Item 1. Business
Unless otherwise indicated, all references to “First Security,” “we,” “us,” and “our” in this Annual Report on Form 10-K refer to First Security Group, Inc. and our wholly-owned subsidiary, FSGBank, National Association (“FSGBank”).
BUSINESS
First Security Group, Inc.
We are a bank holding company headquartered in Chattanooga, Tennessee. We currently operate 30 full-service banking offices through our wholly-owned bank subsidiary, FSGBank. We serve the banking and financial needs of various communities in eastern and middle Tennessee, as well as northern Georgia.
Through FSGBank, we offer a range of lending services that are primarily secured by single and multi-family real estate, residential construction and owner-occupied commercial buildings. In addition, we focus on serving the needs of small- to medium-sized businesses, by offering a range of lending, deposit and wealth management services to these businesses and their owners. Our principal source of funds for loans and securities is core deposits gathered through our branch network. We offer a wide range of deposit services, including checking, savings, money market accounts and certificates of deposit, and obtain most of our deposits from individuals and businesses in our market areas, including the vast majority of our loan customers. Our wealth management division offers private client services, financial planning, trust administration, investment management and estate planning services. We also provide mortgage banking and electronic banking services, such as Internet banking, online bill payment, cash management, ACH originations, and remote deposit capture. We actively pursue business relationships by utilizing the business contacts of our Board of Directors, senior management and local bankers, thereby capitalizing on our extensive knowledge of the local marketplace.
First Security Group, Inc. was incorporated in 1999 as a Tennessee corporation to serve as a bank holding company, and is regulated and supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As of December 31, 2011, we had total assets of approximately $1.1 billion, total deposits of approximately $1.0 billion and stockholders’ equity of approximately $68.2 million.
FSGBank, National Association
FSGBank currently operates 30 full-service banking-offices along the Interstate corridors of eastern and middle Tennessee and northern Georgia, and is primarily regulated by the Office of the Comptroller of the Currency (the “OCC”). In Dalton, Georgia, FSGBank operates under the name of Dalton Whitfield Bank, while FSGBank operates under the name of Jackson Bank & Trust along the Interstate 40 corridor. FSGBank also provides trust and investment management, mortgage banking, financial planning and electronic banking services, such as Internet banking (www.FSGBank.com), online bill payment, cash management, ACH originations, and remote deposit capture.
FSGBank is the successor to our three previous banks: Dalton Whitfield Bank (organized in 1999), Frontier Bank (acquired in 2000) and First State Bank (acquired in 2002). Dalton Whitfield Bank was a state bank organized under the laws of Georgia engaged in a general commercial banking business. Dalton Whitfield Bank opened for business in September 1999, and simultaneously acquired selected assets and substantially all of the deposits of Colonial Bank’s three branches located in Dalton, Georgia. In 2003, Premier National Bank of Dalton merged with and into Dalton Whitfield Bank for an aggregate purchase price of $11.7 million in cash and stock.
Frontier Bank was a state savings bank organized under the laws of Tennessee in 2000 as First Central Bank of Monroe County. We acquired First Central Bank of Monroe County in 2000 for an aggregate purchase price of
$2.3 million in cash. After the acquisition, First Central Bank of Monroe County was renamed Frontier Bank and re-chartered as a state bank under the laws of Tennessee to engage in a general commercial banking business. Outside of the Chattanooga market, Frontier Bank operated under the name of “First Security Bank.”
First State Bank was a state bank organized under the laws of Tennessee engaged in a general commercial banking business since its organization in 1974. We acquired First State Bank in 2002 for an aggregate purchase price of $8.6 million in cash.
During 2003, we converted each of our three subsidiary banks into national banks, renamed each bank “FSGBank, National Association” and merged the banks under the charter previously held by Frontier Bank. As a result, we consolidated our banking operations into one subsidiary, FSGBank. FSGBank currently conducts its banking operations in Dalton, Georgia under the name “Dalton Whitfield Bank.”
Since the mergers in 2003, FSGBank has continued the commercial banking business of its predecessors. In addition, in December of 2003, FSGBank acquired certain assets and assumed substantially all of the deposits and other liabilities of National Bank of Commerce’s three branch offices located in Madisonville, Sweetwater and Tellico Plains, Tennessee.
In October 2004, FSGBank acquired 100% of the capital stock of Kenesaw Leasing and J&S Leasing, both Tennessee corporations, from National Bank of Commerce for $13.0 million in cash. Both companies continue to operate as wholly-owned subsidiaries of FSGBank. Kenesaw Leasing leases new and used equipment, fixtures and furnishings to owner-managed businesses, while J&S Leasing leases forklifts, heavy equipment and other machinery primarily to companies in the trucking and construction industries.
In August 2005, we acquired Jackson Bank & Trust (“Jackson Bank”) for an aggregate purchase price of $33.3 million in cash. Jackson Bank was a state commercial bank headquartered in Gainesboro, Tennessee. Jackson Bank was merged into FSGBank, but we continue to operate our banking operations in Jackson and Putnam Counties, Tennessee under the name of “Jackson Bank & Trust.”
FSGBank is a member of the Federal Reserve Bank of Atlanta and a member of the Federal Home Loan Bank of Cincinnati (the “FHLB”). FSGBank’s deposits are insured by the FDIC. FSGBank operates 24 full-service banking offices in eastern and middle Tennessee and six offices in northern Georgia.
Market Area and Competition
We currently conduct business principally through 30 branches in our market areas of Bradley, Hamilton, Jackson, Jefferson, Knox, Loudon, McMinn, Monroe, Putnam and Union Counties, Tennessee and Catoosa and Whitfield Counties, Georgia. Our markets follow the Interstate 75 corridor between Dalton, Georgia (approximately one hour north of Atlanta, Georgia) and Jefferson City, Tennessee (approximately 30 minutes north of Knoxville, Tennessee) and the Interstate 40 corridor between Nashville, Tennessee and Knoxville, Tennessee. Based upon data available from the FDIC as of June 30, 2011, FSGBank’s total deposits ranked 6th among financial institutions in our market area, representing approximately 4.0% of the total deposits in our market area.
The table below shows our deposit market share in the counties we serve according to data from the FDIC website as of June 30, 2011.
Our brokered deposits, totaling $277.8 million at June 30, 2011, are included in the totals for Hamilton County.
Subsequent to June 30, 2011, we closed two offices in Jackson County, two in Monroe County, and one each in Union and Loudon County.
Our retail, commercial and mortgage divisions operate in highly competitive markets. We compete directly in retail and commercial banking markets with other commercial banks, savings and loan associations, credit unions, mortgage brokers and mortgage companies, mutual funds, securities brokers, consumer finance companies, other lenders and insurance companies, locally, regionally and nationally. Many of our competitors compete with offerings by mail, telephone, computer and/or the Internet. Interest rates, both on loans and deposits, and prices of services are significant competitive factors among financial institutions generally. Office locations, types and quality of services and products, office hours, customer service, a local presence, community reputation and continuity of personnel are also important competitive factors that we emphasize.
Many other commercial or savings institutions currently have offices in our primary market areas. These institutions include many of the largest banks operating in Tennessee and Georgia, including some of the largest banks in the country. Many of our competitors serve the same counties we do. Within our market area, there are 71 different commercial or savings institutions.
Virtually every type of competitor has offices in Atlanta, Georgia, approximately 75 miles from Dalton and 100 miles from Chattanooga. In our market area, our largest competitors include First Tennessee, SunTrust, Regions, BB&T, Bank of America and Wells Fargo. These institutions, as well as other competitors of ours, have greater resources, have broader geographic markets, have higher lending limits, offer various services that we do not offer and can better afford and make broader use of media advertising, support services and electronic technology than we do. To offset these competitive disadvantages, we depend on our reputation as being an independent and locally-owned community bank and as having greater personal service, community involvement and ability to make credit and other business decisions quickly and locally.
Lending Activities
We originate loans primarily secured by single and multi-family real estate, residential construction and owner-occupied commercial buildings. In addition, we make loans to small and medium-sized commercial businesses, as well as to consumers for a variety of purposes.
Our loan portfolio at December 31, 2011 was comprised as follows:
In addition, we have entered into contractual obligations, via lines of credit and standby letters of credit, to extend approximately $108.3 million and $8.0 million, respectively, in credit as of December 31, 2011. We use the same credit policies in making these commitments as we do for our other loans. At December 31, 2011, our contractual obligations to extend credit were comprised as follow:
Real Estate-Residential 1-4 Family. Our residential mortgage loan program primarily originates loans for the purchase of residential property to individuals for other third-party lenders. Residential loans to individuals retained in our loan portfolio primarily consist of first liens on 1-4 family residential mortgages, home equity loans and lines of credit. These loans are generally made on the basis of the borrower’s ability to repay the loan from his or her employment and other income and are secured by residential real estate, the value of which is reasonably ascertainable. We expect that these loan-to-value ratios will be sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market. We generally do not retain long term, fixed rate residential real estate loans in our portfolio due to interest rate and collateral risks and low levels of profitability.
Real Estate-Commercial, Multi-Family and Farmland. We make commercial mortgage loans to finance the purchase of real property as well as loans to smaller business ventures, credit lines for working capital and short-term seasonal or inventory financing, including letters of credit, that are also secured by real estate. Commercial mortgage lending typically involves higher loan principal amounts, and the repayment of loans is dependent, in large part, on sufficient income from the properties collateralizing the loans to cover operating expenses and debt service. As a general practice, we require our commercial mortgage loans to be collateralized by well-managed income producing property with adequate margins and to be guaranteed by responsible parties. In addition, a substantial percentage of our commercial mortgage loan portfolio is secured by owner-occupied commercial buildings. We look for opportunities where cash flow from the business located in the owner-occupied building provides adequate debt service coverage and the guarantor’s net worth is centered on assets other than the project we are financing. Our commercial mortgage loans are generally collateralized by first liens on real estate, have fixed or floating interest rates and amortize over a 10 to 20-year period with balloon payments due at the end of one to five years. Payments on loans collateralized by such properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market.
In underwriting commercial mortgage loans, we seek to minimize our risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition. Our underwriting analysis also includes credit checks, reviews of appraisals and environmental hazards or EPA reports and a review of the financial condition of the borrower. We attempt to limit our risk by analyzing our borrowers’ cash flow and collateral value on an ongoing basis.
Real Estate-Construction. We also make construction and development loans to residential and, to a lesser extent, commercial contractors and developers located within our market areas. Construction loans generally are secured by first liens on real estate and have floating interest rates. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the value of the project is dependent on its successful completion. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, upon the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, there is no assurance that we will be able to recover all of the unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While we have underwriting procedures designed to identify what we believe to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above. We are currently in the process of reducing our exposure to construction and development loans.
Commercial-Loans. Our commercial loan portfolio includes loans to smaller business ventures, credit lines for working capital and short-term seasonal or inventory financing, as well as letters of credit that are generally secured by collateral other than real estate. Commercial borrowers typically secure their loans with assets of the business, personal guaranties of their principals and often mortgages on the principals’ personal residences. Our commercial loans are primarily made within our market areas and are underwritten on the basis of the commercial borrower’s ability to service the debt from income. In general, commercial loans involve more credit risk than residential and commercial mortgage loans, but less risk than consumer loans. The increased risk in commercial loans is generally due to the type of assets collateralizing these loans. The increased risk also derives from the expectation that commercial loans generally will be serviced from the operations of the business, and those operations may not be successful.
Consumer. We make a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. Consumer loans entail greater risk than other loans, particularly in the case of consumer loans that are unsecured or secured by depreciating assets such as automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment for the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by job loss, divorce, illness or personal hardships.
Leases, Net of Unearned Income. Our commercial lease portfolio includes leases made by our leasing companies, Kenesaw Leasing and J&S Leasing. Kenesaw Leasing leases new and used equipment, fixtures and furnishings to owner-managed businesses, while J&S Leasing leases forklifts, heavy equipment and other machinery to owner-managed businesses primarily in the trucking and construction industries. The leased property usually serves as collateral for the lease. Our commercial leases are underwritten on the basis of the value of the underlying leased property as well as the basis of the commercial lessee’s ability to service the lease. Commercial leases generally entail greater risks than commercial loans or loans secured by real estate, but less risk than unsecured consumer loans. The increased risk in commercial leases is generally due to the rolling stock nature of the items leased, as well as the illiquid nature of the secondary market for used equipment. The increased risk also derives from the low barriers to entry in the trucking and construction industries. We are currently in the process of reducing our exposure to commercial leases by focusing our efforts on portfolio management of existing relationships instead of new business development.
Credit Risks. The principal economic risk associated with each category of the loans that we make is the creditworthiness of the borrower and the ability of the borrower to repay the loan. General economic conditions and the strength of the services and retail market segments affect borrower creditworthiness. General factors affecting a commercial borrower’s ability to repay include interest rates, inflation and the demand for the commercial borrower’s products and services, as well as other factors affecting a borrower’s customers, suppliers and employees.
Risks associated with real estate loans also include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and, in the case of commercial borrowers, the quality of the borrower’s management. Consumer loan repayments depend upon the borrower’s financial stability and are more likely to be adversely affected by divorce, job loss, illness and personal hardships.
Lending Policies. Our Board of Directors has established and periodically reviews our bank’s lending policies and procedures. We have established common documentation and standards based on the type of loans among our regions. There are regulatory restrictions on the dollar amount of loans available for each lending relationship. National banking regulations provide that no loan relationship may exceed 15% of a bank’s Tier 1 capital. At December 31, 2011, our legal lending limit was approximately $9.5 million. In addition, we have established a “house” limit of $8.5 million for each lending relationship. Any loan request exceeding the house limit must be approved by a committee of our Board of Directors. We occasionally sell participation interests in loans to other lenders, primarily when a loan exceeds our house lending limits.
Concentrations. The retail nature of our commercial banking operations allows for diversification of depositors and borrowers, and we believe that our business does not depend upon a single or a few customers. We also do not believe that our credits are concentrated within a single industry or group of related industries.
The economy in our Dalton, Georgia market area is generally dependent upon the carpet industry and changes in construction of residential and commercial establishments. While the Dalton economy is dominated by the carpet and carpet-related industries, we do not have any one customer from whom more than 10% of our revenues are derived. However, we have multiple customers, commercial and retail, that are directly or indirectly affected by, or are engaged in businesses related to the carpet industry that, in the aggregate, have historically provided greater than 10% of our revenues.
The federal banking regulators have issued guidance regarding the risks posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans and loans
secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines to help identify institutions that are potentially exposed to significant CRE risk:
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total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or
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total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
As of December 31, 2011, our concentrations were within the thresholds of the CRE guidance.
In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2011, approximately 85.2% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower but may deteriorate in value during the time the credit is extended. If the value of real estate in our core markets were to decline further, a significant portion of our loan portfolio could become under-collateralized.
We offer a variety of loan products with payment terms and rate structures that have been designed to meet the needs of our customers within an established framework of acceptable credit risk. Payment terms range from fully amortizing loans that require periodic principal and interest payments to terms that require periodic payments of interest-only with principal due at maturity. Interest-only loans are a typical characteristic in commercial and home equity lines-of-credit and construction loans (residential and commercial). As of December 31, 2011, we had approximately $151.7 million of interest-only loans, which primarily consist of home equity loans (43.9%), construction and land development loans (17.7%), commercial and industrial loans (16.5%) and commercial real estate loans (7.4%). The loans have an average maturity of approximately 24 months or less, with the exception of home equity lines-of-credit which have an average maturity of approximately three and a half years. The interest-only loans are fully underwritten and within our lending policies.
We do not offer, hold or service option adjustable rate mortgages that may expose the borrowers to future increases in repayments in excess of changes resulting solely from increases in the market rate of interest (loans subject to negative amortization).
Deposits
Our principal source of funds for loans and investing in securities is core deposits. We offer a wide range of deposit services, including checking, savings, money market accounts and certificates of deposit. We obtain most of our deposits from individuals and businesses in our market areas. We believe that the rates we offer for core deposits are competitive with those offered by other financial institutions in our market areas. We have also chosen to obtain a portion of our deposits from outside our market through brokered deposits. Our brokered deposits represented 23.4% of total deposits as of December 31, 2011. Other sources of funding include advances from the FHLB, subordinated debt and other borrowings. These other sources enable us to borrow funds at rates and terms, which at times, are more beneficial to us. During the fourth quarter of 2009 and first quarter of 2010, we enhanced our liquidity by issuing over $255 million in brokered certificates of deposits and placing the excess funds in our interest bearing deposit account at the Federal Reserve Bank of Atlanta. As a result of the Consent Order, discussed below, we may not accept, renew or roll over brokered deposits without prior approval of the FDIC. Accordingly, principal sources of funds are currently limited to non-brokered deposits, other borrowings and our existing cash reserves. At December 31, 2011, our cash balance at the Federal Reserve Bank of Atlanta was approximately $249 million. This excess cash is available to fund our contractual obligations and prudent investment opportunities.
Other Banking Services
Given client demand for increased convenience and account access, we offer a range of products and services, including 24-hour internet banking, ACH transactions, remote deposit capture, wire transfers, direct deposit, traveler’s checks, safe deposit boxes, and United States savings bonds. We earn fees for most of these services. We also receive ATM transaction fees from transactions performed by our customers participating in a shared network of ATMs and a debit card system that our customers can use throughout Tennessee and Georgia, as well as in other states. Additionally, we offer wealth management services including private client services, financial planning, trust administration, investment management and estate planning services.
Securities
After establishing necessary cash reserves and funding loans, we invest our remaining liquid assets in securities allowed under banking laws and regulations. We invest primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States, other taxable securities and in certain obligations of states and municipalities. We also invest excess funds in federal funds with our correspondent banks and in our interest bearing account at the Federal Reserve Bank of Atlanta. The sale of federal funds represents a short-term loan from us to another bank. Risks associated with securities include, but are not limited to, interest rate fluctuation, market illiquidity, maturity and concentration.
Seasonality and Cycles
Although we do not consider our commercial banking business to be seasonal, our mortgage banking business is somewhat seasonal, with the volume of home financings, in particular, being lower during the winter months. Additionally, the Dalton, Georgia economy is seasonal and cyclical as a result of its dependence upon the carpet industry and changes in construction of residential and commercial establishments. While the Dalton, Georgia economy is dominated by the carpet and carpet-related industries, we do not have any one customer from whom more than 10% of our revenues are derived. However, we have multiple customers, commercial and retail, that are directly or indirectly affected by, or are engaged in businesses related to the carpet industry that, in the aggregate, have historically provided greater than 10% of our revenues.
Employees
On December 31, 2011, we had 296 full-time employees and 10 part-time employees. We consider our employee relations to be good, and we have no collective bargaining agreements with any employees.
Website Address
Our corporate website address is www.FSGBank.com. From this website, select the “About” tab followed by selecting “Investor Relations.” Our filings with the Securities and Exchange Commission (the “SEC”), including but not limited to our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports are available and accessible soon after we file them with the SEC.
SUPERVISION AND REGULATION
Both First Security and FSGBank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws are generally intended to protect depositors, not stockholders. Legislation and regulations authorized by legislation influence, among other things:
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how, when and where we may expand geographically;
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into what product or service market we may enter;
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how we must manage our assets or liabilities; and
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under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.
Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.
First Security
Because we own all of the capital stock of FSGBank, we are a bank holding company under the Federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve Board.
Written Agreement. Effective September 7, 2010, First Security entered into a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Atlanta (the “Federal Reserve Bank”). The Agreement is designed to enhance our ability to act as a source of strength to FSGBank. Substantially all of the requirements of the Agreement are similar to those already in effect for FSGBank pursuant to the Consent Order entered into with the Office of the Comptroller of the Currency on April 28, 2010, and discussed below.
Pursuant to the Agreement, First Security is prohibited from declaring or paying dividends without prior written consent from the Federal Reserve Bank. In addition, pursuant to the Agreement, without the prior written consent of regulators, First Security is prohibited from taking dividends, or any other form of payment representing a reduction of capital, from FSGBank; incurring, increasing or guaranteeing any debt; or redeeming any shares of First Security’s common stock. First Security is also obligated to provide quarterly written progress reports to the Federal Reserve Bank.
In accordance with the Agreement, First Security submitted to the Federal Reserve Bank a copy of FSGBank’s capital plan that had previously been submitted to the OCC. The Agreement does not contain specific target capital ratios or specific timelines, but requires that the plan address First Security’s current and future capital requirements, FSGBank’s current and future capital requirements, the adequacy of FSGBank’s capital taking into account its risk profile, and the source and timing of additional funds necessary to fulfill First Security’s and FSGBank’s future capital requirements. Neither the OCC nor the Federal Reserve Bank approved the initial capital plan and FSGBank is not in compliance with the capital requirements contained in the Consent Order. A revised capital and strategic plan, developed by the current management team, was submitted to the OCC and Federal Reserve Bank in March 2012.
The provisions of the Agreement remain in effect and enforceable until stayed, modified, terminated or suspended by the Federal Reserve Bank. We are currently deemed not in compliance with several provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve
Bank. We can provide no assurances that we will be able to comply fully with the Agreement, that efforts to comply with the Agreement will not have a material adverse effect on the operations and financial condition of First Security, or that further enforcement actions won’t be imposed on First Security.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve Board’s prior approval before:
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acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
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acquiring all or substantially all of the assets of any bank; or
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merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned. The Federal Reserve Board’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if we are adequately capitalized and adequately managed, we or any other bank holding company located within Tennessee or Georgia, may purchase a bank located outside of Tennessee or Georgia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Tennessee or Georgia may purchase a bank located inside Tennessee or Georgia. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. Currently, Georgia law prohibits a bank holding company from acquiring control of a financial institution until the target financial institution has been incorporated for three years, and Tennessee law prohibits a bank holding company from acquiring control of a financial institution until the target financial institution has been incorporated for five years. Because FSGBank has been chartered for more than five years, this restriction would not limit our ability to be acquired.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve Board approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
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the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or
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no other person owns a greater percentage of that class of voting securities immediately after the transaction.
Our common stock is registered under Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenging rebuttable presumptions of control.
Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve Board to be closely related to banking or managing or controlling banks, as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the
regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities.
To qualify to become a financial holding company, FSGBank and any other depository institution subsidiary of First Security must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, we must file an election with the Federal Reserve Board to become a financial holding company and must provide the Federal Reserve Board with 30 days’ written notice prior to engaging in a permitted financial activity. To date, we have not elected to become a financial holding company.
Support of FSGBank. Under Federal Reserve Board policy, we are expected to act as a source of financial strength for FSGBank and to commit resources to support FSGBank. In addition, pursuant to the Dodd-Frank Wall Street and Consumer Protection Act (the “Dodd-Frank Act”), the federal banking regulators are required to issue, within two years of enactment, rules that require a bank holding company to serve as a source of financial strength for any depository institution subsidiary. This support may be required at times when, without this Federal Reserve Board policy or the impending rules, we might not be inclined to provide it. In addition, any capital loans made by us to FSGBank will be repaid only after FSGBank’s deposits and various other obligations are repaid in full. In the unlikely event of our bankruptcy, any commitment that we give to a bank regulatory agency to maintain the capital of FSGBank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Non-Bank Subsidiary Examination and Enforcement. As a result of the Dodd-Frank Act, all non-bank subsidiaries not currently regulated by a state or federal agency will now be subject to examination by the Federal Reserve Board in the same manner and with the same frequency as if its activities were conducted by the lead bank subsidiary. These examinations will consider whether the activities engaged in by the non-bank subsidiary pose a material threat to the safety and soundness of its insured depository institution affiliates, are subject to appropriate monitoring and control, and comply with applicable laws. Pursuant to this authority, the Federal Reserve Board may also take enforcement action against non-bank subsidiaries.
TARP Participation. On October 14, 2008, the U.S. Treasury announced the capital purchase component of TARP. This program was instituted by the U.S. Treasury pursuant to the Emergency Economic Stabilization Act of 2008, which provides up to $700 billion to the U.S. Treasury to, among other things, take equity ownership positions in financial institutions. The TARP capital purchase program is intended to encourage financial institutions to build capital and thereby increase the flow of financing to businesses and consumers. We participated in the capital purchase component of TARP.
FSGBank
Because FSGBank is chartered as a national bank, it is primarily subject to the supervision, examination and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines FSGBank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because FSGBank’s deposits are insured by the FDIC to the maximum extent provided by law, FSGBank is subject to certain FDIC regulations and the FDIC also has back-up examination and enforcement power over FSGBank. FSGBank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations.
Consent Order. On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, FSGBank consented and agreed to the issuance of a Consent Order (the “Order”) by the OCC. In the negotiated Order, FSGBank and the OCC agreed as to areas of FSGBank’s operations that warrant improvement and a plan for making those improvements. The Order imposes no fines or penalties on FSGBank. FSGBank’s customer deposits remain fully insured by the FDIC to the maximum extent allowed by law; the Order does not impact this coverage in any manner.
We are currently deemed not in compliance with several provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. We can provide no assurances that we will be able to comply fully with the Order, that efforts to comply with the Order will not have a material adverse effect on the operations and financial condition of FSGBank, or that further enforcement actions won’t be imposed on FSGBank.
Pursuant to the Order, FSGBank was required to appoint a compliance committee to oversee FSGBank’s compliance with the Order. FSGBank’s compliance committee currently consists of the Bank’s independent directors: William F. Grant, III, William C. Hall, Carol H. Jackson, Robert P. Keller, Ralph L. Kendall, Kelly P. Kirkland, and Robert R. Lane.
Under the Order, FSGBank is required to develop and submit to the OCC for review a written strategic plan covering at least a three-year period. The strategic plan is required to, among other things, include objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, and reduction in the volume of nonperforming assets, together with strategies to achieve these objectives. The OCC did not accept our initial written strategic plan submitted during 2010. We have submitted a new five-year strategic plan developed by the current management team that we believe addresses all required items.
Within 120 days from the effective date of the Order, the Bank was required to achieve and thereafter maintain total capital at least equal to 13% of risk-weighted assets and Tier 1 capital at least equal to 9% of adjusted total assets. Within 90 days from the effective date of the Order, the Bank was required to develop and submit to the OCC for review a written capital plan covering at least a three-year period. The capital plan shall, among other things, included specific plans for maintaining adequate capital and a discussion of the sources and timing of additional capital and contingency plans for alternative sources of capital. The OCC has not accepted our capital plan. As of December 31, 2011, FSGBank’s total risk-based capital ratio was 10.9% and its leverage ratio was 5.6%. We are considering a variety of strategic alternatives intended to achieve and maintain the prescribed capital ratios.
Under the Order, FSGBank’s Board of Directors prepared a written assessment of the capabilities of the Bank’s executive officers to perform present and anticipated duties, including the execution of the strategic plan. If any changes are deemed necessary by the Board, the OCC shall have the power to disapprove the appointment of a new proposed executive officer. The Order also requires annual written performance appraisals for each executive officer.
Within 60 days from the effective date of the Order, FSGBank was required to review and revise its existing credit policy to improve the Bank’s loan portfolio management, as well as FSGBank’s policies related to leasing, retail credit, and collateral exceptions. Within 90 days of the effective date of the Order, FSGBank was required to review and revise its independent and on-going loan review program. Ongoing reviews may, however, continue to result in positive or negative changes to certain loan classifications.
FSGBank was also required to review and revise its program for the Allowance for Loan and Lease Losses (“ALLL”). The Board of Directors is required to review the adequacy of the ALLL quarterly, and any deficiency shall be remedied in the calendar quarter it is discovered. Within 90 days of the effective date of the Order, FSGBank was required to review and revise its existing program to protect the Bank’s interest in criticized assets. Beginning with the effective date of the Order, FSGBank may not extend any credit to, or for the benefit of, any borrower who has a loan that is criticized as “doubtful,” “substandard” or “special mention,” unless FSGBank documents that such extension of credit is in FSGBank’s best interest. We believe we have revised and implemented an ALLL program that complies with all regulatory and accounting guidance.
Within 90 days of the effective date of the Order, FSGBank was required to review and revise the Bank’s existing written concentration management program, and adopt plans to reduce the risk of exposure to any
concentration deemed imprudent. Within 60 days of the effective date of the Order, FSGBank was required to review and revise its comprehensive liquidity risk management program, including the preparation of periodic liquidity reports and a contingency funding plan. We believe we have revised and implemented a concentration management program that complies with all regulatory guidance.
Because the Order establishes specific capital amounts to be maintained by FSGBank, FSGBank may not be considered better than “adequately capitalized” for capital adequacy purposes, even if FSGBank exceeds the levels of capital set forth in the Order. As an adequately capitalized institution, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC.
The Order will remain in effect and enforceable until it is modified, terminated, suspended or set aside by the OCC. FSGBank is committed to complying with the terms of the Order. FSGBank reports to the OCC monthly regarding its progress in complying with the provisions included in the Order. Compliance with the terms of the Order is an ongoing priority for the Board of Directors and management of FSGBank.
Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under both Tennessee and Georgia law, FSGBank may open branch offices throughout Tennessee or Georgia with the prior approval of the OCC. Prior to the enactment of the Dodd-Frank Act, FSGBank and any other national- or state-chartered bank were generally permitted to branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. However, interstate branching is now permitted for all national- and state-chartered banks as a result of the Dodd-Frank Act, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories in which all institutions are placed: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The federal banking agencies have also specified by regulation the relevant capital levels for each category.
As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. As of December 31, 2010 and 2011, the Bank was considered “adequately capitalized” for regulatory purposes.
A “well capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or other remediation, and significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.
An “adequately capitalized” bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a Tier 1 leverage ratio of at least 4%. A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the applicable regulatory authorities. Institutions that are not well capitalized are also prohibited, except in very
limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC. In addition, all institutions are generally prohibited from making capital distributions and paying management fees to controlling persons if, subsequent to such distribution or payment, the institution would be undercapitalized. Finally, an adequately capitalized bank may be forced to comply with operating restrictions similar to those placed on undercapitalized banks.
