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Table of Contents

 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2011.
or
     
o   Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     .
Commission File No. 0-24172
Southeastern Bank Financial Corporation
(Exact name of registrant as specified in its charter)
     
Georgia   58-2005097
(State of Incorporation)   (I.R.S. Employer Identification No.)
3530 Wheeler Road, Augusta, Georgia 30909
(Address of principal executive offices)
(706) 738-6990
(Issuer’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the issuer 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
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
6,677,667 shares of common stock, $3.00 par value per share, outstanding as of October 27, 2011.
 
 

 

 


 

SOUTHEASTERN BANK FINANCIAL CORPORATION
FORM 10-Q
INDEX
         
    Page  
       
 
       
       
 
       
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    *  
 
       
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
     
*  
No information submitted under this caption

 

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PART I
FINANCIAL INFORMATION
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data)
                 
    September 30,        
    2011     December 31,  
    (Unaudited)     2010  
Assets
               
 
               
Cash and due from banks
  $ 74,260     $ 42,305  
Interest-bearing deposits in other banks
    8,992       22,810  
 
           
Cash and cash equivalents
    83,252       65,115  
 
               
Investment securities
               
Available-for-sale
    596,936       586,302  
Held-to-maturity, at cost (fair values of $0 and $311, respectively)
          310  
 
               
Loans held for sale
    23,504       12,775  
 
               
Loans
    838,777       874,095  
Less allowance for loan losses
    29,339       26,657  
 
           
Loans, net
    809,438       847,438  
 
               
Premises and equipment, net
    28,051       29,416  
Accrued interest receivable
    6,159       6,382  
Bank-owned life insurance
    30,446       24,178  
Restricted equity securities
    5,277       5,707  
Other real estate owned
    7,859       7,751  
Prepaid FDIC assessment
    3,537       4,784  
Deferred tax asset
    11,926       14,595  
Other assets
    3,041       2,352  
 
           
 
               
 
  $ 1,609,426     $ 1,607,105  
 
           

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data)
                 
    September 30,        
    2011     December 31,  
    (Unaudited)     2010  
Liabilities and Stockholders’ Equity
               
 
               
Deposits
               
Noninterest-bearing
  $ 135,465     $ 120,139  
Interest-bearing:
               
NOW accounts
    330,319       356,267  
Savings
    478,583       409,584  
Money management accounts
    41,937       36,937  
Time deposits over $100
    290,300       346,721  
Other time deposits
    124,668       141,089  
 
           
 
    1,401,272       1,410,737  
 
               
Securities sold under repurchase agreements
    540       818  
Advances from Federal Home Loan Bank
    52,000       60,000  
Accrued interest payable and other liabilities
    17,268       12,645  
Subordinated debentures
    22,947       22,947  
 
           
 
               
Total liabilities
    1,494,027       1,507,147  
 
           
 
               
Stockholders’ equity:
               
Preferred stock, no par value; 10,000,000 shares authorized; 0 shares outstanding in 2011 and 2010, respectively
           
Common stock, $3.00 par value; 10,000,000 shares authorized; 6,677,059 and 6,675,147 shares issued and outstanding in 2011 and 2010, respectively
    20,031       20,025  
Additional paid-in capital
    62,729       62,618  
Retained earnings
    27,580       19,548  
Accumulated other comprehensive income (loss), net
    5,059       (2,233 )
 
           
 
               
Total stockholders’ equity
    115,399       99,958  
 
           
 
               
 
  $ 1,609,426     $ 1,607,105  
 
           
See accompanying notes to consolidated financial statements.

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except share data)
(Unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Interest income:
                               
Loans, including fees
  $ 12,636     $ 13,611     $ 38,090     $ 40,471  
Investment securities
    4,450       4,169       13,280       11,543  
Federal funds sold
          2             9  
Interest-bearing deposits in other banks
    35       112       120       294  
 
                       
Total interest income
    17,121       17,894       51,490       52,317  
 
                       
 
                               
Interest expense:
                               
Deposits
    3,394       5,187       11,316       15,873  
Securities sold under repurchase agreements
    1       2       5       18  
Other borrowings
    637       912       2,014       2,757  
 
                       
Total interest expense
    4,032       6,101       13,335       18,648  
 
                       
 
                               
Net interest income
    13,089       11,793       38,155       33,669  
 
                               
Provision for loan losses
    3,535       4,759       10,198       11,841  
 
                       
 
                               
Net interest income after provision for loan losses
    9,554       7,034       27,957       21,828  
 
                       
 
                               
Noninterest income:
                               
Service charges and fees on deposits
    1,729       1,802       5,057       5,145  
Gain on sales of loans
    2,097       2,877       5,024       6,453  
Gain (loss) on sale of fixed assets
          (1 )     17       26  
Investment securities gains, net
    250       775       369       937  
Other-than-temporary loss
                               
Total impairment loss
    (64 )     (96 )     (191 )     (96 )
Less loss recognized in other comprehensive income
    (24 )           (89 )      
 
                       
Net impairment loss recognized in earnings
    (40 )     (96 )     (102 )     (96 )
Retail investment income
    444       497       1,408       1,248  
Trust service fees
    284       276       849       853  
Increase in cash surrender value of bank-owned life insurance
    302       257       768       709  
Miscellaneous income
    169       149       574       466  
 
                       
Total noninterest income
    5,235       6,536       13,964       15,741  
 
                       
 
                               
Noninterest expense:
                               
Salaries and other personnel expense
    5,990       6,115       17,208       17,524  
Occupancy expenses
    1,088       1,132       3,315       3,469  
Other real estate losses, net
    572       708       1,033       1,036  
Other operating expenses
    2,972       3,028       8,904       8,948  
 
                       
Total noninterest expense
    10,622       10,983       30,460       30,977  
 
                       
 
                               
Income before income taxes
    4,167       2,587       11,461       6,592  
 
                               
Income tax expense
    1,243       752       3,430       1,882  
 
                       
 
                               
Net income
  $ 2,924     $ 1,835     $ 8,031     $ 4,710  
 
                       
 
                               
Comprehensive income
  $ 5,637     $ 2,380     $ 15,323     $ 10,311  
 
                       

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except share data)
(Unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
                               
Basic net income per share
  $ 0.44     $ 0.27     $ 1.20     $ 0.71  
 
                       
 
                               
Diluted net income per share
  $ 0.44     $ 0.27     $ 1.20     $ 0.71  
 
                       
 
                               
Weighted average common shares outstanding
    6,677,059       6,674,465       6,676,463       6,673,912  
 
                       
 
                               
Weighted average number of common and common equivalent shares outstanding
    6,677,059       6,674,465       6,676,463       6,673,912  
 
                       
See accompanying notes to consolidated financial statements.

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
Cash flows from operating activities:
               
Net income
  $ 8,031     $ 4,710  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation
    1,862       2,018  
Deferred income tax benefit
    (1,974 )     (1,982 )
Provision for loan losses
    10,198       11,841  
Net investment securities gains
    (369 )     (937 )
Other-than-temporary impairment losses
    102       96  
Net amortization of premium on investment securities
    2,301       1,057  
Increase in CSV of bank-owned life insurance
    (768 )     (709 )
Stock options compensation cost
    95       181  
Gain on disposal of premises and equipment
    (17 )     (26 )
Deferred gain on the sale of other real estate
          (17 )
Loss (gain) on the sale of other real estate
    222       (344 )
Provision for other real estate valuation allowance
    811       1,380  
Gain on sales of loans
    (5,024 )     (6,453 )
Real estate loans originated for sale
    (171,672 )     (244,807 )
Proceeds from sales of real estate loans
    165,968       238,612  
Decrease (increase) in accrued interest receivable
    223       (135 )
Decrease in other assets
    559       6,357  
Increase in accrued interest payable and other liabilities
    2,579       2,928  
 
           
Net cash provided by operating activities
    13,127       13,770  
 
           
 
               
Cash flows from investing activities:
               
Proceeds from sales of securities
    66,946       41,907  
Proceeds from maturities and calls of available-for-sale securities
    143,928       139,190  
Proceeds from maturities and calls of held-to-maturity securities
          180  
Purchase of available-for-sale securities
    (209,255 )     (407,589 )
Purchase of restricted equity securities
    (38 )      
Proceeds from redemption of FHLB stock
    468       426  
Net decrease in loans
    22,443       32,343  
Purchase of bank-owned life insurance
    (5,500 )      
Additions to premises and equipment
    (520 )     (290 )
Proceeds from sale of other real estate
    4,218       7,760  
Proceeds from sale of premises and equipment
    40       30  
 
           
Net cash provided by (used in) investing activities
    22,730       (186,043 )
 
           

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
 
Cash flows from financing activities:
               
Net (decrease) increase in deposits
    (9,465 )     154,819  
Net decrease in securities sold under repurchase agreements
    (278 )     (2,750 )
Payments of Federal Home Loan Bank advances
    (8,000 )     (10,000 )
Proceeds from other borrowed funds
          100  
Proceeds from Directors’ stock purchase plan
    23       18  
 
           
Net cash (used in) provided by financing activities
    (17,720 )     142,187  
 
           
 
               
Net increase (decrease) in cash and cash equivalents
  $ 18,137     $ (30,086 )
 
               
Cash and cash equivalents at beginning of period
    65,115       147,994  
 
           
 
               
Cash and cash equivalents at end of period
  $ 83,252     $ 117,908  
 
           
 
               
Supplemental disclosures of cash paid during the period for:
               
Interest
  $ 14,038     $ 18,780  
 
           
 
               
Income taxes
  $ 4,669     $ (1,213 )
 
           
 
               
Supplemental information on noncash investing activities:
               
Loans transferred to other real estate
  $ 5,359     $ 7,911  
 
           
See accompanying notes to consolidated financial statements.

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011
Note 1 — Summary of Significant Accounting Policies
(a) Basis of Presentation
The accompanying consolidated financial statements include the accounts of Southeastern Bank Financial Corporation (the “Company”), and its wholly-owned subsidiaries, Georgia Bank & Trust Company of Augusta (“GB&T”) and Southern Bank & Trust (“SB&T”). Significant intercompany transactions and accounts are eliminated in consolidation. Dollar amounts are rounded to thousands except share and per share data.
The financial statements for the three and nine months ended September 30, 2011 and 2010 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2010.
In the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations and cash flows for the interim periods have been made. All such adjustments are of a normal recurring nature. The results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of the results of operations which the Company may achieve for the entire year.
Some items in the prior period financial statements were reclassified to conform to the current presentation.
(b) Interest Rate Swap Derivatives
At the inception of a derivative contract, the Company designates the derivative, based on the Company’s intentions and belief as to likely effectiveness as a hedge. A hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability is referred to as a “cash flow hedge.” For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. The changes in the fair value of the hedge that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings.

 

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Net cash settlements are recorded in interest income or interest expense, based on the item being hedged. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in the cash flows of the hedged items. To the extent that the cumulative change in anticipated cash flows from the hedging derivative offsets from 80% to 125% of the cumulative change in anticipated interest cash flows from the hedged exposure, the hedge will be deemed effective. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
(c) Recent Accounting Pronouncements
In January 2010, the FASB amended previous guidance related to fair value measurements and disclosures, which requires new disclosures for transfers in and out of Levels 1 and 2 and requires a reconciliation to be provided for the activity in Level 3 fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Levels 1 and 2 and provide an explanation for the transfers. This guidance is effective for interim periods beginning after December 15, 2009, and did not have a material effect on the Company’s results of operations or financial position.
In the reconciliation for fair value measurements using unobservable inputs (Level 3) a reporting entity should present separately information about purchases, sales, issuances, and settlements on a gross basis rather than a net basis. Disclosures relating to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurement became effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position but did require expansion of the Company’s disclosures about fair value measurements.

 

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In July 2010, the FASB amended existing guidance related to financing receivables and the allowance for credit losses, which requires further disaggregated disclosures that improve financial statement users’ understanding of 1) the nature of an entity’s credit risk associated with its financing receivables and 2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this standard did not have a material effect on the Company’s result of operations or financial position but did require expansion of the Company’s disclosures.
In April 2011, the FASB amended existing guidance to assist creditors in determining whether a modification of the terms of a receivable meets the definition of a troubled debt restructuring (“TDR”). The guidance does not change previous standards that a restructuring of debt constitutes a TDR “if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider,” but provides clarification on determining whether a debtor is in financial difficulty and if a concession was granted. The guidance is effective for interim and annual periods beginning on or after June 15, 2011, and should be applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The adoption of this guidance did not have a material effect on the Company’s results of operations or financial position, but did require expansion of the Company’s disclosures.
In June 2011, the FASB amended existing guidance relating to presentation of other comprehensive income in a convergence effort with international accounting standards. This guidance eliminates the option to present the components of comprehensive income as a part of the statement of changes in stockholders’ equity and requires a consecutive presentation of net income and other comprehensive income, and a reconciliation of the components of other comprehensive income. Similar to the requirements of existing guidance, entities are required to present on the face of the financial statements reclassification adjustments for items that are reclassified from OCI to net income in the statements where the components of net income and OCI are presented. The amendments in this guidance should be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted and the amendments do not require any transition disclosures. The adoption of this guidance will not have an effect on the Company’s results of operations or financial position but will require expansion of the Company’s financial statement presentation.

