UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2010
or
Commission File Number: 001-16715
First Citizens BancShares, Inc.
(Exact name of Registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
(919) 716-7000
(Registrant’s telephone number, including area code)
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 twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes x No ¨
Indicate by check mark whether the Registrant 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 such shorter period that the Registrant was required to submit and post such files) Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of ‘accelerated filer’ and ‘large accelerated filer’ in Rule 12b-2 of the Exchange Act:
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Class A Common Stock—$1 Par Value—8,756,778 shares
Class B Common Stock—$1 Par Value—1,677,675 shares
(Number of shares outstanding, by class, as of August 6, 2010)
INDEX
PART I.
FINANCIAL INFORMATION
Item 1.
Consolidated Statements of Income for the three and six month periods ended June 30, 2010 and June 30, 2009
Consolidated Statements of Changes in Shareholders’ Equity for the six month periods ended June 30, 2010 and June 30, 2009
Consolidated Statements of Cash Flows for the six month periods ended June 30, 2010 and June 30, 2009
Item 2.
Item 3.
Item 4.
PART II.
OTHER INFORMATION
Item 6.
2
Part 1
Item 1. Financial Statements (Unaudited)
First Citizens BancShares, Inc. and Subsidiaries
Consolidated Balance Sheets
Unaudited
Assets
Cash and due from banks
Overnight investments
Investment securities available for sale
Investment securities held to maturity
Loans held for sale
Loans and leases:
Covered by loss share agreements
Not covered by loss share agreements
Less allowance for loan and lease losses
Net loans and leases
Premises and equipment
Other real estate owned:
Income earned not collected
Receivable from FDIC for loss share agreements
Goodwill
Other intangible assets
Other assets
Total assets
Liabilities
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Short-term borrowings
Long-term obligations
Other liabilities
Total liabilities
Shareholders’ Equity
Common stock:
Class A - $1 par value (8,756,778 shares issued for all periods)
Class B - $1 par value (1,677,675 shares issued for all periods)
Surplus
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying Notes to Consolidated Financial Statements.
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Consolidated Statements of Income
Interest income
Loans and leases
Investment securities:
U. S. Government
Residential mortgage backed securities
Corporate bonds
State, county and municipal
Other
Total investment securities interest and dividend income
Total interest income
Interest expense
Deposits
Total interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Noninterest income
Gain on acquisitions
Cardholder and merchant services
Service charges on deposit accounts
Wealth management services
Fees from processing services
Securities (losses) gains
Other service charges and fees
Mortgage income
Insurance commissions
ATM income
Adjustments to FDIC receivable for loss share agreements
Total noninterest income
Noninterest expense
Salaries and wages
Employee benefits
Occupancy expense
Equipment expense
FDIC deposit insurance
Foreclosure-related expenses
Total noninterest expense
Income before income taxes
Income taxes
Net income
Average shares outstanding
Net income per share
4
Consolidated Statements of Changes in Shareholders’ Equity
Balance at December 31, 2008
Comprehensive loss:
Change in unrealized securities gains arising during period, net of $13,108 deferred tax benefit
Change in unrecognized loss on cash flow hedge, net of $1,670 deferred tax
Total comprehensive loss
Cash dividends of $0.60 per share
Balance at June 30, 2009
Balance at December 31, 2009
Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests effective January 1, 2010
Comprehensive income:
Change in unrealized securities gains arising during period, net of $2,238 deferred tax
Change in unrecognized loss on cash flow hedge, net of $2,346 deferred tax benefit
Total comprehensive income
Balance at June 30, 2010
At June 30, 2010, Accumulated Other Comprehensive Loss includes on an after-tax basis $27,418 in unrealized gains on investment securities available for sale, $43,131 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $6,844 on cash flow hedges.
At June 30, 2009, Accumulated Other Comprehensive Income includes on an after-tax basis $25,069 in unrealized gains on investment securities available for sale, $75,815 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $3,897 on cash flow hedges.
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Consolidated Statements of Cash Flows
OPERATING ACTIVITIES
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of intangibles
Deferred tax (benefit) expense
Change in current taxes payable
Depreciation
Change in accrued interest payable
Change in income earned not collected
Securities losses (gains)
Origination of loans held for sale
Proceeds from sale of loans held for sale
Gain on sale of loans held for sale
Proceeds from sale of other real estate
Loss on sale of other real estate
Net amortization of premiums and discounts
Net change in other assets
Net change in other liabilities
Net cash provided by operating activities
INVESTING ACTIVITIES
Net change in loans and leases outstanding
Purchases of investment securities available for sale
Proceeds from maturities of investment securities held to maturity
Proceeds from maturities of investment securities available for sale
Proceeds from sales of investment securities available for sale
Net change in overnight investments
Additions to premises and equipment
Net cash received from acquisitions
Net cash used by investing activities
FINANCING ACTIVITIES
Net change in time deposits
Net change in demand and other interest-bearing deposits
Net change in short-term borrowings
Origination of long-term obligations
Cash dividends paid
Net cash provided by financing activities
Change in cash and due from banks
Cash and due from banks at beginning of period
Cash and due from banks at end of period
CASH PAYMENTS FOR:
Interest
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized securities gains (losses)
Unrealized (loss) gain on cash flow hedge
Transfers of loans to other real estate
Acquisitions:
Assets acquired
Liabilities assumed
Net assets acquired
See accompanying Notes to Consolidated Financial Statements
6
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Note A
Accounting Policies and Other Matters
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. Accordingly, they do not include all of the information and notes required by US GAAP for complete financial statements.
In the opinion of management, the consolidated financial statements contain all material adjustments necessary to present fairly the financial position of First Citizens BancShares, Inc. and Subsidiaries (BancShares) as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of income and expenses during the period. Actual results could differ from those estimates.
Management has evaluated subsequent events through the filing date of the Quarterly Report on Form 10-Q.
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in BancShares’ 2009 Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2010. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.
FDIC-Assisted Transactions
US GAAP requires that the acquisition method of accounting be used for all business combinations, including those resulting from FDIC-assisted transactions and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date. In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.
During 2010 and 2009, BancShares’ wholly-owned subsidiary First-Citizens Bank & Trust Company (FCB) acquired assets and assumed liabilities of four entities as noted below (collectively referred to as “the Acquisitions”) with the assistance of the Federal Deposit Insurance Corporation (FDIC), which had been appointed Receiver of each entity by its respective state banking authority.
Name of entity
Headquarters location
Date of transaction
The acquired assets and assumed liabilities were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the Acquisitions. Management judgmentally assigned risk ratings to loans based on credit quality, appraisals and estimated collateral values, estimated expected cash flows, and applied appropriate liquidity and coupon discounts to measure fair values for loans. Other real estate acquired through foreclosure was valued based upon pending sales contracts and appraised values, adjusted for current market conditions. FCB also recorded identifiable intangible assets representing the estimated values of the assumed core deposits and other customer relationships. Management used quoted or current market prices to determine the fair value of investment securities, short-term borrowings and long-term obligations.
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Loans and Leases
Loans and leases that are held for investment purposes are carried at the principal amount outstanding. Loans that are classified as held for sale are carried at the lower of aggregate cost or fair value. Interest on substantially all loans is accrued and credited to interest income on a constant yield basis based upon the daily principal amount outstanding.
Acquired loans are recorded at fair value at the date of acquisition. The fair values of acquired loans with evidence of credit deterioration since origination (impaired loans) are recorded net of a nonaccretable difference and, if appropriate, an accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable difference, which is included in the carrying amount of acquired loans. Subsequent decreases to the expected cash flows will generally result in a provision for credit losses. Subsequent increases in expected cash flows result in either a reversal of the provision for credit losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable yield. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan when there is a reasonable expectation regarding the amount and timing of such cash flows. BancShares did not estimate the amount and timing of cash flows for impaired loans acquired from TVB and VB, but cash flow analyses were performed on all loans deemed impaired that were acquired from First Regional and SAB in order to determine the cash flows expected to be collected.
Receivable from FDIC for Loss Share Agreements
The receivable from the FDIC for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable should the assets be sold. Fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses using the applicable loss share percentages and the estimated true-up payment at the expiration of the loss share agreements, if applicable. These cash flows were discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC and the true-up payment to the FDIC, when applicable. The FDIC receivable has been reviewed and updated prospectively as loss estimates related to covered loans and other real estate owned change and as reimbursements are received from the FDIC.
Other Real Estate Owned Covered by Loss Share Agreements
Other real estate owned (OREO) covered by loss share agreements with the FDIC are reported exclusive of expected reimbursement cash flows from the FDIC. Subsequent downward adjustments to the estimated recoverable value of covered OREO result in a reduction of covered OREO, a charge to other expense and an increase in the FDIC receivable for the estimated amount to be reimbursed, with a corresponding amount recorded as other noninterest income. OREO is presented at the estimated present value that management expects to receive when the property is sold, net of related costs of disposal. Management used appraisals of properties to determine fair values and applied additional discounts where appropriate for passage of time or, in certain cases, for subsequent events occurring after the appraisal date.
Recently Adopted Accounting Policies and Other Regulatory Issues
Under revisions to US GAAP that became effective January 1, 2010, the concept of a qualifying special-purpose entity (QSPE) was removed, resulting in a change in the accounting for QSPEs that were previously exempt. Further changes required evaluation of variable interests to determine whether a controlling financial interest exists. Upon adoption, the off-balance sheet accounting treatment for the 2005 asset securitization of home equity loans was discontinued, and the loans that were sold in the securitization and the corresponding debt obligations were reported on the consolidated balance sheet in the first quarter of 2010. The adoption resulted in increases of $97,291 in noncovered revolving mortgage loans, $681 in allowance for loan and lease losses, $86,926 in long-term obligations, and $3,189 in deferred tax liabilities. The retained interest in the residual interest strip and the servicing asset were written off, resulting in reductions of $1,287 and $304 to investment securities available for sale and other assets, respectively. The adoption also resulted in an adjustment to the beginning balance of retained earnings in the amount of $4,904.
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Note B
Federally Assisted Acquisitions of First Regional Bank and Sun American Bank
On January 29, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of First Regional from the FDIC, as Receiver. First Regional operated through 8 offices in the state of California, primarily serving Southern California. The FDIC took First Regional under receivership upon its closure by the California Department of Financial Institutions. FCB’s bid to the FDIC included the purchase of substantially all of First Regional’s assets at a discount of $299,400 in exchange for assuming certain First Regional deposits and certain other liabilities. No cash, deposit premium or other consideration was paid by FCB. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, there is no reimbursement by the FDIC until net losses reach $41,815. The FDIC will reimburse FCB for 80 percent of net losses incurred up to $1,017,000, and 95 percent of net losses exceeding $1,017,000.
The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On March 17, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $203.4 million, less (ii) the sum of (a) 25 percent of the asset discount, or $74.9 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Current projections suggest a true-up payment of $65,919 will be payable under the First Regional loss share agreements. This estimate is subject to change over the term of the agreements.
The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC and considering an estimate of a contingent true-up payment to the FDIC, FCB recorded a receivable of $365,170 at the time of acquisition. During the second quarter of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and increased the receivable by $24,391.
On March 5, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of SAB from the FDIC, as Receiver. SAB operated 12 offices in the state of Florida, primarily serving South Florida. The FDIC took SAB under receivership upon its closure by the Florida Office of Financial Regulation. FCB’s bid to the FDIC included the purchase of substantially all of SAB’s assets at a discount of $69,400 in exchange for assuming certain SAB deposits and certain other liabilities. The FDIC paid FCB $31,965 in additional cash consideration at closing. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, the FDIC will reimburse FCB for 80 percent of net losses incurred up to $99,000 and 95 percent of net losses exceeding $99,000.
The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On May 15, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $19.8 million, less (ii) the sum of (a) 25 percent of the asset discount, or $17.5 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Although no true-up payment is currently projected under the SAB loss share agreements, those projections are subject to change.
