Exhibit 13

 

FINANCIAL HIGHLIGHTS

 

 

 

 

The purpose of this discussion and analysis is to aid in understanding significant changes in the financial condition of Seacoast Banking Corporation of Florida and its subsidiaries (the Company) and their results of operations during 2010, 2009 and 2008. Nearly all of the Company’s operations are contained in its banking subsidiary, Seacoast National Bank (Seacoast National or the Bank). This discussion and analysis is intended to highlight and supplement information presented elsewhere in the annual report on Form 10-K, particularly the consolidated financial statements and related notes appearing in Item 8. For purposes of the following discussion, the words the “Company,” “we,” “us,” and “our” refer to the combined entities of Seacoast Banking Corporation of Florida and its direct and indirect wholly owned subsidiaries.

 

Overview

 

The year ended December 31, 2010 was another difficult year for the U.S. economy and for the financial services industry generally. High credit costs, primarily the result of loan portfolio pressure stemming from ongoing deterioration in real estate values, as well as increasing unemployment and other factors, continued to negatively impact the Company’s earnings. Property value declines, which began in late 2007, continued throughout 2010 in most of our markets. While the Company did not have material exposure to many of the issues that originally plagued the industry (e.g., sub-prime loans, structured investment vehicles and collateralized debt obligations), the Company’s exposure to construction and land development and the residential housing sector pressured its loan portfolio, resulting in increased credit costs and foreclosed asset expenses. As the economic downturn continued, consumer confidence and weak economic conditions began to impact areas of the economy outside of the housing sector and restrained new loan demand from credit worthy borrowers. Throughout this difficult operating environment, the Company has been proactively positioning its business for growth in the future by aggressively focusing on improving credit quality, de-risking the overall loan portfolio, disposing of problem assets, and focusing on growing core deposits. Under these conditions, the Company reported a net loss to common shareholders of $37.0 million for the year ended December 31, 2010, or $0.48 per diluted share, compared with a net loss to common shareholders of $150.4 million for 2009, or $4.74 per diluted share.

 

Common Stock Offering

 

In April 2010, the Company issued $50 million of Series B Mandatorily Convertible Noncumulative Nonvoting Preferred Stock (“Series B Preferred Stock”), resulting in approximately $47.1 million in additional Tier 1 risk-based equity, net of issuance costs, pursuant to a private placement. The shares of Series B Preferred Stock were mandatorily convertible into common shares five days subsequent to shareholder approval, which was granted at the Company’s annual meeting on June 22, 2010. Upon the conversion of the Series B Preferred Stock, approximately 34,482,759 shares of our common stock were issued pursuant to the Investment Agreement, dated as of April 8, 2010 between the Company and the investors.

 

Merchant Processing Sale

 

In November 2010, we sold our merchant portfolio for a gain of $600,000. Seacoast National will receive fee income for new accounts opened prospectively and will have more competitive offerings for current and new customers.

 

Our Business

 

The Company is a single-bank holding company with operations on Florida’s southeast coast (ranging from Palm Beach County in the south to Brevard County in the north) as well as Florida’s interior around Lake Okeechobee and up through Orlando. The Company has 39 full service offices. The Company, through Seacoast National, provides a broad range of community banking services to commercial, small business and retail customers, offering a variety of transaction and savings deposit products, treasury management services, investment brokerage services, secured and unsecured loan products, including revolving credit facilities, and

letters of credit and similar financial guarantees. Seacoast National also provides trust and investment management services to retirement plans, corporations and individuals.

 

The coastal markets in which the Company operates have had population growth rates over the past 10 years of over 20 percent, and while the recession has adversely affected these markets, we expect these markets will prove resilient because these areas are attractive markets to live in. Prospectively, the Company will consider strategic acquisitions as part of the Company’s overall future growth plans in complementary and attractive markets within the State of Florida.

 

Strategic Review

 

The Company operates both a full retail banking strategy in its core markets which are some of Florida’s wealthiest, as well as a complete commercial banking strategy. The Company’s core markets are comprised of Martin, St. Lucie and Indian River counties located on Florida’s southeast coast and Okeechobee County which is contiguous to these coastal counties. Our core markets contain 25 of the 39 retail locations, including four private banking centers. Because of the branch coverage in these markets, the Company has a significant presence providing convenience to customers, and resulting in a larger deposit market share. The Company’s deposit mix is favorable with 66 percent of average deposit balances comprised of NOW, savings, money market and noninterest bearing transaction customer accounts. The cost of deposits averaged 0.90 percent for 2010 (compared to 1.39 percent for 2009 and 2.30 percent for 2008), which the Company believes ranks among the lowest when compared to other banks operating in the Company’s market. As part of the Company’s complete retail product and service offerings, customers are provided wealth management services through its full service broker dealer and trust wealth management divisions.

 

During the last three years, the Company has improved its acquisition, retention and mix of deposits. This has resulted in lower funding costs and improved profitability, customer satisfaction and liquidity. Prospectively, the Company intends to continue to utilize similar strategies along with new strategies and resources to improve its performance.

 

During 2010 and 2009, the Company had limited commercial/commercial real estate loan production of $10 million and $14 million, respectively, when compared to $117 million in 2008. This lower production was reflective of the unprecedented housing and commercial real estate market decline and recessionary environment generally, as well as the Company’s efforts to reduce its concentration in commercial real estate and construction and land development loans, which began in 2007. In 2010, the Company closed $152 million in residential loans, an improvement over 2009’s result of $145 million, as well as 2008’s $105 million. In 2008, a slower residential real estate market and uncertain economic conditions severely dampened residential home sales and residential loan production. Stabilizing home values and lower interest rates improved the Company’s residential loan production in 2009, and improved further in 2010.

 

At the end of 2010 and 2009, our commercial real estate, or “CRE”, loans were $591.4 million and $709.2 million, respectively, down 16.6 percent and 20.9 percent from the respective prior years. Under regulatory guidelines for commercial real estate concentrations, Seacoast National’s total commercial real estate loans outstanding at December 31, 2010 (as defined in the guideline) represent 218 percent of risk-based capital at December 31, 2010, below the regulatory threshold for extra scrutiny. Our construction and land development loans were $79.3 million at December 31, 2010, down $83.6 million from $162.9 million at December 31, 2009, which was down 58.8 percent from $395.2 million at December 31, 2008. The size of our average commercial construction and land development loans has also decreased over the three year period from $1,494,000 in 2008 to $939,000 in 2009 to $735,000 in 2010.

 

The Company’s net interest margin has declined from 3.58 percent in 2008 to 3.55 percent in 2009, and 3.37 percent in 2010. During 2010, a further decline in loans of 11.2 percent, a higher level of cash liquidity, and lower loan and investment security yields were largely offset by improved loan quality, a larger investment securities portfolio and reduced deposit costs. The Board of Governors of the Federal Reserve System (the “Federal Reserve”) has made a historic effort over the past three years to rejuvenate the economy and limit the effect of the recession by lowering interest rates to 0 to 25 basis points and expanding various liquidity programs. Recently, the Federal Reserve reaffirmed its forecast for a moderate economic recovery

through 2011, although trimming its growth estimates from previous forecasts. As a result of the slow economic recovery and revised growth forecasts, the Federal Reserve has reaffirmed that it will maintain key interest rates at record lows for an extended period of time as long as the economic data support the low rates. These low rates impact our net interest margin. Fourth quarter 2010’s net interest margin was 3.42 percent, reflecting an increase of five basis points from last year’s fourth quarter, as a result of lower deposit rates. The net interest margin is likely to remain under pressure until economic conditions stabilize and outstanding nonaccrual loans are reduced further. Opportunities for margin improvement include continued improvements in deposit mix, increased interest rates and loan growth.

 

Loan Growth and Lending Policies

 

In the last several years, as the economic environment in Florida weakened, the Company has increased its focus and monitoring of its exposure to residential land, acquisition and development loans. These activities resulted in greater loan pay-downs, guarantor performance, and the obtaining of additional collateral. The Company also utilized loan sales to better control the level of these assets and other commercial real estate loans, with $28 million in loan sales during 2010, $89 million in loan sales during 2009 and $68 million in loan sales during 2008. Overall, the Company’s exposure to residential land, acquisition and development loans was reduced from its peak of $352 million or 20.2 percent of total loans in early 2007 to $14 million or 1.1 percent at December 31, 2010.

 

For 2010, 2009 and 2008, balances in the loan portfolio declined 11.2 percent, 16.7 percent and 11.7 percent, respectively, reflecting the recessionary climate, significantly lower loan demand and loan sales. During 2010, negative loan growth slowed each quarter and declined 1.8 percent in the fourth quarter, as increased production occurred in consumer and commercial lending compared to prior quarters. The Company expects loan growth opportunities for all types of lending prospectively as the economy stabilizes and improves, including commercial lending to targeted segments, consumer auto and 1-4 family agency conforming residential mortgages.

 

Deposit Growth, Mix and Costs

 

The Company’s focus on high quality customer service and convenient branch locations supports its strategy to provide stable, low cost deposit funding growth over the long term. Over the past three years, the Company has strengthened its retail deposit franchise using new strategies and product offerings, while maintaining its focus on building customer relationships. In 2010, the retail bank added 7,495 new core deposit households, up 1,125 or 17.7 percent from the prior year. Retail household growth for 2010 has improved as a result of the Company’s retail deposit program and more recently expanded efforts to attract new commercial deposit accounts.

 

Interest rates decreased dramatically during 2008 and 2009 as the economic climate worsened and the Federal Reserve implemented interest rate reduction strategies. As a result, during 2010, average low cost NOW, savings and money market deposits increased 6.4 percent. At December 31, 2009, these deposits were 4.5 percent higher than at December 31, 2008, after decreasing 24.0 percent during 2008. Also, certificates of deposit (CDs) declined $137.4 million and $60.6 million during 2010 and 2009, respectively, in part due to a decline of $31.6 million and $61.8 million in higher cost brokered CDs over each period compared. The Company’s overall deposit mix remains favorable and its average cost of deposits, including noninterest bearing demand deposits, remains low. The average cost of deposits for the Company continued to trend lower in 2010. In 2010, the cost of deposits was 0.90 percent, decreasing 49 basis points from 1.39 percent the prior year and from 2.39 percent in 2008. During 2010, noninterest bearing demand deposits increased 7.8 percent, versus the past two years, when noninterest bearing demand deposits decreased 2.4 percent, and 16.0 percent, respectively.

 

During 2010 and 2009, total deposits declined $142 million, or 8.0 percent, and $31 million, or 1.7 percent, year over year, respectively, and sweep repurchase agreements decreased $7 million, or 7.1 percent, in 2010, after decreasing $52 million, or 32.9 percent, year over year during 2009. Declines in brokered CDs and single service deposit customers were the cause of the overall decline in deposits during

2010 and 2009. Most of the decline in sweep repurchase agreements during 2009 and 2010 was in public funds, principally from lower tax collector receipts. As reported throughout 2009 and 2010, the Company has been executing a retail strategy and has experienced strong growth in core deposit relationships when compared to prior results. In the fourth quarter of 2010, new household deposit relationships were particularly strong, with 1,612 new personal checking retail relationships opened during the quarter up 478 accounts or 42.1 percent from the same quarter a year ago and up 255 accounts or 18.8 percent from the third quarter of 2010. Likewise, new commercial business checking deposit relationships increased by 71.6 percent compared with the same quarter one year ago. New personal checking relationships have increased as a result of our programs with improved market share, increased average services per household and decreased customer attrition. Since initial implementation in 2008, the acquisition of new retail checking deposit households and the average services per household have increased 51.7 percent as of 2010 and 40.8 percent as of 2009, respectively.

 

Critical Accounting Policies and Estimates

 

The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, (“GAAP”), including prevailing practices within the financial services industry. The preparation of consolidated financial statements requires management to make judgments in the application of certain of its accounting policies that involve significant estimates and assumptions. These estimates and assumptions, which may materially affect the reported amounts of certain assets, liabilities, revenues and expenses, are based on information available as of the date of the financial statements, and changes in this information over time and the use of revised estimates and assumptions could materially affect amounts reported in subsequent financial statements. Management, after consultation with the Company’s Audit Committee, believes the most critical accounting estimates and assumptions that involve the most difficult, subjective and complex assessments are:

 

 

The following is a discussion of the critical accounting policies intended to facilitate a reader’s understanding of the judgments, estimates and assumptions underlying these accounting policies and the possible or likely events or uncertainties known to us that could have a material effect on our reported financial information. For more information regarding management’s judgments relating to significant accounting policies and recent accounting pronouncements, see “Notes to Consolidated Financial Statements, Note A-Significant Accounting Policies.”

 

Allowance and Provision for Loan Losses

 

Management determines the provision for loan losses charged to operations by continually analyzing and monitoring delinquencies, nonperforming loans and the level of outstanding balances for each loan category, as well as the amount of net charge-offs, and by estimating losses inherent in its portfolio. While the Company’s policies and procedures used to estimate the provision for loan losses charged to operations are considered adequate by management, factors beyond the control of the Company, such as general economic conditions, both locally and nationally, make management’s judgment as to the adequacy of the provision and allowance for loan losses necessarily approximate and imprecise (see “Nonperforming Assets”).

 

The provision for loan losses is the result of a detailed analysis estimating an appropriate and adequate allowance for loan losses. The analysis includes the evaluation of impaired loans as prescribed under FASB Accounting Standards Codification (“ASC”) 310 as well as, an analysis of homogeneous loan pools not individually evaluated as prescribed under ASC 450. For the first, second, third and fourth quarters of 2010, the provision for loan losses was $2.1 million, $16.7 million, $8.9 million and $4.0 million, respectively, substantially lower than provisioning in 2009 for the first, second, third and fourth quarters of $11.7 million,

$26.2 million, $45.4 million and $41.5 million, respectively. The net charge-offs for the first, second, third and fourth quarters of 2010 were $3.5 million, $20.2 million, $10.7 million and $4.7 million, and totaled $39.1 million or 2.95 percent of average total loans for the year, much less than net charge-offs for 2009 which totaled $109.0 million or 6.86 percent of average total loans. Delinquency trends show continued stability (see “Nonperforming Assets”).