 

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Note 2 — Investment Securities
The following tables summarize the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio at September 30, 2011 and December 31, 2010 and the corresponding amounts of unrealized gains and losses therein.
                                 
    September 30, 2011  
            Gross     Gross        
    Amortized     unrealized     unrealized     Estimated  
    cost     gains     losses     fair value  
    (Dollars in thousands)  
Available-for-sale
                               
Obligations of U.S. Government agencies
  $ 175,434       1,160       (29 )     176,565  
Obligations of states and political subdivisions
    89,267       4,597       (14 )     93,850  
Mortgage backed securities
                               
U.S. GSE’s* MBS — residential
    159,498       4,540       (124 )     163,914  
U.S. GSE’s CMO
    115,230       1,777       (353 )     116,654  
Other CMO
    2,293             (195 )     2,098  
Corporate bonds
    44,891       129       (1,165 )     43,855  
 
                       
 
  $ 586,613       12,203       (1,880 )     596,936  
 
                       
     
*  
Government sponsored entities
                                 
    December 31, 2010  
            Gross     Gross        
    Amortized     unrealized     unrealized     Estimated  
    cost     gains     losses     fair value  
    (Dollars in thousands)  
Available-for-sale
                               
Obligations of U.S. Government agencies
  $ 202,153       527       (1,763 )     200,917  
Obligations of states and political subdivisions
    67,137       318       (3,337 )     64,118  
Mortgage backed securities
                               
U.S. GSE’s MBS — residential
    141,524       1,880       (1,679 )     141,725  
U.S. GSE’s CMO
    139,208       1,756       (630 )     140,334  
Other CMO
    3,382       50       (359 )     3,073  
Corporate bonds
    36,551       467       (885 )     36,133  
Equity securities
    2                   2  
 
                       
 
  $ 589,957       4,998       (8,653 )     586,302  
 
                       
 
                               
Held-to-maturity
                               
Obligations of states and political subdivisions
  $ 310       1             311  
 
                       
 
  $ 310       1             311  
 
                       

 

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Proceeds from sales of securities and the associated gains (losses) for the three and nine months ended September 30, 2011 and 2010 were as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
 
                               
Proceeds
  $ 6,962     $ 21,543     $ 66,946     $ 41,907  
Gross Gains
    233       822       672       1,178  
Gross Losses
          (70 )     (358 )     (284 )
The amortized cost and fair value of the investment securities portfolio excluding equity securities are shown 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.
                 
    September 30, 2011  
    Amortized     Estimated  
    cost     fair value  
    (Dollars in thousands)  
Available-for-sale:
               
One year or less
  $ 161       163  
After one year through five years
    24,155       24,175  
After five years through ten years
    75,124       76,401  
After ten years
    487,173       496,197  
 
           
 
  $ 586,613       596,936  
 
           

 

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The following tables summarize the investment securities with unrealized losses at September 30, 2011 and December 31, 2010, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.
                                                 
    September 30, 2011  
    Less than 12 months     12 months or longer     Total  
    Estimated     Unrealized     Estimated     Unrealized     Estimated     Unrealized  
    fair value     loss     fair value     loss     fair value     loss  
    (Dollars in thousands)  
Temporarily impaired
                                               
Obligations of U.S. Government agencies
  $ 15,499       25       2,587       4       18,086       29  
Obligations of states and political subdivisions
    1,299       14                   1,299       14  
Mortgage backed securities
                                               
U.S. GSE’s MBS — residential
    7,725       28       427       96       8,152       124  
U.S. GSE’s CMO
    25,125       296       5,476       57       30,601       353  
Other CMO
    291       16       1,315       160       1,606       176  
Corporate bonds
    11,711       447       11,441       718       23,152       1,165  
 
                                   
 
  $ 61,650       826       21,246       1,035       82,896       1,861  
 
                                   
 
                                               
Other-than-temporarily impaired
                                               
Mortgage backed securities
                                               
Other CMO
  $             492       19       492       19  
 
                                   
 
  $ 61,650       826       21,738       1,054       83,388       1,880  
 
                                   
                                                 
    December 31, 2010  
    Less than 12 months     12 months or longer     Total  
    Estimated     Unrealized     Estimated     Unrealized     Estimated     Unrealized  
    fair value     loss     fair value     loss     fair value     loss  
    (Dollars in thousands)  
Temporarily impaired
                                               
Obligations of U.S. Government agencies
  $ 99,306       1,763                   99,306       1,763  
Obligations of states and political subdivisions
    45,906       3,245       2,309       92       48,215       3,337  
Mortgage backed securities
                                               
U.S. GSE’s MBS — residential
    81,783       1,538       509       141       82,292       1,679  
U.S. GSE’s CMO
    46,776       630                   46,776       630  
Other CMO
                2,085       359       2,085       359  
Corporate bonds
    22,385       481       3,880       404       26,265       885  
 
                                   
 
  $ 296,156       7,657       8,783       996       304,939       8,653  
 
                                   
Other-Than-Temporary Impairment — September 30, 2011
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under the provisions of ASC 320-10, Investments — Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

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When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
As of September 30, 2011, the Company’s security portfolio consisted of 358 securities, 45 of which were in an unrealized loss position. Of these securities with unrealized losses, 97.71% were related to the Company’s mortgage-backed and corporate securities as discussed below.
Mortgage-backed Securities
At September 30, 2011, $280,568 or approximately 99.26% of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2011.
The Company’s mortgage-backed securities portfolio also includes five non-agency collateralized mortgage obligations with a market value of $2,098 which had unrealized losses of approximately $195 at September 30, 2011. These non-agency securities were rated AAA at purchase.
At September 30, 2011, four of these non-agency securities were rated below investment grade and a cash flow analysis was performed. According to our model, none of these securities were considered other-than-temporarily impaired. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. During the first quarter of 2011, one of the non-agency mortgage-backed securities was considered to be other-than-temporarily impaired with an OTTI loss of $127, of which $62 was recognized in earnings. An additional OTTI loss of $64, of which $40 was recognized in earnings, was taken on this security during the third quarter of 2011. This security remains classified as available-for-sale at September 30, 2011.

 

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At September 30, 2011, the fair values of three collateralized mortgage obligations totaling $1,722 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on a yield of 10% that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.
Corporate Securities
The Company holds twenty-two corporate securities totaling $43,855, of which fourteen had an unrealized loss of $1,165. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At September 30, 2011, seven securities to three issuers were not rated. None of the issuers were in default but in January of 2011 the Company was notified that two trust preferred securities totaling $1,250 to two issuers not rated had elected to defer interest payments. The issuers are both bank holding companies with operations in the Southeast. One of the issuers of $1,000 of such securities announced a successful capital raise which was completed in the first quarter of 2011 and during the third quarter this issuer brought current all interest previously deferred. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Although one issuer continues to indicate they will defer payments going forward, the Company has considered the capital position of the subsidiary banks, the liquidity of the holding company, the existence and severity of publicly available regulatory agreements, and the fact that these deferrals are coming after the most severe impact of the national and regional recession. The prospect of capital formation in the current market, improving operating results of the industry overall have caused the Company to conclude that a return to normal subsidiary dividends and thus interest payments on the debt for these issuers is reasonably assured at this time. Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2011.

 

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At September 30, 2011, the fair values of four corporate securities totaling $2,446 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on a yield of 10% or current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
The table below presents a roll forward of the credit losses recognized in earnings for the nine month period ended September 30, 2011.
         
Beginning balance, January 1, 2011
  $ 571  
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized
     
Additions/Subtractions
       
Amounts realized for securities sold during the period
     
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis
     
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security
     
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized
    102  
 
     
 
       
Ending balance, September 30, 2011
  $ 673  
 
     
Total other-than-temporary impairment recognized in accumulated other comprehensive income for the nine month period was $89 as of September 30, 2011.
Other-Than-Temporary Impairment — September 30, 2010
As of September 30, 2010, the Company’s security portfolio consisted of 305 securities, 52 of which were in an unrealized loss position. The majority or 95.00% of unrealized losses were related to the Company’s mortgage-backed and corporate securities. Based on management’s evaluation at September 30, 2010, one security was determined to be other-than-temporarily impaired, as discussed below.

 

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Mortgage-backed Securities
At September 30, 2010, $256,375 or approximately 98.52% of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2010.
The Company’s mortgage-backed securities portfolio also includes five non-agency collateralized mortgage obligations with a market value of $3,858, of which four had unrealized losses of approximately $87 at September 30, 2010. These non-agency securities were rated AAA at purchase.
At September 30, 2010, four of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. Upon completion of the September 30, 2010 analysis, our model indicated other-than-temporary impairment on one of these securities. This security had OTTI losses of $96 and remained classified as available-for-sale at September 30, 2010.
At September 30, 2010, the fair values of three collateralized mortgage obligations totaling $2,925 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on a yield that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.
Corporate Securities
The Company holds nineteen corporate securities totaling $32,990, of which seven had an unrealized loss of $273. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At September 30, 2010 two of the corporate securities were rated below investment grade. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. 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 September 30, 2010.

 

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At September 30, 2010, the fair values of twelve corporate securities totaling $10,919 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
The table below presents a roll forward of the credit losses recognized in earnings for the nine month period ended September 30, 2010.
         
Beginning balance, January 1, 2010
  $ 475  
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized
    96  
Additions/Subtractions
       
Amounts realized for securities sold during the period
     
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis
     
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security
     
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized
     
 
     
 
       
Ending balance, September 30, 2010
  $ 571  
 
     
Total other-than-temporary impairment recognized in accumulated other comprehensive income for the nine month period ended September 30, 2010 was not material.

 

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Note 3 — Loans
The following table summarizes loans at September 30, 2011 and December 31, 2010.
                 
    September 30, 2011     December 31, 2010  
    (Dollars in thousands)  
 
               
Commercial, financial, and agricultural
  $ 160,567       189,128  
Real estate:
               
Commercial
    338,205       327,458  
Residential
    158,826       157,680  
Acquisition, development and construction
    165,745       182,412  
Consumer installment
    15,338       17,412  
 
           
 
  $ 838,681       874,090  
 
Less allowance for loan losses
    29,339       26,657  
Less deferred loan origination fees (costs)
    (96 )     (5 )
 
           
 
  $ 809,438       847,438  
 
           

 

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The following tables present the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2011 and December 31, 2010.
                                                                 
    September 30, 2011  
    Commercial,                                            
    Financial, and     CRE - Owner     CRE - Non Owner     Residential     ADC     ADC              
    Agricultural     Occupied     Occupied     Real Estate     CSRA     Other     Consumer     Total  
    (Dollars in thousands)  
Allowance for loan losses:
                                                               
Beginning balance
  $ 3,463       3,921       4,777       5,372       5,097       3,396       631       26,657  
Charge-offs
    1,154       621       621       1,605       1,255       2,260       526       8,042  
Recoveries
    154       5             23             6       338       526  
Provision
    1,391       2,926       1,117       1,510       1,067       2,122       65       10,198  
 
                                               
Ending balance
  $ 3,854       6,231       5,273       5,300       4,909       3,264       508       29,339  
 
                                               
 
                                                               
Ending balance attributable to loans:
                                                               
Individually evaluated for impairment
    125                   35                         160  
Collectively evaluated for impairment
    3,729       6,231       5,273       5,265       4,909       3,264       508       29,179  
 
                                               
 
  $ 3,854       6,231       5,273       5,300       4,909       3,264       508       29,339  
 
                                               
 
                                                               
Loans:
                                                               
Individually evaluated for impairment
    2,396       4,231       6,494       4,584       4,646       4,547       133       27,031  
Collectively evaluated for impairment
    158,171       187,596       139,884       154,242       134,944       21,608       15,205       811,650  
 
                                               
 
  $ 160,567       191,827       146,378       158,826       139,590       26,155       15,338       838,681  
 
                                               
                                                                 
    December 31, 2010  
    Commercial,                                            
    Financial, and     CRE - Owner     CRE - Non Owner     Residential     ADC     ADC              
    Agricultural     Occupied     Occupied     Real Estate     CSRA     Other     Consumer     Total  
    (Dollars in thousands)  
Allowance for loan losses:
                                                               
Ending balance attributable to loans:
                                                               
Individually evaluated for impairment
  $       3       210       42       156       1,063             1,474  
Collectively evaluated for impairment
    3,463       3,918       4,567       5,330       4,941       2,333       631       25,183  
 
                                               
 
  $ 3,463       3,921       4,777       5,372       5,097       3,396       631       26,657  
 
                                               
 
                                                               
Loans:
                                                               
Individually evaluated for impairment
    1,744       519       3,407       4,971       4,492       9,915             25,048  
Collectively evaluated for impairment
    187,384       183,944       139,588       152,709       144,078       23,927       17,412       849,042  
 
