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Hancock Holding Company and SubsidiariesNotes to Condensed Consolidated Financial Statements(Unaudited)
1. Basis of Presentation
The condensed consolidated financial statements of Hancock Holding Company and all majority-owned subsidiaries (the “Company”) included herein are unaudited; however, they include all adjustments of a normal recurring nature which, in the opinion of management, are necessary to present fairly the Company’s Condensed Consolidated Balance Sheets at March 31, 2007 and December 31, 2006, the Company’s Condensed Consolidated Statements of Stockholders’ Equity and Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 and the Company’s Condensed Consolidated Statements of Income for the three months ended March 31, 2007 and 2006. Although the Company believes the disclosures in these financial statements are adequate to make the interim information presented not misleading, certain information relating to the Company’s organization and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in this Form 10-Q pursuant to Securities and Exchange Commission rules and regulations. These financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2006 and the notes thereto included in the Company’s Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results expected for the full year.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period and disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowance for loan losses, investments, intangible assets and goodwill, property, plant and equipment, income taxes, insurance, employment benefits and contingent liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
Certain reclassifications have been made to conform prior year financial information to the current period presentation. These reclassifications had no material impact on the condensed consolidated financial statements.
Critical Accounting Policies
There have been no material changes or developments in the Company’s evaluation of accounting estimates and underlying assumptions or methodologies that the Company believes to be Critical Accounting Policies and Estimates as disclosed in our Form 10-K, for the year ended December 31, 2006.
2. Securities
During the quarter ended March 31, 2007, a subsidiary of the Company, Magna Insurance Company, sold three securities out of its portfolio to provide liquidity for surrenders of annuities for Magna Insurance Company. These three securities had a gross loss of $4,160.
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Balance of allowance for loan losses at beginning of period
In some instances, loans are placed on nonaccrual status. All accrued but uncollected interest related to the loan is deducted from income in the period the loan is assigned a nonaccrual status. For such period as a loan is in nonaccrual status, any cash receipts are applied first to principal, second to expenses incurred to cause payment to be made and lastly to the recovery of any reversed interest income and interest that would be due and owing subsequent to the loan being placed on nonaccrual status.
Nonaccrual loans and foreclosed assets, which make up total non-performing assets, amounted to approximately 0.16% and 0.13% of total loans at March 31, 2007 and December 31, 2006, respectively. Interest recognized on nonaccrual loans is immaterial to the Company’s operating results.
As of March 31, 2007 and December 31, 2006, the Company had $17.2 million in loans carried at fair value.
The Company held $21.3 million and $16.9 million in loans held for sale at March 31, 2007 and December 31, 2006, respectively, carried at fair value. These loans are originated on a best-efforts basis, whereby a commitment by a third party to purchase the loan has been received concurrent with the Banks’ commitment to the borrower to originate the loan.
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Hancock Holding Company and SubsidiariesNotes to Condensed Consolidated Financial Statements – (Continued)(Unaudited)
3. Loans and Allowance for Loan Losses (continued)
The following table sets forth, for the periods indicated, certain ratios related to the Company’s charge-offs, allowance for loan losses and outstanding loans:
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4. Goodwill and Other Intangible Assets
Goodwill represents costs in excess of the fair value of net assets acquired in connection with purchase business combinations. In accordance with the provisions of SFAS No. 142 “Goodwill and Other Intangibles”, the Company tests its goodwill for impairment annually. No impairment charges were recognized as of March 31, 2007. The carrying amount of goodwill was $62.3 million as of March 31, 2007 and December 31, 2006.
The following tables present information regarding the components of the Company’s identifiable intangible assets, and related amortization for the dates indicated (amounts in thousands):
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4. Goodwill and Other Intangible Assets (continued)
The remaining amortization expense for the core deposit intangibles in 2007 is estimated to be approximately $0.9 million. The amortization expense for core deposit intangibles is estimated to be approximately $1.1 million in 2008, $1.1 million in 2009, $1.1 million in 2010, $0.9 million in 2011 and the remainder of $1.4 million thereafter. The amortization of the value of business acquired, non-compete agreements and trade name are expected to approximate $349,974 for the remainder of 2007, $404,327 in 2008, $369,709 in 2009, $311,091 in 2010, $267,673 in 2011 and the remainder of $715,226 thereafter. The weighted-average amortization period used for intangibles is 10 years.