 

Table 12 provides certain information concerning the Company’s allowance and provisioning for loan losses for the years indicated.

 

Net charge-offs during 2008 and 2009 were higher than in prior years due to higher losses in the commercial construction and land development portfolio secured by residential land. The higher charge-offs reflected declining real estate values and the Company reducing its commercial real estate (“CRE”) loan concentrations by selling $43.9 million of loans which accounted for $20.6 million of total net charge-offs during 2009. During 2010, the Company sold $27.6 million of loans which accounted for $11.1 million of total net charge-offs. With timely and more aggressive collection efforts, loan sales, and charge-offs, the Company’s residential construction and land development loans have been reduced to $14.0 million or 1.1 percent of total loans at December 31, 2010 (see “Loan Portfolio”), down from approximately $47.6 million or 3.4 percent of total loans at December 31, 2009. Total CRE loans declined 16.6 percent from $709.2 million at December 31, 2009 to $591.4 million at December 31, 2010. Under regulatory guidelines for commercial real estate concentrations, Seacoast National’s total commercial real estate loans outstanding (as defined in the guidance) represented 218 percent of total risk based capital at December 31, 2010. The reduction in the Company’s exposure to commercial construction and land development portfolio secured by residential property in 2009 reduced earnings volatility in 2010 as a result of lower net charge-offs.

 

The Company has also reduced its concentrations of large individual loan relationships over the periods compared, which the Company believes will reduce overall risk in its loan portfolio. The following table details the Company’s reduced exposure to large residential construction and land development loans over the past five quarters, as evidenced by loans in this portfolio with balances of $4 million or more declining from $12.5 million at December 31, 2009 to no outstanding balance at December 31, 2010. Of the remaining $14.0 million in residential construction and land development loans with balances of less than $4 million, $2.2 million or 16 percent are classified as nonperforming.

 

QUARTERLY TRENDS — LOANS AT END OF PERIOD

 

The Company’s other loan portfolios related to residential real estate are amortizing loans. The Company has never offered sub-prime, Alt A, Option ARM or any negative amortizing residential loans, programs or products, although it has originated and holds residential mortgage loans from borrowers with original or current FICO credit scores that are currently less than “prime” FICO credit scores. Substantially all residential originations have been underwritten to conventional loan agency standards, including loans having balances that exceed agency value limitations.

 

The Company selectively adds residential mortgage loans to its portfolio, primarily loans with adjustable rates. Home equity loans (amortizing loans for home improvements with maturities of 10 to 15 years) totaled $73.4 million and home equity lines totaled $57.7 million at December 31, 2010, compared to $86.8 million and $60.1 million at December 31, 2009. Each borrower’s credit was fully documented as part of the Company’s underwriting of home equity lines. The Company never promoted home equity lines greater than 80 percent of value or used credit scoring solely as the underwriting criteria. Therefore this portfolio of loans, primarily to customers with other relationships to Seacoast National, has performed better than portfolios of our peers. Net charge-offs for the twelve months ended 2010 totaled $1,694,000 for home equity lines, compared to $2,782,000 for 2009, and home equity lines past due 90 days or more and nonaccrual lines (aggregated) were $1,738,000 and $99,000 at December 31, 2010 and 2009, respectively.

 

Since year-end 2009, nonaccrual loans declined by $29.6 million to $68.3 million at December 31, 2010 (see “Nonperforming Assets”). Loans have declined $156.9 million or 11.2 percent since year-end 2009 (see “Loan Portfolio”).

 

Congress and bank regulators have encouraged recipients of Troubled Asset Relief Program (“TARP”) capital to use such capital to make more loans. In that respect, the Company has successfully increased its residential mortgage production in 2010 and 2009. A total of 1,168 applications were taken during 2010 with an aggregate value of $244 million with $152 million in loans closed, and 1,257 applications were taken in 2009 with an aggregate value of $268 million with $145 million in loans closed. Existing home sales and home mortgage loan refinancing activity in the Company’s markets have increased during 2010. However, demand for new home construction is expected to remain soft.

 

Management continuously monitors the quality of the loan portfolio and maintains an allowance for loan losses it believes sufficient to absorb probable losses inherent in the loan portfolio. The allowance for loan losses totaled $37,744,000 or 3.04 percent of total loans at December 31, 2010, $7,448,000 less than at December 31, 2009. The allowance for loan losses totaled $45,192,000 or 3.23 percent of total loans at December 31, 2009, $15,804,000 greater than at December 31, 2008. The allowance for loan losses framework has two basic elements: specific allowances for loans individually evaluated for impairment, and a formula-based component for pools of homogeneous loans within the portfolio that have similar risk characteristics, which are not individually evaluated.

 

The first element of the ALLL analysis involves the estimation of allowance specific to individually evaluated impaired loans, including accruing and nonaccruing restructured commercial and consumer loans. In this process, a specific allowance is established for impaired loans based on an analysis of the most probable sources of repayment, including discounted cash flows, liquidation of collateral, or the market value of the loan itself. It is the Company’s policy to charge off any portion of the loan deemed a loss. Restructured consumer loans are also evaluated in this element of the estimate. As of December 31, 2010, the specific allowance related to impaired loans individually evaluated totaled $14.4 million, compared to $13.0 million as of December 31, 2009.

 

The second element of the ALLL, the general allowance for homogeneous loan pools not individually evaluated, is determined by applying allowance factors to pools of loans within the portfolio that have similar risk characteristics. The general allowance factors are determined using a baseline factor that is developed from an analysis of historical net charge-off experience and qualitative factors designed and intended to measure expected losses. These baseline factors are developed and applied to the various loan pools. Adjustments may be made to baseline reserves for some of the loan pools based on an assessment of internal and external influences on credit quality not fully reflected in the historical loss. These influences may include

elements such as changes in concentration risk, macroeconomic conditions, and/or recent observable asset quality trends.

 

In addition, our analyses of the adequacy of the allowance for loan losses also takes into account qualitative factors such as credit quality, loan concentrations, internal controls, audit results, staff turnover, local market conditions and loan growth.

 

The Company’s independent Credit Administration Department assigns all loss factors to the individual internal risk ratings based on an estimate of the risk using a variety of tools and information. Its estimate includes consideration of the level of unemployment which is incorporated into the overall allowance. In addition, the portfolio is segregated into a graded loan portfolio, residential, installment, home equity, and unsecured signature lines, and loss factors are calculated for each portfolio. The loss factors assigned to the graded loan portfolio are based on historical migration of actual losses by grade and a range of losses over various periods. Loss factors for the other portfolios are based on historical losses over the prior 12 months and prospective factors that consider loan type, delinquencies, loan to value, purpose of the loan, and type of collateral.

 

Our charge-off policy meets or exceeds regulatory minimums. Losses on unsecured consumer loans are recognized at 90 days past due compared to the regulatory loss criteria of 120 days. Secured consumer loans, including residential real estate, are typically charged-off or charged down between 120 and 180 days past due, depending on the collateral type, in compliance with Federal Financial Institution Examination Council guidelines. Commercial loans and real estate loans are typically placed on nonaccrual status when principal or interest is past due for 90 days or more, unless the loan is both secured by collateral having realizable value sufficient to discharge the debt in-full and the loan is in the legal process of collection. Secured loans may be charged-down to the estimated value of the collateral with previously accrued unpaid interest reversed. Subsequent charge-offs may be required as a result of changes in the market value of collateral or other repayment prospects. Initial charge-off amounts are based on valuation estimates derived from appraisals, broker price opinions, or other market information. Generally, new appraisals are not received until the foreclosure process is completed; however, collateral values are evaluated periodically based on market information and incremental charge-offs are recorded if it is determined that collateral values have declined from their initial estimates.

 

Management continually evaluates the allowance for loan losses methodology seeking to refine and enhance this process as appropriate, and it is likely that the methodology will continue to evolve over time.

 

In general, collateral values for residential real estate have declined since 2006, with values being more stable over the last 12 months to 24 months. Loans originated from 2005 through 2007 have seen property values decline approximately 50 percent from their original appraised values, more than the decline on loans originated in other years. Declining residential collateral value has affected our actual loan losses over the last three years, but values appear to be stabilizing over the last twelve months. Residential loans that become 90 days past due are placed on nonaccrual. A specific allowance is made for any loan that becomes 120 days past due. Residential loans are subsequently written down if they become 180 days past due and such write-downs are supported by a current appraisal, consistent with current banking regulations.

 

Our Loan Review unit is independent, and performs loan reviews and evaluates a representative sample of credit extensions after the fact for appropriate individual internal risk ratings. Loan Review has the authority to change internal risk ratings and is responsible for assessing the adequacy of credit underwriting. This unit reports directly to the Directors’ Loan Committee of Seacoast National’s Board of Directors.

 

Table 13 summarizes the Company’s allocation of the allowance for loan losses to real estate loans, commercial and financial loans, and installment loans to individuals, and information regarding the composition of the loan portfolio at the dates indicated.

 

During the first, second, third and fourth quarters of 2010, net charge-offs totaled $3,541,000, $20,209,000, $10,700,000 and $4,678,000, respectively. This compares to $8,540,000 in the first quarter of 2009, $15,109,000 in the second quarter of 2009, $40,142,000 in the third quarter of 2009 and $45,172,000 in the fourth quarter of 2009. Some of the increase in charge-offs during 2009 and 2010 were related to loan

sales to reduce risk in the loan portfolio. Although there is no assurance that we will not have elevated charge-offs in the future, we believe that we have significantly reduced the risks in our loan portfolio and that with stabilizing market conditions, future charge-offs should decline. Net charge-offs for the year ended December 31, 2010 totaled $39,128,000, compared to net charges-offs of $108,963,000 and $81,148,000 for the years ended December 31, 2009 and 2008, respectively (See “Table 12 — Summary of Loan Loss Experience” for detail on net charge-offs for the last five years).

 

Concentrations of credit risk, discussed under the caption “Loan Portfolio” of this discussion and analysis, can affect the level of the allowance and may involve loans to one borrower, an affiliated group of borrowers, borrowers engaged in or dependent upon the same industry, or a group of borrowers whose loans are predicated on the same type of collateral. The Company’s most significant concentration of credit is a portfolio of loans secured by real estate. At December 31, 2010, the Company had $1.140 billion in loans secured by real estate, representing 91.9 percent of total loans, down from $1.272 billion, representing 91.0 percent at December 31, 2009. In addition, the Company is subject to a geographic concentration of credit because it only operates in central and southeastern Florida. The Company’s exposure to construction and land development credits is secured by project assets and personal guarantees and totals $79.3 million at December 31, 2010 down from $170.9 million at December 31, 2009. The Company considers exposure to this industry group, together with an assessment of current trends and expected future financial performance in our evaluation of the adequacy of the allowance for loan losses. The significant decline in this concentration is one factor which supports the lower overall allowance for loan losses at December 31, 2010 compared to December 31, 2009.

 

While it is the Company’s policy to charge off in the current period loans in which a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, borrower payment behaviors and local market conditions as well as conditions affecting individual borrowers, management’s judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer companies identified by the regulatory agencies.

 

In assessing the adequacy of the allowance, management relies predominantly on its ongoing review of the loan portfolio, which is undertaken both to ascertain whether there are probable losses that must be charged off and to assess the risk characteristics of the portfolio in aggregate. This review considers the judgments of management, and also those of bank regulatory agencies that review the loan portfolio as part of their regular examination process. Our bank regulators have generally agreed with our credit assessments, however the regulators could seek additional provisions to our allowance for loan losses, which will reduce our earnings.

 

Seacoast National entered into a formal agreement with the Office of the Comptroller of the Currency (the “OCC”) on December 16, 2008 to improve its asset quality. Under the formal agreement, Seacoast National’s board of directors appointed a compliance committee to monitor and coordinate Seacoast National’s performance under the formal agreement. The formal agreement provides for the development and implementation of written programs to reduce Seacoast National’s credit risk, monitor and reduce the level of criticized assets, and manage commercial real estate loan (“CRE”) concentrations in light of current adverse CRE market conditions. The Company believes it has complied with this formal agreement.

 

Nonperforming Assets

 

Table 14 provides certain information concerning nonperforming assets for the years indicated.

 

Nonperforming assets at December 31, 2010 totaled $93,981,000 and are comprised of $68,284,000 of nonaccrual loans and $25,697,000 of other real estate owned (“OREO”), compared to $123,261,000 at December 31, 2009 (comprised of $97,876,000 in nonaccrual loans and $25,385,000 of OREO). At December 31, 2010, approximately 92.5 percent of nonaccrual loans were secured with real estate, the remainder principally by marine vessels. See the table below for details about nonaccrual loans. At

December 31, 2010, nonaccrual loans have been written down by approximately $32.4 million or 35.9 percent of the original loan balance (including specific impairment reserves). New nonperforming loans have declined during 2010 compared to 2009. The table below shows the nonperforming inflows by quarter for 2010 and 2009.

 

 

Sales of loans were nominal during the first and fourth quarters of 2010, compared to second and third quarter 2010 loan sales. For 2010, sales totaled $28 million at an average price of nearly 56 percent of the outstanding ledger balance. For 2009, sales totaled $82 million, at a similar average price of approximately 50 percent of the outstanding ledger balance. Prospectively, the Company anticipates loan sales will continue to play a lesser role in connection with liquidation efforts, since we have substantially reduced our largest borrower concentrations. The Company pursues loan restructurings in selected cases where it expects to realize better values than may be expected through traditional collection activities. The Company has worked with retail mortgage customers, when possible, to achieve lower payment structures in an effort to avoid foreclosure. Troubled debt restructurings (“TDRs”) are part of the Company’s loss mitigation activities and can include rate reductions, payment extensions and principal deferrals. Company policy requires TDRs be classified as nonaccrual loans until (under certain circumstances) performance can be verified, which usually requires six months of performance under the restructured loan terms. Some TDRs that have never been past due continue as accruing loans, of which $10.9 million were performing. Accruing restructured loans totaled $66.4 million at December 31, 2010 compared to 57.4 million at December 31, 2009.

