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EXCEL - IDEA: XBRL DOCUMENT - MOUNTAIN NATIONAL BANCSHARES INC | Financial_Report.xls |
EX-32.2 - EXHIBIT 32.2 - MOUNTAIN NATIONAL BANCSHARES INC | c24824exv32w2.htm |
EX-31.2 - EXHIBIT 31.2 - MOUNTAIN NATIONAL BANCSHARES INC | c24824exv31w2.htm |
EX-32.1 - EXHIBIT 32.1 - MOUNTAIN NATIONAL BANCSHARES INC | c24824exv32w1.htm |
EX-31.1 - EXHIBIT 31.1 - MOUNTAIN NATIONAL BANCSHARES INC | c24824exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-49912
MOUNTAIN NATIONAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Tennessee | 75-3036312 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) | ||
300 East Main Street | ||
Sevierville, Tennessee | 37862 | |
(Address of principal executive offices) | (Zip Code) |
(865) 428-7990
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date. Common stock outstanding: 2,631,611 shares as of November 1, 2011.
MOUNTAIN NATIONAL BANCSHARES, INC.
Quarterly Report on Form 10-Q
For the quarter ended September 30, 2011
Table of Contents
2
Table of Contents
PART I FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 29,757,337 | $ | 30,039,647 | ||||
Federal funds sold |
13,341,766 | 2,536,173 | ||||||
Total cash and cash equivalents |
43,099,103 | 32,575,820 | ||||||
Securities available for sale |
84,860,770 | 86,316,591 | ||||||
Securities held to maturity, fair value $1,536,740 at September 30, 2011 and
$1,303,080 at December 31, 2010 |
1,364,529 | 1,317,951 | ||||||
Restricted investments, at cost |
3,846,950 | 3,843,150 | ||||||
Loans, net of allowance for loan losses of $14,871,902 at September 30, 2011 and
$10,942,414 at December 31, 2010 |
319,863,462 | 363,413,050 | ||||||
Investment in partnership |
4,387,805 | 4,303,600 | ||||||
Premises and equipment |
31,787,333 | 32,600,673 | ||||||
Accrued interest receivable |
1,318,568 | 1,495,869 | ||||||
Cash surrender value of company owned life insurance |
12,073,444 | 11,774,605 | ||||||
Other real estate owned |
8,688,283 | 13,140,698 | ||||||
Other assets |
4,538,234 | 6,424,504 | ||||||
Total assets |
$ | 515,828,481 | $ | 557,206,511 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Deposits: |
||||||||
Noninterest-bearing demand deposits |
$ | 48,774,381 | $ | 47,638,792 | ||||
NOW accounts |
49,566,341 | 57,344,798 | ||||||
Money market accounts |
53,116,932 | 49,701,122 | ||||||
Savings accounts |
22,863,231 | 23,733,795 | ||||||
Time deposits |
260,236,454 | 271,172,901 | ||||||
Total deposits |
434,557,339 | 449,591,408 | ||||||
Securities sold under agreements to repurchase |
842,025 | 432,016 | ||||||
Accrued interest payable |
738,387 | 719,133 | ||||||
Subordinated debentures |
13,403,000 | 13,403,000 | ||||||
Federal Home Loan Bank advances |
55,200,000 | 55,200,000 | ||||||
Other liabilities |
2,236,904 | 2,186,784 | ||||||
Total liabilities |
506,977,655 | 521,532,341 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity: |
||||||||
Preferred stock, no par value; 1,000,000 shares authorized; 0
shares issued and outstanding |
| | ||||||
Common stock, $1.00 par value; 10,000,000 shares authorized; 2,631,611
shares issued and outstanding |
2,631,611 | 2,631,611 | ||||||
Additional paid-in capital |
42,306,663 | 42,229,713 | ||||||
Retained earnings (deficit) |
(36,577,058 | ) | (8,122,476 | ) | ||||
Accumulated other comprehensive income (loss) |
489,610 | (1,064,678 | ) | |||||
Total shareholders equity |
8,850,826 | 35,674,170 | ||||||
Total liabilities and shareholders equity |
$ | 515,828,481 | $ | 557,206,511 | ||||
See accompanying Notes to Consolidated Financial Statements
3
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Nine months ended September 30, | Three months ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
INTEREST INCOME |
||||||||||||||||
Loans |
$ | 13,727,447 | $ | 15,772,088 | $ | 4,490,514 | $ | 5,353,095 | ||||||||
Taxable securities |
1,752,287 | 1,967,474 | 570,823 | 596,385 | ||||||||||||
Tax-exempt securities |
174,642 | 197,216 | 58,515 | 51,912 | ||||||||||||
Federal funds sold and deposits in other banks |
30,222 | 51,482 | 14,448 | 23,988 | ||||||||||||
Total interest income |
15,684,598 | 17,988,260 | 5,134,300 | 6,025,380 | ||||||||||||
INTEREST EXPENSE |
||||||||||||||||
Deposits |
4,130,903 | 6,080,931 | 1,313,099 | 1,872,433 | ||||||||||||
Federal funds purchased |
| 3,062 | | 1,732 | ||||||||||||
Repurchase agreements |
10,740 | 20,204 | 3,967 | 5,892 | ||||||||||||
Federal Reserve and Federal Home Loan Bank
advances |
1,682,505 | 1,926,529 | 567,033 | 638,096 | ||||||||||||
Subordinated debentures |
248,209 | 252,284 | 86,066 | 90,171 | ||||||||||||
Total interest expense |
6,072,357 | 8,283,010 | 1,970,165 | 2,608,324 | ||||||||||||
Net interest income |
9,612,241 | 9,705,250 | 3,164,135 | 3,417,056 | ||||||||||||
Provision for loan losses |
23,865,488 | 702,200 | 3,502,000 | 155,500 | ||||||||||||
Net interest income after provision for loan losses |
(14,253,247 | ) | 9,003,050 | (337,865 | ) | 3,261,556 | ||||||||||
NONINTEREST INCOME |
||||||||||||||||
Service charges on deposit accounts |
1,097,708 | 1,245,962 | 351,945 | 401,455 | ||||||||||||
Other fees and commissions |
1,101,560 | 1,103,780 | 387,544 | 421,560 | ||||||||||||
Gain on sale of mortgage loans |
47,918 | 122,206 | 6,951 | 52,876 | ||||||||||||
Investment gains and losses, net |
198,325 | 1,511,005 | 150,316 | 318,850 | ||||||||||||
Other real estate gains and losses, net |
(4,716,559 | ) | 283,400 | (23,114 | ) | 51,447 | ||||||||||
Other noninterest income |
609,154 | 717,691 | 276,155 | 283,666 | ||||||||||||
Total noninterest income |
(1,661,894 | ) | 4,984,044 | 1,149,797 | 1,529,854 | |||||||||||
NONINTEREST EXPENSE |
||||||||||||||||
Salaries and employee benefits |
6,050,829 | 6,313,570 | 2,039,091 | 1,882,609 | ||||||||||||
Occupancy expenses |
1,351,266 | 1,317,526 | 447,883 | 450,176 | ||||||||||||
FDIC assessment expense |
1,227,128 | 931,159 | 431,371 | 319,406 | ||||||||||||
Other operating expenses |
4,769,298 | 4,750,024 | 1,454,507 | 1,819,531 | ||||||||||||
Total noninterest expense |
13,398,521 | 13,312,279 | 4,372,852 | 4,471,722 | ||||||||||||
Income (loss) before income tax expense (benefit) |
(29,313,662 | ) | 674,815 | (3,560,920 | ) | 319,688 | ||||||||||
Income tax expense (benefit) |
(859,080 | ) | (147,478 | ) | (339,974 | ) | (31,205 | ) | ||||||||
Net income (loss) |
$ | (28,454,582 | ) | $ | 822,293 | $ | (3,220,946 | ) | $ | 350,893 | ||||||
EARNINGS (LOSS) PER SHARE |
||||||||||||||||
Basic |
$ | (10.81 | ) | $ | 0.31 | $ | (1.22 | ) | $ | 0.13 | ||||||
Diluted |
$ | (10.81 | ) | $ | 0.31 | $ | (1.22 | ) | $ | 0.13 |
See accompanying Notes to Consolidated Financial Statements
4
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
For the Nine Months Ended September 30, 2011 and 2010
(unaudited)
(unaudited)
Accumulated | ||||||||||||||||||||||||
Additional | Retained | Other | Total | |||||||||||||||||||||
Comprehensive | Common | Paid-in | Earnings | Comprehensive | Shareholders | |||||||||||||||||||
Income (Loss) | Stock | Capital | (Deficit) | Income/(Loss) | Equity | |||||||||||||||||||
BALANCE, January 1, 2010 |
$ | 2,631,611 | $ | 42,125,828 | $ | 2,328,702 | $ | 283,014 | $ | 47,369,155 | ||||||||||||||
Share-based compensation |
69,820 | 69,820 | ||||||||||||||||||||||
Comprehensive income (loss): |
||||||||||||||||||||||||
Net income |
$ | 822,293 | 822,293 | 822,293 | ||||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||
Change in unrealized gains (losses) on
securities available-for-sale |
(642 | ) | (642 | ) | (642 | ) | ||||||||||||||||||
Total comprehensive income |
821,651 | |||||||||||||||||||||||
BALANCE, September 30, 2010 |
2,631,611 | 42,195,648 | 3,150,995 | 282,372 | 48,260,626 | |||||||||||||||||||
BALANCE, January 1, 2011 |
$ | 2,631,611 | $ | 42,229,713 | $ | (8,122,476 | ) | $ | (1,064,678 | ) | $ | 35,674,170 | ||||||||||||
Share-based compensation |
76,950 | 76,950 | ||||||||||||||||||||||
Comprehensive income (loss): |
||||||||||||||||||||||||
Net loss |
(28,454,582 | ) | (28,454,582 | ) | (28,454,582 | ) | ||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||
Change in unrealized gains (losses) on
securities available-for-sale |
1,554,288 | 1,554,288 | 1,554,288 | |||||||||||||||||||||
Total comprehensive loss |
$ | (26,900,294 | ) | |||||||||||||||||||||
BALANCE, September 30, 2011 |
$ | 2,631,611 | $ | 42,306,663 | $ | (36,577,058 | ) | $ | 489,610 | $ | 8,850,826 | |||||||||||||
See accompanying Notes to Consolidated Financial Statements
5
Table of Contents
MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine months ended September 30, | ||||||||
2011 | 2010 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net income (loss) |
$ | (28,454,582 | ) | $ | 822,293 | |||
Adjustments to reconcile net income (loss) to net cash
provided by operating activities: |
||||||||
Depreciation |
1,089,049 | 1,233,346 | ||||||
Net realized gains on securities available for sale |
(198,325 | ) | (1,499,481 | ) | ||||
Net realized gains on securities held to maturity |
| (11,524 | ) | |||||
Net amortization on available for sale securities |
861,623 | 476,332 | ||||||
Increase in held to maturity due to accretion |
(46,578 | ) | (46,050 | ) | ||||
Provision for loan losses |
23,865,488 | 702,200 | ||||||
Net (gain) loss on other real estate |
4,716,559 | (283,400 | ) | |||||
Gross mortgage loans originated for sale |
(2,141,974 | ) | (10,299,858 | ) | ||||
Gross proceeds from sale of mortgage loans |
1,958,632 | 9,369,399 | ||||||
Gain on sale of mortgage loans |
(47,918 | ) | (122,206 | ) | ||||
Increase in cash surrender value of life insurance |
(298,839 | ) | (306,105 | ) | ||||
Investment in partnership |
(84,205 | ) | (95,317 | ) | ||||
Share-based compensation |
76,950 | 69,820 | ||||||
Change in operating assets and liabilities: |
||||||||
Accrued interest receivable |
177,301 | 1,148,927 | ||||||
Accrued interest payable |
19,254 | 99,941 | ||||||
Other assets and liabilities |
1,420,981 | 761,129 | ||||||
Net cash provided by operating
activities |
2,913,416 | 2,019,446 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Activity in available-for-sale securities: |
||||||||
Proceeds from sales |
11,350,632 | 103,501,336 | ||||||
Proceeds from maturities, prepayments and calls |
15,884,337 | 333,006,249 | ||||||
Purchases |
(24,372,750 | ) | (366,111,112 | ) | ||||
Activity in held-to-maturity securities: |
||||||||
Proceeds from sales |
| 520,000 | ||||||
Purchases of restricted investments |
(3,800 | ) | (27,100 | ) | ||||
Loan originations and principal collections, net |
16,313,914 | 12,898,134 | ||||||
Purchase of premises and equipment |
(165,758 | ) | (235,739 | ) | ||||
Proceeds from sale of other real estate |
3,227,352 | 1,169,954 | ||||||
Net cash provided by investing
activities |
22,233,927 | 84,721,722 | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net decrease in deposits |
(15,034,069 | ) | (47,588,890 | ) | ||||
Proceeds from Federal Reserve/Federal Home Loan Bank advances |
| 43,000,000 | ||||||
Matured Federal Reserve/Federal Home Loan Bank advances |
| (50,700,000 | ) | |||||
Net increase (decrease) in securities sold under
agreements to repurchase |
410,009 | (1,020,723 | ) | |||||
Net cash used in financing activities |
(14,624,060 | ) | (56,309,613 | ) | ||||
NET INCREASE IN CASH AND CASH EQUIVALENTS |
10,523,283 | 30,431,555 | ||||||
CASH AND CASH EQUIVALENTS, beginning of period |
32,575,820 | 14,104,636 | ||||||
CASH AND CASH EQUIVALENTS, end of period |
$ | 43,099,103 | $ | 44,536,191 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
||||||||
Cash paid for: |
||||||||
Interest |
$ | 6,053,103 | $ | 8,183,069 | ||||
Income taxes |
| 50,000 | ||||||
Non-cash investing and financing activities: |
||||||||
Transfers from loans to other real estate owned |
4,598,624 | 3,176,944 | ||||||
Loans advanced for sales of other real estate |
997,178 | 1,629,360 | ||||||
Transfers from held-to-maturity to available-for-sale securities |
| 439,097 |
See accompanying Notes to Consolidated Financial Statements
6
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation and Accounting Policies
The unaudited consolidated financial statements in this report have been prepared in
conformity with U.S. generally accepted accounting principles (GAAP) for interim financial
information and with the instructions of Form 10-Q and Rule 10-01 of Regulation S-X. The
consolidated financial statements include the accounts of Mountain National Bancshares, Inc., a
Tennessee corporation (the Company), and its subsidiaries. The Companys principal subsidiary is
Mountain National Bank, a national association (the Bank). All material intercompany accounts and
transactions have been eliminated in consolidation.
Loss contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable and
an amount or range of loss can be reasonably estimated. Management does not believe there are
now such matters that will have a material effect on the financial statements.
Certain information and note disclosures normally included in the Companys annual audited
financial statements prepared in accordance with generally accepted accounting principles have been
condensed or omitted from the unaudited financial statements in this report. Consequently, the
quarterly financial statements should be read in conjunction with the notes included herein and the
notes to the audited financial statements presented in the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2010. The unaudited quarterly financial statements reflect all
adjustments that are, in the opinion of management, necessary for a fair presentation of the
results of operations for interim periods presented. All such adjustments were of a normal,
recurring nature. The results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the complete fiscal year.
Reclassifications: Some items in prior year financial statements were reclassified to conform
to current presentation.
Note 2. New Accounting Standards
In April 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-02, A
Creditors Determination of Whether a Restructuring Is a Troubled Debt Restructuring. ASU No.
2011-02 intended to provide additional guidance to assist creditors in determining whether a
restructuring of a receivable meets the criteria to be considered a Troubled Debt Restructuring
(TDR). The amendments in this ASU were effective for the quarter ended September 30, 2011 and
were applied retrospectively to the beginning of the current year. Adoption of this guidance did
not have a significant impact on the Companys financial results.
In April 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for
Repurchase Agreements. ASU No. 2011-03 modifies the criteria for determining when repurchase
agreements would be accounted for as a secured borrowing rather than as a sale. Currently, an
entity that maintains effective control over transferred financial assets must account for the
transfer as a secured borrowing rather than as a sale. The provisions of ASU No. 2011-03 remove
from the assessment of effective control the criterion requiring the transferor to have the ability
to repurchase or redeem the financial assets on substantially the agreed terms, even in the event
of default by the transferee. The FASB believes that contractual rights and obligations determine
effective control and that there does not need to be a requirement to assess the ability to
exercise those rights. ASU No. 2011-03 does not change the other existing criteria used in the
assessment of effective control. The provisions of ASU No. 2011-03 are effective prospectively for
transactions, or modifications of existing transactions, that occur on or after January 1, 2012.
Adoption of this ASU is not expected to have a material impact on the Companys financial results.
7
Table of Contents
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The
provisions of ASU No. 2011-05 allow an entity the option to present the total of comprehensive
income, the components of net income, and the components of other comprehensive income either in a
single continuous statement of comprehensive income or in two separate but consecutive statements.
In both choices, an entity is required to present each component of net income along with total net
income, each component of other comprehensive income along with a total for other comprehensive
income, and a total amount for comprehensive income. The statement(s) are required to be presented
with equal prominence as the other primary financial statements. ASU No. 2011-05 eliminates the
option to present the components of other comprehensive income as part of the statement of changes
in shareholders equity but does not change the items that must be reported in other comprehensive
income or when an item of other comprehensive income must be reclassified to net income. The
provisions of ASU No. 2011-05 are effective for the Companys interim reporting period beginning on
or after December 15, 2011, with retrospective application required. The adoption of ASU No.
2011-05 is expected to result in presentation changes to the Companys statements of income and the
addition of a statement of comprehensive income, but is not expected to have any impact on the
Companys statements of condition.
8
Table of Contents
Note 3. Investment Securities
The following table summarizes the amortized cost and fair value of the available-for-sale and
held-to-maturity investment securities portfolio at September 30, 2011 and December 31, 2010 and
the corresponding amounts of unrealized gains and losses therein.
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
September 30, 2011 |
||||||||||||||||
Available-for-sale |
||||||||||||||||
U. S. Government securities |
$ | 249,993 | $ | 3 | $ | | $ | 249,996 | ||||||||
Obligations of states and political
subdivisions |
5,228,915 | 176,884 | (27,313 | ) | 5,378,486 | |||||||||||
Mortgage-backed
securities-residential |
77,758,223 | 1,474,065 | | 79,232,288 | ||||||||||||
Total available-for-sale securities |
$ | 83,237,131 | $ | 1,650,952 | $ | (27,313 | ) | $ | 84,860,770 | |||||||
Held-to-maturity |
||||||||||||||||
Obligations of states and political
subdivisions |
$ | 1,364,529 | $ | 172,211 | $ | | $ | 1,536,740 | ||||||||
December 31, 2010 |
||||||||||||||||
Available-for-sale |
||||||||||||||||
U. S. Government securities |
$ | 249,879 | $ | | $ | (13 | ) | $ | 249,866 | |||||||
Obligations of states and political
subdivisions |
5,201,492 | 17,407 | (296,786 | ) | 4,922,113 | |||||||||||
Mortgage-backed
securities-residential |
81,754,184 | 134,557 | (744,129 | ) | 81,144,612 | |||||||||||
Total available-for-sale securities |
$ | 87,205,555 | $ | 151,964 | $ | (1,040,928 | ) | $ | 86,316,591 | |||||||
Held-to-maturity |
||||||||||||||||
Obligations of states and political
subdivisions |
$ | 1,317,951 | $ | | $ | (14,871 | ) | $ | 1,303,080 | |||||||
9
Table of Contents
The amortized cost and fair value of the investment securities portfolio are shown below
by expected maturity. Expected maturities may differ from contractual maturities if borrowers have
the right to call or prepay obligations with or without call or prepayment penalties.
September 30, 2011 | ||||||||
Amortized | Fair | |||||||
Cost | Value | |||||||
Maturity |
||||||||
Available-for-sale |
||||||||
Within one year |
$ | 249,993 | $ | 249,996 | ||||
One to five years |
265,120 | 266,901 | ||||||
Five to ten years |
1,816,494 | 1,919,395 | ||||||
Beyond ten years |
3,147,301 | 3,192,190 | ||||||
Mortgage-backed
securities-residential |
77,758,223 | 79,232,288 | ||||||
Total |
$ | 83,237,131 | $ | 84,860,770 | ||||
Held-to-maturity |
||||||||
Five to ten years |
747,347 | 820,000 | ||||||
Beyond ten years |
617,182 | 716,740 | ||||||
Total |
$ | 1,364,529 | $ | 1,536,740 | ||||
The following table summarizes the investment securities with unrealized losses at
September 30, 2011 and December 31, 2010 aggregated by major security type and length of time in a
continuous unrealized loss position.
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Loss | Value | Loss | Value | Loss | |||||||||||||||||||
September 30, 2011 |
||||||||||||||||||||||||
Available-for-sale |
||||||||||||||||||||||||
Obligations of states and
political subdivisions |
| | 1,259,493 | (27,313 | ) | 1,259,493 | (27,313 | ) | ||||||||||||||||
Total available-for-sale |
$ | | $ | | $ | 1,259,493 | $ | (27,313 | ) | $ | 1,259,493 | $ | (27,313 | ) | ||||||||||
December 31, 2010 |
||||||||||||||||||||||||
Available-for-sale |
||||||||||||||||||||||||
U.S. Government
securities |
$ | 249,866 | $ | (13 | ) | $ | | $ | | $ | 249,866 | $ | (13 | ) | ||||||||||
Obligations of states and
political subdivisions |
3,632,820 | (112,755 | ) | 1,571,970 | (198,902 | ) | 5,204,790 | (311,657 | ) | |||||||||||||||
Mortgage-backed
securities-residential |
57,369,268 | (744,129 | ) | | | 57,369,268 | (744,129 | ) | ||||||||||||||||
Total available-for-sale |
$ | 61,251,954 | $ | (856,897 | ) | $ | 1,571,970 | $ | (198,902 | ) | $ | 62,823,924 | $ | (1,055,799 | ) | |||||||||
Proceeds from sales of securities were approximately $11 million and $104 million for the
nine months ended September 30, 2011 and 2010, respectively. Gross gains of $198,325 and $1,570,376
and gross losses of $0 and $59,371 were realized on these sales during the nine months ended
September 30, 2011 and 2010, respectively.
