First Financial Bankshares - 10-Q quarterly report FY

 

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ           Accelerated filer o            Non-accelerated filer o

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

          Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of August 1, 2006:

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-Q, words such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, “predict”, “project”, and similar expressions, as they relate to us or management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to those listed in “Item 1A-Risk Factors” in our Annual Report on Form 10-K and the following:

Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The consolidated balance sheets of First Financial Bankshares, Inc. at June 30, 2006 and 2005 and December 31, 2005, and the consolidated statements of earnings and comprehensive earnings for the three and six months ended June 30, 2006 and 2005, changes in shareholders’ equity for the six months ended June 30, 2006 and the year ended December 31, 2005, and cash flows for the six months ended June 30, 2006 and 2005, follow on pages 4 through 8.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

     

See notes to consolidated financial statements.

     See notes to consolidated financial statements.

In the opinion of management, the unaudited consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations. All adjustments were of a normal recurring nature. However, the results of operations for the three and six months ended June 30, 2006, are not necessarily indicative of the results to be expected for the year ending December 31, 2006, due to seasonality, changes in economic conditions, interest rate fluctuations and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted under SEC rules and regulations.

On April 26, 2005, the Company’s Board of Directors declared a four-for-three stock split in the form of a 33% stock dividend effective June 1, 2005. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock in the consolidated financial statements.

On April 25, 2006, the shareholders of the Company voted at the Annual Shareholders’ Meeting to change the par value of stock from $10.00 to $0.01 per share. In the three months ended June 30, 2006, the Company transferred appropriate amounts from common stock to capital surplus in the consolidated financial statements to reflect this change in par value.

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods. In computing diluted earnings per common share for the three months and six months ended June 30, 2006 and 2005, the Company assumes that all outstanding options to purchase common stock have been exercised at the beginning of the year (or the time of issuance, if later). The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended June 30, 2006 and 2005, were 20,722,054 and 20,692,904 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per share for the six months ended June 30, 2006 and 2005, were 20,718,763 and 20,688,637, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended June 30, 2006 and 2005, were 20,775,448 and 20,768,007, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the six months ended June 30, 2006 and 2005, were 20,775,648 and 20,768,694, respectively. See Note 2 above.

The Company grants stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. Prior to 2006, the Company accounted for stock option grants using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). Under APB 25, because the exercise price of the Company’s employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized.

In December 2004, Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment,” was issued. SFAS No. 123R requires companies to recognize in the statement of earnings the grant-date fair value of stock options issued to employees. The statement was effective January 1, 2006. The Company recorded stock option expense totaling $38,000 and $82,000 for the three and six months ended June 30, 2006, respectively, using the modified prospective method for transition to the new rules whereby grants after the implementation date, as well as unvested awards granted prior to the implementation date, are measured and accounted for under SFAS No. 123R.

The additional disclosure requirements of SFAS No. 123R have been omitted due to immateriality.

The Company’s defined benefit pension plan was frozen effective January 1, 2004 and no additional years of service will accrue to participants, unless the pension plan is reinstated at a future date. The pension plan covered substantially all of the Company’s employees. The benefits were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. Contributions to the pension plan through December 31, 2003 were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. As a result of freezing the pension plan, we do not expect contributions or pension expense to be significant in future years. Accordingly, no amount of net periodic benefit cost was recorded in the three months and six months ended June 30, 2006 and 2005 as the interest cost component is generally offset with the expected return on plan assets.

The Company did not make a contribution to the pension plan during the years ended December 31, 2004 or 2005 and does not expect to make a contribution during the year ending December 31, 2006, as permitted by the Internal Revenue Service’s funding standards.

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new interpretation is effective for fiscal years beginning after December 15, 2006. The Company believes that implementation of the provisions of the new interpretation will not have a significant impact on the Company’s financial position on results of operations.