 

At December 31, 2010 and 2009, total TDRs (performing and nonperforming) were comprised of the following loans by type of modification:

 

 

At December 31, 2010, loans totaling $134,634,000 were considered impaired (comprised of total nonaccrual and TDRs) and $14,362,000 of the allowance for loan losses was allocated for potential losses on these loans, compared to $155,310,000 and $13,042,000, respectively, at December 31, 2009.

 

For more than 33 months, management has maintained an intensive focus on the commercial real estate portfolio given the general economic stress in the Company’s markets. The majority of these credits have been reviewed using current financial information and were appropriately risk graded. During 2009, additional reviews of all internally classified CRE loans were conducted. This included tests of cash flows against current outlook, the borrowers’ current condition and borrower financial trends. As a result of the reviews conducted, nonperforming loans increased and likely peaked in the third quarter of 2009 and have been lower each quarter thereafter. Even so, nonperforming assets are subject to changes in the economy, both nationally and locally, changes in monetary and fiscal policies, changes in borrowers’ payment behaviors and changes in conditions affecting various borrowers from Seacoast National.

 

All impaired loans are reviewed quarterly to determine if valuation adjustments are necessary based on known changes in the market and/or the project assumptions. When necessary, the “As Is” appraised value may be adjusted based on more recent appraisal assumptions received by the Company on other similar properties, the tax assessed market value, comparative sales and/or an internal valuation. If an updated assessment is deemed necessary and an internal valuation cannot be made, an external “As Is” appraisal will be obtained. If the “As Is” appraisal does not appropriately reflect the current fair market value, in the Company’s opinion, a specific reserve is established and/or the loan is written down to the current fair market value.

 

Collateral dependent, impaired loans are loans that are solely dependent on the liquidation of the collateral for repayment. All OREO/REPO loans are reviewed quarterly to determine if valuation adjustments are necessary based on known changes in the market and/or project assumptions. When necessary, the “As Is” appraisal is adjusted based on more recent appraisal assumptions received by the Company on other similar properties, the tax assessment market value, comparative sales and/or an internal valuation is performed. If an updated assessment is deemed necessary, and an internal valuation cannot be made, an external appraisal will be requested. Upon receipt of the “As Is” appraisal a charge-off is recognized for the difference between the loan amount and its current fair market value.

 

“As Is” values are used to measure fair market value on impaired loans, OREO and REPOs.

 

Any loan that is partially charged-off remains in nonperforming status until it is paid off regardless of current valuation of the loan.

 

In accordance with regulatory reporting requirements, loans are placed on non-accrual following the Retail Classification of Loan interagency guidance. Typically loans 90 days or more past due are reviewed for impairment, and if deemed impaired, are placed on non-accrual. Once impaired, the current fair market value of the collateral is assessed and a specific reserve and/or charge-off taken. Quarterly thereafter, the loan carrying value is analyzed and any changes are appropriately made as described above.

Upon receipt of an appraisal, an appraisal review is performed and a specific reserve or charge-off is processed, if warranted.

 

Fair Value and Other than Temporary Impairment of Securities

 

At December 31, 2010, outstanding securities designated as available for sale totaled $435,140,000. The fair value of the available for sale portfolio at December 31, 2010 was more than historical amortized cost, producing net unrealized gains of $2,986,000 that have been included in other comprehensive income (loss) as a component of shareholders’ equity (net of taxes). The Company made no change to the valuation techniques used to determine the fair values of securities during 2010 and 2009. The fair value of each security available for sale was obtained from independent pricing sources utilized by many financial institutions. The fair value of many state and municipal securities are not readily available through market sources, so fair value estimates are based on quoted market price or prices of similar instruments. Generally, the Company obtains one price for each security. However, actual values can only be determined in an arms-length transaction between a willing buyer and seller that can, and often do, vary from these reported values. Furthermore, significant changes in recorded values due to changes in actual and perceived economic conditions can occur rapidly, producing greater unrealized losses or gains in the available for sale portfolio.

 

The credit quality of the Company’s securities holdings currently is investment grade. Any securities rated below investment grade are tested for other than temporary impairment, or “OTTI”. As of December 31, 2010, the Company’s investment securities, except for approximately $9.1 million of securities issued by states and their political subdivisions, generally are traded in liquid markets. U.S. Treasury and U.S. Government agency obligations totaled $340.3 million, or 78 percent of the total available for sale portfolio. The remainder of the portfolio primarily consists of private label securities secured by collateral originated in 2005 or prior with amortized loan to values below 70%, and current FICO scores above 700. Generally these securities have credit support exceeding 5%. The collateral underlying these mortgage investments are primarily 30- and 15-year fixed rate, 5/1 and 10/1 adjustable rate mortgage loans. Historically, the mortgage loans serving as collateral for those investments have had minimal foreclosures and losses.

 

These investments are reviewed quarterly for other than temporary impairment, by considering the following primary factors: percent decline in fair value, rating downgrades, subordination, duration, amortized loan-to-value, and the ability of the issuers to pay all amounts due in accordance with the contractual terms. Prices obtained from pricing services are usually not adjusted. Based on our internal review procedures and the fair values provided by the pricing services, we believe that the fair values provided by the pricing services are consistent with the principles of ASC 820. However, on occasion pricing provided by the pricing services may not be consistent with other observed prices in the market for similar securities. Using observable market factors, including interest rate and yield curves, volatilities, prepayment speeds, loss severities and default rates, the Company may at times validate the observed prices using a discounted cash flow model and using the observed prices for similar securities to determine the fair value of its securities.

 

Changes in the fair values, as a result of deteriorating economic conditions and credit spread changes, should only be temporary. Further, management believes that the Company’s other sources of liquidity, as well as the cash flow from principal and interest payments from the securities portfolio, reduces the risk that losses would be realized as a result of a need to sell securities to obtain liquidity.

 

The Company also holds stock in the Federal Home Loan Bank of Atlanta (“FHLB”) totaling $6.4 million as of December 31, 2010, $0.7 million less than at year-end 2009. The FHLB had eliminated its dividend for the first quarter of 2009 but has since reinstated dividends. The FHLB also instituted quarterly rather than daily repurchases of FHLB activity-based stock in February 2009. The Company accounts for its FHLB stock based on the industry guidance in ASC 942, Financial Services — Depository and Lending, which requires the investment to be carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We evaluated our holdings in FHLB stock at December 31, 2010 and believe our holdings in the stock are ultimately recoverable at par. We do not have operational or liquidity needs that would require redemption of the FHLB stock in the foreseeable future and, therefore, have determined that the stock is not other-than-temporarily impaired.

Realization of Deferred Tax Assets

 

At December 31, 2010, the Company has net deferred tax assets (“DTA”) of $18.9 million which are supported by tax planning strategies that could produce gains from transactions involving bank premises, investments, and other items that could be implemented during the NOL carry forward period. In comparison, at December 31, 2009 the Company had net deferred tax assets of $18.8 million.

 

As a result of the losses incurred in 2008, 2009, and 2010 the Company was and is in a three-year cumulative pretax loss position. A cumulative loss position is considered significant negative evidence in assessing the prospective realization of a DTA from a forecast of future taxable income. The use of the Company’s forecast of future taxable income was not considered positive evidence which could be used to offset the negative evidence at this time. Therefore, the Company has recorded deferred tax valuation allowances for its net operating loss carryforwards totaling approximately $48 million at December 31, 2010. Should the economy show signs of improvement and our credit costs continue to moderate, management anticipates that increased reliance on its forecast of future taxable earnings would result in tax benefits as the recording of valuation allowances would no longer be necessary. It is management’s opinion that Seacoast National’s future taxable income will ultimately allow for the recovery of the NOL, and the realization of its deferred tax assets.

 

Contingent Liabilities

 

The Company is subject to contingent liabilities, including judicial, regulatory and arbitration proceedings, and tax and other claims arising from the conduct of our business activities. These proceedings include actions brought against the Company and/or our subsidiaries with respect to transactions in which the Company and/or our subsidiaries acted as a lender, a financial advisor, a broker or acted in a related activity. Accruals are established for legal and other claims when it becomes probable the Company will incur an expense and the amount can be reasonably estimated. Company management, together with attorneys, consultants and other professionals, assesses the probability and estimated amounts involved in a contingency. Throughout the life of a contingency, the Company or our advisors may learn of additional information that can affect our assessments about probability or about the estimates of amounts involved. Changes in these assessments can lead to changes in recorded reserves. In addition, the actual costs of resolving these claims may be substantially higher or lower than the amounts reserved for those claims. At December 31, 2010 and 2009, the Company had no significant accruals for contingent liabilities.

 

Results of Operations

 

Earnings Summary

 

Net loss available to common shareholders for 2010 totaled $36,951,000 or $0.48 per average common diluted share, compared to 2009’s net loss of $150,434,000 or $4.74 per average common diluted share and 2008’s net loss of $45,712,000 or $2.41 per average common diluted share. The improved performance for 2010 from 2009 reflects lower credit costs, primarily through provisioning for loan losses.

Net Interest Income

 

Net interest income (on a fully taxable equivalent basis) for 2010 totaled $66,485,000, decreasing from 2009’s result by $7,362,000 or 10.0 percent. The following table details net interest income and margin results (on a tax equivalent basis) for the past five quarters:

 

 

Fully taxable equivalent net interest income is a common term and measure used in the banking industry but is not a term used under generally accepted accounting principles (“GAAP”). We believe that these presentations of tax-equivalent net interest income and tax equivalent net interest margin aid in the comparability of net interest income arising from both taxable and tax-exempt sources over the periods presented. We further believe these non-GAAP measures enhance investors’ understanding of the Company’s business and performance, and facilitate an understanding of performance trends and comparisons with the performance of other financial institutions. The limitations associated with these measures are the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently, including as a result of using different assumed tax rates. These disclosures should not be considered an alternative to GAAP. The following information is provided to reconcile GAAP measures and tax equivalent net interest income and net interest margin on a tax equivalent basis.

 

 

During 2010, net interest income and net interest margin (on a tax equivalent basis) have stabilized despite the challenging lending environment and the reduction of interest due to nonaccrual loans. Net interest margin on a tax equivalent basis decreased 18 basis points to 3.37 percent for 2010 compared to 2009. Increased nonaccrual loans and changes in the earnings assets mix have been the primary forces that have adversely affected our net interest income and net interest margin (on a tax equivalent basis) when comparing results for 2010 and 2009 to 2008 and prior periods.

 

The earning asset mix changed year over year impacting net interest income. For 2010, average loans (the highest yielding component of earning assets) as a percentage of average earning assets totaled 67.2 percent, compared to 76.3 percent a year ago. Average securities as a percent of average earning assets increased from 17.4 percent a year ago to 21.2 percent during 2010 and interest bearing deposits and other investments increased to 11.6 percent in 2010 from 6.3 percent in 2009. In addition to decreasing average total loans as a percentage of earning assets, the mix of loans changed, with commercial and commercial real estate volumes representing 51.6 percent of total loans at December 31, 2010 (compared to 55.1 percent at December 31, 2009). This reflects our reduced exposure to commercial construction and land development loans on residential and commercial properties, which declined by $33.6 million and $43.7 million, respectively, from

December 31, 2009 to December 31, 2010. Lower yielding residential loan balances with individuals (including home equity loans and lines, and personal construction loans) represented 44.2 percent of total loans at December 31, 2010 (versus 40.3 percent a year ago) (see “Loan Portfolio”).

 

The yield on earning assets for 2010 was 4.30 percent, 62 basis points lower than for 2009, a reflection of the lower interest rate environment and earning asset mix. The Federal Reserve decreased interest rates by 400 basis points during 2008 and has indicated its intent to continue rates at their historical lows for an extended period. The following table details the yield on earning assets (on a tax equivalent basis) for the past five quarters which shows that the margin has been stable over the last half of 2010:

 

 

The yield on loans decreased 10 basis points to 5.25 percent over the last twelve months, with nonaccrual loans totaling $68.3 million or 5.5 percent of total loans at December 31, 2010 (versus $97.9 million or 7.0 percent of total loans a year ago), improving the yield on our loan portfolio. The yield on investment securities was lower, decreasing 122 basis points year over year to 3.41 percent for 2010, due primarily to purchases of securities at lower yields available in current markets, which diluted the overall portfolio yield year over year. The dilution in yield on investment securities was less severe in the fourth quarter than over the past two quarters, with a decline of 108 basis points for fourth quarter 2010’s yield year over year, comparing to a decline of 156 basis points for the third quarter 2010 year over year, versus 140 basis points for second quarter 2010 year over year, and a decline of 78 basis points for the first quarter of 2010 year over year. Interest bearing deposits and other investments yielded 0.43 percent for 2010, below 2009’s yield of 0.51 percent. The Company has approximately $100 million of excess cash liquidity it can invest in securities or loans at higher yields when management deems it appropriate.

 

Average earning assets for 2010 decreased $106.9 million or 5.1 percent compared to 2009’s average balance. Average loan balances decreased $260.2 million or 16.4 percent to $1,327.1 million, while average investment securities were $54.2 million or 14.9 percent higher totaling $417.6 million and average interest bearing deposits and other investments increased $99.1 million or 75.7 percent to $229.9 million. The decline in average earning assets is consistent with reduced funding as a result of a planned reduction of brokered deposits (only $7.1 million remain outstanding at December 31, 2010), the maturity of a $15.0 million advance from the FHLB in November 2009, and lower sweep repurchase arrangements (declining $30.1 million from a year ago, principally in public funds as a result of lower tax receipts).

 

Commercial and commercial real estate loan production for 2010 totaled approximately $10 million, compared to production for 2009 of $14 million. In comparison, commercial and commercial real estate loan production for 2008 totaled $117 million. Period-end total loans outstanding have declined by $156.9 million or 11.2 percent since December 31, 2009, and declined similarly at year-end 2009 year over year, by $279.2 million or 16.7 percent. Economic conditions in the markets the Company serves are expected to continue to be challenging, and although we continue to make loans, these conditions are expected to have a negative impact on loan growth, but possibly to a lessened degree if the consensus opinion that conditions will improve in 2011 is realized. At December 31, 2010 the Company’s total commercial and commercial real estate loan pipeline was $28 million, versus $47 million at December 31, 2009.