10
Table of Contents
During the first quarter of 2010, the Bank sold one security classified as held-to-maturity.
The remaining held-to-maturity security in the Banks portfolio was reclassified as available for
sale. The approximately $1.4 million residual balance in held-to-maturity securities at September
30, 2011 represents securities held in the portfolio of MNB Investments, Inc., a consolidated
subsidiary of the Bank. MNB Investments, Inc. does not intend and it is not more likely than not
that it would be required to sell these securities prior to maturity.
Proceeds from sales of securities available for sale were approximately $7 million and $12
million for the three months ended September 30, 2011 and 2010, respectively. Gross gains of
$150,316 and $318,849 and no losses were realized on these sales during the third quarter of 2011
and 2010, respectively.
Other-Than-Temporary-Impairment
Management evaluates securities for other-than-temporary impairment (OTTI) at least on a
quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
In determining OTTI, management considers many factors, including: (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic
conditions, and (4) whether the entity has the intent to sell the debt security or more likely than
not will be required to sell the debt security before its anticipated recovery. The assessment
of whether an other-than-temporary decline exists involves a high degree of subjectivity and
judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity
intends to sell the security or it is more likely than not it will be required to sell the
security before recovery of its amortized cost basis, less any current-period credit loss. If
an entity intends to sell or it is more likely than not it will be required to sell the security
before recovery of its amortized cost basis, less any current-period credit loss, the OTTI
shall be recognized in earnings equal to the entire difference between the investments amortized
cost basis and its fair value at the balance sheet date. Otherwise, the OTTI shall be separated
into the amount representing the credit loss and the amount related to all other factors. The
amount of the total OTTI related to the credit loss is determined based on the present
value of cash flows expected to be collected and is recognized in earnings. The amount of
the total OTTI related to other factors is recognized in other comprehensive income (loss), net of
applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings
becomes the new amortized cost basis of the investment.
As of September 30, 2011, the Companys securities portfolio consisted of 84 securities, 3 of
which were in an unrealized loss position. The majority of unrealized losses are related to the
Companys mortgage-backed securities and obligations of states and political subdivisions, as
discussed below.
Unrealized losses on mortgage-backed securities and obligations of states and political
subdivisions have not been recognized into income because the issuer(s) bonds are of high credit
quality, the decline in fair value is largely due to changes in interest rates and other market
conditions, and because the Company does not have the intent to sell these securities and it is
likely that it will not be required to sell the securities before their anticipated recovery. The
Company does not consider these securities to be other-than-temporarily impaired at September 30,
2011.
Note 4. Net Earnings (Loss) Per Common Share
Net earnings (loss) per common share are based on the weighted average number of common shares
outstanding during the period. Diluted earnings per common share include the effects of potential
common shares outstanding, including shares issuable upon the exercise of options for which the
exercise price is lower than the market price of the common stock, during the period.
11
Table of Contents
The following is a summary of the basic and diluted earnings (loss) per share calculation for
the three and nine months ended September 30, 2011 and 2010:
Nine-Months Ended | Three-Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Basic earnings (loss) per share calculation: |
||||||||||||||||
Numerator Net income (loss) |
$ | (28,454,582 | ) | $ | 822,293 | $ | (3,220,946 | ) | $ | 350,893 | ||||||
Denominator Average common shares outstanding |
2,631,611 | 2,631,611 | 2,631,611 | 2,631,611 | ||||||||||||
Basic net income (loss) per share |
$ | (10.81 | ) | $ | 0.31 | $ | (1.22 | ) | $ | 0.13 | ||||||
Diluted earnings (loss) per share calculation: |
||||||||||||||||
Numerator Net income (loss) |
(28,454,582 | ) | 822,293 | (3,220,946 | ) | 350,893 | ||||||||||
Denominator Average common shares outstanding |
2,631,611 | 2,631,611 | 2,631,611 | 2,631,611 | ||||||||||||
Dilutive shares contingently issuable |
| | | | ||||||||||||
Average dilutive common shares outstanding |
2,631,611 | 2,631,611 | 2,631,611 | 2,631,611 | ||||||||||||
Diluted net income (loss) per share |
$ | (10.81 | ) | $ | 0.31 | $ | (1.22 | ) | $ | 0.13 |
During the nine months ended September 30, 2011 and 2010, there were options for the
purchase of 117,148 and 122,133 shares, respectively, outstanding during each time period that were
antidilutive. During the three months ended September 30, 2011 and 2010, there were options for the
purchase of 117,148 and 122,133 shares, respectively, outstanding during each time period that were
antidilutive. These shares were accordingly excluded from the calculations above.
12
Table of Contents
Note 5. Loans and Allowance for Loan Losses
At September 30, 2011 and December 31, 2010, the Banks loans consisted of the following (in
thousands):
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
Mortgage loans on real estate: |
||||||||
Residential 1-4 family |
$ | 73,465 | $ | 86,403 | ||||
Residential multifamily |
9,769 | 6,147 | ||||||
Commercial real estate |
126,427 | 133,917 | ||||||
Construction and land
development |
64,994 | 83,543 | ||||||
Second mortgages |
7,400 | 8,880 | ||||||
Equity lines of credit |
24,022 | 25,391 | ||||||
306,077 | 344,281 | |||||||
Commercial loans |
23,841 | 24,944 | ||||||
Consumer installment loans: |
||||||||
Personal |
2,864 | 2,855 | ||||||
Credit cards |
1,953 | 2,275 | ||||||
4,817 | 5,130 | |||||||
Total Loans |
334,735 | 374,355 | ||||||
Less: Allowance for loan losses |
(14,872 | ) | (10,942 | ) | ||||
Loans, net |
$ | 319,863 | $ | 363,413 | ||||
Loans held for sale at September 30, 2011 and December 31, 2010 were $447,760 and
$216,500, respectively. These loans are included in residential 1-4 family loans in the table
above.
Loans are stated at unpaid principal balances, less the allowance for loan losses. The
recorded investment in loans presented throughout the Notes to the Consolidated Financial
Statements is defined as the outstanding principal balance of loans
and does not include accrued interest of approximately $982,000 and
$1,195,000 as of September 30, 2011 and December 31, 2010,
respectively, as it is deemed immaterial to the financial statements. Interest income is accrued on
the unpaid principal balance.
13
Table of Contents
The following table presents the recorded investment in loans and the balance in the allowance
for loan losses (ALLL) by portfolio segment and based on impairment method as of September 30,
2011 and December 31, 2010 (in thousands):
Collectively Evaluated | Individually Evaluated | |||||||||||||||||||||||
for Impairment | for Impairment | Total | ||||||||||||||||||||||
September 30, | December 31, | September 30, | December 31, | September 30, | December 31, | |||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Loans: |
||||||||||||||||||||||||
Construction and development |
$ | 38,117 | $ | 42,026 | $ | 26,877 | $ | 41,517 | $ | 64,994 | $ | 83,543 | ||||||||||||
Residential real estate |
87,724 | 97,639 | 26,932 | 29,182 | 114,656 | 126,821 | ||||||||||||||||||
Commercial real estate |
103,087 | 112,389 | 23,340 | 21,529 | 126,427 | 133,918 | ||||||||||||||||||
Commercial |
23,841 | 24,831 | | 113 | 23,841 | 24,944 | ||||||||||||||||||
Consumer/other |
2,830 | 2,839 | 34 | 15 | 2,864 | 2,854 | ||||||||||||||||||
Credit cards |
1,953 | 2,275 | | | 1,953 | 2,275 | ||||||||||||||||||
Total ending loan balance |
$ | 257,552 | $ | 281,999 | $ | 77,183 | $ | 92,356 | $ | 334,735 | $ | 374,355 | ||||||||||||
Allowance for loan losses: |
||||||||||||||||||||||||
Construction and development |
$ | 2,804 | $ | 1,445 | $ | 923 | $ | 1,647 | $ | 3,727 | $ | 3,092 | ||||||||||||
Residential real estate |
3,336 | 1,653 | 2,040 | 2,444 | 5,376 | 4,097 | ||||||||||||||||||
Commercial real estate |
2,277 | 1,444 | 1,930 | 617 | 4,207 | 2,061 | ||||||||||||||||||
Commercial |
356 | 395 | | 1 | 356 | 396 | ||||||||||||||||||
Consumer/other |
55 | 97 | | 1 | 55 | 98 | ||||||||||||||||||
Credit cards |
151 | 121 | | | 151 | 121 | ||||||||||||||||||
Unallocated |
1,000 | 1,077 | | | 1,000 | 1,077 | ||||||||||||||||||
Total ending allowance
balance |
$ | 9,979 | $ | 6,232 | $ | 4,893 | $ | 4,710 | $ | 14,872 | $ | 10,942 | ||||||||||||
The following table details the changes in the allowance for loan losses for the three
and nine months ended September 30, 2011 by portfolio segment (in thousands):
Construction and | Residential | Commercial | Consumer / | Credit | ||||||||||||||||||||||||||||
Development | Real Estate | Real Estate | Commercial | Other | Cards | Unallocated | Total | |||||||||||||||||||||||||
Nine months ended September 30, 2011 |
||||||||||||||||||||||||||||||||
Beginning balance |
$ | 3,092 | $ | 4,097 | $ | 2,061 | $ | 396 | $ | 98 | $ | 121 | $ | 1,077 | $ | 10,942 | ||||||||||||||||
Charged-off loans |
(8,987 | ) | (8,392 | ) | (2,479 | ) | (118 | ) | (87 | ) | (149 | ) | | (20,212 | ) | |||||||||||||||||
Recovery of previously
charged-off loans |
113 | 62 | 68 | 13 | 12 | 8 | | 276 | ||||||||||||||||||||||||
Provision for loan losses |
9,509 | 9,609 | 4,557 | 65 | 32 | 171 | (77 | ) | 23,866 | |||||||||||||||||||||||
Ending balance |
$ | 3,727 | $ | 5,376 | $ | 4,207 | $ | 356 | $ | 55 | $ | 151 | $ | 1,000 | $ | 14,872 | ||||||||||||||||
Three months ended September 30, 2011 |
||||||||||||||||||||||||||||||||
Beginning balance |
$ | 3,951 | $ | 3,822 | $ | 4,499 | $ | 452 | $ | 106 | $ | 260 | $ | 1,100 | $ | 14,190 | ||||||||||||||||
Charged-off loans |
(1,367 | ) | (735 | ) | (776 | ) | (37 | ) | (54 | ) | (45 | ) | | (3,014 | ) | |||||||||||||||||
Recovery of previously
charged-off loans |
96 | 56 | 19 | 13 | 4 | 6 | | 194 | ||||||||||||||||||||||||
Provision for loan losses |
1,047 | 2,233 | 465 | (72 | ) | (1 | ) | (70 | ) | (100 | ) | 3,502 | ||||||||||||||||||||
Ending balance |
$ | 3,727 | $ | 5,376 | $ | 4,207 | $ | 356 | $ | 55 | $ | 151 | $ | 1,000 | $ | 14,872 | ||||||||||||||||
14
Table of Contents
A summary of transactions in the ALLL for the three and nine months ended September 30,
2010 is as follows (in thousands):
Nine Months Ended | Three Months Ended | |||||||
September 30, 2010 | September 30, 2010 | |||||||
Beginning balance |
$ | 11,353 | $ | 10,374 | ||||
Charged-off loans |
(2,357 | ) | (412 | ) | ||||
Recovery of previously
charged-off loans |
440 | 21 | ||||||
Provision for loan losses |
702 | 155 | ||||||
Ending balance |
$ | 10,138 | $ | 10,138 | ||||
Credit Quality Indicators:
The Company uses several credit quality indicators, which are updated at least annually, to
manage credit risk in an ongoing manner. The Company categorizes loans into risk categories based
on relevant information about the ability of borrowers to service their debt such as the following:
current financial information, historical payment experience, credit documentation, public
information and current economic trends, among other factors. The Company uses an internal credit
risk rating system that categorizes loans into pass, special mention or classified categories.
Credit risk ratings are applied to all loans individually with the exception of credit cards.
The following are the definitions of the Companys risk ratings:
Pass: | Loans that are not adversely rated, are contractually current as to principal and interest and are otherwise in compliance with the contractual terms of the loan or lease agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass. | |||
Special Mention: | Loans classified as special mention have a potential weakness that deserves managements close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institutions credit position at some future date. | |||
Substandard/ Accruing: |
Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. | |||
Substandard/ Nonaccrual: |
A loan classified as nonaccrual has all the deficiencies of a loan graded substandard but collection of the full amount of principal and interest owed is uncertain or unlikely and collateral support, if any, may be weak. |
15
Table of Contents
Doubtful: | Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing estimations, facts, conditions and values, highly questionable and improbable. Doubtful loans include only the portion of each specific loan deemed uncollectible and the classification can change as certain current information and facts are ascertained. |
The following table presents by class and by risk category, the recorded investment in the
Companys loans as of September 30, 2011 and December 31, 2010 (in thousands):
As of September 30, 2011 | ||||||||||||||||||||||||
Not | Special | Substandard | Substandard | |||||||||||||||||||||
Rated | Pass | Mention | Accruing | Nonaccrual | Doubtful | |||||||||||||||||||
Construction and development |
$ | | $ | 30,349 | $ | 3,605 | $ | 14,046 | $ | 16,043 | $ | 951 | ||||||||||||
Commercial real estate mortgage |
| 99,841 | 2,388 | 14,478 | 9,720 | | ||||||||||||||||||
Commercial and industrial |
| 23,032 | 244 | 565 | | | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
| 49,724 | 2,874 | 11,356 | 9,511 | | ||||||||||||||||||
Home equity and
junior liens |
| 27,979 | 182 | 2,487 | 774 | | ||||||||||||||||||
Multi-family |
| 4,053 | | 1,982 | 3,734 | | ||||||||||||||||||
Total residential real estate |
| 81,756 | 3,056 | 15,825 | 14,019 | | ||||||||||||||||||
Consumer and other |
| 2,745 | 7 | 88 | 24 | | ||||||||||||||||||
Credit cards |
1,953 | | | | | | ||||||||||||||||||
Total |
$ | 1,953 | $ | 237,723 | $ | 9,300 | $ | 45,002 | $ | 39,806 | $ | 951 | ||||||||||||
As of December 31, 2010 | ||||||||||||||||||||||||
Not | Special | Substandard | Substandard | |||||||||||||||||||||
Rated | Pass | Mention | Accruing | Nonaccrual | Doubtful | |||||||||||||||||||
Construction and development |
$ | | $ | 36,086 | $ | 284 | $ | 19,244 | $ | 26,977 | $ | 952 | ||||||||||||
Commercial real estate mortgage |
| 99,649 | 1,044 | 26,863 | 6,362 | | ||||||||||||||||||
Commercial and industrial |
| 24,274 | 207 | 395 | 67 | | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
| 54,332 | 2,905 | 11,720 | 17,446 | | ||||||||||||||||||
Home equity and
junior liens |
| 30,841 | 669 | 1,561 | 1,201 | | ||||||||||||||||||
Multi-family |
| 4,454 | | 1,692 | | | ||||||||||||||||||
Total residential real estate |
| 89,627 | 3,574 | 14,973 | 18,647 | | ||||||||||||||||||
Consumer and other |
| 2,755 | 41 | 59 | | | ||||||||||||||||||
Credit cards |
2,275 | | | | | | ||||||||||||||||||
Total |
$ | 2,275 | $ | 252,391 | $ | 5,150 | $ | 61,534 | $ | 52,053 | $ | 952 | ||||||||||||
16
Table of Contents
The following table presents the aging of the recorded investment in past due loans,
including the payment status of loans on non-accrual which have been incorporated into the table,
as of September 30, 2011 and December 31, 2010 by class of loans (in thousands):
As of September 30, 2011 | ||||||||||||||||||||||||
30-59 | 60-89 | Greater Than | ||||||||||||||||||||||
Days | Days | 90 Days | Total | Total | ||||||||||||||||||||
Past Due | Past Due | Past Due | Past Due | Current | Loans | |||||||||||||||||||
Construction and development |
$ | 16 | $ | 1,455 | $ | 1,546 | $ | 3,017 | $ | 61,977 | $ | 64,994 | ||||||||||||
Commercial real estate mortgage |
279 | 421 | 4,204 | 4,904 | 121,523 | 126,427 | ||||||||||||||||||
Commercial and industrial |
2,969 | 47 | | 3,016 | 20,825 | 23,841 | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
482 | 1,169 | 4,832 | 6,483 | 66,982 | 73,465 | ||||||||||||||||||
Home equity and
junior liens |
491 | | 492 | 983 | 30,439 | 31,422 | ||||||||||||||||||
Multi-family |
1,697 | | 3,734 | 5,431 | 4,338 | 9,769 | ||||||||||||||||||
Total residential real estate |
2,670 | 1,169 | 9,058 | 12,897 | 101,759 | 114,656 | ||||||||||||||||||
Consumer and other |
29 | 25 | | 54 | 2,810 | 2,864 | ||||||||||||||||||
Credit cards |
2 | | | 2 | 1,951 | 1,953 | ||||||||||||||||||
Total |
$ | 5,965 | $ | 3,117 | $ | 14,808 | $ | 23,890 | $ | 310,845 | $ | 334,735 | ||||||||||||
As of December 31, 2010 | ||||||||||||||||||||||||
30-59 | 60-89 | Greater Than | ||||||||||||||||||||||
Days | Days | 90 Days | Total | Total | ||||||||||||||||||||
Past Due | Past Due | Past Due | Past Due | Current | Loans | |||||||||||||||||||
Construction and development |
$ | 265 | $ | 49 | $ | 394 | $ | 708 | $ | 82,835 | $ | 83,543 | ||||||||||||
Commercial real estate mortgage |
214 | 326 | 2,573 | 3,113 | 130,805 | 133,918 | ||||||||||||||||||
Commercial and industrial |
| | | | 24,944 | 24,944 | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
948 | 2,580 | | 3,528 | 82,875 | 86,403 | ||||||||||||||||||
Home equity and
junior liens |
| 409 | 62 | 471 | 33,800 | 34,271 | ||||||||||||||||||
Multi-family |
| | | | 6,146 | 6,146 | ||||||||||||||||||
Total residential real estate |
948 | 2,989 | 62 | 3,999 | 122,821 | 126,820 | ||||||||||||||||||
Consumer and other |
14 | 10 | | 24 | 2,831 | 2,855 | ||||||||||||||||||
Credit cards |
43 | 1 | 19 | 63 | 2,212 | 2,275 | ||||||||||||||||||
Total |
$ | 1,484 | $ | 3,375 | $ | 3,048 | $ | 7,907 | $ | 366,448 | $ | 374,355 | ||||||||||||
Delinquent loans increased approximately $16 million during the two periods compared in
the tables above. Included in the September 30, 2011 past due loan balance is approximately $13.7
million, or 57% of the past due total, that was classified as collateral dependent with a recorded
investment equal to the short-term liquidation value of the collateral. At December 31, 2010,
approximately $2.5 million, or 32% of the past due total, was classified as collateral dependent
and reported at the fair value of the underlying collateral. All
collateral dependent loans are classified as impaired loans.
17
Table of Contents
All interest accrued but not collected for loans that are placed on nonaccrual or charged off
is reversed against interest income. The interest on these loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual. Generally, loans are
returned to accrual status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured, which usually requires a minimum of six
months sustained repayment performance.
Nonperforming loans include both smaller balance homogeneous loans that are collectively
evaluated for impairment and individually classified as impaired loans.
The following table presents the recorded investment in nonperforming loans by class of loans
as of September 30, 2011 and December 31, 2010 (in thousands):
As of September 30, 2011 | ||||||||
Loans Past Due Over | ||||||||
Nonaccrual | 90 Days Still Accruing | |||||||
Construction and development |
$ | 16,994 | $ | | ||||
Commercial real estate mortgage |
9,720 | 1,907 | ||||||
Commercial and industrial |
| | ||||||
Residential real estate |
||||||||
Residential mortgage |
9,511 | 342 | ||||||
Home equity and
junior liens |
774 | | ||||||
Multi-family |
3,734 | | ||||||
Total residential real estate |
14,019 | 342 | ||||||
Consumer and other |
24 | | ||||||
Total nonperforming loans |
$ | 40,757 | $ | 2,249 | ||||
As of December 31, 2010 | ||||||||
Loans Past Due Over | ||||||||
Nonaccrual | 90 Days Still Accruing | |||||||
Construction and development |
$ | 27,929 | $ | | ||||
Commercial real estate mortgage |
6,362 | 413 | ||||||
Commercial and industrial |
67 | | ||||||
Residential real estate |
||||||||
Residential mortgage |
17,446 | | ||||||
Home equity and
junior liens |
1,201 | | ||||||
Total residential real estate |
18,647 | | ||||||
Credit cards |
| 19 | ||||||
Total nonperforming loans |
$ | 53,005 | $ | 432 | ||||
18
Table of Contents
The following table presents loans individually evaluated for impairment by class of
loans as of September 30, 2011 and December 31, 2010 (in thousands):
As of September 30, 2011 | ||||||||||||
Unpaid | Allowance for | |||||||||||
Principal | Recorded | Loan Losses | ||||||||||
Balance | Investment | Allocated | ||||||||||
With no related allowance recorded: |
||||||||||||
Construction and development |
$ | 20,963 | $ | 13,382 | $ | | ||||||
Commercial real estate mortgage |
4,615 | 2,969 | | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
12,478 | 7,492 | | |||||||||
Home equity and
junior liens |
774 | 604 | | |||||||||
Total residential real estate |
13,252 | 8,096 | | |||||||||
Consumer and other |
37 | 34 | | |||||||||
Total with no related allowance recorded |
$ | 38,867 | $ | 24,481 | $ | | ||||||
With an allowance recorded: |
||||||||||||
Construction and development |
$ | 13,515 | $ | 13,495 | $ | 923 | ||||||
Commercial real estate mortgage |
20,420 | 20,371 | 1,930 | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
11,943 | 11,929 | 1,083 | |||||||||
Home equity and
junior liens |
1,190 | 1,190 | 84 | |||||||||
Multi-family |
5,758 | 5,717 | 873 | |||||||||
Total residential real estate |
18,891 | 18,836 | 2,040 | |||||||||
Total with an allowance recorded |
$ | 52,826 | $ | 52,702 | $ | 4,893 | ||||||
Total impaired loans |
$ | 91,693 | $ | 77,183 | $ | 4,893 | ||||||
As of December 31, 2010 | ||||||||||||
Unpaid | Allowance for | |||||||||||
Principal | Recorded | Loan Losses | ||||||||||
Balance | Investment | Allocated | ||||||||||
With no related allowance recorded: |
||||||||||||
Construction and development |
$ | 18,005 | $ | 13,216 | $ | | ||||||
Commercial real estate mortgage |
5,559 | 4,834 | | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
4,358 | 4,336 | | |||||||||
Home equity and
junior liens |
468 | 468 | | |||||||||
Total residential real estate |
4,826 | 4,804 | | |||||||||
Total with no related allowance recorded |
$ | 28,390 | $ | 22,854 | $ | | ||||||
With an allowance recorded: |
||||||||||||
Construction and development |
$ | 28,505 | $ | 28,301 | $ | 1,647 | ||||||
Commercial real estate mortgage |
16,743 | 16,695 | 617 | |||||||||
Commercial and industrial |
113 | 113 | 1 | |||||||||
Residential real estate |
||||||||||||
Residential mortgage |
22,349 | 22,298 | 2,335 | |||||||||
Home equity and
junior liens |
388 | 388 | 17 | |||||||||
Multi-family |
1,692 | 1,692 | 92 | |||||||||
Total residential real estate |
24,429 | 24,378 | 2,444 | |||||||||
Consumer and other |
15 | 15 | 1 | |||||||||
Total with an allowance recorded |
$ | 69,805 | $ | 69,502 | $ | 4,710 | ||||||
Total impaired loans |
$ | 98,195 | $ | 92,356 | $ | 4,710 | ||||||
The unpaid principal balance of loans individually evaluated for
impairment includes principal amounts classified as partial
charge-offs. The recorded investment is shown net of these amounts
and reflects the carrying value of the loans. As discussed below
under Part I - Item 2 Managements Discussion and Analysis of
Financial Condition and Results of Operations Allowance for Loan Losses, the Company
recorded a significant amount of partial charge-offs during the three
and nine months ended September 30, 2011.
