Item 1B.
Unresolved Staff Comments
The Company currently operates two main offices, ten branches and an operations center. The principal administrative offices of the Company are located at 3530 Wheeler Road, Augusta, Georgia. Locations in Georgia include the main office, four branch offices in Augusta, Georgia, two branches in Martinez, Georgia and two branches in Evans, Georgia. SB&T locations include the main office and one additional branch in Aiken, South Carolina, and one leased facility in North Augusta, South Carolina. All banking offices except the leased facility are owned by the Company, are not subject to mortgage, and are covered by appropriate insurance for replacement value.
Each banking office in metro Augusta is a brick building with a teller line, customer service area, offices for the Company’s lenders, drive-in teller lanes, a vault with safe deposit boxes, and a walk-up or drive-up automated teller machine. The banking offices are generally 3,000 to 5,000 square foot buildings. Exceptions are the main office with approximately 14,000 square feet, the Washington Road branch with 1,800 square feet, and the Cotton Exchange branch with 7,500 square feet of space.
The Pine Log Road office, located in Aiken, South Carolina, opened in September 2006, and consists of a 4,000 square foot banking office with all the facilities of the metro Augusta offices. In July 2007, a 1,600 square foot drive-thru facility was opened in Evans, Georgia, and in August 2007, a 4,600 square foot full-service branch was opened in North Augusta, South Carolina. On January 10, 2008, SB&T opened its second branch in Aiken, South Carolina and relocated its main office to a 3,168 square foot wood frame historic home on Laurens Street.
In 1997, the Company acquired 24,000 square feet of commercial office space located at 3515 Wheeler Road, across the street from the main office. This office space is partially leased but mainly occupied by the Company’s mortgage operations, wealth management and construction lending departments.
Due to continued growth, the Company purchased a commercial building with approximately 45,000 square feet of office space on Columbia Road in Martinez in May 2006. This office space was renovated during 2006 and 2007, and operational functions including data processing, deposit operations, human resources, loan operations, credit administration and accounting were relocated to this facility in October 2007.
The Company’s automated teller machine network includes three drive-up machines located in major retail shopping areas as well as machines located at eleven of the twelve branch offices.
See Note 7 to the Consolidated Financial Statements for additional information concerning the Company’s premises and equipment and Note 8 to the Consolidated Financial Statements for additional information concerning the Company’s commitments under various equipment leases.
In the ordinary course of business, the Company and its subsidiaries are parties to various legal proceedings. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, there is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision would result in a material adverse change to the consolidated results of operations or financial condition of the Company or its subsidiaries.
PART II
Item 5.
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of February 17, 2011, there were approximately 997 holders of record of the Company’s common stock. As of February 17, 2011, there were 6,675,851 shares of the Company’s common stock outstanding. The Company’s common stock is traded via the Over-the-Counter Bulletin Board under the trading symbol “SBFC”. The following table reflects the range of high and low bid quotations, adjusted for stock dividends and splits, in the Company’s common stock for the past two years:
Southeastern Bank Financial Corporation Stock Price
The Company declared cash dividends of $0.13 per share on January 21, 2009, but suspended cash dividends as of April 22, 2009. The Company’s primary sources of income are dividends and other payments received from its subsidiaries. The amount of dividends that may be paid by GB&T and SB&T to the Company depends upon the subsidiaries’ earnings and capital position and is limited by federal and state law, regulations and policies.
Cash dividends on GB&T’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time when GB&T’s paid-in capital and appropriated earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the GDBF’s current rules and regulations require prior approval before cash dividends may be declared and paid if: (i) the bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the bank’s loans classified as adverse as to repayment or recovery by the GDBF at the most recent examination of the bank exceeds 80% of the bank’s equity as reflected at such examination. The SCSBFI permits a bank to pay cash dividends of up to 100% of net income in any given calendar year without prior regulatory approval if the bank received a composite “1” or “2” rating in its last state or federal examination.
The Company’s ability to pay cash dividends is further subject to continued payment of interest that is owed on subordinated debentures issued in connection with the Southeastern Bank Financial Statutory Trust I issuance in December 2005 of $10,000 of trust preferred securities, the Southeastern Bank Financial Trust II issuance in March 2006 of $10,000 of trust preferred securities, and the issuance in May 2009 of $2,947 of subordinated debentures to R.W. Pollard Enterprises, LLLP. As of December 31, 2010, the Company had approximately $22,947 of subordinated debentures outstanding. On $20,000 of the subordinated debt, the Company has the right to defer payment of interest for a period not exceeding 20 consecutive quarters. If the Company defers, or fails to make, interest payments on the subordinated debentures, the Company will be prohibited, subject to certain exceptions, from paying cash dividends on common stock until all deferred interest is paid and interest payments on the subordinated debentures resumes.
There were no shares repurchased under an existing stock repurchase plan or otherwise during the fourth quarter of 2010.
The Company did not sell any of its equity securities without registration under the Securities Act of 1933, as amended, during the fourth quarter of 2010.
See “Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for a table presenting information on equity securities subject to future issuance under the Company’s equity compensation plans.
The selected consolidated financial data presented on the following page as of December 31, 2010 and 2009 and for each of the years in the three-year period ended December 31, 2010 is derived from the audited consolidated financial statements and related notes included in this report and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data as of December 31, 2007 and 2006 is derived from audited consolidated financial statements that are not included in this report but that are included in the Annual Reports on Form 10-K filed with the Securities and Exchange Commission for those years. The per share data presented on the following page has been adjusted accordingly for the 10% stock dividend paid June 2, 2008.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollar amounts are expressed in thousands unless otherwise noted)
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and its subsidiaries, Georgia Bank & Trust Company of Augusta (“GB&T”) and Southern Bank & Trust (“SB&T”), during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and related notes to the consolidated financial statements.
Overview
The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the Augusta-Richmond County, GA-SC metropolitan statistical area, the Company had 18.62% of all deposits and was the second largest depository institution and the largest locally based institution at June 30, 2010 based on deposit levels, as cited from the FDIC’s website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services, by adding locations, and by focusing on the customer relationship management philosophy. The Company is committed to building lifelong relationships with its customers, employees, shareholders, and the communities it serves.
Net income in 2010 was $6,856 compared to a net loss of $7,985 in 2009. Although economic conditions continued to contribute to problems with loan quality, earnings were positively impacted by a decrease in the provision for loan loss expense of $15,103 primarily due to decreased losses on nonperforming assets.
The Company’s primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans decreased primarily due to decreased volumes and elevated levels of nonaccrual loans. Service charges and fees on deposits decreased due to decreases in NSF income on retail checking accounts, as a result of decreased economic activity, somewhat offset by increases in debit/ATM card income. Gain on sales of mortgage loans for 2010 increased slightly over 2009 due to higher production levels resulting from declining interest rates. Retail investment income experienced an increase due to increased activity and bond trading. Trust service fees increased due to improving market conditions. As portfolio balances increased, the level of fee based assets under management increased which resulted in higher income. Salary and benefit expenses have increased $928 from 2009 primarily due to increased incentive accruals, retail investment and trust commissions and expenses related to group insurance costs. Occupancy expense decreased $110 from 2009 primarily due to decreased depreciation expense, as a result of several assets which became fully depreciated in the first half of the year. Other operating expenses decreased $795 from 2009 primarily due to decreased maintenance agreement expense and decreased FDIC insurance expense.
The Company continues to maintain a defensive posture as uncertainty remains about the sustainability of economic recovery and has continued to focus on the net interest margin, capital preservation, liquidity management and risk mitigation. Balance sheet management, including rate changes on deposits, investment purchases and liability mix including wholesale funds levels have been key areas of focus in 2010.
Over the past four years, assets grew from $1,041,202 at December 31, 2006 to $1,607,105 at December 31, 2010. From year end 2006 to year end 2010, loans increased $138,983, and deposits increased $608,974. Net interest income for the year ended 2006 was $34,203 compared to net interest income of $45,876 in 2010. The Company has paid cash dividends of $0.13 per share each quarter since 2004 but elected to suspend dividends effective April 22, 2009 to conserve capital.
The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments received from mortgage backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net interest income in a ramp up and down annually 300 basis points (3.00%) scenario and as it applies to economic value of equity in a shock up and down 300 basis points (3.00%) scenario. The Company monitors operating expenses through responsibility center budgeting. See “Interest Rate Sensitivity” below.
Critical Accounting Estimates
The accounting and financial reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels; (4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management’s assessment of economic conditions. The Company’s Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.
The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.
Please see “Allowance for Loan Losses” and “Non-Performing Assets” for a further discussion of the Company’s loans, loss experience, and methodology in determining the allowance.
Fair Value of Financial Instruments
A significant portion of the Company’s assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, tax credits, mortgage banking derivatives and other real estate owned. At December 31, 2010 and December 31, 2009 the percentage of total assets measured at fair value was 38.58% and 23.89% respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At December 31, 2010, 5.59% of assets measured at fair value were based on significant unobservable inputs. This consisted primarily of available-for-sale securities, impaired loans and other real estate. This represents approximately 2.16% of the Company’s total assets. See Note 6 “Fair Value Measurements” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.
Other Real Estate Owned
Assets acquired through or instead of loan foreclosure are initially recorded at lower of cost or fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of property are capitalized.
Investment Securities
The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. As of December 31, 2010, the Company had approximately $13,657 of available-for-sale securities, which is approximately 0.85% of total assets, valued using unobservable inputs (Level 3). These securities were primarily non-agency mortgage-backed securities and single issuer subordinated debentures issued by financial institutions.
Results of Operations
Total assets increased $115,986, or 7.78% in 2010 compared to year end 2009 due primarily to an increase in deposits of $130,203 offset partially by repayment of other borrowings. Loans declined $63,394 or 6.76% due primarily to economic conditions and lack of demand. Management responded to the growth in deposits, the reduction in loans and a high level of liquidity at the end of 2009 by increasing investment securities. Investments increased $279,906 or 91.26% in 2010 compared to year end 2009. The Company recorded net income of $6,856 in 2010 compared to a net loss of $7,985 in 2009. The increase in net income is primarily attributable to a $15,103 decrease in provision for loan losses associated with a somewhat improved level of nonperforming assets and loan charge-offs. Loan charge-offs decreased from $24,133 in 2009 to $12,588 in 2010 and resulted primarily from lower losses in segments of the Company’s acquisition, development and construction loan portfolio (“ADC”) outside of its primary market. Loans participated with other banks on properties in the metro Atlanta market as well as ADC loans in the Athens and Savannah, Georgia markets experienced a lower level of charge offs in 2010. During 2010 losses increased somewhat in the Company’s primary market area of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA).
Interest income decreased $886 or 1.25% to $69,874 in 2010. Interest income on loans decreased $2,489 from 2009 and was primarily the result of a decline in volume as average loans decreased $60,382. Partially offsetting this was an increase in average yield from 5.70% in 2009 to 5.80% in 2010. Interest income on investment securities increased $1,499 in 2010 primarily as a result of a $152,373 increase in the average balance of the investment portfolio in 2010. The yield on the taxable investment portfolio declined from 4.88% in 2009 to 3.49% in 2010.
