Item 1. Business.
Trinity Capital Corporation
General. Trinity Capital Corporation (“Trinity”), a financial holding company organized under the laws of the State of New Mexico, is the sole shareholder of Los Alamos National Bank (the “Bank”), the sole shareholder of TCC Appraisal Services Corporation (“TCC Appraisals”), and the sole shareholder of Title Guaranty & Insurance Company (“Title Guaranty”). The Bank is the sole shareholder of TCC Advisors Corporation (“TCC Advisors”). Trinity is located in Los Alamos, New Mexico, a small community in the Jemez Mountains of Northern New Mexico. Los Alamos has approximately 19,000 residents and enjoys worldwide recognition as the birthplace of the atomic bomb. Today, Los Alamos National Laboratory (the “Laboratory”) remains a pre-eminent research facility for scientific and technological development in numerous scientific fields. The Laboratory employs (directly and indirectly) approximately 9,650 residents of Northern New Mexico, making it the largest employer in Los Alamos County. The Laboratory remains the cornerstone of the community and has attracted numerous other scientific businesses to the area.
Los Alamos National Bank is a full-service commercial banking institution with four bank offices in Los Alamos, White Rock and Santa Fe, New Mexico and a Loan Production Office in Albuquerque, New Mexico. The Bank was founded in 1963 by local investors to provide convenient, full-service banking to the unique scientific community that developed around the Laboratory and has expanded and continues to expand its market share and customer-base. In 1999, the Bank established its first office in Santa Fe after acquiring a substantial number of customers based in Santa Fe. In 2004, the Bank added a second office in Santa Fe to better serve its growing customer-base and continue to attract new customers. As of the June 30, 2007, Summary of Deposits (SOD) report published by the Federal Deposit Insurance Corporation, the Bank had the largest share of deposits in Santa Fe County. In 2005, the Bank determined the need for an additional site in Albuquerque, New Mexico to serve our commercial loan customers and established a Loan Production Office. Trinity also acquired a ground lease covering additional land in Santa Fe where we plan to begin construction on a third Santa Fe Bank office in 2008 to continue to better serve our customers on the southern side of Santa Fe and attract additional commercial and consumer customers based in this area. The Bank provides a broad range of banking products and services, including credit, cash management, deposit, asset management and trust products to our targeted customer base of individuals and small and medium-sized businesses. As of December 31, 2007, the Bank had total assets of $1.4 billion, net loans of $1.2 billion and deposits (net of deposits of affiliates) of $1.2 billion. The Bank created TCC Advisors in February 2006 to enable us to manage certain assets and register with the SEC as a Registered Investment Advisor should we choose to do so in the future. In February 2006, TCC Funds, a Delaware statutory trust was created with Trinity as its sponsor, to allow for the creation of a mutual fund.
Trinity acquired Title Guaranty in May 2000, making it the only title company in New Mexico to be owned by a financial or bank holding company. Title Guaranty is a title insurance company organized under the laws of the State of New Mexico doing business in Los Alamos and Santa Fe Counties. Title Guaranty opened its Santa Fe office in the Bank’s downtown Santa Fe facility in February 2005. The services provided by Title Guaranty complement those provided by Trinity’s other subsidiaries. Title Guaranty provides title insurance, closing services, escrow and notary service, title searches and title reports for Los Alamos and Santa Fe Counties.
TCC Appraisals is a real estate appraisal company created by Trinity in January 2006. TCC Appraisals provides residential real estate appraisals for properties in Los Alamos and Santa Fe Counties. TCC Appraisals’ offices are located in the Company’s headquarter building in Los Alamos.
Corporate Structure. Trinity was organized in 1975 as a bank holding company, as defined in the Bank Holding Company Act of 1956, as amended, (“BHCA”) and in 2000 elected to become a financial holding company, as defined in that Act. Trinity acquired the stock of the Bank in 1977 and serves as the holding company for the Bank. In 2000, Trinity purchased Title Guaranty. In 2006, Trinity created TCC Appraisals. Title Guaranty, TCC Appraisals, and the Bank are wholly-owned subsidiaries of Trinity. The Bank created TCC Advisors in February 2006. In addition, Trinity owns all the common shares of four business trusts, created by Trinity for the sole purpose of issuing trust preferred securities which had an aggregate outstanding balance of $37.1 million at December 31, 2007. Trinity redeemed the trust preferred securities issued under Trinity Capital Trust II in December 2006 and dissolved that entity. In February 2006, Trinity created TCC Funds, a Delaware statutory trust created to allow for the creation and holding of mutual funds. Trinity’s sole business is the ownership of the outstanding shares of the Bank, TCC Appraisals, Title Guaranty and the administration of the Trusts. The address of our headquarters is 1200 Trinity Drive, Los Alamos, New Mexico 87544, our main telephone number is (505) 662-5171 and our general email address is tcc@lanb.com.
We maintain a website at www.lanb.com/tcc. We make available free of charge on or through our website, the annual report on Form 10-K, proxy statements, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The Company will also provide copies of its filings free of charge upon written request to: TCC Stock Representative, Trinity Capital Corporation, 1200 Trinity Drive, Los Alamos, New Mexico 87544. In addition, you may read and copy any materials we filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers such as Trinity. Our filings are also available free of charge on the SEC’s website at http://www.sec.gov.
Regulation and Supervision
Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of Trinity may be affected not only by management decisions and general economic conditions, but also by the requirements of state and federal statutes and by the regulations and policies of various bank regulatory authorities, including the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities have an impact on the business of Trinity. The effect of applicable statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of Trinity and its subsidiaries and is intended primarily for the protection of FDIC-insured deposit funds and depositors, rather than shareholders.
The following is a summary of the material elements of the regulatory framework that applies to Trinity and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of Trinity and its subsidiaries.
General. Trinity, as the sole shareholder of the Bank, is a financial holding company. As a financial holding company, Trinity is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1959, as amended (the “BHCA”). In accordance with Federal Reserve policy, Trinity is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where Trinity might not otherwise do so. Under the BHCA, Trinity is subject to periodic examination by the Federal Reserve. Trinity is also required to file with the Federal Reserve periodic reports of Trinity’s operations and such additional information regarding Trinity and its subsidiaries as the Federal Reserve may require.
Acquisitions, Activities and Change in Control.The primary purpose of a bank or financial holding company (collectively referred to herein as “bank holding company”) is to control banks.Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the voting shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.
The BHCA generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.” Under current regulations of the Federal Reserve, this authority would permit Trinity to engage in a variety of banking-related businesses, including the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Trinity has elected (and the Federal Reserve has accepted Trinity’s election) to operate as a financial holding company.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances at 10% ownership.
Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2007, Trinity had regulatory capital in excess of the Federal Reserve’s minimum requirements.
Dividends. Trinity’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. New Mexico law prohibits Trinity from paying dividends if, after giving effect to the dividend: (i) Trinity would be unable to pay its debts as they become due in the usual course of its business; or (ii) Trinity’s total assets would be less than the sum of its total liabilities and (unless Trinity’s articles of incorporation otherwise permit) the maximum amount that then would be payable, in any liquidation, in respect of all outstanding shares having preferential rights in liquidation. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends unless its net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with its capital needs, asset quality, and overall financial condition. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. Trinity’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, Trinity is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Los Alamos National Bank
General. Los Alamos National Bank is a national banking organization created under the laws of the United States of America. The Bank is regulated primarily by the OCC, a branch of the Department of Treasury. The Bank currently has four full-service bank offices and one Loan Production Office. A fifth office is planned for construction in 2008. On December 31, 2007, the Bank received approval from the OCC for full-service operations at both the new Santa Fe office and to expand to full-service operations at the current Loan Production Office in Albuquerque. In February 2006, the Bank created TCC Advisors as a wholly owned subsidiary of the Bank.
Products and Services. The Bank provides a full range of financial services for deposit customers and we lend money to credit-worthy borrowers at competitive interest rates. Our strategy has been to position ourselves in the market as a low-fee, high-value community bank. Our products include certificates of deposits, checking and saving accounts, on-line banking, Individual Retirement Accounts, loans, mortgage loan servicing, trust and brokerage services, international services, and safe deposit boxes. These business activities make up our three key processes: investment of funds, generation of funds and service-for-fee income. We achieved our success in part by minimizing charges relating to the investment and generation of funds processes, i.e. loans, credit cards, checking, and savings accounts. The profitability of our operations depend primarily on our net interest income, which is the difference between total interest earned on interest-earning assets and total interest paid on interest-bearing liabilities, and our ability to maintain efficient operations. In addition to our net interest income, we produce income through our mortgage servicing operations and other income processes, such as trust and brokerage. A more complete description of our products and services makeup can be found under “Management’s Discussion and Analysis and Results of Operations” in Item 7 in this Form 10-K.
Lending Activities.
General. We provide a broad range of commercial and retail lending services to corporations, partnerships, individuals and government agencies. We actively market our services to qualified borrowers. Lending officers continually build relationships with new borrowers entering our market areas as well as long-standing members of the local business community. We have established lending policies which include a number of underwriting factors to be considered in making a loan, including location, loan to value ratio, cash flow and the credit history of the borrower. Our current maximum lending limit to one borrower is approximately $19.7 million. Our loan portfolio is comprised primarily of loans in the areas of commercial real estate, residential real estate, construction, general commercial and consumer lending. As of December 31, 2007, residential mortgages made up approximately 30.8% of our loan portfolio; commercial real estate loans comprised approximately 32.6%; construction lending comprised 21.3%; general commercial loans comprised 10.1%; and consumer lending comprised 5.2%.
Residential Real Estate Loans. Residential mortgage lending has been a focal point since our formation in 1963. The majority of the residential mortgage loans we originate and retain are in the form of 15- and 30-year variable rate loans. We also originate 15- to 30-year fixed rate residential mortgages and we sell most of these to outside investors. We retain the servicing of almost all of the residential mortgages we originate. We believe the retention of mortgage servicing provides us with a relatively steady source of fee income as compared to fees generated solely from mortgage origination operations. Moreover, the retention of such servicing rights allows us to continue to have regular contact with mortgage customers and solidifies relationships with those customers. We do not engage in financing sub-prime loans nor do we participate in any sub-prime lending programs.
Commercial Real Estate Loans. The largest portion of our loan portfolio is comprised of commercial real estate loans. Our focus in Commercial Real Estate lending concentrates on loans to building contractors and developers. The primary repayment risk for a commercial real estate loan is the failure of the business due to economic events or governmental regulations outside of the control of the borrower or lender that negatively impact the future cash flow and market values of the affected properties. We have collateralized these loans and, in most cases, take personal guarantees to help assure repayment. Our commercial real estate loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying real estate acting as collateral. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the real estate and enforcement of a personal guarantee, if any exists
Construction Loans. We are active in financing construction of residential and commercial properties in New Mexico, primarily in Northern New Mexico. We manage the risk of construction lending through the use of underwriting and construction loan guidelines and require the work be done by reputable contractors. Construction loans are structured either to be converted to permanent loans at the end of the construction phase or to be paid off upon receiving financing from another financial institution. The amount financed on construction loans is based on the appraised value of the property, as determined by an independent appraiser, and an analysis of the potential marketability and profitability of the project and the costs of construction. Construction loans generally have terms that do not exceed 24 months. Loan proceeds are typically disbursed on a percentage of completion basis, as determined by inspections, with all construction required to be completed prior to the final disbursement of funds.
Construction loans afford us the opportunity to increase the interest rate sensitivity of our loan portfolio and to receive yields higher than those obtainable on adjustable rate mortgage loans secured by existing residential properties. These higher yields correspond to the higher risks associated with construction lending.
Commercial Loans. The Bank is an active commercial lender. Our focus in commercial lending concentrates on loans business services companies and retailers. The Bank provides various credit products to our commercial customers including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and other purposes. Collateral on commercial loans typically includes accounts receivable, furniture, fixtures, inventory and equipment. In addition, almost all commercial loans also have personal guarantees to assure repayment. The terms of most commercial loans range from one to seven years. A significant portion of our commercial business loans has floating interest rates or reprice within one year.
Consumer Loans. We also provide all types of consumer loans including motor vehicle, home improvement, student loans, credit cards, signature loans and small personal credit lines. Consumer loans typically have shorter terms and lower balances with higher yields as compared to our other loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.
Additional information on the risks associated with our banking activities and products and concentrations can be found under Risk Factors in Section 1A of this Form 10-K.
Market Area.