                                               
 
  $ 189,128       184,463       142,995       157,680       148,570       33,842       17,412       874,090  
 
                                               

 

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The following tables present loans individually evaluated for impairment by class of loans as of September 30, 2011 and December 31, 2010.
                                                 
    September 30, 2011  
                    Allowance for     Average             Cash Basis  
    Unpaid Principal     Recorded     Loan Losses     Recorded     Interest Income     Interest Income  
    Balance (1)     Investment     Allocated     Investment     Recognized     Recognized  
    (Dollars in thousands)  
With no related allowance recorded: (2)
                                               
Commercial, financial, and agricultural:
                                               
Commerical
  $ 100       100             100              
Financial
                                   
Agricultural
    1,299       1,299             1,324       31       31  
Equity lines
    732       732             732              
Other
                                   
Commercial real estate:
                                               
Owner occupied
    4,231       4,231             4,530       13       13  
Non Owner occupied
    6,494       6,499             6,487              
Residential real estate:
                                               
Secured by first liens
    4,185       4,187             4,736       13       13  
Secured by junior liens
    239       239             428       9       9  
Acquisition, development and construction:
                                               
Residential
                                   
Other
    9,193       9,193             11,921              
Consumer
    133       133             133              
 
                                   
 
    26,606       26,613             30,391       66       66  
 
                                   
With an allowance recorded:
                                               
Commercial, financial, and agricultural:
                                               
Commerical
    72       72       10       3              
Financial
                                   
Agricultural
    193       193       115       88              
Equity lines
                                   
Other
                                   
Commercial real estate:
                                               
Owner occupied
                                   
Non Owner occupied
                                   
Residential real estate:
                                               
Secured by first liens
    160       161       35       160              
Secured by junior liens
                                   
Acquisition, development and construction:
                                               
Residential
                                   
Other
                                   
Consumer
                                   
 
                                   
 
    425       426       160       251              
 
                                   
 
                                               
 
  $ 27,031       27,039       160       30,642       66       66  
 
                                   
     
(1)  
The Unpaid Principal Balance is net of any partial charge-offs.
 
(2)  
No specific allowance for credit losses is allocated to these loans since they are sufficiently collateralized or had charge-offs.

 

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    December 31, 2010  
                    Allowance for  
    Unpaid Principal     Recorded     Loan Losses  
    Balance     Investment     Allocated  
    (Dollars in thousands)  
With no related allowance recorded:
                       
Commercial, financial, and agricultural:
                       
Commerical
  $ 8       8        
Financial
                 
Agricultural
    1,016       1,016        
Equity lines
    720       720        
Other
                 
Commercial real estate:
                       
Owner occupied
    390       390        
Non Owner occupied
    180       180        
Residential real estate:
                       
Secured by first liens
    1,742       1,742        
Secured by junior liens
                 
Acquisition, development and construction:
                       
Residential
    636       636        
Other
    5,987       5,987        
Consumer
                 
 
                 
 
    10,679       10,679        
 
                 
With an allowance recorded:
                       
Commercial, financial, and agricultural:
                       
Commerical
                 
Financial
                 
Agricultural
                 
Equity lines
                 
Other
                 
Commercial real estate:
                       
Owner occupied
    129       129       3  
Non Owner occupied
    3,227       3,230       210  
Residential real estate:
                       
Secured by first liens
    3,229       3,234       42  
Secured by junior liens
                 
Acquisition, development and construction:
                       
Residential
    156       156        
Other
    7,628       7,638       1,219  
Consumer
                 
 
                 
 
    14,369       14,387       1,474  
 
                 
 
                       
 
  $ 25,048       25,066       1,474  
 
                 

 

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Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2011 and December 31, 2010.
                 
    September 30, 2011  
            Loans Past Due  
            90 Days or More  
    Nonaccrual     Still Accruing  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
               
Commerical
  $ 382        
Financial
           
Agricultural
    1,912        
Equity lines
    1,553        
Other
           
Commercial real estate:
               
Owner occupied
    4,363        
Non Owner occupied
    5,345        
Residential real estate:
               
Secured by first liens
    3,904        
Secured by junior liens
    311        
Acquisition, development and construction:
               
Residential
    4        
Other
    9,368        
Consumer
    270        
 
           
 
  $ 27,412        
 
           

 

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Table of Contents

                 
    December 31, 2010  
            Loans Past Due  
            90 Days or More  
    Nonaccrual     Still Accruing  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
               
Commerical
  $ 190        
Financial
           
Agricultural
    1,250        
Equity lines
    1,136        
Other
    348        
Commercial real estate:
               
Owner occupied
    1,207        
Non Owner occupied
    2,586        
Residential real estate:
               
Secured by first liens
    4,551       69  
Secured by junior liens
    183        
Acquisition, development and construction:
               
Residential
    1,275        
Other
    10,678        
Consumer
    301        
 
           
 
  $ 23,705       69  
 
           
The following tables present the aging of the recorded investment in past due loans as of September 30, 2011 and December 31, 2010 by class of loans.
                                                 
    September 30, 2011  
    30 - 89 Days     90 Days or     Nonaccrual     Total     Loans Not        
    Past Due     More Past Due     Loans     Past Due     Past Due     Total  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
                                               
Commerical
  $ 148             382       530       95,669       96,199  
Financial
                            3,307       3,307  
Agricultural
    136             1,912       2,048       12,627       14,675  
Equity lines
    139             1,553       1,692       37,915       39,607  
Other
                            6,779       6,779  
Commercial real estate:
                                               
Owner occupied
    2,187             4,363       6,550       185,282       191,832  
Non Owner occupied
    1,176             5,345       6,521       139,852       146,373  
Residential real estate:
                                               
Secured by first liens
    1,058             3,904       4,962       144,310       149,272  
Secured by junior liens
    47             311       358       9,196       9,554  
Acquisition, development and construction:
                                               
Residential
                4       4       38,934       38,938  
Other
    1,972             9,368       11,340       115,467       126,807  
Consumer
    167             270       437       14,901       15,338  
 
                                   
 
  $ 7,030             27,412       34,442       804,239       838,681  
 
                                   

 

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    December 31, 2010  
    30 - 89 Days     90 Days or     Nonaccrual     Total     Loans Not        
    Past Due     More Past Due     Loans     Past Due     Past Due     Total  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
                                               
Commerical
  $ 170             190       360       117,786       118,146  
Financial
                            3,588       3,588  
Agricultural
                1,250       1,250       12,940       14,190  
Equity lines
    214             1,136       1,350       41,687       43,037  
Other
                348       348       9,819       10,167  
Commercial real estate:
                                               
Owner occupied
    317             1,207       1,524       182,939       184,463  
Non Owner occupied
    521             2,586       3,107       139,888       142,995  
Residential real estate:
                                               
Secured by first liens
    2,417       69       4,551       7,037       140,238       147,275  
Secured by junior liens
    155             183       338       10,067       10,405  
Acquisition, development and construction:
                                               
Residential
                1,275       1,275       41,538       42,813  
Other
    121             10,678       10,799       128,800       139,599  
Consumer
    31             301       332       17,080       17,412  
 
                                   
 
  $ 3,946       69       23,705       27,720       846,370       874,090  
 
                                   
Troubled Debt Restructurings:
The Company has troubled debt restructurings (TDRs) with a balance of $4,572 and $3,514 included in impaired loans at September 30, 2011 and December 31, 2010, respectively. Specific reserves of $45 and $80 have been allocated to customers whose loan terms have been modified in TDRs as of September 30, 2011 and December 31, 2010. The Company is not committed to lend additional amounts as of September 30, 2011 and December 31, 2010 to customers with outstanding loans that are classified as TDRs. The following table presents TDRs as of September 30, 2011.

 

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    September 30, 2011  
            Pre-Modification     Post-Modification  
    Number of     Outstanding     Outstanding  
    Loans     Recorded Investment     Recorded Investment  
    (Dollars in thousands)  
Troubled Debt Restructurings:
                       
Commercial, financial, and agricultural:
                       
Commerical
    1     $ 72     $ 72  
Financial
                 
Agricultural
                 
Equity lines
                 
Other
                 
Commercial real estate:
                       
Owner occupied
    3       711       580  
Non Owner occupied
    5       2,527       2,047  
Residential real estate:
                       
Secured by first liens
    7       2,121       1,739  
Secured by junior liens
    2       143       83  
Acquisition, development and construction:
                       
Residential
                 
Other
                 
Consumer
    2       53       51  
 
                 
Total
    20     $ 5,627     $ 4,572  
 
                 
During the periods ended September 30, 2011 and 2010, the terms of certain loans were modified as TDRs. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.
Modifications involving a reduction of the stated interest rate of the loan were for rate reductions ranging from 2.00% to 5.00%. Modifications involving an extension of the maturity date were for periods ranging from 2 months to 84 months.

 

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The following table presents loans by class modified as TDRs that occurred during the three and nine months ended September 30, 2011 and 2010.
                                                 
    Three Months Ended
September 30, 2011
    Three Months Ended
September 30, 2010
 
            Pre-Modification     Post-Modification             Pre-Modification     Post-Modification  
    Number of     Outstanding     Outstanding     Number of     Outstanding     Outstanding  
    Loans     Recorded Investment     Recorded Investment     Loans     Recorded Investment     Recorded Investment  
    (Dollars in thousands)     (Dollars in thousands)  
Troubled Debt Restructurings:
                                               
Commercial, financial, and agricultural:
                                               
Commerical
    1     $ 72     $ 72       1     $ 126     $ 117  
Financial
                                   
Agricultural
                                   
Equity lines
                                   
Other
                                   
Commercial real estate:
                                               
Owner occupied
    1       193       187                    
Non Owner occupied
                      1       196       185  
Residential real estate:
                                               
Secured by first liens
    1       161       161                    
Secured by junior liens
                      1       48       44  
Acquisition, development and construction:
                                               
Residential
                                   
Other
                                   
Consumer
    1       33       32                    
 
                                   
Total
    4     $ 459     $ 452       3     $ 370     $ 346  
 
                                   
                                                 
    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
            Pre-Modification     Post-Modification             Pre-Modification     Post-Modification  
    Number of     Outstanding     Outstanding     Number of     Outstanding     Outstanding  
    Loans     Recorded Investment     Recorded Investment     Loans     Recorded Investment     Recorded Investment  
    (Dollars in thousands)     (Dollars in thousands)  
Troubled Debt Restructurings:
                                               
Commercial, financial, and agricultural:
                                               
Commerical
    1     $ 72     $ 72       1     $ 126     $ 117  
Financial
                                   
Agricultural
                                   
Equity lines
                                   
Other
                                   
Commercial real estate:
                                               
Owner occupied
    3       711       580       1       131       130  
Non Owner occupied
    1       76       75       3       1,831       1,802  
Residential real estate:
                                               
Secured by first liens
    5       1,044       552                    
Secured by junior liens
    2       143       83       1       48       44  
Acquisition, development and construction:
                                               
Residential
                                   
Other
                                   
Consumer
    2       53       51                    
 
                                   
Total
    14     $ 2,099     $ 1,413       6     $ 2,136     $ 2,093  
 
                                   
The TDRs described above increased the allowance for loan losses by $170 and $410 for the three and nine months ended September 30, 2011 and resulted in charge-offs of $125 and $365 for the three and nine months ended September 30, 2011, respectively.
For the three and nine months ended September 30, 2010, the TDRs described above increased the allowance for loan losses by $0 and $350, respectively. There were no charge-offs taken on these TDRs for the three and nine months ended September 30, 2010.

 

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Charge-offs on such loans are factored into the rolling historical loss rate, which is used in the calculation of the allowance for loan losses.
A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. During the nine months ended September 30, 2011, one residential real estate loan with a recorded investment of $10 at September 30, 2011 defaulted resulting in a $36 charge-off during the third quarter of 2011. There were no TDRs with payment defaults during the nine months ended September 30, 2010. As of September 30, 2011, all other TDRs are performing according to their modified terms.
The terms of certain other loans were modified during the nine month period ended September 30, 2011 and 2010 that did not meet the definition of a TDR. These loans have a total recorded investment as of September 30, 2011 and 2010 of $10,453 and $8,210, respectively. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.
Certain loans which were modified during the nine month period ended September 30, 2011 and 2010 and did not meet the definition of a TDR, as the modification was a delay in a payment that was considered to be insignificant, had delays in payment ranging from 30 days to 4 months.
Credit Quality Indicators:
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, through its originating account officer, places an initial credit risk rating on every loan. An annual review and analysis of loan relationships (irrespective of loan types included in the overall relationship) with total related exposure of $500 or greater is performed by the Credit Administration department in order to update risk ratings given current available information. The Company uses the following definitions for risk ratings.
Watch: Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard: 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.

 

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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 facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of September 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows.
                                 
