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EX-32 - FIRST FINANCIAL SERVICE CORP | v177373_ex32.htm |
EX-21 - FIRST FINANCIAL SERVICE CORP | v177373_ex21.htm |
EX-23 - FIRST FINANCIAL SERVICE CORP | v177373_ex23.htm |
EX-99.2 - FIRST FINANCIAL SERVICE CORP | v177373_ex99-2.htm |
EX-99.1 - FIRST FINANCIAL SERVICE CORP | v177373_ex99-1.htm |
EX-31.1 - FIRST FINANCIAL SERVICE CORP | v177373_ex31-1.htm |
EX-31.2 - FIRST FINANCIAL SERVICE CORP | v177373_ex31-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the fiscal year ended December 31, 2009
Commission
File Number: 0-18832
FIRST
FINANCIAL SERVICE CORPORATION
(Exact
name of registrant as specified in its charter)
Kentucky
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61-1168311
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(State
or other jurisdiction of incorporation
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(I.R.S.
Employer
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or
organization)
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Identification
No.)
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2323
Ring Road, Elizabethtown, Kentucky
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42701
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(Address
of principal executive offices)
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Zip
Code
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Registrant's
telephone number, including area code: (270) 765-2131
Securities
registered pursuant to Section 12(b) of the Act:
Common
Stock, par value $1.00 per share
(Title of
Class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past ninety days. Yes x No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of “accelerated filer”, “large accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large
Accelerated Filer ¨ Accelerated Filer
x
Non-Accelerated Filer ¨ Smaller
Reporting Company ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨ No
x
The
aggregate market value of the outstanding voting stock held by non-affiliates of
the registrant based on a June 30, 2009 closing price of $17.41 as quoted on the
NASDAQ Global Market was $67,818,044. Solely for purposes of
this calculation, the shares held by directors and executive officers of the
registrant and by any stockholder beneficially owning more than 5% of the
registrant's outstanding common stock are deemed to be shares held by
affiliates.
As of
February 26, 2010 there were issued and
outstanding 4,717,682 shares of the
registrant's common stock.
DOCUMENTS
INCORPORATED BY REFERENCE
1.
|
Portions
of the Registrant’s Definitive Proxy Statement for the 2010 Annual Meeting
of Shareholders to be held May 19, 2010are
incorporated by reference into Part III of this Form
10-K.
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FIRST
FINANCIAL SERVICE CORPORATION
2009
ANNUAL REPORT AND FORM 10-K
TABLE
OF CONTENTS
PART
I.
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||
ITEM
1.
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Business
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3
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ITEM
1A.
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Risk
Factors
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13
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ITEM
1B.
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Unresolved
Staff Comments
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17
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ITEM
2.
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Properties
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18
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ITEM
3.
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Legal
Proceedings
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18
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ITEM
4.
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Reserved
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18
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PART
II.
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||
ITEM 5.
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Market
Price of and Dividends on the Registrant’s Common Equity,
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Related
Stockholder Matters and Issuer Purchases of Equity
Securities
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19
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ITEM
6.
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Selected
Financial Data
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21
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ITEM
7.
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Management’s
Discussion and Analysis of Financial Condition and Results
of
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Operations
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21
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ITEM 7A.
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Quantitative
and Qualitative Disclosures about Market Risk
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39
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ITEM 8.
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Financial
Statements and Supplementary Data
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41
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ITEM 9.
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Changes
in and Disagreements with Accountants on Accounting and
Financial
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Disclosure
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78
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ITEM
9A.
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Controls
and Procedures
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78
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PART
III.
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ITEM
10.
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Directors
and Executive Officers of the Registrant
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78
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ITEM 11.
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Executive
Compensation
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78
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ITEM
12.
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Security
Ownership of Certain Beneficial Owners and Management and
Related
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Stockholder
Matters
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78
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ITEM
13.
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Certain
Relationships and Related Transactions
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79
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ITEM
14.
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Principal
Accountant Fees and Services
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79
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PART
IV.
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||
ITEM
15.
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Exhibits
and Financial Statement Schedules
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79
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SIGNATURES
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80
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PRELIMINARY
NOTE REGARDING
FORWARD-LOOKING
STATEMENTS
Statements
in this report that are not statements of historical fact are forward-looking
statements. First Financial Service Corporation (the “Corporation”) may make
forward-looking statements in future filings with the Securities and Exchange
Commission (“SEC”), in press releases, and in oral and written statements made
by or with the approval of the Corporation. Forward-looking
statements include, but are not limited to: (1) projections of revenues, income
or loss, earnings or loss per share, capital structure and other financial
items; (2) plans and objectives of the Corporation or its management or Board of
Directors; (3) statements regarding future events, actions or economic
performance; and (4) statements of assumptions underlying such
statements. Words such as “estimate,” “strategy,” “believes,”
“anticipates,” “expects,” “intends,” “plans,” “targeted,” and similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements.
Various
risks and uncertainties may cause actual results to differ materially from those
indicated by our forward-looking statements. In addition to those
risks described under “Item 1A Risk Factors,” of this report and our Annual
Report on Form 10-K, the following factors could cause such differences: changes
in general economic conditions and economic conditions in Kentucky and the
markets we serve, any of which may affect, among other things, our level of
non-performing assets, charge-offs, and provision for loan loss expense; changes
in interest rates that may reduce interest margins and impact funding sources;
changes in market rates and prices which may adversely impact the value of
financial products including securities, loans and deposits; changes in tax
laws, rules and regulations; various monetary and fiscal policies and
regulations, including those determined by the Federal Reserve Board, the
Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of
Financial Institutions (“KDFI”); competition with other local and regional
commercial banks, savings banks, credit unions and other non-bank financial
institutions; our ability to grow core businesses; our ability to develop and
introduce new banking-related products, services and enhancements and gain
market acceptance of such products; and management’s ability to manage these and
other risks.
Our
forward-looking statements speak only as of the date on which they are made, and
we undertake no obligation to update any forward-looking statement to reflect
events or circumstances after the date of the statement to reflect the
occurrence of unanticipated events.
PART
I
ITEM
1. Business
First
Financial Service Corporation was incorporated in August 1989 under Kentucky law
and became the holding company for First Federal Savings Bank of Elizabethtown
(the “Bank’), effective on June 1, 1990. Since that date, we have
engaged in no significant activity other than holding the stock of the Bank and
directing, planning and coordinating its business activities. Unless
the text clearly suggests otherwise, references to "us," "we," or "our" include
First Financial Service Corporation and its wholly owned subsidiary, the
Bank. Accordingly, the information set forth in this report,
including financial statements and related data, relates primarily to the Bank
and its subsidiaries. In 2004 we amended our articles of
incorporation to change our name from First Federal Financial Corporation of
Kentucky to First Financial Service Corporation.
We are
headquartered in Elizabethtown, Kentucky and were originally founded in 1923 as
a state-chartered institution and became federally chartered in 1940. In 1987,
we converted to a federally chartered savings bank and converted from mutual to
stock form. We are a member of the FHLB of Cincinnati and, since
converting to a state charter in 2003, have been subject to regulation,
examination and supervision by the FDIC and the KDFI. Our deposits
are insured by the Deposit Insurance Fund and administered by the
FDIC.
On June
25, 2008, we expanded our operations into southern Indiana with the acquisition
of FSB Bancshares, Inc., the bank holding company for The Farmers State
Bank. The Farmers State Bank had approximately $65.7 million in total
assets and $55.8 million in deposits. The Farmers State Bank had four
banking offices in Harrison and Floyd Counties in Indiana, which are adjacent to
four Kentucky counties where we currently operate and are part of the Louisville
MSA. Upon completion of the acquisition, these four offices became
branches of First Federal Savings Bank.
General
Business Overview
We serve
the needs and cater to the economic strengths of the local communities in which
we operate, and we strive to provide a high level of personal and professional
customer service. We offer a variety of financial services to our retail and
commercial banking customers. These services include personal and corporate
banking services and personal investment financial counseling
services.
3
Our full
complement of lending services includes:
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a
broad array of residential mortgage products, both fixed and adjustable
rate;
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consumer
loans, including home equity lines of credit, auto loans, recreational
vehicle, and other secured and unsecured
loans;
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specialized
financing programs to support community
development;
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mortgages
for multi-family real estate;
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commercial
real estate loans;
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commercial
loans to businesses, including revolving lines of credit and term
loans;
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real
estate development;
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construction
lending; and
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agricultural
lending.
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We
also provide a broad selection of deposit instruments. These
include:
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multiple
checking and NOW accounts for both personal and business
accounts;
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various
savings accounts, including those for minors;
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money
market accounts;
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tax
qualified deposit accounts such as Health Savings Accounts and Individual
Retirement Accounts; and
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a
broad array of certificate of deposit
products.
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We
also support our customers by providing services such as:
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acting
as a federal tax depository;
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providing
access to merchant bankcard
services;
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supplying
various forms of electronic funds
transfer;
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providing
debit cards and credit cards; and
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providing
telephone and Internet banking.
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Through our personal investment
financial counseling services, we offer a wide variety of mutual funds, equity
investments, and fixed and variable annuities. We invest in the wholesale
capital markets to manage a portfolio of securities and use various forms of
wholesale funding. The security portfolio contains a variety of instruments,
including callable debentures, taxable and non-taxable debentures, fixed and
adjustable rate mortgage backed securities, and collateralized mortgage
obligations.
Our
results of operations depend primarily on net interest income, which is the
difference between interest income from interest-earning assets and interest
expense on interest-bearing liabilities. Our operations are also affected by
non-interest income, such as service charges, loan fees, gains and losses from
the sale of mortgage loans and revenue earned from bank owned life insurance.
Our principal operating expenses, aside from interest expense, consist of
compensation and employee benefits, occupancy costs, data processing expense,
FDIC insurance premiums and provisions for loan losses.
4
Market
Area
We
operate 22 full-service banking centers and a commercial private banking center
in eight contiguous counties in central Kentucky along the Interstate 65
corridor and within the Louisville metropolitan area, including southern
Indiana. Our markets range from Metro Louisville in Jefferson County,
Kentucky approximately 40 miles north of our headquarters in Elizabethtown,
Kentucky to Hart County, Kentucky, approximately 30 miles south of Elizabethtown
to Harrison County, Indiana approximately 60 miles northwest of our
headquarters. Our markets are supported by a diversified industry
base and have a regional population of over 1 million. Louisville and
Jefferson County comprise the 16th largest
city in the United States. We operate in Hardin, Nelson, Hart,
Bullitt, Meade and Jefferson counties in Kentucky and in Harrison and Floyd
counties in southern Indiana. We control in the aggregate over 22% of
the deposit market share in our central Kentucky markets outside of
Louisville. Over the past three years, these counties have
demonstrated a growth rate in deposits of 13%. Based on the continued
economic slow-down, management anticipates that our markets may not continue to
grow at a similar rate experienced over the last few years. However,
we believe we will still be well positioned to benefit from growth in our local
markets when the economy rebounds in the future.
Since
2004, we have expanded our presence in the Louisville market, primarily through
our commercial lending operations. In an effort to better serve these
customers and to enhance our retail branch network in Louisville, we opened our
fourth new full-service state of the art retail facility in the third quarter of
2009. These facilities represent our state of the art prototype branch with a
retail-focused design. This design features an internet café with
access to online banking and bill payment services. Large plasma
screens in the lobby provide customers with current news and information about
bank products and services as well as upcoming community events. The
facilities are staffed to offer a full range of financial services to the
growing retail and commercial customer base. We also opened a commercial private
banking office in Louisville during 2007. It is the first of its type
for our company designed to better serve our high net worth commercial
customers. Our acquisition of FSB Bancshares, Inc. has broadened or
retail branch network in the Louisville market, which now extends into southern
Indiana. As of the latest June 30, 2009 FDIC data, the Bank is ranked
12th
in deposit market shares in the Louisville Metropolitan Statistical
Area. Based on our service-focused operating strategy, we believe we
can increase our presence in Louisville, where five large out-of-state holding
companies hold the largest deposit market shares.
All of
our market areas will likely benefit from the Fort Knox Military Base
Realignment passed into law during 2006. Fort Knox is located in
Hardin County, where we have a 24% market share. With the base
realignment, Fort Knox will receive several additional military units including
the Light Infantry Brigade Combat Team, the Combat Service Support Units and the
Human Resource Command. These military units will bring an estimated
2,000 additional civilian positions and 2,000 additional military positions with
an estimated $300 million in annual payroll to this area beginning in late 2009
through 2011. Over $900 million in renovations to Fort Knox are
planned to accommodate these units, including the construction of approximately
800,000 square feet of office space to house the Human Resource
Command. We anticipate the base realignment will result in
substantial growth in the retail, housing, and service industries in our
area. During the second quarter of 2009, we opened a new
full-service facility at the main entrance to the Fort Knox Military
Base. We have already experienced commercial loan growth as a result
of ongoing development and have active retail and commercial strategies prepared
in anticipation of the new personnel arriving in our market area.
General
and Operating Strategies
Our
operating strategy is to serve the needs and cater to the economic strengths of
the local communities in which we operate and strive to provide a high level of
personal and professional customer service. We offer a variety of
financial services to our retail and commercial banking customers.
Our
growth strategy is focused on a combination of acquisitions and expansion in our
existing markets through internal growth as well as establishing new branches
when market conditions support such expansion.
Branch
Expansion. Management
continues to consider growing markets for branch expansion. Because
of the economic growth in our markets over the past several years, we may
consider further branch expansion in our current or surrounding market areas.
However, we do not rule out branch expansion in other areas experiencing
economic growth.
In May
2009, we opened the Fort Knox banking center, our twenty-first banking center,
which expanded our current footprint in Hardin County, Kentucky. The
Fort Knox banking center complements our existing branch located in Radcliff,
Kentucky and is located just outside the main entrance to the Fort Knox military
base. We also completed the construction of our twenty-second
banking center which opened in July 2009. The branch is located in the
Middletown area of Louisville, Kentucky.
Internal
Growth. Management
believes that its largest source of internal growth is through our ongoing
solicitation program conducted by branch managers and lending officers, followed
by referrals from customers. The primary source for referrals is positive
customer endorsements regarding our customer service and response
time.
5
Our goal
is to maintain a profitable, customer-focused financial institution. We believe
that our existing structure, management, data and operational systems are
sufficient to achieve further internal growth in asset size, revenues and
capital without proportionate increases in operating costs. This growth should
also allow us to increase the lending limits, thereby enabling us to increase
our ability to serve the needs of existing and new customers. Our operating
strategy has always been to provide high quality community banking services to
our customers and increase market share through active solicitation of new
business, repeat business and referrals from customers, and continuation of
selected promotional strategies.
We
believe that our banking customers seek a banking relationship with a
service-oriented community banking organization. Our operational systems have
been designed to facilitate personalized service. Management believes our
banking locations have an atmosphere that encourages personalized services and
decision-making, plus we are of sufficient financial size to offer broad product
lines to meet customers' needs. We also believe that economic expansion in our
market areas will continue to contribute to internal growth. Through our primary
emphasis on customer service and our management's
banking experience, we intend to continue internal growth by attracting
customers and primarily focusing on the following:
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Products Offered—We
offer personal and corporate banking services, mortgage origination,
mortgage servicing, personal investment, and financial counseling services
as well as internet and telephone banking. We offer a full range of
commercial banking services, including cash management and remote deposit,
checking accounts, ATM's, checking accounts with interest, savings
accounts, money market accounts, certificates of deposit, NOW accounts,
Health Savings Accounts, Individual Retirement Accounts, brokerage and
residential mortgage services, branch banking, and debit and credit cards.
We also offer installment loans, including auto, recreational vehicle, and
other secured and unsecured loans sourced directly by our branches. See
"Lending Activities" below for a discussion of products we provide to
commercial accounts.
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Operational
Efficiencies—We seek to maximize operational and support
efficiencies consistent with maintaining high quality customer service. We
share a common information system designed to enhance customer service and
improve efficiencies by providing system-wide voice and data communication
connections. We have consolidated loan processing, bank balancing,
financial reporting, investment management, information systems, payroll
and benefit management, loan review, and audits to operate more
efficiently.
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Marketing Activities—We
focus on a proactive solicitation program for new business, as well as
identifying and developing products and services that satisfy customer
needs. We actively sponsor community events within our branch areas. We
believe that active community involvement enhances our reputation and
contributes to our long-term
success.
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Acquisitions. Management
believes that current economic conditions, the consolidation in the banking
industries, along with the easing of restrictions on bank branching, increased
regulatory burdens, and concerns about technology and marketing are likely to
lead owners of community banks and agencies within the Bank’s market areas to
explore the possibility of sale or combination with broader-based financial
service companies such as ourselves.
In
addition, branching opportunities have arisen from time to time as a result of
divestiture of branches by large national and regional bank holding companies of
certain overlapping branches resulting from consolidations. As a result, branch
locations become available for purchase from time to time and we may consider
these opportunities if economic conditions are favorable.
Historically,
management has been very selective when evaluating a potential
acquisition based upon factors such as the operating strategy, market, financial
condition, and the culture of the acquisition candidate. Our most
recent acquisition, completed on June 25, 2008, was the acquisition of FSB
Bancshares, Inc. and its wholly owned subsidiary, The Farmers State
Bank. The Farmers State Bank had approximately $65.7 million in total
assets and $55.8 million in deposits with offices in Harrison and Floyd County,
Indiana. These counties are adjacent to Kentucky counties where we
operate and are part of the Louisville MSA.
6
Lending
Activities
Commercial Real
Estate & Construction Lending. The largest portion of our lending
activity is the origination of commercial loans that are primarily secured by
real estate, including construction loans. We generate loans
primarily in our market area. In recent years, we have put greater emphasis on
originating loans for small and medium-sized businesses from our various
locations. We make commercial loans to a variety of
industries. Substantially all of the commercial real estate loans we
originate have adjustable interest rates with maturities of 25 years or less or
are loans with fixed interest rates and maturities of five years or less. At
December 31, 2009, we had $627.8 million outstanding in commercial real estate
loans. The security for commercial real estate loans includes retail businesses,
warehouses, churches, apartment buildings and motels. In addition, the payment
experience of loans secured by income producing properties typically depends on
the success of the related real estate project and thus may be more vulnerable
to adverse conditions in the real estate market or in the economy
generally.
Loans
secured by multi-family residential property, consisting of properties with more
than four separate dwelling units, amounted to $38.6 million of the loan
portfolio at December 31, 2009. These loans are included in the
$627.8 million outstanding in commercial real estate loans discussed
above. We generally do not lend above 75% of the appraised values of
multi-family residences on first mortgage loans. The mortgage loans we currently
offer on multi-family dwellings are generally one or five year ARMs with
maturities of 25 years or less.
Construction
loans involve additional risks because loan funds are advanced upon the security
of the project under construction, which is of uncertain value before the
completion of construction. The uncertainties inherent in estimating
construction costs, delays arising from labor problems, material shortages, and
other unpredictable contingencies make it relatively difficult to evaluate
accurately the total loan funds required to complete a project and related
loan-to-value ratios. The analysis of prospective construction loan projects
requires significantly different expertise from that required for permanent
residential mortgage lending. At December 31, 2009, we had $14.6
million outstanding in construction loans.
Our
underwriting criteria are designed to evaluate and minimize the risks of each
construction loan. Among other things, we consider evidence of the availability
of permanent financing or a takeout commitment to the borrower; the reputation
of the borrower and his or her financial condition; the amount of the borrower's
equity in the project; independent appraisals and cost estimates;
pre-construction sale and leasing information; and cash flow projections of the
borrower.
Commercial
Business Lending. The commercial business loan portfolio has
grown in recent years as a result of our focus on small business
lending. We make secured and unsecured loans for commercial,
corporate, business, and agricultural purposes, including issuing letters of
credit and engaging in inventory financing and commercial leasing
activities. Commercial loans generally are made to
small-to-medium size businesses located within our defined market
area. Commercial loans generally carry a higher yield and are made
for a shorter term than real estate loans. Commercial loans, however, involve a
higher degree of risk than residential real estate loans due to potentially
greater volatility in the value of the assigned collateral, the need for more
technical analysis of the borrower’s financial position, the potentially greater
impact that changing economic conditions may have on the borrower’s ability to
retire debt, and the additional expertise required for commercial lending
personnel. Commercial business loans outstanding at
December 31, 2009, totaled $62.9 million.
Residential Real
Estate. Residential
mortgage loans are secured primarily by single-family homes. The
majority of our mortgage loan portfolio is secured by real estate in our markets
outside of Louisville and our residential mortgage loans do not have sub-prime
characteristics. Fixed rate residential real estate loans we originate have
terms ranging from ten to thirty years. Interest rates are competitively priced
within the primary geographic lending market and vary according to the term for
which they are fixed. At December 31, 2009, we had $179.0 million in
residential mortgage loans outstanding.
We
generally emphasize the origination of adjustable-rate mortgage loans ("ARMs")
when possible. We offer seven ARM products with an annual adjustment,
which is tied to a national index with a maximum adjustment of 2% annually, and
a lifetime maximum adjustment cap of 6%. As of December 31, 2009,
approximately 42.8% of our residential real estate loans were adjustable rate
loans with adjustment periods ranging from one to seven years and balloon loans
of seven years or less. The origination of these ARMs can be more
difficult in a low interest rate environment where there is a significant demand
for fixed rate mortgages. We limit the maximum loan-to-value ratio on
one-to-four-family residential first mortgages to 90% of the appraised value and
generally limit the loan-to-value ratio on second mortgages on
one-to-four-family dwellings to 90%.
Consumer
Lending. Consumer loans
include loans on automobiles, boats, recreational vehicles and other consumer
goods, as well as loans secured by savings accounts, home improvement loans, and
unsecured lines of credit. As of December 31, 2009, consumer loans outstanding
were $111.5 million. These loans involve a higher risk of default than loans
secured by one-to-four-family residential loans. We believe, however, that the
shorter term and the normally higher interest rates available on various types
of consumer loans help maintain a profitable spread between the average loan
yield and cost of funds. Home equity lines of credit as of December 31, 2009,
totaled $52.3 million.
7
Our
underwriting standards reflect the greater risk in consumer lending than in
residential real estate lending. Among other things, the capacity of
individual borrowers to repay can change rapidly, particularly during an
economic downturn, collection costs can be relatively higher for smaller loans,
and the value of collateral may be more likely to depreciate. Our
Consumer Lending Policy establishes the appropriate consumer lending authority
for all loan officers based on experience, training, and past performance for
approving high quality loans. Loans beyond the authority of
individual officers must be approved by additional officers, the Executive Loan
Committee or the Board of Directors, based on the size of the loan. We require
detailed financial information and credit bureau reports for each consumer loan
applicant to establish the applicant’s credit history, the adequacy of income
for debt retirement, and job stability based on the applicant’s employment
records. Co-signers are required for applicants who are determined
marginal or who fail to qualify individually under these
standards. Adequate collateral is required on the majority of
consumer loans. The Executive Loan Committee monitors and evaluates
unsecured lending activity by each loan officer.
The
indirect consumer loan portfolio is comprised of new and used automobile,
motorcycle and all terrain vehicle loans originated on our behalf by a select
group of auto dealers within the service area. Indirect consumer
loans are considered to have greater risk of loan losses than direct consumer
loans due to, among other things: borrowers may have no existing
relationship with us; borrowers may not be residents of the lending area; less
detailed financial statement information may be collected at application;
collateral values can be more difficult to determine; and the condition of
vehicles securing the loan can deteriorate rapidly. To address the
additional risks associated with indirect consumer lending, the Executive Loan
Committee continually evaluates data regarding the dealers enrolled in the
program, including monitoring turn down and delinquency rates. All applications
are approved by
specific lending officers, selected based on experience in this field, who
obtain credit bureau reports on each application to assist in the
decision. Aggressive collection procedures encourage more timely
recovery of late payments. At December 31, 2009, total loans under
the indirect consumer loan program totaled $36.6 million.
Subsidiary
Activities
First
Service Corporation of Elizabethtown (“First Service”), our licensed brokerage
affiliate, provides investment services to our customers and offers tax-deferred
annuities, government securities, mutual funds, and stocks and
bonds. First Service employs four full-time employees. The
net income of First Service was $26,000 for the year ended December 31,
2009.
First
Federal Office Park, LLC, holds commercial lots adjacent to our home office on
Ring Road in Elizabethtown, that are available for sale. Currently, one of the
original nine lots held for sale remains unsold.
We
provide title insurance coverage for mortgage borrowers through two
subsidiaries: First Heartland Title, LLC, and First Federal Title
Services, LLC. First Heartland Title is a joint venture with a title insurance
company in Hardin County and First Federal Title Services is a joint venture
with a title insurance company in Louisville. We hold a 48% interest
in First Heartland Title and a 49% interest in First Federal Title Services. The
subsidiaries generated $132,000 in income for the year ended December 31, 2009,
of which our portion was $63,000.
Heritage
Properties, LLC, holds real estate acquired through foreclosure which is
available for sale. Currently, forty-one properties valued at $8.4
million are held for sale.
Competition
We face
substantial competition both in attracting and retaining deposits and in
lending. Direct competition for deposits comes from commercial banks,
savings institutions, and credit unions located in north-central Kentucky and
southern Indiana, and less directly from money market mutual funds and from
sellers of corporate and government debt securities.
The
primary competitive factors in lending are interest rates, loan origination fees
and the range of services offered by the various financial
institutions. Competition for origination of real estate loans
normally comes from commercial banks, savings institutions, mortgage bankers,
mortgage brokers, and insurance companies. Retail establishments
effectively compete for loans by offering credit cards and retail installment
contracts for the purchase of goods, merchandise and services (for example, Home
Depot, Lowe’s, etc.). We believe that we have been able to compete
effectively in our primary market area.
We have
offices in nine cities in six central Kentucky counties and offices in four
cities in two southern Indiana counties. In addition to the financial
institutions with offices in these counties, we compete with several commercial
banks and savings institutions in surrounding counties, many of which have
assets substantially greater than we have. These competitors attempt to gain
market share through their financial product mix, pricing strategies, internet
banking and banking center locations. In addition, Kentucky's
interstate banking statute, which permits banks in all states to enter the
Kentucky market if they have reciprocal interstate banking statutes, has further
increased competition for us. We believe that competition from both
bank and non-bank entities will continue to remain strong in the near
future.
8
The
following table shows our market share and rank in terms of deposits as of June
30, 2009, in each Kentucky and Indiana county where we have
offices. We have four offices in Jefferson County, which is
Louisville, Kentucky. The Louisville metropolitan area has a
population of more than one million.
County
|
Number of Offices
|
FFKY Market Share %
|
FFKY Rank
|
|||
Hardin
|
5
|
24.0
|
1
|
|||
Nelson
|
2
|
7.0
|
5
|
|||
Hart
|
1
|
22.0
|
2
|
|||
Bullitt
|
3
|
22.0
|
2
|
|||
Meade
|
3
|
56.0
|
1
|
|||
Jefferson
|
4
|
<1.0
|
N/M
|
|||
Harrison
|
3
|
11.0
|
5
|
|||
Floyd
|
|
1
|
|
<1.0
|
|
N/M
|
Employees
As of
December 31, 2009, we had 333 employees, of which 315 were full-time and 18
part-time. None of our employees are subject to a collective
bargaining agreement, and we believe that we enjoy good relations with our
personnel.
Regulation
General
Regulatory Matters. The Bank is a
Kentucky chartered commercial bank and are subject to supervision and
regulation, which involves regular bank examinations, by both the FDIC and the
KDFI. Our deposits are insured by the FDIC. Kentucky’s
banking statutes contain a “super-parity” provision that permits a well-rated
Kentucky bank to engage in any banking activity in which a national bank
operating in any state, a state bank, thrift or savings bank operating in any
other state, or a federally chartered thrift or federal savings association
meeting the qualified thrift lender test and operating in any state could
engage, provided the Kentucky bank first obtains a legal opinion specifying the
statutory or regulatory provisions that permit the activity.
In
connection with our conversion, we registered to become a bank holding company
under the Bank Holding Company Act of 1956, and are subject to supervision and
regulation by the Federal Reserve Board. As a bank holding company,
we are required to file with the Federal Reserve Board annual and quarterly
reports and other information regarding our business operations and the business
operations of our subsidiaries. We are also subject to examination by
the Federal Reserve Board and to its operational guidelines. We are subject to
the Bank Holding Company Act and other federal laws and regulations on the types
of activities in which we may engage, and to other supervisory requirements,
including regulatory enforcement actions for violations of laws and
regulations.
Acquisitions and
Change in Control. As a bank holding
company, we must obtain Federal Reserve Board approval before acquiring,
directly or indirectly, ownership or control of more than 5% of the voting stock
of a bank, and before engaging, or acquiring a company that is not a bank but is
engaged in certain non-banking activities. In approving these
acquisitions, the Federal Reserve Board considers a number of factors, and
weighs the expected benefits to the public such as greater convenience,
increased competition and gains in efficiency, against the risks of possible
adverse effects such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The
Federal Reserve Board also considers the financial and managerial resources of
the bank holding company, its subsidiaries and any company to be acquired, and
the effect of the proposed transaction on these resources. It also
evaluates compliance by the holding company's financial institution subsidiaries
and the target institution with the Community Reinvestment Act. The
Community Reinvestment Act generally requires each financial institution to take
affirmative steps to ascertain and meet the credit needs of its entire
community, including low and moderate income neighborhoods.
Federal
law also prohibits a person or group of persons from acquiring “control” of a
bank holding company without notifying the Federal Reserve Board in advance, and
then only if the Federal Reserve Board does not object to the proposed
transaction. The Federal Reserve Board has established a rebuttable
presumptive standard that the acquisition of 10% or more of the voting stock of
a bank holding company would constitute an acquisition of control of the bank
holding company. In addition, any company is required to obtain the
approval of the Federal Reserve Board before acquiring 25% (5% in the case of an
acquirer that is a bank holding company) or more of any class of a bank holding
company’s voting securities, or otherwise obtaining control or a “controlling
influence” over a bank holding company.
Other Financial
Activities. The
Gramm-Leach-Bliley Act of 1999 permits a bank holding company to elect to become
a financial holding company, which permits the holding company to conduct
activities that are “financial in nature.” To become and maintain its
status as a financial holding company, the bank holding company and all of its
affiliated depository institutions must be well-capitalized, well managed, and
have at least a satisfactory Community Reinvestment Act rating. We have not
filed an election to become a financial holding company.
9
Other Holding
Company Regulations. Federal law
substantially restricts transactions between financial institutions and their
affiliates. As a result, a bank is limited in extending credit to its
holding company (or any non-bank subsidiary), in investing in the stock or other
securities of the bank holding company or its non-bank subsidiaries, and/or in
taking such stock or securities as collateral for loans to any
borrower. Moreover, transactions between a bank and a bank holding
company (or any non-bank subsidiary) must generally be on terms and under
circumstances at least as favorable to the bank as those prevailing in
comparable transactions with independent third parties or, in the absence of
comparable transactions, on terms and under circumstances that in good faith
would be available to nonaffiliated companies.
Under
Federal Reserve Board policy, a bank holding company is expected to act as a
source of financial strength to, and to commit resources to support, its bank
subsidiaries. This support may be required at times when, absent such a policy,
the bank holding company may not be inclined to provide it. In addition, any
capital loans by the bank holding company to its bank subsidiaries are
subordinate in right of payment to deposits and to certain other indebtedness of
the bank subsidiary. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of subsidiary banks will be assumed by
the bankruptcy trustee and entitled to a priority of payment.
Capital
Requirements. The
Federal Reserve Board and the FDIC have substantially similar risk-based and
leverage capital guidelines applicable to the banking organizations they
supervise. Under the risk-based capital requirements, we are
generally required to maintain a minimum ratio of total capital to risk-weighted
assets (including certain off-balance sheet activities, such as standby letters
of credit) of 8%. At least half of the total capital must be composed of common
equity, retained earnings and qualifying perpetual preferred stock and certain
hybrid capital instruments, less certain intangibles (“Tier 1 capital”). The
remainder may consist of certain subordinated debt, certain hybrid capital
instruments, qualifying preferred stock and a limited amount of the loan loss
allowance (“Tier 2 capital” which, together with Tier 1 capital, composes “total
capital”). To be considered well-capitalized under the risk-based capital
guidelines, an institution must maintain a total risk-weighted capital ratio of
at least 10% and a Tier 1 risk-weighted ratio of 6% or greater. For further
information, see “Item 7-Management’s Discussion and Analysis of Financial
Condition and Results of Operations-Capital.”
The
Federal Deposit Insurance Corporation Act of 1991 (“FDICIA”), among other
things, identifies five capital categories for insured depository institutions:
well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized. The Corporation and
the Bank are classified as “well-capitalized.” FDICIA also requires
the bank regulatory agencies to implement systems for “prompt corrective action”
for institutions that fail to meet minimum capital requirements within these
five categories, with progressively more severe restrictions on operations,
management and capital distributions according to the category in which an
institution is placed. Failure to meet capital requirements can also cause an
institution to be directed to raise additional capital. FDICIA also
mandates that the agencies adopt safety and soundness standards relating
generally to operations and management, asset quality and executive
compensation, and authorizes administrative action against an institution that
fails to meet such standards.
In
addition, the Federal Reserve Board and the FDIC have each adopted risk-based
capital standards that explicitly identify concentrations of credit risk and the
risk arising from non-traditional activities, as well as an institution’s
ability to manage these risks, as important factors to be taken into account by
each agency in assessing an institution’s overall capital adequacy. The capital
guidelines also provide that an institution’s exposure to a decline in the
economic value of its capital due to changes in interest rates be considered by
the agency as a factor in evaluating a banking organization’s capital adequacy.
In addition to the “prompt corrective action” directives, failure to meet
capital guidelines can subject a banking organization to a variety of other
enforcement remedies, including additional substantial restrictions on its
operations and activities, termination of deposit insurance by the FDIC, and
under some conditions the appointment of a conservator or receiver.