19
Table of Contents
The following table presents by class, information related to the average recorded
investment and interest income recognized on impaired loans for the three and nine months ended
September 30, 2011 (in thousands):
Nine Months Ended September 30, 2011 | Three Months Ended September 30, 2011 | |||||||||||||||
Average Recorded | Interest Income | Average Recorded | Interest Income | |||||||||||||
Investment | Recognized | Investment | Recognized | |||||||||||||
With no related allowance recorded: |
||||||||||||||||
Construction and development |
$ | 13,022 | $ | 18 | $ | 13,531 | $ | 1 | ||||||||
Commercial real estate mortgage |
4,304 | 4 | 3,469 | (11 | ) | |||||||||||
Commercial and industrial |
2 | 1 | 4 | | ||||||||||||
Residential real estate |
||||||||||||||||
Residential mortgage |
6,983 | 7 | 7,857 | 1 | ||||||||||||
Home equity and
junior liens |
645 | | 425 | | ||||||||||||
Total residential real estate |
7,628 | 7 | 8,282 | 1 | ||||||||||||
Consumer and other |
18 | 1 | 36 | | ||||||||||||
Total with no related allowance recorded |
$ | 24,974 | $ | 31 | $ | 25,322 | $ | (9 | ) | |||||||
With an allowance recorded: |
||||||||||||||||
Construction and development |
$ | 22,081 | $ | 296 | $ | 16,043 | $ | 100 | ||||||||
Commercial real estate mortgage |
18,622 | 502 | 20,727 | 232 | ||||||||||||
Commercial and industrial |
57 | | | | ||||||||||||
Residential real estate |
||||||||||||||||
Residential mortgage |
15,941 | 348 | 11,990 | 79 | ||||||||||||
Home equity and
junior liens |
1,038 | 34 | 1,221 | 11 | ||||||||||||
Multi-family |
2,275 | 22 | 2,858 | 22 | ||||||||||||
Total residential real estate |
19,254 | 404 | 16,069 | 112 | ||||||||||||
Consumer and other |
7 | | | | ||||||||||||
Total with an allowance recorded |
$ | 60,021 | $ | 1,202 | $ | 52,839 | $ | 444 | ||||||||
Total impaired loans |
$ | 84,995 | $ | 1,233 | $ | 78,161 | $ | 435 | ||||||||
For the three and nine months ended September 30, 2011, the amount of interest income
recognized by the Company within the period that the loans were impaired was primarily related to
loans modified in a troubled debt restructuring that remained on accrual status. For the three and
nine months ended September 30, 2011, the amount of interest income recognized using a cash-basis
method of accounting during the period that the loans were impaired was not material.
Troubled Debt Restructurings:
Impaired loans also include loans that the Bank has elected to formally restructure due to the
weakening credit status of a borrower such that the restructuring may facilitate a repayment plan
that minimizes the potential losses, if any, that the Bank may have to otherwise incur. These loans
are classified as impaired loans and, if on nonaccruing status as of the date of the restructuring,
the loans are included in the nonperforming loan balances noted above. Not included in
nonperforming loans are loans that have been restructured that were performing as of the
restructure date.
The Company offers various types of concessions when modifying a loan which often involve one
or a combination of the following: reducing the stated interest rate of the loan; extending the
maturity date at a stated rate of interest lower than the current market rate for new debt with
similar risk; granting or extending temporary interest-only payment periods; or a permanent
reduction of the recorded investment in the loan. Additional collateral, a co-borrower, or a
guarantor is often requested. In most cases, the objective is to reduce the scheduled payments to
accommodate the borrowers financial needs for a period of time, normally one to two years. The
Companys modifications are individually designed to meet the specific needs of each borrower.
20
Table of Contents
Loans modified in a TDR are typically already on non-accrual status and partial charge-offs
have in some cases already been taken against the outstanding loan balance. As a result, loans
modified in a TDR for the Company may have the financial effect of increasing the specific
allowance associated with the loan. An allowance for impaired consumer and commercial loans that
have been modified in a TDR is measured based on the present value of expected future cash flows
discounted at the loans effective interest rate or the estimated fair value of the collateral,
less any selling costs, if the loan is collateral dependent. Management exercises significant
judgment in developing these estimates.
The following presents by class, information related to loans modified as TDRs during the
three and nine months ended September 30, 2011.
Nine Months Ended September 30, 2011 | Three Months Ended September 30, 2011 | |||||||||||||||||||||||
Post | Post | |||||||||||||||||||||||
Modification | Modification | |||||||||||||||||||||||
Pre | Outstanding | Pre | Outstanding | |||||||||||||||||||||
Modification | Recorded | Modification | Recorded | |||||||||||||||||||||
Outstanding | Investment, | Outstanding | Investment, | |||||||||||||||||||||
Number of | Recorded | net of related | Number of | Recorded | net of related | |||||||||||||||||||
Contracts | Investment | allowance | Contracts | Investment | allowance | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Troubled Debt Restructurings 1 |
||||||||||||||||||||||||
Construction and development |
4 | $ | 511 | $ | 500 | 1 | $ | 106 | $ | 106 | ||||||||||||||
Commercial real estate mortgage |
1 | 428 | 279 | | | | ||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||
Residential mortgage |
5 | 3,286 | 1,843 | 1 | 536 | 347 | ||||||||||||||||||
Home equity and
junior liens |
1 | 171 | 163 | | | | ||||||||||||||||||
Multi-family |
1 | 285 | 280 | 1 | 285 | 280 | ||||||||||||||||||
Total residential real estate |
7 | 3,742 | 2,286 | 2 | 821 | 627 | ||||||||||||||||||
Total |
12 | 4,681 | 3,065 | 3 | 927 | 733 | ||||||||||||||||||
1 | The period end balances are inclusive of all partial paydowns and charge-offs
since the modification date. Loans modified in a TDR that were fully paid down, charged-off or
foreclosed upon by period end are not reported. |
The TDRs described above increased the allowance for loan losses by approximately
$223,000 and resulted in charge offs of approximately $1,394,000 during the nine-month period ended
September 30, 2011. These TDRs increased the allowance for loan losses by approximately $193,000
and resulted in charge offs of approximately $1,000 during the third quarter of 2011.
21
Table of Contents
The following presents by class, loans modified as TDRs for which there was a payment default
within twelve months following the modification during the three and nine months ended September
30, 2011.
Loans Modified as a TDR Within the Previous Twelve Months | ||||||||||||||||
That Subsequently Defaulted During the | ||||||||||||||||
Nine Months Ended September 30, 2011 | Three Months Ended September 30, 2011 | |||||||||||||||
Recorded | Recorded | |||||||||||||||
Investment | Investment | |||||||||||||||
Number of | (as of | Number of | (as of | |||||||||||||
Contracts | period end)1 | Contracts | period end)1 | |||||||||||||
(in thousands) | ||||||||||||||||
Commercial real estate mortgage |
1 | $ | 431 | 1 | $ | 431 | ||||||||||
Residential real estate
Residential mortgage |
2 | 1,405 | 2 | 1,405 | ||||||||||||
Total residential real estate |
2 | 1,405 | 2 | 1,405 | ||||||||||||
Total |
3 | 1,836 | 3 | 1,836 | ||||||||||||
1 | The period end balances are inclusive of all partial paydowns and charge-offs
since the modification date. Loans modified in a TDR that were fully paid down, charged-off or
foreclosed upon by period end are not reported. |
A loan is considered to be in payment default once it is 60 days contractually past due
under the modified terms.
TDRs that subsequently defaulted described above were each considered collateral dependent as
of September 30, 2011, and did not have specific reserves within the allowance for loan losses but
resulted in charge offs of approximately $567,000 and $717,000 during the three and nine-month
periods ended September 30, 2011, respectively.
If loans modified in a TDR subsequently default, the Company evaluates the loan for possible
further impairment. The allowance may by increased, adjustments may be made in the allocation of
the allowance, or partial charge-offs may be taken to further write-down the carrying value of the
loan.
The Company had allocated approximately $3,457,000 and $3,700,000 of specific reserves to
customers whose loan terms have been modified in TDRs as of September 30, 2011 and December 31,
2010, respectively. The decrease in specific reserves allocated to TDRs during the first nine
months of 2011 of approximately $243,000 was primarily attributable to partial charge-offs of
collateral dependent loans that are also TDRs. The Company had approximately $66,996,000 of loans
outstanding to customers whose loans were classified as TDRs at September 30, 2011 as compared to
approximately $82,443,000 at December 31, 2010. Currently, the Company has committed to lend
additional amounts totaling approximately $1,380,000 related to loans classified as TDRs. At
September 30, 2011 and December 31, 2010, there were approximately $32,436,000 and $35,752,000,
respectively, of accruing restructured loans that remain in a performing status; however, these
loans are included in impaired loan totals.
The terms of certain other loans were modified during the three and nine-month periods ending
September 30, 2011 that did not meet the definition of a TDR. These loans involved either a
modification of the terms of a loan to borrowers who were not experiencing financial difficulties
or a delay in payment that was considered to be insignificant. The recorded investment in these
loans at September 30, 2011 was not significant.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation
is performed of the probability that the borrower will be in payment default on any of its debt in
the foreseeable future without the modification. This evaluation is performed under the Companys
loan workout policies and procedures.
22
Table of Contents
Certain loans which were modified during the three and nine-month periods ending September 30,
2011 and did not meet the definition of a TDR as the modification was a delay in a payment that was
considered to be insignificant were not material.
Note 6. Comprehensive Income (Loss)
Comprehensive income (loss) is made up of net income (loss) and other comprehensive income
(loss). Other comprehensive income (loss) is made up of changes in the unrealized gain (loss) on
securities available for sale. Comprehensive income (loss) for the three and nine months ended
September 30, 2011 was ($2,672,763) and ($26,900,294), respectively, as compared to $192,014 and
$821,651 for the three and nine months ended September 30, 2010, respectively.
Note 7. Fair Value
Fair value is the exchange price that would be received for an asset or paid to transfer a
liability (exit price) in the principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the measurement date. There are three levels
of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices
for similar assets or liabilities; quoted prices in markets that are not active; or other
inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions
about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value
of each type of financial instrument:
Investment Securities Available for Sale Securities classified as available for sale are
reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair
value measurements from an independent service provider. The fair value measurements consider
observable data that may include dealer quotes, market spreads, cash flows, the U. S. Treasury
yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit
information and the securities terms and conditions, among other things.
Impaired Loans The fair value of impaired loans with specific allocations of the allowance
for loan losses may be based on recent real estate appraisals. These appraisals may utilize a
single valuation approach or a combination of approaches including comparable sales and the income
approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for
differences between the comparable sales and income data available. Such adjustments are usually
significant and typically result in a Level 3 classification of the inputs for determining fair
value. If the recorded investment in an impaired loan exceeds the measure of fair value, a
valuation allowance may be established as a component of the allowance for loan losses or the
expense is recognized as a charge-off. As a result of partial charge-offs, certain impaired loans
are carried at fair value with no allocation. Certain impaired loans are not measured at fair
value, which generally includes troubled debt restructurings that are measured for impairment based
upon the present value of expected cash flows discounted at the loans original effective interest
rate, and are excluded from the assets measured on a nonrecurring basis.
23
Table of Contents
Other Real Estate The fair value of other real estate (ORE) is generally based on current
appraisals, comparable sales, and other estimates of value obtained principally from independent
sources, adjusted for estimated selling costs. At the time of foreclosure, any excess of the loan
balance over the fair value of the real estate held as collateral is treated as a charge against
the ALLL. Gains or losses on sale and any subsequent adjustments to the value are recorded as a
gain or loss on ORE. ORE is classified within Level 3 of the hierarchy.
Assets and Liabilities Measured on a Recurring Basis
The following table summarizes assets and liabilities measured at fair value on a recurring
basis as of September 30, 2011 and December 31, 2010, segregated by the level of the valuation
inputs within the fair value hierarchy utilized to measure fair value:
Fair Value Measurements at | ||||||||
September 30, 2011 Using: | ||||||||
Significant Other | ||||||||
Observable Inputs | ||||||||
Carrying Value | (Level 2) | |||||||
Assets: |
||||||||
Available for sale securities: |
||||||||
U. S. Government securities |
$ | 249,996 | $ | 249,996 | ||||
Obligations of states and political
subdivisions |
5,378,486 | 5,378,486 | ||||||
Mortgage-backed
securities-residential |
79,232,288 | 79,232,288 | ||||||
Total available for sale securities |
$ | 84,860,770 | $ | 84,860,770 | ||||
Fair Value Measurements at | ||||||||
December 31, 2010 Using: | ||||||||
Significant Other | ||||||||
Observable Inputs | ||||||||
Carrying Value | (Level 2) | |||||||
Assets: |
||||||||
Available for sale securities: |
||||||||
U. S. Government securities |
$ | 249,866 | $ | 249,866 | ||||
Obligations of states and
political subdivisions |
4,922,113 | 4,922,113 | ||||||
Mortgage-backed securities
-residential |
81,144,612 | 81,144,612 | ||||||
Total available for sale
securities |
$ | 86,316,591 | $ | 86,316,591 | ||||
For the three and nine months ended September 30, 2011, there were no transfers between
Level 1 and Level 2.
24
Table of Contents
Assets and Liabilities Measured on a Non-Recurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis, that is,
the instruments are not measured at fair value on an ongoing basis but are subject to fair value
adjustments in certain circumstances (for example, when there is evidence of impairment). The
following table summarizes assets and liabilities measured at fair value on a non-recurring basis
as of September 30, 2011 and December 31, 2010, segregated by the level of the valuation inputs
within the fair value hierarchy utilized to measure fair value:
Fair Value Measurements at | ||||||||
September 30, 2011 Using: | ||||||||
Significant | ||||||||
Unobservable Inputs | ||||||||
Carrying Value | (Level 3) | |||||||
Assets: |
||||||||
Impaired loans: |
||||||||
Construction and
development |
$ | 12,149,554 | $ | 12,149,554 | ||||
Commercial real estate |
4,156,481 | 4,156,481 | ||||||
Residential real estate |
10,702,118 | 10,702,118 | ||||||
Total impaired loans |
27,008,153 | 27,008,153 | ||||||
Other real estate: |
||||||||
Construction and
development |
1,540,507 | 1,540,507 | ||||||
Commercial real estate |
2,434,176 | 2,434,176 | ||||||
Residential real estate |
4,463,600 | 4,463,600 | ||||||
Total other real estate |
8,438,283 | 8,438,283 | ||||||
Total Assets
Measured at Fair Value on a Non-Recurring Basis |
$ | 35,446,436 | $ | 35,446,436 | ||||
Fair Value Measurements at | ||||||||
December 31, 2010 Using: | ||||||||
Significant | ||||||||
Unobservable Inputs | ||||||||
Carrying Value | (Level 3) | |||||||
Assets: |
||||||||
Impaired loans: |
||||||||
Construction and
development |
$ | 8,826,040 | $ | 8,826,040 | ||||
Commercial real estate |
3,378,152 | 3,378,152 | ||||||
Residential real estate |
4,045,756 | 4,045,756 | ||||||
Total impaired loans |
16,249,948 | 16,249,948 | ||||||
Other real estate: |
||||||||
Construction and
development |
2,229,161 | 2,229,161 | ||||||
Commercial real estate |
1,404,833 | 1,404,833 | ||||||
Residential real estate |
7,518,670 | 7,518,670 | ||||||
Total other real estate |
11,152,664 | 11,152,664 | ||||||
Total Assets
Measured at Fair Value on a Non-Recurring Basis |
$ | 27,402,612 | $ | 27,402,612 | ||||
At September 30, 2011, impaired loans measured at fair value, which are evaluated for
impairment using the fair value of collateral, had a carrying amount of $28,982,828, with a
valuation allowance of $1,974,675 resulting in an additional provision for loan losses of
$2,434,286 and $10,513,352 for the three- and nine-month periods ended September 30, 2011,
respectively. At December 31, 2010, impaired loans measured at fair value had a carrying amount of
$17,718,189, with a valuation allowance of $1,468,241 resulting in an additional provision for loan
losses of $4,514,585 for the year ended December 31, 2010. Impaired loans carried at fair value
include loans that have been written down to fair value through the partial charge-off of principal
balance. Accordingly, these loans do not have a specific valuation allowance as their balances
represent fair value.
25
Table of Contents
The September 30, 2011 carrying amount of ORE
measured at fair value is made up of the outstanding balance of
$12,792,422, net of a valuation allowance of $4,354,139, resulting in
net write-downs of
approximately $144,000 and $4,946,000 for the three and nine months ended September 30, 2011,
respectively. These write-downs include charge-offs recorded at the
time of foreclosure. The December 31, 2010 carrying amount of ORE measured at fair value is made up of the outstanding balance of
$12,244,144, net of a valuation allowance of $1,091,480, resulting in
net write-downs of
approximately $1,211,000 for the year ended December 31, 2010. Valuation adjustments include both charge offs and holding gains and
losses. The fair value of ORE is based upon appraisals performed by qualified, licensed appraisers.
Appraisals are obtained at the time of foreclosure and at least annually thereafter or more often
if management determines property values have significantly declined.
Fair Value of Financial Instruments
Fair value estimates are made at a specific point in time, based on relevant market
information about the financial instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the Companys entire holdings of a particular
financial instrument. Because no market exists for a significant portion of the Companys
financial instruments, fair value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various financial instruments, and
other factors. These estimates are subjective in nature; involve uncertainties and matters of
judgment; and, therefore, cannot be determined with precision. Changes in assumptions could
significantly affect the estimates. Accordingly, the aggregate fair value amounts presented are not
intended to represent the underlying value of the Company.
Fair value estimates are based on existing financial instruments without attempting to
estimate the value of anticipated future business and the value of assets and liabilities that are
not considered financial instruments. The following methods and assumptions were used to estimate
the fair value of each class of financial instruments:
Cash and cash equivalents:
For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
Investment Securities:
The fair value of securities is estimated as previously described for securities available for
sale, and in a similar manner for securities held to maturity.
Restricted investments:
Restricted investments consist of Federal Home Loan Bank (FHLB) and Federal Reserve Bank
stock. It is not practicable to determine the fair value due to restrictions placed on the
transferability of the stock.
Loans:
The fair value of loans is calculated by discounting scheduled cash flows through the
estimated maturity using estimated market discount rates, adjusted for credit risk and servicing
costs. The estimate of maturity is based on historical experience with repayments for each loan
classification, modified, as required, by an estimate of the effect of current economic and lending
conditions. The allowance for loan losses is considered a reasonable discount for credit risk.
26
Table of Contents
Deposits:
The fair value of deposits with no stated maturity, such as demand deposits, money market
accounts, and savings deposits, is equal to the amount payable on demand. The fair value of time
deposits is based on the discounted value of contractual cash flows. The discount rate is
estimated using the rates currently offered for deposits of similar remaining maturities.
Federal funds purchased, Federal Reserve Bank advances and securities sold under agreements to
repurchase:
The estimated value of these liabilities, which are extremely short term, approximates their
carrying value.
Subordinated debentures:
For the subordinated debentures with a floating interest rate tied to LIBOR, the fair value is
based on the discounted value of contractual cash flows. The discount rate is estimated using the
most recent offering rates available for subordinated debentures of similar amounts and remaining
maturities.
Federal Home Loan Bank advances:
For FHLB advances the fair value is based on the discounted value of contractual cash flows.
The discount rate is estimated using the rates currently offered for FHLB advances of similar
amounts and remaining maturities.
Accrued interest receivable and payable:
The carrying amounts of accrued interest receivable and payable approximate their fair value.
Commitments to extend credit, letters of credit and lines of credit:
The fair value of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers
the difference between current levels of interest rates and the committed rates. The fair values
of these commitments are insignificant and are not included in the table below.
