Item 1B.
UNRESOLVED STAFF COMMENTS
There are currently no unresolved Commission staff comments.
The Company’s main office is located in a company owned 33,000 square foot building located at 719 Harkrider Street in downtown Conway, Arkansas. As of December 31, 2009 our bank subsidiary owned or leased a total of 49 branches throughout Arkansas, 9 branches in the Florida Keys and 3 branches in Southwest Florida. The Company also owns or leases other buildings that provide space for operations, mortgage lending and other general purposes. We believe that our banking and other offices are in good condition and are suitable to our needs.
While we and our bank subsidiary and other affiliates are from time to time parties to various legal proceedings arising in the ordinary course of their business, management believes, after consultation with legal counsel, that there are no proceedings threatened or pending against us or our bank subsidiary or other affiliates that will, individually or in the aggregate, have a material adverse effect on our business or consolidated financial condition.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the Nasdaq National Market in the Global Select Market System under the symbol “HOMB”. The following table sets forth, for all the periods indicated, cash dividends declared, and the high and low closing bid prices for our common stock (stock dividend adjusted).
As of February 24, 2010, there were 812 stockholders of record of the Company’s common stock.
Our policy is to declare regular quarterly dividends based upon our earnings, financial position, capital improvements and such other factors deemed relevant by the Board of Directors. The dividend policy is subject to change, however, and the payment of dividends is necessarily dependent upon the availability of earnings and future financial condition. In January 2009, the Company issued 50,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A totaling $50.0 million to the United States Department of Treasury under the Capital Purchase Program of the Emergency Economic Stabilization Act of 2008. The agreement between the Company and the Treasury limits the payment of dividends on the Common Stock to a quarterly cash dividend of not more than $0.06 per share without approval by the Treasury. This limitation will be in effect until the earlier of January 16, 2012, and the day we redeem all the Series A Preferred Shares or UST transfers them all to a third party.
There were no sales of our unregistered securities during the period covered by this report.
We currently maintain a compensation plan, Home BancShares, Inc. 2006 Stock Option and Performance Incentive Plan, which provides for the issuance of stock-based compensation to directors, officers and other employees. This plan has been approved by the stockholders. The following table sets forth information regarding outstanding options and shares reserved for future issuance under the foregoing plan as of December 31, 2009:
Performance Graph
Below is a graph which summarizes the cumulative return earned by the Company’s stockholders since its shares of common stock were registered under Section 12 of the Exchange Act on June 22, 2006, compared with the cumulative total return on the Russell 2000 Index and SNL Bank and Thrift Index. This presentation assumes that the value of the investment in the Company’s common stock and each index was $100.00 on June 22, 2006 and that subsequent cash dividends were reinvested.
Item 6.
Item 6.
SELECTED FINANCIAL DATA.
Summary Consolidated Financial Data
Summary Consolidated Financial Data - Continued
(a) All per share amounts have been restated to reflect the effect of the 8% stock dividend during 2008.
(1)
Diluted cash earnings per share reflect diluted earnings per share plus per share intangible amortization expense, net of the corresponding tax effect. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Table 20,” for the non-GAAP tabular reconciliation.
(2)
Shares of Class A preferred stock and Class B preferred stock outstanding on December 31, 2005 are assumed to have been converted to their equivalent shares/value of common stock.
(3)
Tangible calculations eliminate the effect of goodwill and acquisition-related intangible assets and the corresponding amortization expense on a tax-effected basis.
(4)
The efficiency ratio is calculated by dividing non-interest expense less amortization of core deposit intangibles by the sum of net interest income on a tax equivalent basis and non-interest income.
(5)
Leverage ratio is Tier 1 capital to quarterly average total assets less intangible assets and gross unrealized gains/losses on available-for-sale investment securities.
(6)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Table 21,” for the non-GAAP tabular reconciliation.
(7)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Table 22,” for the non-GAAP tabular reconciliation.
(8)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Table 23,” for the non-GAAP tabular reconciliation.
(9)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Table 24,” for the non-GAAP tabular reconciliation.
(10)
Fully taxable equivalent (assuming an income tax rate of 39.225%).
Item 7.
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis presents our consolidated financial condition and results of operations for the years ended December 31, 2009, 2008 and 2007. This discussion should be read together with the “Summary Consolidated Financial Data,” our financial statements and the notes thereto, and other financial data included in this document. In addition to the historical information provided below, we have made certain estimates and forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these estimates and in the forward-looking statements as a result of certain factors, including those discussed in the section of this document captioned “Risk Factors,” and elsewhere in this document. Unless the context requires otherwise, the terms “us”, “we”, and “our” refer to Home BancShares, Inc. on a consolidated basis.
General
We are a bank holding company headquartered in Conway, Arkansas, offering a broad array of financial services through our wholly owned bank subsidiary, Centennial Bank. As of December 31, 2009, we had, on a consolidated basis, total assets of $2.68 billion, loans receivable of $1.95 billion, total deposits of $1.84 billion, and stockholders’ equity of $465.0 million.
We generate most of our revenue from interest on loans and investments, service charges, and mortgage banking income. Deposits and FHLB borrowed funds are our primary source of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. We measure our performance by calculating our return on average common equity, return on average assets, and net interest margin. We also measure our performance by our efficiency ratio, which is calculated by dividing non-interest expense less amortization of core deposit intangibles by the sum of net interest income on a tax equivalent basis and non-interest income.
Key Financial Measures
(1)
See Table 20 “Diluted Cash Earnings Per Share” for a reconciliation to GAAP for diluted cash earnings per share.
(a)
All per share amounts have been restated to reflect the effect of the 8% stock dividend during 2008.
2009 Overview
Our net income increased 165.0% to $26.8 million for the year ended December 31, 2009, from $10.1 million for the same period in 2008. On a diluted earnings per share basis, our net earnings increased 124.0% to $1.12 for the year ended December 31, 2009, as compared to $0.50 for the same period in 2008.
The increase in 2009 earnings is associated with several items. During 2009, we incurred merger expenses related to the consolidation of our charters and a special assessment from the FDIC. During 2008, we had a higher provision for loan losses and other real estate owned (“OREO”) losses, sold our investment in White River Bancshares, conducted an efficiency study and incurred investment security impairments. Other 2008 to 2009 changes include a 27 basis point increase in net interest margin, reduced salaries and employee benefits and increases in recurring FDIC and state assessment fees.
We do not consider the merger expenses or the special assessment to be part of 2009 core earnings. Excluding the $1.6 million after tax or $0.07 diluted earnings per share negative impact of these two non-core items, core net income and core diluted earnings per common share for 2009 were $28.4 million and $1.19, respectively.
Our return on average assets was 1.03% for the year ended December 31, 2009, compared to 0.39% for the same period in 2008. Our return on average common equity was 7.45% for the year ended December 31, 2009, compared to 3.51% for the same period in 2008. The changes were primarily due to the previously discussed changes in net income for the year ended December 31, 2009, compared to the same period in 2008.
Our net interest margin, on a fully taxable equivalent basis, was 4.09% for the year ended December 31, 2009, compared to 3.82% for the same period in 2008. Our ability to improve pricing on our deposits and hold down the decline of interest rates on loans allowed the Company to expand net interest margin.
Our efficiency ratio (calculated by dividing non-interest expense less amortization of core deposit intangibles by the sum of net interest income on a tax equivalent basis and non-interest income) was 55.98% for the year ended December 31, 2009, compared to 62.68% for the same period in 2008. The improvement in our efficiency ratio is primarily due the on-going implementation of the efficiency study and charter consolidation combined with the improvements in our net interest margin.
Our total assets increased $104.8 million, a growth of 4.1%, to $2.68 billion as of December 31, 2009, from $2.58 billion as of December 31, 2008. Our loan portfolio decreased $5.9 million, a decline of 0.3%, to $1.95 billion as of December 31, 2009, from $1.96 billion as of December 31, 2008. Stockholders’ equity increased $181.9 million, a growth of 64.3%, to $465.0 million as of December 31, 2009, compared to $283.0 million as of December 31, 2008. The increase in stockholders’ equity is primarily associated with the issuance of $50.0 million of preferred stock to the United States Department of Treasury and the net issuance of $107.3 million or 5,692,500 shares of common stock resulting from our 2009 common stock offering combined with retained earnings for the year ended December 31, 2009. Excluding the issuance of the $50.0 million of preferred stock and the net issuance of the $107.3 million of common stock, the growth in stockholders’ equity for the year ended December 31, 2009 was 8.7%.
As of December 31, 2009, our non-performing loans increased to $39.9 million, or 2.05%, of total loans from $29.9 million, or 1.53%, of total loans as of December 31, 2008. The allowance for loan losses as a percent of non-performing loans decreased to 107.57% as of December 31, 2009, compared to 135.08% from December 31, 2008. The increase in non-performing loans is primarily the result of the continued unfavorable economic conditions, particularly in Florida the market. Non-performing loans in Florida were $30.2 million at December 31, 2009 compared to $17.3 million as of December 31, 2008.
As of December 31, 2009, our non-performing assets increased to $56.8 million, or 2.12%, of total assets from $36.7 million, or 1.42%, of total assets as of December 31, 2008. The increase in non-performing assets is primarily the result of the continued unfavorable economic conditions, particularly in the Florida market. Non-performing assets in Florida were $40.8 million at December 31, 2009 compared to $22.0 million as of December 31, 2008.
2008 Overview
Our net income decreased 50.5% to $10.1 million for the year ended December 31, 2008, from $20.4 million for the same period in 2007. On a diluted earnings per share basis, our net earnings decreased 53.7% to $0.50 for the year ended December 31, 2008, as compared to $1.08 (stock dividend adjusted) for the same period in 2007.
The 2008 year to date decrease in earnings is primarily associated with an increase in our provision for loan losses associated with the unfavorable economic conditions, particularly in the Florida market, combined with write-downs on other real estate owned, merger expenses from our bank charter consolidation and an impairment write-off on two trust preferred investment securities. These items were mitigated by our acquisition of Centennial Bancshares, Inc., a gain on the sale of our investment in White River Bancshares, Inc. and organic growth of our bank subsidiary.
Our return on average assets was 0.39% for the year ended December 31, 2008, compared to 0.92% for the same period in 2007. Our return on average equity was 3.51% for the year ended December 31, 2008, compared to 8.50% for the same period in 2007. The changes were primarily due to the previously discussed changes in net income for the year ended December 31, 2008, compared to the same period in 2007.
Our net interest margin, on a fully taxable equivalent basis, was 3.82% for the year ended December 31, 2008, compared to 3.52% for the same period in 2007. Our strong loan growth which was funded by run off in the investment portfolio and deposit growth in 2008, combined with our acquisition of Centennial Bancshares, Inc. and improved pricing on our deposits allowed the Company to improve net interest margin.
Our efficiency ratio (calculated by dividing non-interest expense less amortization of core deposit intangibles by the sum of net interest income on a tax equivalent basis and non-interest income) was 62.68% for the year ended December 31, 2008, compared to 62.10% for the same period in 2007. The change in our efficiency ratio is primarily due to continued improvement of our operations offset with the previously discussed changes in net income for the year ended December 31, 2008, compared to the same period in 2007.
Our total assets increased $288.5 million, a growth of 12.6%, to $2.58 billion as of December 31, 2008, from $2.29 billion as of December 31, 2007. Our loan portfolio increased $349.2 million, a growth of 21.7%, to $1.96 billion as of December 31, 2008, from $1.61 billion as of December 31, 2007. Stockholders’ equity increased $30.0 million, a growth of 11.9%, to $283.0 million as of December 31, 2008, compared to $253.1 million as of December 31, 2007. Asset and loan increases are primarily associated with our acquisition of Centennial Bancshares, Inc. and organic growth of our bank subsidiary. During 2008, we experienced $156.4 million of organic loan growth. The increase in stockholders’ equity was primarily the result of the $24.3 million in additional capital that was issued upon our acquisition of Centennial Bancshares, Inc. combined with the retained earnings during 2008.
As of December 31, 2008, our non-performing loans increased to $29.9 million, or 1.53%, of total loans from $3.3 million, or 0.20%, of total loans as of December 31, 2007. The allowance for loan losses as a percent of non-performing loans decreased to 135.08% as of December 31, 2008, compared to 904% from December 31, 2007. Unfavorable economic conditions in the Florida market increased our non-performing loans by $17.3 million. The remaining increase in non-performing loans is associated with our Arkansas market which includes an increase of $620,000 from our acquisition of Centennial Bancshares, Inc.
As of December 31, 2008, our non-performing assets increased to $36.7 million, or 1.42%, of total assets from $8.4 million, or 0.36%, of total assets as of December 31, 2007. The increase in non-performing assets is primarily the result of the $26.6 million increase in non-performing loans combined with a $1.7 million increase in foreclosed assets held for sale.
Critical Accounting Policies
Overview. We prepare our consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions. Our accounting policies are described in detail in the notes to our consolidated financial statements included as part of this document.
We consider a policy critical if (i) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate; and (ii) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe that the accounting policies most critical to us are those associated with our lending practices, including the accounting for the allowance for loan losses, foreclosed assets, investments, intangible assets, income taxes and stock options.
Investments. Securities available-for-sale are reported at fair value with unrealized holding gains and losses reported as a separate component of stockholders’ equity and other comprehensive income (loss), net of taxes. Securities that are held as available-for-sale are used as a part of our asset/liability management strategy. Securities that may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital, and other similar factors are classified as available-for-sale.
Loans Receivable and Allowance for Loan Losses. Substantially all of our loans receivable are reported at their outstanding principal balance adjusted for any charge-offs, as it is management’s intent to hold them for the foreseeable future or until maturity or payoff. Interest income on loans is accrued over the term of the loans based on the principal balance outstanding.
The allowance for loan losses is established through a provision for loan losses charged against income. The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable credit losses on identifiable loans that may become uncollectible and probable credit losses inherent in the remainder of the loan portfolio. The amounts of provisions for loan losses are based on management’s analysis and evaluation of the loan portfolio for identification of problem credits, internal and external factors that may affect collectability, relevant credit exposure, particular risks inherent in different kinds of lending, current collateral values and other relevant factors.
We consider a loan to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms thereof. We apply this policy even if delays or shortfalls in payments are expected to be insignificant. The aggregate amount of impaired loans is used in evaluating the adequacy of the allowance for loan losses and amount of provisions thereto. Losses on impaired loans are charged against the allowance for loan losses when in the process of collection it appears likely that losses will be realized. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When accrual of interest is discontinued, all unpaid accrued interest is reversed.