An “undercapitalized” bank fails to meet the required minimum level for any relevant capital measure. A bank that reaches the undercapitalized level is likely subject to a formal agreement or another formal supervisory sanction. An undercapitalized bank is not only subject to the requirements placed on adequately capitalized banks, but also becomes subject to the following operating and managerial restrictions, which:
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prohibit capital distributions;
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prohibit payment of management fees to a controlling person;
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require the bank to submit a capital restoration plan within 45 days of becoming undercapitalized;
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require close monitoring of compliance with capital restoration plans, requirements and restrictions by the primary federal regulator;
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restrict asset growth by requiring the bank to restrict its average total assets to the amount attained in the preceding calendar quarter;
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prohibit the acceptance of employee benefit plan deposits;
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require prior approval by the primary federal regulator for acquisitions, branching and new lines of business; and
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prohibit any material changes in accounting methods.
Finally, an undercapitalized institution may be required to comply with operating restrictions similar to those placed on significantly undercapitalized institutions.
A “significantly undercapitalized” bank has a total risk-based capital ratio less than 6%, a Tier 1 risk-based capital less than 3%, and a Tier 1 leverage ratio less than 3%. In addition to being subject to the restrictions applicable to undercapitalized institutions, significantly undercapitalized banks may, at the discretion of the bank’s primary federal regulator, become subject to the following additional restrictions, which:
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require the sale of enough securities so that the bank is adequately capitalized or, if grounds for conservatorship or receivership exist, the merger or acquisition of the bank;
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restrict affiliate transactions;
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restrict interest rates paid on deposits;
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further restrict growth, including a requirement that the bank reduce its total assets;
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restrict or prohibit all activities that are determined to pose an excessive risk to the bank;
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require the bank to elect new directors, dismiss directors or senior executive officers, or employ qualified senior executive officers to improve management;
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prohibit the acceptance of deposits from correspondent banks, including renewals and rollovers of prior deposits;
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require prior approval of capital distributions by holding companies;
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require holding company divestiture of the financial institution, bank divestiture of subsidiaries and/or holding company divestiture of other affiliates; and
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require the bank to take any other action the federal regulator determines will “better achieve” prompt corrective action objectives.
Finally, without prior regulatory approval, a significantly undercapitalized institution must restrict the compensation paid to its senior executive officers, including the payment of bonuses and compensation that exceeds the officer’s average rate of compensation during the 12 calendar months preceding the calendar month in which the bank became undercapitalized.
A “critically undercapitalized” bank has a ratio of tangible equity to tangible assets that is equal to or less than 2%. In addition to the appointment of a receiver in not more than 90 days, or such other action as determined by an institution’s primary federal regulator, an institution classified as critically undercapitalized is subject to the restrictions applicable to undercapitalized and significantly undercapitalized institutions, and is further prohibited from doing the following without the prior written regulatory approval:
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entering into material transactions other than in the ordinary course of business;
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extending credit for any highly leveraged transaction;
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amending the institution’s charter or bylaws, except to the extent necessary to carry out any other requirements of law, regulation or order;
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making any material change in accounting methods;
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engaging in certain types of transactions with affiliates;
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paying excessive compensation or bonuses, including golden parachutes;
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paying interest on new or renewed liabilities at a rate that would increase the institution’s weighted average cost of funds to a level significantly exceeding the prevailing rates of its competitors; and
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making principal or interest payment on subordinated debt 60 days or more after becoming critically undercapitalized.
In addition, a bank’s primary federal regulator may impose additional restrictions on critically undercapitalized institutions consistent with the intent of the prompt corrective action regulations. Once an institution has become critically undercapitalized, subject to certain narrow exceptions such as a material capital remediation, federal banking regulators will initiate the resolution of the institution.
FDIC Insurance Assessments. FSGBank’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the maximum amount permitted by law, which was permanently increased to $250,000 by the Dodd-Frank Act. The FDIC uses the DIF to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. Pursuant to the Dodd-Frank Act, the FDIC must take steps, as necessary, for the DIF reserve ratio to reach 1.35% of estimated insured deposits by September 30, 2020. The Bank is thus subject to FDIC deposit premium assessments.
Currently, the FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information-supervisory risk ratings for all institutions, financial ratios for most institutions, including the Bank, and a “scorecard” calculation for large institutions. For institutions assigned to the lowest risk category, the annual assessment rate ranges between 2.5 and 9 cents per $100 of assessment base, defined as total assets less tangible equity. For institutions assigned to higher risk categories, assessment rates range from 9 to 45 cents per $100 of assessment base. These ranges reflect a possible downward adjustment for unsecured debt outstanding and in the case of institutions outside the lowest risk category, possible upward adjustments for brokered deposits.
On September 29, 2009, the FDIC announced a uniform three basis points increase effective January 1, 2011, and on November 12, 2009, adopted a rule requiring nearly all FDIC-insured depository institutions, including the Bank, to prepay their DIF assessments for the fourth quarter of 2009 and for the following three years on December 30, 2009. At that time, the FDIC indicated that the prepayment of DIF assessments was in lieu of additional special assessments; however, there can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future.
The FDIC retains the flexibility to, without further notice-and-comment rulemaking, adopt rates that are higher or lower than the stated base assessment rates, provided that the FDIC cannot (i) increase or decrease the total rates from one quarter to the next by more than two basis points, or (ii) deviate by more than two basis points from the stated assessment rates. Although the Dodd-Frank Act requires that the FDIC eliminate its requirement to pay dividends to depository institutions when the reserve ratio exceeds a certain threshold, the FDIC has adopted a decreasing schedule of assessment rates that would take effect when the DIF reserve ratio first meets or exceeds 1.15%. If the DIF reserve ratio meets or exceeds 1.15%, base assessment rates would range from 1.5 to 40 basis points; if the DIF reserve ratio meets or exceeds 2%, base assessment rates would range from 1 to 38 basis points; and if the DIF reserve ratio meets or exceeds 2.5%, base assessment rates would range from 0.5 to 35 basis points. All base assessment rates are subject to adjustments for unsecured debt and brokered deposits.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (“FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2011 ranged from 0.68 cents to 1.00 cents per $100 of assessable deposits. These assessments will continue until the debt matures between 2017 and 2019.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
FDIC Transaction Account Guarantee Program. Under the Temporary Liquidity Guarantee Program (“TLGP”), the FDIC fully guaranteed funds in non-interest bearing deposit accounts held at participating FDIC-insured institutions, regardless of dollar amount. The temporary guarantee was originally scheduled to expire at the end of 2009, but was subsequently extended to December 31, 2010. Pursuant to the Dodd-Frank Act, beginning on the scheduled termination date for the Transaction Account Guarantee Program, or TAGP, and continuing through December 31, 2012, unlimited insurance coverage will be provided for funds held in non-interest bearing transaction accounts, including Interest on Lawyer Trust Accounts (IOLTAs). During the TAGP extension period, the FDIC imposed a surcharge between 15 and 25 basis points on the daily average balance in excess of $250,000 held in non-interest bearing transaction accounts. Pursuant to the Dodd-Frank Act, however, institutions are no longer separately assessed for the additional coverage, and the unlimited insurance is included in assessments for the overall insurance program. One distinction from this new insurance and the TAGP, is the exclusion of minimal interest-bearing NOW accounts, which were previously covered under the TAGP. FSGBank did not opt out of the original or extension periods of the Transaction Account Guarantee component of the TLGP, thus providing the maximum available insurance for our customers.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking regulators shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on FSGBank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (“ALLL”) represents one of the most significant estimates in our financial statements and regulatory reports. Because of its significance, we have developed a system by which we develop, maintain and document a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. The “Interagency Policy Statement on the Allowance for Loan and Lease Losses” issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the bank’s stated policies and procedures, management’s best judgment and relevant
supervisory guidance. Consistent with supervisory guidance, we maintain our allowance at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as the estimation for probable incurred credit losses inherent in the remainder of the loan and lease portfolio. The allowance for loan and lease losses, and our methodology for calculating the allowance, are fully described in Note 1 to our consolidated financial statements under “Allowance for Loan and Lease Losses” and in the “Management’s Discussion and Analysis-Statement of Financial Condition-Allowance for Loan and Lease Losses” section.
Commercial Real Estate Lending. Our lending operations may be subject to enhanced scrutiny by federal banking regulators based on our concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:
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total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or
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total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
As of December 31, 2011, our CRE concentrations were within the thresholds of the CRE guidance. Specifically, our ratio of total capital to construction, land development and other land loans was 75.3% and our total CRE concentration was 210.6%.
Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,100,000 per day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties.
Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue regulatory orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.
Other Regulations. Interest and other charges collected or contracted for by FSGBank are subject to state usury laws and federal laws concerning interest rates. Our loan operations are also subject to federal laws applicable to credit transactions, such as the:
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Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
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Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
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National Flood Insurance Act and Flood Disaster Protection Act, requiring flood insurance to extend or renew certain loans in flood plains;
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Real Estate Settlement Procedures Act, requiring certain disclosures concerning loan closing costs and escrows, and governing transfers of loan servicing and the amounts of escrows in connection with loans secured by one-to-four family residential properties;
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Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended by the Servicemembers’ Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the United States military;
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Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for consumer loans to military service members and their dependents; and
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Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), imposing requirements and limitations on specific financial transactions and account relationships, intended to guard against money laundering and terrorism financing;
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sections 22(g) and 22(h) of the Federal Reserve Act which set lending restrictions and limitations regarding loans and other extensions of credit made to executive officers, directors, principal shareholders and other insiders; and
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rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
FSGBank’s deposit operations are subject to federal laws applicable to depository accounts, such as:
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Truth-In-Savings Act, requiring certain disclosures of consumer deposit accounts:
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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
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Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and
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rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
The Consumer Financial Protection Bureau. The Dodd-Frank Act creates the Consumer Financial Protection Bureau (the “Bureau”) within the Federal Reserve Board. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions.
Capital Adequacy
First Security and FSGBank are required to comply with the capital adequacy standards established by the Federal Reserve. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for member banks and bank holding companies.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets, and classification as adequately capitalized, is 8%. A bank that fails to meet the required minimum guidelines is classified as undercapitalized and subject to operating and managerial restrictions. A bank, however, that significantly exceeds its capital requirements and maintains a ratio of total capital to risk-weighted assets of 10% is classified as well capitalized unless it is subject to a regulatory order requiring it to maintain specified capital levels, in which case it is considered adequately capitalized. The Consent Order requires FSGBank to maintain a total capital to risk-weighted assets ratio of greater than 13%.
Total capital consists of two components: Tier 1 capital and Tier 2 capital. Tier 1 capital generally consists of common stockholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 capital must equal at least 4% of risk-weighted assets. Tier 2 capital generally consists of subordinated debt, other preferred stock and hybrid capital, and a limited amount of loan loss reserves. The total amount of Tier 2 capital is limited to 100% of Tier 1 capital. FSGBank’s ratio of total capital to risk-weighted assets and ratio of Tier 1 capital to risk-weighted assets were 10.9% and 9.7% at December 31, 2011, respectively, compared 12.2% and 10.9%, as of December 31, 2010.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2011, our leverage ratio was 5.6%, as compared to 7.1% on December 31, 2010. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities. The Consent Order requires FSGBank to maintain a leverage ratio in excess of 9%.
Provisions of the Dodd-Frank Act commonly referred to as the “Collins Amendment” established new minimum leverage and risk-based capital requirements on bank holding companies and eliminated the inclusion of “hybrid capital” instruments in Tier 1 capital by certain institutions.
The Dodd-Frank Act establishes certain regulatory capital deductions with respect to hybrid capital instruments, such as trust preferred securities, that will effectively disallow the inclusion of such instruments in Tier 1 capital if such capital instrument is issued on or after May 19, 2010. However, preferred shares issued to the U.S. Department of the Treasury (the “Treasury”) pursuant to the TARP Capital Purchase Program (“TARP CPP”) or TARP Community Development Capital Initiative are exempt from the Collins Amendment and are permanently includable in Tier 1 capital.
Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements. See “Prompt Corrective Action” above.
The OCC, the Federal Reserve Board, and the FDIC have authority to compel or restrict certain actions if FSGBank’s capital should fall below adequate capital standards as a result of operating losses, or if its regulators otherwise determine that it has insufficient capital. Among other matters, the corrective actions may include, removing officers and directors; and assessing civil monetary penalties; and taking possession of and closing and liquidating the Bank.
Generally, the regulatory capital framework under which the First Security and FSGBank operate is in a period of change with likely legislation or regulation that will continue to revise the current standards and very likely increase capital requirements for the entire banking industry. Pursuant to the Dodd-Frank Act, bank regulators are required to establish new minimum leverage and risk-based capital requirements for certain bank holding companies and systematically important non-bank financial companies. The new minimum thresholds will not be lower than existing regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher once established.
Payment of Dividends
First Security is a legal entity separate and distinct from FSGBank. The principal sources of First Security’s cash flow, including cash flow to pay dividends to its stockholders, are dividends and management fees that FSGBank pays to its sole stockholder, First Security. Statutory and regulatory limitations apply to FSGBank’s payment of dividends to First Security as well as to First Security’s payment of dividends to its stockholders.
FSGBank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by FSGBank’s Board of Directors in any year will exceed (1) the total of FSGBank’s net profits for that year, plus (2) FSGBank’s retained net profits of the preceding two years, less any required transfers to surplus.
When First Security received a capital investment from the Treasury under the CPP on January 9, 2009, we became subject to additional limitations on the payment of dividends. These limitations require, among other things, that (i) all dividends for the securities purchased under the CPP be paid before other dividends can be paid and (ii) the Treasury must approve any increases in quarterly common dividends above five cents per share for three years following the Treasury’s investment.
The payment of dividends by First Security and FSGBank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, the OCC may require, after notice and a hearing, that FSGBank stop or refrain from engaging in any practice it considers unsafe or unsound. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
On February 24, 2009, the Federal Reserve clarified its guidance on dividend policies for bank holding companies through the publication of a Supervisory Letter. As part of the letter, the Federal Reserve encouraged bank holding companies, particularly those that had participated in the CPP, to consult with the Federal Reserve prior to dividend declarations, and redemption and repurchase decisions even when not explicitly required to do
so by federal regulations. The Federal Reserve has indicated that CPP recipients, such as First Security, should consider and communicate in advance to regulatory staff how a company’s proposed dividends, capital repurchases and capital redemptions are consistent with First Security’s obligation to eventually redeem the securities held by the Treasury. This new guidance is largely consistent with prior regulatory statements encouraging bank holding companies to pay dividends out of net income and to avoid dividends that could adversely affect the capital needs or minimum regulatory capital ratios of the bank holding company and its subsidiary bank. Additionally, pursuant to the Agreement, First Security is required to obtain prior written authorization before declaring a dividend.
Restrictions on Transactions with Affiliates
First Security and FSGBank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
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a bank’s loans or extensions of credit to affiliates;
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a bank’s investment in affiliates;
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assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
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loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
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a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. We must also comply with other provisions designed to avoid the taking of low-quality assets.
First Security and FSGBank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
FSGBank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders, and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Effective July 21, 2011, an insured depository institution is prohibited from engaging in asset purchases or sales transactions with its officers, directors or principal shareholders unless (1) the transaction is on market terms and (2) if the transaction represents greater than 10% of the capital and surplus of the bank, a majority of disinterested directors has approved the transaction.
Limitations on Senior Executive Compensation
In June of 2010, federal banking regulators issued guidance designed to help ensure that incentive compensation policies at banking organizations do not encourage excessive risk-taking or undermine the safety and soundness of the organization. In connection with this guidance, the regulatory agencies announced that they will review incentive compensation arrangements as part of the regular, risk-focused supervisory process.
Regulatory authorities may also take enforcement action against a banking organization if its incentive compensation arrangement or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and the organization is not taking prompt and effective measures to correct the deficiencies. To ensure that incentive compensation arrangements do not undermine safety and soundness at insured depository institutions, the incentive compensation guidance sets forth the following key principles:
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incentive compensation arrangements should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose the organization to imprudent risk;
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incentive compensation arrangements should be compatible with effective controls and risk management; and
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incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the board of directors.
Due to First Security’s participation in the CPP, First Security is also subject to additional executive compensation limitations. For example, First Security must:
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ensure that its senior executive incentive compensation packages do not encourage excessive risk;
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subject senior executive compensation to “clawback” if the compensation was based on inaccurate financial information or performance metrics;
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prohibit any golden parachute payments to senior executive officers; and
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agree not to deduct more than $500,000 from taxable income for a senior executive officer’s compensation.
The Dodd-Frank Act
The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes previously discussed and including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased regulatory examination fees; and (iii) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the OCC and the FDIC.
Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging potential changes to the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Item 1A.
Item 1A. Risk Factors
An investment in our common stock involves risks. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
RISKS ASSOCIATED WITH OUR BUSINESS
We are currently operating under a Consent Order from the OCC and a Written Agreement from the Federal Reserve Bank, which may impact our operations and generally require significant management attention.
While we continue to make progress on compliance with our regulatory agreements, we are currently not in compliance with certain components of the agreements. Our compliance efforts require a significant amount of our management’s time and attention. Continuing non-compliance may result in additional restrictions and/or enforcement actions that may negatively impact our operations. Further risk factors address specific operational regulatory and market risks.
We have incurred operating losses and cannot assure you that we will be profitable in the future.
We incurred a net loss allocated to common stockholders of $25.1 million, or $15.79 per share, for the year ended December 31, 2011, due primarily to credit losses and associated costs, including a significant provision for loan losses. Although we have taken steps to reduce our credit exposure, we likely will continue to have a higher than normal level of non-performing assets and charge-offs into 2012, which would continue to adversely impact our overall financial condition and results of operations.
We may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition and results of operations.
Like other lenders, we face the risk that our customers will not repay their loans. A customer’s failure to repay us is usually preceded by missed monthly payments. In some instances, however, a customer may declare bankruptcy prior to missing payments, and, following a borrower filing bankruptcy, a lender’s recovery of the credit extended is often limited. Since our loans are secured by collateral, we may attempt to seize the collateral when and if customers default on their loans. However, the value of the collateral may not equal the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from our customers. Rising delinquencies and rising rates of bankruptcy in our market area generally and among our customers specifically can be precursors of future charge-offs and may require us to increase our allowance for loan and lease losses. Higher charge-off rates and an increase in our allowance for loan and lease losses may hurt our overall financial performance if we are unable to increase revenue to compensate for these losses and may also increase our cost of funds.
Our allowance for loan and lease losses may not be adequate to cover actual losses, and we may be required to materially increase our allowance, which may adversely affect our capital, financial condition and results of operations.
We maintain an allowance for loan and lease losses, which is a reserve established through a provision for loan losses charged to expenses, that represents management’s best estimate of probable credit losses that have been incurred within the existing portfolio of loans. The allowance for loan and lease losses and our methodology for calculating the allowance are fully described in Note 1 to our consolidated financial statements under “Allowance for Loan and Lease Losses”, and in the “Management’s Discussion and Analysis-Statement of Financial Condition-Allowance for Loan and Lease Losses” section. In general, an increase in the allowance for loan and lease losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our capital, financial condition and results of operations.
The allowance, in the judgment of management, is established to reserve for estimated loan losses and risks inherent in the loan portfolio. The determination of the appropriate level of the allowance for loan and lease losses involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in the allowance for loan and lease losses. In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require an increase in the provision for loan losses or the recognition of additional loan charge offs, based on judgments that are different than those of management. As we are consistently adjusting our loan portfolio and underwriting standards to reflect current market conditions, we can provide no assurance that our methodology will not change, which could result in a charge to earnings.
We continually reassess the creditworthiness of our borrowers and the sufficiency of our allowance for loan and lease losses as part of FSGBank’s credit functions. Our allowance for loan and lease losses increased from 3.30% of total loans at December 31, 2010 to 3.35% at December 31, 2011. We recorded a provision for loan losses during the year ended December 31, 2011 of approximately $10.9 million, which was significantly lower than the $34.7 million and $25.4 million recognized for the years ending December 31, 2010 and 2009, respectively. We charged-off approximately $15.3 million in loans, net of recoveries, during the year ended December 31, 2011, which was significantly lower than in 2010 but higher than in previous periods. We will likely experience additional classified loans and non-performing assets in the foreseeable future, as well as related increases in loan charge-offs, as the deterioration in the credit and real estate markets causes borrowers to default. Further, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, likely will be negatively affected by the current downturn in the real estate market, and therefore may result in an inability to realize a full recovery in the event that a borrower defaults on a loan. Any additional non-performing assets, loan charge-offs, increases in the provision for loan losses or the continuation of aggressive charge-off policies or any inability by us to realize the full value of underlying collateral in the event of a loan default, will negatively affect our business, financial condition, and results of operations and the price of our securities. Further, there can be no assurance that our allowance for loan and lease losses at December 31, 2011 will be sufficient to cover future credit losses.
We make and hold in our portfolio a significant number of land acquisition and development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions.
We offer land acquisition and development, and construction loans for builders and developers, and as of December 31, 2011, we had $53.8 million in such loans outstanding, representing 75.3% of FSGBank’s total risk-based capital. These land acquisition and development, and construction loans are more risky than other types of loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting and project risks. Project risks include cost overruns, borrower credit risk, project
completion risk, general contractor credit risk, and environmental and other hazard risks. Market risks are risks associated with the sale of the completed residential units. They include affordability risk, which means the risk that borrowers cannot obtain affordable financing, product design risk, and risks posed by competing projects. There can be no assurance that losses in our land acquisition and development and construction loan portfolio will not exceed our reserves, which could adversely impact our earnings. Given the current environment, the non-performing loans in our land acquisition and development and construction portfolio are likely to increase during 2012, and these non-performing loans could result in a material level of charge-offs, which would negatively impact our capital and earnings.
If the value of real estate in our core markets were to decline further, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.
In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2011, approximately 85.2% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower but may deteriorate in value during the time the credit is extended. If the value of real estate in our core markets were to decline further, a significant portion of our loan portfolio could become under-collateralized. As a result, if we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.
The amount of our OREO may result in additional losses, and costs and expenses that will negatively affect our operations.
At December 31, 2011, we had a total of $25.1 million of OREO. This level of OREO is due, among other things, to the continued deterioration of the residential real estate market and the tightening of the credit market. The costs and expenses to maintain the real estate are proportionate to our level of OREO. Due to the on-going economic downturn, the amount of OREO may continue to remain elevated in the coming months. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and may reduce our ultimate realization from any OREO sales.
Our ability to retain, attract and motivate qualified individuals may be limited by our financial and regulatory condition, restrictions on our ability to compensate those individuals, and the need for regulatory non-objection to fill certain positions.
Our success depends on our ability to retain, attract and motivate qualified individuals in key positions throughout the organization. Our financial and regulatory condition may limit our ability to retain, attract and motivate qualified individuals. Among other factors, the decline in our stock price has limited the real and perceived value of our historical stock compensation, and our condition may be viewed as a liability by current and prospective employees.
We are generally prohibited from entering into, amending, or renewing any agreement that provides for golden parachute payments to an institution-affiliated party or from making such golden parachute payments, absent approval from the federal banking regulators. As a participant in the CPP, we are subject to specified limits on the compensation we can pay to certain senior executive officers. The limitations, which include restrictions on bonus and other incentive compensation payable to First Security’s senior executive officers, a prohibition on any “golden parachute” payments and a “clawback” of any bonus that was based on materially inaccurate financial data or other performance metric, could limit our ability to retain, attract and motivate the best executive officers because other competing employers may not be subject to these limitations.
We are also currently required to notify the federal banking regulators in advance of employing any senior executive officer or changing the responsibilities of a senior executive officer. This requirement could prevent us from hiring the individuals of our choosing, could discourage potential applicants, or otherwise delay our ability to fill vacant positions.
If we are unable to retain, attract and motivate qualified individuals in key positions, our business and results of operations could be adversely affected.
We have had significant turnover in our senior management team and this turnover could negatively impact our future results of operations.
Our success depends substantially on the skill and abilities of our executive officers and senior officers. The loss of key personnel has impacted our operations, and we have added several new senior officers during 2011 and 2012. During 2011, the Chief Executive Officer and the Chief Financial Officer each resigned from the Company, and the Company hired new individuals to serve as Chief Executive Officer, Chief Financial Officer, and Senior Lender. During 2012, the Company moved its Chief Risk Officer into a newly created position of Chief Administrative Officer and hired individuals to serve as Chief Credit Officer, Retail Banking Officer and Director of Wealth Management and Trust. The Company may be unable to retain some other employees based on turnover in the senior management team. While certain members of the management team have previously worked together, we cannot assure you that the collective new team will be successful in executing our strategy and improving our current results of operations.
Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition.
We will realize additional future losses if the proceeds we receive upon liquidation of non-performing assets are less than the fair value of such assets.
We have announced a strategy to manage our non-performing assets aggressively, a portion of which may not be currently identified. Non-performing assets are recorded on our financial statements at fair value, as required under GAAP, unless these assets have been specifically identified for liquidation, in which case they are recorded at the lower of cost or estimated net realizable value. In current market conditions, we are likely to realize additional future losses if the proceeds we receive upon dispositions of non-performing assets are less than the recorded fair value of such assets.
We are subject to risks in the event of certain borrower defaults, which could have an adverse impact on our liquidity position and results of operations.
We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of certain borrower defaults, which could adversely affect our liquidity position, results of operations, and financial condition. When we sell mortgage loans, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which the loans were originated. In the event of a
breach of any of the representations and warranties related to a loan sold, we could be liable for damages to the investor up to and including a “make whole” demand that involves, at the investor’s option, either reimbursing the investor for actual losses incurred on the loan or repurchasing the loan in full. Our maximum exposure to credit loss in the event of make whole loan repurchase claim would be the unpaid principal balance of the loan to be repurchased along with any premium paid by the investor when the loan was purchased and other minor collection cost reimbursements. While we have taken steps to enhance our underwriting policies and procedures, these steps might not be effective and might not lessen the risks associated with loans sold in the past. If repurchase demands increase, our liquidity position, results of operations, and financial condition could be adversely affected.
Negative publicity about financial institutions, generally, or about First Security or FSGBank, specifically, could damage First Security’s reputation and adversely impact its liquidity, business operations or financial results.
Reputation risk, or the risk to our business from negative publicity, is inherent in our business. Negative publicity can result from the actual or alleged conduct of financial institutions, generally, or First Security or FSGBank, specifically, in any number of activities, including leasing and lending practices, corporate governance, and actions taken by government regulators in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action, any of which could negatively affect our liquidity, business operations or financial results.
Increases in our expenses and other costs, including those related to centralizing our credit functions, could adversely affect our financial results.
Our expenses and other costs, such as operating expenses and hiring new employees to enhance our credit and underwriting administration, directly affect our earnings results. In light of the extremely competitive environment in which we operate, and because the size and scale of many of our competitors provides them with increased operational efficiencies, it is important that we are able to successfully manage such expenses. We are aggressively managing our expenses in the current economic environment, but as our business develops, changes or expands, and as we hire additional personnel, additional expenses can arise. Other factors that can affect the amount of our expenses include legal and administrative cases and proceedings, which can be expensive to pursue or defend. In addition, changes in accounting policies can significantly affect how we calculate expenses and earnings.
Changes in the interest rate environment could reduce our net interest income, which could reduce our profitability.
As a financial institution, our earnings significantly depend on our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes in the Federal Reserve Board’s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates. In addition, any significant increase in prevailing interest rates could adversely affect our mortgage banking business because higher interest rates could cause customers to request fewer refinancings and purchase money mortgage originations.
We face strong competition from larger, more established competitors that may inhibit our ability to compete and expose us to greater lending risks.
The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other financial institutions, which operate in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established and much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our markets, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.
Our ability to diversify our economic risks is limited by our own local markets and economies. We lend primarily to individuals and to small to medium-sized businesses, which may expose us to greater lending risks than those of banks lending to larger, better capitalized businesses with longer operating histories. As an example, our market area in northern Georgia is highly dependent on the home furnishings and carpet industry centered near Dalton, Georgia. Because of the downturn in residential construction, this industry has suffered a business decline, which has adversely affected the performance of our operations in Dalton and surrounding areas. As a community bank, we are less able to spread the risk of unfavorable local economic conditions than larger or more regional banks. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
The soundness of our financial condition may also affect our competitiveness. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Customers may decide not to do business with us due to our financial condition. In addition, our ability to compete is impacted by the limitations on our activities imposed under the Order and the Agreement. We have faced and continue to face, additional regulatory restrictions that our competitors may not be subject to, including improving the overall risk profile of the Company and restrictions on the amount of interest we can pay on deposit accounts, which could adversely impact our ability to compete and attract and retain customers.
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
Our agreement with the Treasury under the CPP is subject to unilateral change by the Treasury, which could adversely affect our business, financial condition, and results of operations.
Under the CPP, the Treasury may unilaterally amend the terms of its agreement with us in order to comply with any changes in federal law. We cannot predict the effects of any of these changes and of the associated amendments. It is possible, however, that any such amendment could have a material impact on us or our operations.
The costs and effects of litigation, investigations or similar matters, or adverse facts and developments related thereto, could materially affect our business, operating results and financial condition.
We may be involved from time to time in a variety of litigation, investigations or similar matters arising out of our business. Our insurance may not cover all claims that may be asserted against it and indemnification rights to which we are entitled may not be honored, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed our insurance coverage, they could have a material adverse effect on our business, financial condition and results of operations. In addition, premiums for insurance covering the financial
and banking sectors are rising. We may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms or at historic rates, if at all.
Changes in tax rates, interpretations of tax laws, the status of examinations by tax authorities and newly enacted statutory, judicial and regulatory guidance could materially affect our business, operating results and financial condition.