 

A total of 37, 28, 15 and 21 applications were received seeking restructured residential mortgages during the first, second, third and fourth quarters of 2010, respectively, compared to 93, 102, 73 and 48 in the first, second, third and fourth quarters of 2009, respectively. The Company continues to lend, and we have expanded our residential mortgage loan originations and seek to expand loans to small businesses in 2011. However, as consumers and businesses seek to reduce their borrowings, and the economy remains weak, opportunities to lend prudently to creditworthy borrowers are expected to remain a challenge.

 

Closed residential mortgage loan production for the first, second, third and fourth quarters of 2010 totaled $33 million, $33 million, $38 million and $49 million, respectively, of which $22 million, $24 million, $28 million and $23 million was sold servicing-released, respectively. In comparison, $36 million in

residential loans were produced in the fourth quarter of 2009, of which $19 million was sold servicing-released $28 million in residential loans were produced in the third quarter of 2009, all of which was sold servicing-released, $43 million in residential loans were produced in the second quarter of 2009, of which $24 million was sold servicing-released, and $38 million in residential loans were produced in the first quarter of 2009, with $20 million sold servicing-released. Applications for residential mortgages totaled $244 million during 2010, compared to $268 million for 2009. Existing home sales and home mortgage loan refinancing activity in the Company’s markets have increased, but demand for new home construction is expected to remain soft into 2011.

 

During the first, second, and third quarters of 2010, proceeds from the sale of mortgage backed securities totaling $59.2 million, $27.9 million and $20.5 million, respectively, included securities gains of $2,100,000, $1,377,000 and $210,000, respectively. No sales occurred in the fourth quarter 2010. Because of historically tight spreads it was believed these securities had minimal opportunity to further increase in value. During 2010, maturities (primarily pay-downs of $136.0 million) totaled $141.9 million and securities portfolio purchases totaled $298.2 million. Purchases in 2010 were conducted principally to reinvest funds from maturities, and invest proceeds from loan sales and principal amortization, and the sale of the mortgage backed securities. In comparison, during the fourth, third and second quarters of 2009, the sale of mortgage backed securities totaling $33.8 million, $23.9 million and $29.5 million, respectively, resulted in securities gains of $2,188,000, $1,425,000 and $1,786,000 for each quarter. There were no investment sales in the first quarter 2009. Management believed these securities had minimal opportunity to further increase in value as well. During 2009, maturities (principally pay-downs of $81.4 million) totaled $105.0 million and securities portfolio purchases totaled $255.7 million. Securities purchases during 2009 were conducted to reinvest proceeds from the sale of securities, as well as maturities and pay-downs, and proceeds from pooled loan sales and loan principal reductions.

 

For 2010, the cost of average interest-bearing liabilities decreased 52 basis points to 1.13 percent from 2009, reflecting the lower interest rate environment and improved deposit mix. The following table details the cost of average interest bearing liabilities for the past five quarters:

 

 

During 2010, the Company’s retail core deposit focus continues to produce strong growth in core deposit customer relationships when compared to prior year results, and resulted in increased balances which offset most of the planned certificate of deposit runoff during 2010. The improved deposit mix and lower rates paid on interest bearing deposits during 2010 (and last several quarters) reduced the overall cost of interest bearing deposits to 0.92 percent for the fourth quarter of 2010, 43 basis points lower than [the same quarter] a year ago. A significant component favorably affecting the Company’s net interest margin, the average balances of lower cost interest bearing deposits (NOW, savings and money market) totaled 59.7 percent of total average interest bearing deposits for 2010, an improvement compared to the average of 53.3 percent a year ago. The average rate for lower cost interest bearing deposits for 2010 was 0.46 percent, down by 29 basis points from 2009’s rate. CD rates paid were also lower in 2010, averaging 1.97 percent, a 70 basis point decrease compared to 2009. Average CDs (the highest cost component of interest bearing deposits) were 40.3 percent of interest bearing deposits for 2010, compared to 46.7 percent for 2009.

 

Average deposits totaled $1,706.4 million during 2010, and were $72.6 million lower compared to 2009, due primarily to a planned reduction of brokered deposits and single service time deposit customers. Total average sweep repurchase agreements for 2010 were $30.1 million lower versus a year ago, a result of public fund customers maintaining larger balances in repurchase agreements during 2009. Average aggregate amounts for NOW, savings and money market balances increased $51.4 million or 6.4 percent to $852.8 million for 2010 compared to 2009, noninterest bearing deposits increased $1.3 million or 0.5 percent to $277.8 million for 2010 compared to 2009, and average CDs decreased by $125.3 million or 17.9 percent to $575.8 million over the same period. With the low interest rate environment and lower CD rate offerings available, customers have been more complacent and are leaving more funds in lower cost average balances in savings and other

liquid deposit products that pay no interest or a lower interest rate. Average deposits in the Certificate of Deposit Registry program (“CDARs”), a program that began in mid-2008 and allows customers to have CDs safely insured beyond the Federal Deposit Insurance Corporation (“FDIC”) deposit insurance limits, have declined $8.0 million from a year ago to $7.7 million for 2010. The higher balance during 2009 reflected the deposit retention efforts that occurred during the financial market disruption a year ago and emphasis on safety at that time. The CDARs product continues to be a favored offering for homeowners’ associations concerned with FDIC insurance coverage.

 

FDIC deposit insurance has been permanently increased from $100,000 to $250,000 per depositor based on recent legislation passed by Congress. The increase had been temporarily in place since October 14, 2008 and was set to expire on December 31, 2013. Under the FDIC’s Temporary Liquidity Guarantee, or “TLG”, program, the entire amount in any eligible noninterest bearing transaction deposit account is guaranteed by the FDIC to the extent such balances are not covered by FDIC insurance. Seacoast National is participating in the TLG program to offer the best possible FDIC coverage to its customers. The TLG program expired December 31, 2010, but provisions under the recent Dodd-Frank legislation will provide coverage for all noninterest bearing transaction account balances at all financial institutions through December 31, 2012.

 

Average short-term borrowings have been principally comprised of sweep repurchase agreements with customers of Seacoast National, which decreased $30.1 million to $87.1 million or 25.7 percent from 2009. Public fund clients with larger balances have the most significant influence on average sweep repurchase agreement balances outstanding during the year, with balances typically peaking during the fourth and first quarters each year. During 2010 and 2009, no federal funds purchased were utilized. Other borrowings are comprised of subordinated debt of $53.6 million related to trust preferred securities issued by trusts organized by the Company, and advances from the FHLB of $50.0 million. Other than the maturity of a $15.0 million FHLB advance in November 2009, no other changes have occurred to other borrowings since year-end 2007 (see “Note I — Borrowings” to the Company’s consolidated financial statements).

 

Company management believes its market expansion, branding efforts and retail deposit growth strategies have produced new relationships and core deposits, which have assisted in maintaining a stable net interest margin. Reductions in nonperforming assets also are expected to be accretive to the Company’s future net interest margin.

 

Net interest income (on a fully taxable equivalent basis) for 2009 totaled $73,847,000, decreasing from 2008 by $3,670,000 or 4.7 percent. Net interest margin on a tax equivalent basis declined three basis points in 2009 to 3.55 percent. Nonaccrual loans were the primary force that has adversely affected net interest income and net interest margin when comparing 2009 to 2008. During 2009, unrecognized interest on loans placed on nonaccrual of $6,602,000 was a primary contributor to the decline from the prior year (see “Table 14 — Nonperforming Assets”).

 

The earning asset mix changed in 2009 from 2008. For 2009, average loans (the highest yielding component of earning assets) as a percentage of average earning assets totaled 76.3 percent, compared to 84.2 percent in 2008. Average securities as a percent of average earning assets increased from 13.5 percent for 2008 to 17.4 percent during 2009 and federal funds sold and other investments increased to 6.3 percent from 2.3 percent in 2008. In addition to decreasing average total loans as a percentage of earning assets, the mix of loans changed, with commercial and commercial real estate volumes representing 55.1 percent of total loans at December 31, 2009 (compared to 58.4 percent at December 31, 2008). This reflected our reduced exposure to commercial construction and land development loans on residential and commercial properties, which declined by $82.3 million and $131.8 million, respectively, from December 31, 2008 to December 31, 2009. Lower yielding residential loan balances with individuals (including home equity loans and lines, and personal construction loans) represented 40.3 percent of total loans at December 31, 2009 (versus 37.2 percent at year-end 2008).

 

The yield on earning assets for 2009 was 4.92 percent, 97 basis points lower than for 2008, a reflection of the lower interest rate environment, as well as higher nonperforming loans. The yield on loans declined 77 basis points to 5.35 percent over the last twelve months for the same reasons noted above. Nonaccrual loans totaling $97.9 million or 7.0 percent of total loans at December 31, 2009, versus $87.0 million or

5.2 percent of total loans at year-end 2008, reducing the yield on the loan portfolio. The yield on investment securities was lower as well, decreasing 40 basis points year over year to 4.63 percent, due primarily to purchases of securities at lower yields available in current markets, which diluted the overall portfolio yield year over year. Federal funds sold and other investments yielded 0.51 percent for 2009, lower when compared to 2.46 percent for 2008. The dramatic reduction in interest rates during 2008, with the Federal Reserve lowering the target federal funds rate to 0 to 25 basis points and the Treasury yield curve shifting lower, limited opportunities to invest at higher interest rates.

 

Average earning assets for 2009 decreased $82.5 million or 3.8 percent compared to 2008. Average loan balances decreased $234.4 million or 12.9 percent to $1,587.3 million, while average investment securities were $70.9 million or 24.2 percent higher, totaling $363.3 million and average federal funds sold and other investments increased $81.0 million or 162.6 percent to $130.8 million. The decline in average earning assets was consistent with reduced funding as a result of deposit declines in the Company’s central Florida region (resulting from slower economic growth) and a planned reduction of brokered deposits.

 

Commercial and commercial real estate loan production for 2009 totaled $14 million. In comparison, commercial and commercial real estate loan production for 2008 totaled $117 million. Period-end total loans outstanding declined by $279.2 or 16.7 percent in 2009, and declined similarly during 2008 by $221.7 million or 11.7 percent. At December 31, 2009 the Company’s total commercial and commercial real estate loan pipeline was $47 million, versus $127 million at December 31, 2008.

 

The cost of average interest-bearing liabilities in 2009 decreased 113 basis points to 1.65 percent from 2008, reflecting the lower interest rate environment. During 2009, the Company’s retail core deposit focus produced strong growth in core deposit customer relationships when compared to 2008’s results, and resulted in increased balances which offset planned certificate of deposit runoff during all four quarters of 2009. A total of 7,045 new households were added in 2009. The improved deposit mix and lower rates paid on interest bearing deposits during 2009 reduced the overall cost of interest bearing deposits to 1.39 percent, 91 basis points lower than a year earlier. Still a significant component favorably affecting the Company’s net interest margin, the average balances of lower cost interest bearing deposits (NOW, savings and money market) totaled 53.3 percent of total average interest bearing deposits for 2009, although this was lower than the average of 57.9 percent a year ago, as a result of customers shifting balances from these lower rate products to certificates in this low interest rate environment. The average rate for lower cost interest bearing deposits for 2009 was 0.75 percent, down by 113 basis points from 2008’s rate. CD rates paid were also lower compared to 2008, lower by 124 basis points and averaging 2.67 percent for 2009. Average CDs (the highest cost component of interest bearing deposits) were 46.7 percent of interest bearing deposits for 2009, compared to 42.1 percent for 2008.

 

Average deposits totaled $1,778.9 million during 2009, and were $109.3 million lower compared to 2008, due primarily to deposit declines in the Company’s central Florida region and a planned reduction of brokered deposits. Total average sweep repurchase agreements for 2009 were $26.0 million higher as a result of normal seasonal funding trends for public fund customers. Total average deposits plus sweep repurchase agreements of $1,896.1 million during 2009 were down $83.3 million or 4.2 percent from 2008’s average. The average aggregate amounts of NOW, savings and money market balances decreased $116.2 million or 12.7 percent to $801.4 million for 2009 compared to 2008, noninterest bearing deposits decreased $26.2 million or 8.6 percent to $276.4 million, and average CDs increased by $33.0 million or 4.9 percent to $701.1 million. As a result of the low interest rate environment, customers deposited more funds into CDs during 2009, while maintaining lower average balances in savings and other liquid deposit products that pay no interest or a lower interest rate. In addition, Seacoast National joined the CDARS program on July 1, 2008, which allows customers to have CDs safely insured beyond the FDIC deposit insurance limits. This benefited deposit retention efforts during the financial market disruption and provided a new product offering to homeowners’ associations concerned with FDIC insurance coverage.

 

During 2009, average short-term borrowings increased $26.0 million or 28.6 percent from 2008. Most of the increase in average sweep repurchase agreement balances was due to efforts to reduce FDIC insurance costs by migrating public fund deposits beginning late in the fourth quarter of 2008.

Noninterest Income

 

Noninterest income, excluding gains or losses from securities, totaled $19,245,000 for 2010, $230,000 or 1.2 percent higher than for 2009. For 2009, noninterest income of $19,015,000, was $3,226,000, or 14.5 percent lower than for 2008. Noninterest income accounted for 22.5 percent of total revenue (net interest income plus noninterest income, excluding securities gains or losses) in 2010, compared to 20.5 percent a year ago and 22.4 percent in 2008.

 

Table 6 provides detail regarding noninterest income components for the past three years.