Dividends. The Corporation
is a legal entity separate and distinct from the Bank. The majority
of our revenue is from dividends we receive from the Bank. The Bank
is subject to laws and regulations that limit the amount of dividends it can
pay. If, in the opinion of a federal regulatory agency, an institution under its
jurisdiction is engaged in or is about to engage in an unsafe or unsound
practice, the agency may require, after notice and a hearing, that the
institution cease and desist from such practice. The federal banking agencies
have indicated that paying dividends that deplete an institution's capital base
to an inadequate level would be an unsafe and unsound banking practice. Under
FDICIA, an insured institution may not pay a dividend if payment would cause it
to become undercapitalized or if it already is undercapitalized. Moreover, the
Federal Reserve Board and the FDIC have issued policy statements providing that
bank holding companies and banks should generally pay dividends only out of
current operating earnings.
Under
Kentucky law, dividends by Kentucky banks may be paid only from current or
retained net profits. Before any dividend may be declared for any
period (other than with respect to preferred stock), a bank must increase its
capital surplus by at least 10% of the net profits of the bank for the period
until the bank's capital surplus equals the amount of its stated capital
attributable to its common stock. Moreover, the KDFI Commissioner
must approve the declaration of dividends if the total dividends to be declared
by a bank for any calendar year would exceed the bank's total net profits for
such year combined with its retained net profits for the preceding
two years, less any required transfers to surplus or a fund for the retirement
of preferred stock or debt. We are also subject to the Kentucky
Business Corporation Act, which generally prohibits dividends to the extent they
result in the insolvency of the corporation from a balance sheet perspective or
if becoming unable to pay debts as they come due.
10
Consumer
Protection Laws. We are subject to
a number of federal and state laws designed to protect borrowers and promote
lending to various sectors of the economy and population. These laws
include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the
Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate
Settlement Procedures Act, and state law counterparts.
Federal
law currently contains extensive customer privacy protections
provisions. Under these provisions, a financial institution must
provide to its customers, at the inception of the customer relationship and
annually thereafter, the institution’s policies and procedures regarding the
handling of customers’ nonpublic personal financial
information. These provisions also provide that, except for certain
limited exceptions, an institution may not provide such personal information to
unaffiliated third parties unless the institution discloses to the customer that
such information may be so provided and the customer is given the opportunity to
opt out of such disclosure. Federal law makes it a criminal offense,
except in limited circumstances, to obtain or attempt to obtain customer
information of a financial nature by fraudulent or deceptive means.
The
Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in
meeting the credit needs of the communities we serve, including low- and
moderate-income neighborhoods and persons. The FDIC's assessment of
our record is made available to the public. The assessment also is
part of the Federal Reserve Board's consideration of applications to acquire,
merge or consolidate with another banking institution or its holding company, to
establish a new branch office or to relocate an office. The Federal
Reserve Board will also assess the CRA record of the subsidiary banks of a bank
holding company in its consideration of any application to acquire a bank or
other bank holding company, which may be the basis for denying the
application.
Bank Secrecy
Act. The Bank Secrecy
Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory
reporting standards for currency transactions and improve detection and
investigation of criminal, tax and other regulatory violations. BSA and
subsequent laws and regulations require us to take steps to prevent the use of
the Bank in the flow of illegal or illicit money, including, without limitation,
ensuring effective management oversight, establishing sound policies and
procedures, developing effective monitoring and reporting capabilities, ensuring
adequate training and establishing a comprehensive internal audit of BSA
compliance activities.
In recent
years, federal regulators have increased the attention paid to compliance with
the provisions of BSA and related laws, with particular attention paid to “Know
Your Customer” practices. Banks have been encouraged by regulators to
enhance their identification procedures prior to accepting new customers in
order to deter criminal elements from using the banking system to move and hide
illegal and illicit activities.
USA Patriot
Act. The USA PATRIOT
Act of 2001 (the “Patriot Act”) contains anti-money laundering measures
affecting insured depository institutions, broker-dealers and certain other
financial institutions. The Patriot Act requires financial
institutions to implement policies and procedures to combat money laundering and
the financing of terrorism, including standards for verifying customer
identification at account opening, and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering. The
Patriot Act also grants the Secretary of the Treasury broad authority to
establish regulations and to impose requirements and restrictions on financial
institutions’ operations. In addition, the Patriot Act requires the
federal bank regulatory agencies to consider the effectiveness of a financial
institution’s anti-money laundering activities when reviewing bank mergers and
bank holding company acquisitions.
Federal Deposit
Insurance Assessments. The deposits of our bank subsidiary are
insured up to applicable limits by the Deposit Insurance Fund, or the DIF, of
the FDIC and are subject to deposit insurance assessments to maintain the DIF.
The FDIC utilizes a risk-based assessment system that imposes insurance premiums
based upon a risk matrix that takes into account a bank's capital level and
supervisory rating.
Effective
January 1, 2007, the FDIC imposed deposit assessment rates based on the risk
category of the bank subsidiary. Risk Category I is the lowest risk
category while Risk Category IV is the highest risk category. Because
of favorable loss experience and a healthy reserve ratio in the Bank Insurance
Fund, or the BIF, of the FDIC, well-capitalized and well-managed banks, have in
recent years paid minimal premiums for FDIC insurance. With the additional
deposit insurance, a deposit premium refund, in the form of credit offsets, was
granted to banks that were in existence on December 31, 1996 and paid deposit
insurance premiums prior to that date. For 2007 and the first half of
2008, our subsidiary bank utilized the credits to offset a majority of its FDIC
insurance assessment.
On
October 16, 2008, the FDIC published a restoration plan designed to replenish
the Deposit Insurance Fund over a period of five years and to increase the
deposit insurance reserve ratio, which decreased to 1.01% of insured deposits on
June 30, 2008, to the statutory minimum of 1.15% of insured deposits by December
31, 2013. In order to implement the restoration plan, the FDIC
proposes to change both its risk-based assessment system and its base assessment
rates. For the first quarter of 2009 only, the FDIC increased all
FDIC deposit assessment rates by 7 basis points. These new rates range from 12
to 14 basis points for Risk Category I institutions to 50 basis points for Risk
Category IV institutions.
11
Under the
FDIC's restoration plan, the FDIC proposes to establish new initial base
assessment rates that will be subject to adjustment as described
below. Beginning April 1, 2009, the base assessment rates would range
from 12 to 16 basis points for Risk Category I institutions to 45 basis points
for Risk Category IV institutions.
Changes
to the risk-based assessment system would include increasing premiums for
institutions that rely on excessive amounts of brokered deposits, increasing
premiums for excessive use of secured liabilities (including Federal Home Loan
Bank advances), lowering premiums for smaller institutions with very high
capital levels, and adding financial ratios and debt issuer ratings to the
premium calculations for banks with over $10 billion in assets, while providing
a reduction for their unsecured debt.
Either an
increase in the Risk Category of the Company’s bank subsidiary or adjustments to
the base assessment rates could result in a material increase in our expense for
federal deposit insurance.
In
addition, all institutions with deposits insured by the FDIC are required to pay
assessments to fund interest payments on bonds issued by the Financing
Corporation (FICO), a mixed-ownership government corporation established to
recapitalize a predecessor to the Deposit Insurance Fund. The current annualized
assessment rate is 1.14 basis points, or approximately .285 basis points per
quarter. These assessments will continue until the Financing Corporation bonds
mature in 2019.
The FDIC
implemented a five basis point emergency special assessment on insured
depository institutions as of June 30, 2009. The special assessment
was paid on September 30, 2009. This assessment resulted in a cost of
$477,000 and is reflected in our income statement for 2009. The
interim rule also authorizes the FDIC to impose an additional emergency
assessment of up to 10 basis points in respect to deposits for quarters ended
after June 30, 2009 if necessary to maintain public confidence in federal
deposit insurance. In addition, during the fourth quarter of 2009,
the FDIC approved that all banks prepay three and a quarter years worth of FDIC
assessments on December 31, 2009. The prepayment is based on average
third quarter deposits. The prepaid amount will be amortized over the
prepayment period. Our prepayment was $7.5 million of which $494,000
was reflected in our 2009 income statement related to the fourth quarter
premium.
Emergency
Economic Stabilization Act. In October 2008, the Emergency
Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the
Treasury Department to purchase from financial institutions and their holding
companies up to $700 billion in mortgage loans, mortgage-related securities and
certain other financial instruments, including debt and equity securities issued
by financial institutions and their holding companies in a troubled asset relief
program (“TARP”). The purpose of TARP is to restore confidence and stability to
the U.S. banking system and to encourage financial institutions to increase
their lending to customers and to each other. The Treasury Department has
allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under
the CPP, Treasury has purchased debt or equity securities from participating
institutions, including us. The TARP also includes direct purchases or
guarantees of troubled assets of financial institutions. Participants in the CPP
are subject to executive compensation limits and are encouraged to expand their
lending and mortgage loan modifications. For details regarding our sale of
$20 million of preferred stock to the Treasury Department through the CPP, see
“Item7 –
Management’s Discussion and Analysis of Financial Condition and Results of
Operation – Capital and
Note 12 of the Notes to Consolidated Financial Statements.”
EESA also
increased FDIC deposit insurance on most accounts from $100,000 to $250,000.
This increase is in place until December 31, 2013 and is not covered by deposit
insurance premiums paid by the banking industry.
Temporary
Liquidity Guarantee Program. The FDIC established a Temporary Liquidity
Guarantee Program (“TLGP”) on October 14, 2008. The TLGP includes the
Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit
insurance coverage through June 30, 2010 for noninterest-bearing transaction
accounts (typically business checking accounts) and certain funds swept into
noninterest-bearing savings accounts. Institutions participating in the TAGP pay
a 10 basis points fee (annualized) on the balance of each covered account in
excess of $250,000, while the extra deposit insurance is in place. The TLGP also
includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees
certain senior unsecured debt of FDIC-insured institutions and their holding
companies. The unsecured debt must be issued on or after October 14, 2008 and
not later than October 31, 2009, and the guarantee is effective through the
earlier of the maturity date or June 30, 2012. The DGP coverage limit is
generally 125% of the eligible entity’s eligible debt outstanding on September
30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain
insured institutions, 2% of their liabilities as of September 30, 2008.
Depending on the term of the debt maturity, the nonrefundable DGP fee ranges
from 50 to 100 basis points (annualized) for covered debt outstanding until the
earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for all
eligible entities, unless the entity opted out on or before December 5, 2008.
First Financial Service Corporation’s bank subsidiary elected to participate in
the TAGP and both the bank subsidiary and the holding company are eligible to
participate in DGP.
Certificate of
Deposit Account Registry Service. To mitigate the risks
associated with carrying balances in excess of federally insured limits, we are
participating in the Certificate of Deposit Account Registry Service
(“CDARS”). CDARS is a system that allows certificates of deposit that
would be in excess of FDIC coverage in a single financial institution to be
redistributed to other financial institutions within the CDARS network in
increments under the current FDIC coverage limit. Consequently, the
full amount of the certificates of deposit becomes eligible for FDIC
protection.
12
American Recovery
and Reinvestment Act. On February 17, 2009, the American Recovery and
Reinvestment Act of 2009 (“ARRA”) was signed into law by President Obama. ARRA
includes a wide variety of programs intended to stimulate the economy and
provide for extensive infrastructure, energy, health, and education needs. In
addition, ARRA imposes certain new executive compensation and corporate
expenditure limits on all current and future CPP recipients, including First
Financial Service
Corporation,
until the institution has repaid the Treasury. ARRA also permits CPP
participants to redeem the preferred shares held by the Treasury Department
without penalty and without the need to raise new capital, subject to the
Treasury’s consultation with the recipient’s appropriate regulatory
agency.
Available
Information
The
periodic reports that we file with the SEC are available at the SEC’s website at
http://www.sec.gov. Additionally,
all reports we file with the SEC, plus ownership reports filed by our directors
and executive officers and additional shareholder information is available free
of charge on our website at http://www.ffsbky.com.
We post these reports to our website as soon as reasonably practicable after
filing them with the SEC.
ITEM
1A. Risk Factors
The risks
identified below, as well as in the other cautionary statements made throughout
this report, identify factors that could materially and adversely affect our
business, future results of operations, and future cash flows.
Our
business has been and may continue to be adversely affected by current
conditions in the financial markets and by economic conditions
generally.
The
capital and credit markets have been experiencing severe recessionary conditions
for more than a year. In some cases, the markets have produced
downward pressure on stock prices and credit availability for certain issuers
without regard to those issuers’ underlying financial
strength. Reduced consumer spending and the absence of liquidity in
the global credit markets during the current recession have depressed business
activity across a wide range of industries. Unemployment has also
increased significantly.
Sustained
weakness or weakening in business and economic conditions generally or
specifically in our markets has had and could continue to have the following
adverse effects on our business:
|
·
|
A
decrease in the demand for loans and other products and services that we
offer;
|
|
·
|
A
decrease in the value of our loans held for sale or other assets secured
by consumer or commercial real
estate;
|
|
·
|
An
impairment of certain intangible
assets;
|
|
·
|
An
increase in the number of clients who become delinquent, file for
protection under bankruptcy laws or default on their loans or other
obligations to us.
|
An
increase in the number of delinquencies, bankruptcies or defaults has resulted
in a higher level of nonperforming assets, net charge-offs, and provision for
loan losses.
Overall,
during the past year, the general business environment has had an adverse effect
on our business, and there can be no assurance that the environment will improve
in the near term. Until conditions improve, we expect our businesses, financial
condition and results of operations to be adversely affected.
Ongoing
market developments may continue to adversely affect our industry, businesses
and results of operations.
Since
mid-2007, the financial services industry as a whole, as well as the securities
markets generally, have been materially and adversely affected by very
significant declines in the values of nearly all asset classes and by a very
serious lack of liquidity. Financial institutions in particular have been
subject to increased volatility and an overall loss in investor
confidence. Concerns about the stability of the financial markets
generally and the strength of counterparties have caused many lenders and
institutional investors to reduce, and in some cases, cease to provide funding
to borrowers including financial institutions.
The lack
of available credit, loss of confidence in the financial sector, increased
volatility in the financial markets and reduced business activity have
materially and adversely affected our business, financial condition and results
of operations. Further negative market developments may affect consumer
confidence levels and may cause adverse changes in payment patterns, causing
increases in delinquencies and default rates, which may impact our charge-offs
and provisions for credit losses. A worsening of these conditions would likely
exacerbate the adverse effects of these difficult market conditions on us and
others in the financial services industry.
13
Our
decisions regarding credit risk may not be accurate, and our allowance for loan
losses may not be sufficient to cover actual losses, which could adversely
affect our business, financial condition and results of operations.
We
maintain an allowance for loan losses at a level we believe is adequate to
absorb any probable incurred losses in our loan portfolio based on historical
loan loss experience, specific problem loans, value of underlying collateral and
other relevant factors. If our assessment of these factors is ultimately
inaccurate, the allowance may not be sufficient to cover actual loan losses,
which would adversely affect our operating results. Our estimates are subjective
and their accuracy depends on the outcome of future events. Changes in economic,
operating and other conditions that are generally beyond our control, including
changes in interest rates, could cause actual loan losses to increase
significantly. In addition, bank regulatory agencies, as an integral part of
their supervisory functions, periodically review the adequacy of our allowance
for loan losses. Regulatory agencies have from time to time required
us to increase our provision for loan losses or to recognize further loan
charge-offs when their judgment has differed from ours, and may do so in the
future, which could have a material negative impact on our operating
results.
Our
loan portfolio possesses increased risk due to our relatively high concentration
of loans collateralized by real estate.
Approximately
87.0% of our loan
portfolio as of December 31, 2009 was comprised of loans collateralized by real
estate. An adverse change in the economy affecting values of real estate
generally or in our primary markets such as we have recently experienced could
significantly impair the value of our collateral and our ability to sell the
collateral upon foreclosure. The real estate collateral in each case provides an
alternate source of repayment in the event of default by the borrower and may
deteriorate in value during the time the credit is extended. When real estate
values decline, it becomes more likely that we would be required to increase our
allowance for loan losses as we did in 2009. If during a period of reduced real
estate values we are required to liquidate the collateral securing a loan to
satisfy the debt or to increase our allowance for loan losses, it could
materially reduce our profitability and adversely affect our financial
condition.
Declines
in asset values may result in impairment charges and adversely affect the value
of our investments, financial performance and capital.
Under
U.S. generally accepted accounting principles, we are required to review our
investment portfolio periodically for the presence of other-than-temporary
impairment of our securities, taking into consideration current market
conditions, the extent and nature of change in fair value, issuer rating changes
and trends, volatility of earnings, current analysts’ evaluations, our ability
and intent to hold investments until a recovery of fair value, as well as other
factors. Adverse developments with respect to one or more of the foregoing
factors may require us to deem particular securities to be
other-than-temporarily impaired, with the reduction in the value recognized as a
charge to earnings. Recent market volatility has made it extremely difficult to
value certain securities. Subsequent valuations, in light of factors prevailing
at that time, may result in significant changes in the values of these
securities in future periods. Any of these factors could require us to recognize
further impairments in the value of our securities portfolio, which may have an
adverse effect on our results of operations in future periods.
Our
profitability depends significantly on local economic conditions.
Because
most of our business activities are conducted in central Kentucky and adjacent
counties of Indiana, and most of our credit exposure is in that region, we are
at risk from adverse economic or business developments affecting this area,
including declining regional and local business activity, a downturn in real
estate values and agricultural activities and natural disasters. To
date, the declines in real estate values in our markets have been moderate
compared to the severe declines experienced in other regions. To the
extent the central Kentucky economy further declines, the rates of
delinquencies, foreclosures, bankruptcies and losses in our loan portfolio would
likely increase. Moreover, the value of real estate or other collateral that
secures our loans could be adversely affected by economic downturn or a
localized natural disaster. An economic downturn or other events that affect our
markets could, therefore, result in losses that may materially and adversely
affect our business, financial condition, results of operations and future
prospects.
Our
small to medium-sized business target market may have fewer resources to weather
the downturn in the economy.
Our
strategy includes lending to small and medium-sized businesses and other
commercial enterprises. Small and medium-sized businesses frequently have
smaller market shares than their competitors, may be more vulnerable to economic
downturns, often need substantial additional capital to expand or compete and
may experience substantial variations in operating results, any of which may
impair a borrower’s ability to repay a loan. In addition, the success of a small
and medium-sized business often depends on the management talents and efforts of
one or two persons or a small group of persons, and the death, disability or
resignation of one or more of these persons could have a material adverse impact
on the business and its ability to repay our loan. Economic downturns and other
events could have a more pronounced negative impact on our target market, which
could cause us to incur substantial credit losses that could materially harm our
operating results.
14
Our
profitability is vulnerable to fluctuations in interest rates.
Changes
in interest rates could harm our financial condition or results of
operations. Our results of operations depend substantially
on net
interest income, the difference between interest earned on interest-earning
assets (such as investments and loans) and interest paid on interest-bearing
liabilities (such as deposits and borrowings). Interest rates are
highly sensitive to many factors, including governmental monetary policies and
domestic and international economic and political conditions. Factors
beyond our control, such as inflation, recession, unemployment, and money supply
may also affect interest rates. If our interest-earning assets mature
or reprice more quickly than our interest-bearing liabilities in a given period,
as a result of decreasing interest rates, our net interest income may
decrease. Likewise, our net interest income may decrease if
interest-bearing liabilities mature or reprice more quickly than
interest-earning assets in a given period as a result of increasing interest
rates.
Fixed-rate
loans increase our exposure to interest rate risk in a rising rate environment
because interest-bearing liabilities would be subject to repricing before assets
become subject to repricing. Adjustable-rate loans decrease the risk
associated with changes in interest rates but involve other risks, such as the
inability of borrowers to make higher payments in an increasing interest rate
environment. At the same time, for secured loans, the marketability
of the underlying collateral may be adversely affected by higher interest
rates. In the current low interest rate environment, there may be an
increase in prepayments on loans as the borrowers refinance their loans at lower
interest rates, which could reduce net interest income and harm our results of
operations.
We
may need to raise additional capital in the future, but that capital may not be
available when needed or at all.
We may
need to raise additional capital in the future to provide us with sufficient
capital resources and liquidity to meet our commitments and business needs. Our
ability to raise additional capital, if needed, will depend on, among other
things, conditions in the capital markets at that time, which are outside of our
control, and our financial performance. We cannot assure you that
capital will be available to us on acceptable terms or at all. An
inability to raise additional capital on acceptable terms when needed could have
a materially adverse effect on our businesses, financial condition and results
of operations.
If
we cannot borrow funds through access to the capital markets, we may not be able
to meet the cash flow requirements of our depositors and borrowers, or meet the
operating cash needs of the Corporation to fund corporate expansion or other
activities.
Our
liquidity policies and limits are established by the Board of Directors, with
operating limits set by the Asset Liability Committee (“ALCO”), based upon
analyses of the ratio of loans to deposits, the percentage of assets funded with
non-core or wholesale funding. The ALCO regularly monitors the
overall liquidity position of the Bank and the Corporation to ensure that
various alternative strategies exist to cover unanticipated events that could
affect liquidity. Liquidity is the ability to meet cash flow needs on
a timely basis at a reasonable cost. If our liquidity policies and
strategies don’t work as well as intended, then we may be unable to make loans
and to repay deposit liabilities as they become due or are demanded by
customers. The ALCO follows established board-approved policies and
monitors guidelines to diversify our wholesale funding sources to avoid
concentrations in any one-market source. Wholesale funding sources
include Federal funds purchased, securities sold under repurchase agreements,
non-core brokered deposits, and medium and long-term debt, which includes
Federal Home Loan Bank (“FHLB”) advances that are collateralized with
mortgage-related assets.
We
maintain a portfolio of securities that can be used as a secondary source of
liquidity. There are other available sources of liquidity, including the sale or
securitization of loans, the ability to acquire additional non-core brokered
deposits, additional collateralized borrowings such as FHLB advances, the
issuance of debt securities, and the issuance of preferred or common securities
in public or private transactions. If we were unable to access any of
these funding sources when needed, we might not be able to meet the needs of our
customers, which could adversely impact our financial condition, our results of
operations, cash flows, and our level of regulatory-qualifying
capital. For further discussion, see the “Liquidity” section of
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
We
face strong competition from other financial institutions and financial service
companies, which could adversely affect our results of operations and financial
condition.
We
compete with other financial institutions in attracting deposits and making
loans. Our competition in attracting deposits comes principally from commercial
banks, credit unions, savings and loan associations, securities brokerage firms,
insurance companies, money market funds and other mutual funds. Competition in
making loans in the Louisville metropolitan area has increased in recent years
after changes in banking law allowed several banks to enter the market by
establishing new branches. Likewise, competition is increasing in our other
markets, which may adversely affect our ability to maintain our market
share.
Competition
in the banking industry may also limit our ability to attract and retain banking
clients. We maintain smaller staffs of associates and have fewer financial and
other resources than larger institutions with which we
compete. Financial institutions that have far greater resources and
greater efficiencies than we do may have several marketplace advantages
resulting from their ability to:
15
|
·
|
offer
higher interest rates on deposits and lower interest rates on loans than
we can;
|
|
·
|
offer
a broader range of services than we
do;
|
|
·
|
maintain
numerous branch locations; and
|
|
·
|
mount
extensive promotional and advertising
campaigns.
|
In
addition, banks and other financial institutions with larger capitalization and
other financial intermediaries may not be subject to the same regulatory
restrictions as we are and may have larger lending limits than we do. Some of
our current commercial banking clients may seek alternative banking sources as
they develop needs for credit facilities larger than we can accommodate. If we
are unable to attract and retain customers, we may not be able to maintain
growth and our results of operations and financial condition may otherwise be
negatively impacted.
While
management continually monitors and improves our system of internal controls,
data processing systems, and corporate wide processes and procedures, there can
be no assurance that we will not suffer losses from operational risk in the
future.
Management
maintains internal operational controls and we have invested in technology to
help us process large volumes of transactions. However, there can be
no assurance that we will be able to continue processing at the same or higher
levels of transactions. If our systems of internal controls should
fail to work as expected, if our systems were to be used in an unauthorized
manner, or if employees were to subvert the system of internal controls,
significant losses could occur.
We
process large volumes of transactions on a daily basis and are exposed to
numerous types of operation risk, which could cause us to incur substantial
losses. Operational risk resulting from inadequate or failed internal
processes, people, and systems includes the risk of fraud by employees or
persons outside of our company, the execution of unauthorized transactions by
employees, errors relating to transaction processing and systems, and breaches
of the internal control system and compliance requirements. This risk
of loss also includes potential legal actions that could arise as a result of
the operational deficiency or as a result of noncompliance with applicable
regulatory standards.
We
establish and maintain systems of internal operational controls that provide
management with timely and accurate information about our level of operational
risk. While not foolproof, these systems have been designed to manage
operational risk at appropriate, cost effective levels. We have also
established procedures that are designed to ensure that policies relating to
conduct, ethics, and business practices are followed. Nevertheless,
we experience loss from operational risk from time to time, including the
effects of operational errors, and these losses may be substantial.
We
operate in a highly regulated environment and, as a result, are subject to
extensive regulation and supervision that could adversely affect our financial
performance and our ability to implement our growth and operating
strategies.
We are
subject to examination, supervision and comprehensive regulation by federal and
state regulatory agencies, which is described under “Item 1 Business –
Regulation.” Regulatory oversight of banks is primarily intended to
protect depositors, the federal deposit insurance funds, and the banking system
as a whole, not our shareholders. Compliance with these regulations is costly
and may make it more difficult to operate profitably.
Federal
and state banking laws and regulations govern numerous matters including the
payment of dividends, the acquisition of other banks and the establishment of
new banking offices. We must also meet specific regulatory capital requirements.
Our failure to comply with these laws, regulations and policies or to maintain
our capital requirements affects our ability to pay dividends on common stock,
our ability to grow through the development of new offices and our ability to
make acquisitions. We currently may not pay a dividend from the Bank
to the Corporation without the prior written consent of our primary banking
regulators, which limits our ability to pay dividends on our common
stock. These limitations may also prevent us from successfully
implementing our growth and operating strategies.
In
addition, the laws and regulations applicable to banks could change at any time,
which could significantly impact our business and profitability. For example,
new legislation or regulation could limit the manner in which we may conduct our
business, including our ability to attract deposits and make
loans. Events that may not have a direct impact on us, such as the
bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators
and banking regulators and other agencies such as the Financial Accounting
Standards Board, the SEC, the Public Company Accounting Oversight Board and
various taxing authorities to respond by adopting and or proposing substantive
revisions to laws, regulations, rules, standards, policies, and
interpretations. The nature, extent, and timing of the adoption of
significant new laws and regulations, or changes in or repeal of existing laws
and regulations may have a material impact on our business and results of
operations. Changes in regulation may cause us to devote substantial
additional financial resources and management time to compliance, which may
negatively affect our operating results.
16
Our
issuance of securities to the US Department of the Treasury may limit our
ability to return capital to our shareholders and is dilutive to our common
shares. In addition, the dividend rate increases substantially after
five years if we cannot redeem the shares by that time.
On
January 9, 2009, as part of the Capital Purchase Program established by the U.S.
Department of the Treasury under the Emergency Economic Stabilization Act of
2008 (“EESA”), we sold $20 million of senior preferred stock to the Department
of the Treasury. We also issued to the Department of the Treasury a
warrant to purchase approximately 216,000 shares of our common stock at $13.89
per share. The terms of the transaction with the Department of the Treasury
limit our ability to pay dividends and repurchase our shares. For three years
after issuance or until the Department of the Treasury no longer holds any
preferred shares, we will not be able to increase our dividends above the most
recent level before October 14, 2008 ($.19 per common share on a quarterly
basis) nor repurchase any of our shares without the Department of the Treasury’s
approval with limited exceptions, most significantly purchases in connection
with benefit plans. Also, we will not be able to pay any dividends at all unless
we are current on our dividend payments on the preferred shares. These
restrictions, as well as the dilutive impact of the warrant, may have an adverse
effect on the market price of our common stock.
Unless we
are able to redeem the preferred stock during the first five years, the
dividends on this capital will increase substantially at that point, from 5%
(approximately $1 million annually) to 9% (approximately $1.8 million annually).
Depending on market conditions and our financial performance at the time, this
increase in dividends could significantly impact our capital and
liquidity.
The
US Department of the Treasury has the unilateral ability to change some of the
restrictions imposed on us by virtue of our sale of securities to
it.
Our
agreement with the US Department of the Treasury under which it purchased our
securities imposes restrictions on our conduct of our business, including
restrictions related to our payment of dividends and repurchase of our stock and
related to our executive compensation and governance. The US Department of the
Treasury has the right under this agreement to unilaterally amend it to the
extent required to comply with any future changes in federal statutes. The
American Recovery and Reinvestment Act of 2009 amended provisions of EESA
relating to compensation and governance as they affect companies that have sold
securities to the US Department of the Treasury. In some cases, these amendments
require action by the US Department of the Treasury to implement them. These
amendments could have an adverse impact on the conduct of our business, as could
additional amendments in the future that impose further requirements or amend
existing requirements.
ITEM
1B. Unresolved Staff Comments
We have
no unresolved SEC staff comments.
17
ITEM
2. Properties
Our
executive offices and principal support are located at 2323 Ring Road in
Elizabethtown, Kentucky. Our operational functions are located at
2323 Ring Road and 101 Financial Place in Elizabethtown,
Kentucky. All of our banking centers are located in Kentucky and
Southern Indiana. The location of our 22 full-service banking
centers, an operations building and a commercial private banking center, whether
owned or leased, and their respective approximate square footage is described in
the following table.
APPROXIMATE
|
||||||
OWNED OR
|
SQUARE
|
|||||
BANKING CENTERS IN KENTUCKY
|
LEASED
|
FOOTAGE
|
||||
ELIZABETHTOWN
|
||||||
2323
Ring Road
|
Owned
|
57,295 | ||||
325
West Dixie Avenue
|
Owned
|
5,880 | ||||
2101
North Dixie Avenue
|
Owned
|
3,150 | ||||
101
Financial Place
|
Owned
|
20,619 | ||||
RADCLIFF
|
||||||
475
West Lincoln Trail
|
Owned
|
2,728 | ||||
1671
North Wilson Road
|
Owned
|
3,479 | ||||
BARDSTOWN
|
||||||
401
East John Rowan Blvd.
|
Owned
|
4,500 | ||||
315
North Third Street
|
Owned
|
1,271 | ||||
MUNFORDVILLE
|
||||||
925
Main Street
|
Owned
|
2,928 | ||||
SHEPHERDSVILLE
|
||||||
395
N. Buckman Street
|
Owned
|
7,600 | ||||
1707
Cedar Grove Road, Suite 1
|
Leased
|
3,425 | ||||
MT.
WASHINGTON
|
||||||
279
Bardstown Road
|
Owned
|
6,310 | ||||
BRANDENBURG
|
||||||
416
East Broadway
|
Leased
|
4,395 | ||||
50
Old Mill Road
|
Leased
|
575 | ||||
FLAHERTY
|
||||||
4055
Flaherty Road
|
Leased
|
1,216 | ||||
LOUISVILLE
|
||||||
11810
Interchange Drive
|
Owned
|
4,675 | ||||
3650
South Hurstbourne Parkway
|
Owned
|
4,428 | ||||
12629
Taylorsville Road
|
Owned
|
3,479 | ||||
4965
U.S. Highway 42, Suite 2100
|
Leased
|
2,035 | ||||
301
Blakenbaker Parkway
|
Owned
|
3,479 | ||||
BANKING CENTERS IN INDIANA
|
||||||
CORYDON
|
||||||
2030
Hwy 337 NW
|
Leased
|
2,000 | ||||
ELIZABETH
|
||||||
8160
Beech Street NE
|
Owned
|
2,442 | ||||
GEORGETOWN
|
||||||
6500
State Road 64
|
Owned
|
3,536 | ||||
LANESVILLE
|
||||||
7340
Main Street
|
Owned
|
4,230 |
ITEM
3. Legal Proceedings
Although,
from time to time, we are involved in various legal proceedings in the normal
course of business, there are no material pending legal proceedings to which we
are a party, or to which any of our property is subject.
ITEM
4. Reserved
18
PART
II
ITEM
5.
|
Market
Price of and Dividends on the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities
|
(a) Market
Information
Our
common stock is traded on the Nasdaq Global Market (“NASDAQ”) under the symbol
“FFKY”. The following table shows the high and low closing prices of
our Common Stock and the dividends paid.
|
Quarter
Ended
|
|||||||||||||||
|
||||||||||||||||
2009:
|
3/31
|
6/30
|
9/30
|
12/31
|
||||||||||||
|
||||||||||||||||
High
|
$ | 13.71 | $ | 19.99 | $ | 17.77 | $ | 13.06 | ||||||||
Low
|
10.00 | 11.37 | 13.47 | 8.24 | ||||||||||||
Cash
dividends
|
0.19 | 0.19 | 0.05 | - | ||||||||||||
|
||||||||||||||||
2008:
|
3/31
|
6/30
|
9/30
|
12/31
|
||||||||||||
|
||||||||||||||||
High
|
$ | 24.42 | $ | 23.96 | $ | 21.00 | $ | 20.50 | ||||||||
Low
|
20.88 | 18.14 | 15.83 | 10.25 | ||||||||||||
Cash
dividends
|
0.19 | 0.19 | 0.19 | 0.19 |
(b) Holders
At
December 31, 2009, the number of shareholders was approximately
1,257.
(c) Dividends
During
the fourth quarter of 2009, we announced the suspension of future cash dividend
payments in order to conserve capital and maintain liquidity. It is
unlikely that we will declare or pay any common stock cash dividends in
2010. Under our agreement with the Treasury Department, until the
earlier of January 9, 2012 or until we redeem all of the preferred shares sold
under the CPP, we will not be able to increase our dividends above the most
recent level ($.19 per common share on a quarterly basis).
First
Financial Service Corporation is a Kentucky corporation, and our shareholders
are entitled to receive such dividends and other distributions when, as and if
declared from time to time by our board of directors out of funds legally
available for distributions to shareholders. Any future determinations relating
to the payment of dividends will be made at the discretion of our board of
directors and will depend on a number of factors, including our future earnings,
capital requirements, financial condition, future prospects and other factors
that our board of directors may deem relevant. As a bank holding
company, our ability to declare and pay dividends also depends on federal
regulatory considerations, including the guidelines of the Federal Reserve
regarding capital adequacy and dividends.
