Item 1. General Business
We were incorporated as a Delaware corporation on March 12, 1999, as GIBC, Inc. and changed our name to “Nexity Financial Corporation” on March 26, 1999.
We operate a wholly-owned subsidiary bank, Nexity Bank, which is headquartered in Birmingham, Alabama with additional correspondent banking offices in Atlanta, Georgia; Myrtle Beach and Columbia, South Carolina; Dallas, Texas; Orlando, Florida; Milwaukee, Wisconsin; and Charlotte and Raleigh, North Carolina. We acquired all of the outstanding common stock of Peoples State Bank, Grant, Alabama, on November 1, 1999. On January 5, 2000, we changed the name of Peoples State Bank to Nexity Bank. The branch in Grant continued to operate as a traditional bank under the name “Peoples State Bank” until December 31, 2000, when the assets and liabilities of the Grant Branch were sold.
We compete in two areas of the commercial banking industry: correspondent banking and Internet banking. The correspondent banking business includes providing bank and bank-related services to community banks. Correspondent banking services include loan participations, investment services, and clearing and cash management services. The Internet banking business includes providing consumer and small-business banking services via the Internet without a branch banking network.
At December 31, 2007, we had total consolidated assets of $947.2 million, total consolidated deposits of $709.2 million, and total consolidated stockholders’ equity of $66.5 million.
Banking Operations
Nexity Bank is an Alabama state chartered bank. Its primary regulators are the Federal Deposit Insurance Corporation and the Alabama State Banking Department. We conduct deposit business in all 50 states in the United States and conduct loan business primarily in the southeastern United States and Texas.
On January 5, 2000, we received approval from the FDIC to initiate Internet banking operations. On February 22, 2000, these operations began from our office in Birmingham, Alabama.
Correspondent Banking
We provide correspondent banking services to community banks primarily in the southeastern United States and Texas. These services include loan participations, investment services, and clearing and cash management services.
We generate approximately 75% of our loan production through loan participations, bank stock loans, bank holding company loans, and loans to banks in organization with community banks. Loan participations are loans purchased from community banks because the community bank could not make the loan on its own. The primary reasons that a community bank sells loan participations are because the loan exceeds the bank’s legal lending limit, it wishes to manage liquidity, or for other special needs. Our correspondent lenders focus primarily on small and medium-sized banks in Alabama, Florida, Georgia, North Carolina, South Carolina, and Texas. Our lenders have a high level of experience purchasing and selling loans with community banks and analyzing the different types of loans in these market areas.
The loans generated through community bank loan participations are typically real estate construction loans, commercial real estate loans, and loans secured by common stock of community banks. Construction and commercial real estate loans typically exceed the community bank’s legal lending limit, and the size of the loan participation is usually between $1 million and $5 million. We underwrite each loan participation purchased using standard underwriting policies and procedures. These loans are geographically dispersed through our market areas, resulting in no significant concentration in one small geographic region or state. We manage our risk by making loans on owner-occupied or income producing properties and by requiring collateral values that exceed the loan amount, adequate cash flow to service the debt, and in most cases, the personal guarantees of principals of the borrowers.
We provide investment services to community banks including fixed income securities sales, investment portfolio management services, including bond accounting and safekeeping, and asset/liability management services. Our investment sales team markets primarily U.S. Treasury and Agency securities, including mortgage-backed securities products and municipal securities. Investment representatives also provide portfolio management strategies to community banks. We also offer bond portfolio accounting and safekeeping services, as well as asset/liability management services. Our primary asset/liability management services are interest-rate risk modeling and consulting on strategies for effective balance sheet management.
Our clearing and cash management services allow community banks to outsource their daily funds management. We will automatically invest or borrow federal funds through an account that is linked to their accounts with the Federal Reserve Bank. Community banks can access their intra-day account information via the Internet. The online system allows them to perform wire transfers, ACH transactions, currency and coin orders, and other important banking operations. This system also allows access to critical loan participation accounting information and bond accounting and safekeeping reports.
Internet Banking
We provide deposit products and services to consumers and small businesses via the Internet. The Internet provides an efficient distribution channel for serving deposit customers across the United States. We use the Internet to provide advantages to customers desiring to purchase financial products with typically more attractive rates than are available through traditional banking channels, together with easy access to account and product information. Customers may access Nexity Bank on a 24/7 basis through any Internet service provider by means of an acceptable secure Web browser or by telephone or U.S. mail. Customers can access funds using ATM or debit cards. Customers may review account activity, enter transactions into an on-line account register, pay bills electronically and print bank statement reports, all on a real-time basis.
We also market home equity loan products to consumers through the Internet. Home equity loan products account for approximately 5.6% of loans outstanding. We use credit scoring systems in the underwriting process as well as external service providers for loan documentation and closing processes.
Nexity Investments, Inc.
During 2006, Nexity Bank established Nexity Investments, Inc. to provide investment portfolio management services.
Nexity Financial Services, Inc.
During 2002, Nexity Bank established Nexity Financial Services, Inc. to offer fixed annuity insurance products to consumers in the states of Alabama, Florida, Georgia, South Carolina, North Carolina, New York, Illinois, California and Tennessee. Nexity Financial Services of Florida, Inc. and Nexity Financial Services of New York, Inc. were also formed to offer these products. Nexity Financial Services, Inc. began offering services
to consumers in June 2003. After interest rates decreased during the latter part of 2003 and several insurance company providers reduced their efforts in the product, Nexity Financial Services, Inc. staff were re-assigned within the company with one staff member maintaining the licenses and maintaining the minimal number of existing accounts.
In 2007, Nexity Financial Services, Inc. was restructured from a subsidiary of Nexity Bank to a subsidiary of Nexity Financial Corporation. Nexity Financial Services received approval from the Financial Industry Regulatory Authority (FINRA) in September, as a full service securities broker dealer. From its headquarters in Charlotte, North Carolina, Nexity Financial Services assists community banks in designing and operating Wealth Management services to meet the financial needs of individuals and businesses within their respective communities. NFS combines the expertise of a firm dedicated to community banks, with the same extensive products and services already available from the nation’s largest brokerage firms and banks. From recruiting and staffing, to private labeling and compliance oversight, Nexity assists institutions in building successful, profitable investment programs.
Competition
All aspects of our business are highly competitive. Generally, we compete with other financial institutions including large banks in major financial centers and other financial intermediaries, such as savings and loan associations, credit unions, consumer finance companies, investment companies, mutual funds, other mortgage companies and financial service operations of major commercial and retail corporations. Competition among financial institutions is based on a variety of factors including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of service rendered, and the convenience of service delivery. We compete in two areas of the commercial banking industry: correspondent banking and Internet banking.
Correspondent Banking
Bankers’ banks have a special banking charter and compete with us on loan participations, investment services, and clearing and cash management services. They typically fund their balance sheet primarily with overnight federal funds purchased from community banks daily. Silverton Bank in Atlanta, Georgia is our primary competitor in correspondent banking and has total assets of approximately $2.4 billion. We compete with it in virtually the same geographic market with similar products and services. Regional banks in our geographical area provide correspondent banking services as well, but these banks offer correspondent services that are typically ancillary to the traditional banking activities they conduct. We attempt to distinguish our services by concentrating our efforts on start-up banks and small to medium-sized community banks and compete in this market segment by offering responsive, high-quality service.
Internet Banking
There are two primary groups that provide competition for Internet banking services: financial institutions that market products and services via the Internet, and financial institutions that only offer products and services via the Internet to their existing customer base. Because Internet banking is a process that tends to draw deposits nationally based upon attractive deposit rates (as is the case with us), the Internet banking competitive landscape is fragmented, and we do not believe any one competitor or group of competitors has a dominant market share.
Financial institutions typically offer similar deposit products and services as those we provide utilizing the Internet. These services are primarily marketed through websites such as bankrate.com. Countrywide Bank, Corus Bank, Giantbank.com, GMAC Bank, and E*Trade Bank, are some of the institutions that compete with us on bankrate.com. Some financial institutions (including large money center banks) also market their products and services through this channel. These institutions are our primary competition, given that the second group’s strategy is more defensive in nature. We concentrate our Internet banking efforts on money market accounts, short-term certificates of deposit, and home equity lines of credit and compete in this market segment by offering responsive, high-quality service with user-friendly technology and competitive pricing.
Nexity Bank advertises nationally primarily online on bankrate.com, bankrate monitor and through online search key words. Our competitors include money center banks and other competitors who are larger than us which have greater resources. We believe we have competed effectively in the Internet market even with our larger competitors. Our funding strategy has effectively provided adequate funding of our balance sheet growth to date. The attractive rates we offer with the Internet deposits are supported by a seven-day a week customer service call center which assists new and existing customers with questions, concerns and inquiries. We believe seven-day a week call center support enhances customer loyalty in an online environment of not meeting face to face with the customer base.
Our business model allows us to offer products and services within both the correspondent and Internet banking areas in a branchless banking structure. The branchless banking structure reduces our required investment in physical assets and employees. The competitors described above typically compete with us in either correspondent or Internet banking.
Employees
At December 31, 2007, we employed 117 full-time equivalent employees, 73 of which are located in Birmingham, Alabama. We provide a variety of benefit programs including a retirement plan as well as health, life, disability, and other insurance. We also maintain training, educational, and affirmative action programs designed to prepare employees for positions of increasing responsibility.
Impact of Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.
Supervision And Regulation
Nexity Financial Corporation is a bank holding company and financial holding company, registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended (“BHC Act”). As such, we and our subsidiaries are subject to the supervision, examination, and reporting requirements of the BHC Act and the regulations of the Federal Reserve.
Acquisition of Banks
The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:
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Acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
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Acquiring all or substantially all of the assets of any bank; or
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Merging or consolidating with any other bank holding company.