Interest expense decreased $4,485 to $23,998 in 2010. Interest expense on deposits decreased $3,784 to $20,465 primarily due to continuing declines in cost of funds somewhat offset by the growth of deposits. Average interest bearing deposits grew $142,225, or 12.86% in 2010. The most significant increases were in average balances of NOW and savings and money market accounts which increased $120,570 and $84,754, respectively. Average time deposits decreased $63,099 due in part to customers transferring to NOW and savings accounts as well as balances of brokered CDs which decreased from $255,876 at year end 2009 to $183,732 at year end 2010.
Noninterest income increased $347 in 2010 and was due to several factors including reduced impairment losses recognized in earnings of $879, increased retail investment income of $487, increased gain on sale of loans of $131 and increased trust service fees of $88. Offsetting these were decreased investment securities gains of $1,261 and decreased service charges and fees on deposit accounts of $125.
Noninterest expense decreased $4,696 or 10.10% in 2010 due primarily to decreased losses on sale of other real estate. Increased salaries and other personnel expense were offset by decreases in occupancy and other operating expenses. The operating efficiency ratio improved from 75.66% in 2009 to 63.59% in 2010.
The earnings performance of the Company is reflected in its return on average assets and average equity of 0.44% and 6.81%, respectively, during 2010 compared to (0.54%) and (7.92%), respectively, during 2009. Basic net income (loss) per share on weighted average common shares outstanding increased to $1.03 in 2010 compared to ($1.24) in 2009 and $1.27 in 2008. Diluted net income (loss) per share on weighted average common and common equivalent shares outstanding increased to $1.03 in 2010 compared to ($1.24) in 2009 and $1.26 in 2008.
Net Interest Income
The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, average yields earned and rates paid on those respective balances, and the resulting interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.
Average Balances, Income and Expenses, Yields and Rates
2010 compared with 2009:
Interest earning asset yields declined 39 basis points while interest bearing liability rates declined 49 basis points. As a result the Company’s average interest rate spread improved to 3.05% in 2010 as compared to 2.95% in 2009. The year over year decline in asset yields and liability costs were a result of lower market interest rates. These factors contributed to a small improvement in the net interest margin from 3.12% in 2009 to 3.18% in 2010.
The increase in average investments of $152,373 and average interest bearing deposits in other banks of $18,612 were funded primarily by increases in average interest bearing deposits of $142,225 and decreases in average loans of $60,382. For 2010, average total assets were $1,575,360, a 6.67% increase over 2009. Average interest-earning assets for 2010 were $1,445,067, or 91.73% of average total assets.
Interest income is the largest contributor to income. Interest income on loans, including loan fees, decreased $2,489 from 2009 to $53,707 in 2010. The decline was driven principally by lower average balances of loans offset in part by a 10bp increase in average yield. The average yield increased in part due to lower levels of interest reversals on non accruing loans. Average non-accrual loans decreased $7,426 from $38,651 in 2009 to $31,225 in 2010. Also, the reversal of interest income on loans placed on non-accrual declined from $1,302 in 2009 to $686 for the year ended 2010. If these non-accrual loans had been accruing interest under their original terms, approximately $1,204 in 2010 and $2,377 in 2009 would have been recognized in earnings. Interest income on investments increased $1,499 or 10.50% to $15,781 in 2010. Average investment balances increased $152,373 or 51.69% but the effect on income was substantially reduced due to a decline in the average portfolio yield. The average yield on the taxable investment portfolio declined from 4.88% in 2009 to 3.49% in 2010. Market yields available on high quality investments made during the year were lower in 2010 and were impacted by the investment of funds from increased deposits, maturities of investments coupled with funds reinvested from the liquidation of certain securities based on asset liability strategies. Average yields on interest-earning assets were 4.84% in 2010, compared to 5.23% in 2009.
Interest expense on deposits decreased $3,784 from 2009 to $20,465 in 2010. Declining interest rates paid on deposits more than offset the additional interest due to growth. The mix of interest bearing deposits also affects the interest rate spread. During 2010 the proportion of higher cost time deposits as a percent of interest bearing liabilities decreased from 46.22% to 38.31% while lower cost money management, savings and checking accounts increased from 42.26% to 54.59%. The overall result was an increase in net interest income of $3,599 or 8.51% in 2010 over 2009.
A key performance measure for net interest income is the “net interest margin”, or net interest income divided by average interest-earning assets. Unlike the “net interest spread” (the difference between interest rates earned on assets and interest rates paid on liabilities), the net interest margin is affected by the level of non-interest sources of funding used to support interest-earning assets. The Company’s net interest spread increased 10bp to 3.05% in 2010 while the net interest margin increased 6bp from 3.12% in 2009 to 3.18% in 2010. The net interest margin increase was slightly smaller than the increase in spread in 2010 due to the benefit of noninterest sources decreasing from 0.17% in 2009 to 0.13% in 2010 reflecting the reduced benefit of such balances in the net interest margin. The high level of competition in the local market for both loans and particularly deposits continues to influence the net interest margin. The net interest margin continues to be supported by demand deposits which provide a noninterest-bearing source of funds. The Company continues to focus on demand deposits and NOW accounts to help prevent further deterioration in the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing sources of funds. The net interest spread eliminates the impact of noninterest-bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in interest rates in 2010, the net interest spread increased 10 basis points to 3.05% in 2010.
2009 compared with 2008:
Interest earning asset yields declined sharply in 2009 compared to 2008, decreasing 87 basis points while interest bearing liability rates declined 93 basis points. As a result the Company’s average interest rate spread improved slightly to 2.95% in 2009 as compared to 2.89% in 2008. The year over year decline in asset yields and liability costs were a result of decreased market interest rates coupled with an increased level of liquidity. The Federal Reserve Board decreased its target Federal Funds rate seven times totaling 400 basis points during 2008. As a result, the prime interest rate dropped from 7.25% at year end 2007 to 3.25% at year end 2008. A significant portion of the Company’s loan portfolio adjusts immediately to these changes in rates while deposit liabilities typically lag. In addition, the yield on federal funds sold declined 144 basis points and negatively impacted overall asset yields. These factors contributed to the net interest margin declining from 3.24% in 2008 to 3.12% in 2009.
The increase in average loans of $33,505, average investments of $39,284, average interest bearing deposits in other banks of $45,952 and average cash and due from banks of $27,002 were funded by increases in average interest bearing deposits of $158,885 and other borrowings of $4,497, offset in part by decreases in federal funds purchased and securities sold under repurchase agreements of $19,806. For 2009, average total assets were $1,476,887, a 12.02% increase over 2008. Average interest-earning assets for 2009 were $1,351,939, or 91.54% of average total assets.
Interest income is the largest contributor to income. Interest income on loans, including loan fees, decreased $5,372 from 2008 to $56,196 in 2009. Declining interest rates accounted for approximately $7,264 reduction in interest but was offset by approximately $2,164 due to increased average balances of loans. Also affecting the overall yield on loans was an increase in average non-accrual loans of approximately $15,951 in 2009. Loans placed on non-accrual resulted in the reversal of interest income of $1,302 for the year ended 2009 and $1,003 in 2008. If these non-accrual loans had been accruing interest under their original terms, approximately $2,377 in 2009 and $1,561 in 2008 would have been recognized in earnings. Interest income on investments increased $691 to $14,282 primarily as a result of higher average balances partially offset by lower investment yields in 2009. The average yield on the taxable investment portfolio declined from 5.38% in 2008 to 4.88% in 2009 and accounted for $1,185 in decreased interest in 2009. Market yields available on high quality investments made during the year were lower in 2009 and were impacted by the investment of funds from increased deposits, maturities of investments coupled with funds reinvested from the liquidation of certain securities based on asset liability strategies. Interest income on federal funds sold decreased as the average yield declined from 1.57% in 2008 to 0.13% in 2009. Average yields on interest-earning assets were 5.23% in 2009, compared to 6.10% in 2008.
Interest expense on deposits decreased $5,768 from 2008 to $24,249 in 2009. Declining interest rates paid on deposits more than offset the additional interest due to growth. The mix of interest bearing deposits also affects the interest rate spread. During 2009 the proportion of higher cost time deposits as a percent of interest bearing liabilities increased from 40.34% to 46.22% while lower cost money management and savings accounts decreased from 31.96% to 27.28%. The overall result was an increase in net interest income of $2,091 or 5.20% in 2009 from 2008.
In 2009, the Company’s net interest margin decreased to 3.12% from 3.24% in 2008. The net interest margin deteriorated in 2009 as the benefit of noninterest sources decreased from 0.35% in 2008 to 0.17% in 2009 reflecting the reduced benefit of such balances in the net interest margin. The 2009 net interest spread of 2.95% increased 6 basis points from 2008 as a result of changes in interest rates.
Changes in the net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits. The following table: “Analysis of Changes in Net Interest Income” indicates the changes in the Company’s net interest income as a result of changes in volume and rate from 2010 to 2009, and 2009 to 2008. The analysis of changes in net interest income included in the following table indicates that on an overall basis in 2010 to 2009, the increase in the balances or volumes of interest-earning assets created a positive impact in net income. This was somewhat offset by the impact of increased volumes of interest-bearing liabilities. The rate environment of 2010 resulted in significant rate decreases on interest-earning assets and interest-bearing liabilities. In 2009 to 2008, the increase in the balances or volumes of interest-earning assets created a positive impact in net income which was partially offset by the impact of increased volumes of interest-bearing liabilities. Declining rates in 2009 resulted in rate decreases on interest-earning assets and interest-bearing liabilities.
Analysis of Changes in Net Interest Income
The variances for each major category of interest-earning assets and interest-bearing liabilities are attributable to (a) changes in volume (changes in volume times prior year rate), (b) changes in rate (changes in rate times prior year volume) and (c) combined (changes in rate times the change in volume).
Provision for Loan Losses
The provision for loan losses is the charge to operating earnings necessary to maintain the allowance for loan losses at a level which, in management’s estimate, is adequate to cover the estimated amount of probable incurred losses in the loan portfolio. The provision for loan losses totaled $15,801 for the year ended December 31, 2010 compared to $30,904 for the year ended December 31, 2009. See “Allowance for Loan Losses” for further analysis of the provision for loan losses.
Noninterest Income
Noninterest income consists of revenues generated from a broad range of financial services and activities, including service charges on deposit accounts, gain on sales of loans, fee-based services, and products where commissions are earned through sales of products such as real estate mortgages, retail investment services, trust services, and other activities. In addition, increases in cash surrender value of bank-owned life insurance, gain on sale of fixed assets, other-than-temporary losses and gains or losses realized from the sale of investment securities are included in noninterest income.
2010 compared with 2009:
Noninterest income for 2010 was $21,086, an increase of $347 or 1.67% from 2009. The net increase was the result of several offsetting factors. Net investment securities gains declined $1,261 or 49.80% primarily due to reduced sales activity in 2010. Net impairment losses declined $879 or 90.15% due primarily to large impairments recognized in 2009. Retail investment income increased $487 or 41.45% due to increased brokerage activity in 2010. Gain on sales of loans increased $131 or 1.54% and trust service fees increased $88 or 8.46% both due to increased volume. Service charges and fees on deposits declined $125 or 1.77%. The reduced level of service charges was primarily due to decreases in NSF income on retail checking accounts resulting from decreased economic activity.