As a bank
holding company, our principal source of revenue is the dividends that may be
declared from time to time by the Bank out of funds legally available for
payment of dividends. Currently, the Bank must obtain the written consent of its
primary regulators before declaring or paying any future dividends to the
Corporation. In addition to this current restriction, various banking
laws applicable to the Bank limit the payment of dividends to us. A Kentucky
chartered bank may declare a dividend of an amount of the bank’s net profits as
the board deems appropriate. The approval of the KDFI is required if the total
of all dividends declared by the bank in any calendar year exceeds the total of
its net profits for that year combined with its retained net profits for the
preceding two years, less any required transfers to surplus or a fund for the
retirement of preferred stock or debt.
19
(d) Securities
Authorized for Issuance Under Equity Compensation Plans
The
following table summarizes the securities authorized for issuance under our
equity compensation plans as of December 31, 2009. We have no equity
compensation plans that have not been approved by our shareholders.
Number of securities
|
||||||||||||
Number of securities
|
remaining available for
|
|||||||||||
to be issued
|
Weighted-average
|
future issuance under
|
||||||||||
upon exercise of
|
exercise price of
|
equity compensation plans
|
||||||||||
outstanding options,
|
outstanding options,
|
(excluding securities
|
||||||||||
Plan category
|
warrants and rights
|
warrants and rights
|
reflected in column (1))
|
|||||||||
|
||||||||||||
Equity
compensation plans approved by security
holders
|
279,706 | $ | 15.12 | 454,750 |
See Note
16 of the Notes to Consolidated Financial Statements for additional information
required by this item.
(e)
Issuer
Purchases of Equity Securities
We did
not repurchase any shares of our common stock during the quarter ended December
31, 2009
(f)
Performance
Graph
The graph
below compares the cumulative total return on the common stock of the
Corporation between December 31, 2004 through December 31, 2009 with the
cumulative total return of the NASDAQ Composite Index and a peer group index
over the same period. Dividend reinvestment has been
assumed. The graph was prepared assuming that $100 was invested on
December 31, 2004 in the common stock of the Corporation and in the
indexes. The stock price performance shown on the graph below is not
necessarily indicative of future stock performance.
20
ITEM
6. Selected Consolidated Financial and Other
Data
(Dollars
in thousands, except per share data)
|
At
December 31,
|
|||||||||||||||||||
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Financial
Condition Data:
|
||||||||||||||||||||
Total
assets
|
$ | 1,209,504 | $ | 1,017,047 | $ | 872,691 | $ | 822,826 | $ | 766,513 | ||||||||||
Net
loans outstanding (1)
|
985,390 | 899,436 | 760,114 | 698,026 | 635,740 | |||||||||||||||
Investments
|
46,931 | 22,797 | 39,685 | 52,447 | 61,555 | |||||||||||||||
Deposits
|
1,049,815 | 775,399 | 689,243 | 641,037 | 591,106 | |||||||||||||||
Borrowings
|
72,245 | 165,816 | 105,883 | 106,724 | 107,875 | |||||||||||||||
Stockholders'
equity
|
85,132 | 72,952 | 73,460 | 72,098 | 64,741 | |||||||||||||||
Number
of:
|
||||||||||||||||||||
Offices
|
22 | 20 | 15 | 14 | 14 | |||||||||||||||
Full
time equivalent employees
|
324 | 316 | 284 | 270 | 254 | |||||||||||||||
Year
Ended December 31,
|
||||||||||||||||||||
2009
|
2008
|
2007
|
2006
|
2005
|
||||||||||||||||
Operations
Data:
|
||||||||||||||||||||
Interest
income
|
$ | 58,856 | $ | 57,564 | $ | 60,545 | $ | 53,832 | $ | 45,368 | ||||||||||
Interest
expense
|
21,792 | 24,799 | 29,751 | 24,108 | 17,862 | |||||||||||||||
Net
interest income
|
37,064 | 32,765 | 30,794 | 29,724 | 27,506 | |||||||||||||||
Provision
for loan losses
|
9,524 | 5,947 | 1,209 | 540 | 1,258 | |||||||||||||||
Non-interest
income
|
8,519 | 8,449 | 8,203 | 7,739 | 8,067 | |||||||||||||||
Non-interest
expense
|
43,917 | 28,286 | 23,790 | 21,952 | 20,759 | |||||||||||||||
Income
tax expense/(benefit)
|
(1,149 | ) | 2,184 | 4,646 | 4,634 | 4,412 | ||||||||||||||
Net
income/(loss)
|
(6,709 | ) | 4,797 | 9,352 | 10,337 | 9,144 | ||||||||||||||
Earnings/(loss)
per common share: (2)
|
||||||||||||||||||||
Basic
|
(1.65 | ) | $ | 1.03 | $ | 1.98 | $ | 2.14 | $ | 1.89 | ||||||||||
Diluted
|
(1.65 | ) | 1.02 | 1.96 | 2.12 | 1.88 | ||||||||||||||
Book
value per common share (2)
|
13.87 | 15.63 | 15.76 | 14.95 | 13.43 | |||||||||||||||
Dividends
paid per common share (2)
|
0.43 | 0.76 | 0.73 | 0.66 | 0.59 | |||||||||||||||
Return
on average assets
|
(.61 | )% | 0.51 | % | 1.10 | % | 1.31 | % | 1.22 | % | ||||||||||
Average
equity to average assets
|
8.56 | % | 8.02 | % | 8.54 | % | 8.71 | % | 8.33 | % | ||||||||||
Return
on average equity
|
(7.18 | )% | 6.37 | % | 12.88 | % | 15.03 | % | 14.60 | % | ||||||||||
Efficiency
ratio (3)
|
70 | % | 69 | % | 61 | % | 59 | % | 58 | % |
(1)
|
Includes
loans held for sale.
|
(2)
|
Amounts
adjusted to reflect 10% stock dividends declared August 15, 2006, and
August 16, 2007.
|
(3)
|
Excludes
goodwill impairment
|
ITEM
7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Management’s
Discussion and Analysis of Financial Condition and Results of Operations
analyzes the major elements of our balance sheets and statements of
operations. This section should be read in conjunction with our
Consolidated Financial Statements and accompanying Notes and other detailed
information.
OVERVIEW
Over the
past several years we have focused on enhancing and expanding our retail and
commercial banking network in our core markets as well as establishing our
presence in the Louisville market. Our core markets, where we have a
combined 22% market share, have become increasingly competitive as several new
banks have entered those markets during the past few years. In order
to protect and grow our market share, we are replacing existing branches with
newer, enhanced facilities and anticipate constructing new facilities over the
next few years. In addition to the enhancement and expansion in our
core markets, we have been increasing our presence in the Louisville
market. Our acquisition of FSB Bancshares, Inc. has broadened our
retail branch network in the Louisville market, which now extends into southern
Indiana. Approximately 55% of the deposit base in the Louisville
market is controlled by five out-of-state banks. While the market is
very competitive, we believe this creates an opportunity for smaller community
banks with more power to make decisions locally. We believe our
investment in these initiatives along with our continued commitment to a high
level of customer service will enhance our market share in our core markets and
our development in the Louisville market.
Our
retail branch network continues to generate encouraging
results. Total deposits have grown 64% over the past three years.
Total deposits were $1.0 billion at December 31, 2009, an increase of $274.4
million from December 31, 2008. After our acquisition of Farmers
State Bank in 2008, our retail branch network in the Louisville market has
broadened to sixteen offices. In May 2009,
we opened the Fort Knox banking center, our twenty-first banking center, which
expanded our current footprint in Hardin County, Kentucky. The Fort
Knox banking center complements our existing branch located in Radcliff,
Kentucky and is located just outside the main entrance to the Fort Knox military
base. We also completed the construction of our twenty-second
banking center which opened in July 2009. The branch is located in the
Middletown area of Louisville, Kentucky. Competition for deposits
continues to be challenging in all of the markets we serve. We believe this
intense competition combined with continued re-pricing of variable rate loans
could add to additional margin compression.
21
Our
retail branch network continues to generate encouraging
results. Total deposits have grown 64% over the past three years.
Total deposits were $1.0 billion at December 31, 2009, an increase of $274.4
million from December 31, 2008. After our acquisition of Farmers
State Bank in 2008, our retail branch network in the Louisville market has
broadened to sixteen offices. In May 2009, we opened the Fort Knox
banking center, our twenty-first banking center, which expanded our current
footprint in Hardin County, Kentucky. The Fort Knox banking center
complements our existing branch located in Radcliff, Kentucky and is located
just outside the main entrance to the Fort Knox military
base. We also completed the construction of our twenty-second
banking center which opened in July 2009. The branch is located in the
Middletown area of Louisville, Kentucky. Competition for deposits
continues to be challenging in all of the markets we serve. We believe this
intense competition combined with continued re-pricing of variable rate loans
could add to additional margin compression.
We have
developed a strong commercial real estate niche in our markets. We
have an experienced team of bankers who focus on providing service and
convenience to our customers. It is quite common for our bankers to
close loans at a customer’s place of business or even the customer’s personal
residence. This high level of service has been well received in
our Louisville market, which is dominated by regional banks. To
further develop our commercial banking relationships in Louisville, we opened a
private banking office in April 2007. This upscale facility
complements our full service centers in Louisville by attracting commercial
deposit relationships in conjunction with our commercial lending
relationships.
Our
emphasis on commercial lending generated 42% growth in the total loan portfolio
and 48% growth in commercial loans over the past three
years. Commercial loans were $705.3 million at December 31, 2009, an
increase of $67.7 million, or 10.6% from December 31, 2008.
The 2009
results include goodwill impairment of $11.9 million (related to the January
1995 acquisition of Bullitt Federal Savings Bank, the July 1998 acquisition of
three Bank One Corporation branches and the June 2008 acquisition of FSB
Bancshares, Inc.). This impairment loss reflects the results of our
impairment testing due to declining market conditions. While this
charge flows through our income statement, it is a non-cash item that does not
impact our liquidity or adversely affect regulatory or tangible capital
ratios.
Despite
the continued adverse economic conditions during 2009, the Corporation’s capital
position remained well-capitalized as defined by regulatory
standards. Our capital position was further bolstered in the first
quarter of 2009 by our participation in the U.S. Treasury Department Capital
Purchase Program (“CPP”). Under the CPP, we sold $20 million of
cumulative perpetual preferred shares to the U.S. Treasury in a transaction that
closed on January 9, 2009.
We
believe that the current adverse economic conditions will be long
lasting. During the last quarter of 2008, the continued economic
slowdown moved to sectors not previously impacted, including consumer,
commercial, industrial among others. Credit issues are broadening in
these sectors and economic recovery is most likely several quarters
away. We will continue to monitor credit quality very closely in 2010
as this recession persists. As the economy and the financial sector
continue to struggle, probable losses in the loan portfolio could increase,
resulting in higher provision for loan losses during 2010.
CRITICAL
ACCOUNTING POLICIES
Our
accounting and reporting policies comply with U.S. generally accepted accounting
principles and conform to general practices within the banking
industry. The accounting policy relating to the allowance for loan
losses is critical to the understanding of our results of operations since the
application of this policy requires significant management assumptions and
estimates that could result in materially different amounts to be reported if
conditions or underlying circumstances were to change.
Allowance for
Loan Losses – We
maintain an allowance sufficient to absorb probable incurred credit losses
existing in the loan portfolio. Our Allowance for Loan Loss Review Committee,
which is comprised of senior officers, evaluates the allowance for loan losses
on a quarterly basis. We estimate the allowance using past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower’s ability to repay, estimated value of the underlying
collateral, and current economic conditions. While we estimate the
allowance for loan losses based in part on historical losses within each loan
category, estimates for losses within the commercial real estate portfolio
depend more on credit analysis and recent payment performance. Allocations of
the allowance may be made for specific loans or loan categories, but the entire
allowance is available for any loan that, in management’s judgment, should be
charged off.
The
allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful. The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors. Allowance estimates are developed with actual loss
experience adjusted for current economic conditions. Allowance
estimates are considered a prudent measurement of the risk in the loan portfolio
and are applied to individual loans based on loan type.
Based on
our calculation, an allowance of $17.7 million or 1.78% of total loans
was our estimate of probable losses within the loan portfolio as of December 31, 2009. This estimate resulted
in a provision for loan losses on the income statement of $9.5 million for the
2009 period. If
the mix and amount of future charge off percentages differ significantly from
those assumptions used by management in making its determination, the allowance
for loan losses and provision for loan losses on the income statement could be
materially increased.
22
Goodwill and
Other Intangible Assets – Costs in excess of the
estimated fair value of identified assets acquired through purchase transactions
are recorded as an asset. An annual impairment analysis is required to be
performed to determine if the asset is impaired and needs to be written down to
its fair value. This assessment is conducted annually or more frequently if
conditions warrant. In making these impairment analyses, management must make
subjective assumptions regarding the fair value of our assets and liabilities.
It is possible that these judgments may change over time as market conditions or
our strategies change, and these changes may cause us to record impairment
changes to adjust the goodwill to its estimated fair value. Based on
the December 31, 2009 analysis, an impairment of $11.9 million was
identified. The impairment charge is a non-cash item that does not
impact our liquidity or adversely affect regulatory or tangible capital
ratios.
Impairment of
Investment Securities –
We review all unrealized losses on our investment securities to determine
whether the losses are other-than-temporary. We evaluate our
investment securities on at least a quarterly basis and more frequently when
economic or market conditions warrant, to determine whether a decline in their
value below amortized cost is other-than-temporary. We evaluate a
number of factors including, but not limited to: valuation estimates provided by
investment brokers; how much fair value has declined below amortized cost; how
long the decline in fair value has existed; the financial condition of the
issuer; significant rating agency changes on the issuer; and management’s
assessment that we do not intend to sell or will not be required to sell the
security for a period of time sufficient to allow for any anticipated recovery
in fair value.
The term
“other-than-temporary” is not intended to indicate that the decline is
permanent, but indicates that the possibility for a near-term recovery of value
is not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the
investment. Once a decline in value is determined to be
other-than-temporary, the cost basis of the security is written down to fair
value and a corresponding charge to earnings is recognized.
Real estate
owned – The
estimation of fair value is significant to real estate owned acquired through
foreclosure. These assets are recorded at fair value less estimated
selling costs at the date of foreclosure. Fair value is based on the
appraised market value of the property based on sales of similar assets when
available. The fair value may be subsequently reduced if the
estimated fair value declines below the original appraised value.
RESULTS
OF OPERATION
Net loss
for the period ended December 31, 2009 was $(6.7) million or $(1.65) per diluted
common share compared to net income of $4.8 million or $1.02 per diluted common
share for the same period in 2008. Earnings decreased for
2009 compared to 2008 due to a decrease in our net interest margin, an increase
in provision for loan loss expense, write downs taken on investment securities
that were other-than-temporarily impaired, write downs taken on real estate
acquired through foreclosure, higher FDIC insurance premiums, a goodwill
impairment charge and higher operating expenses. Net income available to
common shareholders was also impacted by dividends paid on preferred
shares. Our book value per common share decreased from $15.63 at
December 31, 2008 to $13.87 at December 31, 2009.
Net
income for the period ended December 31, 2008 was $4.8 million or $1.02 per
diluted common share compared to $9.4 million or $1.96 per diluted common share
for the same period in 2007. Earnings decreased for
2008 compared to 2007 due to a decrease in our net interest margin, an increase
in provision for loan loss expense, a higher level of non-interest expense
related to our expansion efforts, a write down taken on investment securities
that were other-than-temporarily impaired and a write down on real estate
acquired through foreclosure. Our book value per
common share decreased from $15.76 at December 31, 2007 to $15.63 at December
31, 2008. Net
income for 2008 generated a return on average assets of 0.51% and a return on
average equity of 6.37%. These compare with a
return on average assets of 1.10% and a return on average equity of 12.88% for
the 2007 period.
Net Interest
Income – The principal source of our revenue is net interest
income. Net interest income is the difference between interest income
on interest-earning assets, such as loans and securities and the interest
expense on liabilities used to fund those assets, such as interest-bearing
deposits and borrowings. Net interest income is affected by both changes in the
amount and composition of interest-earning assets and interest-bearing
liabilities as well as changes in market interest rates.
The
growth in our commercial loan portfolio has increased net interest
income. The increase in the volume of interest earning assets
increased net interest income by $4.3 million for 2009 compared to a year
ago. Average interest earning assets increased $148.9 million for
2009 compared to 2008. Despite the increase in interest earning
assets, our net interest margin realized a modest decline of twelve basis
points. The yield on earning assets averaged 5.79% for 2009 compared
to an average yield on earning assets of 6.63% for the same period in
2008. This decrease was offset by a decrease in our cost of
funds. Net interest margin as a percent of average earning assets
decreased to 3.66%
for 2009 compared to 3.78% for the 2008 period.
Our cost
of funds averaged 2.33% for the 2009 period compared to an average cost of funds
of 3.10% for the same period in 2008. Going forward, our cost of funds is
expected to continue to decrease as certificates of deposit re-price and roll
off into new certificates of deposit at lower interest rates.
23
Our net
interest margin is likely to compress in future quarters as a result of the FOMC
decreasing the Federal Funds rate by 500 basis points since September
2007. The current Federal Funds rate is a range of 0.00% to
0.25%. Correspondingly, variable rate loans that are tied to the
prime rate are immediately re-priced downward when the prime rate
decreases. However, interest rates paid on customer deposits, which
are priced off of the London Interbank Offering Rate (LIBOR), have not adjusted
downward proportionately with the declining interest yields on loans and
investments. LIBOR, which is a market driven rate, did not decline in
rate as much as the prime rate. Therefore, we do not expect our
deposit costs to decline as fast as our yield on loans. Fifty-eight
percent of deposits are time deposits that re-price over a longer period of
time. This difference in the timing of the re-pricing of our assets
and deposits is expected to continue to lower our net interest
margin.
Comparative
information regarding net interest income follows:
2009/2008
|
2008/2007
|
|||||||||||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
Change
|
Change
|
|||||||||||||||||
Net
interest income, tax equivalent basis
|
$ | 37,326 | $ | 32,970 | $ | 31,009 | 13.2 | % | 6.3 | % | ||||||||||||
Net
interest spread
|
3.46 | % | 3.53 | % | 3.53 | % | (7 | ) |
bp
|
- |
bp
|
|||||||||||
Net
interest margin
|
3.66 | % | 3.78 | % | 3.89 | % | (12 | ) |
bp
|
(11 | ) |
bp
|
||||||||||
Average
earnings assets
|
$ | 1,020,803 | $ | 871,940 | $ | 796,275 | 17.1 | % | 9.5 | % | ||||||||||||
Prime
rate at year end
|
3.25 | % | 3.25 | % | 7.25 | % | - |
bp
|
(400 | ) |
bp
|
|||||||||||
Average
prime rate
|
3.25 | % | 5.09 | % | 8.05 | % | (184 | ) |
bp
|
(296 | ) |
bp
|
||||||||||
bp
= basis point = 1/100th of a percent
|
Prime
rate is included above to provide a general indication of the interest rate
environment in which we operate. A large portion of our variable rate
loans were indexed to the prime rate and re-price as the prime rate changes,
unless they reach a contractual floor or ceiling.
24
AVERAGE
BALANCE SHEETS
The
following table provides information relating to our average balance sheet and
reflects the average yield on assets and average cost of liabilities for the
indicated periods. Yields and costs for the periods presented are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively.
Year Ended December 31,
|
||||||||||||||||||||||||||||||||||||
2009
|
2008
|
2007
|
||||||||||||||||||||||||||||||||||
(Dollars in thousands)
|
Average
|
Average
|
Average
|
Average
|
Average
|
Average
|
||||||||||||||||||||||||||||||
Balance
|
Interest
|
Yield/Cost
|
Balance
|
Interest
|
Yield/Cost
|
Balance
|
Interest
|
Yield/Cost
|
||||||||||||||||||||||||||||
ASSETS
|
||||||||||||||||||||||||||||||||||||
Interest
earning assets:
|
||||||||||||||||||||||||||||||||||||
U.S.
Treasury and agencies
|
$ | 11,537 | $ | 251 | 2.18 | % | $ | 6,469 | $ | 257 | 3.97 | % | $ | 18,147 | $ | 651 | 3.59 | % | ||||||||||||||||||
Mortgage-backed
securities
|
6,963 | 290 | 4.16 | % | 9,006 | 390 | 4.33 | % | 11,993 | 517 | 4.31 | % | ||||||||||||||||||||||||
Equity
securities
|
959 | 106 | 11.05 | % | 1,543 | 67 | 4.34 | % | 2,036 | 75 | 3.68 | % | ||||||||||||||||||||||||
State and political
subdivision securities (1)
|
11,848 | 771 | 6.51 | % | 9,426 | 600 | 6.37 | % | 9,935 | 633 | 6.37 | % | ||||||||||||||||||||||||
Corporate
bonds
|
187 | 117 | 62.57 | % | 2,533 | 159 | 6.28 | % | 4,358 | 307 | 7.04 | % | ||||||||||||||||||||||||
Loans (2)
(3) (4)
|
971,750 | 57,113 | 5.88 | % | 830,748 | 55,739 | 6.71 | % | 741,274 | 58,019 | 7.83 | % | ||||||||||||||||||||||||
FHLB
stock
|
8,515 | 383 | 4.50 | % | 8,116 | 423 | 5.21 | % | 7,621 | 503 | 6.60 | % | ||||||||||||||||||||||||
Interest
bearing deposits
|
9,044 | 87 | 0.96 | % | 4,099 | 134 | 3.27 | % | 911 | 55 | 6.04 | % | ||||||||||||||||||||||||
Total
interest earning assets
|
1,020,803 | 59,118 | 5.79 | % | 871,940 | 57,769 | 6.63 | % | 796,275 | 60,760 | 7.63 | % | ||||||||||||||||||||||||
Less: Allowance
for loan losses
|
(14,972 | ) | (9,114 | ) | (7,966 | ) | ||||||||||||||||||||||||||||||
Non-interest
earning assets
|
86,398 | 76,343 | 61,912 | |||||||||||||||||||||||||||||||||
Total
assets
|
$ | 1,092,229 | $ | 939,169 | $ | 850,221 | ||||||||||||||||||||||||||||||
LIABILITIES
AND
|
||||||||||||||||||||||||||||||||||||
STOCKHOLDERS'
EQUITY
|
||||||||||||||||||||||||||||||||||||
Interest
bearing liabilities:
|
||||||||||||||||||||||||||||||||||||
Savings
accounts
|
$ | 119,745 | $ | 905 | 0.76 | % | $ | 106,901 | $ | 1,666 | 1.56 | % | $ | 96,221 | $ | 3,017 | 3.14 | % | ||||||||||||||||||
NOW
and money market accounts
|
179,917 | 1,402 | 0.78 | % | 136,796 | 1,307 | 0.96 | % | 123,408 | 2,166 | 1.76 | % | ||||||||||||||||||||||||
Certificates
of deposit and other time deposits
|
515,764 | 15,610 | 3.03 | % | 444,718 | 17,539 | 3.94 | % | 424,603 | 20,336 | 4.79 | % | ||||||||||||||||||||||||
Short-term
borrowings
|
50,602 | 152 | 0.30 | % | 44,454 | 896 | 2.02 | % | 36,782 | 1,935 | 5.26 | % | ||||||||||||||||||||||||
FHLB
advances
|
52,742 | 2,405 | 4.56 | % | 53,009 | 2,413 | 4.55 | % | 34,732 | 1,580 | 4.55 | % | ||||||||||||||||||||||||
Subordinated
debentures
|
18,000 | 1,318 | 7.32 | % | 14,667 | 978 | 6.67 | % | 10,000 | 717 | 7.17 | % | ||||||||||||||||||||||||
Total
interest bearing liabilities
|
936,770 | 21,792 | 2.33 | % | 800,545 | 24,799 | 3.10 | % | 725,746 | 29,751 | 4.10 | % | ||||||||||||||||||||||||
Non-interest
bearing liabilities:
|
||||||||||||||||||||||||||||||||||||
Non-interest
bearing deposits
|
58,945 | 57,962 | 46,343 | |||||||||||||||||||||||||||||||||
Other
liabilities
|
3,073 | 5,349 | 5,508 | |||||||||||||||||||||||||||||||||
Total
liabilities
|
998,788 | 863,856 | 777,597 | |||||||||||||||||||||||||||||||||
Stockholders'
equity
|
93,441 | 75,313 | 72,624 | |||||||||||||||||||||||||||||||||
Total
liabilities and stockholders' equity
|
$ | 1,092,229 | $ | 939,169 | $ | 850,221 | ||||||||||||||||||||||||||||||
Net
interest income
|
$ | 37,326 | $ | 32,970 | $ | 31,009 | ||||||||||||||||||||||||||||||
Net
interest spread
|
3.46 | % | 3.53 | % | 3.53 | % | ||||||||||||||||||||||||||||||
Net
interest margin
|
3.66 | % | 3.78 | % | 3.89 | % | ||||||||||||||||||||||||||||||
Ratio
of average interest earning assets to average interest bearing
liabilities
|
108.97 | % | 108.92 | % | 109.72 | % |
(1) Taxable equivalent yields are calculated assuming a 34% federal income tax rate.
(2) Includes loan fees,
immaterial in amount, in both interest income and the calculation of yield on
loans.
(3) Calculations include
non-accruing loans in the average loan amounts outstanding.
(4) Includes loans held for
sale.
25
RATE/VOLUME
ANALYSIS
The table
below shows changes in interest income and interest expense for the periods
indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in rate (changes in rate multiplied by old volume); (2) changes in
volume (change in volume multiplied by old rate); and (3) changes in rate-volume
(change in rate multiplied by change in volume). Changes in
rate-volume are proportionately allocated between rate and volume
variance.
Year Ended
|
Year Ended
|
|||||||||||||||||||||||
December 31,
|
December 31,
|
|||||||||||||||||||||||
2009 vs. 2008
|
2008 vs. 2007
|
|||||||||||||||||||||||
Increase (decrease)
|
Increase (decrease)
|
|||||||||||||||||||||||
Due to change in
|
Due to change in
|
|||||||||||||||||||||||
(Dollars
in thousands)
|
Net
|
Net
|
||||||||||||||||||||||
Rate
|
Volume
|
Change
|
Rate
|
Volume
|
Change
|
|||||||||||||||||||
Interest
income:
|
||||||||||||||||||||||||
U.S.
Treasury and agencies
|
$ | (150 | ) | $ | 144 | $ | (6 | ) | $ | 64 | $ | (458 | ) | $ | (394 | ) | ||||||||
Mortgage-backed
securities
|
(14 | ) | (86 | ) | (100 | ) | 2 | (129 | ) | (127 | ) | |||||||||||||
Equity
securities
|
72 | (33 | ) | 39 | 12 | (20 | ) | (8 | ) | |||||||||||||||
State
and political subdivision securities
|
14 | 157 | 171 | (1 | ) | (32 | ) | (33 | ) | |||||||||||||||
Corporate
bonds
|
229 | (271 | ) | (42 | ) | (148 | ) | - | (148 | ) | ||||||||||||||
Loans
|
(7,409 | ) | 8,783 | 1,374 | (8,825 | ) | 6,545 | (2,280 | ) | |||||||||||||||
FHLB
stock
|
(60 | ) | 20 | (40 | ) | (111 | ) | 31 | (80 | ) | ||||||||||||||
Interest
bearing deposits
|
(137 | ) | 90 | (47 | ) | (35 | ) | 114 | 79 | |||||||||||||||
Total
interest earning assets
|
(7,455 | ) | 8,804 | 1,349 | (9,042 | ) | 6,051 | (2,991 | ) | |||||||||||||||
Interest
expense:
|
||||||||||||||||||||||||
Savings
accounts
|
(942 | ) | 181 | (761 | ) | (1,655 | ) | 304 | (1,351 | ) | ||||||||||||||
NOW
and money market accounts
|
(269 | ) | 364 | 95 | (1,073 | ) | 214 | (859 | ) | |||||||||||||||
Certificates
of deposit and other time deposits
|
(4,466 | ) | 2,537 | (1,929 | ) | (3,724 | ) | 927 | (2,797 | ) | ||||||||||||||
Short-term
borrowings
|
(853 | ) | 109 | (744 | ) | (1,380 | ) | 341 | (1,039 | ) | ||||||||||||||
FHLB
advances
|
4 | (12 | ) | (8 | ) | 1 | 832 | 833 | ||||||||||||||||
Subordinated
debentures
|
103 | 237 | 340 | (53 | ) | 314 | 261 | |||||||||||||||||
Total
interest bearing liabilities
|
(6,423 | ) | 3,416 | (3,007 | ) | (7,884 | ) | 2,932 | (4,952 | ) | ||||||||||||||
Net
change in net interest income
|
$ | (1,032 | ) | $ | 5,388 | $ | 4,356 | $ | (1,158 | ) | $ | 3,119 | $ | 1,961 |
Non-Interest
Income and Non-Interest Expense
The
following tables compare the components of non-interest income and expenses for
the years ended December 31, 2009, 2008 and 2007. The tables show the
dollar and percentage change from 2008 to 2009 and from 2007 to
2008. Below each table is a discussion of significant changes and
trends.
2009/2008
|
2008/2007
|
|||||||||||||||||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
Change
|
%
|
Change
|
%
|
|||||||||||||||||||||
Non-interest
income
|
||||||||||||||||||||||||||||
Customer
sevice fees on deposit accounts
|
$ | 6,677 | $ | 6,601 | $ | 5,792 | $ | 76 | 1.2 | % | $ | 809 | 14.0 | % | ||||||||||||||
Gain
on sale of mortgage loans
|
1,194 | 697 | 569 | 497 | 71.3 | % | 128 | 22.5 | % | |||||||||||||||||||
Gain
on sale of securities
|
- | 55 | - | (55 | ) | -100.0 | % | 55 | 100.0 | % | ||||||||||||||||||
Gain
on sale of real estate held for development
|
- | - | 227 | - | 0.0 | % | (227 | ) | -100.0 | % | ||||||||||||||||||
Losses
on securities impairment
|
(862 | ) | (516 | ) | - | (346 | ) | 67.1 | % | (516 | ) | 100.0 | % | |||||||||||||||
Write
down on real estate acquired through foreclosure
|
(578 | ) | (162 | ) | - | (416 | ) | 256.8 | % | (162 | ) | 100.0 | % | |||||||||||||||
Brokerage
commissions
|
373 | 469 | 424 | (96 | ) | -20.5 | % | 45 | 10.6 | % | ||||||||||||||||||
Other
income
|
1,715 | 1,305 | 1,191 | 410 | 31.4 | % | 114 | 9.6 | % | |||||||||||||||||||
$ | 8,519 | $ | 8,449 | $ | 8,203 | $ | 70 | 0.8 | % | $ | 246 | 3.0 | % |
26
We
originate qualified VA, KHC, RHC and conventional secondary market loans and
sell them into the secondary market with servicing rights
released. Prevailing mortgage interest rates remained at attractive
levels during 2009 helping to contribute to the increase in the volume of loans
closed for 2009.
We invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, obligations of states and political
subdivisions, corporate bonds, mutual funds, stocks and
others. During 2008 we recorded a gain on sale of investments of
$55,000. Gains on investment securities are infrequent and are not a
consistent recurring core source of income.
We
recognized other-than-temporary impairment charges of $862,000 for the expected
credit loss during the 2009 period on all five of our trust preferred
securities. Management believes this impairment was primarily attributable to
the current economic environment which caused the financial conditions of some
of the issuers to deteriorate. During 2008, we recognized other-than-temporary
impairment charges of $516,000 on certain equity securities with a cost basis of
$840,000.
Further
reducing non-interest income for the 2009 period was a 10% or $578,000
write-down of the carrying value of real estate owned properties that had been
held for twelve months.
Other
income increased year to date as a result of gains recorded on the sale of a
real estate acquired through foreclosure properties and loan underwriter fees
due to increased loan demand.
2009/2008
|
2008/2007
|
|||||||||||||||||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
Change
|
%
|
Change
|
%
|
|||||||||||||||||||||
Non-interest
expenses
|
||||||||||||||||||||||||||||
Employee
compensation and benefits
|
$ | 15,834 | $ | 14,600 | $ | 12,593 | $ | 1,234 | 8.5 | % | $ | 2,007 | 15.9 | % | ||||||||||||||
Office
occupancy expense and equipment
|
3,271 | 2,865 | 2,373 | 406 | 14.2 | % | 492 | 20.7 | % | |||||||||||||||||||
Marketing
and advertising
|
844 | 782 | 914 | 62 | 7.9 | % | (132 | ) | -14.4 | % | ||||||||||||||||||
Outside
services and data processing
|
3,194 | 3,324 | 2,632 | (130 | ) | -3.9 | % | 692 | 26.3 | % | ||||||||||||||||||
Bank
franchise tax
|
960 | 1,010 | 923 | (50 | ) | -5.0 | % | 87 | 9.4 | % | ||||||||||||||||||
FDIC
insurance premiums
|
1,900 | 716 | 77 | 1,184 | 165.4 | % | 639 | 829.9 | % | |||||||||||||||||||
Write
off of issuance cost of Trust Preferred Securities
|
- | - | 229 | - | 0.0 | % | (229 | ) | -100.0 | % | ||||||||||||||||||
Goodwill
impairment
|
11,931 | - | - | 11,931 | 100.0 | % | - | 0.0 | % | |||||||||||||||||||
Amortization
of core deposit intangible
|
403 | 207 | - | 196 | 94.7 | % | 207 | 100.0 | % | |||||||||||||||||||
Other
expense
|
5,580 | 4,782 | 4,049 | 798 | 16.7 | % | 733 | 18.1 | % | |||||||||||||||||||
$ | 43,917 | $ | 28,286 | $ | 23,790 | $ | 15,631 | 55.3 | % | $ | 4,496 | 18.9 | % |
Employee
compensation and benefits is the largest component of non-interest
expense. Increases for 2009 were due to inflationary salary
increases, higher costs of benefits and to additional associates hired related
to our expansion efforts. These associates were hired for a new
Bullitt County retail branch facility that opened in August 2008, a new Hardin
County retail branch facility that opened in May 2009, a new Louisville retail
branch facility that opened in July 2009 and to fill other positions to support
our growth. We also added twenty additional associates in the second
quarter of 2008 as a result of the acquisition in Southern Indiana.