27
Table of Contents
The carrying amounts and estimated fair values of the Companys financial instruments at
September 30, 2011 and December 31, 2010, not previously presented, are as follows (in thousands):
September 30, 2011 | December 31, 2010 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Amount | Fair Value | Amount | Fair Value | |||||||||||||
Assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 43,099 | $ | 43,099 | $ | 32,576 | $ | 32,576 | ||||||||
Investment securities held to
maturity |
1,365 | 1,537 | 1,318 | 1,303 | ||||||||||||
Restricted investments |
3,847 | N/A | 3,843 | N/A | ||||||||||||
Loans, net |
319,863 | 311,424 | 363,413 | 358,587 | ||||||||||||
Accrued interest receivable |
1,319 | 1,319 | 1,496 | 1,496 | ||||||||||||
Liabilities: |
||||||||||||||||
Noninterest-bearing demand deposits |
$ | 48,774 | $ | 48,774 | $ | 47,639 | $ | 47,639 | ||||||||
NOW accounts |
49,566 | 49,566 | 57,345 | 57,345 | ||||||||||||
Savings and money market accounts |
75,980 | 75,980 | 73,435 | 73,435 | ||||||||||||
Time deposits |
260,236 | 261,373 | 271,173 | 272,304 | ||||||||||||
Subordinated debentures |
13,403 | 7,966 | 13,403 | 7,276 | ||||||||||||
Federal funds purchased and
securities
sold under agreements to repurchase |
842 | 842 | 432 | 432 | ||||||||||||
Federal Reserve/Federal Home Loan
Bank advances |
55,200 | 62,590 | 55,200 | 61,136 | ||||||||||||
Accrued interest payable |
738 | 738 | 719 | 719 |
Note 8. Regulatory Matters
The Bank and Company are subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action applicable to the Bank, the Bank and Company
must meet specific capital guidelines that involve quantitative measures of assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank
and Company to maintain minimum amounts and ratios of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). In addition, the Companys and the Banks regulators may impose additional
capital requirements on financial institutions and their bank subsidiaries, like the Company and
the Bank, beyond those provided for statutorily, which standards may be in addition to, and require
higher levels of capital, than the general statutory capital adequacy requirements. As discussed
below, the Bank has agreed to maintain certain of its capital ratios above minimum statutory
levels. As of September 30, 2011 and discussed below, the Bank failed to meet all capital adequacy
requirements to which it is subject. Continued failure to maintain capital ratios above minimum
regulatory standards or further declines in these ratios below levels considered to be unsafe for
the Bank could result in further regulatory actions as discussed in more detail under Part II
Other Information Item 1A. Risk Factors.
28
Table of Contents
The Bank has previously entered into a formal written agreement in which it made certain
commitments to the OCC, including commitments to, among other things, implement a program to reduce
the high level of credit risk in the Bank including strengthening credit underwriting and problem
loan workouts and collections, reduce its level of criticized assets, implement a concentration
risk management program related to commercial real estate lending, improve procedures related to
the maintenance of the Banks ALLL, strengthen the Banks internal loan review program, strengthen
the Banks loan workout department, and develop a liquidity plan that improves the Banks reliance
on wholesale funding sources.
In the fourth quarter of 2010, the OCC informed the Bank that, because the OCC did not believe
that the Bank had fully satisfied the requirements of the formal written agreement, the formal
written agreement would be replaced with a consent order containing requirements for further
improvements in the Banks operations. On October 27, 2011, the Bank executed a Stipulation and
Consent (the Consent) to the issuance of a Consent Order (the Order) by the OCC. Under the
terms of the Order, the Bank is required, among other things, to take the following actions:
| Maintain a committee of its board of directors to oversee the Banks compliance with the
Order; |
| Develop, within 60 days of the date of the Order, a strategic plan covering at least a
three-year period that establishes objectives for the Banks overall risk profile, earnings
performance, growth, balance sheet mix, off-balance sheet activities, liability structure,
capital adequacy, reduction in volume of nonperforming assets, product line development,
and market segments that the Bank intends to promote or develop, together with strategies
to achieve those objectives; |
| Develop and implement, within 60 days of the date of the Order, a capital plan that
increases the Banks Total risk-based capital ratio and Tier 1 capital ratio to at least
12% and 9%, respectively, within 120 days of the date of the Order; |
| Prepare and submit, within 90 days of the date of the Order, a written assessment of the
capabilities of certain of the Banks officers and, if the board of directors determines an
officers performance needs improvement, implement a written program to improve the
officers performance, skills and abilities; |
| Ensure adherence to the Banks written program to reduce and manage the high level of
credit risk in the Bank, and at least quarterly prepare a written assessment of the Banks
credit risk and the Banks adherence to the program; |
| Implement and adhere to a written program designed to protect the Banks interest in
those assets criticized as doubtful, substandard or special mention; |
| Not extend, directly or indirectly, any additional credit to any borrower whose loans or
other extensions of credit are criticized and whose aggregate loans and extensions of
credit exceed $250,000, unless the board of directors makes certain determinations; |
| Establish, within 60 days of the date of the Order, an effective independent and ongoing
independent loan review program to review, at least semi-annually, the Banks loan
portfolio, to assure timely identification and categorization of problem credits; |
| Maintain and adhere to a written policy and procedures for the maintenance of an
adequate Allowance for Loan and Lease Losses; |
| Adopt, implement and ensure adherence to an independent, risk-based audit program of all
Bank operations and ensure immediate actions are undertaken to remedy deficiencies cited in
audit reports; |
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| Revise and maintain, within 60 days of the date of the Order, a comprehensive liability
risk management program; and |
| Agree to certain limitations on third party contracts. |
On June 30, 2011, the Banks total risk-based capital to risk-weighted assets ratio was 7.69%,
which was below the necessary ratio of 8.0% for total risk-based capital to risk-weighted assets
specified in the OCCs prompt corrective action regulations. As a result, the Bank was in the
undercapitalized category under those regulations and was subject to restrictions on payments of
any dividends or management fees, on asset growth and on expansion of assets without prior
regulatory approval. Additionally, because it is not considered adequately capitalized the Bank
may not accept employee benefit plan deposits, may not accept, renew or rollover brokered deposits,
and is restricted on the yield it may offer on deposits. The Bank also was required to file a
capital restoration plan specifying the steps the Bank would take to become adequately
capitalized (i.e. have capital above the minimum ratio), the levels of capital to be attained each
year the plan is in effect, the steps the Bank will take to comply with the growth and other
restrictions applicable to it and the level of activities it will engage in. In addition, the
Company is required to provide a guarantee of the capital restoration plan, including any
commitment to raise capital made in the plan and a pledge of assets, if any, acceptable to the OCC.
If the Bank fails to comply with the terms of the capital restoration plan that it submits to the
OCC, the Company will be obligated to pay the Bank pursuant to the guarantee the lesser of five
percent of the Banks totals assets at the time the Bank was undercapitalized, or the amount which
is necessary to bring the Bank into compliance with all adequately capitalized standards at the
time it failed to comply.
On October 3, 2011, the Bank submitted a capital restoration plan to the OCC, and on October
21, 2011, the OCC disapproved and did not accept such plan because the OCC was unable to determine
that the capital restoration plan was based on realistic assumptions or was likely to succeed in
restoring the Banks capital. As a result of the OCCs action, for purposes of the prompt
corrective action regulations, the Bank will be treated as if it were in the significantly
undercapitalized category until it submits an acceptable capital restoration plan and such plan is
accepted by the OCC. As long as the Bank is treated as in the significantly undercapitalized
category it is subject to the additional restriction that it cannot pay any bonus to any senior
executive officer or provide compensation to any senior executive officer exceeding the officers
average rate during the twelve calendar months ending September 30, 2011. During the period that
the Bank is actually significantly undercapitalized or treated as such on account of its failure
to have a capital restoration plan accepted by the OCC, the OCC may impose additional requirements,
including requiring recapitalization or sale of additional shares or sale of the Bank, restricting
asset growth activities, limiting interest rates the Bank can pay on deposits, prohibiting
acceptance of deposits from correspondents, requiring the dismissal of directors or senior
executive officers, employing new executive officers, or requiring divestiture or sale of the Bank.
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS |
The following discussion and analysis is designed to provide a better understanding of various
factors related to the financial condition and results of operations of the Company and its
subsidiaries, including the Bank. This section should be read in conjunction with the financial
statements and notes thereto which are contained in Item 1 above and the Companys Annual Report on
Form 10-K for the year ended December 31, 2010, including Managements Discussion and Analysis of
Financial Condition and Results of Operations.
To better understand financial trends and performance, the Companys management analyzes
certain key financial data in the following pages. This analysis and discussion reviews the
Companys results of operations and financial condition for the three and nine months ended
September 30, 2011. This discussion is intended to supplement and highlight information contained
in the accompanying unaudited consolidated financial statements as of and for the three- and
nine-month periods ended September 30, 2011. The Company has also provided some comparisons of the
financial data for the three- and nine-month periods ended September 30, 2011, against the same
period in 2010, as well as the Companys year-end results as of and for the year ended December 31,
2010, to illustrate significant changes in performance and the possible results of trends revealed
by that historical financial data. This discussion should be read in conjunction with our
financial statements and notes thereto, which are included under Item 1 above.
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Special Cautionary Notice Regarding Forward-Looking Statements
Certain of the statements made herein are forward-looking statements within the meaning of,
and subject to the protections of Section 27A of the Securities Act of 1933, as amended, (the
Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange
Act).
Forward-looking statements include statements with respect to our beliefs, plans, objectives,
goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and
involve known and unknown risks, uncertainties and other factors, which may be beyond our control,
and which may cause our actual results, performance or achievements to be materially different from
future results, performance or achievements expressed or implied by such forward-looking
statements.
All statements other than statements of historical fact are statements that could be
forward-looking statements. You can identify these forward-looking statements through our use of
words such as may, will, anticipate, assume, should, indicate, attempt, would,
believe, contemplate, expect, seek, estimate, continue, plan, point to, project,
predict, could, intend, target, potential, and other similar words and expressions of the
future. These forward-looking statements may not be realized due to a variety of factors,
including those risk factors set forth in the Companys Annual Report on Form 10-K for the year
ended December 31, 2010, the Companys Quarterly Reports on Form 10-Q for the quarters ended March
31, 2011 and June 30, 2011 and below under Part II, Item 1A. Risk Factors and, without
limitation:
| the effects of greater than anticipated deterioration in economic and business
conditions (including in the residential and commercial real estate construction and
development segment of the economy) nationally and in our local market; |
| deterioration in the financial condition of borrowers resulting in significant
increases in loan losses and provisions for those losses; |
| increased levels of non-performing and repossessed assets; |
| lack of sustained growth in the economy in the Sevier County and Blount County,
Tennessee area; |
| government monetary and fiscal policies as well as legislative and regulatory
changes, including changes in banking, securities and tax laws and regulations; |
| the risks of changes in interest rates on the levels, composition and costs of
deposits, loan demand, and the values of loan collateral, securities, and interest
sensitive assets and liabilities; |
| the effects of competition from a wide variety of local, regional, national and other
providers of financial, and investment services; |
| the failure of assumptions underlying the establishment of reserves for possible loan
losses and other estimates; |
| the risks of mergers, acquisitions and divestitures, including, without limitation,
the related time and costs of implementing such transactions, integrating operations as
part of these transactions and the possible failure to achieve expected gains, revenue
growth and/or expense savings from such transactions; |
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| the effects of failing to comply with our regulatory commitments, including those
contained in the consent order our bank subsidiary entered into on October 27, 2011 (the
Consent Order); |
| our ability to raise sufficient amounts of capital to enable the Bank to achieve the
capital commitments it has made to its primary regulators; |
| changes in accounting policies, rules and practices; |
| changes in technology or products that may be more difficult, or costly, or less
effective, than anticipated; |
| the effects of war or other conflicts, acts of terrorism or other catastrophic events
that may affect general economic conditions; |
| the effects on deposit liabilities and liquidity as a result of the restrictions on
our bank subsidiarys ability to pay interest on deposits above certain national rate
caps as a result of our bank subsidiary entering into the Consent Order; |
| the effects on deposit liabilities and liquidity as a result of the limitations on
our bank subsidiarys ability to make, renew or rollover brokered deposits as a result
of our bank subsidiary entering into the Consent Order; |
| results of regulatory examinations; |
| the remediation efforts related to the Companys material weakness in internal
control over financial reporting; |
| the ability to raise additional capital; |
| the prepayment of FDIC insurance premiums and higher FDIC assessment rates; |
| the effects of negative publicity; |
| the effectiveness of the Companys activities in improving, resolving or liquidating
lower quality assets; |
| the Companys recording of a further allowance related to its deferred tax asset; and |
| other factors and information described in this report and in any of our other
reports that we make with the Securities and Exchange Commission (the Commission)
under the Exchange Act. |
All written or oral forward-looking statements that are made by or attributable to us are
expressly qualified in their entirety by this cautionary notice. Except as required by the Federal
securities laws, we have no obligation and do not undertake to update, revise or correct any of the
forward-looking statements after the date of this report, or after the respective dates on which
such statements otherwise are made.
Recent Regulatory Developments
In the first quarter of 2009, the OCC conducted an examination of the Bank and found that the
Banks condition had significantly deteriorated since the OCCs most recent examination of the
Bank. The Banks asset quality and earnings had both significantly declined since the OCCs last
examination of the Bank and the Banks dependence on brokered deposits and other sources of
non-core funding was too high.
Following discussions with the OCC, the Banks board of directors entered into a formal
written agreement requiring that the Bank take a number of actions to improve the Banks operations
including the following:
| reduce the high level of credit risk and strengthen the Banks credit underwriting,
particularly in the commercial real estate portfolio, including improving its management
and training of commercial real estate lending personnel; |
| strengthen its problem loan workouts and collection department; |
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| improve its loan review program, including its internal loan review staffing; |
| reduce the level of criticized assets and the concentrations of commercial real estate
loans; |
| improve its credit underwriting standards for commercial real estate; |
| engage in portfolio stress testing and sensitivity analysis of the Banks commercial
real estate concentrations; |
| improve its methodology of calculating the allowance for loan and lease losses; and |
| reduce its levels of brokered deposits and other wholesale funding. |
The board of directors and members of the Banks management took a number of actions in an
effort to comply with the terms of the formal written agreement, including:
| the hiring of a new Chief Credit Officer, a new Loan Review Officer and other credit
personnel; |
| the retention of a third party loan reviewer to review over 80 percent of the total
outstanding loans in the loan portfolio; |
| the adoption of action plans for all criticized assets, along with revised procedures
for eliminating the basis for criticism of problem credit and disposing of nonperforming
assets; |
| the adoption of a revised credit risk management program and enhanced credit risk review
process; |
| improvements to the Banks allowance methodology; |
| implementation of a full-time special assets department with improved policies; and |
| adoption of revised liquidity plans. |
Although the Bank has instituted a number of improvements to its practices in an effort to
comply with the terms of the formal written agreement, the OCC informed the Bank after its 2010 and
2011 examinations that, because the OCC did not believe that the Bank had fully satisfied the
requirements of the formal written agreement, the formal written agreement would be replaced with a
consent order containing requirements for further improvements in the Banks operations. On October
27, 2011, the Bank executed a Stipulation and Consent (the
Consent) to the issuance of the
Order by the OCC. Under the terms of the Order, the Bank is required, among other
things, to take the following actions:
| Maintain a committee of the board of directors to oversee the Banks compliance with the
Order; |
| Develop, within 60 days of the date of the Order, a strategic plan covering at least a
three-year period that establishes objectives for the Banks overall risk profile, earnings
performance, growth, balance sheet mix, off-balance sheet activities, liability structure,
capital adequacy, reduction in volume of nonperforming assets, product line development,
and market segments that the Bank intends to promote or develop, together with strategies
to achieve those objectives; |
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| Develop and implement, within 60 days of the date of the Order, a capital plan that
increases the Banks Total risk-based capital ratio and Tier 1 capital ratio to at least
12% and 9%, respectively, within 120 days of the date of the Order; |
| Prepare and submit, within 90 days of the date of the Order, a written assessment of the
capabilities of certain of the Banks officers and, if the board of directors determines an
officers performance needs improvement, implement a written program to improve the
officers performance, skills and abilities; |
| Ensure adherence to the Banks written program to reduce and manage the high level of
credit risk in the Bank, and at least quarterly prepare a written assessment of the Banks
credit risk and the Banks adherence to the program; |
| Implement and adhere to a written program designed to protect the Banks interest in
those assets criticized as doubtful, substandard or special mention; |
| Not extend, directly or indirectly, any additional credit to any borrower whose loans or
other extensions of credit are criticized and whose aggregate loans and extensions of
credit exceed $250,000, unless the board of directors makes certain determinations; |
| Establish, within 60 days of the date of the Order, an effective independent and ongoing
independent loan review program to review, at least semi-annually, the Banks loan
portfolio, to assure timely identification and categorization of problem credits; |
| Maintain and adhere to a written policy and procedures for the maintenance of an
adequate Allowance for Loan and Lease Losses; |
| Adopt, implement and ensure adherence to an independent, risk-based audit program of all
Bank operations and ensure immediate actions are undertaken to remedy deficiencies cited in
audit reports; |
| Revise and maintain, within 60 days of the date of the Order, a comprehensive liability
risk management program; and |
| Agree to certain limitations on third party contracts. |
The Banks board of directors and senior management have initiated efforts to comply with the
terms of the Order, but we can provide no assurance that our efforts will satisfy the OCC.
On June 30, 2011, the Banks total risk-based capital to risk-weighted assets ratio was 7.69%,
which was below the ratio of 8.0% for total risk-based capital to risk-weighted assets required to
be considered adequately capitalized under the OCCs prompt corrective action regulations. As a
result, the Bank was in the undercapitalized category under those regulations and was subject to
restrictions on payments of any dividends or management fees, on asset growth and on expansion of
assets without prior regulatory approval. Additionally, because it is not considered adequately
capitalized the Bank may not accept employee benefit plan deposits, may not accept, renew or
rollover brokered deposits, and is restricted on the yield it may offer on deposits. The Bank also
was required to file a capital restoration plan specifying the steps the Bank would take to become
adequately capitalized (i.e. have capital above the minimum ratio), the levels of capital to be
attained each year the plan is in effect, the steps the Bank will take to comply with the growth
and other restrictions applicable to it and the level of activities it will engage in. In addition,
the Company is required to provide a guarantee of the capital plan, including any commitment to
raise capital made in the plan and a pledge of assets, if any, acceptable to the OCC. If the Bank
fails to comply with the terms of the capital restoration plan that it submits to the OCC, the
Company will be obligated to pay the Bank pursuant to the guarantee the lesser of five percent of
the Banks totals assets at the time the Bank was undercapitalized, or the amount which is
necessary to bring the Bank into compliance with all adequately capitalized standards at the time
it failed to comply.
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On October 3, 2011, the Bank submitted a capital restoration plan to the OCC, and on October
21, 2011, the OCC disapproved and did not accept such plan because the OCC was unable to determine
that the capital restoration plan was based on realistic assumptions or was likely to succeed in
restoring the Banks capital. As a result of the OCCs action, for purposes of the prompt
corrective action regulations, the Bank will be treated as if it were in the significantly
undercapitalized category until it submits an acceptable capital restoration plan and such plan is
accepted by the OCC. As long as the Bank is treated as in the significantly undercapitalized
category it is subject to the additional restriction that it cannot pay any bonus to any senior
executive officer or provide compensation to any senior executive officer exceeding the officers
average rate during the twelve calendar months ending September 30, 2011. During the period that
the Bank is actually significantly undercapitalized or treated as such on account of its failure
to have a capital restoration plan accepted by the OCC, the OCC may impose additional requirements,
including requiring recapitalization or sale of additional shares or sale of the Bank, restricting
asset growth activities, limiting interest rates the Bank can pay on deposits, prohibiting
acceptance of deposits from correspondents, requiring the dismissal of directors or senior
executive officers, employing new executive officers, or requiring divestiture or sale of the Bank.
Since the Bank agreed to maintain capital levels above those required by the federal banking
statutes, certain actions have been taken, and are ongoing, that are designed to improve the Banks
capital ratios by influencing the underlying metrics. The reduction of total assets of the Bank can
have an impact on the Tier 1 capital ratio. Since December 31, 2009 the Bank has reduced total
assets approximately $124,000,000 from approximately $640,000,000 to approximately $516,000,000 at
September 30, 2011. This reduction in assets was accomplished by reducing wholesale funding
including brokered deposits and Federal Home Loan Bank advances as well as the reduction of public
funds deposits. Additionally, loans outstanding and the bond investment portfolio were reduced
subsequent to the capital requirement. Expense reduction measures were put in place during the
first and second quarters of 2010 which included a significant reduction of salaries and benefits.
In addition, the Company is actively exploring other potential strategic transactions that could
provide additional capital for the Bank, including private equity financing, issuance of shares to
existing shareholders or other strategic transactions.
Despite the efforts taken by the Company and the Bank to preserve the Banks capital, the size
of losses the Bank has suffered in the second and third quarters of 2011 have limited the
effectiveness of these capital preservation measures. During the second quarter of 2011,
managements actions regarding its change in the strategic plan involving liquidation of certain
impaired loans as described under Allowance for Loan Losses below had a significant impact on the
regulatory capital ratios. Additionally, the decrease in the Companys ORE balance during the
quarter had a significant negative impact on regulatory capital ratios and was primarily the result
of managements decision to record a sizable valuation allowance against its portfolio with the
intention of liquidating these nonperforming assets more expeditiously than what was experienced
and projected at the previous price levels, also as part of the change in the strategic plan as
discussed in more detail under Noninterest Expense below. Also, during the quarter, the Banks
increase of the deferred tax asset valuation allowance as discussed in more detail under Income
Taxes below reduced the income tax benefit that would have typically been recognized and had a
significant negative impact on regulatory capital. The cumulative effect of these actions reduced
the Banks capital ratios to the levels noted above. The Companys ratios were further impacted due
to the reduction in the amount of Trust Preferred Securities allowed in the calculation of their
regulatory capital ratios.
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Overview
We conduct our operations, which consist primarily of traditional commercial banking
operations, through the Bank. Through the Bank we offer a broad range of traditional banking
services from our corporate headquarters in Sevierville, Tennessee, our Blount County regional
headquarters in Maryville, Tennessee, through eight additional branches in Sevier County,
Tennessee, and two additional branches in Blount County, Tennessee. Our banking operations
primarily target individuals and small businesses in Sevier and Blount Counties and the surrounding
area. The retail nature of the Banks commercial banking operations allows for diversification of
depositors and borrowers, and we believe that the Bank is not dependent upon a single or a few
customers. But, due to the predominance of the tourism industry in Sevier County, a significant
portion of the Banks commercial loan portfolio is concentrated within that industry, including the
residential real estate and commercial real estate segments of that industry. The predominance of
the tourism industry also makes our business more seasonal in nature, particularly with respect to
deposit levels, than may be the case with banks in other market areas. The tourism industry in
Sevier County has remained relatively strong during recent years and we anticipate that this trend
will continue during the remainder of 2011. Additionally, we have a significant concentration of
commercial and residential real estate construction and development loans. Economic downturns
relating to sales of these types of properties have adversely affected the Banks operations
creating risk independent of the tourism industry.
