures
implemented during the first quarter of 2010 including staff reductions as well as reductions in
remaining employees salaries, health insurance costs, 401(k) match expenses and fees paid to
members of the board of directors, among other things. The decrease in non-interest expense was
also attributable to a decrease in ORE expense related to maintenance and upkeep of our foreclosed
properties. The decrease in non-interest expense was negatively impacted during the three months
ended March 31, 2011 by an increase in FDIC assessment expense as well as increases in other
general areas, primarily professional fees and credit/debit card related expenses.
The following table presents the main components that make up the changes in non-interest
expense:
Three months ended | ||||||||||||||||
3/31/11 | 3/31/10 | $ change | % change | |||||||||||||
(dollars in thousands) | ||||||||||||||||
Salaries and employee benefits |
$ | 1,995 | $ | 2,342 | (347 | ) | -14.82 | % | ||||||||
Other real estate expense |
153 | 206 | (53 | ) | -25.73 | % | ||||||||||
FDIC assessment expense |
352 | 312 | 40 | 12.82 | % | |||||||||||
Occupancy expenses |
454 | 449 | 5 | 1.11 | % |
47
Table of Contents
Income Taxes
The Companys income tax expense (benefit) for the three months ended March 31, 2011 and 2010
is presented in the following table:
Provision for Income Taxes and Effective Tax Rates
(dollars in thousands)
(dollars in thousands)
Three months ended | ||||||||
3/31/11 | 3/31/10 | |||||||
Provision expense (benefit) |
99 | (22 | ) | |||||
Pre-tax income (loss) |
(3,280 | ) | 307 | |||||
Effective tax rate |
-3.02 | % | -7.17 | % |
During the first quarter of 2011, the Banks effective income tax expense rate was primarily
the result of increasing the deferred tax asset valuation allowance. Recording a valuation
allowance requires recognition of tax expense which, when applied to a pretax loss, causes a
negative effective tax rate. Additionally, tax exempt income has the effect of increasing a taxable
loss, therefore increasing effective tax rates as a percentage of pretax income. This is the
opposite effect on tax rates when a company has pretax income. During the first quarter of 2010,
the Banks tax exempt income was enough to offset its taxable income resulting in a net tax benefit
during the period and a negative effective tax rate. Tax exempt income effectively reduces the
statutory tax rate and, as was the case during the first quarter of 2010, can potentially reduce
the rate below zero.
For each period presented above, the effective tax rate was positively impacted by the
continuing tax benefits generated from MNB Real Estate, Inc., which is a real estate investment
trust subsidiary formed during the second quarter of 2005. The income generated from tax-exempt
municipal bonds and bank owned life insurance also continues to improve our effective tax rate.
Additionally, during 2006, the Bank became a partner in Appalachian Fund for Growth II, LLC with
three other Tennessee banking institutions. This partnership has invested in a program that is
expected to generate a federal tax credit in the amount of approximately $200,000 during 2011. The
program is also expected to generate a one-time state tax credit in the amount of $200,000 to be
utilized over a maximum of 20 years to offset state tax liabilities.
The Company had net deferred tax assets of approximately $104,000 as of March 31, 2011. A
valuation allowance is recognized for a deferred tax asset if, based on the weight of available
evidence, it is more-likely-than-not that some portion of the entire deferred tax or asset will not
be realized. In making such judgments, significant weight is given to evidence that can be
objectively verified. As a result of increased credit losses, the Company entered into a three-year
cumulative pre-tax loss position in 2010. A cumulative loss position is considered significant
negative evidence in assessing the reliability deferred tax asset which is difficult to overcome.
The Companys estimate of the realization of its deferred tax assets was based on future reversals
of existing taxable temporary differences and taxable income in prior carry back years. The Company
did not consider future taxable income in determining the reliability of its deferred assets.
During the first quarter of 2011, we recorded an additional valuation allowance of approximately
$1,273,000. The timing of the reversal of the valuation allowance is dependent on our assessment of
future events and will be based on the circumstances that exist as of that future date.
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the Companys reports and other information filed with the
Commission, under the Exchange Act, is recorded, processed, summarized and reported within the time
periods specified in the Commissions rules and forms, and that such information is accumulated and
communicated to the management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure.
48
Table of Contents
The Company carried out an evaluation, under the supervision and with the participation of
management, including the Companys Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon the foregoing, the Chief Executive Officer along
with the Chief Financial Officer concluded that certain deficiencies identified in internal
controls and procedures created a material weakness and resulted in the Companys disclosure
controls and procedures not being effective to ensure that information required to be disclosed in
the Companys reports under the Exchange Act was recorded, summarized and reported within the time
periods specified in the Commissions rules and forms as of the end of the period covered by this
report. Based on this determination of the existence of a material weakness, which began during the
fourth quarter of 2010 and continued into the first quarter of 2011, management identified certain
areas requiring internal control and procedure improvements.
Changes in Internal Control over Financial Reporting
During Managements assessment of the Companys internal control over financial reporting at
December 31, 2010 and continuing into the first quarter of 2011, the following deficiencies were
noted: 1) Loans determined to be collateral dependent were not properly identified in a timely
manner which created a material internal control deficiency. Procedures have been put in place by
the Banks Special Assets Department to ensure loans that are dependent upon the sale of the
underlying collateral for repayment are properly identified and documented when the determination
is made the loan is collateral dependent and this information is incorporated in the allowance for
loan loss calculation. 2) Appraisals and appraisal reviews from an independent third-party
appraiser or collateral valuations performed internally for loans determined to be collateral
dependent were not ordered, received or reviewed prior to the reporting date which could result in
overstatement of loans and income and understatement of the provision for loan losses, charge off
and the allowance for loan losses. The Special Assets Department has created procedures and updated
the Appraisal Policy to address this deficiency. The remediation plan for these internal control
deficiencies is noted below. Other than the items noted above, during the first quarter of 2011
there were no other changes in the Companys internal control over financial reporting that have
materially affected, or that are reasonably likely to materially affect, the Companys internal
control over financial reporting.