We are subject to various taxing jurisdictions where we conduct business. We assess the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other pertinent information and maintain tax accruals consistent with our evaluation. This evaluation incorporates assumptions and estimates that involve a high degree of judgment and subjectivity. Changes in the results of these evaluations could have a material impact on our operating results.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Our loan policies require certain due diligence of high risk industries and properties with the intention of lowering our risk of a non-performing loan and/or foreclosed property.
Electronic intrusion attempts could result in expenses being incurred.
We maintain many bank records in electronic formats. The data is stored on secure networks with appropriate security measures to protect that data from unauthorized retrieval or usage. Should the data controls be bypassed, additional expenses could be incurred associated with correction of manipulated data, restoration of systems, revising security controls, notification of affected customers, and addressing reputational damage.
RISKS RELATED TO RECENT MARKET, LEGISLATIVE AND REGULATORY EVENTS
We are subject to an Order that could have a material negative effect on our business, operating flexibility, financial condition and the value of our common stock. In addition, addressing the Order will require significant time and attention from our management team, which may increase our costs, impede the efficiency of our internal business processes and adversely affect our profitability in the near-term.
On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order the Bank by and through its Board of Directors consented and agreed to the issuance of a Consent Order by the OCC, the Bank’s primary regulator. The Bank and the OCC agreed as to the areas of the Bank’s operations that warrant improvement and a plan for making those improvements. The Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Bank is required to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan and lease losses, liquidity management, criticized asset, loan review and credit.
While the Company has taken, and intends to continue to take, such actions as may be necessary to enable the Bank to comply with the requirements of the Order, there can be no assurance that the Bank will be able to
comply fully with the provisions of the Order, or that efforts to comply with the Order, particularly the limitations on interest rates offered by the Bank, will not have adverse effects on the operations and financial condition of the Company and the Bank.
We are currently deemed not in compliance with certain provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. We can provide no assurances that we will be able to comply fully with the Order, that efforts to comply with the Order will not have a material adverse effect on the operations and financial condition of FSGBank, or that further enforcement actions won’t be imposed on FSGBank.
We are not currently in compliance with the capital requirements contained in our Order and may need to raise capital to comply, but that capital may not be available when it is needed or it could be dilutive to our existing stockholders, which could adversely affect our financial condition and our results of operations.
The Order required the Bank to, within 120 days of the effective date of the Order, achieve and thereafter maintain total capital at least equal to 13% of risk-weighted assets and Tier 1 capital at least equal to 9% of adjusted total assets. As of December 31, 2011, the Bank’s total risk-based capital ratio was approximately 10.9% and its leverage ratio was approximately 5.6%. The Company is considering a variety of strategic alternatives intended to achieve and maintain the prescribed capital ratios.
Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. If we need to raise additional capital, there is no guarantee that we will be able to borrow funds or successfully raise capital at all or on terms that are favorable or otherwise not dilutive to existing stockholders. If we cannot raise additional capital when needed, our ability to operate our business could be materially impaired. The failure to satisfy the capital requirements of the Order could result in further enforcement actions by the OCC, including the OCC requiring that the Bank develop a plan to sell, merge or liquidate the Bank.
We are subject to an Agreement that could have a material negative effect on our business, operating flexibility, financial condition and the value of our common stock.
On September 7, 2010, First Security entered into an Agreement with the Federal Reserve Bank. The Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. Pursuant to the Agreement, the Company is prohibited from declaring or paying dividends without prior written consent from the Federal Reserve Bank. In addition, pursuant to the Agreement, without the prior written consent of regulators, the Company is prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank; incurring, increasing or guaranteeing any debt; or redeeming any shares of the Company’s common stock. The Company will also provide quarterly written progress reports to the Federal Reserve Bank. The Company was also required to submit to the Federal Reserve Bank a written plan designed to maintain sufficient capital at the Company, on a consolidated basis, and at the Bank.
We are currently deemed not in compliance with several provisions of the Agreement, including the submission of an acceptable capital plan. During March 2012, we submitted a revised five-year strategic and capital plan, developed by the current management team, that we believe addresses the requirements of the Agreement. Any material failure to comply with the provisions of the Agreement could result in further enforcement actions by the Federal Reserve Bank. While the Company intends to take such actions as may be necessary to comply with the requirements of the Agreement, there can be no assurance that the Company will be able to comply fully with the provisions of the Agreement, or that efforts to comply with the Agreement, particularly the limitations on dividend payments, will not have adverse effects on the operations and financial condition of the Company and the value of our common stock.
Our inability to accept, renew or roll over brokered deposits without the prior approval of the FDIC could adversely affect our liquidity.
As of December 31, 2011, we had approximately $238.4 million in out of market deposits, including brokered certificates of deposit and CDARS®, which represented approximately 23.4% of our total deposits. Because the Order establishes specific capital amounts to be maintained by the Bank, the Bank may not be considered better than “adequately capitalized” for capital adequacy purposes, even if the Bank exceeds the levels of capital set forth in the Order. As an adequately capitalized institution, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC. As of December 31, 2011, brokered deposits maturing in the next 24 months totaled $150.8 million. Funding sources for the maturing brokered deposits include, among other sources: our cash account at the Federal Reserve Bank of Atlanta; growth, if any, of core deposits from current and new retail and commercial customers; scheduled repayments on existing loans; and the possible pledge or sale of investment securities. As an adequately capitalized institution, the Bank also may not pay interest on deposits that are more than 75 basis points above the rate applicable to the applicable market of the Bank as determined by the FDIC. These interest rate limitations may limit the ability of the Bank to increase or maintain core deposits from current and new deposit customers. The limitations on our ability to accept, renew or roll over brokered deposits, or pay more than 75 basis points above the applicable rate could adversely affect our liquidity.
A continuation of the current economic downturn in the housing market and the homebuilding industry and in our markets generally could adversely affect our financial condition, results of operations or cash flows.
Our long-term success depends upon the growth in population, income levels, deposits and housing starts in our primary market areas. If the communities in which FSGBank operates do not grow, or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. The unpredictable economic conditions we have faced over the last 36 months have had an adverse effect on the quality of our loan portfolio and our financial performance. Economic recession over a prolonged period or other economic problems in our market areas could have a material adverse impact on the quality of the loan portfolio and the demand for our products and services. Future adverse changes in the economies in our market areas may have a material adverse effect on our financial condition, results of operations or cash flows. Further, the banking industry in Tennessee and Georgia is affected by general economic conditions such as inflation, recession, unemployment and other factors beyond our control.
Since the third quarter of 2007, the residential construction and commercial development real estate markets have experienced a variety of difficulties and changed economic conditions. As a result, there has been substantial concern and publicity over asset quality among financial institutions due in large part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. As of December 31, 2011, our non-performing assets had decreased to $72.4 million, or 6.49% of our total assets, as compared to $79.2 million, or 6.78% as of December 31, 2010. However, the housing and the residential mortgage markets continue to experience a variety of difficulties and changed economic conditions.
The homebuilding and residential mortgage industry has experienced a significant and sustained decline in demand for new homes and a decrease in the absorption of new and existing homes available for sale in various markets. Our customers who are builders and developers face greater difficulty in selling their homes in markets where these trends are more pronounced. Consequently, we are facing increased delinquencies and non-performing assets as these builders and developers are forced to default on their loans with us. We do not know when or to what extent the housing market will improve, and accordingly, additional downgrades, provisions for loan losses and charge-offs related to our loan portfolio may occur. If market conditions continue to deteriorate, our non-performing assets may continue to increase and we may need to take additional valuation adjustments on our loan portfolios and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default and the net realizable value of real estate owned.
Negative developments in the financial industry, and the domestic and international credit markets may adversely affect our operations and results.
Negative developments during 2008 in the global credit and derivative markets resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2012. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. If these negative trends continue, our business operations and financial results may be negatively affected.
The FDIC Deposit Insurance assessments that we are required to pay may continue to materially increase in the future, which would have an adverse effect on our earnings.
As an insured depository institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. These assessments are required to ensure that FDIC deposit insurance reserve ratio meets or exceeds a specified minimum ratio. Under the Dodd-Frank Act, which was signed into law on July 21, 2010, the FDIC deposit insurance reserve ratio must be increased to at least 1.35% of insured deposits by September 30, 2020. Under the Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances, must establish and implement a plan to restore the deposit insurance reserve ratio to at least the minimum, over a five-year period, when the reserve ratio falls below the minimum ratio. In addition, the Dodd-Frank Act grants to the FDIC greater authority to build up excess reserves when the deposit insurance fund has otherwise met its targets.
The recent failures of numerous financial institutions have significantly increased the deposit insurance fund’s loss provisions, resulting in a decline in the reserve ratio. The FDIC imposed special assessments on banks during 2009 to address this decline and also required the majority of insured institutions to prepay slightly over three years of estimated insurance assessments. Additional insured institution failures in the next few years could result in a continued decline in the reserve ratio. While institutions such as ours with less than $10 billion in assets will be exempt from increased premiums required specifically to support the increase in the reserve requirement, we may nonetheless be subject to increased premiums generally over future periods.
It is possible that the FDIC may impose additional special assessments in the future as part of its restoration plan. If the FDIC does impose additional special assessments, or otherwise further increases assessment rates, our earnings could be further adversely impacted.
The Dodd-Frank Act and related regulations may adversely affect our business, financial condition, liquidity or results of operations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act created a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions, including those with $10 billion or less in assets, will be subject to the Consumer Financial Protection Bureau’s rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things, includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set by the Federal Reserve under a restrictive “reasonable and proportional cost” per transaction standard and (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than $15 billion in assets.
At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact us. However, compliance with these new laws and regulations may increase our costs, limit our ability to pursue attractive business opportunities, cause us to modify our strategies and business operations and increase our capital requirements and constraints, any of which may have a material adverse impact on our business, financial condition, liquidity or results of operations.
RISKS ASSOCIATED WITH AN INVESTMENT IN OUR COMMON STOCK
If we fail to continue to meet all applicable continued listing requirements of the Nasdaq Global Select Market and Nasdaq determines to delist our common stock, the market liquidity and market price of our common stock could decline, and our ability to access the capital markets could be negatively affected.
Our common stock is listed on the Nasdaq Global Select Market. To maintain that listing, we must satisfy minimum financial and other continued listing requirements. While we intend to maintain our listing on Nasdaq, if we fail to meet the requirements for continued listing or we are unable to cure any events of noncompliance in a timely or effective manner, our common stock could be delisted.
The perception or possibility that our common stock could be delisted in the future could negatively affect its liquidity and price. Delisting would have an adverse effect on the liquidity of the common shares and, as a result, the market price for the common stock might become more volatile. Delisting could also make it more difficult for us to raise additional capital, if needed, on terms acceptable to us or at all. Although quotes for our common stock would continue to be available on the OTC Bulletin Board or on the “Pink Sheets” in the event of a delisting from Nasdaq, such alternatives are generally considered to be less efficient markets, and the stock price, as well as the liquidity of the common stock, may be adversely affected as a result.
The trading volume of our common stock is less than that of other larger financial services companies.
Although our common stock is traded on the Nasdaq Global Select Market, the trading volume of our common stock is less than that of other larger financial services companies. For the public trading market for our common stock to have the desired characteristics of depth, liquidity and orderliness requires the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall more than would otherwise be expected if the trading volume of our common stock were commensurate with the trading volumes of the common stock of larger financial services companies.
Tennessee law and our charter limit the ability of others to acquire us.
Various anti-takeover protections for Tennessee corporations are set forth in the Tennessee Business Corporation Act, the Business Combination Act, the Control Share Acquisition Act, the Greenmail Act and the Investor Protection Act. Because our common stock is registered with the SEC under the Securities Exchange Act of 1934, the Business Combination Act automatically applies to us unless our stockholders adopt a charter or bylaw amendment which expressly excludes us from the anti-takeover provisions of the Business Combination Act two years prior to a proposed takeover. Our Board of Directors has no present intention of recommending such charter or bylaw amendment.
These statutes have the general effect of discouraging, or rendering more difficult, unfriendly takeover or acquisition attempts. Such provisions could be beneficial to current management in an unfriendly takeover attempt but could have an adverse effect on stockholders who might wish to participate in such a transaction.
Our future operating results may be below securities analysts’ or investors’ expectations, which could cause our stock price to decline.
We may be unable to generate significant revenues or grow at the rate expected by securities analysts or investors. In addition, our costs may be higher than we, securities analysts or investors expect. If we fail to generate sufficient revenues or our costs are higher than we expect, our results of operations will suffer, which in turn could cause our stock price to decline.
Our operating results in any particular period may not be a reliable indication of our future performance. In some future quarters, our operating results may be below the expectations of securities analysts or investors. If this occurs, the price of our common stock will likely decline.
We have elected to defer the dividend payments on our Series A Preferred Stock during 2010 and 2011; as a result, we are unable to pay dividends on our common stock until we pay all dividends in arrears on the Series A Preferred Stock.
On January 9, 2009, we issued senior preferred stock (the “Series A Preferred Stock”) to the Treasury in an aggregate amount of $33 million, along with a warrant to purchase 82,363 shares of common stock (the “Warrant”). On January 27, 2010, our Board of Directors elected to suspend the dividend on our common stock and elected to defer the dividend payment on our Series A Preferred Stock for the first quarter of 2010; our Board of Directors similarly elected on a quarterly basis to defer the three other scheduled dividend payments on our Series A Preferred Stock during 2010, four in 2011 and the first scheduled dividend payment of 2012. We may not pay dividends on common stock unless all dividends have been paid on the securities issued to the Treasury under the CPP; having deferred these dividend payments, we are prohibited on paying any future dividends on our common stock until all dividends payable to the Treasury under the CPP have been paid in full.
Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our Board of Directors may deem relevant. The holders of our common stock are entitled to receive dividends when, and if declared by our Board of Directors out of funds legally available for that purpose. As part of our consideration to pay future cash dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business. In addition, our ability to pay dividends is restricted by federal policies and regulations. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. Further, our principal sources of funds to pay dividends are cash dividends and management fees that we receive from FSGBank, and the Order and the Agreement preclude the payment of dividends by FSGBank without prior regulatory consent.
The Series A Preferred Stock issued to the Treasury impacts net income available to our common stockholders and our earnings per share.
As long as shares of our Series A Preferred Stock issued under the CPP are outstanding, no dividends may be paid on our common stock unless all dividends on the Series A Preferred Stock have been paid in full. Any dividends declared on shares of our Series A Preferred Stock will reduce the net income available to common stockholders and our earnings per common share. Additionally, issuance of the Warrant, in conjunction with the issuance of the Series A Preferred Stock, may be dilutive to our earnings per share. The shares of First Security’s Series A Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up.
We can provide no assurances as to when the Series A Preferred Stock can be redeemed and the Warrant can be repurchased.
Subject to consultation with our banking regulators, we intend to repurchase the Series A Preferred Stock and the Warrant issued to the Treasury when we believe the credit metrics in our loan portfolio have improved
for the long-term and the overall economy has rebounded. However, there can be no assurance when the Series A Preferred Stock and the Warrant can be repurchased, if at all. Until such time as the Series A Preferred Stock and the Warrant are repurchased, we will remain subject to the terms and conditions of those instruments. Further, our continued participation in the CPP subjects us to increased regulatory and legislative oversight, including with respect to executive compensation. These oversight and legal requirements under the CPP, as well as any other requirement that the Treasury could adopt in the future, may have unforeseen or unintended adverse effects on the financial services industry as a whole, and particularly on CPP participants such as ourselves.
Holders of the Series A Preferred Stock have limited voting rights.
Except in connection with the election of two directors to our Board of Directors and as otherwise required by law, holders of the Series A Preferred Stock have limited voting rights. In addition to any other vote or consent of stockholders required by law or our amended and restated charter, the vote or consent of holders owning at least 66 2/3% of the shares of Series A Preferred Stock outstanding is required for (1) any authorization or issuance of shares ranking senior to the Series A Preferred Stock; (2) any amendment to the rights of the Series A Preferred Stock that adversely affects the rights, preferences, privileges or voting power of the Series A Preferred Stock; or (3) consummation of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding or are converted into or exchanged for preference securities of the surviving entity other than us and have such rights, preferences, privileges and voting power as are not materially less favorable than those of the holders of the Series A Preferred Stock.
Item 1B.
Item 1B. Unresolved Staff Comments
There are no written comments from the Commission staff regarding our periodic or current reports under the Act which remain unresolved.
Item 2.
Item 2. Properties
During 2011, we conducted our business primarily through our corporate headquarters located at 531 Broad Street, Chattanooga, Hamilton County, Tennessee.
We believe that our banking offices are in good condition, are suitable to our needs and, for the most part, are relatively new. The following table summarizes pertinent details of our owned or leased branch, loan production and leasing offices.
As of December 31, 2011, we owned one additional plot of land. The vacant lot is located at 1020 South Highway 92, Dandridge, Jefferson County, Tennessee (1.0 acres). The lot is currently available for sale and is included in our other real estate owned portfolio. We originally purchased this site for bank purposes.
Subsequent to June 30, 2011, we closed two offices in Jackson County, two in Monroe County, and one in Loudon County. Since we own these branches, they are included in our other real estate owned portfolio and are currently available for sale.
Additionally, we closed a leased branch location in Union County, Tennessee on October 31, 2011.
We are not aware of any environmental problems with the properties that we own or lease that would be material, either individually, or in the aggregate, to our operations or financial condition.
Item 3.
Item 3. Legal Proceedings
While we are from time to time a party to various legal proceedings arising in the ordinary course of our business, management believes, after consultation with legal counsel, that there are no proceedings threatened or pending against us that will, individually or in the aggregate, have a material adverse affect on our business or consolidated financial condition.
Item 4.
Item 4. Mine Safety Disclosure
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Since August 10, 2005, our common stock has been traded on the Nasdaq Global Select Market under the symbol FSGI. On March 29, 2012, there were 635 registered holders of record of our common stock. The high and low prices per share were as follows:
It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. For a foreseeable period of time, our principal source of cash will be dividends and management fees paid by FSGBank to us. There are certain restrictions on these payments imposed by federal banking laws, regulations and authorities.
The declaration and payment of dividends on our common stock will depend upon our earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by our Board of Directors. On January 27, 2010, our Board of Directors elected to suspend the dividend on our common stock and elected to defer the dividend payment on our Series A Preferred Stock for the first quarter of 2010. Over the balance of 2010 and 2011, the Board of Directors elected on a quarterly basis to continue to defer the dividend payments for the Series A Preferred Stock. In light of this action, we make no assurance that we will pay any dividends in the future. We may not pay dividends on our common stock unless all dividends have been paid on the securities issued to the Treasury under the CPP; having deferred the dividend payments scheduled for payment in 2010 and 2011, we are prohibited on paying any future dividends on our common stock until all dividends payable to the Treasury under the CPP have been paid in full.
On July 23, 2008, our Board of Directors approved a loan, which was subsequently amended on January 28, 2009, in the amount of $12.7 million from First Security Group, Inc. to First Security Group, Inc. 401(k) and Employee Stock Ownership Plan (the “401(k) and ESOP Plan”). The purpose of the loan is to purchase Company shares in open market transactions. The shares will be used for future Company matching contributions within the 401(k) and ESOP Plan. As of December 31, 2011, the plan held 30,725 unallocated shares at a weighted average price of $106.69. The purchase program concluded on December 31, 2009.
As previously disclosed, on December 28, 2011, First Security awarded its CEO, Michael Kramer, 35,000 shares of First Security’s common stock as part of the company’s inducement for Mr. Kramer to join First Security. The shares are subject to a restricted stock agreement limiting the vesting and transferability of the shares in accordance with the TARP executive compensation requirements. In issuing the securities, First Security relied on Section 4(2) of the Securities Act of 1933, as amended.
Item 6.
Item 6. Selected Financial Data
Our selected financial data is presented below as of and for the years ended December 31, 2007 through 2011. The selected financial data presented below as of December 31, 2011 and 2010 and for each of the years in the three-year period ended December 31, 2011, are derived from our audited financial statements and related notes included in this Annual Report on Form 10-K and should be read in conjunction with the consolidated financial statements and related notes, along with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 47. The selected financial data as of December 31, 2009, 2008 and 2007 and for the two years ended December 31, 2008 have been derived from our audited financial statements that are not included in this Annual Report on Form 10-K. All per share data and the number of shares outstanding has been retroactively adjusted for the one-for-ten reverse stock split effected on September 19, 2011. Certain of the measures set forth below are non-GAAP financial measures under the rules and regulations promulgated by the SEC. For a discussion of management’s reasons to present such data and a reconciliation to GAAP, please see “GAAP Reconciliation and Management Explanation for Non-GAAP Financial Measures” following the tables.
Performance ratios are calculated using net (loss) income available to common shareholders, excluding the goodwill impairment.
GAAP Reconciliation and Management Explanation for Non-GAAP Financial Measures
The information set forth above contains certain financial information determined by methods other than in accordance with GAAP. Management uses these “non-GAAP” measures in their analysis of First Security’s performance. Non-GAAP measures typically adjust GAAP performance measures to exclude the effects of charges, expenses and gains related to the consummation of mergers and acquisitions and costs related to the integration of merged entities. These non-GAAP measures may also exclude other significant gains, losses or expenses that are unusual in nature and not expected to recur. Since these items and their impact on our performance are difficult to predict, management believes presentations of financial measures excluding the impact of these items provide useful supplemental information that is important for a proper understanding of the operating results of our core business. Additionally, management utilizes measures involving a tangible basis which exclude the impact of intangible assets such as goodwill and core deposit intangibles. As these assets are normally created through acquisitions and not through normal recurring operations, management believes that the exclusion of these items presents a more comparable assessment of the aforementioned measures on a recurring basis.
Specifically, management uses “non-interest expense, excluding goodwill impairment,” “net (loss) income available to common stockholders, excluding goodwill impairment, net of tax,” “net (loss) income, excluding goodwill impairment per share,” “return on average common equity,” “return on average tangible assets,” “return on average tangible common equity,” “return on average assets, excluding goodwill impairment,” “return on average common equity, excluding goodwill impairment,” “return on average tangible assets, excluding goodwill impairment,” and “return on average tangible common equity, excluding goodwill impairment.” Our management uses these non-GAAP measures in its analysis of First Security’s performance, as further described below.
•
“Non-interest expense, excluding goodwill impairment” is defined as non-interest expense reduced by the effect of goodwill impairment. “Net (loss) income available to common stockholders, excluding goodwill impairment” is defined as net income, increased by the effect of impairment of goodwill, net of tax. “Net (loss) income, excluding goodwill impairment per share” is defined as net income, increased by the effect of impairment of goodwill, net of tax, divided by total common shares outstanding. Our management includes these measures because it believes that they are important when measuring First Security’s performance exclusive of the effects of impairment of goodwill. As of September 30, 2009, the annual assessment of goodwill indicated a full impairment of goodwill; accordingly, no further goodwill remains on the books of First Security. The goodwill impairment is a
one-time, non-cash accounting adjustment that has no effect on First Security’s cash flows, liquidity, tangible capital, or ability to conduct business and as such, management believes excluding this charge is appropriate to properly measure First Security’s performance. These three non-GAAP financial measures exclude the effect of the goodwill impairment on the most comparable GAAP measures: non-interest expense (to measure the overall level of First Security’s recurring non-interest related expenses); net (loss) income available to common stockholders (to reflect the recurring overall net income available to stockholders collectively); and net (loss) income per share (to reflect the recurring overall net income available to stockholders on a per share basis).
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“Return on average common equity” is defined as annualized earnings for the period divided by average equity reduced by average preferred stock. Our management includes this measure in addition to return on average equity, the most comparable GAAP measure, because it believes that it is important when measuring First Security’s performance exclusive of the effects of First Security’s outstanding preferred stock, which has a fixed return, and that this measure is important to many investors in First Security’s common stock.
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“Return on average tangible assets” is defined as annualized earnings for the period divided by average assets reduced by average goodwill and other intangible assets. “Return on average tangible common equity” is defined as annualized earnings for the period divided by average equity reduced by average preferred stock and average goodwill and other intangible assets. Our management includes these measures because it believes that they are important when measuring First Security’s performance exclusive of the effects of goodwill and other intangibles recorded in First Security’s historic acquisitions, exclusive of the effects of First Security’s outstanding preferred stock, which has a fixed return, and these measures are used by many investors as part of their analysis of First Security’s performance.
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“Return on average assets, excluding goodwill impairment” is defined as net income, increased by the effect of impairment of goodwill, net of tax, divided by average assets. “Return on average common equity, excluding goodwill impairment” is defined as net income, increased by the effect of impairment of goodwill, net of tax, divided by average equity reduced by average preferred stock. “Return on average tangible assets, excluding goodwill impairment” is defined as net income, increased by the effect of impairment of goodwill, net of tax, divided by average assets reduced by average goodwill and other intangible assets. “Return on average tangible common equity, excluding goodwill impairment” is defined as net income, increased by the effect of impairment of goodwill, net of tax, divided by average equity reduced by average preferred stock and average goodwill and other intangible assets. The most comparable GAAP measure for each of these measures is return on average assets. Our management includes these measures because it believes that they are important when measuring First Security’s performance exclusive of the effects of impairment of goodwill. As of September 30, 2009, the annual assessment of goodwill indicated a full impairment of goodwill; accordingly, no further goodwill remains on the books of First Security. The goodwill impairment is a one-time, non-cash accounting adjustment that has no effect on First Security’s cash flows, liquidity, tangible capital, or ability to conduct business and as such, management believes excluding this charge is necessary to properly measure First Security’s performance.
These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. The following table provides a more detailed analysis of these non-GAAP performance measures.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
The following is management’s discussion and analysis (MD&A) which should be read in conjunction with “Selected Financial Data” and our consolidated financial statements and notes included in this Annual Report on Form 10-K. The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as applying to all related forward-looking statements wherever they appear in this Annual Report. Our actual results could differ materially from those discussed in this Annual Report on Form 10-K.
Year Ended December 31, 2011
The following discussion and analysis sets forth the major factors that affected First Security’s financial condition as of December 31, 2011 and 2010, and results of operations for the three years ended December 31, 2011 as reflected in the audited financial statements.
Strategic Initiatives for 2011
During 2011, we continued to execute certain strategic initiatives that began during 2009 and 2010. Additionally, we consolidated six branches while launching deposit and lending campaigns, as discussed in further detail below. We believe our strategic initiatives are positioning us appropriately for both short-term stability and long-term success. Executed initiatives include centralizing loan underwriting and approval, deepening senior management, improving our liquidity position and outsourcing the marketing and sales function for most of our foreclosed properties.
Strategic Initiative-Strengthening Management-Currently, we have completed the restructuring of our executive and senior management team. Michael Kramer was appointed as CEO and President in December 2011. This was followed by the appointment of three executive vice presidents in February 2012; Chief Credit Officer, Retail Banking Officer and Director of FSGBank’s Wealth Management and Trust Department. Additionally, a Chief Lending Officer joined the Bank in August 2011. We also promoted two tenured managers to the roles of Chief Administrative Officer in February 2012 and Chief Financial Officer in February 2011.
Strategic Initiative-Strengthening Board of Directors-During 2011, three additional directors were appointed to the Board. During 2012, two additional directors have been appointed with two additional candidates pending regulatory non-objection. We anticipate the completion of a restructured Board of Directors by mid-year 2012.
Strategic Initiative-Strengthening Capital-Management is pursuing various options to restore its capital to a satisfactory level, including, but not limited to, a private stock placement. Since December 2011, management has been in preliminary discussions with multiple potential investors. While no letters of intent or binding commitments have been executed, in management’s opinion, the reaction of potential investors has generally been positive and has led to continuing discussions.
Strategic Initiative-Improving Asset Quality- Management is evaluating various options to reduce the level of nonperforming assets, including, but not limited to, select asset divestitures of nonperforming assets. Additionally, management has implemented an incentive plan for the Special Assets department that rewards both reductions in nonperforming assets and achieving historical realization rates. We expect this to produces higher volumes of nonperforming asset resolutions during 2012 as compared to 2011, which, when combined with the expectation of lower inflows into nonperforming loans, should reduce the overall level of nonperforming assets.
Strategic Initiative-Triumph Investment Managers-As announced on May 4, 2011, we engaged Triumph Investment Managers, LLC (Triumph) to provide strategic advisory services and subsequently
appointed Mr. Robert P. Keller, a managing director of Triumph, to our Board of Directors. The mutual goal of this engagement is to create and restore shareholder value through the realignment of the organizational structure and the installation of a philosophy that provides for greater accountability. Triumph and management will evaluate, monitor, and, as appropriate, refine, these existing initiatives, while also considering others.
Strategic Initiative-Branch Consolidation-During the third quarter of 2011, six branch locations were selected for consolidation. Five of those offices were consolidated on October 31, 2011 and the remaining branch was consolidated on December 30, 2011. The cost savings are estimated to be $1 million per year.
Strategic Initiative-Deposit and Lending Campaigns-During June 2011 and continuing into the third quarter, we launched two consecutive five-week deposit campaigns aimed to increase our customer base and core deposits. These campaigns generated strong response throughout our branch network and resulted in nearly $55 million of new deposits. We may run additional deposit campaigns in 2012. During September 2011 and continuing into the fourth quarter, we launched several lending campaigns that we believe will stabilize our loan portfolio and position us for loan growth for 2012.
Replacement of Auditors
Effective July 8, 2011, First Security’s Audit/Corporate Governance Committee (the “Audit Committee”) approved the dismissal of Joseph Decosimo and Company, PLLC as First Security’s independent registered public accounting firm. Effective July 11, 2011, the Audit Committee approved the engagement of Crowe Horwath, LLP as First Security’s independent registered public accounting firm for its 2011 fiscal year.
Reverse Stock Split and NASDAQ Bid Price Compliance
On September 19, 2011 (the “Effective Date”), we completed a one-for-ten reverse stock split of our common stock. In connection with the reverse stock split, every ten shares of issued and outstanding First Security common stock at the Effective Date were exchanged for one share of newly issued common stock. Fractional shares were rounded up to the next whole share. Other than the number of authorized shares of common stock disclosed in the Consolidated Balance Sheets, all prior period share amounts have been retroactively restated to reflect the reverse stock split. For additional information related to the reverse stock split, see Notes 2 and 16 to our consolidated financial statements.