Additionally, the BHC Act provides that the Federal Reserve may not approve any of these transactions if it would substantially lessen competition or otherwise function as a restraint of trade, or result in or tend to create a monopoly, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public
interest in meeting the convenience and needs of the communities to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the communities to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Change in Bank Control
Subject to various exceptions, the BHC Act and the federal Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
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The bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or
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No other person owns a greater percentage of that class of voting securities immediately after the transaction.
Our common stock is registered under the Securities Exchange Act of 1934. The regulations provide a procedure for challenge of the rebuttable control presumption.
Permitted Activities
The Gramm-Leach-Bliley Act of 1999 amends the BHC Act and expands the activities in which bank holding companies and affiliates of banks are permitted to engage. The Gramm-Leach-Bliley Act eliminates many federal and state law barriers to affiliations among banks and securities firms, insurance companies, and other financial service providers. Because we have qualified for and have elected to become a financial holding company, as described below, we may engage in activities that are:
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Financial in nature;
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Incidental to a financial activity; or
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Complementary to a financial activity and do not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.
The Gramm-Leach-Bliley Act expressly lists the following activities as financial in nature:
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Lending, trust and other banking activities;
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Insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;
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Providing financial, investment, or advisory services;
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Issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;
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Underwriting, dealing in or making a market in securities;
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Activities that the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be a proper incident to banking or managing or controlling banks;
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Activities permitted outside of the United States that the Federal Reserve has determined to be usual in connection with banking or other financial operations abroad;
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Merchant banking through securities or insurance affiliates; and
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Insurance company portfolio investments.
The Gramm-Leach-Bliley Act also authorizes the Federal Reserve, in consultation with the Secretary of the Treasury, to determine activities in addition to those listed above that are financial in nature or incidental to such financial activity. In determining whether a particular activity is financial in nature or incidental or complementary to a financial activity, the Federal Reserve must consider (1) the purpose of the BHC Act and Gramm-Leach-Bliley Act, (2) changes or reasonably expected changes in the marketplace in which financial holding companies compete and in the technology for delivering financial services, and (3) whether the activity is necessary or appropriate to allow financial holding companies to effectively compete with other financial service providers and to efficiently deliver information and services.
To qualify to become a financial holding company, each of our depository institution subsidiaries must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, we must file an election with the Federal Reserve to become a financial holding company and provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. We filed an election, which became effective March 5, 2007 to become a financial holding company.
Under the BHC Act, a bank holding company, which has not qualified or elected to become a financial holding company, is generally prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking activities unless, prior to the enactment of the Gramm-Leach-Bliley Act, the Federal Reserve had found those activities to be so closely related to banking as to be a proper incident to the business of banking. Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
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Acquiring or servicing loans;
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Leasing personal property;
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Conducting discount securities brokerage activities;
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Performing selected data processing services;
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Acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
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Performing selected insurance underwriting activities.
Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of any of its bank subsidiaries.
FDIC Insurance
The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described below, with the “undercapitalized” category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institution’s primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Capital Adequacy
Both Nexity Financial Corporation and Nexity Bank are required to comply with the capital adequacy standards established by the Federal Reserve Bank, the FDIC and the State Banking Department of Alabama. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. Nexity Bank is also subject to risk-based and leverage capital requirements adopted by the State Banking Department of Alabama and the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 capital and Tier 2 capital. Tier 1 capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 capital must equal at least 4% of risk- weighted assets. Tier 2 capital generally consists of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The total amount of Tier 2 capital is limited to 100% of Tier 1 capital.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. The guidelines also provide that bank holding companies experiencing high internal growth, as is our case, or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels. Furthermore, the Federal Reserve has indicated that it will consider a bank holding company’s Tier 1 capital leverage ratio, after deducting all intangibles, and other indicators of capital strength in evaluating proposals for expansion or new activities.
For further information concerning our regulatory ratios at December 31, 2007, please see Note 19, Regulatory Matters, of our 2007 Consolidated Financial Statements and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Nexity Financial Corporation and Nexity Bank were classified as “well capitalized” at December 31, 2007.
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) into one of which all institutions are placed. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
Restrictions on Transactions with Affiliates
Both Nexity Financial Corporation and Nexity Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
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A bank’s loans or extensions of credit to affiliates;
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A bank’s investment in affiliates;
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Assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
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The amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
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A bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. Nexity Bank must also comply with other provisions designed to avoid the taking of low-quality assets.
Nexity Financial Corporation and Nexity Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Nexity Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal stockholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.
Community Reinvestment
The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the FDIC and/or the Federal Reserve shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on Nexity Bank. Additionally, banks are required to publicly disclose the terms of various Community Reinvestment Act-related agreements. Nexity Bank received a “satisfactory” CRA rating from the FDIC at its last examination.
Privacy
Under the Gramm-Leach-Bliley Act, financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’ own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers. Nexity Bank has established a privacy policy to ensure compliance with federal requirements and is posted on our website, www.nexitybank.com.
Other Consumer Laws and Regulations
Interest and other charges collected or contracted for by Nexity Bank are subject to state usury laws and federal laws concerning interest rates. Nexity Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:
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Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
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Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
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Bank Secrecy Act, governing how banks and other firms report certain currency transactions which may involve “money laundering” activities;
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Soldiers’ and Sailors’ Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service; and
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Rules and regulations of the various federal agencies charged with the responsibility of implementing the federal laws.
Nexity Bank’s deposit operations are subject to the:
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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
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Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Anti-Terrorism Legislation
On October 26, 2001, the President of the United States signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism “USA PATRIOT” Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers.
In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the Gramm-Leach-Bliley Act, as discussed above. Nexity Bank currently has policies and procedures in place designed to comply with the USA PATRIOT Act.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the Federal Reserve’s statutory power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Available Information
We are subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934, and in accordance therewith, file periodic reports, proxy statements, and other information with the SEC. This Annual Report on Form 10-K and exhibits along with such future periodic reports, proxy statements, and other information may be inspected and copied at the public reference facilities maintained by the SEC at its principal offices at 100 F. Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the public reference facilities by contacting the SEC at 1-800-SEC-0330. Copies of such materials may also be obtained at prescribed rates by writing to the SEC. The SEC maintains a website (http://www.sec.gov) that contains registration statements, reports, proxy and information statements and other information regarding registrants that file electronically with the SEC.
We maintain a website at www.nexitybank.com. We will make financial reports available as the reports are filed and distributed to the SEC pursuant to Section 13 (a) of the Exchange Act. These documents will be made available on our website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. You may also request a copy of these filings, at no cost, by writing or telephoning us at the following address:
Nexity Financial Corporation
ATTENTION: Investor Relations
3500 Blue Lake Drive, Suite 330
Birmingham, Alabama
(205) 298-6391
Item 1A.
Item 1A. Risk Factors
Our business, operations, and financial condition are subject to various risks. Some of these risks are described below. This section does not describe all risks that may be applied to our company, our industry, or our business, and it is intended only as a summary of certain material risk factors.
We may experience rapid growth in the future that could strain our limited resources. Our failure to effectively manage such growth could adversely affect our ability to earn profits.
We have several offices located throughout the southeastern United States and Texas that are thinly staffed. In some of these offices, we share administrative support staff with other companies. If we fail to anticipate growth in our lending business or are otherwise unable to provide adequate staffing in any of the markets in which we operate, our credit quality, underwriting functions and risk management could be adversely affected, resulting in a reduced ability to earn profits.
Failure to implement our business strategy or to manage our growth effectively may adversely affect our financial performance.
Our business strategy is dependent upon our ability to offer secure, convenient, cost-effective and comprehensive financial services on the Internet and to community banks throughout the southeastern United States and Texas. The growth and expansion of our business model may place significant demands on our management, operational and financial resources. Successful implementation of our business strategy will require continued growth of the Internet banking market and correspondent services market and will depend on our ability to: (i) implement and grow the earning asset strategy; (ii) develop new strategic alliances for products and services; (iii) increase significantly the number of customers using the Internet for their financial service requirements; (iv) implement and improve the bank’s operational, financial and management information systems; (v) hire and train qualified personnel; and (vi) satisfy regulatory requirements related to our expansion plans.
Our business model contains inherent risk because we rely on third-party information in making lending decisions. If this information is inadequate, we may fail to realize risks in loans that we make, which could adversely affect our credit quality and ability to earn profits.
We are primarily engaged in the business of correspondent banking. We buy loan participations that smaller banks originate and then sell to the secondary market, and we fund loans smaller banks cannot fully fund due to their low lending limits. As part of this process, we often rely on information provided to us by independent, third-party banks that are more familiar than we are with the markets in which the loans are originated. If such third-party information is incomplete or inaccurate, or if we fail to adequately review such information, we may fail to realize risks in the loans we make, which could adversely affect our credit quality, resulting in a reduced ability to earn profits.
Our business model contains inherent lending and regulatory risk because we have significant Internet bank operations and often have little personal interaction with our customers.
A particular risk associated with Internet banking generally is the absence of personal contact with customers, which may make it difficult to verify the creditworthiness of customers and collateral for home equity loans, especially with out-of-area borrowers. Lack of personal contact with our customers could lead us to underestimate risks in the home equity loans we make or deposit accounts opened, which could adversely affect our credit quality or fraud account experience, resulting in a reduced ability to earn profits. It also requires that we maintain heightened safeguards against identity theft, fraud and Bank Secrecy Act violations, and we may design or administer these safeguards in a manner that does not protect us adequately against these issues.
Our deposit customers are likely to be sensitive to price fluctuations for products and may have limited loyalty to us.
The market for Internet banking continues to evolve. Therefore, we are unable to predict whether customers will continue to use the Internet to an extent necessary to support our business. Attractive rates offered by Nexity Bank may attract a segment of short-term depositors who could close their accounts in pursuit of higher rates
elsewhere. We expect that some customer attrition will occur especially within the first few months after a new customer begins to use the Bank’s services. We believe that customers who experience difficulty in accessing our bank or in conducting transactions early in their relationship with the Bank could terminate their relationship. In addition, one aspect of the current Internet banking business is that while many customers use an Internet bank for interest bearing deposit accounts, they are sometimes reluctant to use an Internet bank for other banking services such as loans. Customer attrition, or reluctance of customers to use the full range of services offered by Nexity Bank in a totally online environment, could have a material adverse effect on our business, operating results and financial condition.