During the first quarter of 2011, management took the following remediation actions regarding
the above referenced internal control deficiencies:
1) | During the first quarter of 2011, the OCC, during their regular safety and soundness
exam, determined several loans were not properly identified by the Bank as collateral
dependent as of December 31, 2010. Collateral dependent loans require a charge off of the
loan balance if the recorded investment in the loan exceeds the underlying collateral value
net of cost to sell. To make the determination the proper recorded investment has been
recorded, the current appraised value of the collateral must be obtained. The Special
Assets Department, formed during 2009, is in charge of complying with these requirements.
During the first quarter of 2011, procedures were put in place in the Special Assets
Department to comply with these requirements and the results of their efforts have been
incorporated into the financial statements as of March 31, 2011. |
||
2) | As noted in item 1, collateral dependent loans require the Bank to obtain a current
appraisal or collateral valuation performed internally to allow for the determination as to
whether there is sufficient collateral securing the loan. In addition to the requirement of
obtaining the appraisal, the appraisal must be reviewed by an independent third-party
appraiser charged with determining the appraisal has been properly performed. After the
review, the Bank determines if the appraisal is acceptable, then provides the documentation
to the Accounting Department to incorporate the results into the calculation of the
allowance for loan losses. Failure to comply with any of these steps could result in the
overstatement of both assets and income. The Special Assets Department, as noted in item 1,
is in charge of complying with these requirements and during the first quarter of 2011,
procedures were put in place to comply with these requirements and the results of their
efforts have been incorporated into the financial statements as of March 31, 2011. |
49
Table of Contents
3) | During the first quarter of 2011, Management sought to ensure proper controls are in
place so that when either evidence of impairment of a loan exists or prior to the annual
appraisal date, the Special Assets Department will order appraisals or collateral
valuations in a timely manner to allow for proper review and incorporation of the results
into the allowance for loan loss calculation. Additional controls have also been developed
and incorporated into the process to assure a potential impairment is recorded when
appraisal or valuation and review process is not complete as of a reporting date. |
||
4) | The Bank has revised its policy and procedures to require independent third-party
appraisals or collateral valuations performed internally for all loans considered to be
impaired, classified or worse. The Special Assets Department, as noted in item 1, is in
charge of complying with these requirements and during the first quarter of 2011,
procedures were put in place to comply with these requirements and the results of their
efforts have been incorporated into the financial statements as of March 31, 2011. |
The identified material weakness in our internal controls over financial reporting will not be
considered remediated until the new controls are fully implemented, in operation for a sufficient
period of time, tested, and concluded by management to be operating effectively.
PART II OTHER INFORMATION
ITEM 1A. | RISK FACTORS |
Except as set forth below, there were no material changes to the risk factors previously
disclosed in Part I, Item 1A, of the Companys Annual Report on Form 10-K for the fiscal year ended
December 31, 2010:
The effectiveness of our asset management activities are critical to our ability to improve,
resolve or liquidate nonperforming loans and other real estate and thereby reduce loan losses and
other real estate expense.
Over the past two years, we have undertaken various initiatives to enhance our credit review, loan
administration and special asset management and administration procedures, and we believe that
these enhancements should begin to reduce the levels of our problem and potential problem assets.
However, continued improvement is dependent to a degree on market conditions and other factors
beyond our control and if we are unable to successfully manage our problem and potential problem
assets in a timely matter, we could experience materially increased loan losses and other real
estate expenses.
ITEM 6. | EXHIBITS |
Exhibits
The following exhibits are filed as a part of or incorporated by reference in this report:
Exhibit No. | Description | |||
3.1 | Charter of the Company (1) |
|||
3.2 | Amended and Restated Bylaws of the Company, as amended (2) |
|||
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended |
|||
31.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended |
|||
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|||
32.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |
(1) | Incorporated by reference to the Registrants Registration Statement on Form S-1 (333-168281)
as filed with the Securities and Exchange Commission on July 22, 2010. |
|
(2) | Incorporated by reference to the Registrants Form 8-K as filed with the Securities and Exchange
Commission March 31, 2010. |
50
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MOUNTAIN NATIONAL BANCSHARES, INC. |
||||
Date: May 16, 2011 | /s/ Dwight B. Grizzell | |||
Dwight B. Grizzell | ||||
President and Chief Executive Officer | ||||
Date: May 16, 2011 | /s/ Richard A. Hubbs | |||
Richard A. Hubbs | ||||
Senior Vice President and Chief Financial Officer |
51
Table of Contents
EXHIBIT INDEX
Exhibit No. | Description | |||
3.1 | Charter of the Company (1) |
|||
3.2 | Amended and Restated Bylaws of the Company, as amended (2) |
|||
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended |
|||
31.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant
to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended |
|||
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|||
32.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 |
(1) | Incorporated by reference to the Registrants Registration Statement on Form S-1 (333-168281)
as filed with the Securities and Exchange Commission on July 22, 2010. |
|
(2) | Incorporated by reference to the Registrants Form 8-K as filed with the Securities and
Exchange Commission on March 31, 2010. |
52