In addition to our twelve existing locations, we own one property in Knox County for use in
future branch expansion. This property is not currently under development. Management does not
anticipate construction of any additional branches during 2011 or 2012.
The net loss for the three- and nine-month periods ended September 30, 2011 as compared to net
income for the same periods during 2010 was as follows:
9/30/2011 | 9/30/2010 | $ change | ||||||||||
Net Income (Loss) |
||||||||||||
Nine months ended |
(28,454,582 | ) | 822,293 | (29,276,875 | ) | |||||||
Three months ended |
(3,220,946 | ) | 350,893 | (3,571,839 | ) |
The net loss for the third quarter and first nine months of 2011 was primarily
attributable to the Companys provision for loan losses as discussed in more detail below under
Provision for Loan Losses. The decrease from net income for the third quarter and first nine months
of 2010 to a net loss for the same periods during 2011 was also the result of an increase in net
loss on ORE related to the Bank recording a significant ORE valuation allowance as discussed in
more detail under Noninterest Expense below. Additionally, there was a reduction in net investment
gains, included in noninterest income, during the three and nine months ended September 30, 2011
compared to the same periods in 2010, as discussed in more detail below under Noninterest Income.
Basic and diluted earnings per share decreased from basic and diluted earnings per share of
$0.31, in the first nine months of 2010 to basic and diluted loss per share of ($10.81), in the
first nine months of 2011. During the third quarter of 2011, basic and diluted loss per share
decreased to ($1.22) from basic and diluted earnings per share of $0.13 in the third quarter of
2010. The change in net loss per share for the three and nine months ended September 30, 2011, as
compared to net earnings per share for the same periods in 2010, was due primarily to the change
from net income in the third quarter and first nine months of 2010 to a net loss in the third
quarter and first nine months of 2011.
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The change in total assets, total liabilities and shareholders equity for the nine months
ended September 30, 2011, was as follows:
9/30/11 | 12/31/10 | $ change | % change | |||||||||||||
Total Assets |
$ | 515,828,481 | $ | 557,206,511 | $ | (41,378,030 | ) | -7.43 | % | |||||||
Total Liabilities |
506,977,655 | 521,532,341 | (14,554,686 | ) | -2.79 | % | ||||||||||
Shareholders Equity |
8,850,826 | 35,674,170 | (26,823,344 | ) | -75.19 | % |
The net decrease in total assets was primarily the result of a decrease in net loans of
approximately $44 million and a decrease in ORE of approximately $4 million, as discussed in more
detail below under Loans. The decrease in total assets was partially offset by the approximately
$11 million increase in cash and cash equivalents. The net decrease in total liabilities was
primarily attributable to a decrease in time deposits and NOW accounts of approximately $11 million
and $8 million, respectively, offset in part by an increase in money markets of approximately $3
million, as discussed in more detail below under Deposits.
The decrease in shareholders equity was primarily attributable to the net loss for the nine
months ended September 30, 2011.
Balance Sheet Analysis
The following table presents an overview of selected period-end balances at September 30, 2011
and December 31, 2010, as well as the dollar and percentage change for each:
9/30/11 | 12/31/10 | $ change | % change | |||||||||||||
Cash and equivalents |
$ | 43,099,103 | $ | 32,575,820 | $ | 10,523,283 | 32.30 | % | ||||||||
Loans |
334,735,364 | 374,355,464 | (39,620,100 | ) | -10.58 | % | ||||||||||
Allowance for loan losses |
14,871,902 | 10,942,414 | 3,929,488 | 35.91 | % | |||||||||||
Investment securities |
86,225,299 | 87,634,542 | (1,409,243 | ) | -1.61 | % | ||||||||||
Premises and equipment |
31,787,333 | 32,600,673 | (813,340 | ) | -2.49 | % | ||||||||||
Other real estate owned |
8,688,283 | 13,140,698 | (4,452,415 | ) | -33.88 | % | ||||||||||
Noninterest-bearing deposits |
48,774,381 | 47,638,792 | 1,135,589 | 2.38 | % | |||||||||||
Interest-bearing deposits |
385,782,958 | 401,952,616 | (16,169,658 | ) | -4.02 | % | ||||||||||
Total deposits |
434,557,339 | 449,591,408 | (15,034,069 | ) | -3.34 | % | ||||||||||
Federal Reserve/Federal Home
Loan Bank advances |
$ | 55,200,000 | $ | 55,200,000 | $ | | 0.00 | % |
Loans
At September 30, 2011, loans comprised 73.0% of the Banks earning assets. The decrease in our
loan portfolio was primarily attributable to a decrease in construction and land development loans
and 1-4 family residential loans, which was primarily the result of recording net charge-offs of
approximately $20.2 million during the first nine months of 2011 as discussed in more detail under
Provision for Loan Losses. Loans also decreased approximately $4.9 million during the nine months
ended September 30, 2011 due to property foreclosures which are subsequently classified as ORE.
Additionally, the general pay down of loan balances pursuant to managements strategy to reduce
loans in order to reduce asset levels in light of capital reductions contributed to the overall
decrease in loans. Total earning assets, as a percentage of total assets, were 88.9% at September
30, 2011, compared to 86.8% at December 31, 2010, and 87.2% at September 30, 2010. Total earning
assets relative to total assets increased for the nine-month period ended September 30, 2011 and as
compared to September 30, 2010 due to the continued decrease in total assets which was more
substantial than the decrease in earning assets. The average yield on loans, including loan fees,
during the first nine months of 2011 was 5.13% compared to 5.26% for the first nine months of 2010.
The decrease in the average yield on loans was the result of several factors including the increase
in average TDRs involving interest rate concessions and the continued significant level of average
non-accrual loans as a percentage of our loan portfolio.
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The following table presents the Companys ORE activity by property type during the first nine
months of 2011:
December 31, | Gain/(Loss) | Valuation | September 30, | |||||||||||||||||||||
2010 | Additions | Sales | on Sale | Adjustments | 2011 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Construction, land development
and other land |
$ | 2,595 | $ | 1,107 | $ | (988 | ) | $ | 63 | $ | (987 | ) | $ | 1,790 | ||||||||||
1-4 family residential properties |
3,799 | 2,115 | (2,443 | ) | 22 | (1,404 | ) | 2,089 | ||||||||||||||||
Multifamily residential
properties |
4,640 | | | | (2,265 | ) | 2,375 | |||||||||||||||||
Nonfarm nonresidential properties |
2,107 | 1,639 | (855 | ) | (57 | ) | (400 | ) | 2,434 | |||||||||||||||
Total |
$ | 13,141 | $ | 4,861 | $ | (4,286 | ) | $ | 28 | $ | (5,056 | ) | $ | 8,688 | ||||||||||
The decrease in the Companys ORE balance during the nine month period ended September
30, 2011 was primarily the result of managements decision, with concurrence of the Board of
Directors, to record a sizable valuation allowance against its portfolio during the second quarter
with the intention of liquidating these nonperforming assets more expeditiously than what was
experienced and projected at the previous price levels. Management, with concurrence of the Board
of Directors, determined that certain properties held in ORE were not likely to be successfully
disposed of in an acceptable time-frame using routine marketing efforts. It became apparent that
certain properties were going to require extended holding periods to sell the properties at recent
appraised values. Appraisals received during the third quarter of 2011 indicate a continuing
decline from the appraised values received during the first and second quarter of 2011. The further
decline in real estate values, primarily in Sevier County, could result in an increased valuation
allowance against the ORE properties.
Given our change in strategy to reduce nonperforming assets in an accelerated manner,
management adjusted downward the valuations for certain properties in our ORE portfolio to reflect
the likely net realizable value achievable by aggressively marketing these properties. The
foreclosure of additional properties slightly exceeded the sale of properties previously held as
ORE during the first nine months of 2011, however, ORE sales during the third quarter of 2011 were
approximately $2.8 million compared to approximately $1.5 million during the first six months of
the year, evidencing the development of managements accelerated liquidation strategy. One
property, an operating nightly condominium rental operation located in Pigeon Forge, Tennessee,
which previously secured a loan for approximately $5,116,000, represents approximately $2,375,000,
or 27%, of the ORE balance at September 30, 2011 (included in multifamily residential properties in
the table above). The condominiums are currently under management contract with an experienced
nightly rental management company as we seek to market the sale of the properties. Since September
30, 2011, the Company closed sales for 5 of the 19 total condominiums it owned in this development.
There are contracts pending for the sale of 9 additional condominium units. The completed sales
have not resulted in any material gains or losses and we do not anticipate recognizing any material
gains or losses should the pending sales contracts be executed under their projected terms.
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Allowance for Loan Losses
The allowance for loan losses represents managements assessment and estimates of the risks
associated with extending credit and its evaluation of the quality of our loan portfolio. This
evaluation is based on the provisions of US GAAP and, as such, management believes the allowance
for loan losses is appropriate at each balance sheet date according to the requirements of US GAAP.
Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses
and the appropriate provision required to maintain the allowance for loan losses at a level
believed to be adequate to absorb probable incurred loan losses. In assessing the adequacy of the
allowance, management reviews the size, quality and risk of loans in the portfolio. Management also
considers such factors as the Banks loan loss experience, the amount of past due and nonperforming
loans, impairment of loans, specific known risks, the status, amounts and values of nonperforming
assets (including loans), underlying collateral values securing loans, current and anticipated
economic conditions and other factors which affect the allowance for potential credit losses. Based
on an analysis of the credit quality of the loan portfolio prepared by the Banks risk officer, the
CFO presents a quarterly analysis of the adequacy of the allowance for loan losses for review by
our board of directors.
Our allowance for loan losses is also subject to regulatory examinations and determinations as
to adequacy, which may take into account such factors as the methodology used to calculate the
allowance and the level of risk in the loan portfolio. During their routine examinations of banks,
regulatory agencies may advise a bank to make additional provisions to its allowance for loan
losses, which would negatively impact a banks results of operations, when the opinion of the
regulators regarding credit evaluations and allowance for loan loss methodology differ materially
from those of the banks management.
Concentrations of credit risk typically involve loans to one borrower, an affiliated group of
borrowers, borrowers engaged in or dependent upon the same industry, or a group of borrowers whose
loans are secured by the same type of collateral. Our most significant concentration of credit
risks lies in the high proportion of our loans to businesses and individuals dependent on the
tourism industry and loans to subdividers and developers of land. The Bank assesses loan risk by
primary concentrations of credit by industry and loans directly related to the tourism industry are
monitored carefully. At September 30, 2011, approximately $164 million in loans, or 49% of our
total loans, were to businesses and individuals whose ability to repay depends to a significant
extent on the tourism industry in the markets we serve as compared to approximately $192 million in
loans, or 51% of our total loans, at December 31, 2010. The most significant decreases in this
category were loans to overnight rentals by agency and loans to subdividers and developers which
decreased approximately $16 million and $13 million, respectively.
While it is the Banks policy to charge off in the current period loans for which a loss is
considered confirmed, there are additional risks of losses which cannot be quantified precisely or
attributed to particular loans or classes of loans. Because the risk of loss includes unpredictable
factors, such as the state of the economy and conditions affecting individual borrowers,
managements judgments regarding the appropriate size of the allowance for loan losses is
necessarily approximate and imprecise, and involves numerous estimates and judgments that may
result in an allowance that is insufficient to absorb all incurred loan losses.
Management is not aware of any loans classified for regulatory purposes as loss, doubtful,
substandard, or special mention that have not been identified and sufficiently provided for in the
allowance for loan losses which (1) represent or result from trends or uncertainties which
management reasonably expects will materially impact future operating results, liquidity, or
capital resources, or (2) represent material credits about which management is aware of any
information which causes management to have serious doubts as to the ability of such borrowers to
comply with the loan repayment terms.
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Individually impaired loans are loans that the Bank does not expect to collect all amounts due
according to the contractual terms of the loan agreement and include any loans that meet the
definition of a TDR, as discussed in more detail below. In some cases, collection of amounts due
becomes dependent on liquidating the collateral securing the impaired loan. Collateral dependent
loans do not necessarily result in the loss of principal or interest amounts due; rather the cash
flow is disrupted until the underlying collateral can be liquidated. As a result, the Banks
impaired loans may exceed nonaccrual loans which are placed on nonaccrual status when questions
arise about the future collectability of interest due on these loans. The status of impaired loans
is subject to change based on the borrowers financial position.
Problem loans are identified and monitored by the Banks watch list report which is generated
during the loan review process. This process includes review and analysis of the borrowers
financial statements and cash flows, delinquency reports and collateral valuations. The watch list
includes all loans determined to be impaired. Management determines the proper course of action
relating to these loans and receives monthly updates as to the status of the loans.
The following table presents impaired loans as of September 30, 2011 and December 31, 2010:
September 30, 2011 | December 31, 2010 | |||||||||||||||
Impaired | % of total | Impaired | % of total | |||||||||||||
Loans | loans | Loans | loans | |||||||||||||
($ in thousands) | ||||||||||||||||
Construction, land
development
and other land loans |
$ | 26,877 | 8.03 | % | $ | 41,517 | 11.09 | % | ||||||||
Commercial real estate |
23,340 | 6.97 | % | 21,529 | 5.75 | % | ||||||||||
Consumer real estate |
26,932 | 8.05 | % | 29,182 | 7.80 | % | ||||||||||
Other loans |
34 | 0.01 | % | 128 | 0.03 | % | ||||||||||
Total |
$ | 77,183 | 23.06 | % | $ | 92,356 | 24.67 | % | ||||||||
The decrease in impaired loans from December 31, 2010 to September 30, 2011 was primarily
the result of the partial charge-off of collateral dependent loans during the first nine months of
2011. Otherwise, the sustained, high level of impaired loans continues to relate to the weak
residential and commercial real estate market in the Banks market areas. Within this segment of
the portfolio, the Bank has traditionally made loans to, among other borrowers, home builders and
developers of land. These borrowers have continued to experience stress during the current real
estate recession due to a combination of declining demand for residential real estate, excessive
volume of properties available and the resulting price and collateral value declines. In addition,
housing starts in the Banks market areas continue to be at historically low levels. An extended
recessionary period in real estate will likely cause the Banks real estate mortgage loans, which
include construction and land development loans, to continue to underperform and may result in
increased levels of impaired loans and non-performing assets, which may negatively impact the
Companys results of operations.
Collateral dependent loans are recorded at the lower of cost or the appraised value net of
estimated selling costs. It is generally determined these loans will be repaid by the liquidation
of the collateral securing the loans. Management obtains independent appraisals of the collateral
securing collateral dependent loans at least annually, or more frequently during periods of
significant devaluation of real estate, like those currently being experienced, from independent
licensed real estate appraisers and the carrying amount of the loans that exceed the appraised
value net of estimated selling costs is taken as a charge against the allowance for loan losses and
may result in additional charges to the provision expense. For any impaired loans for which the
principal collateral is real estate, the Bank obtains a current appraisal at least every six
months. The Company utilizes an independent advisor to review appraisals for consistency and to
assist the Company in identifying deficiencies in the appraisal results. If necessary, the Company
notifies the appraiser of any defects in the appraisal and engages a second independent appraiser
to perform a second appraisal, which appraisal results the Company uses. All loans considered
collateral dependent are included in nonperforming loan balances and are generally nonaccrual
loans. Management has recorded partial charge offs on these collateral dependent loans totaling
approximately $14,746,000 as of September 30, 2011.
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Throughout the economic recession that began during 2008, management has attempted to work
with borrowers experiencing financial difficulty placing particular emphasis on TDRs for borrowers
that were unable to meet the terms of their original contractual agreement, primarily, due to
diminished cash flow. During the second quarter of 2011, management re-evaluated the Banks
strategic plan and made the decision it could no longer continue to renew TDRs with respect to a
significant portion of the impaired loans. This decision was based on managements continuing
review and analysis of the loan portfolio, the extended time period required to rehabilitate
certain TDRs, the lack of improvement in the performance of certain borrowers, the continuing
economic decline of real estate values in the local markets, the extended economic downturn
projected for both the local and national markets and increasing regulatory scrutiny.
TDRs are restructured loans due to a borrower experiencing financial difficulty and the Bank
granting concessions it would not normally otherwise grant in an effort to facilitate a repayment
plan that minimizes the potential losses, if any, that we might incur. These concessions generally
include a reduced interest rate for a limited period of time to allow the borrower to improve their
economic position, especially during this period of economic downturn. The Banks TDRs are due to
lack of real estate sales and weak or insufficient cash flows of the guarantors of the loans due to
the current economic climate. Management has made an attempt to identify all loans where, by
granting certain concessions, borrowers have additional time to recover from the economic downturn,
and in certain instances, have been able to significantly reduce or repay their loans. The Bank
reviews each problem loan separately when determining specific concessions to grant. Our loan
modifications generally involve a reduced rate of interest that is below current market rates for a
specified term usually ranging from one to two years. Additional concessions could involve
extending an amortization period up to thirty years or revising scheduled payments. At the end of
each loans revised maturity date, the Bank re-evaluates the credit to determine if additional time
is warranted to enable the borrower to perform under normal credit underwriting standards.
Concessions could also involve restructuring a loan into tranches with the primary note
meeting all credit underwriting standards and secondary notes being classified as nonaccrual loans
or being charged off through the ALLL. Generally, these types of restructurings require the
borrower to demonstrate the ability to perform under the restructured loan agreement with the loan
being designated nonaccrual until performance is considered likely to occur. These types of
restructurings are not material at this time.
Restructurings are not generally utilized to prevent a loan from being placed on nonaccrual
status. All restructured loans are included in the impaired loan category with loans in compliance
with modified terms accounted for on the accrual basis with a specific reserve calculated using the
discounted cash flow method. TDRs that are not in compliance with modified terms are also
classified as nonaccrual loans and specific performance according to the contractual terms of the
TDR is required prior to these loans being accounted for on an accrual basis.
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During the second quarter of 2011, management, with the concurrence of the Board of Directors,
determined that the liquidation of certain impaired loans would be a part of the strategy to reduce
nonperforming assets similar to the strategy taken with other real estate owned. This liquidation
process, involving determination the loans were collateral dependent, resulted in a charge to the
provision for loan loss expense of approximately $13,561,000 of the approximately $17,363,000
expensed during the quarter. It is managements intention to liquidate these loans within twelve
months or less which will result in reducing non-performing assets. This liquidation process
involves foreclosure of the real estate securing these loans or allowing borrowers to utilize short
sales, the sale of the real estate at a price less than the balance of the loan secured by the real
estate. The determination of the fair value of the real estate and resultant charge off to the
ALLL is based on current estimations of short-term liquidation values. Management has determined
these values on a property by property evaluation with the intention of achieving short-term
liquidation rather than utilizing a more normal marketing approach of twelve months or longer. The
resulting liquidation values for the collateral dependent loans are less than the values management
would have otherwise recorded for these loans had the decision not been made to liquidate.
Appraisals received during the third quarter and continuing into the fourth quarter of 2011
indicate a continuing decline in property values as compared to appraisals received during the
first and second quarters of 2011. This decline in property values did not materially affect
managements original estimation and resultant short-term liquidation values recorded for
collateral dependent loans during the second quarter of 2011.
Certain impaired loans were TDRs prior to the determination they were collateral dependent.
The following table presents the recorded investment in collateral dependent loans and TDRs
considered collateral dependent at September 30, 2011 and December 31, 2010 (in thousands):
Balance | Net | Miscellaneous | Balance | |||||||||||||||||||||||||||||
December 31, | Number | Additions/ | Charge | Payoffs/ | Principal | September 30, | Number | |||||||||||||||||||||||||
2010 | of Loans | Deletions | Offs | Foreclosures | Changes | 2011 | of Loans | |||||||||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||||||||||
Construction and development |
$ | 16,007 | 18 | $ | 6,258 | $ | (8,106 | ) | $ | (1,626 | ) | $ | (100 | ) | $ | 12,433 | 16 | |||||||||||||||
Commercial real estate mortgage |
4,743 | 6 | 3,713 | (1,981 | ) | (1,808 | ) | (22 | ) | 4,645 | 8 | |||||||||||||||||||||
Commercial and industrial |
| | 88 | (80 | ) | (8 | ) | | | | ||||||||||||||||||||||
Residential real estate |
||||||||||||||||||||||||||||||||
Residential mortgage |
8,054 | 12 | 5,038 | (5,425 | ) | (714 | ) | (41 | ) | 6,912 | 21 | |||||||||||||||||||||
Home equity and
junior liens |
| | 952 | (348 | ) | | | 604 | 3 | |||||||||||||||||||||||
Multi-family |
| | 1,697 | | | | 1,697 | 1 | ||||||||||||||||||||||||
Total residential real estate |
8,054 | 12 | 7,687 | (5,773 | ) | (714 | ) | (41 | ) | 9,213 | 25 | |||||||||||||||||||||
Consumer and other |
| | 13 | (3 | ) | | | 10 | 1 | |||||||||||||||||||||||
Total |
$ | 28,804 | 36 | $ | 17,759 | $ | (15,943 | ) | $ | (4,156 | ) | $ | (163 | ) | $ | 26,301 | 50 | |||||||||||||||
At December 31, 2010 there were thirty-six loans considered collateral dependent with
balances totaling approximately $28,804,000 as compared to fifty loans with balances totaling
approximately $26,301,000 at September 30, 2011. Collateral dependent loans that are also reported
as TDRs were approximately $22,214,000 at December 31, 2010 and approximately $20,179,000 at
September 30, 2011. During the third quarter and first nine months of 2011 approximately $2,382,000
and $15,943,000, respectively, was charged off to the ALLL as a result of the write down of these
collateral dependent loans based on managements estimate of the net realizable proceeds from the
short-term liquidation of the collateral as part of the strategy to reduce non-performing assets.
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All TDRs are classified as impaired loans and, if on nonaccruing status as of the date of
restructuring, the loans are included in the nonperforming loan balances. Not included in
nonperforming loans are loans that have been restructured that were performing as of the
restructure date. The table below presents the Companys TDRs at September 30, 2011 and December
31, 2010.