Our operations could be interrupted if our third-party service providers experience difficulty or terminate their services.
We outsource certain operational functions to third parties. If our third-party service providers experience difficulties or terminate their services and we are unable to replace them with another service provider, our operations could be adversely affected. We depend significantly, and will continue to depend, on a number of relationships with third-party service providers.
Our continued pace of growth may require us to raise additional capital in the future, but that capital 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 anticipate that our existing capital resources will satisfy our current capital requirements. We may, however, need to raise additional capital to support our continued future growth.
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. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us or you. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired.
We do not plan to pay dividends for the foreseeable future.
We do not intend to pay cash dividends in the foreseeable future, and any earnings are expected to be retained for use in developing and expanding our business.
Our business is subject to the success of the local economies where we operate.
Our success significantly depends upon the growth in population, income levels, and housing starts in the local economies where we operate. If the principal communities in which we operate (Birmingham, Alabama; Atlanta, Georgia; Myrtle Beach and Columbia, South Carolina; Orlando, Florida, Milwaukee, Wisconsin, Charlotte, North Carolina; Dallas, Texas; and the southeastern United States generally) do not grow or if prevailing economic conditions are unfavorable, our business may not succeed. Adverse economic conditions in our specific market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and results of operations. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
Adverse market or economic conditions in any of the local communities where we operate may disproportionately increase the risk that our borrowers will be unable to make their loan payments. An economic downturn could cause our interest income and net interest margin to decrease and our loan loss provision to increase, resulting in losses that materially adversely affect our business, financial condition, results of operations and cash flows.
Additionally, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. As of December 31, 2007, approximately 73% of our loans held for investment were secured by real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in any of the local communities in which we operate could adversely affect the value of our assets, our revenues, results of operations and financial condition.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant loan losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. As we expand into new markets, our determination of the size of the allowance could be understated due to our lack of familiarity with market-specific factors.
If our assumptions are wrong, our current allowance may not be sufficient to cover our loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease our net income. Our allowance for loan losses was $8.0 million as of December 31, 2007 and $7.4 million as of December 31, 2006. Our allowance for loan losses was $6.5 million and $4.9 million as of December 31, 2005 and 2004, respectively.
In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on our operating results.
Unexpected changes in interest rates may decrease our net interest income.
If we are unsuccessful in managing interest rate fluctuations, our net interest income could decrease materially. Our operations depend substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Like most depository institutions, our earnings and net interest income are affected by changes in market interest rates and other economic factors beyond our control. If our interest income and net interest margin decrease and our loan loss provision increases, we could experience losses that materially adversely affect our business, financial condition and results of operations and cash flows.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. In the correspondent banking area, we compete primarily with The Bankers Bank which is based in Atlanta, Georgia and is approximately twice our size in terms of assets and has a significant presence in the southeastern United States and a longer operating history than we have. We also compete with Internet, commercial and correspondent banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere and provide Internet banking services similar to ours.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. As a result, we may face a competitive disadvantage.
Our success is dependent in part on our ability to keep pace with rapid technological change.
The Internet and the online commerce industry are characterized by rapid technological change, changes in user and customer requirements and preferences, frequent new product and service introductions embodying new technologies and the emergence of new industry standards and practices that could render our existing technology and systems obsolete. Our success will depend, in part, on our ability to license leading technologies useful in our business, enhance our services, develop new services and technology that address the increasingly sophisticated and varied needs of our prospective customers, and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. The development of such technology entails significant technical and business risks. There can be no assurance that we will successfully use new technologies effectively or adapt our transaction-processing systems to customer requirements or emerging industry standards. If we are unable, for technical, legal, financial or other reasons, to adapt in a timely manner in response to changing market conditions or customer requirements, our business, operating results and financial condition could be materially adversely affected.
Failure to introduce new products and services successfully may cause us to lose market share.
Our success will depend in part upon our ability to offer new products and provide new financial services that meet changing customer requirements. If we fail to offer financial products and services that appeal to customers more than those offered by our competitors, we may lose market share, which could adversely affect our ability to earn profits.
Our operations could be interrupted if our network or computer systems fail or experience a security breach.
Our computer systems and network infrastructure could be vulnerable to unforeseen problems. Our operations in the Internet banking and correspondent banking markets are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could result in a loss of customers and, thereby, have a material adverse effect on our business, operating results and financial condition.
Nexity Bank management invested in redundant systems infrastructure for the bank including hardware, software and monitoring tools at the AT&T Co-location facility in Lithia Springs, Georgia. The redundant systems are securedly housed in this facility including redundant electrical power, air systems and duplicated internet access lines. Nexity Bank also has a “Command Center” in Birmingham, Alabama on a separate grid for operating the back up facility in the event of a local building outage of the headquarters office.
In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure used by us against damage from physical break-ins, security breaches and other disruptive problems caused by other Internet users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through such computer systems and network infrastructure, which may result in significant liability to us and deter potential customers. There can be no assurance that our security measures will be successful. A failure of our security measures could have a material adverse effect on our business, operating results and financial condition.
We are subject to a variety of laws, many of which may be unclear in their application to Internet operations.
Nexity Bank must comply with both state and federal law as it conducts banking business over the Internet. As an institution conducting business on a multi-state basis, Nexity Bank must comply with the individual laws and regulations of each host state. These laws may include various state licensing and registration requirements that are generally applicable to banks as well as state laws and regulations that specifically govern electronic commerce. Compliance with electronic commerce laws may present a particular challenge as these laws are still being developed in many states. In addition to these state laws and regulations, Congress has considered the adoption of laws that may apply to commerce over the Internet, and, thus, future federal laws and regulations also may significantly affect the way Nexity Bank conducts business.
A widespread security breach on the Internet may adversely affect our deposits.
We depend on the Internet for our deposits. Widespread security breaches on the Internet may cause people to avoid conducting business, including banking, on the Internet and may inhibit growth of our deposits and ability to generate profits.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
In February of 2007, we purchased 4.5 acres of land within the Colonnade Development in Birmingham, AL for $2.4 million to be used for the future expansion.
We lease office space at 3500 Blue Lake Drive, Suite 330, Birmingham, Alabama 35243. This location is the main office for Nexity Financial Corporation and Nexity Bank. The office space consists of 15,000 square feet and the lease expires on August 30, 2007. We also lease space in Woodstock, Georgia, Myrtle Beach and Columbia, South Carolina, Grapevine, Texas, Orlando, Florida, Charlotte and Raleigh, North Carolina, and Brookfield, Wisconsin. The annual rentals totaled $703,496 during 2007. At December 31, 2007, future minimum rental commitments under non-cancelable operating leases that have a remaining life in excess of one year are summarized as follows:
We maintain adequate insurance on these properties.
Item 3.
Item 3. Legal Proceedings
From time to time, we are involved in legal proceedings and claims that arise in the ordinary course of business.
Item 4.
Item 4. Submission of Matters to a Vote of Shareholders
No matter was submitted to a vote of security holders by solicitation of proxies or otherwise during the fourth quarter of 2007.
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market for Common Stock and Related Matters
Nexity’s common stock trades on the National Association of Securities Dealers Automated Quotation (“NASDAQ”) National Market under the symbol NXTY. Nexity began trading on the NASDAQ National Market on September 21, 2005. At December 31, 2007, Nexity had 221 shareholders of record and 7,769,394 shares outstanding. Nexity has made no cash dividends to its stockholders since its formation and does not expect to do so for the foreseeable future.
Unregistered Sales of Securities
None.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by Item 201(d) of Regulation S-K is provided under Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, “Securities Authorized for Issuance under Equity Compensation Plans,” which is incorporated herein by reference.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In connection with stock repurchases, we have repurchased shares of our common stock in private transactions and open-market purchases, as authorized by our Board of Directors. The following table presents information about our stock repurchases during the three months ended December 31, 2007.
Issuer Purchases of Equity Securities
(1) In March of 2006, April of 2007, and July of 2007, we announced stock repurchase plans authorizing the Corporation to repurchase up to 400,000, 250,000, and 800,000 shares of common stock, respectively, for an aggregate total of 1,450,000 shares.
Performance Graph
Item 6.
Item 6. Selected Financial Data
Our summary consolidated financial data is presented below as of and for the years ended December 31, 2003, through 2007. The financial data below has been adjusted to reflect the one-for-four reverse stock split approved by our stockholders on August 31, 2005, and effective September 1, 2005. On September 21, 2005, we completed our initial public offering and raised $25.4 million, net of offering costs. The summary consolidated financial data presented below as of December 31, 2007 and 2006 and for each of the years in the three-year period ended December 31, 2007, are derived from our audited financial statements and related notes included in this report and should be read in conjunction with the consolidated financial statements and related notes, along with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. The summary consolidated financial data as of December 31, 2005, 2004 and 2003 and for each of the years in the two-year period ended December 31, 2004 have been derived from our audited financial statements that are not included in this Annual Report on Form 10-K.
* Our effective tax rates were 29.6% for 2007, 36.4% for 2006, 33.1% for 2005, 4.8% for 2004, and (12.4%) for 2003. In 2004 and 2003, we realized substantially all of our loss carryforwards from previous years.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion and tabular data presented below analyze major factors and trends regarding our financial condition and results of operations for each of the three years in the period ended December 31, 2007. Unless otherwise noted, these numbers have been adjusted to reflect the one-for-four reverse stock split effective September 1, 2005.