5. Mortgage Banking (including Mortgage Servicing Rights)
The Company adopted FASB Statement No. 156, Accounting for Servicing of Financial Assets (“SFAS No. 156”) on January 1, 2007 without material impact. SFAS No. 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable, and permits an entity to subsequently measure those servicing assets and servicing liabilities at fair value. Under SFAS No. 156, the Company decided to continue to use the amortization method instead of adopting the fair value measurement method. Management has determined that it has one class of servicing rights – mortgage servicing rights – which are based on the type of loan. The following are the risk characteristics of the underlying financial assets used to stratify servicing assets for purposes of measuring impairment: interest rate, type of product (fixed vs. variable), duration and asset quality. The fair value of the mortgage servicing rights was $2.1 million and $2.2 million as of March 31, 2007 and December 31, 2006, respectively. The fair value was based upon Bloomberg prepayment speeds for the performing portion of the portfolio and actual prepayment speeds for the watch list portion of the portfolio. The following table shows the amount of contractually specified fees for the three months ended March 31, 2007 and 2006, respectively:
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5. Mortgage Banking (including Mortgage Servicing Rights) (continued)
The gross carrying amount of mortgage servicing rights is equal to the net carrying amount. There was no valuation allowance on the mortgage servicing rights portfolio for the three months ended March 31, 2007 and the twelve months ended December 31, 2006.
The changes in the carrying amounts of mortgage servicing rights for the three months ended March 31, 2007 and for the twelve months ended December 31, 2006 are as follows ( in thousands):
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6. Comprehensive Loss
Comprehensive income (loss) is the change in equity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
In addition to net income, the Company has identified changes related to other nonowner transactions in the Consolidated Statements of Stockholders’ Equity. Changes in other nonowner transactions consist of changes in the fair value of securities available for sale and liability adjustments for pension and post-retirement benefit plans.
In the calculation of comprehensive income, certain reclassification adjustments are made to avoid duplicating items that are displayed as part of net income and other comprehensive income in that period or earlier periods. The following table reflects the reclassification amounts and the related tax effects of changes in fair value of securities available for sale and the liability adjustment for pension and post-retirement benefit plans for the year ended December 31, 2006 and the three months ended March 31, 2007.
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7. Earnings Per Share
Following is a summary of the information used in the computation of earnings per common share (in thousands):
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8. Stock-Based Payment Arrangements
Stock Option Plans
At March 31, 2007, the Company had two stock option plans. The 1996 Hancock Holding Company Long-Term Incentive Plan (the “1996 Plan”) that was approved by the Company’s shareholders in 1996 was designed to provide annual incentive stock awards. Awards as defined in the 1996 Plan include, with limitations, stock options (including restricted stock options), restricted and performance shares, and performance stock awards, all on a stand-alone, combination or tandem basis. A total of fifteen million (15,000,000) common shares can be granted under the 1996 Plan with an annual grant maximum of two percent (2%) of the Company’s outstanding common stock as reported for the fiscal year ending immediately prior to such plan year. Grants of restricted stock awards are limited to one-third of the grant totals.
The exercise price is equal to the market price on the date of grant, except for certain of those granted to major stockholders where the option price is 110% of the market price. Options awards generally vest based on five years of continuous service and have ten-year contractual terms. The Company’s policy is to issue new shares upon share option exercise and issue treasury shares upon restricted stock award vesting. The 1996 Long-Term Incentive Plan expired in 2006.
In March of 2005, the stockholders of the Company approved Hancock Holding Company’s 2005 Long-Term Incentive Plan (the “2005 Plan”). The 2005 Plan is designed to enable employees and directors to obtain a proprietary interest in the Company and to attract and retain outstanding personnel. The 2005 Plan provides that awards for up to an aggregate of five million (5,000,000) shares of the Company’s common stock may be granted during the term of the 2005 Plan. The 2005 Plan limits the number of shares for which awards may be granted during any calendar year to two percent (2%) of the outstanding Company’s common stock as reported for the fiscal year ending immediately prior to such plan year.