General. The economy in Northern New Mexico has remained fairly stable, although somewhat slower than historical activity levels. Unemployment remained low and approximately 7,300 new jobs were added to the New Mexico economy in 2007. Foreclosure rates have remained low in New Mexico relative to other states. New Mexico remains aggressive in lobbying new businesses to move to the state. The overall outlook for the New Mexico economy in 2008 is expected to be one of moderate, but steady growth through 2012.
Los Alamos. The Bank’s customers are concentrated in northern and central New Mexico, particularly in Santa Fe and Los Alamos counties. Los Alamos, the base of our operations, lies within Los Alamos County. Los Alamos County has approximately 19,000 residents. Los Alamos County experienced minimal growth in its population of 1.3% from 1990 to 2000 and 3.7% from April 1, 2000 to July 1, 2006, due in part to the lack of significant parcels of additional land for development. The primary employer in Los Alamos County is the Laboratory, one of the world’s premier national security and scientific research and development institutions. The Laboratory is operated by Los Alamos National Security, LLC for the Department of Energy. The Laboratory employs approximately 9,000 employees and an additional 650 subcontractors. Most of the employees are scientists, engineers and technicians working in the areas of national security, bio-sciences, chemistry, computer science, earth and environmental sciences, materials science and physics, contributing to Los Alamos County’s exceptional percentages of the population with high school diplomas or equivalents (96.3%) and those with bachelor or higher degrees (60.5%) compared with national averages of 80.4% and 24.4% respectively. The concentration of highly skilled and highly educated residents provides the Bank with a sophisticated customer base and supports an average median income approximately 113% greater than the national average and an unemployment rate (1.7%) almost one-third the national average (5.0%). Median home values in Los Alamos County are well above average, $228,300 compared to $119,600 nationally, as is homeownership at 78.6% compared to a national average of 66.2%.
Santa Fe. In 1999, the Bank opened its first full-service office in Santa Fe, New Mexico and opened a second full-service office in Downtown Santa Fe in August of 2004. The Bank intends to open a third full-service office in south Santa Fe in 2009. The Bank’s continued expansion into Santa Fe has permitted the convenient provision of products and services to our existing customer base in Santa Fe as well as attracting new customers in Santa Fe. The addition of our second office in Santa Fe resulted in a considerable growth of our customer base by providing a convenient location for the large number of businesses and customers based near the Santa Fe Plaza, which is located near the center of the business district and government facilities. As of June 30, 2007, the Bank was the largest depository in Santa Fe according to the FDIC’s Summary of Deposits report.
Santa Fe serves as the capital of New Mexico and is located approximately 35 miles southeast of Los Alamos. The primary employers in Santa Fe County are the state and federal governments. Santa Fe County has approximately 142,000 residents with its local economy based primarily on government and tourism. We expanded to the Santa Fe market, in part, to take advantage of the population growth, which has been higher than the state and national averages. Santa Fe County is one of the fastest growing counties in the state, with an estimated increase in population of 30.7% from 1990 to 2000 compared to 20.1% for the state and 13.2% for the country as a whole, and 10.1% between April 1, 2000 and July 1, 2006, compared to 7.5% for the state and 6.4% for the country as a whole. Santa Fe County also has higher than average percentages of its population with high school diplomas or equivalents (84.5%) and those with bachelor or higher degrees (36.9%). The average median income in Santa Fe County is slightly higher (1.36%) than the national average and unemployment level (2.7%) almost one-half the national average (5.0%). Median home values in Santa Fe County are 55.36% above the national average, at $189,400 compared to $119,600 nationally, and homeownership is slightly higher at 68.6% compared to a national average of 66.2%.
Albuquerque. The Bank opened a Loan Production Office in the Uptown area of Albuquerque, New Mexico in 2005. This office currently only offers loan services; however, the Bank received approval from the OCC on December 31, 2007 to provide full-services at this location. The Bank is currently evaluating its present and future opportunities in the Albuquerque area and incorporating these into our business strategy. As of December 31, 2007, the Bank had approximately $20.2 million in commercial loans, $63.7 million in commercial real estate loans, $33.9 in residential loans, $27.3 million in construction loans, $4.0 in consumer loans and $37.2 million in deposits in the greater Albuquerque area. Albuquerque is a city of approximately 472,000 and is located approximately 60 miles south of Los Alamos. The Albuquerque economy is more varied than either Los Alamos or Santa Fe, without a predominant industry or employer. Albuquerque had an estimated increase in population of 16.6% from 1990 to 2000 compared to 20.1% for the state and 13.2% for the country as a whole, and an increase of 5.1% between April 1, 2000 and July 1, 2006, compared to 7.5% for the state and 6.4% for the country as a whole. While Albuquerque has not grown as quickly as the overall state increases, the areas surrounding Albuquerque are some of the fastest growing in the state: the City of Rio Rancho, on the northern limits of Albuquerque grew 59.25% from 1990 to 2000 and an additional 40.33% from April 1, 2000 to July 1, 2006; Sandoval County to the north of Albuquerque, which includes the City of Rio Rancho, grew 41.99% from 1990 to 2000 and 25.6% from April 1, 2000 to July 1, 2006; and Bernalillo County, which includes Albuquerque, grew 15.83% from 1990 to 2000 and 10.6% from April 1, 2000 to July 1, 2006. Albuquerque has higher than average percentages of its population with high school diplomas or equivalents (85.9%) and those with bachelor or higher degrees (31.8%). The average median income in Albuquerque is 13.67% lower than the national average and unemployment levels (3.5%) are thirty-percent lower than the national average (5.0%). Median home values in Albuquerque are 6.68% above the national average, at $127,600 compared to $119,600 nationally, but homeownership is slightly lower at 60.4% compared to a national average of 66.2%.
Competition. We face strong competition both in originating loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, savings institutions and mortgage bankers making loans secured by real estate located in our market area. Commercial banks and finance companies, including finance company affiliates of automobile manufacturers, provide vigorous competition in consumer lending. We compete for real estate and other loans principally on the basis of the interest rates and loan fees we charge, the types of loans we originate and the quality and speed of services we provide to borrowers. Insurance companies and internet-based financial institutions present growing areas of competition both for loans and deposits.
There is substantial competition in attracting deposits from other commercial banks, savings institutions, money market and mutual funds, credit unions and other investment vehicles. Our ability to attract and retain deposits depends on our ability to provide investment opportunities that satisfy the requirements of investors as to rate of return, liquidity, risk and other factors. Under the Gramm-Leach-Bliley Act enacted in 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This has significantly changed the competitive environment in which we conduct business. The financial services industry has also become more competitive as technological advances enable companies to provide financial services to customers outside their traditional geographic markets and provide alternative methods for financial transactions. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
Employees. As of December 31, 2007, the Bank had approximately 271 full time-equivalent employees. We are not a party to any collective bargaining agreements. Employee relations are excellent as evidenced by the results of our annual employee satisfaction surveys. Over the last six years, the results of the employee satisfaction survey have consistently shown satisfaction levels exceeding our peers according to the independent consultant hired to administer and evaluate our surveys.
Regulation and Supervision
General. Los Alamos National Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit accounts of Los Alamos National Bank are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations, and Los Alamos National Bank is a member of the Federal Reserve System. As a national bank, Los Alamos National Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC, the chartering authority for national banks. The FDIC, as administrator of the DIF, also has regulatory authority over Los Alamos National Bank. Los Alamos National Bank is also a member of the Federal Home Loan Bank System, which provides a central credit facility primarily for member institutions.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. Under the regulations of the FDIC, as presently in effect, insurance assessments range from 0.05% to 0.43% of total deposits (subject to adjustment by the FDIC and the application of assessment credits, if any, issued by the FDIC in 2007).
FICO Assessments. The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Federal Savings and Loan Insurance Corporation Recapitalization Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year non-callable bonds of approximately $8.2 billion that mature by 2019. Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2007, the FICO assessment rate was approximately 0.01% of deposits.
Supervisory Assessments. National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC. The amount of the assessment is calculated using a formula that takes into account the bank’s size and its supervisory condition.During the year ended December 31, 2007, Los Alamos National Bank paid supervisory assessments to the OCC totaling $293 thousand.
Capital Requirements.The OCC has established the following minimum capital standards for national banks, such as Los Alamos National Bank: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.
The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the OCC provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.
Further, federal law and regulations provide various incentives to financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.” Under the regulations of the OCC, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.
Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
As of December 31, 2007: (i) Los Alamos National Bank was not subject to a directive from the OCC to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) Los Alamos National Bank exceeded its minimum regulatory capital requirements under OCC capital adequacy guidelines; and (iii) Los Alamos National Bank was “well-capitalized,” as defined by OCC regulations.
Dividends. The National Bank Act imposes limitations on the amount of dividends that may be paid by a national bank, such as Los Alamos National Bank. Generally, a national bank may pay dividends out of its undivided profits in such amounts and at such times as the bank’s board of directors deems prudent. Without prior OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s year-to-date net income plus the bank’s retained net income for the two preceding years.
The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, Los Alamos National Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2007. As of December 31, 2007, approximately $18.1 million was available to be paid as dividends by Los Alamos National Bank. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of any dividends by Los Alamos National Bank if the OCC determines such payment would constitute an unsafe or unsound practice.
Insider Transactions.Los Alamos National Bank is subject to certain restrictions imposed by federal law on extensions of credit to Trinity, on investments in the stock or other securities of Trinity and the acceptance of the stock or other securities of Trinity as collateral for loans. Los Alamos National Bank also is subject to certain restrictions imposed by federal law on extensions of credit by Los Alamos National Bank to its directors and officers, to directors and officers of Trinity and its subsidiaries, to principal shareholders of Trinity and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of Trinity or Los Alamos National Bank or a principal shareholder of Trinity may obtain credit from banks with which Los Alamos National Bank maintains correspondent relationships.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.
Branching Authority. National banks headquartered in New Mexico, such as Los Alamos National Bank, have the same branching rights in New Mexico as banks chartered under New Mexico law, subject to OCC approval. New Mexico law grants New Mexico-chartered banks the authority to establish branches anywhere in the State of New Mexico, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.
Financial Subsidiaries. Under Federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investments in financial subsidiaries). Los Alamos National Bank has not applied for approval to establish any financial subsidiaries.
Federal Reserve System. Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $43.9 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $43.9 million, the reserve requirement is $1.038 million plus 10% of the aggregate amount of total transaction accounts in excess of $43.9 million. The first $9.3 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. Los Alamos National Bank is in compliance with the foregoing requirements.
Title Guaranty & Insurance Company
General. Title Guaranty is a title insurance company organized under the laws of New Mexico and doing business in Los Alamos and Santa Fe Counties. Trinity acquired Title Guaranty in May of 2000 to provide services related to the lending activities of the Bank. Title Guaranty has provided services to the Los Alamos community since its founding in 1963 and handled approximately 70% of the mortgages recorded in Los Alamos County in 2007. Title Guaranty continues to face strong competition in Los Alamos County from the two other title companies in Los Alamos which collectively handled approximately 30% of the mortgages recorded in Los Alamos County in 2007. Title Guaranty opened a second office in the Bank’s Downtown Santa Fe facility in February 2005, securing a title plant under a lease and purchase agreement with LandAmerica Capitol City Title Services, Inc. to provide title services and products in Santa Fe County. Title Guaranty faces strong competition in Santa Fe County from numerous other title companies. In 2007, Title Guaranty handled approximately 4.88% of the mortgages recorded in Santa Fe County. Title Guaranty is regulated by the New Mexico Public Regulation Commission’s Department of Insurance with which Title Guaranty is required to file annual experience reports and who audits Title Guaranty annually. The annual experience report requires that Title Guaranty be audited by a certified public accountant.
Products and Services. The products and services offered by Title Guaranty include: title insurance; closings, including purchase/sale, commercial, construction, refinance, tax deferred exchange, relocation, and courtesy; escrow and notary services; title searches; and title reports. Title insurance covers lenders, investors, and property owners from potential losses that can arise in real estate ownership and is typically required for loans collateralized by real property. To streamline its processes, Title Guaranty employs current technology allowing customers to view the status of their file online. Title Guaranty’s national underwriters are Chicago Title Insurance Company, Commonwealth Land Title Insurance Company, Fidelity National Title Insurance Company, Lawyers Title Insurance Corporation, United General Title Insurance Company and First American Title Insurance Company.