The following discussion and analysis should be read in conjunction with the financial information and the Consolidated Financial Statements (including the notes thereto) contained elsewhere in this annual report on Form 10-K. To the extent that any statement below (or elsewhere in this document) is not a statement of historical fact and could be considered a forward-looking statement, actual results could differ materially from those in the forward-looking statement.
Forward-Looking Statements
Some of our statements in this annual report on Form 10-K are forward-looking statements. The words “expect”, “anticipate”, “intend”, “consider”, “plan”, “believe”, “seek”, “should”, “estimate”, and similar expressions are intended to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management. Our actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors including various risks to which our business is subject. Such risks are described further above at Item 1A, “Risk Factors,” and include, without limitation:
(i) unanticipated deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses,
(ii) increased competition with other financial institutions,
(iii) lack of sustained growth in the economy in the southeastern United States and the Dallas, Texas area,
(iv) rapid fluctuations or unanticipated changes in interest rates,
(v) the inability of our bank subsidiary, Nexity Bank, to satisfy regulatory requirements,
(vi) our ability to keep pace with technological changes, and
(vii) changes in the legislative and regulatory environment, including compliance with the various provisions of the Sarbanes Oxley Act of 2002.
Many of such factors are beyond our ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. We do not intend to update or reissue any forward-looking statements contained in this report as a result of new information or other circumstances that may become known to us.
Overview
We were founded in 1999 and operate as a financial holding company that competes in two areas of the commercial banking industry: correspondent banking and Internet banking. Our correspondent banking division markets to community banks primarily in the southeastern United States and Texas. Our Internet banking division provides banking services to consumers and small businesses across the United States.
Correspondent banking services include loan participations, investment services, and clearing and cash management services. Income from loan participations was 72.0% total revenue for the year ended December 31, 2007. For the years ended December 31, 2006, and 2005 loan participation income was 72.4%, and 68.6%, respectively, of total revenue. No other product or service accounts for 15% or more of total consolidated
revenue. Our asset growth is dependent on our ability to grow loans outstanding and we generate approximately 90% of our loan production through loan participations with community banks. We fund this loan production primarily with deposit products and services offered to consumers and small businesses via the Internet. The Internet provides an efficient distribution channel for serving deposit customers without the costly investment in a branch banking network.
Our primary source of revenue is net interest income. Our net interest income accounted for 86.1% of total revenue for the year ended December 31, 2007 and 92.9%, and 91.6%, for the years ended December 31, 2006 and 2005, respectively. Interest income on loans accounted for 79.7% of total interest income for the year ended December 31, 2007 and 78.6% and 75.7%, for the years ended 2006 and 2005 respectively.
Our net interest income decreased to $24.4 million for the year ended December 31, 2007 from $25.1 million for the year ended December 31, 2006. This decrease was primarily attributable to a lower net interest margin. The net interest margin decreased from 3.15% in 2006 to 2.80% in 2007. An analysis of net interest income is provided in the “Results of Operations” section of management’s discussion and analysis.
Our earnings performance is dependent on our ability to generate net interest income and the primary source of net interest income is interest income on loans. The primary risks associated with our income generation are credit risk and interest rate risk.
Noninterest income totaled $3.9 million in 2007 and $1.9 million in 2006 and in 2005. The increase in noninterest income in 2007 was mostly due to higher brokerage and investment services income.
Noninterest expense increased $4.1 million or 26.1% and totaled $20.0 million in 2007 compared with $15.8 million in 2006, and $14.1 million in 2005. Noninterest expense was higher primarily due to higher salaries and employee benefits and other operating expenses related to the expansion of our correspondent banking business, investment services business, and Wealth Management business.
In 2007 we maintained our credit quality remained at a satisfactory level. While net charge-offs decreased in 2007, nonperforming assets rose during the year. We manage credit risk with underwriting procedures prior to originating loans and ongoing review systems during the life of the loan. These procedures are discussed in more detail in the section entitled “Loans” in this management’s discussion and analysis. At December 31, 2007, nonperforming assets as a percent of total loans and other real estate owned increased to 2.00% from 0.87% at December 31, 2006. Net charge-offs as a percent of average loans decreased to 0.07% for the year ended December 31, 2007 from 0.12% in 2006.
Short-term interest rates, including the prime lending rate decreased during the second half of 2007. During this period of declining interest rates, our net interest margin weakened. We manage interest rate risk with monthly analysis of trends related to our net interest margin and the impact of changing interest rates. We also model future performance expectations based on changing interest rates with a simulation model for asset/liability management. These procedures are discussed in more detail in the section entitled “Market Risk and Asset/Liability Management” in this management’s discussion and analysis.
Total assets were $947.2 million at December 31, 2007, up 6.3% from $891.0 million at December 31, 2006. Loans increased $38.9 million or 6.4% in 2007. Deposits were up $50.8 million or 7.7% at December 31, 2007.
Our strategy is to continue to focus on growing our correspondent bank business by developing existing relationships with community banks in the southeastern United States and Texas and aggressively pursuing new relationships in these market areas. We will also focus on cross-selling our correspondent bank products and services to our community bank customers which will stimulate growth and supplement our revenue generation. We will continue to research new products and services as well as enhancements to our existing offerings to meet the changing needs of community banks.
We seek to maintain a safe and secure environment for our business transacted via the Internet. We will continue to invest in new technologies and systems to protect our information and enhance our Internet banking products and services. We intend to position our deposit product offerings to provide the necessary funding growth for our balance sheet by monitoring the competitive landscape for interest rates and marketing channels for new customers. We will also continue to develop cross-selling opportunities to our Internet banking customers, which will stimulate deposit growth and supplement our revenue generation.
Critical Accounting Policies and Estimates
Our accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during periods presented. Different assumptions in the application of these methods or policies could result in material changes in our consolidated financial statements. As such, the following policies are considered “critical accounting policies” for us.
Allowance for Loan Losses
Management’s determination of the adequacy of the allowance for loan losses, which is based on the factors and risk identification procedures discussed in the following pages, requires the use of judgments and estimates that may change in the future. Changes in the factors used by management to determine the adequacy of the allowance, or the availability of new information, could cause the allowance for loan losses to be increased or decreased in future periods. Bank regulatory agencies, as part of their examination process, may also require that additions be made to the allowance for loan losses based on their judgments and estimates.
Estimates of Fair Value
The estimation of fair value is significant to a number of the Company’s assets, including, but not limited to, investment securities, other real estate owned, intangible assets and other repossessed assets. Investment securities are recorded at fair value while other real estate owned, intangible assets and other repossessed assets are recorded at either cost or fair value, whichever is lower. Fair values for investment securities are based on quoted market prices, and if not available, quoted prices on similar instruments. The fair values of other real estate owned and repossessions are typically determined based on third-party appraisals less estimated costs to sell. Intangible assets are periodically evaluated to determine if any impairment might exist. The estimation of fair value and subsequent changes of fair value of investment securities, other real estate owned, repossessions and intangible assets can have a significant impact on the value of the Company, as well as have an impact on the recorded values and subsequently reported net income.
Deferred Tax Assets
Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax asset. Management believes that Nexity Bank will generate sufficient operating earnings to realize the deferred tax benefits. Our 2004 to 2006 consolidated income tax returns are open for examination by governmental authorities. Examination of our income tax returns or changes in tax law may impact our tax liabilities and resulting provisions for income taxes. See the section below entitled “Income Taxes”.
Results of Operations
The primary factors affecting the decrease in net income for 2007 were an increase in noninterest expense of $4.1 million or 26.1% and a $715,488 or 2.9% decrease in net interest income. These changes were partially offset by a $2.0 million or 106.3% increase in noninterest income, a $1.3 million or 36.0% decrease in taxes, and a $795,000 decrease in the provision for loan losses.
Return on average assets and return on average stockholders’ equity are key measures of earnings performance. Return on average assets decreased from 0.75% in 2006 to 0.59% in 2007. Return on average stockholders’ equity decreased from 9.78% in 2006 to 8.03% in 2007.
Net Interest Income
Net interest income, the major component of our income, is the amount by which interest and fees generated by earning assets exceed the total interest costs of the funds used to carry them. Changes in the level of interest rates and the change in the amount and composition of earning assets and interest-bearing liabilities affect net interest income. Table 1, Comparative Average Balance Sheets-Yields and Costs, compares average balance sheet items and analyzes net interest income on a tax equivalent basis for the three years ended December 31, 2007, 2006 and 2005.
Table 1
Comparative Average Balance Sheets-Yields and Costs
(1) Average loan balances are stated net of unearned income and include nonaccrual loans.
(2) The weighted average yields on securities are calculated on the basis of the yield to maturity based on the book value of each security. Non-taxable income has been adjusted to a tax-equivalent basis using a federal tax rate of approximately 34%.
(1) Average loan balances are stated net of unearned income and include nonaccrual loans.
(2) The weighted average yields on securities are calculated on the basis of the yield to maturity based on the book value of each security. Non-taxable income has been adjusted to a tax-equivalent basis using a federal tax rate of approximately 34%.
Net interest income on a tax equivalent basis decreased $683,379 or 2.7% from $25.1 million in 2006 to $24.4 million in 2007. Net interest income was lower in 2007 due to a lower net interest margin. Net interest income on a tax equivalent basis was $20.9 million in 2005, which resulted in a net interest margin of 3.13%.
Interest income on a tax equivalent basis increased $6.6 million or 11.4% in 2007 due to increased volume of earning assets and increased yield on earning assets. Average earning assets increased 9.5% to $873.0 million or 96.7% of average total assets in 2007, compared with $797.3 million or 98.6% in 2006. The yield on earning assets increased 13 basis points from 7.24% in 2006 to 7.37% in 2007. The two primary types of earning assets
are loans and investment securities. The income generated from these assets is a function of their quality, growth, and yield. The growth in these earning assets was primarily the result of improved quality loan demand as average loans increased $68.9 million or 12.7%. Average investment securities increased $13.2 million or 5.7%. The yield on earning assets for the year ended December 31, 2005 was 6.15%.