2009 compared with 2008:
Noninterest income for 2009 was $20,739, an increase of $4,034 or 24.15% from 2008. Gain on sales of loans increased $2,746 as falling rates caused an increase in mortgage refinance activity coupled with improved pricing. Investment securities gains increased $2,609 due to increased sales of investments which occurred in part to asset liability strategies during the year. These increases were partially offset by other-than-temporary impairment losses of $975 and reduced service charges and fees on deposits of $240. The reduced level of service charges was primarily due to lower returned check fees resulting from decreased economic activity.
The following table presents the principal components of noninterest income for the last three years:
Noninterest Income
Noninterest Expense
2010 compared with 2009:
Noninterest expense totaled $41,815 in 2010, a decrease of $4,696 or 10.10% over 2009.
The significant decrease in noninterest expense in 2010 primarily resulted from decreased losses on sales of other real estate which decreased $4,719. The higher levels in 2009 were due to a bulk sale of ORE assets. During the fourth quarter of 2009, management became concerned with declining real estate values on foreclosed properties and concluded that liquidation of a significant portion of such assets was necessary to avoid further value declines
Salaries and other personnel expense increased $928 or 4.12% due primarily to increased incentive compensation accruals of $493, a $177 increase in commissions paid due to higher retail investment and trust commissions, an increase in group insurance costs of $204 offset in part by a $212 decrease in salaries expense due to a small decline in average full time equivalent employees. In addition, no merit increases were granted for officer level and above in 2010.
FDIC insurance expense decreased $455 or 16.71% due primarily to a special assessment of $670 levied in 2009. Occupancy expense decreased $110 in 2010 due primarily to reduced maintenance and lease contracts as a result of cost control initiatives. Loan costs remained elevated at $954 an increase of $37 over the prior year due primarily to continued expense associated with problem asset resolution and foreclosed properties.
2009 compared with 2008:
Noninterest expense totaled $46,511 in 2009, an increase of $9,759 or 26.55% over 2008.
The significant increase in noninterest expense in 2009 was from losses on sales of other real estate which increased $5,804 and a $588 valuation allowance established based on recent appraisals. The increase was due primarily to aggressive liquidation of such assets in the fourth quarter. Proceeds from sales of other real estate totaled $5,753 and a loss of $5,225 was recorded on those sales.
Salaries and other personnel expense increased $1,682 or 8.06% due primarily to a $795 increase in accruals to the Company’s non-qualified defined benefit plan, due to a reduction in the discount rate and newly added participants, and a $787 increase in retail investment and trust commissions.
FDIC insurance expense increased $1,825 or 203.14% due primarily to a special assessment of $670 and increased assessment rates. Occupancy expense increased $317 in 2009 due primarily to depreciation expense on purchases of upgraded computer systems and software. Loan costs increased $322 primarily related to the increase in expense from foreclosed properties.
The Company continues to monitor expenditures in all organizational units by utilizing specific cost-accounting and reporting methods as well as responsibility center budgeting. The following table presents the principal components of noninterest expense for the years ended December 31, 2010, 2009 and 2008.
Noninterest Expense
The Company’s efficiency ratio (noninterest expense as a percentage of net interest income and noninterest income, excluding gains and losses on the sale of investments) decreased to 63.59% in 2010 compared to 75.66% in 2009, and 64.52% in 2008.
Income Taxes
Income tax expense totaled $2,490 in 2010 compared to a benefit of $6,414 in 2009. The effective tax rate as a percentage of pre-tax income was 26.64% in 2010, 44.54% in 2009, and 31.63% in 2008.
At December 31, 2010, the Company maintains net deferred tax assets of $14,595. ASC 740-30-25 provides accounting guidance for determining when a company is required to record a valuation allowance on it deferred tax assets. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset. In making this assessment, all sources of taxable income available to realize the deferred tax asset are considered including taxable income in prior carry-back years, future reversals of existing temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards. Based on management’s assessment, no valuation allowance was deemed necessary at December 31, 2010.
The Company has no net operating loss carryforwards. The Company was able to carryback both the federal and state net operating losses (NOLs) sustained in 2009. These carrybacks generated a federal tax refund of $2,755 that was received in the first quarter of 2010 and a state tax refund of $495 that had not been received as of year end.
The Company was also able to carryback a capital loss sustained in 2009. This carryback generated a tax refund of $226, which was received in the second quarter of 2010.
Financial Condition
Composition of the Loan Portfolio
Loans are the primary component of the Company’s interest-earning assets and generally are expected to provide higher yields than the other categories of earning assets. Those higher yields reflect the inherent credit risks associated with the loan portfolio. Management attempts to control and balance those risks with the rewards associated with higher returns.
Loans outstanding averaged $902,346 in 2010 compared to $965,111 in 2009 and $934,512 in 2008. At December 31, 2010, loans totaled $874,095 compared to $937,489 at December 31, 2009, a decrease of $63,394 or 6.76%.
The Company experienced significant decreases in loan volumes and balances during 2009 and 2010 as the economy continued to worsen and as the Company worked through problem acquisition development and construction loans (“ADC loans”). ADC loans declined $87,650 or 32.46% in 2010. Partially offsetting this decline was an increase in commercial and residential real estate loans which increased $4,594 and $10,277 or 1.42% and 6.97% respectively in 2010.
The following table sets forth the composition of the Company’s loan portfolio as of December 31st for the past five years. The Company’s loan portfolio does not contain any concentrations of loans exceeding 10% of total loans which are not otherwise disclosed as a category of loans in this table. The Company has not invested in loans to finance highly-leveraged transactions (“HLT”), such as leveraged buy-out transactions, as defined by the Federal Reserve and other regulatory agencies. Loans made by a bank for recapitalization or acquisitions (including acquisitions by management or employees) which result in a material change in the borrower’s financial structure to a highly-leveraged condition are considered HLT loans. The Company had no foreign loans or loans to lesser-developed countries as of December 31st of any of the years presented.
Loan Portfolio Composition
Loans may be periodically renewed with principal reductions and appropriate interest rate adjustments. Loan maturities as of December 31, 2010 are set forth in the following table based upon contractual terms. Actual cash flows may differ as borrowers generally have the right to prepay without prepayment penalties.
Loan Maturity Schedule
At December 31, 2010
The following table presents an interest rate sensitivity analysis of the Company’s loan portfolio as of December 31, 2010. The loans outstanding are shown in the time period where they are first subject to repricing.
Sensitivity of Loans to Changes in Interest Rates
At December 31, 2010
Non-Performing Assets
As a result of management’s ongoing review of the loan portfolio, loans are classified as nonaccrual when it is not reasonable to expect collections of interest and principal under the original terms, generally when a loan becomes 90 days or more past due. These loans are classified as nonaccrual, even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. When a loan is placed on nonaccrual, the interest which has been accrued but remains unpaid is reversed and deducted from current period interest income. No additional interest is accrued and recognized as income on the loan balance until the collection of both principal and interest becomes reasonably certain. Also, there may be write downs, and ultimately, the total charge-off of the principal balance of the loan, which could necessitate additional charges to earnings through the provision for loan losses.
If non accruing loans had been accruing interest under their original terms, approximately $1,204 in 2010, $2,377 in 2009 and $1,561 in 2008 would have been recognized as earnings.
The Company is required to identify impaired loans and evaluate the collectability of both contractual interest and principal of loans when assessing the need for a loss allowance. Large pools of smaller balance homogeneous loans are collectively evaluated for impairment. A loan is considered impaired, when based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement. The amount of the impairment is measured based on the present value of future cash flows discounted at the loan’s effective interest rate or, if the loan is collateral dependent or foreclosure is probable, the fair value of collateral, less estimated selling expenses. Regulatory guidance is also considered. At December 31, 2010 and 2009, the Company had impaired loans of $25,048 and $34,667, respectively. Allowances for losses on impaired loans totaled $1,474 on balances of $14,369 and $1,979 on balances of $24,276, respectively at December 31, 2010 and 2009. Charge-offs of $6,155 were taken on these impaired loans during 2010. The amount of impaired loans, for which there is no related allowance for credit losses, totaled $10,679 and $10,391 at December 31, 2010 and 2009, respectively. Impaired loans for which there is no related allowance for credit losses are secured by collateral with fair value less estimated selling expenses in excess of the carrying amount of the loan.
Non-performing assets include nonaccrual loans, loans past due 90 days or more, restructured loans and other real estate owned. The following table, “Non-Performing Assets”, presents information on these assets as of December 31st, for the past five years. Non-performing assets were $34,000 at December 31, 2010 or 3.86% of period end loans and other real estate owned. This compares to $40,231 or 4.26% of total loans and other real estate owned at December 31, 2009.
At December 31, 2010 and 2008 there were $69 and $7,298, respectively of loans past due 90 days or more and still accruing. There were no loans past due 90 days or more and still accruing at December 31, 2009, 2007 and 2006. All loans past due 90 days or more are classified as nonaccrual loans unless the loan officer believes that both principal and interest are collectible, in which case the loan continues to accrue interest.
Troubled debt Restructurings (TDRs) are troubled loans on which the original terms have been modified in favor of the borrower or either principal or interest has been forgiven due to deterioration in the borrower’s financial condition. There were $3,514 in TDRs at December 31, 2010, of which $970 were on nonaccrual status. TDRs totaled $1,656 at December 31, 2009 and are included under nonaccrual loans in the table below
Non-Performing Assets
(1)
Restructured loans on nonaccrual status at year end are included under nonaccrual loans in the table.
The net decrease in nonaccrual loans reflects decreased levels of acquisition, development and construction loans offset in part by an increase in nonaccrual commercial and commercial real estate loans. The table below provides additional detail on loans greater than $800 at December 31, 2010.
The table below presents a roll forward of other real estate owned for the twelve month period ended December 31, 2010 and 2009, respectively.
Other Real Estate Owned
The following table provides details of other real estate owned as of December 31, 2010 and 2009, respectively.
The net decrease in other real estate owned is due to the continuing process of resolving problem loans.
Potential Problem Loans
In addition to loans disclosed above as past due, nonaccrual and restructured as of December 31, 2010, management also identified further weaknesses in $28,829 of already classified loans. These loans, principally classified for regulatory purposes as substandard, are principally commercial real estate and ADC loans in the company’s primary market area. Estimated potential losses from these potential credit weaknesses have been provided for in determining the allowance for loan losses at December 31, 2010.
Allowance for Loan Losses
The allowance for loan losses represents an allocation for the estimated amount of probable incurred losses in the loan portfolio. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.
The Company’s Board of Directors, with the recommendation of management, approves the appropriate level for the allowance for loan losses based upon internal policies and procedures, historical loan loss ratios, loan volume, size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, value of the collateral underlying the loans, specific problem loans and present or anticipated economic conditions and trends. The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics.