 

For 2010, revenues from the Company’s wealth management services businesses (trust and brokerage) decreased year over year, by $363,000 or 10.3 percent, and were lower in 2009 than for 2008 by $927,000 or 20.9 percent. Included in the $363,000 decrease, trust revenue was lower by $121,000 or 5.8 percent and brokerage commissions and fees were lower by $242,000 or 17.1 percent. Economic uncertainty is the primary issue affecting clients of the Company’s wealth management services. It is expected that fees from wealth management will improve as the economy and stock market improve. Of the $927,000 decrease during 2009, trust revenue was lower by $246,000 or 10.5 percent and brokerage commissions and fees were lower by $681,000 or 32.5 percent. Included in the $681,000 decline in brokerage commissions and fees for 2009 was a decline of $410,000 in revenue from insurance annuity sales year over year reflecting the lower interest rate environment, and a $229,000 reduction in mutual fund commissions. Lower inter vivos trust and agency fees were the primary cause for the decline in trust income during 2009, as these decreased $48,000 and $241,000, respectively, from 2008, as well as lower testamentary fee income, which decreased $26,000. Estate income was partially offsetting, increasing by $94,000 from 2008’s results.

 

Service charges on deposits for 2010 were $566,000 or 8.7 percent lower year over year versus 2009’s result, and were $898,000 or 12.2 percent lower in 2009 year over year versus 2008. Overdraft income was the primary cause, declining $444,000 during 2010 compared to 2009, and declining $826,000 in 2009 compared to 2008. Overdraft fees represented approximately 76 percent of total service charges on deposits for 2010, comparable with the average for all of 2009 and slightly lower than the 78 percent average for 2008. We are pleased with this result for 2010 considering all financial institutions adopted procedures beginning on July 1, 2010 expected to result in a negative impact on overdraft fee income. Service charges on deposits increased each quarter throughout 2010 reflecting the growth in core deposit households over the last two years. Growth rates for remaining service charge fees on deposits have been nominal or declining, as the trend over the past few years is for customers to prefer deposit products which have no fees or where fees can be avoided by maintaining higher deposit balances.

 

For 2010, fees from the non-recourse sale of marine loans originated by our Seacoast Marine Division of Seacoast National increased $181,000 or 15.7 percent compared to 2009, versus a decrease of $1,151,000, or 50.0 percent compared to 2008. The Seacoast Marine Division originated $25 million, $17 million, $17 million and $20 million in loans during the first, second, third and fourth quarters of 2010 (a total of $79 million for 2010), respectively, compared to $20 million in loans originated in the first and second quarters of 2009, $15 million during the third quarter of 2009, and $15 million during the fourth quarter of 2009 (a total of $70 million for 2009). These production levels are significantly lower than loan production of $143 million during 2008 and 2007, respectively, and are reflective of the general economic downturn. Of the loans originated during the first, second, third and fourth quarters of 2010, $20 million, $17 million, $17 million and $20 million were sold (93.7 percent of production). This compares to sales as a percentage of production of 97.1 percent and 99.3 percent for all of 2009 and 2008, respectively. As economic conditions deteriorated over 2008, attendance at boat shows by consumers, manufacturers, and marine retailers was lower than in prior years, and as a result marine sales and loan volumes related to such sales were lower. The Seacoast Marine Division is headquartered in Ft. Lauderdale, Florida with lending professionals in Florida, California, Washington and Oregon.

 

Greater usage of check or debit cards over the past several years by core deposit customers and an increased cardholder base has increased our interchange income. For 2010, debit card income increased $550,000 or 21.0 percent from 2009, and was $160,000 or 6.5 percent higher for 2009, compared to 2008’s income. Other deposit-based electronic funds transfer (“EFT”) income decreased $10,000 or 3.0 percent in

2010 compared to 2009, after decreasing $28,000 or 7.8 percent in 2009 compared to 2008’s revenue. Debit card and other deposit-based EFT revenue is dependent upon business volumes transacted, as well as the fees permitted by VISA^® and MasterCard^®. During 2009, our other deposit-based EFT income was adversely affected by lower fees from non-customers utilizing Seacoast National’s automatic teller machines (“ATMs”) which likely reflected the economic recession and decreased tourist and vacation activity. It is uncertain how the Dodd-Frank regulation will impact this source of fee revenue in 2011 and beyond but it is expected to reduce fees collected by financial institutions.

 

Merchant income was $450,000 or 25.5 percent lower for 2010, compared to one year earlier, and was $635,000 or 26.5 percent lower for 2009 versus 2008’s result. Merchant income as a source of revenue is dependent upon the volume of credit card transactions that occur with merchants who have business demand deposits with Seacoast National. Merchant income historically has been highest in the first quarter each year, reflecting seasonal sales activity. During the fourth quarter of 2010, the merchant portfolio was sold for a gain of $600,000, recorded in other income for the quarter. The sale in the fourth quarter reduced income for the quarter by approximately $200,000. Seacoast National will receive fee income for new accounts opened prospectively and will have more competitive offerings for current and new customers. In addition, this will reduce annual revenue by approximately $1.3 million and expenses by nearly the same amount as the margin earned on this business was very thin.

 

The Company originates residential mortgage loans in its markets, with loans processed by commissioned employees of Seacoast National. Many of these mortgage loans are referred by the Company’s branch personnel. Mortgage banking fees in 2010 increased $373,000 or 21.4 percent from 2009, and were $628,000 or 56.2 percent higher for 2009 than for 2008. Mortgage banking revenue as a component of overall noninterest income was 11.0 percent for 2010, improving from 9.2 percent for all of 2009 and 5.2 percent for 2008. Sales of residential loans for the fourth quarter of 2010 totaled $23 million, compared to $22 million, $24 million and $28 million in the first, second and third quarters of 2010, respectively. Sales of residential loans in 2009 totaled $91 million, versus $50 million in 2008. Mortgage revenues are dependent upon favorable interest rates, as well as good overall economic conditions, including the volume of new and used home sales. We are beginning to see some signs of stability for residential real estate sales and activity in our markets, with transactions increasing, prices firming and affordability improving. The Company had more mortgage loan origination opportunities in markets it serves during 2009 and this continued in 2010. The Company also began offering FHA loans during the second quarter of 2009, a product previously not offered. The Company increased production in 2010 by increasing its market share and the Company was the number one originator in its Martin, St. Lucie and Indian River counties of home purchase mortgages. The Company has never had to repurchase a sold mortgage loan and believes that its processes and controls make it unlikely that it has any material exposure in the future.

 

Other income for 2010 increased $515,000 or 36.7 percent compared to a year ago, and for 2009 decreased $375,000 or 21.1 percent compared to 2008’s result Fourth quarter 2010 included a $600,000 gain on the sale of the merchant portfolio. Partially offsetting for 2010, operating income from check charges and letter of credit fees declined year over year by $51,000 and $11,000, and most other line items in other income were slightly lower, including wire transfer fees, income from sales of cashiers checks and money orders, and miscellaneous other fees. The comparison of other income between 2009 and 2008 was affected by $305,000 of additional income realized upon the redemption of Visa^® Inc. shares in the first quarter of 2008 as part of Visa’s initial public offering.

 

Noninterest Expenses

 

The Company’s overhead ratio has typically been in the low 60’s in recent years. However, lower earnings in 2010, 2009, and 2008 resulted in this ratio increasing to 104.6 percent, 86.9 percent and 77.8 percent, respectively. When compared to 2009, total noninterest expenses for 2010 decreased by $41,080,000 or 31.2 percent to $90,667,000, and when comparing 2009 to 2008, total noninterest expenses increased $52,857,000 to $131,747,000. Noninterest expenses for 2009 included a write-down of goodwill of $49,813,000. Without the impact of this write-down of goodwill, noninterest expenses for 2010 were $8,733,000 or 10.7 percent higher than 2009 and $3,044,000 or 3.9 percent higher for 2009 versus 2008. The

primary cause for the increase in 2010 over 2009 was higher net losses on OREO and repossessed assets and asset disposition costs (aggregated) of $3,571,000 recorded in the first quarter of 2010, which together with second and third quarter 2010’s decreases in losses year over year of $1,025,000 and $629,000, respectively, and a fourth quarter increase of $7,565,000, totaled a $9,482,000 increase for the 2010. Noninterest expenses for 2009 also included a special assessment imposed by the FDIC in the second quarter totaling $996,000, and deposit insurance premiums that were $1,928,000 higher due to the FDIC’s deposit insurance premium rates more than doubling.

 

Noninterest expenses for 2010 have been in line with our expectations. Salaries, wages and benefits were $677,000 or 2.1 percent lower for 2010 compared to the same period in 2009. Cost reductions were also achieved in outsourced data processing, communication costs, occupancy, and furniture and equipment expenses, all of which declined when comparing 2010’s results to 2009. Salaries, wages and benefits (excluding one-time severance payments) were also $4,909,000 or 13.2 percent lower for 2009 compared to the same period in 2008, reflecting the elimination of bonus compensation for most positions and profit sharing contributions for all associates, reductions in matching contributions associated with salary savings plans, lower credit related costs, executive retirements, job eliminations, branch consolidation(s), freezing of executive salaries, and reduced salary increases for other associates. Executive cash incentive compensation was not paid in 2010, 2009 or 2008. Cost reductions were also achieved in data processing, furniture and equipment expenses, and marketing, all of which declined during 2009 when compared to 2008.

 

Table 7 provides detail of noninterest expense components for the years ending December 31, 2010, 2009 and 2008.

 

Salaries and wages for 2010 decreased $285,000 or 1.1 percent to $26,408,000 compared to the prior year, and for 2009 were $3,466,000 or 11.5 percent lower when compared to 2008’s salary costs. Severance during 2010 was $243,000 lower in 2010 than a year ago. Savings from the branch closures in 2009 and lower commission payments due to lower revenues generated from wealth management and weak lending production were also causes for the decrease for 2010, compared to 2009. Reduced headcount (including the branch consolidations in 2008) and limited accruals for incentive payments due to lower revenues generated from wealth management and weak lending production were the primary causes of decreases in 2009 compared to 2008. Severance payments during 2009 totaled $582,000, which were $379,000 more than in 2008. Base salaries for 2009 were $2,563,000 or 9.3 percent lower year over year compared to 2008 when 446 FTE’s were employed.

 

As a recipient of funding from the U.S. Treasury’s TARP Capital Purchase Program (“CPP”), the Company is subject to various limitations on senior executive officers’ compensation pursuant the U.S. Treasury’s standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds equity pursuant to the TARP CPP, including common stock which may be issued pursuant to the Warrant issued by the Company to the U.S. Treasury. These standards generally apply to the Company’s chief executive officer, chief financial officer and the three next most highly compensated senior executive officers (see “The TARP CPP, the ARRA and other proposed rules impose certain executive compensation and corporate governance requirements that may adversely affect us and our business, including our ability to recruit and retain qualified employees” under “Part II Other Information, Item 1A. Risk Factors” on the Company’s Form 10K filed for December 31, 2010).

 

In 2010, employee benefits costs decreased by $392,000 or 6.4 percent to $5,717,000 from a year ago, and were lower by $1,064,000 or 14.8 percent for 2009 when compared to 2008. The Company recognized lower claims experience in 2010 for its self-funded health care plan compared to 2009, with a decrease of $397,000 in expenditures. In addition, 401K costs were $43,000 lower for 2010 versus a year ago and payroll taxes decreased by $28,000, reflecting lower FTEs for 2010. Partially offsetting, unemployment compensation costs were $76,000 higher year over year for 2010 due to the state of Florida increasing rates to replenish funding pools for compensation disbursements. For 2009, the Company recognized higher claims experience in the first six months of the year for its self-funded health care plan compared to 2008, with the expectation that these costs would be lower in future periods due to lower FTE’s resulting in fewer participants in the plan for 2009 and larger discounts on services under a more comprehensive network of providers. During the third

and fourth quarters of 2009, the Company had improved experience, with group health care costs declining $385,000 or 19.6 percent compared to 2008’s third and fourth quarters (combined). In addition, the Company achieved a $141,000 reduction in payroll taxes year over year compared to 2008 and profit sharing accruals for the Company’s 401K plan were reduced by $945,000 during 2009, versus 2008. The Company met with its self-funded plan provider and discussed possible impacts of U.S. Health Care Reform and determined that no immediate or material financial statement impacts are apparent.

 

Outsourced data processing costs totaled $7,092,000 for 2010, a decrease of $51,000 or 0.7 percent from a year ago. In comparison, for 2009 outsourced data processing costs totaled $7,143,000, a decrease of $469,000 or 6.2 percent from 2008’s result. Seacoast National utilizes third parties for its core data processing systems and merchant services processing. Outsourced data processing costs are directly related to the number of transactions processed. Merchant services processing expenses were $409,000 lower than a year ago for 2009, and with the sale of the merchant portfolio in the fourth quarter of 2010 will no longer be incurred prospectively. Partially offsetting, core data processing and check card processing costs were $285,000 and $48,000 higher for 2010, versus a year ago. For 2009, merchant services processing expenses were $531,000 lower than for 2008, and the primary cause for the overall reduction. Outsourced data processing costs can be expected to increase as the Company’s business volumes grow and new products such as bill pay, internet banking, etc. become more popular.

 

Telephone and data line expenditures, including electronic communications with customers and between branch locations and personnel, as well as third party data processors, decreased by $330,000 or 18.0 percent to $1,505,000 for 2010 when compared to 2009, and for 2009 were $61,000 or 3.2 percent lower than for 2008. Improved systems and monitoring of services utilized as well as reducing the number telephone lines (in part due to our branch consolidations) has reduced our communication costs, and these costs should continue to be lower prospectively.

 

Total occupancy, furniture and equipment expenses for 2010 decreased $1,031,000 or 9.5 percent to $9,878,000, year over year, versus 2009. For 2009, these costs were $224,000 or 2.0 percent lower compared to 2008. Branch consolidations and closures were the primary contributors to the reduction in cost during 2010 and 2009. Included in the $1,031,000 decrease during 2010 were lease payments for bank premises decreasing $292,000, and lower depreciation, utility costs (power, lights and water) and real estate taxes, declining $386,000, $181,000 and $174,000, respectively. Office relocation costs were lower as well, by $28,000 during 2010 compared to 2009. Included in the $224,000 decrease during 2009 were lease payments for bank premises decreasing $138,000 and repair and maintenance costs declining $117,000.