The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC, FCB recorded a receivable of $92,360 at the time of acquisition. During the second quarter of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and decreased the receivable by $2,626.
The acquisitions of First Regional and SAB were accounted for using the acquisition method of accounting. The statement of net assets acquired, adjustments to the acquisition date fair values made in the second quarter and the resulting bargain purchase gains are presented in the following tables. As indicated in the explanatory notes that accompany the following tables, the purchased assets, assumed liabilities and identifiable intangible assets were recorded at their respective acquisition date estimated fair values. Fair values are subject to refinement for up to one year after the closing date of each merger as additional information regarding closing date fair values becomes available. Adjustments to the estimated fair values made in the second quarter were based on additional information regarding the acquisition date fair values, which included updated appraisals on several commercial properties on acquired impaired loans and updated financial statements for some borrowers which allowed for adjustments to expected cash flows that more closely reflect the borrowers’ ability to repay the debt.
9
First quarter noninterest income included bargain purchase gains of $137,447 that resulted from the 2010 Acquisitions. The gains resulted from the difference between the estimated fair values of acquired assets and assumed liabilities. During the second quarter of 2010, adjustments were made to the gains based on additional information regarding the respective acquisition date fair values, which reduced the gains by a net of $5,026. These adjustments were made retroactive to the first quarter of 2010, the period the 2010 acquisitions were consummated, resulting in an adjusted gain of $132,421. FCB recorded a deferred tax liability for the gains totaling $51,856. To the extent there are additional adjustments to the respective acquisition date fair values up to one year following the respective acquisitions, there will be additional adjustments to the gains.
The following tables identify the assets acquired and liabilities assumed by FCB from First Regional and SAB. The tables provide the balances recorded by First Regional and SAB at the time of the respective FDIC-assisted transactions, the fair value adjustments recorded and the resulting adjusted fair values recorded by FCB for the acquisition date.
First Regional Bank
Acquisition date: January 29, 2010
Loans covered by loss share agreements
Other real estate owned covered by loss share agreements
Intangible assets
Total assets acquired
Total liabilities assumed
Excess of assets acquired over liabilities assumed
Aggregate fair value adjustments
Gain on acquisition of First Regional
10
Sun American Bank
Acquisition date: March 5, 2010
Cash received from the FDIC
Gain on acquisition of Sun American
Explanation of fair value adjustments
a - Adjustment reflects the fair value adjustments based on FCB’s evaluation of the acquired loan portfolio.
b - Adjustment reflects the estimated OREO losses based on FCB’s evaluation of the acquired OREO portfolio.
c - Adjustment reflects the estimated fair value of payments FCB will receive from the FDIC under the loss share agreements.
d - Adjustment reflects the estimated value of intangible assets, which includes core deposit intangibles and when applicable, trust customer relationships.
e - Adjustment reflects the amount needed to adjust the carrying value of other assets to estimated fair value.
f - Adjustment arises since the rates on short-term borrowings are higher than rates available on similar borrowings at date of acquisition.
g - Adjustment arises since the rates on long-term obligations are higher than rates available on similar borrowings at date of acquisition.
h - Adjustment reflects amount needed to adjust the carrying value of other liabilities to estimated fair value.
Results of operations for First Regional and SAB prior to their respective acquisition dates are not included in the income statement.
Due to the significant amount of fair value adjustments, the resulting accretion of those fair value adjustments and the protection resulting from the FDIC loss share agreements, historical results of First Regional and SAB are not relevant to BancShares’ results of operations. Therefore, no pro forma information is presented.
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Note C
Investments
The aggregate values of investment securities at June 30, 2010, December 31, 2009 and June 30, 2009, along with unrealized gains and losses determined on an individual security basis are as follows:
June 30, 2010
Residential mortgage-backed securities
Equity securities
Total investment securities available for sale
December 31, 2009
June 30, 2009
Total investment securities held to maturity
Investments in corporate bonds represent debt securities issued by various financial institutions under the Temporary Liquidity Guarantee Program. These debt obligations were issued with the full faith and credit of the United States of America. The guarantee for these securities is triggered when an issuer defaults on a scheduled payment.
12
The following table provides maturity information for investment securities as of the dates indicated. Callable securities are assumed to mature on their earliest call date.
Maturing in:
One year or less
One through five years
Five through 10 years
Over 10 years
The following table provides information regarding securities with unrealized losses as of June 30, 2010, December 31, 2009 and June 30, 2009:
Investment securities available for sale:
U.S. Government
Total
Investment securities held to maturity:
Corporate Bonds
13
Investment securities with an aggregate fair value of $1,619 have had continuous unrealized losses for more than twelve months as of June 30, 2010 with an aggregate unrealized loss of $51. These 21 investments include residential mortgage-backed and state, county and municipal securities. None of the unrealized losses identified as of June 30, 2010 related to the marketability of the securities or the issuer’s ability to honor redemption obligations. Consequently, the securities were not deemed to be other than temporarily impaired.
With respect to investment securities held to maturity, BancShares has the ability and intent to hold those securities until they mature.
For each period presented, securities gains (losses) include the following:
Gross gains on sales of investment securities available for sale
Gross losses on sales of investment securities available for sale
Other than temporary impairment loss on equity investments
Total securities gains (losses)
Investment securities having an aggregate carrying value of $1,694,084 at June 30, 2010, $2,121,783 at December 31, 2009 and $2,012,080 at June 30, 2009, were pledged as collateral to secure public funds on deposit, to secure certain short-term borrowings and for other purposes as required by law.
14
Note D
Loans and leases outstanding include the following as of the dates indicated:
Loans and leases not covered by loss share agreements
Real estate:
Construction and land development
Commercial mortgage
Residential mortgage
Revolving mortgage
Other mortgage
Total real estate loans
Commercial and industrial
Consumer
Lease financing
Total loans and leases not covered by loss share agreements
Total loans and leases
Total loans covered by loss share agreements
Impaired loans are loans that have evidence of deterioration in credit quality since origination, suggesting it is probable that all contractually required payments will not be collected. The following table provides information on all impaired loans, exclusive of those loans evaluated collectively as a homogeneous group.
Impaired loans:
Allowance for loan and lease losses related to:
Impaired loans covered by loss share agreements
Impaired loans and leases not covered by loss share agreements
Impaired loans with no allowance for loan and lease loss:
Interest previously accrued on acquired loans covered by loss share agreements with the FDIC (Covered Loans) placed on nonaccrual status is charged against interest income. Payments received are applied against the principal balance of the fully impaired loans until such time as full collection of the remaining recorded balance is expected. Additional interest payments received after that time are recorded as interest income on a cash basis.
15
When the fair values of Covered Loans were established, certain loans were identified as impaired. Due to uncertainty regarding the timing of future cash flows, no accretable yield is being recorded for loans deemed impaired at acquisition from TVB and VB, and these loans are being accounted for using the cost recovery method. Cash flow analyses were completed for loans deemed impaired at acquisition from First Regional and SAB and therefore the accretion method is being applied with respect to recognition of accretable yield on those loans.
The following table provides changes in the carrying value of acquired impaired loans during the six-month period ended June 30, 2010:
Balance, December 31, 2009
Fair value of acquired impaired loans covered by loss share agreements
Reductions for repayments, foreclosures and decreases in fair value
Balance, June 30, 2010
16
Information regarding the June 30, 2010 and December 31, 2009 carrying amount of acquired loans that were identified as impaired at acquisition follows:
Outstanding balance
Carrying amount
The cash flow analyses prepared for loans originated by First Regional and SAB are being used to determine the amount of accretable yield recognized on those loans identified as impaired at acquisition. Improvements in fair values subsequent to acquisition on several loans for TVB and VB resulted in the reclassification of nonaccretable yield to accretable yield.
Additions
Accretion
Reclassifications from (to) nonaccretable difference
Disposals
Note E
Allowance for Loan and Lease Losses
Activity in the allowance for loan and lease losses is summarized as follows:
Balance, January 1
Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests, effective January 1, 21010
Loans and leases charged-off:
Loans and leases recovered:
Net charge-offs
Balance, June 30
Allowance for loan and lease losses allocated to:
17
Note F
The following table provides changes in the receivable from the FDIC during the first six months of 2010:
Additional receivable from 2010 acquisitions
Accretion of premium and discount, net
Receipt of payments from FDIC
Post-acquisition adjustments
The receivable from the FDIC for loss share agreements is measured separately from the related covered assets and is recorded at fair value. The fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses and the applicable loss share percentages.
Post-acquisition adjustments represent the net change in loss estimates related to covered loans and other real estate owned as a result of changes in estimated fair values and the allowance for loan and lease losses related to covered loans. For loans covered by loss share agreements, subsequent decreases in the amount expected to be collected from the borrower result in a provision for loan and lease losses, an increase in the allowance for loan and lease losses, and a proportional adjustment to the receivable from the FDIC for the estimated amount to be reimbursed. Subsequent increases in the amount expected to be collected result in the reversal of any previously recorded provision for loan and lease losses and related allowance for loan and lease losses and adjustments to the receivable from the FDIC, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded. Adjustments related to acquisition date fair values, made within one year after the closing date of the respective acquisition, are reflected in the bargain purchase gain.
Note G
Estimated Fair Values
Fair value estimates are made at a specific point in time based on relevant market information and information about each financial instrument. Where information regarding the fair value of a financial instrument is publicly available, those values are used, as is the case with investment securities, residential mortgage loans and certain long-term obligations. In these cases, an open market exists in which those financial instruments are actively traded.
Because no market exists for many financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. For those financial instruments with a fixed interest rate, an analysis of the related cash flows was the basis for estimating fair values. The expected cash flows were then discounted to the valuation date using an appropriate discount rate. The discount rates used represent the rates under which similar transactions would be currently negotiated. For each period presented, the fair value for loans, net of allowance for loan and lease losses, included an adjustment to reflect the unfavorable liquidity conditions that existed in various financial markets. Generally, the fair value of variable rate financial instruments equals the book value.
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Loans covered by loss share agreements, net of allowance for loan and lease losses
Loans and leases not covered by loss share agreements, net of allowance for loan and lease losses
Stock issued by:
Federal Home Loan Bank of Atlanta
Federal Home Loan Bank of San Francisco
Federal Home Loan Bank of Seattle
Accrued interest payable
For off-balance sheet commitments and contingencies, carrying amounts are reasonable estimates of the fair values for such financial instruments. Carrying amounts include unamortized fee income and, in some cases, reserves for any credit losses from those financial instruments. These amounts are not material to BancShares’ financial position.
Fair value represents the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, BancShares considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. As required under US GAAP, individual fair value estimates are ranked based on the relative reliability of the inputs used in the valuation. Fair values determined using level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities that are not actively traded in observable markets are based on level 3 inputs, which are considered to be nonobservable.
Among BancShares’ assets and liabilities, investment securities available for sale and interest rate swaps accounted for as cash flow hedges are reported at their fair values on a recurring basis. Certain other assets are adjusted to their fair value on a nonrecurring basis, including loans held for sale, which are carried at the lower of cost or market. Impaired loans, OREO, goodwill and other intangible assets are periodically tested for impairment. Loans held for investment, deposits, short-term borrowings and long-term obligations are not reported at fair value. BancShares did not elect to voluntarily report any assets or liabilities at fair value.
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For assets and liabilities carried at fair value on a recurring basis, the following table provides fair value information as of June 30, 2010, December 31, 2009 and June 30, 2009:
Description
Assets measured at fair value
State, county, municipal
Liabilities measured at fair value
Interest rate swaps accounted for as cash flow hedges
Prices for US Government securities and corporate bonds are readily available in the active markets in which those securities are traded and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for mortgage-backed securities, state, county and municipal securities are obtained using the fair values of similar assets and the resulting fair values are shown in the ‘Level 2 input’ column. At December 31, 2009, the fair value for the retained residual interest from a securitization transaction was determined
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based on Level 3 nonobservable inputs. Based on changes to US GAAP related to accounting for QSPEs and controlling financial interests that became effective January 1, 2010, the previously securitized loans were consolidated and the residual interest strip was removed from the consolidated balance sheet. There were no transfers between Level 1 and Level 2 inputs during the six months ended June 30, 2010.