Employees. As of December 31, 2007, Title Guaranty had approximately 10 full time-equivalent employees. Title Guaranty is not a party to any collective bargaining agreements. Employee relations are excellent as evidenced by the results of our annual employee satisfaction surveys.
TCC Appraisal Services Corporation
General. TCC Appraisals is an appraisal company organized under the laws of New Mexico and doing business in Los Alamos County. Trinity acquired TCC Appraisals in January 2006 to provide services related to the lending activities of the Bank. TCC Appraisals handled approximately 85% of the residential appraisals in Los Alamos County in 2007. TCC Appraisals has limited competition in Los Alamos County in the form of a handful of appraisers who combined handle approximately 15% of residential appraisals. Our staff appraiser is regulated by the New Mexico Appraiser Board and is required to comply with the Uniform Standards of Professional Appraisal Practice (USPAP). Our staff appraiser is licensed by the New Mexico Appraiser Board and has not had any complaints filed against him with the State.
Products and Services. Currently, TCC Appraisals provides residential appraisal services within Los Alamos and Santa Fe Counties. The primary customer for TCC Appraisals in 2007 was the Bank. TCC Appraisals’ other customers include other lenders, attorneys and homeowners.
Employees. As of December 31, 2007, TCC Appraisals had 2 full time-equivalent employees. TCC Appraisals is not a party to any collective bargaining agreements. Employee relations are excellent as evidenced by the results of our annual employee satisfaction surveys.
Trinity Capital Trust I, III, IV and V
Trinity Capital Trust I, Trinity Capital Trust III, Trinity Capital Trust IV, and Trinity Capital Trust V (the “Trusts”) are Delaware statutory business trusts formed in 2000, 2004, 2005, and 2006, for the purpose of issuing $10 million, $6 million, $10 million, and $10 million in trust preferred securities and lent the proceeds to Trinity. In December of 2006, Trinity redeemed all amounts due under Trinity Capital Trust II which was created in 2001 for the purpose of issuing $6 million in trust preferred securities. Trust II has been dissolved. Trinity guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.
All trust preferred securities are currently included in the Tier 1 capital of Trinity for regulatory capital purposes. However, the Federal Reserve Board recently enacted a rule that may limit the inclusion of some of our trust preferred securities in Tier 1 capital for regulatory capital purposes after 2009, although we believe that we will be able to continue treating it all as Tier 1 capital under the rule. See Note 9, “Junior Subordinated Debt Owed to Unconsolidated Trusts” and Note 17, “Regulatory Matters” in the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data,” of this report.
Item 1A.
Item 1A. Risk Factors
In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors:
Our profitability is dependent upon the health of the markets in which we operate. As the largest employer in Northern New Mexico, the health of the Laboratory is central to the economic health of both northern and central New Mexico. The main indicator of the Laboratory’s health is its funding. The Laboratory’s 2008 fiscal budget was approved with a stabilized level of funding at approximately $2.2 billion and the 2009 fiscal budget is expected to include a slight increase in funding. The Laboratory recently provided a voluntary separation package, resulting in approximately 430 employees departing, many of whom were at retirement age and continue to reside in Los Alamos or the surrounding counties, and has announced that it expects no further reductions in force. Any material decrease in the Laboratory’s funding may affect our customers' business and financial interests, adversely affect economic conditions in our market area, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. The economy in Northern New Mexico as a whole has remained fairly stable, although somewhat slower than historical activity levels.
Interest rates and other conditions impact our results of operations. Our profitability is in part a function of net interest margin. Like most banking institutions, our net interest margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented at “Quantitative and Qualitative Disclosures About Market Risk” included under Item 7A of Part II of this Form 10-K. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.
We must effectively manage our credit risk, including risks specific to real estate value due to the large concentration of real estate loans in our loan portfolio. There are risks inherent in making any loan, including risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan underwriting procedures, careful monitoring of the concentration of our loans within specific industries, monitoring of our collateral values and market conditions, and periodic independent reviews of outstanding loans by our audit department, a third-party loan review as well as external auditors. However, we cannot assure such approval and monitoring procedures will eliminate these credit risks.
The majority of the Bank’s loan portfolio is invested in commercial real estate, residential real estate, construction, general commercial and consumer lending. The maximum amount we can loan to any one customer and their related entities (our “legal lending limit”) is smaller than the limits of our national and regional competitors with larger lending limits. While there is little demand for loans over our legal lending limit ($19.7 million), we can and have engaged in participation loans with other financial institutions to respond to customer requirements. However, there are some loans and relationships that we cannot effectively compete for due to our size
Real estate lending (including commercial, construction, and residential) is a large portion of our loan portfolio. These categories constitute $993.1 million, or approximately 84.7% of our total loan portfolio as of December 31, 2007. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans are secured by real estate as a secondary form of collateral, adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, commercial real estate lending typically involves larger loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service.Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.
The Bank’s residential mortgage loan operations include origination, sale and servicing. The Bank’s residential mortgage loan portfolio does not include subprime mortgages and contains a limited number of non-traditional residential mortgages. The Bank employs prudent underwriting standards in making residential mortgage loans. The majority of the residential mortgage loans originated by the Bank are sold to third-party investors, primarily to the Federal National Mortgage Association (“Fannie Mae”). The Bank continues to service the majority of loans that are sold to third-party investors, to build on our relationship with the customers and provide a continuing source of income through mortgage servicing right fees. Neither Trinity nor the Bank have purchased or engaged in loan pools, such as CDOs, SIVs, or other instruments which contain subprime mortgage loans and have recently seen losses in value. As such, Trinity does not foresee any charge-offs, write-downs or other losses outside the ordinary course of business with respect to our residential mortgage operations.
The current real estate market in New Mexico has slowed, but not to the same extent as other areas of the nation. Residential real estate time on-the-market has increased, but home values have generally remained constant or increased slightly in our market areas. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition. To mitigate such risk, we employ the use of either TCC Appraisals or independent third parties to conduct appraisals on our real estate collateral and adhere to limits set on the percentages for the loan amount to the appraised value of the collateral. We continually monitor the real estate markets and economic conditions in the areas in which our loans are concentrated.
Our construction and development loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate and we may be exposed to more losses on these projects than on other loans. At December 31, 2007, construction loans, including land acquisition and development, totaled $249.3 million, or 21.3%, of our total loan portfolio. Construction, land acquisition and development lending involve additional risks because funds are advanced based upon the value of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property and the general effects of the national and local economies, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project. If we are forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time. We have attempted to address these risks through our underwriting procedures, compliance with applicable regulations, requiring that advances typically be made on a percentage of completion basis as determined by independent third party inspectors, and by limiting the amount of construction development lending.
Our allowance for loan losses must be managed to provide sufficient reserves to absorb potential losses in our loan portfolio. We established our allowance for loan losses in consultation with management, consultants and external auditor recommendations, and maintain it at a level considered adequate by management to absorb probable loan losses based on a continual analysis of our portfolio and market environment. The amount of loan losses is susceptible to changes in economic, operating and other conditions within our market, which may be beyond our control, and such losses may exceed current estimates. At December 31, 2007, our allowance for loan losses as a percentage of total loans was 1.15% and as a percentage of total non-performing loans was approximately 114.79%. Although management believes that the allowance for loan losses is adequate to absorb losses on any existing loans that may become uncollectible, we cannot predict loan losses with certainty, and we cannot assure that our allowance for loan losses will prove sufficient to cover actual loan losses. In addition, our regulators may require us to change the amount of our reserves for loan loss which must be funded from net income. Additional reserve allocations or loan losses in excess of our reserves may adversely affect our business, financial condition and results of operations. Additional information regarding our allowance for loan losses and the methodology we use to determine an appropriate level of reserves is located in the “Management’s Discussion and Analysis” section included under Item 7 of Part II of this Form 10-K.
Our growth must be effectively managed and our growth strategy involves risks that may impact our net income. As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets to take advantage of expanding market share by opening new offices. To the extent that we undertake additional office openings, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations for a period of time, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Our current growth strategies involve internal growth from our current offices and the opening of an additional office in Santa Fe during 2009. This new site will be approximately 15,000 square feet. Our experience has been rapid absorption of our Santa Fe offices, with our existing Santa Fe offices becoming profitable well ahead of budget; however, such rapid absorption is not guaranteed in the future.
We must compete with other banks and financial institutions in all lines of business. The banking and financial services business in our market is highly competitive. Our competitors include large regional banks, local community banks, savings institutions, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers. Many of these competitors are not subject to the same regulatory restrictions and may therefore enable them to provide customers with an alternative to traditional banking services.
Increased competition in our market and market changes, such as interest rate changes, force management to better control costs in order to absorb any resultant narrowing of our net interest margin, i.e., the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities. Without effective management and cost controls, net income may be adversely impacted by changing conditions and competition. Our efficiency leads to a decreased cost of operation that allows us to effectively anticipate and respond to market and competitive changes without adversely affecting net income.
We may need to raise additional capital in the future, which may not be available when it is needed. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We manage our growth rate to ensure that our existing capital resources will satisfy our capital requirements for the foreseeable future. However, regulatory requirements, growth in assets outpacing growth in capital or our growth strategy may present conditions that would create a need for additional capital from the capital markets. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. There may not always be capital available or available on favorable terms. These conditions may alter our strategic direction and require us to manage our growth to remain within capital limits relying solely on our earnings for capital formation, thereby materially reducing our growth rate.
Our ability to attract and retain management and key personnel may affect future growth and earnings. Much of our success to date has been influenced strongly by our ability to attract and to retain management experienced in banking and financial services and individuals familiar with the communities in our market areas. Our ability to retain executive officers, current management, office managers and loan officers at the Bank will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of any key personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition and results of operations.
Government regulation can result in limitations on our operations. We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Federal Reserve, the OCC and the FDIC. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. These bank regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to the banking industry could change at any time and we cannot predict the affects of these changes on our business and profitability. While we expect some regulatory changes to result from recent events leading to large losses from subprime and non-traditional mortgages and associated pooled security instruments, we believe that the Bank will benefit from the expected prohibition of abuses in the mortgage industry and increased disclosure requirements. However, any changes in regulation could also increase our cost of compliance and adversely affect profitability.
Technology is continually changing and we must effectively implement new innovations in providing services to our customers. The financial services industry is undergoing rapid technological changes with frequent innovations in technology-driven products and services. In addition to better serving customers, the effective use of technology increases our efficiency and enables us to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers using innovative methods, processes and technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. In order to anticipate and develop new technology, we employ a full staff of internal information system developers and consider this area a core part of our business. In the past, we have been able to respond to technological changes faster and with greater flexibility than our competitors. However, we must continue to make substantial investments in technology, which may affect our net income.
There is a limited trading market for our common shares and, as with all companies, shareholders may not be able to resell shares at or above the price shareholders paid for them. Our common stock is not listed on any automated quotation system or securities exchange and no firm makes a market in our stock.The trading in our common shares has less liquidity than many other companies quoted on the national securities exchanges or markets. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot insure volume of trading in our common shares will increase in the future.
System failure or breaches of our network security could subject us to increased operating costs, damage to our reputation, litigation and other liabilities. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us as well as damage to our reputation in general.
The Federal Financial Institutions Examination Council (FFIEC) issued guidance for “Strong Authentication/Two Factor Authentication” in the Internet banking environment. All financial institutions were required to make changes to their online banking systems to meet the new FFIEC requirements. In response to this guidance, Trinity incorporated multiple layers of security to protect our customers’ financial data. Included in our security layers are highly sophisticated systems that continually monitor online banking activity. These systems constantly compare past and current activity to build system intelligence, providing profiles for each customer. We also altered our login pages to let our customers know they are communicating with the Bank and not a “spoofed” site. A Security-phrase is now required and entered via a virtual keyboard anytime we identify activity that warrants additional security concern (e.g., transferring funds out of our customers’ ownership). We have also made available, and in some cases require, the use of security tokens that generate a one-time-password. We further employ external information technology auditors to conduct extensive auditing and testing for any weaknesses in our systems, controls, firewalls and encryption to reduce the likelihood of any security failures or breaches. Although we, with the help of third-party service providers and auditors, intend to continue implementing security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse affect on our financial condition and results of operations.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors. Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Employee errors could include data processing system failures and errors. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence. To mitigate operational risks, we maintain a system of internal controls and insurance coverage. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse affect on our business, financial condition and results of operations.