    September 30, 2011  
    Pass     Watch     Substandard     Doubtful  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
                               
Commerical
  $ 87,763       5,127       3,309        
Financial
    954       2,353              
Agricultural
    10,102       1,927       2,646        
Equity lines
    36,692       1,114       1,801        
Other
    5,846       328       605        
Commercial real estate:
                               
Owner occupied
    163,709       13,622       14,501        
Non Owner occupied
    114,798       23,861       7,714        
Residential real estate:
                               
Secured by first liens
    129,525       11,057       8,690        
Secured by junior liens
    8,230       926       398        
Acquisition, development and construction:
                               
Residential
    37,974       760       204        
Other
    93,399       10,888       22,520        
Consumer
    14,466       397       475        
 
                       
 
  $ 703,458       72,360       62,863        
 
                       

 

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    December 31, 2010  
    Pass     Watch     Substandard     Doubtful  
    (Dollars in thousands)  
Commercial, financial, and agricultural:
                               
Commerical
  $ 103,337       8,074       6,735        
Financial
    1,103       2,485              
Agricultural
    9,343       2,609       2,238        
Equity lines
    39,144       1,915       1,978        
Other
    8,893       926       348        
Commercial real estate:
                               
Owner occupied
    157,155       22,329       4,979        
Non Owner occupied
    119,160       16,579       7,256        
Residential real estate:
                               
Secured by first liens
    124,261       14,837       8,177        
Secured by junior liens
    9,418       708       279        
Acquisition, development and construction:
                               
Residential
    38,374       2,721       1,718        
Other
    92,514       23,285       23,800        
Consumer
    16,247       567       598        
 
                       
 
  $ 718,949       97,035       58,106        
 
                       
Note 4 — Fair Value Measurements
Fair value is the exchange price that would be received to sell 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 at the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:
     
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 market 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 company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

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In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.
Interest Rate Swap Derivatives: The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date (Level 2 inputs). The fair value adjustment is included in other liabilities.
Mortgage Banking Derivatives: The fair value of mortgage banking derivatives is determined by individual third party sales contract prices for the specific loans held at each reporting period end (Level 2 inputs). The fair value adjustment is included in other assets.
Loans Held for Sale: Loans held for sale are carried at fair value, as determined by outstanding commitments, from third party investors (Level 2).
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally 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 typically significant and result in a Level 3 classification of the inputs for determining fair value.
Investments in Tax Credits: The fair values for tax credits are measured on a recurring basis and are based upon total credits and deductions remaining to be allocated and total estimated credits and deductions to be allocated (Level 3 inputs).
Other Real Estate Owned: The fair value of other real estate owned is generally 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 typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

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Assets and Liabilities Measured on a Recurring Basis
The following tables present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy as of September 30, 2011 and December 31, 2010.
                                 
            Quoted Prices in             Significant  
            Active Markets for     Significant Other     Unobservable  
    September 30,     Identical Assets     Observable Inputs     Inputs  
    2011     (Level 1)     (Level 2)     (Level 3)  
    (Dollars in thousands)  
Assets:
                               
Available-for-sale securities
                               
Obligations of U.S. Government agencies
  $ 176,565       53,030       123,535        
Obligations of states and political subdivisions
    93,850             93,850        
Mortgage-backed securities
                               
U.S. GSE’s MBS — residential
    163,914             163,478       436  
U.S. GSE’s CMO
    116,654             116,654        
Other CMO
    2,098             376       1,722  
Corporate bonds
    43,855             41,409       2,446  
 
                       
Total available-for-sale securities
  $ 596,936       53,030       539,302       4,604  
 
                       
 
                               
Tax credits
    296                   296  
 
                               
Loans held for sale
    23,504             23,504        
 
                               
Mortgage banking derivatives
    49             49        
 
                       
 
                               
 
  $ 620,785       53,030       562,855       4,900  
 
                       
 
                               
Liabilities:
                               
Interest rate swap derivatives
    2,044             2,044        
 
                       
 
                               
 
  $ 2,044             2,044        
 
                       

 

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            Quoted Prices in             Significant  
            Active Markets for     Significant Other     Unobservable  
    December 31,     Identical Assets     Observable Inputs     Inputs  
    2010     (Level 1)     (Level 2)     (Level 3)  
    (Dollars in thousands)  
Available-for-sale securities
                               
Obligations of U.S. Government agencies
  $ 200,917       31,405       169,512        
Obligations of states and political subdivisions
    64,118             64,118        
Mortgage-backed securities
                               
U.S. GSE’s MBS — residential
    141,725             141,216       509  
U.S. GSE’s CMO
    140,334       985       139,349        
Other CMO
    3,073             663       2,410  
Corporate bonds
    36,133             25,395       10,738  
Equity securities
    2       2              
 
                       
Total available-for-sale securities
  $ 586,302       32,392       540,253       13,657  
 
                       
 
                               
Tax credits
    356                   356  
 
                               
Loans held for sale
    12,775             12,775        
 
                               
Mortgage banking derivatives
    2             2        
 
                       
 
                               
Total
  $ 599,435       32,392       553,030       14,013  
 
                       
During the nine months ended September 30, 2011, six U.S. agency securities with a market value of $15,564 were transferred out of Level 2 and into Level 1. During the first quarter of 2011, eight corporate securities with a market value of $7,278 were transferred out of Level 3 and into Level 2 based on observable market data for these securities due to increased market activity for these securities. The tables below present a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of September 30, 2011 and 2010.

 

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    Fair Value Measurements Using Significant Unobservable Inputs  
            (Level 3)        
            Available-for-sale        
    Tax credits     Securities     Total  
    (Dollars in thousands)  
Beginning balance, January 1, 2011
  $ 356       13,657       14,013  
Total gains or losses (realized/unrealized)
                       
Included in earnings
                       
Gain (loss) on sales
                 
Other-than-temporary impairment
          (102 )     (102 )
Amortization of tax credit investment
    (60 )           (60 )
Included in other comprehensive income
          (1,673 )     (1,673 )
Purchases, sales, issuances and settlements
                       
Purchases
                 
Sales
                 
Issuances
                 
Settlements
                 
Transfers into Level 3
                 
Transfers out of Level 3
          (7,278 )     (7,278 )
 
                 
 
                       
Ending balance, September 30, 2011
  $ 296       4,604       4,900  
 
                 
                         
    Fair Value Measurements Using Significant Unobservable Inputs  
            (Level 3)        
            Available-for-sale        
    Tax credits     Securities     Total  
    (Dollars in thousands)  
 
                       
Beginning balance, January 1, 2010
  $ 435       14,365       14,800  
Total gains or losses (realized/unrealized)
                       
Included in earnings
                       
Gain (loss) on sales
          (122 )     (122 )
Other-than-temporary impairment
          (96 )     (96 )
Amortization of tax credit investment
    (60 )           (60 )
Included in other comprehensive income
          1,940       1,940  
Purchases, sales, issuances and settlements
                       
Purchases
                 
Sales
          (1,790 )     (1,790 )
Issuances
                 
Settlements
                 
Transfers into Level 3
                 
Transfers out of Level 3
                 
 
                 
 
                       
Ending balance, September 30, 2010
  $ 375       14,297       14,672  
 
                 

 

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Assets and Liabilities Measured on a Non-Recurring Basis
Assets and liabilities measured at fair value on a non-recurring basis as of September 30, 2011 and December 31, 2010 are summarized below.
                                 
            Quoted Prices in             Significant  
            Active Markets for     Significant Other     Unobservable  
    September 30,     Identical Assets     Observable Inputs     Inputs  
    2011     (Level 1)     (Level 2)     (Level 3)  
    (Dollars in thousands)  
Assets:
                               
Impaired loans
                               
Commercial, financial, and agricultural
  $ 240                   240  
Real estate:
                               
Commercial
    7,196                   7,196  
Residential
    3,174                   3,174  
Acquisition, development and construction
    7,498                   7,498  
Consumer installment
    82                   82  
 
                       
Total impaired loans (1)
  $ 18,190                   18,190  
 
                       
 
                               
Other real estate owned
    7,859                   7,859  
 
                       
 
                               
Total
  $ 26,049                   26,049  
 
                       
     
(1)  
Includes loans directly charged down to fair value.
                                 
            Quoted Prices in                
            Active Markets for             Significant  
            Identical     Significant Other     Unobservable  
    December 31,     Assets     Observable Inputs     Inputs  
    2010     (Level 1)     (Level 2)     (Level 3)  
    (Dollars in thousands)  
Assets:
                               
Impaired loans
                               
Commercial, financial, and agricultural
  $                    
Real estate:
                               
Commercial
    3,143                   3,143  
Residential
    3,187                   3,187  
Acquisition, development and construction
    6,565                   6,565  
Consumer installment
                       
 
                       
Total impaired loans
  $ 12,895                   12,895  
 
                       
 
                               
Other real estate owned
    7,751                   7,751  
 
                       
 
                               
Total
  $ 20,646                   20,646  
 
                       

 

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The following represents impairment charges recognized during the period:
Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $18,350, with a valuation allowance of $160, resulting in an additional provision for loan losses of $1,057 and $3,934 for the three and nine months ended September 30, 2011, respectively. Impaired loans that are not carried at fair value had a carrying amount of $8,681 at September 30, 2011.
As of December 31, 2010, impaired loans had a carrying amount of $14,369, with a valuation allowance of $1,474, resulting in an additional provision for loan losses of $6,831 for the year ending 2010. Impaired loans that are not carried at fair value had a carrying amount of $10,679 at December 31, 2010.
Other real estate owned, which is carried at lower of cost or fair value, was $7,859 which consisted of the outstanding balance of $10,371, less a valuation allowance of $2,512, resulting in a write down of $563 and $811 for the three and nine months ended September 30, 2011, respectively.
As of December 31, 2010, other real estate owned was $7,751 which consisted of the outstanding balance of $9,866, less a valuation allowance of $2,115, resulting in a write down of $1,909 for the year ending 2010.
Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and 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 Company’s entire holdings of a particular financial instrument.
Because no market exists for a portion of the Company’s 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 and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet 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. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.

 

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The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
  (a)  
Cash and Cash Equivalents
 
     
Fair value equals the carrying value of such assets due to their nature.
 
  (b)  
Loans, net
 
     
The fair value of loans is calculated using discounted cash flows by loan type. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of related accrued interest receivable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed. The carrying amount of real estate loans originated for sale approximates their fair value. The allowance for loan losses is considered a reasonable discount for credit risk.
 
  (c)  
Deposits
 
     
Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities. The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values. The carrying amount of related accrued interest payable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed.
 
  (d)  
Securities Sold Under Repurchase Agreements
 
     
Fair value approximates the carrying value of such liabilities due to their short-term nature.
 
  (e)  
Advances from Federal Home Loan Bank
 
     
The fair value of the Federal Home Loan Bank (“FHLB”) advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms.
 
  (f)  
Subordinated debentures
 
     
The fair value for subordinated debentures is calculated based upon current market spreads to LIBOR for debt of similar remaining maturities and collateral terms.

 

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  (g)  
Commitments
 
     
The difference between the carrying values and fair values of commitments to extend credit are not significant and are not disclosed.
The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2011 and December 31, 2010 are as follows:
                 
    September 30, 2011  
    Carrying     Estimated  
    amount     fair value  
    (Dollars in thousands)  
Financial assets:
               
Cash and cash equivalents
  $ 83,252       83,252  
Loans, net
    832,942       832,913  
Financial liabilities:
               
Deposits with stated maturities
    414,968       418,317  
Deposits without stated maturities
    986,304       986,304  
Securities sold under repurchase agreements
    540       540  
Advances from FHLB
    52,000       58,734  
Subordinated debentures
    22,947       15,120  
                 
    December 31, 2010  
    Carrying     Estimated  
    amount     fair value  
    (Dollars in thousands)  
Financial assets:
               
Cash and cash equivalents
  $ 65,115       65,115  
Loans, net
    860,213       858,505  
Financial liabilities:
               
Deposits with stated maturities
    487,810       491,867  
Deposits without stated maturities
    922,927       922,927  
Securities sold under repurchase agreements
    818       818  
Advances from FHLB
    60,000       64,615  
Subordinated debentures
    22,947       14,978  
Note 5 — Interest Rate Swap Derivatives
The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.

 

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During May 2011, the Company entered into two interest rate swaps with notional amounts totaling $10 million, which were designated as cash flow hedges of certain subordinated debentures and were determined to be fully effective during all periods presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swaps is recorded in other liabilities with changes in fair value recorded in other comprehensive income. The Company expects the hedges to remain highly effective during the remaining terms of the swaps.
Summary information about the interest rate swaps designated as cash flow hedges as of September 30, 2011 is as follows:
         
    September 30, 2011  
    (Dollars in thousands)  
Notional Amounts
  $ 10,000  
Weighted average pay rates
    5.35 %
Weighted average receive rates
    1.65 %
Weigted average maturity
  16.75 years  
Unrealized losses
  $ 2,044  
The swaps are forward starting and have effective dates of March 15, 2012 and June 15, 2012. No interest income (expense) has been recorded on these swap transactions during 2011. When interest income (expense) is recorded it will be reported as a component of interest expense in other borrowings.
If the fair value falls below specified levels, the Company is required to pledge collateral against these derivative contract liabilities. As of September 30, 2011, the Company had pledged $1,984 with the counterparty. Under certain circumstances, including a downgrade of its credit rating below specified levels, the counterparty is required to pledge collateral against these derivative contract liabilities. As of September 30, 2011, no collateral had been received from the counterparty.