The fair value of each option award is estimated on the date of grant using Black-Scholes-Merton option valuation model that uses the assumptions noted in the following table. No grants have been issued in 2007. Expected volatilities are based on implied volatilities from traded options on the Company’s stock, historical volatility of the Company’s stock and other factors. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
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8. Stock-Based Payment Arrangements (continued)
A summary of option activity under the plans for the three months ended March 31, 2007, and changes during the three months then ended is presented below:
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9. Retirement Plans
Net periodic benefits cost includes the following components for the three months ended March 31, 2007 and 2006:
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12. Income Taxes
The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, An Interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007 and determined that there was no need to make an adjustment to retained earnings due to the adoption of this Interpretation. The total balance of unrecognized tax benefits at January 1, 2007, was $317,175. The Company does not expect that unrecognized tax benefits will significantly increase or decrease within the next 12 months.
It is the Company’s policy to recognize interest and penalties accrued relative to unrecognized tax benefits in income tax expense. As of January 1, 2007, $36,735 in interest, and $80,053 in penalties, had been accrued on the Company’s balance sheet.
The Company and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various returns in the states where its banking offices are located. Its filed income tax returns are no longer subject to examination by taxing authorities for years before 2003.
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13. Segment Reporting
The Company’s primary segments are geographically divided into the Mississippi (MS), Louisiana (LA), Florida (FL) and Alabama (AL) markets. Each segment offers the same products and services but is managed separately due to different pricing, product demand, and consumer markets. Each segment offers commercial, consumer and mortgage loans and deposit services. In the following tables, the column “Other” includes additional consolidated subsidiaries of the Company: Hancock Investment Services, Inc. and subsidiaries, Hancock Insurance Agency, Inc. and subsidiaries, Harrison Finance Company, Magna Insurance Company and subsidiary and three real estate corporations owning land and buildings that house bank branches and other facilities.
Following is selected information for the Company’s segments (amounts in thousands):
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13. Segment Reporting (continued)
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14. New Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”) which permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. Some requirements apply differently to entities that do not report net income. The FASB’s stated objective in issuing this standard is as follows: “to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.”
The fair value option established by Statement 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. The Company will adopt the provisions of SFAS No. 159 in the first quarter of 2008, as required.
In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”). This pronouncement requires an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability on its balance sheet. SFAS No. 158 also requires an employer to recognize changes in that funded status in the year in which the changes occur through comprehensive income effective for fiscal years ending after December 15, 2006. In addition, this statement requires an employer to measure the funded status of a plan as of its year-end balance sheet date effective for fiscal years ending after December 15, 2008. The Company adopted the requirement to recognize the funded status of the benefit plans and related disclosure requirements as of December 31, 2006. The Company is currently evaluating the requirements of SFAS No. 158 related to the measurement date and has not yet determined the impact of adoption on the Company’s consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS No. 157”) which defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company will be required to adopt SFAS No. 157 in the first quarter of fiscal year 2008. Management is currently evaluating the requirements of SFAS No. 157 but does not expect the impact to be significant.
In September 2006, the FASB ratified the consensus the EITF reached regarding EITF No.06-5, Accounting for Purchases of Life Insurance - Determining the Amount that Could Be Realized in Accordance with FASB Technical Bulletin 85-4 (“EITF 06-5”). The EITF concluded that a policyholder should consider any additional amounts included in the contractual terms of the life insurance policy in determining the “amount that could be realized under the insurance contract.” For group policies with multiple certificates or multiple policies with a group rider, the Task Force also tentatively concluded that the amount that could be realized should be determined at the individual policy or certificate level, i.e., amounts that would be realized only upon surrendering all of the policies or certificates would not be included when measuring the assets. The Company adopted EITF 06-5 effective January 1, 2007. The adoption of EITF 06-5 has not had a material impact on the Company’s financial condition or results of operations.