Troubled Debt Restructurings | ||||||||
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
In compliance with
modified terms |
$ | 32,436 | $ | 35,752 | ||||
30-89 days past due |
16 | | ||||||
Greater than 90 days
past due |
1,907 | | ||||||
Nonaccrual |
32,637 | 46,691 | ||||||
Total TDRs |
$ | 66,996 | $ | 82,443 |
The overall decrease in TDRs from December 31, 2010 to September 30, 2011 was primarily
the result of charge-offs which were concentrated among the nonaccrual TDRs and the shift in the
Banks strategy with respect to the renewal of TDRs described above. TDRs at September 30, 2011
were approximately 86.8% of total impaired loans. The TDRs related primarily to construction and
development loans totaling approximately $25,874,000, or 33.5% of impaired loans, 1-4 family
residential loans totaling approximately $18,358,000, or 23.8% of impaired loans and commercial
real estate loans totaling approximately $17,545,000, or 22.7% of impaired loans.
The Banks allowance for loan losses as a percentage of total loans at September 30, 2011 and
December 31, 2010 was as follows:
Allowance for | Total | % of total | ||||||||||
loan losses | loans | loans | ||||||||||
($ in thousands) | ||||||||||||
As of: |
||||||||||||
September 30, 2011 |
$ | 14,872 | $ | 334,735 | 4.44 | % | ||||||
December 31, 2010 |
10,942 | 374,355 | 2.92 | % |
Our allowance for loan losses increased approximately $3,930,000 during the first nine
months of 2011 since provision for loan losses exceeded net charge-offs. The allowance for loan
losses as a percentage of total loans and non-accrual loans at September 30, 2011 was 4.44% and
36.49%, respectively, compared to 2.92% and 20.64%, respectively, at December 31, 2010. The
allowance for loan losses attributable to loans collectively evaluated for impairment, also
identified as the general component and described in more detail in the following paragraph,
increased 166 basis points during the first nine months of 2011 from 2.21% at December 31, 2010, to
3.87% at September 30, 2011. Management continues to evaluate and adjust our allowance for loan
losses, and presently believes the allowance for loan losses is adequate to provide for probable
losses inherent in the loan portfolio. Management believes the loans, including those loans that
were delinquent at September 30, 2011, that will result in additional charge-offs have been
identified and adequate provision has been made in the allowance for loan loss balance. No
assurance can be given, however, that adverse economic circumstances, declines in real estate
values or other events or changes in borrowers financial conditions, particularly borrowers in the
real estate construction and development business, will not result in increased losses in the
Banks loan portfolio or in the need for increases in the allowance for loan losses through
additional provision expense in future periods.
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Table of Contents
Within the allowance, there are specific and general loss components as disclosed in more
detail under Note 5. Loans and Allowance for Loan Losses. The specific loss component is assessed
for non-homogeneous loans that management believes to be impaired. Loans are considered to be
impaired when it is determined that the obligor will not pay all contractual principal and interest
due. For loans determined to be impaired, the loans carrying value is compared to its fair value
using one of the following fair value measurement techniques: present value of expected future cash
flows, observable market price, or fair value of the associated collateral less costs to sell. An
allowance is established when the fair value is lower than the carrying value of that loan. The
general component covers non-classified and classified non-impaired loans and is based on a five
year loss migration analysis, updated quarterly, that tracks the five year historic progression of
loans through the risk grade categories and indicates estimated loss ratios based on the Banks
loan risk grading system for real estate and commercial and industrial loans. The loan categories
comprise approximately 98.6% of loans at September 30, 2011 and December 31, 2010, and are
segregated by Call Report classification and/or risk grade and are adjusted for certain
environmental factors management believes to be relevant. The estimated loss ratio, weighted
heavily for the most recent two years, is applied against each segregated classification. Consumer
loans, which comprise approximately 1.4% of loans at
September 30, 2011 and December 31, 2010, have
an allowance established for non-classified and classified non-impaired loans based upon a five
calendar year plus current year to date historical loss factor. This loss factor, also adjusted for
certain environmental factors, is applied against the segregated categories that are determined by
product type.
Past Due Loans
The following table presents the Banks delinquent and nonaccrual loans for the periods
indicated:
Past due 30 to | Past due 90 days | |||||||||||||||||||||||
89 days and still | % of total | or more and | % of total | % of total | ||||||||||||||||||||
accruing | loans | still accruing | loans | Nonaccrual | loans | |||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||
As of September 30, 2011 |
||||||||||||||||||||||||
Construction, land
development
and other land loans |
$ | 16 | 0.00 | % | $ | | 0.00 | % | $ | 16,994 | 5.08 | % | ||||||||||||
Commercial real estate |
279 | 0.08 | % | 1,907 | 0.57 | % | 9,720 | 2.90 | % | |||||||||||||||
Consumer real estate |
2,491 | 0.74 | % | 342 | 0.10 | % | 14,019 | 4.19 | % | |||||||||||||||
Commercial loans |
3,016 | 0.90 | % | | 0.00 | % | | 0.00 | % | |||||||||||||||
Consumer loans |
48 | 0.01 | % | | 0.00 | % | 24 | 0.01 | % | |||||||||||||||
Total |
$ | 5,850 | 1.75 | % | $ | 2,249 | 0.67 | % | $ | 40,757 | 12.18 | % | ||||||||||||
As of December 31, 2010 |
||||||||||||||||||||||||
Construction, land
development
and other land loans |
$ | 265 | 0.07 | % | $ | | 0.00 | % | $ | 27,929 | 7.46 | % | ||||||||||||
Commercial real estate |
541 | 0.14 | % | 413 | 0.11 | % | 6,362 | 1.70 | % | |||||||||||||||
Consumer real estate |
1,130 | 0.30 | % | | 0.00 | % | 18,647 | 4.98 | % | |||||||||||||||
Commercial loans |
| 0.00 | % | | 0.00 | % | 67 | 0.02 | % | |||||||||||||||
Consumer loans |
68 | 0.02 | % | 19 | 0.01 | % | | 0.00 | % | |||||||||||||||
Total |
$ | 2,004 | 0.54 | % | $ | 432 | 0.12 | % | $ | 53,005 | 14.16 | % | ||||||||||||
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Table of Contents
Delinquent and nonaccrual loans at both September 30, 2011 and December 31, 2010
consisted primarily of construction and land development loans and commercial and consumer real
estate loans. The Banks delinquent loan balances tend to fluctuate relative to, among other
things, the seasonality and performance of the tourism industry in our market area. The increase in
the balance of loans delinquent 30 to 89 days was primarily attributable to two loans totaling
approximately $4 million, rather than a significant deterioration of the portfolio generally. Of
these 2 loans, one was paid current shortly after quarter end. The other has been subject to
ongoing evaluation through routine loan review and allowance for loan loss assessments as the
proper course of action is determined. The increase in loans delinquent 90 days or more and still
accruing was primarily attributable to one loan of approximately $2 million. This loan has also
been under close review for some time as available workout options are considered. The decrease in
nonaccrual loans was primarily the result of increased charge-offs related to our strategy change
to more aggressively dispose of certain nonperforming assets. There continues to be stress in the
local real estate market as discussed in more detail below. Certain nonaccrual loans are carried on
a cash basis nonaccrual status until an acceptable payment history can be established to support
placing the loan back on accrual. During this time, the loans continue to be reported as
non-performing assets while payments are being collected.
Notwithstanding the general favorable trends in tourism in Sevier County, residential and
commercial real estate sales continued to be weak during first nine months of 2011, following the
same pattern that began during the second half of 2008 and continued throughout 2009 and 2010. The
reduced sales have negatively impacted past due, nonaccrual and charged-off loans. Price declines
from 2009 to the present have had an adverse impact on overall real estate values. These trends
have had the greatest effect on the construction and development and commercial real estate
portfolios, resulting in the significant increase in nonaccrual loans beginning in 2009 and
continuing through the first quarter of 2011, and the significant valuation allowance related to
ORE that was recorded in the second quarter of 2011. Many of the borrowers in these categories are
dependent upon real estate sales to generate the cash flows used to service their debt. Since real
estate sales have been depressed, many of these borrowers have experienced greater difficulty
meeting their obligations, and to the extent that sales remain depressed, these borrowers may
continue to have difficulty meeting their obligations.
Investment Securities
Our investment portfolio consists of U.S. Treasury securities, securities of U.S. government
agencies, mortgage-backed securities and municipal securities. The investment securities portfolio
is the second largest component of our earning assets and represented 16.7% of total assets at
quarter-end, up from 15.7% at December 31, 2010, reflecting a slight decrease in investment
securities coupled with a more substantial decrease in total assets during the first nine months of
2011. The approximately $1.4 million decrease in investment securities during the nine months ended
September 30, 2011 was primarily attributable to fluctuations in pledging requirements related to
the Banks secured liabilities. As an integral component of our asset/liability management
strategy, we manage our investment securities portfolio to maintain liquidity, balance interest
rate risk and augment interest income. In addition to meeting pledging requirements for borrowings,
we also use our investment securities portfolio to secure public deposits. The average yield on our
investment securities portfolio during the first nine months of 2011 was 2.75% versus 2.28% for the
first nine months of 2010 reflecting a shift in the composition of our portfolio. During the first
nine months of 2010, the Bank was in the process of liquidating a significant portion of its
investment securities portfolio as a result of decreased pledging requirements related to public
funds deposits. Therefore, the majority of the segment intended for liquidation had been
transferred to shorter term, more liquid but lower yielding investments. During the first nine
months of 2011, the Banks portfolio allocation by type of security was more historically
characteristic. Net unrealized gains (losses) on securities available for sale, included in
accumulated other comprehensive income (loss), decreased by approximately $1,554,000, net of income
taxes, during the first nine months of 2011 from a net unrealized loss of approximately $1,064,000
at December 31, 2010, to a net unrealized gain of approximately $490,000 at September 30, 2011.
45
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Deposits
The table below sets forth the total balances of deposits by type as of September 30, 2011 and
December 31, 2010, and the dollar and percentage change in balances over the intervening period:
September 30, | December 31, | $ | % | |||||||||||||
2011 | 2010 | change | change | |||||||||||||
(in thousands) | ||||||||||||||||
Non-interest bearing
accounts |
$ | 48,774 | $ | 47,638 | $ | 1,136 | 2.38 | % | ||||||||
NOW accounts |
49,566 | 57,345 | (7,779 | ) | -13.57 | % | ||||||||||
Money market accounts |
53,117 | 49,701 | 3,416 | 6.87 | % | |||||||||||
Savings accounts |
22,863 | 23,734 | (871 | ) | -3.67 | % | ||||||||||
Certificates of deposit |
219,356 | 222,550 | (3,194 | ) | -1.44 | % | ||||||||||
Brokered deposits |
19,973 | 27,019 | (7,046 | ) | -26.08 | % | ||||||||||
Individual retirement
accounts |
20,908 | 21,604 | (696 | ) | -3.22 | % | ||||||||||
TOTAL DEPOSITS |
$ | 434,557 | $ | 449,591 | $ | (15,034 | ) | -3.34 | % |
The balance in NOW accounts primarily consists of public funds deposits that are
generally obtained through a bidding process under varying terms. Notable fluctuations in this
category are fairly common and are dependent upon the cash flows of the various municipalities.
The decrease in certificates of deposit was the result of seasonal reductions. At September
30, 2011, brokered deposits represented approximately 4.6% of total deposits and management intends
to seek to further reduce the level of brokered deposits approximately $3.4 million during the
remainder of 2011 based on scheduled maturities. Because the Banks capital levels do not meet the
minimum requirements specified in the OCCs prompt corrective action regulations, and because
higher capital levels have been specified in the Order, the Bank may not accept employee benefit
plan deposits, may not accept, renew or roll over brokered deposits and may not pay interest on
deposits at rates that are more than 75 basis points above the rate applicable to the applicable
market of the Bank as determined by the FDIC. As of September 30, 2011, brokered deposits maturing
in the next 24 months totaled approximately $20.1 million. Funding sources for the maturing
brokered deposits include, among other sources: our cash account at the Federal Reserve Bank of
Atlanta; growth, if any, of core deposits from current and new retail and commercial customers;
scheduled repayments on existing loans; and the possible pledge or sale of investment securities.
These deposit and interest rate limitations may limit the ability of the Bank to increase or
maintain core deposits from current and new deposit customers.
The total average cost of interest-bearing deposits (including demand, savings and certificate
of deposit accounts) for the nine-month period ended September 30, 2011 was 1.43%, down from 1.79%
for the same period a year ago primarily reflecting the continued downward repricing of the Banks
time deposits as they mature and are renewed at current market rates. Additionally, the average
cost of interest bearing demand and savings deposits decreased due to rate reductions. Competitive
pressures in our markets, however, have limited, and are likely to continue to limit, our ability
to realize the full effect of the ongoing low interest rate environment.
46
Table of Contents
Funding Resources, Capital Adequacy and Liquidity
Our funding sources primarily include deposits and repurchase accounts. The Bank, being
situated in a market area that relies on tourism as its principal industry, can be subject to
periods of reduced deposit funding because tourism in Sevier County and Blount County is seasonably
slower in the winter months. The Bank manages seasonal deposit outflows through its secured and
unsecured Federal Funds lines of credit at several correspondent banks. Available lines totaled
$30.5 million with $12.5 million secured and accessible as of September 30, 2011, and are available
on one days notice. The Bank also has a cash management line of credit in the amount of $100
million from the FHLB as well as a line of credit from the Federal Reserve Discount Window that
totaled approximately $11 million at September 30, 2011, none of which was borrowed as of that
date. The borrowing capacity can be increased based on the amount of collateral pledged.
Capital adequacy is important to the Banks continued financial safety and soundness and
growth. Our banking regulators have adopted risk-based capital and leverage guidelines to measure
the capital adequacy of national banks. In addition, the Companys and the Banks regulators may
impose additional capital requirements on financial institutions and their bank subsidiaries, like
the Company and the Bank, beyond those provided for statutorily, which standards may be in addition
to, and require higher levels of capital, than the general capital adequacy guidelines. Under the
terms of the Order, the Bank will be required to achieve by February 24, 2012 and thereafter
maintain a Tier 1 leverage capital ratio of 9% and a total risk-based capital ratio of 12%. The 9%
ratio is the same as that required by the OCC in an individual minimum capital requirement (IMCR)
for the Bank effective in February 2010 and the 12% ratio is slightly below the 13% ratio required
by the IMCR. As of September 30, 2011, the Bank failed to satisfy these ratios, as well as the
requirements for being considered adequately capitalized, as described below.
Following passage of the Dodd Frank Wall Street Reform and Consumer Protection Act (the
Reform Act), the Federal Reserve Board is required to adopt regulations requiring bank holding
companies like the Company to be subject to capital requirements that are at least as severe as
those imposed on banks under current federal regulations. Trust preferred and cumulative preferred
securities will no longer be deemed Tier 1 capital for bank holding companies with over $10 billion
in total assets at December 31, 2009 following passage of the Reform Act, but trust preferred
securities issued by bank holding companies with under $10 billion in total assets at December 31,
2009 will be grandfathered in and continue to count as Tier 1 capital, subject to limitation based
on a percentage of core capital. Accordingly, the Companys trust preferred securities will
continue to count as Tier 1 capital. Since regulations implementing the statutory minimum capital
requirements for bank holding companies have not yet been promulgated, the Company is not yet
subject to such requirements.
47
Table of Contents
The table below sets forth the Companys capital ratios as of the periods indicated along with
the anticipated requirement once implementing regulations are adopted.
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
Tier 1 Risk-Based Capital |
2.99 | % | 11.87 | % | ||||
Anticipated
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Total Risk-Based Capital |
5.77 | % | 13.27 | % | ||||
Anticipated
Regulatory Minimum |
8.00 | % | 8.00 | % | ||||
Tier 1 Leverage |
2.14 | % | 8.34 | % | ||||
Anticipated
Regulatory Minimum |
4.00 | % | 4.00 | % |
The table below sets forth the Banks capital ratios as of the periods indicated.
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
Tier 1 Risk-Based Capital |
5.78 | % | 11.97 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Well-capitalized minimum |
6.00 | % | 6.00 | % | ||||
Total Risk-Based Capital |
7.06 | % | 13.23 | % | ||||
Regulatory Minimum |
8.00 | % | 8.00 | % | ||||
Well-capitalized minimum |
10.00 | % | 10.00 | % | ||||
Level required by the
Order (see below) |
12.00 | % | 13.00 | % | ||||
Tier 1 Leverage |
4.14 | % | 8.41 | % | ||||
Regulatory Minimum |
4.00 | % | 4.00 | % | ||||
Well-capitalized minimum |
5.00 | % | 5.00 | % | ||||
Level required by the
Order (see below) |
9.00 | % | 9.00 | % |
On October 27, 2011, the OCC issued the Order that, among other things, required the Bank
to attain on or before February 24, 2012 and thereafter maintain a minimum Tier 1 capital to
average assets ratio of 9% and a minimum total capital to risk-weighted assets ratio of 12%. The 9%
ratio was the same as in the Banks IMCR while the 12% ratio was a slight reduction from the 13%
required under the IMCR. Prior to December 28, 2011, the Bank is required to submit to the OCC a
capital plan to achieve these ratios, and if the OCC determines it has no supervisory objection to
the capital plan, to implement it within five days. As noted above, the Bank had 4.14% of Tier 1
capital to average assets and 7.06% of total capital to risk-weighted assets at September 30, 2011
and thus substantially below the requirements. The Banks Tier 1 capital at September 30, 2011 was
approximately $25,270,000 below the amount needed to meet the agreed-upon Tier 1 capital to average
assets ratio of 9%. The Banks total risk-based capital at September 30, 2011 was approximately
$18,385,000 below the amount needed to meet the agreed-upon total capital to risk-weighted assets
ratio of 12%.
In addition to the capital requirements established under the Order, under the OCCs prompt
corrective action regulations, as discussed above, the Bank is treated as significantly
undercapitalized because it has failed to submit an acceptable capital restoration plan under the
OCCs prompt corrective action regulations. Until is submits an acceptable capital restoration plan
and the Company submits the required guarantee of the capital restoration plan, the Bank is subject
to certain restrictions restricting payment of capital distributions or management fees,
restricting asset growth, requiring prior approval of asset expansion proposals and limiting
compensation paid to senior executive officers. In view of the substantial levels of capital
required, the Board of Directors and management are exploring additional sources of capital and
funding as well as the sale of control of the Company and/or the Bank to reach the required levels.
In the current economic environment, however, there can be no assurance that it will be able to do
so or, if it can, what the cost of doing so will be.
48
Table of Contents
Liquidity is the ability of a company to convert assets into cash or cash equivalents without
significant loss. Our liquidity management involves maintaining our ability to meet the day-to-day
cash flow requirements of our customers, whether they are depositors wishing to withdraw funds or
borrowers requiring funds to meet their credit needs. Without proper liquidity management, we would
not be able to perform the primary function of a financial intermediary and would, therefore, not
be able to meet the production and growth needs of the communities we serve.
The Companys primary source of liquidity is dividends paid to it by the Bank and cash that
has not been injected into the Bank. The Bank is required by federal law to obtain the prior
approval of the OCC for payments of dividends if the total of all dividends declared by its board
of directors in any year will exceed (1) the total of its net profits for that year, plus (2) its
retained net profits of the preceding two years, less any required transfers to surplus. Given the
losses experienced by the Bank during 2009, 2010 and 2011, the Bank currently may not, without the
prior approval of the OCC, pay any dividends to the Company.
On December 14, 2010, the Company exercised its rights to defer regularly scheduled interest
payments on all of its issues of junior subordinated debentures relating to outstanding trust
preferred securities. Management cannot currently project the length of time it will be necessary
to extend the deferral of these payments and therefore anticipates deferring payment indefinitely.
The regular scheduled interest payments will continue to be accrued for payment in the future and
reported as an expense for financial statement purposes. At September 30, 2011, total interest
accrued for these deferred payments was approximately $341,000.
Supervisory guidance from the Federal Reserve Board indicates that bank holding companies that
are experiencing financial difficulties generally should eliminate, reduce or defer dividends on
Tier 1 capital instruments including trust preferred securities, preferred stock or common stock,
if the holding company needs to conserve capital for safe and sound operation and to serve as a
source of strength to its subsidiaries. The Company has informally committed to the Federal Reserve
Board that it will not (1) declare or pay dividends on the Companys common or preferred stock, or
(2) incur any additional indebtedness without in each case, the prior written approval of the
Federal Reserve Board.
The primary function of asset and liability management is not only to assure adequate
liquidity in order for us to meet the needs of our customer base, but also to maintain an
appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that we
can also meet the investment objectives of our shareholders. Daily monitoring of the sources and
uses of funds is necessary to maintain an acceptable cash position that meets both the needs of our
customers and the objectives of our shareholders. In a banking environment, both assets and
liabilities are considered sources of liquidity funding and both are therefore monitored on a daily
basis.
Off-Balance Sheet Arrangements
Our only material off-balance sheet arrangements consist of commitments to extend credit and
standby letters of credit issued in the ordinary course of business to facilitate customers
funding needs or risk management objectives.
49
Table of Contents
Commitments and Lines of Credit
In the ordinary course of business, the Bank has granted commitments to extend credit and
standby letters of credit to approved customers. Generally, these commitments to extend credit
have been granted on a temporary basis for seasonal or inventory requirements and have been
approved by the loan committee. These commitments are recorded in the financial statements as they
are funded. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitment amounts expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash requirements.
Following is a summary of the commitments outstanding at September 30, 2011 and December 31,
2010.
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
(in thousands) | ||||||||
Commitments to extend credit |
$ | 35,962 | $ | 41,155 | ||||
Standby letters of credit |
7,085 | 5,288 | ||||||
TOTALS |
$ | 43,047 | $ | 46,443 |
Commitments to extend credit include unused commitments for open-end lines secured by 1-4
family residential properties, commitments to fund loans secured by commercial real estate,
construction loans, land development loans, and other unused commitments. Commitments to fund
commercial real estate, construction, and land development loans increased by approximately $13,000
to approximately $7,717,000 at September 30, 2011, compared to commitments of approximately
$7,704,000 at December 31, 2010, however; demand for these lines of credit remains low reflecting
current economic conditions in our market.