 

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Note 6 — Comprehensive Income
Other comprehensive income for the Company consists of changes in net unrealized gains and losses on investment securities available-for-sale and interest rate swap derivatives. The following table presents total comprehensive income as of September 30, 2011 and 2010.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
 
                               
Net income
  $ 2,924     $ 1,835     $ 8,031     $ 4,710  
Other comprehensive income:
                               
Net change in unrealized derivative losses
    (1,938 )           (2,044 )      
Net change in unrealized investment gains
    6,588       1,556       14,245       9,899  
Reclassification adjustment for investment gains, net of OTTI included in net income
    (210 )     (679 )     (267 )     (841 )
Tax effect
    (1,727 )     (332 )     (4,643 )     (3,457 )
 
                       
Other comprehensive income
    2,713       545       7,292       5,601  
 
                       
 
                               
Total comprehensive income
  $ 5,637     $ 2,380     $ 15,323     $ 10,311  
 
                       
Note 7 — Dividends
The Company suspended the payment of quarterly cash dividends on the Company’s common stock effective April 22, 2009. The Company considered the action prudent in order to maintain its capital position in the current state of the economy. The Company plans to reinstate the dividend payment at an appropriate time once economic conditions improve and stabilize.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollar amounts are expressed in thousands unless otherwise noted)
Overview
Southeastern Bank Financial Corporation (the “Company”) operates two wholly-owned subsidiaries in the Augusta-Richmond County, GA-SC metropolitan area — Georgia Bank & Trust Company (“GB&T”) and Southern Bank & Trust (“SB&T”), a South Carolina State Bank (collectively, the “Banks”). GB&T was organized by a group of local citizens and commenced business on August 28, 1989, with one branch location. Today, it is Augusta’s largest community banking company operating nine full service branches in Augusta, Martinez, and Evans, Georgia. Mortgage origination offices are located in Augusta and Savannah, Georgia. SB&T was organized by the Company during 2005 and 2006 and opened its main office on September 12, 2006. Today it operates three full service branches in North Augusta and Aiken, South Carolina. The Company’s Operations Center is located in Martinez, Georgia and services both subsidiaries.
On August 2, 2011, the Company filed an Interagency Bank Merger Act Application with the appropriate regulatory agencies for approval of a merger between GB&T and SB&T with GB&T the surviving entity. The consolidation is intended to lower the Company’s cost structure while allowing GB&T and the former SB&T to continue with operating autonomy in areas that impact customer relationships. On October 20, 2011, the regulatory agencies approved the merger. Management anticipates the two banks will merge operations in the fourth quarter of 2011. The Company anticipates, but has not quantified, cost savings to occur in the areas of information technology, audit and regulatory exam expense and other back office operational costs.
The Company’s primary market includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA). The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast.
The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the primary market area, Augusta-Richmond County, GA-SC metropolitan area, the Company had 19.46% of all deposits and was the second largest depository institution at June 30, 2011, as cited from the Federal Deposit Insurance Corporation’s website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on customer relationship management philosophy. The Company is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

 

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The Company’s primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans decreased during the first nine months of 2011 as compared to the first nine months of 2010 and is due primarily to decreased loan volume. Interest income on investment securities increased primarily due to a significantly larger investment portfolio but the increase was limited by declining yields on the portfolio. The average portfolio yield has decreased in part due to declining market interest rates which caused higher yielding securities to be called. Decreases in non-sufficient funds (“NSF”) income on retail checking accounts, due primarily to decreased economic activity, were mostly offset by increases in ATM/Debit card income for the first nine months of 2011. For the nine month period, gain on sales of loans decreased and resulted primarily from decreased mortgage refinancing activity during the first nine months of the year. Investment securities gains decreased on a net basis during the first nine months of 2011 as compared to the same period last year due in part to selected sales of higher duration securities to reduce exposure to rising interest rates and a settlement of $149 with an institution regarding premium amortization on certain bonds purchased in 2010.
Table 1 — Selected Financial Data
                         
    September 30,     December 31,     September 30,  
    2011     2010     2010  
    (Dollars in thousands)  
 
                       
Assets
  $ 1,609,426     $ 1,607,105     $ 1,646,725  
Investment securities
    596,936       586,612       541,859  
Loans
    838,777       874,095       888,596  
Deposits
    1,401,272       1,410,737       1,435,353  
 
                       
Annualized return on average total assets
    0.67 %     0.44 %     0.41 %
Annualized return on average equity
    10.18 %     6.81 %     6.33 %
The Company continues to focus on the net interest margin, regulatory capital levels, liquidity management, asset quality and risk mitigation. Asset levels have remained relatively flat due to the Company’s focus on improving regulatory capital levels and have been driven by a $9,465 decrease in deposits during the first nine months of 2011, most of which occurred in the second quarter. Loan balances have trended lower as demand has remained weak while investment portfolio balances have increased over the comparable periods in order to obtain an improvement in net interest income.

 

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Annualized return on average total assets and annualized return on average equity have improved in 2011 as compared to 2010. The increased returns were due primarily to increased net interest income and somewhat decreased provision for loan losses. Net income for the nine months ended September 30, 2011 was $8,031 compared to $4,710 for the same period in 2010. The effects of the economic downturn continue to negatively affect financial results primarily through a lack of loan demand and a continued elevated level of provision for loan losses.
The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments from mortgage-backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net interest income in a ramp up and down annually 400 basis points (4.00%) scenario and as it applies to economic value of equity in a shock up and down 400 basis points (4.00%) scenario. The Company monitors operating expenses through responsibility center budgeting.
Forward-Looking Statements
Southeastern Bank Financial Corporation may, from time to time, make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economies, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

 

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Critical Accounting Estimates
The accounting and financial reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, derivatives, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels; (4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management’s assessment of economic conditions. The Company’s Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.
The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.

 

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Fair Value of Financial Instruments
A significant portion of the Company’s assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, tax credits, derivatives and other real estate owned. At September 30, 2011 and December 31, 2010 the percentage of total assets measured at fair value was 40.19% and 38.58%, respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At September 30, 2011 4.78% of assets measured at fair value were based on significant unobservable inputs. This represents approximately 1.92% of the Company’s total assets. See Note 4 “Fair Value Measurements” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.
Other Real Estate Owned
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of real estate owned are capitalized.
Interest Rate Swap Derivatives
The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date. The fair value adjustment is included in other liabilities. See Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.
Investment Securities
The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. As of September 30, 2011, the Company had approximately $4,604 of available-for-sale securities, which is approximately 0.29% of total assets, valued using unobservable inputs (Level 3). These securities were primarily non-agency mortgage-backed securities and subordinated debentures issued by financial institutions.

 

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Results of Operations
Net income for the first nine months of 2011 was $8,031, an increase of $3,321 compared with net income of $4,710 for the first nine months of 2010. The increase in net income was primarily a result of an increase in net interest income of $4,486 due primarily to declining costs of deposits and an increased level of investments.
Noninterest income decreased a net of $1,777 or 11.29% for the nine months ended September 30, 2011 and resulted primarily from decreases in gain on sales of loans and investment securities offset in part by an increase in retail investment income and cash surrender value of bank-owned life insurance. Gain on sales of loans decreased $1,429 or 22.14% as mortgage production decreased in the first nine months of 2011. Retail investment income increased $160 or 12.82% due to increased brokerage activity. Net investment securities gains year to date are $369 as compared to net securities gains of $937 in 2010.
Noninterest expense totaled $30,460 for the nine months ended September 30, 2011, a decrease of $517 or 1.67% compared to the same period ended September 30, 2010. Notable changes included a decrease in FDIC insurance of $279 and a decrease in salaries and other personnel expense of $316.
Table 2 — Selected Balance Sheet Data
                                 
    September 30,     December 31,     Variance  
    2011     2010     Amount     %  
    (Dollars in thousands)  
Cash, due from banks and interest-bearing deposits
  $ 83,252     $ 65,115     $ 18,137       27.85 %
Investment securities
    596,936       586,612       10,324       1.76 %
Loans
    838,777       874,095       (35,318 )     (4.04 %)
Other real estate owned
    7,859       7,751       108       1.39 %
Assets
    1,609,426       1,607,105       2,321       0.14 %
Deposits
    1,401,272       1,410,737       (9,465 )     (0.67 %)
Securities sold under repurchase agreements
    540       818       (278 )     (33.99 %)
Advances from Federal Home Loan Bank
    52,000       60,000       (8,000 )     (13.33 %)
Liabilities
    1,494,027       1,507,147       (13,120 )     (0.87 %)
Stockholders’ equity
    115,399       99,958       15,441       15.45 %
Table 2 highlights significant changes in the balance sheet at September 30, 2011 as compared to December 31, 2010. Total assets increased $2,321 and reflect an increase in investment securities of $10,324 coupled with an increase in cash, due from banks and interest bearing deposits of $18,137 and an increase in bank-owned life insurance of $6,268. Total liabilities decreased $13,120 and reflect a decrease in deposits of $9,465 and a decrease in advances from Federal Home Loan Bank of $8,000. Somewhat offsetting this decrease was a $4,623 increase in accrued interest payable and other liabilities, which reflects $2,044 in unrealized losses on interest rate swap derivatives.

 

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The Company has continued to maintain a relatively high level of liquid funds in light of current economic conditions and volatility in the banking industry but has elected to invest a portion of these funds and funds obtained through deposit growth and loan repayments into the investment portfolio. Loan demand was weak during the first nine months of 2011 and resulted in a decrease in loans of $35,318. The change in investment securities during the year included maturities and calls of bonds and selected sales of high duration securities for interest rate risk management purposes. These changes coupled with reinvestment of proceeds contributed to the average yield of the taxable investment portfolio to decline from 3.77% to 3.00%.
The decrease in deposits was net of the repayment of approximately $28,390 in brokered deposits which totaled $155,342 at September 30, 2011 compared to $183,732 at December 31, 2010. NOW accounts decreased $25,948 and retail time deposits decreased $72,842. These decreases were offset by savings accounts which increased $68,999 and noninterest-bearing deposits which increased $15,326.
The annualized return on average assets for the Company was 0.67% for the nine months ended September 30, 2011, compared to 0.41% for the same period last year.
The annualized return on average stockholders’ equity was 10.18% for the nine months ended September 30, 2011, compared to 6.33% for the same period last year.
Net Interest Income
The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, annualized average yields earned and rates paid on those respective balances, and the actual interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

 

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Table 3 — Average Balances, Income and Expenses, Yields and Rates
                                                 
    Three Months Ended Sept. 30, 2011     Three Months Ended Sept. 30, 2010  
            Annualized                     Annualized        
            Average     Amount             Average     Amount  
    Average     Yield or     Paid or     Average     Yield or     Paid or  
    Amount     Rate     Earned     Amount     Rate     Earned  
    (Dollars in thousands)  
Interest-earning assets:
                                               
Loans
  $ 877,342       5.66 %   $ 12,636     $ 922,049       5.80 %   $ 13,611  
Investment securities
                                               
Taxable
    520,963       3.03 %     3,940       459,384       3.41 %     3,915  
Tax-exempt
    53,117       3.84 %     510       24,072       4.22 %     254  
Federal funds sold
          0.00 %           4,870       0.16 %     2  
Interest-bearing deposits in other banks
    17,997       0.76 %     35       75,084       0.59 %     112  
 
                                       
Total interest-earning assets
  $ 1,469,419       4.60 %   $ 17,121     $ 1,485,459       4.75 %   $ 17,894  
 
                                       
 
                                               
Interest-bearing liabilities:
                                               
Deposits
  $ 1,262,385       1.07 %   $ 3,394     $ 1,276,453       1.61 %   $ 5,187  
Securities sold under repurchase agreements
    642       0.62 %     1       520       1.54 %     2  
Other borrowings
    74,947       3.37 %     637       95,673       3.78 %     912  
 
                                       
Total interest-bearing liabilities
  $ 1,337,974       1.20 %   $ 4,032     $ 1,372,646       1.76 %   $ 6,101  
 
                                       
 
                                               
Net interest margin/income:
            3.51 %   $ 13,089               3.12 %   $ 11,793  
 
                                           
Table 4 — Average Balances, Income and Expenses, Yields and Rates
                                                 
    Nine Months Ended Sept. 30, 2011     Nine Months Ended Sept. 30, 2010  
            Annualized                     Annualized        
            Average     Amount             Average     Amount  
    Average     Yield or     Paid or     Average     Yield or     Paid or  
    Amount     Rate     Earned     Amount     Rate     Earned  
    (Dollars in thousands)  
Interest-earning assets:
                                               