For significant problem loans, management’s review consists of the evaluation of the financial condition and strengths of the borrower, cash flows available for debt repayment, related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual problem loan, management classifies the loan accordingly and allocates a portion of the allowance for loan losses for that loan based on the results of the evaluations described above.
Additions to the allowance for loan losses, which are expensed on the Company’s income statement as the “provision for loan losses”, are made periodically to maintain the allowance for loan losses at an appropriate level based upon management’s analysis of risk in loan portfolio. The Company’s provision for loan losses in 2010 was $15,801, a decrease of $15,103, or 48.87% from the 2009 provision of $30,904.
The Company’s approach to ALLL reserve calculation uses two distinct perspectives, the guidelines of using Financial Accounting Standards ASC 450 (Accounting for Contingencies) and ASC 310 (Accounting by Creditors for Impairment of a Loan, for individual loans). The process is generally as follows:
•
Loans are grouped accordingly in categories of similar risk characteristics (Portfolio segments).
•
For each loan category, a four year average rolling historical net loss rate is calculated, with the loss rate more heavily weighted to the most recent two years loss history. An emergence factor is then applied to the average historical net loss rate.
•
The historical loss ratios are adjusted for internal and external qualitative factors within each loan category. The qualitative factor adjustment may be further increased for loan classifications of watch rated and substandard within each category. Factors include:
•
levels and trends in delinquencies and impaired/classified/graded loans;
•
changes in the quality of the loan review system;
•
trends in volume and terms of loans;
•
effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;
•
experience, ability, and depth of lending management and other relevant staff;
•
national and local economic trends and conditions;
•
changes in the value of underlying collateral;
•
other external factors-competition, legal and regulatory requirements;
•
effects of changes in credit concentrations
•
The resultant loss factor is applied to each loan pool to calculate the ALLL for each loan pool.
The table below indicates the allocated allowance for all loans according to loan type determined through the Company’s comprehensive allowance methodology for the years indicated. Because these allocations are based upon estimates and subjective judgment, it is not necessarily indicative of the specific amounts or loan categories in which loan losses may occur.
Allocation of the Allowance for Loan Loss
(1)
Percent of gross loans in each category to total loans adjusted for loans recorded at fair value
The allocation of the allowance for loan losses on commercial real estate loans increased $2,989 and was due in part to an increased level of classified/watch rated loans coupled with an increase in balances. The allocation of the allowance for loan losses for commercial, financial and agricultural loans increased $2,021 and was due in part to an increased level of classified/watch rated loans coupled with an increase in balances and charge offs during 2010.
In response to the economic environment, management ceased originating and participating in new out of market ADC lending opportunities, has curtailed ADC lending in its primary market and is allowing the portfolio segment to contract to reduce the Company’s near term exposure. Accordingly, in 2010, the total ADC portfolio declined $87,650 or 32.46%. In the CSRA, demand for origination of ADC loans was slow during 2010, and new loans were granted generally in pre-sold situations, or with those borrowers with longstanding superior credit relationships with the bank, having a limited number of speculative houses in inventory. The CSRA ADC portfolio declined $46,823 or 23.96%.
In 2010 charge offs declined for problem ADC loans in the Atlanta (ADC participations - Georgia), Savannah, Georgia and Athens, Georgia markets to $3,305 or 28.78% of net charge-offs. In 2009 these loans accounted for $16,427 or 70.48% of net charge-offs. Athens, GA ADC loans declined $8,853 or 44.20% to $11,178. Savannah, GA ADC loans declined $8,681 or 44.14% to $10,985. ADC participations - Georgia declined $3,393 or 34.30% to $6,500.
ADC loans in Greenville, SC experienced $1,344 in charge-offs in 2010. The charge offs related to a single borrower with upper end residential construction loans and land. The total loans in this category declined $18,911 or 91.87% to $1,673. Approximately $9,666 of the decrease was due to completed construction of an apartment complex which was reclassified to non-owner occupied commercial real estate. The loan is performing and is currently expected to be repaid upon the borrower obtaining permanent financing, or held in the portfolio. Approximately $2,625 of the decrease related to townhouses which were sold. Approximately $2,979 of the decrease related to land which was reclassified to OREO in the third quarter. In addition, approximately $1,375 of the decrease was due to completion of an office building which was reclassified to owner occupied commercial real estate. The loan is performing and currently expected to remain in the portfolio.
ADC loans in the CSRA experienced a higher level of charge-offs in 2010. Charge-offs totaled $3,270 or 28.48% of net charge-offs in 2010 compared to $725 of charge-offs or 3.11% of net charge-offs in 2009. Although the CSRA market has not experienced the same level of property value declines and delinquency as the previously identified markets it has been affected by the national recession. Management believes the local market has performed better due to several factors, including: (1) the level of military spending due to the ongoing expansion of the Army’s Fort Gordon and its missions, (2) the ongoing expansion and economic opportunities provided by the medical community around the state’s Medical College of Georgia, and (3) the reduced level of volatility shown in the Augusta/CSRA residential housing market. However, the CSRA has experienced a much higher than historical level of classified/watch rated loans as well as loans considered impaired. In addition, slow absorption on certain real estate developments has impacted property valuations. These factors, in addition to higher loss experience have contributed to an increase in the allowance.
The following table provides selected asset quality information related to the acquisition, development and construction loan portfolio as of December 31, 2010, 2009 and 2008.
Acquisition Development and Construction Loans
The following table provides details regarding charge-offs and recoveries by loan category during the most recent five year period, as well as supplemental information relating to both net loan losses, the provision and the allowance for loan losses during each of the past five years. Net charge-offs for 2010 represented 1.27% of average loans outstanding, compared to 2.42% for 2009 and 0.65% for 2008.
Allowances for Loan Losses
At December 31, 2010, the allowance for loan losses was 3.05% of outstanding loans, up from 2.38% at December 31, 2009 and 1.49% at December 31, 2008. Although net charge-offs decreased, the Company has continued to experience elevated levels of net charge-offs in the real estate construction and real estate mortgage categories in 2010. Impaired loans are evaluated based on recent appraisals of the collateral. Collateral values are monitored and further charge-offs are taken if it is determined that collateral values have continued to decline.
Management considers the allowance appropriate based upon its analysis of risk in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct. While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans. Because management evaluates such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required. See “Critical Accounting Estimates.”
Investment Securities
The Company’s investment securities portfolio increased $279,906 to $586,612 at year-end 2010 from 2009. The Company maintains an investment strategy of seeking portfolio yields within acceptable risk levels, as well as providing liquidity. The Company maintains two classifications of investments: “Held to Maturity” and “Available for Sale.” “Available for Sale” securities are carried at fair market value with related unrealized gains or losses included in stockholders’ equity as accumulated other comprehensive income, whereas the “Held to Maturity” securities are carried at amortized cost. As a consequence, with a higher percentage of securities being placed in the “Available for Sale” category, the Company’s stockholders’ equity is more volatile than it would be if a larger percentage of investment securities were placed in the “Held to Maturity” category. Although equity is more volatile, management has discretion, with respect to the “Available for Sale” securities, to proactively adjust to favorable market conditions in order to provide liquidity and realize gains on the sales of securities. The changes in values in the investment securities portfolio are not taken into account in determining regulatory capital requirements. As of December 31, 2010, except for the U.S. Government agencies and government sponsored entities, there was no issuer who represented 10% or more of stockholders’ equity within the investment portfolio. As of December 31, 2010 and 2009, the estimated fair value of investment securities as a percentage of their amortized cost was 99.38% and 99.30%, respectively. At December 31, 2010, the investment securities portfolio had gross unrealized gains of $4,998 and gross unrealized losses of $8,653, for a net unrealized loss of $3,655. As of December 31, 2009 and 2008, the investment securities portfolio had a net unrealized loss of $2,171 and a net unrealized gain of $81, respectively. The following table presents the amortized cost of investment securities held by the Company at December 31, 2010, 2009 and 2008.
Investment Securities
The following table represents maturities and weighted average yields of debt securities at December 31, 2010. Yields are based on the amortized cost of securities. Maturities are based on the contractual maturities. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Maturity Distribution and Yields of Investment Securities
Deposits
The Company’s average interest bearing liabilities increased $93,583 or 7.48% from 2009 to 2010. Average noninterest-bearing deposits increased $4,091 or 3.56%. Average deposits increased $146,316 or 11.98% over 2009 and were net of a reduction of $72,144 in brokered deposits. Average borrowings decreased $48,642 or 33.76% from 2009 to 2010. The majority of the growth in deposits reflects the Company’s strategy of consistently emphasizing deposit growth, as deposits are the primary source of funding for balance sheet growth. Borrowed funds consist of short-term borrowings, securities sold under agreements to repurchase with the Company’s commercial customers and reverse repurchase agreements with SunTrust Robinson Humphrey and Center State Bank, federal funds purchased, subordinated debentures and borrowings from the Federal Home Loan Bank.
Average interest-bearing liabilities increased $143,576 or 12.97% from 2008 to 2009, while average noninterest-bearing deposits increased $5,017 or 4.57% during the same period.
The following table presents the average amount outstanding and the average rate paid on deposits and borrowings by the Company for the years 2010, 2009 and 2008:
Average Deposit and Borrowing Balances and Rates
The following table presents the maturities of the Company’s time deposits over $100 at December 31, 2010:
Maturities of Time Deposits
This table indicates that the majority of time deposits of $100 or more have a maturity of less than twelve months. This is reflective of both the Company’s market and recent interest rate environments. Large time deposit customers tend to be extremely rate sensitive, making these deposits a volatile source of funding for liquidity planning purposes. However, dependent upon pricing, these deposits are virtually always available in the Company’s market. At December 31, 2010, the Company had $93,901 of brokered certificates of deposit that mature after 12 months. The Company does not have any time deposits of $100 or more that are not certificates of deposit.
Off-Balance Sheet Arrangements
The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company follows the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Unfunded commitments to extend credit where contractual amounts represent potential credit risk totaled $136,194 and $174,894 at December 31, 2010 and 2009, respectively. These commitments are primarily at variable interest rates.
The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available for sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.
The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’ contractual obligations, consisting of deposits, FHLB advances and borrowed funds by contractual maturity date.
Commitments and Contractual Obligations
Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.
Asset/Liability Management, Interest Rate Sensitivity and Liquidity
General. It is the objective of the Company to manage assets and liabilities to preserve the integrity and safety of the deposit and capital base of the Company by protecting the Company from undue exposure to poor asset quality and interest rate risk. Additionally, the Company pursues a consistent level of earnings as further protection for the depositors and to provide an appropriate return to stockholders on their investment.
These objectives are achieved through compliance with an established framework of asset/liability, interest rate risk, loan, investment, and capital policies. Management is responsible for monitoring policies and procedures that result in proper management of the components of the asset/liability function to achieve stated objectives. The Company’s philosophy is to support quality asset growth primarily through growth of core deposits, which include non-volatile deposits of individuals, partnerships and corporations. Management seeks to invest the largest portion of the Company’s assets in loans that meet the Company’s quality standards. Alternative investments are made in the investment portfolio. The Company’s asset/liability function and related components of liquidity and interest rate risk are monitored on a continuous basis by management. The Board of Directors reviews and monitors these functions on a monthly basis.
