Item 1. Business
General
Reliance Bancshares, Inc. (the “Company” or “Reliance”) is a multi-bank holding company that was incorporated in Missouri on July 24, 1998. The Company organized its first subsidiary commercial bank, Reliance Bank, in Missouri, which secured insurance from the Federal Deposit Insurance Corporation (“FDIC”) and began conducting business on April 16, 1999 in Des Peres, Missouri with full depository and loan capabilities. The Company organized an additional subsidiary, Reliance Bank, FSB in Fort Myers, Florida as a federal savings bank after operating as a loan production office of Reliance Bank since 2004. The Company applied for and received a federal charter from the Office of Thrift Supervision (the “OTS”), secured insurance from the FDIC and began conducting business on January 17, 2006. The Company’s two subsidiaries, Reliance Bank and Reliance Bank, FSB, are sometimes referred to as the “Banks.” Unless otherwise indicated, references to the “Company” shall be intended to be references to Reliance Bancshares, Inc. and its subsidiaries.
On April 27, 2007, the Company filed its Form 10 registration statement with the Securities and Exchange Commission (the “SEC”) pursuant to Section 12(g) of the Securities Exchange Act of 1934, as amended. The effective date of the registration statement was June 26, 2007.
The Company’s headquarters and executive offices are located at 10401 Clayton Road, Frontenac, Missouri, 63131, (314) 569-7200.
Available Information
All of the Company’s reports required to be filed by Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, will be available or accessible free of charge, including copies of our future Annual Reports on Form 10-K, future Quarterly Reports on Form 10-Q, future Current Reports on Form 8-K, future Proxy Statements, and any amendments to those reports at our website with the address “www.reliancebancshares.com”. All reports will be made available as soon as reasonably practicable after they are filed with or furnished to the SEC. You may also request any materials we file with the SEC from the SEC’s Public Reference Room at 100 F. Street, NE, Washington, D.C., 20549, or by calling (800) SEC-0330. In addition, our filings with the SEC are electronically available via the SEC’s website at http://www.sec.gov.
For general information about Reliance Bank and Reliance Bank, FSB, please visit our current websites at www.reliancebankstl.com and www.reliancebankfsb.com, respectively.
Recent Developments
The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. Pursuant to EESA, the United States Treasury Department (the “Treasury”) has the authority to among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to its authority under EESA, the Treasury created the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) under which the Treasury was authorized to invest in non-voting, senior preferred stock of U.S. banks and savings associations or their holding companies.
The Treasury has invested in the Company through the EESA and CPP. On February 13, 2009, the Company issued 40,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series A for a total of $40,000,000, and 2,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series B for no additional funds, to the Treasury in connection with the Company’s participation in the CPP. The funds received by the Company are included in the financial data or calculations for this filing.
The Series A preferred stock accrues a dividend at the rate of 5% per annum for the first five years and 9% thereafter. Dividends are payable quarterly and each share has a liquidation amount of $1,000 and has liquidation rights in pari passu with other preferred stock, which is paid in liquidation prior to Company’s common stock. The Series B preferred stock accrues a dividend at the rate of 9% per annum, payable quarterly, and includes other provisions similar to the Series A preferred stock with liquidation at $1,000 per share. On February 11, 2011, the Company announced that it was suspending dividends on its Series A and Series B preferred stock effective immediately in order to positively manage capital.
The American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted on February 17, 2009. Among other things, ARRA sets forth additional limits on executive compensation at all financial institutions receiving federal funds under any program, including the CPP, both retroactively and prospectively. The executive compensation restrictions in ARRA, which will be further described in rules and regulations to be established, include among others: limits on compensation incentives, prohibitions on “golden parachute payments”, the establishment by publicly registered CPP recipients of a board compensation committee comprised entirely of independent directors for the purpose of reviewing employee compensation plans, and the requirement of a non-binding vote on executive pay packages at each annual shareholder meeting until the government funds are repaid. The full impact of the ARRA is not yet certain because additional regulatory action is required.
On November 10, 2009, the Company authorized 25,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series C for sale with an offering price of $1,000 per share. The offering was extended to existing shareholders who are accredited investors (as such term is defined in Regulation D of the Securities Act of 1933, as amended) and to other accredited investors to subscribe for and purchase shares of this series. At December 31, 2010, the Company had subscriptions and payments totaling $555,000 for the purchase of 555 shares. The Series C preferred stock accrues a dividend at the rate of 7% per annum, payable quarterly and includes a liquidation preference of $1,000 per share. On February 11, 2011, the Company announced that it was suspending dividends on its Series C preferred stock effective immediately in order to positively manage capital.
Regulatory Agreements
The Company and the Banks have entered into a certain Agreement and memoranda of understanding (“MOU”) with regulatory authorities as listed below. The Agreement and MOUs are informal administrative agreements pursuant to which the Company and the Banks have agreed to take various actions and comply with certain requirements to facilitate improvement in financial condition.
On November 30, 2009, Reliance Bank’s Board of Directors entered into an Agreement with the Missouri Division of Finance and the Federal Deposit Insurance Corporation (“FDIC”) to, among other things, (a) develop a plan to reduce the level of risk in each criticized asset aggregating $2,000,000 or more included in the September 21, 2009 Missouri Division of Finance examination report; (b) maintain the reserve for possible loan losses at a level which is reasonable in relation to the degree of risk inherent in the Bank’s loan portfolio; (c) develop and adopt policies and procedures designed to identify and monitor concentrations of credit, including out-of-territory loans and loan participations purchased; (d) formulate plans to reduce the Bank’s concentrations of credit, particularly in commercial real estate and land acquisition and development lending; (e) review and revise the Bank’s formal loan policy to address weaknesses noted in the September 21, 2009 Missouri Division of Finance examination report; (f) cease making or extending any loans which might violate the Bank’s written loan policy, except in those instances in which the Board of Directors has made a prior determination that a variance from loan policy is in the best interests of the Bank, with such Board decisions appropriately documented in the minutes of the Board of Director meetings; (g) develop a formal written profit plan, which will provide a three-year budget projection for asset growth and dividend payouts to ensure Tier 1 leverage capital is maintained at least a 7% level; and (h) maintain a Tier 1 leverage capital ratio of at least 7%, and other capital ratios such that the Bank will remain well-capitalized, and not
pay any dividends, management fees or bonuses, or increase any executive salary or other compensation that would reduce the Bank to a level below a well-capitalized status.
On February 10, 2010, Reliance Bank, FSB’s Board of Directors entered into a MOU with the OTS to, among other things, (a) develop a business plan for the years ending December 31, 2010, 2011, and 2012 which shall include (1) strategies to preserve and enhance the Bank’s capital sufficient to meet its needs and support its risk profile; (2) achieve core profitability by the end of 2010; and (3) establish and maintain Board-approved loan concentration limits expressed as a percentage of risk-based capital that takes into account the Bank’s current capital position, local and regional market conditions, and the credit risks posed by higher risk loans; (b) continue to take steps to identify, classify, and properly account for problem assets, including but not limited to (1) conducting periodic asset quality reviews to identify and assign appropriate classifications to all problem assets; (2) performing analyses on all impaired assets identified by the review required by subparagraph (b)(1) above; and (3) estimating potential losses in identified problem assets, while establishing an appropriate reserve for loan losses for all classified assets; (c) develop a detailed, written plan with specific strategies, targets, and timeframes to reduce the Bank’s level of criticized assets; (d) review the adequacy of the Bank’s reserve for loan losses policies, procedures and methodologies on at least an annual basis to ensure the timely establishment and maintenance of an adequate reserve for loan losses account balance; (e) identify and monitor all loan modifications and troubled debt restructurings, with delinquent loans that are modified being classified as substandard and placed on nonaccrual status for at least six months; (f) prohibit the increase in the dollar amount of brokered deposits; (g) analyze the major differences in and bases for significant differences in the value of assets, liabilities, and off-balance-sheet positions calculated by the OTS Net Portfolio Value and the Bank’s internal economic value of equity model; and (h) correct all deficiencies and weaknesses identified in the October 5, 2009 OTS report of examination.
On March 16, 2010, the Company entered into a MOU with the Federal Reserve Bank of St. Louis (“Federal Reserve”) requiring the Company to, among other things, (a) utilize its financial and managerial resources to assist the Banks in addressing weaknesses identified during their most recent regulatory examinations, and achieving/maintaining compliance with any supervisory action between the Banks and their primary regulators; (b) declare no corporate dividends without the prior written approval of the Federal Reserve; (c) incur no additional debt without the prior written approval of the Federal Reserve; and (d) make no distributions of interest or other sums on its preferred stock without the prior written approval of the Federal Reserve.
On February 14, 2011, Reliance Bank’s Board of Directors entered into a Consent Order (the Consent Order) with the FDIC to (a) develop a written management plan to have and retain qualified management; (b) charge off adversely classified assets identified during the FDIC’s September 20, 2010 examination of Reliance Bank; (c) develop a written plan to reduce Reliance Bank’s risk exposure in each asset in excess of $2,000,000 classified as substandard or doubtful in the FDIC’s Report of Examination for its September 20, 2010 examination; (d) not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit or obligation with Reliance Bank that has been, in whole or in part, charged off or adversely classified as substandard or doubtful in the FDIC’s Report of Examination, unless the denial of additional credit would be detrimental to Reliance Bank, as determined by the Bank’s Board of Directors; (e) develop a written plan for systematically reducing and monitoring the Bank’s concentrations of credit as listed in the FDIC’s Report of Examination, to an amount that is commensurate with Reliance Bank’s business strategy, management expertise, size, and location; (f) review and maintain an adequate reserve for loan losses on a quarterly basis; (g) maintain minimum capital ratios of an 8% Tier 1 leverage capital ratio and 12% Total risk-based capital ratio; (h) not increase salaries or pay bonuses for any executive officer, pay management fees, or declare or pay any dividends; (i) review the liquidity, contingent funding, and interest rate risk policies and plans and develop or amend such policies and plans to address how the Bank will increase its liquid assets and reduce its reliance on volatile liabilities for liquidity purposes; (j) not accept, increase, renew, or rollover any brokered deposits; (k) develop a written three-year business/strategic plan and one-year profit and budget plan; (l) eliminate and/or correct any violations of laws, rules, and regulations identified in the FDIC’s Report of Examination; and (m) provide periodic progress reports on the above matters to the FDIC.
The Agreement, MOUs and Consent Order will remain in effect until modified or terminated by the applicable regulatory authority. We do not expect the actions called for by the Agreement and MOUs to change our business strategy in any material respect, although they may have the effect of limiting or
delaying our ability or plans to expand. Management has taken various actions to comply with the Agreement, MOUs and Consent Order and will diligently endeavor to take all actions necessary for compliance.
Market Area and Approach to Geographic Expansion
Reliance Bank
In the greater St. Louis Metropolitan Statistical Area, (“MSA”), which includes St. Louis bordering counties in Illinois, Reliance Bank has facilities in twenty locations. Reliance Bank strategically chose to locate these branches within six to seven miles of each other so as not to over-saturate any one municipality or area. Still, in any given area, customers are within a few miles of local branches. When choosing branch locations, we have also focused on areas that we believe have high growth potential, a high concentration of closely-held businesses and a large number of professionals and executives. Typically, a high growth potential location consists of both commercial and residential development, which provides us with potential commercial and individual customers.
Reliance Bank, FSB
The current primary market area of Reliance Bank, FSB is Lee County on the southwest coast of Florida. Reliance Bank, FSB has a total of three locations, and is headquartered in Fort Myers, Florida.
Reliance Bank, FSB’s original strategy was to expand in Lee County and Collier County, in southwest Florida, as these areas have experienced high growth rates in recent years. However, with the unprecedented downturn in the economy, specifically in the Southwest Florida real estate market, Reliance Bank, FSB has amended its strategy and did not establish any new branches while the economy is recovering. Reliance Bank, FSB plans to work within the community to build stronger customer relationships, deposit growth and loan production.
Competition
The Company and its subsidiaries operate in highly competitive markets. We face substantial competition in all phases of operations from a variety of different competitors in the St. Louis and Fort Myers markets, including: (i) large national and super-regional financial institutions that have well-established branches and significant market share in the communities we serve; (ii) finance companies, investment banking and brokerage firms, and insurance companies that offer bank-like products; (iii) credit unions, which can offer highly competitive rates on loans and deposits as they receive tax advantages not available to commercial or community banks; (iv) other commercial or community banks, including start-up banks, that can compete with us for customers who desire a high degree of personal service; (v) national and super-regional banks offering mortgage loan application services; (vi) both local and out-of-state trust companies and trust service offices; and (vii) multi-bank holding companies with substantial capital resources and lending capacity.
Many of the larger banks have established specialized units, which target private businesses and high net worth individuals. Also, the St. Louis market has recently experienced an increase in de novo (i.e., new start-up) banks that have opened within the past five years.
Reliance Bank and Reliance Bank, FSB have both grown rapidly with aggressive branching in both markets. Because of the Company’s continued use of earnings for this expansion, we have not historically issued dividends on common stock and do not anticipate doing so in the foreseeable future. We have also recently suspended the dividends on our outstanding classes of preferred stock. The Company has incurred significant expenses due to its aggressive organic growth plan. This increased expense has negatively impacted our short term earnings per share. Both Reliance Bank and Reliance Bank, FSB are comfortable with the amount of branches they have established in both areas and therefore, did not expand in 2010.
Supervision and Regulation
We are subject to various state, federal and self-regulatory organization banking laws, regulations and policies in place to protect customers and, to some extent, shareholders, which impose specific requirements and restrictions on our operations. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company and its subsidiaries.
The following is a summary of significant regulations:
The Holding Company
Bank Holding Company Act of 1956: The Company is a multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). As such, we are subject to regulation and examination by the Federal Reserve Board and are required to file periodic reports of our operations and such additional information as the Federal Reserve may require. Financial holding companies must be well managed and well capitalized pursuant to the standards set by the Federal Reserve and have at least a “satisfactory” rating under the Community Reinvestment Act.
Under the BHCA, bank holding companies are generally required to obtain the prior approval of the Federal Reserve before (i) acquiring substantially all the assets of any bank, (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares), or (iii) merging or consolidating with another bank holding company.
Gramm-Leach Bliley Act of 1999: The Gramm-Leach-Bliley Act of 1999 (“GLBA”) eliminates many of the restrictions placed on the activities of certain qualified financial or bank holding companies. The GLBA also restricts the Company and the Banks from sharing certain customer personal information with non-affiliated third parties and requires disclosure of the policies and practices regarding such data sharing.
Source of Strength; Cross-Guarantee: Federal Reserve policy requires that we commit resources to support our subsidiaries and in implementing this policy, the Federal Reserve takes the position that it may require us to provide financial support when we otherwise would not consider it necessary to do so.
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002 (“SOX”) generally applies to all publicly-held companies and was enacted to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws promulgated by the SEC. SOX requires, among other things, (i) certification of financial statements by the Chief Executive Officer and the Chief Financial Officer and (ii) adoption of procedures designed to ensure the adequacy of the internal controls and financial reporting processes of public companies. Companies with securities listed on national securities exchanges must also comply with strict corporate governance requirements.
Reliance Bank
Because Reliance Bank is not a member of the Federal Reserve System, the Missouri Division of Finance and the FDIC are its primary regulators. Between these two regulatory authorities, all areas of the Bank’s operations are monitored or regulated, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuance of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. In addition, Reliance Bank must maintain certain capital ratios and is subject to limitations on total investments in real estate, bank premises, and furniture and fixtures.
Transactions with Affiliates and Insiders: Regulation W, promulgated by the Federal Reserve, imposes regulations on certain transactions with affiliates, including the amount of loans and extensions of credit to affiliates, investments in affiliates and the amount of advances to third parties collateralized by the securities
or obligations of affiliates. Regulation W also requires, among other things, that Reliance Bank transact business with affiliates on terms substantially the same, or at least as favorable to Reliance Bank, as those prevailing at the time for comparable transactions with non-affiliates.
Community Reinvestment Act: The Community Reinvestment Act (the “CRA”) requires that the Company and its subsidiaries take certain steps to meet the credit needs of varying income level households in their local communities. The Company’s record of meeting such needs is considered by the FDIC when evaluating mergers and acquisitions and applications to open a branch or facility. Both Reliance Bank and Reliance Bank, FSB have satisfactory ratings under the CRA.
Check 21: The Check Clearing for the 21st Century Act (“Check 21”) is designed to foster innovation in the payments system and to enhance its efficiency by reducing some of the legal impediments to check clearing. The law facilitates check clearing by creating a new negotiable instrument called a substitute check, which permits banks to clear original checks, to process check information electronically, and to deliver substitute checks to banks that want to continue receiving paper checks. A substitute check is the legal equivalent of the original check and includes all the information contained on the original check. The law does not require banks to accept checks in electronic form nor does it require banks to use the new authority granted by Check 21 to create substitute checks.
USA Patriot Act: The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) requires financial institutions to take certain steps to protect against money laundering, such as establishing anti-money laundering programs and maintaining controls with respect to private and foreign banking matters.
Limitations on Loans and Transactions: The Federal Reserve Act generally imposes certain limitations on extensions of credit and other transactions by and between banks that are members of the Federal Reserve and other affiliates (which includes any holding company of which a bank is a subsidiary and any other non-bank subsidiary of such holding company). Banks that are not members of the Federal Reserve are also subject to these limitations. Further, federal law prohibits a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or the furnishing of services.
Other Regulations: Interest and certain other charges collected or contracted for by the Bank are subject to state usury laws and certain federal laws concerning interest rates. The Bank’s loan operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers; the 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; the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; the Fair Credit Reporting Act of 1978 governing information given to credit reporting agencies; the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies; the Soldiers’ and Sailors Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying obligations of, persons in military service; and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations of the Banks are also subject to the 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, and the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs 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.
Deposit Insurance: The Bank is FDIC-insured, and is therefore required to pay deposit insurance premium assessments to the FDIC.
Pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “FDIRA”) in 2006, the previously separate deposit insurance funds for banks and savings associations were merged into a single deposit insurance fund administered by the FDIC. The Bank’s deposits are insured up to applicable limitations by that deposit insurance fund.
Following the adoption of the FDIRA, the FDIC has the opportunity, through its rulemaking authority, to better price deposit insurance for risk than was previously authorized. The FDIC adopted regulations that create a system of risk-based assessments. Under the regulations, there are four risk categories, and each insured institution is assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with the highest regulatory composite ratings are placed in Risk Category I, while other institutions are placed in Risk Categories II, III or IV depending on their capital levels and composite ratings. Currently, Reliance Bank, FSB is ranked as Risk Category I and Reliance Bank is ranked as Risk Category II. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC, which currently is 1.25% of insured deposits. The FDIC may set the reserve ratio annually at between 1.15% and 1.50% of insured deposits. Deposit insurance assessments will be collected for a quarter, at the end of the next quarter. Assessments are based on deposit balances at the end of the quarter, except for institutions with $1 billion or more in assets, such as the Bank, and any institution that becomes insured on or after January 1, 2007 which will have their assessment base determined using average daily balances of insured deposits.