Office
occupancy expense and equipment and marketing and advertising increased due to
additional operating expenses related to our expansion efforts. We
have opened two full-service banking centers at Fort Knox and in the Middletown
area of Jefferson County since May 2009.
The FDIC
implemented a five basis point emergency special assessment on insured
depository institutions as of June 30, 2009. The special assessment
was paid on September 30, 2009. This assessment resulted in a cost of
$477,000 and is reflected in our income statement for 2009. The
interim rule also authorizes the FDIC to impose an additional emergency
assessment of up to 10 basis points in respect to deposits for quarters ended
after June 30, 2009 if necessary to maintain public confidence in federal
deposit insurance. In addition, during the fourth quarter of 2009,
the FDIC approved that all banks prepay three and a quarter years worth of FDIC
assessments on December 31, 2009. The prepayment is based on average
third quarter deposits. The prepaid amount will be amortized over the
prepayment period. Our prepayment was $7.5 million of which $494,000
was reflected in our 2009 income statement related to the fourth quarter
premium. Given the enacted increases in
assessments for insured financial institutions in 2009, we
anticipate that FDIC assessments on
deposits will have a significantly greater impact upon operating expenses for
the next few years.
27
The
second largest expense incurred in 2009 was a goodwill impairment charge of
$11.9 million. Annual analysis of goodwill indicated an impairment
charge was necessary due to continued market deterioration. While
this charge flows through our income statement, it is a non-cash item that does
not impact our liquidity or adversely affect regulatory or tangible capital
ratios.
Other
expense increased due to increases in interchange expense, postage and courier,
loan expenses, REO expense and other operating expenses. Interchange
expense increased due to the switch to real-time debit card processing, which is
more expensive per item than the batch processing method we used
previously. REO expense relating to repair, maintenance and
taxes increased due to increases in real estate we acquired through
foreclosure.
Our
efficiency ratio, excluding goodwill impairment, was 70% for 2009 compared to
69% for the 2008 period. The increase principally reflects our recent
expansion efforts.
Income
Taxes
The
effective tax rate decreased to 15% for the year ended December 31, 2009
compared to 31% for the year ended December 31, 2008. The decrease in
the tax rate is related primarily to the loss generated from the goodwill
impairment as a portion of this goodwill arose from a taxable business
combination. Other factors which present a favorable tax rate are
income from tax-free loans, tax-exempt income on state and municipal securities,
and income on bank owned life insurance, which is not taxable.
ANALYSIS
OF FINANCIAL CONDITION
Total
assets at December 31, 2009 increased to $1.2 billion compared to $1.0 billion
at December 31, 2008. The increase was primarily driven by an
increase in loans of $86.0 million and an increase in investment securities of
$24.1 million. Total loans have increased 10% during 2009 and have
been increasing substantially over the past several years. We expect
this growth rate to slow in the next few years. Offsetting this
increase was the $11.9 million write-down of goodwill. The growth in
loans and investment securities was funded with deposits, which increased $274.4
million for the period. The increase in deposits was also used to pay
down our short-term borrowings.
Loans
Net loans
increased $86.0 million to $985.4 million at December 31, 2009 compared to
$899.4 million at December 31, 2008. Our commercial real estate
portfolio increased $64.5 million to $627.8 million at December 31,
2009. Real estate construction loans decreased due to the economic
slow-down while our residential mortgage loan, consumer, home equity and
indirect consumer portfolios all increased for the 2009 period. For 2010, we
believe the growth in commercial real estate loans may not continue at the rate
experienced over the last few years due to the current economic
slow-down. However, we also believe we will be well positioned to
benefit from growth in our local markets when the economy rebounds.
Loan Portfolio
Composition. The following table presents a summary of the
loan portfolio, net of deferred loan fees, by type. There are no
foreign loans in our portfolio and other than the categories noted; there is no
concentration of loans in any industry exceeding 10% of total
loans.
December 31,
|
||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||||||||||||||||||||||
Amount
|
%
|
Amount
|
%
|
Amount
|
%
|
Amount
|
%
|
Amount
|
%
|
|||||||||||||||||||||||||||||||
Type
of Loan:
|
||||||||||||||||||||||||||||||||||||||||
Real
Estate:
|
||||||||||||||||||||||||||||||||||||||||
Residential
|
$ | 179,130 | 17.86 | % | $ | 165,318 | 18.11 | % | $ | 132,209 | 17.21 | % | $ | 137,155 | 19.44 | % | $ | 142,358 | 22.14 | % | ||||||||||||||||||||
Construction
|
14,567 | 1.45 | 17,387 | 1.90 | 21,383 | 2.78 | 23,953 | 3.39 | 13,579 | 2.11 | ||||||||||||||||||||||||||||||
Commercial
|
627,788 | 62.58 | 563,314 | 61.70 | 470,929 | 61.32 | 410,146 | 58.12 | 353,637 | 54.99 | ||||||||||||||||||||||||||||||
Consumer
and home equity
|
74,844 | 7.46 | 69,649 | 7.63 | 63,090 | 8.21 | 62,805 | 8.90 | 66,208 | 10.29 | ||||||||||||||||||||||||||||||
Indirect
consumer
|
36,628 | 3.65 | 31,754 | 3.48 | 27,721 | 3.61 | 30,857 | 4.37 | 31,577 | 4.91 | ||||||||||||||||||||||||||||||
Commercial,
other
|
61,969 | 6.18 | 56,012 | 6.13 | 51,924 | 6.76 | 40,121 | 5.68 | 35,161 | 5.47 | ||||||||||||||||||||||||||||||
Loans
held for sale
|
8,183 | 0.82 | 9,567 | 1.05 | 780 | 0.10 | 673 | 0.10 | 597 | 0.09 | ||||||||||||||||||||||||||||||
Total
loans
|
$ | 1,003,109 | 100.00 | % | $ | 913,001 | 100.00 | % | $ | 768,036 | 100.00 | % | $ | 705,710 | 100.00 | % | $ | 643,117 | 100.00 | % |
28
Loan Maturity
Schedule. The following table shows at December 31, 2009, the
dollar amount of loans, net of deferred loan fees, maturing in the loan
portfolio based on their contractual terms to maturity.
Due after
|
||||||||||||||||
Due during
|
1 through
|
Due after 5
|
||||||||||||||
the year ended
|
5 years after
|
years after
|
||||||||||||||
December 31,
|
December 31,
|
December 31,
|
Total
|
|||||||||||||
2010
|
2009
|
2009
|
Loans
|
|||||||||||||
(Dollars in thousands)
|
||||||||||||||||
Residential
mortgage
|
$ | 10,971 | $ | 37,213 | $ | 130,946 | $ | 179,130 | ||||||||
Real
estate construction
|
13,527 | 1,040 | - | 14,567 | ||||||||||||
Real
estate commercial
|
232,059 | 360,140 | 35,589 | 627,788 | ||||||||||||
Consumer,
home equity and indirect consumer
|
12,362 | 62,730 | 36,380 | 111,472 | ||||||||||||
Commercial,
other
|
27,531 | 32,765 | 1,673 | 61,969 | ||||||||||||
Loans
held for sale
|
8,183 | - | - | 8,183 | ||||||||||||
Total
|
$ | 304,633 | $ | 493,888 | $ | 204,588 | $ | 1,003,109 |
The
following table breaks down loans maturing after one year, by fixed and
adjustable rates.
Floating or
|
||||||||||||
Fixed Rates
|
Adjustable Rates
|
Total
|
||||||||||
(Dollars in thousands)
|
||||||||||||
Residential
mortgage
|
$ | 96,111 | $ | 72,048 | $ | 168,159 | ||||||
Real
estate construction
|
271 | 769 | 1,040 | |||||||||
Real
estate commercial
|
257,186 | 138,543 | 395,729 | |||||||||
Consumer,
home equity and indirect consumer
|
65,065 | 34,045 | 99,110 | |||||||||
Commercial,
other
|
26,872 | 7,566 | 34,438 | |||||||||
Total
|
$ | 445,505 | $ | 252,971 | $ | 698,476 |
Allowance
and Provision for Loan Losses
Our
financial performance depends on the quality of the loans we originate and
management’s ability to assess the degree of risk in existing loans when it
determines the allowance for loan losses. An increase in loan
charge-offs or non-performing loans or an inadequate allowance for loan losses
could reduce net interest income, net income and capital and limit the range of
products and services we can offer.
The
Allowance for Loan Loss Review Committee evaluates the allowance for loan losses
quarterly to maintain a level sufficient to absorb probable incurred credit
losses existing in the loan portfolio. Periodic provisions to the
allowance are made as needed. The Committee determines the allowance
by applying loss estimates to graded loans by categories, as described
below. In addition, the Committee analyzes such factors as changes in
lending policies and procedures; underwriting standards; collection; charge-off
and recovery history; changes in national and local economic business conditions
and developments; changes in the characteristics of the portfolio; ability and
depth of lending management and staff; changes in the trend of the volume and
severity of past due, non-accrual and classified loans; troubled debt
restructuring and other loan modifications; and results of regulatory
examinations.
2008 was
a tumultuous year for the U.S. economy and the financial service industry.
Declining property values led to declining valuations for loan
portfolios. The property value declines, which began in the second
half of 2007, continued throughout 2009. The markets we serve have
generally avoided the severe property value declines experienced in other parts
of the country; nonetheless, the impact in our markets was still
significant. During the second half of 2008 and throughout 2009, we
substantially increased our provision for loan losses for our general and
specific reserves as adverse conditions were identified. 2010 will
continue to be a challenging time for our financial institution as we manage the
overall level of our credit quality. It is likely that provision for
loan losses will remain elevated in the near term.
29
The
following table analyzes loan loss experience for the periods
indicated.
Year Ended December 31,
|
||||||||||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Balance
at beginning of period
|
$ | 13,565 | $ | 7,922 | $ | 7,684 | $ | 7,377 | $ | 6,489 | ||||||||||
Allowance
related to acquisition
|
- | 327 | - | - | - | |||||||||||||||
Loans
charged-off:
|
||||||||||||||||||||
Real
estate mortgage
|
127 | 15 | 18 | 3 | 15 | |||||||||||||||
Consumer
|
778 | 515 | 385 | 446 | 584 | |||||||||||||||
Commercial
|
4,721 | 364 | 807 | 165 | 67 | |||||||||||||||
Total
charge-offs
|
5,626 | 894 | 1,210 | 614 | 666 | |||||||||||||||
Recoveries:
|
||||||||||||||||||||
Real
estate mortgage
|
2 | 4 | 10 | 7 | 4 | |||||||||||||||
Consumer
|
205 | 239 | 222 | 287 | 290 | |||||||||||||||
Commercial
|
49 | 20 | 7 | 87 | 2 | |||||||||||||||
Total
recoveries
|
256 | 263 | 239 | 381 | 296 | |||||||||||||||
Net
loans charged-off
|
5,370 | 631 | 971 | 233 | 370 | |||||||||||||||
Provision
for loan losses
|
9,524 | 5,947 | 1,209 | 540 | 1,258 | |||||||||||||||
Balance
at end of period
|
$ | 17,719 | $ | 13,565 | $ | 7,922 | $ | 7,684 | $ | 7,377 | ||||||||||
Allowance
for loan losses to total loans (excluding loans held for
sale)
|
1.78 | % | 1.50 | % | 1.03 | % | 1.09 | % | 1.15 | % | ||||||||||
Net
charge-offs to average loans outstanding
|
0.55 | % | 0.08 | % | 0.13 | % | 0.03 | % | 0.06 | % | ||||||||||
Allowance
for loan losses to total non-performing loans
|
47 | % | 81 | % | 89 | % | 159 | % | 118 | % |
The
provision for loan losses increased by $3.6 million to $9.5 million in 2009
compared to 2008. The increase was partially related to growth in the
loan portfolio, but primarily from the specific reserves set aside for loans
classified during 2009 and increases in general reserve provisioning levels.
During the fourth quarter of 2009, we added specific reserves to several large
commercial real estate relationships based on updated appraisals of the
underlying collateral. The higher provision was also due to our
increasing the general reserve factors for commercial real estate loans during
the period as the level of classified loans has increased sharply since 2008.
The allowance for loan losses increased $4.1 million to $17.7 million from
December 31, 2008 to December 31, 2009. The increase was due to
an increase in net loans for 2009, as well as the provision recorded to reflect
a $24.9 million increase in classified loans for the 2009 period. The increase in
charge-offs for the 2009 period was primarily attributed to a charge-down of
$2.0 million on one large commercial real estate relationship that we foreclosed
on during the second quarter of 2009. $1.7 million of the $2.0
million charge-down was previously reserved during the prior
year. Also, during the fourth quarter of 2009, we took a write-down
of $500,000 on a commercial real estate relationship that was classified and
recorded a charge-off of $822,000 on another commercial real estate
relationship. Additionally, charge-offs were generally higher in all
areas of the loan portfolio for 2009.
The
provision for loan losses increased by $4.7 million to $5.9 million in 2008
compared to 2007. The increase was related to a $1.7 million specific
reserve for a classified commercial real estate development loan. This
relationship had been previously classified during the first quarter of
2008. We also recorded a $1.2 million specific reserve on a
commercial real estate relationship during the fourth quarter of
2008. The reserve was increased based on an updated appraisal of the
underlying collateral. The increase in the provision was also related
to strong loan growth in the overall portfolio as well as from specific reserves
on several other commercial real estate relationships. The provision
for the 2007 period was smaller due to the improved performance of one of our
credit relationships, which reduced the allowance allocated to the
loan. The allowance for loan losses increased $5.6 million to $13.6
million from December 31, 2007 to December 31, 2008. The increase included
the addition of $327,000 as a result of the FSB Bancshares, Inc. acquisition, an
increase in net loans for 2008, as well as the provision recorded to reflect a
$26.5 million increase in classified loans for the 2008 period.
30
The
following table depicts management’s allocation of the allowance for loan losses
by loan type. Allowance and allocation is based on management’s
current evaluation of risk in each category, economic conditions, past loss
experience, loan volume, past due history and other factors. Since
these factors and management’s assumptions are subject to change, the allocation
is not a prediction of future portfolio performance.
December 31,
|
||||||||||||||||||||||||||||||||||||||||
2009
|
2008
|
2007
|
2006
|
2005
|
||||||||||||||||||||||||||||||||||||
Amount of
|
Percent of
|
Amount of
|
Percent of
|
Amount of
|
Percent of
|
Amount of
|
Percent of
|
Amount of
|
Percent of
|
|||||||||||||||||||||||||||||||
(Dollars in thousands)
|
Allowance
|
Total loans
|
Allowance
|
Total loans
|
Allowance
|
Total loans
|
Allowance
|
Total loans
|
Allowance
|
Total loans
|
||||||||||||||||||||||||||||||
Residential
mortgage
|
$ | 517 | 19 | % | $ | 455 | 19 | % | $ | 348 | 17 | % | $ | 340 | 20 | % | $ | 373 | 22 | % | ||||||||||||||||||||
Consumer
|
1,634 | 11 | 1,415 | 11 | 1,293 | 12 | 1,298 | 13 | 1,372 | 15 | ||||||||||||||||||||||||||||||
Commercial
|
15,568 | 70 | 11,695 | 70 | 6,281 | 71 | 6,046 | 67 | 5,632 | 63 | ||||||||||||||||||||||||||||||
Total
|
$ | 17,719 | 100 | % | $ | 13,565 | 100 | % | $ | 7,922 | 100 | % | $ | 7,684 | 100 | % | $ | 7,377 | 100 | % |
Federal
regulations require banks to classify their own assets on a regular
basis. The regulations provide for three categories of classified
loans – substandard, doubtful and loss.
The
following table provides information with respect to classified loans for the
periods indicated:
December
31,
|
||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Classified
Loans
|
||||||||||||
Substandard
|
$ | 65,408 | $ | 41,901 | $ | 15,442 | ||||||
Doubtful
|
370 | - | 38 | |||||||||
Loss
|
1,178 | 114 | 52 | |||||||||
Total
Classified
|
$ | 66,956 | $ | 42,015 | $ | 15,532 |
As we
focused on credit quality during 2008 and 2009, there was a significant
migration of loans into the Special Mention and Substandard loan
categories. If economic conditions continue to put stress on our
borrowers going forward, this may result in higher provisions for loan
losses. We expect that the economy will remain weak at least for the
next several quarters. Credit quality will continue to be a primary
focus in 2010 and going forward.
The $23.5
million increase in substandard assets for 2009 was primarily the result of downgrading loans
with eleven borrowers with balances ranging from $708,000 to $6.1 million. Offsetting this increase
was the transfer of a classified loan having a balance of $4.1 million to real
estate acquired through foreclosure. Approximately $41.0 million of the total
classified loans were related to real estate development or real estate
construction loans in our market area. Classified consumer loans
totaled $1.3 million, classified mortgage loans totaled $4.3 million and
classified commercial loans totaled $23.4 million. For more
information on collection efforts, evaluation of collateral and how loss amounts
are estimated, see “Non-Performing Assets,” below.
Although
we may allocate a portion of the allowance to specific loans or loan categories,
the entire allowance is available for active charge-offs. We develop
our allowance estimates based on actual loss experience adjusted for current
economic conditions. Allowance estimates represent a prudent
measurement of the risk in the loan portfolio, which we apply to individual
loans based on loan type.
Non-Performing
Assets
Non-performing
assets consist of certain restructured loans for which interest rate or other
terms have been renegotiated, loans on which interest is no longer accrued, real
estate acquired through foreclosure and repossessed assets. We
do not have any loans longer than 90 days past due still on
accrual. Loans, including impaired loans, are placed on non-accrual
status when they become past due 90 days or more as to principal or interest,
unless they are adequately secured and in the process of
collection. Loans are considered impaired when we no longer
anticipate full principal or interest payments in accordance with the
contractual loan terms. If a loan is impaired, we allocate a portion
of the allowance so that the loan is reported, net, at the present value of
estimated future cash flows using the loan’s existing rate, or at the fair value
of collateral if repayment is expected solely from collateral.
We review
our loans on a regular basis and implement normal collection procedures when a
borrower fails to make a required payment on a loan. If the
delinquency on a mortgage loan exceeds 90 days and is not cured through normal
collection procedures or an acceptable arrangement is not worked out with the
borrower, we institute measures to remedy the default, including commencing a
foreclosure action. We generally charge off consumer loans when
management deems a loan uncollectible and any available collateral has been
liquidated. We handle commercial business and real estate loan
delinquencies on an individual basis with the advice of legal
counsel.
31
We
recognize interest income on loans on the accrual basis except for those loans
in a non-accrual of income status. We discontinue accruing interest on impaired
loans when management believes, after consideration of economic and business
conditions and collection efforts that the borrowers’ financial condition is
such that collection of interest is doubtful, typically after the loan becomes
90 days delinquent. When we discontinue interest accrual, we reverse
existing accrued interest and subsequently recognize interest income only to the
extent we receive cash payments.
We
classify real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure as real estate owned until such time as it is sold. We classify new
and used automobile, motorcycle and all terrain vehicles acquired as a result of
foreclosure as repossessed assets until they are sold. When such property is
acquired we record it at the lower of the unpaid principal balance of the
related loan or its fair market value. We charge any write-down of
the property at the time of acquisition to the allowance for loan
losses. Subsequent gains and losses are included in non-interest
income and non-interest expense.
Real
estate owned acquired through foreclosure is recorded at lower of cost or fair
value less estimated selling costs at the date of foreclosure. Fair
value is based on the appraised market value of the property based on sales of
similar assets. The fair value may be subsequently reduced if the
estimated fair value declines below the original appraised value. Real estate
acquired through foreclosure increased $2.5 million to $8.4 million at December
31, 2009. The increase was primarily the result of a commercial
credit relationship totaling $2.2 million that was transferred during the second
quarter of 2009.
The
following table provides information with respect to non-performing assets for
the periods indicated.
December 31,
|
||||||||||||||||||||
(Dollar
in thousands)
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Restructured
|
$ | 9,812 | $ | 1,182 | $ | 2,335 | $ | 2,470 | $ | 3,104 | ||||||||||
Past
due 90 days still on accrual
|
- | - | - | - | - | |||||||||||||||
Loans
on non-accrual status
|
28,186 | 15,587 | 6,554 | 2,368 | 3,128 | |||||||||||||||
Total
non-performing loans
|
37,998 | 16,769 | 8,889 | 4,838 | 6,232 | |||||||||||||||
Real
estate acquired through foreclosure
|
8,428 | 5,925 | 1,749 | 918 | 1,022 | |||||||||||||||
Other
repossessed assets
|
103 | 91 | 52 | 82 | 119 | |||||||||||||||
Total
non-performing assets
|
$ | 46,529 | $ | 22,785 | $ | 10,690 | $ | 5,838 | $ | 7,373 | ||||||||||
Interest
income that would have been earned on non-performing loans
|
$ | 2,234 | $ | 825 | $ | 696 | $ | 368 | $ | 432 | ||||||||||
Interest
income recognized on non-performing loans
|
211 | 75 | 188 | 227 | 219 | |||||||||||||||
Ratios: Non-performing
loans to total loans (excluding loans held for sale)
|
3.82 | % | 1.86 | % | 1.16 | % | 0.69 | % | 0.97 | % | ||||||||||
Non-performing
assets to total loans (excluding loans held for sale)
|
4.68 | % | 2.52 | % | 1.39 | % | 0.83 | % | 1.15 | % |
Non-performing
loans increased $21.2 million to $38.0 million at December 31, 2009 compared to
$16.8 million at December 31, 2008. The increase in non-accrual loans
consist primarily of seven credit relationships with balances ranging from
$640,000 to $5.1 million. Offsetting this increase was the transfer of a
non-accrual loan having a balance of $4.1 million to real estate acquired
through foreclosure. These credit relationships
are secured by real estate and we have provided adequate allowance based on
current information. All non-performing loans are considered
impaired.
Non-performing
assets for the 2009 period include $9.8 million in restructured commercial,
mortgage and consumer loans. Restructured loans primarily consist of
five credit relationships with balances ranging from $115,000 to $6.1
million. The terms of these loans have been renegotiated to
reduce the rate of interest and extend the term, thus reducing the amount of
cash flow required from the borrower to service the loans. The borrowers are
currently meeting the terms of the restructured loans.
Investment
Securities
Interest
on securities provides us our largest source of interest income after interest
on loans, constituting 3.0% of the total interest income for the year ended
December 31, 2009. The securities portfolio serves as a source of
liquidity and earnings and contributes to the management of interest rate
risk. We have the authority to invest in various types of liquid
assets, including short-term United States Treasury obligations and securities
of various federal agencies, obligations of states and political subdivisions,
corporate bonds, certificates of deposit at insured savings and loans and banks,
bankers' acceptances, and federal funds. We may also invest a portion
of our assets in certain commercial paper and corporate debt
securities. We are also authorized to invest in mutual funds and
stocks whose assets conform to the investments that we are authorized to make
directly. The available-for-sale investment portfolio increased by $30.0 million
due to the purchase of a government-sponsored mortgage-backed security, two U.S.
Government agency securities and nine state and municipal obligations. The
held-to-maturity investment portfolio decreased by $5.9 million as securities
were called for redemption in accordance with their terms due to decreasing
rates.
32
We review
all unrealized losses at least on a quarterly basis to determine whether the
losses are other than temporary and more frequently when economic or market
concerns warrant. We consider the length of time and the extent to which the
fair value has been less than cost, the financial condition and near-term
prospects of the issuer, and whether management has the intent to sell the debt
security or whether it is more likely than not that we will be required to sell
the debt security before its anticipated recovery. In analyzing an
issuer’s financial condition, we may consider whether the securities are issued
by the federal government or its agencies, whether downgrades by bond rating
agencies have occurred, and the results of reviews of the issuer’s financial
condition.
The
unrealized losses on the state and municipal securities were caused primarily by
interest rate decreases. The contractual terms of those investments
do not permit the issuer to settle the securities at a price less than the
amortized cost of the investment. Because we do not have the intent
to sell these securities and it is likely that we will not be required to sell
the securities before their anticipated recovery, we do not consider these
investments to be other-than-temporarily impaired at December 31,
2009. We also considered the financial condition and near term
prospects of the issuer and identified no matters that would indicate less than
full recovery.
We have
evaluated the decline in the fair value of our trust preferred securities, which
are directly related to the credit and liquidity crisis being experienced in the
financial services industry over the past year. The trust
preferred securities market is currently inactive making the valuation of trust
preferred securities very difficult. The trust preferred securities
are valued by management using unobservable inputs through a discounted cash
flow analysis as permitted under current accounting guidance and using the
expected cash flows appropriately discounted using present value
techniques. Refer to Note 4 – Fair Value for more
information.
We
recognized other-than-temporary impairment charges of $862,000 for the expected
credit loss during the 2009 period on five of our trust preferred securities
with an original cost basis of $3.0 million. All of our trust
preferred securities are currently rated below investment grade. One of our
trust preferred securities continues to pay interest as scheduled through
December 31, 2009, and is expected to continue paying interest as
scheduled. The other four trust preferred securities are paying
either partial or full interest in kind instead of full cash
interest. See Note 2 – Securities for more
information. Management will continue to evaluate these securities
for impairment quarterly.
As
discussed in Note 1, in early April 2009, the FASB issued FASB ASC
320-10-65, Recognition and
Presentation of Other-Than-Temporary Impairments. Among other provisions,
the guidance requires entities to split other than temporarily impaired charges
between credit losses (i.e., the loss based on the entity’s estimate of the
decrease in cash flows, including those that result from expected voluntary
prepayments), which are charged to earnings, and the remainder of the impairment
charge (non-credit component) to accumulated other comprehensive income. This
requirement pertains to both securities held to maturity and securities
available for sale. The guidance is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009. We incorporated this guidance in our
review of impairment as of March 31, 2009.
33
The
following table provides the carrying value of our securities portfolio at the
dates indicated.
December 31,
|
||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Securities
available-for-sale:
|
||||||||||||
U.S.
Treasury and agencies
|
$ | 20,080 | $ | - | $ | 501 | ||||||
Government-sponsored
mortgage-backed residential
|
9,752 | 6,139 | 7,576 | |||||||||
Equity
|
990 | 948 | 1,522 | |||||||||
State
and municipal
|
14,893 | 8,615 | 9,598 | |||||||||
Trust
preferred securities
|
49 | 73 | 2,807 | |||||||||
Total
|
$ | 45,764 | $ | 15,775 | $ | 22,004 | ||||||
Securities
held-to-maturity:
|
||||||||||||
U.S.
Treasury and agencies
|
$ | - | $ | 4,503 | $ | 14,098 | ||||||
Government-sponsored
mortgage-backed residential
|
902 | 1,780 | 3,142 | |||||||||
State
and municipal
|
245 | 481 | - | |||||||||
Trust
preferred securities
|
20 | 258 | 441 | |||||||||
Total
|
$ | 1,167 | $ | 7,022 | $ | 17,681 |
The
following table provides the scheduled maturities, amortized cost, fair value
and weighted average yields for our securities at December 31,
2009.
Weighted
|
||||||||||||
Amortized
|
Fair
|
Average
|
||||||||||
(Dollars in thousands)
|
Cost
|
Value
|
Yield*
|
|||||||||
Securities
available-for-sale:
|
||||||||||||
Due
after one year through five years
|
22,179 | 22,331 | 2.37 | |||||||||
Due
after five years through ten years
|
1,911 | 1,955 | 4.14 | |||||||||
Due
after ten years
|
22,129 | 20,488 | 4.15 | |||||||||
Equity
|
933 | 990 | 8.16 | |||||||||
Total
|
$ | 47,152 | $ | 45,764 | 3.39 |
Weighted
|
||||||||||||
Amortized
|
Fair
|
Average
|
||||||||||
(Dollars in thousands)
|
Cost
|
Value
|
Yield*
|
|||||||||
Securities
held-to-maturity:
|
||||||||||||
Due
in one year or less
|
$ | 1,026 | $ | 1,034 | 3.88 | % | ||||||
Due
after five years through ten years
|
78 | 79 | 2.76 | |||||||||
Due
after ten years
|
63 | 63 | 3.41 | |||||||||
Total
|
$ | 1,167 | $ | 1,176 | 3.78 |
*The
weighted average yields are calculated on amortized cost on a non tax-equivalent
basis.
Deposits
We rely
primarily on providing excellent customer service and long-standing
relationships with customers to attract and retain deposits. Market interest
rates and rates on deposit products offered by competing financial institutions
can significantly affect our ability to attract and retain
deposits. We attract both short-term and long-term deposits from the
general public by offering a wide range of deposit accounts and interest rates.
In recent years market conditions have caused us to rely increasingly on
short-term certificate accounts and other deposit alternatives that are more
responsive to market interest rates. We use forecasts based on
interest rate risk simulations to assist management in monitoring our use of
certificates of deposit and other deposit products as funding sources and the
impact of the use of those products on interest income and net interest margin
in various rate environments.
In
conjunction with our initiatives to expand and enhance our retail branch
network, we emphasize growing our customer checking account base to better
enhance profitability and franchise value. Total deposits increased
$274.4 million compared to December 31, 2008. The increase was the result of
several actions we have taken, including deposit promotions, an increase in
public fund accounts as well as utilizing our wholesale funding sources. Retail
and commercial deposits increased $117.8 million during 2009. Public funds
increased $22.9 million, brokered deposits increased $112.4 million and we added
$21.3 million in CDARS certificates for the 2009
period. Brokered deposits were $127.8 million at December 31,
2009 compared to $15.4 million at December 31, 2008.
34
To
evaluate our funding needs in light of deposit trends resulting from these
changing conditions, management and Board committees evaluate simulated
performance reports that forecast changes in margins. We continue to
offer attractive certificate rates for various terms to allow us to retain
deposit customers and reduce interest rate risk during the current rate
environment, while protecting the margin.
We offer
a broad selection of deposit instruments, including non-interest bearing
checking, statement and passbook savings accounts, health savings accounts, NOW
accounts, money market accounts and fixed and variable rate certificates with
varying maturities. We also offer tax-deferred individual retirement
accounts. The flow of deposits is influenced significantly by general economic
conditions, changes in interest rates and competition. As of December
31, 2009, approximately 42% of our deposits consisted of various savings and
demand deposit accounts from which customers can withdraw funds at any time
without penalty. Management periodically adjusts interest rates paid
on our deposit products, maturity terms, service fees and withdrawal
penalties.
We also
offer certificates of deposit with a variety of terms, interest rates and
minimum deposit requirements. The variety of deposit accounts allows
us to compete more effectively for funds and to respond with more flexibility to
the flow of funds away from depository institutions into direct investment
vehicles such as government and corporate securities. However, market
conditions continue to significantly affect our ability to attract and maintain
deposits and our cost of funds.
The
following table breaks down our deposits.
December 31,
|
||||||||
(Dollars
in thousands)
|
2009
|
2008
|
||||||
Non-interest
bearing
|
$ | 63,950 | $ | 55,668 | ||||
NOW
demand
|
117,319 | 99,890 | ||||||
Savings
|
131,401 | 111,310 | ||||||
Money
market
|
127,885 | 40,593 | ||||||
Certificates
of deposit
|
609,260 | 467,938 | ||||||
Total
|
$ | 1,049,815 | $ | 775,399 |
As of
December 31, 2009, certificates of deposits in amounts of $100,000 or more total
$326.8 million, with $194.7 million held by persons residing within our service
areas. An additional $117.8 million of certificates of deposits in amounts of
$100,000 or more were obtained from deposit brokers and $14.3 million were
obtained from our participation in the Certificate of Deposit Account Registry
Service (“CDARS”) at December 31, 2009. CDARS is a system that allows
certificates of deposit that would be in excess of FDIC coverage in a single
financial institution to be redistributed to other financial institutions within
the CDARS network in increments under the current FDIC coverage
limit. Brokered deposits consist of certificates of deposit placed by
deposit brokers for a fee and can be utilized to support our asset
growth.
The
following table shows at December 31, 2009 the amount of our certificates of
deposit of $100,000 or more by time remaining until maturity.
Certificates
|
||||
Maturity Period
|
of Deposit
|
|||
(In
Thousands)
|
||||
Three
months or less
|
$ | 34,875 | ||
Three
through six months
|
89,239 | |||
Six
through twelve months
|
94,553 | |||
Over
twelve months
|
108,137 | |||
Total
|
$ | 326,804 |
Short-term
Borrowings
Short-term
borrowings consist of a borrowing against a line of credit with a correspondent
bank for 2009 and primarily federal funds purchased from the FHLB of Cincinnati
and two correspondent banks for 2008. We had short-term borrowings of
$1.5 million at December 31, 2009 and $94.9 million at December 31,
2008. These borrowings averaged a rate of .30% and 2.02% for 2009 and
2008.
35
Advances
from Federal Home Loan Bank
Deposits
are the primary source of funds for our lending and investment activities and
for our general business purposes. We can also use advances
(borrowings) from the Federal Home Loan Bank (FHLB) of Cincinnati to compensate
for reductions in deposits or deposit inflows at less than projected
levels. Advances from the FHLB are secured by our stock in the FHLB,
certain securities, certain commercial real estate loans and substantially all
of our first mortgage, multi-family and open end home equity
loans. At December 31, 2009 we had $52.7 million in advances
outstanding from the FHLB, and the capacity to increase our borrowings an
additional $71.1 million.
The FHLB
of Cincinnati functions as a central reserve bank providing credit for savings
banks and other member financial institutions. As a member, we are
required to own capital stock in the FHLB and are authorized to apply for
advances on the security of such stock and certain of our home mortgages, other
real estate loans and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided that we meet
certain creditworthiness standards. For further information, see Note 9 of the
Notes to Consolidated Financial Statements in this Annual Report.
The
following table provides information about our FHLB advances and short-term
borrowings as of and for the periods ended.