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14. New Accounting Pronouncements (continued)
In September 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The Company adopted SOP 05-1 effective January 1, 2007. The adoption of SOP 05-1 has not had a material impact on the Company’s financial condition or results of operations.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
General
The following discussion should be read in conjunction with our financial statements included with this report and our financial statements and related Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2006 included in our Annual Report on Form 10-K. Our discussion includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on certain assumptions we consider reasonable. For information about these assumptions, you should refer to the section below entitled “Forward-Looking Statements.”
We were organized in 1984 as a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and are headquartered in Gulfport, Mississippi. We currently operate more than 140 banking and financial services offices and more than 130 automated teller machines (ATMs) in the states of Mississippi, Louisiana, Florida and Alabama through four wholly-owned bank subsidiaries, Hancock Bank, Gulfport, Mississippi (Hancock Bank MS), Hancock Bank of Louisiana, Baton Rouge, Louisiana (Hancock Bank LA), Hancock Bank of Florida, Tallahassee, Florida (Hancock Bank FL) and Hancock Bank of Alabama, Mobile, Alabama (Hancock Bank AL). Hancock Bank MS, Hancock Bank LA, Hancock Bank FL and Hancock Bank AL are referred to collectively as the “Banks.”
The Banks are community oriented and focus primarily on offering commercial, consumer and mortgage loans and deposit services to individuals and small to middle market businesses in their respective market areas. Our operating strategy is to provide our customers with the financial sophistication and breadth of products of a regional bank, while successfully retaining the local appeal and level of service of a community bank. At March 31, 2007, we had total assets of $5.8 billion and employed on a full-time equivalent basis 1,311 persons in Mississippi, 573 persons in Louisiana, 43 persons in Florida and 2 persons in Alabama.
Selected Financial Data
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Liquidity Management and Contractual Obligations
Liquidity Management
Liquidity management encompasses our ability to ensure that funds are available to meet the cash flow requirements of depositors and borrowers, while also ensuring that we have adequate cash flow to meet our various needs, including operating, strategic and capital. In addition, our principal source of liquidity is dividends from our subsidiary banks.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities and occasional sales of various assets. Short-term investments such as federal funds sold, securities purchased under agreements to resell and maturing interest-bearing deposits with other banks are additional sources of funding.
The liability portion of the balance sheet provides liquidity through various customers’ interest-bearing and non-interest-bearing deposit accounts. Purchases of federal funds, securities sold under agreements to repurchase and other short-term borrowings are additional sources of liquidity and represent our incremental borrowing capacity. Our short-term borrowing capacity includes an approved line of credit with the Federal Home Loan Bank of $346.8 million and borrowing capacity at the Federal Reserve’s Discount Window in excess of $100 million.
During the quarter ended March 31, 2007, our subsidiary, Magna Insurance Company, sold three securities out of their portfolio to provide liquidity for surrenders of annuities for Magna Insurance Company. These three securities had a gross loss of $4,160.
The following liquidity ratios at March 31, 2007 and December 31, 2006 compare certain assets and liabilities to total deposits or total assets:
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Contractual Obligations
Payments due from us under specified long-term and certain other binding contractual obligations were scheduled in our annual report on Form 10-K for the year ended December 31, 2006. The most significant obligations, other than obligations under deposit contracts and short-term borrowings, were for operating leases for banking facilities.
Results of Operations
Net Income
Net income for the first quarter of 2007 totaled $19.2 million, a decrease of $2.8 million, or 13%, from the first quarter of 2006. Diluted earnings per share for the first quarter of 2007 were $0.58, a decrease of $0.09 from the same quarter a year ago. Return on average assets for the first quarter of 2007 was 1.32% compared to 1.49% for the first quarter of 2006. Return on average common equity was 13.77% compared to 18.34% for the same quarter a year ago.
Net Interest Income
Net interest income (te) for the first quarter decreased $4.5 million, or 8%, from the first quarter of 2006. The primary driver of the $4.5 million decrease in net interest income (te) was a $104.7 million, or 2%, decrease in average earning assets mainly from a reduction in total borrowings of $82.0 million, or 29%, and a decrease in average deposits of $39.8 million, or .8%. Our net interest margin (te) was 4% in the first quarter, 26 basis points narrower than the same quarter a year ago as the increase in the average earning asset yield (46 basis points) did not offset the increase in total funding costs (72 basis points).