Failure to pay interest on our debt may adversely impact our ability to pay dividends. As of December 31, 2007, we had $37.1 million of junior subordinated debentures that are held by four business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our Common Stock. In 2007, the interest payments totaled $3.1 million; however, the amount is subject to change each year due to a variable rate applicable to $6 million of the debentures. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock. Deferral of interest payments could also cause a decline in the market price of our Common Stock.
Item 1B.
Item 1B. Unresolved Staff Comments.
None
Item 2.
Item 2. Properties.
As of March 17, 2008, the Company conducted operations through five locations as shown below. Trinity is headquartered in the main Bank office in Los Alamos, New Mexico. Four banking offices are owned by the Bank and are not subject to any mortgages or material encumbrances; our Loan Production Office is leased office space. In addition to our offices, the Bank operates 27 automatic teller machines (“ATMs”) throughout northern New Mexico. The ATMs are housed either on bank properties or on leased property.
In addition to the properties at which offices are currently located, Trinity holds ground leases on approximately 3 acres of vacant land located at the intersection of Vegas Verdes Drive and Cerrillos Road in Santa Fe, New Mexico (referred to below as Santa Fe Office III (Cerrillos Road)). We are currently working on plans to construct a third Santa Fe office at this location. We anticipate construction will begin in 2008 with the office opening in 2009. A portion of the property will be sub-leased to additional tenants. We believe our facilities are adequate for our existing business as well as our present and immediately foreseeable needs.
Item 3.
Item 3. Legal Proceedings.
Trinity, the Bank, Title Guaranty, TCC Appraisals, TCC Advisors and TCC Funds are not involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business and those otherwise specifically stated herein, which, in the opinion of management, in the aggregate, are material to our consolidated financial condition.
The Bank is a stockholder of Visa, Inc., which is subject to an adverse judgment in a class action lawsuit arising from certain overcharges of fees. The effect of this judgment is immaterial to the Company’s financials.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the quarter ended December 31, 2007.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Trinity’s common stock is not listed on any automated quotation system or securities exchange. No firm makes a market in our stock. As of March 10, 2008, there were 6,499,587 shares of common stock outstanding and approximately 1,400 shareholders of record. The most recent reported sale price of Trinity’s stock as of December 31, 2007 was $26.99 per share.
The tables below show the reported high and low sales prices of the common stock during the periods indicated. The prices below are only the trades where the price was disclosed to the Company. Private sales, where the value of the shares traded were not given to us, are not included. The following figures have been adjusted for all stock splits:
Dividend Policy
Since January 2006, Trinity paid dividends on our common stock as follows:
Trinity’s ability to pay dividends to shareholders is largely dependent upon the dividends it receives from the Bank and the Bank is subject to regulatory limitations on the amount of cash dividends it may pay. Please see “Business-Trinity Capital Corporation-Supervision and Regulation-Dividends” and “Business-Los Alamos National Bank-Supervision and Regulation-Dividends” under Item 1 for a more detailed description of these limitations.
We have the right to, and may from time to time, enter into borrowing arrangements or issue other debt instruments, the provisions of which may contain restrictions on payment of dividends and other distributions on Trinity common stock and Trinity preferred stock. We have issued in the aggregate approximately $37.1 million in junior subordination debentures to Trinity Capital Trust I, Trinity Capital Trust III, Trinity Capital Trust IV and Trinity Capital Trust V. All of the common stock of the trusts is owned by Trinity and the debentures are the only assets of the trusts. Under the terms of the debentures, we may be prohibited, under certain circumstances, from paying dividends on shares of its common stock. None of these circumstances currently exist. As of the date hereof, we have not entered into any other arrangements that contain restrictions on the payment of dividends. We believe that Trinity can continue to pay comparable cash dividends to shareholders in the future, assuming that (a) we continue to be profitable, (b) we do not experience any unusual growth that would necessitate higher capital retention and (c) the regulatory environment on minimum capital requirements or maximum dividends paid does not change.
Issuer Purchases of Equity Securities
During the fourth quarter of 2007, we repurchased the following securities:
_________________________
(1)
In September 2007, a former employee exercised the put option on shares owned in the Employee Stock Ownership Plan. An initial repurchase of 5,342 was made in September 2007, with the remaining shares repurchased in December 2007. Total shares repurchased by Trinity under the put option were 16,010.
Shareholder Return Performance Graph
The following graph and related information shall not be deemed to be filed, but rather furnished to the SEC by inclusion herein.
The following graph shows a comparison of cumulative total returns for Trinity, the NASDAQ Stock Market, an index of all bank stocks followed by SNL, an index of bank stock for banks with $1 billion to $5 billion in total assets followed by SNL, and an index of bank stocks that are quoted on the OTC-Bulletin Board and on Pink Sheets. The cumulative total shareholder return computations assume the investment of $100.00 on December 31, 2002 and the reinvestment of all dividends. Figures for Trinity’s common stock represent inter-dealer quotations, without retail markups, markdowns or commissions and do not necessarily represent actual transactions. The graph was prepared using data provided by SNL Securities LC, Charlottesville, Virginia.
In the past, the Company compared its Total Return Performance only to the NASDAQ Composite and SNL’s >$500M OTC-BB and Pink Banks. The Company decided to add additional comparative indexes as they more provide a more complete picture of the peer groups with whom the Company’s management compares the Company performance.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth certain consolidated financial and other data of Trinity at the dates and for the periods indicated.
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(1)
Computed by dividing total stockholders’ equity, including net stock owned by Employee Stock Ownership Plan (“ESOP”), by shares outstanding at end of period.
(2)
Computed by dividing dividends declared per common share by earnings per common share.
(3)
Computed by dividing dividends on consolidated statements of changes in stockholders’ equity by weighted average common shares outstanding.
The following table reconciles net interest income on a fully tax-equivalent basis for the periods presented:
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(1)
Calculated by dividing net income by average assets.
(2)
Calculated by dividing net income by the average stockholders’ equity, including stock owned by ESOP participants, net of unearned ESOP shares, during the year.
(3)
Calculated by dividing net interest income (adjusted to a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences) by average earning assets.
(4)
Calculated by dividing operating expense by the sum of net interest income and other income.
(5)
Ratios presented are for Trinity on a consolidated basis. See Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
This discussion is intended to focus on certain financial information regarding Trinity and the Bank and is written to provide the reader with a more thorough understanding of its financial statements. The following discussion and analysis of Trinity’s financial position and results of operations should be read in conjunction with the information set forth in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” and the consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
Special Note Concerning Forward-Looking Statements
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1A of Part I of this Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These additional factors include, but are not limited to, the following:
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Critical Accounting Policies
Allowance for Loan Losses: The allowance for loan losses is that amount which, in management's judgment, is considered appropriate to provide for potential losses in the loan portfolio. In analyzing the adequacy of the allowance for loan losses, management uses a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of periodic internal and external loan reviews. Historical loss experience factors and specific reserves for impaired loans, combined with other considerations, such as delinquency, non-accrual, trends on criticized and classified loans, economic conditions, concentrations of credit risk, and experience and abilities of lending personnel, are also considered in analyzing the adequacy of the allowance. Management uses a systematic methodology, which is applied at least quarterly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses it considers adequate to provide for anticipated loan losses. This methodology includes a periodic detailed analysis of the loan portfolio, a systematic loan grading system and a periodic review of the summary of the allowance for loan and lease loss balance. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
Three methods are used to evaluate the adequacy of the allowance for loan losses: (1) specific identification, based on management’s assessment of loans in our portfolio and the probability that a charge-off will occur in the upcoming quarter, per SFAS 114; (2) losses probable in the loan portfolio besides those specifically identified, based upon a migration analysis of the percentage of loans currently performing that have probable losses, as set forth in SFAS 5; and (3) qualitative adjustments based on management’s assessment of certain risks such as delinquency trends, watch-list and classified trends, changes in concentrations, economic trends, industry trends, non-accrual trends, exceptions and loan-to-value guidelines, management and staff changes and policy or procedure changes (as set forth in SFAS 5).
While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations.
Mortgage Servicing Right (MSR) Assets: Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank. As of December 31, 2007, mortgage loans serviced for others totaled $944.5 million. The MSRs on these loans total $8.1 million as of December 31, 2007. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. In determining the fair value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and discount rates, are held constant over the estimated life of the portfolio. Fair values of the MSRs are calculated on a monthly basis. The values are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors. MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.
The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borrowers will prepay the underlying mortgages by refinancing at a lower rate. Accordingly, higher interest rates decrease the likelihood of prepayment, extending the life of the MSRs and increasing the value of these assets. Lower interest rates increase the likelihood of prepayment, contracting the life of the MSRs and decreasing the value of these assets. This can have a significant impact on our income. There is no certainty on the direction and amount of interest rate changes looking forward, and therefore, there is no certainty on the amount or direction of the change in valuation.
An analysis of changes in mortgage servicing rights asset follows:
Below is an analysis of changes in the mortgage servicing right asset valuation allowance:
The fair values of the MSRs were $8.5 million, $9.5 million and $10.5 million on December 31, 2007, 2006 and 2005, respectively.
The primary risk characteristics of the underlying loans used to stratify the servicing assets for the purposes of measuring impairment are interest rate and original term.
Our valuation allowance is used to recognize impairments of our MSRs. An MSR is considered impaired when the market value of the MSR is below the amortized book value of the MSR. The MSRs are accounted by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches. Each tranche is evaluated separately for impairment.
We have our MSRs analyzed for impairment on a monthly basis. The underlying loans on all serviced loans are analyzed and, based upon the value of MSRs that are traded on the open market, a current market value for each risk tranche in our portfolio is assigned. We then compare that market value to the current amortized book value for each tranche. The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to income.
The following assumptions were used to calculate the market value of the MSRs as of December 31, 2007, 2006 and 2005:
Overview
The year 2007 was the most profitable year in the history of the Company. During 2007 we experienced asset growth of $20.4 million (1.5%) but an increase in income of $3.0 million (29.3%), mainly due to an increase in net interest income of $3.2 million. The slow asset growth was part of the general economic slowdown experienced in the nation and our market area during the year, and it is anticipated that this trend will continue into 2008. Despite slow growth, the Bank grew to have the largest market share in Santa Fe County as measured by the Summery of Deposits (SOD) report compiled by the FDIC as of June 30, 2007. The Bank also received an “Outstanding” rating in our 2007 Community Reinvestment Act (CRA) examination. Fewer than 15% of banks nationwide receive this rating.
Income Statement Analysis
Net Income-General. Trinity’s net income for the year ended December 31, 2007, totaled $13.3 million or $2.03 diluted earnings per share, compared to $10.3 million or $1.56 diluted earnings per share for 2006, an increase of $3.0 million in net income and an increase of $0.47 in diluted earnings per share. This increase in net income was primarily due to an increase in net interest income of $3.2 million and a decrease in the provision for loan losses expense of $972 thousand. The increase in net interest income was primarily due to an increase in the volume of earning assets. The provision for loan losses decreased between 2006 and 2007 due to a one-time contribution to the provision in the first quarter of 2006 based upon a single commercial loan which was subsequently charged-off in 2006 and an additional contribution in the third quarter 2006 based on the reserve for loan loss analysis which were not repeated in 2007. In addition, non-interest expense increased $811 thousand and non-interest income increased $221 thousand. The increase in non-interest expense was mainly due to an increase in salaries and employee benefits. The increase in non-interest income was mainly due to an increase in loan and other fees. Income tax expenses increased $537 thousand due to higher pre-tax income, which was partially offset by changes in tax estimates between the two periods.
The profitability of the Company’s operations depends primarily on its net interest income, which is the difference between total interest earned on interest-earning assets and total interest paid on interest-bearing liabilities. The Company’s net income is affected by its provision for loan losses as well as other income and other expenses. The allowance for loan losses reflects the amount thought to be adequate to cover probable credit losses in the loan portfolio. Non-interest income or other income consists of mortgage loan servicing fees, loan and other fees, service charges on deposits, gain on sale of loans, gain on sale of securities and other operating income. Other expenses include salaries and employee benefits, occupancy expenses, data processing expenses, marketing, amortization and valuation of mortgage servicing rights, supplies expense, loss on sale of other real estate owned, postage and other expenses.