Loans are placed on non-accrual status when management believes that the borrower’s financial condition, after giving consideration to economic and business conditions and collection efforts, is such that collection of interest is doubtful, or generally when loans are 90 days or more past due. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Accrued interest related to non-accrual loans is generally charged against the allowance for loan losses when accrued in prior years and reversed from interest income if accrued in the current year. Interest income on non-accrual loans may be recognized to the extent cash payments are received, although the majority of payments received are usually applied to principal. Non-accrual loans are generally returned to accrual status when principal and interest payments are less than 90 days past due, the customer has made required payments for at least six months, and we reasonably expect to collect all principal and interest.
Foreclosed Assets Held for Sale. Assets acquired by foreclosure or in settlement of debt and held for sale are valued at estimated fair value as of the date of foreclosure, and a related valuation allowance is provided for estimated costs to sell the assets. Management evaluates the value of foreclosed assets held for sale periodically and increases the valuation allowance for any subsequent declines in fair value. Changes in the valuation allowance are charged or credited to gain or loss on OREO.
Intangible Assets. Intangible assets consist of goodwill and core deposit intangibles. Goodwill represents the excess purchase price over the fair value of net assets acquired in business acquisitions. The core deposit intangible represents the excess intangible value of acquired deposit customer relationships as determined by valuation specialists. The core deposit intangibles are being amortized over 84 to 114 months on a straight-line basis. Goodwill is not amortized but rather is evaluated for impairment on at least an annual basis. We perform an annual impairment test of goodwill and core deposit intangibles as required by FASB ASC 350, Intangibles - Goodwill and Other in the fourth quarter.
Income Taxes. We use the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based upon the difference between the values of the assets and liabilities as reflected in the financial statements and their related tax basis using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Any estimated tax exposure items identified would be considered in a tax contingency reserve. Changes in any tax contingency reserve would be based on specific development, events, or transactions.
We and our subsidiary file consolidated tax returns. Our subsidiary provides for income taxes on a separate return basis, and remits to us amounts determined to be currently payable.
Stock Options. In accordance with FASB ASC 718, Compensation - Stock Compensation and FASB ASC 505-50, Equity-Based Payments to Non-Employees, the fair value of each option award is estimated on the date of grant. The Company recognizes compensation expense for the grant-date fair value of the option award over the vesting period of the award.
Acquisitions and Equity Investments
On January 1, 2008, we acquired Centennial Bancshares, Inc., an Arkansas bank holding company. Centennial Bancshares, Inc. owned Centennial Bank, located in Little Rock, Arkansas which had total assets of $234.1 million, loans of $192.8 million and total deposits of $178.8 million on the date of acquisition. The consideration for the merger was $25.4 million, which was paid approximately 4.6%, or $1.2 million in cash and 95.4%, or $24.3 million, in shares of our common stock. In connection with the acquisition, $3.0 million of the purchase price, consisting of $139,000 in cash and 140,456 shares of our common stock, was placed in escrow related to possible losses from identified loans and an IRS examination. In the first quarter of 2008, the IRS examination was completed which resulted in $1.0 million of the escrow proceeds being released. In the fourth quarter of 2009, approximately $334,000 of losses from the escrowed loans was identified. After, we were reimbursed 100% for those losses. The remaining escrow funds were released. In addition to the consideration given at the time of the merger, the merger agreement provided for additional contingent consideration to Centennial’s stockholders of up to a maximum of $4 million, which could be paid in cash or our common stock at the election of the former Centennial accredited stockholders, based upon the 2008 earnings performance. The final contingent consideration was computed and agreed upon in the amount of $3.1 million on March 11, 2009. We paid this amount to the former Centennial stockholders on a pro rata basis on March 12, 2009. All of the former Centennial stockholders elected to receive the contingent consideration in cash. As a result of this transaction, we recorded total goodwill of $15.4 million and a core deposit intangible of $694,000 during 2008 and 2009.
In January 2005, we purchased 20% of the common stock during the formation of White River Bancshares, Inc. of Fayetteville, Arkansas for $9.1 million. White River Bancshares owns all of the stock of Signature Bank of Arkansas, with branch locations in northwest Arkansas. In January 2006, White River Bancshares issued an additional $15.0 million of common stock. To maintain our 20% ownership, we made an additional investment of $3.0 million in January 2006. During April 2007, White River Bancshares acquired 100% of the stock of Brinkley Bancshares, Inc. in Brinkley, Arkansas. As a result, we made a $2.6 million additional investment in White River Bancshares on June 29, 2007 to maintain our 20% ownership. On March 3, 2008, White River Bancshares repurchased our 20% investment in their company which resulted in a one-time gain of $6.1 million.
In our continuing evaluation of our growth plans for the Company, we believe properly priced bank acquisitions can complement our organic growth and de novo branching growth strategies. In the near term, our principal acquisition focus will be to expand our presence in Arkansas and other nearby markets, and in Florida, through pursuing FDIC-assisted acquisition opportunities. In our opinion, the fastest and lowest-risk way for well capitalized institutions like Home BancShares to gain meaningful market share in a profitable manner is to participate in accretive FDIC-assisted acquisitions. We are continually evaluating potential bank acquisitions to determine what is in the best interest of our Company. Our goal in making these decisions is to maximize the return to our investors.
Branches
We intend to continue opening new (commonly referred to de novo) branches in our current markets and in other attractive market areas if opportunities arise. During 2009, we opened a branch location in the Arkansas community of Heber Springs. During 2008, we opened two de novo branch locations. These branch locations are located in the Arkansas communities of Morrilton and Cabot. Presently, we are evaluating additional opportunities but have no firm commitments for any additional de novo branch locations.
As a result of the evaluation process for cost saving opportunities under the efficiency study, three existing Arkansas branches were closed during the second quarter of 2009. The locations closed were located in New Edinburg, Kingsland and one of our two Heights neighborhood locations in Little Rock.
Charter Consolidation
We have recently combined the charters of our subsidiary banks into a single charter and adopted Centennial Bank as the common name. In the fourth quarter of 2008, First State Bank and Marine Bank consolidated and adopted Centennial Bank as its new name. Community Bank and Bank of Mountain View were completed in the first quarter of 2009, and Twin City Bank and the original Centennial Bank finished the process in June of 2009.
All of our banks now have the same name, logo and charter, allowing for a more customer-friendly banking experience and seamless transactions across our entire banking network. We remain committed, however, to our community banking philosophy and will continue to rely on local community bank boards and management built around experienced bankers with strong local relationships.
Holding Company Status
During the second quarter of 2008, we changed from a financial holding company to a bank holding company. Since we were not utilizing any of the additional permitted activities allowed to our financial holding company status, this will not change any of our current business practices.
Results of Operations for the Years Ended December 31, 2009, 2008 and 2007
Our net income increased 165.0% to $26.8 million for the year ended December 31, 2009, from $10.1 million for the same period in 2008. On a diluted earnings per share basis, our net earnings increased 124.0% to $1.12 for the year ended December 31, 2009, as compared to $0.50 for the same period in 2008.
The increase in 2009 earnings is associated with several items. During 2009, we incurred merger expenses related to the consolidation of our charters and a special assessment from the FDIC. During 2008, we had a higher provision for loan losses and OREO losses, sold our investment in White River Bancshares, conducted an efficiency study and incurred investment security impairments. Other 2008 to 2009 changes include a 27 basis point increase in net interest margin, reduced salaries and employee benefits and increases in recurring FDIC and state assessment fees.
We do not consider the merger expenses or the special assessment to be part of 2009 core earnings. Excluding the $1.6 million after tax or $0.07 diluted earnings per share negative impact of these two non-core items, core net income and core diluted earnings per common share for 2009 were $28.4 million and $1.19, respectively.
Our net income decreased 50.5% to $10.1 million for the year ended December 31, 2008, from $20.4 million for the same period in 2007. On a diluted earnings per share basis, our net earnings decreased 53.7% to $0.50 for the year ended December 31, 2008, as compared to $1.08 (stock dividend adjusted) for the same period in 2007.
The 2008 year to date decrease in earnings is primarily associated with an increase in our provision for loan losses associated with the unfavorable economic conditions, particularly in the Florida market, combined with write-downs on other real estate owned, merger expenses from our bank charter consolidation and an impairment write-off on two trust preferred investment securities. These items were mitigated by our acquisition of Centennial Bancshares, Inc., a gain on the sale of our investment in White River Bancshares, Inc. and organic growth of our bank subsidiaries.
Net Interest Income
Net interest income, our principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors affecting the level of net interest income include the volume of earning assets and interest-bearing liabilities, yields earned on loans and investments and rates paid on deposits and other borrowings, the level of non-performing loans and the amount of non-interest-bearing liabilities supporting earning assets. Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis. The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate.
The Federal Reserve Board sets various benchmark rates, including the Federal Funds rate, and thereby influences the general market rates of interest, including the deposit and loan rates offered by financial institutions. The Federal Funds rate, which is the cost to banks of immediately available overnight funds, began in 2007 at 5.25%. The 5.25% rate then remained constant until September 18, 2007, when the Federal Funds rate was lowered by 50 basis points to 4.75%. The Federal Funds rate decreased another 25 basis points on October 31, 2007 and December 11, 2007 declining to 4.25%. During 2008, the rate decreased by 75 basis points on January 22, 2008, 50 basis points on January 30, 2008, 75 basis points on March 18, 2008, 25 basis points on April 30, 2008 and 50 basis points to a rate of 1.50% as of October 8, 2008. The rate continued to fall 50 basis points on October 29, 2008 and 75 to 100 basis points to a low of 0.25% to 0% on December 16, 2008.
Net interest income on a fully taxable equivalent basis increased $7.1 million, or 8.0%, to $96.2 million for the year ended December 31, 2009, from $89.1 million for the same period in 2008. This increase in net interest income was the result of a $12.6 million decrease in interest income combined with a $19.7 million decrease in interest expense. The $12.6 million decrease in interest income was primarily the result of the repricing of our earning assets in the declining interest rate environment offset slightly by a higher level of earning assets. The repricing of our earning assets in the declining interest rate environment resulted in a $13.5 million decrease in interest income while the higher level of earning assets resulted in an increase in interest income of $0.9 million, for the year ended December 31, 2009. The $19.7 million decrease in interest expense for the year ended December 31, 2009, is primarily the result of our interest bearing liabilities repricing in the declining interest rate environment combined with a reduction in our interest bearing liabilities. The repricing of our interest bearing liabilities in the declining interest rate environment resulted in a $17.1 million decrease in interest expense. The reduction of our interest bearing liabilities resulted in lower interest expense of $2.6 million.
Net interest income on a fully taxable equivalent basis increased $18.6 million, or 26.4%, to $89.1 million for the year ended December 31, 2008, from $70.5 million for the same period in 2007. This increase in net interest income was the result of a $4.5 million increase in interest income combined with a $14.1 million decrease in interest expense. The $4.5 million increase in interest income was primarily the result of our acquisition of Centennial Bancshares, Inc. and organic growth of our bank subsidiaries offset by the repricing of our earning assets in the declining interest rate environment. The higher level of earning assets resulted in an improvement in interest income of $25.7 million, and our earning assets repricing in the declining interest rate environment resulted in a $21.2 million decrease in interest income for the year ended December 31, 2008. The $14.1 million decrease in interest expense for the year ended December 31, 2008, is primarily the result of our interest bearing liabilities repricing in the declining interest rate environment offset by our acquisition of Centennial Bancshares, Inc. and organic growth of our bank subsidiaries. The repricing of our interest bearing liabilities in the declining interest rate environment resulted in a $24.8 million decrease in interest expense for the year ended December 31, 2008. The higher level of interest-bearing liabilities resulted in additional interest expense of $10.7 million.
Net interest margin, on a fully taxable equivalent basis, was 4.09% for the year ended December 31, 2009 compared to 3.82% for the same period in 2008, respectively. Our ability to improve pricing on our deposits and hold the decline of interest rates on loans to a minimum allowed the Company to expand net interest margin.
Tables 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the years ended December 31, 2009, 2008 and 2007, as well as changes in fully taxable equivalent net interest margin for the years 2009 compared to 2008 and 2008 compared to 2007.
Table 1: Analysis of Net Interest Income
Table 2: Changes in Fully Taxable Equivalent Net Interest Margin
Table 3 shows, for each major category of earning assets and interest-bearing liabilities, the average amount outstanding, the interest income or expense on that amount and the average rate earned or expensed for the years ended December 31, 2009, 2008 and 2007. The table also shows the average rate earned on all earning assets, the average rate expensed on all interest-bearing liabilities, the net interest spread and the net interest margin for the same periods. The analysis is presented on a fully taxable equivalent basis. Non-accrual loans were included in average loans for the purpose of calculating the rate earned on total loans.
Table 3: Average Balance Sheets and Net Interest Income Analysis
Table 4 shows changes in interest income and interest expense resulting from changes in volume and changes in interest rates for the year ended December 31, 2009 compared to 2008 and 2008 compared to 2007 on a fully taxable basis. The changes in interest rate and volume have been allocated to changes in average volume and changes in average rates, in proportion to the relationship of absolute dollar amounts of the changes in rates and volume.
Table 4: Volume/Rate Analysis
Provision for Loan Losses
Our management assesses the adequacy of the allowance for loan losses by applying the provisions of FASB ASC 310-10-35 (formerly Statement of Financial Accounting Standards No. 5, Accounting for Contingencies and No. 114, Accounting by Creditors for Impairment of a Loan). Specific allocations are determined for loans considered to be impaired and loss factors are assigned to the remainder of the loan portfolio to determine an appropriate level in the allowance for loan losses. The allowance is increased, as necessary, by making a provision for loan losses. The specific allocations for impaired loans are assigned based on an estimated net realizable value after a thorough review of the credit relationship. The potential loss factors associated with the remainder of the loan portfolio are based on an internal net loss experience, as well as management’s review of trends within the portfolio and related industries.
During these tough economic times, the Company continues to follow our historical conservative procedures for lending and evaluating the provision and allowance for loan losses. We have not and do not participate in higher risk lending such as subprime. Our practice continues to be primarily traditional real estate lending with strong loan-to-value ratios. While there have been declines in our collateral value, particularly Florida, these declines have been addressed in our assessment of the adequacy of the allowance for loan losses.
Generally, commercial, commercial real estate, and residential real estate loans are assigned a level of risk at origination. Thereafter, these loans are reviewed on a regular basis. The periodic reviews generally include loan payment and collateral status, the borrowers’ financial data, and key ratios such as cash flows, operating income, liquidity, and leverage. A material change in the borrower’s credit analysis can result in an increase or decrease in the loan’s assigned risk grade. Aggregate dollar volume by risk grade is monitored on an ongoing basis.
Our management reviews certain key loan quality indicators on a monthly basis, including current economic conditions, delinquency trends and ratios, portfolio mix changes, and other information management deems necessary. This review process provides a degree of objective measurement that is used in conjunction with periodic internal evaluations. To the extent that this review process yields differences between estimated and actual observed losses, adjustments are made to the loss factors used to determine the appropriate level of the allowance for loan losses.
Our Company is primarily a real estate lender in Arkansas and Florida. As such we are subject to declines in asset quality when real estate prices fall during a recession. The current recession has harshly impacted the real estate market in Florida. During 2008, many real estate values declined in the 20 plus percent range in Florida. The decline in the Florida real estate prices did slowdown in 2009 compared to 2008. The decline in Florida real estate prices for 2009 were about half of those from the previous year. The Arkansas economy has been stable over the past several years with no boom or bust. As a result, the Arkansas economy has fared much better with only low single digit declines in real estate values in 2009 and 2008.
During the first quarter of 2008, we began to experience a decline in our asset quality, particularly in the Florida market. In 2008, non-performing loans started the year at $3.3 million but ended the year at $29.9 million. As of December 31, 2009, non-performing loans are $39.9 million.
The provision for loan losses represents management’s determination of the amount necessary to be charged against the current period’s earnings, to maintain the allowance for loan losses at a level that is considered adequate in relation to the estimated risk inherent in the loan portfolio. The provision was $11.2 million for the year ended December 31, 2009, $27.0 million for 2008, and $3.2 million for 2007.
Our provision for loan losses decreased $15.9 million, or 58.7% to $11.2 million for the year ended December 31, 2009, from $27.0 million for 2008. The decrease in the provision for loan losses is primarily associated with a more modest decline in asset quality versus the previous year. In 2008 our non-performing loans increased $26.6 million compared to $10.0 million increase during 2009. The 2009 decline in our asset quality is primarily related to the unfavorable economic conditions that continue to impact our Florida market. The provision for loan losses in our Florida market was approximately $7.7 million for 2009.
Our provision for loan losses increased $23.8 million, or 733.3% to $27.0 million for the year ended December 31, 2008, from $3.2 million for 2007. The increase in the provision is primarily associated with the $26.6 million decline in asset quality in 2008, particularly in our Florida market combined with growth in the loan portfolio. The decrease in our asset quality is primarily related to the unfavorable economic conditions that impacted our Florida market. The provision for loan losses in our Florida market was approximately $21.5 million for 2008.
Non-Interest Income
Total non-interest income was $30.7 million in 2009, compared to $28.7 million in 2008 and $25.8 million in 2007. Our recurring non-interest income includes service charges on deposit accounts, other service charges and fees, mortgage lending, mortgage servicing, insurance, increase in cash value of life insurance and dividends.
Table 5 measures the various components of our non-interest income for the years ended December 31, 2009, 2008, and 2007, respectively, as well as changes for the years 2009 compared to 2008 and 2008 compared to 2007.
Table 5: Non-Interest Income
Non-interest income increased $1.9 million, or 6.8%, to $30.7 million for the year ended December 31, 2009 from $28.7 million for the same period in 2008. The primary factors that resulted in the increase include:
•
The $895,000 aggregate increase in service charges on deposit accounts was related to organic growth of our bank’s service charges and an improved fee process.
•
The $388,000 aggregate decrease in dividends from FHLB, FRB & Bankers bank is primarily the result of lower yields in the current economic recession.
•
The equity in earnings of unconsolidated affiliate was related to the 20% interest in White River Bancshares that we purchased during 2005. Because the investment in White River Bancshares is accounted for on the equity method, we recorded our share of White River Bancshares’ operating earnings. White River Bancshares repurchased our interest in their company on March 3, 2008. This resulted in a one time gain on the sale of the equity investment of $6.1 million.
•
The $2.9 million loss on OREO in 2008 is primarily the result of a $2.4 million write down on OREO related to a foreclosure on an owner occupied commercial rental center in the Florida market. Due to the unfavorable economic conditions in the Florida market, the current fair market value estimate required for this write down to be taken on the property.
•
During 2008, we became aware that two investment securities in our other securities category had become other than temporarily impaired. As a result of this impairment we charged off these two securities. The total of this charge-off was $5.9 million for 2008. Reference the Investment Securities MD&A discussion for additional information.
•
The $956,000 aggregate decrease in other income is primarily the result of a fourth quarter 2008 gain of $448,000 that is the product of our ownership of Arkansas Banker’s Bank stock.
Non-interest income increased $3.0 million, or 11.5%, to $28.7 million for the year ended December 31, 2008 from $25.8 million for the same period in 2007. The primary factors that resulted in the increase include:
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Of the aggregate increase in service charges on deposit accounts, our acquisition of Centennial Bancshares, Inc. accounted for $576,000 of the increase for the year ended December 31, 2008. The remaining increase is related to organic growth of our bank subsidiaries and an improved fee process.
•
Of the aggregate increase in other service charges and fees, our acquisition of Centennial Bancshares, Inc. accounted for $136,000 of the increase for the year ended December 31, 2008. The remaining increases are a result of increased retention of interchange fees and organic growth of our bank subsidiaries.
•
Of the aggregate increase in mortgage lending income, our acquisition of Centennial Bancshares, Inc. accounted for $688,000 of the increase for the year ended December 31, 2008. The remaining increase is related to organic growth of our bank subsidiaries.
•
The new revenue source mortgage servicing income was related to our acquisition of Centennial Bancshares, Inc. As a result of this acquisition, we now have a mortgage loan servicing portfolio of approximately $262.0 million and purchased mortgage servicing rights of $1.9 million.
•
The equity in earnings of unconsolidated affiliate is related to the 20% interest in White River Bancshares that we purchased during 2005. Because the investment in White River Bancshares is accounted for on the equity method, we recorded our share of White River Bancshares’ operating earnings. White River Bancshares had been operating at a loss as a result of their status as a start up company until late in 2007. White River Bancshares repurchased our interest in their company on March 3, 2008. This resulted in a one time gain on the sale of the equity investment of $6.1 million.
•
The $2.9 million loss on OREO is primarily the result of a $2.4 million write down on OREO related to a foreclosure on an owner occupied commercial rental center in the Florida market. Due to the unfavorable economic conditions in the Florida market, the current fair market value estimate required for this write down to be taken on the property.
•
During 2008, we became aware that two investment securities in our other securities category had become other than temporarily impaired. As a result of this impairment we charged off these two securities. The total of this charge-off was $5.9 million or $0.18 diluted earnings per share (stock dividend adjusted) for 2008. Reference the Investment Securities MD&A discussion for additional information.
•
The $772,000 aggregate increase in other income is primarily the result of a fourth quarter gain of $448,000 that is the product of our ownership of Arkansas Bankers’ Bank stock. The Company does not believe this gain will be of a recurring nature.
We have a mortgage loan servicing portfolio of approximately $209.6 million and purchased mortgage servicing rights of $1.1 million. During 2009, we began exploring opportunities to increase our mortgage servicing portfolio. This exploration has been moved to a lower priority as a result of the current opportunities to expand our franchise through FDIC assisted acquisitions.
Non-Interest Expense
Non-interest expense consists of salary and employee benefits, occupancy and equipment, data processing, and other expenses such as advertising, amortization of intangibles, amortization of mortgage servicing rights, electronic banking expense, FDIC and state assessment, mortgage servicing and legal and accounting fees.
Table 6 below sets forth a summary of non-interest expense for the years ended December 31, 2009, 2008, and 2007, as well as changes for the years ended 2009 compared to 2008 and 2008 compared to 2007.
Table 6: Non-Interest Expense
Non-interest expense decreased $2.8 million, or 3.7%, to $72.9 million for the year ended December 31, 2009, from $75.7 million for the same period in 2008. During the year ended December 31, 2009, we incurred $1.5 million of merger expenses and a $1.2 million for the special assessment from the FDIC. During 2008, we conducted an efficiency study for $860,000. Excluding these non-core items, core non-interest expense was $70.2 million for the year ended December 31, 2009 compared to $74.9 million for the same period in 2008. This decrease is the result of our on-going implementation of the efficiency study and recently completed charter consolidation, particularly in the reduced personnel costs offset by the recurring FDIC and state assessment fees and the normal increase in cost of doing business.
Non-interest expense increased $14.2 million, or 23.0%, to $75.7 million for the year ended December 31, 2008, from $61.5 million for the same period in 2007. The increase is the result of our acquisition of Centennial Bancshares, Inc. during the first quarter of 2008, the continued expansion of the Company , additional costs related to an efficiency study performed by a third party during 2008, the merger expenses associated with our charter consolidation combined with the normal increased cost of doing business. The most significant component of the increase was $6.8 million of additional non-interest expense from our acquisition of Centennial Bancshares, Inc. The cost of the efficiency study was $860,000 for 2008 and is included in other professional fees. During 2008 and 2007, we opened two de novo branch locations in Florida and six in Arkansas.
The Board of Directors of the FDIC has increased insured institutions’ normal recurring assessment and imposed a special assessment. These increased assessment fees are in response to the current banking crisis in the United States.
The efficiency study was fully implemented in the fourth quarter of 2009.
Income Taxes
The provision for income taxes increased $10.2 million, or 531.8%, to $12.1 million for the year ended December 31, 2009, from $1.9 million for 2008. The provision for income taxes decreased $6.6 million, or 77.5%, to $1.9 million for the year ended December 31, 2008, from $8.5 million for 2007. The effective tax rate for the years ended December 31, 2009, 2008 and 2007 were 31.2%, 16.0% and 29.4%, respectively.
The higher effective income tax rate for 2009 is primarily associated with our higher pre-tax income for 2009. During 2008, we recorded $12.0 million of pre-tax income compared to $38.9 million in 2009 or an increase of $26.9 million. The increased pre-tax income at our marginal tax rate of 39.225% resulted in an increase of income taxes of approximately $10.6 million or 103.3% of the change for 2009.
The lower effective income tax rate for 2008 is primarily associated with our lower pre-tax income for the current year. During 2007, we recorded $28.9 million of pre-tax income compared to $12.0 million in 2008 or a reduction of $16.9 million. The reduced pre-tax income at our marginal tax rate of 39.225% resulted in a reduction of income taxes of approximately $6.6 million or 100.6% of the change for 2008.
Financial Conditions as of and for the Years Ended December 31, 2008 and 2007
Our total assets increased $104.8 million, a growth of 4.1%, to $2.68 billion as of December 31, 2009, from $2.58 billion as of December 31, 2008. Our loan portfolio decreased $5.9 million, a decline of 0.3%, to $1.95 billion as of December 31, 2009, from $1.96 billion as of December 31, 2008. Stockholders’ equity increased $181.9 million, a growth of 64.3%, to $465.0 million as of December 31, 2009, compared to $283.0 million as of December 31, 2008. The increase in stockholders’ equity is primarily associated with the issuance of $50.0 million of preferred stock to the United States Department of Treasury and the net issuance of $107.3 million or 5,692,500 shares of common stock resulting from our 2009 common stock offering combined with retained earnings for the year ended December 31, 2009. Excluding the issuance of the $50.0 million of preferred stock and the net issuance of the $107.3 million of common stock, the growth in stockholders’ equity for the year ended December 31, 2009 was 8.7%.
Loan Portfolio
Our loan portfolio averaged $1.97 billion during 2009, $1.92 billion during 2008 and $1.52 billion during 2007. Net loans were $1.91 billion, $1.92 billion and $1.58 billion as of December 31, 2009, 2008 and 2007, respectively. The 2009 flat loan growth from our historical expansion rates was not unexpected. Our customers have grown more cautious in this troubled economy.
The most significant components of the loan portfolio were commercial real estate, residential real estate, consumer, and commercial and industrial loans. These loans are primarily originated within our market areas of central Arkansas, north central Arkansas, northwest Arkansas, southern Arkansas, southwest Florida and the Florida Keys and are generally secured by residential or commercial real estate or business or personal property within our market areas.
As a result of the current recession, certain credit markets have experienced difficult conditions and volatility during 2008 and 2009, particularly Florida. The Florida market currently is approximately 92.7% secured by real estate and 16.2% of our loan portfolio.
Table 7 presents our period end loan balances by category as of the dates indicated.
Table 7: Loan Portfolio
Commercial Real Estate Loans. We originate non-farm and non-residential loans (primarily secured by commercial real estate), construction/land development loans, and agricultural loans, which are generally secured by real estate located in our market areas. Our commercial mortgage loans are generally collateralized by first liens on real estate and amortized over a 10 to 20 year period with balloon payments due at the end of one to five years. These loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary source of repayment, the financial strength of any guarantor, the strength of the tenant (if any), the borrower’s liquidity and leverage, management experience, ownership structure, economic conditions and industry specific trends and collateral. Generally, we will loan up to 85% of the value of improved property, 65% of the value of raw land and 75% of the value of land to be acquired and developed. A first lien on the property and assignment of lease is required if the collateral is rental property, with second lien positions considered on a case-by-case basis.
As of December 31, 2009, commercial real estate loans totaled $1.21 billion, or 62.1% of our loan portfolio which is comparable to $1.16 million, or 59.3% of our loan portfolio, as of December 31, 2008. Florida commercial real estate loans are approximately 9.9% of our loan portfolio.
Residential Real Estate Loans. We originate one to four family, owner occupied residential mortgage loans generally secured by property located in our primary market area. The majority of our residential mortgage loans consist of loans secured by owner occupied, single family residences. Residential real estate loans generally have a loan-to-value ratio of up to 90%. These loans are underwritten by giving consideration to the borrower’s ability to pay, stability of employment or source of income, debt-to-income ratio, credit history and loan-to-value ratio.
As of December 31, 2009, we had $445.1 million, or 22.8% of our loan portfolio, in residential real estate loans which is comparable to the $447.7 million, or 22.9% of our loan portfolio, as of December 31, 2008. Florida residential real estate loans are approximately 5.1% of our loan portfolio.
Consumer Loans. Our consumer loan portfolio is composed of secured and unsecured loans originated by our banks. The performance of consumer loans will be affected by the local and regional economy as well as the rates of personal bankruptcies, job loss, divorce and other individual-specific characteristics.
As of December 31, 2009, our installment consumer loan portfolio totaled $39.1 million, or 2.0% of our total loan portfolio, compared to the $46.6 million, or 2.4% of our loan portfolio as of December 31, 2008. This decrease is associated with normal payoffs and pay downs combined with flat loan demand.
Commercial and Industrial Loans. Commercial and industrial loans are made for a variety of business purposes, including working capital, inventory, equipment and capital expansion. The terms for commercial loans are generally one to seven years. Commercial loan applications must be supported by current financial information on the borrower and, where appropriate, by adequate collateral. Commercial loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary sources of repayment, the financial strength of any guarantor, the borrower’s liquidity and leverage, management experience, ownership structure, economic conditions and industry specific trends and collateral. The loan to value ratio depends on the type of collateral. Generally speaking, accounts receivable are financed at between 50% and 80% of accounts receivable less than 60 days past due. Inventory financing will range between 50% and 60% (with no work in process) depending on the borrower and nature of inventory. We require a first lien position for those loans.
As of December 31, 2009, commercial and industrial loans outstanding totaled $219.8 million, or 11.3% of our loan portfolio, compared to $255.2 million, or 13.0% of our loan portfolio, as of December 31, 2008. This decrease is associated with normal payoffs and pay downs combined with flat loan demand.
Table 8 presents the distribution of the maturity of our loans as of December 31, 2009. The table also presents the portion of our loans that have fixed interest rates versus interest rates that fluctuate over the life of the loans based on changes in the interest rate environment. A loan is considered fixed rate if the loan is currently at its adjustable floor or ceiling. As a result of the low interest rates environment, the Company has approximately $203.8 million of loans that cannot be additionally priced down but could price up if rates were to return to higher levels. These loans are shown as fixed rate in the table below.
Table 8: Maturity of Loans
Non-Performing Assets
We classify our problem loans into three categories: past due loans, special mention loans and classified loans (accruing and non-accruing).
When management determines that a loan is no longer performing, and that collection of interest appears doubtful, the loan is placed on non-accrual status. Loans that are 90 days past due are placed on non-accrual status unless they are adequately secured and there is reasonable assurance of full collection of both principal and interest. Our management closely monitors all loans that are contractually 90 days past due, treated as “special mention” or otherwise classified or on non-accrual status. Generally, non-accrual loans that are 120 days past due without assurance of repayment are charged off against the allowance for loan losses.
Table 9 sets forth information with respect to our non-performing assets as of December 31, 2009, 2008, 2007, 2006, and 2005. As of these dates, we did not have any non-performing restructured loans.
Table 9: Non-performing Assets
Our non-performing loans are comprised of non-accrual loans and loans that are contractually past due 90 days. Our bank subsidiary recognizes income principally on the accrual basis of accounting. When loans are classified as non-accrual, the accrued interest is charged off and no further interest is accrued, unless the credit characteristics of the loan improves. If a loan is determined by management to be uncollectible, the portion of the loan determined to be uncollectible is then charged to the allowance for loan losses.
Since December 31, 2007, the declining real estate market, particularly in Florida, has and may continue to increase our level of non-performing loans. While we believe our allowance for loan losses is adequate at December 31, 2009, as additional facts become known about relevant internal and external factors that affect loan collectability and our assumptions, it may result in us making additions to the provision for loan loss during 2010.
As of December 31, 2009, we had $35.2 million of restructured loans that are in compliance with the modified terms and are not reported as past due or non-accrual in Table 9. Of the $35.2 million in restructured loans, $12.7 million are also reported as impaired loans. Most of these credits are where borrowers have continued to pay as agreed but negotiated a lower interest rate due to general economic pressures rather than credit specific pressure. Our Florida market contains $29.2 million of these restructured loans.
Total foreclosed assets held for sale were $16.5 million as of December 31, 2009, compared to $6.8 million as of December 31, 2008 for an increase of $9.7 million. The increase is primarily the result of foreclosure on two Florida housing developments in the Keys. Each of the two housing developments has vacant lots and one completed model home. The foreclosed assets held for sale are comprised of $10.7 million of assets located in Florida with the remaining $5.8 million of assets located in Arkansas. The Florida foreclosed assets at September 30, 2009 included a substantially vacant owner occupied commercial rental center in the Keys. This property was sold during the fourth quarter of 2009. The two Florida housing developments are currently listed for sale with a broker.
Total non-performing loans were $39.9 million as of December 31, 2009, compared to $29.9 million as of December 31, 2008 for an increase of $10.0 million. The increase in non-performing loans is primarily from our Florida market. Non-performing loans are $30.2 million in the Florida market.
If the non-accrual loans had been accruing interest in accordance with the original terms of their respective agreements, interest income of approximately $2.0 million for the year ended December 31, 2009, $1.0 million in 2008, and $270,000 in 2007 would have been recorded. Interest income recognized on the non-accrual loans for the years ended December 31, 2009, 2008 and 2007 was considered immaterial.
A loan is considered impaired when it is probable that we will not receive all amounts due according to the contracted terms of the loans. Impaired loans may include non-performing loans (loans past due 90 days or more and non-accrual loans) and certain other loans identified by management that are still performing. As of December 31, 2009, average impaired loans were $41.0 million compared to $29.4 million as of December 31, 2008. As of December 31, 2009, impaired loans were $44.4 million compared to $31.5 million as of December 31, 2008 for an increase of $12.9 million. As a result of the unfavorable economic conditions that are impacting our Florida market, impaired loans in Florida increased $13.5 million.
Non-performing loans and impaired loans are defined differently. Some loans may be included in both categories.
Allowance for Loan Losses
Overview. The allowance for loan losses is maintained at a level which our management believes is adequate to absorb all probable losses on loans in the loan portfolio. The amount of the allowance is affected by: (i) loan charge-offs, which decrease the allowance; (ii) recoveries on loans previously charged off, which increase the allowance; and (iii) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, it is necessary for our management to monitor fluctuations in the allowance resulting from actual charge-offs and recoveries and to periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions. If actual losses exceed the amount of allowance for loan losses, our earnings could be adversely affected.
As we evaluate the allowance for loan losses, we categorize it as follows: (i) specific allocations; (ii) allocations for classified assets with no specific allocation; (iii) general allocations for each major loan category; and (iv) miscellaneous allocations.
Specific Allocations. As a general rule, if a specific allocation is warranted, it is the result of an analysis of a previously classified credit or relationship. Our evaluation process in specific allocations includes a review of appraisals or other collateral analysis. These values are compared to the remaining outstanding principal balance. If a loss is determined to be reasonably possible, the possible loss is identified as a specific allocation. If the loan is not collateral dependent, the measurement of loss is based on the expected future cash flows of the loan.
Allocations for Classified Assets with No Specific Allocation. We establish allocations for loans rated “special mention” through “loss” in accordance with the guidelines established by the regulatory agencies. A percentage rate is applied to each loan category to determine the level of dollar allocation.
General Allocations. We establish general allocations for each major loan category. This section also includes allocations to loans, which are collectively evaluated for loss such as residential real estate, commercial real estate consumer loans and commercial and industrial loans. The allocations in this section are based on a historical review of loan loss experience and past due accounts. We give consideration to trends, changes in loan mix, delinquencies, prior losses, and other related information.
Miscellaneous Allocations. Allowance allocations other than specific, classified, and general are included in our miscellaneous section.
Charge-offs and Recoveries. Total charge-offs decreased to $10.5 million for the year ended December 31, 2009, compared to $20.9 million for the same period in 2008. Total recoveries increased to $1.9 million for the year ended December 31, 2009, compared to $1.5 million for the same period in 2008. The changes in net charge-offs are due to the unfavorable economic conditions particularly in Florida. During 2008 when real estate prices were harshly impacted by the recession, we took a proactive stance on our asset quality by increasing charge-offs. In 2009 real estate prices continued to fall but at lower pace than 2008, resulting in a reduced level of charge-offs than the previous year.
Table 10 shows the allowance for loan losses, charge-offs and recoveries as of and for the years ended December 31, 2009, 2008, 2007, 2006 and 2005.
Table 10: Analysis of Allowance for Loan Losses
Allocated Allowance for Loan Losses. We use a risk rating and specific reserve methodology in the calculation and allocation of our allowance for loan losses. While the allowance is allocated to various loan categories in assessing and evaluating the level of the allowance, the allowance is available to cover charge-offs incurred in all loan categories. Because a portion of our portfolio has not matured to the degree necessary to obtain reliable loss data from which to calculate estimated future losses, the unallocated portion of the allowance is an integral component of the total allowance. Although unassigned to a particular credit relationship or product segment, this portion of the allowance is vital to safeguard against the imprecision inherent in estimating credit losses.
The changes for the period ended December 31, 2009 in the allocation of the allowance for loan losses for the individual types of loans are primarily associated with the changes in asset quality, net charge-offs during the year and normal changes in the outstanding loan portfolio for those loan types from December 31, 2008.
Table 11 presents the allocation of allowance for loan losses as of the dates indicated.
Table 11: Allocation of Allowance for Loan Losses
(1)
Percentage of loans in each category to loans receivable
Investment Securities
Our securities portfolio is the second largest component of earning assets and provides a significant source of revenue. Securities within the portfolio are classified as held-to-maturity, available-for-sale, or trading based on the intent and objective of the investment and the ability to hold to maturity. Fair values of securities are based on quoted market prices where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities. As of December 31, 2009 and 2008, we had no held-to-maturity or trading securities.
Securities available-for-sale are reported at fair value with unrealized holding gains and losses reported as a separate component of stockholders’ equity as other comprehensive income. Securities that are held as available-for-sale are used as a part of our asset/liability management strategy. Securities classified as available-for-sale may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital, and other similar factors. Available-for-sale securities were $322.1 million as of December 31, 2009, compared to $355.2 million as of December 31, 2008. The estimated effective duration of our securities portfolio was 2.9 years as of December 31, 2009.
As of December 31, 2009, $115.6 million, or 35.9%, of the available-for-sale securities were invested in mortgage-backed securities, compared to $182.0 million, or 51.2%, of the available-for-sale securities in the prior year. To reduce our income tax burden, $145.9 million, or 45.3%, of the available-for-sale securities portfolio as of December 31, 2009, was primarily invested in tax-exempt obligations of state and political subdivisions, compared to $119.8 million, or 33.7%, of the available-for-sale securities as of December 31, 2008. Also, we had approximately $56.1 million, or 17.4%, in obligations of U.S. Government-sponsored enterprises in the available-for-sale securities portfolio as of December 31, 2009, compared to $50.4 million, or 14.2%, of the available-for-sale securities in the prior year.
Certain investment securities are valued at less than their historical cost. These declines primarily resulted from the volatility in the markets. Based on evaluation of available evidence, we believe the declines in fair value for these securities are temporary. For debt securities that management has no intent to sell and believes that it more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the noncredit loss is recognized in accumulated other comprehensive income. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than temporary impairment is identified.
During 2008, we became aware that two investment securities in our other securities category had become other than temporarily impaired. As a result of this impairment we charged off these two securities. The total of this charge-off was $5.9 million or $0.18 diluted earnings per share (stock dividend adjusted) for 2008. These investment securities are a pool of other financial holding companies’ subordinated debentures throughout the country. Since the federal government has begun to seize institutions in these pools, it has resulted in our investment becoming worthless.
Table 12 presents the carrying value and fair value of investment securities for each of the years indicated.
Table 12: Investment Securities
Table 13 reflects the amortized cost and estimated fair value of debt securities as of December 31, 2009, by contractual maturity and the weighted average yields (for tax-exempt obligations on a fully taxable equivalent basis) of those securities. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
Table 13: Maturity Distribution of Investment Securities
Deposits
Our deposits averaged $1.82 billion for the year ended December 31, 2009, and $1.86 billion for 2008. Total deposits decreased $12.5 million, or 0.7%, to $1.84 billion as of December 31, 2009, from $1.85 billion as of December 31, 2008. On January 1, 2008, as a result of our acquisition of Centennial Bancshares, Inc., deposits increased by $178.8 million. Deposits are our primary source of funds. We offer a variety of products designed to attract and retain deposit customers. Those products consist of checking accounts, regular savings deposits, NOW accounts, money market accounts and certificates of deposit. Deposits are gathered from individuals, partnerships and corporations in our market areas. In addition, we obtain deposits from state and local entities and, to a lesser extent, U.S. Government and other depository institutions.
Our policy also permits the acceptance of brokered deposits. As of December 31, 2009 and December 31, 2008, brokered deposits were $71.0 million and $111.0 million, respectively. Included in these brokered deposits are $36.8 million and $39.9 million of Certificate of Deposit Account Registry Service (CDARS) as of December 31, 2009 and December 31, 2008, respectively. CDARS are deposits we have swapped our customer with other institutions. This gives our customer the potential for FDIC insurance of up to $50 million.
The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements. We will continue to manage interest expense through deposit pricing and do not anticipate a significant change in total deposits unless our liquidity position changes. We believe that additional funds can be attracted and deposit growth can be accelerated through deposit pricing if we experience increased loan demand or other liquidity needs.
The Federal Reserve Board sets various benchmark rates, including the Federal Funds rate, and thereby influences the general market rates of interest, including the deposit and loan rates offered by financial institutions. The Federal Funds rate, which is the cost to banks of immediately available overnight funds, began in 2007 at 5.25%. The 5.25% rate then remained constant until September 18, 2007, when the Federal Funds rate was lowered by 50 basis points to 4.75%. The Federal Funds rate decreased another 25 basis points on October 31, 2007 and December 11, 2007 declining to 4.25%. During 2008, the rate decreased by 75 basis points on January 22, 2008, 50 basis points on January 30, 2008, 75 basis points on March 18, 2008, 25 basis points on April 30, 2008 and 50 basis points to a rate of 1.50% as of October 8, 2008. The rate continued to fall 50 basis points on October 29, 2008 and 75 to 100 basis points to a low of 0.25% to 0% on December 16, 2008.
Table 14 reflects the classification of the average deposits and the average rate paid on each deposit category which is in excess of 10 percent of average total deposits, for the years ended December 31, 2009, 2008, and 2007.
Table 14: Average Deposit Balances and Rates
Table 15 presents our maturities of large denomination time deposits as of December 31, 2009 and 2008.
Table 15: Maturities of Large Denomination Time Deposits ($100,000 or more)
Securities Sold Under Agreements to Repurchase
During 2008, the U.S. regulatory agencies implemented the Transaction Account Guarantee Program. Under the Transaction Account Guarantee Program through June 30, 2010, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules. Since business non-interest bearing accounts currently have unlimited deposit insurance coverage, many of our business customers have chosen to move their money from repurchase agreements to non-interest bearing demand accounts to take advantage of this unlimited coverage. As a result, securities sold under agreements to repurchase decreased $51.4 million, or 45.3%, from $113.4 million as of December 31, 2008 to $62.0 million as of December 31, 2009.
FHLB Borrowings
Our FHLB borrowed funds were $264.4 million and $283.0 million at December 31, 2009 and December 31, 2008, respectively. All of the outstanding balance for December 31, 2009 and 2008 are long-term advances. Our remaining FHLB borrowing capacity was $418.3 million and $191.5 million as of December 31, 2009 and December 31, 2008, respectively. Expected maturities will differ from contractual maturities, because FHLB may have the right to call or prepay certain obligations. The increase in FHLB borrowing capacity is a result of the higher eligibility rates from Centennial Bank (formerly First State Bank) being applied to the loans of the former charters which collapsed into Centennial Bank (formerly First State Bank) during the first six months of this year. Centennial Bank’s (formerly First State Bank) eligibility rates will be reevaluated and it is projected that the FHLB borrowing capacity will lower in the future.
Subordinated Debentures
Subordinated debentures, which consist of guaranteed payments on trust preferred securities, were $47.5 million and $47.6 million as of December 31, 2009 and 2008, respectively.
Table 16 reflects subordinated debentures as of December 31, 2009 and 2008, which consisted of guaranteed payments on trust preferred securities with the following components:
Table 16: Subordinated Debentures
The trust preferred securities are tax-advantaged issues that qualify for Tier 1 capital treatment subject to certain limitations. Distributions on these securities are included in interest expense. Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds in our subordinated debentures, the sole asset of each trust. The trust preferred securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the subordinated debentures held by the trust. We wholly own the common securities of each trust. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon our making payment on the related subordinated debentures. Our obligations under the subordinated securities and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by us of each respective trust’s obligations under the trust securities issued by each respective trust.
Presently, the funds raised from the trust preferred offerings will qualify as Tier 1 capital for regulatory purposes, subject to the applicable limit, with the balance qualifying as Tier 2 capital.
The Company holds two trust preferred securities which are currently callable without penalty based on the terms of the specific agreements. The 2009 agreement between the Company and the Treasury limits our ability to retire any of our qualifying capital. As a result, the notes previously mentioned are not currently eligible to be paid off.
Stockholders’ Equity
Stockholders’ equity was $465.0 million at December 31, 2009 compared to $283.0 million at December 31, 2008, an increase of 64.3%. As of December 31, 2009 and 2008 our equity to asset ratio was 15.5% and 11.0%, respectively. Book value per common share was $16.18 at December 31, 2009 compared to $14.25 at December 31, 2008, a 13.5% increase. The increase in stockholders’ equity was primarily the result of the issuance of preferred stock to the Treasury, the public stock offering and retained earnings during the year. The increase in book value per common share was primarily the result of the public stock offering and retained earnings during the year.
Stock Offering. In September 2009, the Company raised common equity through an underwritten public offering by issuing 4,950,000 shares of common stock at $19.85. The net proceeds of the offering after deducting underwriting discounts and commissions and offering expenses were $93.3 million. In October 2009, the underwriter’s of our stock offering exercised and completed their option to purchase an additional 742,500 shares of common stock at $19.85 to cover over-allotments. The net proceeds of the exercise of the over-allotment option after deducting underwriting discounts and commissions were $14.0 million. The total net proceeds of the offering after deducting underwriting discounts and commissions and offering expenses were $107.3 million.
Troubled Asset Relief Program. On January 16, 2009, we issued and sold, and the United States Department of the Treasury purchased, (1) 50,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series A, liquidation preference of $1,000 per share, and (2) a ten-year warrant to purchase up to 288,129 shares of the Company’s common stock, par value $0.01 per share, at an exercise price of $26.03 per share, for an aggregate purchase price of $50.0 million in cash. Cumulative dividends on the Preferred Shares will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter. As a result of the recent public stock offering, the number of shares of common stock underlying the ten-year warrant held by the Treasury, has been reduced by half to 144,064 shares of our common stock at an exercise price of $26.03 per share.
These preferred shares will qualify as Tier 1 capital. As a result of the stock offering in 2009, the preferred shares are callable at par. The Treasury must approve any quarterly cash dividend on our common stock above $0.06 per share or share repurchases until three years from the date of the investment unless the shares are paid off in whole or transferred to a third party.
Common Stock Cash Dividends. We declared cash dividends on our common stock of $0.240, $0.222 and $0.134 for the years ended December 31, 2009, 2008 and 2007, respectively. The common per share amounts are reflective of the 8% stock dividend during 2008.
Stock Dividends. On July 16, 2008, our Board of Directors declared an 8% stock dividend which was paid August 27, 2008 to stockholders of record as of August 13, 2008. Except for fractional shares, the holders’ of our common stock received 8% additional common stock on August 27, 2008. The common stockholders did not receive fractional shares; instead they received cash at a rate equal to the closing price of a share on August 28, 2008 times the fraction of a share they otherwise would have been entitled to.
All common share and common per share amounts have been restated to reflect the retroactive effect of the stock dividend. After issuance, this stock dividend lowered our total capital position by approximately $13,000 as a result of the cash paid in lieu of fractional shares. Our financial statements reflect an increase in the number of outstanding shares of common stock, an increase in surplus and reduction of retained earnings.
Repurchase Program. On January 18, 2008, we announced the adoption by our Board of Directors of a stock repurchase program. The program authorizes us to repurchase up to 1,080,000 shares (stock dividend adjusted) of our common stock. Under the repurchase program, there is no time limit for the stock repurchases, nor is there a minimum number of shares that we intend to repurchase. The repurchase program may be suspended or discontinued at any time without prior notices. The timing and amount of any repurchases will be determined by management, based on its evaluation of current market conditions and other factors. The stock repurchase program will be funded using our cash balances, which we believe are adequate to support the stock repurchase program and our normal operations. As of December 31, 2008, we have not repurchased any shares in the program. The 2009 agreement between the Company and the Treasury limits our ability to repurchase common stock.
Liquidity and Capital Adequacy Requirements
Parent Company Liquidity. The primary sources for payment of our operating expenses and dividends are current cash on hand ($176.4 million as of December 31, 2009) and dividends received from our bank subsidiary.
Dividend payments by our bank subsidiary are subject to various regulatory limitations. During the first six months of 2009, the Company did not request any dividends from its banking subsidiary. In the third quarter of 2009, the Company received a dividend of $2.1 million from its banking subsidiary. As a result of the additional common equity raised through an underwritten public offering during September 2009, the Company did not request a dividend in the fourth quarter of 2009 and does not anticipate requesting dividends from its banking subsidiary during the upcoming year.
Risk-Based Capital. We as well as our bank subsidiary are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and other discretionary actions by regulators that, if enforced, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators as to components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes that, as of December 31, 2009 and December 31, 2008, we met all regulatory capital adequacy requirements to which we were subject.
Table 17 presents our risk-based capital ratios as of December 31, 2009 and 2008.
Table 17: Risk-Based Capital
As of the most recent notification from regulatory agencies, our bank subsidiary was “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized”, our banking subsidiary and we must maintain minimum leverage, Tier 1 risk-based capital, and total risk-based capital ratios as set forth in the table. There are no conditions or events since that notification that we believe have changed the bank subsidiary’s category.
Table 18 presents actual capital amounts and ratios as of December 31, 2009 and 2008, for our bank subsidiary and us.
Table 18: Capital and Ratios
Off-Balance Sheet Arrangements and Contractual Obligations
In the normal course of business, we enter into a number of financial commitments. Examples of these commitments include but are not limited to operating lease obligations, FHLB advances, lines of credit, subordinated debentures, unfunded loan commitments and letters of credit.
Commitments to extend credit and letters of credit are legally binding, conditional agreements generally having certain expiration or termination dates. These commitments generally require customers to maintain certain credit standards and are established based on management’s credit assessment of the customer. The commitments may expire without being drawn upon. Therefore, the total commitment does not necessarily represent future requirements.
Table 19 presents the funding requirements of our most significant financial commitments, excluding interest, as of December 31, 2009.
Table 19: Funding Requirements of Financial Commitments
Non-GAAP Financial Measurements
We had $57.7 million, $56.6 million, and $45.2 million total goodwill, core deposit intangibles and other intangible assets as of December 31, 2009, 2008 and 2007, respectively. Because of our level of intangible assets and related amortization expenses, management believes diluted cash earnings per share, tangible book value per share, cash return on average assets, cash return on average tangible equity and tangible equity to tangible assets are useful in evaluating our company. These calculations, which are similar to the GAAP calculation of diluted earnings per share, book value, return on average assets, return on average stockholders’ equity, and equity to assets, are presented in Tables 20 through 24, respectively.
Table 20: Diluted Cash Earnings Per Share
Table 21: Tangible Book Value Per Share
Table 22: Cash Return on Average Assets
Table 23: Cash Return on Average Tangible Equity
Table 24: Tangible Equity to Tangible Assets
Quarterly Results
The Company reported a net loss of $9.4 million, or $0.46 diluted loss per share for the fourth quarter of 2008. During this quarter, the Company experienced several items that it does not consider part of its core earnings. These items include an increased provision for loan losses over our normal quarterly provision, $2.4 million of write-downs on other real estate owned, $1.8 million of merger expenses from our bank charter consolidation, a $3.9 million impairment write-down on two trust preferred investment securities and $448,000 of other income resulting from our ownership of Arkansas Banker’s Bank stock during their fourth quarter reorganization.
The increased fourth quarter 2008 provision for loan loss was primarily attributable to the increase in non-performing loans during the quarter as a result of rapidly deteriorating Florida market conditions. During 2008, non-performing loans increased from $16.1 million in the third quarter to $29.9 million during the fourth quarter, most of which was concentrated in Florida. The write-down on other real estate was primarily due to the declining market value of one commercial property in Florida. The write-down on trust preferred investment securities was a result of bank closures in the fourth quarter that occurred within the pool.
Table 25 presents selected unaudited quarterly financial information for 2009 and 2008.
Table 25: Quarterly Results
Recent Accounting Pronouncements
See Note 23 to the Consolidated Financial Statements for a discussion of certain recent accounting pronouncements.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Liquidity and Market Risk Management
Liquidity Management. Liquidity refers to the ability or the financial flexibility to manage future cash flows to meet the needs of depositors and borrowers and fund operations. Maintaining appropriate levels of liquidity allows us to have sufficient funds available for reserve requirements, customer demand for loans, withdrawal of deposit balances and maturities of deposits and other liabilities. Our primary source of liquidity at our holding company is dividends paid by our bank subsidiary. Applicable statutes and regulations impose restrictions on the amount of dividends that may be declared by our bank subsidiary. Further, any dividend payments are subject to the continuing ability of the bank subsidiary to maintain compliance with minimum federal regulatory capital requirements and to retain its characterization under federal regulations as a “well-capitalized” institution.
Our bank subsidiary has potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers. Many of these obligations and commitments to fund future borrowings to our loans customers are expected to expire without being drawn upon, therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position.
Liquidity needs can be met from either assets or liabilities. On the asset side, our primary sources of liquidity include cash and cash equivalents, federal funds sold, maturities of investment securities and scheduled repayments and maturities of loans. We maintain adequate levels of cash and equivalents to meet our day-to-day needs. As of December 31, 2009, our cash and cash equivalents balances were $173.5 million, or 6.5% of total assets, compared to $54.2 million, or 2.1% of total assets, as of December 31, 2008. Our investment securities and Fed funds sold were $333.9 million as of December 31, 2009 and $363.1 million as of December 31, 2008.
As of December 31, 2009, $79.1 million, or 38.3%, of our securities portfolio, excluding mortgage-backed securities, matured within one year, and $109.5 million, or 53.0%, excluding mortgage-backed securities, matured after one year but within five years. As of December 31, 2008, $61.0 million, or 35.2%, of our securities portfolio, excluding mortgage-backed securities, matured within one year, and $77.7 million, or 44.8%, excluding mortgage-backed securities, matured after one year but within five years. As of December 31, 2009 and 2008, $293.3 million and $187.5 million, respectively, of securities were pledged as collateral for various public fund deposits and securities sold under agreements to repurchase.
Our commercial and real estate lending activities are concentrated in loans with maturities of less than five years with both fixed and adjustable rates. As of December 31, 2009 and 2008, approximately $1.08 billion, or 55.4%, and $1.06 billion, or 54.0%, respectively, of our loans matured within one year and/or had adjustable interest rates. A loan is considered fixed rate if the loan is currently at its adjustable floor or ceiling. As a result of the low interest rate environment, the Company has approximately $203.8 million of loans that cannot be additionally priced down but could price up if rates were to return to higher levels. Additionally, we maintain loan participation agreements with other financial institutions in which we could participate out loans for additional liquidity should the need arise.
On the liability side, our principal sources of liquidity are deposits, borrowed funds, and access to capital markets. Customer deposits are our largest sources of funds. As of December 31, 2009, our total deposits were $1.84 billion, or 68.4% of total assets, compared to $1.85 billion, or 71.6% of total assets, as of December 31, 2008. We attract our deposits primarily from individuals, business, and municipalities located in our market areas.
We may occasionally use our Fed funds lines of credit in order to temporarily satisfy short-term liquidity needs. We have Fed funds lines with three other financial institutions pursuant to which we could have borrowed up to $17.5 million and $84.1 million on an unsecured basis as of December 31, 2009 and 2008, respectively. These lines may be terminated by the respective lending institutions at any time. As a result of our recent charter consolidation, there has been reduction in our availability to borrow Fed funds on an unsecured basis.
We also maintain lines of credit with the Federal Home Loan Bank. Our FHLB borrowings were $264.4 million as of December 31, 2009 and $283.0 million as of December 31, 2008. All of the outstanding balance for December 31, 2009 and 2008 are long-term advances. Our FHLB borrowing capacity was $418.3 million and $191.5 million as of December 31, 2009 and 2008, respectively.
We believe that we have sufficient liquidity to satisfy our current operations.
Market Risk Management. Our primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. We do not hold market risk sensitive instruments for trading purposes.
Asset/Liability Management. Our management actively measures and manages interest rate risk. The asset/liability committees of the boards of directors of our holding company and bank subsidiary are also responsible for approving our asset/liability management policies, overseeing the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviewing our interest rate sensitivity position.
One of the tools that our management uses to measure short-term interest rate risk is a net interest income simulation model. This analysis calculates the difference between net interest income forecasted using base market rates and using a rising and a falling interest rate scenario. The income simulation model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our assets are floating rate loans, which are assumed to re-price immediately, and proportional to the change in market rates, depending on their contracted index. Some loans and investments include the opportunity of prepayment (embedded options), and accordingly the simulation model uses indices to estimate these prepayments and reinvest their proceeds at current yields. Our non-term deposit products re-price more slowly, usually changing less than the change in market rates and at our discretion.
This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet remains static and that its structure does not change over the course of the year. It does not account for all factors that impact this analysis, including changes by management to mitigate the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change.
Furthermore, loan prepayment rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was increased and decreased over twelve months by 200 and 100 basis points, respectively. At December 31, 2009, our net interest margin exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us.
Table 26 presents our sensitivity to net interest income as of December 31, 2009.
Table 26: Sensitivity of Net Interest Income
Interest Rate Sensitivity. Our primary business is banking and the resulting earnings, primarily net interest income, are susceptible to changes in market interest rates. It is management’s goal to maximize net interest income within acceptable levels of interest rate and liquidity risks.
A key element in the financial performance of financial institutions is the level and type of interest rate risk assumed. The single most significant measure of interest rate risk is the relationship of the repricing periods of earning assets and interest-bearing liabilities. The more closely the repricing periods are correlated, the less interest rate risk we assume. We use repricing gap and simulation modeling as the primary methods in analyzing and managing interest rate risk.
Gap analysis attempts to capture the amounts and timing of balances exposed to changes in interest rates at a given point in time. As of December 31, 2009 our one-year cumulative repricing gap was 12.8%. The 2009 stock offering proceeds have yet to be deployed and increased our one-year cumulative repricing gap by 4.7%. Excluding these non-deployed funds our gap position as of December 31, 2009 was asset sensitive with a one-year cumulative repricing gap of 8.1%, compared to 4.1% as of December 31, 2008. During these periods, the amount of change our asset base realizes in relation to the total change in market interest rate exceeds that of the liability base.
We have a portion of our securities portfolio invested in mortgage-backed securities. Mortgage-backed securities are included based on their assumed maturity dates. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Table 27 presents a summary of the repricing schedule of our interest-earning assets and interest-bearing liabilities (gap) as of December 31, 2009.
Table 27: Interest Rate Sensitivity
Item 8.
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control Over Financial Reporting
The management of Home BancShares, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Accordingly, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management determined that the Company’s internal control over financial reporting as of December 31, 2009 is effective based on the specified criteria.
BKD, LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, is included herein.
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Home BancShares, Inc.
Conway, Arkansas
We have audited the accompanying consolidated balance sheets of Home BancShares, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2009. The Company’s management is responsible for these financial statements. 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. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Home BancShares, Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December, 31, 2009, 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), Home BancShares, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 5, 2010, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ BKD, LLP
Little Rock, Arkansas
March 5, 2010
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Home BancShares, Inc.
Conway, Arkansas
We have audited Home BancShares, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for 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 Report on Internal Control Over Financial Reporting. 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. Our audit also included 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 in the United States of America. 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 the 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, Home BancShares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Home BancShares, Inc. and our report dated March 5, 2010 expressed an unqualified opinion thereon.
/s/ BKD, LLP
Little Rock, Arkansas
March 5, 2010
Home BancShares, Inc.
Consolidated Balance Sheets
See accompanying notes.
Home BancShares, Inc.
Consolidated Statements of Income
See accompanying notes.
Home BancShares, Inc.
Consolidated Statements of Stockholders’ Equity
See accompanying notes.
Home BancShares, Inc.
Consolidated Statements of Cash Flows
See accompanying notes.
Home BancShares, Inc.
Notes to Consolidated Financial Statements
1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Home BancShares, Inc. (the Company or HBI) is a bank holding company headquartered in Conway, Arkansas. The Company is primarily engaged in providing a full range of banking services to individual and corporate customers through its wholly owned community bank subsidiary - Centennial Bank (the Bank). During 2009, the Company completed the combination of its former bank charters into a single charter, adopting Centennial Bank as the common name. The Bank has locations in central Arkansas, north central Arkansas, southern Arkansas, the Florida Keys and southwestern Florida. The Company is subject to competition from other financial institutions. The Company also is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.
A summary of the significant accounting policies of the Company follows:
Operating Segments
Community banking is the Company’s only operating segment. No revenues are derived from foreign countries and no single external customer comprises more than 10% of the Company’s revenues.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of foreclosed assets. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets, management obtains independent appraisals for significant properties.
Principles of Consolidation
The consolidated financial statements include the accounts of HBI and its subsidiary. Significant intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications
Various items within the accompanying financial statements for previous years have been reclassified to provide more comparative information. These reclassifications had no effect on net earnings or stockholders’ equity.
Cash and Cash Equivalents
Cash and cash equivalents consists of cash on hand, demand deposits with banks and interest-bearing deposits with other banks. The financial institutions holding the Company’s cash accounts are participating in the FDIC’s Transaction Account Guarantee Program. Under that program, through June 30, 2010, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account.
Investment Securities
Interest on investment securities is recorded as income as earned. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains or losses on the sale of securities are determined using the specific identification method.
Management determines the classification of securities as available-for-sale, held to maturity, or trading at the time of purchase based on the intent and objective of the investment and the ability to hold to maturity. Fair values of securities are based on quoted market prices where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities. The Company has no trading securities.
Securities available-for-sale are reported at fair value with unrealized holding gains and losses reported as a separate component of stockholders’ equity and other comprehensive income (loss), net of taxes. Securities that are held as available-for-sale are used as a part of HBI’s asset/liability management strategy. Securities that may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital, and other similar factors are classified as available-for-sale.
Securities held to maturity are reported at amortized historical cost. Securities that management has the intent and ability to hold until maturity or on a long-term basis are classified as held to maturity.
During 2009, the Company adopted new accounting guidance related to recognition and presentation of other-than-temporary impairment (ASC 320-10). When the Company does not intend to sell a debt security, and it is more likely than not, the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. As a result of this guidance, there was no impact on the Company’s consolidated statement of income as of December 31, 2009.
Prior to the adoption of the recent accounting guidance during 2009, management considered, in determining whether other-than-temporary impairment exists, (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 and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Loans Receivable and Allowance for Loan Losses
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balance adjusted for any charge-offs, deferred fees or costs on originated loans. Interest income on loans is accrued over the term of the loans based on the principal balance outstanding. Loan origination fees and direct origination costs are capitalized and recognized as adjustments to yield on the related loans.
The allowance for loan losses is established through a provision for loan losses charged against income. The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable credit losses on existing loans that may become uncollectible and probable credit losses inherent in the remainder of the loan portfolio. The amounts of provisions to the allowance for loan losses are based on management’s analysis and evaluation of the loan portfolio for identification of problem credits, internal and external factors that may affect collectability, relevant credit exposure, particular risks inherent in different kinds of lending, current collateral values and other relevant factors.
The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, or collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risking rating data.
Loans considered impaired, under FASB ASC 310-10-35 (formerly SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures), are loans for which, 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. The Company applies this policy even if delays or shortfalls in payment are expected to be insignificant. The aggregate amount of impairment of loans is utilized in evaluating the adequacy of the allowance for loan losses and amount of provisions thereto. Losses on impaired loans are charged against the allowance for loan losses when in the process of collection it appears likely that such losses will be realized. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When accrual of interest is discontinued, all unpaid accrued interest is reversed.
Groups of loans with similar risk characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements.
Loans are placed on non-accrual status when management believes that the borrower’s financial condition, after giving consideration to economic and business conditions and collection efforts, is such that collection of interest is doubtful, or generally when loans are 90 days or more past due. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Accrued interest related to non-accrual loans is generally charged against the allowance for loan losses when accrued in prior years and reversed from interest income if accrued in the current year. Interest income on non-accrual loans may be recognized to the extent cash payments are received, but payments received are usually applied to principal. Non-accrual loans are generally returned to accrual status when principal and interest payments are less than 90 days past due, the customer has made required payments for at least six months, and the Company reasonably expects to collect all principal and interest.
Foreclosed Assets Held for Sale
Real estate and personal properties acquired through or in lieu of loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis.
Valuations are periodically performed by management, and the real estate and personal properties are carried at fair value less cost to sell. Gains and losses from the sale of other real estate and personal properties are recorded in non-interest income, and expenses used to maintain the properties are included in non-interest expenses.
Bank Premises and Equipment
Bank premises and equipment are carried at cost or fair market value at the date of acquisition less accumulated depreciation. Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets. Accelerated depreciation methods are used for tax purposes. Leasehold improvements are capitalized and amortized by the straight-line method over the terms of the respective leases or the estimated useful lives of the improvements whichever is shorter. The assets’ estimated useful lives for book purposes are as follows:
Bank premises.
15-40 years
Furniture, fixtures, and equipment
3-15 years
Investments in Unconsolidated Affiliates
The Company had a 20.4% investment in White River Bancshares, Inc. (WRBI) at December 31, 2007. The Company’s investment in WRBI at December 31, 2007 totaled $13.8 million. On March 3, 2008, WRBI repurchased the Company’s interest in WRBI which resulted in a one-time gain of $6.1 million. Prior to this date, the investment in WRBI was accounted for on the equity method. The Company’s share of WRBI operating income included in non-interest income in 2008 and 2007 totaled $102,000 and $86,000, respectively. The Company’s share of WRBI unrealized loss on investment securities available-for-sale at December 31, 2007 amounted to $92,000. See the “Acquisitions” footnote related to the Company’s acquisition of WRBI during 2005.
The Company has invested funds representing 100% ownership in five statutory trusts which issue trust preferred securities. The Company’s investment in these trusts was $1.4 million at December 31, 2009 and 2008 and $1.3 million at December 31, 2007. Under accounting principles generally accepted in the United States of America, these trusts are not consolidated.
The summarized financial information below represents an aggregation of the Company’s unconsolidated affiliates as of December 31, 2009, 2008 and 2007, and for the years then ended:
Intangible Assets
Intangible assets consist of goodwill and core deposit intangibles. Goodwill represents the excess purchase price over the fair value of net assets acquired in business acquisitions. Core deposit intangibles represent the estimated value related to customer deposit relationships in the Company’s acquisitions. The core deposit intangibles are being amortized over 84 to 114 months on a straight-line basis. Goodwill is not amortized but rather is evaluated for impairment on at least an annual basis. The Company performed its annual impairment test of goodwill and core deposit intangibles during 2009, 2008 and 2007, as required by FASB ASC 350, Intangibles - Goodwill and Other. The tests indicated no impairment of the Company’s goodwill or core deposit intangibles.
Mortgage Servicing Rights
Mortgage servicing rights are purchased servicing rights acquired in HBI’s acquisition of Centennial Bancshares, Inc. on January 1, 2008. As of December 31, 2009, the mortgage loan servicing portfolio of approximately $209.6 million and purchased mortgage servicing rights of $1.1 million is being sub-serviced by a third party. The Company did not add any loans to this portfolio during 2009 or 2008. These rights are amortized in proportion to and over the period of estimated servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate.
Securities Sold Under Agreements to Repurchase
The Company sells securities under agreements to repurchase to meet customer needs for sweep accounts. At the point funds deposited by customers become investable, those funds are used to purchase securities owned by the Company and held in its general account with the designation of Customers’ Securities. A third party maintains control over the securities underlying overnight repurchase agreements. The securities involved in these transactions are generally U.S. Treasury or Federal Agency issues. Securities sold under agreements to repurchase generally mature on the banking day following that on which the investment was initially purchased and are treated as collateralized financing transactions which are recorded at the amounts at which the securities were sold plus accrued interest. Interest rates and maturity dates of the securities involved vary and are not intended to be matched with funds from customers.
Derivative Financial Instruments
The Company may enter into derivative contracts for the purposes of managing exposure to interest rate risk. The Company records all derivatives on the balance sheet at fair value. Historically the Company’s policy has been not to invest in derivative type investments.
The Company has executed two back-to-back interest rate swap agreements associated with one borrower in the loan portfolio. Though the Company is not applying hedge accounting, the swaps are identical offsets of one another, thereby resulting in a net income impact of zero. They are being adjusted to the fair value in accordance with FASB ASC 815, Derivatives and Hedging. The notional amount of the loans was $20.4 million at December 31, 2009 and 2008. The impact to the 2009 and 2008 financial statements was $1.6 million and $757,000, respectively in other assets with a corresponding amount in other liabilities.
Stock Options
Prior to 2006, we elected to follow FASB ASC 718, Compensation - Stock Compensation (formerly Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees) and related interpretations in accounting for employee stock options using the fair value method. Under this topic, because the exercise price of the options equals the estimated market price of the stock on the issuance date, no compensation expense is recorded. On January 1, 2006, we adopted FASB ASC 718, which establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods and services, or (ii) incurs liabilities in exchange for goods and services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of the equity instruments. FASB ASC 718 eliminates the ability to account for stock-based compensation and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to the management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company and its subsidiary file consolidated tax returns. Its subsidiary provides for income taxes on a separate return basis, and remit to the Company amounts determined to be currently payable.
Earnings per Share
Basic earnings per share are computed based on the weighted average number of shares outstanding during each year. Diluted earnings per share are computed using the weighted average common shares and all potential dilutive common shares outstanding during the period. The following table sets forth the computation of basic and diluted earnings per share (EPS) for the years ended December 31 (stock dividend adjusted):
Warrants to purchase 144,064 shares of common stock at $26.03 were outstanding at December 31, 2009, but were not included in the computation of diluted EPS because the exercise prices were greater than the average market price of the common shares.
2. Acquisitions
On January 1, 2008, the Company acquired Centennial Bancshares, Inc., an Arkansas bank holding company. Centennial Bancshares, Inc. owned Centennial Bank, located in Little Rock, Arkansas which had total assets of $234.1 million, loans of $192.8 million and total deposits of $178.8 million on the date of acquisition. The consideration for the merger was $25.4 million, which was paid approximately 4.6%, or $1.2 million in cash and 95.4%, or $24.3 million, in shares of our common stock. In connection with the acquisition, $3.0 million of the purchase price, consisting of $139,000 in cash and 140,456 shares of our common stock, was placed in escrow related to possible losses from identified loans and an IRS examination. In the first quarter of 2008, the IRS examination was completed which resulted in $1.0 million of the escrow proceeds being released. In the fourth quarter of 2009, approximately $334,000 of losses from the escrowed loans was identified. After, we were reimbursed 100% for those losses. The remaining escrow funds were released. In addition to the consideration given at the time of the merger, the merger agreement provided for additional contingent consideration to Centennial’s stockholders of up to a maximum of $4 million, which could be paid in cash or our common stock at the election of the former Centennial accredited stockholders, based upon the 2008 earnings performance. The final contingent consideration was computed and agreed upon in the amount of $3.1 million on March 11, 2009. The Company paid this amount to the former Centennial stockholders on a pro rata basis on March 12, 2009. All of the former Centennial stockholders elected to receive the contingent consideration in cash. As a result of this transaction, the Company recorded total goodwill of $15.4 million and a core deposit intangible of $694,000 during 2008 and 2009.
In January 2005, HBI purchased 20% of the common stock during the formation of White River Bancshares, Inc. of Fayetteville, Arkansas for $9.1 million. White River Bancshares owns all of the stock of Signature Bank of Arkansas, with branch locations in the northwest Arkansas area. In January 2006, White River Bancshares issued an additional $15.0 million of their common stock. To maintain a 20% ownership, the Company made an additional investment in White River Bancshares of $3.0 million in January 2006. During April 2007, White River Bancshares acquired 100% of the stock of Brinkley Bancshares, Inc. in Brinkley, Arkansas. As a result, HBI made a $2.6 million additional investment in White River Bancshares on June 29, 2007 to maintain its 20% ownership. On March 3, 2008, White River BancShares repurchased HBI’s 20% investment in White River Bancshares resulting in a one-time gain for HBI of $6.1 million.
3. Investment Securities
The amortized cost and estimated fair value of investment securities were as follows:
Assets, principally investment securities, having a carrying value of approximately $231.3 million and $187.5 million at December 31, 2009 and 2008, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. Also, investment securities pledged as collateral for repurchase agreements totaled approximately $62.0 million and $113.4 million at December 31, 2009 and 2008, respectively.
The amortized cost and estimated fair value of securities at December 31, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
For purposes of the maturity tables, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on anticipated maturities. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.
There were no securities classified as held to maturity at December 31, 2009, 2008 and 2007.
During the year ended December 31, 2009, $35.7 million in available-for-sale securities were sold. The gross realized gains and losses on these sales totaled $995,000 and $994,000, respectively for the year ended December 31, 2009. The income tax expense/benefit related to net security gains and losses was 39.225% of the gross amount for 2009. During the year ended December 31, 2008 and 2007, no available-for-sale securities were sold.
The Company evaluates all securities quarterly to determine if any unrealized losses are deemed to be other than temporary. In completing these evaluations the Company follows the requirements of FASB ASC 320, Investments - Debt and Equity Securities. Certain investment securities are valued less than their historical cost. These declines are primarily the result of the rate for these investments yielding less than current market rates. Based on evaluation of available evidence, management believes the declines in fair value for these securities are temporary. The Company does not intend to sell or believe it will be required to sell these investments before recovery of their amortized cost bases, which may be maturity. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.
During 2008, the Company became aware that two investment securities in the other securities category had become other than temporarily impaired. As a result of this impairment the Company charged off these two securities. The total of this charge-off was $5.9 million or $0.18 diluted earnings per share for 2008. These investment securities are a pool of other financial holding companies’ subordinated debentures throughout the country. Since the federal government has begun to seize institutions in these pools, it resulted in our investment becoming worthless. No other securities were written down for other than temporarily impairment for 2009, 2008 and 2007.
For the year ended December 31, 2009, the Company had $4.1 million in unrealized losses, which were in continuous loss positions for more than twelve months. Included in the $4.1 million in unrealized losses are $1.5 million in unrealized losses, which were associated with government-sponsored securities and government-sponsored mortgage-back securities. The Company’s assessments indicated that the cause of the market depreciation was primarily the change in interest rates and not the issuer’s financial condition, or downgrades by rating agencies. In addition, approximately 80.5% of the Company’s investment portfolio matures in five years or less. As a result, the Company has the ability and intent to hold such securities until maturity.
The following shows gross unrealized losses and estimated fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual investment securities have been in a continuous loss position as of December 31, 2009 and 2008:
4. Loans receivable and Allowance for Loan Losses
The various categories of loans are summarized as follows:
The following is a summary of activity within the allowance for loan losses:
At December 31, 2009 and 2008, accruing loans delinquent 90 days or more totaled $2.9 million and $1.4 million, respectively. Non-accruing loans at December 31, 2009 and 2008 were $37.1 million and $28.5 million, respectively. As of December 31, 2009, we had $35.2 million of restructured loans that are in compliance with the modified terms and are not reported as past due or non-accrual. Most of these credits are where borrowers have continued to pay as agreed but negotiated a lower interest rate due to general economic pressures rather than credit specific pressure.
Mortgage loans held for resale of approximately $4.8 million and $6.4 million at December 31, 2009 and 2008, respectively, are included in residential 1-4 family loans. Mortgage loans held for sale are carried at the lower of cost or fair value, determined using an aggregate basis. Gains and losses resulting from sales of mortgage loans are recognized when the respective loans are sold to investors. Gains and losses are determined by the difference between the selling price and the carrying amount of the loans sold, net of discounts collected or paid. The Company obtains forward commitments to sell mortgage loans to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale. The forward commitments acquired by the Company for mortgage loans in process of origination are not mandatory forward commitments. These commitments are structured on a best efforts basis; therefore the Company is not required to substitute another loan or to buy back the commitment if the original loan does not fund. Typically, the Company delivers the mortgage loans within a few days after the loans are funded. These commitments are derivative instruments and their fair values at December 31, 2009 and 2008 were not material.
At December 31, 2009 and 2008, impaired loans totaled $44.4 million and $31.5 million, respectively. As of December 31, 2009 and 2008, average impaired loans were $41.0 million and $29.4 million, respectively. All impaired loans had designated reserves for possible loan losses. Reserves relative to impaired loans at December 31, 2009, were $16.6 million and $10.9 million at December 31, 2008. Interest recognized on impaired loans during 2009 and 2008 was $2.1 million and $2.0 million, respectively.
5. Goodwill and Core Deposits and Other Intangibles
Changes in the carrying amount and accumulated amortization of the Company’s core deposits and other intangibles at December 31, 2009 and 2008, were as follows:
The carrying basis and accumulated amortization of core deposits and other intangibles at December 31, 2009 and 2008 were:
Core deposit and other intangible amortization for the years ended December 31, 2009, 2008 and 2007 was approximately $1.8 million, $1.8 million and $1.8 million, respectively. Including all of the mergers completed, HBI’s estimated amortization expense of core deposits and other intangibles for each of the years 2010 through 2014 is: 2010 - $1.8 million; 2011 - $1.1 million; 2012 - $619,000; 2013 - $619,000; and 2014 - $530,000;.
The carrying amount of the Company’s goodwill was $53.0 million and $50.0 million at December 31, 2009 and 2008, respectively. Goodwill is tested annually for impairment. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements.
6. Deposits
The aggregate amount of time deposits with a minimum denomination of $100,000 was $482.6 million and $500.7 million at December 31, 2009 and 2008, respectively. Interest expense applicable to certificates in excess of $100,000 totaled $13.0 million, $19.6 million and $22.8 million for the years ended December 31, 2009, 2008 and 2007, respectively. As of December 31, 2009 and 2008, brokered deposits were $71.0 million and $111.0 million, respectively.
The following is a summary of the scheduled maturities of all time deposits at December 31, 2009 (in thousands):
Deposits totaling approximately $206.6 million and $278.2 million at December 31, 2009 and 2008, respectively, were public funds obtained primarily from state and political subdivisions in the United States.
7. FHLB Borrowed Funds
The Company’s FHLB borrowed funds were $264.4 million and $283.0 million at December 31, 2009 and 2008, respectively. All of the outstanding balance for December 31, 2009 and 2008 are long-term advances. The long-term FHLB advances mature from the current year to 2025 with interest rates ranging from 2.020% to 5.076% and are secured by loans in the Company’s loan portfolio. Advances are subject to restrictions or penalties in the event of prepayment.
Additionally, the Company had $128.1 million and $217.2 million at December 31, 2009 and 2008, respectively, in letters of credit under a FHLB blanket borrowing line of credit, which are used to collateralize public deposits at December 31, 2009 and 2008, respectively.
Maturities of borrowings with original maturities exceeding one year at December 31, 2009, are as follows (in thousands):
8. Subordinated Debentures
Subordinated debentures at December 31, 2009 and 2008 consisted of guaranteed payments on trust preferred securities with the following components:
The trust preferred securities are tax-advantaged issues that qualify for Tier 1 capital treatment subject to certain limitations. Distributions on these securities are included in interest expense. Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds thereof in junior subordinated debentures of the Company, the sole asset of each trust. The preferred trust securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the junior subordinated debentures held by the trust. The Company wholly owns the common securities of each trust. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated debentures. The Company’s obligations under the junior subordinated securities and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by the Company of each respective trust’s obligations under the trust securities issued by each respective trust.
Presently, the funds raised from the trust preferred offerings will qualify as Tier 1 capital for regulatory purposes, subject to the applicable limit, with the balance qualifying as Tier 2 capital.
The Company holds two trust preferred securities which are currently callable without penalty based on the terms of the specific agreements. The 2009 agreement between the Company and the Treasury limits our ability to retire any of our qualifying capital. As a result, the notes previously mentioned are not currently eligible to be paid off.
9. Income Taxes
The following is a summary of the components of the provision for income taxes:
The reconciliation between the statutory federal income tax rate and effective income tax rate is as follows:
The types of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts that give rise to deferred income tax assets and liabilities, and their approximate tax effects, are as follows:
The Company adopted the provisions of FASB ASC 740-10-25 (formerly FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes), on January 1, 2007. The implementation of this topic did not have any effect on the Company’s financial statements.
The Company and its subsidiary file income tax returns in the U.S. federal jurisdiction and the states of Arkansas and Florida. With a few exceptions, the Company is no longer subject to U.S. federal and state tax examinations by tax authorities for years before 2006. The Company’s Federal tax return and its state tax returns are not currently under examination.
The Company recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense. During the years ended December 31, 2009, 2008 and 2007, the Company did not recognize any interest or penalties. The Company did not have any interest or penalties accrued at December 31, 2009, 2008 and 2007.
10. Common Stock and Stock Compensation Plans
Common Stock
In September 2009, the Company raised common equity through an underwritten public offering by issuing 4,950,000 shares of common stock at $19.85. The net proceeds of the offering after deducting underwriting discounts and commissions and offering expenses were $93.3 million. In October 2009, the underwriter’s of our stock offering exercised and completed their option to purchase an additional 742,500 shares of common stock at $19.85 to cover over-allotments. The net proceeds of the exercise of the over-allotment option after deducting underwriting discounts and commissions were $14.0 million. The total net proceeds of the offering after deducting underwriting discounts and commissions and offering expenses were $107.3 million.
On January 16, 2009, we issued and sold, and the United States Department of the Treasury purchased, (1) 50,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series A, liquidation preference of $1,000 per share, and (2) a ten-year warrant to purchase up to 288,129 shares of the Company’s common stock, par value $0.01 per share, at an exercise price of $26.03 per share, for an aggregate purchase price of $50.0 million in cash. Cumulative dividends on the Preferred Shares will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter. As a result of the recent public stock offering, the number of shares of common stock underlying the ten-year warrant held by the Treasury, has been reduced by half to 144,064 shares of our common stock at an exercise price of $26.03 per share.
These preferred shares will qualify as Tier 1 capital. The preferred shares will be callable at par after three years. Prior to the end of three years, the preferred shares may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock. The Treasury must approve any quarterly cash dividend on our common stock above $0.06 per share or share repurchases until three years from the date of the investment unless the shares are paid off in whole or transferred to a third party.
On July 16, 2008, our Board of Directors declared an 8% stock dividend which was paid August 27, 2008 to stockholders of record as of August 13, 2008. Except for fractional shares, the holders’ of our common stock received 8% additional common stock on August 27, 2008. The common stockholders did not receive fractional shares; instead they received cash at a rate equal to the closing price of a share on August 28, 2008 times the fraction of a share they otherwise would have been entitled to.
All share and per share amounts occurring before August 27, 2008 have been restated to reflect the retroactive effect of the stock dividend. After issuance, this stock dividend lowered our total capital position by approximately $13,000 as a result of the cash paid in lieu of fractional shares. Our financial statements reflect an increase in the number of outstanding shares of common stock, an increase in surplus and reduction of retained earnings.
Stock Compensation Plans
The Company has performance based stock options that were on a five-year cliff-vesting schedule with the options vesting on December 31, 2009. The options issued were subject to achievement of financial goals by the Company and the bank subsidiary over the five-year period ending December 31, 2009. Since a portion of the financial performance targets were not met, 104,188 of 285,185 remaining performance options were forfeited at December 31, 2009. The remaining 180,997 shares became fully vested on December 31, 2009.
The intrinsic value of the stock options outstanding at December 31, 2009, 2008, and 2007 was $9.5 million, $16.3 million and $9.2 million, respectively. The intrinsic value of the stock options vested at December 31, 2009, 2008 and 2007 was $9.3 million, $10.1 million and $6.2 million, respectively.
The intrinsic value of the stock options exercised during 2009, 2008 and 2007 was $1.3 million, $1.1 million, and $647,000, respectively.
Total unrecognized compensation cost, net of income tax benefit, related to non-vested awards, which are expected to be recognized over the vesting periods, was approximately $77,000 as of December 31, 2009.
The Company has a stock option and performance incentive plan. The purpose of the plan is to attract and retain highly qualified officers, directors, key employees, and other persons, and to motivate those persons to improve our business results. This plan provides for the granting of incentive nonqualified options to purchase up to 1,620,000 of common stock in the Company.
The table below summarized the transactions under the Company’s stock option plans at December 31, 2009, 2008 and 2007 and changes during the years then ended:
Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, is based on the grant date fair value. For stock option awards, the fair value is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options granted but are not considered by the model. Accordingly, while management believes that the Black-Scholes option-pricing model provides a reasonable estimate of fair value, the model does not necessarily provide the best single measure of fair value for the Company’s employee stock options. There were no options granted during 2009. The weighted-average fair value of options granted during 2008 and 2007 was $2.62 and $4.95 per share, respectively. The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
The expected divided yield is based on historical data. The expected volatility is based on published indexes of publicly traded bank holding companies with similar market capitalization. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life of options granted is derived using the simplified method and represents the period of time that options granted are expected to be outstanding. The simplified method will continue to be used until the Company has sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded.
The following is a summary of currently outstanding and exercisable options at December 31, 2009:
During the third quarter of 2009, the Company granted 6,400 shares of restricted common stock to its President and Chief Operating Officer. The restricted shares will vest 25% annually over four years beginning on the first anniversary of the grant. These restricted shares are also limited by the 2009 agreement between the Company and the Treasury. This agreement has additional provisions concerning the transferability of the shares and the continuation of performing substantial services for the Company.
During the fourth quarter of 2009, the Company granted 4,545 shares of restricted common stock. The restricted shares will vest equally each year over three years beginning on the third anniversary of the grant.
11. Non-Interest Expense
The table below shows the components of non-interest expense for years ended December 31:
12. Employee Benefit Plans
401(k) Plan
The Company has a retirement savings 401(k) plan in which substantially all employees may participate. The Company matches employees’ contributions based on a percentage of salary contributed by participants. The plan also allows for discretionary employer contributions. The Company’s expense for the plan was $366,000, $630,000 and $423,000 in 2009, 2008 and 2007, respectively, which is included in salaries and employee benefits expense.
Chairman’s Retirement Plan
On April 20, 2007, the Company’s board of directors approved a Chairman’s Retirement Plan for John W. Allison, the Company’s Chairman and CEO. The Chairman’s Retirement Plan provides a supplemental retirement benefit of $250,000 a year for 10 consecutive years or until Mr. Allison’s death, whichever occurs later. The benefits under the plan vest based on Mr. Allison’s age beginning at age 61 and fully vest when Mr. Allison reaches age 65. The benefits will also become 100% vested if, before Mr. Allison reaches the age of 65, he dies, becomes disabled, is involuntarily terminated from the Company without cause, or there is a change in control of the Company. The vested benefits will be paid in monthly installments. The benefit payments will begin on the earlier of Mr. Allison reaching age 65 or the termination of his employment with the Company for any reason other than death. If Mr. Allison dies before the benefits commence or during the 10 year guaranteed benefit period, his beneficiary will receive any remaining payments due. If he dies after the guaranteed benefit period, no further benefits will be paid. An expense of $561,000 and $535,000 was accrued for 2009 and 2008 for this plan, respectively.
13. Related Party Transactions
In the ordinary course of business, loans may be made to officers and directors and their affiliated companies at substantially the same terms as comparable transactions with other borrowers. At December 31, 2009 and 2008, related party loans were approximately $50.0 million and $158.6 million, respectively. New loans and advances on prior commitments made to the related parties were $20.6 million and $129.5 million for the years ended December 31, 2009 and 2008, respectively. Repayments of loans made by the related parties were $14.4 million and $116.3 million for the years ended December 31, 2009 and 2008, respectively. As a result of changes in composition of the Company’s related parties in 2009, the Company reduced $114.8 million of related party loans during 2009.
At December 31, 2009 and 2008, directors, officers, and other related interest parties had demand, non interest-bearing deposits of $30.9 million and $21.5 million, respectively, savings and interest-bearing transaction accounts of $426,000 and $1.2 million, respectively, and time certificates of deposit of $4.6 million and $9.8 million, respectively.
During 2009 and 2008, rent expense totaling $80,000 and $84,000, respectively, was paid to related parties.
During 2008, Centennial Bank (former First State Bank) purchased First State Plaza from a related interest party, Allison, Adcock, Rankin, LLC. The building, located in west Conway was purchased at fair market value for $3.4 million. The land and building was appraised for $1.1 million and $2.3 million, respectively.
14. Leases
The Company leases certain premises and equipment under noncancelable operating leases with terms up to 15 years which are charged to expense over the lease term as it becomes payable. The Company’s leases do not have rent holidays. In addition, any rent escalations are tied to the consumer price index or contain nominal increases and are not included in the calculation of current lease expense due to the immaterial amount. At December 31, 2009, the minimum rental commitments under these noncancelable operating leases are as follows (in thousands):
15. Concentration of Credit Risks
The Company’s primary market area is in central Arkansas, north central Arkansas, northwest Arkansas, southern Arkansas, southwest Florida and the Florida Keys (Monroe County). The Company primarily grants loans to customers located within these geographical areas unless the borrower has an established relationship with the Company.
The diversity of the Company’s economic base tends to provide a stable lending environment. Although the Company has a loan portfolio that is diversified in both industry and geographic area, a substantial portion of its debtors’ ability to honor their contracts is dependent upon real estate values, tourism demand and the economic conditions prevailing in its market areas.
16. Significant Estimates and Concentrations
Accounting principles generally accepted in the United Sates of America require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations. Estimates related to the allowance for loan losses and certain concentrations of credit risk are reflected in Note 4, while deposit concentrations are reflected in Note 6.
Although the Company has a diversified loan portfolio, at December 31, 2009 and 2008, commercial real estate loans represented 62.1% and 59.3% of gross loans and 260.5% and 410.0% of total stockholders’ equity, respectively. Residential real estate loans represented 22.8% and 22.9% of gross loans and 95.7% and 158.2% of total stockholders’ equity at December 31, 2009 and 2008, respectively.
The current economic environment presents financial institutions with unprecedented circumstances and challenges which in some cases have resulted in large declines in the fair values of investments and other assets, constraints on liquidity and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans. The financial statements have been prepared using values and information currently available to the Company.
Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
17. Commitments and Contingencies
In the ordinary course of business, the Company makes various commitments and incurs certain contingent liabilities to fulfill the financing needs of their customers. These commitments and contingent liabilities include lines of credit and commitments to extend credit and issue standby letters of credit. The Company applies the same credit policies and standards as they do in the lending process when making these commitments. The collateral obtained is based on the assessed creditworthiness of the borrower.
At December 31, 2009 and 2008, commitments to extend credit of $299.4 million and $351.2 million, respectively, were outstanding. A percentage of these balances are participated out to other banks; therefore, the Company can call on the participating banks to fund future draws. Since some of these commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.
Outstanding standby letters of credit are contingent commitments issued by the Company, generally to guarantee the performance of a customer in third-party borrowing arrangements. The term of the guarantee is dependent upon the credit worthiness of the borrower some of which are long-term. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments. The maximum amount of future payments the Company could be required to make under these guarantees at December 31, 2009 and 2008, is $15.6 million and $18.0 million, respectively.
The Company and/or its bank subsidiary have various unrelated legal proceedings, most of which involve loan foreclosure activity pending, which, in the aggregate, are not expected to have a material adverse effect on the financial position of the Company and its subsidiary.
18. Financial Instruments
Effective January 1, 2008, the Company adopted FASB ASC 820, Fair Value Measurements and Disclosures. FASB ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FASB ASC 820 has been applied prospectively as of the beginning of the period.
FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 also establishes a fair value hierarchy which 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 value:
Level 1
Quoted prices in active markets for identical assets or liabilities
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
Available-for-sale securities are the only material instruments valued on a recurring basis which are held by the Company at fair value. The Company does not have any Level 1 securities. Primarily all of the Company’s securities are considered to be Level 2 securities. These Level 2 securities consist of U.S. government-sponsored enterprises, mortgage-backed securities plus state and political subdivisions. As of year end 2009, Level 3 securities were immaterial.
Impaired loans are the only material instruments valued on a non-recurring basis which are held by the Company at fair value. Loan impairment is reported when full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan is confirmed. Impaired loans, net of specific allowance, were $27.8 million and $20.6 million as of December 31, 2009 and December 31, 2008, respectively. This valuation would be considered Level 3, consisting of appraisals of underlying collateral.
Foreclosed assets held for sale are the only material non-financial assets valued on a non-recurring basis which are held by the Company at fair value, less estimated costs to sell. At foreclosure, if the fair value, less estimated costs to sell, of the real estate acquired is less than the Company’s recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Additionally, valuations are periodically performed by management and any subsequent reduction in value is recognized by a charge to income. The fair value of foreclosed assets held for sale is estimated using Level 2 inputs based on observable market data. As of December 31, 2009 and December 31, 2008, the fair value of foreclosed assets held for sale, less estimated costs to sell was $16.5 million and $6.8 million, respectively.
Compared to prior years, the adoption of FASB ASC 820 did not have a material impact on our 2009 or 2008 consolidated financial statements.
Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed in these notes:
Cash and cash equivalents and federal funds sold - For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Net loans receivable, net of impaired loans - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are assumed to approximate the carrying amounts. The fair values for fixed-rate loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics.
Accrued interest receivable - The carrying amount of accrued interest receivable approximates its fair value.
Deposits and securities sold under agreements to repurchase - The fair values of demand, savings deposits and securities sold under agreements to repurchase are, by definition, equal to the amount payable on demand and therefore approximate their carrying amounts. The fair values for time deposits are estimated using a discounted cash flow calculation that utilizes interest rates currently being offered on time deposits with similar contractual maturities.
Federal funds purchased - The carrying amount of federal funds purchased approximates its fair value.
Accrued interest payable - The carrying amount of accrued interest payable approximates its fair value.
FHLB and other borrowed funds - For short-term instruments, the carrying amount is a reasonable estimate of fair value. The fair value of long-term debt is estimated based on the current rates available to the Company for debt with similar terms and remaining maturities.
Subordinated debentures - The fair value of subordinated debentures is estimated using the rates that would be charged for subordinated debentures of similar remaining maturities.
Commitments to extend credit, letters of credit and lines of credit - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.
The following table presents the estimated fair values of the Company’s financial instruments. The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.
19. Regulatory Matters
The Bank is subject to a legal limitation on dividends that can be paid to the parent company without prior approval of the applicable regulatory agencies. Arkansas bank regulators have specified that the maximum dividend limit state banks may pay to the parent company without prior approval is 75% of the current year earnings plus 75% of the retained net earnings of the preceding year. Since the Bank is also under supervision of the Federal Reserve, they are further limited if the total of all dividends declared in any calendar year by the Bank exceeds the Bank’s net profits to date for that year combined with its retained net profits for the preceding two years. During the first six months of 2009, the Company did not request any dividends from its banking subsidiary. In the third quarter of 2009, the Company received a dividend of $2.1 million from its banking subsidiary. As a result of the additional common equity raised through an underwritten public offering during September 2009, the Company did not request dividends from its banking subsidiary during the fourth quarter of 2009 and does not anticipate requesting dividends from its banking subsidiary during 2010.
The Company’s subsidiary is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s 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 classifications 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 the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of December 31, 2009, the Company meets all capital adequacy requirements to which it is subject.
As of the most recent notification from regulatory agencies, the subsidiary was well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and its subsidiary must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institutions’ categories.
The Company’s actual capital amounts and ratios along with the Company’s bank subsidiary are presented in the following table.
20. Additional Cash Flow Information
In connection with the Centennial Bancshares, Inc. acquisition accounting for using the purchase method, the Company acquired approximately $241.5 million in assets, assumed $218.9 million in liabilities, issued $24.3 million of equity and received net funds of $1.7 million during 2008. The following is summary of the Company’s additional cash flow information during the years ended:
21. Condensed Financial Information (Parent Company Only)
Condensed Balance Sheets
Condensed Statements of Income
Condensed Statements of Cash Flows
22. Fourth Quarter Adjustments (Unaudited)
The Company reported a net loss of $9.4 million, or $0.46 diluted loss per share for the fourth quarter of 2008. During this quarter, the Company experienced several items that it does not consider part of its core earnings. These items include an increased provision for loan losses over our normal quarterly provision, $2.4 million of write-downs on other real estate owned, $1.8 million of merger expenses from our bank charter consolidation, a $3.9 million impairment write-down on two trust preferred investment securities and $448,000 of other income resulting from our ownership of Arkansas Bankers’ Bank stock during their fourth quarter reorganization.
The increased fourth quarter 2008 provision for loan loss was primarily attributable to the increase in non-performing loans during the quarter as a result of rapidly deteriorating Florida market conditions. During 2008, non-performing loans increased from $16.1 million in the third quarter to $29.9 million during the fourth quarter, most of which was concentrated in Florida. The write-down on other real estate was primarily due to the declining market value of one commercial property in Florida. The write-down on trust preferred investment securities was a result of bank closures in the fourth quarter that occurred within the pool.
23. Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) issued FASB ASC 805, Business Combinations, which established principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
In March 2008, the FASB issued FASB ASC 815, Derivatives and Hedging. FASB ASC 815 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
On April 9, 2009, the FASB finalized three FASB Staff Positions (“FSPs”) regarding the accounting treatment for investments including mortgage-backed securities. These FSPs changed the method for determining if an other-than-temporary impairment (“OTTI”) exists and the amount of OTTI to be recorded through an entity’s income statement. The changes brought about by the FSPs provide greater clarity and reflect a more accurate representation of the credit and noncredit components of an OTTI event. The three FSPs are as follows:
•
FASB ASC 820-10-65-4, Fair Value Measurements and Disclosures provides guidelines for making fair value measurements that determine fair value when the volume and level of activity for assets or liabilities have significantly decreased and identify transactions that are not orderly.
•
FASB ASC 320-10-65, Investments - Debt and Equity Securities provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities.
•
FASB ASC 825-10-65, Financial Instruments enhances consistency in financial reporting by increasing the frequency of fair value disclosures.
The adoption of these did not have a material effect on the Company’s results of operations or financial position.
In May 2009, FASB issued FASB ASC 855, Subsequent Events with the objective to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. FASB ASC 855 sets forth: (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. FASB ASC 855 is effective for interim and annual financial periods ending after June 15, 2009. The adoption of FASB ASC 855 on June 30, 2009, did not have an impact on the Company’s consolidated financial statements.
In June 2009, FASB issued FASB ASC 860, Transfers and Servicing. The objective of FASB ASC 860 is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. FASB ASC 860 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The Company is currently evaluating the impact of the adoption of this standard, but does not expect it have a material effect on the Company’s financial position or results of operation.
In June 2009, FASB issued FASB ASC 810, Consolidation. The objective of FASB ASC 810 is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. FASB ASC 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company is currently evaluating the impact of the adoption of this standard, but does not expect it have a material effect on the Company’s financial position or results of operation.
Presently, the Company is not aware of any other changes from the Financial Accounting Standards Board that will have a material impact on the Company’s present or future financial statements.
25. Subsequent Events
On January 31, 2010, Ron W. Strother, President, Chief Operating Officer and director of the Company died. As a result of his death, his shares of restricted stock became fully vested. The Company will expense these shares in the first quarter of 2010 at a cost of approximately $159,000 pre-tax.
Subsequent events have been evaluated through the date the financial statements were issued.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
No items are reportable.
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
An evaluation as of the end of the period covered by this annual report was carried out under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our “disclosure controls and procedures,” which are defined under SEC rules as controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective. As a result of this evaluation, there were no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the date of evaluation.
No items are reportable.
PART III
Item 10.
Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNACE
Incorporated herein by reference from the Company’s definitive proxy statement for the Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A.
Incorporated herein by reference from the Company’s definitive proxy statement for the Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A.
Item 12.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated herein by reference from the Company’s definitive proxy statement for the Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A.
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Incorporated herein by reference from the Company’s definitive proxy statement for the Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A.
Item 14.
Item 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated herein by reference from the Company’s definitive proxy statement for the Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report:
(a)
1 and 2. Financial Statements and any Financial Statement Schedules
The financial statements and financial statement schedules listed in the accompanying index to the consolidated financial statements and financial statement schedules are filed as part of this report.
(b)
Listing of Exhibits.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated as of March 5, 2010.
/s/ John W. Allison
/s/ C. Randall Sims
/s/ Randy E. Mayor
John W. Allison
C. Randall Sims
Randy E. Mayor
Chairman of the Board of
Chief Executive Officer and
Chief Financial Officer,
Directors
Director (Principal Executive
Officer)
Treasurer and Director (Principal Financial Officer)
/s/ Robert H. Adcock, Jr.
/s/ Richard H. Ashley
Robert H. Adcock, Jr.
Richard H. Ashley
Dale A. Bruns
Vice Chairman of the Board and Director
Director
Director
/s/ Richard A. Buckheim
/s/ Jack E. Engelkes
/s/ James G. Hinkle
Richard A. Buckheim
Jack E. Engelkes
James G. Hinkle
Director
Director
Director
/s/ Alex R. Lieblong
/s/ William G. Thompson
/s/ Brian S. Davis
Alex R. Lieblong
William G. Thompson
Brian S. Davis
Director
Director
Chief Accounting Officer and Investor Relations Officer
(Principal Accounting Officer)