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The following tables detail the components of our net interest spread and net interest margin.
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Provision for Loan Losses
The amount of the allowance for loan losses equals the cumulative total of the provisions for loan losses, reduced by actual loan charge-offs, and increased by recoveries of loans previously charged-off. Provisions are made to the allowance to reflect the currently perceived risks of loss associated with our loan portfolio. A specific loan is charged-off when management believes, after considering, among other things, the borrower’s financial condition and the value of any collateral, that collection of the loan is unlikely.
Annualized net charge-offs, as a percent of average loans, were 0.18% for the first quarter of 2007, compared to -0.01% in the first quarter of 2006. During the first quarter of 2006, we recorded a large recovery that drove the negative net charge-off ratio. The provision for the quarter ended March 31, 2007 reflects more normalized activity and is within management’s expectations.
The following information is useful in determining the adequacy of the loan loss allowance and loan loss provision. The ratios are calculated using average loan balances. (Dollar amounts shown are in thousands.)
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The components of noninterest income for the three months ended March 31, 2007 and 2006 are presented in the following table:
Noninterest Expense
Operating expenses for the first quarter were $0.2 million, or .4%, higher compared to the same quarter a year ago. The increase from the same quarter a year ago was reflected in higher levels of personnel expense (up $0.4 million) and occupancy expense (up $0.4 million), with lower levels of equipment expense (down $0.4 million) and other expenses (down $0.2 million).
The following table presents the components of noninterest expense for the three months ended March 31, 2007 and 2006.
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Income Taxes
Our effective federal income tax rate continues to be less than the statutory rate of 35% due primarily to tax-exempt interest income. For the three months ended March 31, 2007 and 2006, the effective federal income tax rate was approximately 29% and 33%, respectively. The decrease in the effective rate in 2007 is due primarily to the increase in the percentage of tax-exempt interest income as it relates to book income. The total amount of tax-exempt income earned during the first three months of 2007 was $4.4 million compared to $3.5 million for the comparable period in 2006. Tax-exempt income for three months ended March 31, 2007 consisted of $1.7 million from securities and $2.7 million from loans and leases. Tax-exempt income for the first three months of 2006 consisted of $1.7 million from securities and $1.8 million from loans and leases.
Off-Balance Sheet Transactions
In the normal course of business, we enter into financial instruments, such as commitments to extend credit and letters of credit, to meet the financing needs of our customers. Such instruments are not reflected in the accompanying condensed consolidated financial statements until they are funded and involve, to varying degrees, elements of credit risk not reflected in the condensed consolidated balance sheets. The contract amounts of these instruments reflect our exposure to credit loss in the event of non-performance by the other party on whose behalf the instrument has been issued. We undertake the same credit evaluation in making commitments and conditional obligations as we do for on-balance-sheet instruments and may require collateral or other credit support for off-balance-sheet financial instruments.
At March 31, 2007, we had $1.2 billion in unused loan commitments outstanding, of which approximately $478.4 million were at variable rates, with the remainder at fixed rates. A commitment to extend credit is an agreement to lend to a customer as long as the conditions established in the agreement have been satisfied. A commitment to extend credit generally has a fixed expiration date or other termination clauses and may require payment of a fee by the borrower. Since commitments often expire without being fully drawn, the total commitment amounts do not necessarily represent our future cash requirements. We continually evaluate each customer’s credit worthiness on a case-by-case basis. Occasionally, a credit evaluation of a customer requesting a commitment to extend credit results in our obtaining collateral to support the obligation.
Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The credit risk involved in issuing a letter of credit is essentially the same as that involved in extending a loan. At March 31, 2007, we had $70.5 million in letters of credit issued and outstanding.
The following table shows the commitments to extend credit and letters of credit at March 31, 2007 according to expiration date.