 

For 2010, marketing expenses, including sales promotion costs, ad agency production and printing costs, newspaper and radio advertising, and other public relations costs associated with the Company’s efforts to market products and services, increased by $843,000 or 40.8 percent to $2,910,000 when compared to 2009. Marketing expense for 2010 reflects a focused campaign in our markets targeting the customers of competing financial institutions and promoting our brand. Agency production costs (primarily related to newly created television ads), as well as media costs (newspaper, television and radio advertising), direct mail activities, and sales promotions have been ramped up the most during 2010 versus a year ago, by $255,000, $111,000, $217,000 and $157,000, respectively. Also increasing were business meals and entertainment expenditures and public relations costs (up $66,000 and $51,000, respectively), partially offset by printing related costs for brochures and other marketing materials (declining $35,000 on an aggregate basis). In comparison, for 2009, marketing expenses decreased by $547,000 or 20.9 percent to $2,067,000 when compared to 2008. Agency production, printing and media costs (including newspaper, radio and television) were $273,000 lower for 2009, compared to 2008, and public relations, business meals and donations were lower by $116,000, $92,000 and $67,000, respectively, compared to 2008.

 

Legal and professional fees increased by $993,000 or 14.2 percent to $7,977,000 for 2010, compared to a year ago for 2009, and were $1,322,000 or 23.3 percent greater for 2009, versus 2008. Legal fees were $493,000 lower for 2010 year over year, but were $1,221,000 higher for 2009 compared to 2008, primarily due to costs related to problem assets, principally OREO. Compared to 2009, regulatory examination fees and CPA fees on an aggregate basis were $63,000 higher for 2010. Professional fees were $1,422,000 higher in

2010 versus 2009 and were $227,000 higher in 2009 than for 2008, reflecting strategic planning and risk management assistance. Professional fees have generally been higher during this period of increased regulatory compliance. The Company also uses the consulting services of a former bank regulator who also serves as a director of Seacoast National to assist it with its compliance with the bank’s formal agreement with the OCC and regulatory examinations. For 2010, 2009 and 2008, Seacoast National paid $524,000, $410,000 and $211,000, respectively, for these services.

 

The FDIC assessment for the fourth quarter of 2010 totaled $947,000, compared to first, second and third quarter 2010’s assessments of $1,006,000, $1,039,000 and $966,000, respectively. FDIC assessments for the first, second, third and fourth quarters of 2009 totaled $877,000, $2,026,000, $1,007,000 and $1,042,000, respectively. For 2008, assessments for the year summed to only $2,028,000. The second quarter 2009 assessment included a special assessment of $976,000, based upon 5 basis points of total assets less Tier 1 risk-based capital. In addition, on April 1, 2009 a higher base assessment went into effect as well as the FDIC’s implementation of a more complex risk-based formula to calculate assessments. The FDIC also mandated the prepayment of assessments for the next three years plus fourth quarter 2009’s assessment that was remitted on December 30, 2009. The amount of the prepayment totaled $14.8 million. The Company anticipates that FDIC insurance costs are likely to remain elevated, with assessments possibly increasing even more depending on the severity of bank failures and their impact on the FDIC’s Deposit Insurance Fund.

 

Net losses on other real estate owned (OREO) and repossessed assets, and asset disposition expenses associated with the management of OREO and repossessed assets (aggregated) totaled $4,073,000, $415,000, $1,436,000 and $9,885,000 for the first, second, third and fourth quarters of 2010, respectively, compared to $502,000, $1,440,000, $2,065,000 and $2,320,000 for the same periods in 2009, and totaled $1,424,000 for all of 2008. These costs moderated somewhat during the second and third quarters of 2010. Of the $15,809,000 total for 2010, assets disposition costs summed to $2,268,000 and net losses on OREO and repossessed assets totaled $13,541,000. These costs will likely continue to be higher into 2011 as problem assets migrate toward liquidation.

 

Other noninterest expenses increased $498,000 or 5.6 percent to $9,413,000 when comparing 2010 to a year ago, and were lower in 2009 compared to 2008 by $274,000 or 3.0 percent, at $8,915,000. One-time settlements regarding a branch lease terminated in 2009 and a customer dispute for $150,000 and $350,000, respectively, recorded in 2010 were the primary contributors to the increase year over year for 2010. Also increasing year over year for 2010 were employee placement and relocation fees (up $268,000, including headhunter fees), insurance (up $273,000, including property and casualty as well as other liability coverage), credit information costs (up $91,000), check printing costs (up $91,000), and dealer referral fees (up $105,000, related to marine lending). Partially offsetting, stationery and supplies expenditures were lower in 2010 (down $107,000), as were charge-offs related to robbery and customer fraud (down $220,000), memberships, books and publications (down $51,000), property appraisals (down $135,000) and amortization of intangibles (down $274,000). Increasing year over year for 2009 were correspondent bank clearing charges (up $174,000, because lower analysis credits provided for compensating balances in the current lower interest rate environment make the payment of charges more sensible), directors’ fees (up $185,000, reflecting more frequent meetings than in 2008), employee placement fees (up $129,000, principally headhunter fees), and higher losses associated with robbery and customer fraud (up $142,000). More than offsetting were decreases in expenditures for stationery and supplies (down $204,000), postage and courier costs (down $97,000, primarily overnight services), insurance costs (down $106,000, including property and casualty as well as other liability coverage), education (down $37,000, with fewer education programs offered internally), travel related costs (down $172,000, including mileage reimbursement, airline and hotel costs), bank paid closing costs (down $108,000, as home equity line closing costs paid by Seacoast National were limited), and origination fees for marine loan production (down $148,000). Benefiting 2008’s first quarter was a $130,000 reversal of an accrual for the Company’s portion of Visa^® litigation and settlement costs, as a result of Visa’s successful initial public offering (IPO).

Interest Rate Sensitivity

 

Fluctuations in interest rates may result in changes in the fair value of the Company’s financial instruments, cash flows and net interest income. This risk is managed using simulation modeling to calculate the most likely interest rate risk utilizing estimated loan and deposit growth. The objective is to optimize the Company’s financial position, liquidity, and net interest income while limiting their volatility.

 

Senior management regularly reviews the overall interest rate risk position and evaluates strategies to manage the risk. The Company’s most recent Asset and Liability Management Committee (“ALCO”) model simulation indicates net interest income would increase 8.9 percent if interest rates are shocked 200 basis points up over the next 12 months and 3.7 percent if interest rates are shocked up 100 basis points. Prior discussions focused on rates gradually increasing over the projected period, however recent regulatory guidance has placed more emphasis on rate shocks.

 

The Company had a negative gap position based on contractual and prepayment assumptions for the next 12 months, with a negative cumulative interest rate sensitivity gap as a percentage of total earning assets of 25.3 percent at December 31, 2010 (see “Table 19 — Interest Rate Sensitivity Analysis”), compared to a negative gap of 24.7 percent a year ago.

 

The computations of interest rate risk do not necessarily include certain actions management may undertake to manage this risk in response to changes in interest rates. Derivative financial instruments, such as interest rate swaps, options, caps, floors, futures and forward contracts may be utilized as components of the Company’s risk management profile.

 

Market Risk

 

Market risk refers to potential losses arising from changes in interest rates, and other relevant market rates or prices.

 

Interest rate risk, defined as the exposure of net interest income and Economic Value of Equity, or “EVE,” to adverse movements in interest rates, is the Company’s primary market risk, and mainly arises from the structure of the balance sheet (non-trading activities). The Company is also exposed to market risk in its investing activities. The Company’s Asset/Liability Committee, or “ALCO,” meets regularly and is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. The policies established by the ALCO are reviewed and approved by the Company’s Board of Directors. The primary goal of interest rate risk management is to control exposure to interest rate risk, within policy limits approved by the Board. These limits reflect the Company’s tolerance for interest rate risk over short-term and long-term horizons.

 

The Company also performs valuation analyses, which are used for evaluating levels of risk present in the balance sheet that might not be taken into account in the net interest income simulation analyses. Whereas net interest income simulation highlights exposures over a relatively short time horizon, valuation analysis incorporates all cash flows over the estimated remaining life of all balance sheet positions. The valuation of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows minus the discounted value of liability cash flows, the net result of which is the EVE. The sensitivity of EVE to changes in the level of interest rates is a measure of the longer-term re-pricing risks and options risks embedded in the balance sheet. In contrast to the net interest income simulation, which assumes interest rates will change over a period of time, EVE uses instantaneous changes in rates. EVE values only the current balance sheet, and does not incorporate the growth assumptions that are used in the net interest income simulation model. As with the net interest income simulation model, assumptions about the timing and variability of balance sheet cash flows are critical in the EVE analysis. Particularly important are the assumptions driving prepayments and the expected changes in balances and pricing of the indeterminate life deposit portfolios. Based on our most recent modeling, an instantaneous 100 basis point increase in rates is estimated to decrease the EVE 3.4 percent versus the EVE in a stable rate environment, while a 200 basis point increase in rates is estimated to decrease the EVE 5.9 percent.

While an instantaneous and severe shift in interest rates is used in this analysis to provide an estimate of exposure under an extremely adverse scenario, a gradual shift in interest rates would have a much more modest impact. Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon, i.e., the next fiscal year. Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, change in yield curve relationships, and changing product spreads that could mitigate the adverse impact of changes in interest rates.

 

Liquidity Risk Management and Contractual Commitments

 

Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liability, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost effectively and to meet current and future potential obligations such as loan commitments and unexpected deposit outflows.

 

In the table that follows, all deposits with indeterminate maturities such as demand deposits, NOW accounts, savings accounts and money market accounts are presented as having a maturity of one year or less.

 

Contractual Commitments

 

 

Funding sources primarily include customer-based core deposits, collateral-backed borrowings, cash flows from operations, and asset securitizations and sales.

 

Cash flows from operations are a significant component of liquidity risk management and we consider both deposit maturities and the scheduled cash flows from loan and investment maturities and payments. Deposits are also a primary source of liquidity. The stability of this funding source is affected by numerous factors, including returns available to customers on alternative investments, the quality of customer service levels, safety and competitive forces. We routinely use securities and loans as collateral for secured borrowings. In the event of severe market disruptions, we have access to secured borrowings through the FHLB and the Federal Reserve Bank of Atlanta.

 

Contractual maturities for assets and liabilities are reviewed to meet current and expected future liquidity requirements. Sources of liquidity, both anticipated and unanticipated, are maintained through a portfolio of high quality marketable assets, such as residential mortgage loans, securities held for sale and interest bearing deposits. The Company also has access to borrowed funds such as an FHLB line of credit and the Federal Reserve Bank of Atlanta under its borrower-in-custody program. The Company is also able to provide short term financing of its activities by selling, under an agreement to repurchase, United States Treasury and Government agency securities not pledged to secure public deposits or trust funds. At December 31, 2010, Seacoast National had available lines of credit under current lendable collateral value, which are subject to change, of $340 million. Seacoast National had $120 million of United States Treasury and Government agency securities and mortgage backed securities not pledged and available for use under repurchase agreements, and had an additional $212 million in residential and commercial real estate loans available as collateral. In comparison, at December 31, 2009, the Company had available lines of credit of $293 million,

and had $24 million of Treasury and Government agency securities and mortgage backed securities not pledged and available for use under repurchase agreements, as well as an additional $237 million in residential and commercial real estate loans available as collateral.

 

Liquidity, as measured in the form of cash and cash equivalents (including interest bearing deposits), totaled $211,405,000 on a consolidated basis at December 31, 2010 as compared to $215,100,000 at December 31, 2009. The composition of cash and cash equivalents has changed from a year ago. During 2010, cash and due from banks increased $3,158,000 to $35,358,000 while interest bearing deposits decreased to $176,047,000 from $182,900,000. The interest bearing deposits are maintained in Seacoast National’s account at the Federal Reserve Bank of Atlanta. Cash and cash equivalents vary with seasonal deposit movements and are generally higher in the winter than in the summer, and vary with the level of principal repayments and investment activity occurring in Seacoast National’s securities and loan portfolios.

 

The Company does not rely or is dependent on off-balance sheet financing or wholesale funding.

 

The Company is a legal entity separate and distinct from Seacoast National and its other subsidiaries. Various legal limitations, including Section 23A of the Federal Reserve Act and Federal Reserve Regulation W, restrict Seacoast National from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company has traditionally relied upon dividends from Seacoast National and securities offerings to provide funds to pay the Company’s expenses, to service the Company’s debt and to pay dividends upon Company common stock. In 2008 and 2007, Seacoast National paid dividends to the Company that exceeded its earnings in those years. Seacoast National cannot currently pay dividends to the Company without prior OCC approval. At December 31, 2010, the Company had cash and cash equivalents at the parent of approximately $21.6 million, comprised of remaining proceeds from our common stock offering which was consummated in the second quarter of 2010. In comparison, at December 31, 2009, the Company had cash and cash equivalents at the parent of approximately $13.1 million, comprised of remaining funds provided through a common stock offering consummated in August 2009. All of the TARP CPP funds derived in December 2008 have been contributed as additional capital to Seacoast National. The Company has suspended all dividends upon its Series A preferred stock issued through the TARP CPP and its common stock, and has deferred distributions on its subordinated debt related to trust preferred securities issued through affiliated trusts. Additional losses could prolong Seacoast National’s inability to pay dividends to its parent without regulatory approval (see “Capital Resources”).

 

Off-Balance Sheet Transactions

 

In the normal course of business, we engage in a variety of financial transactions that, under generally accepted accounting principles, either are not recorded on the balance sheet or are recorded on the balance sheet in amounts that differ from the full contract or notional amounts. These transactions involve varying elements of market, credit and liquidity risk.

 

The two primary off-balance sheet transactions the Company has engaged in are:

 

 

Derivative transactions are often measured in terms of a notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instruments. The notional amount is not usually exchanged, but is used only as the basis upon which interest or other payments are calculated.

 

The derivatives the Company uses to manage exposure to interest rate risk are interest rate swaps. All interest rate swaps are recorded on the balance sheet at fair value with realized and unrealized gains and losses included either in the results of operations or in other comprehensive income, depending on the nature and purpose of the derivative transaction.