At June 30, 2010, other assets include $71,959 of stock in various Federal Home Loan Banks (FHLB). The FHLB stock, which is redeemable only through the issuer, is carried at its par value. The investment in the FHLB stock is considered a long-term investment and its value is based on the ultimate recoverability of par value. Management has concluded that the investment in FHLB stock was not other-than-temporarily impaired as of June 30, 2010.
Under the terms of the existing cash flow hedges, BancShares pays a fixed payment to the counterparty in exchange for receipt of a variable payment that is determined based on the 3-month LIBOR rate. The fair value of the cash flow hedges are therefore based on projected LIBOR rates for the duration of the hedges, values that, while observable in the market, are subject to adjustment due to pricing considerations for the specific instrument.
For those investment securities available for sale with fair values that are determined by reliance on significant nonobservable inputs, the following table identifies the factors causing the change in fair value during the first six months of 2010 and 2009:
Beginning balance, January 1,
Total gains (losses), realized or unrealized:
Included in earnings
Included in other comprehensive income
Purchases, sales, issuances and settlements, net
Transfers in/out of Level 3
Ending balance, June 30
No gains or losses were reported for the six month periods ended June 30, 2010 and 2009 that relate to fair values estimated based on significant nonobservable inputs. The investment securities valued using level 3 inputs that were transferred out during the first quarter of 2010 result from changes in US GAAP adopted January 1, 2010 related to investments in the retained interest of a residual interest strip that resulted from an asset securitization.
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Certain assets and liabilities are carried at fair value on a nonrecurring basis. Loans held for sale are carried at the lower of aggregate cost or fair value and are therefore carried at fair value only when fair value is less than the asset cost. Certain impaired loans are also carried at fair value. For assets and liabilities carried at fair value on a nonrecurring basis, the following table provides fair value information as of June 30, 2010, December 31, 2009 and June 30, 2009:
Covered by loss share
agreements
Not covered by loss share
The values of loans held for sale are based on prices observed for similar pools of loans. The values of impaired loans are determined by either the collateral value or by the discounted present value of the expected cash flows. No financial liabilities were carried at fair value on a nonrecurring basis as of June 30, 2010 or December 31, 2009.
Certain non-financial assets and non-financial liabilities are measured at fair value on a nonrecurring basis. OREO is measured and reported at fair value using Level 2 inputs for observable market data or Level 3 inputs for valuations based on nonobservable criteria. During the six month period ended June 30, 2010, foreclosures of other real estate not covered by loss share agreements totaled $16,217, all of which were valued using Level 3 inputs. In connection with the measurement and initial recognition of noncovered OREO, BancShares recognized loan charge-offs totaling $8,497. Based on updates to Level 3 inputs, noncovered OREO with a fair value of $6,006 as of June 30, 2010 incurred write-downs that totaled $1,160 during the six month period ended June 30, 2010.
Note H
Employee Benefit Plans
Pension expense is a component of employee benefits expense. For the three and six month periods ended June 30, 2010 and 2009, the components of pension expense are as follows:
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Service cost
Interest cost
Expected return on assets
Amortization of prior service cost
Amortization of net actuarial loss
Total pension expense
For the six month periods ended June 30, 2010 and 2009 the assumed discount rate is 6.00 percent, the expected long-term rate of return on plan assets is 8.00 percent and the assumed rate of salary increases is 4.50 percent.
Note I
Contingencies
BancShares and various subsidiaries have been named as defendants in various legal actions arising from their normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those other matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.
Note J
Derivatives
At June 30, 2010, BancShares had two interest rate swaps that qualify as cash flow hedges under US GAAP. The fair values of these derivatives are included in other liabilities in the consolidated balance sheets and in the net change in other liabilities in the consolidated statements of cash flows.
The interest rate swaps are used for interest rate risk management purposes and convert variable-rate exposure on outstanding debt to a fixed rate. The interest rate swaps each have a notional amount of $115,000, representing the amount of variable-rate trust preferred capital securities issued during 2006. The 2006 interest rate swap hedges interest payments through June 2011 and requires fixed-rate payments by BancShares at 7.125 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR, which is equal to the interest paid to the holders of the trust preferred capital securities. The 2009 interest rate swap hedge interest payments from July 2011 through June 2016 and requires fixed-rate payments by BancShares at 5.50 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR. As of June 30, 2010, collateral with a fair value of $10,366 was pledged to secure the existing obligation under the interest rate swaps. For both swaps, settlement occurs quarterly.
2006 interest rate swap hedging variable rate exposure on trust preferred capital securities 2006-2011
2009 interest rate swap hedging variable rate exposure on trust preferred capital securities 2011-2016
For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion, representing the excess of the cumulative change in the fair value of the derivative over the cumulative change in expected future discounted cash flows on the hedged transaction, is recorded in the consolidated income statement. BancShares’ interest rate swaps have been fully effective since inception. Therefore, changes in the fair value of the interest rate swaps have had no impact on net income. For the six month periods ended June 30, 2010 and 2009, BancShares recognized interest expense of $2,951 and $2,238, respectively, resulting from the interest rate swaps, none of which related to ineffectiveness.
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The following table discloses activity in accumulated other comprehensive income (loss) related to the interest rate swaps during the six month periods ended June 30, 2010 and 2009.
Accumulated other comprehensive loss resulting from interest rate swaps as of January 1, net of tax
Other comprehensive (loss) income recognized during six month period ended June 30, net of tax
Accumulated other comprehensive loss resulting from interest rate swaps as of June 30, net of tax
BancShares monitors the credit risk of the interest rate swap counterparty.
Note K
Segment Disclosures
BancShares conducts its banking operations through its two wholly-owned subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets, except California, Washington and Florida, and has separate management groups. Additionally, the financial results and trends of ISB reflect the de novo nature of its growth.
FCB operates from a single charter from its branch network in North Carolina, Virginia, West Virginia, Maryland, Tennessee, California, Washington, Florida and Washington, DC. FCB’s entrance into California, Washington and Florida during 2009 and 2010 resulted from participation in FDIC-assisted transactions. ISB began operations in 1997 and operates from a thrift charter in Florida, Georgia, Texas, New Mexico, Arizona, California, Oregon, Washington, Colorado, Oklahoma, Missouri and Kansas.
Management has determined that FCB and ISB are reportable business segments. In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. The ‘Other’ category in the accompanying table includes activities of the parent company and Neuse, Incorporated (Neuse), a subsidiary that owns real property used in the banking operation and owns other real estate. The other real estate owned (non-performing assets) by Neuse relates to loans originated by ISB. During 2009, Neuse purchased some of ISB’s OREO to reduce ISB’s nonperforming assets. To facilitate the potential purchase of additional OREO in the future, ISB has agreed to lend Neuse up to $15,000 under a revolving line of credit. No amount was owed by Neuse to ISB as of June 30, 2010 under the revolving line of credit.
The adjustments in the accompanying tables represent the elimination of the impact of certain intercompany transactions. The adjustments for interest income and interest expense neutralize the earnings and cost of intercompany borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of management fees and other service fees paid from one company to another within BancShares’ consolidated group.
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Allowance for loan and lease losses
Nonperforming assets:
Nonperforming assets
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Provision for credit losses
Net interest income after
provision for credit losses
Income (loss) before income taxes
Net income (loss)
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Net interest income after provision for credit losses
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Management’s discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2010, the reclassifications have no effect on shareholders’ equity or net income as previously reported. Unless otherwise noted, the terms we, us and BancShares refer to the consolidated financial position and consolidated results of operations for BancShares.
FDIC-ASSISTED TRANSACTIONS
First Regional Bank. On January 29, 2010, First-Citizens Bank & Trust Company (FCB) entered into an agreement with the FDIC to purchase substantially all the assets and assume the majority of the liabilities of First Regional Bank (First Regional) of Los Angeles, California. Immediately prior to the effectiveness of the transaction, the FDIC had been appointed Receiver of First Regional by the California Department of Financial Institutions.
Table 1 identifies the assets acquired and liabilities assumed, the fair value adjustments, the amounts recorded by FCB, and the calculation of the gain recognized.
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The loans and other real estate acquired through foreclosure are covered by loss share agreements that provide for the FDIC to absorb 80 percent of losses incurred on covered loans and other real estate in excess of $41.8 million. The 80 percent coverage ratio applies to losses up to $1.0 billion with losses in excess of $1.0 billion covered by the FDIC at a rate of 95 percent. FCB recorded a receivable from the FDIC equal to $389.6 million as an estimate of the fair value of the amount that will be reimbursed by the FDIC from the loss share agreements. The Purchase and Assumption Agreement between FCB and the FDIC includes a true-up payment at the end of year 10. On March 17, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $203.4 million, less (ii) the sum of (a) 25 percent of the asset discount, or $74.9 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements.
First quarter noninterest income included a bargain purchase gain of $110.3 million that resulted from the FDIC-assisted acquisition of First Regional. During the second quarter of 2010, adjustments were made to the initial gain based on additional information regarding the respective acquisition date fair values, which reduced the gain by $5.7 million. These adjustments were made retroactive to the first quarter of 2010 resulting in an adjusted gain of $104.6 million. Our operating results for the period ended June 30, 2010 include the results of the acquired assets and liabilities for the period from January 29, 2010 through June 30, 2010. Accretion and amortization of various purchase accounting discounts and premiums were recorded in the first and second quarters of 2010.
Sun American Bank. On March 5, 2010, FCB entered into an agreement with the FDIC to purchase substantially all the assets and assume the majority of the liabilities of Sun American Bank (SAB) of Boca Raton, Florida. Immediately prior to the effectiveness of the acquisition, the FDIC had been appointed Receiver of SAB by the Florida Office of Financial Regulation.
Table 2 identifies the assets acquired and liabilities assumed, the fair value adjustments, the amounts recorded by FCB, and the calculation of the gain recognized.
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The loans and other real estate acquired through foreclosure are covered by loss share agreements that provide for the FDIC to absorb 80 percent of all losses incurred on covered loans and other real estate up to $99.0 million. Losses in excess of $99.0 million are covered by the FDIC at a rate of 95 percent. FCB recorded a receivable from the FDIC equal to $92.4 million as an estimate of the fair value of the amount that will be reimbursed by the FDIC from the loss share agreements. The Purchase and Assumption Agreement between FCB and the FDIC includes a true-up payment at the end of year 10. On May 15, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $19.8 million, less (ii) the sum of (a) 25 percent of the asset discount, or $17.5 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements.
First quarter noninterest income included a bargain purchase gain of $27.1 million that resulted from the FDIC-assisted acquisition of SAB. During the second quarter of 2010, adjustments were made to the initial gain based on additional information regarding the respective acquisition date fair values, which increased the gain by $656,000. These adjustments were made retroactive to the first quarter of 2010 resulting in an adjusted gain of $27.8 million. Our operating results for the period ended June 30, 2010 include the results of the acquired assets and liabilities for the period from March 5, 2010 through June 30, 2010. Accretion and amortization of various purchase accounting discounts and premiums were recorded in the first and second quarters of 2010.
The 2010 transactions involving First Regional and SAB represented the third and fourth transactions involving BancShares since July 17, 2009. Table 3 provides information regarding the four entities from which we have acquired assets and assumed liabilities in FDIC-assisted transactions during 2010 and 2009. Adjustments to acquisition date fair values are subject to change for one year following the closing date of each respective acquisition.