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Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements. We prepare these financial statements in conformity with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We base our estimates on historical experience, available information and various other assumptions we believe to be reasonable under the circumstances. On an on-going basis, we evaluate our estimates; however, actual results may differ from these estimates under different assumptions or conditions. There have been no material changes or developments in our evaluation of the accounting estimates and the underlying assumptions or methodologies that we believe to be Critical Accounting Policies and Estimates as disclosed in our Form 10-K for the year ended December 31, 2006.
New Accounting Pronouncements
The fair value option established by Statement 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. We will adopt the provisions of SFAS No. 159 in the first quarter of 2008, as required.
In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”). This pronouncement requires an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability on its balance sheet. SFAS No. 158 also requires an employer to recognize changes in that funded status in the year in which the changes occur through comprehensive income effective for fiscal years ending after December 15, 2006. In addition, this statement requires an employer to measure the funded status of a plan as of its year-end balance sheet date effective for fiscal years ending after December 15, 2008. We adopted the requirement to recognize the funded status of the benefit plans and related disclosure requirements as of December 31, 2006. We are currently evaluating the requirements of SFAS No. 158 related to the measurement date and have not yet determined the impact of adoption on our consolidated financial position, results of operations and cash flows.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS No. 157”) which defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We will be required to adopt SFAS No. 157 in the first quarter of fiscal year 2008. Management is currently evaluating the requirements of SFAS No. 157 but does not expect the impact to be significant.
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In September 2006, the FASB ratified the consensus the EITF reached regarding EITF No.06-5, Accounting for Purchases of Life Insurance - Determining the Amount that Could Be Realized in Accordance with FASB Technical Bulletin 85-4 (“EITF 06-5”). The EITF concluded that a policyholder should consider any additional amounts included in the contractual terms of the life insurance policy in determining the “amount that could be realized under the insurance contract.” For group policies with multiple certificates or multiple policies with a group rider, the Task Force also tentatively concluded that the amount that could be realized should be determined at the individual policy or certificate level, i.e., amounts that would be realized only upon surrendering all of the policies or certificates would not be included when measuring the assets. We adopted EITF 06-5 effective January 1, 2007. The adoption of EITF 06-5 has not had a material impact on our financial condition or results of operations.
In September 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. We adopted SOP 05-1 effective January 1, 2007. The adoption of SOP 05-1 has not had a material impact on our financial condition or results of operations.
Forward Looking Information
Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company’s anticipated future financial performance. This Act provides a safe harbor for such disclosures that protects the companies from unwarranted litigation if the actual results are different from management expectations. This report contains forward-looking statements and reflects management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. These forward-looking statements are subject to a number of factors and uncertainties that could cause our actual results and experience to differ from the anticipated results and expectations expressed in such forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our net earnings are dependent, in part, on our net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. Interest rate risk sensitivity is the potential impact of changing rate environments on both net interest income and cash flows. In an attempt to manage our exposure to changes in interest rates, management monitors interest rate risk and administers an interest rate risk management policy designed to produce a relatively stable net interest margin in periods of interest rate fluctuations.
Notwithstanding our interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income and the fair value of our investment securities. As of quarter close, the effective duration of the securities portfolio was 2.18. A rate increase of 100 basis points would move the effective duration to 2.53, while a reduction in rates of 100 basis points would result in an effective duration of 1.46.
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The foregoing disclosures related to our market risk should be read in conjunction with our audited consolidated financial statements, related notes and management’s discussion and analysis for the year ended December 31, 2006 included in our 2006 Annual Report on Form 10-K.
Item 4. Controls and Procedures
At the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officers and the Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15 (e) and 15d-15 (e) under the Exchange Act). Based upon that evaluation, our Chief Executive Officers and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report to timely alert them to material information relating to us (including our consolidated subsidiaries) required to be included in our Exchange Act filings.
Our management, including the Chief Executive Officers and Chief Financial Officer, identified no change in our internal control over financial reporting that occurred during the three month period ended March 31, 2007, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
Item 1A. Risk Factors.
There have been no material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2006.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
The following table provides information with respect to purchases made by the issuer or any affiliated purchaser of the issuer’s equity securities.
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Item 4. Submission of Matters to a Vote of Security Holders.
Item 6. Exhibits.
(a) Exhibits:
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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.
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Index to Exhibits