December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
(Dollars in thousands)
|
||||||||||||
Average
balance outstanding
|
$ | 103,344 | $ | 97,463 | $ | 71,514 | ||||||
Maximum
amount outstanding at any month-end during the period
|
167,409 | 147,816 | 96,318 | |||||||||
Year
end balance
|
54,245 | 147,816 | 95,883 | |||||||||
Weighted
average interest rate:
|
||||||||||||
At
end of year
|
4.36 | % | 1.81 | % | 4.19 | % | ||||||
During
the year
|
2.47 | % | 3.40 | % | 4.92 | % |
Subordinated
Debentures
In 2008,
First Federal Statutory Trust III, an unconsolidated trust subsidiary of First
Financial Service Corporation, issued $8.0 million in trust preferred
securities. The trust loaned the proceeds of the offering to us in
exchange for junior subordinated deferrable interest debentures which we used to
finance the purchase of FSB Bancshares, Inc. The subordinated debentures, which
mature on June 24, 2038, can be called at par in whole or in part on or after
June 24, 2018. The subordinated debentures pay a fixed rate of 8% for thirty
years. We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years. The subordinated debentures are considered as Tier I capital
for the Corporation under current regulatory guidelines.
A
different trust subsidiary issued 30 year cumulative trust preferred securities
totaling $10 million at a 10 year fixed rate of 6.69% adjusting quarterly
thereafter at LIBOR plus 160 basis points. The subordinated
debentures, which mature March 22, 2037, can be called at par in whole or in
part on or after March 15, 2017. We have the option to defer interest
payments on the subordinated debt from time to time for a period not to exceed
five consecutive years. The subordinated debentures are considered as Tier I
capital for the Corporation under current regulatory guidelines.
Our trust
subsidiaries loaned the proceeds of their offerings of trust preferred
securities to us in exchange for junior subordinated deferrable interest
debentures. In accordance with current accounting guidance, these trusts are not
consolidated with our financial statements but rather the subordinated
debentures are shown as a liability.
LIQUIDITY
Liquidity
risk arises from the possibility we may not be able to satisfy current or future
financial commitments, or may become unduly reliant on alternative funding
sources. The objective of liquidity risk management is to ensure that we can
meet the cash flow requirements of depositors and borrowers, as well as our
operating cash needs, at a reasonable cost, taking into account all on- and
off-balance sheet funding demands. We maintain an investment and funds
management policy, which identifies the primary sources of liquidity,
establishes procedures for monitoring and measuring liquidity, and establishes
minimum liquidity requirements in compliance with regulatory guidance. The Asset
Liability Committee continually monitors our liquidity
position.
36
Our
sources of funds include the sale of securities in the available-for-sale
portion of the investment portfolio, the payment of principal on loans and
mortgage-backed securities, proceeds realized from loans held for sale, brokered
deposits and other wholesale funding. We also secured federal funds
borrowing lines from three of our correspondent banks. Two of the
lines are for $15 million each and the other one is for $5
million. Our banking centers also provide access to retail deposit
markets. If large certificate depositors shift to our competitors or
other markets in response to interest rate changes, we have the ability to
replenish those deposits through alternative funding
sources. Traditionally, we have also borrowed from the FHLB to
supplement our funding requirements. At December 31, 2009, we had
sufficient collateral available to borrow, approximately, an additional $71.1
million in advances from the FHLB. We believe we have the
ability to raise deposits, when needed, by offering rates at or slightly above
market rates. In the event the Bank would fall below well-capitalized
status, we would be subject to wholesale funding restrictions as well as
interest rate restrictions used to attract core deposits.
At the
holding company level, the Corporation uses cash to pay dividends to
stockholders, repurchase common stock, make selected investments and
acquisitions, and service debt. The main sources of funding for the Corporation
include dividends from the Bank, borrowings and access to the capital
markets. The Corporation maintains a loan agreement with a
correspondent bank. As of December 31, 2009, the outstanding balance
of this loan was $1.5 million. During January 2010, the Corporation
paid down the outstanding loan balance by $500,000. The loan matures
on January 31, 2011 and principal and interest of $ 86,000 is due monthly at a
rate of prime plus one percent with a floor of 6.00%.
The
primary source of funding for the Corporation has been dividends and returns of
investment from the Bank. Kentucky banking laws limit the amount of dividends
that may be paid to the Corporation by the Bank without prior approval of the
KDFI. Under these laws, the amount of dividends that may be paid in
any calendar year is limited to current year’s net income, as defined in the
laws, combined with the retained net income of the preceding two years, less any
dividends declared during those periods. As a result of a $6
million dividend in 2008 used to finance the purchase of FSB Bancshares, Inc.,
the Bank needed and obtained partial approval for its 2009 dividends. We
currently have a regulatory agreement with the FDIC that requires us to obtain
the consent of the Regional Director of the FDIC and the Commissioner of the
KDFI to declare and pay cash dividends. Because of these limitations,
consolidated cash flows as presented in the consolidated statements of cash
flows may not represent cash immediately available to the
Corporation. During 2009, the Bank declared and paid dividends of
$3.1 million to the Corporation.
CAPITAL
Stockholders’
equity increased $12.2 million during 2009, primarily due to the sale of $20
million of preferred stock to the U.S. Treasury Department under the Capital
Purchase Program. This increase was offset by net loss recorded for
the year due to a goodwill impairment charge. Average stockholders’ equity to
average assets ratio increased to 8.56% at December 31, 2009 compared to 8.02%
at the end of 2008.
On
January 9, 2009, we sold $20 million of cumulative perpetual preferred shares,
with a liquidation preference of $1,000 per share (the “Senior Preferred
Shares”) to the U.S. Treasury under the terms of its Capital Purchase
Program. The Senior Preferred Shares constitute Tier 1 capital and
rank senior to our common shares. The Senior Preferred Shares pay
cumulative dividends at a rate of 5% per year for the first five years and will
reset to a rate of 9% per year after five years. The Senior Preferred Shares may
be redeemed at any time, at our option.
Under the
terms of our CPP stock purchase agreement, we also issued the U.S. Treasury a
warrant to purchase an amount of our common stock equal to 15% of the aggregate
amount of the Senior Preferred Shares, or $3 million. The warrant
entitles the U.S. Treasury to purchase 215,983 common shares at a purchase price
of $13.89 per share. The initial exercise price for the warrant and
the number of shares subject to the warrant were determined by reference to the
market price of our common stock calculated on a 20-day trailing average as of
December 8, 2008, the date the U.S. Treasury approved our
application. The warrant has a term of 10 years and is
potentially dilutive to earnings per share.
During
2009 we did not purchase any shares of our own common stock. However,
the terms of our Senior Preferred Shares do not allow us to repurchase shares of
our common stock without the consent of the U.S. Treasury until the Senior
Preferred Shares are redeemed.
Each of
the federal bank regulatory agencies has established minimum leverage capital
requirements for banks. Banks must maintain a minimum ratio of Tier 1 capital to
adjusted average quarterly assets ranging from 3% to 5%, subject to federal bank
regulatory evaluation of an organization’s overall safety and
soundness. We intend to maintain a capital position that meets or
exceeds the “well capitalized” requirements established for banks by the
FDIC. We currently have a regulatory agreement with the FDIC that requires us to maintain a
Tier 1 leverage ratio of 8%. We are currently in compliance with the
Tier 1 capital requirement.
37
The
following table shows the ratios of Tier 1 capital and total capital to
risk-adjusted assets and the leverage ratios for the Corporation and the Bank as
of December 31, 2009.
Capital Adequacy Ratios as of
|
||||||||||||||||
|
December 31, 2009
|
|||||||||||||||
|
Regulatory
|
Well-Capitalized
|
||||||||||||||
Risk-Based Capital Ratios
|
Minimums
|
Minimums
|
The Bank
|
The Corporation
|
||||||||||||
Tier
1 capital (1)
|
4.00 | % | 6.00 | % | 9.99 | % | 10.09 | % | ||||||||
Total
risk-based capital (2)
|
8.00 | % | 10.00 | % | 11.25 | % | 11.35 | % | ||||||||
Tier
1 leverage ratio (3)
|
4.00 | % | 5.00 | % | 8.90 | % | 8.66 | % |
(1)
|
Shareholders’
equity plus corporation-obligated mandatory redeemable capital securities,
less unrealized gains (losses) on debt securities available for sale, net
of deferred income taxes, less nonqualifying intangible assets; computed
as a ratio of risk-weighted assets, as defined in the risk-based capital
guidelines.
|
(2)
|
Tier
1 capital plus qualifying loan loss allowance and subordinated debt;
computed as a ratio of risk-weighted assets, as defined in the risk-based
capital guidelines.
|
(3)
|
Tier
1 capital computed as a percentage of fourth quarter average assets less
nonqualifying intangibles.
|
OFF
BALANCE SHEET ARRANGEMENTS
Our off
balance sheet arrangements consist of commitments to make loans, unused borrower
lines of credit, and stand by letters of credit, which are disclosed in Note 20
to the consolidated financial statements.
AGGREGATE
CONTRACTUAL
OBLIGATIONS
Greater than
|
Greater than
|
|||||||||||||||||||
Less than
|
one year to
|
3 years to
|
More than
|
|||||||||||||||||
December 31, 2009
|
Total
|
one year
|
3 years
|
5 years
|
5 years
|
|||||||||||||||
(Dollars in thousands)
|
||||||||||||||||||||
Aggregate Contractual Obligations:
|
||||||||||||||||||||
Time
deposits
|
$ | 609,260 | $ | 388,177 | $ | 189,517 | $ | 16,864 | $ | 14,702 | ||||||||||
FHLB
borrowings
|
52,745 | 140 | 25,260 | 10,335 | 17,010 | |||||||||||||||
Short-term
borrowings
|
1,500 | 1,500 | - | - | - | |||||||||||||||
Subordinated
debentures
|
18,000 | - | - | - | 18,000 | |||||||||||||||
Lease
commitments
|
6,029 | 578 | 956 | 570 | 3,925 |
FHLB
borrowings represent the amounts that are due to the FHLB of Cincinnati. These
amounts have fixed maturity dates. Four of these borrowings, although
fixed, are subject to conversion provisions at the option of the
FHLB. The FHLB has the right to convert these advances to a variable
rate or we can prepay the advances at no penalty. There is a
substantial penalty if we prepay the advances before the FHLB exercises its
right. We do not believe these advances will be converted in the near
term.
The
subordinated debentures, which mature June 24, 2038 and March 22, 2037, are
redeemable before the maturity date at our option on or after June 24, 2018 and
March 15, 2017 at their principal amount plus accrued interest. The
subordinated debentures are also redeemable in whole or in part from time to
time, upon the occurrence of specific events defined within the trust
indenture. The interest rate on the subordinated debentures is at a
30 year fixed rate of 8.00% and a 10 year fixed rate of 6.69% adjusting
quarterly thereafter at LIBOR plus 1.60%. We have the option to defer
distributions on the subordinated debentures from time to time for a period not
to exceed 20 consecutive quarters.
Lease
commitments represent the total future minimum lease payments under
non-cancelable operating leases.
IMPACT
OF INFLATION & CHANGING PRICES
The
consolidated financial statements and related financial data presented in this
filing have been prepared in accordance with U.S. generally accepted accounting
principles, which require the measurement of financial position and operating
results in historical dollars without considering changes in the relative
purchasing power of money over time due to inflation.
The
primary impact of inflation on our operations is reflected in increasing
operating costs. Unlike most industrial companies, virtually all of
the assets and liabilities of a financial institution are monetary in
nature. As a result, changes in interest rates have a more
significant impact on our performance than the effects of general levels of
inflation and changes in prices. Periods of high inflation are often
accompanied by relatively higher interest rates, and periods of low inflation
are accompanied by relatively lower interest rates. As market
interest rates rise or fall in relation to the rates earned on our loans and
investments, the value of these assets decreases or increases
respectively.
38
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
Asset
/Liability Management and Market Risk
To
minimize the volatility of net interest income and exposure to economic loss
that may result from fluctuating interest rates, we manage our exposure to
adverse changes in interest rates through asset and liability management
activities within guidelines established by our Asset Liability Committee
(“ALCO”). The ALCO, comprised of senior management representatives,
has the responsibility for approving and ensuring compliance with
asset/liability management policies. Interest rate risk is the
exposure to adverse changes in the net interest income as a result of market
fluctuations in interest rates. The ALCO, on an ongoing basis,
monitors interest rate and liquidity risk in order to implement appropriate
funding and balance sheet strategies. Management considers interest
rate risk to be our most significant market risk.
We
utilize an earnings simulation model to analyze net interest income
sensitivity. We then evaluate potential changes in market interest
rates and their subsequent effects on net interest income. The model
projects the effect of instantaneous movements in interest rates of both 100 and
200 basis points. We also incorporate assumptions based on the
historical behavior of our deposit rates and balances in relation to changes in
interest rates into the model. These assumptions are inherently
uncertain and, as a result, the model cannot precisely measure future net
interest income or precisely predict the impact of fluctuations in market
interest rates on net interest income. Actual results will differ
from the model’s simulated results due to timing, magnitude and frequency of
interest rate changes as well as changes in market conditions and the
application and timing of various management strategies.
Our
interest sensitivity profile was asset sensitive at December 31, 2009 and
December 31, 2008. Given a sustained 100 basis point decrease in
rates, our base net interest income would decrease by an estimated 2.84% at December 31,
2009 compared to a decrease of 2.67% at December 31, 2008. Given a 100 basis point
increase in interest rates our base net interest income would increase by
an estimated 2.70%
at December 31, 2009 compared to an increase of 1.49% at December 31,
2008.
Our
interest sensitivity at any point in time will be affected by a number of
factors. These factors include the mix of interest sensitive assets
and liabilities, their relative pricing schedules, market interest rates,
deposit growth, loan growth, decay rates and prepayment speed
assumptions.
We use
various asset/liability strategies to manage the re-pricing characteristics of
our assets and liabilities designed to ensure that exposure to interest rate
fluctuations is limited within our guidelines of acceptable levels of
risk-taking. As demonstrated by the December 31, 2009 and December
31, 2008 sensitivity tables, our balance sheet has an asset sensitive position.
This means that our earning assets, which consist of loans and investment
securities, will change in price at a faster rate than our deposits and
borrowings. Therefore, if short term interest rates increase, our net
interest income will increase. Likewise, if short term interest rates
decrease, our net interest income will decrease.
39
Our
sensitivity to interest rate changes is presented based on data as of December
31, 2009 and 2008.
December
31, 2009
|
||||||||||||||||||||
Decrease in Rates
|
Increase in Rates
|
|||||||||||||||||||
200
|
100
|
100
|
200
|
|||||||||||||||||
(Dollars
in thousands)
|
Basis Points
|
Basis Points
|
Base
|
Basis Points
|
Basis Points
|
|||||||||||||||
Projected
interest income
|
||||||||||||||||||||
Loans
|
$ | 55,484 | $ | 56,942 | $ | 58,564 | $ | 60,162 | $ | 61,850 | ||||||||||
Investments
|
2,271 | 2,116 | 2,150 | 2,552 | 2,953 | |||||||||||||||
Total
interest income
|
57,755 | 59,058 | 60,714 | 62,714 | 64,803 | |||||||||||||||
Projected
interest expense
|
||||||||||||||||||||
Deposits
|
15,938 | 16,077 | 16,587 | 16,920 | 18,043 | |||||||||||||||
Borrowed
funds
|
3,753 | 3,753 | 3,752 | 4,329 | 4,905 | |||||||||||||||
Total
interest expense
|
19,691 | 19,830 | 20,339 | 21,249 | 22,948 | |||||||||||||||
Net
interest income
|
$ | 38,064 | $ | 39,228 | $ | 40,375 | $ | 41,465 | $ | 41,855 | ||||||||||
Change
from base
|
$ | (2,311 | ) | $ | (1,147 | ) | $ | 1,090 | $ | 1,480 | ||||||||||
%
Change from base
|
(5.72 | )% | (2.84 | )% | 2.70 | % | 3.67 | % |
December
31, 2008
|
||||||||||||||||||||
Decrease in Rates
|
Increase in Rates
|
|||||||||||||||||||
200
|
100
|
100
|
200
|
|||||||||||||||||
(Dollars
in thousands)
|
Basis Points
|
Basis Points
|
Base
|
Basis Points
|
Basis Points
|
|||||||||||||||
Projected
interest income
|
||||||||||||||||||||
Loans
|
$ | 50,663 | $ | 52,195 | $ | 53,664 | $ | 55,105 | $ | 56,577 | ||||||||||
Investments
|
966 | 985 | 1,002 | 1,033 | 1,063 | |||||||||||||||
Total
interest income
|
51,629 | 53,180 | 54,666 | 56,138 | 57,640 | |||||||||||||||
Projected
interest expense
|
||||||||||||||||||||
Deposits
|
15,815 | 16,026 | 16,419 | 16,984 | 17,523 | |||||||||||||||
Borrowed
funds
|
3,559 | 3,570 | 3,743 | 4,135 | 4,525 | |||||||||||||||
Total
interest expense
|
19,374 | 19,596 | 20,162 | 21,119 | 22,048 | |||||||||||||||
Net
interest income
|
$ | 32,255 | $ | 33,584 | $ | 34,504 | $ | 35,019 | $ | 35,592 | ||||||||||
Change
from base
|
$ | (2,249 | ) | $ | (920 | ) | $ | 515 | $ | 1,088 | ||||||||||
%
Change from base
|
(6.52 | )% | (2.67 | )% | 1.49 | % | 3.15 | % |
40
ITEM 8. Financial
Statements and Supplementary Data
FIRST
FINANCIAL SERVICE CORPORATION
Table
of Contents
Audited
Consolidated Financial Statements:
·
|
Report
on Management’s Assessment of Internal Control Over Financial
Reporting
|
42
|
·
|
Report
of Independent Registered Public Accounting Firm
|
43
|
·
|
Consolidated
Balance Sheets
|
44
|
·
|
Consolidated
Statements of Operations
|
45
|
·
|
Consolidated
Statements of Comprehensive Income (Loss)
|
46
|
·
|
Consolidated
Statements of Changes in Stockholders’ Equity
|
47
|
·
|
Consolidated
Statements of Cash Flows
|
48
|
·
|
Notes
to Consolidated Financial Statements
|
49
|
41
Management’s Report
on Internal Control Over Financial Reporting
First
Financial Service Corporation is responsible for the preparation, integrity, and
fair presentation of the consolidated financial statements included in this
annual report. We, as management of First Financial Service Corporation, are
responsible for establishing and maintaining effective internal control over
financial reporting that is designed to produce reliable financial statements in
conformity with U. S. generally accepted accounting principles. Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk
that controls may become inadequate because of
changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
Management
assessed the system of internal control over financial reporting as of December
31, 2009, in relation to criteria for effective internal control over financial
reporting as described in "Internal Control - Integrated Framework," issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on
this assessment, management concludes that, as of December 31, 2009, its system
of internal control over financial reporting is effective and meets the criteria
of the "Internal Control - Integrated Framework”. Crowe Horwath LLP,
independent registered public accounting firm, has issued an attestation report
on the Corporation's internal control over financial reporting dated March 15,
2010.
Date: March
16, 2010
|
By:
|
/s/ B.
Keith Johnson
|
B.
Keith Johnson
|
||
Chief
Executive Officer
|
||
Date:
March 16, 2010
|
By:
|
/s/
Steven M. Zagar
|
Steven
M. Zagar
|
||
|
Chief
Financial Officer
|
|
Principal
Accounting Officer
|
42
Crowe
Horwath LLP
Independent
Member Crowe Horwath International
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors and Stockholders
First
Financial Service Corporation
Elizabethtown,
Kentucky
We have
audited the accompanying consolidated balance sheets of First Financial Service
Corporation as of December 31, 2009 and 2008 and the related consolidated
statements of operations, comprehensive income (loss), changes in
stockholders’ equity, and cash flows for each of the three years in the period
ended December 31, 2009. We also have audited First Financial
Service Corporation’s internal control over financial reporting as of December
31, 2009, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). First Financial Service Corporation’s
management is responsible for these financial statements, for maintaining
effective internal control over financial reporting, and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control over Financial
Reporting. Our responsibility is to express an opinion on these
financial statements and an opinion on the company's internal control over
financial reporting based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other
procedures as we considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of First Financial Service
Corporation as of December 31, 2009 and 2008, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2009, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion First
Financial Service Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control – Integrated
Framework issued by the COSO.
Crowe
Horwath LLP
|
Louisville,
Kentucky
March 15,
2010
43
FIRST
FINANCIAL SERVICE CORPORATION
Consolidated
Balance Sheets
December 31,
|
||||||||
(Dollars
in thousands, except share data)
|
2009
|
2008
|
||||||
ASSETS:
|
||||||||
Cash
and due from banks
|
$ | 21,253 | $ | 17,310 | ||||
Interest
bearing deposits
|
77,280 | 3,595 | ||||||
Total
cash and cash equivalents
|
98,533 | 20,905 | ||||||
Securities
available-for-sale
|
45,764 | 15,775 | ||||||
Securities
held-to-maturity, fair value of $1,176 (2009) and $6,846
(2008)
|
1,167 | 7,022 | ||||||
Total
securities
|
46,931 | 22,797 | ||||||
Loans
held for sale
|
8,183 | 9,567 | ||||||
Loans,
net of unearned fees
|
994,926 | 903,434 | ||||||
Allowance
for loan losses
|
(17,719 | ) | (13,565 | ) | ||||
Net
loans
|
985,390 | 899,436 | ||||||
Federal
Home Loan Bank stock
|
8,515 | 8,515 | ||||||
Cash
surrender value of life insurance
|
9,008 | 8,654 | ||||||
Premises
and equipment, net
|
31,965 | 30,068 | ||||||
Real
estate owned:
|
||||||||
Acquired
through foreclosure
|
8,428 | 5,925 | ||||||
Held
for development
|
45 | 45 | ||||||
Other
repossessed assets
|
103 | 91 | ||||||
Goodwill
|
- | 11,931 | ||||||
Core
deposit intangible
|
1,300 | 1,703 | ||||||
Accrued
interest receivable
|
5,658 | 4,379 | ||||||
Deferred
income taxes
|
4,515 | 1,147 | ||||||
Prepaid
FDIC premium
|
7,022 | - | ||||||
Other
assets
|
2,091 | 1,451 | ||||||
TOTAL
ASSETS
|
$ | 1,209,504 | $ | 1,017,047 | ||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
LIABILITIES:
|
||||||||
Deposits:
|
||||||||
Non-interest
bearing
|
$ | 63,950 | $ | 55,668 | ||||
Interest
bearing
|
985,865 | 719,731 | ||||||
Total
deposits
|
1,049,815 | 775,399 | ||||||
Short-term
borrowings
|
1,500 | 94,869 | ||||||
Advances
from Federal Home Loan Bank
|
52,745 | 52,947 | ||||||
Subordinated
debentures
|
18,000 | 18,000 | ||||||
Accrued
interest payable
|
360 | 288 | ||||||
Accounts
payable and other liabilities
|
1,952 | 2,592 | ||||||
TOTAL
LIABILITIES
|
1,124,372 | 944,095 | ||||||
Commitments
and contingent liabilities (See Note 19)
|
- | - | ||||||
STOCKHOLDERS'
EQUITY:
|
||||||||
Serial
preferred stock, $1 par value per share; authorized 5,000,000 shares;
issued and outstanding, 20,000 shares with a liquidation preference of
$1,000/share (2009)
|
19,781 | - | ||||||
Common
stock, $1 par value per share; authorized 10,000,000 shares; issued and
outstanding, 4,709,839 shares (2009), and 4,668,030 shares
(2008)
|
4,710 | 4,668 | ||||||
Additional
paid-in capital
|
34,984 | 34,145 | ||||||
Retained
earnings
|
26,720 | 36,476 | ||||||
Accumulated
other comprehensive loss
|
(1,063 | ) | (2,337 | ) | ||||
TOTAL
STOCKHOLDERS' EQUITY
|
85,132 | 72,952 | ||||||
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$ | 1,209,504 | $ | 1,017,047 |
See
notes to the consolidated financial statements.
44
FIRST
FINANCIAL SERVICE CORPORATION
Consolidated
Statements of Operations
Year Ended December 31,
|
||||||||||||
(Dollars in thousands, except per share data)
|
2009
|
2008
|
2007
|
|||||||||
Interest
and Dividend Income:
|
||||||||||||
Loans,
including fees
|
$ | 57,113 | $ | 55,739 | $ | 58,019 | ||||||
Taxable
securities
|
1,234 | 1,429 | 2,108 | |||||||||
Tax
exempt securities
|
509 | 396 | 418 | |||||||||
Total
interest income
|
58,856 | 57,564 | 60,545 | |||||||||
Interest
Expense:
|
||||||||||||
Deposits
|
17,917 | 20,512 | 25,519 | |||||||||
Short-term
borrowings
|
152 | 896 | 1,935 | |||||||||
Federal
Home Loan Bank advances
|
2,405 | 2,413 | 1,580 | |||||||||
Subordinated
debentures
|
1,318 | 978 | 717 | |||||||||
Total
interest expense
|
21,792 | 24,799 | 29,751 | |||||||||
Net
interest income
|
37,064 | 32,765 | 30,794 | |||||||||
Provision
for loan losses
|
9,524 | 5,947 | 1,209 | |||||||||
Net
interest income after provision for loan losses
|
27,540 | 26,818 | 29,585 | |||||||||
Non-interest
Income:
|
||||||||||||
Customer
service fees on deposit accounts
|
6,677 | 6,601 | 5,792 | |||||||||
Gain
on sale of mortgage loans
|
1,194 | 697 | 569 | |||||||||
Gain
on sale of securities
|
- | 55 | - | |||||||||
Gain
on sale of real estate held for development
|
- | - | 227 | |||||||||
Total
other-than-temporary impairment losses
|
(1,077 | ) | (516 | ) | - | |||||||
Portion
of loss recognized in other comprehensive income/(loss) (before
taxes)
|
215 | - | - | |||||||||
Net
impairment losses recognized in earnings
|
(862 | ) | (516 | ) | - | |||||||
Write
down on real estate acquired through foreclosure
|
(578 | ) | (162 | ) | - | |||||||
Brokerage
commissions
|
373 | 469 | 424 | |||||||||
Other
income
|
1,715 | 1,305 | 1,191 | |||||||||
Total
non-interest income
|
8,519 | 8,449 | 8,203 | |||||||||
Non-interest
Expense:
|
||||||||||||
Employee
compensation and benefits
|
15,834 | 14,600 | 12,593 | |||||||||
Office
occupancy expense and equipment
|
3,271 | 2,865 | 2,373 | |||||||||
Marketing
and advertising
|
844 | 782 | 914 | |||||||||
Outside
services and data processing
|
3,194 | 3,324 | 2,632 | |||||||||
Bank
franchise tax
|
960 | 1,010 | 923 | |||||||||
FDIC
insurance premiums
|
1,900 | 716 | 77 | |||||||||
Write
off of issuance cost of Trust Preferred Securities
|
- | - | 229 | |||||||||
Goodwill
impairment
|
11,931 | - | - | |||||||||
Amortization
of intangible assets
|
510 | 284 | - | |||||||||
Other
expense
|
5,473 | 4,705 | 4,049 | |||||||||
Total
non-interest expense
|
43,917 | 28,286 | 23,790 | |||||||||
Income/(loss)
before income taxes
|
(7,858 | ) | 6,981 | 13,998 | ||||||||
Income
taxes/(benefits)
|
(1,149 | ) | 2,184 | 4,646 | ||||||||
Net
income/(loss)
|
(6,709 | ) | 4,797 | 9,352 | ||||||||
Less:
|
||||||||||||
Dividends
on preferred stock
|
(980 | ) | - | - | ||||||||
Accretion
on preferred stock
|
(52 | ) | - | - | ||||||||
Net
income/(loss) available to common shareholders
|
$ | (7,741 | ) | $ | 4,797 | $ | 9,352 | |||||
Shares
applicable to basic income per common share
|
4,695 | 4,666 | 4,722 | |||||||||
Basic
income/(loss) per common share
|
$ | (1.65 | ) | $ | 1.03 | $ | 1.98 | |||||
Shares
applicable to diluted income per common share
|
4,695 | 4,686 | 4,774 | |||||||||
Diluted
income/(loss) per common share
|
$ | (1.65 | ) | $ | 1.02 | $ | 1.96 | |||||
Cash
dividends declared per common share
|
$ | 0.430 | $ | 0.760 | $ | 0.726 |
See
notes to the consolidated financial statements.
45
FIRST
FINANCIAL SERVICE CORPORATION
Consolidated
Statements of Comprehensive Income/(Loss)
Year Ended December 31,
|
||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Net
Income/(Loss)
|
$ | (6,709 | ) | $ | 4,797 | $ | 9,352 | |||||
Other
comprehensive income (loss):
|
||||||||||||
Change
in unrealized gain (loss) on securities available-for-sale
|
1,414 | (3,529 | ) | (601 | ) | |||||||
Change
in unrealized gain (loss) on securities available-for-sale for which a
portion of other-than-temporary impairment has been recognized into
earnings
|
(107 | ) | - | - | ||||||||
Reclassification
of realized amount on securities available-for-sale losses
(gains)
|
832 | 461 | - | |||||||||
Non-credit
component of other-than- temporary impairment on held-to-maturity
securities
|
(215 | ) | - | - | ||||||||
Accretion
of non-credit component of other- than-temporary impairment on
held-to-maturity securities
|
6 | - | - | |||||||||
Net
unrealized gain (loss) recognized in comprehensive income
|
1,930 | (3,068 | ) | (601 | ) | |||||||
Tax
effect
|
(656 | ) | 1,043 | 204 | ||||||||
Total
other comphrehensive income (loss)
|
1,274 | (2,025 | ) | (397 | ) | |||||||
Comprehensive
Income/(Loss)
|
$ | (5,435 | ) | $ | 2,772 | $ | 8,955 |
The
following is a summary of the accumulated other comprehensive income balances,
net of tax:
Balance
|
Current
|
Balance
|
||||||||||
at
|
Period
|
at
|
||||||||||
12/31/2008
|
Change
|
12/31/2009
|
||||||||||
Unrealized
gains (losses) on securities available-for-sale
|
$ | (2,337 | ) | $ | 1,412 | $ | (925 | ) | ||||
Unrealized
gains (losses) on held-to-maturity securities for which OTTI has been
recorded, net of accretion
|
- | (138 | ) | (138 | ) | |||||||
Total
|
$ | (2,337 | ) | $ | 1,274 | $ | (1,063 | ) |
See
notes to the consolidated financial statements.
46
FIRST
FINANCIAL SERVICE CORPORATION
Consolidated
Statements of Changes in Stockholders' Equity
Years
Ending December 31, 2009, 2008 and 2007
(Dollars
In Thousands, Except Per Share Amounts)
Shares
|
Amount
|
Additional
Paid-in
|
Retained
|
Accumulated
Other
Comprehensive
(Loss), Net of
|
||||||||||||||||||||||||||||
Preferred
|
Common
|
Preferred
|
Common
|
Capital
|
Earnings
|
Tax
|
Total
|
|||||||||||||||||||||||||
Balance,
January 1, 2007
|
- | 4,384 | $ | - | $ | 4,384 | $ | 27,419 | $ | 40,210 | $ | 85 | $ | 72,098 | ||||||||||||||||||
Net
income
|
9,352 | 9,352 | ||||||||||||||||||||||||||||||
Stock
dividend-10%
|
424 | 424 | 10,493 | (10,917 | ) | - | ||||||||||||||||||||||||||
Stock
issued for stock options exercised and employee benefit
plans
|
9 | 9 | 165 | 174 | ||||||||||||||||||||||||||||
Stock-based
compensation expense
|
110 | 110 | ||||||||||||||||||||||||||||||
Net
change in unrealized gains (losses) on securities available- for-sale, net
of tax
|
(397 | ) | (397 | ) | ||||||||||||||||||||||||||||
Cash
dividends declared and cash dividends for fractional shares for stock
dividend ($.73 per share)
|
(3,420 | ) | (3,420 | ) | ||||||||||||||||||||||||||||
Stock
repurchased
|
- | (156 | ) | - | (156 | ) | (4,301 | ) | - | - | (4,457 | ) | ||||||||||||||||||||
Balance,
December 31, 2007
|
- | 4,661 | - | 4,661 | 33,886 | 35,225 | (312 | ) | 73,460 | |||||||||||||||||||||||
Net
income
|
4,797 | 4,797 | ||||||||||||||||||||||||||||||
Stock
issued for employee benefit plans
|
7 | 7 | 137 | 144 | ||||||||||||||||||||||||||||
Stock-based
compensation expense
|
122 | 122 | ||||||||||||||||||||||||||||||
Net
change in unrealized gains (losses) on securities available- for-sale, net
of tax
|
(2,025 | ) | (2,025 | ) | ||||||||||||||||||||||||||||
Cash
dividends declared ($.76 per share)
|
- | - | - | - | - | (3,546 | ) | - | (3,546 | ) | ||||||||||||||||||||||
Balance,
December 31, 2008
|
- | 4,668 | - | 4,668 | 34,145 | 36,476 | (2,337 | ) | 72,952 | |||||||||||||||||||||||
Net
income/(loss)
|
(6,709 | ) | (6,709 | ) | ||||||||||||||||||||||||||||
Issuance
of preferred stock and a common stock warrant
|
20,000 | 19,729 | 271 | 20,000 | ||||||||||||||||||||||||||||
Shares
issued under dividend reinvestment program
|
22 | 22 | 281 | 303 | ||||||||||||||||||||||||||||
Stock
issued for stock options exercised
|
12 | 12 | 89 | 101 | ||||||||||||||||||||||||||||
Stock
issued for employee benefit plans
|
8 | 8 | 95 | 103 | ||||||||||||||||||||||||||||
Stock-based
compensation expense
|
103 | 103 | ||||||||||||||||||||||||||||||
Net
change in unrealized gains (losses) on securities available- for-sale, net
of tax
|
933 | 933 | ||||||||||||||||||||||||||||||
Unrealized
loss on held-to-maturity securities for which an other-than-temporary
impairment charge has been recorded, net of tax
|
(138 | ) | (138 | ) | ||||||||||||||||||||||||||||
Change
in unrealized gains (losses) on securities available-for-sale for which a
portion of an other-than-temporary impairment charge has been recognized
into earnings, net of reclassification and taxes
|
479 | 479 | ||||||||||||||||||||||||||||||
Dividends
on preferred stock
|
(980 | ) | (980 | ) | ||||||||||||||||||||||||||||
Accretion
of preferred stock discount
|
52 | (52 | ) | - | ||||||||||||||||||||||||||||
Cash
dividends declared ($.43 per share)
|
- | - | - | - | - | (2,015 | ) | - | (2,015 | ) | ||||||||||||||||||||||
Balance,
December 31, 2009
|
20,000 | 4,710 | $ | 19,781 | $ | 4,710 | $ | 34,984 | $ | 26,720 | $ | (1,063 | ) | $ | 85,132 |
See
notes to the consolidated financial statements.