On October 3, 2011, NASDAQ notified us that we had regained compliance with the Bid Price Rule after our closing bid price was in excess of $1.00 for 10 consecutive business days.
Regulatory Matters
Effective September 7, 2010, First Security entered into an Agreement with the Federal Reserve Bank. The Agreement is designed to ensure First Security is a source of strength to FSGBank. Substantially all of the requirements of the Agreement are similar to those already in effect for FSGBank pursuant to the Consent Order that is described below. On September 14, 2010, we filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides a copy of the fully executed Agreement.
We are currently deemed not in compliance with some provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve Bank. We can provide no assurances that we will be able to comply fully with the Agreement, that efforts to comply with the Agreement will not have a material adverse effect on the operations and financial condition of First Security, or that further enforcement actions won’t be imposed on First Security.
Effective April 28, 2010, FSGBank reached an agreement with its primary regulator, the OCC, regarding the issuance of a Consent Order. The Order is a result of the OCC’s regular examination of FSGBank in the fall of 2009 and directs FSGBank to take actions intended to strengthen its overall condition. All customer deposits
remain fully insured by the FDIC to the maximum extent allowed by law; the Order does not impact this coverage in any manner. On April 29, 2010, First Security filed a current report on Form 8-K describing the Order and the related actions taken by the Bank to date. The Form 8-K also provides a copy of the fully executed Order.
We are currently deemed not in compliance with certain provisions of the Order, including the capital requirements. The Order required FSGBank to maintain certain capital ratios within 120 days of it execution. The December 31, 2011 Call Report was the sixth public financial statement related to a period subsequent to the 120 day requirement. As of December 31, 2011, the Bank’s total capital to risk-weighted assets was 10.9% and the Tier 1 capital to adjusted total assets was 5.6%. The Bank has notified the OCC of the non-compliance. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. We can provide no assurances that we will be able to comply fully with the Order, that efforts to comply with the Order will not have a material adverse effect on the operations and financial condition of FSGBank, or that further enforcement actions won’t be imposed on FSGBank.
Prior to and following the OCC’s regularly scheduled exam in the fall of 2009, we developed and began implementing a number of strategic initiatives designed to improve both the operations and the financial performance of First Security. A primary change involved the centralization of key functions, including all aspects of credit administration. During 2011 and the first quarter of 2012, the management team underwent significant turnover and change. The Chief Executive Officer, Chief Financial Officer and Chief Credit Officer all resigned during the first two quarters of 2011. The Board of Directors appointed Michael Kramer as CEO and President in December 2011 and he subsequently hired a Chief Credit Officer and two additional senior management positions during the first quarter of 2012. With the changes in management, we began the process of developing a new strategic and capital plan to serve as the framework for the Company. This plan was submitted during the first quarter of 2012. We believe the successful execution of this strategic and capital plan will result in full compliance with the Order and Agreement and position us for long-term growth and a return to profitability.
Overview
Market Conditions
Most indicators point toward the overall U.S. economy continuing to improve during 2012. As our financial results can be a reflection of our regional economy, we closely monitor and evaluate local and regional economic trends.
Announced in 2010, Amazon.com opened two distribution centers in our markets in 2011. The $139 million investments created more than 2,000 full-time jobs in Hamilton and Bradley counties along with more than 2,000 seasonal jobs. Amazon is currently in the process of expanding its Chattanooga facility and anticipates the expansion will translates to additional hiring, with a peak of 5,000 positions in 2012.
Announced in 2008, the $1 billion Volkswagen automotive production facility has produced more than 50,000 2012 Passats since beginning production on May 24, 2011. As of February 16, 2012, Volkswagen employed approximately 2,500 direct hires, and has announced that an additional 200 jobs will be added. Volkswagen estimates an additional 9,500 supplier-related jobs have been or will be added to the region. Volkswagen is also reported to be considering Chattanooga for an expansion to include production of Audi vehicles.
Also announced in 2008, Wacker Chemical is building a $1.8 billion polysilicon production plant for the solar power industry near Cleveland, Tennessee. The plant is expected to create an additional 600 direct jobs for our market area. We believe the positive economic impact on Chattanooga and the surrounding region from Volkswagen and other recently announced large economic investments will be significant and it may stabilize and possibly increase real estate values and enhance economic activity within our market area.
While the national economy continues to struggle to recover from the recession, with higher unemployment across the country, our larger market areas benefit from more stable rates of employment. Our major market areas of Chattanooga and Knoxville have a lower unemployment rate of 7.3% and 6.4%, respectively, as of December 2011, than the Tennessee rate of 8.1%. The economy of the Dalton, Georgia MSA is primarily centered on the carpet and floor-covering industries. With the decline in housing starts and the overall economy, Dalton has been the most negatively impacted region in our footprint, with the carpet industry in the Dalton area experiencing layoffs of approximately 600 jobs in the latter half of 2011 and early 2012. The unemployment rate in the Dalton MSA is 12.1% (as of December 2011) compared to the Georgia rate of 9.4%. All three MSAs have experienced a decrease in the number of unemployed workers since December 2010, with declines of 11.3% in Chattanooga and 14.7% in both Knoxville and Dalton since the peak in June 2009. We believe these positive employment trends will continue into 2012.
Our market area has also benefited from a relatively stable housing environment. According to the National Association of REALTORS, the median sales prices of existing single-family homes declined only modestly in 2011, with the Chattanooga MSA declining 2.3% and the Knoxville MSA down 1.9% year-over-year. The decline in the median sales price from 2009 to 2011 was 1.0% for the Chattanooga MSA and 0.3% for the Knoxville MSA compared to 3.4% decrease for the nation and a 3.7% decline for the census region identified as the South as of December 31, 2011. The National Association of REALTORS forecasts median home prices as increasing modestly in 2012 and 2013 for both new and existing homes.
CPP Investment
On January 9, 2009, as part of the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program (“TARP”) of the United States Department of Treasury (“Treasury”), we agreed to issue and sell, and the Treasury agreed to purchase (1) 33,000 shares of our Fixed Rate Cumulative Perpetual Preferred Stock (Preferred Shares), Series A, having a liquidation preference of $1,000 per share and (2) a ten-year warrant to purchase up to 82,363 shares of our common stock, $0.01 par value, at an exercise price of $60.10 per share, for an aggregate purchase price of $33 million in cash. The Preferred Shares qualify as Tier 1 capital and pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Dividends are payable quarterly on February 15, May 15, August 15 and November 15 of each year.
As previously reported, William F. Grant, III and Robert R. Lane were elected to the First Security Group, Inc. (“First Security”) Board of Directors, in 2012. Both were elected to the Board of Directors of First Security pursuant to the terms of First Security’s outstanding Series A Preferred Stock. Under the terms of the Series A Preferred Stock, Treasury has the right to appoint up to two directors to First Security’s Board of Directors at any time that dividends payable on the Series A Preferred Stock have not been paid for an aggregate of nine quarterly dividend periods. The terms of the Series A Preferred Stock provide that Treasury will retain the right to appoint such directors at subsequent annual meetings of shareholders until all accrued and unpaid dividends for all past dividend periods have been paid. Members of the Board of Directors elected by Treasury have the same fiduciary duties and obligations to all of the shareholders of First Security as any other member of the Board of Directors.
While Treasury’s contractual rights do not address service on First Security’s subsidiary FSGBank’s Board of Directors, First Security has reviewed the qualifications of Mr. Lane and Mr. Grant and believes their respective appointments to the FSGBank Board of Directors is in the best interests of First Security and its stockholders.
Financial Results
As of December 31, 2011, we had total consolidated assets of $1.1 billion, total loans of $584.5 million, total deposits of $1.0 billion and stockholders’ equity of $68.2 million. In 2011, our net loss allocated to common stockholders was $25.1 million, resulting in a net loss of $15.79 per share (basic and diluted). During 2011, we recognized $10.9 million in provision for loan and lease losses.
As of December 31, 2010, we had total consolidated assets of $1.2 billion, total loans of $727.1 million, total deposits of $1.0 billion and stockholders’ equity of $93.4 million. In 2010, our net loss allocated to common stockholders was $46.4 million, resulting in a net loss of $29.46 per share (basic and diluted). During 2010, we recognized $33.6 million in provision for loan and lease losses as well as a deferred tax asset valuation allowance of $24.6 million. All prior periods have been restated to give retroactive effect to the one-for-ten reverse stock split that took effect on September 19, 2011.
As of December 31, 2009, we had total consolidated assets of $1.4 billion, total loans of $952.0 million, total deposits of $1.2 billion and stockholders’ equity of $141.2 million. In 2009, our net loss allocated to common stockholders was $35.4 million, resulting in net loss of $22.77 per share (basic and diluted). During 2009, we recognized a goodwill impairment of $27.2 million, or $24.8 million after-tax. Excluding the goodwill impairment, our net loss allocated to common stockholders was $10.6 million, or $6.80 per share (basic and diluted). The goodwill impairment represents a one-time, non-cash accounting adjustment and had no impact on cash flows, liquidity, tangible capital or our ability to conduct business.
Net interest income for 2011 declined by $6.9 million compared to 2010 primarily as a result of the reduction in the loan portfolio as well as the negative spread created by the issuance of brokered deposits in 2010 and the associated increase in interest bearing cash. The provision for loan and lease losses decreased $22.7 million as a result of the decreased level of charge-offs. Noninterest income declined by $853 thousand primarily a result of lower deposit fees. Noninterest expense increased by $2.9 million. The increase was largely due to increases in write-downs and holding costs on OREO and repossessions, professional fees, and data processing expenses, partially offset by reductions in salary and benefit expense and FDIC insurance expense. Full-time equivalent employees were 303 at December 31, 2011, compared to 311 at December 31, 2010.
Net interest income for 2010 declined by $7.5 million compared to 2009 primarily as a result of the reduction in the loan portfolio as well as the negative spread created by the issuance of brokered deposits and the associated increase in interest bearing cash. The provision for loan and lease losses increased $8.2 million as a result of the increased level of charge-offs. Noninterest income declined by $832 thousand primarily a result of lower deposit fees and lower mortgage loan and related fee income. Noninterest expense, excluding the 2009 goodwill impairment of $27.2 million, increased by $3.5 million. The increase was largely due to increases in write-downs on OREO and repossessions, higher FDIC insurance expense and higher professional fees, partially offset by reductions in salary and benefit expense. Full-time equivalent employees were 311 at December 31, 2010, compared to 347 at December 31, 2009.
Our efficiency ratio, excluding the goodwill impairment, increased to 132.3% in 2011 versus 102.4% in 2010 and 79.3% in 2009. The efficiency ratio for 2011 increased as a result of the combined $7.8 million decline in net interest income and noninterest income and the $2.9 million increase in noninterest expense. The stabilization and improvement of our efficiency ratio to more historical levels is dependent on our ability to stabilize the loan portfolio and reduce expenses associated with nonperforming assets.
Net interest margin in 2011 was 2.77%, or 15 basis points lower, compared to the prior period of 2.92%. The net interest margin of our peer group (as reported on the December 31, 2011 Uniform Bank Performance Report) was 3.81% and 3.69% for 2011 and 2010, respectively. During the fourth quarter of 2009 and first quarter of 2010, we issued over $255 million in brokered deposits to build excess cash reserves to reduce liquidity risk resulting from deteriorating asset quality and the Consent Order. Average other earning assets increased to $219.3 million in 2011 from $217.4 million in 2010 and $30.6 million in 2009. The impact of the excess liquidity is estimated to have reduced our net interest margin by approximately 100 basis points. We anticipate that our margin will improve during 2012 as brokered deposits mature and the excess liquidity declines. Our expectations are dependent on our ability to raise core deposits, our loan and deposit pricing, and any possible actions by the Federal Reserve Board to the target federal funds rate.
Critical Accounting Policies
Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Our significant accounting policies are described in Note 1, “Accounting Policies,” to the consolidated financial statements and are integral to understanding MD&A. Critical accounting policies include the initial adoption of an accounting policy that has a material impact on our financial presentation as well as accounting estimates reflected in our financial statements that require us to make estimates and assumptions about matters that were highly uncertain at the time. Disclosure about critical estimates is required if different estimates that we reasonably could have used in the current period would have a material impact on the presentation of our financial condition, changes in financial condition or results of operations. The following is a description of our critical accounting policies.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is established and maintained at levels management deems adequate to absorb credit losses inherent in the portfolio as of the balance sheet date. The allowance is increased through the provision for loan and lease losses and reduced through loan and lease charge-offs, net of recoveries. The level of the allowance is based on known and inherent risks in the portfolio, past loan loss experience, underlying estimated values of collateral securing loans, current economic conditions and other factors as well as the level of specific impairments associated with impaired loans. This process involves our analysis of complex internal and external variables and it requires that we exercise judgment to estimate an appropriate allowance. Changes in the financial condition of individual borrowers, economic conditions or changes to our estimated risks could require us to significantly decrease or increase the level of the allowance. Such a change could materially impact our net income as a result of the change in the provision for loan and lease losses. Refer to the “Provision for Loan and Lease Losses” and “Allowance” sections within MD&A for a discussion of our methodology of establishing the allowance as well as Note 1 to our notes to the consolidated financial statements.
Estimates of Fair Value
Fair value is used on a recurring basis for certain assets and liabilities in which fair value is the primary basis of accounting. Our available-for-sale securities and held for sale loans are measured at fair value on a recurring basis. Additionally, fair value is used to measure certain assets and liabilities on a non-recurring basis. We use fair value on a non-recurring basis for other real estate owned, repossessions and collateral associated with impaired collateral-dependent loans. Fair value is also used in certain impairment valuations, including assessments of goodwill, other intangible assets and long-lived assets.
Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Estimating fair value in accordance with applicable accounting guidance requires that we make a number of significant judgments. Accounting guidance provides three levels of fair value. Level 1 fair value refers to observable market prices for identical assets or liabilities. Level 2 fair value refers to similar assets or liabilities with observable market data. Level 3 fair value refers to assets and liabilities where market prices are unavailable or impracticable to obtain for similar assets or liabilities. Level 3 valuations require modeling techniques, such as discounted cash flow analyses. These modeling techniques incorporate our assessments regarding assumptions that market participants would use in pricing the asset or the liability.
Changes in fair value could materially impact our financial results. Refer to Note 18, “Fair Value Measurements” in the notes to our consolidated financial statements for a discussion of our methodology of calculating fair value.
Goodwill
Our policy is to assess goodwill for impairment on an annual basis or between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its
carrying amount. Impairment is a condition that exists when the carrying amount of goodwill exceeds its implied fair value. As more fully described below, we recorded a full goodwill impairment during 2009.
Income Taxes
We are subject to various taxing jurisdictions where we conduct business and we estimate income tax expense based on amounts that we expect to owe to these jurisdictions. We evaluate the reasonableness of our effective tax rate based on a current estimate of annual net income, tax credits, non-taxable income, non-deductible expenses and the applicable statutory tax rates. The estimated income tax expense or benefit is reported in the consolidated statements of income.
The accrued tax liability or receivable represents the net estimated amount due or to be received from tax jurisdictions either currently or in the future and are reported in other liabilities or other assets, respectively, in our consolidated balance sheets. We assess the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other pertinent information and maintain tax accruals consistent with our evaluation. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations by tax authorities and newly enacted statutory, judicial and regulatory guidance that could impact the relative merits of tax positions. These changes, if or when they occur, could impact accrued taxes and future tax expense and could materially affect our financial results.
We periodically evaluate our uncertain tax positions and estimate the appropriate level of tax reserves related to each of these positions. Additionally, we evaluate our deferred tax assets for possible valuation allowances based on the amounts expected to be realized. The evaluation of uncertain tax positions and deferred tax assets involves a high degree of judgment and subjectivity. Changes in the results of these evaluations could have a material impact on our financial results. Refer to Note 13, “Income Taxes,” in the notes to our consolidated financial statements as well as the Income Taxes section of MD&A for more information.
Results of Operations
We reported a net loss allocated to common stockholders for 2011 of $25.1 million versus $46.4 million for 2010 and $35.4 million for 2009. In 2011, the net loss per share was $15.79 (basic and diluted) on approximately 1.6 million weighted average shares outstanding. In 2010, the net loss per share was $29.46 (basic and diluted) on approximately 1.6 million weighted average shares outstanding. Excluding the goodwill impairment of $24.8 million after-tax, or $27.2 million before-tax, our 2009 net loss was $10.6 million, or $6.80 per share (basic and diluted). As above, these figures reflect the effect of the one-for-ten reverse stock split.
The net loss allocated to common shareholders in 2011 was below the 2010 level predominately as a result of lower provision expense and interest expense. As of December 31, 2011, we had 30 banking offices, including the headquarters and 303 full time equivalent employees.
The following table summarizes the components of income and expense and the changes in those components for the past three years.
Further explanation, with year-to-year comparisons of the income and expense, is provided below.
Net Interest Income
Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. In 2011, net interest income was $27.8 million, or 19.9% less than the 2010 level of $34.7 million, which was 17.8% less than the 2009 level of $42.2 million.
The level of net interest income is determined primarily by the average balances (volume) of interest earning assets and the various rate spreads between our interest earning assets and our funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest earning assets and interest bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.
The following table summarizes net interest income on a fully tax-equivalent basis and average yields and rates paid for the years ended December 31, 2011, 2010 and 2009.
Average Consolidated Balance Sheets and Net Interest Analysis
Fully Tax-Equivalent Basis
Nonaccrual loans have been included in the average balance. Only the interest collected on such loans has been included as income.
Interest income from securities and loans includes the effects of taxable-equivalent adjustments using a federal income tax rate of approximately 34% for all years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable equivalent adjustment amounts included in the above table were $721 thousand, $803 thousand and $919 thousand for the years ended December 31, 2011, 2010 and 2009, respectively.
The following table shows the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category.
Change in Interest Income and Expense on a Tax Equivalent Basis
Net Interest Income-Volume and Rate Changes
Interest income in 2011 was $42.8 million, a 22.1% decrease from the 2010 level of $54.9 million, which was a 14% decrease from the 2009 level of $64.0 million. For 2011, average loans declined by $198 million, or 23.4%. The decline in average loans was largely offset by a $140 million decrease in deposits. The net impact for changes in volumes of interest-earning assets in 2011 reduced interest income by $11.2 million. Decreased earnings from lower volumes of earning assets were partially offset by the decline in volume and yields on interest-bearing liabilities. Average loans decreased in 2011 by $198 million, or 23.4%, while average interest-bearing liabilities declined by 14.4% or $146 million, with average brokered deposits accounting for $67 million, a 19.5% reduction. The total impact on net interest income from changes in volume was a reduction of $8 million comparing 2011 to 2010. For 2010, average interest-earning assets increased 5.5% to $1.2 billion. However, the associated increase in earnings from the higher volumes was offset by the decline in the yields of earning assets and a shift to lower yielding earning assets. Average loans decreased $131.8 million, or 13%. This decline was fully offset by an increase in other earning assets, primarily cash held at the Federal Reserve Bank of Atlanta. Average other earning assets increased $186.8 million to $217.4 million. The total impact on interest income from changes in volume was a reduction of $7.2 million comparing 2010 to 2009.
The reduction in yield on average earning assets reduced interest income by $1.0 million in 2011. The tax-equivalent yield on average earning assets declined 36 basis points in 2011 to 4.23% from 4.59% in 2010. The reduction in yield on earning assets was primarily attributable to a decline in yield on taxable investment securities to 2.74% in 2011 from 3.51% in 2010. For 2010, the reduction in yield of average earning assets reduced interest income by $2.0 million. The tax equivalent yield on earning assets decreased 105 basis points in 2010 to 4.59% from 5.64% in 2009. The reduction in yield on earning assets was primarily related to the shifting of assets from high yielding loans to lower yielding investment securities and interest bearing cash. We continue to maintain an asset sensitive balance sheet, which means that earning assets reprice faster than interest bearing liabilities and thus interest income declines faster than interest expense in a declining rate environment and conversely, interest income will increase faster than interest expense in a rising rate environment.
Total interest expense was $15.0 million in 2011, compared to $20.2 million in 2010 and $21.8 million in 2009. Decreases in retail and jumbo CDs of $21.3 million and $30.6 million, respectively, reduced interest expense in 2011 by $1.1 million, while declining interest rates on those deposits reduced interest expense $2.2 million. During the fourth quarter of 2009 and first quarter of 2010, we issued over $255 million in brokered deposits to reduce the increasing liquidity risk associated with our declining asset quality. As we are restricted from renewing brokered deposits, our average balance of brokered deposits will decline as maturies occur. During 2011, brokered deposits decreased by $66.7 million, reducing interest expense by $1.7 million. Average brokered deposits increased by $106.6 million in 2010, adding $5.4 million in interest expense. For 2011, the net impact on changes in volume of interest bearing liabilities resulted in a $3.1 million decrease in interest expense. In 2010, the net impact on changes in volume of interest bearing liabilities resulted in a $4.3 million increase to interest expense over 2009 levels.
Deposit pricing, especially for time deposits, typically lags changes in the target federal funds rate, and therefore we realized a consistent but gradual reduction in our costs of deposits throughout 2010 and 2011. The reduction of costs on interest bearing liabilities reduced interest expense $2.1 million in 2011 and $5.9 million in 2010. The average rate paid on interest bearing liabilities for 2011 decreased by 27 basis points to 1.73% after having decreased by 34 basis points from 2.34% to 2.00% in 2010. The average rate paid on in-market retail CDs declined by 63 basis points and the average rate paid on jumbo CDs declined by 56 basis points, resulting in a savings of $2.2 million.
We expect average earning assets to stabilize in 2012 as loan volume improves and investment securities increase through the reallocation of our excess cash reserves into higher yielding assets. The average yield on loans in 2012 is anticipated to decline slightly compared to 2011 as we expect to operate in a more competitive environment during 2012. We expect average brokered deposits to decline during 2012 while all other interest bearing liabilities increase, with average interest bearing liabilities comparable to 2011 levels. Rates paid on deposits are expected to decline slightly compared to 2011 rates as higher rate brokered CDs are replaced with lower rate core deposits.
Net Interest Income-Net Interest Spread and Net Interest Margin
The banking industry uses two key ratios to measure relative profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The net interest rate spread does not consider the impact of noninterest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing noninterest bearing deposits in earning assets.
First Security’s net interest rate spread (on a tax equivalent basis) was 2.50% in 2011, 2.59% in 2010 and 3.30% in 2009, while the net interest margin (on a tax equivalent basis) was 2.77% in 2011, 2.92% in 2010 and 3.75% in 2009. The decrease in the net interest spread and net interest margin for 2011 and 2010 was primarily
due to reductions in our loan portfolio as well as the negative spread created by the issuance of brokered deposits in late 2009 and early 2010 and the associated increase in our interest bearing cash account at the Federal Reserve Bank of Atlanta. Noninterest bearing deposits contributed 27 basis points to the margin during 2011 compared to 33 basis points in 2010 and 45 basis points in 2009.
In prior years, we terminated two sets of interest rate swaps. The combined gains at termination were $7.8 million, which are being accreted into income over the remaining life of the originally hedged items. The swaps added $1.8 million, $2.0 million and $2.3 million in interest income for the years ended December 31, 2011, 2010 and 2009, respectively. For 2012, we estimate the terminated swaps will add approximately $1.3 million to interest income.
We anticipate our net interest spread and net interest margin to stabilize and improve during 2012. However, improvement is dependent on multiple factors including our ability to raise core deposits, our growth or contraction in loans, our deposit and loan pricing, maturities of brokered deposits, and any possible further action by the Federal Reserve Board to adjust the target federal funds rate.
Provision for Loan and Lease Losses
The provision for loan and lease losses charged to operations during 2011 decreased $22.7 million to $10.9 million in 2011, compared to $33.6 million in 2010 and $25.4 million in 2009. Net charge-offs totaled $15.3 million for 2011, $36.1 million for 2010, and $16.3 million for 2009. Net charge-offs as a percentage of average loans were 2.36% in 2011, 4.27% in 2010 and 1.66% in 2009. Quarterly, we estimate the allowance for loan losses, as described in detail below. The allowance is funded through provision expense. For 2011, various factors contributed to a lower provision expense. Primarily, net charge-offs significantly declined in 2011 as compared to 2010. Additionally, while the allowance to total loans ratio increased during 2011, the required allowance declined as a result of the decrease in the loan portfolio. Collectively, these factors resulted in a provision expense of $10.9 million, or approximately 67% less than 2010.
The decrease in our provision for loan and lease losses in 2011 relative to 2010 was a result of our analysis of inherent risks in the loan portfolio in relation to the portfolio’s growth, the level of impaired, past due, charged-off, classified and non-performing loans, as well as increased environmental risk factors due to the general economic conditions. During 2011, while we experienced lower charge-offs, we continued to have high levels of classified and non-performing loans, and thus, we increased the ratio of the allowance to total loans from 3.30% to 3.35%. In 2010, we significantly increased our allowance for loan and lease losses from 2.78% of total loans as of December 31, 2009 to 3.30% of total loans as of December 31, 2010. The provision expense associated with increasing our reserve as a percentage of loans was approximately $0.3 million in 2011 and $3.8 million in 2010. As of December 31, 2011, we determined our allowance of $19.6 million was adequate to provide for credit losses, which we describe more fully below in the Allowance for Loan and Lease Loss section of MD&A.
We will continue to provide provision expense to maintain an allowance level adequate to absorb known and estimated losses inherent in our loan portfolio. As the determination of provision expense is a function of the adequacy of the allowance for loan and lease losses, we cannot reasonably estimate the provision expense for 2012. Furthermore, the provision expense could materially increase or decrease in 2012 depending on a number of factors, including, among others, the level of net charge-offs, the amount of classified loans and the value of collateral associated with impaired loans.
Noninterest Income
Total noninterest income for 2011 was $8.7 million compared to $9.5 million in 2010 and $10.3 million in 2009. The following table presents the components of noninterest income for years ended December 31, 2011, 2010 and 2009.
Noninterest Income
Our largest sources of noninterest income are service charges and fees on deposit accounts. Total service charges, including non-sufficient funds (NSF) fees, were $3.1 million, or 36% of total noninterest income, compared with $3.9 million, or 41% of total noninterest income for 2010, and $4.6 million, or 45% of total noninterest income for 2009. While service charges and fees on deposit accounts typically correspond to the level and mix of our customer deposits, the continued implementation of the Dodd-Frank financial reform legislation may directly or indirectly impact the fee structure of our deposit products; therefore, we cannot reasonably estimate deposit fees for future periods.
Point-of-sale fees increased 6.1% to $1.35 million in 2011 compared to 2010. POS fees are primarily generated when our customers use their debit cards for retail purchases. We anticipate POS fees to continue to grow as customer trends show increased use of debit cards, although it is unclear if provisions affecting interchange fees for card issuers included in the Dodd-Frank financial reform legislation will have a future material impact on this product and its revenue.
Mortgage loan and related fees for 2011 were $737 thousand, compared to $909 thousand in 2010 and $1.0 million in 2009.
Our process to originate and sell a conforming mortgage in the secondary market typically takes 30 to 60 days from the date of mortgage origination to the date the mortgage is sold to an investor in the secondary market. Due to the normal processing time, we will have a certain amount of held for sale loans at any time. We sell these loans with the right to service the loan being released to the purchaser for a fee. Mortgages originated for sale in the secondary markets totaled $30.0 million for 2011, $46.2 million for 2010 and $61.1 million for 2009. Mortgages sold in the secondary market totaled $30.4 million for 2011, $44.9 million for 2010 and $61.5 million for 2009. For 2012, we anticipate expanding the number of seasoned mortgage originators to increase loan and fee volumes.
Bank-owned life insurance income remained stable at $1.0 million for 2011 compared to 2010 and 2009. The Company is the owner and beneficiary of these contracts. The income generated by the cash value of the insurance policies accumulates on a tax-deferred basis and is tax free to maturity. Additionally, the insurance death benefit will be a tax free payment to the Company. This tax-advantaged asset enables us to provide benefits to our employees. On a fully tax equivalent basis, the weighted average interest rate earned on the policies was 5.7% during 2011.
During 2011, we did not sell any available-for-sale securities. During 2010, we sold approximately $14.8 million of investment securities for a net gain of $57 thousand. During 2009, we did not sell any available-for-sale securities.
Other income for 2011 was $2.4 million, compared to the 2010 level of $2.3 million and the 2009 level of $2.5 million. The components of other income primarily consist of ATM fee income, trust fee income, underwriting revenue, safe deposit box fee income and gains on sales of other real estate, repossessions, leased equipment and premises and equipment. Gains on sales declined $41 thousand and trust fees decreased $35 thousand in 2011 compared to 2010. We anticipate our other income to be consistent or to increase in 2012.
Noninterest Expense
Total noninterest expense for 2011 was $48.2 million, compared to $45.3 million in 2010 and $68.9 million in 2009. Noninterest expense for 2009 included a full impairment to goodwill of $27.2 million. Excluding this one-time, non-cash expense, noninterest expense for 2009 was $41.7 million. For 2011, higher costs associated with nonperforming assets fully offset the savings in salaries and benefits and decreases in FDIC insurance. The following table represents the components of noninterest expense for the years ended December 31, 2011, 2010 and 2009.
Noninterest Expense
Total salaries and benefits decreased $1.4 million, or 7.2% in 2011 compared to 2010. The decrease in salaries and benefits is primarily related to fewer full-time equivalent employees and cost savings in employee benefits including reducing the employer match on the 401(k) and ESOP Plan from 6% to 1% as of July 1, 2010. As of December 31, 2011, we had 30 full service banking offices with 303 full-time equivalent employees. As of December 31, 2010, we had 37 full service banking offices and one leasing/loan production facility with 311 full-time equivalent employees; as of December 31, 2009, we had 39 full service banking offices and one leasing/loan production facility with 347 full-time equivalent employees.