As of September 30, 2008, the reserve ratio of the deposit insurance fund fell to 0.76%. On October 7, 2008, the FDIC established a restoration plan to restore the reserve ratio to at least 1.15% within five years (effective February 27, 2009 the FDIC extended this time to seven years) and proposed rules increasing the assessment rate for deposit insurance and making adjustments to the assessment system. On December 16, 2008, the FDIC adopted and issued a final rule increasing the rates banks pay for deposit insurance uniformly by 7 basis points (annualized) effective January 1, 2009. Under the final rule, risk-based rates for the first quarter 2009 assessment will range between 12 and 50 basis points (annualized). The 2009 first quarter assessment rates established by the FDIC provide that the highest rated institutions, those in Risk Category I, will pay premiums of between 12 and 14 basis points and the lowest rated institutions, those in Risk Category IV, will pay premiums of 50 basis points. On February 27, 2009, the FDIC adopted a final rule amending the way that the assessment system differentiates for risk and setting new assessment rates beginning with the second quarter of 2009. Beginning April 1, 2009, for the highest rated institutions, those in Risk Category I, the initial base assessment rate will be between 12 and 16 basis points and for the lowest rated institutions, those in Risk Category IV, the initial base assessment rate will be 45 basis points. The final rule modifies the means to determine a Risk Category I institution’s initial base assessment rate. It also provides for the following adjustments to an institution’s assessment rate: (1) a decrease for long-term unsecured debt, including most senior and subordinated debt and, for small institutions, a portion of Tier 1 capital; (2) an increase for secured liabilities above a threshold amount; and (3) for institutions in risk categories other than Risk Category I, an increase for brokered deposits above a threshold amount. After applying these adjustments, for the highest rated institutions, those in Risk Category I, the total base assessment rate was between 7 and 24 basis points and for the lowest rated institutions, those in Risk Category IV, the total base assessment rate was between 40 and 77.5 basis points.
On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each institution’s assets minus Tier 1 capital as of June 30, 2009, which was collected on September 30, 2009. The amount of the special assessment for any institution was not to exceed 10 basis points times the institution’s assessment base for the second quarter.
On November 12, 2009, the FDIC adopted a final rule amending the assessment regulations to require institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012, on December 30, 2009. The prepayment for the fourth quarter of 2009 and all of 2010 was determined by multiplying the total base assessment rate that the institution paid for the third quarter of 2009 by the corresponding prepaid assessment base for each quarter. The prepayment for 2011 and 2012 was determined by multiplying the prepaid assessment rate plus 75 basis points times the corresponding prepaid assessment base for each quarter. For each quarter of the prepayment period, an institution’s prepaid assessment base was calculated by increasing its third quarter 2009 assessment base at an annual rate of 5 percent.
On November 21, 2008, the FDIC adopted final regulations implementing the Temporary Liquidity Guarantee Program (“TLGP”) pursuant to which depository institutions could elect to participate. Pursuant to the TLGP, the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30,
2009 (the “Debt Guarantee”), and (ii) provide full FDIC deposit insurance coverage for non-interest bearing deposit transaction accounts regardless of dollar amount for an additional fee assessment by the FDIC (the “Transaction Account Guarantee”). These accounts are mainly payment-processing accounts, such as business payroll accounts. The Transaction Account Guarantee expired on June 30, 2010. Participating institutions were assessed a 10 basis point surcharge on the portion of eligible accounts that exceeds the general limit on deposit insurance coverage. Reliance Bank and Reliance Bank, FSB elected to participate in this Program.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution (i) has engaged or is engaging in unsafe or unsound practices, (ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance, if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of Reliance Bank.
Beginning with the second quarter of 2011, as mandated by the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the assessment base that the FDIC will use to calculate assessment premiums will be a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger thatn the deposit base, the range of assessment rates will change to a low of 2.5 basis points through a high of 45 basis points, per $100 of assets; however, the dollar amount of total actual premiums is expected to be roughly the same.
The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. Those new formulas begin in the second quarter of 2011, but do not affect the Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0% and has announced that any reimbursements from the fund are indefinitely suspended.
Reliance Bank, FSB
Reliance Bank, FSB is a federally chartered thrift, and as such, is regulated by the same agencies as its affiliate, Reliance Bank. The principal difference is that the FSB’s primary regulator is the OTS in lieu of the Missouri Division of Finance. As such, all of the above mentioned federal regulations apply to Reliance Bank, FSB. Additionally, under OTS regulations, Reliance Bank, FSB must maintain its standing as a “qualified thrift lender.” To maintain this status, it is required to comply with restrictions and limitations imposed by OTS regulations on the percentage of its loan portfolio that may be invested in different types of loans; specifically, Reliance Bank, FSB must maintain at least 65% of its loan portfolio in “qualified thrift investments,” which are essentially residential real estate loans. There are a wide variety of loans that qualify for this purpose.
Recent Legislation Affecting the Financial Services Industry
The Dodd-Frank Act, which became law in July 2010, significantly changes regulation of financial institutions and the financial services industry, including: creating a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation; centralizing responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws; permanently raising the current standard maximum deposit insurance amount to $250,000; establishing strengthened capital standards for banks, and disallowing certain trust preferred securities from qualifying as Tier 1 capital (subject to certain grandfather provisions for trust preferred securities); establishing new minimum mortgage underwriting standards; granting the Federal Reserve Board the power to regulate debit card interchange fees; and implementing corporate governance changes. Many aspects of the Dodd-Frank
Act are subject to rulemaking that will take effect over several years, thus making it difficult to assess the impact of the statute on the financial industry, including the Company, at this time.
It is difficult to predict at this time the specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. 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 presently 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.
Employees
As of December 31, 2010, we had approximately 212 full-time equivalent employees. None of the Company’s employees are covered by a collective bargaining agreement. Management believes that its relationship with its employees is good.
Item 1A.
Item 1A. Risk Factors
An investment in shares of our Common Stock involves various risks. Before deciding to invest in our Common Stock, you should carefully consider the risks described below in conjunction with the other information in this Annual Report. Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks identified throughout this Annual Report, or by other risks that have not been identified or that we may believe are immaterial or unlikely. The value or market price of our Common Stock could decline due to any of these risks, 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.
The current economic environment poses challenges for us and could adversely affect our financial condition and results of operations.
We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. The capital and credit markets have been experiencing volatility and disruption for more than 36 months. The volatility and disruption we have experienced are ongoing. The risks associated with our business become more acute in periods of a slowing economy or slow growth. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. We retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.
Our loan portfolio includes commercial real estate loans, residential mortgage loans, and construction and land development loans. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. In addition, a deepening of the national economic recession or further deterioration in local economic conditions in our markets could drive losses beyond that which is provided for in our reserve for loan losses and result in the following other consequences: increases in loan delinquencies, problem assets and foreclosures may increase; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.
The impact of recent and future legislation may affect our business.
Congress and the Treasury Department have recently adopted legislation and taken actions to address the disruptions in the financial system and declines in the housing market. It is not clear at this time what impact EESA, TARP, ARRA, other liquidity and funding initiatives of the Treasury and other bank regulatory agencies that have been previously announced, and any additional programs that may be initiated in the future, will have on the financial markets and the financial services industry. The actual impact that EESA and such related measures undertaken to alleviate the credit crisis will have generally on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced, is unknown. The failure of such measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock. Finally, there can be no assurance regarding the specific impact that such measures may have on us.
In addition to the legislation mentioned above, federal and state governments could pass additional legislation responsive to current credit conditions. As an example, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for several years. In recent months, the volatility and disruption have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, our ability to access capital may be adversely affected which, in turn, could adversely affect our business, financial condition and results of operations.
Additional increases in insurance premiums could affect our earnings.
The FDIC insures the Bank’s deposits up to certain limits. The FDIC charges us premiums to maintain the Deposit Insurance Fund. Current economic conditions have increased the deposit premiums as a result of bank failures. The FDIC takes control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC has designated the Deposit Insurance Fund long -term target reserve ratio at 1.25 percent of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15 percent, the statutory minimum.
The FDIC expects a higher ratio of insured institution failures in the next few years, which may result in a continued decline in the reserve ratio. As discussed above, the FDIC has developed a restoration plan that uniformly increases assessments by 7 basis points (annualized) effective January 1, 2009. Effective April 1, 2009, the plan also has made changes to the deposit insurance assessment system requiring riskier institutions to pay a larger share. Even though we fully paid FDIC deposit insurance for the year 2009, as well as prepaying for the years 2010, 2011, and 2012, there is no guarantee the FDIC will not implement further increases during these three years, even though prepaid. If these assessments increase significantly it could adversely affect our earnings.
A future reduction in liquidity in the banking system could increase our costs.
The Federal Reserve Bank has been providing vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Company or reducing the availability of funds to the Company to finance its existing operations.
Difficult market conditions have adversely affected our industry.
We are particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past two years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and securities and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional financial institutions. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets have adversely affected our business, financial condition and results of operations. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
Our business is impacted by the local economies in which we operate.
Because the majority of our borrowers and depositors are individuals and businesses located and doing business in the St. Louis and Fort Myers metropolitan areas, our success depends to a significant extent upon economic conditions in the St. Louis and Fort Myers metropolitan areas. Adverse economic conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorder, terrorism, weather-related conditions and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the St. Louis or Fort Myers metropolitan areas could adversely affect the value of our assets, revenues, results of operations and financial condition. Our loan production offices (“LPOs”) in Phoenix and Houston could also be impacted by local economies in regards to loan production and growth. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
If the value of real estate in the St. Louis and Fort Myers metropolitan areas were to continue to decline materially, a significant portion of our loan portfolio would become under-collateralized, which could have a material adverse effect on us.
With most of our loans concentrated in the St. Louis and Fort Myers metropolitan areas at this time, a continued decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans. A continued decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, the subsequent decrease in asset quality could require additions to our reserve for possible loan losses through increased provisions for loan losses, which would hurt our profits. Also, a further decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters. A negative development in any of these factors could adversely affect our results of operations and financial condition.
Our reserve for possible loan losses may be insufficient to absorb losses in our loan portfolio.
Like most financial institutions, we maintain a reserve for possible loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our reserve for possible loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding
balance sheet date. However, our reserve for possible loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.
In evaluating the adequacy of our reserve for possible loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.
At December 31, 2010, our reserve for possible loan losses as a percentage of total loans was 3.84%. Federal and state regulators, as an integral part of their examination process, periodically review our reserve for possible loan losses and may require us to increase our reserve for possible loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our reserve for possible loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
Fluctuations in interest rates could reduce our profitability and affect the value of our assets.
Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., the prime commercial rate) may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected. In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, origination volume and overall profitability.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be adversely affected. Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.
We are dependent upon the services of our management team.
Our future success and profitability is substantially dependent upon the management and banking abilities of our executive management team. We believe that our future results will also depend in part upon our attracting and retaining highly skilled and qualified senior and middle management. We are especially dependent on a limited number of key management personnel, none of whom has an employment agreement with us, except for our Chairman, our Chief Executive Officer and our Executive Vice President. The loss of the Chairman, the Chief Executive Officer, Executive Vice President or other senior executive officers could have a material adverse impact on our operations because other officers may not have the experience and expertise to readily replace these individuals. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting or retaining such personnel. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.
Our failure to recruit and retain qualified lenders could adversely affect our ability to compete successfully and affect our profitability.
Our success and future growth depend heavily on our ability to attract and retain highly skilled and motivated lenders and other banking professionals. We compete against many institutions with greater financial resources both within our industry and in other industries to attract these qualified individuals. Our failure to recruit and retain adequate talent could reduce our ability to compete successfully and could adversely affect our business and profitability.
Competition from financial institutions and other financial service providers may adversely affect our growth and profitability.
The banking business is highly competitive and we experience competition in each of our markets 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 mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. Many of our competitors are larger financial institutions. While we believe we successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, smaller resources and smaller lending limits, lack of geographic diversification and inability to spread our marketing costs across a broader market. In recent years, several new financial institutions have been established in the St. Louis and Fort Myers metropolitan areas. These new financial institutions have and are expected to continue to price their loans and deposits aggressively in order to attract customers. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will be successful.
We may have fewer resources than many of our competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business.
Security breaches in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business. Additionally, we outsource our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations.
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the Federal Reserve, OTS, the Missouri Division of Finance, its chartering authorities, and by the FDIC, as insurer of our deposits. Such regulation and supervision govern the activities in which we may engage, and are intended primarily for the protection of the insurance fund and for the depositors and borrowers of the Banks. The regulation and supervision by the Federal Reserve, OTS, the Missouri Division of Finance and the FDIC are not intended to protect the interests of investors in our Common Stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our reserve for possible loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. As an example, the GLBA eliminates many of the restrictions placed on the activities of certain qualified financial or bank holding companies. We will incur additional expenses as a publicly reporting company as a result of compliance costs associated with the SEC’s public reporting requirements. In addition, SOX and the related rules and regulations promulgated by the SEC that are now applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices, including the costs of completing our audits and maintaining our internal controls.
Our controls and procedures may fail or be circumvented.
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
We are subject to credit risk.
When we loan money, commit to loan money or enter into a letter of credit or other contract with a counterparty, we incur credit risk, or the risk of losses if our borrowers do not repay their loans or our counterparties fail to perform according to the terms of their contracts. A number of our products expose us to credit risk, including loans and lending commitments, and assets held for sale. The credit quality of our portfolio can have a significant impact on our earnings. We estimate and establish reserves for credit risks and credit losses inherent in our credit exposure (including unfunded credit commitments). This process, which is critical to our financial results and condition, requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans. As is the case with any such assessments, there is always the chance that we will fail to identify the proper factors or that we will fail to accurately estimate the impacts of factors that we identify.
Changes in interest rates could adversely affect profitability.
The Company may be unable to manage interest rate risk that could reduce its net interest income. Like other financial institutions, the Company’s results of operations are affected principally by net interest income, which is the difference between interest earned on loans and investments and interest expense paid on deposits and other borrowings. The Company cannot predict or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve, affect interest income and interest expense. While the Company continually takes measures intended to manage the risks from changes in market interest rates, changes in interest rates can still have a material adverse effect on the Company’s profitability. For example, upward fluctuations in interest rates in the credit market may force the Company to either pay higher rates on its deposits or risk losing such deposits to other investments. At the same time, the Company may have loaned funds to customers at long-term fixed rates and thus would not be able to correspondingly increase its interest income. Conversely, during periods of decreasing interest rates, customers with higher rate long term fixed rate loans may seek to refinance their loans, thereby decreasing the Company’s interest income.
ITEM 1b.
ITEM 1b. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our executive offices are located at 10401 Clayton Road, Frontenac, Missouri, 63131. As of December 31, 2010, the Company’s subsidiary, Reliance Bank, had a total of twenty banking locations in Missouri and Illinois. Reliance Bank owns nineteen of the bank branch buildings, as well as the underlying real property on fourteen of them. One branch operates in a leased building, and the remaining five branch buildings, although owned, are subject to ground leases that expire between 2015 and 2026 and include one or more renewal options.
As of December 31, 2010, the Company’s subsidiary, Reliance Bank, FSB, had three locations in Florida. Reliance Bank, FSB leases one of these locations, and owns the other two.
As of December 31, 2010, the Company’s subsidiary, Reliance Loan Center in Phoenix, Arizona had one leased location.
As of December 31, 2010, the Company’s subsidiary, Reliance Loan Center in Houston, Texas had one leased location.
Item 3.
Item 3. Legal Proceedings
The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes that there are no such proceedings pending or threatened against the Company or its subsidiaries which, if determined adversely, would have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company or any of its subsidiaries.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant’s common equity, related stockholder matters and issuer purchases of equity securities
The Class A Common Stock of the Company, par value $0.25 (the “Common Stock”), is not registered under the Securities Act of 1933, as amended, however is registered under Section 12(g) of the Securities Exchange Act of 1934, as amended. The Common Stock is quoted on the Over-the-Counter Bulletin Board under the symbol “RLBS,” but the Company is unaware as to any transactions involving its Common Stock other than occasional trades and private transactions between shareholders and third parties.
The high and low price per share paid for the Common Stock as determined by reference to offering prices of the Common Stock during the previous two fiscal years are reflected in the following table:
As of March 18, 2011 there were approximately 747 holders of our Common Stock.
Dividends
The Company has never paid any cash dividends and has no current intention to pay dividends on common in the immediate future.
The following Stock Performance Graph and related information should not be deemed “soliciting material” or to be “filed” with the SEC nor shall such performance be incorporated by reference into any future filings under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
The following graph compares the Company’s cumulative stockholder return on its common stock from June 26, 2007 through December 31, 2010, the measurement period. The graph compares the Company’s common stock with the NASDAQ Composite and the SNL $1B-$5B Bank Index. The graph assumes an investment of $100.00 in the Company’s common stock and each index on June 26, 2007 and reinvestment of all quarterly dividends. The investment is measured as of the fiscal year end. While there are no assurances, the Company believes that this trend will reverse as the economy improves.
Stock Performance Graph
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2010, regarding securities issued and to be issued under our equity compensation plans that were in effect during the year ended December 31, 2010:
Recent Sales of Unregistered Equity Securities
The Company sold 1,400,517 shares of the Company’s common stock at the offering price of $3.00 per share at various times during the year ended 2010. This represented an aggregate offering price of $4,201,551. This offering was extended to accredited investors (as such term is defined in Regulation D under the Securities Act of 1933, as amended), and was intended to qualify for exemption from registration pursuant to Rule 506 of Regulation D.
In addition, at various times during 2010 the Company sold 250 shares of our Series C Preferred Stock for an aggregate consideration of $250,000.00. These shares were not registered and were sold in reliance upon the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.
Item 6.
Item 6. selected financial data
The following consolidated selected financial data is derived from the Company’s audited financial statements as of and for the five years ended December 31, 2010. This information should be read in connection with our audited consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report.
Item 7.
Item 7.
Management’s discussion and analysis of financial condition and results of operations
The following presents management’s discussion and analysis of the consolidated financial condition and results of operations of Reliance Bancshares, Inc. (the “Company”) for each of the years in the three-year period ended December 31, 2010. This discussion and analysis is intended to review the significant factors affecting the financial condition and results of operations of the Company, and provides a more comprehensive review which is not otherwise apparent from the consolidated financial statements alone. This discussion should be read in conjunction with “Selected Financial Data,” the Company’s consolidated financial statements and the notes thereto and other financial data appearing elsewhere herein.