As a multi-bank financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges on deposits. Our primary source of funding for our loans is deposits we hold in our subsidiary banks. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form 10-Q as well as those included in the Company’s 2005 Annual Report on Form 10-K. On April 26, 2005, the Company’s Board of Directors declared a four-for-three stock split in the form of a 33% stock dividend effective for shareholders of record on May 16, 2005.

We prepare consolidated financial statements based on the application of certain accounting policies, accounting principles generally accepted in the United States and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

The following discussion addresses our allowance for loan loss and our provision for loan losses, which we deem to be our most critical accounting policy. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe that these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period.

The allowance for loan losses is an amount we believe will be adequate to absorb inherent estimated losses on existing loans for which full collectibility is unlikely based upon our review and evaluation of the loan portfolio. The allowance for loan losses is increased by charges to income and decreased by charged off loans (net of recoveries).

Our methodology is based on guidance provided in SEC Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues” and includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS 118, and allowance allocations determined in accordance with SFAS No. 5, “Accounting for Contingencies”. We have developed a consistent, well- documented loan review methodology that includes allowances assigned to certain classified loans, allowances assigned based upon estimated loss factors and qualitative reserves.

The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review staff and regulatory examiners.

Our allowance for loan losses is comprised of three elements: (i) specific reserves determined in accordance with SFAS 114 based on probable losses on specific loans; (ii) general reserves determined in accordance with SFAS 5 that consider historical loss rates, loan classifications and other factors; and (iii) a qualitative reserve determined in accordance with SFAS 5 based upon general economic conditions and other qualitative risk factors both internal and external to the Company. We regularly evaluate our allowance for loan losses to maintain an adequate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of the specific reserves include the credit worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All nonaccrual loans rated substandard or worse and greater than $50,000 are specifically reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, a certain portion of the loan portfolio is assigned a reserve allocation percentage. The reserve allocation percentage is multiplied by the outstanding loan principal balance, less cash secured loans, government guaranteed loans and classified loans to calculate the required general reserve. The general reserve allocation percentages assigned to groups of loans consider historical loss rates, loan classifications and other factors. The qualitative reserves are determined by evaluating such things as current economic conditions and trends, changes in lending staff, policies or procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. The portion of the allowance that is not derived by the general reserve allocation percentages compensates for the uncertainty and complexity in estimating loan losses including factors and conditions that may not be fully reflected in the determination and application of the general reserve allocation percentages.

Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The bank regulatory agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful.

Our policy requires measurement of the allowance for an impaired collateral-dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan’s observable market price.

Net income for the second quarter of 2006 totaled $11.45 million, an increase of $844 thousand or 8.0% from the same period last year. The 2005 earnings included the special distribution of proceeds from the merger of PULSE EFT Association and Discover Financial Services, Inc., the second of which we received and recognized in income in the second quarter of 2005, in the amount of $333 thousand, net of related income tax. Excluding the gain on the special distribution in 2005, our earnings increased $1.2 million, or 11.5%, over the prior year. This increase is principally attributable to an increase in net interest income of $2.8 million, an increase in ATM and credit card fees of $318 thousand, higher service charges on deposits of $270 thousand, increased trust fees of $125 thousand and an increase in the gain on sale of student loans of $140 thousand. Offsetting these items were increases in salaries and employee benefits of $1.0 million, net occupancy expense of $257 thousand and equipment expense of $303 thousand, primarily attributable to our acquisitions. Fees from ATM and credit card transactions increased $318 thousand in the second quarter of 2006 over 2005 as a result of continued increased use of our debit cards and the opening of new accounts.

On a basic earnings per share basis, earnings amounted to $0.55 per share for the second quarter of 2006, as compared to $0.51 per share for the second quarter of 2005. Return on average assets and return on average equity for the second quarter of 2006 amounted to 1.68% and 16.48%, respectively. For the same periods in 2005, return on average assets and return on average equity amounted to 1.76% and 15.70%, respectively.