During 2007, loans, which are typically our highest yielding earning asset, increased as a percentage of earning assets. Average loans were 70.2% of average earning assets in 2007 versus 68.2% in 2006. The yield on loans increased 1 basis point from 8.35% in 2006 to 8.36% in 2007. The yield on loans for 2005 was 7.01%. The yield on taxable investment securities increased from 4.81% in 2006 to 4.98% in 2007. The yield on Federal funds sold and securities purchased under agreements to resell, collectively, increased 32 basis points from 5.00% in 2006 to 5.32% in 2007. The yield on interest-bearing deposits with banks decreased 277 basis points from 9.01% in 2006 to 6.24% in 2007.
Our cost of funds increased $7.3 million or 22.3% in 2007 due to the increased volume of interest-bearing liabilities and the increased rate paid on interest-bearing liabilities. Average interest-bearing liabilities increased $85.6 million or 11.7% in 2007 to $817.5 million or 93.6% of average earning assets compared to $731.9 million or 91.8% average earning assets in 2006. Interest-bearing deposits were up $61.5 million or 10.0%, primarily driven by growth in time deposits. Average long-term debt increased $9.9 million from $104.3 million in 2006 to $114.2 million in 2007. The average rate paid on interest-bearing liabilities increased 42 basis points from 4.46% in 2006 to 4.88% in 2007. The average rate paid on interest-bearing liabilities was 3.24% in 2005. Average certificates of deposit were 52.1% of interest-bearing liabilities in 2007 versus 52.3% in 2006. Average long-term debt was 14.0% of interest-bearing liabilities in 2007 versus 14.3% in 2006.
The Federal Reserve decreased the federal funds target rate by 100 basis points in 2007, in increments of 50, 25, and 25 basis points, respectively, versus a 100 basis points increase in the federal funds target rate in 2006. The prime-lending rate changed by the same amount at each of these time periods.
The net interest margin, computed by dividing net interest income by average earning assets, reflects the impact of noninterest-bearing funds on net interest income. Noninterest bearing funds decreased as a percent of earning assets in 2007 to 6.4% from 8.2% in 2006 primarily due to growth in interest bearing liabilities outpacing growth in interest earning assets. Table 2, Analysis of Net Interest Income Changes, shows the impact of balance sheet changes, which occurred during 2007, and the changes in interest rate levels.
Table 2
Analysis of Net Interest Income Changes
(1) Volume-rate changes have been allocated to each category based on the percentage of the total change.
(2) Balances of nonaccrual loans have been included for computational purposes.
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, should be adequate to absorb the inherent losses on outstanding loans. The provision for loan losses was $805,000, $1,600,000, and $1,870,000 in 2007, 2006, and 2005, respectively. The provision for loan losses was $795,000 lower in 2007 primarily because of lower net charge-offs and slower loan growth.
Net loan charge-offs were $423,467, or 0.07% of average loans in 2007 compared to $654,912, or 0.12% of average loans in 2006 and $315,105, or 0.07% of average loans in 2005. The allowance for loan losses totaled 1.24% of total loans as of December 31, 2007 compared to 1.22% of loans as of December 31, 2006, and 1.25% as of December 31, 2005. See the sections entitled “Loans,” “Nonperforming Assets,” and “Allowance for Loan Losses” below for additional information.
Noninterest Income
Noninterest income consists of service charges on deposit accounts, gains on investment securities transactions, brokerage and investment services income, and other commissions and fees generated from various banking activities. We anticipate noninterest income becoming a more important contributing factor to our overall profitability. Noninterest income totaled $3.9 million in 2007 compared to $1.9 million in 2006 and 2005.
The largest component of noninterest income is brokerage and investment services income. Brokerage and investment services income is generated through our correspondent banking services, which began operations in 2002. The bulk of the fees generated are through fixed income investment sales to correspondent bank customers. Fees are also generated from the facilitation of brokered CDs and trust preferred securities offerings for these same customers. Brokerage and investment services income was $2.3 million in 2007 compared to $851,987 in 2006 and $691,632 in 2005. The increase in 2007 was primarily due to our expansion in Milwaukee.
Commissions and fees include revenues from debit card services and loan participation fees. Commissions and fees increased by $92,939 in 2007 compared to 2006 primarily due to higher loan participation fee income.
Gains on sales of investment securities were $292,051 in 2007, up from $240,952 in 2006 and down from $468,351 in 2005. The net gains in all three years resulted primarily from investment strategies used to take advantage of current market conditions and to provide liquidity for anticipated loan demand.
Service charges on deposit accounts were up $62,851 to $172,970 in 2007 compared to $110,119 in 2006 and $89,914 in 2005 due to higher correspondent banking analysis service charges.
Other operating income was up $418,118 to $802,082 in 2007 compared to $383,964 in 2006 and $367,228 in 2005 due primarily to increases in income from our federal funds agent program and our investment in bank owned life insurance.
Table 3
Other operating income
Noninterest Expense
Noninterest expense increased $4.1 million or 26.1% and totaled $20.0 million in 2007 compared with $15.8 million in 2006. In 2006, noninterest expense increased $1.7 million or 12.2% from $14.1 million in 2005. Noninterest expense was higher primarily due to higher salaries and employee benefits and expenses related to the expansion of our correspondent banking business and brokerage and investment services business.
Salaries and employee benefits, the largest component of noninterest expense, totaled $11.7 million in 2007, $9.5 million in 2006, and $8.6 million in 2005. The increases during 2007 and 2006 were primarily due to investment in new personnel and increased incentive pay as our performance improved. Merit increases also contributed to this increase. At the end of 2007, we employed 117 full time equivalent employees, compared to 94 at the end of 2006 and 87.5 at the end of 2005.
Net occupancy expense increased 26.9% in 2007, largely due to the expansion of our office in Birmingham, and the opening of offices in Charlotte, Orlando and Milwaukee. Equipment expense increased $119,325 or 16.6% in 2007 largely due to increased maintenance contract expense and furniture and equipment expenses in our new offices.
Other operating expense increased 33.8% in 2007 largely due to higher travel and lodging expense, write down of other real estate, legal fees, and telephone and data communications expense. Travel and lodging expense increased $103,525 or 20.1% in 2007 largely due to the expansion of our correspondent banking business and brokerage and investment services business. Legal fees increased $200,065 or 165.5% in 2007 primarily due to our expansion efforts and management of our other real estate. We also had a $297,500 nonrecurring charge for the settlement of a lawsuit related to the discharge of two employees in the fourth quarter of 2007. Telephone and data communications expense increased $135,980 or 33.3% in 2007 due to our expansion in Milwaukee, Florida, and our Wealth Management business in Charlotte, NC.
Table 4
Other operating expense
Our overhead efficiency ratio was 70.2% in 2007 compared to 59.2% in 2006 and 63.3% in 2005. The efficiency ratio measures the amount of expense incurred to generate a dollar of revenue. The efficiency ratio
increased in 2007 because of higher overhead related to our expansion efforts. Our efficiency ratio improved from 2005 to 2006 because growth in revenue outpaced growth in overhead. We anticipate further improvement in this ratio as we continue to grow.
Income Taxes
Nexity Financial Corporation and its subsidiaries file a consolidated federal income tax return. We account for income taxes using the liability method pursuant to Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Under this method, our deferred tax assets and liabilities were determined by applying federal and state tax rates currently in effect to our cumulative temporary book/tax differences. Temporary differences are differences between financial statement carrying amounts and the corresponding tax bases of assets and liabilities. Deferred taxes are provided as a result of such temporary differences. In 2007, we adopted FASB Interpretation No. 48 (“FIN48”), “Accounting for Uncertainty in Income Taxes.”
Total income tax expense included in the Consolidated Statements of Income was $2.2 million in 2007, compared to $3.5 million in 2006. Our effective income tax rates were 29.6% in 2007, 36.4% in 2006, and 33.1% for 2005. The effective tax rate decreased in 2007 compared to 2006 primarily due to lower income before income taxes and tax planning strategies implemented in the fourth quarter of 2006, which included investments in tax preferred assets.
We monitor relevant income tax laws for changes in laws or court rulings that may affect on our accrued income taxes and income tax planning. We consider the impact on estimates and judgments used in our income tax calculations and make necessary adjustments.
Our federal and state income tax returns for the years 2004 through 2006 are open for review and examination by governmental authorities. In the normal course of these examinations, we are subject to challenges from governmental authorities regarding amounts of taxes due. We believe adequate provision for income taxes has been recorded for all years open for review.
Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing, nature and amount of future income earned by certain subsidiaries and the implementation of various plans to maximize realization of the deferred tax asset. Management believes that the subsidiaries will generate sufficient operating earnings to realize the deferred tax benefits. At December 31, 2007 we had a net operating loss carryforwards for state tax purposes of $5.2 million compared with $2.7 million at December 31, 2006. We had no valuation allowance at December 31, 2007 and 2006.
For further information concerning income tax expense, refer to Note 9, Income Taxes, of our 2007 Consolidated Financial Statements.
Balance Sheet Review
Investment Securities
The investment securities portfolio serves as a vehicle to generate interest and dividend income from the investment of funds, provide liquidity to meet funding requirements, manage interest rate risk, and provide collateral for public deposits and borrowed money. All investment securities are generally classified as available-for-sale and are recorded at fair value. We primarily invest in securities of U.S. government sponsored agencies and corporations and mortgage related securities with average lives approximating five years.
Table 5
Investment Securities Portfolio Composition
Investment securities were $244.8 million at December 31, 2007, compared with $239.5 million at December 31, 2006. At December 31, 2007, investment securities represented 25.8% of total assets compared with 26.9% at December 31, 2006. The reason for the slight decrease in the mix of investment securities was loan growth in 2007. We had a net unrealized loss on investment securities available-for-sale, net of tax, of $839,029 at December 31, 2007, compared with $2.0 million at the same time last year. We have the ability and intent to hold these securities until such time as the value recovers or the securities mature. We believe, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The amortized cost, fair value, tax equivalent yield, and contractual maturity schedule of debt securities at December 31, 2007 are shown in Table 6. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
Table 6
Investment Securities Maturity Schedule
(December 31, 2007)
(Dollars in thousands
(1) Equity securities have no contractual maturity or yield and accordingly are excluded from the yield calculation.