Total occupancy expense for 2011 decreased by 6% compared with 2010, which was 2% higher than total occupancy expense in 2009. The decrease in 2011 was primarily due to closing seven branches in 2011, while the increase in 2010 was primarily due to higher insurance expense and increases in lease expense for branch locations. As of December 31, 2011, we leased six facilities and the land for three branches. As a result, occupancy expense is higher than if we owned these facilities, including the real estate, but conversely, we have been able to deploy the capital into earning assets rather than capital expenditures for facilities.
Furniture and equipment, communication, and printing and supplies expense decreased both in 2011 and 2010 due to cost controls implemented. Advertising expenses increased in 2011 due to increased marketing, including the 2011 deposit and loan campaigns.
Professional fees increased by $286 thousand, or 9.1% from 2010 to 2011, and increased $1.0 million, or 48%, from 2009 to 2010. The increases were primarily due to additional legal costs associated with the higher levels of non-performing assets. Professional fees also include fees related to investor relations, outsourcing compliance and information technology audits and a portion of internal audit to Professional Bank Services, as well as external audit, tax services and legal and accounting advice related to, among other things, foreclosures, lending activities, employee benefit programs, prospective capital offerings and regulatory matters. We anticipate professional fees to be consistent or lower for 2012.
The premium paid for FDIC deposit insurance decreased $514 thousand in 2011 compared to 2010, compared to an increase of $1.9 million to $3.8 million in 2010 compared to 2009. The decrease in 2011 was the result of a change in the calculation of the FDIC insurance premium base as the result of the Dodd-Frank Act, more fully described above. The increase for 2010 is an indirect result of the items in the Consent Order, including the deterioration of our asset quality and its impact on our financial results, among other items.
Data processing expense was higher in 2011 compared to 2010 and 2009. The monthly fees associated with data processing are typically based on transaction volume.
Write-downs on OREO and repossessions increased $3.2 million, or 91.8%, from 2010 to 2011, and $2.2 million, or 167.9%, from 2009 to 2010. At foreclosure or repossession, the fair value of the property is determined and a charge-off to the allowance is recorded, if applicable. Any decreases in value subsequent to the initial determination of fair value are recorded as a write-down. As a general policy, we re-assess the fair value of OREO and repossessions on at least an annual basis or sooner if indications exist that deterioration in value has occurred. Write-downs are based on property-specific appraisals or valuations. Additionally, we evaluate on an ongoing basis our realization rate compared to our book value. As a result of this analysis, we recorded additional write-downs during 2011 to reduce each property to the historical realization rates. Write-downs for 2012 are dependent on real estate market conditions and our ability to liquidate properties.
Losses on OREO, repossessions and fixed assets increased $222 thousand, or 19.1% from 2010 to 2011, and $559 thousand, or 92.7% from 2009 to 2010. The majority of losses were related to sales of foreclosed properties. For 2012, we anticipate elevated levels in losses as we seek to liquidate existing properties in a more expeditious manner, including possible bulk sales.
OREO and repossession holding costs include, among other items, maintenance, repairs, utilities, taxes and storage costs. Holding costs increased $685 thousand, or 41.8% from 2010 to 2011, and $533 thousand, or 48.3%, from 2009 to 2010. Historically, our holding costs have been commensurate with the level of nonperforming assets. For 2012, we anticipate comparable or lower holding costs depending on our ability to liquidate our OREO properties in a more expeditious manner.
Our policy is to assess goodwill for impairment on an annual basis or between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its carrying amount. Impairment is the condition that exists when the carrying amount of goodwill exceeds its
implied fair value. Accounting guidance requires us to estimate the fair value in making the assessment of impairment at least annually. We engaged an independent valuation firm to assist in computing the fair value estimate for the goodwill as of September 30, 2009. The firm utilizes two separate valuation methodologies and compares the results of each methodology in order to determine the fair value of the goodwill associated with our prior acquisitions. The impairment testing is a two-step process. Step 1 compares the fair value of the reporting unit to the carrying value. If the fair value is below the carrying value, Step 2 is performed. Step 2 involves a process similar to business combination accounting in which fair values are assigned to all assets, liabilities and other (non-goodwill) intangibles. The result of Step 2 is the implied fair value of goodwill. If the implied fair value of goodwill is below the recorded goodwill amount, an impairment charge is recorded for the difference.
The results of the third-party goodwill assessment for 2009 indicated a full impairment and therefore we recorded a $27.2 million goodwill impairment as of September 30, 2009. The impairment was primarily a result of the continuing economic downtown and its implication on bank valuations. The one-time, non-cash accounting adjustment has no impact on cash flows, liquidity, tangible capital or our ability to conduct business. Additionally, as goodwill is excluded from regulatory capital, the impairment had no impact on the regulatory capital ratios of First Security or FSGBank.
Intangible asset amortization increased by $22 thousand, or 4.8%, in 2011 compared to 2010 and decreased by $28 thousand, or 5.8%, in 2010 as compared to 2009. The core deposit intangible assets amortize on an accelerated basis over an estimated useful life of ten years. The following table represents our anticipated intangible asset amortization over the next five years, excluding new acquisitions, if any.
Other expense increased by $574 thousand, or 12.9%, for 2011 compared to 2010, and decreased by $761 thousand, or 14.6%, for 2010 compared to 2009. The increase in 2011 is primarily the result of increased costs of insurance as well as higher shareholder expenses associated with the 10-for-1 reverse stock split. The decline in 2010 is primarily as a result of the $500 thousand arbitration settlement in 2009, described below, as well as decreased credit reporting fees and franchise tax expense.
On January 19, 2010, we settled the $2.3 million arbitration claim involving the April 15, 2009 termination of employment of Lloyd L. Montgomery, III, our former President and Chief Operating Officer. The settlement agreed to pay Mr. Montgomery $500 thousand. The settlement amount was accrued in other expense during 2009. Through the settlement agreement, both parties agreed to release all claims against one another and to dismiss the arbitration claim with prejudice. The settlement agreement also provides that Mr. Montgomery’s confidentiality and non-solicitation obligations under his employment agreement shall remain in effect.
Income Taxes
We recorded income tax expense of $392 thousand in 2011, compared to income tax expense of $9.7 million in 2010 and tax benefits of $8.3 million in 2009. During 2011, we recorded a $10.8 million deferred tax valuation allowance and in 2010 a $24.6 million deferred tax valuation allowance to reduce our net deferred tax assets to an amount that we consider realizable. The remaining deferred tax asset is anticipated to be realized through available carryback tax periods. A valuation allowance is required when it is “more likely than not” that the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions. We identified as positive evidence the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years as well as current business trends. As conditions change, we will evaluate the need to increase or decrease the valuation allowance. Currently, we anticipate increasing the valuation allowance to offset any future recorded tax benefit to result in minimal, if any, income tax expense or benefit.
For 2009, our tax-exempt income from municipal securities and bank-owned life insurance was approximately $2.6 million. The goodwill impairment included $20.2 million that was not deductible for tax purposes. Excluding these non-taxable items, our pre-tax 2009 net loss would decrease to approximately $24.1 million, resulting in an effective tax rate of approximately 34%.
At December 31, 2011, we evaluated our significant uncertain tax positions. Under the “more-likely-than-not” threshold guidelines, we believe we have identified all significant uncertain tax benefits. We evaluate, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a component of income tax expense in our consolidated financial statements. During 2009, we accrued $1.1 million for an uncertain tax position and approximately $155 thousand in associated interest and penalties. During 2010 and 2011, certain tax refunds were withheld and applied to the disputed uncertain tax position. As of December 31, 2011, the accrual for uncertain tax positions, including accumulated interest and penalties, totaled $1.0 million.
Statement of Financial Condition
Our total assets were $1.1 billion at December 31, 2011, a decrease of $53.6 million, or 4.6%, over 2010. The decline in assets was concentrated in our loan portfolio, which declined $142.6 million during 2011. The decline in loans was partially offset by increases in investment securities and interest-bearing deposits in banks, primarily our cash account at the Federal Reserve Bank of Atlanta. During 2012, we anticipate that our total assets will increase as loans grow in response to increased marketing and lender accountability measures. Additionally, we anticipate funding prudent investment opportunities through growth in core deposits and with our existing cash reserves.
Loans
The effects of the economic recession, as well as our active efforts to reduce certain credit exposures and their related balance sheet risk, resulted in declining loan balances during 2011.
During 2011, total loans declined $142.6 million, or 20%, compared to year-end 2010. During 2011, we reduced our exposure to construction and land development loans by $30.4 million, or 36%, and commercial and industrial loans by $23.2 million, or 28%. Commercial real estate loans declined by $31.3 million, or 14%, and residential 1-4 family loans declined by $34.4 million, or 14%. All other loan categories declined as well with the exception of leases, which increased 9% on earned income.
During the fourth quarter of 2011, we launched an advertising campaign aimed at generating loan demand and attracting new credit-worthy customers. We anticipate our loans to stabilize during 2012. However, funding of future loans may be restricted by our ability to raise core deposits, although we may use our current cash reserves, as necessary and appropriate. Loan growth may also be restricted by the necessity for us to maintain appropriate capital levels, as well as adequate liquidity.
The following table presents a summary of the loan portfolio by category for the last five years.
Loans Outstanding
Substantially all of our loans are to customers located in Georgia and Tennessee, in our immediate markets. We believe that we are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations. We also believe that the loan portfolio is diversified among loan collateral types, as noted by the following table.
Loans by Collateral Type
The following table sets forth the maturity distribution of the loan portfolio as of December 31, 2011. Our loan policy does not permit automatic roll-over of matured loans.
Allowance for Loan and Lease Losses
Allowance-Overview
The allowance for loan and lease losses reflects our assessment and estimate of the risks associated with extending credit and our evaluation of the quality of the loan portfolio. We regularly analyze our loan portfolio in an effort to establish an allowance that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:
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our loan loss experience;
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specific known risks;
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the status and amount of past due and non-performing assets;
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underlying estimated values of collateral securing loans;
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current and anticipated economic conditions; and
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other factors which we believe affect the allowance for potential credit losses.
The allowance is composed of two primary components: (1) specific impairments for substandard/nonaccrual loans and leases and (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, as well as general allocations for the remaining pools of loans. We accumulate pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions.
The following loan portfolio segments have been identified: (1) Real estate: Residential 1-4 family, (2) Real estate: Commercial, (3) Real estate: Construction, (4) Real estate: Multi-family and farmland, (5) Commercial, (6) Consumer, (7) Leases and (8) Other. We evaluate the risks associated with these segments based upon specific characteristics associated with the loan segments. The risk associated with the Real estate: Construction portfolio is most directly tied to the probability of declines in value of the residential and commercial real estate in our market area and secondarily to the financial capacity of the borrower. The risk associated with the Real estate: Commercial portfolio is most directly tied to the lease rates and occupancy rates for commercial real estate in our market area and secondarily to the financial capacity of the borrower. The other portfolio segments have various risk characteristics, including, but not limited to: the borrower’s cash flow, the value of the underlying collateral, and the capacity of guarantors.
An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan and lease losses is prepared jointly by our accounting and credit administration departments and presented to our Board of Directors or the Directors’ Loan Committee on at least a quarterly basis. Based on our analysis, we may determine that our future provision expense needs to increase or decrease in order for us to remain adequately
reserved for probable, incurred loan losses. As stated earlier, we make this determination after considering both quantitative and qualitative factors under appropriate regulatory and accounting guidelines.
Our allowance for loan and lease losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance compared to a group of peer banks. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance methodology differ materially from the bank’s methodology. We believe our allowance methodology is in compliance with regulatory interagency guidance as well as applicable GAAP guidance.
While it is our policy to charge-off all or a portion of certain loans in the current period when a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because the assessment of these risks includes assumptions regarding local and national economic conditions, our judgment as to the adequacy of the allowance may change from our original estimates as more information becomes available and events change.
Allowance-Loan Pools
As indicated in the Allowance-Overview above, we analyze our allowance by segregating our portfolio into two primary categories: impaired loans and non-impaired loans. Impaired loans are individually evaluated, as further discussed below. Non-impaired loans are segregated first by loan risk rating and then into homogeneous pools based on loan type, collateral or purpose of proceeds. We believe our loan pools conform to regulatory and accounting guidelines.
Impaired loans generally include those loan relationships in excess of $500 thousand with a risk rating of substandard/nonaccrual or doubtful. For these loans, we determine the impairment based upon one of the following methods: (1) discounted cash flows, (2) observable market pricing or (3) the fair value of the collateral. The amount of the estimated loss, if any, is then specifically reserved in a separate component of the allowance unless the relationship is considered collateral dependent, in which the estimated loss is charged-off in the current period.
For non-impaired loans, we first segregate special mention and non-impaired substandard loans into two distinct pools. All remaining loans are further segregated into homogeneous pools based on loan type, collateral or purpose of proceeds. Each of these pools is evaluated individually and is assigned a loss factor based on our best estimate of the loss that potentially could be realized in that pool of loans. The loss factor is the sum of an objectively calculated historical loss percentage and a subjectively calculated risk percentage. The actual annual historical loss factor is typically a weighted average of each period’s loss. For the historical loss factor, we utilize a migration loss analysis. Each period may be assigned a different weight depending on certain trends and circumstances. The subjectively calculated risk percentage is the sum of eight qualitative and environmental risk categories. These categories are evaluated separately for each pool. The eight risk categories are: (1) underlying collateral value, (2) lending practices and policies, (3) local and national economies, (4) portfolio volume and nature, (5) staff experience, (6) credit quality, (7) loan review and (8) competition, regulatory and legal issues.
Allowance-Loan Risk Ratings
A consistent and appropriate loan risk rating methodology is a critical component of the allowance. We classify loans as: pass, special mention, substandard/impaired, substandard/non-impaired, doubtful or loss. The following describes our loan classifications and the various risk indicators associated with each risk rating.
A pass rating is assigned to those loans that are performing as contractually agreed and do not exhibit the characteristics of the criticized and classified risk ratings as defined below. Pass loan pools do not include the
unfunded portions of binding commitments to lend, standby letters of credit, deposit secured loans or mortgage loans originated with commitments to sell in the secondary market. Loans secured by segregated deposits held by FSGBank are not required to have an allowance reserve, nor are originated held-for-sale mortgage loans pending sale in the secondary market.
A special mention loan risk rating is considered criticized but is not considered as severe as a classified loan risk rating. Special mention loans contain one or more potential weakness(es), which if not corrected, could result in an unacceptable increase in credit risk at some future date. These loans may be characterized by the following risks and/or trends:
Loans to Businesses:
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Downward trend in sales, profit levels and margins
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Impaired working capital position compared to industry
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Cash flow strained in order to meet debt repayment schedule
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Technical defaults due to noncompliance with financial covenants
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Recurring trade payable slowness
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High leverage compared to industry average with shrinking equity cushion
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Questionable abilities of management
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Weak industry conditions
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Inadequate or outdated financial statements
Loans to Businesses or Individuals:
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Loan delinquencies and overdrafts may occur
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Original source of repayment questionable
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Documentation deficiencies may not be easily correctable
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Loan may need to be restructured
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Collateral or guarantor offers adequate protection
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Unsecured debt to tangible net worth is excessive
A substandard loan risk rating is characterized as having specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic, or managerial nature, and may warrant non-accrual status. Substandard loans have a greater likelihood of loss and may require a protracted work-out plan. Substandard/impaired loans are relationships in excess of $500 thousand and are individually reviewed. In addition to the factors listed for special mention loans, substandard loans may be characterized by the following risks and/or trends:
Loans to Businesses:
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Sustained losses that have severely eroded equity and cash flows
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Concentration in illiquid assets
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Serious management problems or internal fraud
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Chronic trade payable slowness; may be placed on COD or collection by trade creditor
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Inability to access other funding sources
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Financial statements with adverse opinion or disclaimer; may be received late
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Insufficient documented cash flows to meet contractual debt service requirements
Loans to Businesses or Individuals:
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Chronic or severe delinquency or has met the retail classification standards which is generally past dues greater than 90 days
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Frequent overdrafts
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Likelihood of bankruptcy exists
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Serious documentation deficiencies
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Reliance on secondary sources of repayment which are presently considered adequate
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Demand letter sent
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Litigation may have been filed against the borrower
Loans with a risk rating of doubtful are individually analyzed to determine our best estimate of the loss based on the most recent assessment of all available sources of repayment. Doubtful loans are considered impaired and placed on nonaccrual. For doubtful loans, the collection or liquidation in full of principal and/or interest is highly questionable or improbable. We estimate the specific potential loss based upon an individual analysis of the relationship risks, the borrower’s cash flow, the borrower’s management and any underlying secondary sources of repayment. The amount of the estimated loss, if any, is then either specifically reserved in a separate component of the allowance or charged-off. In addition to the characteristics listed for substandard loans, the following characteristics apply to doubtful loans:
Loans to Businesses:
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Normal operations are severely diminished or have ceased
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Seriously impaired cash flow
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Numerous exceptions to loan agreement
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Outside accountant questions entity’s survivability as a “going concern”
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Financial statements may be received late, if at all
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Material legal judgments filed
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Collection of principal and interest is impaired
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Collateral/Guarantor may offer inadequate protection
Loans to Businesses or Individuals:
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Original repayment terms materially altered
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Secondary source of repayment is inadequate
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Asset liquidation may be in process with all efforts directed at debt retirement
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Documentation deficiencies not correctable
The consistent application of the above loan risk rating methodology ensures we have the ability to track historical losses and appropriately estimate potential future losses in our allowance. Additionally, appropriate loan risk ratings assist us in allocating credit and special asset personnel in the most effective manner. Significant changes in loan risk ratings can have a material impact on the allowance and thus a material impact on our financial results by requiring significant increases or decreases in provision expense.
Allowance-Analysis and Discussion
The following table presents an analysis of the changes in the allowance for loan and lease losses for the past five years. The provision for loan and lease losses in the table below does not include our provision accrual for unfunded commitments of $24 thousand, $24 thousand, $24 thousand, $24 thousand and $40 thousand for 2011, 2010, 2009, 2008 and 2007, respectively. The reserve for unfunded commitments is included in other liabilities in our consolidated balance sheets and totaled $253 thousand and $229 thousand as of December 31, 2011 and 2010, respectively.
Analysis of Changes in Allowance for Loan and Lease Losses
The following table presents the allocation of the allowance for loan and lease losses for each respective loan category with the corresponding percent of loans in each category to total loans. The comprehensive allowance analysis jointly developed by our credit administration and accounting groups enable us to allocate the allowance based on risk elements within the portfolio. The unallocated reserve is available as a general reserve against the entire loan portfolio and is related to factors such as current economic conditions which are not directly associated with a specific loan category.
Allocation of the Allowance for Loan and Lease Losses
Represents the percentage of loans in each category to total loans.
Over the last two years, our allowance as a percentage of total loans significantly increased due to higher levels of non-performing loans and the elevated level of charge-offs during 2010. The allowance to total loans increased to 3.35% as of December 31, 2011, compared to 3.30% as of December 31, 2010 and 2.78% as of December 31, 2009. As of December 31, 2011, $18.1 million of the allowance was associated with general reserves and $1.5 million was associated with specific reserves.
The following table provides the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of December 31, 2011:
As of December 31, 2011, the largest components of the allowance were associated with 1-4 family residential real estate loans, commercial loans and commercial real estate loans. These classifications have higher levels of substandard, non-impaired loans. These loans are subject to general allowance allocations based on historical loss and qualitative and environmental factors. The allowance allocation associated with construction and land development loans declined by $1.4 million during 2011. The allowance allocated to commercial and industrial loans declined by $2.1 million during 2011. Each is a result of significant charge-offs during 2011 as well as a declining level of substandard, impaired loans at year-end. The elevated level of charge-offs in 2011 will continue to impact the loss factors within the allowance during future periods.
We believe that the allowance for loan and lease losses at December 31, 2011 is sufficient to absorb probable, incurred losses inherent in the loan portfolio based on our assessment of the information available, including the results of extensive internal and independent reviews of our loan portfolio, as discussed in the Asset Quality and Non-Performing Asset section below. Our assessment involves uncertainty and judgment; therefore, the level of the allowance as compared to total loans may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant.
Asset Quality and Non-Performing Assets
Asset Quality Strategic Initiatives for 2011 and Beyond
Our ability to return to profitability is largely dependent on properly addressing and improving asset quality. As of December 31, 2011, our loan portfolio was 50.6% of total assets. Over the past two and half years, we’ve implemented a number of significant strategies to further address our asset quality. The implementation of these strategies has assisted our ability to reduce our total nonperforming loans in 2011 by $9.2 million, or approximately 15.6%, and to reduce our total nonperforming assets by $6.9 million, or approximately 8.7%. We believe our continued implementation of these, and related, strategies, will enable us to show further improvement in our asset quality in 2012.
During the fourth quarter of 2009, we began the process of restructuring our credit administration department to add additional depth and expertise and to fully centralize our credit underwriting process. With the additional depth and expertise of the restructured credit department, in 2010 we centralized our loan underwriting, document preparation and collections processes. This centralization has improved consistency, increased quality and provided higher levels of operational efficiencies. Collectively, we believe these changes will assist in reducing current and future non-performing assets.
In the fourth quarter of 2009, we engaged an outside firm to conduct an extensive loan review. The primary purpose of this loan review was to evaluate individual credits for compliance with credit and underwriting standards, and to assess the potential impairment of certain credits in which we might experience additional risks of loss. Subsequently, we have used third parties to supplement the coverage of our internal loan review department. Our internal loan review department performs risk-based reviews and historically targets 60% to 70% of our portfolio over an 18-month cycle. During 2011, we achieved the 60% to 70% review of our portfolio over a 12-month cycle, focusing on a risk-based approach. We anticipate similar coverage during 2012.
During the second half of 2010, we began outsourcing the marketing and sales process of our OREO properties to market leading real estate companies. We experienced higher volumes of OREO sales in 2011 and expect higher levels in 2012 as we are considering possible bulk sale transactions.
Throughout 2010 and 2011, we have hired multiple experienced special assets officers and centralized the handling of all classified loans by our special assets team.
During 2011, we hired Joseph E. Dell, Jr. as Executive Vice President and Chief Lending Officer. Prior to joining First Security, Mr. Dell spent 25 years with First Commonwealth Bank in Indiana, PA, a $6 billion community bank, where he served in various senior and executive roles, including Chief Lending Officer. With the assistance of others, Mr. Dell is seeking to instill a credit culture in our commercial lenders to improve asset quality going forward.
On February 9, 2012, we hired Christopher G. Tietz as Executive Vice President and Chief Credit Officer. Mr. Tietz has over 25 years of banking knowledge with extensive experience in credit administration. Mr. Tietz joined First Security from First Place Bank in Warren, Ohio, a $3 billion bank, where he served as EVP and Chief Credit Officer since May 2011. From 2005 to April 2011, Mr. Tietz worked for Monroe Bank in Bloomington, Indiana as Chief Credit Officer. Mr. Tietz began his career in Nashville, Tennessee with First American National Bank where he spent fifteen years, with the final five years serving as EVP and Regional Senior Credit Officer. Mr. Tietz is currently evaluating the credit administration department and is charged with establishing a strong credit culture. Based on his initial assessment, we believe the framework for a strong credit culture is now largely in place.
Asset Quality and Non-Performing Assets Analysis and Discussion
Our asset quality ratios were mixed in 2011 compared to 2010. As of December 31, 2011, our allowance for loan and lease losses as a percentage of total loans was 3.35% compared to 3.30% as of December 31, 2010. Net charge-offs were 2.36% of average loans for 2011 compared to 4.27% for 2010. Non-performing loans to total loans increased to 8.51% as of year-end 2011 from 8.10% as of year-end 2010, while non-performing assets as a percentage of total assets improved from 6.78% at year-end 2010 to 6.49% at year-end 2011. The allowance as a percentage of total non-performing loans was 39.41% as of year-end 2011 compared to 40.73% for 2010.
Non-performing assets include non-accrual loans, restructured loans, OREO and repossessed assets. We place loans on non-accrual status when we have concerns related to our ability to collect the loan principal and interest, and generally when such loans are 90 days or more past due. The following table presents our non-performing assets and related ratios.
Nonperforming Assets
The following table provides further information, including classification, for nonaccrual loans and other real estate owned for the past three years.
Non-Performing Assets-Classification and Number of Units
Nonaccrual loans totaled $46.9 million, $54.1 million and $45.5 million as of December 31, 2011, 2010 and 2009, respectively. We place loans on nonaccrual when we have concerns relating to our ability to collect the loan principal and interest, and generally when loans are 90 or more days past due. As previously described, we have individually reviewed each nonaccrual relationship in excess of $500 thousand for possible impairment. We measure impairment by adjusting the loans to either the present value of expected cash flows, the fair value of the collateral or observable market prices. As of December 31, 2011, the book value of impaired loans totaled $33.5 million, or 20% less than impaired loans as of December 31, 2010. The associated unpaid principal balances of the impaired loans totaled $42.8 million as of December 31, 2011. This represents an approximately 22% discount through previously recorded partial charge-offs and specific reserves currently in the allowance. As of December 31, 2010, the book value of impaired loans totaled $41.6 million with the unpaid principal balances totaling $59.4 million.
From year-end 2010 to year-end 2011, nonaccrual loans decreased by $7.2 million, or 13%. As shown above, construction and land development nonaccrual loans decreased by $10.9 million to $14.7 million comparing year-end 2010 to year-end 2011. This decrease is primarily attributable to additional writedowns taken in 2011 on six loans. Commercial real estate nonaccrual loans increased by $3.3 million from year-end 2010 to year-end 2011. The increase is primarily associated with one relationship. We are actively pursuing the appropriate strategies to reduce the current level of nonaccrual loans through longer-term reworks of the credits, charge-offs and/or foreclosure.
Other real estate owned increased to $25.1 million as of December 31, 2011 compared to $24.4 million as of December 31, 2010. During 2011, we sold 78 properties for $10.5 million, compared to 36 sold properties for $5.6 million in 2010. We anticipate continuing an aggressive sales approach during 2012 to dispose of our current properties, which may include select bulk sales.
Loans 90 days past due and still accruing were $2.8 million as of December 31, 2011 compared to $4.8 million as of December 31, 2010. Of these past due loans as of December 31, 2011, commercial real estate loans totaled $1.2 million, or 43% of the total past dues while commercial and industrial loans totaled $620 thousand, or 22% of the total.
As of December 31, 2011, we owned repossessed assets, which are carried at fair value less anticipated selling costs, in the amount of $302 thousand compared to $763 thousand as of December 31, 2010. The majority of our repossessions are related to our leasing portfolio that primarily includes trucking and construction equipment leases.
Our asset quality ratios are less favorable compared to our peer group. Our peer group, as defined by the Uniform Bank Performance Report (UBPR), consists of all commercial banks between $1 billion and $3 billion in total assets. The following table provides our asset quality ratios as of December 31, 2011 compared to our UBPR peer group ratios.
Asset Quality Ratios
Non-performing loans consist of nonaccrual loans and loans 90 days past due that are still accruing.
We believe that overall asset quality has stabilized and will begin to improve in 2012. Our special asset department actively collects past due loans and develops action plans for classified and criticized loans and leases. For OREO properties, we are focused on achieving the proper level of balance between maximizing the realized value upon sale and minimizing the holding period and carrying costs with a bias towards liquidation.
Investment Securities and Other Earning Assets
The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of our consolidated balance sheet while providing a
vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. Currently, all of our investments are classified as available-for-sale. As of December 31, 2011, we had no plans to liquidate a significant amount of any securities; however, the securities classified as available-for-sale may be used for liquidity purposes should management deem it to be in our best interest.
Securities in our portfolio totaled $193.0 million at December 31, 2011, compared to $154.2 million at December 31, 2010. We believe our current level of investment securities provides an appropriate level of liquidity and provides a proper balance to our interest rate and credit risk in our loan portfolio. As of December 31, 2011, the available-for-sale securities portfolio had unrealized gains of approximately $4.3 million as compared to unrealized gains of $2.8 million at December 31, 2010. Our securities portfolio at December 31, 2011 consisted of tax-exempt municipal securities, federal agency bonds, federal agency issued Real Estate Mortgage Investment Conduits (REMICs) and federal agency issued pools.
The following table provides the amortized cost of our securities, as of December 31, 2011, by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the tax equivalent yields for each maturity range.
Maturity of AFS Investment Securities-Amortized Cost
The following table details our investment portfolio by type of investment.
Investment Securities by Type-Amortized Cost
We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. All securities held are historically traded in liquid markets, except for seven bonds, which are valued utilizing Level 3 inputs. The Level 3 securities include a $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by the Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee. Two pooled trust preferred securities with a book value of $36 thousand are also valued using Level 3 inputs. Additionally, we have four municipal bonds that were transferred into Level 3 due to lack of comparable sales transactions during 2011. These four bonds total $1.1 million.
As of December 31, 2011, we performed an impairment assessment of the securities in our portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) we intend to sell the security, (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (3) we do not expect to recover the security’s entire amortized cost basis, even if we do not intend to sell. Additionally, accounting guidance requires that for impaired securities that we do not intend to sell and/or that it is not more-likely-than-not that we will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, we consider factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
The following table shows the gross unrealized losses and fair value of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010.
As of December 31, 2011, gross unrealized losses in the Company’s portfolio totaled $220 thousand, compared to $656 thousand as of December 31, 2010. The unrealized losses in federal agencies, mortgage-backed and municipal securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. Based on results of the Company’s impairment assessment, the unrealized losses at December 31, 2011 are considered temporary.
As of December 31, 2011, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders’ equity. The following table presents the amortized cost and market value of the securities from each such issuer as of December 31, 2011.
At December 31, 2011 and 2010, our interest-bearing deposits in banks totaled $249.2 million and $200.6 million, respectively. We are holding our excess liquidity in our Federal Reserve cash account. The yield on the account is approximately 25 basis points.