Table 3
Entity
Venture Bank
Temecula Valley Bank
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EXECUTIVE OVERVIEW AND PERFORMANCE SUMMARY
BancShares is a financial holding company headquartered in Raleigh, North Carolina that offers full-service banking through two wholly-owned banking subsidiaries, First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in eight states and the District of Columbia. ISB operates branches in urban areas of twelve states. Beyond the traditional branch network, we offer customer sales and service through telephone, online banking and an extensive ATM network.
BancShares’ earnings and cash flows are primarily derived from the commercial banking activities conducted by its banking subsidiaries. We offer commercial and consumer loans, deposit and treasury services products, cardholder and merchant services, wealth management services as well as various other products and services typically offered by commercial banks. FCB and ISB gather deposits from retail and commercial customers. BancShares and its subsidiaries also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in interest-earning assets such as loans and leases, investment securities and overnight investments. We also invest in the bank premises, furniture and equipment used to conduct the subsidiaries’ commercial banking business.
Various external factors influence the focus of our business efforts. Due to unprecedented asset quality challenges, capital shortages and the onset of a global economic recession, the U.S. banking industry experienced serious financial challenges during the period from 2008 through mid-2010. During this time of industry-wide turmoil, while maintaining our long-standing attention to prudent banking practices, we have modified our growth focus to benefit from the opportunities that currently exist through participation in FDIC-assisted transactions involving distressed financial institutions. BancShares’ ability to participate in FDIC-assisted transactions creates opportunities to significantly increase our business volumes in markets in which we presently operate and to expand our banking presence to additional markets which we deem demographically attractive. Additionally, due to purchase discounts and loss share agreements that protect us from a substantial portion of the asset quality risk that we would otherwise incur, we are able to create a substantial portion of the equity required to fund the transactions through significant acquisition gains.
Despite the recognition of significant acquisition gains during 2010 and 2009, recessionary economic conditions, high rates of unemployment, and a growing inability for some businesses and consumers to meet their debt service obligations continue to exert pressure on our core earnings and profitability.
In addition, real estate demand in many of our markets remains weak, resulting in continued depressed real estate prices that have adversely affected collateral values for many borrowers. In particular, the stressed residential real estate markets in Georgia and Florida had a material negative impact on the profitability of ISB during 2009. The financial impact of depressed real estate markets continues to affect earnings during 2010 at a more modest rate.
The demand for our deposit and treasury services products has been influenced by extraordinarily low interest rates and instability in alternative investment markets. Our balance sheet liquidity position remains strong, but our continuing participation in FDIC-assisted transactions creates pressure on liquidity management due to the uncertainty regarding retention of assumed deposit liabilities at a reasonable cost.
Ongoing economic weakness continues to have a significant impact on virtually all financial institutions in the United States, including BancShares. In addition to the various actions previously enacted by governmental agencies and the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, it is likely that further changes will occur as the Federal government attempts to restore stability to the financial services sector.
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We operate in diverse geographic markets and can increase our business volumes and profitability by offering competitive products and superior customer service. In addition to our focus on retaining customers of the four banks involved in the FDIC-assisted transactions, we continue to concentrate our marketing efforts on business owners, medical and other professionals and financially active individuals. We seek to increase fee income in areas such as wealth management, cardholder and merchant services, and insurance and treasury services. Leveraging on our investments in technology, we also focus on opportunities to generate income by providing various processing services to other banks.
BancShares’ consolidated net income during the second quarter of 2010 equaled $28.6 million, an increase of $22.4 million over the $6.2 million earned during the corresponding period of 2009. The annualized return on average assets and equity amounted to 0.54 percent and 6.83 percent respectively during the second quarter of 2010, compared to 0.14 and 1.73 percent during the same period of 2009. Net income per share during the second quarter of 2010 totaled $2.74, compared to $0.59 during the second quarter of 2009. The increase in net income during 2010 resulted from higher net interest income and noninterest income offset in part by increased provision for loan and lease losses and noninterest expenses.
For the six-month period ending June 30, 2010, net income equaled $133.2 million compared to $14.9 million earned during the same period of 2009. Return on assets and equity during 2010 equaled 1.31 percent and 16.46 percent respectively, up from 0.18 percent and 2.09 percent during the six-month period ended June 30, 2009. Net income per share equaled $12.76 during the first six months of 2010 compared to $1.42 in the first six months of 2009. The increase in net income during 2010 was attributable primarily to gains arising from FDIC-assisted transactions completed during the first quarter of 2010.
Net interest income increased $47.8 million from $117.0 million in the second quarter of 2009 to $164.9 million in 2010, an increase of 40.9 percent resulting from balance sheet growth caused primarily by acquisitions and a significant improvement in the net yield on interest-earning assets. The net yield on interest-earning assets improved by 52 basis points from 3.02 in the second quarter 2009 to 3.54 percent in 2010 due to favorable changes in deposit costs and the positive impact of yields and rates on acquired loans and assumed deposits. Year-to-date net interest income increased $83.1 million, or 35.7 percent during 2010. The net yield on interest-earning assets increased 47 basis points to 3.54 percent during the six-month period ended June 30, 2010.
The provision for loan and lease losses recorded during the second quarter of 2010 equaled $31.8 million, compared to $20.8 million during the second quarter of 2009. During the first six months of 2010, the provision for loan and lease losses equaled $48.8 million, an increase of $9.3 million or 23.5 percent from the same period of 2009. The current year increase was caused primarily by post-acquisition deterioration of acquired loans from TVB and VB covered by loss share agreements with the FDIC.
Noninterest income increased $21.2 million or 29.7 percent in the second quarter of 2010 and $160.1 million or 113.4 percent in the first six months of 2010 when compared to the same period of 2009. The significant increase during the six-month period ended June 30, 2010 is primarily due to gains on acquisitions totaling $132.6 million. Noninterest expense increased $22.7 million or 14.2 percent in the second quarter of 2010 and $41.1 million or 13.1 percent in the first six months of 2010 when compared to the same period in 2009. The increase in noninterest expense is due to acquisition related activities, including operating costs for acquired branches and expenses related to the operation and disposition of other real estate.
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Summary of Operations
Gains on acquisitions
Other noninterest income
Net interest income, taxable equivalent
Per Share Data
Cash dividends
Market price at period end (Class A)
Book value at period end
Tangible book value at period end
Selected Quarterly Averages
Investment securities
Loans and leases (covered and not covered)
Interest-earning assets
Interest-bearing liabilities
Shareholders’ equity
Shares outstanding
Selected Quarter-End Balances
Selected Ratios and Other Data
Rate of return on average assets (annualized)
Rate of return on average shareholders’ equity
(annualized)
Net yield on interest-earning assets (taxable equivalent)
Allowance for loan and lease losses to noncovered loans and leases at period end
Nonperforming assets to total loans and leases plus other real estate at period end:
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Leverage capital ratio
Dividend payout ratio
Average loans and leases to average deposits
Average loans and leases includes nonaccrual loans and loans held for sale.
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INTEREST-EARNING ASSETS
Interest-earning assets include loans and leases, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and repricing characteristics of the underlying asset. Riskier investments typically carry a higher interest rate, but expose us to potentially increased levels of default.
We have historically focused on maintaining high asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. That focus on asset quality also influences the composition of our investment securities portfolio. At June 30, 2010, United States Treasury and government agency securities represent 81.9 percent of our investment securities portfolio; corporate bonds issued under the FDIC’s Treasury Liquidity Guaranty Program represent 13.0 percent; and residential mortgage-backed securities represent 4.7 percent of the total portfolio. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.
During 2010, changes in our interest-earning assets primarily reflect the impact of assets acquired in the FDIC-assisted transactions. The investment securities portfolio changes are primarily based on trends among loans and leases, deposits and short-term borrowings. When inflows arising from deposit and treasury services products exceed loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan demand exceeds growth in deposits and short-term borrowings, we allow overnight investments to decline and use proceeds from maturing securities to fund loan demand.
During the second quarter of 2010, interest-earning assets averaged $18.78 billion, an increase of $2.46 billion or 15.1 percent since December 31, 2009 and $3.1 billion or 19.4 percent from the second quarter of 2009. This increase results from assets acquired in the FDIC-assisted transactions and deposit growth in excess of loan and lease demand.
Loans and leases. At June 30, 2010, December 31, 2009 and June 30, 2009, loans and leases totaled $13.99 billion, $12.82 billion and $11.52 billion, respectively. Loans covered by loss share agreements with the FDIC totaled $2.37 billion at June 30, 2010 compared to $1.17 billion at December 31, 2009. There were no covered loans outstanding at June 30, 2009. Loans not covered by loss share agreements equaled $11.62 billion at June 30, 2010, a slight decrease from December 31, 2009 and an increase of $99.4 million or 0.9 percent over June 30, 2009.
Commercial real estate loans not covered by loss share agreements totaled $4.63 billion at June 30, 2010, 39.8 percent of noncovered loans and leases. This balance represents an increase of $73.3 million or 1.6 percent since December 31, 2009 and $228.1 million or 5.2 percent since June 30, 2009. Demand for loans secured by owner-occupied medical and professional facilities remained reasonably strong through December 31, 2009, but weakened during the first half of 2010. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.
At June 30, 2010, revolving mortgage loans not covered by loss share agreements totaled $2.19 billion, representing 18.8 percent of total noncovered loans outstanding, an increase of $40.8 million or 1.9 percent since December 31, 2009 and $135.1 million or 6.6 percent compared to June 30, 2009. The 2010 increase results from changes to accounting for QSPEs and controlling financial interests that became effective on January 1, 2010. As a result of the accounting change, $97.3 million of revolving mortgage loans that were previously securitized, sold and removed from the consolidated balance sheet were returned to the balance sheet in the first quarter of 2010 upon adoption of the new accounting guidance.
Commercial and industrial loans not covered by loss share agreements equaled $1.80 billion or 15.5 percent of total noncovered loans and leases. These loans decreased $31.2 million or 1.7 percent since December 31, 2009 and $57.4 million or 3.1 percent since June 30, 2009 due to a decline in customer demand driven by recessionary economic conditions.
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(thousands)
Loans and leases not covered by loss share agreements:
Loans covered by loss share agreements:
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Construction and land development loans not covered by loss share agreements totaled $627.9 million or 5.4 percent of total loans at June 30, 2010, an increase of $5.5 million or 0.9 percent since December 31, 2009 and a decrease of $50.0 million or 7.4 percent since June 30, 2009. Of the $627.9 million of noncovered construction loans outstanding as of June 30, 2010, $59.0 million was in the Atlanta, Georgia and southwest Florida markets. Both of these market areas experienced significant reductions in real estate values during the continuing recession. The majority of the remaining $568.9 million of noncovered construction and land development loans are in North Carolina and Virginia where real estate values have declined more modestly.
Consumer loans not covered by loss share agreements totaled $815.0 million at June 30, 2010, down $127.0 million or 13.5 percent since December 31, 2009 and $255.3 million or 23.9 percent from June 30, 2009. This decline results from our decision during 2008 to discontinue originations of sales finance loans through our dealer network and the general decline in consumer borrowing in 2009 and early 2010 due to recessionary economic conditions.
Among loans covered by loss share agreements, commercial real estate loans totaled $1.07 billion at June 30, 2010, representing 45.1 percent of the total covered portfolio compared to $590.4 million or 50.3 percent of total covered loans as of December 31, 2009. Construction and land development loans totaled $733.3 million, or 31.0 percent of total covered loans at June 30, 2010, an increase of $427.3 million from the December 31, 2009 total of $306.0 million, which represented 26.1 percent of the total covered loans. Commercial and industrial loans totaled $220.9 million or 9.3 percent of total covered loans at June 30, 2010, an increase of $125.7 million from the December 31, 2009 total of $95.2 million, which represented 8.1 percent of total covered loans. Residential mortgage loans covered by the FDIC totaled $74.0 million or 3.1 percent of the covered portfolio as of June 30, 2010 compared to $152.3 million or 13.0 percent of total covered loans at December 31, 2009.