The credit risk of these transactions is managed by establishing a credit limit for counterparties and through collateral agreements. The fair value of interest rate swaps recorded in the balance sheet at December 31, 2010 included derivative product assets of $38,000. In comparison, at December 31, 2009 net derivative product assets of $24,000 were outstanding.

 

Lending commitments include unfunded loan commitments and standby and commercial letters of credit. A large majority of loan commitments and standby letters of credit expire without being funded, and accordingly, total contractual amounts are not representative of our actual future credit exposure or liquidity requirements. Loan commitments and letters of credit expose the Company to credit risk in the event that the customer draws on the commitment and subsequently fails to perform under the terms of the lending agreement.

 

Loan commitments to customers are made in the normal course of our commercial and retail lending businesses. For commercial customers, loan commitments generally take the form of revolving credit arrangements. For retail customers, loan commitments generally are lines of credit secured by residential property. These instruments are not recorded on the balance sheet until funds are advanced under the commitment. For loan commitments, the contractual amount of a commitment represents the maximum potential credit risk that could result if the entire commitment had been funded, the borrower had not performed according to the terms of the contract, and no collateral had been provided. Loan commitments were $90 million at December 31, 2010, and $97 million at December 31, 2009 (see “Note P-Contingent Liabilities and Commitments with Off-Balance Sheet Risk” to the Company’s consolidated financial statements).

 

Income Taxes

 

No income tax benefit was recorded for the first, second, third or fourth quarters of 2010, consistent with the third and fourth quarters of 2009. In comparison, an income tax benefit of $3.1 million and $8.7 million was recorded for the first and second quarters of 2009, respectively. The income tax benefit for 2009 was 7.6 percent of loss before taxes, and compared to 32.6 percent for 2008.

 

The tax benefit for the net loss for the first, second, third and fourth quarters of 2010 totaled $0.6 million, $5.3 million, $2.8 million and $3.9 million, respectively. The deferred tax valuation allowance was increased by a like amount, and therefore there was no change in the carrying value of deferred tax assets which are supported by tax planning strategies (see “Critical Accounting Estimates — Deferred Tax Assets”). The tax benefit for the net loss for the third and fourth quarters of 2009 totaled $29.7 million, and also was offset by a valuation allowance of a like amount. As the economy shows signs of improvement and our credit costs moderate, we anticipate that we will be able to place increased reliance on our forecast of future taxable earnings, which would result in realization of future tax benefits (see “Note L — Income Taxes” to the Company’s consolidated financial statements).

 

Capital Resources

 

Table 8 summarizes the Company’s capital position and selected ratios. The Company’s equity capital at December 31, 2010 totaled $166.3 million and the ratio of shareholders’ equity to period end total assets was 8.25 percent, compared with 7.06 percent at December 31, 2009, and 9.33 percent at December 31, 2008. Seacoast’s management uses certain “non-GAAP” financial measures in its analysis of the Company’s performance. Seacoast’s management uses this measure to assess the quality of capital and believes that investors may find it useful in their analysis of the Company. This capital measure is not necessarily comparable to similar capital measures that may be presented by other companies.

 

The Company’s capital position remains strong, meeting the general definition of “well capitalized”, with a total risk-based capital ratio of 17.84 percent at December 31, 2010, higher than December 31, 2009’s ratio of 15.16 percent and higher than 14.00 percent at December 30, 2008. The Bank agreed with its primary regulator, the OCC, to maintain a Tier 1 capital (to adjusted average assets) (“leverage ratio”) ratio of at least 7.50 percent and a total risk-based capital ratio of at least 12.00 percent as of March 31, 2009 . Subsequently, as of January 31, 2010, following our capital raise, the Bank agreed to maintain a leverage ratio minimum of

8.50 percent. As of December 31, 2010, the Bank’s leverage ratio was 9.29 percent, compared to 8.43 percent at December 31, 2009 and 7.80 percent and December 31, 2008. The agreement with the OCC as to minimum capital ratios does not change the Bank’s status as “well-capitalized” for bank regulatory purposes, to which the Bank is currently in compliance.

 

The Company and Seacoast National are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal bank regulatory authority may prohibit the payment of dividends where it has determined that the payment of dividends would be an unsafe or unsound practice. The Company is a legal entity separate and distinct from Seacoast National and its other subsidiaries, and the Company’s primary source of cash and liquidity, other than securities offerings and borrowings, is dividends from its bank subsidiary. Prior OCC approval presently is required for any payments of dividends from Seacoast National to the Company.

 

The OCC and the Federal Reserve have policies that encourage banks and bank holding companies to pay dividends from current earnings, and have the general authority to limit the dividends paid by national banks and bank holding companies, respectively, if such payment may be deemed to constitute an unsafe or unsound practice. If, in the particular circumstances, either of these federal regulators determined that the payment of dividends would constitute an unsafe or unsound banking practice, either the OCC or the Federal Reserve may, among other things, issue a cease and desist order prohibiting the payment of dividends by Seacoast National or us, respectively. Under a recently adopted Federal Reserve policy, the board of directors of a bank holding company must consider different factors to ensure that its dividend level is prudent relative to the organization’s financial position and is not based on overly optimistic earnings scenarios such as any potential events that may occur before the payment date that could affect its ability to pay, while still maintaining a strong financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company, such as Seacoast, should consult with the Federal Reserve and eliminate, defer, or significantly reduce the bank holding company’s dividends if: (i) its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or (iii) it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.

 

As a result of our participation in the TARP CPP program, additional restrictions have been imposed on our ability to declare or increase dividends on shares of our common stock, including a restriction on paying quarterly dividends above $0.01 per share. Specifically, we are unable to declare dividend payments on our common, junior preferred or pari passu preferred shares if we are in arrears on the dividends on the Series A Preferred Stock. Further, without the Treasury’s approval, we are not permitted to increase dividends on our common stock above $0.01 per share until December 19, 2011 unless all of the Series A Preferred Stock has been redeemed or transferred by the Treasury. In addition, we cannot repurchase shares of common stock or use proceeds from the Series A Preferred Stock to repurchase trust preferred securities. The consent of the Treasury generally is required for us to make any stock repurchase until December 19, 2011 unless all of the Series A Preferred Stock has been redeemed or transferred by the Treasury to a third party. Further, our common, junior preferred or pari passu preferred shares may not be repurchased if we have not declared and paid all Series A Preferred Stock dividends.

 

Beginning in the third quarter of 2008, we reduced the dividend on our common stock to $0.01 per share and, as of May 19, 2009, we suspended the payment of dividends. On May 19, 2009, our board of directors decided to suspend regular quarterly cash dividends on our outstanding common stock and Series A Preferred Stock pursuant to a request from the Federal Reserve as a result of recently adopted Federal Reserve policies related to dividends and other distributions. The Company suspended the payment of dividends on its trust preferred securities as well. Dividends will be suspended until such time as dividends are allowed by the Federal Reserve.

 

As of December 31, 2010, our accumulated deferred dividend payments on Series A Preferred Stock was $4,893,000 and our accumulated deferred interest payment on trust preferred securities was $1,968,000.

Securities Offerings

 

In December 2008, the Company sold $50.0 million of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $0.10 per share, the “Series A Preferred Stock”) and warrants (the “Warrant”) to acquire 1,179,245 shares of common stock to the U.S. Treasury (the “Treasury”). The shares of Series A Preferred Stock qualify as Tier 1 capital for regulatory capital purposes and pay cumulative dividends at a rate of 5 percent per annum for the first five years, and thereafter at a rate of 9 percent per annum. The Series A Preferred Stock may be redeemed by the Company after three years without restrictions. As a result of the public issuance of common stock the Company has notified Treasury to reduce the Warrant it holds to purchase common stock by 50 percent to 589,625 shares.

 

During the third quarter of 2009, the Company enhanced capital by selling 33,675,000 shares of its common stock at a price to the public of $2.25 per share for total gross proceeds of approximately $75.8 million. On December 17, 2009, Seacoast sold 6,000,000 shares of its common stock at $2.25 per share to CapGen Capital Group III LP (“CapGen”), a Delaware limited partnership, pursuant to the definitive Stock Purchase Agreement dated as of October 23, 2009 between the Company and CapGen. The Company received total gross proceeds of $13.5 million from the sale, and incurred $540,000 of fees paid to the placement agent.

 

A stock offering was completed during April of 2010 adding $50 million of Series B Mandatorily Convertible Noncumulative Nonvoting Preferred Stock (“Series B Preferred Stock”) as permanent capital, resulting in approximately $47.1 million in additional Tier 1 risk-based equity, net of issuance costs. The shares of Series B Preferred Stock were mandatorily convertible into common shares five days subsequent to shareholder approval, which was granted at the Company’s annual meeting on June 22, 2010. Upon the conversion of the Series B Preferred Stock, approximately 34,465,000 shares of the Company’s common stock were issued pursuant to the Investment Agreement, dated as of April 8, 2010 between the Company and the investors, a copy of which was filed with the SEC on July 14, 2010 as Exhibit 10.1 to the Company’s Form 8-K/A

 

Financial Condition

 

Total assets decreased $134,934,000 or 6.3 percent to $2,016,381,000 at December 31, 2010, after decreasing $163,121,000 or 7.0 percent to $2,151,315,000 in 2009.

 

Loan Portfolio

 

Table 9 shows total loans (net of unearned income) for commercial and residential real estate, commercial and financial and consumer loans outstanding.

 

The Company defines commercial real estate in accordance to the guidance on “Concentrations in Commercial Real Estate Lending” (the “Guidance”) issued by the federal bank regulatory agencies in 2006, which defines commercial real estate (“CRE”) loans as exposures secured by land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50 percent or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. Loans to REITs and unsecured loans to developers that closely correlate to the inherent risks in CRE markets would also be considered CRE loans under the Guidance. Loans on owner occupied CRE are generally excluded.

 

Total loans (net of unearned income and excluding the allowance for loan losses) were $1,240,608,000 at December 31, 2010, $156,895,000 or 11.2 percent less than at December 31, 2009, and were $1,397,503,000 at December 31, 2009, $279,225,000 or 16.7 percent lower than at December 31, 2008.

 

Overall loan growth was negative when comparing outstanding balances at December 31, 2010, December 31, 2009 and December 31, 2008, as a result of the economic recession, including lower demand for commercial loans, and the Company’s successful divestiture of specific problem loans (including

residential construction and land development loans) through loan sales. Total problem loans sold in 2010, 2009 and 2008 totaled $28 million, $89 million and $68 million, respectively, with the Company significantly reducing its exposure to construction and land development loans and improving the Company’s overall risk profile.

 

As shown in the supplemental loan tables below, commercial real estate loans decreased $117.8 million or 16.6 percent from December 31, 2009 to $591.4 million at December 31, 2010 and residential real estate loans decreased $14.2 million or 2.5 percent to $548.5 million. The primary cause for the decrease in commercial real estate loans was a reduction in construction and land development loans for residential and commercial properties of $33.6 million or 70.6 percent and $43.7 million or 56.4 percent, respectively. Total outstanding balances for these portfolios have been reduced to $14.0 million and $33.8 million, respectively, at December 31, 2010. Also decreasing, commercial real estate mortgages were lower by $40.5 million or 6.9 percent to $543.6 million at December 31, 2010. Construction and land development loans to individuals for personal residences included in residential real estate loans were lower as well, declining $6.3 million or 16.7 percent to $31.5 million at December 31, 2010. Also declining were fixed rate residential real estate mortgages, home equity mortgages and home equity lines, declining $6.0 million or 6.8 percent, $13.4 million or 15.4 percent, and $2.4 million or 4.0 percent, respectively, and totaling $82.6 million, $73.4 million and $57.7 million at December 31, 2010. Adjustable rate residential real estate mortgages were higher year over year, by $13.9 million or 4.8 percent to $303.3 million. Commercial and financial loans and consumer loans (principally installment loans to individuals) decreased $12.3 million or 20.1 percent and $12.4 million or 19.4 percent, respectively, from a year ago to $48.8 million and $51.6 million at December 31, 2010, reflecting the impact on lending of the economic downturn.

Construction and land development loans, including loans secured by commercial real estate, were comprised of the following types of loans at December 31, 2010 and 2009:

 

 

 

 

The Company’s ten largest commercial real estate funded and unfunded loan relationships at December 31, 2010 aggregated to $151.5 million (versus $173.2 million a year ago) and for the top 30 commercial real estate relationships in excess of $5 million the aggregate funded and unfunded totaled $292.5 million (compared to 41 relationships aggregating to $405.5 million a year ago).

Commercial real estate mortgage loans, excluding construction and development loans, were comprised of the following loan types at December 31, 2010 and 2009:

 

 

Fixed rate and adjustable rate loans secured by commercial real estate, excluding construction loans, totaled approximately $329 million and $215 million, respectively, at December 31, 2010, compared to $344 million and $240 million, respectively, a year ago.

 

Residential mortgage lending is an important segment of the Company’s lending activities. The Company has never offered sub-prime, Alt A, Option ARM or any negative amortizing residential loans, programs or products, although we have originated and hold residential mortgage loans from borrowers with original or current FICO credit scores that are less than “prime.” Substantially all residential originations have been underwritten to conventional loan agency standards, including loans having balances that exceed agency value limitations. The Company selectively adds residential mortgage loans to its portfolio, primarily loans with adjustable rates. The Company’s asset mitigation employees handle all foreclosure actions together with outside legal counsel and has never had its foreclosure documentation or processes questioned by any party involved in the transaction.

 

Exposure to market interest rate volatility with respect to long-term fixed rate mortgage loans held for investment is managed by attempting to match maturities and re-pricing opportunities and through loan sales of most fixed rate product. Closed residential mortgage loan production for 2010 totaled $153 million, with production by quarter as follows: fourth quarter 2010 production totaled $49 million, of which $23 million was sold servicing-released, third quarter 2010 production totaled $38 million, of which $28 million was sold servicing-released, second quarter 2010 production totaled $33 million, of which $24 million was sold servicing-released, and first quarter 2010 production totaled $33 million, with $22 million sold servicing-released.