47
FIRST
FINANCIAL SERVICE CORPORATION
Consolidated
Statements of Cash Flows
|
Year Ended December 31,
|
|||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Operating
Activities:
|
||||||||||||
Net
income/(loss)
|
$ | (6,709 | ) | $ | 4,797 | $ | 9,352 | |||||
Adjustments
to reconcile net income/(loss) to net cash provided by operating
activities:
|
||||||||||||
Provision
for loan losses
|
9,524 | 5,947 | 1,209 | |||||||||
Depreciation
on premises and equipment
|
1,738 | 1,592 | 1,425 | |||||||||
Loss
on impairment of goodwill
|
11,931 | - | - | |||||||||
Federal
Home Loan Bank stock dividends
|
- | (309 | ) | - | ||||||||
Intangible
asset amortization
|
510 | 284 | - | |||||||||
Net
amortization (accretion) available-for-sale
|
(101 | ) | (3 | ) | (2 | ) | ||||||
Net
amortization (accretion) held-to-maturity
|
9 | 10 | 20 | |||||||||
Impairment
loss on securities available-for-sale
|
831 | 516 | - | |||||||||
Impairment
loss on securities held-to-maturity
|
31 | - | - | |||||||||
Gain
on sale of investments available-for-sale
|
- | (55 | ) | - | ||||||||
Gain
on sale of real estate held for development
|
- | - | (227 | ) | ||||||||
Gain
on sale of mortgage loans
|
(1,194 | ) | (697 | ) | (569 | ) | ||||||
Origination
of loans held for sale
|
(130,893 | ) | (58,332 | ) | (34,206 | ) | ||||||
Proceeds
on sale of loans held for sale
|
133,471 | 50,242 | 34,668 | |||||||||
Deferred
taxes
|
(4,024 | ) | (1,785 | ) | 54 | |||||||
Stock-based
compensation expense
|
103 | 122 | 110 | |||||||||
Prepaid
FDIC premium
|
(7,022 | ) | - | - | ||||||||
Changes
in:
|
||||||||||||
Cash
surrender value of life insurance
|
(354 | ) | (364 | ) | (343 | ) | ||||||
Interest
receivable
|
(1,279 | ) | (55 | ) | (230 | ) | ||||||
Other
assets
|
(747 | ) | 54 | 244 | ||||||||
Interest
payable
|
72 | (933 | ) | 820 | ||||||||
Accounts
payable and other liabilities
|
(640 | ) | (46 | ) | 468 | |||||||
Net
cash from operating activities
|
5,257 | 985 | 12,793 | |||||||||
Investing
Activities:
|
||||||||||||
Cash
paid for acquisition of Farmers State Bank, net of cash
acquired
|
- | (1,466 | ) | - | ||||||||
Sales
of securities available-for-sale
|
- | 669 | - | |||||||||
Purchases
of securities available-for-sale
|
(30,811 | ) | (524 | ) | (395 | ) | ||||||
Maturities
of securities available-for-sale
|
2,231 | 2,557 | 6,015 | |||||||||
Maturities
of securities held-to-maturity
|
5,606 | 13,161 | 6,523 | |||||||||
Net
change in loans
|
(99,377 | ) | (92,055 | ) | (63,991 | ) | ||||||
Net
purchases of premises and equipment
|
(3,635 | ) | (4,306 | ) | (5,260 | ) | ||||||
Sales
of real estate held for development
|
- | - | 519 | |||||||||
Net
cash from investing activities
|
(125,986 | ) | (81,964 | ) | (56,589 | ) | ||||||
Financing
Activities
|
||||||||||||
Net
change in deposits
|
274,416 | 30,405 | 48,206 | |||||||||
Change
in short-term borrowings
|
(93,369 | ) | 52,069 | (25,700 | ) | |||||||
Advances
from Federal Home Loan Bank
|
- | - | 25,000 | |||||||||
Repayments
to Federal Home Loan Bank
|
(202 | ) | (136 | ) | (141 | ) | ||||||
Proceeds
from issuance of subordinated debentures
|
- | 8,000 | 10,000 | |||||||||
Payoff
of subordinated debentures
|
- | - | (10,000 | ) | ||||||||
Issuance
of preferred stock, net
|
20,000 | - | - | |||||||||
Issuance
of common stock under dividend reinvestment program
|
303 | - | - | |||||||||
Issuance
of common stock for stock options exercised
|
101 | - | 72 | |||||||||
Issuance
of common stock for employee benefit plans
|
103 | 144 | 102 | |||||||||
Dividends
paid on common stock
|
(2,015 | ) | (3,546 | ) | (3,420 | ) | ||||||
Dividends
paid on preferred stock
|
(980 | ) | - | - | ||||||||
Common
stock repurchased
|
- | - | (4,457 | ) | ||||||||
Net
cash from financing activities
|
198,357 | 86,936 | 39,662 | |||||||||
Increase
(Decrease) in cash and cash equivalents
|
77,628 | 5,957 | (4,134 | ) | ||||||||
Cash
and cash equivalents, beginning of year
|
20,905 | 14,948 | 19,082 | |||||||||
Cash
and cash equivalents, end of year
|
$ | 98,533 | $ | 20,905 | $ | 14,948 |
See
notes to the consolidated financial statements.
48
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
The
following is a description of the significant accounting policies First
Financial Service Corporation follows in preparing and presenting its
consolidated financial statements:
Principles of Consolidation and
Business – The
consolidated financial statements include the accounts of First Financial
Service Corporation and its wholly owned subsidiary, First Federal Savings
Bank. First Federal Savings Bank has three wholly owned subsidiaries,
First Service Corporation of Elizabethtown, Heritage Properties, LLC and First
Federal Office Park, LLC. Unless the text clearly suggests otherwise,
references to "us," "we," or "our" include First Financial Service Corporation
and its wholly-owned subsidiary. All significant intercompany
transactions and balances have been eliminated in consolidation.
Our
business consists primarily of attracting deposits from the general public and
origination of mortgage loans on commercial property, single-family residences
and multi-family housing. We also make home improvement loans,
consumer loans and commercial business loans. Our primary lending
area is a region within North Central Kentucky and Southern
Indiana. The economy within this region is diversified with a variety
of medical service, manufacturing, and agricultural industries, and Fort Knox, a
military installation.
The
principal sources of funds for our lending and investment activities are
deposits, repayment of loans, Federal Home Loan Bank advances and other
borrowings. Our principal source of income is interest on
loans. In addition, other income is derived from loan origination
fees, service charges, returns on investment securities, gain on sale of
mortgage loans, and brokerage and insurance commissions.
Our
subsidiary First Service Corporation is a licensed broker providing investment
services and offering tax-deferred annuities, government securities and stocks
and bonds to our customers. Heritage Properties, LLC holds real
estate acquired through foreclosure which is available for sale. First Federal
Office Park, LLC, another subsidiary, holds a commercial lot adjacent to our
home office on Ring Road in Elizabethtown, which is available for
sale.
Estimates and Assumptions –
The preparation of consolidated financial statements in conformity with U.S.
generally accepted accounting principles requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of the amount of revenues and expenses during the reporting
period. Actual results could differ from those
estimates. The allowance for loan losses and the fair value of
financial instruments are particularly subject to change.
Cash Flows – For purposes of
the statement of cash flows, we consider all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents. Cash and cash equivalents include cash on hand, amounts
due from banks, federal funds sold and certain interest bearing
deposits. Net cash flows are reported for interest-bearing deposits,
loans, short-term borrowings and deposits.
Securities – We classify
investments into held-to-maturity and available-for-sale. Debt
securities in which management has a positive intent and ability to hold are
classified as held-to-maturity and are carried at cost adjusted for the
amortization of premiums and discounts using the interest method over the terms
of the securities. Debt and equity securities, which do not fall into
this category, are classified as available-for-sale. Unrealized
holding gains and losses, net of tax, on available-for-sale securities are
reported as a component of accumulated other comprehensive income.
Interest
income includes amortization of purchase premium or
discount. Premiums and discounts on securities are amortized on the
level-yield method without anticipating prepayments, except for mortgage backed
securities where prepayments are anticipated. Gains and losses on
sales are recorded on the trade date and determined using the specific
identification method.
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.
49
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES –
(Continued)
|
Loans – Loans are stated at
unpaid principal balances, less undistributed construction loans, and net
deferred loan origination fees. We defer loan origination fees and
discounts net of certain direct origination costs. These net deferred
fees are amortized using the level yield method on a loan-by-loan basis over the
lives of the underlying loans.
Interest
income on loans is accrued on the unpaid principal balance except for those
loans in nonaccrual status. The accrual of interest is discontinued
when a loan becomes 90 or more days delinquent. When interest accrual
is discontinued, all accrued interest not received is reversed against interest
income. Interest income is subsequently recognized only to the extent
cash payments are received. Interest accruals resume when the loan
becomes less than 90 days delinquent.
Allowance for Loan Losses –The
allowance for loan losses is a valuation allowance for probable incurred credit
losses. Loan losses are charged against the allowance when we believe
the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance. Our periodic
evaluation of the allowance is based on our past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect the
borrower’s ability to repay, estimated value of any underlying collateral, and
current economic conditions. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that, in
management’s judgment, should be charged-off.
The
allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful. The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors.
Loans are
considered impaired when, based on current information and events, it is
probable that full principal or interest payments are not anticipated in
accordance with the contractual loan terms. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported,
net, at the present value of estimated future cash flows using the loan’s
existing rate, or at the fair value of collateral if repayment is expected
solely from collateral. If these allocations cause the allowance for
loan losses to require an increase, such increase is reported in the provision
for loan losses.
Commercial
and commercial real estate loans are individually evaluated for
impairment. Individual consumer and residential loans are evaluated
for impairment based on regulatory guidelines and are separately identified for
impairment disclosures. Troubled debt restructurings consist of
loans which terms have been modified due to adverse changes in the borrower’s
financial position. Troubled debt restructurings are measured at the
present value of estimated future cash flows using the loan’s effective rate at
inception.
Mortgage Banking Activities –
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of aggregate cost or market value. To deliver
closed loans to the secondary market and to control its interest rate risk prior
to sale, we enter into “best efforts” agreements to sell loans. The
aggregate market value of mortgage loans held for sale considers the price of
the sales contracts. The loans are sold with servicing
released.
Loan
commitments related to the origination of mortgage loans held for sale are
accounted for as derivative instruments. Our commitments are for
fixed rate mortgage loans, generally lasting 60 to 90 days and are at market
rates when initiated. Considered derivatives, we had commitments to
originate $5.8 million and $12.7 million in
loans at December 31, 2009 and 2008, which we intend to sell after the loans are
closed.
The fair
value was not material. Substantially all of the gain on sale generated from
mortgage banking activities continues to be recorded when closed loans are
delivered into the sales contracts.
Federal Home Loan Bank Stock –
The Bank is a member of the FHLB system. Members are required to own
a certain amount of stock based on the level of borrowings and other factors,
and may invest in additional amounts. Investment in
stock of Federal Home Loan Bank is carried at cost, and periodically evaluated
for impairment. Both cash and stock dividends are reported as
income.
50
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES –
(Continued)
|
Cash Surrender Value of Life
Insurance – We have purchased life insurance policies on certain key
executives. Company owned life insurance is recorded at the amount
that can be realized under the insurance contract at the balance sheet date,
which is the cash surrender value adjusted for other charges or other amounts
due that are probable at settlement.
Premises and Equipment – Land
is carried at cost. Premises and equipment are stated at cost less
accumulated depreciation. Buildings and related components are
depreciated using the straight-line method with useful lives ranging from 5 to
40 years. Furniture, fixtures and equipment are depreciated using the
straight-line method with useful lives ranging from 3 to 15 years.
Real Estate Owned – Real
estate properties acquired through foreclosure and in settlement of loans are
stated at fair value less estimated selling costs at the date of
foreclosure. The excess of cost over fair value less the estimated
costs to sell at the time of foreclosure is charged to the allowance for loan
losses. Costs relating to development and improvement of property are
capitalized when such amounts do not exceed fair value. Costs
relating to holding property are not capitalized and are charged against
operations in the current period.
Real Estate Held for
Development – Real estate properties held for development and sale are
carried at the lower of cost, including cost of development and improvement
subsequent to acquisition, or fair value less estimated selling
costs. The portion of interest costs relating to the development of
real estate is capitalized.
Other Repossessed Assets
– Consumer
assets acquired through repossession and in settlement of loans, typically
automobiles, are carried at lower of cost or fair value at the date of
repossession. The excess cost over fair value at time of repossession
is charged to the allowance for loan losses.
Goodwill and Other Intangible Assets
– Goodwill resulting from business combinations prior to January 1, 2009
represents the excess of the purchase price over the fair value of the net
assets of businesses acquired. Goodwill resulting from business
combinations after January 1, 2009 is generally determined as the excess of the
fair value of the consideration transferred, plus the fair value of any
non-controlling interests in the acquiree, over the fair value of the net assets
acquired and liabilities assumed as of the acquisition date. Goodwill
and intangible assets acquired in a purchase business combination and determined
to have an indefinite useful life are not amortized, but tested for impairment
at least annually. We have selected December 31 as the date to
perform the annual impairment test. Intangible assets with definite
useful lives are amortized over their estimated useful lives to their estimated
residual values.
Other
intangible assets consist of core deposit and acquired customer relationship
intangible assets arising from whole bank and branch
acquisitions. They are initially measured at fair value and then are
amortized on an accelerated method over their estimated useful lives, which
range from 7 to 10 years.
Long-Term Assets – Premises
and equipment, core deposit and other intangible assets, and other long-term
assets are reviewed for impairment when events indicate their carrying amount
may not be recoverable from future undiscounted cash flows. If
impaired, the assets are recorded at fair value.
Brokerage and Insurance Commissions
– Brokerage
commissions are recognized as income on settlement date. Insurance
commissions on loan products (credit life, mortgage life, accidental death, and
guaranteed auto protection) are recognized as income over the life of the
loan.
Stock Based Compensation –
Compensation cost is recognized for stock options issued to employees, based on
the fair value of these awards at the date of grant. A Black-Scholes model is
utilized to estimate the fair value of stock options. Compensation cost is
recognized over the required service period, generally defined as the vesting
period.
Income Taxes – Income tax
expense is the total of the current year income tax due or refundable and the
change in deferred tax assets and liabilities. Deferred tax assets
and liabilities are the expected future tax amounts for the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be
realized.
51
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES –
(Continued)
|
A tax
position is recognized as a benefit only if it is “more likely than not” that
the tax position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount
of tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the “more likely than not”
test, no tax benefit is recorded. We recognize interest and penalties
related to income tax matters in income tax expense.
Employee Stock Ownership Plan
– Compensation expense is based on the market price of shares as they are
committed to be released to participant accounts. Dividends on
allocated ESOP shares reduce retained earnings. Since the ESOP has
not acquired shares in advance of allocation to participant accounts, the plan
has no unallocated shares.
Earnings/(Loss) Per Common
Share – Basic earnings (loss) per common share is net income available to
common shareholders divided by the weighted average number of common shares
outstanding during the period. Diluted earnings per common share
include the dilutive effect of additional potential common shares issuable under
stock options. Earnings (loss) and dividends per share are restated
for all stock dividends through the date of issuance of the financial
statements.
Loss Contingencies – In the normal course of
business, there are various outstanding legal proceedings and
claims. In the opinion of management the disposition of such legal
proceedings and claims will not materially affect our consolidated financial
position, results of operations or liquidity.
Comprehensive Income/(Loss) –
Comprehensive income (loss) consists of net income (loss) and other
comprehensive income (loss). Other comprehensive income (loss)
includes unrealized gains and losses on securities available-for-sale and the
unrecognized loss on held-to-maturity securities for which an
other-than-temporary charge has been recorded, which are also recognized as a
separate component of equity, net of tax.
Loan Commitments and Related
Financial Instruments – Financial instruments include off-balance sheet
credit instruments, such as commitments to make loans and commercial letters of
credit, issued to meet customer financing needs. The face amount for
these items represents the exposure to loss, before considering customer
collateral or ability to repay. Such financial instruments are
recorded when they are funded.
Dividend Restriction – Banking
regulations require maintaining certain capital levels and may limit the
dividends paid by the bank to the holding company or by the holding company to
shareholders.
Fair Value of Financial Instruments
– Fair values of financial instruments are estimated using relevant
market information and other assumptions, as more fully disclosed in a separate
note. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments, and
other factors, especially in the absence of broad markets for particular
items. Changes in assumptions or in market conditions could
significantly affect the estimates.
Operating Segments – Segments
are parts of a company evaluated by management with separate financial
information. Our internal financial information is primarily reported
and evaluated in three lines of business, banking, mortgage banking, and
brokerage. These segments are dominated by banking at a magnitude for
which separate individual segment disclosures are not required.
Reclassifications – Some items
in the prior year financial statements were reclassified to conform to the
current presentation.
Adoption
of New Accounting Standards – In June 2009,
the FASB replaced The
Hierarchy of Generally Accepted Accounting Principles, with the FASB Accounting Standards
Codification™ (The Codification) as the source of authoritative
accounting principles recognized by the FASB to be applied by nongovernmental
entities in the preparation of financial statements in conformity with GAAP.
Rules and interpretive releases of the Securities and Exchange Commission under
authority of federal securities laws are also sources of authoritative GAAP for
SEC registrants. The Codification was effective for financial statements issued
for periods ending after September 15, 2009. The adoption of this guidance
for the reporting period ending September 30, 2009 did not have a material
effect on the Company's results of operations or financial position.
52
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES –
(Continued)
|
In early
April 2009, the FASB issued three staff positions related to fair value which
are discussed below:
|
§
|
FASB
ASC 820-10, Determining
Fair Value When the Volume and Level of Activity for the Asset or
Liability Have Significantly Decreased and Identifying Transactions That
are Not Orderly, provides additional guidance for estimating fair
value when the volume and level of activity for the asset or liability
have significantly decreased. This topic also includes guidance on
identifying circumstances that indicate a transaction is not orderly. This
standard emphasizes that even if there has been a significant decrease in
the volume and level of activity for the asset or liability and regardless
of the valuation technique(s) used, the objective of a fair value
measurement remains the same. Fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale) between
market participants at the measurement date under current market
conditions. This standard requires a reporting entity: (1) disclose
in interim and annual periods the inputs and valuation technique(s) used
to measure fair value and a discussion of changes in valuation techniques
and related inputs, if any, during the period, and (2) define major category for
equity securities and debt securities to be major security types.
This guidance is effective for interim reporting periods ending
after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. We early adopted this standard for
our first quarter ended March 31, 2009, but its adoption did not have a
material impact.
|
|
§
|
FASB
ASC 320-10-65, Recognition and Presentation
of Other-Than-Temporary Impairments, categorizes losses on debt
securities available-for-sale or held-to-maturity determined by management
to be other-than-temporarily impaired into losses due to credit issues and
losses related to all other factors. Other-than-temporary
impairment (OTTI) exists when it is more likely than not that the security
will mature or be sold before its amortized cost basis can be
recovered. An OTTI related to credit losses should be
recognized through earnings. An OTTI related to other factors
should be recognized in other comprehensive income. The
standard does not amend existing recognition and measurement guidance
related to other-than-temporary impairments of equity
securities. This guidance is effective for interim reporting
periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. We early adopted this standard
for our first quarter ended March 31, 2009. Previous
other-than-temporary impairment charges were recorded on equity securities
so there is no cumulative effect adjustment upon
adoption.
|
53
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES –
(Continued)
|
FASB ASC
820-10, Fair Value
Measurements, was issued in September 2006and provides guidance that
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. This guidance also
establishes a fair value hierarchy about the assumptions used to measure fair
value and clarifies assumptions about risk and the effect of a restriction on
the sale or use of an asset. This guidance was effective for fiscal
years beginning after November 15, 2007. In February 2008, the FASB
issued guidance that delayed the effective date of this fair value guidance for
all nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed at fair value on a recurring basis ( at least annually)
to fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years. The impact of adoption was not
material.
FASB ASC
805, Business Combinations,
was issued in December 2007. This statement establishes principles and
requirements for how the acquirer of a business recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any non-controlling interest in the acquire, including the recognition and
measurement of goodwill acquired in a business combination. This statement is
effective for business combinations where the acquisition date is on or after
fiscal years beginning after December 15, 2008. Adoption of this standard is
expected to have an impact on our accounting for any business combinations
closing on or after January 1, 2009.
Newly Issued But Not Yet Effective
Accounting Standards –FASB ASC 810, Accounting for Transfers of
Financial Assets, was issued in June 2009. This statement
amends and removes the concept of a qualifying special-purpose entity and limits
the circumstances in which a financial asset, or portion of a financial asset,
should be derecognized when the transferor has not transferred the entire
financial asset to an entity that is not consolidated with the transferor in the
financial statements being presented and/or when the transferor has continuing
involvement with the transferred financial asset. The new standard will become
effective for us on January 1, 2010. Adoption of this standard is not
expected to have a material impact.
SFAS
167, Amendments to FASB
Interpretation No. 46(R) (not yet integrated into the ASC), was also
issued in June 2009 and amends tests for variable interest entities to determine
whether a variable interest entity must be consolidated. This standard requires
an entity to perform an analysis to determine whether an entity’s variable
interest or interests give it a controlling financial interest in a variable
interest entity. This statement requires ongoing reassessments of whether an
entity is the primary beneficiary of a variable interest entity and enhanced
disclosures that provide more transparent information about an entity’s
involvement with a variable interest entity. The new standard will become
effective for us on January 1, 2010. Adoption of this standard is not
expected to have a material impact.
54
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
|
SECURITIES
|
The
amortized cost basis and fair values of securities are as follows:
Gross
|
Gross
|
|||||||||||||||
Amortized
|
Unrealized
|
Unrealized
|
||||||||||||||
(Dollars in thousands)
|
Cost
|
Gains
|
Losses
|
Fair Value
|
||||||||||||
Securities
available-for-sale:
|
||||||||||||||||
December
31, 2009:
|
||||||||||||||||
U.S.
Treasury and agencies
|
$ | 20,000 | $ | 80 | $ | - | $ | 20,080 | ||||||||
Government-sponsored
mortgage-backed residential
|
9,632 | 171 | (51 | ) | 9,752 | |||||||||||
Equity
|
933 | 60 | (3 | ) | 990 | |||||||||||
State
and municipal
|
14,604 | 399 | (110 | ) | 14,893 | |||||||||||
Trust
preferred securities
|
1,983 | - | (1,934 | ) | 49 | |||||||||||
Total
|
$ | 47,152 | $ | 710 | $ | (2,098 | ) | $ | 45,764 | |||||||
December
31, 2008:
|
||||||||||||||||
Government-sponsored
mortgage-backed residential
|
$ | 6,079 | $ | 70 | $ | (10 | ) | $ | 6,139 | |||||||
Equity
|
933 | 17 | (2 | ) | 948 | |||||||||||
State
and municipal
|
9,558 | 3 | (946 | ) | 8,615 | |||||||||||
Trust
preferred securities
|
2,732 | - | (2,659 | ) | 73 | |||||||||||
Total
|
$ | 19,302 | $ | 90 | $ | (3,617 | ) | $ | 15,775 | |||||||
Gross
|
Gross
|
|||||||||||||||
Amortized
|
Unrecognized
|
Unrecognized
|
||||||||||||||
Cost
|
Gains
|
Losses
|
Fair
Value
|
|||||||||||||
Securities
held-to-maturity:
|
||||||||||||||||
December
31, 2009:
|
||||||||||||||||
Government-sponsored
mortgage-backed residential
|
$ | 902 | $ | 6 | $ | - | $ | 908 | ||||||||
State
and municipal
|
245 | 3 | - | 248 | ||||||||||||
Trust
preferred securities
|
20 | - | - | 20 | ||||||||||||
Total
|
$ | 1,167 | $ | 9 | $ | - | $ | 1,176 | ||||||||
December
31, 2008:
|
||||||||||||||||
U.S.
Treasury and agencies
|
$ | 4,503 | $ | 54 | $ | - | $ | 4,557 | ||||||||
Government-sponsored
mortgage-backed residential
|
1,780 | - | (7 | ) | 1,773 | |||||||||||
State
and municipal
|
481 | 2 | - | 483 | ||||||||||||
Trust
preferred securities
|
258 | - | (225 | ) | 33 | |||||||||||
Total
|
$ | 7,022 | $ | 56 | $ | (232 | ) | $ | 6,846 |
The
amortized cost and fair value of securities at December 31, 2009, by contractual
maturity, are shown below. Securities not due at a single maturity
date, primarily mortgage-backed and equity securities, are shown
separately.
Available for Sale
|
Held-to-Maturity
|
|||||||||||||||
Amortized
|
Fair
|
Amortized
|
Fair
|
|||||||||||||
(Dollars in thousands)
|
Cost
|
Value
|
Cost
|
Value
|
||||||||||||
Due
in one year or less
|
$ | - | $ | - | $ | 245 | $ | 248 | ||||||||
Due
after one year through five years
|
20,115 | 20,196 | - | - | ||||||||||||
Due
after five years through ten years
|
932 | 920 | - | - | ||||||||||||
Due
after ten years
|
15,540 | 13,906 | 20 | 20 | ||||||||||||
Government-sponsored
mortgage-backed residential
|
9,632 | 9,752 | 902 | 908 | ||||||||||||
Equity
|
933 | 990 | - | - | ||||||||||||
$ | 47,152 | $ | 45,764 | $ | 1,167 | $ | 1,176 |
55
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
|
SECURITIES
– (Continued)
|
The
following schedule shows the proceeds from sales of available-for-sale
securities and the gross realized gains on those sales:
Year Ended December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Proceeds
from sales
|
$ | - | $ | 669 | $ | - | ||||||
Gross
realized gains
|
$ | - | $ | 55 | $ | - |
Tax
expense related to the realized gain for the year ended December 31, 2008 was
$19,000.
Investment
securities pledged to secure public deposits and FHLB advances had an amortized
cost of $28.6 million and fair value of $28.8 million at December 31, 2009 and a
$19.6 million amortized cost and a $18.8 fair value at December 31,
2008.
Securities
with unrealized losses at year-end 2009 and 2008 aggregated by major security
type and length of time in a continuous unrealized loss position are as
follows:
(Dollars in thousands)
|
Less than 12 Months
|
12 Months or More
|
Total
|
|||||||||||||||||||||
December 31, 2009
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||||||
Description of Securities
|
Value
|
Loss
|
Value
|
Loss
|
Value
|
Loss
|
||||||||||||||||||
Government-sponsored
mortgage-backed residential
|
$ | 5,141 | $ | (51 | ) | $ | - | $ | - | $ | 5,141 | $ | (51 | ) | ||||||||||
Equity
|
75 | (3 | ) | - | - | 75 | (3 | ) | ||||||||||||||||
State
and municipal
|
1,161 | (22 | ) | 2,456 | (88 | ) | 3,617 | (110 | ) | |||||||||||||||
Trust
preferred securities
|
- | - | 49 | (1,934 | ) | 49 | (1,934 | ) | ||||||||||||||||
Total
temporarily impaired
|
$ | 6,377 | $ | (76 | ) | $ | 2,505 | $ | (2,022 | ) | $ | 8,882 | $ | (2,098 | ) | |||||||||
Less
than 12 Months
|
12
Months or More
|
Total
|
||||||||||||||||||||||
December 31, 2008
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||||||
Description
of Securities
|
Value
|
Loss
|
Value
|
Loss
|
Value
|
Loss
|
||||||||||||||||||
Government-sponsored
mortgage-backed residential
|
$ | 3,944 | $ | (15 | ) | $ | 526 | $ | (2 | ) | $ | 4,470 | $ | (17 | ) | |||||||||
Equity
|
6 | (2 | ) | - | - | 6 | (2 | ) | ||||||||||||||||
State
and municipal
|
938 | (99 | ) | 7,450 | (847 | ) | 8,388 | (946 | ) | |||||||||||||||
Trust
preferred securities
|
106 | (2,884 | ) | - | - | 106 | (2,884 | ) | ||||||||||||||||
Total
temporarily impaired
|
$ | 4,994 | $ | (3,000 | ) | $ | 7,976 | $ | (849 | ) | $ | 12,970 | $ | (3,849 | ) |
We
evaluate investment securities with significant declines in fair value on a
quarterly basis to determine whether they should be considered
other-than-temporarily impaired under current accounting guidance, which
generally provides that if a security is in an unrealized loss position, whether
due to general market conditions or industry or issuer-specific factors, the
holder of the securities must assess whether the impairment is
other-than-temporary.
As
discussed in Note 1, in early April 2009, the FASB issued FASB ASC
320-10-65, Recognition and
Presentation of Other-Than-Temporary Impairments. Among other
provisions, the guidance requires entities to split other than temporary
impairment charges between credit losses (i.e., the loss based on the entity’s
estimate of the decrease in cash flows, including those that result from
expected voluntary prepayments), which are charged to earnings, and the
remainder of the impairment charge (non-credit component) to accumulated other
comprehensive income. This requirement pertains to both securities held to
maturity and securities available for sale.
56
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
|
SECURITIES
– (Continued)
|
The
unrealized losses on the state and municipal securities were caused primarily by
interest rate decreases. The contractual terms of those investments
do not permit the issuer to settle the securities at a price less than the
amortized cost of the investment. Because we do not have the intent
to sell these securities and it is likely that we will not be required to sell
the securities before their anticipated recovery, we do not consider these
investments to be other-than-temporarily impaired at December 31,
2009. We also considered the financial condition and near term
prospects of the issuer and identified no matters that would indicate less than
full recovery.
As
discussed in Note 4 - Fair Value, the fair value of our portfolio of trust
preferred securities, has decreased significantly as a result of the current
credit crisis and lack of liquidity in the financial markets. There
are limited trades in trust preferred securities and the majority of holders of
such instruments have elected not to participate in the market unless they are
required to sell as a result of liquidation, bankruptcy, or other forced or
distressed conditions.
To
determine if the five trust preferred securities were other than temporarily
impaired as of December 31, 2009, we used a discounted cash flow
analysis. The cash flow models were used to determine if the current
present value of the cash flows expected on each security were still equivalent
to the original cash flows projected on the security when
purchased. The cash flow analysis takes into consideration
assumptions for prepayments, defaults and deferrals for the underlying pool of
banks, insurance companies and REITs.
Management
works with independent third parties to identify its best estimate of the cash
flow estimated to be collected. If this estimate results in a present value of
expected cash flows that is less than the amortized cost basis of a security
(that is, credit loss exists), an OTTI is considered to have occurred. If there
is no credit loss, any impairment is considered temporary. The cash flow
analysis we performed included the following general assumptions:
|
·
|
We
assume default rates on individual entities behind the pools based on
Fitch ratings for financial institutions and A.M. Best ratings for
insurance companies. These ratings are used to predict the
default rates for the next several quarters. Two of the trust
preferred securities hold a limited number of real estate investment
trusts (REITs) in their pools. REITs are evaluated on an
individual basis to predict future default
rates.
|
|
·
|
We
assume that annual defaults for the remaining life of each security will
be 37.5 basis points.
|
|
·
|
We
assume a recovery rate of 15% on deferrals after two
years.
|
|
·
|
We
assume 2% prepayments through the five year par call and then 2% per annum
for the remaining life of the
security.
|
|
·
|
Our
securities have been modeled using the above assumptions by FTN Financial
using the forward LIBOR curve plus original spread to discount projected
cash flows to present values.
|
Additionally,
in making our determination, we considered all available market information that
could be obtained without undue cost and effort, and considered the unique
characteristics of each trust preferred security individually by assessing the
available market information and the various risks associated with that security
including:
|
·
|
Valuation
estimates provided by our investment
broker;
|
|
·
|
The
amount of fair value decline;
|
|
·
|
How
long the decline in fair value has
existed;
|
|
·
|
Significant
rating agency changes on the
issuer;
|
|
·
|
Level
of interest rates and any movement in pricing for credit and other
risks;
|
|
·
|
Information
about the performance of the underlying institutions that issued the debt
instruments, such as net income, return on equity, capital adequacy,
non-performing assets, Texas ratios,
etc;
|
|
·
|
Our
intent to sell the security or whether it is more likely than not that we
will be required to sell the security before its anticipated recovery;
and
|
|
·
|
Other
relevant observable inputs.
|
57
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
|
SECURITIES
– (Continued)
|
The following table details the
five debt securities with other-than-temporary impairment at December 31, 2009
and the related credit losses recognized in earnings:
Moody's
|
% of Current
|
||||||||||||||||||||||||||||||
Credit
|
Current
|
Current
|
Deferrals and
|
||||||||||||||||||||||||||||
Ratings
|
Moody's
|
Estimated
|
Deferrals
|
Defaults
|
|||||||||||||||||||||||||||
(Dollars in thousands)
|
When
|
Credit
|
Par
|
Book
|
Fair
|
and
|
to Current
|
OTTI
|
|||||||||||||||||||||||
Security
|
Tranche
|
Purchased
|
Ratings
|
Value
|
Value
|
Value
|
Defaults
|
Collateral
|
Recognized
|
||||||||||||||||||||||
Preferred
Term Securities IV
|
Mezzanine
|
A3
|
Ca
|
$ | 244 | $ | 199 | $ | 24 | $ | 18,000 | 27 | % | $ | 44 | ||||||||||||||||
Preferred
Term Securities VI
|
Mezzanine
|
A1
|
|
Caa1
|
259 | 20 | 20 | 28,000 | 69 | % | 31 | ||||||||||||||||||||
Preferred
Term Securities XV B1
|
Mezzanine
|
A2
|
Ca
|
1,004 | 822 | 15 | 141,050 | 24 | % | 192 | |||||||||||||||||||||
Preferred
Term Securities XXI C2
|
Mezzanine
|
A3
|
Ca
|
1,018 | 582 | 6 | 197,500 | 26 | % | 469 | |||||||||||||||||||||
Preferred
Term Securities XXII C1
|
Mezzanine
|
A3
|
Ca
|
503 | 380 | 4 | 339,500 | 25 | % | 126 | |||||||||||||||||||||
Total
|
$ | 3,028 | $ | 2,003 | $ | 69 | $ | 862 |
The table
below presents a rollforward of the credit losses recognized in earnings for the
period ended December 31, 2009:
(Dollars
in thousands)
|
||||
Beginning
balance January 1, 2009
|
$ | - | ||
Additions
for amounts related to credit loss for which an other-than-temporary
impairment was not previously recognized
|
862 | |||
Reductions
for amounts realized for securities sold during the period
|
- | |||
Reductions
for 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 fo amortized cost basis
|
- | |||
Reductions
for increase in cash flows expected to be collected that are recognized
over the remaining life of the security
|
- | |||
Ending
balance December 31, 2009
|
$ | 862 |
3.
|
LOANS
|
Loans are
summarized as follows:
December 31,
|
||||||||
(Dollars in thousands)
|
2009
|
2008
|
||||||
Commercial
|
$ | 62,940 | $ | 56,863 | ||||
Real
estate commercial
|
627,788 | 563,314 | ||||||
Real
estate construction
|
14,567 | 17,387 | ||||||
Residential
mortgage
|
178,985 | 165,337 | ||||||
Consumer
and home equity
|
74,844 | 69,649 | ||||||
Indirect
consumer
|
36,628 | 31,754 | ||||||
Loans
held for sale
|
8,183 | 9,567 | ||||||
1,003,935 | 913,871 | |||||||
Less:
|
||||||||
Net
deferred loan origination fees
|
(826 | ) | (870 | ) | ||||
Allowance
for loan losses
|
(17,719 | ) | (13,565 | ) | ||||
(18,545 | ) | (14,435 | ) | |||||
Net
Loans
|
$ | 985,390 | $ | 899,436 |
We
utilize eligible real estate loans to collateralize advances and letters of
credit from the Federal Home Loan Bank. We had $553 million
and $515 million in
residential mortgage, commercial real estate, multi-family and open end home
equity loans pledged under this arrangement at December 31, 2009 and
2008.