We expect non-acquisition loan growth for 2010 to be extremely limited due to the generally weak demand for loans and widespread customer desire to deleverage. Loan projections are subject to change due to further economic deterioration or improvement and other external factors.
Investment securities. Investment securities available for sale equaled $3.77 billion at June 30, 2010, compared to $2.93 billion at December 31, 2009 and $3.75 billion at June 30, 2009. Available for sale securities are reported at their aggregate fair value, and unrealized gains and losses are included as a component of other comprehensive income, net of deferred taxes. Investment securities held to maturity totaled $3.1 million at June 30, 2010, compared to $3.6 million at December 31, 2009 and $4.1 million at June 30, 2009.
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U. S. Government:
Within one year
One to five years
Over ten years
Five to ten years
State, county and municipal:
Corporate bonds (2)
Total investment securities
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Income on interest-earning assets. Interest income amounted to $217.4 million during the second quarter of 2010, a $40.6 million or 23.0 percent increase from the second quarter of 2009. During the second quarter of 2010, the improvement in interest income was the result of higher average balances and a slightly improved yield. Average interest-earning assets increased $3.10 billion or 19.4 percent from $15.73 billion to $18.78 billion. The taxable-equivalent yield on interest-earning assets equaled 4.66 percent for the second quarter of 2010, compared to 4.59 percent for the corresponding period of 2009 as reflected in Table 7.
For the first six months of 2010, interest income equaled $418.1 million, a $61.6 million or 17.3 percent increase from the first six months of 2009 also caused by higher average balances and yield. Average interest-earning assets for the first six months of 2010 increased $2.55 billion or 16.4 percent from 15.55 billion to $18.10 billion. The taxable-equivalent yield on interest-earning assets equaled 4.68 percent for the first six months of 2010, compared to 4.65 percent for the corresponding period of 2009 as reflected in Table 8.
Loan and lease interest income for the second quarter of 2010 equaled $202.5 million, an increase of $47.1 million from the second quarter of 2009, the combined result of higher average volume and higher yields. Average loans and leases increased $2.54 billion or 21.8 percent from the first quarter of 2009 to the first quarter of 2010. The taxable-equivalent yield was 5.74 percent during the second quarter of 2010, a 29 basis point increase from the same period of 2009. The increased yield resulted primarily from the favorable impact of acquired loans.
Loan and lease interest income for the first six months of 2010 equaled $389.6 million, an increase of $77.6 million from the first six months of 2009 due to improved average balances and yield. Average loans and leases increased $2.31 billion or 19.9 percent from the first six months of 2009 to the first six months of 2010. The taxable-equivalent yield was 5.65 percent during the first six months of 2010, a 23 basis point increase from the same period of 2009.
Interest income earned on the investment securities portfolio amounted to $14.3 million during the second quarter of 2010 and $21.2 million during the same period of 2009, a decrease of $6.9 million or 32.3 percent. This decrease in income is the result of substantially lower yields. The taxable-equivalent yield decreased 92 basis points from 2.46 percent in the second quarter of 2009 to 1.54 percent in the second quarter of 2010. This reduction in yields was caused by extraordinarily low market interest rates. We anticipate the yield on investment securities will remain depressed until the Federal Reserve begins to raise the benchmark fed funds rates, an action that would likely lead to higher asset yields.
Interest income earned on the investment securities portfolio during the first six months of 2010 amounted to $27.5 million, compared to $44.0 million during the same period of 2009, a decrease of $16.5 million or 37.6 percent. The taxable-equivalent yield decreased 101 basis points from 2.69 percent in the first six months of 2009 to 1.68 percent during the same period of 2010.
INTEREST-BEARING LIABILITIES
Interest-bearing liabilities include interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits represent our primary funding source, although we also utilize non-deposit borrowings to stabilize our liquidity base and to fulfill commercial customer demand for treasury services. Certain of our long-term borrowings currently qualify as capital under guidelines established by the Federal Reserve and other banking regulators. The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions that cause our $265 million of trust preferred capital securities to fully cease qualification as Tier I capital effective January 1, 2015.
Deposits. At June 30, 2010, total deposits equaled $17.79 billion, an increase of $2.45 billion or 16.0 percent since December 31, 2009 and $3.43 billion or 23.9 percent over June 30, 2009 primarily due to the assumption of deposit liabilities resulting from the FDIC-assisted transactions and healthy organic growth. Average interest-bearing deposits were $14.12 billion during the second quarter of 2010, an increase of $2.10 billion or 17.4 percent from the fourth quarter of 2009 and $2.64 billion or 23.0 percent from the second quarter of 2009. Average money market accounts increased $679.2 million from the fourth quarter of 2009 and $980.2 million or 25.7 percent from the second quarter of 2009, due to acquisitions and customers holding available liquidity in flexible deposit accounts. During the second quarter of 2010, time deposits averaged $6.88 billion, up $1.27 billion or 22.7 percent from December 31, 2009 and $1.31 billion or 23.6 percent from the second quarter of 2009.
Due to the ongoing industry-wide liquidity challenges and our historic focus on maintaining a liquid balance sheet, we continue to focus on deposit attraction and retention as a key business objective. We endeavor to retain a significant portion of core demand and money market account balances and reasonably priced time deposits assumed in the FDIC-assisted transactions. Ultimately, our ability to satisfy customer loan demand could be constrained unless we are able to continue to generate new deposits at a reasonable cost.
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Short-term borrowings At June 30, 2010, short-term borrowings totaled $541.7 million compared to $642.4 million at December 31, 2009 and $599.9 million at June 30, 2009. For the quarters ended June 30, 2010, December 31, 2009 and June 30, 2009, short-term borrowings averaged $561.7 million, $651.8 million and $631.4 million, respectively. The $69.6 million or 11.0 percent reduction in average short-term borrowings since June 30, 2009 resulted from reductions in overnight investments from treasury management services caused in turn by extraordinarily low market interest rates.
Long-term obligations. Long-term obligations equaled $918.9 million at June 30, 2010, up $121.6 million from December 31, 2009 and $183.1 million from June 30, 2009, resulting from the assumption of Federal Home Loan Bank (FHLB) obligations in the FDIC-assisted transactions.
Expense on interest-bearing liabilities. Interest expense amounted to $52.6 million during the second quarter of 2010, a $7.2 million or 12.1 percent decrease from the second quarter of 2009. The decreased level of interest expense was the net result of lower rates and higher average volume. The rate on average interest-bearing liabilities equaled 1.35 percent during the second quarter of 2010, a 52 basis point decrease from the second quarter of 2009. Average interest-bearing liabilities increased $2.99 billion or 23.8 percent from second quarter of 2009 to the second quarter of 2010 due to the four FDIC-assisted transactions since July 2009 and strong organic growth in legacy markets.
During the first six months of 2010, interest expense equaled $102.2 million, compared to $123.7 million during the first six months of 2009, a 17.3 percent decrease. The rate of average interest-bearing liabilities equaled 1.36 percent during the first six months of 2010, a 60 basis point decrease from the first six months of 2009. Average interest-bearing liabilities increased $2.38 billion or 18.7 percent from the first six months of 2009 to the first six months of 2010.
NET INTEREST INCOME
Net interest income totaled $164.9 million during the second quarter of 2010, an increase of $47.8 million or 40.9 percent from the second quarter of 2009. The taxable-equivalent net yield on interest-earning assets equaled 3.54 percent for the second quarter of 2010, up 52 basis points from the 3.02 percent recorded for the second quarter of 2009 due to favorable changes in deposit costs and the positive impact of yields and rates on acquired loans and assumed deposits.
During the first six months of 2010, net interest income totaled $315.9 million, an increase of $83.1 million or 35.7 percent from the first six months of 2010. The taxable-equivalent net yield on interest-earning assets equaled 3.54 percent for the first six months of 2010, up 49 basis points from the 3.05 percent recorded for the first six months of 2009.
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Total interest-earning assets
Interest-bearing deposits:
Checking With Interest
Savings
Money market accounts
Time deposits
Total interest-bearing deposits
Total interest-bearing liabilities
Interest rate spread
Net interest income and net yield on interest-earning assets
Loans and leases include loans covered by loss share agreements, loans not covered by loss share agreements, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent and state income tax rates of 6.9 percent for each period. The taxable-equivalent adjustment was $1,075 and $1,318 for 2010 and 2009, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.
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Loans and leases include loans covered by loss share agreements, loans not covered by loss share agreements, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent and state income tax rates of 6.9 percent for each period. The taxable-equivalent adjustment was $2,115 and $2,738 for 2010 and 2009, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.
NONINTEREST INCOME
Growth of noninterest income is essential to our ability to sustain adequate profitability levels. Traditionally, the primary sources of noninterest income are cardholder and merchant services income, service charges on deposit accounts, revenues derived from wealth management services and fees from processing services.
Noninterest income equaled $92.6 million during the second quarter of 2010, an increase of $21.2 million or 29.7 percent during the same period of 2009. Included in noninterest income during the second quarter of 2010 is $12.7 million of favorable adjustments to the receivable from the FDIC for the recoverable portion of unfavorable changes to the estimated fair values of purchased assets. In addition, wealth management services income, deposit service charges and cardholder and merchant service fees were all higher. Offsetting these increases, mortgage income, ATM income and insurance commissions declined.
During the first six months of 2010, noninterest income amounted to $301.2 million, compared to $141.1 million during the same period of 2009. Of the $160.1 million increase in noninterest income, $132.6 million resulted from 2010 gains recognized in conjunction with the FDIC-assisted transactions and $15.5 million from favorable post-acquisition adjustments to the receivable from the FDIC. Excluding the acquisition gains and post-acquisition adjustments, noninterest income increased $12.0 million or 8.5 percent.
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Cardholder and merchant services generated $28.5 million of revenue during the second quarter of 2010, an increase of $4.4 million or 18.2 percent compared to the second quarter of 2009. During the first six months of 2010, cardholder and merchant services generated $52.3 million of revenue, compared to $45.6 million during the same period of 2009. This $6.7 million or 14.7 percent increase resulted from growth in merchant discount and interchange income from credit cards and Visa check cards. Transaction volume continued to grow both within our legacy franchise and as a result of acquisitions.
Service charges on deposit accounts equaled $19.5 million and $19.2 million for the second quarter of 2010 and 2009, respectively. The $350,000 or 1.8 percent increase was caused by slightly higher levels of bad check charges. During the first six months of 2010, service charges on deposit accounts increased $1.3 million or 3.6 percent to $38.3 million. Service charge income includes fees derived from an overdraft protection program that, based on legislative changes that will become effective during the third quarter of 2010, is likely to produce significantly lower revenues. BancShares has begun an initiative to educate its’ customers on the changes to overdraft protection regulations and how these changes impact their existing services. The impact to service charge revenue will depend on the customers’ decision to participate in these services subsequent to the regulatory changes.
Fees from wealth management services amounted to $14.2 million during the second quarter of 2010 and $26.0 million year-to-date compared to $11.5 million and $22.3 million, respectively during the same period of 2009. The $3.7 million or 16.6 percent increase year-to-date was due to higher trust, brokerage and asset management revenues.
Mortgage income decreased from $2.4 million in the second quarter of 2009 to $1.9 million in the second quarter of 2010 and $2.5 million during the first six months of 2010, compared to the same period of 2009. This decrease was the result of lower service released premiums and loan origination fees due principally to reduced refinance activity.
NONINTEREST EXPENSE
The primary components of noninterest expense are salaries and related employee benefits, occupancy costs for branch offices and support facilities, and equipment and software costs related to branch offices and technology. Noninterest expense equaled $354.7 million for the first six months of 2010, a $41.1 million or 13.1 percent increase over the $313.6 million recorded during the same period of 2009. Expenses attributable to the FDIC-assisted acquisitions including branch offices, support staff within the acquired markets and various foreclosure-related costs amounted to $40.4 million.