The Company has prepared all of the consolidated financial information in this report in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. No assurances can be given that actual results will not differ from those estimates.
Overview
The Company provides a full range of banking services to individual and corporate customers throughout the St. Louis metropolitan area in Missouri and Illinois and southwestern Florida through the 23 locations of its wholly owned subsidiaries, Reliance Bank and Reliance Bank, FSB (hereinafter referred to as the “Banks”). Since its opening in 1999 through December 31, 2010, Reliance Bank has established a total of 20 branch locations in the St. Louis metropolitan area of Missouri and Illinois and Loan Production Offices (“LPOs”) in Houston, Texas and Phoenix, Arizona, and has total assets, loans and deposits of $1.2 billion, $920 million, and $1 billion, respectively, at December 31, 2010.
On January 17, 2006, the Company opened a new Federal Savings Bank, Reliance Bank, FSB, in Ft. Myers, Florida. Since its opening in 2006 through December 31, 2010, Reliance Bank, FSB has established three branch locations in southwestern Florida and has total assets, loans, and deposits of $85.3 million, $50.1 million, and $76.5 million, respectively, at December 31, 2010.
The St. Louis metropolitan, southwestern Florida, Houston and Phoenix markets in which the Company’s banking subsidiaries operate are highly competitive in the financial services area. The Banks are subject to competition from other financial and nonfinancial institutions providing financial products throughout these markets.
Executive Summary of Results of Operations and Financial Condition
The Company’s consolidated net loss for the years ended December 31, 2010, 2009, and 2008 totaled $48,528,489, $29,357,361, and $319,230, respectively. The December 31, 2010 loss includes a $26.1 million charge to establish a valuation allowance for deferred tax assets (see Results of Operations for detail discussion). The Company’s financial results were driven largely by stresses related to the commercial real estate sector in the Florida and St. Louis metropolitan markets.
Provision and Asset Quality
Credit costs continued to weigh heavily on 2010 earnings, as the Company recorded $41.5 million in provision for loan losses, largely related to asset quality deterioration in the Company’s land development, construction and commercial real estate portfolios. Provision for loan losses for 2009 was $53.5 million. The Company experienced an increase in non-performing loans due to the current economic environment. Non-performing loans as of December 31, 2010 totaled $171.1 million, compared with $72.1 million as of December 31, 2009. Net charge-offs during 2010 and 2009 were $36.4 million and $35.5, respectively.
Management remains focused on improving credit quality and as a result of continued economic strains has implemented rigorous problem credit action plans. During 2010, the Company has added personnel to address asset quality issues and dispose of non-performing assets.
Improved Net Interest Margin
2010 net interest margin grew by 7.8% over the same period in 2009, driven by a 39.4% drop in 2010 interest expense compared to 2009. The composition of the Company’s funding sources has shifted to lower cost transaction and savings accounts and away from higher cost time deposits. For the year ended December 31, 2010, average balances of transaction and savings accounts increased to 48.4% of total funding sources in 2010 as compared to 35.5% during 2009. Also, for the year ended December 31, 2010, average balances of time deposits decreased to 42.3% of total funding sources in 2010 as compared to 53.5% during the same period in 2009.
These increases in lower cost deposits helped reduce the Company’s cost of funds to 1.96% from 2.93% for the year ended December 31, 2010 and 2009, respectively. Management has placed increased focus on growing low cost core transaction deposits, by concentrating on overall customer deposit relationships, allowing for a reduction in total deposit pricing and increased customer retention.
Following are certain percentages generally followed in the banking industry:
Critical Accounting Policies
The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they are likely to change over time or prove to be different than actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations are discussed throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to our Consolidated Financial Statements for the years ended December 31, 2010, 2009, and 2008 included elsewhere herein.
Reserve for Possible Loan Losses
Subject to the use of estimates, assumptions, and judgments, management’s evaluation process used to determine the adequacy of the reserve for possible loan losses combines several factors: management’s ongoing review of the loan portfolio; consideration of past loan loss experience; trends in past due and nonperforming loans; risk characteristics of the various classifications of loans, existing economic conditions; the fair value of underlying collateral; input from regulators; and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the reserve, could change significantly. In addition, as an integral part of their examination process, various
regulatory agencies also review the reserve for possible loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examinations, or may have particular views of the level of loan loss reserve. The Company believes the reserve for possible loan losses is adequate and properly recorded in the consolidated financial statements.
Deferred Tax Assets
The Company recognizes deferred tax assets and liabilities for the estimated future tax effects of temporary differences, net operating loss carryforwards and tax credits. Deferred tax assets are recognized subject to management’s judgment based upon available evidence that realization is more likely than not. In the event that management determines the Company would not be able to realize all or part of net deferred tax assets in the future, deferred tax assets are reduced by a deferred tax asset valuation allowance, which results from a direct charge to income tax expense in the period that such determination is made. Likewise, the Company would reverse the valuation allowance when realization of the deferred tax asset is expected and decrease income tax expense, accordingly.
Results of Operations for the Three-Year Period Ended December 31, 2010
Net Interest Income
The Company’s net interest income increased by $2,924,853 (7.78%) to $40,509,237 for the year ended December 31, 2010 from the $37,584,384 earned for the year ended December 31, 2009, which was an increase of $1,090,445 (2.99%) from the $36,493,939 earned in 2008. The Company’s net interest margin for the years ended December 31, 2010, 2009, and 2008 was 3.08%, 2.55%, and 2.88%, respectively. The increase in margin percentage from 2009 is primarily attributed to lower cost of funds on the Company’s retail deposit products with a shift in funding composition toward lower cost deposit products. The Company’s average rate on interest-bearing liabilities for the years ended December 31, 2010 and 2009 were 1.96% and 2.93%, respectively. These gains were partially offset by a decrease in yield on loans due to an increase in non-performing loans. The Company’s average yield on loans for the years ended December 31, 2010 and 2009 were 5.33% and 5.57%, respectively.
Average earning assets for 2010 decreased $163,703,339 (10.95%) to $1,330,650,715 from the level of $1,494,354,054 for 2009. Average earning assets for 2009 increased $203,514,070 (15.77%) from the level of $1,290,839,984 for 2008. A significant portion of the decline from 2009 can be attributed to the decrease in outstanding loan balances. Total average loans declined $147,794,178 (12.17%) in 2010 to $1,066,142,431 from the level of $1,213,936,609 for 2009, which was an increase of $98,720,183 (8.85%) from the level of $1,115,216,426 for 2008. The depressed economy has reduced the Company’s opportunities for loan growth in its current markets and a redirection away from commercial real estate, which, in the near term, will reduce loan balances.
Total average investment securities for 2010 decreased $14,205,751 (5.59%) to $239,910,442 from the level of $254,116,193 for 2009, which was a decrease of $85,827,133 (51.00%) from the level of $168,289,060 for 2008. The Company uses its investment portfolio to (a) provide support for borrowing arrangements for securities sold under repurchase agreements, (b) provide support for pledging purposes for deposits of governmental and municipal deposits over FDIC insurance limits, (c) provide a secondary source of liquidity through “laddered” maturities of such securities, and (d) provide increased interest income over that which would be earned on overnight/daily fund investments. The total carrying value of securities pledged to secure public funds and repurchase agreements was approximately $150,544,000, $160,923,000, and $180,767,000 at December 31, 2010, 2009, and 2008, respectively. The Banks have also pledged letters of credit from the Federal Home Loan Banks totaling $9,118,574 as additional collateral to secure public funds at December 31, 2010.
Average short-term investments can fluctuate significantly from day to day based on a number of factors, including, but not limited to, the collected balances of customer deposits, loan demand and investment security maturities. Excess funds not invested in loans or investment securities are invested in overnight funds with various unaffiliated financial institutions. The average balances of such short-term investments for the years ended December 31, 2010, 2009, and 2008 were $24,597,842, $26,301,252, and $7,334,498 respectively.
A key factor in increasing the Company’s net interest margin is to maintain a higher percentage of earning assets in the loan category, which is the Company’s highest earning asset category. However, average loans as a percentage of average earning assets were 80.12% for 2010, which was a 111 basis point decrease under the 81.23% percentage achieved in 2009, which was a 516 basis point decrease under the 86.39% percentage achieved in 2008. This decline resulted from the depressed economic environment in the Banks’ market areas, resulting in fewer lending opportunities for the Banks. The average loan balances include nonperforming loans, which do not add any interest and reduce the overall loan yields disclosed. Total nonperforming loans at December 31, 2010, 2009, and 2008 were $171,089,003, $72,077,434, and $34,896,410, respectively.
Total average interest-bearing deposits for 2010 decreased $87,644,019 (7.45%) to $1,089,127,193 from the level of $1,176,771,212 for 2009, which was an increase of $226,232,142 (23.80%) from the level of $950,539,070 for 2008. As discussed in the following paragraphs, while the overall balance has declined, the mix of deposit balances has moved away from the higher cost time deposits to savings and transaction accounts. With the decline in loan demand and low rates available on investments, the Banks have not needed as much in deposits.
The Company’s short-term borrowings consist of overnight funds borrowed from unaffiliated financial institutions and securities sold under sweep repurchase agreements with larger deposit customers and a short term note payable obtained in 2008 by the Company in the amount of $7,000,000, and repaid in 2009. The average balances of such borrowings for the years ended December 31, 2010, 2009, and 2008 totaled $19,701,175, $22,476,551, and $88,748,506, respectively. Short-term borrowings can fluctuate significantly based on short-term liquidity needs and changes in deposit volumes.
The Company has used longer-term advances from the Federal Home Loan Banks to match with longer-term fixed rate assets. During the three-year period ended December 31, 2010, average longer-term borrowings were $98,296,595, $131,038,979, and $125,117,708, for 2010, 2009, and 2008, respectively.
The overall mix of the Company’s funding sources has a significant impact on the Company’s net interest margin. Following is a summary of the percentage of the various components of average interest-bearing liabilities and noninterest-bearing deposits to the total of all average interest-bearing liabilities and noninterest-bearing deposits (hereinafter described as total funding sources):
The overall level of interest rates will also cause fluctuations between categories. The Company has sought to increase the percentage of its noninterest-bearing deposits to total funding sources and increase its percentage of lower cost savings and interest-bearing transaction accounts. Through deposit campaigns, the Company increased its percentage of average savings accounts to 25.40% of total average funding sources for the year ended December 31, 2010, compared to 18.88% and 4.30% for the years ended December 31, 2009 and 2008, respectively. Also, average interest-bearing transaction accounts increased to 18.01% of total average funding sources for the year ended December 31, 2010, from 12.11% and 13.29% for the years ended December 31, 2009 and 2008, respectively. This shift in deposits was also helped by an extremely low interest rate environment, in which customers are less willing to roll over maturing certificates of deposit to longer term instruments at the present low rates.
The increases in lower cost deposits, coupled with maturities of higher rate certificates of deposit, helped reduce the rates paid on total interest-bearing liabilities. Average rates on interest bearing liabilities were 1.96%, 2.93%, and 3.58% for the years ended December 31, 2010, 2009 and 2008, respectively. Given the low rate of interest rates for all deposits, customers are more willing to maintain their accounts in lower-yielding savings accounts, with the expectation that rates will eventually increase, rather than locking up their funds in lower-yielding time deposits for any length of time.
The Company was also able to reduce the percentage of longer-term advances and higher cost certificates of deposit. Average balances for time deposits were 42.28%, 53.52%, and 60.28% for the years ended December 31, 2010, 2009 and 2008, respectively. Certificates of deposit have a lagging effect with interest rate changes, as most certificates of deposit have longer maturities at fixed rates. Depositors are also less likely to lock into the current low interest rates for an extended period of time with certificates of deposit.
Management has placed increased focus on growing lower-cost core transaction deposits by concentrating on overall customer deposit relationships, allowing for a reduction in total deposit pricing and increased customer retention.
The following tables show the condensed average balance sheets for the periods reported and the percentage of each principal category of assets, liabilities and stockholders’ equity to total assets. Also shown is the average yield on each category of interest-earning assets and the average rate paid on each category of interest-bearing liabilities for each of the periods reported.
(1)
Interest includes loan fees, recorded as discussed in Note 1 to the Company’s consolidated financial statements.
(2)
Average balances include nonaccrual loans. The income on such loans is included in interest, but is recognized only upon receipt.
(3)
Interest yields are presented on a tax-equivalent basis. Nontaxable income has been adjusted upward by the amount of Federal income tax that would have been paid if the income had been taxed at a rate of 34%, adjusted downward by the disallowance of the interest cost to carry nontaxable loans and securities.
The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in volume and changes in yield/rates:
(1)
Change in volume multiplied by yield/rate of prior year.
(2)
Change in yield/rate multiplied by volume of prior year.
NOTE:
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Provision for Possible Loan Losses
The provision for possible loan losses charged to earnings for the years ended December 31, 2010, 2009, and 2008 totaled $41,491,947, $53,450,000, and $11,148,000, respectively. During this same time period, the Company incurred net charge-offs of $36,412,441 in 2010, $35,534,253 in 2009, and $6,527,189 in 2008. At December 31, 2010, 2009, and 2008, the reserve for possible loan losses as a percentage of net outstanding loans was 3.84, 2.83%, and 1.14%, respectively. The reserve for possible loan losses as a percentage of nonperforming loans (comprised of loans for which the accrual of interest has been discontinued and loans still accruing interest that were 90 days delinquent) was 21.80%, 44.70%, and 41.00% at December 31, 2010, 2009, and 2008, respectively. The continued significant decline of the real estate market has resulted in an increase in the level of non-performing loans and a required higher provision for loan losses during 2010. Even though problem loans have increased in 2010, the majority of the increase has been loans originated outside the Florida market and loss exposure outside of Florida has been much less severe for Reliance. See further discussion regarding the Company’s credit risk management in the section below entitled “Risk Management.”
Noninterest Income
Total noninterest income for the year ended December 31, 2010 excluding security sale gains and losses, increased $640,602 (24.84%) to $3,219,119 from the $2,578,517 earned for the year ended December 31, 2009, which had increased $217,095 (9.19%) over the $2,361,422 earned for the year ended December 31, 2008. The Company recognized a gain during 2010 of $244,369 on the sale of approximately $4.0 million of loans guaranteed by the Small Business Administration. Other real estate income increased $368,964 (172.44%) to $582,934 from the $213,970 earned for the year ended December 31, 2009, as the increased level of properties owned provided more rental income opportunities.
The Company recorded net security sale gains of $287,509 in 2010, compared with net security sale gains of $1,346,565 and $321,113 in 2009 and 2008, respectively. From time to time, the Company will sell certain of its available-for-sale investment securities for short-term liquidity purposes or longer-term asset/liability management reasons. See further discussion below in the section entitled “Liquidity and Rate Sensitivity Management.”
Noninterest Expense
Noninterest expense increased $5,694,345 (16.73%) for the year ended December 31, 2010 to $39,740,734 from the $34,046,389 incurred for the year ended December 31, 2009, which was a $4,618,799 (15.70%) increase over the $29,427,590 of noninterest expenses incurred for the year ended December 31, 2008. Savings achieved by the Company’s cost reduction efforts were more than offset by the increase in costs of other real estate owned and insurance assessments from the FDIC.
Total personnel costs decreased $265,808 (1.92%) in 2010 to $13,601,820 from the $13,867,628 of personnel costs incurred in 2009, which was a decrease of $2,047,462 (12.86%) from the $15,915,090 of personnel costs incurred in 2008. During 2009, the Company implemented a plan to reduce operating costs, which included a reduction in staffing levels, and a reduction in certain benefits.
Other real estate expense increased significantly in 2010 to $13,147,525, which was an increase of $6,984,212 (113.32%) over the $6,163,313 of other real estate expenses incurred in 2009, which had increased by $4,580,715 (289.44%) from the $1,582,598 incurred in 2008. Approximately $3.4 million of the 2010 expense amount relates to the transfer of four parcels of land from land and construction in process to other real estate owned, with the balance written down to their appraised values. The parcels were originally purchased for future expansion; however, the Company determined that it would not be constructing branches on those sites in the foreseeable future. Total other real estate owned net losses and write-downs for 2010 were $10,902,221, as the continued decline in the real estate markets has necessitated such write-downs.
Total occupancy and equipment expenses decreased $41,531 (0.98%) to $4,215,238 in 2010 from the $4,256,769 incurred in 2009, which had decreased $246,356 (5.47%) from the $4,503,125 incurred in 2008. Certain assets became fully depreciated and a temporary facility was closed in 2009, which reduced the Company’s depreciation expense charged to this category.
The Company’s FDIC assessment has increased significantly during the three year period ended December 31, 2010. This assessment increased $114,217 (4.16%) in 2010 to $2,859,649, from the $2,745,432 paid in 2009, which was an increase of $1,833,339 (201.00%) from the $912,093 paid in 2008. During 2009, the FDIC imposed a special assessment, which was levied on all banks, varying based on size, to replenish the FDIC’s insurance fund.
Total data processing expenses for 2010 decreased $287,802 (14.76%) to $1,662,425, from the $1,950,227 incurred in 2009, which had increased $69,259 (3.68%) from the $1,880,968 incurred in 2008. The decrease from 2009 to 2010 was due to cost reduction efforts.
Income Taxes
Applicable income tax expenses (benefits) totaled $11,311,673 for the year ended December 31, 2010, compared with $(16,629,562) and $(1,079,886) for the years ended December 31, 2009 and 2008, respectively. The Company is required to provide a valuation reserve on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. The Company had not established a valuation reserve at December 31, 2009 or 2008 due to management’s belief and analysis that future income levels would be sufficient to realize the net deferred tax assets recorded. In 2010, the Company received a total of $1,951,677 for the carryback of net operating losses for tax reporting purposes of prior years. At December 31, 2010, the Company has established deferred tax assets of $13,609,596 for net operating loss carryforwards for tax reporting purposes totaling $38,561,563 which will expire beginning in 2029, if unused. The Company has also established deferred tax assets for operating loss carry forwards for Florida state income tax reporting purposes totaling $1,084,856 for losses incurred by Reliance Bank, F.S.B. Such operating losses totaled $19,724,646 at December 31, 2010, and will begin to expire, if unused by 2023.
Given the Company’s losses that have occurred through 2010, the Company has established a valuation reserve of $26,076,828 for its deferred tax assets.