Tax equivalent net interest income for the second quarter of 2006 amounted to $27.7 million as compared to $24.9 million for the same period last year. Our rates on interest earning assets increased approximately 65 basis points while our rates paid on deposits increased approximately 93 basis points. The increase in volume of average interest earning assets of $264.7 million combined with the increase in rates to improve interest income. Average interest bearing liabilities increased $210.8 million, and coupled with the increase in rates, partially offset the increase in interest income. Average earning assets were $2.473 billion for the second quarter of 2006, which is 12.0% greater than for the second quarter of 2005. Average interest bearing liabilities were $1.813 billion for the second quarter of 2006, which is 13.2% greater than for the second quarter of 2005. The Company’s interest spread decreased to 3.82% for 2006 from 4.07% for 2005. The Company’s net interest margin was 4.50% for the second quarter of 2006, compared to 4.53% for the same period of 2005. Our net interest margin continued to decline primarily due to the overall flat interest rate curve coupled with our 56% loan to deposit ratio and more aggressive pricing of our interest bearing deposits as a result of competitive pressures.

The provision for loan losses for the second quarter of 2006 totaled $389 thousand compared to $323 thousand for the same period in 2005. The increase was due primarily to loan growth and change in classification of certain loans. Gross chargeoffs for the quarter ended June 30, 2006 totaled $379 thousand compared to $552 thousand for the same period of 2005. Recoveries of previously charged-off loans totaling $347 thousand in the quarter ended June 30, 2006 (as compared to $143 thousand in the same period of 2005) offset the chargeoffs experienced. On an annualized basis, net chargeoffs as a percentage of average loans were 0.01% for the second quarter of 2006, as compared to a 0.14% net chargeoff for the same period in 2005. The Company’s allowance for loan losses totaled $15.5 million at June 30, 2006, up $1.2 million from the balance of $14.3 million at June 30, 2005. The increased allowance is primarily due to additions from our acquisitions and changes in certain loan classifications. The Company’s allowance as a percentage of nonperforming loans amounted to 370.0% at June 30, 2006. As of June 30, 2006, management of the Company believes the Company’s balance in allowance for loan losses is adequate to provide for loans existing in its portfolio that are deemed uncollectible.

Total noninterest income for the second quarter of 2006 was $10.95 million, as compared to $10.54 million for the same period last year. The Company recognized a $513 thousand gain from the special distribution of proceeds from the merger of PULSE EFT Association and Discover Financial Services, Inc. in the second quarter of 2005. Trust fees totaled $1.83 million for 2006, up $125 thousand over the same period in 2005 due to increased volume of trust assets managed. The market value of trust assets managed totaled $1.542 billion at June 30, 2006 compared to $1.370 billion at June 30, 2005. Service fees on deposits totaled $5.66 million for the second quarter of 2006, compared to $5.39 million for the same period of 2005, an improvement of $271 thousand. The Company’s real estate mortgage fees of $560 thousand were slightly more than the $510 thousand recognized in the second quarter of 2005.

Noninterest expense for the second quarter of 2006 amounted to $20.84 million as compared to $18.86 million for the same period in 2005. Salaries and benefits expense, the Company’s largest noninterest expense item, increased 10.0% to $11.13 million in 2006, up $1.0 million over the same period in 2005. This increase resulted primarily from the increase in number of employees resulting from acquisitions, the opening of five new branches and overall pay increases effective during the first quarter of 2006. Net occupancy expense increased approximately $257 thousand, to $1.5 million, also attributable to facilities obtained through acquisitions, the opening of new branches and to increased utility costs. Equipment expense increased $303 thousand in 2006 over 2005 due to the depreciation of new technology expenditures made in the latter part of 2005 and depreciation associated with acquisitions.

The Company’s other categories of expense increased $404 thousand in the second quarter of 2006 compared to the second quarter of 2005. Contributing to this increase were a volume related increase of $153 thousand related to ATM and credit card expenses (related income increased $318 thousand) and a $209 thousand increase in core deposit intangible asset amortization related to acquisitions. Offsetting these increases was a decrease of $72 thousand in our correspondent bank services charges.