50
Table of Contents
Income Statement Analysis
The following tables set forth the amount of our average balances, interest income or interest
expense for each category of interest-earning assets and interest-bearing liabilities and the
average interest rate for total interest-earning assets and total interest-bearing liabilities, net
interest spread and net interest margin for the three and nine months ended September 30, 2011 and
2010 (dollars in thousands):
Net Interest Income Analysis
For the Nine Months Ended September 30, 2011 and 2010
(in thousands, except rates)
For the Nine Months Ended September 30, 2011 and 2010
(in thousands, except rates)
Interest | ||||||||||||||||||||||||
Average Balance | Income/Expense | Yield/Rate | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||
Loans |
$ | 357,901 | $ | 401,061 | $ | 13,727 | $ | 15,772 | 5.13 | % | 5.26 | % | ||||||||||||
Investment Securities: |
||||||||||||||||||||||||
Available for sale |
88,522 | 121,594 | 1,739 | 1,976 | 2.63 | % | 2.17 | % | ||||||||||||||||
Held to maturity |
1,339 | 1,380 | 47 | 46 | 4.69 | % | 4.46 | % | ||||||||||||||||
Equity securities |
3,845 | 3,835 | 141 | 143 | 4.90 | % | 4.99 | % | ||||||||||||||||
Total securities |
93,706 | 126,809 | 1,927 | 2,165 | 2.75 | % | 2.28 | % | ||||||||||||||||
Federal funds sold and other |
15,431 | 25,874 | 30 | 51 | 0.26 | % | 0.26 | % | ||||||||||||||||
Total interest-earning
assets |
467,038 | 553,744 | 15,684 | 17,988 | 4.49 | % | 4.34 | % | ||||||||||||||||
Nonearning assets |
63,439 | 74,423 | ||||||||||||||||||||||
Total Assets |
$ | 530,477 | $ | 628,167 | ||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||
Interest bearing deposits: |
||||||||||||||||||||||||
Interest bearing
demand deposits |
104,794 | 123,908 | 747 | 1,031 | 0.95 | % | 1.11 | % | ||||||||||||||||
Savings deposits |
23,210 | 22,566 | 123 | 196 | 0.71 | % | 1.16 | % | ||||||||||||||||
Time deposits |
258,166 | 306,665 | 3,261 | 4,854 | 1.69 | % | 2.12 | % | ||||||||||||||||
Total interest bearing deposits |
386,170 | 453,139 | 4,131 | 6,081 | 1.43 | % | 1.79 | % | ||||||||||||||||
Securities sold under agreements
to repurchase |
835 | 1,783 | 11 | 20 | 1.76 | % | 1.50 | % | ||||||||||||||||
Federal Home Loan Bank advances
and other borrowings |
55,200 | 63,833 | 1,682 | 1,930 | 4.07 | % | 4.04 | % | ||||||||||||||||
Subordinated debt |
13,403 | 13,403 | 248 | 252 | 2.47 | % | 2.51 | % | ||||||||||||||||
Total interest-bearing liabilities |
455,608 | 532,158 | 6,072 | 8,283 | 1.78 | % | 2.08 | % | ||||||||||||||||
Noninterest-bearing deposits |
46,861 | 45,269 | | | ||||||||||||||||||||
Total deposits and interest-
bearings liabilities |
502,469 | 577,427 | 6,072 | 8,283 | 1.62 | % | 1.92 | % | ||||||||||||||||
Other liabilities |
2,370 | 2,884 | ||||||||||||||||||||||
Shareholders equity |
25,638 | 47,856 | ||||||||||||||||||||||
$ | 530,477 | $ | 628,167 | |||||||||||||||||||||
Net interest income |
$ | 9,612 | $ | 9,705 | ||||||||||||||||||||
Net interest spread (1) |
2.71 | % | 2.26 | % | ||||||||||||||||||||
Net interest margin (2) |
2.75 | % | 2.34 | % |
(1) | Yields realized on interest-earning assets less the rates paid on interest-bearing
liabilities. |
|
(2) | Net interest margin is the result of annualized net interest income divided by average
interest-earning assets for the period. |
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Table of Contents
Net Interest Income Analysis
For the Three Months Ended September 30, 2011 and 2010
(in thousands, except rates)
For the Three Months Ended September 30, 2011 and 2010
(in thousands, except rates)
Interest | ||||||||||||||||||||||||
Average Balance | Income/Expense | Yield/Rate | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||
Loans |
$ | 340,807 | $ | 394,470 | $ | 4,491 | $ | 5,353 | 5.23 | % | 5.38 | % | ||||||||||||
Investment Securities: |
||||||||||||||||||||||||
Available for sale |
90,537 | 86,852 | 569 | 586 | 2.49 | % | 2.68 | % | ||||||||||||||||
Held to maturity |
1,354 | 1,293 | 15 | 15 | 4.40 | % | 4.60 | % | ||||||||||||||||
Equity securities |
3,847 | 3,843 | 45 | 47 | 4.64 | % | 4.85 | % | ||||||||||||||||
Total securities |
95,738 | 91,988 | 629 | 648 | 2.61 | % | 2.79 | % | ||||||||||||||||
Federal funds sold and other |
24,947 | 37,512 | 14 | 24 | 0.22 | % | 0.25 | % | ||||||||||||||||
Total interest-earning
assets |
461,492 | 523,970 | 5,134 | 6,025 | 4.41 | % | 4.56 | % | ||||||||||||||||
Nonearning assets |
58,773 | 75,343 | ||||||||||||||||||||||
Total Assets |
$ | 520,265 | $ | 599,313 | ||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||
Interest bearing deposits: |
||||||||||||||||||||||||
Interest bearing
demand deposits |
105,891 | 95,186 | 237 | 253 | 0.89 | % | 1.05 | % | ||||||||||||||||
Savings deposits |
23,441 | 23,092 | 40 | 60 | 0.68 | % | 1.03 | % | ||||||||||||||||
Time deposits |
257,425 | 302,719 | 1,036 | 1,559 | 1.60 | % | 2.04 | % | ||||||||||||||||
Total interest bearing deposits |
386,757 | 420,997 | 1,313 | 1,872 | 1.35 | % | 1.76 | % | ||||||||||||||||
Securities sold under agreements
to repurchase |
914 | 1,517 | 4 | 6 | 1.74 | % | 1.57 | % | ||||||||||||||||
Federal Home Loan Bank advances
and other borrowings |
55,200 | 61,559 | 567 | 640 | 4.08 | % | 4.12 | % | ||||||||||||||||
Subordinated debt |
13,403 | 13,403 | 86 | 90 | 2.55 | % | 2.66 | % | ||||||||||||||||
Total interest-bearing liabilities |
456,274 | 497,476 | 1,970 | 2,608 | 1.71 | % | 2.08 | % | ||||||||||||||||
Noninterest-bearing deposits |
49,786 | 49,936 | | | ||||||||||||||||||||
Total deposits and interest-
bearings liabilities |
506,060 | 547,412 | 1,970 | 2,608 | 1.54 | % | 1.89 | % | ||||||||||||||||
Other liabilities |
2,530 | 3,511 | ||||||||||||||||||||||
Shareholders equity |
11,675 | 48,390 | ||||||||||||||||||||||
$ | 520,265 | $ | 599,313 | |||||||||||||||||||||
Net interest income |
$ | 3,164 | $ | 3,417 | ||||||||||||||||||||
Net interest spread (1) |
2.70 | % | 2.48 | % | ||||||||||||||||||||
Net interest margin (2) |
2.72 | % | 2.59 | % |
(1) | Yields realized on interest-earning assets less the rates paid on interest-bearing
liabilities. |
|
(2) | Net interest margin is the result of annualized net interest income divided by average
interest-earning assets for the period. |
52
Table of Contents
The following tables set forth the extent to which changes in interest rates and changes in
volume of interest-earning assets and interest-bearing liabilities have affected our interest
income and interest expense during the periods indicated. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes attributable to (1)
change in volume (change in volume multiplied by previous year rate); (2) change in rate (change in
rate multiplied by current year volume); and (3) a combination of change in rate and change in
volume. The changes in interest income and interest expense attributable to both volume and rate
have been allocated proportionately to the change due to volume and the change due to rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
2011 Compared to 2010 | ||||||||||||
Increase (decrease) | ||||||||||||
due to change in | ||||||||||||
Rate | Volume | Total | ||||||||||
(dollars in thousands) | ||||||||||||
Nine months ended September 30, 2011 and 2010 |
||||||||||||
Income from interest-earning assets: |
||||||||||||
Interest and fees on loans |
$ | (348 | ) | $ | (1,697 | ) | $ | (2,045 | ) | |||
Interest on securities |
329 | (567 | ) | (238 | ) | |||||||
Interest on Federal funds sold and other |
| (21 | ) | (21 | ) | |||||||
Total interest income |
(19 | ) | (2,285 | ) | (2,304 | ) | ||||||
Expense from interest-bearing liabilities: |
||||||||||||
Interest on interest-bearing deposits |
(202 | ) | (155 | ) | (357 | ) | ||||||
Interest on time deposits |
(827 | ) | (766 | ) | (1,593 | ) | ||||||
Interest on other borrowings |
6 | (267 | ) | (261 | ) | |||||||
Total interest expense |
(1,023 | ) | (1,188 | ) | (2,211 | ) | ||||||
Net interest income |
$ | 1,004 | $ | (1,097 | ) | $ | (93 | ) | ||||
Three months ended September 30, 2011 and 2010 |
||||||||||||
Income from interest-earning assets: |
||||||||||||
Interest and fees on loans |
$ | (130 | ) | $ | (732 | ) | $ | (862 | ) | |||
Interest on securities |
(45 | ) | 26 | (19 | ) | |||||||
Interest on Federal funds sold and other |
(2 | ) | (8 | ) | (10 | ) | ||||||
Total interest income |
(177 | ) | (714 | ) | (891 | ) | ||||||
Expense from interest-bearing liabilities: |
||||||||||||
Interest on interest-bearing deposits |
(65 | ) | 29 | (36 | ) | |||||||
Interest on time deposits |
(288 | ) | (235 | ) | (523 | ) | ||||||
Interest on other borrowings |
(12 | ) | (67 | ) | (79 | ) | ||||||
Total interest expense |
(365 | ) | (273 | ) | (638 | ) | ||||||
Net interest income |
$ | 188 | $ | (441 | ) | $ | (253 | ) |
53
Table of Contents
The following is a summary of our results of operations (dollars in thousands except per
share amounts):
Nine months ended | Three months ended | |||||||||||||||||||||||||||||||
9/30/11 | 9/30/10 | $ change | % change | 9/30/11 | 9/30/10 | $ change | % change | |||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||
Interest income: |
||||||||||||||||||||||||||||||||
Loans |
$ | 13,727 | $ | 15,772 | (2,045 | ) | -12.97 | % | $ | 4,491 | $ | 5,353 | (862 | ) | -16.10 | % | ||||||||||||||||
Securities |
1,927 | 2,165 | (238 | ) | -10.99 | % | 629 | 648 | (19 | ) | -2.93 | % | ||||||||||||||||||||
Fed funds sold/other |
30 | 51 | (21 | ) | -41.18 | % | 14 | 24 | (10 | ) | -41.67 | % | ||||||||||||||||||||
Total Interest income |
15,684 | 17,988 | (2,304 | ) | -12.81 | % | 5,134 | 6,025 | (891 | ) | -14.79 | % | ||||||||||||||||||||
Interest Expense: |
||||||||||||||||||||||||||||||||
Deposits |
4,131 | 6,081 | (1,950 | ) | -32.07 | % | 1,313 | 1,872 | (559 | ) | -29.86 | % | ||||||||||||||||||||
Other borrowed funds |
1,941 | 2,202 | (261 | ) | -11.85 | % | 657 | 736 | (79 | ) | -10.73 | % | ||||||||||||||||||||
Total interest expense |
6,072 | 8,283 | (2,211 | ) | -26.69 | % | 1,970 | 2,608 | (638 | ) | -24.46 | % | ||||||||||||||||||||
Net interest income |
9,612 | 9,705 | (93 | ) | -0.96 | % | 3,164 | 3,417 | (253 | ) | -7.40 | % | ||||||||||||||||||||
Provision for loan losses |
23,865 | 702 | 23,163 | 3299.57 | % | 3,502 | 156 | 3,346 | 2144.87 | % | ||||||||||||||||||||||
Net interest income
after
provision for loan
losses |
(14,253 | ) | 9,003 | (23,256 | ) | -258.31 | % | (338 | ) | 3,261 | (3,599 | ) | -110.36 | % | ||||||||||||||||||
Noninterest income |
(1,662 | ) | 4,984 | (6,646 | ) | -133.35 | % | 1,150 | 1,530 | (380 | ) | -24.84 | % | |||||||||||||||||||
Noninterest expense |
13,399 | 13,312 | 87 | 0.65 | % | 4,373 | 4,471 | (98 | ) | -2.19 | % | |||||||||||||||||||||
Net income (loss) before
income tax benefit |
(29,314 | ) | 675 | (29,989 | ) | -4442.81 | % | (3,561 | ) | 320 | (3,881 | ) | -1212.81 | % | ||||||||||||||||||
Income tax benefit |
(859 | ) | (147 | ) | (712 | ) | -484.35 | % | (340 | ) | (31 | ) | (309 | ) | -996.77 | % | ||||||||||||||||
Net income (loss) |
$ | (28,455 | ) | $ | 822 | $ | (29,277 | ) | -3561.68 | % | $ | (3,221 | ) | $ | 351 | $ | (3,572 | ) | -1017.66 | % | ||||||||||||
Net Interest Income and Net Interest Margin
Interest Income
The interest income and fees earned on loans are the largest contributing element of interest
income. The decrease in this component of interest income for the nine months ended September 30,
2011 as compared to the same period in 2010 was primarily the result of a decrease in the volume of
average loans as well as a decrease in the average rate earned on loans. Average loans outstanding
decreased approximately $43,160,000, or 10.8%, from September 30, 2010 to September 30, 2011. The
decrease in the average yield on loans was the result of several factors including the increase in
TDRs involving interest rate concessions and the continued significant level of average non-accrual
loans as a percentage of our loan portfolio, as presented in more detail below under Net Interest
Margin. Interest income on securities decreased during the nine-month period ended September 30,
2011 as compared to the same period in 2010 due to the approximately $33,103,000, or 26.1%,
decrease in the volume of average securities from September 30, 2010 to September 30, 2011.
Partially offsetting the reduction in volume, the yield earned on securities increased 47 basis
points during the first nine months of 2011 as compared to the same period in 2010 reflecting a
redistribution of the portfolio from lower to higher yielding investments at September 30, 2011
when compared to September 30, 2010. Additionally, interest income on federal funds sold/other
decreased due to a decrease in the average balance outstanding.
Interest income decreased for the three-month period ended September 30, 2011 as compared to
the three-month period ended September 30, 2010 as a result of the same factors mentioned in the
above paragraph. However, the yield earned on investment securities decreased 18 basis points
during the third quarter of 2011 when compared to the third quarter of 2010. This caused a net
decrease in interest income despite the approximately $3,750,000, or 4.1%, increase in the average
volume of securities outstanding for the periods compared.
54
Table of Contents
Interest Expense
The decrease in interest expense for the nine months ended September 30, 2011 as compared to
the same period in 2010 was attributable to the reduction in both the volume and the average cost
of the Banks interest-bearing liabilities, predominantly the volume and cost of time and interest
bearing demand deposits. The average balance of total interest bearing deposits, the largest
component of interest-bearing liabilities, decreased approximately $66,969,000, or 14.8%, for the
first nine months of 2011 compared to the first nine months of 2010. Additionally, the average rate
paid on total interest bearing deposits decreased 36 basis points between the two periods
contributing to the net decrease in deposit interest expense. Interest expense on FHLB advances and
other borrowings decreased during the nine-month period ended September 30, 2011 compared to the
same period in 2010 due to a decrease in the average borrowed funds balance of approximately
$8,633,000, or 13.5%, during the periods compared. The average rate paid on these liabilities
increased 3 basis points, slightly offsetting the reduction in interest expense. During the first
nine months of 2010, we had, from time to time, borrowings outstanding from the Federal Reserve
Discount Window. These borrowings generally cost less than our outstanding FHLB advances,
consequently reducing the average cost of this category during the first nine months of 2010 as
compared to the same period in 2011. The average balance of subordinated debentures was unchanged
from September 30, 2010 to September 30, 2011. The average cost of these subordinated debentures
decreased 4 basis points, therefore, the related interest expense decreased for the periods
compared.
Interest bearing deposits consist of interest bearing demand deposits, savings and time
deposits. As stated above, the cost of our interest bearing deposits decreased for the first nine
months of 2011 compared to the first nine months of 2010. The largest factor contributing to the
overall reduction in expense was the 43 basis point reduction in the average rate paid on time
deposits from the first nine months of 2010 to the first nine months of 2011, followed by a
reduction in the average balance of these time deposits of approximately $48,499,000, or 15.8%,
between the periods compared. Additionally, the average balance of interest bearing demand deposits
decreased approximately $19,114,000, or 15.4%, during the first nine months of 2011 when compared
to the first nine months of 2010, primarily due to a decrease in average public funds deposits
resulting from managements 2009 strategic initiative that involved not bidding to retain the
deposits of certain municipal entities. The rate paid on these deposits decreased 16 basis points
during the same time period.
Interest expense decreased for the three-month period ended September 30, 2011 as compared to
the three-month period ended September 30, 2010 as a result of the same factors mentioned in the
above paragraph.
Net Interest Income
The decrease in net interest income before the provision for loan losses for the three- and
nine-month periods ended September 30, 2011 when compared to the same periods in 2010 was primarily
the result of a decrease in interest income, mostly related to loans and securities. Decreases in
interest expense, primarily for deposits and FHLB advances, largely offset the decrease in interest
income so that the overall decrease in net interest income was less significant than either of its
components considered separately. Net interest income for the two periods was also influenced by
decreases in the volume of interest-earning assets and interest-bearing liabilities as well as
changes in rates earned and paid on these interest-sensitive balances.
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Net Interest Margin
Our net interest margin, the difference between the yield on earning assets, including loan
fees, and the rate paid on funds to support those assets, increased 13 and 41 basis points,
respectively, for the third quarter and first nine months of 2011 compared to the same periods in
2010. The increase in our net interest margin reflects an increase in the average spread during the
first nine months of 2011 between the rates we earned on our interest-earning assets, which had an
increase in overall yield of 15 basis points to 4.49% at September 30, 2011, as compared to 4.34%
at September 30, 2010, and the rates we paid on interest-bearing liabilities, which had a decrease
of 30 basis points in the overall rate to 1.78% at September 30, 2011, versus 2.08% at September
30, 2010. During the third quarter of 2011, our interest-earning assets had a decrease in overall
yield of 15 basis points to 4.41% at September 30, 2011, as compared to 4.56% at September 30,
2010, while our interest-bearing liabilities had a more substantial decrease of 37 basis points in
the overall rate to 1.71% at September 30, 2011, versus 2.08% at September 30, 2010.
Our net interest margin continues to be negatively impacted by the high level of nonaccrual
loans as well as TDRs involving interest rate concessions. The following table presents the average
balances and net changes for loans, nonaccrual loans and TDRs, as well as the ratio of nonaccrual
loans and TDRs to total loans for the three and nine months ended September 30, 2011 and 2010.
9/30/11 | 9/30/10 | $ change | % change | |||||||||||||
(dollars in thousands) | ||||||||||||||||
Nine months ended |
||||||||||||||||
Average loans |
357,901 | 401,061 | (43,160 | ) | -10.76 | % | ||||||||||
Average nonaccrual
loans |
48,935 | 58,503 | (9,568 | ) | -16.35 | % | ||||||||||
Average TDRs |
74,114 | 60,245 | 13,869 | 23.02 | % | |||||||||||
Average nonaccrual
loans / average loans |
13.7 | % | 14.6 | % | ||||||||||||
Average TDRs
/ average loans |
20.7 | % | 15.0 | % | ||||||||||||
Three months ended |
||||||||||||||||
Average loans |
340,807 | 394,470 | (53,663 | ) | -13.60 | % | ||||||||||
Average nonaccrual
loans |
42,822 | 64,313 | (21,491 | ) | -33.42 | % | ||||||||||
Average TDRs |
71,342 | 78,624 | (7,282 | ) | -9.26 | % | ||||||||||
Average nonaccrual
loans / average loans |
12.6 | % | 16.3 | % | ||||||||||||
Average TDRs
/ average loans |
20.9 | % | 19.9 | % |
The adverse effects of carrying these underperforming assets will continue as long as and
to the extent that the average balances of nonaccrual loans and TDRs remain elevated.
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Provision For Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an
allowance for loan losses and is based on managements evaluation of economic conditions, volume
and composition of the loan portfolio, historical charge-off experience, the level of
non-performing and past due loans, and other indicators derived from reviewing the loan portfolio.
Management performs such reviews quarterly and makes appropriate adjustments to the level of the
allowance for loan losses as a result of these reviews.
As mentioned above in the section titled Allowance for Loan Losses, management determines the
necessary amount, if any, to increase the allowance account through the provision for loan losses.
Although total loans decreased approximately $40 million during the first nine months of 2011, the
increased level of provision for loan loss expense during the third quarter and first nine months
of 2011 was due to increased charge-offs, the majority of which were associated with our strategy
to aggressively liquidate certain nonperforming assets. The resulting recorded values reflect
continued deterioration in the real estate segment of the Companys loan portfolio, particularly
construction and land development, as well as the persistently slow economic conditions. Continuing
reductions in property values and the reduced volume of sales of developed and undeveloped land has
led to an increase of impaired loans determined to be collateral dependent. As the collateral value
for these land loans has declined significantly during 2010 and into 2011, related charge-offs and
provision expense have been incurred. Notwithstanding the assessments made as part of our
liquidation strategy, management has continued its ongoing review of the loan portfolio with
particular emphasis on construction and land development loans and while we believe we have
identified and adequately provided for losses present in the loan portfolio, due to the necessarily
approximate and imprecise nature of the allowance for loan loss estimate, certain projected
scenarios may not occur as anticipated. Additionally, further deterioration of factors relating to
the loan portfolio, such as conditions in the local and national economy and the local real estate
market, could have an added adverse impact and require additional provision expense and higher
allowance levels.