Financial Condition
Total assets of the Company declined $240,682,320 (15.66%) to $1,296,025,264 at December 31, 2010, from $1,536,707,584 at December 31, 2009, which had decreased $37,281,634 (2.37%) in 2007 from $1,573,989,218 at December 31, 2008. The depressed economy has reduced the Company’s opportunities for loan growth in its current markets.
Total deposits of the Company declined $185,900,981 (14.68%) to $1,080,159,216 at December 31, 2010, from $1,266,060,197 at December 31, 2009, which had increased $38,012,898 (3.10%) from $1,228,047,299 at December 31, 2008. The overall decline is consistent with the decline in total assets as less funding is required. However, the Company has achieved increased average growth in interest-bearing transaction and savings accounts with a corresponding reduction in certificates of deposit. See the “Results of Operations” section of the report for additional discussion of changes in deposit composition.
Total short-term borrowings of the Company grew $2,480,923 (19.54%) to $15,177,855 at December 31, 2010, from $12,696,932 at December 31, 2009, which had decreased $51,221,912 (80.14%) from $63,918,844 at December 31, 2008. Short-term borrowings will fluctuate significantly based on short-term liquidity needs and certain seasonal deposit trends. Total long-term advances from the Federal Home Loan Bank declined $11,000,000 (10.58%) to $93,000,000 at December 31, 2010, from $104,000,000 at December 31, 2009, which had decreased $32,000,000 (23.53%) from $136,000,000 at December 31, 2008. These longer-term fixed rate advances are used as an alternative funding source and are matched up with longer-term fixed rate assets.
Total loans declined $170,042,509 (14.91%) to $970,261,366 at December 31, 2010, from $1,140,303,875 at December 31, 2009, which had decreased $113,411,565 (9.05%) from the $1,253,715,440 of total loans at December 31, 2008. The depressed economy and a reduced focus on commercial real estate has reduced the Company’s opportunities for loan growth in its current markets.
Investment securities, all of which are maintained as available-for-sale, decreased $42,520,095 (14.97%) to $241,599,461 at December 31, 2010, from the $284,119,556 at December 31, 2009, which had increased $90,231,064 (46.54%) from the $193,888,492 of investment securities maintained at December 31, 2008. The Company’s investment portfolio growth is dependent upon the level of deposit growth and the funding requirements of the Company’s loan portfolio, as described above.
Total stockholders equity at December 31, 2010, 2009, and 2008 was $104,246,650, $149,669,424, and $139,608,880, respectively, with capital-to-asset percentages of 8.04%, 9.74%, and 8.87%, respectively.
Risk Management
Management’s objective in structuring the balance sheet is to maximize the return on average assets while minimizing the associated risks. The major risks concerning the Company are credit, liquidity and interest rate risks. The following is a discussion concerning the Company’s management of these risks.
Credit Risk Management
Managing risks that the Company’s banking subsidiaries assume in providing credit products to customers is extremely important. Credit risk management includes defining an acceptable level of risk and return, establishing appropriate policies and procedures to govern the credit process and maintaining a thorough portfolio review process.
Of equal importance in the credit risk management process are the ongoing monitoring procedures performed as part of the Company’s loan review process. Credit policies are examined and procedures reviewed for compliance each year. Loan personnel also continually monitor loans after disbursement in an attempt to recognize any deterioration which may occur so that appropriate corrective action can be initiated on a timely basis.
Net charge-offs for 2010 were $36,412,441 compared to $35,534,253 in 2009, and $6,527,189 in 2008. The increased charge-off levels result from the increased levels of nonperforming loans and the decline in the overall valuation of real estate securing such loans. The Company’s banking subsidiaries had no loans to any foreign countries at December 31, 2010 and 2009, nor did they have any concentration of loans to any industry on these dates, although a significant portion of the Company’s loan portfolio is secured by real estate in the St. Louis metropolitan and southwestern Florida areas, particularly commercial and construction and land development real estate loans. The Company has refrained from financing speculative transactions such as highly leveraged corporate buyouts, or thinly-capitalized speculative start-up companies.
A summary of loans by type at December 31, 2010, 2009, 2008, 2007 and 2006 is as follows:
Commercial loans are made based on the borrower’s character, experience, general credit strength, and ability to generate cash flows for repayment from income sources, even though such loans may also be secured by real estate or other assets. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations.
Real estate loans, including commercial real estate, residential real estate, and construction loans, are also based on the borrower’s character, but more emphasis is placed on the estimated collateral values. Commercial real estate loans are mainly for owner-occupied business and industrial properties, multifamily properties, and other commercial properties for which income from the property is the primary source of repayment. Credit risk of these loan types is managed in a similar manner to commercial loans and real estate construction loans by employing sound underwriting guidelines. These loans are underwritten based on the cash flow coverage of the property, typically meet the Company’s loan-to-value guidelines, and generally require either the limited or full guarantee of principal sponsors of the credit.
Real estate construction loans, relating to residential and commercial properties, represent financing secured by real estate under construction for eventual sale. The Company requires third party disbursement on the majority of loans in its builder portfolio and the Company reviews projects regularly for progress status.
Residential real estate loans are predominantly made to finance single-family, owner-occupied properties in the St. Louis metropolitan area and southwestern Florida. Loan-to-value percentage requirements for collateral are based on the lower of the purchase price or appraisal and are normally limited to 80% at loan origination, unless credit enhancements are added. Appraisals are required on all owner-occupied residential real estate loans and private mortgage insurance is required if the loan to value percentage exceeds 85% at loan origination. These loans generally have a short duration of three years or less, with some loans repricing more frequently. Long-term, fixed rate mortgages are generally not retained in the Banks’ loan portfolios, but rather are sold into the secondary market. The Banks have not financed, and do not currently finance, sub-prime mortgage credits.
Consumer and other loans represent loans to individuals on both a secured and unsecured nature. Credit risk is controlled by thoroughly reviewing the credit worthiness of the borrowers on a case-by-case basis.
The continued significant decline of the real estate market in the St. Louis metropolitan and southwestern Florida areas has caused an increase in the Company’s non-performing assets. Following is a summary of information regarding the Bank’s nonperforming loans as of and for each of the years in the five-year period ended December 31, 2010:
Non-performing loans are defined as loans on non-accrual status, loans 90 days or more past due but still accruing, and restructured loans. Loans are placed on non-accrual status when contractually past due 90 days or more as to interest or principal payments, unless the loans are well secured and in process of collection. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on non-accrual status immediately, rather than delaying such action until the loans become 90 days past due. Previously accrued and uncollected interest on such loans is reversed and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal balance of the loan is collectible. If collectability of the principal is in doubt, payments received are applied to loan principal for financial reporting purposes.
Loans past due 90 days or more but still accruing interest are also included in non-performing loans. Loans past due 90 days or more but still accruing interest are classified as such when the underlying loans are both well secured (the collateral value is sufficient to cover principal and accrued interest) and are in the process of collection. Also included in non-performing loans are “restructured” loans. Restructured loans involve the granting of some concession to the borrower involving the modification of terms of the loan, such as changes in payment schedule or interest rate, because of the borrower’s stressed financial condition.
The increase in nonperforming loans is due to the continued weakness in the economy, particularly regarding commercial and construction real estate in the Banks’ markets. The Company has taken a more thorough and thoughtful approach toward collection and resolution of such problem credits. Such loans are continually reviewed for impairment as the underlying real estate values have declined, resulting in additional loan charge-offs. Once foreclosure occurs, additional declines in the value of the properties results in other real estate owned write-downs. The Company believes the reserve for loan losses calculation at December 31, 2010 adequately considers the fair value of the underlying collateral on its problem loan portfolio; however, the values of these properties have continued to deteriorate, requiring the additional provision for loan losses. Additional provisions and other real estate write-downs may be required in subsequent periods if the values of such properties continue to decline.
Of the Company’s $970 million loans outstanding at December 31, 2010, 5% were originated in Florida and 95% outside of Florida. The following table breaks down net charge-offs, non-performing loans and non-performing assets between loans originated in Florida and all other loans:
*
Non-performing assets are comprised of non-performing loans, other real estate owned, and investment securities on nonaccrual.
The continued significant decline of the real estate markets in the St. Louis metropolitan and southwestern Florida areas has caused a significant increase in the Company’s non-performing loans in 2008, 2009 and 2010. At December 31, 2010, non-performing loans had increased $99,011,569 to $171,089,003, from $72,077,434 at December 31, 2009, which had increased $37,181,024 from $34,896,410 at December 31, 2008. The largest components of non-performing loans at December 31, 2010 were primarily comprised of the following loan relationships (which comprises approximately 90% of total non-performing loans):
•
A loan for approximately $10.9 million, secured by an individual warehouse in St. Louis, Missouri. The loan is currently in forbearance as the borrower restructures its business operations. The warehouse is experiencing high vacancy.
•
A $16.3 million loan to a commercial real estate developer in Houston, Texas. The loan is secured by three office buildings and developed commercial land. The borrower and the Company agreed to loan renewal terms in December 2010 that brought the loan current, past due real estate taxes current, and established a reserve account. The borrower continues to negotiate the sale of a tract of ground that is collateral to a national home builder.
•
A loan for approximately $3.4 million to a non-profit organization for the purchase of 482 acres and a 7,000 square foot residence in St. Louis, Missouri. The property is well located in a natural setting that abuts a river. The nonprofit organization has experienced financial setbacks, most notably a decline in contributions.
•
A loan for approximately $4.5 million to a commercial real estate developer for the development of a shopping center. The center has a long-term lease in place with a grocery store. The owner is actively marketing the center to lease the vacant space.
•
Loans totaling approximately $3.2 million to build out a day spa in Missouri. The borrower is in default. The Company is seeking repayment in full through foreclosure and pursuit of guarantors.
•
A loan for approximately $2.8 million to finance the purchase of a retail center in O’Fallon, Missouri. The center is currently experiencing high vacancy in an overdeveloped area. The borrower continues to make monthly interest payments. Additional capital calls from investors have been slow to complete. The loan is in default and the Company has engaged counsel to collect the loan.
•
A loan for approximately $5.7 million to a commercial real estate developer for the construction of medical office buildings in Arizona. The loan is secured by 10 acres. The borrower has agreed to a settlement agreement that has allowed the Company to complete foreclosure of the collateral in late January 2011.
•
A loan for approximately $2.2 million for a 64,000 sq. ft. industrial warehouse used as a sports complex. The owner operates indoor soccer and inline hockey throughout the year. The borrower continues to perform and the Company is encouraging the borrower to seek alternate financing.
•
A loan of approximately $11.7 million on a 61,000 sq. ft. medical office building that is located in St. Louis County, Missouri. A new professional management company has been put in place to take over day-to-day operations. The Company is seeking collection through foreclosure. The process to complete foreclosure has been stalled by a lawsuit. The Company’s counsel is seeking to have the lawsuit dismissed.
•
A loan for approximately $7.8 million to refinance and provide additional capital to complete phase II of a land development in St. Charles, Missouri. The development has slowed significantly and experienced difficult times due to the continuing slow economy.
•
A loan for approximately $1.9 million for the development of eight condominium buildings in St. Louis County, Missouri. Since originated, one building is under construction. The development of the land is fully completed. The borrower has experienced difficulties. The Company is seeking repayment in full through foreclosure and pursuit of guarantors.
•
A loan for approximately $1.2 million for the purchase of two single tenant warehouse properties in Minnesota. The tenant previously occupied both buildings and has now consolidated operations in one building. The second building has been sold and net proceeds paid down the debt. The Company and the borrower are moving forward to restructure the debt with a goal to have this completed in early 2011.
•
A loan for approximately $2.6 million to refinance a commercial building in St. Louis County, Missouri. The building was formerly occupied by a national chain which has since vacated. The borrower and the Company have entered into a forbearance agreement that allows the borrower a short time frame to liquidate the collateral.
•
A loan for approximately $7.0 million to refinance a commercial office property located in Phoenix, Arizona. The building has experienced vacancies. The borrower is developing a plan to increase occupancy and bring the loan current.
•
A loan totaling approximately $1.8 million to entities controlled by a group of Missouri real estate investors for the purchase and development of a parcel of land in St. Charles, Missouri. The majority of the proposed entitlements and development have been completed. The Company reached an agreement with the borrower to move the project forward with a new home builder.
•
A loan for approximately $7.5 million for the purchase of four commercial buildings located in St. Louis County and Jefferson County, MO. The buildings have experienced high vacancy. The loan continues to perform on an interest only basis. The Company is seeking the borrower’s cooperation to restructure the debt.
•
A loan for approximately $1.1 million to refinance a commercial office building in St. Louis County, MO. The borrower has experienced high vacancy that has affected the cash flow of the building. The Company is seeking collection through foreclosure and pursuit of guarantors.
•
A loan for approximately $3.5 million to refinance a commercial retail building located in St. Louis County, MO. The largest tenant has recently vacated and the building also has other vacancies. The Company is seeking repayment in full through foreclosure and pursuit of guarantors.
•
A loan for approximately $5.8 million to purchase a commercial office/warehouse building in St. Louis County, MO. The Company has identified a potential purchaser of the building. Due to outstanding judgments against the borrower, the Company will initiate foreclosure of the collateral.
•
A loan for approximately $13.0 million to refinance a commercial retail center in St. Louis County, MO. The building has experienced increased vacancies and therefore insufficient cash flow to service debt. The Company is seeking repayment in full through foreclosure and pursuit of the guarantors.
•
Loans totaling approximately $14.5 million to finance the equipment, operations and real estate for a joint venture industrial and manufacturing company with its main operations in Texas. The operations have suffered from the economy and the parent company’s bankruptcy. The Company is seeking repayment in full through foreclosure and pursuit of the guarantor.
•
Loans totaling approximately $3.2 million for the construction and operation of a full service car wash in Napa County, California. The plan suffered delays, cost overruns and lower than expected revenues. The borrower is working to increase revenues and bring the loan current.
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A loan for approximately $4.0 million to finance the purchase a private airplane. The lease between the borrower and a third party has been terminated. Additionally, airplane values have experienced significant declines. The borrower is developing a plan to submit to the Company to repay the loan in full.
•
A loan for approximately $2.0 million to finance the purchase of a retail strip center. The center has suffered from vacancy issues and their largest tenant has vacated the premises. The Company has moved towards foreclosure of the asset.
•
A loan for approximately $1.3 million to an individual, secured by the individual’s primary residence in Florida that is in default. The borrower entered into a forbearance agreement, but has now defaulted under that negotiated plan. Foreclosure proceedings have again been initiated.
•
A loan for approximately $2.3 million to a group of Florida investors secured by unimproved property in Florida. After multiple quarters of performance by some of the guarantors, payments have stopped and the parties have engaged legal counsel. The Company has initiated foreclosure. The borrower is in contract with a local government agency to purchase collateral.
•
A loan for approximately $1.0 million to a group of investors secured by an improved commercial lot. The borrower and the Company were unable to reach agreement on further development of the site. Negotiations continue with a possible deed-in-lieu of foreclosure with new notes from the borrower for any deficiencies.
•
A loan for approximately $7.9 million to a group of investors secured by a retail strip center. The borrower and the Company continue to negotiate terms to maintain the property in name of the borrower
•
A loan for approximately $2.0 million to a group of investors secured by a piece of unimproved commercial real estate. The primary guarantor strength has been compromised, resulting in severe cash flow deficiencies. Legal action has been initiated against the borrower and all of the guarantors.
•
A loan for approximately $2.0 million for ground development of a proposed commercial retail strip center and self-storage facility in southwestern Florida. The entity was established by an experienced real estate developer; however, with the deterioration of the real estate market, the project did not begin construction, and the real estate downturn has affected the cash flow of the guarantor. The Company is working with the borrower on a strategy for repayment, resolution of the project, or obtaining a signed deed for the property in lieu of foreclosure.
The Company also has non-performing assets in the form of other real estate owned. The Banks maintained other real estate owned totaling $30,850,543 and $29,085,943 at December 31, 2010 and 2009, respectively. Other real estate owned represents property acquired through foreclosure, or deeded to the Banks in lieu of foreclosure for loans on which borrowers have defaulted as to payment of principal and interest. The following table details the activity within other real estate owned for the year ended December 31, 2010:
During this period of a declining real estate market, the Company has sought to add loans to its portfolio with increased collateral margins or excess payment capacity from proven borrowers to enhance the quality of the loan portfolio, and has often had to offer a competitively lower interest rate on such loans. Given the collateral values maintained on its loan portfolio, including the non-performing loans discussed above, the Company believes the reserve for possible loan losses is adequate to absorb losses in the portfolio existing at December 31, 2010; however, should the real estate market continue to decline, the Company may require additional provisions to the reserve for possible loan losses to address the declining collateral.
Potential Problem Loans
As of December 31, 2010, the Company had 38 loans with a total principal balance of $32,296,693 that were identified by management as having possible credit problems that raise doubts as to the ability of the borrower to comply with the current repayment terms, which are not included in nonperforming loans. These loans were continuing to accrue interest and were less than 90 days past due on any scheduled payments. However, various concerns, including, but not limited to, payment history, loan agreement compliance, adequacy of collateral coverage, and borrowers’ overall financial condition caused management to believe that these loans may result in reclassification at some future time as nonaccrual, past due or restructured. Such loans are not necessarily indicative of future nonperforming loans, as the Company continues to work on resolving issues with both nonperforming and potential problem credits on its watch list.
Policies and Procedures
The Company’s credit management policies and procedures focus on identifying, measuring, and controlling credit exposure. These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal loan review and regulatory bank examinations. The system requires rating all loans at the time they are made, at each renewal date and as conditions warrant.
Adversely rated credits, including loans requiring close monitoring, are included on a monthly loan watch list. Other loans are added whenever any adverse circumstances are detected, which might affect the borrower’s ability to meet the terms of the loan. This could be initiated by any of the following:
•
Delinquency of a scheduled loan payment;
•
Deterioration in the borrower’s financial condition identified in a review of periodic financial statements;
•
Decrease in the value of collateral securing the loan; or
•
Change in the economic environment in which the borrower operates.
Loans on the watch list require periodic detailed loan status reports, including recommended corrective actions, prepared by the responsible loan officer, which are discussed at each monthly loan committee meeting.
Downgrades of loan risk ratings may be initiated by the responsible loan officer, internal loan review, the watch list committee, the loan committee, or senior lending personnel at any time. Upgrades of certain risk ratings may only be made with the concurrence of a majority of the members of the loan committee.
The Company’s loan underwriting policies limit individual loan officers to specific amounts of lending authority, over which various committees must get involved and approve a credit. The Company’s underwriting policies require an analysis of a borrower’s ability to pay the loan and interest on a timely basis in accordance with the loan agreement. Collateral is then considered as a secondary source of payment, should the borrower not be able to pay.