We believe a key indicator of our operating efficiency is expressed by the ratio that is calculated by dividing noninterest expense by the sum of net interest income (on a tax equivalent basis) and noninterest income. This ratio in effect measures the amount of funds expended to generate revenue. Our efficiency ratio was 53.21% for the second quarter of 2005 and 53.91% for the second quarter of 2006. Excluding the effect of the gain on sale of PULSE EFT ownership rights, our second quarter 2005 efficiency ratio was 53.99%.

Net income for the first six months of 2006 totaled $22.92 million, a increase of $235 thousand or 1.0% from the same period last year. The 2005 earnings included the special distribution of proceeds from the merger of PULSE EFT Association and Discover Financial Services, Inc., of which we received and recognized in income in the first six-months of 2005, in the amount of $2.3 million, net of related income tax. Excluding the gain on the special distribution in 2005, our earnings increased $2.5 million, or 12.3%, over the prior year. This increase is principally attributable to an increase in net interest income of $5.6 million, an increase in ATM and credit card fees of $634 thousand, higher service charges on deposits of $540 thousand, increased trust fees of $257 thousand and an increase in the gain on sale of student loans of $253 thousand. Offsetting these items were increases in salaries and employee benefits of $2.6 million, net occupancy expense of $577 thousand and equipment expense of $523 thousand, primarily attributable to our acquisitions. We sold approximately $63

million in student loans in the first six-months of 2006, recognizing a premium of $1.9 million. This compares to a sale of approximately $56 million in student loans, with premium recognition of $1.7 million in the first six-months of 2005. Fees from ATM and credit card transactions increased in the second quarter of 2006 over 2005 as a result of continued increased use of our debit cards and an increase in number of accounts.

On a basic earnings per share basis, earnings amounted to $1.11 per share for the first six months of 2006, as compared to $1.10 per share for the second quarter of 2005. Return on average assets and return on average equity for the first six months of 2006 amounted to 1.69% and 16.59%, respectively. For the same periods in 2005, return on average assets and return on average equity amounted to 1.90% and 17.00%, respectively.

Tax equivalent net interest income for the first six months of 2006 amounted to $54.5 million as compared to $49.0 million for the same period last year. Our rates on interest earning assets increased approximately 62 basis points while our rates paid on deposits increased approximately 92 basis points. The increase in volume of average interest earning assets of $285.9 million combined with the increase in rates to improve interest income. Average interest bearing liabilities increased $234.3 million, and coupled with the increase in rates, partially offset the increase in interest income. Average earning assets were $2.472 billion for the first six months of 2006, which is 13.1% greater than for the second quarter of 2005. Average interest bearing liabilities were $1.828 billion for the first six months of 2006, which is 14.7% greater than for the second quarter of 2005. The Company’s interest spread decreased to 3.82% for 2006 from 4.10% for 2005. The Company’s net interest margin was 4.45% for the first six months of 2006, compared to 4.52% for the same period of 2005. Our net interest margin continued to decline primarily due to the overall flat interest rate curve coupled with our 56% loan to deposit ratio and more aggressive pricing of our interest bearing deposits as a result of competitive pressures.

The provision for loan losses for the first six months of 2006 totaled $722 thousand virtually unchanged from $733 thousand for the same period in 2005. Gross chargeoffs for the six months ended June 30, 2006 totaled $759 thousand compared to $943 thousand for the same period of 2005. Recoveries of previously charged-off loans totaling $791 thousand in the six months ended June 30, 2006 (as compared to $331 thousand in the same period of 2005) offset the chargeoffs experienced and generated a net recovery for the quarter. On an annualized basis, net recoveries as a percentage of average loans were 0.01% for the first six months of 2006, as compared to a 0.10% net chargeoff for the same period in 2005. The Company’s allowance for loan losses totaled $15.5 million at June 30, 2006, up $1.2 million from the balance of $14.3 million at June 30, 2005. The increased allowance is primarily due to additions from our acquisitions and changes in certain loan classifications. The Company’s allowance as a percentage of nonperforming loans amounted to 370.0% at June 30, 2006. As of June 30, 2006, management of the Company believes the Company’s balance in allowance for loan losses is adequate to provide for loans existing in its portfolio that are deemed uncollectible.