The amount of net interest income is affected by changes in the volume and mix of interest-earning assets, the level of interest rates earned on those assets, the volume and mix of interest-bearing liabilities, and the level of interest rates paid on those interest-bearing liabilities. The provision for loan losses is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio, as well as economic and market conditions, which is discussed in more detail in “Critical Accounting Policies-Allowance for Loan Losses.” Other income and other expenses are impacted by growth of operations and growth in the number of accounts through core banking business growth. Growth in operations affects other expenses as a result of additional employees, branch facilities and promotional marketing expense. Growth in the number of accounts affects other income including service fees as well as other expenses such as computer services, supplies, loss (gain) on sale of other real estate owned, postage, telecommunications and other miscellaneous expenses.
Net Interest Income. The following tables present, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, and the resultant costs, expressed both in dollars and rates:
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(1)
Average loans includes non-accrual loans of $9.9 million, $8.2 million and $8.2 million for 2007, 2006 and 2005.
Interest income includes loan origination fees of $3.4 million, $3.4 million and $3.2 million for the years ended December 31, 2007, 2006 and 2005.
(2)
Non-taxable investment income is presented on a fully tax equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences.
(3)
Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and is presented on a fully tax equivalent basis.
(4)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
In 2007, net interest income on a fully tax equivalent basis increased $3.2 million (7.0%) to $49.5 million from $46.3 million in 2006. This increase resulted from an increase in interest income on a fully tax equivalent basis of $12.0 million (14.1%), which was partially offset by an increase in interest expense of $8.8 million (22.4%). The increase in interest income on a fully tax equivalent basis was primarily due to an increase in average interest-earning assets of $112.8 million (9.3%), which accounted for $7.5 million of the increase in interest income on a fully tax equivalent basis. The yield on interest-earning assets also increased 31 basis points, which accounted for $4.5 million of the increase. Interest expense increased primarily due to an increase in the cost of interest-bearing liabilities of 42 basis points, which accounted for $4.7 million of the increase. Average interest-bearing liabilities also increased by $106.4 million (9.7%), which accounted for $4.1 million of the increase. The net interest margin expressed in a fully tax equivalent basis decreased 8 basis points to 3.73% in 2007 from 3.81% in 2006.
In 2006, net interest income on a fully tax equivalent basis increased $4.3 million (10.3%) to $46.3 million from $42.0 million in 2005. This increase resulted from an increase in interest income on a fully tax equivalent basis of $17.2 million (25.2%), which was partially offset by an increase in interest expense of $12.9 million (49.0%). The increase in interest income on a fully tax equivalent basis was primarily due to an increase in the yield on interest-earning assets of 85 basis points, which accounted for $9.6 million of the increase. Average interest-earning assets also increased $111.5 million (10.1%), which accounted for $7.6 million of the increase in interest income on a fully tax equivalent basis. Interest expense increased primarily due to an increase in the cost of interest-bearing liabilities of 96 basis points, which accounted for $9.4 million of the increase. Average interest-bearing liabilities also increased by $88.0 million (8.7%), which accounted for $3.5 million of the increase. The net interest margin expressed in a fully tax equivalent basis increased 1 basis point to 3.81% in 2006 from 3.80% in 2005.
Volume, Mix and Rate Analysis of Net Interest Income. The following table presents the extent to which changes in volume, changes in interest rates, and changes in the interest rates times the changes in volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided on changes in each category due to (i) changes attributable to changes in volume (change in volume times the prior period interest rate) and (ii) changes attributable to changes in interest rate (changes in rate times the prior period volume). Changes attributable to the combined impact of volume and rate have been allocated proportionally to the changes due to volume and the changes due to rate.
_________________________
(1)
Non-taxable investment income is presented on a fully tax equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences.
Other Income. Changes in other income between 2007, 2006 and 2005 were as follows:
In 2007, other income increased $221 thousand (2.1%) to $10.5 million from $10.3 million in 2006. Loan and other fees increased $374 thousand mainly due to an increase in fees collected from ATM operations due largely to more foreign (non-Bank customer) transactions on our ATM machines, as well as an increase in Trust Department fees from an increased volume of business. Other operating income decreased $266 thousand (17.9%) mainly due to a decrease in title insurance premiums collected resultant from a lower number of policies written due to a general slow down in the real estate market. Service charges on deposits increased $153 thousand (9.8%) mainly due to an increase in overdraft fees collected, due to an increase of 8.0% in the overdraft fee during 2007.
In 2006 other income increased $38 thousand (0.4%) to $10.3 million from $10.2 million in 2005. Gain on sale of loans decreased $790 thousand (33.2%) due to the continued drop in mortgage loan activity under a slowing local housing market. Other operating income increased $446 thousand (43.1%) due to activities of the newly formed TCC Appraisal Services Corporation and increased revenues from Title Guaranty. Loans and other fees increased by $263 thousand (9.6%) largely due to a continued increase in ATM switch fees from increased debit card usage.
Other Expenses. Changes in other expenses between 2007 and 2006 and between 2006 and 2005 are as follows:
Other expenses increased $811 thousand (2.4%) to $34.6 million in 2007 from $33.8 million in 2006. Salaries and employee benefits increased $1.0 million (6.0%) largely due to normal merit increases in salaries as well as an increase in the bonuses paid to employees (which is based directly on increases in net income). Other expenses decreased $434 thousand mainly due to a decrease in professional fees expense, as costs incurred in 2006 in connection with a quality assessment of the Bank to help us improve the efficiency of operations were not repeated in 2007. In addition, in 2006 we had a $500 thousand legal expense that was not repeated in 2007. (Gain) loss on sale of other real estate owned decreased $335 thousand (155.8%) mainly due to a drop in the sale activity in other real estate owned between the two periods, as well as a recovery on previously recorded losses on the sale of other real estate owned where the financing was made at below-market rates.
Other expenses increased $3.9 million (13.2%) to $33.8 million in 2006 from $29.9 million in 2005. Amortization and valuation of mortgage servicing rights increased $1.8 million (352.3%) largely due to a decrease in the recovery of mortgage servicing rights impairment in 2006 compared to 2005, due to a slowing of the increase in interest rates. Salaries and employee benefits increased $1.4 million (8.7%) largely due to an increase in the number of employees and normal merit increases in salaries, as well as the expensing of stock incentive plans pursuant to SFAS 123(R) (see “Item 8. Financial Statements and Supplemental Data-Notes to Consolidated Financial Statements-Note 12. Stock Incentives” on p. 72 of this Form 10-K). Other expenses increased $1.0 million (22.1%) due to an increase in other losses ($511 thousand) and bankcard expenses ($277 thousand). Other losses increased mainly due to a $500 thousand legal settlement.
Income Taxes. In 2007, income tax expense increased by $537 thousand (7.9%) from the previous year to a total of $7.4 million from $6.8 million, although the effective tax rate decreased from 39.8% in 2006 to 35.6% in 2007. The decrease was mainly attributable to a change in the estimate of current income tax expense, due to an immaterial over accrual of income taxes in the prior year.
In 2006, income tax expense decreased by $341 thousand (4.8%) from the previous year to a total of $6.8 million from $7.2 million, although the effective tax rate increased from 37.5% in 2005 to 39.8% in 2006. This increase in effective tax rate was attributable to permanent differences arising from the tax treatment of employee stock ownership plan expenses for tax and book purposes.
Balance Sheet Analysis
Balance Sheet-General. Total assets at December 31, 2007 were $1.4 billion, an increase in $20.4 million (1.5%) from December 31, 2006. Net loans increased $38.0 million (3.4%) during 2007, and cash and cash equivalents decreased $28.1 million (38.1%). Total investments increased $9.3 million (8.7%). During the same period, total liabilities increased $13.1 million (1.0%), remaining at $1.3 billion. The increase in total liabilities was primarily due to an increase in total deposits of $12.7 million (1.1%). Stockholders’ equity (including stock owned by the Employee Stock Ownership Plan) increased $7.3 million (9.1%) to $88.0 million on December 31, 2007 compared to $80.7 million on December 31, 2006.
Investment Securities. The primary purposes of the investment portfolio are to provide a source of earnings for liquidity management purposes, to provide collateral to pledge against public deposits and to control interest rate risk. In managing the portfolio, we seek to obtain the objectives of safety of principal, liquidity, diversification and maximized return on funds. For an additional discussion with respect to these matters, see “Liquidity” and “Capital Resources” under Item 7 and “Asset Liability Management” under Item 7A
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Asset Liability Management
Our net interest income is subject to “interest rate risk” to the extent that it can vary based on changes in the general level of interest rates. It is our policy to maintain an acceptable level of interest rate risk over a range of possible changes in interest rates while remaining responsive to market demand for loan and deposit products. The strategy we employ to manage our interest rate risk is to measure our risk using an asset/liability simulation model and adjust the maturity of securities in its investment portfolio to manage that risk.
Interest rate risk can also be measured by analyzing the extent to which the repricing of assets and liabilities are mismatched to create an interest sensitivity “gap.” An asset or liability is considered to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, therefore, a negative gap would tend to adversely affect net interest income. Conversely, during a period of falling interest rates, a negative gap position would tend to result in an increase in net interest income.
The following tables set forth the amounts of interest earning assets and interest bearing liabilities outstanding at December 31, 2007, which we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined based on the earlier of the term to repricing or the term to repayment of the asset or liability. These tables are intended to provide an approximation of the projected repricing of assets and liabilities at December 31, 2007 on the basis of contractual maturities and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be reinvested and/or repriced as a result of contractual amortization and rate adjustments on adjustable-rate loans. The contractual maturities and amortization of loans and investment securities reflect modest prepayment assumptions. While NOW, money market and savings deposit accounts have adjustable rates, it is assumed that the interest rates on these accounts will not adjust immediately to changes in other interest rates. Therefore, the table is calculated assuming that these accounts will reprice based upon an historical analysis of decay rates of these particular accounts, with repricing assigned to these accounts from 1 to 11 months.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates. Additionally, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Therefore, we do not rely solely on a gap analysis to manage our interest rate risk, but rather we use what we believe to be the more reliable simulation model relating to changes in net interest income.
Based on simulation modeling at December 31, 2007 and 2006, our net interest income would change over a one-year time period due to changes in interest rates as follows:
Change in Net Interest Income Over One Year Horizon
Our simulations used assume the following:
1.
Changes in interest rates are immediate.
2. It is our policy that interest rate exposure due to a 2% interest rate rise or fall be limited to 15% of our annual net interest income, as forecasted by the simulation model. As demonstrated by the table above, our interest rate risk exposure was within this policy at December 31, 2007.
Changes in net interest income between the periods above reflect changes in the composition of interest earning assets and interest bearing liabilities, related interest rates, repricing frequencies, and the fixed or variable characteristics of the interest earning assets and interest bearing liabilities. Projections of income given by the model are not actual predictions, but rather show our relative interest rate risk. Actual interest income may vary from model projections.
Item 8.
Item 8. Financial Statements and Supplementary Data.
TRINITY CAPITAL CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENTS
Audited Financial Statements December 31, 2007, 2006, and
INDEX
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
AUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2007. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, based upon criteria in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment, management determined that the Company’s internal control over financial reporting was effective as of December 31, 2007.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Trinity Capital Corporation
We have audited the accompanying balance sheets of Trinity Capital Corporation and subsidiaries (the Company) as of December 31, 2007 and 2006, and the related statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also include performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect of the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Trinity Capital Corporation as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion Trinity Capital Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by COSO.
Albuquerque, New Mexico
March 17, 2008
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006
(Amounts in thousands, except share data)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006
(Amounts in thousands, except share data)
(Continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands except share and per share data)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands except share and per share data)
(Continued from prior page)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands except share and per share data)
(Continued from prior page)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2007, 2006 and 2005
(Amounts in thousands)
(Continued from prior page)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Consolidation: The accompanying consolidated financial statements include the consolidated balances and results of operations of Trinity Capital Corporation (“Trinity”) and its wholly owned subsidiaries: Los Alamos National Bank (the “Bank”), Title Guaranty & Insurance Company (“Title Guaranty”), TCC Appraisal Services Corporation (“TCC Appraisals”), TCC Advisors Corporation (“TCC Advisors”) and TCC Funds, collectively referred to as the “Company.” Trinity Capital Trust I (“Trust I”), Trinity Capital Trust III (“Trust III”), Trinity Capital Trust IV (“Trust IV”) and Trinity Capital Trust V (“Trust V”), collectively referred to as the “Trusts,” are trust subsidiaries of Trinity but are not consolidated in these financial statements (see “Consolidation” accounting policy below). The business activities of the Company consist solely of the operations of its wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods have been made.