 

At December 31, 2010, approximately $303 million or 59 percent of the Company’s residential mortgage balances were adjustable, compared to $289 million or 55 percent at December 31, 2009. Loans secured by residential properties having fixed rates totaled approximately $83 million at December 31, 2010, of which 15- and 30-year mortgages totaled approximately $26 million and $57 million, respectively. The remaining fixed rate balances were comprised of home improvement loans, most with maturities of 10 years or less. In comparison, loans secured by residential properties having fixed rates totaled approximately $89 million at December 31, 2009, with 15- and 30-year fixed rate residential mortgages totaling approximately $30 million

and $59 million, respectively. The Company also has a small home equity line portfolio totaling approximately $58 million at December 31, 2010, slightly lower than the $60 million that was outstanding at December 31, 2009.

 

Commercial loans decreased and totaled $48.8 million at December 31, 2010, compared to $61.1 million a year ago. Commercial lending activities are directed principally towards businesses whose demand for funds are within the Company’s lending limits, such as small- to medium-sized professional firms, retail and wholesale outlets, and light industrial and manufacturing concerns. Such businesses are smaller and subject to the risks of lending to small to medium sized businesses, including, but not limited to, the effects of a downturn in the local economy, possible business failure, and insufficient cash flows.

 

The Company also provides consumer loans (including installment loans, loans for automobiles, boats, and other personal, family and household purposes, and indirect loans through dealers to finance automobiles) which totaled $51.6 million (versus $64.0 million a year ago), real estate construction loans to individuals secured by residential properties which totaled $7.1 million (versus $8.5 million a year ago), and residential lot loans to individuals which totaled $24.4 million (versus $29.3 million a year ago).

 

At December 31, 2010, the Company had commitments to make loans of $90.4 million, compared to $97.3 million at December 31, 2009 and $164.5 million at December 31, 2008 (see “Note P — Contingent Liabilities and Commitments with Off-Balance Sheet Risk” to the Company’s consolidated financial statements).

 

Loan Concentrations

 

Over the past three years, the Company has been pursuing an aggressive program to reduce exposure to loan types that have been most impacted by stressed market conditions in order to achieve lower levels of credit loss volatility. The program included aggressive collection efforts, loan sales and early stage loss mitigation strategies focused on the Company’s largest loans. Successful execution of this program has significantly reduced our exposure to larger balance loan relationships (including multiple loans to a single borrower or borrower group). Commercial loan relationships greater than $10 million were reduced by $435.9 million to $161.7 million at December 31, 2010 compared with year-end 2007.

 

Commercial Relationships Greater than $10 Million (dollars in thousands)

 

 

 

 

Commercial loan relationships greater than $10 million as a percent of tier 1 capital and the allowance for loan losses was reduced to 66.5 percent at December 31, 2010, compared with 85.9 percent at year-end 2009, 162.1 percent at the end of 2008 and 258.1 percent at the end of 2007.

 

Concentrations in total construction and development loans and total commercial real estate (CRE) loans have also been substantially reduced. As shown in the table below, under regulatory guidance for construction and land development and commercial real estate loan concentrations as a percentage of total risk based capital, Seacoast National’s loan portfolio in these categories (as defined in the guidance) have improved.

 

 

Below is the geographic location of the Company’s construction and land development loans (excluding loans to individuals) as a percent of total construction and land development loans. The significant increase in Palm Beach County in 2010 was caused by the decline in construction and land development loans, which declined from $125.1 million at year-end 2009 to $47.8 million at December 31, 2010.

 

 

Deposits and Borrowings

 

Total deposits decreased $142,206,000, or 8.0 percent, to $1,637,228,000 at December 31, 2010 compared to one year earlier, and were $31,007,000, or 1.7 percent lower, at December 31, 2009 compared to 2008, reflecting declining brokered deposits and single service time deposits. Since December 31, 2009, interest bearing deposits (NOW, savings and money markets deposits) decreased $25,663,000 or 3.1 percent to $812,625,000, noninterest bearing demand deposits increased $20,832,000 or 7.8 percent to $289,621,000, and CDs decreased $137,375,000 or 20.4 percent to $534,982,000. Included in CDs, brokered time deposits decreased $31,563,000 to $7,093,000 at December 31, 2010 from the prior year, and were $61,807,000 lower at December 31, 2009, versus 2008. Of the $7,093,000 balance at December 31, 2010, $6,195,000 is

attributable to CDARs. Funds deposited under the CDARs program are required to be classified as brokered deposits. The Company has historically priced CDs conservatively and has continued to follow this strategy.

 

The Company continues to utilize a focused retail deposit growth strategy that has successfully generated core deposit relationships and increased services per household since its implementation in the first quarter of 2008. During 2010, Seacoast National added 7,495 new core deposit households, up by 1,125 deposits, or 17.7, percent from the prior year. Since initial implementation in 2008, the acquisition of new retail checking deposit households and the average services per household have increased 51.7 percent and 40.8 percent, respectively.

 

Securities sold under repurchase agreements decreased over the past twelve months by $7,460,000 or 7.1 percent to $98,213,000 at December 31, 2010. Repurchase agreements are offered by Seacoast National to select customers who wish to sweep excess balances on a daily basis for investment purposes. Public fund depositors switching to sweep repurchase agreements comprised a significant amount of the outstanding balance a year ago, when safety was a major concern for these customers. At December 31, 2010, the number of sweep repurchase accounts was 165, compared to 196 a year ago.

 

At December 31, 2010, other borrowings were comprised of subordinated debt of $53.6 million related to trust preferred securities issued by trusts organized by the Company, and advances from the FHLB of $50.0 million. A $15.0 million FHLB advance matured in November 2009 and the remaining $50.0 million matures in 2017. In 2010, the weighted average cost of our FHLB advances was 3.22 percent, compared to 3.25 percent for 2009.

 

The Company has two wholly owned trust subsidiaries, SBCF Capital Trust I and SBCF Statutory Trust II that were formed in 2005, and in 2007, the Company formed an additional wholly owned trust subsidiary, SBCF Statutory Trust III. The 2005 trusts each issued $20.0 million (totaling $40.0 million) of trust preferred securities and the 2007 trust issued an additional $12.0 million in trust preferred securities. All trust preferred securities are guaranteed by the Company on a junior subordinated basis. The Federal Reserve’s rules permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25 percent of core capital, net of goodwill and intangibles. The Company believes that its trust preferred securities qualify under these revised regulatory capital rules and expects that it will be able to treat $50.0 million of trust preferred securities as Tier 1 capital and $2.0 million as Tier 2 capital. For regulatory purposes, the trust preferred securities are added to the Company’s tangible common shareholders’ equity to calculate Tier I capital. The Company also formed SBCF Capital Trust IV and SBCF Capital Trust V in 2008 which are currently inactive.

 

The weighted average interest rate of our outstanding subordinated debt related to trust preferred securities was 1.91 percent during 2010, compared to 2.53 percent during 2009.

 

Effects of Inflation and Changing Prices

 

The condensed consolidated financial statements and related financial data presented herein have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money, over time, due to inflation.

 

Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the general level of inflation. However, inflation affects financial institutions by increasing their cost of goods and services purchased, as well as the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and shareholders’ equity. Mortgage originations and re-financings tend to slow as interest rates increase, and higher interest rates likely will reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

Securities

 

Information related to yields, maturities, carrying values and unrealized gains (losses) of the Company’s securities is set forth in Tables 15-18.

 

At December 31, 2010, the Company had no trading securities, $435,140,000 in securities available for sale (representing 94.2 percent of total securities), and securities held for investment of $26,861,000 (5.8 percent of total securities). The Company’s securities portfolio increased $51,266,000 or 12.5 percent from December 31, 2009 and $64.8 million, or 18.7 percent from December 31, 2008.

 

As part of the Company’s interest rate risk management process, an average duration for the securities portfolio is targeted. In addition, securities are acquired which return principal monthly that can be reinvested. Agency and private label mortgage backed securities and collateralized mortgage obligations comprise $445,440,000 of total securities, approximately 96 percent of the portfolio. Remaining securities are largely comprised of U.S. Treasury, U.S. Government agency securities and tax-exempt bonds issued by states, counties and municipalities.

 

The duration of the investment portfolio at December 31, 2010 was 30 months, compared to a year ago when the duration was 25 months.

 

Cash and due from banks and interest bearing deposits (aggregated) totaled $211,405,000 at December 31, 2010, compared to $215,100,000 at December 31, 2009, which reflects the decline in the loan portfolio and funds from the capital raised during 2009 and 2010. The Company has maintained additional liquidity during the uncertain environment and may use these funds to increase loans and investments as the economy continues to improve.

 

At December 31, 2010, available for sale securities had gross losses of $3,748,000 and gross gains of $6,734,000, compared to gross losses of $3,288,000 and gross gains of $6,558,000 at December 31, 2009. All of the securities with unrealized losses are reviewed for other-than-temporary impairment at least quarterly. As a result of these reviews during the first, second, third and fourth quarters of 2010 and 2009, it was determined that the unrealized losses were not other than temporarily impaired and the Company has the intent and ability to retain these securities until recovery over the periods presented (see additional discussion under “Critical Accounting Estimates-Fair Value and Other than Temporary Impairment of Securities Classified as Available for Sale”).

 

Company management considers the overall quality of the securities portfolio to be high. The Company has no exposure to securities with subprime collateral and had no Fannie Mae or Freddie Mac preferred stock when these entities were placed in conservatorship. The Company holds no interests in trust preferred securities.

 

Fourth Quarter Review

 

Net loss available to common shareholders for the fourth quarter of 2010 totaled $11,142,000 or $0.12 per average common diluted share, compared to third, second and first quarter 2010’s net losses of $8,575,000 or $0.09 per average common diluted share, $14,733,000 or $0.25 per average common diluted share and $2,501,000 or $0.04 per average common diluted share, respectively. The net loss available to common shareholders in 2010 reflects a significant improvement when compared to losses in 2009 for the fourth quarter of $39,086,000 or $0.73 per average common diluted share. The improved performance for 2010 reflects lower credit costs.

 

The net interest margin improved slightly, increasing 7 basis points during the fourth quarter of 2010 from the third quarter of 2010, and increasing 5 basis points from the fourth quarter of 2009. The Company has continued to benefit from lower rates paid for interest bearing liabilities due to the Federal Reserve’s reduction in interest rates, as well as, an improved mix of deposits and reduction of nonaccrual loans, but a changing earning assets mix has been partially offsetting. The average cost of interest bearing liabilities was 8 basis points lower for the fourth quarter 2010 compared to the third quarter of 2010, 8 basis points lower for the third quarter 2010, compared to the second quarter of 2010, 8 basis points lower for the second quarter of

2010, compared to the first quarter of 2010, and 13 basis points lower for the first quarter of 2010, compared to the fourth quarter of 2009, a total reduction of 37 basis points over the last twelve months. Loans and securities as a percentage of average earning assets increased during the quarter. The yield on earning assets improved by one basis point during the fourth quarter of 2010, compared to the third quarter of 2010, but was 27 basis points lower than for the fourth quarter of 2009. Loan demand was better in the third and fourth quarter of 2010 (compared to the first half of 2010) with improved residential loan production but is expected to continue to be weak into 2011, which may impede further improvement to the yield on earning assets.

 

Noninterest income (excluding securities gains and losses) totaled $5.3 million for the fourth quarter of 2010, compared to $4.8 million for the third quarter of 2010, and $4.6 million for the first and second quarters of 2010 and fourth quarter of 2009. Signs of improved stability in home prices and greater transaction volumes resulted in fee income from residential real estate production higher than first, second and third quarter 2010’s results. Revenue from wealth management services were $29,000 lower and service charges on deposits were $22,000 lower when compared to fourth quarter 2009 but were more than offset by improved results in debit card income, marine finance fees and mortgage banking fees for the fourth quarter of 2010. Consumer activity and spending has been adversely affected by economic conditions and directly affects many of the Company’s fee-based business activities. Service charges and fees derived from customer relationships increased as a result of more accounts and households as a result of the retail deposit growth strategy. Compared to the third quarter 2010 these revenues were up $79,000 or 5.2 percent in the fourth quarter 2010. Overdraft fees related to check card payments beginning in the third quarter were impacted by a requirement that customers elect to opt in for overdraft protection to be available for these types of payments, but the negative impacts were mostly offset by increased fees as a result of the growth in new deposit account households. During November 2010, the merchant portfolio was sold deriving a gain of $600,000 that is reflected in other income. Merchant income for the fourth quarter of 2010 was lower by approximately $200,000 as a result of the sale.

 

Noninterest expenses increased by $7.6 million versus third quarter 2010’s result and were $7.0 million higher when compared to the fourth quarter of 2009. Overhead related to salaries and wages, employee benefits, outsourced data processing costs, communications costs, FDIC insurance assessments and legal and professional costs were lower compared to third quarter 2010. Increases from the third quarter of 2010 were primarily a result of assets dispositions expense and losses on other real estate owned and repossessed assets increasing by $8.4 million on an aggregate basis, and marketing expenses increasing by $187,000, over the period.

 

Our provision for loan losses was $4.8 million lower than in the third quarter of 2010 and was $37.5 million lower than for the fourth quarter of 2009, and totaled $4.0 million for the fourth quarter of 2010 compared to $8.9 million and $45.4 million for the third quarter of 2010 and fourth quarter of 2009, respectively. A portion of net charge-offs during the third quarter of 2010 was related to the sale $5.2 million of nonperforming loans for net proceeds of $2.0 million. Provisions for loans losses were much higher during 2009 as a result of higher net charge-offs and the Company increasing its allowance for loan losses to loans outstanding ratio to 3.23 percent at December 31, 2009, up 148 basis points from December 31, 2008. The allowance for loan losses to loans outstanding ratio at December 31, 2010 was 3.04 percent.

Table 1 — Condensed Income Statement*

 

 

 

 

Table 2 — Changes in Average Earning Assets

 

Table 3 — Rate/Volume Analysis (on a Tax Equivalent Basis)

 

 

 

 

Table 4 — Changes in Average Interest Bearing Liabilities

 

Table 5 — Three Year Summary

 

Average Balances, Interest Income and Expenses, Yields and Rates(1)