Salaries and wages increased $10.7 million or 16.8 percent during the second quarter of 2010 and $17.3 million or 13.4 percent during the first six months of 2010 when compared to the same period of 2009. The increase principally resulted from headcount growth resulting from the FDIC-assisted transactions. Employee benefits expense totaled $18.5 million for the second quarter of 2010 and $34.2 million for the first six months of 2010. The 3.2 percent increase year-to-date is the net impact of reduced executive retirement expenses offset by higher thrift and pension costs.
Occupancy expense totaled $18.5 million in the second quarter of 2010, up $2.5 million or 15.9 percent from 2009. Year-to-date occupancy expense increased $5.0 million or 15.9 percent. Acquisitions accounted for $4.3 million of the year-to-date increase. Higher rent expense and depreciation on bank buildings were the primary causes of the larger expense.
Equipment expense increased $2.9 million or 10.0 percent year-to-date for 2010 caused primarily by higher software-related costs.
FDIC deposit insurance decreased $7.2 million in the second quarter of 2010 and $6.5 million year-to-date when compared to the same periods of 2009. A special FDIC deposit insurance assessment of $7.8 million was expensed in the second quarter of 2009.
Foreclosure-related expenses increased $2.2 million during the second quarter of 2010 and $4.7 million year-to-date when compared to the same periods of 2009. The FDIC-assisted transactions have given rise to $5.8 million of costs in 2010, the majority of which is reimbursable under the FDIC loss share agreements. No costs were incurred on covered OREO in the comparable period of 2009.
Other expenses increased $12.4 million or 37.2 percent during the second quarter of 2010 and $16.6 million or 24.0 percent year-to-date when compared to the same periods of 2009. $7.3 million of the increase is due to collection costs for acquired covered loans and amortization expense from purchase accounting adjustments and core deposit intangibles arising from the FDIC-assisted transactions. Costs related to our customer loyalty programs increased $2.1 million, primarily due to higher costs related to a new debit card program, partially offset by a nonrecurring adjustment to the assumed redemption rate related to a mature credit card program. Fees from processing services grew $1.2 million year-to-date, much of which relates to existing data processing arrangements related to the FDIC-assisted transactions.
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INCOME TAXES
We monitor and evaluate the potential impact of current events on the estimates used to establish income tax expenses and income tax liabilities. On a periodic basis, we evaluate our income tax positions based on current tax law, positions taken by various tax auditors within the jurisdictions that BancShares is required to file income tax returns as well as potential or pending audits or assessments by such tax auditors.
Income tax expense amounted to $80.5 million during the six months ended June 30, 2010, compared to $6.0 million during the same period of 2009. The $74.5 million increase in income tax expense was the direct result of significantly higher pre-tax earnings. The effective tax rates for these periods equaled 37.6 percent and 28.7 percent, respectively. The higher effective tax rate for 2010 reflects the diluted impact of various favorable permanent differences on the current year’s pre-tax income.
SHAREHOLDERS’ EQUITY AND CAPITAL ADEQUACY
We continually monitor the capital levels and ratios for BancShares and the subsidiary banks to ensure that they comfortably exceed the minimum requirements imposed by their respective regulatory authorities and to ensure that the subsidiary banks’ capital is appropriate given each bank’s growth projection and risk profile. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material effect on the financial statements. Table 9 provides information on capital adequacy for BancShares as of June 30, 2010 and 2009.
BancShares continues to exceed minimum capital standards and the banking subsidiaries remain well-capitalized. Due to the adequacy of our capital levels, we did not apply for TARP funding under the TARP Capital Purchase Program.
The sustained growth and operating losses of ISB has required BancShares to infuse significant amounts of capital into ISB to support its expanding balance sheet. Since ISB was formed in 1997, BancShares has provided $402.8 million in capital. BancShares’ prospective capacity to provide capital to support the growth of ISB is highly dependent upon FCB’s ability to return capital through dividends to BancShares. Dividends from FCB to BancShares provide the sole source for capital infusions into ISB. These dividends also fund BancShares’ payment of shareholder dividends and interest payments on a portion of its long-term obligations.
Previously, BancShares’ and FCB’s Tier 2 capital included qualifying subordinated debt issued in the amount of $125.0 million with a scheduled maturity date of June 1, 2015. Beginning in the second quarter of 2010, the amount of this qualifying subordinated debt that is eligible Tier 2 capital decreased $25.0 million since the scheduled maturity date is within 5 years. The amount eligible for Tier 2 capital will decrease by 20 percent of the issued amount each year until the scheduled maturity date. Tier 2 capital is part of total risk-based capital, reflected in Table 9.
In addition, the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act contain provisions that will discontinue our ability to include $265 million of trust preferred capital securities in Tier I risk-based capital effective January 1, 2015. BancShares’ qualified trust preferred capital securities will be phased out in equal increments of $88.3 million over a three year term, beginning in 2013. Based on BancShares’ Tier 1 risk-based capital as of June 30, 2010, the impact of the reduction of $88.3 million would result in a decrease in the Tier 1 risk-based capital ratio of 67 basis points. The elimination of the full $265 million of trust preferred capital securities from June 30, 2010 Tier 1 risk-based capital would result in a Tier 1 risk-based capital ratio of 12.25 percent, a decrease of 201 basis points. Although this is a significant decrease in the Tier 1 risk-based capital ratio, BancShares would continue to remain well-capitalized.
The elimination of $265 million of trust preferred capital securities will also have an impact on the Tier 1 leverage capital ratio. Considering the impact of the elimination of the full $265 million of trust preferred capital securities on a pro forma basis, BancShares’ Tier 1 leverage capital ratio as of June 30, 2010 would decrease by 126 basis points to 7.64 percent. With the requirement to remain well-capitalized at 5.00 percent, the impact of the newly enacted Dodd-Frank Wall Street Reform and Consumer Protection Act has a more significant impact on our Tier 1 leverage capital ratio than on our Tier 1 risk-based capital ratio.
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Tier 1 risk-based capital
Total risk-based capital
Tier 1 leverage capital
RISK MANAGEMENT
In the normal course of business, BancShares is exposed to various risks. To manage the major risks that are inherent in the operation of a financial holding company and to provide reasonable assurance that our long-term business objectives will be attained, various policies and risk management processes identify, monitor and manage risk within acceptable tolerances. Management continually refines and enhances its risk management policies and procedures to maintain effective risk management programs and processes.
The most prominent risk exposures are credit, interest rate and liquidity risk. Credit risk is the risk of not collecting the amount of a loan or investment when it is contractually due. Interest rate risk is the potential reduction of net interest income as a result of changes in market interest rates. Liquidity risk is the possible inability to fund obligations to depositors, creditors, investors or borrowers.
Credit risk. BancShares manages and monitors extensions of credit and the quality of the loan and lease portfolio through rigorous initial underwriting processes and periodic ongoing reviews. With respect to loans originated by us, underwriting standards reflect credit policies applied by our highly centralized credit decision process. Acquired loans are evaluated at the time of acquisition and are recorded at fair value.
We maintain an independent credit review function that conducts risk reviews and analyses for the purpose of ensuring compliance with credit policies and to monitor asset quality trends. The risk reviews include portfolio analysis by geographic location and horizontal reviews across industry sectors within the banking subsidiaries. We strive to identify potential credit problems as early as possible, to take charge-offs or write-downs as appropriate and to maintain adequate allowances for credit losses that are inherent in the loan and lease portfolio. The maintenance of excellent asset quality is one of our key performance measures.
We maintain a well-diversified loan and lease portfolio and seek to avoid the risk associated with large concentrations within specific geographic areas or industries. Despite our focus on diversification, several characteristics of our loan and lease portfolio subject us to notable risk. These include our concentration of real estate loans, medical-related loans, and the existence of high loan-to-value loans.
We have historically carried a significant concentration of real estate secured loans, although our underwriting policies principally rely on adequate borrower cash flow rather than underlying collateral values. When we do rely on underlying real property values, we favor financing secured by owner-occupied real property and as a result a large percentage of our real estate secured loans are owner-occupied. At June 30, 2010, loans secured by real estate not covered by loss share agreements totaled $8.52 billion or 73.3 percent of total noncovered loans and leases compared to $8.34 billion or 71.7 percent of noncovered loans and leases at December 31, 2009 and $8.14 billion or 70.7 percent at June 30, 2009.
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In recent years, we have sought opportunities to provide financial services to businesses associated with and professionals within the medical community. Due to strong loan growth among customers within this industry, our loans and leases to borrowers in medical, dental or related fields totaled $2.98 billion as of June 30, 2010, which represents 25.7 percent of loans and leases not covered by loss share agreements, compared to $2.93 billion or 25.1 percent of noncovered loans and leases at December 31, 2009 and $2.80 billion or 24.3 percent of noncovered loans and leases at June 30, 2009. No other industry represented more than 10 percent of total loans and leases outstanding at June 30, 2010.
Nonperforming assets include nonaccrual loans and leases, other real estate owned (OREO) and restructured loans that are both covered and not covered by FDIC loss share agreements. At June 30, 2010, BancShares’ nonperforming assets amounted to $519.2 million or 3.67 percent of total loans and leases plus OREO, compared to $374.3 million or 2.89 percent at December 31, 2009 and $102.4 million or 0.89 percent at June 30, 2009. The $144.9 million and $416.8 million surge in nonperforming assets since December 31, 2009 and June 30, 2009, respectively was primarily due to the high levels of nonperforming assets resulting from the FDIC-assisted transactions during 2010 and 2009. Of the $519.2 million in nonperforming assets at June 30, 2010, $362.6 million is covered by FDIC loss share agreements that provide significant loss protection to FCB. The nonperforming assets covered by loss share agreements represent 14.7 percent of total covered assets, compared to 17.4 percent at December 31, 2009, the decrease resulting from the First Regional and SAB transactions and continuing asset resolution efforts related to assets acquired during the FDIC-assisted transactions during 2010 and 2009.
Nonperforming assets not covered by loss share agreements amounted to $156.6 million as of June 30, 2010, or 1.34 percent of noncovered loans and leases plus OREO compared to $154.0 million or 1.32 percent at December 31, 2009 and $102.4 million or 0.89 percent at June 30, 2009. The $54.2 million increase in noncovered nonperforming assets since June 30, 2009 was due to higher levels of restructured loans, nonaccrual loans and OREO.
Restructured loans not covered by loss share agreements equaled $46.2 million at June 30, 2010, compared to $55.0 million at December 31, 2009 and $5.3 million at June 30, 2009, the result of modifications made to performing loans to support borrowers who were at risk of defaulting on their loan repayment obligations.
OREO not covered by loss share agreements totaled $46.8 million at June 30, 2010, compared to $40.6 million at December 31, 2009 and $33.3 million at June 30, 2009, the increase primarily relating to real estate exposures in the Atlanta, Georgia and southwest Florida markets, specifically related to residential construction activities. Both markets have experienced significant over-development that has resulted in extremely weak sales of new residential units and significant declines in property values. Once acquired, OREO is periodically reviewed to ensure that the fair value of the property supports the carrying value, with writedowns recorded when necessary.
At June 30, 2010, the allowance for loan and lease losses allocated to noncovered loans totaled $172.2 million or 1.48 percent of loans and leases not covered by loss share agreements, compared to $168.8 million or 1.45 percent at December 31, 2009 and $162.3 million or 1.39 percent at June 30, 2009. The $3.4 million and $9.9 million increase in the allowance for noncovered loan and lease losses since December 31, 2009 and June 30, 2009, respectively, was primarily due to deterioration in credit quality within noncovered commercial loans, revolving mortgage loans, and residential construction loans. An additional allowance of $16.0 million relates to loans covered by loss share agreements at June 30, 2010 with a gross carrying amount of $45.5 million. This $16.0 million allowance was established as a result of post-acquisition deterioration in credit quality for certain covered loans.