Loans
  $ 879,489       5.73 %   $ 38,090     $ 933,036       5.74 %   $ 40,471  
Investment securities
                                               
Taxable
    525,168       3.00 %     11,830       382,836       3.77 %     10,816  
Tax-exempt
    47,849       4.04 %     1,450       22,828       4.24 %     727  
Federal funds sold
          0.00 %           6,481       0.19 %     9  
Interest-bearing deposits in other banks
    28,008       0.57 %     120       75,644       0.52 %     294  
 
                                       
Total interest-earning assets
  $ 1,480,514       4.61 %   $ 51,490     $ 1,420,825       4.88 %   $ 52,317  
 
                                       
 
                                               
Interest-bearing liabilities:
                                               
Deposits
  $ 1,271,616       1.19 %   $ 11,316     $ 1,222,743       1.74 %   $ 15,873  
Securities sold under repurchase agreements
    670       1.04 %     5       1,647       1.46 %     18  
Other borrowings
    78,470       3.43 %     2,014       97,223       3.79 %     2,757  
 
                                       
Total interest-bearing liabilities
  $ 1,350,756       1.32 %   $ 13,335     $ 1,321,613       1.89 %   $ 18,648  
 
                                       
 
                                               
Net interest margin/income:
            3.41 %   $ 38,155               3.13 %   $ 33,669  
 
                                           

 

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Third Quarter 2011 compared to Third Quarter 2010:
Net interest income increased $1,296 (10.99%) during the three month period as compared to the same period in 2010. Loan interest income decreased $975 (7.16%) in the three month period primarily as a result of decreased volumes and slightly lower yields. Nonaccrual loans resulted in the reversal of $59 in interest income in the current quarter compared to $66 in the 2010 quarter. Deposit interest expense decreased $1,793 (34.57%) in the three month period primarily as a result of declining deposit costs on the Company’s checking and savings products. Due to the low interest rate environment, the quarterly annualized average rate of interest bearing liabilities decreased from 1.76% at September 30, 2010 to 1.20% at September 30, 2011.
The Company’s net interest margin for the quarter was 3.51% as compared to 3.12% for the 2010 quarter. The increase in the net interest margin for the three month period was impacted primarily by decreased costs of interest bearing deposits offset in part by declining loans, loan yields and investment portfolio yields. In addition, the Company added to its tax exempt portfolio during the quarter. Average taxable investment securities increased $61,579 (13.40%) while the average yield decreased from 3.41% to 3.03%. Average tax exempt investment securities increased $29,045 (120.66%) while the average yield decreased from 4.22% to 3.84%. Average loans decreased $44,707 (4.85%) with the average yield decreasing from 5.80% to 5.66%. Average interest bearing deposits decreased $14,068 (1.10%) while the average rate paid decreased from 1.61% to 1.07%.
Nine Months Ended 2011 compared to Nine Months Ended 2010:
Net interest income increased $4,486 (13.32%) during the nine month period as compared to the same period in 2010. Loan interest income decreased $2,381 (5.88%) in the nine month period primarily as a result of decreased volume. Deposit interest expense decreased $4,557 (28.71%) in the nine month period primarily as a result of declining deposit costs offset in part by growth in account balances. Annualized loan yields for the year were unchanged and were somewhat impacted by decreases in levels of average nonaccrual loans for the comparable periods offset by lower rates on loan renewals and the repayment of higher yielding loans. Nonaccrual loans resulted in the reversal of $233 in interest income compared to $566 in the same period in 2010. Due to the low interest rate environment, the annualized average rate of interest bearing liabilities decreased from 1.89% at September 30, 2010 to 1.32% at September 30, 2011.
The Company’s net interest margin for the nine months ended September 30, 2011 was 3.41% as compared to 3.13% for the nine months ended September 30, 2010. The increase in the net interest margin for the nine month period was impacted primarily by decreased cost of interest bearing deposits offset in part by declining loans and investment portfolio yields. In addition, the Company added to its tax exempt portfolio during the comparable nine month periods. Average taxable investment securities increased $142,332 (37.18%) while the average yield decreased from 3.77% to 3.00%. Average tax exempt investment securities increased $25,021 (109.61%) while the average yield decreased from 4.24% to 4.04%. Average loans decreased $53,547 (5.74%) with the average yield remaining virtually flat at 5.73%. Average interest bearing deposits increased $48,873 (4.00%) while the average rate paid decreased from 1.74% to 1.19%.

 

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Changes in the net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits. The following tables present the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have impacted the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to changes attributable to change in volume (change in volume multiplied by prior rate), changes attributable to change in rate (change in rate multiplied by prior volume), and changes in rate/volume (change in rate multiplied by change in volume).
Table 5 — Rate/Volume Analysis
                                 
    Three Months Ended  
    September 30, 2011 compared to September 30, 2010  
    Increase (Decrease) due to  
    Volume     Rate     Combined     Total  
    (Dollars in thousands)  
Interest-earning assets:
                               
Loans
    (660 )     (331 )     16       (975 )
Investment securities
                               
Taxable
    525       (441 )     (59 )     25  
Tax-exempt
    306       (23 )     (27 )     256  
Federal funds sold
    (2 )     (2 )     2       (2 )
Interest-bearing deposits in other banks
    (85 )     34       (26 )     (77 )
 
                       
Total interest-earning assets
    84       (763 )     (94 )     (773 )
 
                       
 
                               
Interest-bearing liabilities:
                               
Deposits
    (57 )     (1,755 )     19       (1,793 )
Securities sold under repurchase agreements
    0       (1 )     (0 )     (1 )
Other borrowings
    (197 )     (99 )     21       (275 )
 
                       
Total interest-bearing liabilities
    (254 )     (1,855 )     40       (2,069 )
 
                       
 
                               
Net change in net interest income
                          $ 1,296  
 
                             

 

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Table 6 — Rate/Volume Analysis
                                 
    Nine Months Ended  
    September 30, 2011 compared to September 30, 2010  
    Increase (Decrease) due to  
    Volume     Rate     Combined     Total  
    (Dollars in thousands)  
Interest-earning assets:
                               
Loans
    (2,323 )     (62 )     4       (2,381 )
Investment securities
                               
Taxable
    4,021       (2,192 )     (815 )     1,014  
Tax-exempt
    797       (35 )     (39 )     723  
Federal funds sold
    (9 )     (9 )     9       (9 )
Interest-bearing deposits in other banks
    (185 )     30       (19 )     (174 )
 
                       
Total interest-earning assets
    2,301       (2,268 )     (860 )     (827 )
 
                       
 
                               
Interest-bearing liabilities:
                               
Deposits
    634       (4,991 )     (200 )     (4,557 )
Federal funds purchased / securities sold under repurchase agreements
    (10 )     (6 )     3       (13 )
Other borrowings
    (532 )     (262 )     51       (743 )
 
                       
Total interest-bearing liabilities
    92       (5,259 )     (146 )     (5,313 )
 
                       
 
                               
Net change in net interest income
                          $ 4,486  
 
                             
Provision for Loan Losses
The provision for loan losses is the charge to operating earnings necessary to maintain the allowance for loan losses at a level which, in management’s estimate, is adequate to cover the estimated amount of probable incurred losses in the loan portfolio. The provision for loan losses totaled $3,535 for the three months ended September 30, 2011 compared to $4,759 for the three months ended September 30, 2010 and $10,198 for the nine months ended September 30, 2011 compared to $11,841 for the same period in 2010. See “Allowance for Loan Losses” for further analysis of the provision for loan losses.

 

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Noninterest Income
Table 7 — Noninterest Income
                                                                 
    Three Months Ended                     Nine Months Ended        
    September 30,     Variance     September 30,     Variance  
    2011     2010     Amount     %     2011     2010     Amount     %  
    (Dollars in thousands)     (Dollars in thousands)  
 
                                                               
Service charges and fees on deposits
  $ 1,729     $ 1,802     $ (73 )     (4.05 %)   $ 5,057     $ 5,145     $ (88 )     (1.71 %)
Gain on sales of loans
    2,097       2,877       (780 )     (27.11 %)     5,024       6,453       (1,429 )     (22.14 %)
Gain (loss) on sale of fixed assets
          (1 )     1     NM       17       26       (9 )     (34.62 %)
Investment securities gains (losses), net of other-than-temporary impairment
    210       679       (469 )     (69.07 %)     267       841       (574 )     (68.25 %)
Retail investment income
    444       497       (53 )     (10.66 %)     1,408       1,248       160       12.82 %
Trust services fees
    284       276       8       2.90 %     849       853       (4 )     (0.47 %)
Increase in cash surrender value of bank-owned life insurance
    302       257       45       17.51 %     768       709       59       8.32 %
Miscellaneous income
    169       149       20       13.42 %     574       466       108       23.18 %
 
                                               
Total noninterest income
  $ 5,235     $ 6,536     $ (1,301 )     (19.91 %)   $ 13,964     $ 15,741     $ (1,777 )     (11.29 %)
 
                                               
Third Quarter 2011 compared to Third Quarter 2010:
Noninterest income decreased $1,301 (19.91%) during the three month period as compared to the same period in 2010. The most significant change for the three month period was a decrease in gain on sales of loans due to reduced mortgage financing activity. Gain on sales of loans decreased $780 (27.11%). Also contributing to the decrease was service charges and fees on deposits which decreased $73 (4.05%) primarily due to decreased consumer overdraft fees due to decreased economic activity and regulatory changes in how fees are charged. Investment securities gains (losses), net of other-than-temporary impairment decreased $469 (69.07%). Cash surrender value of bank-owned life insurance increased due to purchases of additional policies in 2011.
Nine Months Ended 2011 compared to Nine Months Ended 2010:
Noninterest income decreased $1,777 (11.29%) during the nine month period as compared to the same period in 2010. The most significant change for the nine month period was a decrease in gain on sales of loans due to reduced mortgage financing activity. Gain on sales of loans decreased $1,429 (22.14%). Increases in retail investment income, cash surrender value of bank-owned life insurance and miscellaneous income were offset by decreases in investment securities gains (losses), net of other-than-temporary impairment and service charges and fees on deposits.

 

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Noninterest Expense
Table 8 — Noninterest Expense
                                                                 
    Three Months Ended                     Nine Months Ended        
    September 30,     Variance     September 30,     Variance  
    2011     2010     Amount     %     2011     2010     Amount     %  
    (Dollars in thousands)     (Dollars in thousands)  
Salaries and other personnel expense
  $ 5,990     $ 6,115     $ (125 )     (2.04 %)   $ 17,208     $ 17,524     $ (316 )     (1.80 %)
Occupancy expenses
    1,088       1,132       (44 )     (3.89 %)     3,315       3,469       (154 )     (4.44 %)
Marketing & business development
    341       315       26       8.25 %     1,040       903       137       15.17 %
Processing expense
    457       392       65       16.58 %     1,277       1,150       127       11.04 %
Legal and professional fees
    446       468       (22 )     (4.70 %)     1,189       1,302       (113 )     (8.68 %)
Data processing expense
    453       347       106       30.55 %     1,191       1,037       154       14.85 %
FDIC insurance
    374       538       (164 )     (30.48 %)     1,352       1,631       (279 )     (17.11 %)
Communications expense
    211       160       51       31.88 %     663       500       163       32.60 %
Loss (gain) on sale of other real estate
    9       25       (16 )     (64.00 %)     222       (344 )     566       (164.53 %)
Provision for other real estate losses
    563       683       (120 )     (17.57 %)     811       1,380       (569 )     (41.23 %)
Other operating expenses
    690       808       (118 )     (14.60 %)     2,192       2,425       (233 )     (9.61 %)
 
                                               
Total noninterest expense
  $ 10,622     $ 10,983     $ (361 )     (3.29 %)   $ 30,460     $ 30,977     $ (517 )     (1.67 %)
 
                                               
Third Quarter 2011 compared to Third Quarter 2010:
Noninterest expense decreased $361 (3.29%) during the three month period as compared to the same period in 2010. The most significant changes for the three month period were accrued FDIC insurance expense which decreased $164 (30.48%) due to a lower accrual rate for deposit insurance beginning in the second quarter of 2011, salaries and other personnel expense which decreased $125 (2.04%) due to lower full time equivalent employees (FTE’s) as compared to the same period in 2010 and lower provision for other real estate losses which decreased $120 (17.57%). Marketing, processing, communications and data processing expenses all increased during the comparable periods.
Occupancy expenses decreased $44 (3.89%) during the three month period and were primarily due to decreased depreciation expense as a result of certain assets becoming fully depreciated.
Other real estate expenses decreased $136 and resulted primarily from a decreased level of additions to the OREO valuation allowance of $120.
Communications expense increased $51 (31.88%) and was due to costs associated with changing carriers. Processing expense increased $65 (16.58%) due to an increase in ATM processing fees in the third quarter of 2011 as compared to the same quarter of 2010.