At December 31, 2011 and 2010, we held $100 thousand in certificates of deposit at other FDIC insured financial institutions. At December 31, 2011 and 2010, we held $26.7 million and $25.8 million, respectively, in bank-owned life insurance.
Deposits and Other Borrowings
Deposits decreased by $29.3 million, or 2.8%, from year-end 2010 to year-end 2011, driven primarily by significant declines in brokered deposits, partially offset by increases in other categories. Retail and jumbo certificates of deposit increased by $49.5 million, or 13.8%, during that same period. Excluding brokered deposits, our deposits increased $47.1 million, or 6.4%, from year-end 2010 to year-end 2011. We define core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposit with denominations less than $100 thousand. Core deposits increased $14.4 million, or 2.5%, from year-end 2010 to year-end 2011 We consider our retail certificates of deposit to be a stable source of funding because they are in-market, relationship-oriented deposits. Core deposit growth is an important tenet of our business strategy.
As discussed in Note 2 of our consolidated financial statements, the presence of a capital requirement restricts the rates that we can offer on deposit products. We received a determination letter from the FDIC designating our market areas as “high rate” markets for 2011 and 2012. As such, we may offer rates up to 75 basis points above the prevailing local market rates.
Brokered deposits decreased $76.4 million, or 24.3%, from year-end 2010 to year-end 2011. The decrease is primarily due to maturities during the second half of 2011. In addition to brokered certificates of deposits, we are a member bank of the Certificate of Deposit Account Registry Service® (CDARS®) network. CDARS® is a network of banks that allows customers’ CDs to receive full FDIC insurance of up to $50 million. Additionally, as a member bank, we have the opportunity to sell one-way time deposits. At year-end 2011, our CDARS® balance consisted of $1.4 million in one-way buy deposits and no reciprocal accounts for our customers. Brokered deposits at December 31, 2011 and 2010, were as follows:
As discussed in Note 2 of our consolidated financial statements, the presence of a capital requirement in our Consent Order restricts our ability to accept, renew, or roll over brokered deposits without prior approval of the FDIC. The liquidity enhancement over the last fifteen months was in part to ensure we have adequate funding to meet our short-term contractual obligations. We believe that our current liquidity, along with maintaining or increasing core deposits, will provide for our short-term contractual obligations, including maturing brokered deposits. The table below is a maturity schedule for our certificates of deposit, including brokered CDs, in amounts of $100 thousand or more as of December 31, 2011.
At December 31, 2011 and 2010, we had securities sold under repurchase agreements with commercial checking customers of $4.5 million and $5.9 million, respectively. We also had a structured repurchase agreement with another financial institution of $10.0 million at December 31, 2011 and December 31, 2010. This agreement has a five-year term with a variable rate of three-month LIBOR minus 75 basis points for the first year and a fixed rate of 3.93% for the remaining term. The agreement was callable on November 6, 2008, the first anniversary, and quarterly thereafter. The stated maturity is November 2012.
As a member of the Federal Home Loan Bank of Cincinnati (FHLB), we have the ability to acquire short and long-term advances through a blanket agreement secured by our unencumbered qualifying 1-4 family first mortgage loans and by pledging investment securities or individual, qualified loans, subject to approval of the FHLB. We also use FSGBank’s borrowing capacity at the FHLB to purchase a letter of credit that we pledged to the State of Tennessee Collateral Pool. The $9 million letter of credit allows us to release investment securities from the Collateral Pool and thus improve our liquidity ratio.
The terms of the other borrowing as of December 31, 2011 are as follows:
Interest Rate Sensitivity
Financial institutions are subject to interest rate risk to the degree that their interest bearing liabilities (consisting principally of customer deposits) mature or reprice more or less frequently, or on a different basis, than their interest earning assets (generally consisting of intermediate or long-term loans, investment securities and federal funds sold). The match between the scheduled repricing and maturities of our earning assets and liabilities within defined time periods is referred to as “gap” analysis. At December 31, 2011, our cumulative one-year gap was a positive (or asset sensitive) $256.8 million, or 32% of total earning assets. At December 31, 2010, our cumulative one-year gap was a positive (or asset sensitive) $417.9 million, or 39% of total earning assets.
During the fourth quarter of 2009 and first quarter of 2010, we issued $255.6 million in brokered certificates of deposits with an average maturity of approximately 2.7 years at a weighted average all-in cost of 2.80%. The issuances established a strong liquidity position that will be used to fund prudent loans and pay for future contractual obligations. At December 31, 2011, we held $249.3 million in interest-bearing cash, which was primarily held at the Federal Reserve Bank of Atlanta. The issuance combined with the retention of the cash positions us to be asset-sensitive in preparation for future increases in interest rates. We anticipate rates to begin to increase in late 2012 or early 2013, depending on economic conditions.
The following “gap” analysis provides information based the next repricing date or the maturity date. The “Interest Rate Risk Income Sensitivity Summary” table located in Item 7A
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk, with respect to First Security, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. We do not deal in international instruments, and therefore are not exposed to the risks inherent to foreign currency. Additionally, as of December 31, 2011, we had no trading assets that exposed us to the risks in market changes.
Our interest rate risk management is the responsibility of our Board of Directors’ Asset/Liability Committee (ALCO). The committee has established policies and limits for management to monitor, measure and coordinate our sources, uses, and pricing of funds.
Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with our interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both a static and dynamic gap report, as well as an income simulation report, to quantify the estimated exposure of net interest income to a sustained change in interest rates.
We monitor and forecast potential interest rate changes based on market data. In a falling interest rate environment, we closely monitor our funding sources and pricing to minimize the impact to our net interest margin for our asset sensitive balance sheet.
The income simulation analysis projects net interest income based on both a rise and fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month period. The model is based on actual repricing dates of interest sensitive assets and interest sensitive liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rates of certain assets.
We measure this exposure based on an immediate change in interest rates of 200 basis points up or down. Given this scenario, we had, at year-end, an exposure to falling rates and a benefit from rising rates. More specifically, the model forecasts a decline in net interest income of $3.7 million, or 22%, as a result of a 200 basis point decline in rates. The model also predicts a $5.4 million increase in net interest income, or 15%, as a result of a 200 basis point increase in rates. The forecasted results of the model for the 200 basis point increase are within the limits specified by our guidelines. The forecasted results for a decline in rates is not within our policy limit, however, a 200 basis point decline in rates is not anticipated. The following chart reflects First Security’s sensitivity to changes in interest rates as of December 31, 2011. The model is based on a static balance sheet and assumes that paydowns and maturities of both assets and liabilities are reinvested in similar instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.
Interest Rate Risk
Income Sensitivity Summary
The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, management cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that management might take in responding to or anticipating changes in interest rates.
We use the Sendero Vision Asset/Liability system which is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration, and income simulations using a wide range of scenarios including interest rate shocks and rate ramps. The system also has the capability to model derivative instruments, such as interest rate swap contracts.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Audit Committee
First Security Group, Inc.
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheet of First Security Group, Inc. (“Company”) as of December 31, 2011 and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the year then ended. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the 2011 consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Security Group, Inc. as of December 31, 2011 and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
As discussed in Note 2 to the consolidated financial statements, the Company has recently incurred substantial losses, largely as a result of declining net interest margins and increased provisions for loan losses. In addition, both the Company and its bank subsidiary, (FSGBank), are under regulatory enforcement orders issued by their primary regulators. FSGBank is not in compliance with its regulatory enforcement order which requires, among other things, increased minimum regulatory capital ratios. FSGBank’s continued non-compliance with its regulatory enforcement order may result in additional adverse regulatory action. Management’s plans with regard to these matters are also discussed in Note 2 to the consolidated financial statements.
Crowe Horwath LLP
/s/ Crowe Horwath LLP
Brentwood, Tennessee
March 30, 2012
Report of Independent Registered Public Accounting Firm
On the Consolidated Financial Statements
Board of Directors and Stockholders
First Security Group, Inc.
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheets of First Security Group, Inc. and subsidiary (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Security Group, Inc. and subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has recently incurred substantial losses. The Company is also operating under formal supervisory agreements (the Agreements) with the Federal Reserve Bank of Atlanta and the Office of the Comptroller of the Currency and is not in compliance with all provisions of the Agreements. Failure to achieve all of the Agreements’ requirements may lead to additional regulatory actions. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Joseph Decosimo and Company, PLLC
Chattanooga, Tennessee
April 15, 2011
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2011 and 2010
The accompanying notes are an integral part of the consolidated financial statements.
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Years Ended December 31, 2011, 2010 and 2009
(in thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2011, 2010 and 2009
(in thousands)
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY-(Continued)
Years Ended December 31, 2011, 2010 and 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2011, 2010 and 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS-(Continued)
Years Ended December 31, 2011, 2010 and 2009
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
First Security Group, Inc. is a bank holding company organized for the principal purpose of acquiring, developing and managing banks. The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry.
The significant accounting policies and practices followed by the Company are as follows:
BASIS OF CONSOLIDATION-The consolidated financial statements include the accounts of First Security Group, Inc. and its wholly-owned subsidiary, FSGBank, National Association (the Bank) (collectively referred to as the Company in the accompanying notes to the consolidated financial statements). All significant intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS-The Company is headquartered in Chattanooga, Tennessee, and provides banking services through the Bank to the various communities in eastern and middle Tennessee and northern Georgia. The Bank’s commercial banking operations are primarily retail-oriented and aimed at individuals and small to medium-sized local businesses. The Bank provides traditional banking services, which include obtaining demand and time deposits and the making of secured and unsecured consumer and commercial loans, as well as trust and investment management, mortgage banking, financial planning and Internet banking (www.FSGBank.com) services.
CASH AND CASH EQUIVALENTS-For the purpose of presentation in the statements of cash flows, the Company considers all cash and amounts due from depository institutions as well as interest bearing deposits in banks that mature within one year and are carried at cost to be cash equivalents. The Bank is required to maintain average reserve balances with the Federal Reserve Bank of Atlanta.
INTEREST BEARING DEPOSITS IN BANKS-Interest bearing deposits in banks mature within one year and are carried at cost.
SECURITIES-Securities that management does not have the intent or ability to hold to maturity are classified as available-for-sale and recorded at fair value. Unrealized gains and losses are excluded from earnings and reported in other comprehensive income, net of tax. Purchase premiums and discounts are recognized in interest income using methods approximating the interest method over the terms of the securities. Gains and losses on sale of securities are recorded on the trade date and determined using the specific identification method.
The Company reviews available-for-sale securities for impairment on a quarterly basis or more frequently when economic conditions warrant such an evaluation. A security is reviewed for impairment if the fair value is less than its amortized cost basis at the measurement date. The Company determines whether a decline in fair value below the amortized cost is other-than-temporary. The Company determines whether it has the intent to sell the security or whether it is more likely than not that it will not be required to sell the security before the recovery of its amortized cost. If either condition is met, the Company will recognize a full impairment and write the available-for-sale security down to fair value though the Consolidated Income Statement. For securities that the Company does not expect to recover the entire amortized cost and do not meet either of the above conditions, the Company records an other-than-temporary loss for the credit loss portion of the impairment through earnings and the temporary impairment related to all other factors through other comprehensive income.
LOANS-Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal
balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level yield method without anticipating prepayments.
The Company also engages in direct lease financing through two wholly owned subsidiaries of the Bank. The net investment in direct financing leases is the sum of all minimum lease payments and estimated residual values, less unearned income. Unearned income is added to interest income over the term of the leases to produce a level yield.
All loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well collateralized and in the process of renewal or collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. At management’s discretion, loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt.
When a loan is placed on nonaccrual status, unpaid interest and fees are reversed against interest income. Interest income on nonaccrual loans, if recognized, is either recorded using the cash basis method of accounting or recognized after the loan is returned to accrual status.
LOANS HELD FOR SALE-Loans held for sale include residential mortgage loans originated for sale into the secondary market. Loans held for sale are carried at fair value. Fair value is determined from observable current market prices.
LOAN ORIGINATION FEES-Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield over the lives of the related loans.
INTEREST INCOME ON LOANS-Interest on loans is accrued and credited to income based on the principal amount outstanding. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed.
ALLOWANCE FOR LOAN AND LEASE LOSSES-The allowance for loan and lease losses is the amount the Company considers adequate to absorb probable, incurred losses within the portfolio based on management’s evaluation of the size and risk characteristics of the loan portfolio. The Company’s methodology is based on authoritative accounting guidance and applicable guidance from regulatory agencies.
The allowance is increased by charges to income (provision for loan and lease losses) and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the allowance is based on the Company’s historical 5-year loan loss experience, known and inherent risks in the portfolio, strength of credit risk management systems, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
The allowance for loan and lease losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Company periodically analyzes the commercial loan and lease portfolios in an effort to establish an allowance that it believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, the Company reviews the size, quality and risk of loans and leases in the portfolio. The Company also, on at least a quarterly basis, considers such factors as:
•
the Company’s loan loss experience;
•
the amount of past due and nonperforming loans;
•
specific known risks;
•
the status of nonperforming assets;
•
underlying estimated values of collateral securing loans;
•
current economic conditions; and
•
other factors which management believes affect the allowance for potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of the allowance is prepared by the Company and is presented to the board of directors on a regular basis.
In addition to the allowance, the Company also estimates probable losses related to unfunded commitments, such as letters of credit and binding unfunded loan commitments. The reserve for unfunded commitments is reported on the Consolidated Balance Sheet in other liabilities and the provision associated with changes in the unfunded commitment reserve is reported as a component of the provision for loan and lease losses in the Consolidated Statements of Income.
The following loan portfolio segments have been identified: (1) Real estate: Residential 1-4 family, (2) Real estate: Commercial, (3) Real estate: Construction, (4) Real estate: Multi-family and farmland, (5) Commercial, (6) Consumer, (7) Leases and (8) Other. We evaluate the risks associated with these segments based upon specific characteristics associated with the loan segments. The risk associated with the Real estate: Construction portfolio is most directly tied to the probability of declines in value of the residential and commercial real estate in our market area and secondarily to the financial capacity of the borrower. The risk associated with the Real estate: Commercial portfolio is most directly tied to the lease rates and occupancy rates for commercial real estate in our market area and secondarily to the financial capacity of the borrower. The other portfolio segments have various risk characteristics, including, but not limited to: the borrower’s cash flow, the value of the underlying collateral, and the capacity of guarantors.
A loan or lease is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate, (2) the loan’s observable market price or (3) the fair value of the collateral if the loan is collateral-dependent. When the fair value of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a specific reserve allocation which is a component of the allowance for loan losses unless the loan is collateral-dependent, in which case the impairment is recorded through a charge-off.
Troubled-debt restructurings (TDRs) are loans in which the borrower is experiencing financial difficulty at the time of restructure, and the Company has granted an economic concession to the borrower. Prior to modifying a borrower’s loan terms, the Company performs an evaluation of the borrower’s financial condition and ability to service under the potential modified loan terms. The types of concessions generally granted are extensions of the loan maturity date and/or reductions in the original contractual interest rate. If a loan is accruing at the time of modification, the loan remains on accrual status and is subject to the Company’s charge-off and nonaccrual policies. If a loan is on nonaccrual before it is determined to be a TDR then the loan remains on nonaccrual. TDRs may be returned to accrual status if there has been at least a six month sustained period of repayment performance by the borrower. Interest income recognition on impaired loans is dependent upon nonaccrual status, TDR designation, and loan type as discussed above.
The Company monitors concentrations of credit risk as defined by applicable accounting and regulatory guidelines.
PREMISES AND EQUIPMENT-Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Expenditures for repairs, maintenance and minor improvements are charged to expense as incurred and additions and improvements that significantly extend the lives of assets are capitalized. Upon sale or other retirement of depreciable property, the cost and related accumulated depreciation are removed from the related accounts and any gain or loss is reflected in operations.
Depreciation is provided using the straight-line method over the estimated lives of the depreciable assets. Buildings are depreciated over a period of forty years. Land and building improvements are depreciated over a ten year period. Leasehold improvements are depreciated over the lesser of the term of the related lease or the estimated useful life of the improvement. Furniture, fixtures and equipment and autos are depreciated over an estimated life of three to seven years. Deferred income taxes are provided for differences in the computation of depreciation for book and tax purposes.
GOODWILL AND OTHER INTANGIBLE ASSETS-Goodwill represents the cost in excess of the fair value of the net assets acquired. Other intangible assets represent identified intangible assets including premiums paid for acquisitions of core deposits (core deposit intangibles), which are amortized over a 10 year period.
Management evaluates whether events or circumstances have occurred that indicate the remaining useful life or carrying value of amortizing intangibles should be revised. The Company tests intangible assets for impairment at year-end or earlier if events and circumstances warrant. For additional information, refer to Note 8, “Goodwill and Other Intangible Assets,” to the consolidated financial statements.
FORECLOSED PROPERTIES AND REPOSSESSIONS-Foreclosed properties are comprised principally of residential and commercial real estate properties obtained in partial or total satisfaction of nonperforming loans. Repossessions are primarily comprised of heavy equipment and other machinery, obtained in partial or total satisfaction of loans or leases. Foreclosed properties and repossessions are recorded at their estimated fair value less anticipated selling costs based upon the property’s or item’s appraised value at the date of transfer, with any difference between the fair value of the property and the carrying value of the loan charged to the allowance for loan and lease losses. Subsequent changes in values are reported as adjustments to the carrying amount, not to exceed the initial carrying value of the assets at the time of transfer. Gains or losses not previously recognized resulting from the sale of foreclosed properties or other repossessed items are recognized on the date of sale. Ongoing operational expenses after acquisition are expensed as incurred and included in other expenses. At December 31, 2011 and 2010, the Company had $25,141 thousand and $24,399 thousand of foreclosed properties, respectively, and $302 thousand and $763 thousand of other repossessed items, respectively. These amounts are included in other assets in the consolidated balance sheet.
INCOME TAXES-The consolidated financial statements have been prepared on the accrual basis. When income and expenses are recognized in different periods for financial reporting purposes and for purposes of computing income taxes currently payable, deferred taxes are provided on such temporary differences. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes in the period in which the change was enacted. Additionally, the Company does not recognize an income tax expense or benefit on permanent differences, such as tax-exempt income and tax credits. Tax years 2008 through 2010 remain open and subject to examination by taxing authorities for the Company’s federal tax returns. Tax years 2005 through 2010 remain open and subject to examinination by taxing authorities for the Company’s Tennessee tax returns.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. In determining whether a valuation allowance is necessary, the Company considers the level of taxable income in prior years to the extent that carrybacks are permitted under current tax laws, as well as estimates of future pre-tax and taxable income and tax planning strategies that may be utilized.
In computing the income tax provision (benefit), the Company evaluates the technical merits of its income tax positions based on current legislative, judicial and regulatory guidance. The Company classifies interest and penalties related to its tax positions as a component of income tax expense (benefit). For additional information, refer to Note 13 “Income Taxes.”
FINANCIAL INSTRUMENTS-In the ordinary course of business, the Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
ADVERTISING COSTS-Advertising costs are charged to expense when incurred. The Company expensed $323 thousand, $155 thousand and $278 thousand in 2011, 2010 and 2009, respectively.
STOCK-BASED COMPENSATION-The Company accounts for stock-based compensation under the fair value recognition provision whereby fair value of the award at the date of grant is expensed over the vesting period of the award. The required disclosures related to the Company’s stock-based employee compensation plans are included in Note 15 “Long-Term Incentive Plan,” to the consolidated financial statements.
RETIREMENT PLANS-Benefit expense associated with retirement plans includes the net periodic costs associated with supplemental retirement plans as well as contributions under the 401(k) and Employee Stock Ownership Plan (“ESOP”).
ESTIMATES AND UNCERTAINTIES-The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, deferred tax assets and the fair value of financial instruments are particularly subject to change.
PER SHARE DATA-Basic earnings per share is computed by dividing net income (loss) allocated to common shareholders by the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during each period, plus common share equivalents calculated for stock options and restricted stock outstanding using the treasury stock method. In periods of a net loss, diluted EPS is calculated in the same manner as basic EPS.
The Company has issued certain restricted stock awards, which are unvested share-based payment awards that contain nonforfeitable rights to dividends. These restricted shares are considered participating securities. Accordingly, the Company calculates net income available to common shareholders pursuant to the two-class method, whereby net income is allocated between common shareholders and participating securities. In periods of a net loss, no allocation is made to participating securities as they are not contractually required to fund net losses.
Net income allocated to common shareholders represents net income (loss) after preferred stock dividends, accretion of the discount on preferred stock issuances, and dividends and allocation of undistributed earnings to the participating securities.
COMPREHENSIVE INCOME-Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities and cash flow derivatives, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. For additional information, refer to Note 3 “Comprehensive Income (Loss)”.
SEGMENT REPORTING-The Company identifies reportable segments based on the authoritative accounting guidance. Reportable segments are determined on the basis of discrete business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). The statement permits aggregation or combination of segments that have similar characteristics. The operations of First Security Group, Inc. and the Bank have similar economic characteristics and are similar in each of the following areas: the nature of products and services, the nature of production processes, the type of customers, the methods of distribution, and the nature of their regulatory environment. Accordingly, the Company’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES-The Company records all derivative financial instruments at fair value in the financial statements. It is the policy of the Company to enter into various derivatives both as a risk management tool and in a dealer capacity to facilitate client transactions. Derivatives are used as a risk management tool to hedge the exposure to changes in interest rates or other identified market risks. As of December 31, 2011, the Company has not entered into a transaction in a dealer capacity.
When a derivative is intended to be a qualifying hedged instrument, the Company prepares written hedge documentation that designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or (2) a hedge of a forecasted transaction, such as, the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).
The written documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item, and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for management’s assertion that the hedge will be highly effective. Methodologies related to hedge effectiveness and ineffectiveness include (1) statistical regression analysis of changes in the cash flows of the actual derivative and a perfectly effective hypothetical derivative, (2) statistical regression analysis of changes in fair values of the actual derivative and the hedged item and (3) comparison of the critical terms of the hedged item and the hedging derivative. Changes in fair value of a derivative that is highly effective and that has been designated and qualifies as a fair value hedge are recorded in current period earnings, along with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Changes in the fair value of a derivative that is highly effective and that has been designed and qualifies as a cash flow hedge are initially recorded in other comprehensive income and reclassified to earnings in conjunction with the recognition of the earnings impacts of the hedged item; any ineffective portion is recorded in current period earnings. Designated hedge transactions are reviewed at least quarterly for ongoing effectiveness. Transactions that are no longer deemed to be effective are removed from hedge accounting classification and the recorded impacts of the hedge are recognized in current period income or expense in conjunction with the recognition of the income or expense on the originally hedged item.
The Company’s derivatives are based on underlying risks, primarily interest rates. The Company has previously utilized cash flow swaps to reduce the risks associated with interest rates. Swaps are contracts in which a series of net cash flows, based on a specific notional amount that is related to an underlying risk, are exchanged over a prescribed period.
When a cash flow swap is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk is equal to the fair value gain of the derivative. The credit exposure for swaps is the replacement cost of contracts that have become favorable. Credit risk is minimized by entering into transactions with high quality counterparties that are initially approved by the Board of Directors and reviewed periodically by the Asset Liability Committee. It is the Company’s policy to require that all derivatives be governed by an International Swap and Derivatives Associations Master Agreement (ISDA). Bilateral collateral agreements may also be required.
FAIR VALUE-The Company determines fair value based on applicable accounting guidance. The guidance establishes a fair value hierarchy, which requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure the fair value, which are provided in Note 18.
RECLASSIFICATIONS-Certain reclassifications have been made to the prior years’ financial statements to conform to the current year presentation.
ACCOUNTING POLICIES RECENTLY ADOPTED-In December 2011, the FASB issued Accounting Standards Update 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” This update amended Update 2011-05 to remove requirements that the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income be included on the face of the financial statements for all periods presented. The guidance, with the exception of the reclassification adjustments, is effective January 1, 2012 and must be applied retrospectively for all periods presented. The Company has adopted the standard as of January 1, 2012. The adoption did not have an impact on the Company’s financial position, results of operations or earnings per share.
In May, 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. Included in the ASU are requirements to disclose additional quantitative disclosures about unobservable inputs for all Level 3 fair value measurements, as well as qualitative disclosures about the sensitivity inherent in recurring Level 3 fair value measurements. The ASU is effective during the interim and annual periods beginning after December 15, 2011. The Company has adopted the standard as of January 1, 2012. The adoption did not have an impact on the Company’s financial position, results of operations or earnings per share.
In April 2011, the FASB issued Accounting Standards Update 2011-02, “The Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This update provides additional guidance in determining what is considered a troubled debt restructuring (“TDR”). The update clarifies the two criteria that are required in determining a TDR. The update is effective for interim or annual periods beginning after June 15, 2011. The disclosure requirements are shown in Note 6 to the consolidated financial statements.
NOTE 2-REGULATORY MATTERS AND MANAGEMENT’S PLANS
Regulatory Matters
First Security Group, Inc.
On September 7, 2010, the Company entered into a Written Agreement (Agreement) with the Federal Reserve Bank of Atlanta (Federal Reserve Bank), the Company’s primary regulator. The Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank.
The Agreement prohibits the Company from declaring or paying dividends without prior written consent of the Federal Reserve Bank. The Company is also prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank without prior written consent.
Within 60 days of the Agreement, the Company was required to submit to the Federal Reserve Bank a written plan designed to maintain sufficient capital at the Company and the Bank. The Company submitted a
copy of the Bank’s capital plan that had previously been submitted to the Office of the Comptroller of the Currency (the “OCC”). Neither the Federal Reserve Bank nor the OCC have accepted that capital plan. A revised five-year strategic and capital plan was submitted to the Federal Reserve Bank and the OCC in March 2012.
The Company is currently deemed not in compliance with certain provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve Bank. Management believes the successful execution of the strategic initiatives discussed above will ultimately result in full compliance with the Agreement and position the Company for long-term growth and a return to profitability.
On September 14, 2010, the Company filed a current report on Form 8-K describing the Agreement. The Form 8-K also provides the final, executed Agreement.
FSGBank, N.A.
On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order (Order), FSGBank, the Company’s wholly-owned subsidiary, consented and agreed to the issuance of a Consent Order by the Office of the Comptroller of the Currency (OCC), the Bank’s primary regulator.
The Bank and the OCC agreed as to the areas of the Bank’s operations that warrant improvement and a plan for making those improvements. The Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Board is required to ensure that competent management is in place in all executive officer positions to manage the Bank in a safe and sound manner. The Bank is also required to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan and lease losses, liquidity management, criticized asset, loan review and credit administration. The Bank is continuing to work with the OCC to correct identified deficiencies in these policies.
Within 120 days of the effective date of the Order, the Bank was required to achieve and thereafter maintain total capital at least equal to 13 percent of risk-weighted assets and Tier 1 capital at least equal to 9 percent of adjusted total assets. As of December 31, 2011, the sixth financial reporting period subsequent to the 120 day requirement, the Bank’s total capital to risk-weighted assets was 11.2 percent and the Tier 1 capital to adjusted total assets was 5.8 percent. The Bank has notified the OCC of the non-compliance.
During the third quarter of 2010, the OCC requested additional information and clarifications to the Bank’s submitted strategic and capital plans as well as the management assessments. A revised five-year strategic and capital plan was submitted to the Federal Reserve Bank and the OCC in March 2012.
Because the Order established specific capital amounts to be maintained by the Bank, the Bank may not be considered better than “adequately capitalized” for capital adequacy purposes, even if the Bank exceeds the levels of capital set forth in the Order. As an adequately capitalized institution, the Bank may not pay interest on deposits that are more than 75 basis points above the rate applicable to the applicable market of the bank as determined by the FDIC. Additionally, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC.
The Bank is currently deemed not in compliance with some provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. Management believes the successful execution of the strategic initiatives discussed above will ultimately result in full compliance with the Order and position the Bank for long-term growth and a return to profitability.
On April 29, 2010, the Company filed a current report on Form 8-K describing the Order. The Form 8-K also provides the final, executed Order.
Management’s Plans
The Company continues to operate in a difficult environment and has been significantly impacted by the downturn in real estate values and the general recessionary economy. The Company has experienced significant net operating losses for the years ended December 31, 2011, 2010, and 2009, substantially resulting from declining net interest margins and elevated levels of provision for loan losses. Both of these financial trends were significantly impacted by significant levels of nonperforming assets and related deterioration in the economy.
During 2011, the Company underwent significant change within the Board of Directors and executive management. The changes were predicated on strengthening and deepening the Company’s leadership in order to successfully execute a strategic and capital plan to return the Company to profitable operations, satisfy the requirements of the regulatory actions detailed below, and lower the level of problem assets to an acceptable level.
In December 2011, the Company appointed Michael Kramer as President and Chief Executive Officer. Subsequently, the Company appointed a Chief Credit Officer, Retail Banking Officer and Director of FSGBank’s Wealth Management and Trust Department. During 2011, the Company added three additional directors to the Board and two additional directors in 2012.
The Company’s strategic plan addresses the actions necessary to restore profitability and achieve full compliance with all regulatory agreements, including, but not limited to, restoring capital to the prescribed regulatory levels of the Consent Order. Management is pursuing various options to restore the Company’s capital to a satisfactory level, including, but not limited to, a private stock placement and select asset divestitures of nonperforming assets. Since December 2011, the Company has been in preliminary discussions with multiple potential investors and asset disposition firms.
The Bank has successfully maintained elevated liquidity and has chosen to do so primarily by maintaining excess cash at the Federal Reserve. The Company’s cash position as of December 31, 2011 was $258,181 thousand, compared to $208,919 thousand and $175,836 thousand for December 31, 2010 and 2009, respectively.