Interest Rate Sensitivity. The process of asset/liability management involves monitoring the Company’s balance sheet in order to determine the potential impact that changes in the interest rate environment would have on net interest income so that the appropriate strategies to minimize any negative impact can be implemented. The primary objective of asset/liability management is to continue the steady growth of net interest income, the Company’s primary earnings component within a context of liquidity requirements.
In theory, interest rate risk can be minimized by maintaining a nominal level of interest rate sensitivity. In practice, however, this is made difficult because of uncontrollable influences on the Company’s balance sheet, including variations in both loan demand and the availability of funding sources.
The measurement of the Company’s interest rate sensitivity is one of the primary techniques employed by the Company in asset/liability management. The dollar difference between assets and liabilities which are subject to interest rate repricing within a given time period, including both floating rate or adjustable instruments and instruments which are approaching maturity, determine the interest sensitivity gap.
The Company manages its sensitivity to interest rate movements by adjusting the maturity of, and establishing rates on, the interest-earning asset portfolio and interest-bearing liabilities in line with management’s expectations relative to market interest rates. The Company would generally benefit from increasing market interest rates when the balance sheet is asset sensitive and would benefit from decreasing market rates when it is liability sensitive. At December 31, 2010, the Company’s interest rate sensitivity position was liability sensitive within the one-year horizon.
The following table “Interest Sensitivity Analysis” details the interest rate sensitivity of the Company at December 31, 2010. The principal balances of the various interest-earning and interest-bearing balance sheet instruments are shown in the time period where they are first subject to repricing, whether as a result of floating or adjustable rate contracts. At December 31, 2008 the Company instituted floors on various categories of its variable rate loan portfolio. In most cases the floors are between 5.50% and 6.00% and based upon the prime interest rate plus a margin. The prime interest rate at December 31, 2010 was 3.25%. At this level the prime based variable rate loans will essentially have the characteristics of fixed rate loans until the prime rate increases above 5.50% to 6.00%. Fixed rate time deposits are presented according to their contractual maturity while variable rate time deposits reprice with the prime rate and are presented in the within three months time frame. Prime savings accounts reprice at management’s discretion when prime is below 5.00% and at 50% of the prime rate when prime is greater than 5.00%. In the table presented below, prime savings reprices in the within three months time frame. Regular savings, money management and NOW accounts do not have a contractual maturity date and are presented as repricing at the earliest date in which the deposit holder could withdraw the funds. All other borrowings are shown in the first period in which they could reprice. In the one-year time period, the pricing mismatch on a cumulative basis was liability sensitive $397,720 or 26.71% of total interest-earning assets. Management has procedures in place to carefully monitor the Company’s interest rate sensitivity as the rate environment changes. It should also be noted that all interest rates do not adjust at the same velocity. As an example, the majority of the savings category listed below is priced on an adjustable basis. When prime is greater than 5.00%, it is fifty percent of the prime rate. Therefore, as the prime rate adjusts 100 basis points, the rate on this liability only adjusts 50 basis points. Moreover, varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities. Investments prepayments are reflected at their current prepayment speeds in the interest sensitivity analysis report. No other prepayments are reflected in the following interest sensitivity analysis report. Prepayments may have significant effects on the Company’s net interest margin. Hence, gap is only a general indicator of interest rate sensitivity and cannot be interpreted as an absolute measurement of the Company’s interest rate risk.
Interest Sensitivity Analysis
At December 31, 2010
Liquidity
Management of the Company’s liquidity position is closely related to the process of asset/liability management. Liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to provide sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. The Company intends to meet its liquidity needs by managing cash and due from banks, federal funds sold and purchased, maturity of investment securities, principal repayments received from mortgage-backed securities and lines of credit as necessary. GB&T and SB&T each maintain a line of credit with the Federal Home Loan Bank approximating 10% of their total assets. Federal Home Loan Bank advances are collateralized by eligible first mortgages, commercial real estate loans and investment securities. GB&T maintains repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $20,000 of which no amounts were outstanding at December 31, 2010. GB&T has a federal funds purchased accommodation with SunTrust Bank, Atlanta, Georgia, for advances up to $10,000 and a $10,000 repurchase line of credit with Center State Bank, Orlando, Florida. Additionally, liquidity needs can be supplemented by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers. The Company also uses retail securities sold under repurchase agreements to fund operations. Retail securities sold under repurchase agreements were $818 at December 31, 2010.
Capital
Total stockholders’ equity was $99,958 at December 31, 2010, an increase of $6,214 or 6.63% from the previous year. The Company purchased no shares of treasury stock in 2010, and 302 shares in 2009 at a cost of $0 and $5, respectively, which is shown as a reduction of stockholders’ equity. The Company issued no shares of treasury stock in 2010 and 302 shares in 2009 at a price of $0 and $5, respectively, for the Director Stock Purchase Plan.
The Company’s average equity to average total assets was 6.39% in 2010 compared to 6.82% in 2009 and 6.78% in 2008. Capital is considered to be adequate to meet present operating needs and anticipated future operating requirements.
Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on the Company’s capital resources or operations. The following table presents the return on equity and assets for the years 2010, 2009 and 2008.
Return on Equity and Assets
At December 31, 2010, the Company was well above the minimum capital ratios required under the regulatory risk-based capital guidelines and was considered well capitalized. The following table presents the capital ratios for the Company and its subsidiaries.
ANALYSIS OF CAPITAL
Cash Flows from Operating, Investing and Financing Activities
Net cash provided by operating activities was $38,351 in 2010, an increase of $19,041 from 2009. Net cash provided by operating activities was $19,310 in 2009, an increase of $11,529 from 2008. An increase in net proceeds from sales of real estate loans over real estate loans originated for sale of $6,387 contributed to the increase.
Net cash provided by investing activities decreased $235,979 in 2010 to a net cash used of $231,487. The decrease was principally due to growth in the investment securities portfolio in 2010. Loans decreased $42,517 in 2010 compared to a decrease in loans of $5,281 in 2009. In addition, the Company received proceeds from sale of other real estate of $8,008. Net cash provided by investing activities increased $189,926 in 2009 to $4,492. Loans decreased $5,281 in 2009 compared to an increase in loans of $127,889 in 2008.
Net cash provided by financing activities in 2010 was $110,257, an increase of $23,833 from 2009. The primary reason was the decrease in federal funds purchased and securities sold under repurchase agreements which was offset by a $10,779 decline in deposit growth compared to 2009. Cash was used to repay $17,000 in advances from Federal Home Loan Bank. Net cash provided by financing activities in 2009 was $86,424, a decrease of $103,939 from 2008. The primary reason for the decrease was slower deposit growth of $46,404 compared to 2008 coupled with a decrease in federal funds purchased and securities sold under repurchase agreements. In addition cash from financing activities included the issuance of common stock of $9,010 and proceeds of issuance of subordinated debt of $2,947. Deposit accounts provided cash flows of $140,982 in 2009, a decrease of $46,404 over 2008. Cash provided by federal funds purchased and securities sold under repurchase agreements decreased $40,752 in 2009. Cash was used to repay $7,000 in advances from Federal Home Loan Bank.
Forward-Looking Statements
The Company may from time to time make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economy, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including regulations relating to branching and acquisitions; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.
Adoption of New Accounting Standards
In July 2010, the FASB amended existing guidance related to financing receivables and the allowance for credit losses, which requires further disaggregated disclosures that improve financial statement users’ understanding of 1) the nature of an entity’s credit risk associated with its financing receivables and 2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this standard is not expected to have a material effect on the Company’s result of operations or financial position but it does require expansion of the Company’s disclosures.
In January 2010, the FASB amended previous guidance related to fair value measurements and disclosures, which requires new disclosures for transfers in and out of Levels 1 and 2 and requires a reconciliation to be provided for the activity in Level 3 fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Levels 1 and 2 and provide an explanation for the transfers. This guidance is effective for interim periods beginning after December 15, 2009, and did not have a material effect on the Company’s results of operations or financial position.
In the reconciliation for fair value measurements using unobservable inputs (Level 3) a reporting entity should present separately information about purchases, sales, issuances, and settlements on a gross basis rather than a net basis. Disclosures relating to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurement will become effective beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position but it will require expansion of the Company’s future disclosures about fair value measurements.
Effects of Inflation and Changing Prices
Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation can increase a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.
Various information shown elsewhere herein will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions and compositions of the loan and security portfolios and the data on the interest sensitivity of loans and deposits should be considered.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Market risk reflects the risk of loss due to changes in the market prices and interest rates. This loss could be reflected in diminished current market values or reduced net interest income in future periods.
The Company’s market risk arises primarily from the interest rate risk inherent in its lending and deposit activities. This risk is managed primarily by careful periodic analysis and modeling of the various components of the entire balance sheet. The investment portfolio is utilized to assist in minimizing interest rate risk in both loans and deposits due to the flexibility afforded in structuring the investment portfolio with regards to various maturities, cash flows and fixed or variable rates.
The following table presents the Company’s projected changes in net interest income for the various rate shock levels as of December 31, 2010 and 2009.
Item 8.
Item 8.
Financial Statements and Supplementary Data
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Southeastern Bank Financial Corporation
Augusta, Georgia
We have audited the accompanying consolidated balance sheets of Southeastern Bank Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income (loss), stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 financial statements referred to above present fairly, in all material respects, the financial position of the Southeastern Bank Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Southeastern Bank Financial Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2011 expressed an unqualified opinion thereon.
/s/ Crowe Horwath LLP
Oak Brook, Illinois
February 25, 2011
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2010 and 2009
(continued)
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2010 and 2009
See accompanying notes to consolidated financial statements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Loss)
Years ended December 31, 2010, 2009 and 2008
(continued)
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Loss)
Years ended December 31, 2010, 2009 and 2008
See accompanying notes to consolidated financial statements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)
Years ended December 31, 2010, 2009 and 2008
(Dollars in thousands, except per share data)
(continued)
(continued)
See accompanying notes to consolidated financial statements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
(continued)
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
See accompanying notes to consolidated financial statements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(1)
Summary of Significant Accounting Policies
Southeastern Bank Financial Corporation and its wholly owned subsidiaries (collectively the “Company”), consisting of Southeastern Bank Financial Corporation (the “Parent”), Georgia Bank & Trust Company of Augusta, Georgia (“GB&T”), and Southern Bank and Trust Company of Aiken, South Carolina (“SB&T”), offer a wide range of lending services, including real estate, commercial, and consumer loans to individuals and small to medium-sized businesses and professionals that are located in, or conduct a substantial portion of their business in, the Richmond and Columbia Counties of Georgia, and Aiken County, South Carolina.
The Company is subject to competition from other financial institutions and is also subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by those regulatory authorities. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a description of the more significant of those policies the Company follows in preparing and presenting its consolidated financial statements.
(a)
Basis of Presentation
The consolidated financial statements include the accounts of Southeastern Bank Financial Corporation and its wholly owned subsidiaries, Georgia Bank & Trust Company of Augusta, Georgia and Southern Bank and Trust Company of Aiken, South Carolina. Significant intercompany transactions and accounts are eliminated in consolidation.
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, other real estate owned and other than temporary impairment of debt securities.
(b)
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, Federal funds sold, and short-term interest-bearing deposits in other banks. Generally, Federal funds are sold for one-day periods. Net cash flows are reported for loan and deposit transactions and for short term borrowings with an original maturity of 90 days or less.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(c)
Investment Securities
The Company classifies its investment securities into one of two categories: available-for-sale and held-to-maturity. Held-to-maturity securities are those debt securities for which the Company has the ability and intent to hold the security until maturity. All other securities are classified as available-for-sale.
Held-to-maturity securities are recorded at cost adjusted for the amortization or accretion of premiums or discounts. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of related tax effects, on securities available-for-sale are excluded from net income and are reported within stockholders’ equity as a component of other comprehensive income (loss) until realized.
A decline in the fair value of securities below their cost that are other than temporary are reflected as realized losses. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. In estimating other-than-temporary impairment, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, whether the market decline was affected by macroeconomic conditions, and whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. If either of the criteria regarding intent or requirement to sell is met, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. For debt securities that do not meet the aforementioned criteria, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. For equity securities, the entire amount of impairment is recognized through earnings.
Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using a method which approximates the effective interest method and takes into consideration prepayment assumptions. Dividends and interest income are recognized when earned. Realized gains and losses for investment securities available-for-sale which are sold are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(d)
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal outstanding less unearned loan fees, reduced by an allowance for loan losses. Interest on loans is calculated using the simple interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the straight line method without anticipating prepayments. Accrual of interest is generally discontinued on loans that become past due 90 days or more. These loans are classified as nonaccrual, even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. When a loan is placed on nonaccrual status, all interest accrued but not received is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Concentration of Credit Risk:
Most of the Company’s business activity is with customers located within the Augusta-Richmond County, GA-SC metropolitan statistical area. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in this area. The Company also has a significant concentration of loans with real estate developers.
Certain Purchased Loans:
The Company purchases individual loans; some of which have shown evidence of credit deterioration since origination. These purchased loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.
Such purchased loans are accounted for individually based on common risk characteristics such as, credit score, loan type, and date of origination. The Company estimates the amount and timing of expected cash flows for each purchased loan, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Over the life of the loan, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Allowance for Loan Losses:
The allowance for loan losses is a valuation allowance for probable incurred credit losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. 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 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.
Commercial and commercial real estate loans over $500 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 4 years. The following portfolio segments have been identified:
The following is a discussion of the risks characteristics of these portfolio segments.
Acquisition, Development & Construction (ADC) - CSRA (Primary Market) - ADC lending carries all of the normal risks involved in lending including the changing nature of borrower and guarantor financial conditions and the knowledge that the sale of the completed lots and/or structures is likely the sole source of repayment as opposed to other forms of borrower cash flow. In addition, this type of lending carries several additional risk factors including: (1) timely project completion (contractor financial condition, commodity prices, weather delays, prospective tenant financial condition); (2) market factors (changing economic conditions, unemployment rates, end-user financing availability, interest rates); (3) competition (similar product availability, bank foreclosed properties); (4) end-product price stability.
ADC - Savannah, Georgia - ADC lending in the Savannah market carries all of the ADC risks outlined for the CSRA plus the additional risk of lending outside of the Company’s traditional market area where our knowledge of that market is not as well developed. Additionally, the Savannah market has additional economic factors at play including the impacts of the port, tourism and secondary (vacation) properties.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
ADC - Greenville, South Carolina - ADC lending in the Greenville market carries all of the risks outlined for the CSRA plus the additional risk of lending outside the Company’s traditional market area. However, since the Company has made the strategic decision to cease operations in this market, the risk remaining in this segment should diminish.
ADC - Athens, Georgia - ADC lending in the Athens market carries all of the risks outlined for the CSRA. Also, Athens continues to operate as a suburb of the greater Atlanta market. As such, it has been more susceptible to the recent significant price declines and project slowdowns caused by the recent recessions. However, since the Company has made the strategic decision to cease operations in this market, the risk remaining in this segment should diminish.
ADC Participations - Florida - ADC participation lending on projects located in Florida carries the ADC CSRA risks outlined above. Additionally, these loans also have the risk of lending out of state (market, legal, etc.) and the risk of loss of control as a junior participant subject to the direction/financial condition of the lead lender. The bank has made the strategic decision to exit this portfolio segment and is not actively seeking or originating new participations in the Florida geography. At December 31, 2010, this portfolio segment has been reduced to two participation loans, both of which have been individually analyzed for impairment and reserved accordingly.
ADC Participations - Georgia - ADC participation lending on projects located in Georgia outside the CSRA carries the ADC CSRA risks outlined above. Additionally, these loans also have the risk of lending out of market and the risk of loss of control as a junior participant subject to the direction/financial condition of the lead lender. The bank has made the strategic decision to exit this portfolio segment and is not actively seeking or originating new participations in the Georgia geography outside of our normal market area. At December 31, 2010, this portfolio segment has been reduced to one participation loan in the FAS 5 category.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Commercial Real Estate - Non Owner Occupied - This lending category includes loans for multi-family, office, warehouse, retail, hotel/motel and other non-owner occupied properties. Loans in this category carry more risk than owner-occupied properties because the property’s cash flow is not derived from the owner of the property’s business, but from unrelated tenants. These outside tenants are each subject to their own set of business risks depending upon their own financial situation, competitors, industry segment and general economic conditions. Therefore, the cash flow from the property in the form of rent may not be as stable as a one-user, owner-occupied property.
The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans that become uncollectible, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to pay. The allowance is evaluated on a regular basis utilizing estimated loss factors for specific types of loans. Such loss factors are periodically reviewed and adjusted as necessary based on actual losses.
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may advise the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The process of assessing the adequacy of the allowance is necessarily subjective. Further, and particularly in terms of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management’s current estimates of probable incurred credit losses inherent within the loan portfolio. As such, there can be no assurance that future loan charge-offs will not exceed management’s current estimate of the allowance for loan losses.
ALLL Methodology
The Company’s approach to ALLL reserve calculation uses two distinct perspectives, the guidelines of using Financial Accounting Standards ASC 450 (Accounting for Contingencies) and ASC 310 (Accounting by Creditors for Impairment of a Loan, for individual loans). The process is generally as follows:
•
Loans are grouped according in categories of similar risk characteristics.(Portfolio segments)
•
For each loan category, a four year average rolling historical net loss rate is calculated, with the loss rate more heavily weighted to the most recent two years loss history. An emergence factor is then applied to the average historical net loss rate.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
•
The historical loss ratios are adjusted for internal and external qualitative factors within each loan category. The qualitative factor adjustment may be further increased for loan classifications of watch rated and substandard within each category. Factors include:
•
levels and trends in delinquencies and impaired/classified/graded loans;
•
changes in the quality of the loan review system;
•
trends in volume and terms of loans;
•
effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;
•
experience, ability, and depth of lending management and other relevant staff;
•
national and local economic trends and conditions;
•
changes in the value of underlying collateral;
•
other external factors-competition, legal and regulatory requirements;
•
effects of changes in credit concentrations
•
The resultant loss factor is applied to each loan pool to calculate the ALLL for each loan pool.
•
The total of each loan pool is then added to the ALLL determined for individual loans evaluated for impairment in accordance with ASC 310.
Loans Held for Sale:
Mortgage loans held for sale are generally sold with servicing rights released. The Company originates mortgages to be held for sale only for loans that have been individually pre-approved by the investor. Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors.
Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
The Company bears minimal interest rate risk on these loans and only holds the loans temporarily until documentation can be completed to finalize the sale to the investor. Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in the fair values of these derivatives are included in net gains on sales of loans. Fair values of these derivatives were $2 and $182 as of December 31, 2010 and 2009, respectively.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(e)
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is provided on the straight-line basis over the estimated useful lives of the related assets, which range from three to forty years. Premises and equipment and other long term assets are reviewed for impairment when events indicate their carrying amounts may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
(f)
Other Real Estate
Assets acquired through or instead of loan foreclosure are initially recorded at lower of cost or fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of property are capitalized.
(g)
Goodwill
Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. The Company’s goodwill is not considered impaired at December 31, 2010.
(h)
Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black- Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(i)
Income Taxes
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
The Company recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other expense.
(j)
Income (Loss) Per Share
Basic net income (loss) per share is net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share includes the dilutive effect of additional potential common shares issuable under stock options. The calculation of diluted earnings (loss) per share for 2010 and 2009 excludes the dilutive effect of stock options outstanding as the effect is anti-dilutive. Income per share is restated for all stock dividends through the date of issuance of the financial statements.
(k)
Other Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
(l)
Segment Disclosures
While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company wide basis. Discrete financial information is not available other than on a Company wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(m)
Adoption of New Accounting Standards
In July 2010, the FASB amended existing guidance related to financing receivables and the allowance for credit losses, which requires further disaggregated disclosures that improve financial statement users’ understanding of 1) the nature of an entity’s credit risk associated with its financing receivables and 2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The new and amended disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this standard is not expected to have a material effect on the Company’s result of operations or financial position but it does require expansion of the Company’s disclosures.
In January 2010, the FASB amended previous guidance related to fair value measurements and disclosures, which requires new disclosures for transfers in and out of Levels 1 and 2 and requires a reconciliation to be provided for the activity in Level 3 fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Levels 1 and 2 and provide an explanation for the transfers. This guidance is effective for interim periods beginning after December 15, 2009, and did not have a material effect on the Company’s results of operations or financial position.
In the reconciliation for fair value measurements using unobservable inputs (Level 3) a reporting entity should present separately information about purchases, sales, issuances, and settlements on a gross basis rather than a net basis. Disclosures relating to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurement will become effective beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position but it will require expansion of the Company’s future disclosures about fair value measurements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(n)
Bank Owned Life Insurance
The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
(o)
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are reported as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the consolidated financial statements.
(p)
Reclassifications
Some items in the prior period financial statements were reclassified to conform to the current presentation.
(q)
Rounding
Dollar amounts are rounded to thousands except share and per share data unless otherwise noted.
(2)
Cash and Due From Banks
(3)
Investment Securities
The following tables summarize the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio at December 31, 2010 and 2009 and the corresponding amounts of unrealized gains and losses therein:
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Investment securities with a carrying amount of approximately $298,254 and $161,449 at December 31, 2010 and 2009, respectively, were pledged to secure public and trust deposits, and for other purposes required or permitted by law.
The amortized cost and fair value of the investment securities portfolio excluding equity securities are shown below by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following tables summarize the investment securities with unrealized losses at year-end 2010 and 2009, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.
Other-Than-Temporary Impairment - December 31, 2010
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under the provisions of ASC 320-10, Investments - Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
As of December 31, 2010, the Company’s security portfolio consisted of 329 securities, 160 of which were in an unrealized loss position. Of these securities with unrealized losses, 41.06% were related to the Company’s mortgage backed and corporate securities as discussed below.
Mortgage-backed Securities
At December 31, 2010, $282,059 or approximately 98.92% of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.
The Company’s mortgage-backed securities portfolio also includes five non-agency collateralized mortgage obligations with a market value of $3,073, of which four had unrealized losses of approximately $359 at December 31, 2010. These non-agency securities were rated AAA at purchase.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
At December 31, 2010, four of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions, the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition, the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. During 2009, two of these securities were considered to be other-than-temporarily impaired. Upon completion of the December 31, 2010 analysis, our model indicated that none of these securities had additional other-than-temporary impairment. During the third quarter of 2010, one of these securities was considered other-than-temporarily impaired and an OTTI loss of $96 was recorded. At December 31, 2010 this security is now in an unrealized gain position and it remains classified as available-for-sale, based on an improvement in underlying assumptions during the fourth quarter.
At December 31, 2010, the fair values of three collateralized mortgage obligations totaling $2,410 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on a yield of 10% over 1 month libor that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.
Corporate Securities
The Company holds twenty corporate securities totaling $36,133, of which thirteen had an unrealized loss of $885 at December 31, 2010. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At December 31, 2010, two of the corporate securities were rated below Investment grade and five securities to two issuers were not rated. None of the issuers were in default at December 31, 2010 but in January of 2011 the Company was notified that two trust preferred securities to the two issuers not rated had elected to defer interest payments. The issuers are both bank holding companies with operations in the Southeast. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Although these issuers have indicated they will defer payments going forward, the Company has considered the capital position of the subsidiary banks, the liquidity of the holding company, the existence and severity of publicly available regulatory agreements, and the fact that these deferrals are coming after the most severe impact of the national and regional recession. The prospect of capital formation in the current market, improving operating results of the industry overall have caused the Company to conclude that a return to normal subsidiary dividends and thus interest payments on the debt for these issuers is reasonably assured at this time. Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
At December 31, 2010, the fair values of twelve corporate securities totaling $10,741 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. The discount rates used in the valuation model were based on current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
The table below presents a rollforward of the credit losses recognized in earnings for the twelve month period ended December 31, 2010:
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Total other-than-temporary impairment recognized in accumulated other comprehensive loss at December 31, 2010 was not material.
Other-Than-Temporary Impairment - December 31, 2009
As of December 31, 2009, the Company’s security portfolio consisted of 247 securities, 100 of which were in an unrealized loss position. The majority of unrealized losses were related to the Company’s mortgage-backed and corporate securities, as discussed below.
Mortgage-backed Securities
At December 31, 2009, $195,995 or approximately 96.23% of the Company’s mortgage-backed securities totaling $203,670 were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2009.
The Company’s mortgage-backed securities portfolio also includes eleven non-agency collateralized mortgage obligations with a market value of $7,675, seven of which had unrealized losses of approximately $301 at December 31, 2009. These non-agency securities were rated AAA at purchase.
At December 31, 2009, five of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI. The assumptions used in the model include expected future default rates, loss severity and prepayments. The model also takes into account the structure of the security including credit support. Based on these assumptions, the model calculates and projects the timing and amount of interest and principal payments expected for the security. In addition, the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment. In 2009 two of these securities had OTTI losses of $491, of which $475 was recorded as expense and $16 was recorded in other comprehensive income or loss. These two securities remained classified as available-for-sale at December 31, 2009.
At December 31, 2009, the fair values of three collateralized mortgage obligations totaling $3,780 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. These securities were previously measured using Level 2 inputs. The discount rates used in the valuation model were based on a yield that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Corporate Securities
The Company held thirteen corporate securities to eight issuers totaling $10,032, of which ten had an unrealized loss of $2,594 at December 31, 2009. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities. At December 31, 2009, three of the corporate securities were rated Speculative and three were rated Investment grade by at least one of the major rating agencies, (Moody’s, S&P and Fitch). Seven of the securities to three issuers were not rated. None of the issuers were in default and to date all interest payments have been made as contracted. The Company considered several factors including the financial condition and near term prospects of the issuers and concluded that the decline in fair value was primarily attributable to temporary illiquidity and an increase in credit spreads for financial institution debt issuers due to the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2009.
At December 31, 2009, the fair values of all thirteen corporate securities were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period. These securities, eight of which totaled $4,307 were previously measured using Level 2 inputs. The discount rates used in the valuation model were based on current spreads to U.S. Treasury rates of long-term corporate debt obligations with maturities and risk characteristics similar to the subordinated debentures being measured. An additional adjustment to the discount rate for illiquidity in the market for subordinated debentures was not considered necessary based on the illiquidity premium already present in the spreads used to estimate the discount rate.
In addition to the securities discussed above, the Company had an investment in the senior debt of Silverton Financial Services, Inc. of $500 for which an other-than-temporary impairment charge was taken in the first half of 2009.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following details the two mortgage-backed securities and one single issuer corporate debt security with OTTI at December 31, 2009 and the related credit losses recognized in earnings:
Further deterioration in economic conditions could cause the Company to record additional impairment charges related to credit losses of up to $2,034 which is the carrying amount of these securities.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Total other-than-temporary impairment recognized in accumulated other comprehensive loss was $16 for securities available-for-sale at December 31, 2009.
The following table details the credit ratings and the total impairment loss related to “all other factors” recorded as a component of accumulated other comprehensive income or loss for the Company’s mortgage-backed securities.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Activity in the allowance for loan losses was as follows:
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2010.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Individually impaired loans were as follows:
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2010.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Troubled Debt Restructurings:
The Company had troubled debt restructurings with a balance of $3,514 and $1,656 included in impaired loans for 2010 and 2009. The Company has allocated $80 and $0 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2010 and 2009. The Company is not committed to lend additional amounts as of December 31, 2010 and 2009 to customers with outstanding loans that are classified as troubled debt restructurings.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company, through its originating account officer, places an initial credit risk rating on every loan. An annual review and analysis of loan relationships (irrespective of loan types included in the overall relationship) with total related exposure of $500 or greater is performed by the Credit Administration department in order to update risk ratings given current available information. The Company uses the following definitions for risk ratings.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Watch: Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of December 31, 2010.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The Company is also committed to extend credit to certain directors and executives of the Company, including companies in which they are principal owners, through personal lines of credit, letters of credit, and other loan commitments. As of December 31, 2010, available balances on these commitments to these persons aggregated approximately $10,728.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Activity in the valuation allowance was as follows:
Expenses related to foreclosed assets include:
(6)
Fair Value Measurements
Fair value is the exchange price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:
Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:
Significant other observable inputs other than Level 1 prices, such as quoted market prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3:
Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3) as more fully discussed in Note 3. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.
Mortgage Banking Derivatives: The fair value of mortgage banking derivatives is determined by individual third party sales contract prices for the specific loans held at each reporting period end (Level 2 inputs). The fair value adjustment is included in other assets.
Loans Held for Sale: Loans held for sale are carried at fair value, as determined by outstanding commitments, from third party investors (Level 2).
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Investments in Tax Credits: The fair values for tax credits are measured on a recurring basis and are based upon total credits and deductions remaining to be allocated and total estimated credits and deductions to be allocated (Level 3 inputs).
Other Real Estate Owned: The fair value of other real estate owned is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Management may adjust the appraised value for estimated costs to sell. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Assets and Liabilities Measured on a Recurring Basis
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Assets and Liabilities Measured on a Non-Recurring Basis
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following represents impairment charges recognized during the period:
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(7)
Premises and Equipment
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The Company is committed under various operating leases for office space and equipment. At December 31, 2010, minimum future lease payments under non-cancelable real property and equipment operating leases are as follows:
The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit is represented by the contractual amount of those instruments. The Company follows the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Lines of credit are legally binding contracts to lend to a customer, as long as there is no violation of any condition established in the contract. These commitments have fixed termination dates and generally require payment of a fee. As commitments often expire prior to being drawn, the amounts above do not necessarily represent the future cash requirements of the commitments. Credit worthiness is evaluated on a case by case basis, and if necessary, collateral is obtained to support the commitment.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Securities Sold Under Repurchase Agreements
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Advances from Federal Home Loan Bank
The Company has an available line of credit from the Federal Home Loan Bank of Atlanta (FHLB) in an amount not to exceed 10% of total assets. The line of credit is reviewed annually by the FHLB. The following advances were outstanding under this line at December 31, 2010 and 2009.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The FHLB has the option to convert the fixed-rate advances and convertible advances to three-month, LIBOR-based floating-rate advances at various dates throughout the terms of the advances.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
In December 2005 the Company issued $10,000 of unsecured subordinated debentures, which bear interest at three-month LIBOR plus 1.40% (1.70% at December 31, 2010), adjusted quarterly, to Southeastern Bank Financial Statutory Trust I. The Company used these funds to capitalize Southern Bank and Trust. Southeastern Bank Financial Statutory Trust I is a wholly owned subsidiary of the Company which is not consolidated in these financial statements. Southeastern Bank Financial Statutory Trust I acquired these debentures using the proceeds of its offerings of $10,000 of Trust Preferred Securities to outside investors. The Trust Preferred Securities qualify as Tier 1 capital under Federal Reserve Board guidelines up to certain limits and accrue and pay distributions quarterly at a variable per annum rate of interest, reset quarterly, equal to LIBOR plus 1.40% of the stated liquidation amount of $1 thousand dollars per Capital Security. The Company has entered into contractual arrangements which constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Southeastern Bank Financial Statutory Trust I under the Trust Preferred Securities.
The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on December 15, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Southeastern Bank Financial Statutory Trust I in whole or in part at any time. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be 100% of their principal amount plus accrued but unpaid interest.
In March 2006 the Company issued $10,000 of unsecured subordinated debentures, which bear interest at three-month LIBOR plus 1.40% (1.70% at December 31, 2010), adjusted quarterly, to Southeastern Bank Financial Trust II. The Company used $5,000 of the proceeds to contribute additional capital to Southern Bank & Trust on June 28, 2007. The remaining $5,000 has been used for general corporate purposes. Southeastern Bank Financial Trust II is a wholly owned subsidiary of the Company which is not consolidated in these financial statements. Southeastern Bank Financial Statutory Trust I acquired these debentures using the proceeds of its offerings of $10,000 of Trust Preferred Securities to outside investors. The Trust Preferred Securities qualify as Tier 1 capital under Federal Reserve Board guidelines up to certain limits and accrue and pay distributions quarterly at a variable per annum rate of interest, reset quarterly, equal to LIBOR plus 1.40% of the stated liquidation amount of $1 thousand dollars per Capital Security. The Company has entered into contractual arrangements which constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Southeastern Bank Financial Trust II under the Trust Preferred Securities.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on June 15, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Southeastern Bank Financial Trust II in whole or in part, on or after June 15, 2011 and in whole or in part at any time within 90 days following the occurrence of a Tax Event, an Investment Company Event or a Capital Treatment Event. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be 100% of their principal amount plus accrued but unpaid interest. Prior to June 15, 2011, the redemption of any debenture following a Tax Event, an Investment Company Event or a Capital Treatment Event, will be an amount in cash equal to 100.785% of the principal amount of the debentures. Thereafter, an amount equal in cash the principal amount of the debentures plus unpaid interest will be redeemed at 100.00%.
In May 2009 the Company issued a $2,947 unsecured subordinated debenture, which bears interest at a rate of 8.0% per annum, to a related party, R.W. Pollard Enterprises, LLP. The Company used the proceeds to increase capital at the Bank. The debenture matures on May 14, 2014 and the Company has the right to redeem the debenture, in whole or in part, at any time after May 14, 2012. As specified in the indenture, if the debenture is redeemed prior to maturity, the redemption price will be the principal amount plus any accrued and unpaid interest.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
ASC 740-30-25 provides accounting guidance for determining when a company is required to record a valuation allowance on its deferred tax assets. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset. In making this assessment, all sources of taxable income available to realize the deferred tax asset are considered including taxable income in prior carry-back years, future reversals of existing temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards. Based on management’s assessment, no valuation allowance was deemed necessary at December 31, 2010.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Georgia and South Carolina. The Company is no longer subject to examination by federal and state taxing authorities for years before 2007.
The Company and its subsidiaries 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 consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2010, that the Company meets all capital adequacy requirements to which it is subject.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
As of December 31, 2010, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. Management is not aware of the existence of any conditions or events occurring subsequent to December 31, 2010 which would affect the Bank’s well capitalized classification.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Southeastern Bank Financial Corporation and Georgia Bank and Trust Company are regulated by the Department of Banking and Finance of the State of Georgia (DBF). The DBF requires that state banks in Georgia generally maintain a minimum ratio of Tier 1 capital to total assets of four and one-half percent (4.5%) for banks and four percent (4%) for holding companies. These ratios are shown in the preceding tables as Tier 1 Capital - leverage (to qtrly average assets). The Company’s ratio at 7.39% and the Bank’s ratio at 7.24% exceed the minimum required, at December 31, 2010.
Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies to 50% of the preceding year’s earnings. Based on this limitation, the amount of cash dividends available for payment in 2011 from GB&T is approximately $3,413 and from SB&T is approximately $203, subject to maintenance of the minimum capital requirements.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The Company also has salary continuation agreements in place with certain key officers. Such agreements are structured with differing benefits based on the participants overall position and responsibility. These agreements provide the participants with a supplemental income upon retirement at age 65, additional incentive to remain with the Company in order to receive these deferred retirement benefits and a compensation package that is competitive in the market. These agreements vest over a ten year period, require a minimum number of years service, and contain change of control provisions. All benefits would cease in the event of termination for cause, and if the participant’s employment were to end due to disability, voluntary termination or termination without cause, the participant would be entitled to receive certain reduced benefits based on vesting and other conditions. The estimated cost of an annuity to pay this obligation is being accrued over the vesting period for each officer. The Company recognized expense of $1,295, $1,512, and $717, during 2010, 2009 and 2008, respectively, related to these agreements. The total amount accrued at December 31, 2010 and 2009 was $6,850 and $5,627, respectively.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
During 2006, the Company adopted the 2006 Long-Term Incentive Plan (the 2006 Plan), approved by shareholders at the annual meeting, which allows for stock options awards for up to 275,000 shares of the Company’s common stock to key employees, officers, directors and independent contractors providing material services to the Company. The purpose of the Plan is to enhance stockholder investment by attracting, retaining and motivating key employees, officers, directors and independent contractors of the Company, and to encourage stock ownership by such persons by providing them with a means to acquire a proprietary interest in the Company’s success, and to align the interests of management with those of stockholders. Under the provisions of the 2006 Plan, the option price is determined by a committee of the board of directors at the time of grant and may not be less than 100% of the fair value of the common stock on the date of the grant of such option. Notwithstanding the foregoing, in the case of an Incentive Stock Option granted to a Participant who is a Ten Percent or more Stockholder, the Option Price shall not be less than one hundred and ten percent (110%) of the Fair Market Value of the Common Stock on the Date of Grant. Generally, when granted, these options vest over a five-year period. All options must be exercised within a ten year period from the date of the grant; however, options issued to a ten percent or more stockholder must be exercised within a five year period from its date of grant. As of December 31, 2010 and 2009, total options granted under this Plan were 100,517. As of December 31, 2010, 174,483 shares remain available for future grants under this Plan.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The fair value of each option is estimated on the date of grant using the Black-Scholes valuation model that uses the assumptions noted in the following table. Expected volatility is the measure of the amount by which the share price is expected to fluctuate during a period. The method used to calculate historical average annualized volatility is based on the closing price of the first trade of each month. Expected dividends are based on the Company’s historical pattern of dividend payments. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The risk-free rate is the U.S. Treasury note at the time of grant for the expected term of the option.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
A summary of activity for stock options with a specified vesting period follows:
Information related to the stock options that vest over a specified period follows:
All stock options issued are incentive stock options and therefore, no tax benefit is realized.
The following table provides information for stock options that vest based on specific loan growth performance targets.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.
Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
(a)
Cash and Cash Equivalents
Fair value equals the carrying value of such assets due to their nature.
(b)
Investment Securities
As discussed in more detail in Note 6, the fair value of investment securities is based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying amount of related accrued interest receivable approximates its fair value and is not disclosed.
(c)
Loans, net
The fair value of loans is calculated using discounted cash flows by loan type. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of related accrued interest receivable approximates its fair value and is not disclosed. The carrying amount of real estate loans originated for sale approximates their fair value. The allowance for loan losses is considered a reasonable discount for credit risk.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(d)
Deposits
Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities. The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values. The carrying amount of related accrued interest payable approximates its fair value and is not disclosed.
(e)
Securities Sold Under Repurchase Agreements
Fair value approximates the carrying value of such liabilities due to their short-term nature.
(f)
Other Borrowed Funds
Fair value approximates the carrying value of such liabilities as the borrowings are at a variable rate of interest.
(g)
Advances from FHLB
The fair value of the FHLB advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms.
(h)
Subordinated debentures
The fair value for subordinated debentures is calculated based upon current market spreads to LIBOR for debt of similar remaining maturities and collateral terms.
(i)
Commitments
The difference between the carrying values and fair values of commitments to extend credit are not significant and are not disclosed.
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(19)
Condensed Financial Statements of Southeastern Bank Financial Corporation (Parent Only)
The following represents Parent Company only condensed financial information of Southeastern Bank Financial Corporation:
Condensed Balance Sheets
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Condensed Statements of Income (Loss)
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Condensed Statements of Cash Flows
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, our management, including our Chief Executive Officer and Chief Financial Officer, reviewed and evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) that is required to be included in the Company’s periodic filings with the Securities and Exchange Commission. During the fourth quarter of 2010, there were no significant changes in the Company’s internal controls that materially affected, or are reasonably likely to materially affect the Company’s internal controls over financial reporting.
Management’s Report on Internal Control over Financial Reporting
The management of Southeastern Bank Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are executed in accordance with appropriate management authorization and accounting records are reliable for the preparation of financial statements in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of the Southeastern Bank Financial Corporation’s internal control over financial reporting as of December 31, 2010. In making our assessment, management has utilized the framework published by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission “Internal Control-Integrated Framework”. Based on our assessment, management has concluded that, as of December 31, 2010, internal control over financial reporting was effective.
/s/ R. Daniel Blanton
Chief Executive Officer
(principal executive officer)
/s/ Ronald L. Thigpen
Chief Operating Officer
/s/ Darrell R. Rains
Chief Financial Officer
(principal financial officer)
Date: February 25, 2011
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
We have audited Southeastern Bank Financial Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Southeastern Bank Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, included in Item 9.A. of the Company’s Annual Report on Form 10-K. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Southeastern Bank Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Southeastern Bank Financial Corporation and Subsidiaries as of December 31, 2010 and 2009 and the related consolidated statements of income (loss), stockholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2010 and our report dated February 25, 2011 expressed an unqualified opinion on those consolidated financial statements.
/s/ Crowe Horwath LLP
Oak Brook, Illinois
February 25, 2011
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers and Corporate Governance
The Company has adopted a Code of Ethics applicable to its senior financial officers. A copy is available, without charge, upon telephonic or written request addressed to Ronald L. Thigpen, Executive Vice President, Chief Operating Officer and Assistant Corporate Secretary, Southeastern Bank Financial Corporation, 3530 Wheeler Road, Augusta, Georgia 30909, telephone (706) 738-6990. The Code of Ethics is also incorporated by reference as an exhibit to this Annual Report on Form 10-K. The remaining information in response to this item is incorporated by reference to the Company’s definitive Proxy Statement for use in connection with the 2011 annual meeting of shareholders (which definitive Proxy Statement shall be filed with the commission not later than April 30, 2011).
Item 11.
Item 11. Executive Compensation
The remaining information in response to this item is incorporated by reference to the Company’s definitive Proxy Statement for use in connection with the 2011 annual meeting of shareholders (which definitive Proxy Statement shall be filed with the commission not later than April 30, 2011).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table provides information regarding compensation plans under which equity securities of the Company are authorized for issuance. All data is presented as of December 31, 2010.
Equity Compensation Plan Table
Additional information in response to this item is incorporated by reference to the Company’s definitive Proxy Statement for use in connection with the 2011 annual meeting of shareholders (which definitive Proxy Statement shall be filed with the commission not later than April 30, 2011).
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information in response to this item is incorporated by reference to the Company’s definitive Proxy Statement for use in connection with the 2011 annual meeting of shareholders (which definitive Proxy Statement shall be filed with the commission not later than April 30, 2011).
Item 14.
Item 14. Principal Accountant Fees and Services
Information in response to this item is incorporated by reference to the Company’s definitive Proxy Statement for use in connection with the 2011 annual meeting of shareholders (which definitive Proxy Statement shall be filed with the Commission not later than April 30, 2011).
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1)
See Item 8 for a list of the financial statements as filed as a part of this report.
(2)
No financial statement schedules are applicable as the required information is included in the financial statements in Item 8.
(3)
The following exhibits are filed as part of this report. Documents incorporated by reference have been filed with the Securities and Exchange Commission. The Company’s Commission file number is: 0-24172. See “Item 1 - Description of Business - General” for additional information regarding the Company’s filings with the Commission.
Exhibit No. and Document
31.1
Certification by the Chief Executive Officer (principal executive officer)
31.2
Certification by the Chief Financial Officer (principal financial officer)
32.1
Certification by the Chief Executive Officer and Chief Financial Officer
*
Denotes a management compensatory agreement or arrangement.
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.
February 25, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated.
February 25, 2011
SIGNATURE
TITLE
/s/ Robert W. Pollard, Jr.
Robert W. Pollard, Jr.
Chairman of the Board and Director
/s/ Edward G. Meybohm
Edward G. Meybohm
Vice Chairman of the Board and Director
/s/ R. Daniel Blanton
R. Daniel Blanton
President, Chief Executive Officer and Director (Principal Executive Officer)
/s/ Ronald L. Thigpen
Ronald L. Thigpen
Executive Vice President, Chief Operating Officer and Director
/s/ Darrell R. Rains
Darrell R. Rains
Group Vice President and Chief Financial Officer (Principal Financial Officer)
EXHIBIT INDEX
*
Denotes a management compensatory agreement or arrangement.