The Company conducts weekly loan committee meetings of all of its loan officers, including the Chief Executive Officer, Chief Risk Officer, Chief Lending Officer, Chief Credit Officer, and the Chief Executive Officer of Reliance Bank FSB. This committee may approve individual credit relationships up to $2,500,000. Larger credits must go to the loan committee of the Board of Directors, which is comprised of three directors on a rotating basis. The Company’s legal lending limit was $31,597,816 at December 31, 2010.
Reserve for Loan Losses
At December 31, 2010, 2009, 2008, 2007, and 2006, the reserve for possible loan losses was $37,301,075, $32,221,569, $14,305,822, $9,685,011, and $7,101,031, respectively, or 3.84%, 2.83%, 1.14%, 1.06%, and 1.06% of net outstanding loans, respectively. The following table summarizes the Company’s loan loss experience for each of the years in the five-year period ended December 31, 2010.
Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses.
Since its inception in 1999, the Company has experienced significant loan growth in the St. Louis metropolitan area, and in southwestern Florida, with expansion to that area by the Company in 2005. The southwestern Florida area began experiencing economic distress ahead of most of the country, with the long-booming real estate market in Florida beginning its decline in 2007. As a result, the Company began experiencing an increase in troubled asset situations in 2007 and began increasing its reserve for loan losses accordingly, as the Florida real estate market weakened. In 2010, after two and one-half years of a free-fall decline in Florida real estate values, Company management believes that the Florida real estate market has begun to stabilize at the low valuation levels to which it has dropped during this economic recession. While the Florida real estate market has begun to stabilize, the real estate markets in the St. Louis metropolitan area (as well as the Houston, Texas and Phoenix, Arizona markets in which the Company has established loan production offices) continue to experience increased stress. Throughout this time period, the Company has attempted to address this dichotomy of markets with the tables presented in its filings that portray the degree to which these geographic areas have been the source of problems.
While considering the level of nonperforming assets when assessing the appropriate level of the reserve for loan losses at a particular point in time, the Company does not use a pre-assigned coverage ratio of nonperforming assets. Since a significant percentage of the Company’s loan portfolio is concentrated in commercial and construction real estate, the most significant factor when determining an appropriate level for the reserve for loan losses is a detailed analysis of the individual credit relationships and their potential for loss after considering the value of the underlying real estate collateral. During the past three years (first in Florida and then migrating to the Company’s other markets in St. Louis, Houston and Phoenix), the Company has experienced continued declines in collateral values (e.g., one credit relationship had collateral with a current appraised value of $2,000,000 at the end of 2008 and a current appraised value of $1,000,000 at the end of 2009 for the same property). Company management has assessed that this additional uncertainty has warranted caution in assessing an appropriate level for the reserve for loan losses, and that somewhat greater conservatism is warranted at this time to ensure that the provisions reflect the level of losses inherent within the portfolio at a particular point in time.
The Company risk rates all of the loans in its loan portfolio, using a 1-7 risk rating system, with a “1” - rated credit being a high quality loan and a “7” - rated credit having some level of loss in the credit. Loan officers are responsible for risk-rating their own credits, including maintaining the risk rating on a current basis. Downgrades are discussed at various management and loan committee meetings. The risk ratings are also subject to an on-going review by an extensive loan review process performed independent of the loan officers. An adequately controlled risk rating process allows Company management to conclude that the Banks’ watch lists (which include all credits risk-rated “4” or greater) are, for all practical purposes, a complete profile of situations with current loss exposure.
All loans included in the watch lists require separate action plans to be developed to reduce the level of risk inherent in the credit relationship. Based on the information included on the watch list and a review of each individual credit relationship thereon, the Company determines whether a credit is impaired. The Company considers a loan to be impaired when all amounts due - both principal and interest - will not be collected in accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value (and marketability), and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.
When measuring impairment for loans, the expected further cash flows of impaired loans are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of collateral for a collateral dependent loan; however, substantially all of the Company’s presently impaired credit relationships are collateralized by (and derive their ultimate cash flows from) commercial, construction, or residential real estate and, accordingly, virtually
all of the Company’s impairment calculations for the present portfolio have been based on the underlying values of the real estate collateral.
The Banks’ watch lists include complete listings of credit relationships that are considered to be impaired, along with an assessment of the estimated impairment loss to be included as specific exposure for impaired loans. Such impairment calculations are based on current (less than six months old) appraisals of the underlying real estate collateral. The Company regularly obtains updated appraisals for all of its impaired credit relationships. As noted above, the continued decline in real estate values experienced by the Company during the past three years has resulted in an increased level of the reserve for loan losses for these specifically identifiable impairment losses.
The sum of all exposure amounts calculated for impaired loans is included in the reserve for loan losses as the specifically-identifiable losses portion of the account balance. This is one portion of the reserve for loan losses. The second portion of the reserve for loan losses is a general reserve for all credit relationships not considered to be specifically impaired. This amount is calculated by first calculating the historical charge-off ratio for each of the particular loan categories and then subjectively adjusting these historical ratios for several economic and environmental factors. The adjusted ratio for each loan category is then applied against the non-impaired loans in that loan category, resulting in a general reserve for that particular loan category. The sum of these general reserve categories, when added to the amount of specifically identified losses on impaired credits, results in the final reserve for loan losses balance for a particular date. The Company follows this process for calculating the reserve for loan losses on a quarterly basis.
In calculating the general portion of the reserve for possible loan losses, the loan categories used are real estate construction, residential real estate, commercial real estate, commercial and industrial, and consumer loans. Through 2009, historical charge-off ratios were calculated on a rolling three-year basis, which resulted in higher reserve levels with the increased levels of charge-offs experienced during the past three years. This was reduced to a rolling two-year historical charge-off ratio in the fourth quarter of 2010. The economic and environmental factors for which adjustments are made to the historical charge-off ratios include the following:
•
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses.
•
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments.
•
Changes in the nature and volume of the portfolio and in the terms of loans.
•
Changes in the experience, ability, and depth of lending management and other relevant staff.
•
Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans.
•
Changes in the quality of the Banks’ loan review systems.
•
Changes in the value of underlying collateral for collateral-dependent loans.
•
The existence and effect of any concentrations of credit, and changes in the level of such concentrations.
•
The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Banks’ existing portfolios.
The total reserve for possible loan losses is available to absorb losses from any segment of the portfolio. Management continues to target and maintain the reserve for possible loan losses equal to the allocation methodology outlined above.
In determining an adequate balance in the reserve for possible loan losses, management places its emphasis as follows: evaluation of the loan portfolio with regard to potential future exposure on loans to specific customers and industries; reevaluation of each watch list loan or loan classified by supervisory authorities; and an overall review of the remaining portfolio in light of loan loss experience normally experienced in our banking market. Any problems or loss exposure estimated in these categories is provided for in the total current period reserve.
The perception of risk with respect to particular loans within the portfolio will change over time as a result of the characteristics and performance of those loans, overall economic and market trends, and the actual and expected trends in non-performing loans.
Based on its review for adequacy, management has estimated those portions of the reserve that could be attributable to major categories of loans as detailed in the following table at year-end for each of the years in the five-year period ended December 31, 2010:
While the Company has no significant specific industry concentration risk, analysis showed that over 91% of the loan portfolio was dependent on real estate collateral at December 31, 2010, including commercial real estate, residential real estate, and construction and land development loans. The following table details the significant categories of real estate loans as a percentage of total regulatory capital:
Outstanding balances in all real estate loan categories have declined between December 31, 2009 and December 31, 2010. However, total regulatory capital declined at a faster pace than most of the loan category declines, thus resulting in the increased percentages noted above.
Liquidity and Rate Sensitivity Management
Management of rate sensitive earning assets and interest-bearing liabilities remains a key to the Company’s profitability. The Company’s operations are subject to risk resulting from interest rate fluctuations to the extent that there is a difference between the amount of the Company’s interest-earning assets and the amount of interest-bearing liabilities that are prepaid or withdrawn, mature or are repriced in specified periods. The principal objective of the Company’s asset/liability management activities is to provide maximum levels of net interest income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Company. The Banks utilize gap analyses as the primary quantitative tool in measuring the amount of interest rate risk that is present at the end of each quarter. Bank management
also monitors, on a quarterly basis, the variability of earnings and fair value of equity in various interest rate environments. Bank management evaluates the Banks’ risk position to determine whether the level of exposure is significant enough to hedge a potential decline in earnings and value or whether the Bank can safely increase risk to enhance returns.
Liquidity is a measurement of the Banks’ ability to meet the borrowing needs and the deposit withdrawal requirements of their customers. The composition of assets and liabilities is actively managed to maintain the appropriate level of liquidity in the balance sheet. Management is guided by regularly reviewed policies when determining the appropriate portion of total assets which should be comprised of readily marketable assets available to meet conditions that are reasonably expected to occur.
Liquidity is primarily provided to the Banks through earning assets, including Federal funds sold and maturities and principal payments in the investment portfolio, all funded through continued deposit growth and short-term borrowings. Secondary sources of liquidity available to the Banks include the sale of securities included in the available-for-sale category (with a carrying value of $241,599,461 at December 31, 2010, of which $150,544,222 is pledged to secure deposits, repurchase agreements certain borrowings and for other purposes) and borrowing capabilities through correspondent banks, the Federal Reserve Bank, and the Federal Home Loan Banks. Maturing loans also provide liquidity on an ongoing basis. Accordingly, Bank management believes it has the liquidity necessary to meet unexpected deposit withdrawal requirements or increases in loan demand.
The Banks have borrowing capabilities through correspondent banks, the Federal Reserve Bank, and the Federal Home Loan Banks of Des Moines and Atlanta. The Banks have Federal funds lines of credit totaling $23,000,000, through correspondent banks, of which $23,000,000 was available at December 31, 2010. Also, Reliance Bank has a credit line with the Federal Home Loan Bank of Des Moines in the amount of $165,779,654 and availability under that line was $66,761,080 as of December 31, 2010. Reliance Bank, FSB maintained a credit line with the Federal Home Loan Bank of Atlanta in the amount of $8,960,000, of which $5,860,000 was available at December 31, 2010. In addition, Reliance Bank maintained a line of credit with the Federal Reserve Bank in the amount of $22,450,433, of which $22,450,433 was available, subject to a collateral and credit review, at December 31, 2010. As of December 31 2010, the combined availability under these arrangements totaled $118,071,513. Company management believes it has the liquidity necessary to meet unexpected deposit withdrawal requirements or increases in loan demand. However, availability of the funds noted above is subject to the Banks’ maintaining a favorable rating by their regulators. If the Banks were to become distressed to the point that their regulatory ratings were lowered, it could negatively impact the ability of the Banks to borrow the funds.
The asset/liability management process, which involves structuring the balance sheet to allow approximately equal amounts of assets and liabilities to reprice at the same time, is a dynamic process essential to minimize the effect of fluctuating interest rates on net interest income. The following table reflects the Company’s interest rate gap (rate-sensitive assets minus rate-sensitive liabilities) analysis as of December 31, 2010, individually and cumulatively, through various time horizons:
Remaining Maturity if Fixed Rate;
Earliest Possible Repricing Interval if Floating Rate
A gap report is used by Bank management to review any significant mismatch between the repricing points of the Banks’ rate sensitive assets and liabilities in certain time horizons. A negative gap indicates that more liabilities reprice in that particular time frame and, if rates rise, these liabilities will reprice faster than the assets. A positive gap would indicate the opposite. Management has set policy limits specifying acceptable levels of interest rate risk as measured by the gap report. Gap reports can be misleading in that they capture only the repricing timing within the balance sheet, and fail to capture other significant risks such as basis risk and embedded options risk. Basis risk involves the potential for the spread relationship between rates to change under different rate environments and embedded options risk relates to the potential for the divergence from expectations in the level and/or timing of cash flows given changes in rates. As indicated in the above table, the Company operates on a short-term basis similar to most other financial institutions, as its liabilities, with savings and interest-bearing transaction accounts included, could reprice more quickly than its assets. However, the process of asset/liability management in a financial institution is dynamic. Bank management believes its current asset/liability management program will allow adequate reaction time for trends in the marketplace as they occur, allowing maintenance of adequate net interest margins.
Bank management also uses fair market value of equity analyses to help identify longer-term risk that may reside on the current balance sheet. The fair market value of equity is represented by the present value of all future income streams generated by the current balance sheet. The Company measures the fair market value of equity as the net present value of all asset and liability cash flows discounted at forward rates suggested by the current Treasury curve plus appropriate credit spreads. This representation of the change in the fair market value of equity under different rate scenarios gives insight into the magnitude of risk to future earnings due to rate changes. Management has set policy limits relating to declines in the market value of equity. The results of these analyses at December 31, 2010 indicate that the Company’s fair market value of equity would decrease 7.00% and 14.57% from an immediate and sustained parallel decrease in interest rates of 100 and 200 basis points, respectively, and increase 6.54% and 10.16%, from a corresponding increase in interest rates of 100 and 200 basis points, respectively.
Following is a more detailed analysis of the maturity and interest rate sensitivity of the Banks’ loan portfolios at December 31, 2010:
For all loans maturing or repricing beyond the one year time horizon at December 31, 2010, following is a breakdown of such loans into fixed and floating rates.
The investment portfolio is closely monitored to assure that the Banks have no unreasonable concentration of securities in the obligations of any single debtor. Other than U.S. Government agency securities, the Banks maintain no concentration of investments in any one political subdivision greater than 10% of its total portfolio.
The book value and estimated market value of the Company’s debt securities at December 31, 2010, 2009 and 2008, all of which are classified as available-for-sale, are summarized in the following table:
The following tables summarize maturity and yield information on the Company’s investment portfolio at December 31, 2010:
Note: While yields by range of maturity are routinely provided by the Company’s accounting system on a tax equivalent basis, the individual amounts of adjustments are not so provided. In total, at an assumed Federal income tax rate of 34%, the adjustment amounted to $463,405.
The Banks’ primary source of liquidity to fund growth is ultimately the generation of new deposits. The following table shows the average daily amount of deposits and the average rate paid on each type of deposit for the years ended December 31, 2010, 2009, and 2008:
As noted in the gap analyses above, at December 31, 2010, a substantial portion of the Company’s time deposits mature within one year, which is common in the present banking market. The following table shows the maturity of time deposits of $100,000 or more and other time deposits at December 31, 2010:
Capital Adequacy
The Federal Reserve Board established risk-based capital guidelines for bank holding companies, which require bank holding companies to maintain minimum levels of “Tier 1 Capital” and “Total Capital.” Tier 1 Capital consists of common and qualifying preferred stockholders’ equity and minority interests in equity accounts of consolidated subsidiaries, less goodwill and 50% of investments in unconsolidated subsidiaries. Total capital consists of, in addition to Tier 1 Capital, mandatory convertible debt, preferred stock not qualifying as Tier 1 Capital, subordinated and other qualifying term debt and a portion of the reserve for possible loan losses, less the remaining 50% of qualifying total capital. Risk-based capital ratios are calculated with reference to risk-weighted assets, which include both on-and off-balance sheet exposures. The minimum required ratio for qualifying Total Capital is 8%, of which at least 4% must consist of Tier 1 Capital.
In addition, Federal Reserve guidelines require bank holding companies to maintain a minimum ratio of Tier 1 Capital to average total assets (net of goodwill) of 3%. The Federal Reserve guidelines state that all of these capital ratios constitute the minimum requirements for the most highly-rated banking organizations, and other banking organizations are expected to maintain capital at higher levels.
The Banks are also required to maintain additional capital, as described in Item 1 above, under agreements with the banking regulators. Company management believes that, as of December 31, 2010, the Company and Banks meet all capital adequacy requirements to which they are subject, except for Reliance Bank, FSB, which was less than adequately capitalized at December 31, 2010 after recording the write-down of land held for future expansion effective December 31, 2010. The Company subsequently injected $500,000 of additional capital into Reliance Bank, F.S.B. on February 16, 2011, which brought the Bank to an adequately capitalized level, but below the threshold required by the regulatory agreement. Also, Reliance Bank, effective with the February 14, 2011 Consent Order, was deemed to be less than well capitalized due to the new, increased capital requirements within the Order.
As of December 31, 2010, the most recent notification from the applicable regulatory authorities categorized Reliance Bank as a well-capitalized bank under the regulatory framework for prompt corrective action. To be categorized as a well-capitalized bank, Reliance Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that Company management believes have changed Reliance Bank’s risk categories.
The actual capital amounts and ratios for the Company, Reliance Bank, and Reliance Bank, FSB at December 31, 2010, 2009, and 2008 are presented in the following table:
Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized banking institutions. The extent of the regulators’ powers depend on
whether the banking institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” which are defined by the regulators as follows:
A critically undercapitalized institution is defined as having a tangible equity to total assets ratio of 2% or less.
Contractual Obligations, Off-Balance Sheet Risk, and Contingent Liabilities
Through the normal course of operations, the Banks have entered into certain contractual obligations and other commitments. Such obligations relate to funding of operations through deposits or debt issuances, as well as leases for premises and equipment. As financial services providers, the Banks routinely enter into commitments to extend credit. While contractual obligations represent future cash requirements of the Banks, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval processes accorded to loans made by the Banks.
The required contractual obligations and other commitments at December 31, 2010 were as follows:
Quantitative and Qualitative Disclosures About Market Risk
For information regarding the market risk of the financial instruments of the Company, see the section entitled “Liquidity and Rate Sensitivity Management” within this “Management’s Discussion and Analysis of Financial Condition and Results of Operation” section.
Effects of Inflation
Persistent high rates of inflation can have a significant effect on the reported financial condition and results of operations of all industries. However, the asset and liability structure of a financial institution is substantially different from that of an industrial company, in that virtually all assets and liabilities of a financial institution are monetary in nature. Accordingly, changes in interest rates may have a significant impact on a financial institution’s performance. Interest rates do not necessarily move in the same direction, or in the same magnitude, as the prices of other goods and services.
Inflation, however, does have an important impact on the growth of total assets in the banking industry, often resulting in a need to increase equity capital at higher than normal rates to maintain an appropriate equity-to-assets ratio. One of the most important effects that inflation has had on the banking industry has been to reduce the proportion of earnings paid out in the form of dividends.
Although it is obvious that inflation affects the growth of total assets, it is difficult to measure the impact precisely. Only new assets acquired each year are directly affected, so a simple adjustment of asset totals by
use of an inflation index is not meaningful. The results of operations also have been affected by inflation, but again there is no simple way to measure the effect on the various categories of income and expense.