The Company’s strategic plan includes maintaining adequate liquidity, reducing nonperforming assets, and appropriately increasing the Company’s capital ratios. Compliance with the capital ratios required in the Consent Order can be achieved by increasing capital and / or through asset sales. The Company’s revised strategic plan has been submitted to the regulatory agencies and the Company is currently implementing the strategic initiatives within the plan.
The Company’s failure to achieve compliance with its regulatory enforcement order may result in additional adverse regulatory action.
NOTE 3-COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in equity, not only reflecting net income but certain other changes as well. The following table presents the comprehensive income for the years ended December 31, 2011, 2010 and 2009, respectively:
NOTE 4-EARNINGS PER SHARE
The difference in basic and diluted weighted average shares is due to the assumed conversion of outstanding stock options, restricted stock awards and common stock warrants using the treasury stock method. The Company has issued certain restricted stock awards, which are unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents. These restricted shares are considered participating securities. Accordingly, the Company calculated net income available to common shareholders pursuant to the two-class method, whereby net income is allocated between common shareholders and participating securities. In periods of a net loss, no allocation is made to participating securities as they are not contractually required to fund net losses. The computation of basic and diluted earnings per share is as follows:
On January 9, 2009, as part of the Capital Purchase Program (CPP) administered by the U.S. Department of the Treasury (Treasury) under the Troubled Asset Relief Program (TARP), the Company issued a ten-year warrant to purchase up to 82,363 shares of the Company’s common stock, $0.01 par value, at an exercise price of $60.10 per share. Note 16 discusses the transaction in further detail. The common stock warrants are treated as outstanding options under the treasury stock method for calculating the weighted average diluted shares outstanding. For the years ended December 31, 2011 and 2010, the common stock warrants were anti-dilutive.
Due to the net loss allocated to common shareholders for all periods shown, all stock options, stock warrants, and restricted stock grants are considered anti-dilutive. As of December 31, 2011, a total of 90 thousand stock options, stock warrants and restricted stock grants were considered anti-dilutive. All prior periods have been restated to give retroactive effect to the one-for-ten reverse stock split that took effect on September 19, 2011.
NOTE 5-SECURITIES
Investment Securities by Type
The amortized cost and fair value of securities, with gross unrealized gains and losses, are as follows:
Proceeds from sales of securities available-for-sale totaled $14,762 thousand for the year ended December 31, 2010. There were no sales of securities during the years ended December 31, 2011 and 2009. Gross realized gains from sales of securities were $368 thousand for the year ended December 31, 2010. Gross realized losses were $311 thousand from sales of securities available-for-sale for the year ended December 31, 2010.
At December 31, 2011 and 2010, federal agencies, municipals and mortgage-backed securities with a carrying value of $22,449 thousand and $21,572 thousand, respectively, were pledged to secure public deposits. At December 31, 2011 and 2010, the carrying amount of securities pledged to secure repurchase agreements was $26,635 thousand and $30,254 thousand, respectively. At December 31, 2011 and 2010, securities of $5,678 thousand and $5,756 thousand, respectively, were pledged to the Federal Reserve Bank of Atlanta to secure the Company’s daytime correspondent transactions.
Maturity of Securities
The amortized cost and fair value of debt securities by contractual maturity at December 31, 2011, are as follows:
Impairment Analysis
The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010.
As of December 31, 2011, the Company performed an impairment assessment of the securities in its portfolio that had an unrealized loss to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) the Company intends to sell the security, (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized costs basis or (3) the Company does not expect to recover the security’s entire amortized cost basis, even if the Company does not intend to sell. Additionally, accounting guidance requires that for impaired securities that the Company does not intend to sell and/or that it is not more-likely-than-not that the Company will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.
In evaluating the recovery of the entire amortized cost basis, the Company considers factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.
As of December 31, 2011, gross unrealized losses in the Company’s portfolio totaled $220 thousand, compared to $656 thousand as of December 31, 2010. The unrealized losses in federal agencies (consisting of five securities) and mortgage-backed (consisting of three securities) securities are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. The unrealized losses in other securities are two trust preferred securities. The unrealized losses in the trust preferred securities are primarily due to widening credit spreads subsequent to purchase and a lack of demand for trust preferred securities. The Company does not
intend to sell the investments with unrealized losses and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. Based on results of the Company’s impairment assessment, the unrealized losses at December 31, 2011 are considered temporary.
NOTE 6-LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Loans by type are summarized as follows:
The loan portfolio includes lease financing receivables consisting of direct financing leases on equipment. The components of the investment in lease financing were as follows:
At December 31, 2011, the minimum future lease payments to be received were as follows:
The allowance for loan and lease losses is composed of two primary components: (1) specific impairments for substandard/nonaccrual loans and leases and (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, as well as all remaining pools of loans. The Company accumulates pools based on the underlying classification of the collateral. Each pool is assigned a loss severity
rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions. The Company determines the allowance on a quarterly basis. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may materially change in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
The following table presents an analysis of the allowance for loan and lease losses for the year ended December 31, 2011. The provisions for loan and lease losses in the table below do not include the Company’s provision accrual for unfunded commitments of $24 thousand, $24 thousand and $24 thousand as of December 31, 2011, 2010 and 2009, respectively. The reserve for unfunded commitments is included in other liabilities in the consolidated balance sheets and totaled $253 thousand and $229 thousand at December 31, 2011 and 2010, respectively.
Allowance for Loan and Lease Losses
For the Year Ended December 31, 2011
Allowance for Loan and Lease Losses
For the Year Ended December 31, 2010
The following table presents an analysis of the allowance for loan and lease losses for individually and collectively evaluated loans as of December 31, 2011 and 2010, by classification.
As of December 31, 2011
As of December 31, 2010
The following table presents an analysis of the allowance for loan and lease losses for the years ended December 31, 2009.
The Company utilizes a risk rating system to evaluate the credit risk of its loan portfolio. The Company classifies loans as: pass, special mention, substandard, doubtful or loss. The Company assigns a pass rating to loans that are performing as contractually agreed and do not exhibit the characteristics of heightened credit risk. The Company assigns a special mention risk rating to loans that are criticized but not considered as severe as a classified loan. Special mention loans generally contain one or more potential weaknesses, which if not corrected, could result in an unacceptable increase in the credit risk at some future date. The Company assigns a substandard risk rating to loans that have specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic or managerial nature and may require nonaccrual status. Substandard loans have a greater likelihood of loss.
The Company segregates substandard loans into two classifications based on the Company’s allowance methodology for impaired loans. The Company defines an impaired loan as a substandard loan relationship in excess of $500 thousand that is also on nonaccrual status. The Company individually reviews these relationships on a quarterly basis to determine the required allowance or loss, as applicable.
For the allowance analysis, the Company’s primary categories are: pass, special mention, substandard-non-impaired, and substandard-impaired. Loans in the substandard and doubtful loan categories are combined and impaired loans are segregated from non-impaired loans. The following table presents the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of December 31, 2011:
The following table presents the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of December 31, 2010:
The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans were $33,489 thousand and $41,606 thousand at December 31, 2011 and 2010, respectively. For impaired loans, the Company generally applies all payments directly to principal. Accordingly, the Company did not recognize any significant amount of interest for impaired loans during the years ended December 31, 2009, 2010 or 2011. The following table presents additional information on the Company’s impaired loans as of December 31, 2011 and December 31, 2010:
Impaired loans averaged $36,851 thousand in 2010 and $27,401 thousand in 2009.
Nonaccrual loans were $46,907 thousand and $54,082 thousand at December 31, 2011 and 2010, respectively. The following table provides nonaccrual loans by type:
The Company monitors loans by past due status. The following table provides the past due status for all loans. Nonaccrual loans are included in the applicable classification.
The following table provides the past due status for all loans as of December 31, 2010. Nonaccrual loans are included in the applicable classification.
The Company has allocated $421 thousand of specific reserves against the principal balances of $824 thousand to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2011, and no specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2010. The Company has not committed to lend additional amounts as of December 31, 2011 and 2010 to customers with outstanding loans that are classified as troubled debt restructurings.
During the year ending December 31, 2011, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.
Modifications involving a reduction of the stated interest rate of the loan were for periods ranging from 3 months to 1 year. There were no modifications during the year ending December 31, 2011 involving an extension of the maturity date.
The following table presents loans by class modified as troubled debt restructurings that occurred during the year ending December 31, 2011:
The troubled debt restructurings described above did not increase the allowance for loan losses or result in charge offs during the year ending December 31, 2011.
The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the year ending December 31, 2011:
A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.
The troubled debt restructurings that subsequently defaulted described above did not increase the allowance for loan losses and resulted in charge offs of $959 thousand during the year ending December 31, 2011.
At December 31, 2011 and 2010, the Company had $138,539 thousand and $161,622 thousand, respectively, of loans pledged to secure borrowings from the Federal Home Loan Bank of Cincinnati. The loans pledged included all residential first mortgage loans.
The Company has entered into transactions with certain directors, executive officers and significant stockholders and their affiliates. The aggregate amount of loans to such related parties at December 31, 2011 and 2010 was $518 thousand and $1,050 thousand, respectively. New loans made to such related parties amounted to $460 thousand and principal and interest payments amounted to $29 thousand for 2011. New loans made to such related parties amounted to $206 thousand and principal and interest payments amounted to $2,280 thousand for 2010. Additionally, new directors for 2010 had loans totaling $746 thousand as of their appointment dates and resigning directors during 2010 had loans totaling $1,426 thousand as of their resignation dates.
NOTE 7-PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
The amount charged to operating expenses for depreciation was $1,491 thousand for 2011, $1,795 thousand for 2010 and $2,076 thousand for 2009.
NOTE 8-GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and Related Impairment Analysis
The Company recorded a full impairment of $27,156 thousand on its goodwill during 2009. The Company’s policy is to assess goodwill for impairment on an annual basis or between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its carrying amount as required by authoritative accounting guidance. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The impairment testing is a two-step process. Step 1 compares the fair value of the reporting unit to the carrying value. If the fair value is below the carrying value, Step 2 is performed. Step 2 involves a process similar to business combination accounting in which fair value is assigned to all assets, liabilities and other (non-goodwill) intangibles. The result of Step 2 is the implied fair value of goodwill. If the implied fair value of goodwill is below the recorded goodwill amount, an impairment charge is recorded for the difference.
The Company engaged an independent valuation firm to assist in computing the fair value estimate for the goodwill impairment assessment as of September 30, 2009. The firm utilized two separate valuation methodologies for Step 1 and compared the results of each to determine the fair value of the goodwill associated with the Company’s prior bank acquisitions. The valuation methodologies utilized included a discounted cash flow valuation technique and a comparison of the average price to book value of comparable bank acquisitions. Both methods indicated a valuation below the book value of the Company. The firm conducted Step 2, which assigned fair values to all assets, liabilities and other (non-goodwill) intangibles. The results of Step 2 indicated a full goodwill impairment of $27,156 thousand that is recorded in non-interest expense in the Consolidated Statements of Income for the year ended December 31, 2009. The impairment was primarily a result of the continuing economic downturn and its implications on bank valuations.
The Company’s goodwill was associated with six prior acquisitions. Three acquisitions were taxable asset purchases and three were non-taxable stock purchases. The 2009 goodwill impairment that was deductible for tax was $6,953 thousand, which added $2,394 thousand to the tax benefit recognized in the third quarter of 2009. The remaining $20,203 thousand goodwill impairment was not deductible for taxes and thus no tax benefit was recognized.
Other Intangible Assets
The Company has other intangible assets in the form of core deposit intangibles. The core deposit intangibles are amortized on an accelerated basis over their estimated useful lives of 10 years. A summary of other intangible assets is as follows:
Amortization expense on other intangible assets was $479 thousand for 2011, $457 thousand for 2010 and $485 thousand for 2009. Amortization expense for the Company’s core deposit intangibles for the next five years is as follows:
NOTE 9-DEPOSITS
The aggregate amount of time deposits of $100 thousand or more was $185,904 thousand and $153,138 thousand at December 31, 2011 and 2010, respectively.
Brokered deposits were as follows:
Brokered certificates of deposits issued in denominations of $100 thousand or more are participated out by the deposit brokers in shares of $100 thousand or less. CDARS® includes $1,405 thousand one-way buy deposits and no First Security customers’ reciprocal accounts as of December 31, 2011.
Scheduled maturities of time deposits as of December 31, 2011, are as follows:
NOTE 10-FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 2011 and December 31, 2010, the Company had no lines of credit to purchase federal funds with correspondent banks.
Securities sold under agreements to repurchase represent the purchase of interests in securities by commercial checking customers. The Company may also enter into structured repurchase agreements with other financial institutions. Repurchase agreements with commercial checking customers are settled the following business day, while structured repurchase agreements with other financial institutions will have varying terms.
At December 31, 2011 and 2010, the Company had securities sold under agreements to repurchase of $4,520 thousand and $5,933 thousand, respectively, by commercial checking customers. The Company had a structured repurchase agreement with another financial institution of $10,000 thousand at December 31, 2011 and 2010. Securities sold under agreements to repurchase are held in safekeeping for the Company and had a carrying value of approximately $26,635 thousand and $30,254 thousand at December 31, 2011 and 2010, respectively. These agreements averaged $15,169 thousand and $18,435 thousand during 2011 and 2010, respectively. The maximum amounts outstanding at any month end during 2011 and 2010 were $15,701 thousand and $20,507 thousand, respectively. Interest expense on repurchase agreements totaled $440 thousand, $474 thousand and $498 thousand for the years ended 2011, 2010 and 2009, respectively.
The structured repurchase agreement with another financial institution provides for a variable rate of three-month LIBOR minus 75 basis points for the first year ending November 6, 2008 and a fixed rate of 3.93% for the remaining term, and is callable on a quarterly basis after the first year. The maturity date is November 6, 2012.
NOTE 11-OTHER BORROWINGS
Other borrowings at December 31, 2011, consist of a mortgage note totaling $58 thousand. Additionally, the Company had an FHLB letter of credit totaling $9,000 thousand which reduces the FHLB borrowing capacity. The letter of credit was not in use as of December 31, 2011. Other borrowings at December 31, 2010, consist of long-term fixed rate advances from the FHLB totaling $3 thousand and a mortgage note totaling $74 thousand. Additionally, the Company had an FHLB letter of credit totaling $9,000 thousand which reduces the FHLB borrowing capacity. The letter of credit was not in use as of December 31, 2010.
Pursuant to the blanket agreement for advances and security agreements with the FHLB, advances as of December 31, 2011 and 2010 are secured by the Company’s unencumbered qualifying 1-4 family first mortgage loans subject to varying limitations determined by the FHLB. Advances for both years are also secured by the FHLB stock owned by the Company. As of December 31, 2011 and 2010, for additional borrowing capacity, the FHLB required the Company to pledge investment securities or individual, qualifying loans, subject to approval of the FHLB. As of December 31, 2011 and 2010, the Company had loans totaling $138,539 thousand and
$161,622 thousand, respectively, pledged as collateral at the FHLB. At December 31, 2011, the Company’s remaining available borrowing capacity with the FHLB was approximately $715 thousand.
As a member of FHLB, the Company must own FHLB stock. The amount of FHLB stock required to be held is subject the Company’s asset size and outstanding FHLB advances. At December 31, 2011 and 2010, the Company owned FHLB stock totaling $2,276 thousand and $2,276 thousand, respectively. The FHLB stock is recorded in other assets on the Company’s consolidated balance sheet.
The Company had no FHLB advances as of December 31, 2011. The terms of the other borrowing as of December 31, 2011 are as follows:
NOTE 12-LEASES
The Company leases bank branches and equipment under operating lease agreements. Minimum lease commitments with remaining noncancelable lease terms in excess of one year as of December 31, 2011, are as follows:
Rent expense totaled $883 thousand, $986 thousand and $954 thousand for the years ended 2011, 2010 and 2009, respectively.
NOTE 13-INCOME TAXES
The income tax (benefit) provision consists of the following:
For 2011, the Company recognized an income tax expense of $392 thousand, compared to an income tax expense of $9,679 thousand for 2010 and income tax benefit of $8,252 thousand for 2009. The following reconciles the income tax provision (benefit) to statutory rates:
The increase in the deferred tax asset valuation allowance fully offset the income tax benefits recognized during 2011. The benefit recognized during 2011 before the valuation allowance primarily related to increases in deferred tax assets, including the year-to-date operating loss.
The components of the net deferred tax asset and liability included in other assets and liabilities consist of the following:
The Company accounts for income taxes in accordance with ASC 740, which requires an asset and liability approach for the financial accounting and reporting of income taxes. Under this method, deferred income taxes are recognized for the expected future tax consequences of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. These balances are measured using the enacted tax rates expected to apply in the year(s) in which these temporary differences are expected to reverse. The effect on deferred income taxes of a change in tax rates is recognized in income in the period when the change is enacted.
In accordance with ASC 740, the Company is required to establish a valuation allowance for deferred tax assets when it is “more likely than not” that a portion or all of the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions.
During 2010, the Company established a deferred tax asset valuation allowance of $24,550 thousand and increased the allowance by $9,694 thousand during 2011, after evaluating all available positive and negative evidence. Positive evidence included the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years and general business and economic trends. As business and economic conditions change, the Company will re-evaluate the valuation allowance.
During 2010, the Company entered into a net operating loss carryforward position for federal tax purposes. The net operating loss and federal tax credits as disclosed above can be carried forward for a 20 year period and if not utilized, will begin expiring in 2030.
The Company evaluated its material tax positions as of December 31, 2011. Under the “more-likely-than-not” threshold guidelines, the Company believes it has identified all significant uncertain tax benefits. The Company evaluates, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a component of income tax expense in the Company’s consolidated financial statements. The roll-forward of unrecognized tax benefits is as follows:
Of this total, $977 thousand represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods.
The uncertain tax position arises in a state tax position. The Company is currently in settlement negotiations with the respective state taxing authority covering the above uncertain tax positions and expects resolution during 2012. The estimate of the reasonably possible change is $977 thousand as of December 31, 2011.
The total amount of interest and penalties recorded in the income statement for the years ended December 31, 2011, 2010 and 2009 were $66 thousand, $65 thousand and $131 thousand, respectively, and the amounts accrued for interest and penalties at December 31, 2011 and 2010 were $262 thousand and $196 thousand, respectively.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the states of Tennessee and Georgia. The Company is no longer subject to examination by taxing authorities for years before 2005.
NOTE 14-RETIREMENT PLANS
401(k) and ESOP Plan
The Company has a 401(k) and employee stock ownership plan (the Plan) covering employees meeting certain age and service requirements. Employees may contribute up to 75% of their compensation subject to certain limits based on federal tax laws. From January 1, 2008 to June 30, 2010, the Company made matching contributions equal to 100% of the employee’s contribution up to 6% of the employee’s compensation. Effective July 1, 2010, the Company’s matching contribution was reduced to 1% of the employee’s compensation. The employer contribution is made in the form of Company common stock on a quarterly basis. The employee and employer contributions and earnings thereon are vested immediately. In its sole discretion at the end of the Plan year, the Company may make supplemental matching contributions or profit sharing contributions.
The Company recognized $99 thousand, $331 thousand and $617 thousand in expense under the Plan for 2011, 2010 and 2009, respectively, which has been included in salaries and employee benefits in the accompanying consolidated statements of income.
The employee stock ownership (ESOP) portion of the Plan purchased shares of common stock with proceeds from advances of a loan from the Company. The loan between the Company and the Plan enabled the Plan to borrow up to $12,745 thousand until December 31, 2009, as amended on January 28, 2009. The loan has a term of 30 years, bears interest at 6.25% and requires annual payments. The loan is secured by the stock purchased by the Plan that has not been allocated to participant accounts. The Company may make discretionary profit sharing contributions to the ESOP. The ESOP contribution will first be used to repay the loan. As the loan is repaid, shares are released from collateral based on the proportion of the payment in relation to total payments required to be made on the loan, and those shares are allocated to the ESOP accounts of participants on a quarterly or annual basis. Cash dividends on financed shares will first be used to repay the acquisition loan. Cash dividends on allocated shares are payable to the participants in cash or reinvested in Company stock no later than 90 days from the end of the Plan year.
Compensation expense is determined by multiplying the per share market price of the common stock by the number of shares to be released. The number of unallocated, committed to be released and allocated shares are as follows:
The cost of the shares not yet committed to be released from collateral is shown as a reduction of stockholders’ equity. Unallocated shares are not considered outstanding for earnings per share purposes. At December 31, 2011, the market value of the 30,725 unallocated shares outstanding totaled $72 thousand. At December 31, 2010, the market value of the 57,772 unallocated shares outstanding totaled $520 thousand.
NOTE 15-LONG-TERM INCENTIVE PLAN
As of December 31, 2011, the Company has two stock-based compensation plans, the 2002 Long-Term Incentive Plan (2002 LTIP) and the 1999 Long-Term Incentive Plan (1999 LTIP). The plans are administered by the Compensation Committee of the Board of Directors (the Committee), which selects persons eligible to receive awards and determines the number of shares and/or options subject to each award, the terms, conditions and other provisions of the award. The plans are described in further detail below.
The 2002 Long-Term Incentive Plan was approved by the stockholders of the Company at the 2002 annual meeting and subsequently amended twice by the stockholders of the Company. The first amendment was approved at the 2004 annual meeting to increase the number of shares available for issuance under the 2002 LTIP to 768 thousand shares. The second amendment at the 2008 annual meeting increased the number of shares available for issuance under the 2002 LTIP to 1,518 thousand shares. Eligible participants include eligible employees, officers, consultants and directors of the Company or any affiliate. Pursuant to the 2002 LTIP, the total number of shares of stock authorized for awards was 1,518 thousand, of which not more than 20% may be granted as awards of restricted stock. The exercise price per share of a stock option granted may not be less than the fair market value as of the grant date. The exercise price must be at least 110% of the fair market value at the grant date for options granted to individuals, who at grant date, are 10% owners of the Company’s voting stock (10% owner). Restricted stock may be awarded to participants with terms and conditions determined by the Committee. The term of each award is determined by the Committee, provided that the term of any incentive stock option may not exceed ten years (five years for 10% owners) from its grant date. Each option award vests in approximately equal percentages each year over a period of not less than three years from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 2002 LTIP or as provided in any award agreement.
The Company’s 1999 Long-Term Incentive Plan (1999 LTIP) is limited to eligible employees. The total number of shares of stock authorized for awards was 936 thousand, of which not more than 10% could be granted as awards of restricted stock. Under the terms of the 1999 LTIP, incentive stock options to purchase shares of the Company’s common stock were granted at a price not less than the fair market value of the stock as of the date of the grant. Options were to be exercised within ten years from the date of grant subject to conditions specified by the plan. Restricted stock could also be awarded by the committee in accordance with the 1999 LTIP. Each award vested in approximately equal percentages each year over a period of not less than three years (with the exception of five grants for a total of 168 thousand shares which previously vested in approximately equal percentages at 6 months, 18 months and 30 months) and vest from the date of grant as determined by the committee subject to accelerated vesting under terms of the 1999 LTIP or as provided in any award agreement.
Stock Options
The Company uses the Black-Scholes option pricing model to estimate fair value of stock-based awards, which uses the assumptions indicated in the table below. Expected volatility is based on the implied volatility of the Company’s stock price. The Company uses historical data to estimate option exercise and employee terminations used in the model. The expected term of options granted is derived using the “simplified” method as permitted under the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 and represents the period of time options granted are expected to be outstanding. The risk-free interest 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. The table below provides the weighted average assumptions used to determine the fair value of stock option grants during the years indicated.
There were no stock options exercised during 2011, 2010 or 2009. At December 31, 2011, there was $79 thousand unrecognized compensation expense related to share-based payments, which is expected to be recognized over a weighted average period of 36 months.
The following is a summary of the status of stock options as of December 31, 2011 and changes during the year then ended:
At December 31, 2011, the strike price of all outstanding options exceeded the share price resulting in no intrinsic value.
The Company recorded compensation expense of $9 thousand, $14 thousand and $270 thousand related to stock options for the years ended December 31, 2011, 2010 and 2009, respectively. As of December 31, 2011, shares available for future grants to employees and directors under existing plans were zero shares and 106 thousand shares for the 1999 LTIP and 2002 LTIP, respectively.
Restricted Stock
The plans described above allow for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The unearned stock-based compensation related to these awards is amortized to compensation expense over the period the restrictions lapse. The share-based expense for these awards was determined based on the market price of the Company’s stock at the grant date applied to the total number of shares that were anticipated to fully vest and then amortized over the vesting period.
The Company recognized $3 thousand, $10 thousand and $74 thousand in stock-based compensation for 2011, 2010 and 2009, respectively, net of forfeitures related to restricted stock. As of December 31, 2011, unearned stock-based compensation of $79 thousand was associated with these awards. This cost is expected to be recognized over a weighted-average period of 27 months. The total fair value of shares vested during 2011 and 2010 was $1 thousand and $2 thousand, respectively.
The following table summarizes the restricted stock activity:
The restricted stock awards granted during 2011 vest two-thirds on the second anniversary of the date of grant, and one-third on the third anniversary of the date of grant.
NOTE 16-STOCKHOLDERS’ EQUITY
Common Stock and ESOP Activity
On January 27, 2010, the Company’s Board of Directors elected to suspend the dividend on the Company’s common stock. The Company may not pay dividends on common stock unless all Preferred Stock dividends have been paid.
On September 7, 2010, the Company entered into a Written Agreement with the Federal Reserve Bank of Atlanta. As part of the Written Agreement, the Company is prohibited from declaring or paying dividends without prior written consent from the Federal Reserve. Note 2 provides additional information on the Written Agreement.
On July 22, 2010, the Company filed with the State of Tennessee, Articles of Amendment to the Charter of Incorporation to increase the number of authorized shares of common stock from 50 million to 150 million, in accordance with shareholder approval obtained on June 30, 2010.
On July 23, 2008, the Board of Directors approved a loan, which was subsequently amended on January 28, 2009, in the amount of $12,745 thousand from First Security Group, Inc. to the First Security Group, Inc. 401(k) and Employee Stock Ownership Plan (401(k) and ESOP plan). The purpose of the loan was to purchase Company shares in open market transactions through December 31, 2009. The shares will be used for future Company matching contributions with the 401(k) and ESOP plan. From January 1, 2009 to December 31, 2009, the Company purchased 24,880 shares at an average cost of $41.10. As of December 31, 2009, the cumulative purchases total 70,068 shares at a total cost of $4,056 thousand, or an average of $57.90 per share. No shares were purchased by the 401(k) and ESOP plan during 2010 or 2011.
On September 13, 2011, shareholders approved at the Company’s annual meeting a proposal to amend the Company’s Articles of Incorporation that effected a one-for-ten (1-for-10) reverse stock split of the Company’s common stock. The reverse stock split was effective at the opening of business on September 19, 2011. Any fractional shares resulting from the reverse stock split were eliminated by rounding up to the next whole share. The Company issued 495 additional common shares as a result of eliminating fractional shares. The number of authorized shares of common stock following the reverse stock split remained at 150,000,000 shares. All prior periods have been restated to give retroactive effect to the one-for-ten reverse stock split that took effect on September 19, 2011.
Preferred Stock
On December 29, 2008, the Company filed with the State of Tennessee Articles of Amendment to the Charter of Incorporation to authorize a class of ten million (10,000,000) shares of preferred stock, no par value. The Articles of Amendment were approved by the shareholders of the Company at a shareholders’ meeting held December 18, 2008, pursuant to a proxy statement filed by the Company on November 24, 2008.
On January 9, 2009, as part of the Capital Purchase Program (CPP) administered by the U.S. Department of the Treasury (Treasury), the Company agreed to issue and sell, and the Treasury agreed to purchase (1) 33,000 shares (Preferred Stock) of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share, and (2) an immediately exercisable ten-year warrant to purchase up to 82,363 shares of the Company’s common stock, $0.01 par value, at an exercise price of $60.10 per share, for an aggregate purchase price of $33,000 thousand in cash. As a participant in the CPP, the Company is subject to limitations on the payments of dividends to common stockholders.
The Preferred Stock qualifies as tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Dividends are payable quarterly on February 15, May 15, August 15 and November 15 of each year or the following business day. The Company recognized $1,650 thousand and $1,650 thousand for the Preferred Stock dividend for the years ended December 31, 2011 and 2010, respectively. Since the January 2010 dividend payment date, the Company has deferred the payment of the Preferred Dividend. As of December 31, 2011 and 2010, $3,506 thousand and $1,856 thousand, respectively, was accrued for the Preferred Stock dividends and is included in other liabilities in the Company’s consolidated balance sheet.
The total purchase price of $33,000 thousand was allocated between the Preferred Stock and the warrants based on the respective fair values of each. The warrants are valued at $2,006 thousand. The Preferred Stock original discount was $2,006 thousand. This discount is being accreted over the expected life of the Preferred Stock, or five years, utilizing the effective interest method. For the years ended December 31, 2011 and 2010, the Company recognized $403 thousand and $379 thousand, respectively, in Preferred Stock discount accretion.
As previously reported, William F. Grant, III and Robert R. Lane were elected to the First Security Board of Directors in 2012. Both were elected to the Board of Directors of First Security pursuant to the terms of First Security’s outstanding Series A Preferred Stock. Under the terms of the Series A Preferred Stock, Treasury has the right to appoint up to two directors to First Security’s Board of Directors at any time that dividends payable on the Series A Preferred Stock have not been paid for an aggregate of nine quarterly dividend periods. The terms of the Series A Preferred Stock provide that Treasury will retain the right to appoint such directors at subsequent annual meetings of shareholders until all accrued and unpaid dividends for all past dividend periods have been paid. Members of the Board of Directors elected by Treasury have the same fiduciary duties and obligations to all of the shareholders of First Security as any other member of the Board of Directors.
NOTE 17-MINIMUM REGULATORY CAPITAL REQUIREMENTS
FSGBank and the Company, as regulated institutions, are subject to various regulatory capital requirements administered by the OCC and Federal Reserve, respectively. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of tier 1 capital (as defined) to the average assets (as defined).