Average investment securities excluding the net unrealized gain or loss on available-for-sale securities were $243.1 million in 2007, an increase of 5.7% from $229.9 million in 2006. The increase in average investment securities was due to the overall growth in the balance sheet and securities purchased to leverage available capital. The average tax equivalent portfolio yield increased 15 basis points in 2007 from 4.97% in 2006 to 5.12% in 2007.
The duration of the debt securities portfolio decreased to approximately 3.9 years at December 31, 2007 from approximately 5.0 years at December 31, 2006 due to the decreasing interest rate environment.
We realized $292,051 in gains from the sale of $36.0 million of available-for-sale securities during 2007 versus $240,952 in gains from the sale of $15.8 million of available-for-sale securities during 2006. We realized $468,351 in gains from the sale of $4.6 million of available-for-sale securities during 2005.
We had no investment securities held-to-maturity and recorded at amortized cost at December 31, 2007 and 2006.
At December 31, 2007, we had no trading securities that were marked to market and held short-term compared to $2.0 million at December 31, 2006.
Loans
Loans, the largest component of earning assets, totaled $644.9 million and represented 68.1% of total assets and 90.9% of total deposits at December 31, 2007, compared with $606.0 million and 68.0% of total assets and 92.0% of total deposits at December 31, 2006. In 2007, average loans grew 12.7% to $612.7 million from $543.8 million in 2006. The primary strategy for loan generation is buying loan participations from community banks. Community banks sell loan participations primarily due to legal lending limitations, liquidity purposes, and other special needs. Our correspondent lenders focus primarily on small and medium-sized banks in Alabama, Georgia, Florida, North Carolina, South Carolina, and Texas. Our lenders have a high level of experience dealing with community banks and analyzing the different types of loans in these market areas.
Loan policies and procedures provide the overall direction for administration of the loan portfolio. The lending strategy focuses on quality growth in each of our market areas. Our loan underwriting process is intended to ensure that sound and consistent credit decisions are made.
In many lending transactions, collateral is obtained to provide an additional measure of security. Generally, the cash flow and earnings power of the borrower represent the primary source of repayment and collateral is considered as an additional safeguard to further reduce credit risk. The need for collateral is determined on a case-by-case basis after considering the current and prospective creditworthiness of the borrower, terms of the lending transaction, and economic conditions.
The loans generated through community bank loan participations are typically real estate construction loans, commercial real estate loans, and loans secured by common stock of community banks. Construction and commercial real estate loans are typically participated because they exceed the community bank’s legal lending limit, and the size of the loan participation is usually between $1 million and $10 million. We use standard underwriting policies and procedures for each loan participation purchased. These loans are geographically dispersed through our market areas and are not significantly concentrated in one small geographic region or state. We attempt to minimize the risk by generally making a significant amount of these type loans only on owner-occupied properties, by requiring collateral values that exceed the loan amount, adequate cash flow to service the debt, and in most cases, the personal guarantees of principals of the borrowers.
We have established concentration limits on commercial real estate-acquisition and development, multifamily, and income producing commercial real estate loans of 575.0% of total capital. At December 31, 2007 these loans totaled $407.1 million or 474.0% of total capital. We have established concentration limits on real estate construction loans of 350.0% of total capital and at December 31, 2007, these loans totaled $298.9 million or 344.3% of total capital. We also have established concentration limits on loans secured by common stock of community banks of 125.0% of total capital and at December 31, 2007 these loans totaled $89.3 million or 102.8% of total capital. This limitation includes loans to stockholders of community banks and not loans made directly to bank holding companies.
Even though loan policies and procedures may provide the basis for a quality loan portfolio with minimal risk, at times individual borrowers do encounter problems, which result in lower credit quality and higher risk of loss. Additionally, general deterioration of loan quality may result from weaknesses in specific industries or the economy in general. During 2007, the residential real estate market did experience credit deterioration attributable to decreasing home sales and prices.
The composition of the loan portfolio at December 31 for the last five years is presented in Table 7, “Loan Portfolio Composition,” below. Commercial, financial, and agricultural loans increased 23.8% from 2006 and represent 24.4% of gross loans at December 31, 2007. The increase in commercial loans is mostly due to an increase in bank holding company loans and loans to banks in formation. Real estate-construction loans, which were 46.4% of gross loans at December 31, 2007, increased 2.8% compared to the previous year. The slight increase in construction loans is due to a slow down in new construction. Real estate-mortgage or commercial real estate loans decreased 3.2% from 2006 and represent 21.0% of gross loans at December 31, 2007. Commercial real estate loans were lower due to weaker loan demand and paydowns of existing loans. Installment loans to individuals, which include residential real estate loans, represent 2.6% of gross loans and increased $2.4 million during 2007. Home equity lines of credit increased $3.0 million from 2006 and represent 5.6% of gross loans at December 31, 2007. Lease financing receivables, which represent less than 0.1% of gross loans at December 31, 2007, decreased $102,793 compared to the previous year. Other loans decreased $126,756 from 2006 and represent less than 0.1% of gross loans at December 31, 2007.
Table 7
Loan Portfolio Composition
Table 8 presents maturities of certain loan classifications based on collateral type at December 31, 2007. The table also provides the breakdown between those loans with a fixed interest rate and those loans with a variable interest rate.
Table 8
Selected Loan Maturities and Interest Rate Sensitivity (December 31, 2007)
Directors and executive officers are loan and deposit customers and have other transactions with us in the ordinary course of business. Total loans to these persons (excluding loans which in the aggregate do not exceed $60,000 to any such person) at December 31, 2007, 2006 and 2005, were $5.9 million, $485,000, and $930,950, respectively. During 2007, $5.9 million in new loans were made, and repayments totaled $474,018. Total commitments to these persons were $6.7 million at December 31, 2007 and $1.0 million at December 31, 2006, and 2005. These loans were made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons and involve no unusual risk of collectibility.
Risk Characteristics of Loan Portfolio
In order to assess the risk characteristics of the loan portfolio, we consider the three major categories of loans: Commercial, Real Estate Construction and Commercial Real Estate. These three categories made up 91.8% of the total loan portfolio, as of December 31, 2006.
Commercial. Our commercial loan portfolio primarily consists of holding company loans, loans secured by common stock of community banks, and various other loans. Commercial loans increased $30.2 million in 2007 to $157.5 million or 24.4% of the total loan portfolio, as of December 31, 2007.
Geographically, over 75% of the loans in the commercial portfolio are in three states: Georgia (50,63%), Alabama (14.46%), and Texas (10.21%).
From 2003 through 2007, net commercial loan losses as a percent of average commercial loans outstanding ranged from a low of 0.06% in 2006 to a high of 1.41% in 2003. Net commercial loan losses in 2007 totaled $368,082 up from $70,000 in 2006.
Real Estate Construction. Our construction portfolio primarily consists of loans for residential property lot development, single family residential and condominium developments. Real estate construction loans increased $8.0 million in 2007 to $298.9 million or 46.4% of the total loan portfolio as of December 31, 2007. The slight growth in construction loans was primarily due to a slow down in new construction in our primary markets. These loans are normally secured by land, buildings, and personal guarantees and are generally pre-sold. Geographically, 70% of the loans are in three states: South Carolina (30.11%), Georgia (28.40%) and Florida (10.99%).
Management closely monitors real estate construction loans, since these loans are generally considered riskier than other types of loans and are particularly vulnerable in economic downturns and periods of high interest rates. We attempt to mitigate this risk by following underwriting standards that generally include: requiring an equity investment, sufficient presales with nonrefundable earnest money to pay off the loan, bonded contracts and personal guarantees from the principals. During 2007, due to the slow down in the real estate market, we started to see, for the first time, a number of individuals opting out of their purchase contracts. This loss of presales was the primary reason for the increase in nonperforming assets.
In 2007, construction loan losses were $0.
Commercial Real Estate. The commercial real estate portfolio primarily consists of loans with maturities of less than five years with amortization schedules typically ranging from 15 to 25 years. Commercial real estate loans decreased $4.5 million in 2007 to $135.2 million or 21.0% of the total loan portfolio as of December 31, 2007. Land, buildings, and personal guarantees normally secure these loans. Geographically, 65% of the loans are in three states: South Carolina (28.096%), Georgia (19.54%) and North Carolina (18.33%). Although some risk is inherent in this type of lending, we manage our risk by following underwriting standards that include adequate cash flow to service the debt, collateral values that exceed the loan amount, and in most cases personal guarantees from the principals. From 2003 through 2007, net commercial real estate loan losses as a percent of average commercial real estate outstanding ranged from a low of 0.00% in 2007 to a high of 0.38% in 2006. Net losses in 2007 were zero, down from $473,428 or 0.38% in 2006.
Nonperforming Assets
Generally, all loans that are past due 90 days or more as to principal or interest, or where reasonable doubt exists as to timely collection, including loans which are individually identified as being impaired, are classified as nonaccrual loans unless well secured and in the process of collection. Previously accrued interest is reversed against current earnings and any subsequent interest is recognized on the cash basis. Interest collections on nonaccrual loans for which ultimate collectibility of principal is uncertain are applied as principal reductions. Otherwise, such collections are credited to income when received.
In accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” we measure loans for impairment when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. It is our policy to apply the provisions of SFAS No. 114 to all impaired commercial, commercial real estate, and real estate construction loans on a loan-by-loan basis.
Nonperforming assets consist of nonaccrual loans on which the ultimate collection of the full amount of principal and/or interest is uncertain, loans past due 90 days or more as to principal or interest, and other real estate owned. We do not have any foreign loans or loans for highly leveraged transactions.