Basis of financial statement presentation: The consolidated financial statements include the accounts of the Company and its subsidiaries. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the year. Actual results could differ from those estimates. Areas involving the use of management’s estimates and assumptions, and which are more susceptible to change in the near term include the allowance for loan losses and initial recording and subsequent valuation for impairment of mortgage servicing rights.
Nature of operations: The Company provides a variety of financial services to individuals, businesses and government organizations through its offices in Los Alamos and Santa Fe, New Mexico. Its primary deposit products are term certificate, NOW and savings accounts and its primary lending products are commercial, residential and construction real estate loans. The Company also offers trust and wealth management services, title insurance products and residential real estate appraisal services.
The Bank conducts its operations from its main office in Los Alamos and separate office locations in Santa Fe and White Rock, New Mexico and provides loan services from its loan production office in Albuquerque, New Mexico. The Bank also operates drive-up facilities and 27 automatic teller machines (ATM’s) in Los Alamos and surrounding geographic areas. Title Guaranty conducts its operations from its offices in Los Alamos and Santa Fe. TCC Appraisals conducts real estate appraisals in Los Alamos and Santa Fe Counties from its office in the Company headquarters.
Deposits with banks, federal funds sold and securities purchased under resell agreements: For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, amounts due from banks (including cash items in process of clearing), interest-bearing deposits with banks and federal funds sold.
Investment securities available for sale: Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.
Securities available for sale are reported at fair value with unrealized gains or losses reported as accumulated other comprehensive income, net of the related deferred tax effect. The amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, are recognized in interest income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. In addition, if a loss is deemed to be other than temporary, it is recognized as a realized loss in the income statement.
Investment securities held to maturity: Securities classified as held to maturity are those securities that the Company has the ability and positive intent to hold until maturity. These securities are reported at amortized cost. Sales of investment securities held to maturity within three months of maturity are treated as maturities.
Other investments: The Bank, as a member of the Federal Home Loan Bank of Dallas (the “FHLB”), is required to maintain an investment in capital stock of the FHLB based upon borrowings made from the FHLB and based upon various classes of loans in the Bank’s portfolio. FHLB and Federal Reserve Bank stock do not have readily determinable fair values as ownership is restricted and it lacks a market. As a result, these stocks are carried at cost and evaluated periodically by management for impairment.
The Company’s investment in the unconsolidated trusts is also reported as an investment in this line of the balance sheet. Also included is the Bank’s investment in certain venture capital funds. In addition, the Bank has other non-marketable investments that are carried at cost and evaluated periodically by management for impairment. Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed rate investments, from rising interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other than temporary based upon the evidence available. Evidence evaluated includes (if applicable), but is not limited to, industry analyst reports, credit market conditions, and interest rate trends. If negative evidence outweighs positive evidence that the carrying amount is recoverable within a reasonable period of time, the impairment is deemed to be other-than-temporary and the security is written down in the period in which such determination is made.
Loans held for sale: Loans held for sale are those loans the Company intends to sell. They are carried at the lower of aggregate cost or market value. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds plus the value of the mortgage servicing rights compared to the carrying value of the loans. These are generally sold within 30 to 60 days of origination.
Loans: Loans are stated at the amount of unpaid principal reduced by the allowance for loan losses and unearned income.
Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan’s yield. The Company is amortizing these amounts over the estimated life of the loan. Commitment fees based upon a percentage of a customer’s unused line of credit and fees related to standby letters of credit are recognized over the commitment period. Net deferred fees on real estate loans sold in the secondary market reduce the cost basis in such loans.
Interest on loans is accrued and reported as income using the interest method on daily principal balances outstanding. The Bank generally discontinues accruing interest on loans when the loan becomes 90 days or more past due or when management believes that the borrower’s financial condition is such that collection of interest is doubtful. Cash collections on nonaccrual loans are credited to the loan balance, and no interest income is recognized on those loans until the principal balance has been determined to be collectible.
Loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectability of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable losses on existing loans, based on an evaluation of the collectability of loans in the portfolio and prior loss experience. The allowance for loan losses is based on management’s evaluation of the loan portfolio giving consideration to the nature and volume of the loan portfolio, the value of underlying collateral, overall portfolio quality, review of specific problem loans, and prevailing economic conditions that may affect the borrower’s ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the subsidiary Bank’s allowance for loan losses, and may require the subsidiary bank to recognize additions to its allowance based on their judgments of information available to them at the time of their examinations.
Premises and equipment: Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization is computed by the straight-line method for buildings and computer equipment over their estimated useful lives. Leasehold improvements are amortized over the term of the related lease or the estimated useful lives of the improvements, whichever is shorter. For owned and capitalized assets, estimated useful lives range from three to 39 years. Maintenance and repairs are charged to expense as incurred, while major improvements are capitalized and amortized to operating expense over their identified useful life. Generally, the useful life on software is three years; on computer and office equipment, five years; on furniture, 10 years; and on building and building improvements, 10 to 39 years.
Other real estate owned (“OREO”): OREO includes real estate assets that have been received in full or partial satisfaction of debt. OREO is initially recorded and subsequently carried at the lower of cost or fair value less estimated selling costs. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sale are included in other non-interest income. Operating results from OREO are recorded in other non-interest expense.
Mortgage servicing rights: The Bank recognizes, as separate assets, rights to service mortgage loans for others, whether the rights are acquired through purchase or after origination and sale of mortgage loans. In cases where the mortgage loan is originated and sold, the total cost of the mortgage loan is allocated to the mortgage servicing right and to the loan based on their relative fair values.
The carrying amount of mortgage servicing rights, and the amortization thereon, is periodically evaluated in relation to estimated fair value. The Bank stratifies the underlying mortgage loan portfolio by certain risk characteristics, such as loan type, interest rate and maturity, for purposes of measuring impairment. The Bank estimates the fair value of each stratum by calculating the discounted present value of future net servicing income based on management’s best estimate of remaining loan lives. The Bank has determined that the primary risk characteristic of the mortgage servicing rights is the contractual interest rate of the underlying mortgage loans.
The carrying value of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues.
Earnings per common share: Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share were determined assuming that all stock options were exercised at the beginning of the years presented. Unearned shares owned by the Employee Stock Ownership Plan (ESOP) are treated as not outstanding for the purposes of computing basic earnings per common share.
Average number of shares used in calculation of earnings per common share and diluted earnings per common share are as follows:
Comprehensive income: Comprehensive income includes net income, as well as the change in net unrealized gain on investment securities available for sale, net of tax. Comprehensive income was $13.6 million, $10.4 million and $11.9 million for 2007, 2006 and 2005.
Segment reporting: The Company is managed as one unit and does not have separate operating segments. The Company’s chief operating decision-makers use consolidated results to make operating and strategic decisions.
Transfers of financial assets: Transfers of financial assets are accounted for as sales only when the control over the financial assets has been surrendered. Control over transferred assets is deemed surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Impairment of long-lived assets: Management periodically reviews the carrying value of its long-lived assets to determine if an impairment has occurred or whether changes in circumstances have occurred that would require a revision to the remaining useful life. In making such determination, management evaluates the performance, on an undiscounted basis, of the underlying operations or assets which give rise to such amount.
Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Stock-based compensation: The Company’s 1998 Stock Option Plan (“1998 Plan”) and Trinity Capital Corporation 2005 Stock Incentive Plan (“2005 Plan”) were created for the benefit of key management and select employees. Under the 1998 Plan, 400,000 shares (as adjusted for the stock split of December 19, 2002) from shares held in treasury or authorized but unissued common stock are reserved for granting options. Under the 2005 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock are reserved for granting stock-based incentive awards. Both of these plans were approved by the Company’s shareholders. The Board of Directors determines vesting and pricing of the awards. All stock options granted through December 31, 2005 were granted at or above the market value of the stock at the date of the grant, with the exception of the July 1998 stock option grant which was granted at $0.25 below the last reported sale price on the date of grant. All stock options vest in equal amounts over a three year period and must be exercised within ten years of the date of grant. Stock appreciation rights granted after December 31, 2005 were also granted at or above the market value of the stock at the date of the grant, with the exception of the January 1, 2006 stock appreciation right grants which were approved on December 15, 2005 and granted at the December 31, 2005 closing price to take advantage of accounting changes favorable to Trinity; and mature at five years.
Recent accounting pronouncements:
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application was encouraged, provided that the reporting entity had not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. There was no material impact on the Company’s financial statements when this standard was adopted on January 1, 2008.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities at fair value. The Standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of a company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which a company has chosen to use fair value on the face of the balance sheet. The new Statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in FASB Statements No. 157, Fair Value Measurements, and No. 107, Disclosures about Fair Value of Financial Instruments. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption was permitted as of the beginning of the previous fiscal year provided that the entity made that choice in the first 120 days of that fiscal year and also elects to apply the provisions of FASB Statement No. 157. There was no material impact on the Company’s financial statements when this standard was adopted on January 1, 2008.
On January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accrual for tax liabilities are adequate for the open years based on an assessment of many factors including past experience and interpretations of tax law. The Company had no unrecognized tax benefits which would require an adjustment to the January 1, 2007 beginning balance of retained earnings. The Company had a net deferred tax liability of $92 thousand and a net deferred tax asset of $1.1 million as of January 1, 2007 and December 31, 2007, respectively.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, and No. 160, Noncontrolling Interests in Consolidated Financial Statements. Effective for fiscal years beginning after December 15, 2008, the standards will improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. Statement 141(R) improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this goal, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Statement 141(R) also will reduce the complexity of existing GAAP. The newly issued standard includes both core principles and pertinent application guidance, eliminating the need for numerous EITF issues and other interpretative guidance. Statement 160 improves the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way-as equity in the consolidated financial statements. Moreover, Statement 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. The Company believes that adoption of these new standards On January 1, 2009 will not have a material effect on these financial statements.
Trust Assets: Assets held by the Bank in fiduciary or agency capacities for its customers are not included in the accompanying consolidated balance sheets as such items are not assets of the Bank.
Reclassifications: Certain prior year amounts have been reclassified to conform to the current year’s presentation.
Note 2. Restrictions on Cash and Due From Banks
The Bank is required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The total of those reserve balances was approximately $1.3 million and $2.6 million at December 31, 2007 and 2006.
The Company maintains some of its cash in bank deposit accounts at financial institutions other than its subsidiaries that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.
Note 3. Investment Securities
Carrying amounts and fair values of investment securities are summarized as follows:
Realized net gains on sale of securities available for sale are summarized as follows:
A summary of unrealized loss information for investment securities, categorized by security type, at December 31, 2007 and 2006 is as follows:
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(1)
$1 thousand of the total unrealized losses twelve months or longer as of December 31, 2007 relates to unrealized losses on U.S. government sponsored agencies with an S&P quality rating of AAA. The Company has the ability to hold these securities until they mature. The remaining $13 thousand of unrealized losses twelve months or longer as of December 31, 2007 relates to unrealized losses on state, county and municipal securities with Moody ratings of Aaa to Aa3. The Company has the ability to hold these securities until they mature.
(2)
$221 thousand of the total unrealized losses twelve months or longer as of December 31, 2006 relates to unrealized losses on U.S. government sponsored agencies with an S&P quality rating of AAA. The Company has the ability to hold these securities until they mature. The remaining $23 thousand of unrealized losses twelve months or longer as of December 31, 2006 relates to unrealized losses on state, county and municipal securities with Moody ratings of Aaa to Aa3. The Company has the ability to hold these securities until they mature.
The amortized cost and fair value of investment securities as of December 31, 2007 by contractual maturity are shown below.
Maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Securities with carrying amounts of $21.1 million and $20.7 million at December 31, 2007 and 2006, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
Note 4. Loans
Loans consisted of:
Loans are made to individuals as well as commercial and tax exempt entities. Specific loan terms vary as to interest rate, repayment and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated, in that the majority of loan customers are located in the markets serviced by the Bank.
Non-performing loans as of December 31, 2007, 2006 and 2005 were as follows:
The reduction in interest income associated with loans on non-accrual status was $882 thousand, $734 thousand and $198 thousand for the years ended December 31, 2007, 2006 and 2005
Information about impaired loans as of and for the years ended December 31, 2007, 2006 and 2005 is as follows:
Activity in the allowance for loan losses was as follows:
Loans outstanding to executive officers and directors of the Company, including companies in which they have management control or beneficial ownership, at December 31, 2007 and 2006, were approximately $2.8 million and $2.2 million. In the opinion of management, these loans have similar terms to other customer loans. An analysis of the activity related to these loans for the years ended December 31, 2007 and 2006 is as follows:
Note 5. Loan Servicing and Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balance of these loans as of December 31, 2007 and 2006, is summarized as follows:
Custodial balances on deposit at the Bank in connection with the foregoing loan servicing were approximately $4.5 million and $4.7 million as of December 31, 2007 and 2006. There were no custodial balances on deposit with other financial institutions during 2007 and 2006.
