Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
31,608,403 common shares were outstanding as of October 31, 2007 for financial statement purposes.
Hancock Holding Company
Index
Part I. Financial Information
Item 1. Financial Statements
Hancock Holding Company and SubsidiariesCondensed Consolidated Balance Sheets(In thousands, except share data)
1
Hancock Holding Company and SubsidiariesCondensed Consolidated Statements of Income(Unaudited)(In thousands, except per share amounts)
2
Hancock Holding Company and SubsidiariesCondensed Consolidated Statements of Stockholders’ Equity(Unaudited)(In thousands, except share and per share data)
3
Hancock Holding Company and SubsidiariesCondensed Consolidated Statements of Cash Flows(Unaudited)(In thousands)
4
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 all of which are of a normal recurring nature which, in the opinion of management, are necessary to present fairly the Company’s Condensed Consolidated Balance Sheets at September 30, 2007 and December 31, 2006, the Company’s Condensed Consolidated Statements of Stockholders’ Equity and Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 and the Company’s Condensed Consolidated Statements of Income for the three and nine months ended September 30, 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 nine months ended September 30, 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 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
Available for Sale Securities
5
Hancock Holding Company and SubsidiariesNotes to Condensed Consolidated Financial Statements – (Continued)(Unaudited)
3. Loans and Allowance for Loan Losses
Loans, net of unearned income, totaled $3.5 billion and $3.2 billion at September 30, 2007 and December 31, 2006, respectively. The Company also held $17.7 million and $16.9 million in loans held for sale at September 30, 2007 and December 31, 2006, respectively, carried at lower of cost or 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.
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.
The Company’s investments in impaired loans at September 30, 2007 and December 31, 2006 were $33.0 million and $26.8 million, respectively. The amount of interest that was not recognized on nonaccrual loans would not have had a material effect on earnings for the three and nine months ended September 30, 2007 and September 30, 2006.
Nonaccrual loans and foreclosed assets, which make up total non-performing assets, amounted to approximately 0.28% and 0.13% of total loans at September 30, 2007 and December 31, 2006, respectively. Interest recognized on nonaccrual loans is immaterial to the Company’s operating results.
The following table presents, for the periods indicated, non-performing assets:
6
3. Loans and Allowance for Loan Losses (continued)
The following table sets forth, for the periods indicated, allowance for loan losses, amounts charged-off and recoveries of loans previously charged-off (in thousands):
7
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:
8
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 Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and Other Intangibles (“SFAS 142”), the Company tests its goodwill for impairment annually. No impairment charges were recognized as of September 30, 2007. The carrying amount of goodwill was $62.3 million as of September 30, 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 (in thousands):
9
4. Goodwill and Other Intangible Assets (continued)
The remaining amortization expense for the core deposit intangibles in 2007 is estimated to be approximately $303,000. The amortization expense for core deposit intangibles is estimated to be approximately $1.114 million in 2008, $1.114 million in 2009, $1.114 million in 2010, $0.909 million in 2011 and the remainder of $1.386 million thereafter. The amortization of the value of business acquired, non-compete agreements and trade name are expected to approximate $110,000 for the remainder of 2007, $404,000 in 2008, $370,000 in 2009, $311,000 in 2010, $268,000 in 2011 and the remainder of $792,000 thereafter. The weighted-average amortization period used for intangibles is 10 years.
5. Mortgage Banking (including Mortgage Servicing Rights)
The Company adopted SFAS 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 versus variable), duration and asset quality. The fair values of the mortgage servicing rights were $1.8 million and $2.2 million as of September 30, 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 amounts (in thousands) of contractually specified fees for the three and nine months ended September 30, 2007 and 2006, respectively:
10
5. Mortgage Banking (including Mortgage Servicing Rights) (continued)
The gross carrying amount of mortgage servicing rights is equal to the net carrying amount. There were no valuation allowances on the mortgage servicing rights portfolio as of September 30, 2007 or December 31, 2006.
The changes in the carrying amounts of mortgage servicing rights as of September 30, 2007 and as of December 31, 2006 are as follows (in thousands):
11
6. Earnings Per Share
Following is a summary of the information used in the computation of earnings per common share (in thousands):
12
7. Stock-Based Payment Arrangements
Stock Option Plans
At September 30, 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. Option 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 upon restricted stock award vesting. The 1996 Long-Term Incentive Plan expired in 2006 and no additional awards may be granted under the 1996 Plan.
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. 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.
13
7. Stock-Based Payment Arrangements (continued)
A summary of option activity under the plans for the nine months ended September 30, 2007, and changes during the nine months then ended is presented below:
The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $4.0 million and $8.2 million, respectively.
A summary of the status of the Company’s nonvested shares as of September 30, 2007, and changes during the nine months ended September 30, 2007, is presented below:
14
8. Retirement Plans
Net periodic benefits cost includes the following components for the three and nine months ended September 30, 2007 and 2006:
15
9. Other Service Charges, Commission and Fees, and Other Income
10. Other Expense
Components of other expense are as follows:
16
11. 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 September 30, 2007, was $30,044. 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 September 30, 2007, $3,571 in interest has 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 2004.
12. 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.
17
12. Segment Reporting (continued)
Following is selected information for the Company’s segments (in thousands):
18
19
13. New Accounting Pronouncements
In November 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings (“SAB No. 109”). SAB No. 109 rescinds SAB No. 105’s prohibition on inclusion of expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB No. 109 also applies to any loan commitments for which fair value accounting is elected under SFAS No. 159. SAB No. 109 is effective prospectively for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The Company is currently assessing the financial impact of adopting SAB No. 109.
In June 2007, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force (“EITF”) Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Award. The objective of this issue is to determine the accounting for the income tax benefits of dividend or dividend equivalents when the dividends or dividend equivalents are: (a) linked to equity-classified nonvested shares or share units or equity-classified outstanding share options and (b) charged to retained earnings under FASB Statement No. 123 (Revised 2004), Share-Based Payment. The Task Force reached a consensus that EITF No. 06-11 should be applied prospectively to the income tax benefits of dividends on equity-classified employee share-based payment awards that are declared in fiscal years beginning after September 15, 2007. Management is currently evaluating the requirements of EITF No. 06-11 but does not expect the impact to be significant.
In March 2007, the FASB ratified EITF No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements. One objective of EITF No. 06-10 is to determine whether a liability for future benefits under a collateral assignment split-dollar life insurance arrangement that provides a benefit to an employee that extends into postretirement periods should be recognized in accordance with SFAS No. 106 or APB Opinion 12, as appropriate, based on the substantive agreement with the employee. Another objective of EITF No. 06-10 is to determine how the asset arising from a collateral assignment split-dollar life insurance arrangement should be recognized and measured. EITF No. 06-10 is effective for fiscal years beginning after December 15, 2007. Management is currently evaluating the requirements of EITF No. 06-10 but does not expect the impact to be significant.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment SFAS 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 SFAS No. 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 but does not expect the impact to be significant.
20
13. New Accounting Pronouncements (continued)
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 SFAS 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 No. 06-5 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 No. 06-5 effective January 1, 2007. The adoption of EITF No. 06-5 has not had a material impact on the Company’s 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. 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.
21
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 September 30, 2007, we had total assets of $5.9 billion and employed on a full-time equivalent basis 1,319 persons in Mississippi, 571 persons in Louisiana, 49 persons in Florida and 27 persons in Alabama.
Net income for the third quarter of 2007 totaled $17.7 million, a decrease of $18.3 million, or 51%, from the third quarter of 2006. Diluted earnings per share for the third quarter of 2007 were $0.55, a decrease of $0.56 from the same quarter a year ago. Return on average assets for the third quarter of 2007 was 1.21% compared to 2.36% for the third quarter of 2006. Return on average common equity was 12.58% compared to 27.58% for the same quarter a year ago.
Net income for 2006 was affected by several items related to the impact of Hurricane Katrina, which made landfall in our operating region on August 29, 2005. In the third quarter of 2006, we reversed $20.0 million from the storm-related allowance for loan losses due to better than expected loss experience with storm-impacted credits, adding $13.0 million in after-tax earnings and $.39 in diluted earnings per share to the third quarter of 2006.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income (te) for the third quarter decreased $5.7 million, or 10%, from the third quarter of 2006. The primary driver of the $5.7 million decrease in net interest income (te) was a $250 million, or 5%, decrease in average earning assets mainly to fund a reduction in total borrowings of $98.6 million, or 32%, and a decrease in average deposits of $114.1 million, or 2%. The decrease in borrowings and deposits was generally attributable to the regional post-Katrina economy. Our net interest margin (te) was 4% in the third quarter, 23 basis points narrower than the same quarter a year ago as the increase in the average earning asset yield (21 basis points) did not offset the increase in total funding costs (45 basis points). See tables on pages 25-30 for details.
22
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. 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. Provisions are made to the allowance to reflect the currently perceived risks of loss associated with our loan portfolio. Management utilizes quantitative methodologies and modeling to determine the adequacy of the allowance for loan and lease losses and is of the opinion that the allowance at September 30, 2007 is adequate.
Annualized net charge-offs, as a percent of average loans, were 0.21% for the third quarter of 2007, compared to 0.34% in the third quarter of 2006.
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 (amounts in thousands).
Accruing loans 90 days or more past due increased $193,000 from September 30, 2006. Since December 31, 2005, accruing loans 90 days or more past due, net of deferrals, have decreased $21.8 million to $3.8 million at September 30, 2007. In the third quarter of 2006, we reversed $20.0 million from the storm-related allowance for loan losses due to better than expected loss experience with storm-impacted credits, adding $13.0 million in after-tax earnings and $.39 in diluted earnings per share to the third quarter of 2006. This decrease is related to improved ability of certain borrowers to meet their regular payments after Hurricane Katrina.
Noninterest Income
Noninterest income (excluding securities transactions) for the third quarter was up $4.9 million, or 19%, compared to the same quarter a year ago. The primary factors impacting the higher levels of non-interest income (excluding securities transactions) as compared to the same quarter a year ago, were higher levels of service charge income (up $1.4 million, or 14%), trust fees (up $0.7 million, or 23%), investment and annuity fees (up $0.7 million, or 29%) and other income (up $1.6 million, or 35%).
The components of noninterest income for the three and nine months ended September 30, 2007 and 2006 are presented in the following table:
23
Noninterest Expense
Operating expenses for the third quarter were $4.9 million, or 10%, higher compared to the same quarter a year ago. The increase from the same quarter a year ago was reflected in higher levels of occupancy expense (up $1.8 million), personnel expense (up $1.5 million) and other operating expense (up $1.4 million).
The following table presents the components of noninterest expense for the three and nine months ended September 30, 2007 and 2006.
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 nine months ended September 30, 2007 and 2006, the effective federal income tax rates were approximately 29% and 32%, 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 nine months of 2007 was $12.7 million compared to $10.9 million for the comparable period in 2006. Tax-exempt income for nine months ended September 30, 2007 consisted of $4.8 million from securities and $7.9 million from loans and leases. Tax-exempt income for the
24
first nine months of 2006 consisted of $5.0 million from securities and $5.9 million from loans and leases.
Selected Financial Data
The following tables contain selected financial data comparing our consolidated results of operations for the three and nine months ended September 30, 2007 and 2006.
25
26
27
28
The following tables detail the components of our net interest spread and net interest margin.
29
30
LIQUIDITY
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 $334.4 million and borrowing capacity at the Federal Reserve’s Discount Window in excess of $100 million.
During the nine months ended September 30, 2007, our subsidiary, Magna Insurance Company, sold thirty securities out of their portfolio to provide liquidity for surrenders of annuities for Magna Insurance Company. These securities had a gross loss of $37,164. During the nine months ended September 30, 2007, FNMA bonds were called at a gross loss of $10, 269.
The following liquidity ratios at September 30, 2007 and December 31, 2006 compare certain assets and liabilities to total deposits or total assets:
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. There have been no material changes since year end.
31
CAPITAL RESOURCES
We continue to maintain an adequate capital position. The ratios as of September 30, 2007 and December 31, 2006 are as follows:
Off-Balance Sheet Arrangements
Loan Commitments and Letters of Credit
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 September 30, 2007, we had $1.2 billion in unused loan commitments outstanding, of which approximately $528.8 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.
32
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 September 30, 2007, we had $84.4 million in letters of credit issued and outstanding.
The following table shows the commitments to extend credit and letters of credit at September 30, 2007 according to expiration date.
Our liability associated with letters of credit is not material to our condensed consolidated financial statements.
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
See Note 13 to our Condensed Consolidated Financial Statements included elsewhere in this report.
Forward Looking Statements
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.
33
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our net income is 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 September 30, 2007, the effective duration of the securities portfolio was 2.38 years. A rate increase (aged, over 1 year) of 100 basis points would move the effective duration to 2.70 years, while a reduction in rates of 100 basis points would result in an effective duration of 1.20 years.
In adjusting our asset/liability position, the Board and management attempt to manage our interest rate risk while enhancing net interest margins. This measurement is done primarily by running net interest income simulations. The net interest income simulations run at September 30, 2007 indicate that we are asset sensitive to some extent as compared to the stable rate environment. Exposure to instantaneous changes in interest rate risk for the current quarter is presented in the following table.
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 nine month period ended September 30, 2007, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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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.
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.
None
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