58
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
3.
|
LOANS
– (Continued)
|
The
allowance for loan loss is summarized as follows:
As of and For the
|
||||||||||||
Years Ended December 31,
|
||||||||||||
(Dollars in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Balance,
beginning of year
|
$ | 13,565 | $ | 7,922 | $ | 7,684 | ||||||
Allowance
related to acquisition
|
- | 327 | - | |||||||||
Provision
for loan losses
|
9,524 | 5,947 | 1,209 | |||||||||
Charge-offs
|
(5,626 | ) | (894 | ) | (1,210 | ) | ||||||
Recoveries
|
256 | 263 | 239 | |||||||||
Balance,
end of year
|
$ | 17,719 | $ | 13,565 | $ | 7,922 |
Impaired
loans are summarized below. There were no impaired loans for the
periods presented without an allowance allocation.
As
of and For the
|
||||||||||||
Years
Ended December 31,
|
||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Year-end
impaired loans
|
$ | 37,998 | $ | 16,769 | $ | 8,889 | ||||||
Amount
of allowance for loan loss allocated
|
4,111 | 3,090 | 117 | |||||||||
Average
impaired loans outstanding
|
27,490 | 11,746 | 6,970 | |||||||||
Interest
income recognized
|
211 | 75 | 188 | |||||||||
Interest
income received
|
211 | 75 | 188 |
We report
non-performing loans as impaired. Our non-performing loans at
year-end were as follows:
December 31,
|
||||||||
(Dollars
in thousands)
|
2009
|
2008
|
||||||
Restructured
|
$ | 9,812 | $ | 1,182 | ||||
Loans
past due over 90 days still on accrual
|
- | - | ||||||
Non
accrual loans
|
28,186 | 15,587 | ||||||
Total
|
$ | 37,998 | $ | 16,769 |
We have
allocated $493,000 of specific reserves to customers whose loan terms have been
modified in troubled debt restructurings as of December 31, 2009. We
are not committed to lend additional funds to debtors whose loans have been
modified in a troubled debt restructuring.
4.
|
FAIR
VALUE
|
U.S. GAAP
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at
the measurement date and establishes a fair value hierarchy that prioritizes the
use of inputs used in valuation methodologies into the following three
levels:
Level 1: Quoted prices
(unadjusted) for identical assets or liabilities in active markets. A
quoted price in an active market provides the most reliable evidence of fair
value and shall be used to measure fair value whenever available.
Level 2: Significant other
observable inputs other than Level 1 prices such as quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market
data.
Level 3: Significant
unobservable inputs that reflect a reporting entity’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.
59
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
4.
|
FAIR
VALUE - (Continued)
|
We used
the following methods and significant assumptions to estimate the fair value of
available-for-sale-securities.
Available-for-sale
securities: The fair values of most equity securities are determined by
obtaining quoted prices on nationally recognized securities exchanges (Level 1
inputs). The fair values of most debt securities are determined by a
matrix pricing, which is a mathematical technique widely used in the industry to
value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities’ relationship to
other benchmark quoted securities (Level 2 inputs). In certain cases
where there is limited activity or less transparency around inputs to the
valuation, securities are classified within (Level 3) of the valuation
hierarchy. Discounted cash flows are calculated using spread to swap
and LIBOR curves that are updated to incorporate loss severities, volatility,
credit spread and optionality. Rating agency and industry research
reports as well as defaults and deferrals on individual securities are reviewed
and incorporated into the calculations.
Assets and Liabilities
Measured at Fair Value on a Recurring Basis
Assets
measured at fair value on a recurring basis are summarized below:
Quoted Prices in
|
||||||||||||||||
Active Markets for
|
Significant Other
|
Significant
|
||||||||||||||
December 31,
|
Identical Assets
|
Observable Inputs
|
Unobservable Inputs
|
|||||||||||||
(Dollars in thousands)
|
2009
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Assets:
|
||||||||||||||||
U.S.
Treasury and agencies
|
$ | 20,080 | $ | - | $ | 20,080 | $ | - | ||||||||
Government-sponsored
mortgage-backed residential
|
9,752 | - | 9,752 | - | ||||||||||||
Equity
|
990 | 699 | - | 291 | ||||||||||||
State
and municipal
|
14,893 | - | 14,893 | - | ||||||||||||
Trust
preferred securities
|
49 | - | - | 49 | ||||||||||||
Total
|
$ | 45,764 | $ | 699 | $ | 44,725 | $ | 340 |
Quoted Prices in
|
||||||||||||||||
Active Markets for
|
Significant Other
|
Significant
|
||||||||||||||
December 31,
|
Identical Assets
|
Observable Inputs
|
Unobservable Inputs
|
|||||||||||||
(Dollars in thousands)
|
2008
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Assets:
|
||||||||||||||||
Government-sponsored
mortgage-backed residential
|
$ | 6,139 | $ | - | $ | 6,139 | $ | - | ||||||||
Equity
|
948 | 657 | - | 291 | ||||||||||||
State
and municipal
|
8,615 | - | 8,615 | - | ||||||||||||
Trust
preferred securities
|
73 | - | - | 73 | ||||||||||||
Total
|
$ | 15,775 | $ | 657 | $ | 14,754 | $ | 364 |
Between
June 2002 and July 2006, we invested in four AFS and one HTM investment grade
tranches of trust preferred collateralized debt obligation (“CDO”)
securities. The securities were issued and are referred to as
Preferred Term Securities Limited (“PreTSL”). The underlying
collateral for the PreTSL is unguaranteed pooled trust preferred securities
issued by banks, insurance companies and REITs geographically dispersed across
the United States. We hold five PreTSL securities, none of which are
currently investment grade. Prior to September 30, 2008, we
determined the fair value of the trust preferred securities using a valuation
technique based on Level 2 inputs. The Level 2 inputs included
estimates of the market value for each security provided through our investment
broker.
Since
late 2007, the markets for collateralized debt obligations and trust preferred
securities have become increasingly inactive. The inactivity was
first evidenced in late 2007 when new issues of similar securities were
discounted in order to complete the offering. Beginning in the second
quarter of 2008, the purchase and sale activity of these securities
substantially decreased as investors elected to hold the securities instead of
selling them at substantially depressed prices. Our brokers have
indicated that little if any activity is occurring in this sector and that the
PreTSL securities trades that are taking place are primarily distressed sales
where the seller must liquidate as a result of insolvency, redemptions or
closure of a fund holding the security, or other distressed
conditions. As a result, the bid-ask spreads have widened
significantly and the volume of trades decreased significantly compared to
historical volumes.
60
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
4.
|
FAIR
VALUE - (Continued)
|
During
2008, we determined that the market for the trust preferred securities that we
hold and for similar CDO securities (such as higher-rated tranches within the
same CDO security) are also not active. That determination was made
considering that there are few observable transactions for the trust preferred
securities or similar CDO securities and the observable prices for those
transactions have varied substantially over time. Consequently, we
have considered those observable inputs and determined that our trust preferred
securities are classified within Level 3 of the fair value
hierarchy.
We have
determined that an income approach valuation technique (using cash flows and
present value techniques) that maximizes the use of relevant observable inputs
and minimizes the use of unobservable inputs is equally or more representative
of fair value than relying on the estimation of market value technique used at
prior measurement dates, which now has few observable inputs and relies on an
inactive market with distressed sales conditions that would require significant
adjustments.
We
received valuation estimates on our trust preferred securities for December 31,
2009. Those valuation estimates were based on proprietary pricing
models utilizing significant unobservable inputs in an inactive market with
distressed sales, Level 3 inputs, rather than actual transactions in an active
market.
In
accordance with current accounting guidance, we determined that a risk-adjusted
discount rate appropriately reflects the reporting entity’s estimate of the
assumptions that market participants would use in an active market to estimate
the selling price of the asset at the measurement date. The
risk-adjusted discount rates used in the proprietary pricing models ranged from
5.7% to 6.4%.
We
conduct a thorough review of fair value hierarchy classifications on a quarterly
basis. Reclassification of certain financial instruments may occur
when input observability changes.
The table
below presents 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) for the periods ended December 31,
2009 and 2008:
Fair Value Measurements
|
||||||||
Using Significant
|
||||||||
Unobservable Inputs
|
||||||||
(Level 3)
|
||||||||
Year Ended
|
||||||||
December 31,
|
||||||||
(Dollars in thousands)
|
2009
|
2008
|
||||||
Beginning
balance
|
$ | 364 | $ | - | ||||
Total
gains or losses:
|
||||||||
Impairment
charges on securities
|
(831 | ) | (349 | ) | ||||
Included
in other comprehensive income
|
807 | - | ||||||
Transfers
in and/or out of Level 3
|
- | 713 | ||||||
Ending
balance
|
$ | 340 | $ | 364 |
61
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
4. FAIR
VALUE - (Continued)
Assets and Liabilities
Measured at Fair Value on a Nonrecurring Basis
Assets
measured at fair value on a nonrecurring basis as of December 31, 2009 are
summarized below:
Quoted Prices in
|
||||||||||||||||
Active Markets for
|
Significant Other
|
Significant
|
||||||||||||||
December 31,
|
Identical Assets
|
Observable Inputs
|
Unobservable Inputs
|
|||||||||||||
(Dollars in thousands)
|
2009
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Assets:
|
||||||||||||||||
Impaired
loans
|
$ | 33,887 | $ | - | $ | - | $ | 33,887 | ||||||||
Real
estate acquired through foreclosure
|
8,428 | - | - | 8,428 | ||||||||||||
Trust
preferred security held-to-maturity
|
20 | - | - | 20 |
Quoted Prices in
|
||||||||||||||||
Active Markets for
|
Significant Other
|
Significant
|
||||||||||||||
December 31,
|
Identical Assets
|
Observable Inputs
|
Unobservable Inputs
|
|||||||||||||
(Dollars in thousands)
|
2008
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Assets:
|
||||||||||||||||
Impaired
loans
|
$ | 13,679 | $ | - | $ | - | $ | 13,679 |
Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $38.0 million, with a
valuation allowance of $4.1 million, resulting in an additional provision for
loan losses of $3.1 million for the 2009 period. Values for
collateral dependent loans are generally based on appraisals obtained from
licensed real estate appraisals and in certain circumstances consideration of
offers obtained to purchase properties prior to
foreclosure. Appraisals for commercial real estate generally use
three methods to derive value: cost, sales or market comparison and income
approach. The cost method bases value on the estimated cost to
replace the current property after considering adjustments for
depreciation. Values of the market comparison approach evaluate the
sales price of similar properties in the same market area. The income
approach considers net operating income generated by the property and an
investors required return. The final value is a reconciliation of
these three approaches and takes into consideration any other factors management
deems relevant to arrive at a representative fair value.
Real
estate owned acquired through foreclosure is recorded at fair value less
estimated selling costs at the date of foreclosure. Fair value is
based on the appraised market value of the property based on sales of similar
assets. The fair value may be subsequently reduced if the estimated
fair value declines below the original appraised value. Fair value adjustments
of $578,000 were made to real estate owned during the period ended December 31,
2009.
Trust
preferred securities which are held-to-maturity are valued using an income
approach valuation technique (using cash flows and present value techniques)
that maximizes the use of relevant observable inputs and minimizes the use of
unobservable inputs. The income approach is equally or more representative of
fair value than relying on the estimation of market value technique used at
prior measurement dates, which now has few observable inputs and relies on an
inactive market with distressed sales conditions that would require significant
adjustments.
We
received valuation estimates on our trust preferred security for December 31,
2009. Those valuation estimates were based on proprietary pricing
models utilizing significant unobservable inputs in an inactive market with
distressed sales, Level 3 inputs, rather than actual transactions in an active
market.
62
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
4.
|
FAIR
VALUE - (Continued)
|
Fair Value of Financial
Instruments
The
estimated fair value of financial instruments not previously presented is as
follows:
|
December 31, 2009
|
December 31, 2008
|
||||||||||||||
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||||||||||
(Dollars in thousands)
|
Value
|
Value
|
Value
|
Value
|
||||||||||||
Financial
assets:
|
||||||||||||||||
Cash
and due from banks
|
$ | 98,533 | $ | 98,533 | $ | 20,905 | $ | 20,905 | ||||||||
Securities
held-to-maturity
|
1,147 | 1,156 | 7,022 | 6,846 | ||||||||||||
Loans
held for sale
|
8,183 | 8,257 | 9,567 | 9,702 | ||||||||||||
Loans,
net
|
977,207 | 982,584 | 889,869 | 925,817 | ||||||||||||
Accrued
interest receivable
|
5,658 | 5,658 | 4,379 | 4,379 | ||||||||||||
FHLB
stock
|
8,515 | N/A | 8,515 | N/A | ||||||||||||
Financial
liabilities:
|
||||||||||||||||
Deposits
|
1,049,815 | 1,042,957 | 775,399 | 777,743 | ||||||||||||
Short-term
borrowings
|
1,500 | 1,500 | 94,869 | 94,869 | ||||||||||||
Advances
from Federal Home Loan Bank
|
52,745 | 55,856 | 52,947 | 57,757 | ||||||||||||
Subordinated
debentures
|
18,000 | 12,743 | 18,000 | 12,804 | ||||||||||||
Accrued
interest payable
|
360 | 360 | 288 | 288 |
The
methods and assumptions used in estimating fair value disclosures for financial
instruments are presented below:
Carrying
amount is the estimated fair value for cash and cash equivalents, interest
bearing deposits, accrued interest receivable and payable, demand deposits,
short-term debt and variable rate loans or deposits that re-price frequently and
fully. Held-to-maturity securities fair values are based on market
prices or dealer quotes and if no such information is available, on the rate and
term of the security and information about the issuer. The value of
loans held for sale is based on the underlying sale commitments. For
fixed rate loans or deposits and for variable rate loans or deposits with
infrequent reprising or reprising limits, fair value is based on discounted cash
flows using current market rates applied to the estimated life. Fair
values of advances from Federal Home Loan Bank and subordinated debentures are
based on current rates for similar financing. The fair value of
off-balance-sheet items is based on the current fees or cost that would be
charged to enter into or terminate such arrangements and is not
material. It is not practicable to determine the fair value of FHLB
stock due to restrictions placed on its transferability.
63
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
5.
|
PREMISES
AND EQUIPMENT
|
Premises
and equipment consist of the following:
December 31,
|
||||||||
(Dollars in thousands)
|
2009
|
2008
|
||||||
Land
|
$ | 7,598 | $ | 7,623 | ||||
Buildings
|
27,020 | 23,879 | ||||||
Furniture,
fixtures and equipment
|
11,976 | 11,560 | ||||||
46,594 | 43,062 | |||||||
Less
accumulated depreciation
|
(14,629 | ) | (12,994 | ) | ||||
$ | 31,965 | $ | 30,068 |
Certain
premises are leased under various operating leases. Rental expense
was $751,000, $432,000 and $370,000, for the years ended December 31, 2009, 2008
and 2007, respectively. Future minimum commitments under these leases
are:
Year
Ended
|
||||
(Dollars
in thousands)
|
December 31,
|
|||
2010
|
$ | 578 | ||
2011
|
528 | |||
2012
|
428 | |||
2013
|
296 | |||
2014
|
274 | |||
Thereafter
|
3,925 | |||
$ | 6,029 |
6.
|
GOODWILL
AND INTANGIBLE ASSETS
|
The
change in the balance of goodwill is as follows.
December 31,
|
||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Beginning
of year
|
$ | 11,931 | $ | 8,384 | $ | 8,384 | ||||||
Acquisition
of FSB Bancshares, Inc.
|
- | 3,547 | - | |||||||||
Goodwill
impairment
|
(11,931 | ) | - | - | ||||||||
End
of year
|
$ | - | $ | 11,931 | $ | 8,384 |
Impairment
exists when a reporting unit’s carrying value of goodwill exceeds its fair
value, which is determined through a two-step impairment test. Step 1
includes the determination of the carrying value of our single reporting unit,
including the existing goodwill and intangible assets, and estimating the fair
value of the reporting unit. We determined the fair value of our
reporting unit and compared it to its carrying amount. If the
carrying amount of a reporting unit exceeds its fair value, we are required to
perform a second step to the impairment test.
Our
annual impairment analysis as of December 31, 2009, indicated that the Step 2
analysis was necessary. Step 2 of the goodwill impairment test is
performed to measure the impairment loss. Step 2 requires that the
implied fair value of the reporting unit goodwill be compared to the carrying
amount of that goodwill. If the carrying amount of the reporting unit
goodwill exceeds the implied fair value of that goodwill, an impairment loss
shall be recognized in an amount equal to that excess. After
performing Step 2 it was determined that the implied value of goodwill was less
than the carrying costs, resulting in an impairment charge of $11.9
million.
64
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
6.
|
GOODWILL
AND INTANGIBLE ASSETS - (Continued)
|
Acquired
intangible assets were as follows at year end:
|
December 31, 2009
|
December 31, 2008
|
||||||||||||||
Gross
|
Gross
|
|||||||||||||||
Carrying
|
Accumulated
|
Carrying
|
Accumulated
|
|||||||||||||
(Dollars in thousands) |
Amount
|
Amortization
|
Amount
|
Amortization
|
||||||||||||
Amortized
intangible assets:
|
||||||||||||||||
Core
deposit intangibles
|
$ | 1,910 | $ | 610 | $ | 1,910 | $ | 207 | ||||||||
Other
customer relationship intangibles
|
669 | 184 | 669 | 77 | ||||||||||||
$ | 2,579 | $ | 794 | $ | 2,579 | $ | 284 |
Aggregate amortization expense was
$510,000, 284,000 and $0 for 2009, 2008 and 2007.
Estimated amortization expense for each
of the next five years:
Year
Ended
|
||||
(Dollars
in thousands)
|
December 31,
|
|||
2010
|
$ | 421 | ||
2011
|
370 | |||
2012
|
322 | |||
2013
|
277 | |||
2014
|
145 | |||
$ | 1,535 |
7.
|
DEPOSITS
|
Time
Deposits of $100,000 or more were $326.8 million and $211.9 million at December
31, 2009 and 2008, respectively. At December 31, 2009, scheduled
maturities of time deposits are as follows:
(Dollars
in thousands)
|
Amount
|
|||
2010
|
$ | 388,177 | ||
2011
|
126,812 | |||
2012
|
62,705 | |||
2013
|
9,375 | |||
2014
|
7,489 | |||
Thereafter
|
14,702 | |||
$ | 609,260 |
8.
|
SHORT-TERM
BORROWINGS
|
Short-term
borrowings consist of a borrowing against a line of credit with a correspondent
bank for 2009 and primarily federal funds purchased from the FHLB of Cincinnati
and two correspondent banks for 2008. We had short-term borrowings of
$1.5 million at December 31, 2009 and $94.9 million at December 31,
2008. These borrowings averaged a rate of .30% and 2.02% for 2009 and
2008.
9.
|
ADVANCES
FROM FEDERAL HOME LOAN BANK
|
Under the
collateral requirements of the Federal Home Loan Bank (FHLB) of Cincinnati, we
have the capacity to borrow an additional $71.1 million from the FHLB at
December 31, 2009. Our convertible fixed rate advances are fixed for
periods ranging from one to three years. At the end of the fixed
rate term and quarterly thereafter, the FHLB has the right to convert these
advances to variable rate advances tied to the three-month LIBOR
index. Upon conversion, we can prepay the advances at no
penalty.
65
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
9.
|
ADVANCES
FROM FEDERAL HOME LOAN BANK -
(Continued)
|
Advances
from the FHLB at year-end are as follows:
December 31,
|
||||||||||||||||
2009
|
2008
|
|||||||||||||||
Weighted-
|
Weighted-
|
|||||||||||||||
(Dollars
in Thousands)
|
Average
|
Average
|
||||||||||||||
Rate
|
Amount
|
Rate
|
Amount
|
|||||||||||||
Fixed
rate advances:
|
||||||||||||||||
Mortgage
matched advances with interest rates from 5.75% to 7.45% due through
2009
|
- | % | $ | - | 6.28 | % | $ | 1 | ||||||||
Convertible
fixed rate advances with interest rates from 3.99% to 5.05% due through
2017
|
4.55 | % | 50,000 | 4.55 | % | 50,000 | ||||||||||
Other
fixed rate advances with interest rates from 4.19% to 5.72% due through
2020
|
4.92 | % | 2,745 | 4.94 | % | 2,946 | ||||||||||
Total
borrowings
|
$ | 52,745 | $ | 52,947 |
The
aggregate minimum annual repayments of borrowings as of December 31, 2009 are as
follows:
(Dollars
in thousands)
|
||||
2010
|
$ | 140 | ||
2011
|
25,130 | |||
2012
|
130 | |||
2013
|
131 | |||
2014
|
10,204 | |||
Thereafter
|
17,010 | |||
$ | 52,745 |
10.
|
HOLDING
COMPANY LOAN AGREEMENT
|
The
Corporation maintains a loan agreement with a correspondent bank. As
of December 31, 2009, the outstanding balance of this loan was $1.5
million. During January 2010, the Corporation paid down the
outstanding loan balance by $500,000. The loan matures on January 31,
2011 and principal and interest of $ 86,000 is due monthly at a rate of prime
plus one percent with a floor of 6.00%.
11.
|
SUBORDINATED
DEBENTURES
|
In 2008,
First Federal Statutory Trust III, an unconsolidated trust subsidiary of First
Financial Service Corporation, issued $8.0 million in trust preferred
securities. The trust loaned the proceeds of the offering to us in
exchange for junior subordinated deferrable interest debentures which we used to
finance the purchase of FSB Bancshares, Inc. The subordinated debentures, which
mature on June 24, 2038, can be called at par in whole or in part on or after
June 24, 2018. The subordinated debentures pay a fixed rate of 8% for thirty
years. We have the option to defer interest payments on the
subordinated debt from time to time for a period not to exceed five consecutive
years. The subordinated debentures are considered as Tier I capital
for the Corporation under current regulatory guidelines.
A
different trust subsidiary issued 30 year cumulative trust preferred securities
totaling $10 million at a 10 year fixed rate of 6.69% adjusting quarterly
thereafter at LIBOR plus 160 basis points. The subordinated
debentures, which mature March 22, 2037, can be called at par in whole or in
part on or after March 15, 2017. We have the option to defer interest
payments on the subordinated debt from time to time for a period not to exceed
five consecutive years. The subordinated debentures are considered as Tier I
capital for the Corporation under current regulatory guidelines.
Our trust
subsidiaries loaned the proceeds of their offerings of trust preferred
securities to us in exchange for junior subordinated deferrable interest
debentures. In accordance with current accounting guidance, these trusts are not
consolidated with our financial statements but rather the subordinated
debentures are shown as a liability.
66
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
12.
|
PREFERRED
STOCK
|
The CPP
is voluntary and requires a participating institution to comply with a number of
restrictions and provisions, including standards for executive compensation and
corporate governance and limitations on share repurchases and the declaration
and payment of dividends on common shares. The standard terms of the CPP require
that a participating financial institution limit the payment of dividends to the
most recent quarterly amount prior to October 14, 2008, which is $0.19 per
share in our case. This dividend limitation will remain in effect until the
earlier of three years or such time that the preferred shares are
redeemed.
Eligible
financial institutions could generally apply to issue senior preferred shares to
the U.S. Treasury in aggregate amounts ranging from 1% to 3% of the
institution’s risk-weighted assets. We applied for an investment by the U.S.
Treasury of $20 million, which was approved by the U.S. Treasury on
December 8, 2008. On January 9, 2009, we issued $20 million
of cumulative perpetual preferred shares, with a liquidation preference of
$1,000 per share (the “Senior Preferred Shares”). The Senior Preferred Shares
constitute Tier 1 capital and rank senior to our common shares. The Senior
Preferred Shares pay cumulative dividends quarterly at a rate of 5% per annum
for the first five years and will reset to a rate of 9% per annum after five
years. The Senior Preferred Shares may be redeemed at any time, at our option.
We also have the ability to defer dividend payments at any time, at our
option.
We also
issued a warrant to purchase 215,983 common shares to the U.S. Treasury at a
purchase price of $13.89 per share. The aggregate purchase price equals 15% of
the aggregate amount of the Senior Preferred Shares purchased by the U.S.
Treasury or $3 million. The initial purchase price per share for the warrant and
the number of common shares subject to the warrant were determined by reference
to the market price of the common shares (calculated on a 20-day trailing
average) on December 8, 2008, the date the U.S. Treasury approved our TARP
application. The warrant has a term of 10 years and is potentially dilutive
to earnings per share.
On
February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”)
was enacted. As required by ARRA, the U.S. Treasury has issued additional
compensation standards on companies receiving financial assistance from the U.S.
government. In addition, ARRA imposes certain new executive compensation and
corporate expenditure limits on each current and future CPP recipient, including
First Financial Service Corporation, until the recipient has repaid the
Treasury. ARRA also permits CPP participants to redeem the preferred
shares held by the Treasury Department without penalty and without the need to
raise new capital, subject to the Treasury’s consultation with the recipient’s
appropriate regulatory agency.
13.
|
INCOME
TAXES
|
We file a
consolidated federal income tax return and income tax is apportioned among all
companies based on their taxable income or loss. Provision for income
taxes is as follows:
Year
Ended December 31,
|
||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Current
|
$ | 2,876 | $ | 3,615 | $ | 4,591 | ||||||
Deferred
|
(4,025 | ) | (1,431 | ) | 55 | |||||||
Total
income tax expense/(benefit)
|
$ | (1,149 | ) | $ | 2,184 | $ | 4,646 |
67
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
13.
|
INCOME
TAXES– (Continued)
|
The
provision for income taxes differs from the amount computed at the statutory
rates as follows:
|
Year
Ended December 31,
|
|||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Federal
statutory rate
|
34.0 | % | 34.0 | % | 34.0 | % | ||||||
Goodwill
impairment
|
(23.2 | ) | - | - | ||||||||
Tax-exempt
interest income
|
2.2 | (1.9 | ) | (1.0 | ) | |||||||
Increase
in cash surrender
|
||||||||||||
value
of life insurance
|
1.5 | (1.8 | ) | (0.8 | ) | |||||||
Dividends
to ESOP
|
0.3 | (0.6 | ) | (0.3 | ) | |||||||
Stock
option expense
|
(0.5 | ) | 0.6 | 0.3 | ||||||||
Effect
of state tax
|
||||||||||||
expense
recorded
|
0.2 | 0.7 | 0.7 | |||||||||
Other
|
0.1 | 0.3 | 0.3 | |||||||||
Effective
rate
|
14.6 | % | 31.3 | % | 33.2 | % |
Temporary
differences between the financial statement carrying amounts and tax bases of
assets and liabilities that give rise to significant portions of deferred income
taxes relate to the following:
December
31,
|
||||||||
(Dollars
in thousands)
|
2009
|
2008
|
||||||
Deferred
tax assets:
|
||||||||
Allowance
for loan losses
|
$ | 6,024 | $ | 4,612 | ||||
Intangibles
and fair value adjustments
|
348 | - | ||||||
Net
unrealized loss on securities available-for-sale
|
547 | 1,204 | ||||||
Other
than temporary impairment
|
469 | 176 | ||||||
Prepaid
retirement benefits
|
179 | 98 | ||||||
Writedowns
of real estate owned
|
205 | 55 | ||||||
Nonaccrual
loan interest
|
580 | 287 | ||||||
Accrued
liabilities and other
|
150 | 234 | ||||||
8,502 | 6,666 | |||||||
Deferred
tax liabilities:
|
||||||||
Depreciation
|
$ | 2,056 | $ | 1,871 | ||||
Federal
Home Loan Bank stock
|
1,554 | 1,554 | ||||||
Intangibles
and fair value adjustments
|
- | 1,796 | ||||||
Deferred
gain on like-kind exchange
|
8 | 8 | ||||||
Other
|
369 | 290 | ||||||
3,987 | 5,519 | |||||||
Net
deferred tax assets
|
$ | 4,515 | $ | 1,147 |
Federal
income tax laws provided savings banks with additional bad debt deductions
through 1987, totaling $9.3 million for us. Accounting standards do
not require a deferred tax liability to be recorded on this amount, which would
otherwise total $3.2 million at December 31, 2009 and 2008. If we
were liquidated or otherwise ceased to be a bank or if tax laws were to change,
the $3.2 million would be recorded as a liability with an offset to
expense.
After
adopting the provisions of ASC 740 in 2007, we recorded $99,000 for uncertain
tax positions which included $138,000 of state income tax expense, $12,000 of
interest, and federal benefit of $51,000. During 2007, we identified that we
were subject to state income tax in a contiguous state under ASC
740. We had $150,000 of gross unrecognized tax
benefits. In 2008, we filed a voluntary disclosure agreement with the
state in which lending activities have occurred and in 2009 filed the
appropriate tax returns. This reversed the entire reserve
recorded. No other accruals for uncertain tax positions were recorded
in 2009. Should the accrual of any interest or penalties relative to
unrecognized tax benefits be necessary, it is our policy to record such accruals
in our income tax accounts; $0 interest was accrued at December 31, 2009 and $
12,000 was accrued at December 31, 2008. We file a consolidated U.S.
federal income tax return and the Company files income tax returns in Kentucky,
Indiana and Tennessee. The Bank is subject to federal income tax and
state income tax in Indiana and Tennessee. These returns are subject
to examination by taxing authorities for all years after 2005.
68
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
14.
|
STOCKHOLDERS’
EQUITY
|
|
(a)
|
Regulatory Capital Requirements
–The Corporation and the Bank are subject to regulatory capital
requirements administered by federal banking agencies. Capital
adequacy guidelines and, additionally for banks, prompt corrective action
regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject
to qualitative judgments by regulators. Failure to meet capital
requirements can initiate regulatory action. Management
believes as of December 31, 2009, the Corporation and Bank met all capital
adequacy requirements to which they are
subject.
|
|
Prompt
corrective action regulations provide five classifications: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms
are not used to represent overall financial condition. If
adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are
limited, as is asset growth and expansion, and capital restoration plans
are required.
|
|
Quantitative
measures established by regulation to ensure capital adequacy require the
Corporation and the Bank to maintain minimum amounts and ratios (set forth
in the following table) of Total and Tier I capital (as defined in the
regulations) to risk weighted assets (as defined) and of Tier I capital
(as defined) to average assets (as
defined).
|
|
At
year end 2009, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, we
must maintain minimum Total Risk Based, Tier I Risk Based and Tier I
Leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed our capital ratings. At year end 2008, the Bank was
categorized as adequately capitalized under the regulatory framework for
prompt corrective action. Subsequent to December 31, 2008, the
Corporation received proceeds under the Capital Purchase
Program. Amounts were contributed to the Bank such that the
Bank became well capitalized.
|
69
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
14.
|
STOCKHOLDERS’
EQUITY – (Continued)
|
The
actual and required capital amounts and ratios are presented
below.