Interest rates in particular are significantly affected by inflation, but neither the timing nor the magnitude of the changes coincide with changes in the consumer price index. Additionally, changes in interest rates on some types of consumer deposits may be delayed. These factors, in turn, affect the composition of sources of funds by reducing the growth of deposits that are less interest sensitive and increasing the need for funds that are more interest sensitive.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Information regarding the market risk of the financial instruments of the Company is included in this report under “Fluctuations in interest rates could reduce our profitability and affect the value of our assets” in Item 1A “Risk Factors” and under “Liquidity and Rate Sensitivity Management” in item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Such information is incorporated in this Item 7A by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements that are filed as part of this report are set forth in Item 15 of this report.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and procedures
Evaluation of Controls and Procedures
Under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), management has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange act of 1934, as amended) and concluded that the Company’s disclosure controls and procedures were adequate and effective as of December 31, 2010.
Changes in Internal Controls over Financial Reporting
There were no changes during the period covered by this Annual Report on Form 10-K in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as such term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2010. The framework on which such evaluation was based is contained in the report entitled “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of December 31, 2010.
This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not
subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this Annual Report.
/s/ Dale E. Oberkfell
Dale E. Oberkfell
Chief Financial Officer (Principal Financial and Principal Accounting Officer)
Item 9b.
Item 9b. Other information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item 10 is set forth under the captions “Proposal 1 Requiring Your Vote: Election of Directors,” “Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Code of Business Conduct and Ethics” and “Board of Directors and Committees: The Audit Committee” in the Company’s Proxy Statement for the 2011 annual meeting of shareholders (the “2011 Proxy Statement”) and is incorporated herein by reference.
There have been no material changes to the procedures by which shareholders may recommend Director nominees to our Board of Directors since the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010.
Item 11.
Item 11. Executive Compensation
The information required by this Item 11 is set forth under the captions “Compensation Discussion and Analysis,” “Compensation Committee Report,” “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation” in the 2011 Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain information required by this Item 12 is set forth under the caption “Stock Ownership of Executive Officers and Certain Beneficial Owners” in the Company’s 2011 Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is set forth under the captions “Interest of Management in Certain Transactions” and “Independent Directors” in the Company’s 2011 Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item 14 is set forth under the caption “Audit Committee Report and Payment of Fees to Auditors” in the Company’s 2011 Proxy Statement and is incorporated herein by reference.
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
The following documents are filed as part of this Annual Report:
(1) Financial Statements
The financial statements filed with this Annual Report are listed in the Index to Consolidated Financial Statements on page.
(2) Schedules
None.
(3) Exhibits
The Exhibits required to be filed as a part of this Annual Report are listed in the attached Index to Exhibits.
(b)
The Exhibits required to be filed as a part of this Annual Report are listed in the attached Index to Exhibits.
(c)
None.
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Reliance Bancshares, Inc.:
We have audited the accompanying consolidated balance sheets of Reliance Bancshares, Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years in the three-year 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 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 Reliance Bancshares, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
March 28, 2011
St. Louis, Missouri
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2010 and 2009
See accompanying notes to consolidated financial statements.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2010, 2009, and 2008
See accompanying notes to consolidated financial statements.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Loss
Years ended December 31, 2010, 2009, and 2008
See accompanying notes to consolidated financial statements.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2010, 2009, and 2008
See accompanying notes to consolidated financial statements.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009, and 2008
See accompanying notes to consolidated financial statements.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009, and 2008
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Reliance Bancshares, Inc. (the Company) provides a full range of banking services to individual and corporate customers throughout the St. Louis metropolitan area in Missouri and Illinois and southwestern Florida through its wholly owned subsidiaries, Reliance Bank and Reliance Bank, FSB (hereinafter referred to as “the Banks”). The Company also has loan production offices in Houston, Texas and Phoenix, Arizona.
The Company and Banks are subject to competition from other financial and nonfinancial institutions providing financial products throughout the St. Louis metropolitan area and southwestern Florida. Additionally, the Company and Banks are subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory agencies.
The accounting and reporting policies of the Company and Banks conform to generally accepted accounting principles within the banking industry. In compiling the consolidated financial statements, management is required 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. Estimates that are particularly susceptible to change in a short period of time include the determination of the reserve for possible loan losses, valuations of other real estate owned, stock options and deferred tax assets, determination of possible impairment of intangible assets and long-lived fixed assets, and other-than-temporary impairment of investments in debt securities. Actual results could differ from those estimates.
Following is a description of the more significant accounting policies of the Company and Banks.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and Banks. All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of Accounting
The Company and Banks utilize the accrual basis of accounting, which includes in the total of net income all revenues earned and expenses incurred, regardless of when actual cash payments are received or paid. The Company is also required to report comprehensive income, of which net income is a component. Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources, including all changes in equity during a period, except those resulting from investments by, and distributions to, owners and cumulative effects of accounting changes and tax benefits recorded directly to retained earnings.
Cash Flow Information
For purposes of the consolidated statements of cash flows, cash equivalents include amounts due from banks and interest-earning deposits in other financial institutions (all of which are payable on demand). Certain balances maintained in other financial institutions are fully insured by the Federal Deposit Insurance Corporation (“FDIC”) under the Federal Deposit Insurance Act through
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2012. After this period, these balances would generally exceed the level of deposits insured by the FDIC.
Following is certain supplemental information relating to the Company’s consolidated statements of cash flows for the years ended December 31, 2010, 2009, and 2008:
Investments in Debt Securities
The Banks classify their debt securities into one of three categories at the time of purchase: trading, available-for-sale, or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near-term. Held-to-maturity securities are those debt securities which the Banks have the ability and intent to hold until maturity. All other debt securities not included in trading or held-to-maturity, and any equity securities, are classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities (for which no securities were so designated at December 31, 2010 and 2009) would be recorded at amortized cost, adjusted for the amortization of premiums or accretion of discounts. Holding gains and losses on trading securities (for which no securities were so designated at December 31, 2010 and 2009) would be included in earnings. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and reported as a component of other comprehensive income in stockholders’ equity until realized. Transfers of securities between categories would be recorded at fair value at the date of transfer. Unrealized holding gains and losses would be recognized in earnings for transfers into the trading category.
Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by the issuers of the securities. Amortization of premiums and accretion of discounts for mortgage-backed securities are recognized as interest income using the interest method, which considers the timing and amount of prepayments of the underlying mortgages in estimating future cash flows for individual mortgage-backed securities. For other debt securities in the available-for-sale and held-to-maturity categories, premiums and discounts are amortized or accreted over the lives of the respective securities, with consideration of historical and estimated prepayment rates, as an adjustment to yield using the interest method. Interest income is recognized when earned. Realized gains and losses from the sale of any securities classified as available-for-sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
Declines in the fair value of securities below their cost that are deemed to be other-than-temporary are reflected in operations as realized losses. In estimating other-than-temporary impairment
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
losses, management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. The analysis requires management to consider various factors, which include (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security; (2) duration and magnitude of the decline in value; (3) the financial condition of the issuer or issuers; (4) structure of the security; and (5) the intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value.
If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, the Company assesses whether the impairment is other-than-temporary. If the Company intends to sell the debt security, an other-than-temporary impairment shall be considered to have occurred. If the Company does not intend to sell the debt security, the Company considers available evidence to assess whether it more likely than not it will be required to sell the security before the recovery of its amortized cost basis. If the Company more likely than not will be required to sell the security before recovery of its amortized cost basis, an other-than-temporary impairment shall be considered to have occurred.
If the Company does not expect to recover the entire amortized cost basis of the security, an other-than-temporary impairment shall be considered to have occurred. Similarly, if the present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (i.e., a credit loss exists), and an other-than-temporary impairment shall be considered to have occurred. In such situations, the credit loss is recorded through earnings as an other-than-temporary impairment.
Loans
Interest on loans is credited to income based on the principal amount outstanding. Loans are considered delinquent whenever interest and/or principal payments have not been received when due. The recognition of interest income is discontinued when, in management’s judgment, the interest will not be collectible in the normal course of business. Subsequent payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income. Loans are returned to accrual status when management believes full collectability of principal and interest is expected. The Banks consider a loan impaired when all amounts due - both principal and interest - will not be collected in accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. When measuring impairment for loans, the expected future cash flows of an impaired loan are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan; however, the Banks would measure impairment based on the fair value of the collateral, using observable market prices, if foreclosure was probable.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Loan origination fees and certain direct loan origination costs are deferred and recognized as an adjustment to interest income over the lives of the related loans using the interest method.
The reserve for loan losses is available to absorb loan charge-offs. The reserve is increased by provisions charged to operations and is reduced by loan charge-offs less recoveries. Loans are partially or fully charged off when Bank management believes such amounts are uncollectible, either through collateral liquidation or cash payment. The provision charged to operations each year is that amount which management believes is sufficient to bring the balance of the reserve to a level adequate to absorb estimated losses inherent in the loan portfolio, based on their knowledge and evaluation of past losses, the current loan portfolio, and the current economic environment in which the borrowers of the Banks operate.
Management believes the reserve for loan losses is adequate to absorb losses in the loan portfolio based upon information available. While management uses available information to recognize losses on loans, future additions to the reserve may be necessary based on changes in economic conditions. Additionally, various regulatory agencies, as an integral part of the examination process, periodically review the Banks’ reserves for loan losses. Such agencies may require the Banks to add to their reserves for loan losses based on their judgments and interpretations about information available to them at the time of their examinations.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation of premises and equipment is computed over the expected lives of the assets, using the straight-line method. Estimated useful lives are 40 years for bank buildings and three to ten years for furniture, fixtures, and equipment. Expenditures for major renewals and improvements of bank premises and equipment (including related interest expense, which was $85,984, for the year ended December 31, 2008) are capitalized, and those for maintenance and repairs are expensed as incurred.
Certain long-lived assets, such as premises and equipment, and certain identifiable intangible assets must be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable. In such situations, recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets, using observable market prices. Assets to be disposed of would be reported at the lower of the carrying amount or estimated fair value, less estimated selling costs.
Other Real Estate Owned
Other real estate owned represents property acquired through foreclosure, or deeded to the Banks in lieu of foreclosure, for loans on which borrowers have defaulted as to payment of principal and interest. Properties acquired are initially recorded at the lower of the Banks’ carrying amount of the related loan or fair value, using observable market prices, less estimated selling costs. Valuations are performed periodically by management, and an allowance for losses is established by means of a charge to noninterest expense if the carrying value of a property exceeds its fair value, using observable market prices, less estimated selling costs. Subsequent increases in the
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
fair value (less estimated selling costs) are recorded through a reversal of the allowance, but not below zero. Costs related to development and improvement of property are capitalized, while costs relating to holding the property are expensed.
Intangible Assets
Identifiable intangible assets include the core deposit premium relating to the Company’s acquisition of The Bank of Godfrey in 2003, which is being amortized into noninterest expense on a straight-line basis over 15 years. Amortization of the core deposit intangible assets existing at December 31, 2010 will be $16,288 for each of the next five years, and $39,362 thereafter.
The excess of the Company’s consideration given in its acquisition of The Bank of Godfrey over the fair value of the net assets acquired is recorded as goodwill, an intangible asset on the consolidated balance sheets. Goodwill is the Company’s only intangible asset with an indefinite useful life, and the Company is required to test the intangible asset for impairment on an annual basis. Impairment is measured as the excess of carrying value over the fair value of an intangible asset with an indefinite life. No impairment writedown was required in 2010, 2009, or 2008.
Federal Home Loan Bank Stock
Included in other assets at December 31, 2010 and 2009 are equity securities totaling $6,256,000 and $7,221,300, respectively, representing common stock of the Federal Home Loan Bank of Des Moines and the Federal Home Loan Bank of Atlanta, which are administered by the Federal Housing Finance Agency. As members of the Federal Home Loan Bank system, the Banks must maintain minimum investments in the capital stock of their respective district Federal Home Loan Banks. The stock is recorded at cost, which represents redemption value.
Securities Sold Under Agreements to Repurchase
The Banks enter into sales of securities under agreements to repurchase at specified future dates. Such repurchase agreements are considered financing arrangements and, accordingly, the obligation to repurchase assets sold is reflected as a short-term borrowing liability in the consolidated balance sheets. Repurchase agreements are collateralized by debt securities which are under the control of the Banks.
Reserve for Unfunded Commitments
A reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities (including unfunded loan commitments and letters of credit) and is included in other liabilities in the consolidated balance sheets. The determination of the appropriate level of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience and credit risk grading. Net adjustments to the reserve for unfunded commitments are included in other noninterest expense in the consolidated statements of operations.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Income Taxes
The Company and Banks file consolidated federal and state income tax returns. Applicable income tax expense is computed based on reported income and expenses, adjusted for permanent differences between reported and taxable income. Penalties and interest assessed by income taxing authorities are included in income tax expense in the year assessed, unless such amounts relate to an uncertain tax position. The Company had no uncertain tax positions at December 31, 2010 or 2009.
The Company and Banks use the asset and liability method of accounting for income taxes, in which deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period which includes the enactment date.
The Company’s consolidated federal income tax returns for the years ended December 31, 2009 and 2008 are presently being audited by the Internal Revenue Service. The Company’s consolidated Illinois state income tax returns for the years ended December 31, 2009 and 2008 were audited by the state of Illinois, with no material differences noted. The Company’s other state income tax returns have never been examined by the applicable state taxing authorities. The Company’s federal and state income tax returns are subject to examination generally for three years after such returns are filed.
Mortgage Banking Operations
The Banks’ mortgage banking operations include the origination of long-term, fixed rate residential mortgage loans for sale in the secondary market. Upon receipt of an application for a residential real estate loan, the Banks generally lock in an interest rate with the applicable investor and, at the same time, lock into an interest rate with the customer. This practice minimizes the Banks’ exposure to risk resulting from interest rate fluctuations. Upon disbursement of the loan proceeds to the customer, the loan is delivered to the applicable investor. Sales proceeds are generally received within two to seven days later. Therefore, no loans held for sale are included in the Banks’ loan portfolios at any point in time, except those loans for which the sale proceeds have not yet been received. Such loans are maintained at the lower of cost or market value, based on the outstanding commitment from the applicable investors for such loans.
Loan origination fees are recognized upon the sale of the related loans and included in the consolidated statements of operations as other noninterest income. The Banks do not retain the servicing rights for any such loans sold in the secondary market.
Stock Issuance Costs
The Company incurs certain costs associated with the issuance of its common and preferred stock. Such costs are recorded as a reduction of equity capital.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Earnings per Share
Basic earnings (loss) per share data is calculated by dividing net earnings (loss) attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution of earnings (loss) per share which could occur under the treasury stock method if contracts to issue common stock, such as stock options, were exercised. The following table presents a summary of per share data and amounts for the periods indicated.
As of December 31, 2010, 2009 and 2008, options to purchase 1,969,916, 2,091,266, and 1,593,450 shares, respectively, were excluded from the earnings per share calculation because their effect was anti-dilutive.
Stock Options
Compensation costs relating to share-based payment transactions are recognized in the Company’s consolidated financial statements over the period of service to which such compensation relates (generally the vesting period), and are measured based on the fair value of the equity instruments issued. The grant date values of share options are estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost would be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
No stock options were granted in 2010. The weighted average fair value of options granted in 2008 was $1.89 for an option to purchase one share of Company common stock; however, the Company’s common stock is not actively traded on any exchange. Accordingly, the availability of fair value information for the Company’s common stock is limited. In using the Black-Scholes option pricing model to value the options, several assumptions have been made in arriving at the estimated fair value of the options granted, including minimal or no volatility in the Company’s common stock price, expected forfeitures of 10%, no dividends paid on the common stock, an expected weighted average option life of six years, and a risk-free interest rate approximating the U.S. treasury rates for the applicable duration period. Any change in these assumptions could have a significant impact on the effects of determining compensation costs. No value was ascribed
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
to the options granted in 2009, as the option price exceeded the market value of the stock on the grant date.
Financial Instruments
For purposes of information included in note 14 regarding disclosures about financial instruments, financial instruments are defined as cash, evidence of an ownership interest in an entity, or a contract that both (a) imposes on one entity a contractual obligation to deliver cash or another financial instrument to a second entity or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (b) conveys to that second entity a contractual right to receive cash or another financial instrument from the first entity or to exchange other financial instruments on potentially favorable terms with the first entity.
Fair Value Measurements
The Company uses fair value measurements to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income, and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
•
Level 1 - Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. treasury and federal agency securities and federal agency mortgage-backed securities, which are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
•
Level 2 - Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or similar assets or liabilities.
•
Level 3 - Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or value assigned to such assets or liabilities.
While certain assets are recorded at the lower of cost or fair value (e.g., other real estate owned, loans held for sale, impaired loans, etc.), the only assets recorded at fair value on a recurring basis by the Company are investments in available-for-sale debt securities, which are measured at fair value using Levels 2 and 3 valuation inputs. For all debt securities other than the trust preferred debt securities described below, the market valuation utilizes several sources, primarily pricing sources, which include observable inputs rather than “significant unobservable inputs” and, therefore, fall into the Level 2 category.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table summarizes financial instruments measured at fair value on a recurring basis as of December 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
Included in investments in available-for-sale debt securities are collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (TRUP CDOs). Given conditions in the debt markets and the absence of observable transactions in the secondary and new issue markets for TRUP CDOs, the few observable transactions and market quotations that are available are not reliable for the purpose of determining fair value, and an income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs is more representative of fair value than the market approach valuation techniques. Accordingly, the TRUP CDOs have been classified within Level 3 of the fair value hierarchy because significant adjustments are required to determine fair value at the measurement date, particularly regarding estimated default probabilities based on the credit quality of the specific issuer institutions for the TRUP CDOs. The TRUP CDOs are the only assets for which fair value is measured on a recurring basis using Level 3 inputs. Following is further information regarding such assets for the years ending December 31, 2010, 2009, and 2008:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Reclassifications
Certain reclassifications have been made to the 2009 and 2008 consolidated financial statement amounts to conform to the 2010 presentation. Such reclassifications have no effect on the previously reported net loss or stockholders’ equity.
Subsequent Events
The Company has considered all events occurring subsequent to December 31, 2010 for possible disclosures through the filing date of this Annual Report on Form 10-K.
NOTE 2 - CASH AND DUE FROM BANKS
The Banks are required to maintain certain daily reserve balances of cash and due from banks in accordance with regulatory requirements. The reserve balances maintained in accordance with such requirements at December 31, 2010 and 2009 were $333,000 and $737,000, respectively.
NOTE 3 - INVESTMENTS IN DEBT SECURITIES
The amortized cost, gross unrealized gains and losses, and estimated fair values of the Banks’ available-for-sale debt securities at December 31, 2010 and 2009 were as follows:
The amortized cost and estimated fair values of debt securities classified as available-for-sale at December 31, 2010, by contractual maturity, are shown below. Expected maturities may differ
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Notes to Consolidated Financial Statements
from contractual maturities because certain issuers have the right to call or prepay obligations with or without prepayment penalties.