An analysis of changes in mortgage servicing rights asset follows:
Below is an analysis of changes in the mortgage servicing right asset valuation allowance:
The fair values of the MSRs were $8.5 million, $9.5 million and $10.5 million on December 31, 2007, 2006 and 2005, respectively.
The primary risk characteristics of the underlying loans used to stratify the servicing assets for the purposes of measuring impairment are interest rate and original term.
Our valuation allowance is used to recognize impairments of our MSRs. An MSR is considered impaired when the market value of the MSR is below the amortized book value of the MSR. The MSRs are accounted by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches. Each tranche is evaluated separately for impairment.
Our MSRs are analyzed for impairment on a monthly basis. The underlying loans on all serviced loans are analyzed and, based upon the value of MSRs that are traded on the open market, a current market value for each risk tranche in our portfolio is assigned. We then compare that market value to the current amortized book value for each tranche. The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to income.
The following assumptions were used to calculate the market value of the MSRs as of December 31, 2007, 2006 and 2005:
Note 6. Premises and Equipment
Premises and equipment consisted of:
Depreciation on premises and equipment totaled $2.3 million, $2.4 million and $2.6 million for the years ended December 31, 2007, 2006 and 2005.
Note 7. Deposits
Deposits consisted of:
At December 31, 2007, the scheduled maturities of time certificates were as follows:
The Company had no brokered deposits at December 31, 2007 or 2006.
Note 8. Short- and Long-term Borrowings, including Borrowings made by Employee Stock Ownership Plan (ESOP)
Notes payable to the Federal Home Loan Bank (FHLB) at December 31, 2007 and 2006 were secured by a blanket assignment of mortgage loans or other collateral acceptable to FHLB, and generally had a fixed rate of interest, interest payable monthly and principal due at end of term, unless otherwise noted. The total value of loans under the blanket assignment as of December 31, 2007 was $431.1 million.
The following is a summary of debt payments required for years after 2007. Included in 2008 is the final payment for the ESOP debt of $271 thousand:
Note 9. Junior Subordinated Debt Owed to Unconsolidated Trusts
The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of December 31, 2007:
On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above. These securities represent preferred beneficial interests in the assets of the Trusts. The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of the Company at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment. The Trusts also issued common equity securities to Trinity in the amounts indicated above. The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the “debentures”) issued by the Company, which have terms substantially similar to the trust preferred securities. The Company has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each interest payment deferred. Under the terms of the debentures, under certain circumstances of default or if the Company has elected to defer interest on the debentures, the Company may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock. The Company used the majority of the proceeds from the sale of the debentures to add to Tier 1 or Tier 2 capital in order to support its growth and to purchase treasury stock.
Trinity owns all of the outstanding common securities of the Trusts. The Trusts are considered variable interest entities (VIEs) under Financial Accounting Standards Board Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”, as revised. Prior to FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. Under FIN 46, a VIE should be consolidated by its primary beneficiary. The Company implemented FIN 46 during the fourth quarter of 2003. Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are no longer included in the consolidated financial statements of the Company. The Company’s prior financial statements have been reclassified to de-consolidate the Company’s investment in the Trusts.
In March 2005, the Board of Governors of the Federal Reserve System issued a final rule allowing bank holding companies to continue to include qualifying trust preferred securities in their Tier 1 Capital for regulatory capital purposes, subject to a 25% limitation to all core (Tier I) capital elements, net of goodwill less any associated deferred tax liability. The final rule provides a five-year transition period, ending March 31, 2009, for application of the aforementioned quantitative limitation. As of December 31, 2007, 81.5% of the trust preferred securities noted in the table above qualified as Tier I capital and 18.5% qualified as Tier 2 capital under the final rule adopted in March 2005.
Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by the Company on a limited basis. The Company also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities. The obligations of the Company under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the trust preferred securities.
On December 8, 2006, the Company exercised its option to call a Trust Preferred Security issue for $6.0 million that was issued originally on November 28, 2001 at a rate of 9.95%. The interest expense and issuance cost amortization during 2006 reflected this issue that is not presented in the table above.
Issuance costs of $615 thousand related to the first two trust preferred securities issues and the issue paid off during 2006 (not presented in the above table) were deferred and are being amortized over the period until mandatory redemption of the securities in March 2030 and September 2034, respectively. During each 2007, 2006 and 2005, respectively, $14 thousand, $194 thousand and $20 thousand of these issuance costs were amortized. The total amount of the issuance costs of the issue paid off in 2006 was amortized during that year. Unamortized issuance costs were $311 thousand, $325 thousand and $519 thousand at December 31, 2007, 2006 and 2005, respectively. There were no issuance costs associated with the other trust preferred security issues.
Dividends accrued and unpaid to securities holders totaled $498 thousand and $488 thousand on December 31, 2007 and 2006, respectively.
Note 10. Description of Leasing Arrangements
The Company is leasing land in Santa Fe with the intention of building an office on the site during 2008. The lease, has an 8 year term and expires in 2014, contains an option to purchase the land at a set price at the termination of the initial term of the lease. This lease is classified as a capital lease. In addition, the Company leases certain equipment, ATM location space, office space and storage space from other parties under operating leases expiring through 2010. Lease payments for the years ended December 31, 2007, 2006 and 2005 totaled $361 thousand, $289 thousand and $112 thousand, respectively.
The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2007:
Commitments for minimum future rentals under the operating leases were as follows at December 31, 2007:
Note 11. Retirement Plans
The Company has a qualified Employee Stock Ownership Plan (“ESOP”) for the benefit of all employees who are at least 18 years of age and have completed 1,000 hours of service during the Plan year. The employee’s interest in the ESOP vests over a period of seven years but will be reduced to a period of six years to comply with the requirements of the Pension Protection Act of 2006. The ESOP was established in January 1989 and is a defined contribution plan subject to the requirements of the Employee Retirement Income Security Act of 1974.
The ESOP provides for annual discretionary contributions by the Company as determined by its Board of Directors. The Company’s discretionary contributions to the ESOP in 2007, 2006 and 2005 were approximately $483 thousand, $512 thousand and $462 thousand, respectively.
The ESOP had a note payable of $271 thousand outstanding with a local bank as of December 31, 2007. The note requires annual principal payments of $471 thousand with a final payment of principal on January 20, 2008. Interest is variable at Citibank Prime (7.25% at December 31, 2007) and is payable semi-annually. Collateral for this loan is Company stock owned by the ESOP and unallocated to the plan participants. Shares are released from collateral based upon the ratio of principal and interest paid during the year to total principal and interest paid for the current year and payable for all future plan years. Allocations of common stock released and forfeitures are based on the eligible base salary compensation of each participant. The note payable is recorded as debt and the shares pledged as collateral netted against stock owned by ESOP participants in the accompanying balance sheets. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.
All shares held by the ESOP, which were acquired prior to the issuance of AICPA Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans (SOP 93-6), are included in the computation of average common shares and common share equivalents. This accounting treatment is grandfathered under SOP 93-6 for shares purchased prior to December 31, 1992. As permitted by SOP 93-6, compensation expense for shares released is equal to the original acquisition cost of the shares if they were acquired prior to December 31, 1992. As shares acquired after SOP 93-6 are released from collateral, the Company reports compensation expense equal to the current fair value of the shares, and the shares become outstanding for earnings-per-share computations.
Shares of the Company held by the ESOP that were acquired prior to December 31, 1992 totaled 257,182 and 265,201 shares at December 31, 2007 and 2006, respectively.
Shares of the Company held by the ESOP that were acquired after December 31, 1992 are as follows:
There was no compensation expense recognized for ESOP shares acquired prior to December 31, 1992 during the years 2007, 2006 and 2005. Compensation expense recognized for ESOP shares acquired after December 31, 1992 during 2007, 2006 and 2005 was $666 thousand, $731 thousand and $683 thousand, respectively.
Under federal income tax regulations, the employer securities that are held by the Plan and its participants and that are not readily tradable on an established market or that are subject to trading limitations include a put option (liquidity put). The liquidity put is a right to demand that the Company buy shares of its stock held by the participant for which there is no readily available market. The put price is representative of the fair value of the stock. The Company may pay the purchase price over a five-year period. The purpose of the liquidity put is to ensure that the participant has the ability to ultimately obtain cash. The fair value of the allocated shares subject to repurchase was $16.4 million and $16.8 million as of December 31, 2007 and 2006.
The Company’s employees may also participate in a tax-deferred savings plan (401(k)) to which the Company does not contribute.
Note 12. Stock Incentives
The Company’s 1998 Stock Option Plan (“1998 Plan”) and Trinity Capital Corporation 2005 Stock Incentive Plan (“2005 Plan”) were created for the benefit of key management and select employees. Under the 1998 Plan, 400,000 shares (as adjusted for the stock split of December 19, 2002) from shares held in treasury or authorized but unissued common stock are reserved for granting options. Under the 2005 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock are reserved for granting stock-based incentive awards. Both of these plans were approved by the Company’s shareholders. The Board of Directors determines vesting and pricing of the awards. All stock options granted through December 31, 2005 were granted at or above the market value of the stock at the date of the grant, with the exception of the July 1998 stock option grant which was granted at $0.25 below the last reported sale price on the date of grant. All stock options vest in equal amounts over a three year period and must be exercised within ten years of the date of grant. Stock appreciation rights granted after December 31, 2005 were also granted at or above the market value of the stock at the date of the grant, with the exception of the January 1, 2006 stock appreciation right grants which were approved on December 15, 2005 and granted at the December 31, 2005 closing price to take advantage of accounting changes favorable to Trinity; and mature at five years.
Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payment, which is an Amendment of FASB Statement Nos. 123 and 95. The Company adopted this standard using the modified prospective transition method. Prior to the adoption of SFAS 123(R), the Company measured stock-based compensation cost in accordance with the methods prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation cost was recognized for options granted and vested before January 1, 2006.
Under the provisions of SFAS 123(R), the Company is required to recognize compensation expense for share-based compensation that vest after adoption of the new standard. The Company uses the Black-Scholes model to value the stock options and stock appreciation rights on the date of the grant, and recognizes this expense over the remaining vesting term for the stock options or stock appreciation rights. Key assumptions used in this valuation method (detailed below) are the volatility of the Company’s stock price, a risk-free rate of return (using the U.S. Treasury yield curve) based on the expected term from grant date to exercise date and an annual dividend rate based upon the current market price. Expected term from grant date is based upon the historical time from grant to exercise experienced by the Company. Because share-based compensation vesting in the current periods was granted on a variety of dates, the assumptions are presented as weighted averages in those assumptions.
The following table details the assumptions used in the Black-Scholes model for share-based compensation granted:
A summary of stock option and stock appreciation right activity under the 1998 Plan and the 2005 Plan as of December 31, 2007, and changes during the year is presented below:
The weighted-average grant date fair value of stock incentives granted during 2007, 2006 and 2005 was $3.74, $4.33 and $5.22, respectively. The total intrinsic value of options exercised during 2007, 2006 and 2005 was $64 thousand, $168 thousand and $56 thousand.
As of December 31, 2007, there was $624 thousand of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 1998 Plan and the 2005 Plan. That cost is expected to be recognized over a weighted-average vesting period of 3.6 years. There were 69,997 shares vested during 2007. The total amount expensed of the shares that vested is $238 thousand in 2007.
The following pro forma information presents net income and earnings per share had the fair value method of SFAS No. 123 been used to measure compensation cost for stock option plans in 2005
Note 13. Income Taxes
The current and deferred components of the provision for Federal income tax expense for the years 2007, 2006 and 2005 are as follows:
A deferred tax asset or liability is recognized to reflect the net tax effects of temporary differences between the carrying amounts of existing assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant temporary differences that gave rise to the deferred tax assets and liabilities as of December 31, 2007 and 2006 were as follows:
The net deferred tax asset of $1.1 million and deferred tax liability of $92 thousand in 2007 and 2006, respectively, was reported in other liabilities.
