Item 1. Business
General
McIntosh Bancshares, Inc. (the “Company”), a registered bank holding company, was incorporated under the laws of Georgia in 1990 and acquired 100% of the outstanding shares of McIntosh State Bank (the “Bank”) on April 25, 1991. The Bank was incorporated under the laws of Georgia on February 14, 1964. In March 1998 the Company capitalized a wholly owned subsidiary, McIntosh Financial Services, Inc. (“MFS”), which was incorporated under the laws of Georgia on January 8, 1998.
Services
The Bank is a community oriented, full-service commercial bank, serving the Georgia counties of Butts, Jasper, and South Henry through offices in Jackson, Monticello, Locust Grove, and McDonough. The Bank closed its Lake Oconee office on September 30, 2009. The Bank has six automated teller machines (ATMs). The Bank emphasizes autonomy for each office with decisions made locally. The Bank offers checking, savings, individual retirement, and time deposit accounts, safe deposit boxes, issues ATM and debit cards, conducts wire
transfers, and offers internet banking and cash management services. The Bank offers lending services for purposes such as commercial, industrial, real estate, municipal, and leasehold financing as well as offers personal secured and unsecured credit. The Bank provides secondary market financing for conforming residential real estate loans through conventional, Veterans Administration, Federal Housing Administration, or Rural Development Authority programs. Neither the Company nor the Bank generates a material amount of revenue from foreign countries, nor does either have material long-lived assets, customer relationships, mortgages or servicing rights, deferred policy acquisition costs, or deferred tax assets in foreign countries. Thus, the Company has no significant risks attributable to foreign operations.
MFS offers mutual fund investments, fixed and variable annuities, life, health, and long term care insurance, estate planning, and investment management services. MFS has separate offices in the Bank’s Jackson, Monticello and McDonough offices.
Loans
The Bank grants both secured and unsecured loans to individuals and businesses. As of December 31, 2009, the Bank’s loan portfolio totaled $277,017,008.
Although the Bank has a diversified loan portfolio, a substantial portion is secured by improved and unimproved real estate which is dependent on the real estate market. As of December 31, 2009, the Bank had a concentration of loans to finance the acquisition, development, and construction (AD&C) of multifamily, commercial, and residential real estate. This AD&C concentration, including associated unfunded commitments, totals $44,763,651 and represents 15% of gross loans and unfunded loan commitments. The Bank has established a maximum of 20% of gross loans plus unfunded commitments on the AD&C portion of the portfolio.
Lending Policy
Standards for extensions of credit are contained in the Bank’s loan policy. Loans are predominately from borrowers within the Bank’s delineated areas of Butts, Jasper, Henry, Greene and Putnam counties. Loans are granted to individuals or businesses on either an unsecured or secured basis. Limits covering the maximum amount of indirect and direct debt to any one borrower, the maximum amount a loan officer may lend, the maximum amount of funds that may be advanced on certain collateral, and the maximum lending authority of the Bank’s loan committee and individual loan officers are contained in the loan policy. The loan policy is reviewed and approved annually by the Bank’s board of directors.
Loans secured by 1-4 family residential real estate are governed by the following underwriting standards:
(a) Owner occupied first mortgage - 89% or less loan-to-value (LTV), 30 year amortization, and debt-to-income not to exceed 40%;
(b) Investor first mortgage - 85% or less LTV, 30 year amortization, and debt service requirement minimum of 1.25:1;
(c) Construction first mortgage - 75% LTV on speculative construction and 80% LTV on presold construction, amortized 15 years if unpaid after 24 months of origination, and debt service requirement minimum of 1.25:1, and;
(d) Home equity second mortgage - 85% or less LTV after considering the unpaid balance of the first mortgage, revolving line of credit with 10 year balloon of principal and interest monthly; and debt-to-income not to exceed 40%.
Loan Review and Non-Performing Assets
The Bank contracts with a third party for its loan review. The scope of loan review represented a cumulative total of 60% of the portfolio outstanding as of December 31, 2009, and included commercial credits in excess of
$500,000, classified (Substandard and Doubtful) or Watch rated loans, and a sample of the consumer loan portfolio. Also included in the scope of loan review are loan administration matters such as potential violations of law, policy and documentation exceptions, and credit collection efforts. Loan review is conducted quarterly. The results are presented to the Company’s Board of Directors and Audit Committee.
All loans are graded according to an initial risk assessment conducted by the originating loan officer. Thereafter, loan grades may change based on results of the external loan review process or an examination, at the direction of an office President, or if the loan becomes delinquent. The Bank’s practice is to charge-off unsecured loans when they become 120 days past due or are rated Loss. The Bank places loans on nonaccrual status once they become 90 days past due. Exceptions may apply if the loan is consumer installment debt or if the loan is secured by a 1-4 family residence and in the process of collection. Nonaccrual loans and loans rated Substandard or Doubtful in excess of $400,000 are reviewed for impairment. Loans deemed collateral dependent are charged down to their net realizable value based on a current valuation of the collateral.
Investment Policy
The Bank’s investment policy establishes objectives for the investment portfolio and the guidelines for bank investments. Bank investments provide liquidity to accommodate deposit or loan fluctuations, secure public deposits, and supplement bank earnings consistent with liquidity, interest sensitivity, and credit quality considerations. Provisions of the investment policy address investment authority and oversight, permissible investments, accounting treatment, selection and monitoring of broker/dealers, and unsuitable investment practices. Portfolio composition and performance as well as individual transactions are regularly reviewed by the Bank’s Asset/Liability Committee (ALCO) and the Board of Directors. The investment policy is reviewed and approved by the Board of Directors annually.
Asset/Liability Management
The Bank’s interest rate risk and liquidity policy establishes Board ALCO and Management ALCO which are responsible for measuring, monitoring, and managing exposure to adverse interest rate movements. Board ALCO is composed of the Bank’s CEO, President, CFO, office Presidents, Chief Credit Officer and four outside directors. Management ALCO is composed of the Bank’s CEO, President, CFO, Chief Credit Officer, Vice President of Accounting, Controller, and Deposit Administrator. The Board ALCO monitors the ALCO process and the Management ALCO develops and implements the strategies. The Bank manages exposure to interest rate movements by modeling static gap, earnings at risk, and economic value of equity (EVE).
Bank management attempts to achieve consistent growth in net interest income (NII) while limiting volatility arising from changes in interest rates. Measuring the maturity and repricing characteristics of assets and liabilities or gap is one method Bank management utilizes to manage exposure to interest rates. The projected repricing and prepayment attributes of earning assets and interest bearing liabilities are based on the current interest rate environment and are subject to change as interest rates fluctuate. The Bank has established guidelines for this measure where cumulative gap must be within positive and negative 15% over select time periods. The following table outlines the Bank’s cumulative gap for the years ending December 31, 2009 and 2008, respectively.
Simulation, or earnings at risk, modeling is also utilized by the Bank to manage interest rate risk. The upcoming 12 month time period is simulated to determine a baseline NII forecast and the sensitivity of this forecast to changes in interest rates. The baseline earnings at risk measure incorporates management’s estimate of
interest rates over the upcoming 12 months and applies those assumptions to earning assets and interest bearing liabilities. Projected rates and volumes for new and renewed loans and deposits are assumed based on experience and forecasts, but are significantly dependent on market conditions. Management measures the change to baseline NII via rate shocks of 100, 200, and 300 basis points (bps). The Bank has established a maximum of a 20% change in baseline NII as a result of the respective rate shocks. The following table outlines the effect of changes in projected NII over the next 12 months as of December 21, 2009 and 2008, respectively.
Bank management also utilizes EVE to monitor and manage the longer term impact of interest rate movements on the Bank’s capital. EVE attempts to measure the change in cash flows of earning assets and liabilities as rates change. Management measures the change to baseline EVE via rate shocks of 100, 200, and 300 bps. The Bank has established a maximum of a 20% change in baseline EVE as a result of the respective rate shocks. The following table outlines the effect of changes in projected EVE as of the years ending December 31, 2009 and 2008, respectively.