Provided below is a summary of available-for sale debt securities which were in an unrealized loss position at December 31, 2010 and 2009:
The obligations of U.S. government agencies and corporations and U.S. agency residential mortgage-backed securities with unrealized losses are primarily issued from and guaranteed by the Federal Home Loan Bank, Federal National Mortgage Association, or Federal Home Loan Mortgage Corporation. The obligations of states and political subdivisions with unrealized losses are primarily comprised of municipal bonds with adequate credit ratings, underlying collateral, and/or cash flow projections. The unrealized losses associated with these securities are not believed to be attributed to credit quality, but rather to changes in interest rates and temporary market movements. In addition, the Banks do not intend to sell the securities with unrealized losses, and it is not more likely than not that the Banks will be required to sell them before recovery of their amortized cost bases, which may be at maturity.
Trust preferred securities are comprised of trust preferred collateralized debt obligations issued by banks, thrifts and insurance companies. The market for trust preferred securities at December 31,
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
2010 and 2009 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spreads in the brokered markets in which trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as a minimal number of trust preferred securities have been issued since 2007. Very few market participants are willing and/or able to transact for these securities. The market values for the securities are very depressed relative to historical levels. The Banks do not intend to sell the trust preferred securities, and it is more likely than not that the Banks will not be required to sell them.
The Banks’ trust preferred securities consist of the following issues at December 31, 2010:
The Company has reviewed its trust preferred security pools and determined that the collateral should be divided between two specific industries for credit analysis - banks and insurance companies. The Company then determined the industry specific default rates for the two industries. The bank rate was determined by reviewing each individual institution and its performance using publicly available information. The insurance company rate was determined by examining a study by a well-known rating agency that displayed the average one-year impairment rate.
To determine a pool-specific loss rate, the Company determined that a common indicator was needed for each issuer. For banks, the Company obtained an estimated regulatory rating from a well-known financial institution rating service to use as an indicator of default probability. The Company then adjusted the default rate from 0.20% to 1.00% based on the regulatory rating obtained. For insurance companies, the Company obtained the rating for the primary insurance company to use as an indicator of default probability and modified the default rate from 0.25% to 1.25% based on the ratings.
To obtain the expected annual default rate for the pool, the Company computed the weighted average rating for each issuer based on the remaining issuance amount as a percentage of the total remaining collateral. Any issuer with a specific default rate was only weighted by the portion of the issuance remaining after the application of the specific default rate. The Company reviews the assumptions quarterly for reasonableness and will update those assumptions that management believes have changed given market conditions, changes in deferrals and defaults, as well as other factors that can impact these assumptions. Based on the results of this analysis, the Company
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
ensures that actual deferrals/defaults as well as forecasted deferrals/defaults of specific institutions are appropriately factored into the cash flow projections for each security.
In the tables above, “Excess subordination as percentage of the remaining performing collateral” (Excess Subordination Ratio) was calculated as follows: (total face value of performing collateral less face value of all outstanding note balances not subordinate to the Company’s investment) ÷ total face value of performing collateral. The Excess Subordination Ratio measures the extent to which there may be tranches within each pooled trust preferred structure available to absorb credit losses before the Company’s securities would be impacted. A positive Excess Subordination Ratio signifies there is some support from subordinate tranches available to absorb losses before the Company’s investment would be impacted, while a negative Excess Subordination Ratio for each of the mezzanine tranche securities indicates there is no support. A negative Excess Subordination Ratio is not definitive, in isolation, for determining whether or not an other-than-temporary credit loss should be recorded for a pooled trust preferred security. Other factors affect the timing and amount of cash flows available for payments to the note holders (investors), including the excess interest paid by the issuers (the issuers typically pay higher rates of interest than are paid out to the note holders).
As noted in the above table, some of the Company’s investments in trust preferred securities have experienced fair value deterioration due to credit losses but are not otherwise considered to be other-than-temporarily impaired (OTTI). The following table provides information about those trust preferred securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income (loss) for the years ended December 31, 2010 and 2009:
The carrying value of debt securities pledged to secure public funds, securities sold under repurchase agreements, certain borrowings, and for other purposes amounted to approximately $150,544,000 and $160,923,000 at December 31, 2010 and 2009, respectively. The Banks have also pledged letters of credit from the Federal Home Loan Banks totaling $9,118,574 and $17,791,974 as additional collateral to secure public funds at December 31, 2010 and 2009, respectively.
During 2010, 2009, and 2008, certain available-for-sale securities were sold for proceeds totaling $20,848,467, $56,075,085, and $35,428,956, respectively, resulting in gross gains of $295,024, $1,346,806, and $342,864, respectively, and gross losses of $7,515, $241, and $21,751, respectively.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 4 - LOANS
The composition of the loan portfolio at December 31, 2010 and 2009 is as follows:
The Banks grant commercial, industrial, residential, and consumer loans (including overdrafts totaling $119,430 and $50,070 at December 31, 2010 and 2009, respectively) throughout the St. Louis, Missouri, Phoenix, Arizona, and Houston, Texas metropolitan areas and southwestern Florida. The Banks do not have any particular concentration of credit in any one economic sector, except that a substantial portion of the portfolio is concentrated in and secured by real estate in the St. Louis, Missouri metropolitan area and southwestern Florida, particularly commercial real estate and construction of commercial and residential real estate. The ability of the Banks’ borrowers to honor their contractual obligations is dependent upon the local economies and their effect on the real estate market.
The aggregate amount of loans to executive officers and directors and loans made for the benefit of executive officers and directors was $36,585,775 and $62,282,603 at December 31, 2010 and 2009, respectively. Such loans were made in the normal course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility. A summary of activity for loans to executive officers and directors for the year ended December 31, 2010 is as follows:
Other changes represent changes in the composition of executive officers, directors, and their related entities which occurred in 2010.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Transactions in the reserve for possible loan losses for the years ended December 31, 2010, 2009, and 2008 are summarized as follows:
The Company risk rates all of the loans in its loan portfolio, using a 1-7 risk rating system, with a “1” rated credit being a high quality loan and a “7” rated credit having some level of loss in the credit. Loan officers are responsible for risk-rating their own credits, including maintaining the risk rating on a current basis. Downgrades are discussed at various management and loan committee meetings. The risk ratings are also subject to an on-going review by an extensive loan review process performed independent of the loan officers. An adequately controlled risk rating process allows Company management to conclude that the Banks’ watch lists (which include all credits risk-rated “4” or greater) are, for all practical purposes, a complete profile of situations with current loss exposure.
All loans included in the watch lists require separate action plans to be developed to reduce the level of risk inherent in the credit relationship. Based on the information included on the watch lists and a review of each individual credit relationship thereon, the Company determines whether a credit is impaired.
When measuring impairment for loans, the expected future cash flows of impaired loans are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of collateral for a collateral dependent loan; however, substantially all of the Company’s presently impaired credit relationships are collateralized by (and derive their ultimate cash flows therefrom) commercial, construction, or residential real estate and, accordingly, virtually all of the Company’s impairment calculations for the present portfolio have been based on the underlying values of the real estate collateral.
The Banks’ watch lists include complete listings of credit relationships that are considered to be impaired, along with an assessment of the estimated impairment loss to be included as specific exposure for impaired loans. Such impairment calculations are based on current appraisals of the underlying real estate collateral. The Company regularly obtains updated appraisals for all of its impaired credit relationships. The continued decline in real estate values experienced by the Company during the three years ended December 31, 2010 has resulted in an increased level of the reserve for loan losses for these specifically identifiable impairment losses.
The sum of all exposure amounts calculated for impaired loans are included in the reserve for loan losses as the specifically-identifiable losses portion of the account balance. This is one portion of the reserve for loan losses. The second portion of the reserve for loan losses is a general reserve for all credit relationships not considered to be specifically impaired. This amount is calculated by first calculating the historical charge-off ratio for each of the particular loan categories and then subjectively adjusting these historical ratios for several economic and environmental factors. The adjusted ratio for each loan category is then applied against the nonimpaired loans in that loan
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
category, resulting in a general reserve for that particular loan category. The sum of these general reserve categories, when added to the amount of specifically identified losses on impaired credits, results in the final reserve for loan losses balance for a particular date. The Banks follow this process for calculating the reserve for loan losses on a quarterly basis.
In calculating the general portion of the reserve for possible loan losses, the loan categories used are real estate construction, residential real estate, commercial real estate, commercial and industrial, and consumer loans. In 2009 and 2008, historical charge-off ratios were calculated on a rolling 36-month basis, which resulted in higher reserve levels with the increased levels of charge-offs experienced during the past three years. Beginning in the fourth quarter of 2010, the Company has reduced this historical “look-back” period to a rolling 24-month period on a consolidated basis to more closely relate current periods with the most recent historical data, and thus require less adjustment for the other environmental factors. This change resulted in an increase to the general portion of the reserve for possible loan losses of approximately $5,696,000 at December 31, 2010 from the amount that would have been required using the rolling 36-month historical charge-off ratios.
The economic and environmental factors for which adjustments are made to the historical charge-off ratios include the following:
•
changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses.
•
changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments.
•
changes in the nature and volume of the portfolio and in the terms of loans.
•
changes in the experience, ability, and depth of lending management and other relevant staff.
•
changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans.
•
changes in the quality of the Banks’ loan review systems.
•
changes in the value of underlying collateral for collateral-dependent loans.
•
the existence and effect of any concentrations of credit, and changes in the level of such concentrations.
•
the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Banks’ existing portfolios.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 2010, the Company’s consolidated reserve for loan losses calculation had the following components (in thousands of dollars):
Specifically identifiable exposure on impaired loans:
General reserve for nonimpaired credits:
At December 31, 2009, the Company’s consolidated reserve for loan losses calculation had the following components (in thousands of dollars):
Specifically identifiable exposure on impaired loans:
General reserve for non-impaired credits:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Following is an analysis of the reserve for possible loan losses by loan type and those that have been specifically evaluated or evaluated in aggregate at December 31, 2010 and 2009 (in thousands of dollars):
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Following is a summary of past due loans by type and by number of days delinquent at December 31, 2010 and 2009 (in thousands of dollars):
Following is a summary of impaired loans by type at December 31, 2010 and 2009 (in thousands of dollars):
Following is a summary of loans on nonaccrual status by type at December 31, 2010 and 2009 (in thousands of dollars):
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Had the Banks’ nonaccrual loans continued to accrue interest, the Banks would have earned additional income of $10,159,025, $4,425,441, and $1,716,845 during the years ended December 31, 2010, 2009, and 2008, respectively.
Following is a summary of loans segregated based on credit quality indicators at December 31, 2010 and 2009 (in thousands of dollars):
NOTE 5 - PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2010 and 2009 is as follows:
Amounts charged to noninterest expense for depreciation aggregated $2,078,116, $2,239,106 and $2,319,204, for the years ended December 31, 2010, 2009, and 2008, respectively.
Certain branch construction contracts have involved contracts for construction with a general contracting company that is majority-owned by one of the Company’s directors. All construction contracts entered into by the Company have been made under formal sealed bid processes. During the years ended December 31, 2010, 2009, and 2008, the Company paid $8,931, $4,122, and $715,470, respectively, to the construction company owned by the Company director for construction costs incurred.
Reliance Bank leases certain premises under noncancelable operating lease agreements that expire at various dates through 2026, with various options to extend the leases. Minimum rental
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
commitments for payments under all noncancelable operating lease agreements at December 31, 2010 for each of the next five years, and in the aggregate, are as follows:
Total rent paid by the Company in 2010, 2009, and 2008 was $710,691, $761,852, and $750,113, respectively.
Reliance Bank leases out a portion of certain of its banking facilities to unaffiliated companies under noncancelable leases that expire at various dates through 2016. Minimum rental income under these noncancelable leases at December 31, 2010, for each of the next five years and in the aggregate, is as follows:
Total rental income recorded by the Reliance Bank in 2010, 2009, and 2008 totaled $261,742, $288,100, and $260,970, respectively.
Included in land and construction in progress at December 31, 2009 were four parcels of property located in southwestern Florida which were purchased for future branch expansion. The Company determined that it would not be constructing branches on those sites in the foreseeable future and, accordingly, has transferred the properties to other real estate owned and recognized an impairment charge of $3,402,512 in other real estate expense, to write down the land to the properties’ fair values based on current appraisals.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 6 - DEPOSITS
A summary of interest-bearing deposits at December 31, 2010 and 2009 is as follows:
Deposits of executive officers, directors and their related interests at December 31, 2010 and 2009 totaled $23,929,128 and $14,687,238, respectively.
Interest expense on deposits for the years ended December 31, 2010, 2009, and 2008 is summarized as follows:
Following are the maturities of time deposits for each of the next five years and in the aggregate at December 31, 2010:
NOTE 7 - INCOME TAXES
The components of income tax expense (benefit) for the years ended December 31, 2010, 2009, and 2008 are as follows:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A reconciliation of expected income tax expense (benefit) computed by applying the Federal statutory rate of 34% to loss before applicable income tax benefit for the years ended December 31, 2010, 2009, and 2008 is as follows:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 2010, 2009, and 2008 are presented below:
The Company is required to provide a valuation reserve on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. The Company had not established a valuation reserve at December 31, 2009 or 2008 due to management’s belief and analysis that future income levels would be sufficient to realize the net deferred tax assets recorded. In 2010, the Company received a total of $1,951,677 for the carryback of net operating losses for tax reporting purposes of prior years. At December 31, 2010, the Company has deferred tax assets of $13,609,596 for net operating loss carryforwards for federal tax reporting purposes totaling $38,561,563 which will expire beginning in 2029, if unused. The Company also has
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
deferred tax assets for operating loss carryforwards for Florida state income tax reporting purposes totaling $1,084,856 for losses incurred by Reliance Bank, F.S.B. Such operating losses totaled $19,724,646 at December 31, 2010, and will begin to expire, if unused, by 2023. Given the Company’s cumulative losses that have occurred through 2010, the Company has established a valuation reserve of $26,076,828 for its deferred tax assets. This valuation reserve will be reversed when the Company demonstrates a consistent earnings trend and begins using the net operating loss for tax reporting purposes.
NOTE 8 - SHORT-TERM BORROWINGS
At December 31, 2010 and 2009, short-term borrowings consisted entirely of securities sold under repurchase agreements of $15,177,855 and $12,696,932, respectively. The Banks also purchase funds from the Federal Home Loan Banks of Des Moines and Atlanta and other financial institutions on a daily basis, when needed for liquidity. At December 31, 2010, Reliance Bank also maintained a line of credit with availability, subject to a collateral and credit review, in the amount of $22,450,433 with the Federal Reserve Bank of St. Louis. Funds purchased, securities sold under repurchase agreements, and the line of credit with the Federal Reserve Bank of St. Louis are collateralized by debt securities with a net carrying value of approximately $85,973,000 and $48,728,000 at December 31, 2010 and 2009, respectively.
During 2008, the Company executed a short-term note payable for $7,000,000 with an unaffiliated financial institution which bore interest at 8.50%. The note was repaid at its maturity on March 31, 2009.
The average balances, maximum month-end amounts outstanding, average rates paid during the year, and average rates at year end for funds purchased and securities sold under repurchase agreements and total short-term borrowings as of and for the years ended December 31, 2010, 2009, and 2008 were as follows:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 9 - LONG-TERM FEDERAL HOME LOAN BANK BORROWINGS
At December 31, 2010, the Banks had fixed rate advances outstanding with the Federal Home Loan Bank of Des Moines and the Federal Home Loan Bank of Atlanta, maturing as follows:
At December 31, 2010, Reliance Bank maintained a line of credit in the amount of $165,779,654 with the Federal Home Loan Bank of Des Moines and had availability under that line of $66,761,080. Federal Home Loan Bank of Des Moines advances are secured under a blanket agreement which assigns all Federal Home Loan Bank of Des Moines stock and one- to four-family and multi-family mortgage and commercial real estate loans. Additionally, at December 31, 2010, Reliance Bank, FSB maintained a line of credit in the amount of $8,960,000 (of which $5,860,000 was available) with the Federal Home Loan Bank of Atlanta, secured by one- to four-family residential loans.
NOTE 10 - EMPLOYEE BENEFITS
The Company sponsors a contributory 401(k) savings plan to provide retirement benefits to eligible employees. Contributions made by the Company in 2010, 2009, and 2008 totaled $86,144, $145,305, and $292,353, respectively.
NOTE 11 - CAPITAL STOCK
The Company has authorized 40,000,000 shares of common stock with a par value of $0.25 per share. At December 31, 2010, 22,481,804 shares were issued and outstanding, with 2,595,250 shares reserved for issuance under the Company’s stock option programs. Holders of the Company’s common stock are entitled to one vote per share on all matters submitted to a shareholder vote. Holders of the Company’s common stock are entitled to receive dividends when, as and if declared by the Company’s Board of Directors. In the event of liquidation of the Company, the holders of the Company’s common stock are entitled to share ratably in the remaining assets after payment of all liabilities and preferred shareholders as described below.
The Company has authorized 2,000,000 shares of no par preferred stock, with 42,555 shares issued and outstanding at December 31, 2010. Preferred stock may be issued by the Company’s Board of Directors from time to time, in series, at which time the terms of such series (par value per share, dividend rates and dates, cumulative or noncumulative, liquidation preferences, etc.) shall be fixed by the Board of Directors. On February 13, 2009, the Company issued 40,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series A for a total of $40,000,000, and 2,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series B for no
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
additional funds, to the United States Department of the Treasury under its Troubled Assets Relief Program Capital Purchase Program authorized by the Emergency Economic Stabilization Act of 2008.
On November 10, 2009, the Company authorized 25,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, no par value, Series C for sale with an offering price of $1,000 per share. The offering was extended to existing shareholders who are accredited investors (as such term is defined in Regulation D of the Securities Act of 1933, as amended) and to other accredited investors to subscribe for and purchase shares of this series. During 2009 and 2010, the Company sold 555 shares for proceeds totaling $555,000.
The Series A preferred stock pays a dividend at the rate of 5% per annum for the first five years and 9% thereafter. Dividends are payable quarterly and each share has a liquidation amount of $1,000 and has liquidation rights in pari passu with other preferred stock and is paid in liquidation prior to the Company’s common stock. The Series B preferred stock pays a dividend at the rate of 9% per annum, payable quarterly and includes other provisions similar to the Series A preferred stock with liquidation at $1,000 per share. The Series C preferred stock pays a dividend at the rate of 7% per annum, payable quarterly and includes other provisions similar to the Series A preferred stock with liquidation at $1,000 per share.