Total noninterest income for the first six months of 2006 was $22.4 million, as compared to $23.9 million for the same period last year. The Company recognized a $3.5 million gain from the special distribution of proceeds from the merger of PULSE EFT Association and Discover Financial Services, Inc. in the first six months of 2005. Trust fees totaled $3.7 million for 2006, up $257 thousand over the same period in 2005 due to increased volume of trust assets managed. The market value of trust assets managed totaled $1.542 billion at June 30, 2006 compared to $1.370 billion at June 30, 2005. Service fees on deposits totaled $10.9 million for the first six months of 2006, compared to $10.4 million for the same period of 2005, an improvement of $540 thousand. During the first six months of 2006, the Company sold approximately $63 million in student loans, recognizing a premium of $1.9 million. In the first six months of 2005, the Company sold approximately $56 million of its student loans, recognizing a premium of $1.7 million. ATM and credit fees increased $634 thousand to $3.0 million in the first six months of 2006 due to increased usage and an increase in the number of deposit accounts. The Company’s real estate mortgage fees of $1.0 million were slightly more than the $922 thousand recognized in 2005.

Noninterest expense for the first six months of 2006 amounted to $41.4 million as compared to $37.4 million for the same period in 2005. Salaries and employee benefits expense, the Company’s largest noninterest expense item, increased 13.1% to $22.4 million in 2006, up $2.6 million over the same period in 2005. The primary causes of this increase were the increase in number of employees resulting from acquisitions, the opening of new branches and overall pay increases effective during the first quarter of 2006. Net occupancy expense increased approximately $577 thousand, to $3.0 million, also attributable to facilities obtained through acquisitions, the opening of new branches and increased utility costs. Equipment expense increased $523 thousand in 2006 over 2005 due to the depreciation of new technology expenditures made in the latter part of 2005 and depreciation associated with acquisitions.

The Company’s other categories of expense increased $414 thousand in the first six months of 2006 compared to the first six months of 2005. Several factors contributed to this increase, including a volume related increase of $284 thousand related to ATM and credit card expenses (related income increase $634 thousand) and a $332 thousand increase in core deposit intangible asset amortization related to our acquisitions. Declines in the other categories of expenses were audit fees of $152 thousand, primarily due to increased 2005 expenses from the implementation of new compliance procedures associated with the Sarbanes-Oxley Act, correspondent bank service charges of $144 thousand and legal, tax and professional fees of $199 thousand.

We believe a key indicator of our operating efficiency is expressed by the ratio that is calculated by dividing noninterest expense by the sum of net interest income (on a tax equivalent basis) and noninterest income. This ratio in effect measures the amount of funds expended to generate revenue. Our efficiency ratio was 53.73% for the first six months of 2006 and 51.32% for the first six months of 2005. Excluding the effect of the Gain on Sale of PULSE EFT ownership rights, our first six months 2005 efficiency ratio was 52.97%.

Total assets at June 30, 2006 amounted to $2.715 billion as compared to $2.734 billion at December 31, 2005, and $2.426 billion at June 30, 2005. Deposits totaled $2.307 billion at June 30, 2006, down $59.7 million from December 31, 2005 amounts. Deposits at June 30, 2005 were $2.094 billion.