 

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Nine Months Ended 2011 compared to Nine Months Ended 2010:
Salaries and other personnel expense decreased $316 (1.80%) during the nine month period as compared to the same period in 2010 and was due primarily to lower FTE’s resulting from the closing of the Athens branch and the Greenville loan office.
Occupancy expenses decreased $154 (4.44%) during the nine month period and were primarily due to decreased depreciation expense as a result of certain assets becoming fully depreciated.
Other real estate expenses decreased $3 and resulted from an increased loss on sale of OREO of $566 offset by a decreased level of additions to the OREO valuation allowance of $569 in the first nine months of 2011 as compared to 2010.
FDIC insurance expense decreased $279 (17.11%) and was due to a lower accrual rate and assessment base for deposit insurance beginning in the second quarter of 2011. Processing expense increased $127 (11.04%) and was due to an increase in ATM processing fees in the first nine months of 2011 as compared to the same period in 2010.
Income Taxes
The Company recognized income tax expense of $1,243 and $3,430 for the three and nine months ended September 30, 2011 as compared to an income tax expense of $752 and $1,882 for the same periods in 2010. The significant increase in pretax income resulted in an increase in income tax expense and a slightly higher effective income tax rate for the three and nine month periods. The effective income tax rate for the three and nine months ended September 30, 2011 was 29.83% and 29.93%, respectively.
At September 30, 2011, the Company maintains net deferred tax assets of $11,926. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset. In making this assessment, all sources of taxable income available to realize the deferred tax asset are considered including taxable income in prior carry-back years, future reversals of existing temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards. Based on management’s assessment, no valuation allowance was deemed necessary at September 30, 2011.
The Company has no net operating loss carryforwards. The Company was able to carryback both the federal and state net operating losses (NOLs) sustained in 2009. These carrybacks generated a federal tax refund of $2,755 that was received in the first quarter of 2010 and a state tax refund of $495, of which $494 was received in the third quarter of 2011.

 

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Loans
The following table presents the composition of the Company’s loan portfolio as of September 30, 2011 and December 31, 2010.
Table 9 — Loan Portfolio Composition
                                 
    September 30, 2011     December 31, 2010  
    Amount     %     Amount     %  
    (Dollars in thousands)  
Commercial financial and agricultural
  $ 160,567       19.14 %   $ 189,128       21.64 %
 
                       
Real estate
                               
Commercial
    338,205       40.32 %     327,458       37.46 %
Residential
    158,826       18.94 %     157,680       18.04 %
Acquisition, development and construction
    165,745       19.76 %     182,412       20.87 %
 
                       
Total real estate
    662,776       79.02 %     667,550       76.37 %
 
                       
Consumer
                               
Direct
    14,470       1.72 %     15,643       1.79 %
Indirect
    495       0.06 %     899       0.10 %
Revolving
    373       0.04 %     870       0.10 %
 
                       
Total consumer
    15,338       1.82 %     17,412       1.99 %
 
                       
Deferred loan origination costs (fees)
    96       0.02 %     5       0.00 %
 
                       
Total
  $ 838,777       100.00 %   $ 874,095       100.00 %
 
                       
At September 30, 2011, the loan portfolio is comprised of 79.02% real estate loans. Commercial, financial and agricultural loans comprise 19.14%, and consumer loans comprise 1.82% of the portfolio.
Commercial real estate comprises 40.32% of the loan portfolio and consist of both non-owner occupied and owner occupied properties where the operations of the commercial entity provide the necessary cash flow to service the debt. For this portion of the real estate loan portfolio, repayment is generally not dependent upon the sale of the real estate held as collateral. Construction and development loans comprise 19.76% of the real estate loan portfolio and the Company has recognized significant losses in this portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the sale of the real estate in the normal course of business and can be impacted by national and local economic conditions. New construction and absorption of existing real estate inventory in the Company’s primary market area of the Augusta-Richmond County, GA-SC MSA have slowed and prices have declined but less than the national rate. The residential category, 18.94% of the portfolio, represents those loans that the Company chooses to maintain in its portfolio rather than selling into the secondary market for marketing and competitive reasons and commercial loans secured by residential real estate.

 

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The Company has no large loan concentrations to individual borrowers. Unsecured loans at September 30, 2011 totaled $16,768.
Interest reserves are established for certain ADC (acquisition development and construction) loans based on the feasibility of the project, the timeframe for completion, the creditworthiness of the borrower and guarantors, and collateral. An interest reserve allows the borrower’s interest cost to be capitalized and added to the loan balance. As a matter of practice the Banks do not generally establish loan funded interest reserves on ADC loans; however, the Company’s loan portfolio includes six loans with interest reserves at September 30, 2011, which were fully advanced at September 30, 2011 and December 31, 2010.
Underwriting for ADC loans with interest reserves follows the same process as those loans without reserves. In order for the Banks to establish a loan-funded interest reserve, the borrower must have the ability to repay without the use of a reserve and a history of developing and stabilizing similar properties. All ADC loans, including those with interest reserves, are carefully monitored through periodic construction site inspections by bank employees or third party inspectors to ensure projects are moving along as planned. Management assesses the appropriateness of the use of interest reserves during the entire term of the loan as well as the adequacy of the reserve. Collateral inspections are completed before approval of advances. Two of these loans have been renewed; one due to delays and time needed to obtain current financial information on the guarantors and another to allow for completion of the final punch list and negotiation of the permanent loan. None of these loans have been restructured or are currently on nonaccrual.
Loan Review and Classification Process
The Company maintains a loan review and classification process which involves multiple officers of the Company and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1- 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful and rating 8 Loss.
When a loan officer originates a new loan, he or she documents the credit file with an offering sheet summary, supplemental underwriting analyses, relevant financial information and collateral evaluations. All of this information is used in the determination of the initial loan risk rating. Then, the Company’s Credit Administration department undertakes an independent credit review of that relationship in order to validate the lending officer’s rating. Lending relationships with total related exposure of $500 or greater are also placed into a tracking database and reviewed by Credit Administration personnel on an annual basis in conjunction with the receipt of updated borrower and guarantor financial information. The individual loan reviews analyze such items as: loan type; nature, type and estimated value of collateral; borrower and/or guarantor estimated financial strength; most recently available financial information; related loans and total borrower exposure; and current/anticipated performance of the loan. The results of such reviews are presented to Executive Management.

 

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Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (loan grade 5) or classified (loan grade 6 through 8) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (5 or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for their criticized credit relationships.
Depending upon the individual facts, circumstances and the result of the Classified/Watch review process, Executive Management may categorize the loan relationship as impaired. Once that determination has occurred, Executive Management in conjunction with Credit Administration personnel, will complete an evaluation of the collateral (for collateral-dependent loans) based upon appraisals on file adjusting for current market conditions and other local factors that may affect collateral value. This judgmental evaluation may produce an initial specific allowance for placement in the Company’s Allowance for Loan Losses calculation. As soon as practical, updated appraisals on the collateral backing that impaired loan relationship are ordered. When the updated appraisals are received, Executive Management with assistance from Credit Administration department personnel reviews the appraisal, and updates the specific allowance analysis for each loan relationship accordingly. The Director’s Loan Committee reviews on a quarterly basis the Classified/Watch reports including changes in credit grades of 5 or higher as well as all impaired loans, the related allowances and OREO.
In general, once the specific allowance has been finalized, Executive Management will authorize a charge-off prior to the following calendar quarter-end in which that reserve calculation is finalized.
The review process also provides for the upgrade of loans that show improvement since the last review.
Nonperforming Assets
Non-performing assets include nonaccrual loans, loans past due 90 days or more, restructured loans and other real estate owned. Table 10 shows the current and prior period amounts of non-performing assets. Non-performing assets were $37,586 at September 30, 2011, compared to $34,000 at December 31, 2010 and $32,557 at September 30, 2010. Significant changes from December 2010 to September 2011 include a $5,915 increase in nonaccrual commercial real estate loans and a decrease of $2,581 in nonaccrual ADC loans. Total nonaccrual loans increased $3,707.

 

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There were no loans past due 90 days or more and still accruing at September 30, 2011 and 2010 compared to $69 at December 31, 2010.
Troubled debt Restructurings (TDRs) are troubled loans on which the original terms have been modified in favor of the borrower or either principal or interest has been forgiven due to deterioration in the borrower’s financial condition. There were $4,564 in TDRs at September 30, 2011, of which $2,248 were on nonaccrual status. TDRs totaled $3,514 at December 31, 2010, of which $970 were on nonaccrual status, and $2,090 at September 30, 2010, of which $1,172 were on nonaccrual status.
Table 10 — Non-Performing Assets
                         
    September 30, 2011     December 31, 2010     September 30, 2010  
    (Dollars in thousands)  
Nonaccrual loans:
                       
Commercial financial and agricultural
  $ 3,847     $ 2,924     $ 746  
Real Estate:
                       
Commercial
    9,708       3,793       4,754  
Residential
    4,215       4,734       4,623  
Acquisition, development and construction
    9,372       11,953       13,999  
Consumer
    270       301       411  
 
                 
Total Nonaccrual loans
    27,412       23,705       24,533  
 
                 
Restructured loans (1)
    2,316       2,544       918  
Other real estate owned
    7,859       7,751       7,106  
 
                 
Total Non-performing assets
  $ 37,587     $ 34,000     $ 32,557  
 
                 
 
                       
Loans past due 90 days or more and still accruing interest
  $     $ 69     $  
 
                 
 
                       
Non-performing assets to total assets
    2.34 %     2.12 %     1.98 %
 
                       
Non-performing assets to total loans and OREO
    4.44 %     3.86 %     3.63 %
 
                       
Allowance for loan loss to total nonaccrual loans
    107.03 %     112.45 %     104.10 %
     
(1)  
Restructured loans on nonaccrual status at period end are included under nonaccrual loans in the table.

 

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The ratio of non-performing assets to total loans and other real estate was 4.44% at September 30, 2011 compared to 3.86% at December 31, 2010 and 3.63% at September 30, 2010. The ratio of allowance for loan losses to total nonaccrual loans was 107.03% at September 30, 2011 compared to 112.45% at December 31, 2010 and 104.10% at September 30, 2010. The resolution of non-performing assets continues to be a priority of management.
Nonaccrual loans have increased from September 30, 2010 despite a significant decline in ADC properties that the Company has been actively addressing over the past two years. Although the exposure has declined, a significant portion of nonaccrual loans continues to be collateral dependent ADC loans as well as commercial real estate loans. The following table provides further information regarding the Company’s nonaccrual loans.
                                                     
                    Nonaccrual                       Appraisal   Appraised  
    Balance     Originated     Date   Trigger   Collateral   Allowance     Method   Date   Value  
    (Dollars in thousands)  
1-4 Family Residential
  $ 852       5/29/2008     12/14/10   financial condition   houses & land   $     collateral value   03/11   $ 1,035  
ADC Loan — Other
    825       04/08-05/08     06/30/11   delinquency   lots         collateral value   09/11     3,400  
Commercial Real Estate
    3,490       03/10/08     06/30/11   delinquency   commercial bldg         collateral value   08/11     5,205  
ADC Loan — Other
    1,225       09/30/08     05/06/10   delinquency   lots & land         collateral value   09/11     1,269  
ADC Loan — CSRA
    1,009       03/07-04/08     11/30/09   delinquency   lots & land         collateral value   03/11     1,075  
Farmland & Equity lines
    837       09/18/08     11/10-12/10   financial condition   house & land         collateral value   11/10 - 12/10     1,943  
ADC Loan — Other
    1,661       10/31/06     08/16/11   financial condition   lots & land         collateral value   09/11     1,739  
Commercial Real Estate
    3,281       03/21/08     08/30/11   financial condition   commercial bldg         collateral value   09/11     4,955  
ADC Loan — Other
    1,785       08/06-01/07     01/28/09   delinquency   land & townhomes         collateral value   09/10 - 04/11     2,354  
ADC Loan — Other
    1,500       03/29/11     03/29/11   financial condition   land         collateral value   06/11     2,178  
 
                                                 
 
  $ 16,465                                              
 
                                                   
Other, net
    10,947                                              
 
                                                 
Nonaccrual loans at September 30, 2011
  $ 27,412                                              
 
                                                 
The following table presents a roll forward of other real estate owned for the nine month periods ended September 30, 2011 and 2010, respectively.
Table 11 — Other Real Estate Owned
                 
    2011     2010  
    (Dollars in thousands)  
 
               
Beginning balance, January 1
  $ 7,751       7,974  
Additions
    5,359       7,911  
Increase in valuation allowance
    (811 )     (1,380 )
Sales
    (4,218 )     (7,760 )
Gain (loss) on sale of OREO
    (222 )     344  
Deferred gain on sale of OREO
          17  
 
           
Ending balance, September 30
  $ 7,859       7,106  
 
           

 

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The following table provides details of other real estate owned as of September 30, 2011 and 2010, respectively.
                 