Table 9
Nonperforming Assets
During 2007, nonperforming assets increased $7.7 million to $13.0 million, compared with $5.3 million reported in 2006. At December 31, 2007, we had loans past due 90 days or more of $741,730 compared to $0 at December 31, 2006. The nonperforming assets to total loans and other real estate owned ratio was 2.0% in 2007, compared to 0.86% in 2006. The increase in nonperforming loans was primarily caused by two real estate construction condominium loans located in Florida. Purchasers are not closing on their contracts, causing a loss of presales.
Allowance for Loan Losses
An analysis of activity in the allowance for loan losses is presented in Tables 10 and 11. The allowance for loan losses is established and maintained through charges to expense in the form of a provision for loan losses. Losses on loans are charged to and recoveries are credited to the allowance at the time the loss or recovery occurs.
Our provision for loan losses is a reflection of actual losses experienced during the year and management’s judgment as to the adequacy of the allowance for loan losses. Some of the factors considered by management in determining the amount of the provision and resulting allowance include: (1) detailed reviews of individual loans; (2) gross and net loan charge-offs in the current year; (3) the current level of the allowance in relation to total loans and to historical loss levels; (4) past due and non-accruing loans; (5) collateral values of properties securing loans; (6) the composition of the loan portfolio (types of loans) and risk profiles; and (7) management’s analysis of economic conditions and the resulting impact on our loan portfolio.
A coordinated effort is undertaken to identify credit losses in the loan portfolio for management purposes and to establish the loan loss provision and resulting allowance for accounting purposes. A regular, formal and ongoing loan review is conducted to identify loans with unusual risks or possible losses. The primary responsibility for this review rests with the management of the loan origination staff. Their work is supplemented with reviews by our internal audit staff and loan review staff. This process provides information that helps in assessing the quality of the portfolio, assists in the prompt identification of problems and potential problems, and aids in deciding if a loan represents a probable loss that should be recognized or a risk for which an allowance should be maintained.
We determine our allowance for loan losses in accordance with SFAS No. 114 and SFAS No. 5. In determining the amount of the allowance for loan losses, management uses information from its ongoing loan review process. The loan portfolio is stratified by loan type and risk-grade. The assigned estimated amount of loss for each stratification is based on several factors, including current and historical loss experience of each loan type, management’s judgment of economic conditions, and risk-grade.
At December 31, 2007 and 2006, we had $38.5 million and $513,920, respectively, in loans considered impaired. Impaired loans had a related specific allowance for loan losses of $2.1 million and $0 at December 31, 2007 and 2006, respectively. There were no material commitments to lend additional funds to customers whose loans were classified as impaired at December 31, 2007 and 2006.
The increase in impaired loans was primarily due to higher impaired real estate construction loans. While these loans were made with enough pre-sold units to pay off the loan, purchasers failed to close on their contracts at project completion. Impaired real estate construction loans increased $34.0 million in 2007, with one project making up half of the increase. Impaired loans include nine loans which totaled $29.7 million at December 31, 2007 that are classified as performing. These loans are considered impaired because we do not expect to collect principal and interest per the terms of the loans. However, we do not anticipate incurring any losses on these loans.
Typically impaired loans are dependent upon collateral for repayment. For these loans, impairment is measured by evaluating estimated net realizable value of collateral as compared to the current investment in the loan. For all other impaired loans, we compare the amount of estimated discounted cash flows to the investment in the loan. In the event a particular loan’s collateral value or discounted cash flows are not sufficient to support the collection of the investment in the loan, the loan is specifically considered in the determination of the allowance for loan losses or a charge is immediately taken against the allowance for loan losses.
Table 10
Summary of Loan Loss Experience
The ratio of net charge-offs to average loans was 0.07% in 2007 and 0.12% in 2006. An $805,000 provision for loans losses was made in 2007, compared with $1,600,000 in 2006.
The lower level of the provision for loan losses during 2007 was primarily attributable to lower net charge - offs and slower loan growth in 2007. Net charge-offs were higher in 2006 than 2005, mostly due to one commercial real estate loan that was carried in nonaccrual loans at December 31, 2005. Net charge-offs were higher in 2003 primarily because of charges related to Internet originated small business lines of credit that were offered briefly during late 2000 and early 2001. Marketing of this product stopped in May 2001.
The provision for loan losses was made to reflect losses inherent in the loan portfolio at the balance sheet date. Specific reserves are provided on impaired loans. The specific reserves are determined on loan-by-loan basis based on an impairment analysis done in accordance with SFAS No. 114. Loans for which specific reserves are provided are excluded from the general allowance calculations described above to prevent redundant reserves.
Although it is our policy to immediately charge off as a loss all loan amounts judged to be uncollectible, historical experience indicates that certain losses exist in the loan portfolio that have not been specifically identified. To anticipate and provide for these unidentifiable losses, the allowance for loan losses is established by charging the provision for loan losses expense against current earnings. No portion of the resulting allowance is in any way allocated or restricted to any individual loan or group of loans. The entire allowance is available to absorb losses from any and all loans.
Table 11
Composition of Allowance for Loan Losses
The unallocated amount represents estimated inherent credit losses in our portfolio as of the balance sheet date. The amount of unallocated allowance decreased 78.0% to $558,158 in 2007 from $2.5 million in 2006. The primary reason for the decline was that the allocation for real estate loans increased. The unallocated amount is subjective and based on primarily qualitative factors and to a lesser extent quantitative factors. In addition, it represents the inherent impressions related to the allowance estimation process. Qualitative factors include recent economic stresses that have occurred and impact our portfolio (depressed economy, loss of consumer confidence, and slowing of real estate market). All of these factors support our conclusion for the current level of unallocated.
The allowance for loan losses is maintained at a level considered adequate by management to provide for potential losses inherent in the loan portfolio. Management evaluates the adequacy of the allowance on a quarterly basis and it is based on a review of individual loans, recent loss experience, current economic conditions, risk identification procedures previously discussed, underlying collateral values, and other relevant factors. Changes in the factors used by management to determine the adequacy of the allowance or the availability of new information could cause the allowance for loan losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require that additions be made to the allowance for loan losses based on their judgments and estimates.
Funding Sources
Total deposits were $709.2 million and represented 74.9% of total assets at December 31, 2007, compared with $658.4 million and 73.9% of total assets at December 31, 2006. In 2007, deposits grew $50.8 million or 7.7% from 2006, primarily due to our competitive rates offered to commercial and consumer customers. In 2007, the mix of interest-bearing deposits changed as certificates of deposit increased 4.0%, and money market deposits increased 15.1%, while interest-bearing checking increased 8.8%, and savings accounts decreased 5.0%. Certificates of deposit represented 60.3% of total deposits in 2007 and 62.4% in 2006. Money market accounts represented 38.4% of total deposits in 2007 and 35.9% in 2006. Interest checking accounts represented 0.6% of total deposits in 2007 and 2006. Savings accounts represented less than 0.1% of deposits in 2007 and 2006. Demand deposits decreased 27.9% to $4.8 million from 2006 to 2007 and represented 0.7% of total deposits in 2007 and 1.0% of total deposits in 2006.
Table 12
Types of Deposits
Table 13 shows a maturity schedule for time deposits at December 31, 2007.
Table 13
Maturity Distribution of Time Deposits of $100,000 or More
Borrowings
We continue to use cost-effective alternative funding sources, including brokered certificates of deposit and Federal Home Loan Bank (“FHLB”) advances to support balance sheet growth and manage interest rate risk.
Average short-term borrowings increased $14.2 million to $17.5 million in 2007 from $3.2 million in 2006. We began providing cash management services to community banks in 2003. As part of this service, we manage a pool of overnight federal funds. Most of this pool is invested with upstream correspondent banks and we use a
portion as a funding source. At December 31, 2007, the pool of federal funds totaled $235.8 million of which we used $16.9 million as a funding source compared with $247.9 million and $35 million at December 31, 2006.
We are a member of the FHLB and may borrow short-term and long-term funds up to thirty percent of our total assets. Pursuant to collateral agreements with the FHLB, advances are secured by U.S. Treasury, Government sponsored agency securities, and mortgage-backed securities. Short-term advances from the FHLB totaled $10.0 million at December 31, 2007 versus $0 at December 31, 2006. The rate on short-term FHLB advances adjusts daily. Advances from the FHLB with an initial maturity of more than one year totaled $120.0 million at December 31, 2007 versus $110.0 million at December 31, 2006. Fixed interest rates on these advances ranged from 2.99% to 4.80%, payable monthly or quarterly, with principal due at various maturities ranging from 2010 to 2017. The increase in long-term borrowings during 2007 and 2006 reflects management’s efforts to extend our maturities for interest rate risk management.
Table 14
Type of Borrowings
We have a revolving line of credit with LaSalle Bank of $15,000,000 of which $1,400,000 was outstanding at December 31, 2007. Under the terms of the Loan Agreement, the loan is secured by 100% of the common stock in the Bank. This advance matures on November 18, 2008 and has a floating rate equal to three month LIBOR, appearing in the Wall Street Journal, plus 150 basis points (1.50%), which was 6.3575% at December 31, 2007. Interest payable quarterly and principal is due at maturity.
The subordinated notes are junior subordinated debentures owed to Nexity Capital Trust II due July 23, 2034. They are secured by trust preferred securities and have 30-year lives with a call option on July 23, 2009 and each interest date thereafter, subject to regulatory approval, or earlier, depending upon certain changes in tax or investment company laws, or regulatory capital requirements. The subordinated notes have a floating rate equal to three month LIBOR plus 280 basis points (2.80%) and reprice quarterly in January, April, July, and October.