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The following table summarizes our loan loss experience and provision for loan losses for the
three and nine months ended September 30, 2011 and 2010.
Nine Months Ended | Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(dollars in thousands) | ||||||||||||||||
Charge-offs: |
||||||||||||||||
Construction and land development |
$ | 8,987 | $ | 679 | $ | 1,367 | $ | 162 | ||||||||
Equity Lines of Credit |
252 | 174 | | 93 | ||||||||||||
Residential 1-4 family |
7,310 | 188 | 501 | 12 | ||||||||||||
Second mortgages |
828 | 45 | 234 | | ||||||||||||
Residential multifamily |
2 | | | | ||||||||||||
Commercial real estate |
2,479 | 831 | 776 | 131 | ||||||||||||
Commercial loans |
118 | 222 | 37 | 11 | ||||||||||||
Consumer loans |
236 | 248 | 99 | 33 | ||||||||||||
Recoveries: |
||||||||||||||||
Construction and land development |
(113 | ) | (390 | ) | (96 | ) | (2 | ) | ||||||||
Equity Lines of Credit |
(11 | ) | (3 | ) | (10 | ) | (2 | ) | ||||||||
Residential 1-4 family |
(19 | ) | (30 | ) | (16 | ) | (30 | ) | ||||||||
Second mortgages |
(30 | ) | | (30 | ) | | ||||||||||
Residential multifamily |
(2 | ) | | | | |||||||||||
Commercial real estate |
(68 | ) | | (19 | ) | | ||||||||||
Commercial loans |
(13 | ) | | (13 | ) | | ||||||||||
Consumer loans |
(20 | ) | (47 | ) | (10 | ) | (17 | ) | ||||||||
Net charge-offs |
19,936 | 1,917 | 2,820 | 391 | ||||||||||||
Average balance of loans outstanding |
357,901 | 401,061 | 340,807 | 394,470 | ||||||||||||
Annualized net charge-offs as % of
average loans |
7.45 | % | 0.64 | % | 3.28 | % | 0.39 | % | ||||||||
Provision for loan losses |
23,865 | 702 | 3,502 | 156 |
As noted in the table above, the majority of net charge-offs during the third quarter and
first nine months of 2011 were related to construction and land development loans followed by
residential 1-4 family real estate loans. As discussed above, the large volume of charge-offs are
the result of managements initiative to begin clearing up certain non-performing assets more
expeditiously than was previously anticipated.
Non-Interest Income
Non-interest income represents the total of all sources of income, other than interest-related
income, which are derived from various service charges, fees and commissions charged for bank
services.
The decrease in non-interest income for the three and nine months ended September 30, 2011, was
primarily attributable to the net loss on ORE. During the second quarter of 2011, in an effort to
liquidate certain nonperforming assets, management enacted a strategy that involved recording a
significant valuation allowance against its ORE portfolio as discussed under Loans. The
approximately $4.6 million valuation allowance recorded during the second quarter of 2011 was
primarily recognized as a loss on ORE. An additional ORE valuation allowance of approximately
$206,000 was recorded during the third quarter of 2011. Non-interest income also decreased during
the periods compared due to nonrecurring investment gains recognized during 2010, related to
managements strategy to manage liquidity and pledging requirements discussed in more detail above
under Investment Securities. Investment gains were a less significant part of non-interest income
for the quarter and nine months ended September 30, 2011. The decrease in non-interest income for
the three and nine month periods ended September 30, 2011 was also affected by a reduction in
deposit service charges, primarily non-sufficient fee income from overdrafts of demand deposit
accounts, as well as a decrease in other noninterest income which was largely the result of a
decrease in income generated by the Banks investment in Appalachian Fund for Growth II, LLC.
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The following table presents the main components that make up the changes in non-interest
income:
Nine months ended | Three months ended | |||||||||||||||||||||||||||||||
9/30/11 | 9/30/10 | $ change | % change | 9/30/11 | 9/30/10 | $ change | % change | |||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||
Net gain (loss) on other real estate |
$ | (4,717 | ) | $ | 283 | (5,000 | ) | -1766.78 | % | $ | (23 | ) | $ | 51 | (74 | ) | -145.10 | % | ||||||||||||||
Investment gains and losses, net |
198 | 1,511 | (1,313 | ) | -86.90 | % | 150 | 319 | (169 | ) | -52.98 | % | ||||||||||||||||||||
Service charges on deposit accounts |
1,098 | 1,246 | (148 | ) | -11.88 | % | 352 | 401 | (49 | ) | -12.22 | % | ||||||||||||||||||||
Other noninterest income |
609 | 718 | (109 | ) | -15.18 | % | 276 | 284 | (8 | ) | -2.82 | % | ||||||||||||||||||||
Gain on sale of mortgage loans |
48 | 122 | (74 | ) | -60.66 | % | 7 | 53 | (46 | ) | -86.79 | % | ||||||||||||||||||||
Other fees and commissions |
1,102 | 1,104 | (2 | ) | -0.18 | % | 388 | 422 | (34 | ) | -8.06 | % |
Non-Interest Expense
Total non-interest expense represents the total costs of operating overhead, such as salaries,
employee benefits, building and equipment costs, telephone costs and marketing costs. Non-interest
expense increased for the nine months ended September 30, 2011 as compared to the first nine months
of 2010, but decreased during the third quarter of 2011 as compared to the third quarter of 2010.
During each period, there was an increase in FDIC assessment expense and a decrease in other
expenses related to a nonrecurring FHLB pre-payment penalty recorded during the third quarter of
2010. The increase in consultant/advisory and legal fees for the nine months ended September 30,
2011 as compared to the same period in 2010 is primarily related to the Companys pursuit of
capital development opportunities as well as the Banks efforts to comply with the formal written
agreement. Salary and employee benefit expenses decreased for the nine months ended September 30,
2011, which is the result of several cost cutting measures implemented during the first quarter of
2010 including staff reductions as well as reductions in remaining employees salaries, health
insurance costs, 401(k) match expenses and fees paid to members of the board of directors, among
other things. Salary and employee benefit expenses increased for the third quarter of 2011
primarily due to an increase in deferred compensation expense as well as a one-time reversal of an
accrued bonus expense recorded during the third quarter of 2010. Additionally, ORE expense related
to maintenance and upkeep of our foreclosed properties decreased for the three and nine-month
periods ended September 30, 2011 as compared to the same periods during 2010.
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The following table presents the main components that make up the changes in non-interest
expense:
Nine months ended | Three months ended | |||||||||||||||||||||||||||||||
9/30/11 | 9/30/10 | $ change | % change | 9/30/11 | 9/30/10 | $ change | % change | |||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||
Salaries and employee benefits |
$ | 6,051 | $ | 6,314 | (263 | ) | -4.17 | % | $ | 2,039 | $ | 1,883 | 156 | 8.28 | % | |||||||||||||||||
FDIC assessment expense |
1,227 | 931 | 296 | 31.79 | % | 431 | 319 | 112 | 35.11 | % | ||||||||||||||||||||||
Occupancy expenses |
1,351 | 1,318 | 33 | 2.50 | % | 448 | 450 | (2 | ) | -0.44 | % | |||||||||||||||||||||
Other operating expenses: |
||||||||||||||||||||||||||||||||
Consultant/advisory fees |
325 | 196 | 129 | 65.82 | % | 39 | 95 | (56 | ) | -58.95 | % | |||||||||||||||||||||
Legal fees |
251 | 106 | 145 | 136.79 | % | 20 | 19 | 1 | 5.26 | % | ||||||||||||||||||||||
Other real estate expense |
469 | 484 | (15 | ) | -3.10 | % | 154 | 156 | (2 | ) | -1.28 | % | ||||||||||||||||||||
FHLB pre-payment penalty |
| 350 | (350 | ) | -100.00 | % | | 350 | (350 | ) | -100.00 | % |
Income Taxes
The Companys income tax expense (benefit) for the three and nine months ended September 30,
2011 and 2010 is presented in the following table:
Provision for Income Taxes and Effective Tax Rates
(dollars in thousands)
(dollars in thousands)
Nine months ended | Three months ended | |||||||||||||||
9/30/11 | 9/30/10 | 9/30/11 | 9/30/10 | |||||||||||||
Provision expense
(benefit) |
(859 | ) | (147 | ) | (340 | ) | (31 | ) | ||||||||
Pre-tax income (loss) |
(29,314 | ) | 675 | (3,561 | ) | 320 | ||||||||||
Effective tax rate |
2.93 | % | -21.78 | % | 9.55 | % | -9.69 | % |
During the third quarter and first nine months of 2011, the Banks effective income tax
rate was primarily the result of continued adjustments to the deferred tax asset valuation
allowance. Recording a valuation allowance requires recognition of tax expense which, if large
enough and when applied to a pretax loss, causes a negative effective tax rate. During the three
and nine months ended September 30, 2011, a more significant income tax benefit would have
typically been recognized based on the Companys pre-tax net loss. However, we recorded a deferred
tax asset valuation allowance that was large enough to offset a substantial amount of the tax
benefit generated by the net loss. Additionally, tax exempt income has the effect of increasing a
taxable loss, therefore increasing effective tax rates as a percentage of pretax income. This is
the opposite effect on tax rates when a company has pretax income. During the third quarter and
first nine months of 2010, the Banks tax exempt income was enough to offset its taxable income
resulting in a net tax benefit during each period and a negative effective tax rate. Tax exempt
income effectively reduces the statutory tax rate and, as was the case for the three and nine
months ended September 30, 2010, can potentially reduce the rate below zero.
For each period presented above, the effective tax rate was positively impacted by the
continuing tax benefits generated from MNB Real Estate, Inc., which is a real estate investment
trust subsidiary formed during the second quarter of 2005. The income generated from tax-exempt
municipal bonds and bank owned life insurance also continues to improve our effective tax rate.
Additionally, during 2006, the Bank became a partner in Appalachian Fund for Growth II, LLC with
three other Tennessee banking institutions. This partnership has invested in a program that is
expected to generate a federal tax credit in the amount of approximately $200,000 during 2011. The
program is also expected to generate a one-time state tax credit in the amount of $200,000 to be
utilized over a maximum of 20 years to offset state tax liabilities.
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The Company had net deferred tax assets of approximately $719,000 as of September 30, 2011. A
valuation allowance is recognized for a deferred tax asset if, based on the weight of available
evidence, it is more-likely-than-not that some portion of the entire deferred tax asset will not be
realized. In making such judgments, significant weight is given to evidence that can be objectively
verified. As a result of increased credit losses, the Company entered into a three-year cumulative
pre-tax loss position in 2010. A cumulative loss position is considered significant negative
evidence in assessing the realizability of a deferred tax asset which is difficult to overcome. The
Companys estimate of the realization of its deferred tax assets was based on taxable income in prior carry back years. The Company
did not consider future taxable income in determining the realizability of its deferred assets.
During the third quarter and first nine months of 2011, we recorded an additional valuation
allowance of approximately $1,048,000 and $10,523,000, respectively. The timing of the reversal of
the valuation allowance is dependent on our assessment of future events and will be based on the
circumstances that exist as of that future date.
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
The Company maintains
disclosure controls and procedures, as defined in Rule 13a-15(e)
and 15d-15(e)
promulgated under the Exchange Act, that are designed to ensure that information required to be
disclosed in the Companys reports and other information filed with the Commission, under the
Exchange Act, is recorded, processed, summarized and reported within the time periods specified in
the Commissions rules and forms, and that such information is accumulated and communicated to the
management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure.
The Company carried out an evaluation, under the supervision and with the participation of
management, including the Companys Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon the foregoing, the Chief Executive Officer along
with the Chief Financial Officer concluded that certain deficiencies identified in internal
controls and procedures created a material weakness and resulted in the Companys disclosure
controls and procedures not being effective to ensure that information required to be disclosed in
the Companys reports under the Exchange Act was recorded, summarized and reported within the time
periods specified in the Commissions rules and forms as of the end of the period covered by this
report. Based on this determination of the existence of a material weakness, which began during the
fourth quarter of 2010, management identified certain areas requiring internal control and
procedure improvements.
Changes in Internal Control over Financial Reporting
During
Managements assessment of the Companys internal control
over financial reporting as defined in Rule 13a-15(f)
and 15d-15(f) promulgated under the Exchange Act at
December 31, 2010, the following deficiencies were noted: 1) Loans determined to be collateral
dependent were not properly identified in a timely manner which created a material internal control
deficiency. Procedures have been put in place by the Banks Special Assets Department to ensure
loans that are dependent upon the sale of the underlying collateral for repayment are properly
identified and documented when the determination is made the loan is collateral dependent and this
information is incorporated in the allowance for loan loss calculation. 2) Appraisals and appraisal
reviews from an independent third-party appraiser or collateral valuations performed internally for
loans determined to be collateral dependent were not ordered, received or reviewed prior to the
reporting date which could result in overstatement of loans and income and understatement of the
provision for loan losses, charge off and the allowance for loan losses. The Special Assets
Department has created procedures and updated the Appraisal Policy to address this deficiency. The
remediation plan for these internal control deficiencies is noted below. Other than the items noted
above, during the third quarter of 2011 there were no other changes in the Companys internal
control over financial reporting that have materially affected, or that are reasonably likely to
materially affect, the Companys internal control over financial reporting.
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During the first quarter of 2011, management took the following remediation actions regarding
the above referenced internal control deficiencies:
1) | During the first quarter of 2011, the OCC, during their regular safety and soundness
exam, determined several loans were not properly identified by the Bank as collateral
dependent as of December 31, 2010. Collateral dependent loans require a charge off of the
loan balance if the recorded investment in the loan exceeds the underlying collateral value
net of cost to sell. To make the determination the proper recorded investment has been
recorded, the current appraised value of the collateral must be obtained. The Special
Assets Department, formed during 2009, is in charge of complying with these requirements.
During the first quarter of 2011, procedures were put in place in the Special Assets
Department to comply with these requirements and the results of their efforts have been
incorporated into the financial statements as of March 31, 2011. |
2) | As noted in item 1, collateral dependent loans require the Bank to obtain a current
appraisal or collateral valuation performed internally to allow for the determination as to
whether there is sufficient collateral securing the loan. In addition to the requirement of
obtaining the appraisal, the appraisal must be reviewed by an independent third-party
appraiser charged with determining the appraisal has been properly performed. After the
review, the Special Assets Department determines if the appraisal is acceptable, then
provides valuation information to the Accounting Department to incorporate the results into
the calculation of the allowance for loan losses. Failure to comply with any of these steps
could result in the overstatement of both assets and income. The Special Assets Department,
as noted in item 1, is in charge of complying with these requirements and during the first
quarter of 2011, procedures were put in place to comply with these requirements and the
results of their efforts have been incorporated into the financial statements as of June
30, 2011. |
3) | During the first quarter of 2011, Management sought to ensure proper controls are in
place so that when either evidence of impairment of a loan exists or prior to the annual
appraisal date, the Special Assets Department will order appraisals or collateral
valuations in a timely manner to allow for proper review and incorporation of the results
into the allowance for loan loss calculation. Additional controls have also been developed
and incorporated into the process to assure a potential impairment is recorded when
appraisal or valuation and review process is not complete as of a reporting date. |
4) | The Bank has revised its policy and procedures to require independent third-party
appraisals or collateral valuations performed internally for all loans considered to be
impaired, classified or worse. The Special Assets Department, as noted in item 1, is in
charge of complying with these requirements and during the first quarter of 2011,
procedures were put in place to comply with these requirements and the results of their
efforts have been incorporated into the financial statements as of June 30, 2011. |
The identified material weakness in our internal controls over financial reporting will not be
considered remediated until the new controls are fully implemented, in operation for a sufficient
period of time, tested, and concluded by management to be operating effectively. Management
anticipates that this remediation process will be completed by December 31, 2011 and that the
Companys internal controls over financial reporting, with respect to this identified material
weakness, will be deemed effective. There are no material costs associated with correcting the
control deficiencies described above.
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PART II OTHER INFORMATION
ITEM 1A. | RISK FACTORS |
Except as set forth below and in the Companys Quarterly Report on Form 10-Q for the quarters
ended March 31, 2011 and June 30, 2011, there were no material changes to the risk factors
previously disclosed in Part I, Item 1A, of the Companys Annual Report on Form 10-K for the fiscal
year ended December 31, 2010:
Our inability to accept, renew or roll over brokered deposits without the prior approval of the
FDIC could adversely affect our liquidity.
As of September 30, 2011, we had approximately $20 million in brokered certificates of deposit
which represented approximately 5% of our total deposits. As long as it is not adequately
capitalized, the Bank may not accept, renew or roll over any brokered deposits or accept any
employee benefit plan deposits. As of September 30, 2011, brokered deposits maturing in the next 24
months totaled approximately $20 million. Funding sources for the maturing brokered deposits
include, among other sources: our cash account at the Federal Reserve Bank of Atlanta; overnight
federal funds sold to correspondent banks; growth, if any, of core deposits from current and new
retail and commercial customers; scheduled repayments on existing loans; and the possible pledge or
sale of investment securities. Because the Bank is treated as significantly undercapitalized, it
is also not permitted to offer to pay interest on deposits at rates that are more than 75 basis
points above the national rate. These interest rate limitations may limit the ability of the Bank
to increase or maintain core deposits from current and new deposit customers. The limitations on
our ability to accept employee benefit plan deposits, to accept, renew or roll over brokered
deposits, or pay more than 75 basis points above the national rate could adversely affect our
liquidity.
As the Banks capital levels decline, the amount that it can lend any one borrower is reduced.
As the Banks capital levels decline, the amount that it can lend any one borrower is reduced. At
September 30, 2011, the Banks legal lending limit under applicable regulations (based upon the
maximum legal lending limits of 25% of capital and surplus) was $5,460,000. As the Banks capital
levels have declined, its legal lending limit has been reduced. If the legal lending limit is
reduced below the level of credit, including lines of credit, that the Bank has extended to a
borrower, it can no longer renew or continue undrawn credit lines or make additional loans or
advances to its largest borrower relationships, and its ability to renew outstanding loans to such
customers is extremely limited. Additionally, if the Bank seeks to reduce the amount of credit that
it has extended to a particular borrower because of a reduction in its legal lending limit, the
borrower may decided to move its loan relationships to another financial institution with legal
lending limits high enough to accommodate the borrowers relationships. A loss of loan customers as
a result of being subject to lower lending limits, could negatively impact the Banks liquidity and
results of operations.
An inability to improve our regulatory capital position could adversely affect our operations and
future prospects.
Our ability to remain in operation as a financial institution is dependent on our ability to raise
sufficient capital or reduce our assets to improve our regulatory capital position. At September
30, 2011, the Bank was classified as undercapitalized, which restricts its operations. Under the
prompt corrective action regulations, the Bank submitted a capital restoration plan with the OCC,
but on October 21, 2011, the OCC advised the Bank that such capital restoration plan was not
acceptable. Therefore, the Bank will continue to be treated as significantly undercapitalized
until such time as it submits an acceptable capital restoration plan and such capital restoration
plan is in fact accepted by the OCC. Also, the Company will be required to guarantee the Banks
capital restoration plan before it can be accepted by the OCC. If the Bank fails to comply with the
terms of the capital restoration plan that is accepted by the OCC, the Company will be obligated to
pay to the Bank the lesser of five percent of the Banks total assets at the time the Bank was
undercapitalized, or the amount which is necessary to bring the Bank into compliance with all
adequately capitalized standards at the time it failed to comply. The Company is exploring
potential strategic transactions that could provide additional capital for the Bank, including
private equity financing, issuance of shares to existing shareholders or other strategic
transactions such as sale of control of the Company. The Bank believes that it is unlikely the OCC
will accept its capital restoration plan unless there is substantial assurance such plan will be
accomplished, and it likely the Bank will continue to be subject to the restrictions imposed by the
prompt corrective action regulations.
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In order for the Bank to achieve and maintain capital levels above those that the Bank is required
by the Order to maintain, we will have to raise additional capital.
The Bank is required by the Order to achieve and maintain a Tier 1 leverage capital ratio of 9% and
a total risk-based capital ratio of 12% by February 24, 2012. The Bank currently fails to satisfy
this requirement, as well as the requirements for being considered adequately capitalized, as of
September 30, 2011. In order to achieve these capital levels, we will be required to raise
additional capital. Our ability to raise additional capital depends to a significant extent on our
financial performance and on forces outside of our control. Accordingly, we may not be able to
raise the capital necessary to ensure that the Bank achieves the capital maintenance requirements
of the Order. If the Bank is unable to achieve these capital requirements, it may face additional
regulatory constraints and the ability of the Bank to continue as a going concern may be materially
impaired.
ITEM 6. | EXHIBITS |
Exhibits
The following exhibits are filed as a part of or incorporated by reference in this report:
Exhibit No. | Description | |||
3.1 | Charter of the Company (1) |
|||
3.2 | Amended and Restated Bylaws of the Company, as amended (2) |
|||
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended |
|||
31.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended |
|||
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|||
32.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |
|||
101 | Interactive Data File |
(1) | Incorporated by reference to the Registrants Registration Statement on Form S-1 (333-168281)
as filed with the Securities and Exchange Commission on July 22, 2010. |
|
(2) | Incorporated by reference to the Registrants Form 8-K as filed with the Securities and Exchange
Commission March 31, 2010. |
64
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MOUNTAIN NATIONAL BANCSHARES, INC. |
||||
Date: November 18, 2011 | /s/ Dwight B. Grizzell | |||
Dwight B. Grizzell | ||||
President and Chief Executive Officer | ||||
Date: November 18, 2011 | /s/ Richard A. Hubbs | |||
Richard A. Hubbs | ||||
Senior Vice President and Chief Financial Officer |
65
Table of Contents
EXHIBIT INDEX
Exhibit No. | Description | |||
3.1 | Charter of the Company (1) |
|||
3.2 | Amended and Restated Bylaws of the Company, as amended (2) |
|||
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended |
|||
31.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended |
|||
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|||
32.2 | Certification of the Senior Vice President and Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |
|||
101 | Interactive Data File |
(1) | Incorporated by reference to the Registrants Registration Statement on Form S-1 (333-168281)
as filed with the Securities and Exchange Commission on July 22, 2010. |
|
(2) | Incorporated by reference to the Registrants Form 8-K as filed with the Securities and
Exchange Commission on March 31, 2010. |
66