The Consent Order, as described in Note 2, requires FSGBank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Order provided 120 days from the effective date of April 28, 2010 to achieve these ratios. Due to the capital requirement within the Order, FSGBank is considered adequately capitalized. As shown below, FSGBank was not in compliance with the capital requirements contained in the order.
The following table provides the regulatory capital ratios as of December 31, 2011 and 2010:
NOTE 18-FAIR VALUE MEASUREMENTS
The authoritative accounting guidance for fair value measurements 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market
for the asset or liability. Authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 and 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The classification of an asset or liability as Level 3 versus Level 2 involves judgment and is based on a variety of subjective factors in order to assess whether a market is inactive, resulting in the application of significant unobservable assumptions to value a financial instrument. A market is considered inactive if significant decreases in the volume and level of activity for the asset or liability have been observed. In determining whether a market is inactive, the Company evaluates such factors as the number of recent transactions in either the primary or secondary markets, whether price quotations are current, the nature of the market participants, the variability of price quotations, the significance of bid/ask spreads, declines in (or the absence of) new issuances and the availability of public information. Inactive markets necessitate the use of additional judgment when valuing financial instruments, such as pricing matrices, cash flow modeling, and the selection of an appropriate discount rate. The assumptions used to estimate the value of an instrument where the market was inactive are based on the Company’s assessment of the assumptions a market participant would use to value the instrument in an orderly transaction and include considerations of illiquidity in the current market environment.
The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 and 2010.
For the three years ended December 31, 2011, the Company did not recognize any realized or unrealized gains or losses on Level 3 fair value assets or liabilities. Additionally, the Company did not purchase or sell any assets into or out of the Level 3 classification. All securities held are historically traded in liquid markets, except for the bonds shown as Level 3 investments as of December 31, 2011. A $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by the Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee. Two investments are pooled trust preferred securities with a book value of $38 thousand. Four municipals that are not rated by credit rating agencies are also shown as Level 3 investments, with a book value of $1,087 thousand. At December 31, 2011, the Company transferred the four municipal bonds into Level 3 due to a lack of comparable sales transactions. The Company did not transfer any assets between the Level 1 and Level 2 classifications.
The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31:
At December 31, 2011, the Company also had assets and liabilities measured at fair value on a non-recurring basis. Items measured at fair value on a non-recurring basis include other real estate owned (OREO), repossessions and collateral-dependent impaired loans. Such measurements were determined utilizing Level 2 and Level 3 inputs.
Upon initial recognition, OREO and repossessions are measured at fair value, which becomes the cost basis. The cost basis is subsequently re-measured at fair value when events or circumstances occur that indicate the initial fair value has declined. The fair value is generally determined using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. Fair value adjustments for OREO and repossessions have generally been classified as Level 3.
The following table presents additional information about changes in assets and liabilities measured at fair value on a recurring basis and for which the Company utilized Level 3 inputs to determine fair value as of December 31, 2011.
The Company recognized a $6 thousand unrealized gain on its pooled trust preferred securities, which are classified as Level 3 fair value assets.
The Company records adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of these loans. Adjustments also include certain impairment amounts for collateral-dependent loans when establishing the allowance for loan and lease losses. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance may be established as a component of the allowance for loan and lease losses or the expense is recognized as a partial charge-off. The fair value of collateral-dependent loans is generally determined using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally available in the marketplace. These measurements have generally been classified as Level 3.
The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis, for which impairment was recognized for the year ended December 31, 2011 and 2010.
The estimated fair values of the Company’s financial instruments are as follows:
The following methods and assumptions were used by the Company in estimating fair value of each class of financial instruments for which it is practicable to estimate that value:
•
Cash and cash equivalents-The carrying value of cash and cash equivalents approximates fair value.
•
Interest bearing deposits in banks-The carrying amounts of interest bearing deposits in banks approximate fair value.
•
Securities-The Company’s securities are valued utilizing Level 2 inputs with the exception of certain bonds valued utilizing Level 3 inputs. Level 2 inputs are based on quoted prices for similar assets in active markets. Pricing matrices and cash flow modeling were used to value the Level 3 securities.
•
Loans held for sale-Fair value for loans held for sale is based on quoted prices for similar assets in active markets.
•
Loans-For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans and other consumer loans are estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans and leases is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit ratings quality. Fair value for impaired loans and leases is estimated using discounted cash flow analysis or underlying collateral values, where applicable.
•
FHLB Stock-FHLB stock is redeemable with the issuer at par and cannot be traded in the market. As such, no significant observable market data for this instrument is available and it is carried at cost.
•
Accrued interest receivable-The carrying value of accrued interest receivable approximates fair value.
•
Deposit liabilities-The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value for fixed-rate certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected maturities on time deposits.
•
Federal funds purchased and securities sold under agreements to repurchase-These borrowings generally mature in 90 days or less and, accordingly, the carrying amount reported in the balance sheet approximates fair value.
•
Accrued interest payable-The carrying value of accrued interest payable approximates fair value.
•
Other borrowings-Other borrowings carrying amount reported in the consolidated balance sheets approximates fair value.
NOTE 19-FAIR VALUE OPTION
Authoritative accounting guidance provides a fair value option election (FVO) that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. The guidance permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The Company records all newly-originated loans held for sale under the fair value option. Origination fees and costs are recognized in earnings at the time of origination. The servicing value is included in the fair value of the loan and recognized at origination of the loan. The Company uses derivatives to hedge changes in servicing value as a result of including the servicing value in the fair value of the loan. The estimated impact from recognizing servicing value, net of related hedging costs, as part of the fair value of the loan is captured in the mortgage loan and related fee component of noninterest income.
As of December 31, 2011 and 2010, there were $2,233 thousand and $2,556 thousand, respectively, in loans held for sale recorded at fair value. For the years ended December 31, 2011 and 2010, approximately $737 thousand and $909 thousand, respectively, in loan origination and related fee income was recognized in noninterest income, and an insignificant amount of origination and related fee expense, respectively, was recognized in noninterest expense utilizing the fair value option.
For the year ended December 31, 2011 and 2010, the Company recognized a loss of $128 thousand and $47 thousand, respectively, due to changes in fair value for loans held-for-sale in which the fair value option was elected. This amount does not reflect the change in fair value attributable to the related hedges the Company used to mitigate the interest rate risk associated with loans held for sale. The changes in the fair value of the hedges were also recorded in the mortgage loan and related fee component of non-interest income, and offset approximately $233 thousand in 2011 and $4 thousand in 2010 of the change in fair value of loans held for sale.
The following table provides the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale for which the fair value option has been elected as of December 31, 2011 and 2010.
NOTE 20-DERIVATIVE FINANCIAL INSTRUMENTS
The Company records all derivative financial instruments at fair value in the financial statements. It is the policy of the Company to enter into various derivatives both as a risk management tool and in a dealer capacity to facilitate client transactions. Derivatives are used as a risk management tool to hedge the exposure to changes in interest rates or other identified market risks. As of December 31, 2011, the Company had not entered into a transaction in a dealer capacity.
When a derivative is intended to be a qualifying hedged instrument, the Company prepares written hedge documentation that designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or (2) a hedge of a forecasted transaction, such as, the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).
The written documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item, and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for management’s assertion that the hedge will be highly effective.
Methodologies related to hedge effectiveness and ineffectiveness include (1) statistical regression analysis of changes in the cash flows of the actual derivative and a perfectly effective hypothetical derivative, (2) statistical regression analysis of changes in fair values of the actual derivative and the hedged item and (3) comparison of the critical terms of the hedged item and the hedging derivative. Changes in fair value of a derivative that is highly effective and that has been designated and qualifies as a fair value hedge are recorded in current period earnings, along with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Changes in the fair value of a derivative that is highly effective and that has been designed and qualifies as a cash flow hedge are initially recorded in other comprehensive income and reclassified to earnings in conjunction with the recognition of the earnings impacts of the hedged item; any ineffective portion is recorded in current period earnings. Designated hedge transactions are reviewed at least quarterly for ongoing effectiveness. Transactions that are no longer deemed to be effective are removed from hedge accounting classification and the recorded impacts of the hedge are recognized in current period income or expense in conjunction with the recognition of the income or expense on the originally hedged item.
The Company’s derivatives are based on underlying risks, primarily interest rates. The Company has utilized cash flow swaps to reduce the risks associated with interest rates. Swaps are contracts in which a series of net cash flows, based on a specific notional amount that is related to an underlying risk, are exchanged over a prescribed period. The Company utilizes forward contacts on the held for sale loan portfolio. The forward contracts hedge against change in fair value of the held for sale loans.
Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk is equal to the fair value gain of the derivative. The credit exposure for swaps is the replacement cost of contracts that have become favorable. Credit risk is minimized by entering into transactions with high quality counterparties that are initially approved by the Board of Directors and reviewed periodically by the Asset Liability Committee. It is the Company’s policy to require that all derivatives be governed by an International Swap and Derivatives Associations Master Agreement (ISDA). Bilateral collateral agreements may also be required.
On August 28, 2007, the Company elected to terminate a series of seven interest rate swaps with a total notional value of $150 million. At termination, the swaps had a market value of $2.0 million. The gain is being accreted into interest income over the remaining expected terms of the hedged variable rate loans. The Company recognized $219 thousand, $394 thousand and $534 thousand in interest income for the years ended December 31, 2011, 2010 and 2009, respectively.
On March 26, 2009, the Company elected to terminate two interest rate swaps with a total notional value of $50 million. At termination, the swaps had a market value of $5.8 million. The Company terminated the swaps to eliminate increasing credit risk with the counterparty. The gain is being accreted into interest income over the
remaining life of the originally hedged items. The Company recognized $1,628 thousand in interest income each for the years ended December 31, 2011 and 2010.
The following table presents the accretion of the remaining gain for the terminated swaps.
The following are the cash flow hedges as of December 31, 2011:
The $881 thousand of gains, net of taxes, recorded in accumulated other comprehensive income as of December 31, 2011 will be reclassified into earnings as interest income over the original life of the respective hedged items.
The following are the cash flow hedges as of December 31, 2010:
The $2,099 thousand of gains, net of taxes, recorded in accumulated other comprehensive income as of December 31, 2010 will be reclassified into earnings as interest income over the original life of the respective hedged items.
For the year ended December 31, 2011 and 2010, no significant amounts were recognized for hedge ineffectiveness.
NOTE 21-COMMITMENTS AND CONTINGENCIES
The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and the issuance of financial guarantees in the form of financial and performance standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as they do for on-balance-sheet instruments.
The Company’s maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at December 31, 2011 and 2010, was as follows:
Commitments to extend credit are agreements to lend to customers. Standby letters of credit are contingent commitments issued by the Company to guarantee performance of a customer to a third party under a contractual non-financial obligation for which it receives a fee. Financial standby letters of credit represent a commitment to guarantee customer repayment of an outstanding loan or debt instrument. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company on extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Additionally, in the ordinary course of business, the Company is subject to regulatory examinations, information gathering requests, inquiries, and investigations. The Company establishes accruals for litigation and regulatory matters when those matters present loss contingencies that the Company determines to be both probable and reasonably estimable. Based on current knowledge, advice of counsel and available insurance coverage, management does not believe that liabilities arising from legal claims, if any, will have a material adverse effect on the Company’s consolidated financial condition, results of operations, or cash flows. However, in light of the significant uncertainties involved in these matters, the early stage of various legal proceedings, and the indeterminate amount of damages sought in some of these matters, it is possible that the ultimate resolution of these matters, if unfavorable, could be material to the Company’s results of operations for any particular period.
The Company intends to vigorously pursue all available defenses to these claims. There are significant uncertainties involved in any litigation. Although the ultimate outcome of these lawsuits cannot be ascertained at this time, based upon information that presently is available to it, management is unable to predict the outcome of these cases and cannot determine the probability of an adverse result or reasonably estimate a range of potential loss, if any. In addition, management is unable to estimate a range of reasonably possible losses with respect to these claims.
As of December 31, 2009, the Company was a defendant in an arbitration claim, in which Lloyd L. Montgomery, III, the Company’s former President and Chief Operating Officer, claimed that the Company wrongfully terminated his employment. On January 19, 2010, the Company settled the $2,300 thousand arbitration claim for $500 thousand. The settlement is reflected in non-interest expense and other liabilities on the Company’s financial statements as of and for the year ended December 31, 2009.
NOTE 22-OTHER ASSETS AND OTHER LIABILITIES
Other assets and other liabilities consist of the following:
NOTE 23-SUPPLEMENTAL FINANCIAL DATA
Components of other noninterest income or other noninterest expense in excess of 1% of the aggregate of total interest income and noninterest income are shown in the following table.
Amounts less than 1% of the aggregate of total interest income plus noninterest income for each year shown are represented by a hyphen and included in “All Other Items” for the applicable year.
NOTE 24-CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to First Security Group, Inc. is as follows:
CONDENSED BALANCE SHEET
CONDENSED STATEMENT OF OPERATIONS
CONDENSED STATEMENT OF CASH FLOWS
NOTE 25-RELATED PARTY TRANSACTIONS
From January 1, 2010 to June 30, 2010 and the years ended December 31, 2009 and 2008, the Company was party to an agreement with Alpha Antiques, whose sole proprietor, Judy Holley, is the spouse of Rodger Holley, the Company’s former Chairman and Chief Executive Officer. Under the agreement, Alpha Antiques provided design and procurement services relating to the design and construction of the Bank’s branches and the management of OREO properties, for which it paid $23 thousand in 2010, $40 thousand in 2009 and $40 thousand in 2008. During 2009 and the first half of 2010, the use of a Company car was provided to assist in managing the increased OREO properties.
During 2010 and 2009, the Company entered into certain sale transactions with Ray Marler, a former director of the Company. The Company sold repossessed assets to companies owned by Mr. Marler. Gross proceeds to the Company during 2010 totaled $67 thousand. During 2009, companies owned by Mr. Marler purchased repossessed assets through a dealer. The proceeds for the 2009 purchases totaled $20 thousand. The Company also utilized Mr. Marler’s companies for certain services associated with other real estate owned. Payments for these services totaled $6 thousand and $7 thousand for the years ended December 31, 2010 and 2009, respectively.
In connection with the acquisition of Premier National Bank of Dalton in 2003, the Bank assumed a lease with First Plaza, L.L.C. J.C. Harold Anders, a former director of the Company through March 25, 2010, is a 14.3% owner of First Plaza. As a result of the agreement, the Bank leases property located at 715 S Thornton Avenue, Dalton, Georgia 30721. The Bank owns a full service branch facility located on this property. From January 1, 2010 through March 25, 2010, the Company recognized $13 thousand of lease expense. The Company recognized lease expense of $54 thousand and $51 thousand for 2009 and 2008, respectively.
Additionally, the Company has entered into loan transactions with certain directors, executive officers and significant stockholders and their affiliates.
NOTE 26-QUARTERLY SUMMARIZED FINANCIAL INFORMATION (UNAUDITED)
The sum of the 2011 and 2010 quarterly net loss per share (basic and diluted) differs from the annual net loss per share (basic and diluted) because of the differences in the weighted average number of common shares outstanding and the common shares used in the quarterly and annual computations as well as differences in rounding.
NOTE 27-BANK-OWNED LIFE INSURANCE
The Company’s Board of Directors approved the purchase of bank-owned life insurance (BOLI) on January 26, 2005. The Company is the owner and beneficiary of these life insurance contracts. The Company invested a total of $17,250 thousand in nine bank-owned life insurance policies during the first half of 2005. In conjunction with the acquisitions of First State Bank and Jackson Bank, the Company assumed $362 thousand and $3,348 thousand, respectively, in bank-owned life insurance. The Company’s investment in bank-owned life insurance is as follows:
The cash surrender value of these policies is reported in other assets in the Company’s consolidated balance sheets. The Company reports income and expenses from the policies as other income and other expense, respectively, in the consolidated statements of operations and expenses. The income is not subject to tax and the expenses are not deductible for tax.
NOTE 28-CONCENTRATIONS OF CREDIT RISK
The Company offers a variety of loan products with payment terms and rate structures that have been designed to meet the needs of its customers within an established framework of acceptable credit risk. Payment terms range from fully amortizing loans that require periodic principal and interest payments to terms that require periodic payments of interest-only with principal due at maturity. Interest-only loans are a typical characteristic in commercial and home equity lines-of-credit and construction loans (residential and commercial). At December 31, 2011, the Company had approximately $279,459 thousand of interest-only loans, which primarily consist of construction and land development real estate loans (23%), commercial and industrial loans (18%) and home equity loans (29%). The loans have an average maturity of approximately eighteen months or less, with the exception of home equity lines-of-credit which have an average maturity of approximately six and a half years. The interest only loans are properly underwritten loans and are within the Company’s lending policies.
The Company has branch locations in Dalton, Georgia where the local economy is generally dependent upon the carpet industry. The Company’s loan portfolio within the Dalton market totals $64,619 thousand.
At December 31, 2011 and 2010, the Company did not offer, hold or service option adjustable rate mortgages that may expose the borrowers to future increases in repayments in excess of changes resulting solely from increases in the market rate of interest (loans subject to negative amortization).
NOTE 29-SUBSEQUENT EVENTS
As previously reported on Form 8-K filed February 7, 2012 and on Form 8-K filed on March 28, 2012, Mr. Robert R. Lane and Mr. William Grant, respectively, were elected to the First Security Group, Inc. (“First Security”) Board of Directors. Mr. Lane and Mr. Grant were elected to the Board of Directors of First Security pursuant to the terms of First Security’s outstanding Series A Fixed Rate Perpetual Preferred Stock (“Series A Preferred Stock”) issued to the United States Department of Treasury (“Treasury”) on January 9, 2009 in connection with First Security’s participation in the TARP Capital Purchase Program. Under the terms of the Series A Preferred Stock, Treasury has the right to appoint up to two directors to First Security’s Board of Directors at any time that dividends payable on the Series A Preferred Stock have not been paid for an aggregate of nine quarterly dividend periods. The terms of the Series A Preferred Stock provide that Treasury will retain the right to appoint such directors at subsequent annual meetings of shareholders until all accrued and unpaid dividends for all past dividend periods have been paid. Members of the Board of Directors elected by Treasury have the same fiduciary duties and obligations to all of the shareholders of First Security as any other member of the Board of Directors. Mr. Lane and Mr. Grant were also elected to the Board of Directors for FSGBank, N.A., subject to regulatory non-objection.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
As reported on Current Form 8-K filed with the Securities and Exchange Commission on July 14, 2011, First Security dismissed Joseph Decosimo and Company, PLLC as its independent registered public accounting firm and engaged Crowe Horwath LLP as its new independent registered public accounting firm for its 2011 fiscal year.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Our CEO and CFO have concluded that our Disclosure Controls were effective at a reasonable assurance level as of December 31, 2011.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are executed in accordance with appropriate management authorization and accounting records are reliable for the preparation of financial statements in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. Management based this assessment on criteria for effective internal control over financial reporting described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.
Based on this assessment, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2011.
Crowe Horwath LLP, an independent registered public accounting firm, has audited the effectiveness of the Company’s internal controls over financial reporting as stated in their report which is included herein.
Changes in Internal Controls
There have been no changes in our internal controls over financial reporting during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
As previously disclosed in First Security’s 2010 Annual Report on Form 10-K, management identified a material weakness in the Company’s entity level controls and therefore concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2010. As previously reported, the 2010 material weakness did not result in any audit adjustments to the 2010 annual consolidated financial statements.
During 2011, various changes occurred that materially affected our control environment and remediated the material weakness in entity level controls. Our remediation efforts included changes and additions to executive and senior management, additions to our Board of Directors, revisions to policies and additional training and education for our employees and Directors.
Collectively, the changes established effective entity level controls, including maintaining of an effective control environment. As disclosed above, management has concluded, and First Security’s independent auditors have concurred, that First Security maintained effective internal control over financial reporting as of December 31, 2011.
Item 9B.
Item 9B. Other Information
Amendment to Triumph Investment Managers Engagement Agreement
Following the successful completion of the previously reported management restructuring of First Security, First Security, FSGBank and Triumph Investment Managers, LLC (“Triumph”) have entered into an Amendment dated March 28, 2012 (the “Amendment”) to the Engagement Agreement dated April 28, 2011 among First Security, FSGBank and Triumph (the “Engagement Agreement”), a copy of which was filed as Exhibit 10.1 to First Security’s Current Report on Form 8-K on May 4, 2011.
The provisions of the Amendment are summarized below. All other provisions of the Engagement Agreement remain in full force and effect, and references to the “Agreement” refer to the Engagement Agreement, as amended by the Amendment. Defined terms used herein have the meanings ascribed to them in the Agreement.
Compensation. The Amendment provides that commencing as of February 1, 2012, Triumph will receive a $10,000 monthly retainer. Triumph is also entitled to reimbursement for up to $3,000 per month in reasonable expenses incurred, subject to a maximum of $72,000 for the term of the Agreement, which expires on April 28, 2013.
The Amendment further provides that upon the achievement of certain Strategic Milestones identified in the Agreement, including FSGBank’s compliance with the capital requirements set forth in its regulatory consent order, First Security will pay Triumph a Success Payment consisting of cash and warrants exercisable for shares of First Security common stock. The Success Payment will vary depending on whether and the extent to which First Security or FSGBank pays an investment banking commission in a sale of Securities prior to achieving the Strategic Milestones. Depending on the relative proportion of any capital raised for which such a commission is paid, the Success Payment will be equal to either: (i) $1.25 million in cash and warrants exercisable for 1.5% of the then-outstanding shares of First Security common stock; (ii) $1.0 million in cash and warrants, or (iii) $750,000 and warrants exercisable for 1.0% of the then-outstanding shares of First Security common stock. Consistent with the terms of the Engagement Agreement, the number of outstanding shares of First Security common stock will be calculated on a fully diluted basis and the exercise price will be equal to the lesser
of: (i) the average closing price of the common stock for the 10 trading days immediately preceding the issuance of the warrants or (ii) the lowest common stock equivalent price at which First Security issued, during the 30 days immediately preceding the issuance of the warrants, Securities constituting 5% or more of its common stock equivalents outstanding immediately prior to the issuance of such Securities. Additional terms of the warrants are described in the Amendment and also remain unchanged from those set forth in the Engagement Agreement.
If First Security enters into an Alternative Transaction (as defined below) before the Strategic Milestones are achieved, then it will pay Triumph $500,000 in cash at the closing of the Alternative Transaction in lieu of any other Success Payment provided for in the Agreement. An “Alternative Transaction” is either: (i) a sale of substantially all of the common stock of First Security or FSGBank; (ii) a sale of substantially all of First Security’s assets; or (iii) a transaction in which any person or entity becomes a beneficial owner of securities of First Security or the Bank representing 25% or more of the votes that may be cast in the election of directors of the applicable issuer.
Board Representation. The Amendment provides that current director, Robert P. Keller, who is also a managing director of Triumph, will continue to be nominated to serve on the boards of each of First Security and FSGBank and will be entitled to receive the same board fees and other compensation that other directors receive.
Termination. The Amendment restates the termination provisions of the Agreement and clarifies certain provisions relating to the payment of fees depending on the basis for termination. Specifically, if Triumph terminates the Agreement for Good Reason or First Security or FSGBank terminates it without Cause, then Triumph will be entitled to the Success Payment if the Strategic Milestones are met or an Alternative Transaction is consummated within 12 months following termination of the Agreement If Triumph terminates the Agreement without Good Reason or First Security or FSGBank terminates it with Cause, then Triumph will not be entitled to any fees beyond those earned at the time of termination.
NASDAQ Market Value Compliance
On March 28, 2012, First Security received a notice from the NASDAQ Stock Market (“NASDAQ”) that its stock had not maintained a minimum Market Value of Publicly Held Shares (“MVPHS”) of $5,000,000 for 30 consecutive business days and was therefore not in compliance with NASDAQ Marketplace Rule 5450(b)(1)(C) (the “MVPHS Rule”). The notification has no immediate effect on the listing or trading of the Company’s stock on NASDAQ.
In accordance with Marketplace Rule 5810(c)(3)(D), First Security may regain compliance with the MVPHS rule if its MVPHS closes at or above $5,000,000 for ten consecutive days by September 24, 2012. In the event First Security does not regain compliance with the MVPHS Rule prior to the expiration of the grace period, it will receive written notification from NASDAQ that its securities are subject to delisting from the NASDAQ Global Select Market. At that time, First Security may be permitted to transfer its common stock to NASDAQ Capital Market if its common stock otherwise satisfies all applicable criteria for listing.
First Security will actively monitor the MVPHS of its stock and will consider available options to resolve the deficiency and regain compliance with the NASDAQ requirements. First Security intends to maintain its listing on NASDAQ.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
We have adopted a Code of Business Conduct and Ethics (the “Code”) that applies to all of our directors, officers and employees. We believe the Code is reasonably designed to deter wrongdoing and to promote honest and ethical conduct, including: the ethical handling of conflicts of interest; full, fair and accurate disclosure in filings and other public communications made by us; compliance with applicable laws; prompt internal reporting of violations of the Code; and accountability for adherence to the Code. We have posted a copy of our Code on our website at www.FSGBank.com.
The information required in Part III, Item 10 is incorporated by reference to the registrant’s definitive proxy statement for the 2012 annual meeting of the shareholders.
Item 11.
Item 11. Executive Compensation
The information required in Part III, Item 11 is incorporated by reference to the registrant’s definitive proxy statement for the 2012 annual meeting of the shareholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information regarding our equity compensation plans under which shares of our common stock are authorized for issuance. The only equity compensation plans maintained by us are the First Security Group, Inc. Second Amended and Restated 1999 Long-Term Incentive Plan and the First Security Group, Inc. 2002 Long-Term Incentive Plan, as amended. All data is presented as of December 31, 2011.
The remaining information for this Item is incorporated by reference to the registrant’s definitive proxy statement for the 2012 annual meeting of the shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required in Part III, Item 13 is incorporated by reference to the registrant’s definitive proxy statement for the 2012 annual meeting of the shareholders.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required in Part III, Item 14 is incorporated by reference to the registrant’s definitive proxy statement for the 2012 annual meeting of the shareholders.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
(1)
The list of all financial statements is included at Item 8.
(2)
The financial statement schedules are either included in the financial statements or are not applicable.
(3)
Exhibits Required by Item 601. The following exhibits are attached hereto or incorporated by reference herein (numbered to correspond to Item 601(a) of Regulation S-K, as promulgated by the Securities and Exchange Commission):
Incorporated by reference to First Security’s Quarterly Report on Form 10-Q for the period ended June 30, 2010.
Incorporated by reference to First Security’s Registration Statement on Form S-1 dated April 20, 2001, File No. 333-59338.
Incorporated by reference to the Exhibit 4.1 to the Current Report on Form 8-K filed January 9, 2009.
Incorporated by reference to the Exhibit 4.2 to the Current Report on Form 8-K filed January 9, 2009.
Incorporated by reference from Appendix A to First Security’s Proxy Statement filed April 30, 2007.
Incorporated by reference to First Security’s Annual Report on Form 10-K for the year ended December 31, 2004.
Incorporated by reference to the Exhibit 10.7 to First Security’s Annual Report on Form 10-K for the year ended December 31, 2010.
Incorporated by reference to First Security’s Quarterly Report on Form 10-Q for the period ended June 30, 2003.
Incorporated by reference to First Security’s Annual Report on Form 10-K for the year ended December 31, 2005.
Incorporated by reference to the Exhibit 10.1 to the Current Report on Form 8-K filed December 1, 2010.
Incorporated by reference to First Security’s Annual Report on Form 10-K for the year ended December 31, 2008.
Incorporated by reference to the Exhibit 10.3 to the Current Report on Form 8-K filed January 9, 2009.
Incorporated by reference to the Exhibit 10.1 to the Current Report on Form 8-K filed January 9, 2009.
Incorporated by reference to First Security’s Annual Report on Form 10-K for the year ended December 31, 2009.
Incorporated by reference to the Exhibit 10.1 to the Current Report on Form 8-K filed April 29, 2010.
Incorporated by reference to the Exhibit 10.2 to the Current Report on Form 8-K filed April 29, 2010.
Incorporated by reference to the Exhibit 10.1 to the Current Report on Form 8-K filed September 14, 2010.
Incorporated by Reference to First Security’s Annual Report on Form 10-K for the year ended December 31, 2003.
Incorporated by Reference to the Exhibit 10.1 to the Current Report on Form 8-K filed April 27, 2011.
Incorporated by Reference to the Exhibit 10.2 to the Current Report on Form 8-K filed April 27, 2011.
Incorporated by Reference to the Exhibit 10.1 to the Current Report on Form 8-K filed April 29, 2011.
Incorporated by Reference to the Exhibit 10.1 to the Current Report on Form 8-K filed December 29, 2011.
* The indicated exhibit is a compensatory plan required to be filed as an exhibit to this Form 10-K.
(b) The Exhibits not incorporated by reference herein are submitted as a separate part of this report.
(c) The financial statement schedules are either included in the financial statements or are not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DATE: March 30, 2012
Pursuant to the requirements of the Securities and Exchange Act of 1934, the report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 30, 2012.
Signature
Title
/S/ D. MICHAEL KRAMER
D. Michael Kramer
(Principal Executive Officer)
Chief Executive Officer,
President and Director
/S/ JOHN R. HADDOCK
John R. Haddock
(Principal Financial and Accounting Officer)
Chief Financial Officer,
Executive Vice President and Secretary
William F. Grant, III
Director
/S/ WILLIAM C. HALL
William C. Hall
Director
/S/ CAROL H. JACKSON
Carol H. Jackson
Director
/S/ ROBERT P. KELLER
Robert P. Keller
Director
/S/ RALPH L. KENDALL
Ralph L. Kendall
Director
/S/ KELLY P. KIRKLAND
Kelly P. Kirkland
Director
/S/ ROBERT R. LANE
Robert R. Lane
Director