On January 18, 2011, the Company’s Board of Directors authorized the deferral of the Company’s February 15, 2011 dividend payment on its preferred stock totaling $554,713.
Stock-Based Compensation
Various stock option plans have been adopted (both incentive stock option plans and nonqualified stock option plans) under which options to purchase shares of Company common stock may be granted to officers, employees and directors of the Company and its subsidiary banks. All options were authorized and granted at prices approximating or exceeding the fair value of the Company’s common stock at the date of grant. Various vesting schedules have been authorized for the options granted to date by the Company’s Board of Directors, including certain performance measures used to determine vesting of certain options granted. Options expire up to ten years from the date of grant if not exercised. For certain of the options granted, the Company’s Board of Directors has the ability, at its sole discretion, to grant to key officers of the Company and Banks, the right to surrender their options held to the Company, in whole or in part, and to receive in exchange therefore, payment by the Company of an amount equal to the excess of the fair value of the shares subject to such options over the exercise price to acquire such options. Such payments may be made in cash, shares of Company common stock, or a combination thereof.
The Company may issue common stock with restrictions to certain key employees. The shares are restricted as to transfer, but are not restricted as to dividend payment or voting rights. The transfer restrictions lapse over time depending upon whether the awards are service-based or performance-based. Service-based awards are contingent upon continued employment, and performance-based awards are based on the Company meeting specified net income goals and continued employment.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Following is a summary of stock option activity for the years ended December 31, 2010 and 2009:
The total intrinsic value of options exercised during 2009 was $228,300.
A summary of the activity of nonvested options for the years ended December 31, 2010 and 2009 is as follows:
The total fair value of shares (based on the fair value of the options at their respective grant dates) subject to options that vested during the years ended December 31, 2010 and 2009 was $510,000 and $385,000, respectively.
As of December 31, 2010, the total unrecognized compensation expense related to nonvested stock options granted was $15,271, and the related weighted average period over which it was expected to be recognized was approximately seven months. During 2010 and 2009, the Company recognized stock option expense of $215,465 and $504,553, respectively.
During 2010, 2009, and 2008 the Company awarded 40,000, 20,000, and 2,500 shares, respectively, of the Company’s common stock on a restricted basis to certain officers which will vest over varying periods up to three years. The awarded shares are being amortized over the estimated vesting periods. The Company also awarded 106,300 shares of the Company’s common
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
stock that are contingent on the Company meeting specified net income goals during 2010, 2011, 2012, and 2013 or the combined four-year period ended December 31, 2013 and continued employment.
A summary of the activity of the Company’s restricted stock awards for the years ended December 31, 2010 and 2009 is as follows:
The Company amortizes the expense related to restricted stock awards as compensation expense over the requisite vesting period specified in the grant. Restricted stock awards granted to senior executive officers will vest in three years after the grant date when all funds received under the Troubled Assets Relief Program Capital Purchase Program have been paid in full. Expense for restricted stock awards of $91,489 and $50,959 was recorded for the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, the total unrecognized compensation expense related to restricted stock awards was $671,802, and the related weighted average period over which it was expected to be recognized was approximately 33 months.
Other Activity in Stockholders’ Equity
Following is a summary of other activity in the consolidated statements of stockholders’ equity for the years ended December 31, 2010, 2009, and 2008:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 12 - PARENT COMPANY FINANCIAL INFORMATION
Subsidiary bank dividends are the principal source of funds for the payment of dividends by the Company to its stockholders and for debt servicing. The Banks are subject to regulation by regulatory authorities that require the maintenance of minimum capital requirements. The Banks are also operating under regulatory agreements which restrict the payment of dividends without prior written consent from their regulators. As of December 31, 2010, there are no regulatory restrictions other than the maintenance of minimum capital standards (as discussed in note 15), as to the amount of dividends the Banks may pay.
Following are condensed balance sheets as of December 31, 2010 and 2009 and the related condensed schedules of operations and cash flows for each of the years in the three-year period ended December 31, 2010 of the Company (parent company only):
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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Notes to Consolidated Financial Statements
NOTE 13 - LITIGATION
During the normal course of business, various legal claims have arisen which, in the opinion of management, will not result in any material liability to the Company.
NOTE 14 - DISCLOSURES ABOUT FINANCIAL INSTRUMENTS
The Banks issue financial instruments with off-balance sheet risk in the normal course of the business of meeting the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit and may involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the balance sheets. The contractual amounts of those instruments reflect the extent of involvement the Banks have in particular classes of these financial instruments.
The Banks’ exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for financial instruments included on the
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
balance sheets. Following is a summary of the Banks’ off-balance sheet financial instruments at December 31, 2010 and 2009:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Of the total commitments to extend credit at December 31, 2010, $17,930,898 was made at fixed rates of interest. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but is generally residential or income-producing commercial property or equipment on which the Banks generally have a superior lien.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party, for which draw requests have historically not been made thereon. Such guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Following is a summary of the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2010 and 2009:
Fair values are calculated using one or more input types, as described in note 1. The following methods and assumptions were used to estimate the fair value for each class of financial instruments for which it is practicable to estimate such value:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Cash and Other Short-Term Instruments - For cash and due from banks (including interest-earning deposits in other financial institutions), accrued interest receivable (payable), loans held for sale, and short-term borrowings, the carrying amount is a reasonable estimate of fair value, as such instruments are due on demand and/or reprice in a short time period.
Investments in Available-for-Sale Debt Securities - Investments in available-for-sale debt securities are recorded at fair value on a recurring basis. The Company’s available-for sale debt securities are measured at fair value using Levels 2 and 3 valuation inputs. For all debt securities other than the trust preferred securities, the market valuation utilizes several sources, primarily pricing services, which include observable inputs rather than “significant unobservable inputs” and therefore, fall into the Level 2 category. Trust preferred securities are valued as described in note 3.
Loans - For certain homogeneous categories of loans, such as residential mortgages and other consumer loans, fair value is 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 is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and with the same remaining maturities. The fair values of impaired loans are measured as the fair value of the underlying collateral, using observable market prices.
Deposits - The fair value of demand deposits, savings accounts, and interest-bearing transaction account deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Long-Term Borrowings - Rates currently available to the Company with similar terms and remaining maturities are used to estimate the fair value of existing long-term debt.
Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms that are competitive in the markets in which it operates.
NOTE 15 - REGULATORY MATTERS
The Company and Banks are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate 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 and Banks must meet specific capital guidelines that involve quantitative measures of the Company and Banks’ assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios (set forth in the table below) 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 average assets (as defined). The Banks are also required to maintain additional capital as described below under agreements with the banking regulators. Company management believes that, as of December 31, 2010, the Company and Banks meet all capital adequacy requirements to which they are subject, except for Reliance Bank, FSB, which was less than adequately capitalized at December 31, 2010 after recording the write-down of land held for future expansion effective December 31, 2010. The Company subsequently injected $500,000 of additional capital into Reliance Bank, FSB on February 16, 2011, which brought the Bank to an adequately capitalized level, but below the threshold required by the regulatory agreement.
As of December 31, 2010, the most recent notification from the applicable regulatory authorities categorized Reliance Bank as a well capitalized bank under the regulatory framework for prompt corrective action. To be categorized as a well capitalized bank, Reliance Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that Company management believes have changed Reliance Bank’s risk categories.
The actual capital amounts and ratios for the Company, Reliance Bank, and Reliance Bank, FSB at December 31, 2010, 2009, and 2008 are presented in the following table:
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
On November 30, 2009, Reliance Bank’s Board of Directors entered into an Agreement (the Agreement) with the Missouri Division of Finance and the Federal Deposit Insurance Corporation (FDIC) to: (a) develop a plan to reduce the level of risk in each criticized asset aggregating $2,000,000 or more included in the September 21, 2009 Missouri Division of Finance examination report; (b) maintain the reserve for possible loan losses at a level which is reasonable in relation to the degree of risk inherent in the Bank’s loan portfolio; (c) develop and adopt policies and procedures designed to identify and monitor concentrations of credit, including out-of-territory loans and loan participations purchased; (d) formulate plans to reduce the Bank’s concentrations of credit, particularly in commercial real estate and land acquisition and development lending; (e) review and revise the Bank’s formal loan policy to address weaknesses noted in the September 21, 2009 Missouri Division of Finance examination report; (f) cease making or extending loans which
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
violate the Bank’s written loan policy, except in those instances in which the Board of Directors has made a prior determination that a variance from loan policy is in the best interests of the Bank, with such Board decisions appropriately documented in the minutes of the Board of Director meetings; (g) develop a formal written profit plan, which will provide a three-year budget projection for asset growth and dividend payouts to ensure Tier 1 leverage capital is maintained at least a 7% level; and (h) maintain a Tier 1 leverage capital ratio of at least 7%, and other capital ratios such that the Bank will remain well-capitalized, and not pay any dividends, management fees or bonuses, or increase any executive salary or other compensation that would reduce the Bank to a level below a well-capitalized status.
On February 10, 2010, Reliance Bank, FSB’s Board of Directors entered into a Memorandum of Understanding (the OTS MOU) with the Office of Thrift Supervision (OTS) to: (a) develop a business plan for the years ended December 31, 2010, 2011, and 2012 which shall include (1) strategies to preserve and enhance the Bank’s capital sufficient to meet its needs and support its risk profile; (2) achieve core profitability by the end of 2010; and (3) establish and maintain Board-approved loan concentration limits expressed as a percentage of risk-based capital that takes into account the Bank’s current capital position, local and regional market conditions, and the credit risks posed by higher risk loans; (b) continue to take steps to identify, classify, and properly account for problem assets, including but not limited to (1) conducting period asset quality reviews to identify and assign appropriate classifications to all problem assets; (2) performing internal impairment analyses for all problem assets identified; and (3) estimating potential losses in identified problem assets, while establishing an appropriate reserve for loan losses for all classified assets; (c) develop a detailed, written plan with specific strategies, targets, and timeframes to reduce the Bank’s level of criticized assets; (d) review the adequacy of the Bank’s reserve for loan losses policies, procedures and methodologies on at least an annual basis to ensure the timely establishment and maintenance of an adequate reserve for loan losses account balance; (e) identify and monitor all loan modifications and troubled debt restructurings, with delinquent loans that are modified being classified as substandard and placed on nonaccrual status for at least six months; (f) prohibit the increase in the dollar amount of brokered deposits; (g) analyze the major differences in and bases for significant differences in the value of assets, liabilities, and off-balance-sheet positions calculated by the OTS Net Portfolio Value and the Bank’s internal economic value of equity model; and (h) correct all deficiencies and weaknesses identified in the October 5, 2009 OTS report of examination.
On March 6, 2010, the Company entered into a Memorandum of Understanding (the Fed MOU) with the Federal Reserve Bank of St. Louis (the Federal Reserve) requiring the Company to, among other things, (a) utilize its financial and managerial resources to assist the Banks in addressing weaknesses identified during their most recent regulatory examinations, and achieving/maintaining compliance with any supervisory action between the Banks and their primary regulators; (b) declare no corporate dividends without the prior written approval of the Federal Reserve; (c) incur no additional debt without the prior written approval of the Federal Reserve; and (d) make no distributions of interest or other sums on its preferred stock without the prior written approval of the Federal Reserve.
On February 14, 2011, Reliance Bank’s Board of Directors entered into a Consent Order (the Consent Order) with the FDIC to (a) develop a written management plan to have and retain qualified management; (b) charge off adversely classified assets identified during the FDIC’s September 20, 2010 examination of Reliance Bank; (c) develop a written plan to reduce Reliance Bank’s risk exposure in each asset in excess of $2,000,000 classified as substandard or doubtful in
RELIANCE BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
the FDIC’s Report of Examination for its September 20, 2010 examination; (d) not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit or obligation with Reliance Bank that has been, in whole or in part, charged off or adversely classified as substandard or doubtful in the FDIC’s Report of Examination, unless the denial of additional credit would be detrimental to Reliance Bank, as determined by the Bank’s Board of Directors; (e) develop a written plan for systematically reducing and monitoring the Bank’s concentrations of credit as listed in the FDIC’s Report of Examination, to an amount that is commensurate with Reliance Bank’s business strategy, management expertise, size, and location; (f) review and maintain an adequate reserve for loan losses on a quarterly basis; (g) maintain minimum capital ratios of an 8% Tier 1 leverage capital ratio and 12% Total risk-based capital ratio; (h) not increase salaries or pay bonuses for any executive officer, pay management fees, or declare or pay any dividends; (i) review the liquidity, contingent funding, and interest rate risk policies and plans and develop or amend such policies and plans to address how the Bank will increase its liquid assets and reduce its reliance on volatile liabilities for liquidity purposes; (j) not accept, increase, renew, or rollover any brokered deposits; (k) develop a written three-year business/strategic plan and one-year profit and budget plan; (l) eliminate and/or correct any violations of laws, rules, and regulations identified in the FDIC’s Report of Examination; and (m) provide periodic progress reports on the above matters to the FDIC.
While no absolute assurance can be given, management of the Company and Banks believe the necessary actions have been or are being taken toward complying with the provisions of the Agreement and OTS and Fed MOUs. It is not presently determinable what actions, if any, the banking regulators might take if the provisions of the Agreement and OTS and Fed MOUs are not complied within the specific time periods required.
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Notes to Consolidated Financial Statements
NOTE 16 - QUARTERLY FINANCIAL INFORMATION (unaudited)
Following is a summary of quarterly financial information for the years ended December 31, 2010, 2009, and 2008:
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Notes to Consolidated Financial Statements
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
By: /s/ Dale E. Oberkfell
Dale E. Oberkfell
Date: March 30, 2011
Chief Financial Officer (Principal Financial and Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Index to Exhibits
3.1
Restated Articles of Incorporation of Reliance Bancshares, Inc. (filed as Exhibit 3.1 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
3.2
Bylaws of Reliance Bancshares, Inc. (filed as Exhibit 3.2 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
3.3
Certificate of Designation establishing Fixed Rate Cumulative Perpetual Preferred Stock, No Par Value, Series A, of Reliance Bancshares, Inc. (filed as Exhibit 4.1 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
3.4
Certificate of Designation establishing Fixed Rate Cumulative Perpetual Preferred Stock, No Par Value, Series B, of Reliance Bancshares, Inc. (filed as Exhibit 4.2 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
3.5
Corrected Certificate of Designation establishing Fixed Rate Cumulative Perpetual Preferred Stock, No Par Value, Series B, of Reliance Bancshares, Inc. (filed as Exhibit 4.3 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
3.6
Notice of Exempt Offerings of Securities for the issuance of Perpetual Convertible Preferred Stock, no par value, Series C. (Filed as Form D with the SEC on December 18, 2009 (File No. 021-137031) and incorporated herein by reference).
10.1
Employment Agreement between Reliance Bancshares, Inc. and Jerry S. Von Rohr, dated July 29, 1998 (filed as Exhibit 10.1 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.2
Assignment of Employment Agreement between Reliance Bancshares, Inc., Reliance Bank and Jerry S. Von Rohr, dated June 16, 1999 (filed as Exhibit 10.2 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.3
First Amendment to Employment Agreement between Reliance Bank and Jerry S. Von Rohr, dated September 1, 2001 (filed as Exhibit 10.3 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.4
Employment Agreement between Reliance Bancshares, Inc., Reliance Bank and Dale E. Oberkfell, dated March 21, 2005 (filed as Exhibit 10.4 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.5
2001 Incentive Stock Option Plan (filed as Exhibit 10.8 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.6
2001 Non-Qualified Stock Option Plan (filed as Exhibit 10.9 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.7
First Amendment of the 2001 Non-Qualified Stock Option Plan (filed as Exhibit 10.10 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.8
Second Amendment of the 2001 Non-Qualified Stock Option Plan (filed as Exhibit 10.11 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.9
2003 Incentive Stock Option Plan (filed as Exhibit 10.12 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.10
2003 Non-Qualified Stock Option Plan (filed as Exhibit 10.13 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.11
First Amendment of the 2003 Non-Qualified Stock Option Plan (filed as Exhibit 10.14 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.12
Second Amendment of the 2003 Non-Qualified Stock Option Plan (filed as Exhibit 10.15 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.13
2004 Non-Qualified Stock Option Plan (filed as Exhibit 10.16 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.14
2005 Incentive Stock Option Plan (filed as Exhibit 10.17 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.15
2005 Non-Qualified Stock Option Plan (filed as Exhibit 10.18 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.16
First Amendment of the 2005 Non-Qualified Stock Option Plan (filed as Exhibit 10.19 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.17
Agreement of Compensation Package between Jerry S. Von Rohr and the Compensation Committee of Reliance Bancshares, Inc., dated December 14, 2005 (filed as Exhibit 10.20 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.18
Reliance Bancshares, Inc. 2005 Employee Stock Purchase Plan (filed as Exhibit 10.21 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
10.19
2007 Non-Qualified Stock Option Plan (filed as Exhibit 10.26 to the registrant’s Amendment No. 2 to its Form 10 (File No. 000-52588) filed on July 19, 2007 and incorporated herein by reference).
10.20
Letter Agreement dated February 13, 2009 including the Securities Purchase Agreement - Standard Terms incorporated by reference therein between the Company and the Treasury (filed as Exhibit 4.3 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
10.21
Form of Omnibus Agreement between Reliance Bancshares, Inc. and each of Jerry S. Von Rohr, Dale E. Oberkfell, David S. Matthews, Daniel W. Jasper and Daniel S. Brown (filed as Exhibit 10.2 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
10.22
Waivers executed by each of Jerry S. Von Rohr, Dale E. Oberkfell, David S. Matthews, Daniel W. Jasper and Daniel S. Brown (filed as Exhibit 10.3 to the registrant’s Form 8-K (File No. 000-52588) filed on February 23, 2009 and incorporated herein by reference).
10.23
Employment Agreement between Reliance Bancshares, Inc. and Allan D. Ivie, IV dated June 4, 2010 (filed as Exhibit 10.1 to the Registrar’s Form 8-K filed on June 24, 2010 and incorporated herein by reference).
14.1
Reliance Bancshares, Inc. Code of Conduct and Ethics (filed as Exhibit 14.1 to the registrant’s Form 10 (File No. 000-52588) filed on April 27, 2007 and incorporated herein by reference).
21.1*
Subsidiaries of Reliance Bancshares, Inc.
31.1*
Chief Executive Officer’s Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Chief Financial Officer’s Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1*
31 C.F.R. Section 30.15 Certification of Principal Executive Officer.
99.2*
31 C.F.R. Section 30.15 Certification of Principal Financial Officer.
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Filed herewith.