Management considers the allowance adequate to absorb estimated probable losses that relate to loans and leases outstanding at June 30, 2010, although future additions may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan and lease losses. Such agencies may require adjustments to the allowance based on information available to them at the time of their examination.
The provision for loan and lease losses recorded during the second quarter of 2010 equaled $31.8 million, compared to $16.9 million during the first quarter of 2010 and $20.8 million during the second quarter of 2009. The $11.1 million increase since the second quarter of 2009 resulted from post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. Exclusive of losses related to loans covered by loss share agreements, net charge-offs declined to $12.6 million during the second quarter of 2010, compared to $20.8 million during the second quarter of 2009. Net charge-offs on noncovered loans equaled $13.6 million during the first quarter of 2010. On an annualized basis, net charge-offs represented 0.43 percent of average noncovered loans and leases during the second quarter of 2010 compared to 0.47 percent in the first quarter of 2010 and 0.73 percent during the second quarter of 2009.
The provision for loan and lease losses during the first six months of 2010 equaled $48.8 million up $9.3 million or 19.0 percent from the comparable period of 2009. The current year increase was caused primarily by post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. Net charge-offs of noncovered loans totaled $26.2 million in 2010,
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down $8.6 million from 2009 as a result of reduced losses on residential construction loans. Annualized year-to-date net charge-offs of noncovered loans represented 0.45 percent of average noncovered loans and leases for 2010, compared to 0.60 percent for 2009.
Table 10 provides details concerning the allowance for loan and lease losses during the past five quarters.
Interest rate risk. Interest rate risk results principally from assets and liabilities maturing or repricing at different points in time, from assets and liabilities repricing at the same point in time but in different amounts and from short-term and long-term interest rates changing in different magnitudes, an event frequently described by the resulting impact on the shape of the yield curve. Market interest rates also have an impact on the interest rate and repricing characteristics of loans and leases that are originated as well as the rate characteristics of our interest-bearing liabilities.
We assess our interest rate risk by simulating future amounts of net interest income under various interest rate scenarios and comparing those results to forecasted net interest income assuming stable rates. Due to the extremely low level of interest rates, the calculation of downward rate simulations is not applicable, and thus we focus our simulations on rising rate interest rate scenarios. These simulations indicate that net interest income will increase by 2.3 percent to 6.4 percent depending upon the speed with which rates increase. We also utilize the market value of equity as a tool in measuring and managing interest rate risk. The market value of equity is estimated to range from 8.3 percent with no change in interest rates to 7.3 percent when rates move up immediately by 200 basis points.
We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our rate sensitivity and interest rate risk. However, during 2006, we entered into an interest rate swap to synthetically convert the variable rate on $115.0 million of junior subordinated debentures to a fixed rate of 7.125 percent for a period of five years. During 2009, we entered into a second interest rate swap covering the period from June 2011 to June 2016 at a fixed interest rate of 5.50 percent. Both of the interest rate swaps qualify as hedges under US GAAP.
Liquidity risk. Liquidity risk results from the mismatching of asset and liability cash flows and the potential inability to secure adequate amounts of funding from traditional sources of liquidity. BancShares manages this risk by structuring its balance sheet prudently and by maintaining various borrowing resources to fund potential cash needs. BancShares has historically maintained a strong focus on liquidity, and we have traditionally relied on our deposit base as our primary liquidity source. Short-term borrowings resulting from commercial treasury customers have also been an important source of liquidity in recent years, although the majority of those borrowings must be collateralized thereby potentially restricting the use of the resulting liquidity. Through our deposit and treasury services pricing strategies, we have the ability to stimulate or curtail liability growth.
Exclusive of deposits assumed in the FDIC-assisted transactions, deposits increased during 2010 and 2009 due to an improved domestic savings rate and a desire by customers to seek safety from uncertain investment instruments. While deposits have continued to grow despite falling interest rates, lower rates have caused a significant reduction in treasury services balances.
The 2010 and 2009 FDIC-assisted transactions have created liquidity pressures and will require us to maintain incremental liquidity in 2010. With respect to the FDIC-assisted transactions, we expect deposit outflows to exceed cash receipts from payments on covered loans and the receivable from the FDIC for loss share agreements, resulting in a net reduction in liquidity. The deposit outflows result from high levels of wholesale and other non-core funding sources typically utilized by failing institutions, large portions of which are typically withdrawn subsequent to the acquisition date. The incremental liquidity to fund our acquisitions has been and will continue to be primarily generated outside of the failed bank markets through increased core deposits within the legacy ISB and FCB franchise.
We occasionally utilize borrowings from the Federal Home Loan Bank of Atlanta as an alternative source of liquidity, and to assist in matching the maturities of longer dated interest-earning assets. At June 30, 2010, we had sufficient collateral pledged to provide access to $1.50 billion of additional borrowings. Additionally, we maintain federal funds lines of credit and other borrowing facilities. At June 30, 2010, BancShares had contingent access to $500.0 million in unsecured borrowings through its various sources.
Once we have satisfied our loan demand and other funding needs, residual liquidity is held in cash or invested in overnight investments and investment securities available for sale. Net of amounts pledged for various purposes, the amount of such immediately available balance sheet liquidity approximated $2.71 billion at June 30, 2010 compared to $1.75 billion at June 30, 2009.
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Allowance for loan and lease losses at beginning of period
Net charge-offs of loans and leases:
Charge-offs
Recoveries
Net charge-offs of loans and leases
Allowance for loan and lease losses at end of period
Allowance for loan and lease losses at end of period allocated to loans and leases:
Detail of net charge-offs of loans and leases:
Total net charge-offs
Reserve for unfunded commitments
Average loans and leases:
Loans and leases at period-end:
Covered by loss sharing agreements
Not covered by loss sharing agreements
Risk Elements
Nonaccrual loans and leases
Other real estate
Troubled debt restructurings
Total nonperforming assets
Nonperforming assets covered by loss share agreements
Nonperforming assets not covered by loss share agreements
Accruing loans and leases 90 days or more past due:
Ratios
Net charge-offs of noncovered loans (annualized) to average noncovered loans and leases
Allowance for loan and lease losses to total loans and leases:
Nonperforming assets to total loans and leases plus other real estate
Accruing loans and leases 90 days or more past due covered by loss share agreements includes impaired loans acquired from FRB and SAB that are being accounted for using the accretable yield method.
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SEGMENT REPORTING
BancShares conducts its banking operations through its two banking subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and has separate management groups, with the exception of California, Washington and Florida where both now operate as a result of the FDIC-assisted transactions. We monitor growth and financial results in these institutions separately and, within each institution, by geographic segregation.
Although FCB has grown through acquisition in certain of its markets, throughout its history the majority of its expansion has been accomplished on a de novo basis. Since ISB began operation in 1997, it has followed a similar business model for growth and expansion on a de novo basis. Due to the rapid pace of its growth and the number of branch offices that have not attained sufficient size to achieve profitability, the financial results and trends of ISB have been significantly affected by the large percentage of markets that are relatively new. Each new market that ISB has entered created additional operating costs that are typically not fully offset by operating revenues until three to five years of operation. Losses incurred since ISB’s inception total $85.9 million, due not only to the rapid rate of expansion but also to large credit costs incurred during the last several years.
IronStone Bank. At June 30, 2010, ISB operated 58 facilities in twelve states. ISB’s total assets equaled $2.81 billion at June 30, 2010 compared to $2.65 billion at June 30, 2009, an increase of $153.1 million or 5.8 percent. ISB recorded a net loss of $964,000 during the first six months of 2010, compared to a net loss of $13.8 million during the same period of 2009. We believe that current year operating results will be favorable compared to 2009 due to lower credit costs and improved net interest income.
Net interest income increased $8.7 million during the first six months of 2010, the result of an improved net yield on interest-earning assets. The provision for credit losses decreased $10.4 million during the first six months of 2010 due to lower net charge-offs and provisions in the residential construction loan portfolio. Net charge-offs decreased from $18.1 million in the first half of 2009 to $8.5 million in the first half of 2010. On an annualized basis, the ratio of current year net charge-offs to average loans and leases outstanding equaled 0.78 percent, compared to 1.66 percent in the prior year.
ISB’s noninterest income increased $652,000 or 10.0 percent during the first half of 2010, due to increases in cardholder and merchant services income. Noninterest expense fell $287,000 or 0.6 percent during the first half of 2010, versus the same period of 2009. Salary expense increased $1.1 million or 7.3 percent as a result of new offices opened in late-2009. Occupancy expense was also up by $782,000 or 9.9 percent. Other expense declined $2.6 million from the prior year primarily due to a reduction in foreclosure-related expenses and FDIC deposit insurance.
First-Citizens Bank & Trust Company. At June 30, 2010, FCB operated 393 branches in eight states and Washington, DC. FCB’s total assets increased from $14.60 billion at June 30, 2009 to $18.16 billion at June 30, 2010, an increase of $3.55 billion or 24.3 percent as a result of assets acquired in FDIC-assisted transactions. FCB recorded net income of $141.4 million during the first half of 2010 compared to $34.6 million during the same period of 2009. This represents a $106.8 million increase in net income caused primarily by acquisition gains in the first quarter of 2010. Excluding the acquisition gains recognized in the first quarter, First Citizens had pre-tax income of $93.6 million, compared to $51.5 million in 2009. FCB’s net interest income increased $77.1 million or 37.8 percent during 2010, due to higher average interest-earning assets and an improved net yield on interest-earning assets.
The provision for loan and lease losses increased $19.7 million due to higher net charge-offs and higher provision for losses on acquired loans. FCB’s ratio of net charge-offs to average noncovered loans and leases equaled 0.38 percent for the first half of 2010 compared to 0.36 percent for the same period of 2009. FCB’s noninterest income increased $157.9 million during the first half of 2010, primarily the result of the nonrecurring gain from the FDIC-assisted transactions. Improvements were also noted in wealth advisory services, deposit service charges and cardholder and merchant services income. Reductions were noted in fees from processing services, mortgage income and ATM income. Noninterest expense increased $37.0 million or 13.4 percent during 2010, caused principally by increased costs as a result of the FDIC-assisted transactions.
LEGAL PROCEEDINGS
BancShares and various subsidiaries have been named as defendants in various legal actions arising from our normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those other matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.
CURRENT ACCOUNTING AND REGULATORY ISSUES
Beginning with the first annual reporting period after November 15, 2009, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities (as defined under previous accounting standards) must be evaluated for consolidation by reporting entities in accordance with applicable consolidation guidance.
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If the evaluation results in consolidation, the reporting entity should apply the transition guidance provided in the pronouncement that requires consolidation. In addition, an enterprise is required to perform an analysis to determine whether the enterprise’s variable interest give it a controlling financial interest in a variable interest entity. This change is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets and variable interest entities. In 2005, FCB securitized and sold approximately $250 million of HELOC loans through the use of a QSPE. This QSPE was determined to be a variable interest entity (VIE) for which FCB is obligated to now recognize the underlying assets and liabilities in the consolidated financial statements. The assets and liabilities were recorded in the first quarter of 2010 with an increase in loans of $97.3 million, an increase in debt of $86.9 million, removal of the carrying value of the residual interest strip in the amount of $1.3 million, recognition of $3.2 million in deferred tax liability, increase in the allowance for loan and losses of $681,000, decrease to the servicing asset for $304,000 and an adjustment to beginning retained earnings for $4.9 million.
Beginning January 1, 2010, new accounting guidance requires expanded disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level-3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. The guidance further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) company’s should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be required beginning January 1, 2011. The remaining disclosure requirements and clarifications became effective on January 1, 2010 and are included in Note G – Estimated Fair Values.