To Be Considered
|
||||||||||||||||||||||||
Well Capitalized
|
||||||||||||||||||||||||
Under Prompt
|
||||||||||||||||||||||||
(Dollars in thousands)
|
For Capital
|
Correction
|
||||||||||||||||||||||
Actual
|
Adequacy Purposes
|
Action Provisions
|
||||||||||||||||||||||
As of December 31, 2009:
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
Total
risk-based capital (to risk- weighted assets)
|
||||||||||||||||||||||||
Consolidated
|
$ | 115,702 | 11.35 | % | $ | 81,550 | 8.00 | % | N/A | N/A | ||||||||||||||
Bank
|
114,514 | 11.25 | 81,467 | 8.00 | 101,834 | 10.00 | ||||||||||||||||||
Tier
I capital (to risk-weighted assets)
|
||||||||||||||||||||||||
Consolidated
|
102,894 | 10.09 | 40,775 | 4.00 | N/A | N/A | ||||||||||||||||||
Bank
|
101,719 | 9.99 | 40,734 | 4.00 | 61,100 | 6.00 | ||||||||||||||||||
Tier
I capital (to average assets)
|
||||||||||||||||||||||||
Consolidated
|
102,894 | 8.66 | 47,533 | 4.00 | N/A | N/A | ||||||||||||||||||
Bank
|
101,719 | 8.90 | 45,732 | 4.00 | 57,165 | 5.00 |
To Be Considered
|
||||||||||||||||||||||||
Well Capitalized
|
||||||||||||||||||||||||
Under Prompt
|
||||||||||||||||||||||||
(Dollars in thousands)
|
For Capital
|
Correction
|
||||||||||||||||||||||
Actual
|
Adequacy Purposes
|
Action Provisions
|
||||||||||||||||||||||
As of December 31, 2008:
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
Total
risk-based capital (to risk- weighted assets)
|
||||||||||||||||||||||||
Consolidated
|
$ | 90,890 | 10.14 | % | $ | 71,717 | 8.00 | % | N/A | N/A | ||||||||||||||
Bank
|
89,224 | 9.97 | 71,625 | 8.00 | 89,531 | 10.00 | ||||||||||||||||||
Tier
I capital (to risk-weighted assets)
|
||||||||||||||||||||||||
Consolidated
|
79,655 | 8.89 | 35,859 | 4.00 | N/A | N/A | ||||||||||||||||||
Bank
|
78,029 | 8.72 | 35,812 | 4.00 | 53,719 | 6.00 | ||||||||||||||||||
Tier
I capital (to average assets)
|
||||||||||||||||||||||||
Consolidated
|
79,655 | 8.09 | 39,367 | 4.00 | N/A | N/A | ||||||||||||||||||
Bank
|
78,029 | 8.10 | 38,546 | 4.00 | 48,182 | 5.00 |
|
(b)
|
Dividend Restrictions –
Our principal source of funds for dividend payments is dividends received
from the Bank. Banking regulations limit the amount of
dividends that may be paid without prior approval of regulatory
agencies. Under these regulations, the amount of dividends that
may be paid in any calendar year is limited to the current year’s net
profits, combined with the retained net profits of the preceding two
years, subject to the capital requirements described above. As
a result of a $6 million dividend in 2008 used to finance the purchase of
FSB Bancshares, Inc., the Bank needed and obtained partial approval for
its 2009 quarterly dividends. We currently have a regulatory agreement
with the FDIC that requires us to obtain the consent of the Regional
Director of the FDIC and the Commissioner of the KDFI to declare and pay
cash dividends. We also have a regulatory agreement with the
FDIC that requires us to maintain a Tier 1 leverage ratio of
8%. We are currently in compliance with the Tier 1 capital
requirement. We have also entered into an agreement with our primary
regulator. Under this agreement, we must obtain regulatory approval
before declaring any dividends. We may not redeem shares or obtain
additional borrowings without prior
approval.
|
|
(c)
|
Liquidation Account – In
connection with our conversion from mutual to stock form of ownership
during 1987, we established a “liquidation account”, currently in the
amount of $521,000 for the purpose of granting to eligible deposit account
holders a priority in the event of future liquidation. Only in
such an event, an eligible account holder who continues to maintain a
deposit account will be entitled to receive a distribution from the
liquidation account. The total amount of the liquidation
account decreases in an amount proportionately corresponding to decreases
in the deposit account balances of the eligible account
holders.
|
|
(d)
|
Capital Purchase Program
– On January 9, 2009, we sold $20 million of cumulative perpetual
preferred shares, with a liquidation preference of $1,000 per share (the
“Senior Preferred Shares”) to the U.S. Treasury under the terms of its
Capital Purchase Plan. The Senior Preferred Shares constitute
Tier 1 capital and rank senior to our common shares. The Senior
Preferred Shares pay cumulative dividends at a rate of 5% per annum for
the first five years and will reset to a rate of 9% per annum after five
years. The Senior Preferred Shares may be redeemed at any time, at our
option. See Note 12 for additional
information.
|
70
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
15.
|
EARNINGS
(LOSS) PER SHARE
|
The
reconciliation of the numerators and denominators of the basic and diluted EPS
is as follows:
Year Ended
|
||||||||||||
(Dollars
in thousands,
|
December 31,
|
|||||||||||
except
per share data)
|
2009
|
2008
|
2007
|
|||||||||
Basic:
|
||||||||||||
Net
income/(loss)
|
$ | (6,709 | ) | $ | 4,797 | $ | 9,352 | |||||
Less:
|
||||||||||||
Preferred
stock dividends
|
(980 | ) | - | - | ||||||||
Accretion
on preferred stock discount
|
(52 | ) | - | - | ||||||||
Net
income (loss) available to common shareholders
|
$ | (7,741 | ) | $ | 4,797 | $ | 9,352 | |||||
Weighted
average common shares
|
4,695 | 4,666 | 4,722 | |||||||||
Diluted:
|
||||||||||||
Weighted
average common shares
|
4,695 | 4,666 | 4,722 | |||||||||
Dilutive
effect of stock options and warrants
|
- | 20 | 52 | |||||||||
Weighted
average common and incremental shares
|
4,695 | 4,686 | 4,774 | |||||||||
Earnings
(Loss) Per Common Share:
|
||||||||||||
Basic
|
$ | (1.65 | ) | $ | 1.03 | $ | 1.98 | |||||
Diluted
|
$ | (1.65 | ) | $ | 1.02 | $ | 1.96 |
Stock
options for 279,706, 124,928 and 28,600 shares of common stock were not included
in the December 31, 2009, 2008 and 2007 computations of diluted earnings per
share because their impact was anti-dilutive. The common stock
warrant for 215,983 shares was not included in the 2009 computation of diluted
earnings per share because its impact was also anti-dilutive.
16.
|
EMPLOYEE BENEFIT
PLANS
|
|
(a)
|
Pension Plan–We are a
participant in the Pentegra Defined Benefit Plan for Financial
Institutions (formerly known as Financial Institutions Retirement Fund)
which is a non-contributory, multiple-employer defined benefit pension
plan, covering employees hired before June 1, 2002. Because the
plan was curtailed, employees hired on or after that date are not eligible
for membership in the fund. Eligible employees are 100% vested
at the completion of five years of participation in the
plan. Our policy is to contribute annually the minimum funding
amounts. Employer contributions and administrative expenses
charged to operations for the years ended December 31, 2009, 2008 and 2007
totaled $233,000, $1,000, and
$158,000, respectively. Accrued
liabilities associated with the plan as of December 31, 2009 and 2008 were
$527,000 and $458,000,
respectively.
|
|
(b)
|
KSOP–We have a combined
401(k)/Employee Stock Ownership Plan. The plan is available to
all employees meeting certain eligibility requirements. The plan allows
employee contributions up to 50% of their compensation up to the annual
dollar limit set by the IRS. The employer matches 100% of the employee
contributions up to 6% of the employee’s compensation. If the
employee does not contribute at least 2% of the employee’s compensation,
then the employer makes a minimum contribution for the employee of 2% of
the employee’s compensation. Employees are 100% vested in
matching contributions upon meeting the eligibility requirements of the
plan. Shares of our common stock are acquired in non-leveraged
transactions. At the time of purchase, the shares are released
and allocated to eligible employees determined by a formula specified in
the plan agreement. Accordingly, the plan has no unallocated
shares. The number of shares to be purchased and allocated is
at the Board of Directors discretion. For 2009, the Board of
Directors decided not to make a contribution to the KSOP plan. Employer
matching contributions and administrative expenses charged to operations
for the plan for the years ended December 31, 2009, 2008 and 2007 were
$552,000, $494,000, and $483,000,
respectively.
|
71
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
16.
|
EMPLOYEE
BENEFIT PLANS – (Continued)
|
Shares in
the plan and the fair value of shares released during the year charged to
compensation expense were as follows:
|
Year
Ended
|
|||||||||||
|
December 31,
|
|||||||||||
|
2009
|
2008
|
2007
|
|||||||||
|
||||||||||||
KSOP
shares (ending)
|
205,289 | 224,956 | 214,195 | |||||||||
Shares
released
|
- | 7,877 | 4,223 | |||||||||
Compensation
expense
|
$ | - | $ | 110,500 | $ | 102,000 |
|
(c)
|
Stock Option Plan – Our
2006 Stock Incentive Plan, which is shareholder approved, succeeded our
1998 Stock Option and Incentive Plan. Under the 2006 Plan, we may grant
either incentive or non-qualified stock options to key employees and
directors for
a total of 647,350 shares of our common stock at not less than fair value
at the date such options are granted. Options available
for future grant under the 1998 Plan totaled 38,500 shares and were rolled
into the 2006 Plan. We believe that
the ability to award stock options and other forms of stock-based
incentive compensation can assist us in attracting and retaining key
employees. Stock-based incentive compensation is also a means to align the
interests of key employees with those of our shareholders by providing
awards intended to reward recipients for our long-term growth. The option to
purchase shares vest over periods of one to five years and expire ten
years after the date of grant. We issue new
shares of common stock upon the exercise of stock options. At December 31,
2009 options available for future grant under the 2006 Plan totaled
454,750. Compensation cost
related to options granted under the 1998 and 2006 Plans that was charged
against earnings for the years ended December 31, 2009, 2008 and 2007 was $103,000,
$122,000 and $102,000,
respectively.
|
The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option valuation model that uses various weighted-average
assumptions. The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant. The expected volatility is based on the
fluctuation in the price of a share of stock over the period for which the
option is being valued and the expected life of the options granted represents
the period of time the options are expected to be outstanding.
The
weighted-average assumptions for options granted during the years ended December
31, 2009, 2008 and 2007 and the resulting estimated weighted average fair value
per share is presented below.
December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Assumptions:
|
||||||||||||
Risk-free
interest rate
|
3.84 | % | 3.48 | % | 4.11 | % | ||||||
Expected
dividend yield
|
6.83 | % | 3.49 | % | 3.17 | % | ||||||
Expected
life (years)
|
10 | 10 | 10 | |||||||||
Expected
common stock
|
||||||||||||
market
price volatility
|
36 | % | 24 | % | 24 | % | ||||||
Estimated
fair value per share
|
$ | 1.51 | $ | 4.84 | $ | 5.78 |
72
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
16.
|
EMPLOYEE
BENEFIT PLANS – (Continued)
|
A summary
of option activity under the 1998 and 2006 Plans for the year ended December 31,
2009 is presented below:
Weighted
|
||||||||||||||||
Weighted
|
Average
|
|||||||||||||||
Number
|
Average
|
Remaining
|
Aggregate
|
|||||||||||||
of
|
Exercise
|
Contractual
|
Intrinsic
|
|||||||||||||
Options
|
Price
|
Term
|
Value
|
|||||||||||||
(Dollars In
Thousands)
|
||||||||||||||||
Outstanding,
beginning of period
|
208,517 | $ | 19.19 | |||||||||||||
Granted
during period
|
136,000 | 9.07 | ||||||||||||||
Forfeited
during period
|
(28,929 | ) | 15.62 | |||||||||||||
Exercised
during period
|
(35,882 | ) | 15.42 | |||||||||||||
Outstanding,
end of period
|
279,706 | $ | 15.12 | 7.7 | $ | - | ||||||||||
Eligible
for exercise at period end
|
101,236 | $ | 20.02 | 5.0 | $ | - |
The total
intrinsic value of options exercised during the periods ended December 31, 2009,
and 2007 was $119,000 and $65,000 respectively. There were no options exercised,
modified or settled in cash during the 2008 period. There was no tax benefit
recognized from the option exercises as they are considered incentive stock
options. Management expects all outstanding unvested options will
vest.
|
As of December 31, 2009 there was
$315,000 of total unrecognized compensation cost related to non-vested
share-based compensation arrangements granted under the 1998 and 2006
Plans. That cost is expected to be
recognized over a weighted-average period of 3.7 years. Cash received from
option exercises under all share-based payment arrangements for the
periods ended December 31, 2009, 2008 and 2007 was $101,000, $0 and
$72,000 respectively.
|
|
(d)
|
Employee Stock Purchase
Plan – We maintain an Employee Stock Purchase Plan whereby eligible
employees have the option to purchase common stock of the Corporation
through payroll deduction at a 10% discount. The purchase price of the
shares under the plan will be 90% of the closing price of the common stock
at the date of purchase. The plan provides for the purchase of up to
100,000 shares of common stock, which may be obtained by purchases issued
from a reserve. Funding for the purchase of common stock is from employee
contributions. Total compensation cost charged against earnings for the
Plan for the periods ended December 31, 2009, 2008 and 2007 totaled
$12,000, $9,000 and $18,000,
respectively.
|
17.
|
CASH
FLOW ACTIVITIES
|
The
following information is presented as supplemental disclosures to the statement
of cash flows.
(a)
|
Cash
Paid for:
|
(Dollars
in thousands)
Year Ended
|
||||||||||||
December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Interest
expense
|
$ | 21,720 | $ | 25,604 | $ | 28,931 | ||||||
Income
taxes
|
$ | 3,014 | $ | 3,649 | $ | 4,526 |
(b)
|
Supplemental
disclosure of non-cash activities:
|
(Dollars
in thousands)
Year Ended
|
||||||||||||
December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Loans
to facilitate sales of real estate owned and repossessed
assets
|
$ | 6,072 | $ | 978 | $ | 1,169 | ||||||
Transfers
from loans to real estate acquired through foreclosure and
repossessed assets
|
$ | 8,587 | $ | 5,196 | $ | 1,970 |
73
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
18.
|
CONDENSED
FINANCIAL INFORMATION (PARENT COMPANY
ONLY)
|
The
following condensed statements summarize the balance sheets, operating results
and cash flows of First Financial Service Corporation (Parent Company
only).
Condensed
Balance Sheets
|
||||||||
December 31,
|
||||||||
(Dollars
in thousands)
|
2009
|
2008
|
||||||
Assets
|
||||||||
Cash
and interest bearing deposits
|
$ | 1,860 | $ | 813 | ||||
Investment
in Bank
|
101,930 | 89,323 | ||||||
Securities
available-for sale
|
978 | 942 | ||||||
Other
assets
|
163 | 172 | ||||||
$ | 104,931 | $ | 91,250 | |||||
Liabilities
and Stockholders' Equity
|
||||||||
Short-term
borrowings
|
$ | 1,500 | $ | - | ||||
Subordinated
debentures
|
18,000 | 18,000 | ||||||
Other
liabilities
|
299 | 298 | ||||||
Stockholders'
equity
|
85,132 | 72,952 | ||||||
$ | 104,931 | $ | 91,250 |
Condensed
Statements of Income/(Loss)
|
||||||||||||
Year Ended
|
||||||||||||
December 31,
|
||||||||||||
(Dollars
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Dividend
from Bank
|
$ | 3,052 | $ | 10,823 | $ | 8,900 | ||||||
Interest
income
|
107 | 70 | 59 | |||||||||
Interest
expense
|
(1,353 | ) | (978 | ) | (717 | ) | ||||||
Gain
on sale of securities
|
- | 55 | - | |||||||||
Losses
on securities impairment
|
- | (516 | ) | - | ||||||||
Other
income
|
1 | 5 | - | |||||||||
Write
off of issuance cost of Trust
|
||||||||||||
Preferred
Securities
|
- | - | (229 | ) | ||||||||
Other
expenses
|
(378 | ) | (520 | ) | (512 | ) | ||||||
Income
before income tax benefit
|
1,429 | 8,939 | 7,501 | |||||||||
Income
tax benefit
|
609 | 703 | 536 | |||||||||
Income
before equity in undistributed
|
||||||||||||
net
income/(loss) of Bank
|
2,038 | 9,642 | 8,037 | |||||||||
Equity
in undistributed net income/(loss)
|
||||||||||||
of
Bank
|
(8,747 | ) | (4,845 | ) | 1,315 | |||||||
Net
income/(loss)
|
$ | (6,709 | ) | $ | 4,797 | $ | 9,352 |
74
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
18.
|
CONDENSED
FINANCIAL INFORMATION (PARENT COMPANY ONLY) –
(Continued
|
Condensed
Statements of Cash Flows
Year Ended
|
||||||||||||
(Dollars
in thousands)
|
December 31,
|
|||||||||||
2009
|
2008
|
2007
|
||||||||||
Operating
Activities:
|
||||||||||||
Net
income/(loss)
|
$ | (6,709 | ) | $ | 4,797 | $ | 9,352 | |||||
Adjustments
to reconcile net income/(loss) to cash provided by operating
activities:
|
||||||||||||
Equity
in undistributed net income/(loss)
|
||||||||||||
of
Bank
|
8,747 | 4,845 | (1,315 | ) | ||||||||
Losses
on securities impairment
|
- | 516 | - | |||||||||
Gain
on sale of securities available-for-sale
|
- | (55 | ) | - | ||||||||
Stock-based
compensation expense
|
103 | 122 | 110 | |||||||||
Changes
in:
|
||||||||||||
Other
assets
|
(107 | ) | (185 | ) | 112 | |||||||
Accounts
payable and other liabilities
|
1 | 177 | 20 | |||||||||
Net
cash from operating activities
|
2,035 | 10,217 | 8,279 | |||||||||
Investing
Activities:
|
||||||||||||
Cash
paid for acquisition of Farmers State Bank
|
- | (14,000 | ) | - | ||||||||
Capital
contributed to Bank
|
(20,000 | ) | (1,100 | ) | - | |||||||
Purchases
of securities available-for-sale
|
- | (524 | ) | - | ||||||||
Sales
of securities available-for-sale
|
- | 669 | - | |||||||||
Net
purchases of premises and equipment
|
- | - | (24 | ) | ||||||||
Net
cash from investing activities
|
(20,000 | ) | (14,955 | ) | (24 | ) | ||||||
Financing
Activities:
|
||||||||||||
Change
in short-term borrowings
|
1,500 | - | - | |||||||||
Proceeds
from issuance of subordinated debentures
|
- | 8,000 | 10,000 | |||||||||
Payoff
of subordinated debentures
|
- | - | (10,000 | ) | ||||||||
Issuance
of preferred stock, net
|
20,000 | - | - | |||||||||
Issuance
of common stock under dividend reinvestment program
|
303 | - | - | |||||||||
Issuance
of common stock for stock options exercised
|
101 | - | 72 | |||||||||
Issuance
of common stock for employee benefit plans
|
103 | 144 | 102 | |||||||||
Dividends
paid on common stock
|
(2,015 | ) | (3,546 | ) | (3,420 | ) | ||||||
Dividends
paid on preferred stock
|
(980 | ) | - | - | ||||||||
Common
stock repurchases
|
- | - | (4,457 | ) | ||||||||
Net
cash from financing activities
|
19,012 | 4,598 | (7,775 | ) | ||||||||
Net
change in cash and interest bearing deposits
|
1,047 | (140 | ) | 480 | ||||||||
Cash
and interest bearing deposits, beginning of year
|
813 | 953 | 401 | |||||||||
Cash
and interest bearing deposits, end of year
|
$ | 1,860 | $ | 813 | $ | 881 |
75
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
19.
|
FINANCIAL
INSTRUMENTS WITH OFF-BALANCE-SHEET
RISK
|
We are a
party to financial instruments with off-balance-sheet risk in the normal course
of business to meet the financing needs of our customers. These financial
instruments primarily include commitments to extend credit, and lines and
letters of credit, and involve, to varying degrees, elements of credit and
interest-rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of these instruments reflect the extent of our
involvement in particular classes of financial instruments.
Our
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit is represented by the
contractual notional amount of those instruments. Creditworthiness for all
instruments is evaluated on a case-by-case basis in accordance with our credit
policies. We use the same credit policies in making commitments and conditional
obligations as we do for on-balance-sheet instruments. Collateral from the
customer may be required based on management’s credit evaluation of the customer
and may include business assets of commercial customers as well as personal
property and real estate of individual customers or guarantors.
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements.
The
contractual amounts of financial instruments with off-balance-sheet risk at year
end were as follows:
(Dollars in thousands)
|
December 31, 2009
|
December 31, 2008
|
|||||||||||||
Fixed
|
Variable
|
Fixed
|
Variable
|
||||||||||||
Rate
|
Rate
|
Rate
|
Rate
|
||||||||||||
Commitments
to make loans
|
$ | - | $ | 496 | $ | 490 | $ | 434 | |||||||
Unused
lines of credit
|
- | 110,484 | - | 105,398 | |||||||||||
Standby
letters of credit
|
- | 9,319 | - | 10,135 | |||||||||||
$ | - | $ | 120,299 | $ | 490 | $ | 115,967 |
At
December 31, 2009 and 2008, we had $126.0 million, and $119.7 million in
letters of credit from the Federal Home Loan Bank issued to collateralize public
deposits. These
letters of credit are secured by a blanket pledge of eligible one-to-four family
residential mortgage loans. (For additional information see Note 3 on Loans and
Note 9 on Advances from the Federal Home Loan Bank.)
20.
|
RELATED
PARTY TRANSACTIONS
|
Certain directors, executive officers
and principal shareholders of the Company, including associates of such persons,
are our loan and deposit customers. Related party deposits at December 31, 2009
and 2008 were $3.5 million and $3.0 million. A summary of the related party loan
activity, for loans aggregating $60,000 or more to any one related party, is as
follows:
Year Ended
|
||||||||
December 31,
|
||||||||
(Dollars
in thousands)
|
2009
|
2008
|
||||||
Beginning
of year
|
$ | 1,306 | $ | 312 | ||||
New
loans
|
1,231 | 1,011 | ||||||
Other
changes
|
978 | - | ||||||
Repayments
|
(1,126 | ) | (17 | ) | ||||
End
of year
|
$ | 2,389 | $ | 1,306 |
76
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
21.
|
SUMMARY
OF QUARTERLY FINANCIAL DATA–
(Unaudited)
|
(Dollars
in thousands except per share data)
Year Ended December 31, 2009:
|
March 31,
|
June 30,
|
September 30,
|
December 31,
|
||||||||||||
Total
interest income
|
$ | 14,358 | $ | 14,578 | $ | 14,859 | $ | 15,061 | ||||||||
Total
interest expense
|
5,469 | 5,322 | 5,472 | 5,529 | ||||||||||||
Net
interest income
|
8,889 | 9,256 | 9,387 | 9,532 | ||||||||||||
Provision
for loan losses
|
2,045 | 1,913 | 2,482 | 3,084 | ||||||||||||
Non-interest
income
|
2,003 | 2,090 | 1,895 | 2,531 | ||||||||||||
Non-interest
expense
|
7,783 | 8,444 | 8,028 | 19,662 | ||||||||||||
Net
income/(loss)
|
761 | 715 | 576 | (8,761 | ) | |||||||||||
Earnings/(loss)
per common share:
|
||||||||||||||||
Basic
|
0.10 | 0.10 | 0.07 | (1.92 | ) | |||||||||||
Diluted
|
0.10 | 0.10 | 0.07 | (1.92 | ) |
Year Ended December 31, 2008:
|
March 31,
|
June 30,
|
September 30,
|
December 31,
|
||||||||||||
Total
interest income
|
$ | 14,516 | $ | 13,762 | $ | 14,830 | $ | 14,456 | ||||||||
Total
interest expense
|
6,771 | 5,759 | 6,406 | 5,863 | ||||||||||||
Net
interest income
|
7,745 | 8,003 | 8,424 | 8,593 | ||||||||||||
Provision
for loan losses
|
584 | 514 | 1,720 | 3,129 | ||||||||||||
Non-interest
income
|
1,954 | 2,140 | 2,367 | 1,988 | ||||||||||||
Non-interest
expense
|
6,335 | 6,517 | 7,637 | 7,797 | ||||||||||||
Net
income/(loss)
|
1,883 | 2,099 | 991 | (176 | ) | |||||||||||
Earnings/(loss)
per common share:
|
||||||||||||||||
Basic
|
0.40 | 0.45 | 0.21 | (0.04 | ) | |||||||||||
Diluted
|
0.40 | 0.45 | 0.21 | (0.04 | ) |
Net
income decreased for all four quarters of 2009 compared to 2008 due to a
decrease in our net interest margin, an increase in provision for loan loss
expense, a higher level of non-interest expense related to our expansion
efforts, write downs taken on investment securities that were
other-than-temporarily impaired and write downs on real estate acquired through
foreclosure. In
addition, we also recorded goodwill impairment charges of $11.9 million during
the fourth quarter of 2009.
Net
income decreased during the third and fourth quarters of 2008 due to a decrease
in our net interest margin, an increase in provision for loan loss expense, a
higher level of non-interest expense related to our expansion efforts, a write
down taken on investment securities that were other-than-temporarily impaired
and a write down on real estate acquired through foreclosure.
77
ITEM
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
None
ITEM
9A.
|
Controls
and Procedures
|
Management
is responsible for establishing and maintaining effective disclosure controls
and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934. As of December 31, 2009, an evaluation was performed under
the supervision and with the participation of management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on that
evaluation, management concluded that disclosure controls and procedures as of
December 31, 2009 were effective in ensuring material information required to be
disclosed in this Annual Report on Form 10-K was recorded, processed,
summarized, and reported in a timely manner as specified in SEC rules and forms.
Additionally, there were no changes in our internal control over financial
reporting that occurred during the quarter ended December 31, 2009 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Management's
responsibilities related to establishing and maintaining effective disclosure
controls and procedures include maintaining effective internal controls over
financial reporting that are designed to produce reliable financial statements
in accordance with accounting principles generally accepted in the United
States. As disclosed in the Management's Report on Internal Control Over
Financial Reporting of this Annual Report, we assessed our system of internal
control over financial reporting as of December 31, 2009, in relation to
criteria for effective internal control over financial reporting as described in
"Internal Control - Integrated Framework," issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, we believe
that, as of December 31, 2009, our system of internal control over financial
reporting met those criteria and is effective.
There
were no significant changes in our internal controls or in other factors that
could significantly affect these controls after the date of the Chief Executive
Officer and Chief Financial Officers evaluation, nor were there any significant
deficiencies or material weaknesses in the controls which required corrective
action.
PART
III
ITEM
10.
|
Directors
and Executive Officers of the
Registrant
|
The
information contained under the sections captioned "Proposal I - Election of
Directors" and “Section 16(a) Beneficial Ownership Reporting Compliance” in the
Company's definitive proxy statement for the 2010 Annual Meeting of Shareholders
(the "Proxy Statement") is incorporated herein by reference.
|
(a)
|
Code
of Ethics
|
You may
obtain copies of First Financial Service Corporation’s code of ethics free of
charge by contacting Janelle Poppe, Corporate Secretary-Treasurer, First Federal
Savings Bank, 2323 Ring Road, Elizabethtown, Kentucky 42701 (telephone)
270-765-2131.
ITEM
11.
|
Executive
Compensation
|
The
information contained under the sections captioned "Executive Compensation” in
the Proxy Statement is incorporated herein by reference.
ITEM
12.
|
Security
Ownership of Certain Beneficial Owners and
Management
|
(a)
|
Security
Ownership of Certain Beneficial
Owners
|
Information
required by this item is incorporated herein by reference to the section
captioned "Voting Securities and Principal Holders Thereof" in the Proxy
Statement
(b)
|
Security
Ownership of Management
|
Information
required by this item is incorporated herein by reference to the sections
captioned "Proposal I - Election of Directors" and "Voting Securities and
Principal Holders Thereof" in the Proxy Statement.
78
(c)
|
Changes
in Control
|
We know
of no arrangements, including any pledge by any person of securities of the
Company, the operation of which may at a subsequent date result in a change of
control of the Company.
ITEM
13.
|
Certain
Relationships and Related
Transactions
|
The
information required by this item is incorporated herein by reference to the
section captioned “Transactions with the Corporation and the Bank” in the Proxy
Statement.
ITEM
14.
|
Principal
Accountant Fees and Services
|
The
information required by this item is incorporated by reference to the section
captioned “Independent Public Accountants” in the Proxy Statement.
PART
IV
ITEM
15.
|
Exhibits
and Financial Statement Schedules
|
1.
|
Financial
Statements Filed
|
|
(a)(1)
|
Report
of Independent Registered Public Accounting Firm - Crowe Horwath,
LLP
|
|
(b)
|
Consolidated
Balance Sheets at December 31, 2009 and
2008.
|
|
(c)
|
Consolidated
Statements of Operations for the years ended December 31, 2009, 2008 and
2007.
|
|
(d)
|
Consolidated
Statements of Comprehensive Income (Loss) for the years ended December 31,
2009, 2008 and 2007.
|
|
(e)
|
Consolidated
Statements of Changes in Stockholders' Equity for the years ended December
31, 2009, 2008 and 2007.
|
|
(f)
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2009, 2008 and
2007.
|
|
(g)
|
Notes
to Consolidated Financial
Statements
|
2.
|
Financial
Statements Schedules
|
All
financial statement schedules have been omitted, as the required information is
either inapplicable or included in the financial statements or related
notes.
3.
|
Exhibits
|
3.1,
4.1
|
Amended
and Restated Articles of Incorporation *
|
||
3.2,
4.2
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation filed
January 7, 2009†
|
||
3.3,
4.3
|
Amended
and Restated Bylaws**
|
||
4.4
|
Shareholder
Rights Agreement dated April 15, 2003***
|
||
10.1
|
2006
Stock Option and Incentive Compensation Plan****
|
||
10.2
|
Form
of Stock Option Agreement**
|
||
10.3
|
Letter
Agreement, dated January 9, 2009, including the Securities Purchase
Agreement-Standard
|
||
Terms
incorporated by reference therein, between First Financial Service
Corporation and the U.S.
|
|||
Department
of Treasury†
|
|||
10.4
|
Warrant
to purchase common stock issued to the U. S. Department of Treasury†
|
||
10.5
|
Form
of Waiver of Senior Executive Officers†
|
||
21
|
Subsidiaries
of the Registrant
|
||
23
|
Consent
of Crowe Horwath LLP, Independent Registered Public Accounting
Firm
|
||
31.1
|
Certification
of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley
Act
|
||
31.2
|
Certification
of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley
Act
|
||
32
|
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350 (As Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002)
|
|
99.1
|
TARP Certification of Chief Executive Officer | ||
99.2
|
TARP Certification of Chief Financial Officer |
*
|
Incorporated
by reference to Form 10-Q filed August 9,
2004.
|
**
|
Incorporated
by reference to Form 10-K dated March 15,
2005.
|
***
|
Incorporated
by reference to Form 8-K dated April 15,
2003.
|
****
|
Incorporated
by reference to Exhibit 10 to Form S-8 Registration
Statement
|
|
(No.
333-142415) filed April 27, 2007.
|
†
|
Incorporated
by reference to Form 8-K dated January 12,
2009
|
79
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
FIRST
FINANCIAL SERVICE CORPORATION
|
||
Date:
3/16/10
|
By:
|
/s/ B. Keith Johnson
|
B.
Keith Johnson
|
||
Chief
Executive Officer
|
||
Duly
Authorized
Representative
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
By:
|
/s/
B. Keith Johnson
|
By:
|
/s/
Bob Brown
|
|
B.
Keith Johnson
|
Bob
Brown
|
|||
Principal
Executive Officer
|
Director
|
|||
&
Director
|
Date:
|
3/16/10
|
Date:
|
3/16/10
|
|
By:
|
/s/
Gail Schomp
|
By:
|
/s/
Diane E. Logsdon
|
|
Gail
Schomp
|
Diane
E. Logsdon
|
|||
Director
|
Director
|
Date:
|
3/16/10
|
Date:
|
3/16/10
|
|
By:
|
/s/
J. Alton Rider
|
By:
|
/s/
John L. Newcomb, Jr.
|
|
J.
Alton Rider
|
John
L. Newcomb, Jr.
|
|||
Director
|
Director
|
Date:
|
3/16/10
|
Date:
|
3/16/10
|
|
By:
|
/s/
Walter D. Huddleston
|
By:
|
/s/
Michael Thomas, DVM
|
|
Walter
D. Huddleston
|
Michael
Thomas, DVM
|
|||
Director
|
Director
|
Date:
|
3/16/10
|
Date:
|
3/16/10
|
|
By:
|
/s/
Stephen Mouser
|
By:
|
/s/
Donald Scheer
|
|
Stephen
Mouser
|
Donald
Scheer
|
|||
Director
|
Director
|
Date:
|
3/16/10
|
Date:
|
3/16/10
|
|
By:
|
/s/
Steven M. Zagar
|
|||
Steven
M. Zagar
|
||||
Chief
Financial Officer
|
||||
Principal
Accounting Officer
|
||||
Date:
|
3/16/10
|
80
INDEX
TO EXHIBITS
Exhibit No.
|
Description
|
|
3.1,
4.1
|
Amended
and Restated Articles of Incorporation *
|
|
3.2,
4.2
|
Articles of
Amendment to the Amended and Restated Articles of Incorporation filed
January 7, 2009†
|
|
3.3,
4.3
|
Amended
and Restated Bylaws**
|
|
4.4
|
Shareholder
Rights Agreement dated April 15, 2003***
|
|
10.1
|
2006
Stock Option and Incentive Compensation Plan****
|
|
10.2
|
Form
of Stock Option Agreement**
|
|
10.3
|
Letter
Agreement, dated January 9, 2009, including the Securities Purchase
Agreement-Standard
|
|
Terms
incorporated by reference therein, between First Financial Service
Corporation and the U.S.
|
||
Department of
Treasury†
|
||
10.4
|
Warrant to purchase
common stock issued to the U. S. Department of Treasury†
|
|
10.5
|
Form of Waiver of
Senior Executive Officers†
|
|
21
|
Subsidiaries
of the Registrant
|
|
23
|
Consent
of Crowe Horwath LLP, Independent Registered Public Accounting
Firm
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley
Act
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley
Act
|
|
32
|
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350
(As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002)
|
99.1
|
TARP Certification of Chief Executive Officer | |
99.2
|
TARP Certification of Chief Financial Officer |
*
|
Incorporated
by reference to Form 10-Q filed August 9,
2004.
|
**
|
Incorporated
by reference to Form 10-K dated March 15,
2005.
|
***
|
Incorporated
by reference to Form 8-K dated April 15,
2003.
|
****
|
Incorporated
by reference to Exhibit 10 to Form S-8 Registration
Statement
|
|
(No.
333-142415) filed April 27, 2007.
|
†
|
Incorporated
by reference to Form 8-K dated January 12,
2009
|
81