Items causing differences between the statutory tax rate and the effective tax rate are summarized as follows:
Note 14. Commitments, Contingencies and Off-Balance Sheet Activities
Credit-related financial instruments: The Company is a party to credit-related commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These credit-related commitments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such credit-related commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these credit-related commitments. The Company follows the same credit policies in making credit-related commitments as it does for on-balance-sheet instruments.
At December 31, 2007 and 2006, the following credit-related commitments were outstanding whose contract amounts represent credit risk:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. Overdraft protection agreements are uncollateralized, but most other unfunded commitments have collateral. These unfunded lines of credit usually do not contain a specified maturity date and may not necessarily be drawn upon to the total extent to which the Company is committed.
Outstanding Letters of Credit: In addition to short and long term borrowings from the Federal Home Loan Bank (FHLB), the FHLB has issued letters of credit to various public entities with deposits at the Bank. These letters of credit are issued to collateralize the deposits of these entities at the Bank as required or allowed under law. The total value of these letters of credit was $129.7 million and $128.1 million as of December 31, 2007 and December 31, 2006, respectively. As of December 31, 2007, all letters of credit had original terms of one year. These letters are secured under the blanket assignment of mortgage loans or other collateral acceptable to the FHLB that also secures our short and long term borrowings from FHLB.
Commercial and standby letters of credit are conditional credit-related commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers. The Company generally holds collateral supporting those credit-related commitments, if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the credit-related commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the summary above. If the credit-related commitment is funded, the Company would be entitled to seek recovery from the customer. At December 31, 2007 and 2006, no amounts have been recorded as liabilities for the Company’s potential obligations under these credit-related commitments. The fair value of these credit-related commitments is approximately equal to the fees collected when granting these letters of credit. These fees collected were $26 thousand and $66 thousand as of December 31, 2007 and 2006, respectively, and are included in “other liabilities” on the Company’s balance sheet.
Concentrations of credit risk: The majority of the loans, commitments to extend credit, and standby letters of credit have been granted to customers in Los Alamos, Santa Fe and surrounding communities. Although the Company has a diversified loan portfolio, a substantial portion of its loans are made to businesses and individuals associated with, or employed by, Los Alamos National Laboratory (“the Laboratory”). The ability of such borrowers to honor their contracts is predominately dependent upon the continued operation and funding of the Laboratory. Investments in securities issued by states and political subdivisions involve governmental entities within the state of New Mexico. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit were granted primarily to commercial borrowers.
Note 15. Litigation
Neither Trinity, the Bank, Title Guaranty, TCC Appraisals, TCC Advisors or TCC Funds are involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business and those otherwise specifically stated herein, which, in the opinion of management, in the aggregate, are not material to our consolidated financial condition.
Note 16. Derivative Financial Instruments
In the normal course of business, the Bank uses a variety of financial instruments to service the financial needs of customers and to reduce its exposure to fluctuations in interest rates. Derivative instruments that the Bank uses as part of its interest rate risk management strategy include mandatory forward delivery commitments and rate lock commitments.
As a result of using over-the-counter derivative instruments, the Bank has potential exposure to credit loss in the event of nonperformance by the counterparties. The Bank manages this credit risk by selecting only well established, financially strong counterparties, spreading the credit risk amongst many such counterparties and by placing contractual limits on the amount of unsecured credit risk from any single counterparty. The Bank’s exposure to credit risk in the event of default by counterparty is the current cost of replacing the contracts net of any available margins retained by the Bank. However, if the borrower defaults on the commitment the Bank requires the borrower to cover these costs.
The Company adopted the provisions of SFAS No. 149 effective July 1, 2003. The Company’s derivative instruments outstanding at December 31, 2007 include commitments to fund loans held for sale. As per Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments, the interest rate lock commitment was valued at zero at inception. The rate locks will continue to be adjusted for changes in value resulting from changes in market interest rates.
The Company originates single-family residential loans for sale pursuant to programs with the Federal National Mortgage Association (“FNMA”). At the time the interest rate is locked in by the borrower, the Company concurrently enters into a forward loan sale agreement with respect to the sale of such loan at a set price in an effort to manage the interest rate risk inherent in the locked loan commitment. Any change in the fair value of the loan commitment after the borrower locks in the interest rate is substantially offset by the corresponding change in the fair value of the forward loan sale agreement related to such loan. The period from the time the borrower locks in the interest rate to the time the Company funds the loan and sells it to FNMA is generally 60 days. The fair value of each instrument will rise or fall in response to changes in market interest rates subsequent to the dates the interest rate locks and forward loan sale agreements are entered into. In the event that interest rates rise after the Company enters into an interest rate lock, the fair value of the loan commitment will decline. However, the fair value of the forward loan sale agreement related to such loan commitment should increase by substantially the same amount, effectively eliminating the Company’s interest rate and price risk.
At December 31, 2007 the Company had notional amounts of $2.0 million contracts with customers and $10.0 million contracts with FNMA in interest rate lock commitments outstanding related to loans being originated for sale. The related fair values of these commitments were an asset of $17 thousand and a liability of $25 thousand as of December 31, 2007.
The Company has outstanding loan commitments, excluding undisbursed portion of loans in process and equity lines of credit, of approximately $164.8 million and $166.1 million as of December 31, 2007 and 2006, respectively. Of these commitments outstanding, the breakdown between fixed and adjustable-rate loans is as follows:
Note 17. Regulatory Matters
The Company’s primary source of cash is dividends from the Bank. The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. Generally, the Company cannot pay dividends that exceed its net income or that can only be funded that weaken its financial health. The Bank cannot pay dividends in any calendar year that, in the aggregate, exceed the Bank’s year-to-date net income plus its retained income for the two proceeding years. Additionally, the Bank cannot pay dividends that are in excess of the amount which would cause the Bank to fall below the minimum required for capital adequacy purposes.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items are calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes the Company and the Bank meet all capital adequacy requirements to which they are subject as of December 31, 2007.
As of December 31, 2007, the Bank was “well capitalized” as defined by OCC regulations. To be categorized as well capitalized the Bank must maintain the total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the well capitalized column in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category subsequent to this time.
The required and actual amounts and ratios for the Company and the Bank are presented below:
_________________________
N/A-not applicable
Note 18. Fair Value Information
Fair values are calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument.
Financial instruments whose carrying value is estimated to be equal to the fair value include: cash and due from banks, interest bearing deposits with banks, accrued interest receivable and payable, loans held for sale, demand deposits, negotiable orders of withdrawal and savings deposits. Management believes that the Company’s demand deposits, negotiable orders of withdrawal and savings deposits provide significant additional value that is not reflected above.
Commitments to extend lines of credit and standby letters of credit have fair values approximately equal to fees generated to extend such commitments and are not material.
Fair value is best determined upon quoted market prices. However, no active market exists for a significant portion of the Company’s financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using the present value of future cash flows, discounted by the current rates offered on financial instruments of a similar nature and term. Financial instruments with variable rates that reprice frequently and have no significant change in credit risk have a fair value equal to carrying value. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Because of the inherent imprecision of estimating fair value discount rates for financial instruments for which no market value exists, management does not believe that the above information reflects the amounts that would be received (including any gains or losses) if assets and liabilities were sold.
Note 19. Condensed Parent Company Financial Information
The condensed financial statements of Trinity Capital Corporation (parent company only) are presented below:
Balance Sheets
Statements of Income
Statements of Cash Flows
Note 20. Income by Quarter (Unaudited)
Presented in the table below is the income of the Company by quarter:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the board of directors and to ensure that information that is required to be disclosed in reports we file with the SEC is properly and timely recorded, processed, summarized and reported. A review and evaluation was performed by our management, including the Company’s Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007 pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon and as of the date of that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures were effective as of December 31, 2007.
Management’s Report on Internal Control Over Financial Reporting
Management’s Report on Internal Control over Financial Reporting appears under Item 8, “Financial Statements and Supplemental Data” on page 47 of this Form 10-K.
Changes in Internal Control over Financial Reporting
There have been no changes to our internal control over financial reporting during the last fiscal quarter that have affected, or are reasonably likely to affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The following information is incorporated herein by reference to Trinity’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2008 under the headings indicated: information with respect to Trinity’s directors, under the heading “Item I - Election of Directors;” information regarding Trinity’s audit committee and its designation of an audit committee financial expert, under the heading “Board of Directors and Corporate Governance - Audit Committee;” information regarding compliance with Section 16(a) of the Securities Exchange Act, under the heading “Section 16(a) Beneficial Ownership Reporting Compliance;” and information regarding Trinity’s executive officers, under the heading “Trinity’s Named Executive Officers.”
Trinity’s Code of Business Conduct and Business Ethics (the “Code”) exemplifies Trinity’s history of requiring adherence to high standards of ethical conduct and business practices. Trinity’s Code is available on Trinity’s website at www.lanb.com/tcc/management.asp. All of Trinity’s employees, officers, including the Chief Executive Officer, the Chief Financial Officer, and all directors are required to fully comply with the Code. If Trinity’s Code is amended or a waiver is granted, such modification or waiver will be posted promptly on the website in accordance with SEC rules.
Item 11.
Item 11. Executive Compensation.
The information regarding executive compensation appears in Trinity’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2008 under the headings “Compensation Discussion and Analysis,” “Executive Compensation” and “Director Compensation” and is incorporated herein by reference; provided, however, that the Compensation Committee Report will not be deemed to be filed with the SEC.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information regarding security ownership of certain beneficial owners and management appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2008 under the heading “Security Ownership of Certain Beneficial Owners, Directors and Management” and is incorporated herein by reference.
Aggregated Equity Plan Information.Our current stock-based benefit plans and arrangements consist of the 1998 Stock Option Plan that was approved by shareholders at the 1998 Annual Meeting and the Trinity Capital Corporation 2005 Stock Incentive Plan that was approved by shareholders at the 2005 Annual Meeting. The following table provides information regarding the plans as of December 31, 2007.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information regarding certain relationships and related transactions appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2008 under the headings “Board of Directors and Corporate Governance - Director Independence” and “Board of Directors and Corporate Governance - Related Party Transactions” and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information regarding the principal accounting fees and services appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2008 under the heading “Item II - Approval of Independent Registered Public Accountants” and is hereby incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
Financial Statements. All financial statements of Trinity are set forth under Item 8 of this Form 10-K.
Exhibits. The following exhibits are filed as part of this Form 10-K:
3.1 (1)
Articles of Incorporation of Trinity Capital Corporation
3.2 (1)
Amended and Restated By-Laws of Trinity Capital Corporation
4.1 (1)
Indenture dated as of March 23, 2000 among Trinity Capital Corporation, Trinity Capital Trust I and The Bank of New York
4.3 (2)
Indenture dated as of May 11, 2004 between Trinity Capital Corporation, Trinity Capital Trust III and Wells Fargo Bank, National Association
4.4 (4)
Indenture dated as of June 29, 2005 between Trinity Capital Corporation, Trinity Capital Trust IV and Wilmington Trust Company
4.5 (5)
Indenture dated as of September 21, 2006 between Trinity Capital Corporation, Trinity Capital Trust V and Wilmington Trust Company.
10.1 (1)
Los Alamos National Bank Employee Stock Ownership Plan
10.2 (1)
Trinity Capital Corporation 1998 Stock Option Plan
10.3 (1)
Promissory Note dated July 16, 2001, in the original principal amount of $3,300,075, made to the benefit of Valley National Bank, located in Espanola, New Mexico
10.4 (2)
Form of stock option grant agreement
10.5 (3)
Trinity Capital Corporation 2005 Stock Incentive Plan
10.6 (3)
Trinity Capital Corporation 2005 Deferred Income Plan
10.7 (6)
Director fee schedule
10.8 (2)
Form of stock appreciation right grant agreement
10.9
Employment Agreement dated January 16, 2007 between Trinity Capital Corporation, Los Alamos National Bank and William C. Enloe
10.10
Employment Agreement dated January 16, 2007 between Trinity Capital Corporation, Los Alamos National Bank and Steve W. Wells
10.11
Amendment to Employment Agreement dated January 16, 2007 between Trinity Capital Corporation, Los Alamos National Bank and William C. Enloe dated March 13, 2008.
10.12
Amendment to Employment Agreement dated January 16, 2007 between Trinity Capital Corporation, Los Alamos National Bank and Steve W. Wells dated March 13, 2008.
21.1
Subsidiaries
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
31.2
Certification on Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 (1)
Audit Committee Charter
_________________________
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.