The recent enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act will result in expansive changes in many areas affecting the financial services industry in general and BancShares in particular. The legislation provides broad economic oversight, consumer financial services protection, investor protection, rating agency reform and derivative regulatory reform. Various corporate governance requirements will result in expanded proxy disclosures and shareholder rights. Additional provisions address the mortgage industry in an effort to strengthen lending practices. Deposit insurance reform will result in permanent FDIC protection for up to $250,000 of deposits and will require the FDIC’s Deposit Insurance Fund to maintain 1.35 percent of insured deposits with the burden for closing the shortfall falling to banks with more than $10.0 billion in assets.
The legislation also imposes new regulatory capital requirements for banks that will result in the disallowance of qualified trust preferred capital securities as Tier 1 capital beginning in 2013. This legislation requires the reduction in Tier 1 capital by the amount of qualified trust preferred capital securities in equal increments over a three year period beginning in 2013. BancShares has $265 million in trust preferred capital securities that is currently outstanding and included as Tier 1 capital. The elimination of $88.3 million from Tier 1 capital will be required over the three year period beginning in 2013. Due to the breadth of the impact of the new legislation, we are unable to estimate the impact of complying with the various provisions.
In July, 2010, the FASB issued Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Loss(ASU 2010-20). In an effort to provide financial statement users with greater transparency about the allowance for loan and lease losses, ASU 2010-20 requires enhanced disclosures regarding the nature of credit risk inherent in the portfolio and how risk is analyzed and assessed in determining the amount of the allowance. Changes in the allowance will also require disclosure. The end-of-period disclosures are effective for BancShares on December 31, 2010. The disclosures related to activity during a period are effective during 2011. The provisions of ASU 2010-20 will affect disclosures regarding the allowance for loan and lease losses, but will have no material impact on financial condition, results of operations or liquidity.
Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, management is not aware of any further recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations.
FORWARD-LOOKING STATEMENTS
Statements in this Report and exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
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Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents filed by us from time to time with the Securities and Exchange Commission.
Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “projects,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of BancShares’ management about future events.
Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, customer acceptance of our services, products and fee structure, the competitive nature of the financial services industry, our ability to compete effectively against other financial institutions in our banking markets, actions of government regulators, the level of market interest rates and our ability to manage our interest rate risk, changes in general economic conditions that affect our loan and lease portfolio, the abilities of our borrowers to repay their loans and leases, the values of real estate and other collateral, the impact of the Acquisitions, and other developments or changes in our business that we do not expect.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have no obligation to update these forward-looking statements.
Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values of financial instruments or reduced net interest income in future periods. As of June 30, 2010, BancShares’ market risk profile has not changed significantly from December 31, 2009. Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty. Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.
BancShares’ management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of BancShares’ disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, BancShares’ disclosure controls and procedures were effective to provide reasonable assurance that BancShares is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.
No change in BancShares’ internal control over financial reporting occurred during the second quarter of 2010 that had materially affected, or is reasonably likely to materially affect, BancShares’ internal control over financial reporting.
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PART II
Unfavorable changes in economic conditions
BancShares’ business is highly affected by national, regional and local economic conditions. These conditions cannot be predicted or controlled, and may have a material impact on our operations and financial condition. Unfavorable economic developments such as an increase in unemployment rates, decreases in real estate values, rapid changes in interest rates, higher default and bankruptcy rates and various other factors could weaken the national economy as well as the economies of specific communities that we serve. Weakness in our market areas, continuation or deepening of the current recession or a prolonged recovery could depress our earnings and financial condition because borrowers may not be able to repay their loans, collateral values may fall, and loans that are currently performing and other long-lived assets may become impaired.
Mergers and acquisitions
We must receive federal and state regulatory approvals before we can acquire a bank or bank holding company or acquire assets and assume liabilities of failed banks from the FDIC. Prior to granting approval, bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition and future prospects including current and projected capital ratios, the competence, experience and integrity of management, our record of compliance with laws and regulations, and the convenience and needs of the communities to be served, including our record of compliance under the Community Reinvestment Act. We cannot be certain when or if any required regulatory approvals will be granted or what conditions may be imposed by the approving authority.
In addition to the risks related to regulatory approvals, complications in the conversion of operating systems, data systems and products may result in the loss of customers, damage to our reputation, operational problems, one-time costs currently not anticipated or reduced cost savings resulting from a merger or acquisition. The integration could result in higher than expected deposit attrition, loss of key employees, disruption of our businesses or the businesses of the acquired company, or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition.
With respect to the FDIC-assisted transactions, the exposures to prospective losses on certain assets are covered by loss share agreements with the FDIC. These loss share agreements impose certain obligations on us that, in the event of noncompliance could result in the disallowance of our rights under the loss share agreements.
Instability in real estate markets
Disruption in residential housing markets including reduced sales activity and falling market prices have adversely affected collateral values and customer demand, particularly with respect to our operations in Atlanta, Georgia and southwest Florida. Instability in residential and commercial real estate markets could result in higher credit losses in the future if customers default on loans that, as a result of lower property values, are no longer adequately collateralized. The weak real estate markets could also affect our ability to sell real estate acquired through foreclosure.
Liquidity
Liquidity is essential to our businesses. Our deposit base represents our primary source of liquidity, and we normally have the ability to stimulate deposit growth through our pricing strategies. However, in circumstances where our ability to generate needed liquidity is impaired, we would need access to alternative liquidity sources such as overnight or other short-term borrowings. While we maintain access to alternative funding sources, we are dependent on the availability of collateral, the counterparty’s willingness to lend to us and their liquidity capacity.
The acquisition gains recorded during 2010 and 2009 are preliminary and subject to revision for a period of one year following the respective acquisition date. Adjustments may be recorded based on additional information received after the acquisition date that affects the respective acquisition date fair values of assets acquired and liabilities assumed. Downward adjustments in values of assets acquired or increases in values of liabilities assumed on the date of acquisition would lower the gains on acquisitions.
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Deposit insurance premiums
During 2009, due to a higher level of bank failures, the FDIC increased recurring deposit insurance premiums, imposed a special assessment on insured financial institutions, and required insured financial institutions to prepay three years of deposit premiums. Due to the continuing volume of bank failures, it is possible that additional funding will be required from insured financial institutions. In addition, recently enacted legislation contains various provisions to reform certain elements of the current deposit insurance system including a higher minimum reserve ratio that must be attained by 2020. These changes could result in further increases in the amount of deposit insurance premiums that we pay.
Access to capital
Based on existing capital levels, BancShares and its subsidiary banks maintain well-capitalized ratios under current leverage and risk-based capital standards including the impact of the acquisitions in 2010 of First Regional and SAB. Historically, our primary capital sources have been retained earnings and debt issued through both private and public markets including trust preferred securities and subordinated debt. The market for trust preferred securities has been severely limited during the current economic environment, and our ability to raise capital by issuing new trust preferred securities at reasonable rates is highly questionable.
Additionally, recent legislation has affected our ability to rely on trust preferred securities as a source of capital. Under the provisions of the 2010 legislation, we will be required to remove one-third of the securities that currently qualify in each of the three years beginning 2013. The elimination of the full $265.0 million would result in a 201 basis point reduction in BancShares’ Tier 1 capital at June 30, 2010 on a pro forma basis. Although BancShares would remain well-capitalized on a pro forma basis, the impact of this legislation on other financial institutions may create an even greater scarcity of capital. A lack of access to new Tier 1 capital could limit our ability to consummate additional acquisitions and meet customer demand for additional extensions of credit.
Reduction in credit ratings
The major rating agencies regularly evaluate our creditworthiness and assign credit ratings to the debt of BancShares and one of our bank subsidiaries. The agencies’ ratings are based on a number of factors, some of which are not within our control. In addition to factors specific to our financial strength and performance, the rating agencies also consider conditions generally affecting the financial services industry. In light of the difficulties currently confronting the financial services industry, there can be no assurance that we will maintain our current credit ratings. Rating reductions could adversely affect our access to funding sources and the cost of obtaining funding. Long-term debt ratings also factor into the calculation of deposit insurance premiums, and a reduction in our subsidiary bank’s ratings would increase premiums and expense.
Condition of other financial institutions
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to numerous financial service providers, including banks, brokers and dealers in securities and other institutional clients. Transactions with other financial institutions expose us to credit risk in the event of default of the counterparty. These types of losses could materially and adversely affect our results of operations or earnings.
Changes in interest rates
Our earnings and financial condition are highly dependent upon net interest income. Compression of interest rate spreads adversely affects our earnings and financial condition. We cannot predict with certainty changes in interest rates or actions by the Federal Reserve that may have a direct impact on market interest rates. While we maintain policies and procedures designed to mitigate the risks associated with changes in interest rates, those changes may nonetheless have significant adverse effects on our profitability.
Changes in banking laws
Financial institutions are regulated under federal and state banking laws and regulations that primarily focus on the protection of depositors, federal deposit insurance funds and the banking system as a whole. Federal and state banking regulators possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on activities that could have a material adverse effect on our results of operations.
In addition, financial institutions are significantly affected by changes in economic and monetary policies. Recently enacted legislation will likely result in increased compliance requirements through the establishment of the Bureau of Consumer Financial Protection.
Competition
There is intense competition among commercial banks in our market areas. In addition, we compete with other providers of financial services, such as credit unions, consumer finance companies, commercial finance and leasing companies and brokerage firms
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as well as other institutions that deliver their products and services through alternative delivery networks. Some of our larger competitors, including various banks that have a significant presence in our market areas, have the capacity to offer products and services we do not offer.
Catastrophic events
The occurrence of catastrophic events including weather-related events such as hurricanes, tropical storms, floods, windstorms or severe winter weather, as well as earthquakes, pandemic disease, fires and other catastrophes could adversely affect our consolidated financial condition or results of operations.
In addition to natural catastrophic events, man-made events such as acts of terror and governmental response to acts of terror could adversely affect general economic conditions, which could have a material impact on our results of operations.
Unpredictable natural and other disasters could have an adverse effect if those events materially disrupt our operations or affect customers’ access to the financial services we offer. Although we carry insurance to mitigate our exposure to certain catastrophic events, catastrophic events could nevertheless affect our results of operations.
Operational and data security risk
We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of illegal activities conducted by employees or outsiders, data security risk and operational errors. Our dependence on automated systems, including the automated systems used by acquired entities and third parties, to record and process transactions may further increase the risk that technical failures or tampering of those systems will result in losses that are difficult to detect. We are also subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control.
Reliance on vendors
Third party vendors provide key components of our business infrastructure. Failures of these third parties to provide services for any reason could adversely affect our ability to deliver products and services to our customers. Replacing critical third party vendors could also result in interruption of service and significant expense.
Litigation
The frequency of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against us may have material adverse financial effects or cause significant reputational harm.
Interpretation of tax laws and regulations
Our interpretation of federal, state or local tax laws and regulations that allow for our estimation of tax liabilities may differ from tax authorities. Those differing interpretations may result in the disallowance of deductions or credits, differences in the timing of deductions or other differences that could result in the payment of additional taxes, interest or penalties that could materially affect our results of operations.
Changes in accounting standards
The Financial Accounting Standards Board periodically modifies the standards that govern the preparation of our financial statements. These changes are not predictable and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results or a cumulative adjustment to retained earnings.
Volatility in stock price and impairment of goodwill
Market prices of our common stock price can fluctuate widely in response to a variety of factors including expectations of operating results, actual operating results, market perception of business combinations, stock prices of other companies that are similar to BancShares, general market expectations related to the financial services industry, and the potential impact of government actions affecting the financial services industry.
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
Goodwill is tested for impairment at least annually and the impairment test compares the estimated fair value of a reporting unit with its net book value. A write-off of impaired goodwill could have a significant impact on our results of operations, but would not impact our capital ratios as such ratios are calculated using tangible capital amounts.
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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.
(Registrant)
/s/ KENNETH A. BLACK
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