Liquidity is measured utilizing a calculation accepted by the Bank’s regulatory authorities. A liquidity ratio of 10% or greater and a loan to funding ratio of less than 85% have been approved by the board of directors as suitable measures of liquidity. As of December 31, 2009, the Bank’s liquidity and loan to funding ratios were 13.3% and 71.6%, respectively. Secondary sources of liquidity include the following: a $6.5 million line of credit with a correspondent bank; the Federal Home Loan Bank of Atlanta totaling $14 million, and the Federal Reserve Bank of Atlanta totaling $15.2 million. As of December 31, 2009, $14 million was outstanding under these lines.
Supervision and Regulation
The Company is a registered bank holding company subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) under the Bank Holding Company Act of 1956, as amended (the “Act”). The Company is required to file financial information with the Federal Reserve periodically and is subject to periodic examination by the Federal Reserve.
The Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) it may acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank that it does not already control; (ii) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of a bank; and (iii) it may merge or consolidate with any other bank holding company. In addition, a bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of the voting shares of any company engaged in non-banking activities. This prohibition does not apply to activities found by the Federal Reserve, by order or regulation, to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation or order to be closely related to banking are: (i) making or servicing loans and certain types of leases; (ii) performing certain data processing services; (iii) acting as fiduciary or investment or financial advisor; (iv) providing discount brokerage services; (v) underwriting bank eligible securities; (vi) underwriting debt and equity securities; (vii) underwriting debt and equity securities on a limited basis through separately capitalized subsidiaries; and (viii) making investments in corporations or projects designed primarily to promote community welfare.
The Gramm-Leach-Bliley Act (GLBA) of 1999 permits eligible banks and bank holding companies to engage in activities and to affiliate with nonbank organizations engaged in activities that are financial in nature or incidental or complimentary to such financial activities. The Federal Reserve has the discretion to determine what activities are complementary to financial activities. The GLBA effectively repeals certain provisions of the Glass-Steagall Act of 1933 which separated banking, insurance, and securities underwriting activities.
Under GLBA, bank holding companies whose banking subsidiaries are well capitalized and well managed may also apply to become a financial holding company. Financial holding companies have the authority to engage in activities that are financial in nature that are not permitted for other bank holding companies. Some of the activities that the Act provides are financial in nature are: (a) lending, exchanging, transferring, investing for others, or safeguarding money or securities; (b) insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker with respect thereto; (c) providing financial, investment, or economic advisory services, including advising an investment company; (d) issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; and (e) underwriting, dealing in, or making a market in securities. The Company is unable to register as a financial holding company due to the Bank being less than well capitalized.
The GBLA also imposed new requirements on financial institutions with respect to consumer privacy. The statute generally prohibits disclosure of consumer information to non-affiliated third parties unless the consumer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to consumers annually. Financial institutions, however, will be required to comply with state law if it is more protective of consumer privacy than GBLA. The statute also directed federal regulators, including the Federal Reserve and Federal Deposit Insurance Corporation (“FDIC”), to prescribe standards for the security of consumer information. The Company and the Bank are subject to such standards, as well as standards for notifying consumers in the event of a security breach.
The Company must also register with the Georgia Department of Banking and Finance (DBF) and file periodic information with the DBF. As part of such registration, the DBF requires information with respect to the financial condition, operations, management, and inter-company relationships of the Company, the Bank, and MFS and related matters. The DBF may also require such other information as is necessary to keep itself informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been complied with, and the DBF may examine the Company.
The Company is an affiliate of the Bank under the Act, which imposes restrictions on (i) loans by the Bank to the Company; (ii) investments in the stock or securities of the Company by the Bank; (iii) the Bank taking the stock or securities of an affiliate as collateral for loans by the Bank to a borrower, and (iv) the purchase of assets from the Company by the Bank. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extensions of credit, lease or sale of property or furnishing of services.
The Bank is regularly examined by the FDIC. The Bank, as a state chartered bank under the laws of Georgia, is subject to the supervision of, and is regularly examined by, the DBF. Both the FDIC and DBF must grant prior approval of any merger, consolidation or other corporate reorganization involving the Bank. A bank can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly controlled institution.
Activities of MFS are governed by the State of Georgia Insurance Department (Department) and the Financial Industry Regulatory Authority (FINRA). The Department and FINRA may examine the activities of MFS at any time. The Department and FINRA require MFS and its representatives to fulfill licensing and continuing education requirements. Customer complaints or compliance lapses deemed serious enough may be cause for licenses to be revoked and the business to cease operation. As of December 31, 2009, MFS is not aware of any matters pending before the Department or FINRA.
Regulatory Order
We have strong ties to our community and have worked with our neighbors to enable these areas to grow and prosper. Much of that growth and prosperity was built on the development of property for housing and business expansion. We made many sound loans to finance such activities and never participated in the sub-prime lending market.
During 2008, our state and our nation faced challenging economic conditions on a scale greater than have been experienced in decades. Like many other community banks, those conditions impacted our Bank.
Recently, we have seen real estate values decline for residential housing and lots. The demand for homes and commercial properties has also declined significantly, and unemployment has increased. As a result, residential and commercial real estate builders and developers, as well as consumer and small business borrowers, experienced difficulty repaying loans to us and to other banks. At the same time, many of these same borrowers watched their retirement savings decline significantly. Because the Bank’s loan portfolio is a reflection of our individual loan customers, the impact of the economy on them has had a corresponding impact on our Bank.
On October 15, 2009, the Bank, the subsidiary bank of the Company, signed an Order to Cease and Desist (the “Order”) issued by the DBF, in consultation with the FDIC. The Order was countersigned by the DBF and the FDIC on October 23, 2009.
The Order is based on the findings of the DBF during an on-site examination conducted as of February 2, 2009. The Order identified the following practices requiring remedial action, which the Board did not admit nor deny: operating with supervision and direction over the Bank’s financial affairs that needs to be improved; operating with a volume of adversely classified assets that needs to be decreased; operating with an allowance for loan and lease losses (“Allowance”) that needs to be increased; operating with level of capital that needs improvement in light of the Bank’s risk profile; operating with an excessive volume of credit concentrations; operating with liquidity that needs improvement; operating with a large volume of nonearning assets; and operating in apparent violations of rules, regulations, and policy statements.
To address the findings of the on-site examination, the Order contains certain operational and financial restrictions related primarily to the Bank’s asset quality, concentrations of credit, allowance for loan and lease losses, and capital. The Bank will be required, among other things, to do the following:
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Increase Board participation in the affairs of the Bank, which includes holding meetings at least monthly and establishing a Directors’ Committee made up of a majority of members who are not officers, to receive reports from management and report to the Board;
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Assess management’s qualifications and ability to comply with the Order and applicable laws and regulations and to operate the Bank in a safe and sound manner;
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Charge-off all assets classified as “Loss” and 50% of assets classified as “Doubtful” in any official report of examination from the FDIC or the DBF;
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Reduce the aggregate balance of assets classified as “Substandard” or “Doubtful” in accordance with a schedule provided in the Order;
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Restrict extensions of credit to any borrower whose extension of credit has been, in whole or in part, charged-off or adversely classified;
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Formulate a plan to reduce risk exposure for any lines of credit that are adversely classified by the FDIC or the DBF and in the aggregate are $1,000,000 or more as of the date of the examination;
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Enhance the Bank’s internal loan review program;
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Maintain an adequate allowance, review the adequacy of the allowance and ensure that its policy for determining the adequacy is comprehensive;
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File a capital plan with the FDIC and the DBF;
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Maintain (a) Tier 1 Capital at or above 8% of total assets and (b) total risk-based capital at or above 10% of total risk-weighted assets;
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Review and, if necessary, revise its written plan detailing appropriate strategies for managing acquisition, development and construction (ADC), and commercial real estate concentration levels;
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Perform a risk segmentation analysis on credit concentrations;
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Review and, if applicable, revise its written liquidity, contingent funding, and asset liability management plans;
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Obtain a waiver from the FDIC prior to accepting, renewing, or rolling over any brokered deposits;
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File a long-term strategic plan with the FDIC and the DBF;
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Correct all cited violations of regulations and contraventions of policy cited in the Bank’s Report of Examination;
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Refrain from paying dividends, directors’ fees, or bonuses without prior regulatory approval; and
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File progress reports with the FDIC and the DBF.
Since the completion of the examination, the Board of Directors has aggressively taken steps to address the findings of the exam. The Bank and its Board of Directors have taken an active role in working with the DBF to improve the condition of the Bank and have already addressed many of the items included in the Order.
The Company and the Bank believe that the proactive steps the management and Board have already undertaken, together with those they plan to take in the future, will help the Bank address the Order and the concerns that gave rise to the Order. Banking products and services and hours of business are the same, and the Bank’s deposits are insured by the FDIC to the maximum limits allowed by law.
This Order does not prevent us from continuing to fully service our customers’ needs and to operate the Bank as we deem best. Instead, this Order is primarily in place due to the decline in capital and our increased level of problem assets. While things have not returned to the stress-free environment we all look forward to, significant progress is being made. Like any business in this area, we suffered through the downturn, and now we will have the opportunity to again prosper as the economy continues its recovery.
Payment of Dividends
The Company is a legal entity separate and distinct from the Bank. Most of the revenues of the Company result from dividends paid to it by the Bank. There are statutory and regulatory requirements applicable to the payment of dividends by the Bank to the Company, its shareholder. Under DBF regulations, the Bank may not declare and pay dividends out of retained earnings without first obtaining the written permission of the DBF unless such bank meets the following requirements: (i) total classified assets as of the most recent examination of the bank does not exceed 80% of equity capital (as defined by the regulation); (ii) the aggregate amount of dividends declared or anticipated to be declared in the calendar year does not exceed 50% of the net profits after taxes but before dividends for the previous calendar year; and (iii) the ratio of equity capital to adjusted assets is not less than 6%.
The payment of dividends by the Company and the Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The Federal Reserve maintains that a bank holding company must serve as source of financial strength to its subsidiary banks. As a result, the
Company may be required to provide financial support to the Bank at a time when, absent such Federal Reserve requirement, the Company may not deem it advisable to provide such assistance. Similarly, the FDIC maintains that insured banks should generally only pay dividends out of current operating earnings and dividends should only be declared and paid after consideration of the bank’s capital adequacy in relation to its assets, deposits, and such other items. For 2010, dividends paid to the Company from the Bank are not permissible as the Bank made no profit in 2009. The Bank was not permitted to pay any dividends to the Company in 2009, due to the losses incurred in 2008. During the year ending December 31, 2008, the Company declared and paid cash dividends totaling $252,988.
Capital Adequacy
The Federal Reserve and the FDIC have implemented substantially identical rules for assessing bank and bank holding company capital adequacy. These regulations establish minimum capital standards in relation to assets and off-balance sheet exposures for credit risk. Bank and bank holding companies are required to have (i) a minimum ratio of Total Capital (as defined) to risk-weighted assets of 8%; (ii) a minimum ratio of Tier One Capital (as defined) to risk-weighted assets of 4%; and (iii) a minimum ratio of stockholder’s equity to risk-weighted assets of 4%. The Federal Reserve and the FDIC also require a minimum leverage capital ratio of Tier One Capital to total assets of 3% for the most highly rated banks and bank holding companies. Tier One Capital generally consists of common equity, minority interests in equity accounts of consolidated subsidiaries, and noncumulative perpetual preferred stock and generally excludes unrealized gains or losses on investment securities, certain intangible assets, and certain deferred tax assets. The Federal Reserve or the FDIC will require a bank or bank holding company to maintain a leverage ratio greater than 3% if either is experiencing or anticipating significant growth, is operating with less than well-diversified risks, or is experiencing financial, operational, or managerial weaknesses.
In addition, the FDIC Improvement Act of 1991 provides for prompt corrective action (PCA) if a bank’s leverage capital ratio reaches 2%. PCA may call for the Bank to be placed in receivership or sold to another depository institution. The FDIC has adopted regulations implementing PCA which place financial institutions in the following four categories based on capitalization ratios: (i) a well capitalized institution has a total risked-based capital ratio of at least 10%, a Tier One risked-based ratio of at least 6%, and leverage capital ratio of at least 5%; (ii) an adequately capitalized institution has a total risked-based capital ratio of at least 8%, a Tier One risked-based ratio of at least 4%, and leverage capital ratio of at least 4%; (iii) an undercapitalized institution has a total risked-based capital ratio under 8%, a Tier One risked-based ratio under 4%, and leverage capital ratio under 4%; and (iv) a critically undercapitalized institution has a leverage capital ratio under 2%. Institutions deemed adequately capitalized are not permitted to accept brokered deposits (unless waived by the FDIC) and have limitations on the interest rates paid on deposit accounts. Institutions in any of the three undercapitalized categories would be prohibited from declaring and paying dividends or making capital distributions. The FDIC regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.
Due to its current condition and results of operation, the Directors of the Company and Bank entered into an informal agreement with the Federal Reserve in the third quarter of 2008, and formal agreements, the Order, with the FDIC, and DBF in the fourth quarter of 2009. These regulatory agreements are designed to help the Company and Bank return to profitability and capital adequacy by improving asset quality. Specifically, the agreements provide for reducing troubled assets; limiting credit to troubled borrowers; maintaining an adequate allowance for loans losses; revising policies to more comprehensively address commercial real estate lending; maintaining a Tier One leverage capital ratio of 8% or more, a Tier One risked-based capital ratio of 6% or more, and a Total risked-based capital ratio of 10% or more; prohibiting the Bank from paying dividends to the Company without prior approval; prohibiting the Company from paying dividends to shareholders without prior approval; prohibiting the Company from incurring debt without prior approval; and prohibiting the Company from repurchasing stock without prior approval. The Bank is presently unable to achieve the Tier One leverage and Total risked-based capital provisions of the agreements but is negotiating for additional capital. See Item 9B for further information.
As of December 31, 2009 the capital ratios for the Company and the Bank are as follows:
Community Reinvestment Act
The Company and the Bank are subject to the provisions of the Community Reinvestment Act of 1977, as amended (the “CRA”) and the federal banking agencies regulations issued thereunder. Under the CRA, all banks and thrifts have a continuing and affirmative obligation, consistent with its safe and sound operation to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.
The CRA requires a depository institution’s primary federal regulator, in connection with its examination of the institution, to assess the institution’s record of assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the institution’s record is made available to the public. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the records of each subsidiary depository institution of the applicant bank holding company, and such records may be the basis for denying the application.
The evaluation system used to judge an institution’s CRA performance consists of three tests: (1) a lending test; (2) an investment test; and (3) a service test. Each of these tests will be applied by the institution’s primary federal regulator taking into account such factors as: (i) demographic data about the community; (ii) the institution’s capacity and constraints; (iii) the institution’s product offerings and business strategy; and (iv) data on the prior performance of the institution and similarly-situated lenders.
In addition, a financial institution will have the option of having its CRA performance evaluated based on a strategic plan of up to five years in length that it had developed in cooperation with local community groups. In order to be rated under a strategic plan, the institution will be required to obtain the prior approval of its federal regulator.
The interagency CRA regulations provide that an institution evaluated under a given test will receive one of four ratings for the test: (1) outstanding; (2) satisfactory; (3) needs to improve; and (4) substantial noncompliance. An institution will receive a certain number of points for its rating on each test, and the points are combined to produce an overall composite rating. Evidence of discriminatory or other illegal credit practices would adversely affect an institution’s overall rating. McIntosh State Bank received a satisfactory rating as a result of its most recent CRA examination.
Anti-Terrorism Legislation
In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (the “USA PATRIOT Act”) Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:
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to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;
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to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;
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to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and
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to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.
The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
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the development of internal policies, procedures, and controls;
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the designation of a compliance officer;
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an ongoing employee training program; and
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an independent audit function to test the programs.
In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the Gramm-Leach-Bliley Act, as discussed above.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) was enacted to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of disclosures pursuant to the securities laws. Sarbanes-Oxley includes important new requirements for public companies in the areas of financial disclosure, corporate governance, and the independence, composition and responsibilities of audit committees. Among other things, Sarbanes-Oxley mandates chief executive and chief financial officer certifications of periodic financial reports, additional financial disclosures concerning off-balance sheet items, and speedier transaction reporting requirements for executive officers, directors and 10% shareholders. In addition, penalties for non-compliance with the Exchange Act were heightened. SEC rules promulgated pursuant to Sarbanes-Oxley impose obligations and restrictions on auditors and audit committees intended to enhance their independence from management, and include extensive additional disclosure, corporate governance and other related rules. Sarbanes-Oxley represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a Board of Directors and Management and between a Board of Directors and its committees.
We have not experienced any significant difficulties in complying with Sarbanes-Oxley. However, we have incurred, and expect to continue to incur, significant costs in connection with compliance with Section 404 of Sarbanes-Oxley, which requires Management to undertake an assessment of the adequacy and effectiveness of our internal controls over financial reporting.
Commercial Real Estate Lending and Concentrations
On December 2, 2006, the federal bank regulatory agencies released Guidance on Concentrations in Commercial Real Estate (“CRE”) Lending, Sound Risk Management Practices (the “Guidance”). The Guidance, which was issued in response to the agencies’ concern that rising CRE concentrations might expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market, reinforces existing regulations and guidelines for real estate lending and loan portfolio management.
Highlights of the Guidance include the following:
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The agencies have observed that CRE concentrations have been rising over the past several years with small to mid-size institutions showing the most significant increase in CRE concentrations over the last decade. However, some institutions’ risk management practices are not evolving with their increasing CRE concentrations, and therefore, the Guidance reminds institutions that strong risk management practices and appropriate levels of capital are important elements of a sound CRE lending program.
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The Guidance applies to national banks and state chartered banks and is also broadly applicable to bank holding companies. For purposes of the Guidance, CRE loans include loans for land development and construction, other land loans and loans secured by multifamily and nonfarm residential properties. The definition also extends to loans to real estate investment trusts and unsecured loans to developers if their performance is closely linked to the performance of the general CRE market.
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The agencies recognize that banks serve a vital role in their communities by supplying credit for business and real estate development. Therefore, the Guidance is not intended to limit banks’ CRE lending. Instead, the Guidance encourages institutions to identify and monitor credit concentrations, establish internal concentration limits, and report all concentrations to management and the board of directors on a periodic basis.
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The agencies recognized that different types of CRE lending present different levels of risk, and therefore, institutions are encouraged to segment their CRE portfolios to acknowledge these distinctions. However, the CRE portfolio should not be divided into multiple sections simply to avoid the appearance of risk concentration.
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Institutions should address the following key elements in establishing a risk management framework for identifying, monitoring, and controlling CRE risk: (1) board of directors and management oversight; (2) portfolio management; (3) management information systems; (4) market analysis; (5) credit underwriting standards; (6) portfolio stress testing and sensitivity analysis; and (7) credit review function.
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As part of the ongoing supervisory monitoring processes, the agencies will use certain criteria to identify institutions that are potentially exposed to significant CRE concentration risk. An institution that has experienced rapid growth in CRE lending, has notable exposure to a specific type of CRE, or is approaching or exceeds specified supervisory criteria may be identified for further supervisory analysis.
Allowance for Loan and Lease Losses
On December 13, 2006, the federal bank regulatory agencies released Interagency Policy Statement on the Allowance for Loan and Lease Losses (“ALLL”), which revises and replaces the banking agencies’ 1993 policy statement on the ALLL. The revised statement was issued to ensure consistency with generally accepted accounting principles (GAAP) and more recent supervisory guidance. The revised statement extends the applicability of the policy to credit unions. Additionally, the agencies issued 16 FAQs to assist institutions in complying with both GAAP and ALLL supervisory guidance.
Highlights of the revised statement include the following:
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The revised statement emphasizes that the ALLL represents one of the most significant estimates in an institution’s financial statements and regulatory reports and that an assessment of the appropriateness of the ALLL is critical to an institution’s safety and soundness.
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Each institution has a responsibility to develop, maintain, and document a comprehensive, systematic, and consistently applied process for determining the amounts of the ALLL. An institution must maintain an ALLL that is sufficient to cover estimated credit losses on individual impaired loans as well as estimated credit losses inherent in the remainder of the portfolio.
•
The revised statement updates the previous guidance on the following issues regarding ALLL: (1) responsibilities of the board of directors, management, and bank examiners; (2) factors to be considered in the estimation of ALLL; and (3) objectives and elements of an effective loan review system.
The Company and its board of directors believe that the Company’s ALLL methodology is comprehensive, systematic, and that it is consistently applied across the Company. The Company believes its management information systems, independent credit administration process, policies and procedures are sufficient to comply with the guidance.
U.S. Treasury’s Troubled Asset Relief Program - Capital Purchase Program
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was enacted that provides the U.S. Secretary of the Treasury (Treasury) with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the provisions resulting from the legislation is the Troubled Asset Relief Program Capital Purchase Program (CPP), which provides direct equity investment in perpetual preferred stock by the Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. The CPP provides for a minimum investment of one percent of total risk-weighted assets and a maximum investment equal to the lesser of three percent of total risk-weighted assets or $25 billion. Participation in the program is not automatic and is subject to approval by the Treasury. The Company did not participate in the CPP.
Temporary Liquidity Guarantee Program
On October 14, 2008, the FDIC announced a new program - the Temporary Liquidity Guarantee Program (TLGP). The TLGP has two components - The Debt Guarantee Program and the Transaction Account Guarantee Program. The Debt Guarantee Program guarantees newly issued senior unsecured debt of a participating organization, up to certain limits established for each institution, issued between October 14, 2008 and June 30, 2009. The FDIC will pay the unpaid principal and interest on an FDIC-guaranteed debt instrument upon the uncured failure of the participating entity to make a timely payment of principal or interest in accordance with the terms of the instrument. The guarantee will remain in effect until June 30, 2012. In return for the FDIC’s guarantee, participating institutions will pay the FDIC a fee based on the amount and maturity of the debt. The Company and Bank have opted to participate in the Debt Guarantee Program; however, have not issued any debt under the program.
The Transaction Account Guarantee Program provides full federal deposit insurance coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount, until June 30, 2010. An annualized 10 basis point assessment on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000 will be assessed on a quarterly basis to insured depository institutions that have not opted out of this component of the TLGP. The Bank has opted to participate in the Transaction Account Guarantee Program.
Insurance of Deposit Accounts
The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the Deposit Insurance Fund (DIF) up to prescribed limits for each depositor. Pursuant to the EESA, the maximum deposit insurance amount has been increased from $100,000 to $250,000. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. Pursuant to the Federal Deposit Insurance Reform Act of 2005, the FDIC is authorized to set the reserve ratio for
the DIF annually at between 1.15% and 1.50% of estimated insured deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. In an effort to restore DIF levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including base assessment rates. Risk adjusted assessment rates for 2009 ranged between 7 and 77.5 cents per $100 in domestic deposits depending on the risk characteristics of the bank. The Bank paid approximately $764,000 for deposit insurance for 2009.
On February 27, 2009, the FDIC approved an interim rule to institute a one-time special assessment of 20 cents per $100 of domestic deposits to restore the DIF reserves depleted by recent bank failures. The interim rule additionally reserves the right of the FDIC to charge an additional up-to-10 basis point special premium at a later point if the DIF reserves continue to fall. The special assessment of 20 cents per $100 of domestic deposits cost the Bank approximately $200,000 for 2009.
Additionally, by participating in the TLGP, banks temporarily become subject to “systemic risk special assessments” of 10 basis points for transaction account balances in excess of $250,000 and assessments up to 100 basis points of the amount of TLGP debt issued. Participation in the program cost the Company $5,027 for 2009. Further, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the DIF. The FICO assessment rates, which are determined quarterly, averaged 0.0026% of insured deposits in fiscal 2009. These assessments will continue until the FICO bonds mature in 2017.
The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DIF.
Other Pending and Proposed Legislation
Other legislative and regulatory initiatives which could affect the Company, the Bank and the banking industry in general are pending, and additional initiatives may be proposed or introduced, before the U.S. Congress, the Georgia legislature and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial institutions, and may subject the Bank to increased regulation, disclosure and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Company or the Bank would be affected thereby.
Employees
At December 31, 2009 the Company had 112 full time equivalent employees. The Company is not a party to any collective bargaining agreement.
Item 2.
Item 2. Properties
The assets of the Company consists almost entirely of its ownership interest in the Bank and MFS. Both the holding company and MFS operate out of premises owned by the Bank. The Bank owns or leases the following properties:
(1) Main Office
210 South Oak Street
Jackson, Georgia 30233
Built in 1964, 11,000 square feet of heated space and five drive-thru lanes.
(2) McLaurin Building
134 South Oak Street
Jackson, Georgia 30233
Built in 1940 and remodeled in 2007, 6,100 square feet of heated space.
(3) Monticello Office
208 East Greene Street
Monticello, Georgia 31064
Built in 1966, 5,100 square feet of heated space, and four remote drive-thru lanes.
(4) Locust Grove Office
3796 Highway 42 South
Locust Grove, Georgia 30248
Built in 2000, 3,700 square feet of heated space, and three drive-thru lanes.
(5) McDonough Office
1100 and 1125 Keys Ferry Court
McDonough, Georgia 30253
Built in 1995, 7,600 square feet of heated space (leased).
(6) Operations Center
264 Alabama Boulevard
Jackson, Georgia 30233
Built in 1998, 17,100 square feet of heated space.
(7) Remote ATMs:
632 East Third Street, Jackson, Georgia 30233
222 Clubhouse Drive, Monticello, Georgia 31064
The Bank owns the furniture, fixtures and equipment located at the above locations.
Item 3.
Item 3. Legal Proceedings
The Bank is from time to time involved in various legal actions arising from normal business activities. Management believes that the liability, if any, arising from such actions will not have a material adverse effect on the Company’s financial condition. Neither the Bank nor the Company is a party to any proceeding to which any director, officer or affiliate of the issuer, any owner of more than five percent (5%) of its voting securities is a party adverse to the Bank or the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders (Removed and Reserved)
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
There is no established public trading market for the Company’s common stock. It is not traded on an exchange or in the over-the-counter market. There is no assurance that an active market will develop for the Company’s common stock in the future. Therefore, management of the Company is furnished with only limited information concerning trades of the Company’s common stock. The following table sets forth for each quarter during the most two recent fiscal years the number of shares traded and the high and low per share sales prices to the extent known to management.
The Company did not pay a dividend in 2009 and paid a quarterly dividend totaling $0.09 per share in 2008. Any declaration and payment of dividends will be based on the Company’s earnings, economic conditions, and the evaluation by the Board of Directors of other relevant factors. The Company’s ability to pay dividends is dependent on cash dividends paid to it by the Bank, its wholly-owned subsidiary. The ability of the Bank to pay dividends to the Company is restricted by applicable regulatory requirements. See “Supervision and Regulation.”
As of March 2, 2010 there were 3,252,581 shares of the Company’s common stock issued and outstanding held of record by approximately 660 persons (not including the number of persons or entities holding stock in nominee or street name through various brokerage houses).
In 1998 the Company adopted an incentive stock option plan (1998 Plan) which authorized the Company to issue to officers and other key employees of McIntosh State Bank options to purchase in the aggregate as many as 35,000 shares of the Company’s common stock. The number of shares so authorized was subject to increase in the event, among other matters, of a stock dividend. As a result of the stock dividends declared by the Company in 1999, 2000, 2001, 2005 and 2007, there are now 46,266 shares of its common stock for which such options may be granted. As of March 3, 2010, all options available under the plan have been granted and 86,125 options expired unexercised during 2009.
In 2006 the Company adopted a compensation plan (2006 Plan) which authorizes the Company to issue to directors, officers and employees of the Company and its affiliates incentive stock options, nonqualified stock options, and/or restricted stock. The 2006 Plan permits up to 210,000 shares of the Company’s common stock to be issued; however, no more than 50,000 shares can be available for issuance as restricted stock. As of December 31, 2009, no restricted shares have been issued. As March 3, 2010, 67,500 incentive stock options have been granted; however, no options have been exercised.
Unregistered Sales of Equity Securities
On December 29, 2008 the Company issued 441,605 common shares to its directors and select executive officers for $6.85 per share. Proceeds from the sale totaled $2,984,619, net of a $40,375 placement fee. The common stock was offered and sold only to accredited investors, as the term is defined under the Securities Act of 1933 and the Company relied on the exemption provided under Rule 506 of Securities Act with respect to the transaction.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Management’s Discussion and Analysis of Financial Condition and Results of Operations for Years ended December 31, 2009 and December 31, 2008.
Financial Condition
The financial condition of the Company as of December 31, 2009 shows assets declined $41.7 million or 9% compared to December 31, 2008. Liquid assets (cash, federal funds sold, interest bearing depository balances, and investment securities), increased $5 million or 5.5% during 2009. The increase in liquid assets from the prior year-end results from a retail deposit campaign that has generated $14.2 million in retail deposits as well as an increase in public funds related to property tax deposits at year end. The increase was partially offset by the maturity of $33.2 million in brokered deposits.
Loans
Gross loans declined $47.3 million or 14.6% during 2009. Loans transferred to other real estate during the year ending December 31, 2009 totaled $19.6 million. With the ongoing deterioration of the economy combined with persistent residential real estate market weakness, management expects loan balances may fall further in coming quarters.
The ALL declined $0.9 million or 10% for the year ending December 31, 2009. The decrease results from approximately $10 million in provision expense and approximately $11 million in net charge-offs. As of December 31, 2009, the ALL as a percentage of gross loans (reserve ratio) is 2.76% versus 2.63% for the prior year-end.
The rise in the overall reserve ratio is due to a rise in the qualitative factors utilized in the methodology used to determine ALL adequacy. Total impaired loans rose $10.1 million or 27% and the level of potential loss on impaired loans declined which resulted in $0.7 million less required reserve. Given the continuing decline in market conditions for commercial and residential real estate, management adjusted its qualitative factors used in determining ALL adequacy in 2009. The following table outlines impaired loans:
The following table outlines the changes in impaired loans:
The following table highlights the ALL by loan category:
The Bank’s delinquency ratio (loans past due 30 days or more and loans on nonaccrual as a percentage of gross loans) rose from 11.43% to 15.66% during the year. The higher delinquency ratio is principally due to $5.5 million more loans on nonaccural. As of December 31, 2009, 61 relationships were on nonaccrual. The following table outlines nonaccrual loans:
In accordance with GAAP, management has identified $3.9 million in loans restructured from their original terms. The result of these trouble debt restructurings is the Bank agreed to forbear on collecting $73,205 in accrued but unpaid interest when the notes matured and were renewed. Of these credits, $1.3 million are currently on nonaccrual and have been reviewed for impairment.
The Bank historically attempts to meet the housing needs of its markets. As of December 31, 2009 and 2008, loans secured by 1-4 family properties totaled 40% and 48%, respectively, of total loans. Following is a table outlining the Bank’s loans on 1-4 family properties:
As of December 31, 2009, the Company continued to have a concentration in AD&C loans. Management has lowered its maximum limit where total AD&C loans may not exceed 20% of the Company’s loan portfolio including unfunded commitments. As of December 31, 2009, AD&C loans represented 15% of gross loans and commitments versus 24% as of the prior year-end. The primary risks of AD&C lending are:
(a) Loans are dependent upon continued strength in demand for residential real estate. Demand for residential real estate is dependent on favorable real estate mortgage rates and population growth from expanding industry and services in the metropolitan Atlanta area;
(b) Loans are concentrated to a limited number of borrowers; and
(c) Loans may be less predictable and more difficult to evaluate and monitor.
Builders and developers are what comprise the AD&C concentration as well as the bulk of the Bank’s nonaccrual loans. Management believes AD&C conditions in the markets served by the Company remain under severe stress from the glut of lot inventory, foreclosure activity, and slow housing turnover. The nationalization of Fannie Mae and Freddie Mac in the second half of 2008 has led to considerably less liquidity for residential mortgages. In addition, underwriting standards have tightened significantly leading to lower home mortgage originations. Bank management believes the effect of the downturn in residential real estate continues to be further aggravated by the level of foreclosure activity for both lots and homes. The result has been, and will likely remain for at least the next 18 months, downward pressure on house and lot prices. The marked decline in residential real estate values experienced during the last 24 months has and will continue to erode or eliminate the collateral margins the Bank typically utilizes to protect itself against losses.
On December 12, 2006 the federal bank regulatory agencies released guidance on Concentration in Commercial Real Estate Lending. This guidance defines commercial real estate (CRE) loans as loans secured by raw land,
land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. Loans for owner occupied CRE are generally excluded from the CRE guidance.
The CRE guidance is triggered where either:
(a) Total loans for construction, land development, and other land represent 100% or more of the Bank’s total risk based capital; or
(b) Total loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land represent 300% or more of the Bank’s total risk based capital.
Banks that are subject to the CRE guidance’s triggers will need to implement enhanced strategic planning, CRE underwriting policies, risk management and internal controls, portfolio stress testing, risk exposure limits, and other policies, including management compensation and incentives, to address the CRE risks. Higher allowances for loan losses and capital levels may also be appropriate.
The following table outlines the Bank’s CRE loans by category and CRE loans as percent of total risked based capital for the years ending December 31, 2009 and 2008.
The following is recap of other real estate activity from December 31, 2008 to December 31, 2009:
The Bank foreclosed 123 properties with carrying balances totaling $19.6 million and sold 63 properties with carrying balances totaling $10.5 million from year-end 2008 to December 31, 2009. The Bank devotes two seasoned construction lenders to marketing its other real estate holdings. Despite these efforts, management believes liquidation of unimproved real estate and residential lot inventory will be protracted until the residential real estate market improves. Through 2009, other real estate properties were sold at an average 12% discount to carrying value. Additions to the base amount reflect improvements made to finish foreclosed residences. Management anticipates an increase in newly foreclosed properties over the next twelve months.
The following is an inventory of other real estate as of December 31, 2009:
Deposits
Total deposits declined $23.9 million or 6% from December 31, 2008 to 2009. The change from the prior year-end is principally attributable to a $33 million or 22% decrease in time deposit balances partially offset by a $15.5 million or 17.3% increase in money market and NOW account balances. Time deposits at December 31, 2009, include $17.7 million in brokered deposits which is a decrease of $33.2 million or 65.2% from December 31, 2008. Brokered deposits include $7.1 million in reciprocal deposits placed under the Certificate of Deposit Account Registry System (CDARS). These CDARS deposits represent stable local deposits, but are designated and reported as brokered deposits under regulatory requirements. The decrease in brokered deposits from December 31, 2008 to 2009 is essentially the result of asset shrinkage and the Company’s inability to renew brokered deposits due to the Order. Time deposits represent 59% and 64% of total deposits as of December 31, 2009 and 2008, respectively. The rise in money market and NOW accounts for the year was related to the Company’s participation in the Transaction Account Guarantee Program as well as deposit campaigns that were implemented during the year. See Liquidity and Interest Rate Risk comments for further discussion.
Capital
For the year ending December 31, 2009, the Company’s equity capital declined $14.3 million or 45% from the prior period. The change in equity capital over the period resulted from a $14.0 million net loss, a $0.8 million decrease in net unrealized gains on securities available for sale, a $0.5 million increase in the after-tax effect of
the Company’s current unfunded pension liability (see footnotes 1 and 9 of the Company’s consolidated financials statements for further discussion), and $75,000 in noncash compensatory stock option expense.
Liquidity
The Bank must maintain, on a daily basis, sufficient funds to cover depositor withdrawals and to supply new borrowers with funds. To meet these obligations, the Bank keeps cash on hand, maintains account balances with its correspondent banks, and purchases and sells Federal funds and other short-term investments. Asset and liability maturities are monitored in order to avoid significant mismatches which could adversely impact liquidity. It is the policy of the Bank to monitor its liquidity to achieve earnings enhancements and meet regulatory requirements while funding its obligations.
Liquidity is monitored daily and formally measured on a monthly basis. As of December 31, 2009, the Bank’s liquidity ratio was 13.3% versus 11.4% as of the prior year-end. In 2009, the Bank’s brokered deposits declined $33.2 million or 65.2% from December 31, 2008. Management will continue to reduce the level of brokered deposits and thus total assets over the next 12 months.
Management has established a noncore funding (wholesale, brokered (excluding CDARs), and out-of-territory deposits) guideline not to exceed 20% of Bank deposits. As of December 31, 2009 and 2008 the Bank’s noncore funding measure was 12.6% and 11.4%, respectively.
The Bank has a $6.5 million secured line of credit with a correspondent bank to supplement short term liquidity. During 2009, the Bank did not utilize the secured line of credit.
The Bank has a $3 million FHLB advance that matures January 2009 and $2 million in fixed rate advances that may convert to 3 month LIBOR in 2010. Management believes unless LIBOR rises significantly before conversion, the FHLB will not exercise its right to convert these advances. Bank management believes that the repayment of $3 million in FHLB advances during 2010 will not materially impact liquidity.
Advances are drawn under a $14 million line of credit with the FHLB. The line of credit with FHLB is secured by a blanket lien on the Bank’s qualified 1-4 family residential mortgages, home equity mortgages, and multifamily mortgages outstanding as well as the Bank’s holdings of FHLB stock. See Table 8 for a recap of Bank borrowing.
In October 2008, the Bank withdrew its pledge of commercial real estate mortgages from the FHLB. Instead, management has elected to pledge commercial real estate mortgages to the Federal Reserve Bank of Atlanta (FRB) where terms are considered more favorable to the Bank. The Bank has available credit with the FRB as of December 31, 2009 of $15 million. No advances on this line occurred in 2009.
In October 2008, the FDIC approved a program to strengthen market stability for financial institutions called the Temporary Liquidity Guaranty Program (TLGP). Provision one of the TLGP allows the FDIC to guaranty the debit issued by financial institutions for liabilities outstanding as of September 30, 2008. The debt guaranty amount for the Bank is $8.4 million. Management did not opt out of the debt guaranty program but decided not to utilize it. Provision two of the TLGP raises the FDIC insurance level for all deposit accounts to $250,000 was extended to December 31, 2013. Management has determined this provision would be beneficial to the Bank and its customers and has opted to take part. The FDIC is not permitted to charge assessments for this added coverage until after December 31, 2009. Provision three of the TLGP allows the FDIC to insure all the Bank’s noninterest bearing and interest bearing deposits paying less than 0.50% was extended through June 30, 2010. Management has determined this provision would be beneficial to the Bank and its customers and has opted to take part. The Bank will pay 10 basis points per annum for this deposit coverage above the $250,000 temporary limit outlined in provision two. Additional expense for participation in this program was approximately $5,000 for 2009.
Beginning in the second quarter of 2007, management began offering a retail repurchase agreement to certain Bank customers. The agreement allows the Bank to sell its investment securities overnight and repurchase those securities the following business day. The rate floats and is tied to the ninety day U. S. Treasury bond. As of December 31, 2009 and 2008, the Bank has sold and is obligated to repurchase $758,493 and $440,757, respectively, in investment securities.
Beginning in the second quarter of 2007, the Bank began participating in a borrowing arrangement with the U. S. Treasury. The Bank, as an approved U. S. Treasury depository, historically accepts treasury, tax, and loan payments. Those payments were previously remitted to the U. S. Treasury on a daily basis; however, now those payments, up to an agreed upon maximum, can remain on deposit with the Bank. This obligation is repaid periodically as the U. S. Treasury requires and bears a variable rate of interest approximating the ninety day U. S. Treasury bond. As of December 31, 2009 and 2008, the Bank had $135,750 and $215,747, respectively, in note obligations under this program.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly susceptible to significant changes. Determination of the Bank’s ALL, the valuation of real estate acquired in connection with foreclosures, or in satisfaction of loans, and the valuation of deferred taxes as critical accounting policies.
The ALL is maintained at a level believed to be appropriate by management to provide for probable loan losses inherent in the portfolio as of each quarter-end. Management’s judgment as to the amount of the ALL, including the allocated and unallocated elements, is a result of ongoing review of lending relationships, the overall risk characteristics of the portfolio segments, changes in the character or size of the portfolio segments, the level of impaired or nonperforming loans, historical net charge-off experience, prevailing economic conditions and other relevant factors. Loans are charged off to the extent they are deemed to be uncollectible. The ALL level is highly dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the timing of collecting nonperforming loans. Such estimates may be subject to frequent adjustments by management and reflected in the provision for loan losses in the periods in which they become known.
Other real estate represents properties acquired through or in lieu of loan foreclosure. Other real estate is initially recorded at the lower of cost or fair value less estimated disposal costs. Any write-down to fair value up to 90 days after transfer to other real estate is charged to the allowance for loan losses. Costs of improvements are capitalized, whereas costs relating to holding other real estate and valuation adjustments subsequent to 90 days of transfer are expensed. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets or liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The determination of current and deferred taxes is based on complex analyses of many factors including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the reversals of temporary differences, and current financial accounting standards. Actual results could differ significantly from the estimates and interpretations used in determining current and deferred taxes.
Off-Balance Sheet Arrangements
As described further in footnote 15 to the Company’s audited financial statements, the Bank’s lending activities regularly result in unfunded commitments to creditworthy customers requesting financing for working capital, construction and development activities, and home equity lines of credit. Commercial unfunded commitments are typically secured by collateral margined in accordance with the Bank’s lending policy. Commercial unfunded commitments, excluding construction and development, are generally for terms less than three years. Unfunded commitments for construction and development are typically for terms less than 18 months. Home equity lines of credit are generally secured by collateral margined in accordance with Bank’s lending policy and mature in ten years. Advances under all loan commitments occur in the normal course of the Bank’s operations. Management considers its unfunded commitments when assessing the Bank’s liquidity and monitoring concentrations of credit. Commitment fees generally represent 0.5% to 1.0% of the total commitment amount (funded and unfunded) and are recognized as origination fees. Origination fees for the years ending December 31, 2009, and 2008 were $100,652 and $369,277, respectively.
From time to time the Bank is asked by its creditworthy customers to issue standby or performance letters of credit. These letters of credit are generally issued for terms no longer than two years and are secured by collateral margined in accordance with the Bank’s lending policy. The Bank has not been asked to perform on any of its outstanding letters of credit during 2009 or 2008. Fees for issuing letters of credit totaled $7,974 and $14,482 for the years ending December 31, 2009 and 2008, respectively.
The following table represents outstanding contingent liabilities by category for the years ending December 31, 2009 and 2008, respectively.
Contractual Obligations
In the ordinary course of operations, the Company enters into certain contractual obligations. The following table summarizes the Company’s significant fixed and determinable contractual obligations, by payment date, as of December 31, 2009.
Results of Operations - Twelve Months Ended December 31, 2009 Compared to 2008
Net interest income for the year ending December 31, 2009 decreased $2.5 million or 20% from the year-ago period. The decrease in net interest income is attributable to the reversal of interest income on loans placed on nonaccrual totaling $0.7 million, holding of other real estate and nonaccrual loans averaging $19.3 million and $33.1 million, respectively, and $432,724 less in loan fee income. Management estimates that the effect of 2009 nonaccrual activity in terms of balance and lost interest income along with balances in other real estate results in $3.3 million in foregone loan interest income. This foregone interest income equates to 0.84% lost to the net interest margin.
The December 31, 2009 tax equivalent net interest margin of 2.69% fell 42 basis points from the year-ago period. Margin decline was attributable to a 32 basis point decrease in the net interest component of the net interest margin and a 10 basis point decline in the loan fee component of the net interest margin relative to the prior year. The decline in the interest component of the net interest margin is principally due to the amount of nonaccrual loans and other real estate. The yield on earning assets declined 102 basis points from 2008 to 2009 while the cost of funds declined 80 basis points over the same period. The Bank’s average loan-to-funding ratio declined from 82.0% to 76.7% for 2008 to 2009.
Total interest income for the year ending December 31, 2009 declined $5.9 million or 23% from the year-ago period. The decrease in interest income was attributable to a decline in average earning assets and the level of nonaccrual loans.
In 2009 versus 2008, total average earning assets declined $32 million or 8% and average nonaccrual loans increased $5.1 million or 18%. The tax equivalent yield on earning assets as of December 31, 2009 was 5.16% and declined 102 basis points from the year-ago period. This decrease results from a 81 basis point fall in loan yield, a 92 basis point decline in investment portfolio yield, and a 178 basis point decline in yield on federal funds sold and interest bearing deposits. The overall decline in yield on earning assets from the year-ago period is principally due to the volume of nonaccrual loans and other real estate.
Interest expense for the twelve months ending December 31, 2009 declined $3.3 million or 26% from the year-ago period. The decrease in interest expense is due to an 80 basis points decline in cost of funds.
The cost of funds as of December 31, 2009 was 2.64% and fell 80 basis points from the year-ago period. The decrease in cost of funds results from a 92 basis point decline in the cost of interest bearing demand deposit accounts, a 47 basis point decline in the cost of funds on savings accounts, an 88 basis point decrease in cost of funds on time deposits, and a 19 basis point decline in borrowed money. The overall decline in the cost of funds from the prior year is mainly attributable to the certificates of deposits re pricing in the lower rate environment as well as the interest rate restrictions the FDIC has placed on troubled financial institutions.
Provision for loan losses for the twelve months ending December 31, 2009 decreased $6.3 million or 40% from the year-ago period. The provision expense was primarily due to $10.5 million in net charge-offs and in problem loans. Refer to the discussion on loans and ALL adequacy for further comment.
During 2009, other income, excluding investment securities, other real estate, and fixed asset gains or losses, declined $285,144 or 7% from the year-ago period. Income from secondary market financing activity declined $211,722 or 38% from the year-ago period due to tightened credit underwriting standards resulting in lower volume. Overdraft fee income declined $170,817 or 9%.
Investment securities losses totaling $1,706,679 represent the write-off of the Company’s equity stake in Silverton Financial Services, Inc. The Company sold approximately $23.5 million in investment securities and recognized a gain on sale of approximately $1.1 million during 2009.
During 2009, other noninterest expense decreased $736,982 or 5% from the year-ago period. This decrease is principally attributable to a $2,694,382 or 30% decline in salary and employee benefit expense, offset by two factors: a $537,977 or 229% increase in collection expenses associated with the increase in noncurrent loans; a $224,297 or 31% increase in other real estate expenses associated with the increased activity in other real estate. From 2008 to 2009 full time equivalent employees declined 13 or 10%.
During 2009, the Company placed a $5.1 million valuation allowance on its deferred tax assets. This valuation allowance resulted in income tax expense of $477,000 during the year in spite of the net operating loss incurred.
McIntosh Bancshares, Inc.
Table 1 - Average Balance Sheets, Interest and Rates
The table below shows the year-to-date average balance for each category of interest earning assets and interest-bearing liabilities for the indicated periods and the average rate of interest earned or paid thereon.
McIntosh Bancshares, Inc.
Table 1 - Average Balance Sheets, Interest and Rates (continued)
Non-accrual loans and the interest income which was recorded on these loans, if any, are included in the yield calculation for loans in all periods reported.
(TE) - Tax Equivalent.
McIntosh Bancshares, Inc.
Table 2 - Rate/Volume Variance Analysis
The following tables show a summary of the changes in interest income and interest expense resulting from changes in volume and changes in rates for each major category of interest-earning assets and interest-bearing liabilities for 2009 over 2008 and 2008 over 2007.
Note: Rate/volume variance were allocated between rate variances and volume variances using a weighted average allocation method.
McIntosh Bancshares, Inc.
Table 2 - Rate/Volume Variance Analysis (continued)
Note: Rate/volume variance were allocated between rate variances and volume variances using a weighted average allocation method.
McIntosh Bancshares, Inc.
Table 3 - Investment Portfolio
The following table presents the carrying value of investments by category at December 31, 2009, 2008, and 2007. Amounts in thousands.
McIntosh Bancshares, Inc.
Table 3 - Investment Portfolio (continued)
The following table presents the maturities of all investment securities at carrying value and the weighted average yields for each category of securities presented:
Mortgage backed securities are included in the maturities categories in which the are anticipated to be repaid based on scheduled maturities.
McIntosh Bancshares, Inc.
Table 4 - Loan Portfolio
The following table presents loans by type and the percentage of loans by type at the end of the last 5 years. Amounts in thousands.
At December 31, 2009, maturities of loans in the indicated classifications were as follows. Amounts in thousands.
McIntosh Bancshares, Inc.
Table 4 - Loan Portfolio (continued)
As of December 31, 2009, the interest terms of loans in the indicated classifications for the indicated maturity ranges are as follows. Amounts in thousands.
The following summarizes past-due and non-accrual loans, other real estate and repossessions and income that would have reported on non-accrual loans for the years ended December 31, 2009, 2008, 2007, 2006, and 2005. Amounts in thousands.
A loan is placed on non-accrual status when, in management’s judgment, the collection of interest appears doubtful. As a result of management’s ongoing review of the loan portfolio, loans are classified as non-accrual generally when they are past due in principal and interest for more than 90 days or it is otherwise not reasonable to expect collection of principal and interest under the original terms. Exceptions are allowed for 90 day past due loans when such loans are well secured and in process of collection. Generally, payments received on non-accrual loans are applied directly to principal.
McIntosh Bancshares, Inc.
Table 5 - Analysis of the Allowance for Loan Losses
The following table summarizes information concerning the allowance for loan loss. Amounts in thousands.
The Company has a dedicated loan review function. Sixty percent of the portfolio was reviewed in 2009 and placed into loan grading categories, which assist in developing lists of potential problem loans. These loans are regularly monitored by the loan review function to ensure early identification of deterioration. The formal allowance for loan loss adequacy test is performed at each calendar quarter end. Specific amounts of loss are estimated on problem loans and historical loss percentages are applied to the balance of the portfolio using certain portfolio stratifications. Additionally, the evaluation takes into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions, regulatory examination results, and the existence of loan concentrations.
The following table presents the allocation of allowance for loan losses by category and the percentage of loans in each category to total loans at end of the last 5 years. Amounts in thousands.
McIntosh Bancshares, Inc.
Table 6 - Deposits
The average balance of the deposits and the average rates paid on such deposits are summarized for the periods indicated in the following table.
Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 2009 summarized as follows. Amounts in thousands.
McIntosh Bancshares, Inc.
Table 7 - Selected Ratios
The following table sets out certain ratios of the Company as of and for the years indicated. Amounts in thousands.
McIntosh Bancshares, Inc.
Table 8 - Analysis of Short-term and Long-term Borrowings
The following table sets out certain information regarding the Company’s borrowings.
McIntosh Bancshares, Inc.
Table 9 - Interest Rate Sensitivity Analysis
Item 8.
Item 8. Financial Statements
The following consolidated financial statements of the Registrant and its subsidiaries are included on Exhibit 13.1 of this Annual Report on Form 10-K:
Consolidated Balance Sheets - December 31, 2009 and 2008
Consolidated Statements of Operations - December 31, 2009 and 2008
Consolidated Statements of Comprehensive Income - December 31, 2009 and 2008
Consolidated Statements of Changes in Stockholders’ Equity - December 31, 2009 and 2008
Consolidated Statements of Cash Flows - December 31, 2009 and 2008
Notes to Consolidated Financial Statements
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
The principal independent accountant of the Company and of the Bank has not resigned, declined to stand for re-election, or been dismissed during the two most recent fiscal years or any later interim period.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and the Principal Financial and Accounting Officer, of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Principal Financial and Accounting Officer concluded that our disclosure controls and procedures are effective.
Management’s Report on Internal Control over Financial Reporting
The management of McIntosh Bancshares, Inc. and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of the Company’s published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The management of McIntosh Bancshares, Inc. and subsidiaries has assessed the effectiveness of the Company’s internal control over financial reporting for the years ending December 31, 2009 and 2008, respectively. To make this assessment, we used the criteria for effective internal control over financial reporting described in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that, as of December 31, 2009 and 2008, respectively, the Company’s internal control over financial reporting met those criteria and is effective.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Controls
There were no changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that have materially affected, or are reasonably likely to materially after these controls.
See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Item 9B.
Item 9B. Other Information
On December 23, 2008, the Company entered into a Debenture Agreement with Redemptus Group, LLC (“Redemptus”) pursuant to which the Company would issue to Redemptus $8 million in debentures as were disclosed in the 8K filed with the Securities and Exchange Commission on December 31, 2008. The terms of the Debenture Agreement were extended until June 30, 2009 as was disclosed in the 8K filed April 6, 2009. The Company and Redemptus were unable to consummate the transaction. Redemptus and the Company remain in negotiations regarding the Debenture Agreement as well as other capital alternatives.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Code of Ethics `
Upon written request, a copy of the McIntosh Bancshares, Inc. Code of Ethics shall be furnished to shareholders without charge. Please direct your written request to Darren M. Cantlay, McIntosh Bancshares, Inc., 210 South Oak Street, Jackson, Georgia 30233.
The remaining information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of or incorporated by reference in this report:
(1) Financial Statements: The consolidated balance sheets of McIntosh Bancshares, Inc. and its subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, consolidated statements of comprehensive income, consolidated statements of changes in stockholders’ equity and consolidated statements of cash flows for each of the years then ended, together with the related notes and the report of Porter Keadle Moore, LLP, independent registered public accounting firm.
(2) Financial statement schedules: All schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.
(3) Exhibits: A list of the Exhibits as required by Item 601 of Regulation S-K to be filed as part of this Annual Report is shown on the “Exhibit Index” filed herewith.
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints William K. Malone, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Registration Statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 26, 2010.
Signature
Title
/s/ William K. Malone
William K. Malone
Director, Chairman of the Board and CEO
/s/ J. Paul Holmes, Jr.
J. Paul Holmes, Jr.
Director
/s/ Dennis Keith Fortson
Dennis Keith Fortson
Director
/s/ John L. Carter
John L. Carter
Director
/s/ William T. Webb
William T. Webb
Director
/s/ George C. Barber
George C. Barber
Director
/s/ Darren M. Cantlay
Darren M. Cantlay
Chief Financial and Accounting Officer
EXHIBIT INDEX