Loans totaled $1.293 billion, $1.289 billion and $1.192 billion at June 30, 2006, December 31, 2005 and June 30, 2005, respectively. As compared to June 30, 2005 amounts, loans at June 30, 2006 reflect (i) a $28.7 thousand increase in commercial, financial and agricultural loans; (ii) a $66.3 million increase in real estate loans; and (iii) a $6.0 million increase in consumer and student loans. Investment securities at June 30, 2006, totaled $1.112 billion as compared to $1.046 billion at year-end 2005 and $980.8 million at June 30, 2005. The unrealized loss in the investment portfolio at June 30, 2006, amounted to $21.3 million; the portfolio had an overall tax equivalent yield of 4.84% for the six months ended June 30, 2006. At June 30, 2006, the investment portfolio had a weighted average life of 3.46 years and modified duration of 2.95 years. At June 30, 2006, the Company did not hold any structured notes and management does not believe that their collateralized mortgage obligations have an interest, credit or other risk greater than their other investments.

Nonperforming assets at June 30, 2006, totaled $4.7 million as compared to $4.2 million at December 31, 2005. At 0.37% of loans plus foreclosed assets, management considers nonperforming assets to be at a manageable level and is unaware of any material classified credit not properly disclosed as nonperforming.

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with, and sell federal funds to, our subsidiary banks. Other sources of funds include our ability to sell securities under agreements to repurchase, and an unfunded $50.0 million line of credit which matures December 31, 2006, established with a nonaffiliated bank.

Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary banks, management considers the current liquidity position to be adequate to meet short- and long-term liquidity needs.

We anticipate that any future acquisitions of financial institutions and expansion of branch locations could place a demand on our cash resources. Available cash at our parent company, available dividends from subsidiary banks, utilization of available lines of credit, and future debt or equity offerings are expected to be the sources of funding for these potential acquisitions or expansions.

The Company’s consolidated statements of cash flows are presented on page 8 of this report. Total equity capital amounted to $279.8 million at June 30, 2006, which was up from $276.3 million at year-end 2005 and $274.0 million at June 30, 2005. The Company’s risk-based capital and leverage ratios at June 30, 2006 were 14.51% and 8.39%, respectively. The second quarter 2006 cash dividend of $0.30 per share totaled $6.22 million and represented 54.3% of second quarter earnings.

Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest bearing liabilities are different. The Company’s exposure to interest rate risk is managed primarily through the Company’s strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities which generate favorable earnings, while limiting the potential negative effects of changes in market interest rates. The Company uses no off-balance-sheet financial instruments to manage interest rate risk. The Company and each subsidiary bank have an asset/liability committee which monitors interest rate risk and compliance with investment policies. Interest-sensitivity gap and simulation analyses are among the ways that the subsidiary banks monitor interest rate risk. As of June 30, 2006, management estimates that, over the next twelve months, an upward shift of interest rates by 200 basis points would result in an increase in projected net interest income of 5.55% and a downward shift of interest rates by 200 basis points would result in a reduction in projected net interest income of 7.24%. These are good faith estimates and assume the composition of our interest sensitive assets and liabilities existing at June 30, 2006, will remain constant over the relevant twelve month measurement period and changes in market interest rates are instantaneous and sustained across the yield curve, regardless of duration or pricing characteristics of specific assets or liabilities. Also, this estimate does not contemplate any actions that we might undertake in response to changes in market interest rates. In management’s opinion, these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. Because interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various

assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, our future results could, in management’s belief, be different from the foregoing estimates, and such changes in results could be material.

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new interpretation is effective for fiscal years beginning after December 15, 2006. The Company believes that implementation of the provisions of the new interpretation will not have a significant impact on the Company’s financial position on results of operations.

Management considers interest rate risk to be a significant market risk for the Company. See “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” for disclosure regarding this market risk.

As of June 30, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rule 15d-15. Our management, including the principal executive officer and principal financial officer, does not expect our disclosure controls and procedures will prevent all errors and all fraud.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints; additionally, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate due to changes in conditions; also the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, our disclosure controls and procedures under Rule 13a-15 and Rule 15d — 15 of the Securities Exchange Act of 1934 are effective at the reasonable assurance level as of June 30, 2006.

Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect these internal controls.

     The following exhibits are filed as part of this report: