Simmons First National - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

SIMMONS FIRST NATIONAL CORPORATION

 

 

 

 

 

870-541-1000

(Registrant's telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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.   SYes   £No

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. (Check one):

 

 

The number of shares outstanding of the Registrant’s Common Stock as of April 28, 2008 was 13,936,856.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SIMMONS FIRST NATIONAL CORPORATION

 

(Unaudited)

NOTE 1:                      BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Simmons First National Corporation and its subsidiaries.  Significant intercompany accounts and transactions have been eliminated in consolidation.

All adjustments made to the unaudited financial statements were of a normal recurring nature.  In the opinion of management, all adjustments necessary for a fair presentation of the results of interim periods have been made. Certain prior year amounts are reclassified to conform to current year classification.  The consolidated balance sheet of the Company as of December 31, 2007 has been derived from the audited consolidated balance sheet of the Company as of that date.  The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2007 filed with the Securities and Exchange Commission.

Recently Issued Accounting Pronouncements

Emerging Issues Task Force (“EITF”) Issue No. 06-4, Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, requires the recognition of a liability and related compensation expense for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to post-retirement periods.  Under EITF 06-4, life insurance policies purchased for the purpose of providing such benefits do not effectively settle an entity's obligation to the employee.  Accordingly, the entity must recognize a liability and related compensation expense during the employee's active service period based on the future cost of insurance to be incurred during the employee's retirement.  If the entity has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in Statement of Financial Accounting Standards (“SFAS”) No. 106, Employer's Accounting for Postretirement Benefits Other Than Pensions.  The Company adopted EITF 06-4 on January 1, 2008 as a change in accounting principle through a cumulative-effect adjustment to retained earnings totaling $1,174,000.  The Company does not expect the adoption of EITF 06-4 to have a material impact on the Company’s ongoing financial position or results of operations.

On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  For additional information, see Note 16 – Fair Value Measurements.

In February 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.  SFAS 159 permits entities to choose to measure eligible items at fair value at specified election dates.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date.  The fair value option (i) may be applied instrument by instrument, with certain exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. While SFAS 159 is effective for the Company beginning January 1, 2008, the Company has not elected the fair value option that is offered by this statement.

There have been no other significant changes to the Company’s accounting policies from the 2007 Form 10-K.

Earnings Per Share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during each year.  Diluted earnings per share are computed using the weighted average common shares and all potential dilutive common shares outstanding during the period.

Following is the computation of per share earnings for the three months ended March 31, 2008 and 2007.

 

 

NOTE 2:                      INVESTMENT SECURITIES

The amortized cost and fair value of investment securities that are classified as held-to-maturity and available-for-sale are as follows:

  

The carrying value, which approximates the fair value, of securities pledged as collateral, to secure public deposits and for other purposes, amounted to $412,266,000 at March 31, 2008 and $410,645,000 at December 31, 2007.

The book value of securities sold under agreements to repurchase amounted to $90,776,000 and $91,466,000 for March 31, 2008 and December 31, 2007, respectively.

Income earned on securities for the three months ended March 31, 2008 and 2007 is as follows:

 

 

Maturities of investment securities at March 31, 2008 are as follows:

 

 

There were no realized gains or losses on investment securities for the three-months ended March 31, 2008 or 2007.

The state and political subdivision debt obligations are primarily non-rated bonds and represent small, Arkansas issues, which are evaluated on an ongoing basis.

NOTE 3:                      LOANS AND ALLOWANCE FOR LOAN LOSSES

The various categories of loans are summarized as follows:

 

At March 31, 2008 and December 31, 2007, impaired loans totaled $12,942,000 and $12,519,000, respectively.  All impaired loans had either specific or general allocations within the allowance for loan losses.  Allocations of the allowance for loan losses relative to impaired loans were $3,106,000 at March 31, 2008 and $2,851,000 at December 31, 2007.  Approximately $59,000 and $73,000 of interest income was recognized on average impaired loans of $12,731,000 and $11,320,000 as of March 31, 2008 and 2007, respectively.  Interest recognized on impaired loans on a cash basis during the first three months of 2008 and 2007 was immaterial.

 

 

 

Goodwill is tested annually for impairment.  If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value.  Subsequent increases in goodwill value are not recognized in the financial statements.

Core deposit premiums are periodically evaluated as to the recoverability of their carrying value.

The carrying basis and accumulated amortization of core deposit premiums (net of core deposit premiums that were fully amortized) at March 31, 2008 and December 31, 2007, were as follows:

 

NOTE 5:                      TIME DEPOSITS

Time deposits include approximately $449,199,000 and $452,262,000 of certificates of deposit of $100,000 or more at March 31, 2008 and December 31, 2007 respectively.

NOTE 6:                      INCOME TAXES

The provision for income taxes is comprised of the following components:

 

 

The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:

 

 

 

 

A reconciliation of income tax expense at the statutory rate to the Company's actual income tax expense is shown below:

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.

The Company files income tax returns in the U.S. federal jurisdiction.  The Company’s U.S. federal income tax returns are open and subject to examinations from the 2004 tax year and forward.  The Company’s various state income tax returns are generally open from the 2004 and later tax return years based on individual state statute of limitations.

 

 

NOTE 7:                      SHORT-TERM AND LONG-TERM DEBT

Long-term debt at March 31, 2008 and December 31, 2007, consisted of the following components:

The trust preferred securities are tax-advantaged issues that qualify for Tier 1 capital treatment. Distributions on these securities are included in interest expense on long-term debt.  Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds thereof in junior subordinated debentures of the Company, the sole asset of each trust.  The preferred securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the junior subordinated debentures held by the trust.  The common securities of each trust are wholly-owned by the Company.  Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated debentures.  The Company’s obligations under the junior subordinated securities and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by the Company of each respective trust’s obligations under the trust securities issued by each respective trust.

Aggregate annual maturities of long-term debt at March 31, 2008 are:

 

 

The Company and/or its subsidiaries have various unrelated legal proceedings, most of which involve loan foreclosure activity pending, which, in the aggregate, are not expected to have a material adverse effect on the financial position of the Company and its subsidiaries.  The Company or its subsidiaries remain the subject of one (1) lawsuit asserting claims against the Company or its subsidiaries.

On October 1, 2003, an action in Pulaski County Circuit Court was filed by Thomas F. Carter, Tena P. Carter and certain related entities against Simmons First Bank of South Arkansas and Simmons First National Bank alleging wrongful conduct by the banks in the collection of certain loans.  The Company was later added as a party defendant.  The plaintiffs are seeking $2,000,000 in compensatory damages and $10,000,000 in punitive damages.  The Company and the banks have filed Motions to Dismiss.  The plaintiffs were granted additional time to discover any evidence for litigation, and have submitted such findings.  At the hearing on the Motions for Summary Judgment, the Court dismissed Simmons First National Bank due to lack of venue.  Venue has been changed to Jefferson County for the Company and Simmons First Bank of South Arkansas.  At this time, no basis for any material liability has been identified.  Non-binding mediation is set for June 24, 2008.  The Company and the bank continue to vigorously defend the claims asserted in the suit.

NOTE 9:                      CAPITAL STOCK

On November 28, 2007, the Company announced the adoption by the Board of Directors of a stock repurchase program.  The program authorizes the repurchase of up to 700,000 shares of Class A common stock, or approximately 5% of the outstanding common stock.  Under the repurchase program, there is no time limit for the stock repurchases, nor is there a minimum number of shares the Company intends to repurchase.  The Company may discontinue purchases at any time that management determines additional purchases are not warranted.  The shares are to be purchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending upon market conditions.  The Company intends to use the repurchased shares to satisfy stock option exercises, payment of future stock dividends and general corporate purposes.

During the three-month period ended March 31, 2008, the Company repurchased 23,480 shares of stock under the repurchase plan with a weighted average repurchase price of $26.65 per share.  Under the current stock repurchase plan, the Company can repurchase an additional 624,490 shares.

NOTE 10:                     UNDIVIDED PROFITS

The Company’s subsidiary banks are subject to a legal limitation on dividends that can be paid to the parent company without prior approval of the applicable regulatory agencies.  The approval of the Comptroller of the Currency is required, if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits, as defined, for that year combined with its retained net profits of the preceding two years.  Arkansas bank regulators have specified that the maximum dividend limit state banks may pay to the parent company without prior approval is 75% of current year earnings plus 75% of the retained net earnings of the preceding year.  At March 31, 2008, the bank subsidiaries had approximately $15.7 million available for payment of dividends to the Company, without prior approval of the regulatory agencies.

 

The Federal Reserve Board's risk-based capital guidelines include the definitions for (1) a well-capitalized institution, (2) an adequately-capitalized institution, and (3) an undercapitalized institution.  The criteria for a well-capitalized institution are: a 5% "Tier l leverage capital" ratio, a 6% "Tier 1 risk-based capital" ratio, and a 10% "total risk-based capital" ratio.  As of March 31, 2008, each of the eight subsidiary banks met the capital standards for a well-capitalized institution.  The Company's “total risk-based capital” ratio was 13.65% at March 31, 2008.

NOTE 11:                     STOCK BASED COMPENSATION

The Company’s Board of Directors has adopted various stock compensation plans.  The plans provide for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, and bonus stock awards.  Pursuant to the plans, shares are reserved for future issuance by the Company, upon exercise of stock options or awarding of bonus shares granted to directors, officers and other key employees.

The table below summarizes the transactions under the Company's active stock compensation plans for the three months ended March 31, 2008:

The following table summarizes information about stock options under the plans outstanding at March 31, 2008:

 

 

 

Stock-based compensation expense totaled $59,766 and $44,300 during the three months ended March 31, 2008 and 2007, respectively.  Stock-based compensation expense is recognized ratably over the requisite service period for all stock-based awards.  Unrecognized stock-based compensation expense related to stock options totaled $410,944 at March 31, 2008.  At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 1.83 years.  Unrecognized stock-based compensation expense related to non-vested stock awards was $816,279 at March 31, 2008.  At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 1.73 years.

Aggregate intrinsic values of outstanding stock options and exercisable stock options at March 31, 2008 were $4.8 million and $4.5 million, respectively.  Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $29.73 as of March 31, 2008, and the exercise price multiplied by the number of options outstanding.  The total intrinsic values of stock options exercised during the three months ended March 31, 2008 and 2007, were $1.2 million and $193,825, respectively.

NOTE 12:                     ADDITIONAL CASH FLOW INFORMATION

 

NOTE 13:                     OTHER OPERATING EXPENSES

Other operating expenses consist of the following:

 

NOTE 14:                     CERTAIN TRANSACTIONS

From time to time the Company and its subsidiaries have made loans and other extensions of credit to directors, officers, their associates and members of their immediate families. From time to time directors, officers and their associates and members of their immediate families have placed deposits with the Company’s subsidiary banks.  Such loans, other extensions of credit and deposits were made in the ordinary course of business, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons and did not involve more than normal risk of collectibility or present other unfavorable features.

 

The Company grants agri-business, commercial and residential loans to customers throughout Arkansas, along with credit card loans to customers throughout the United States.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Each customer's creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the counterparty.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

At March 31, 2008, the Company had outstanding commitments to extend credit aggregating approximately $246,273,000 and $448,300,000 for credit card commitments and other loan commitments, respectively.  At December 31, 2007, the Company had outstanding commitments to extend credit aggregating approximately $244,052,000 and $411,421,000 for credit card commitments and other loan commitments, respectively.

Letters of credit are conditional commitments issued by the Company, to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.  The Company had total outstanding letters of credit amounting to $10,366,000 and $9,906,000 at March 31, 2008 and December 31, 2007, respectively, with terms ranging from 90 days to three years.  At March 31, 2008 and December 31, 2007 the Company’s deferred revenue under standby letter of credit agreements is approximately $10,000 and $42,000, respectively.

NOTE 16:                     FAIR VALUE MEASUREMENTS

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS 157 has been applied prospectively as of the beginning of the year.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  SFAS 157 also establishes a fair value hierarchy which requires the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:

 

 

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-Sale Securities

Available-for-sale securities are the only material instruments valued on a recurring basis which are held by the Company at fair value.  Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.  Level 2 securities include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.  Currently, all of the Company's securities are considered to be Level 2 securities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired Loans

Impaired loans are the only material instruments valued on a nonrecurring basis which are held by the Company at fair value.  Loan impairment is reported when full payment under the loan terms is not expected.  Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate, or the fair value of collateral if the loan is collateral dependent.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance.  If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses.  Loan losses are charged against the allowance when Management believes the uncollectability of a loan is confirmed.  Impaired loans, net of specific allowance, were $9,836,000 as of March 31, 2008.  This valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

 

Certified Public Accountants

200 East Eleventh

Pine Bluff, Arkansas

Audit Committee, Board of Directors and Stockholders

Simmons First National Corporation

Pine Bluff, Arkansas

We have reviewed the accompanying consolidated balance sheet of SIMMONS FIRST NATIONAL CORPORATION as of March 31, 2008, and the related condensed statements of income, stockholders’ equity and cash flows for the three-month periods ended March 31, 2008 and 2007.  These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2007, and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended (not presented herein); and in our report dated February 21, 2008, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2007, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Pine Bluff, Arkansas

May 12, 2008

 

 

and Results of Operations

Simmons First National Corporation recorded net income of $8,816,000 for the three-months ended March 31, 2008, a $2,179,000, or 32.83% increase from net income of $6,637,000 for the same period in 2007.  Diluted earnings per share increased $0.17, or 36.96%, to $0.63 for the three-months ended March 31, 2008, compared to $0.46 for the same period in 2007.  The Company’s return on average assets and return on average stockholders’ equity for the three-month period ended March 31, 2008, were 1.28% and 12.76%, compared to 1.01% and 10.25%, respectively, for the same period in 2007.

During the first quarter of 2008, the Company recorded a nonrecurring $0.05 increase in diluted earnings per share related to the reversal of a $1.2 million pre-tax contingent liability established during the fourth quarter of 2007.  That contingent liability represented the Company’s pro-rata portion of Visa, Inc.’s, and its related subsidiary Visa U.S.A.’s (collectively “Visa”), litigation liabilities, which was satisfied in conjunction with Visa’s initial public offering (“IPO”).  Also as a result of Visa’s IPO, the Company received cash proceeds from the mandatory partial redemption of its equity interest in Visa, resulting in a nonrecurring $3.0 million pre-tax gain in the first quarter 2008, or $0.13 per diluted common share.  Finally, associated with its membership in Visa, the Company received 110,308 class B shares of Visa.  The class B shares have a restricted holding period and the Company will not recognize any gain until such time the shares are redeemed for cash or otherwise disposed of.

Operating earnings (net income excluding nonrecurring items {Visa litigation expense reversal and gain from the cash proceeds on mandatory Visa stock redemption}) for the three-months ended March 31, 2008 and 2007, were $6,258,000 and $6,637,000, respectively.  Diluted operating earnings per share for these same periods were $0.45 and $0.46, respectively, a decrease of $0.01 per share, or 2.2%.

The allowance for loan losses as a percent of total loans was 1.38% as of March 31, 2008.  Non-performing loans equaled 0.60% of total loans, unchanged from year end.  The non-performing asset ratio was 0.79%, up four basis points from year end.  The allowance for loan losses was 229% of non-performing loans.  The Company’s annualized net charge-offs to total loans for the first quarter of 2008 was 0.30%.  Excluding credit cards, the annualized net charge-offs to total loans for the first quarter was 0.19%.  Annualized net credit card charge-offs for the first quarter were 1.47%, more than 400 basis points below the most recently published credit card charge-off industry average.  The Company does not own any securities backed by subprime mortgage assets, and has no mortgage loan products that target subprime borrowers; therefore, our financial results and asset quality have not been significantly affected by the current subprime mortgage crisis.

Total assets for the Company at March 31, 2008, were $2.862 billion, an increase of $169.3 million, or 6.3%, from December 31, 2007.  Stockholders’ equity as of March 31, 2008 was $280.8 million, an increase of $8.4 million, or approximately 3.1%, from December 31, 2007.

Simmons First National Corporation is an Arkansas based financial holding company with eight community banks in Pine Bluff, Lake Village, Jonesboro, Rogers, Searcy, Russellville, El Dorado and Hot Springs, Arkansas. The Company's eight banks conduct financial operations from 89 offices, of which 85 are financial centers, located in 48 communities.

 

 

Overview

The accounting and reporting policies followed by the Company conform, in all material respects, to generally accepted accounting principles and to general practices within the financial services industry.  The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements.

The accounting policies that we view as critical to us are those relating to estimates and judgments regarding (a) the determination of the adequacy of the allowance for loan losses, (b) the valuation of goodwill and the useful lives applied to intangible assets, (c) the valuation of employee benefit plans, and (d) income taxes.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance is maintained at a level considered adequate to provide for potential loan losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of period end.  This estimate is based on management's evaluation of the loan portfolio, as well as on prevailing and anticipated economic conditions and historical losses by loan category.  General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories.  Allowances are accrued on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of loan collateral.  The unallocated reserve generally serves to compensate for the uncertainty in estimating loan losses, including the possibility of changes in risk ratings and specific reserve allocations in the loan portfolio as a result of the Company’s ongoing risk management system.

A loan is considered impaired when it is probable that the Company will not receive all amounts due according to the contractual terms of the loan.  This includes loans that are delinquent 90 days or more, nonaccrual loans and certain other loans identified by management.  Certain other loans identified by management consist of performing loans with specific allocations of the allowance for loan losses.  Specific allocations are applied when quantifiable factors are present requiring a greater allocation than that established using the classified asset approach, as defined by the Office of the

 

 

Comptroller of the Currency.  Accrual of interest is discontinued and interest accrued and unpaid is removed at the time such amounts are delinquent 90 days, unless management is aware of circumstances which warrant continuing the interest accrual.  Interest is recognized for nonaccrual loans only upon receipt and only after all principal amounts are current according to the terms of the contract.

 

Goodwill and Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.  Other intangible assets represent purchased assets that also lack physical substance but can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability.  The Company performs an annual goodwill impairment test in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, which requires that goodwill and intangible assets that have indefinite lives no longer be amortized but be reviewed for impairment annually, or more frequently if certain conditions occur.  Prior to the adoption of SFAS 142, goodwill was being amortized using the straight-line method over a period of 15 years.  Impairment losses on recorded goodwill, if any, will be recorded as operating expenses.

Employee Benefit Plans

The Company has adopted various stock-based compensation plans.  The plans provide for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, and bonus stock awards.  Pursuant to the plans, shares are reserved for future issuance by the Company, upon exercise of stock options or awarding of bonus shares granted to directors, officers and other key employees.

In accordance with SFAS 123R, Share-Based Payment (Revised 2004), the fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses various assumptions.  This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate.  For additional information, see Note 11, Stock-Based Compensation, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report.

Income Taxes

The Company is subject to the federal income tax laws of the United States, and the tax laws of the states and other jurisdictions where it conducts business.  Due to the complexity of these laws, taxpayers and the taxing authorities may subject these laws to different interpretations.  Management must make conclusions and estimates about the application of these innately intricate laws, related regulations, and case law.  When preparing the Company’s tax returns, management attempts to make reasonable interpretations of the tax laws. Taxing authorities have the ability to challenge management’s analysis of the tax law or any reinterpretation management makes in its ongoing assessment of facts and the developing case law.  Management assesses the reasonableness of its effective tax rate quarterly based on its current estimate of net income and the applicable taxes expected for the full year.  On a quarterly basis, management also reviews circumstances and developments in tax law affecting the reasonableness of deferred tax assets and liabilities and reserves for contingent tax liabilities.

 

 

Overview

Net interest income, the Company's principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets.  Factors that determine the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and the amount of non-interest bearing liabilities supporting earning assets.  Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis.  The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate of 37.50%.

The Company’s practice is to limit exposure to interest rate movements by maintaining a significant portion of earning assets and interest bearing liabilities in short-term repricing.  Historically, approximately 70% of the Company’s loan portfolio and approximately 80% of the Company’s time deposits have repriced in one year or less.  These historical percentages are consistent with the Company’s current interest rate sensitivity.

Net Interest Income

For the three-month period ended March 31, 2008, net interest income on a fully taxable equivalent basis was $23.8 million, an increase of $712,000, or 3.1%, over the same period in 2007. The increase in net interest income was the result of a $1.3 million decrease in interest expense offset by a $566,000 decrease in interest income.

The $1.3 million decrease in interest expense is the result of a 41 basis point decrease in cost of funds due to competitive repricing during a falling interest rate environment, coupled with an $81.3 million increase in average interest bearing liabilities.  The growth in average interest bearing liabilities was primarily due to the Company’s initiatives to enhance liquidity during the quarter through (1) the introduction of a new high yield investment deposit account and (2) securing additional long-term FHLB advances.  The lower interest rates accounted for a $1.7 million decrease in interest expense. The most significant component of this decrease was the $666,000 decrease associated with the repricing of the Company’s time deposits that resulted from time deposits that matured during the period or were tied to a rate that fluctuated with changes in market rates.  Historically, approximately 80% of the Company’s time deposits reprice in one year or less.  As a result, the average rate paid on time deposits decreased 28 basis points from 4.64% to 4.36%.  Lower rates on federal funds purchased and other debt resulted in an additional $865,000 decrease in interest expense, with the average rate paid on debt decreasing by 149 basis points from 5.41% to 3.92%.  The higher level of average interest bearing liabilities resulted in a $468,000 increase in interest expense.  More specifically, the higher level of average interest bearing liabilities was the result of increases of approximately $34.1 million from internal deposit growth and $47.2 million in federal funds purchased and other debt.

The $566,000 decrease in interest income primarily is the result of a 43 basis point decrease in yield on earning assets associated with the repricing to a lower interest rate environment, offset by a $102 million increase in average interest earning assets due to internal growth.  The lower interest rates accounted for a $2.3 million decrease in interest income.  The most significant component of this decrease was the $2.1 million decrease associated with the repricing of the Company’s loan portfolio that resulted from loans that matured during the period or were tied to a rate that fluctuated with changes in market rates.  Historically, approximately 70% of the Company’s loan portfolio reprices in one year or less.  As a result, the average rate earned on the loan portfolio decreased 54 basis points from 7.78% to 7.24%.  The growth in average interest earning assets resulted in a $1.7 million improvement in interest income.  The growth in average loans accounted for $1.1 million of this increase, while the growth in investment securities resulted in $561,000 of the increase.

 

Net Interest Margin

The Company’s net interest margin decreased 8 basis points to 3.80% for the three-month period ended March 31, 2008, when compared to 3.88% for the same period in 2007.  This decrease in the net interest margin was primarily due to significant repricing of earning assets due to declining interest rates, along with the Company’s concentrated effort to increase liquidity.  Due to the continued impact of recent rate movements, the Company anticipates further margin compression for the remainder of 2008.

Net Interest Income Tables

Table 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the three-month periods ended March 31, 2008 and 2007, respectively, as well as changes in fully taxable equivalent net interest margin for the three-month periods ended March 31, 2008 versus March 31, 2007.

Table 1:  Analysis of Net Interest Income

(FTE =Fully Taxable Equivalent)