    2011     2010  
    (Dollars in thousands)  
 
               
Other Real Estate:
               
Single family developed lots
  $ 1,590     $ 1,819  
Residential land
    378        
1-4 Family residential
    1,419       1,286  
Commercial real estate
    4,157       2,825  
Condominums
    2,827       2,827  
 
           
 
    10,371       8,757  
 
               
Valuation allowance
    (2,512 )     (1,651 )
 
           
 
  $ 7,859     $ 7,106  
 
           
The increase in other real estate owned is due to the continuing process of resolving problem loans. In the first nine months of 2011, additions to other real estate owned totaled $5,359 and proceeds from sales of other real estate totaled $4,218. In addition, there was an $811 increase to the valuation allowance as a result of declining property values.
Allowance for Loan Losses
The allowance for loan losses represents an allocation for the estimated amount of probable incurred losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans, with particular emphasis on impaired, non-accruing, past due, and other loans that management believes require special attention. The determination of the allowance for loan losses is considered a critical accounting estimate of the Company. See “Critical Accounting Estimates.”
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may advise additions to the allowance based on their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based upon management’s analysis of risk in the loan portfolio. Loans determined to be uncollectible are charged to the allowance for loan losses and subsequent recoveries are added to the allowance. A provision for losses in the amount of $3,535 was charged to expense for the quarter ended September 30, 2011 compared to $4,759 for the 2010 quarter and $10,198 for the nine months ended September 30, 2011 compared to $11,841 for the nine months ended September 30, 2010.

 

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Significant portions of the overall level of losses in 2011 relate to the charge off of specific reserve allowances on impaired loans.
At September 30, 2011 the ratio of allowance for loan losses to period end loans was 3.50% compared to 3.05% at December 31, 2010 and 2.87% at September 30, 2010. Net charge-offs totaled $7,516 of which $3,509, or 46.69%, were related to ADC loans. Of the ADC charge-offs, $1,255 or 35.77% were related to ADC loans in the CSRA and $2,254 or 64.23% were related to ADC loans in other markets. The provisions for loan losses allocated to individual portfolio segments are affected by the calculation of average historical net loss rate factors and by the internal and external qualitative factors within each category. The loan loss provision allocated to the ADC-CSRA portfolio was $1,067 and was affected in part by charge-offs of $1,255, an increase in the level of substandard rated loans and qualitative factors related to trends in classified loans, collateral values and other external factors related to competition, legal and regulatory requirements. The loan loss provision allocated to the ADC-Other portfolio was $2,122 and was affected in part by charge-offs of $2,260 and qualitative factors related to collateral values. The loan loss provision allocated to the commercial real estate owner occupied portfolio was $2,926 and was affected in part by charge-offs of $621, growth in the portfolio and qualitative factors related to collateral values and local economic trends and conditions. The loan loss provision allocated to the commercial, financial and agricultural portfolio was $1,391 and was affected in part by charge-offs of $1,154, an increase in the adjusted historical loss factor and qualitative factors related to collateral values. The loan loss provision allocated to the 1-4 family portfolio was $1,510 and was affected in part by charge-offs of $1,605 and qualitative factors related to national and local economic trends and conditions. The loan loss provision allocated to the non owner occupied commercial real estate portfolio was $1,117 and was affected in part by charge-offs of $621, an increase in the level of impaired and substandard rated loans, and qualitative factors related to trends in impaired, classified and rated loans. See note 3 to the Financial Statements.

 

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Table 12 — Allowance for Loan Losses
                 
    September 30,  
    2011     2010  
    (Dollars in thousands)  
 
               
Total loans outstanding at end of period, net of unearned income
  $ 838,777     $ 888,596  
 
           
 
               
Average loans outstanding, net of unearned income
  $ 865,990     $ 904,808  
 
           
 
               
Balance of allowance for loan losses at beginning of year
  $ 26,657     $ 22,338  
 
               
Charge-offs:
               
Commercial, financial and agricultural
    1,154       477  
Real estate — commercial
    1,242       538  
Real estate — residential mortgage
    1,605       869  
Real estate — acquisition, development and construction
    3,515       7,375  
Consumer
    526       394  
 
           
Total charge-offs
    8,042       9,653  
 
           
 
               
Recoveries of previous loan losses:
               
Commercial, financial and agricultural
    154       159  
Real estate — commercial
    5       10  
Real estate — residential mortgage
    23       51  
Real estate — acquisition, development and construction
    6       543  
Consumer
    338       251  
 
           
Total recoveries
    526       1,014  
 
           
 
               
Net loan losses
    7,516       8,639  
Provision for loan losses
    10,198       11,841  
 
           
Balance of allowance for loan losses at end of period
  $ 29,339     $ 25,540  
 
           
 
               
Allowance for loan losses to period end loans
    3.50 %     2.87 %
Annualized net charge-offs to average loans
    1.16 %     1.28 %

 

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Management considers the current allowance for loan losses appropriate based upon its analysis in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct. While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans. Because management evaluates such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required.
Liquidity and Capital Resources
The Company has maintained adequate liquidity to meet operating and loan funding requirements despite the lack of such demand due to current market conditions. The loan to deposit ratio at September 30, 2011 was 59.86% compared to 61.96% at December 31, 2010 and 61.91% at September 30, 2010. The decrease in the loan to deposit ratio from September 30, 2010 to September 30, 2011 reflects the decreased demand for loans resulting from the slowing economy. Deposits at September 30, 2011 and December 31, 2010 include $155,342 and $183,732 of brokered certificates of deposit, respectively. GB&T and SB&T have also utilized borrowings from the Federal Home Loan Bank. They each maintain a line of credit with the Federal Home Loan Bank approximating 10% of their total assets. Federal Home Loan Bank advances are collateralized by eligible first mortgage loans, commercial real estate loans and investment securities. Federal Home Loan Bank advances totaled $52,000 at September 30, 2011. GB&T and SB&T maintain repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $20,000 and $10,000, respectively, of which no amounts were outstanding at September 30, 2011. GB&T and SB&T have federal funds purchased accommodations with SunTrust Bank, Atlanta, Georgia for advances up to $10,000 and $3,750 respectively, of which no amounts were outstanding at September 30, 2011. GB&T also has a $10,000 repurchase line of credit with Center State Bank, Orlando, Florida on which no amounts were outstanding at September 30, 2011. Additionally, liquidity needs can be supplemented by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers. The Company also uses retail securities sold under repurchase agreements to fund operations. Retail securities sold under repurchase agreements were $540 at September 30, 2011.
Stockholders’ equity to total assets was 7.17% at September 30, 2011 compared to 6.22% at December 31, 2010 and 6.33% at September 30, 2010. The capital of the Company exceeded all required regulatory guidelines at September 30, 2011. The Company’s Tier 1 risk-based, total risk-based and leverage capital ratios were 12.96%, 14.35%, and 8.14%, respectively, at September 30, 2011.

 

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The following table reflects the current regulatory capital levels in more detail, including comparisons to the regulatory minimums.
Table 13 — Regulatory Capital Requirements
September 30, 2011
                                                 
                    Required for capital        
    Actual     adequacy purposes     Excess  
    Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in thousands)  
Southeastern Bank Financial Corporation
                                               
 
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 130,200       12.96 %     40,176       4.00 %     90,024       8.96 %
Total capital
    144,141       14.35 %     80,352       8.00 %     63,789       6.35 %
Tier 1 leverage ratio
    130,200       8.14 %     63,974       4.00 %     66,226       4.14 %
 
                                               
Georgia Bank & Trust Company
                                               
 
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 114,696       12.96 %     35,391       4.00 %     79,305       8.96 %
Total capital
    125,942       14.23 %     70,781       8.00 %     55,161       6.23 %
Tier 1 leverage ratio
    114,696       8.06 %     63,997       4.50 %     50,699       3.56 %
 
                                               
Southern Bank & Trust
                                               
 
                                               
Risk-based capital:
                                               
Tier 1 capital
  $ 14,932       12.55 %     4,758       4.00 %     10,174       8.55 %
Total capital
    16,440       13.82 %     9,516       8.00 %     6,924       5.82 %
Tier 1 leverage ratio
    14,932       8.04 %     7,432       4.00 %     7,500       4.04 %
Georgia Bank & Trust Company is regulated by the Department of Banking and Finance of the State of Georgia (DBF). The DBF requires that state banks in Georgia generally maintain a minimum ratio of Tier 1 capital to total assets of four and one-half percent (4.50%).
Management is not aware of any other events or uncertainties that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations.
Commitments and Contractual Obligations
The Company is a party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company evaluates construction and acquisition and development loans for the percentage completed before extending additional credit. The Company follows the same credit policies in making commitments and contractual obligations as it does for on-balance sheet instruments.

 

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Unfunded commitments to extend credit where contract amounts represent potential credit risk totaled $153,879 at September 30, 2011. These commitments are primarily at variable interest rates.
The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available-for-sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.
The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’s contractual obligations, consisting of deposits, FHLB advances, which are subject to early termination options, and borrowed funds by contractual maturity date.
Table 14 — Commitments and Contractual Obligations
                                 
    Less than     1 - 3     3 - 5     More than  
    1 Year     Years     Years     5 Years  
    (Dollars in thousands)  
 
                               
Lines of credit
  $ 153,879                    
Lease agreements
    280       110       78        
Deposits
    1,229,934       141,973       28,187       1,178  
Securities sold under repurchase agreements
    540                    
FHLB advances
          13,000             39,000  
Subordinated debentures
          2,947             20,000  
 
                       
Total commitments and contractual obligations
  $ 1,384,633     $ 158,030     $ 28,265     $ 60,178  
 
                       
Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.

 

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Effects of Inflation and Changing Prices
Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation can increase a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and refinances tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.
Regulatory Reform Legislation
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Reform Act”) was signed into law. The Dodd-Frank Reform Act represents a significant overhaul of many aspects of the regulation of the financial services industry, although many of its provisions (e.g., the interchange and trust preferred capital limitations) apply to companies that are significantly larger than the Company. The Dodd-Frank Reform Act directs applicable regulatory authorities to promulgate regulations implementing its provisions, and its effect on the Company and on the financial services industry as a whole will be clarified as those regulations are issued. Major elements of the Dodd-Frank Reform Act include:
A permanent increase in deposit insurance coverage to $250,000 per account, permanent unlimited deposit insurance on noninterest-bearing transaction accounts, and an increase in the minimum Deposit Insurance Fund reserve requirement from 1.15% to 1.35%, with assessments to be based on assets as opposed to deposits.
New disclosure and other requirements relating to executive compensation and corporate governance.
Amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations.
The establishment of the Financial Stability Oversight Council, which will be responsible for identifying and monitoring systemic risks posed by financial firms, activities, and practices.
The development of regulations to limit debit card interchange fees.

 

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The future elimination of trust preferred securities as a permitted element of Tier 1 capital.
The creation of a special regime to allow for the orderly liquidation of systemically important financial companies, including the establishment of an orderly liquidation fund.
The development of regulations to address derivatives markets, including clearing and exchange trading requirements and a framework for regulating derivatives-market participants.
Enhanced supervision of credit rating agencies through the Office of Credit Ratings within the SEC.
Increased regulation of asset-backed securities, including a requirement that issuers of asset-backed securities retain at least 5% of the risk of the asset-backed securities.
The establishment of a Bureau of Consumer Financial Protection, within the Federal Reserve, to serve as a dedicated consumer-protection regulatory body.
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
As of September 30, 2011, there were no substantial changes in the interest rate sensitivity analysis or the sensitivity of market value of portfolio equity for various changes in interest rates calculated as of December 31, 2010. A detailed discussion of market risk is provided in the Company’s 2010 Annual Report on Form 10-K.
Item 4.  
Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer (principal executive officer) and its Group Vice President and Chief Financial Officer (principal financial officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, such officers concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) that is required to be included in the Company’s periodic filings with the Securities and Exchange Commission. There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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Part II
OTHER INFORMATION
Item 1.  
Legal Proceedings
There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is subject.
Item 1A.  
Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, which could materially affect its business, financial condition or future results. The risks described in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to management or that management currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On April 15, 2004, the Company announced the commencement of a stock repurchase program, pursuant to which it will, from time to time, repurchase up to 100,000 shares of its outstanding stock. The program does not have a stated expiration date. No stock repurchase programs were terminated during the third quarter of 2011 and there were no shares repurchased under the existing stock repurchase plan or otherwise during the third quarter.
Item 3.  
Defaults Upon Senior Securities
Not applicable
Item 4.  
[Removed and Reserved]
Item 5.  
Other Information
None

 

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Item 6.  
Exhibits
         
  31.1    
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32.1    
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  101    
Interactive Data Files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 in XBRL (eXtensible Business Reporting Language). Pursuant to Regulation 406T of Regulation S-T, these Interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION
Form 10-Q Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  SOUTHEASTERN BANK FINANCIAL CORPORATION
 
 
Date: October 28, 2011  By:   /s/ Darrell R. Rains    
    Darrell R. Rains   
    Group Vice President, Chief Financial Officer
(Duly Authorized Officer of Registrant and
Principal Financial Officer) 
 

 

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