Capital Resources
We maintain a strong level of capital as a margin of safety for our depositors and stockholders, as well as to provide for future growth. On September 21, 2005, we completed our initial public offering and raised $25.4 million, net of offering costs. At December 31, 2007, stockholders’ equity was $66.5 million versus $65.2 million at December 31, 2006. The increase in stockholders’ equity was primarily the result of the retention of earnings. We have not paid any cash dividends.
In March of 2006, April of 2007, and July of 2007, we announced stock repurchase plans authorizing the Corporation to repurchase up to 400,000, 250,000 and 800,000 shares of common stock, respectively, for an aggregate total of 1,450,000 shares. In connection with stock repurchases, we have repurchased shares of our common stock in private transactions and open-market purchases, as authorized by our Board of Directors. At December 31, 2007, we had repurchased 971,286 shares or 67.0% of shares authorized for repurchase at an average price of $10.10 per share. The programs are dependent upon market conditions and other factors. There is no guarantee as to the exact number of shares to be repurchased by the Company. Repurchases under these programs are made using our own cash resources.
Book value per share at December 31, 2007 and 2006 was $8.56 and $7.78, respectively. Tangible book value per share at December 31, 2007 and 2006 was $8.45 and $7.67, respectively. Tangible book value was below book value as a result of an intangible asset related to our banking charter.
Note 19, Regulatory Matters, of our 2007 Consolidated Financial Statements sets forth various capital ratios for us. Due to the adoption of FIN 46, we report debt associated with trust preferred securities on our consolidated balance sheets as subordinated debentures as described in the Borrowing section above. Under current regulatory guidelines, these securities qualify for Tier 1 capital treatment. At December 31, 2007 and 2006, trust preferred securities included in Tier 1 capital totaled $12.0 million. For additional information on these securities, see Note 12, Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trust, of our 2007 Consolidated Financial Statements.
During 1990, the Federal Reserve Board adopted a minimum leverage ratio of 3.0% for bank holding companies. This ratio (defined as stockholders’ equity less goodwill and certain other intangibles divided by average assets) was 8.37% and 9.26% at December 31, 2007 and 2006, respectively. As part of forming the holding company, the Federal Reserve Bank required us to maintain a minimum leverage ratio of 5.0%. The Alabama State Banking Department required Nexity Bank to maintain a minimum leverage ratio of 7.0%. This ratio for Nexity Bank was 8.33% and 8.77% at December 31, 2007 and 2006 respectively.
The Federal Reserve Board adopted risk-based capital guidelines, which assign risk-weightings to assets and off-balance sheet items. The guidelines define and set minimum capital requirements (risk-based capital ratios). All banks are required to maintain core capital (Tier 1) of at least 4.0% of risk-adjusted assets and total capital of 8.0% of risk-adjusted assets. Tier 1 capital consists principally of stockholders’ equity and qualifying trust preferred securities less goodwill and certain other intangibles, while total capital consists of Tier 1 capital, certain debt instruments, and a portion of the allowance for loan losses. Banks, which meet or exceed a Tier 1 ratio of 6.0%, a total capital to risk-adjusted assets ratio of 10.0% and a Tier 1 leverage ratio of 5.0% are considered well-capitalized by regulatory standards. We had a Tier 1 capital ratio of 9.76% and 10.77% at December 31, 2007 and 2006, respectively, and a total risk-based capital ratio of 10.75% and 11.79% at December 31, 2007 and 2006, respectively, well above the regulatory requirements for a well-capitalized institution. Note 19, Regulatory Matters, to our 2007 Consolidated Financial Statements presents our actual capital amounts and ratios at December 31, 2007 and 2006.
Market Risk and Asset/Liability Management
Asset/liability management is the process by which we monitor and attempt to control the mix and maturities of our assets and liabilities in order to maximize net interest income. The functions of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest-sensitive assets and liabilities. We manage exposure to fluctuations in interest rates through policies established by our Asset/Liability Management Committee (“ALCO”) and approved by the Board of Directors. An ALCO report is presented to the Board of Directors on a quarterly basis.
We measure the effects of changes in interest rates through the use of a simulation model. The simulation model is used to analyze the sensitivity of net interest income to a ratable change in interest rates measured over
a 12 month time horizon. The model also measures the sensitivity of the economic value of equity (“EVE”) to an instantaneous change in interest rates. EVE is a measurement of the inherent, long-term economic value to us at a given point in time.
The simulation model uses a budgeted balance sheet and takes into account interest rate changes as well as related assumption changes for various rate scenarios. Factors considered in the model assumptions include contractual maturities, prepayments, repricing characteristics, deposit retention, and the relative sensitivity of assets and liabilities to changes in market interest rates. The model assumptions are updated each quarter. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any additional actions we could undertake in response to changes in interest rates.
Interest-sensitive assets and liabilities are those that are subject to repricing in the near term, including floating rate instruments and those with near-term maturities. The interest-sensitivity gap is the difference between total interest-sensitive assets and liabilities during a given time period. Management’s objective is to maintain the difference between interest-sensitive assets and liabilities at a level that will minimize the effects of significant interest rate shifts on the net interest income.
In analyzing net interest income, we calculate net interest income under several different rate scenarios over a twelve-month period. The model reports a case in which interest rates remain flat and reports variations that occur when rates ratably increase and decrease 100 and 200 basis points. These rates assume a shift in all yield curves as well. The table below shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next twelve months using a budgeted balance sheet for each set of interest rate scenarios, compared to the flat interest rate scenario at December 31, 2007 levels.
Table
Net Interest Income Risk Analysis at December 31, 2007
The overall net interest income profile shows positive changes in net interest income if rates ratably increase 100 or 200 basis points. This increase is primarily attributable to a high level of variable rate loans. The down 100 or 200 basis point scenario reflects greater variation also due to the high level of variable rate loans and certain deposit rates that have reached what management believes to be an acceptable lower limit thus limiting the interest expense reduction from repricing these deposits by the entire 200 basis points.
We also calculate EVE under several different rate scenarios. The model reports a case in which interest rates remain flat and reports variations that occur when rates immediately increase and decrease 200 basis points. These rates assume an instantaneous shift in all the yield curves. The table below shows the effect that the indicated changes in interest rates would have on economic value of equity as projected using a static balance sheet for each set of interest rate scenarios compared to the flat interest rate scenario. The economic value of equity represents the fair value of net assets and is in no way indicative of our stockholders’ equity.
Table 16
Economic Value of Equity Risk Analysis at December 31, 2007
Table 17 shows our interest rate sensitivity at December 31, 2007 indicating an asset-sensitive position in the three months or less period and a liability-sensitive position in the four months to six months period and seven months to twelve months period. On a cumulative basis through one year, our rate sensitive liabilities exceed rate sensitive assets, resulting in a liability-sensitive position of $143.1 million or 15.9% of total interest-earning assets. Generally, a liability-sensitive position indicates that declining interest rates would have a positive impact on net interest income and rising interest rates would adversely affect net interest income. Rising and declining interest rates, respectively, would typically have the opposite effect on net interest income in an asset-sensitive position. Other factors, including the speed at which assets and liabilities reprice in response to changes in market rates and competitive factors, can influence the ultimate impact on net interest income resulting from changes in interest rates. Although management actively monitors and reacts to a changing interest rate environment, it is not possible to fully insulate us against interest rate risk. Given the current mix and maturity of our assets and liabilities, it is possible that a rapid, significant and prolonged increase or decrease in interest rates could have an adverse impact on our net interest margin.
Table 17
Interest Rate Sensitivity Analysis
(December 31, 2006 balances in thousands)
(1) Loan balances do not include nonaccrual loans and loans past due ninety days and still accruing.
(2) Investment securities exclude the unrealized loss on available for sale securities of $1,242,855.
Each of the above analyses may not, on their own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may
react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”), which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies.
We may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities and as one tool to manage our interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. At December 31, 2007, we had not entered into any derivative contracts to assist managing our interest rate sensitivity.
We anticipate that interest rates will decline in 2008 and this could put additional pressure on the net interest margin and on net interest income. Since we have more assets that reprice immediately when interest rates change, it takes approximately six months for us to reprice enough interest-bearing liabilities to match the level of assets. We expect the net interest margin to be lower than our expected range of 2.90%-3.00% until rates reach a stable level.
Liquidity Risk Management
Liquidity management involves meeting our cash flow requirements, which arise primarily from withdrawal of deposits, extensions of credit, and payment of operating expenses. Traditional sources of liquidity for a bank include asset maturities, growth in core deposits and earnings. A bank may achieve its desired liquidity objectives from the management of its assets and liabilities and by internally generated funding through its operations. Funds invested in marketable instruments that can be readily sold and the continuous maturing of other earning assets are sources of liquidity from an asset perspective. The liability base provides sources of liquidity through attraction of increased deposits and borrowing funds from various other institutions.
Changes in interest rates also affect our liquidity position. We currently price deposits in response to market rates and our management intends to continue this policy. If deposits are not priced in response to market rates, a loss of deposits could occur which would negatively affect our liquidity position.
Scheduled loan payments are a relatively stable source of funds, but loan payoffs and deposit flows can fluctuate significantly, being influenced by interest rates, general economic conditions and competition. Additionally, debt security investments are subject to prepayment and call provisions that could accelerate their payoff prior to stated maturity. We attempt to price our deposit products to meet our asset/liability objectives consistent with market conditions. Our ALCO is responsible for monitoring our ongoing liquidity needs. Our regulators also monitor our liquidity and capital resources on a periodic basis.
Nexity Bank has access to borrowings from the FHLB and maintains short-term lines of credit from correspondent banks. FHLB advances outstanding as of December 31, 2007 and 2006, totaled $120.0 million and $110.0 million, respectively. At December 31, 2007, we had $163.7 million of unused borrowing capacity from the FHLB. This capacity may be used when we have available collateral to pledge. Until we make collateral available (other than cash) to secure additional FHLB advances, we will fund our short-term needs principally with deposits, including brokered certificates of deposit, federal funds purchased, and the sale of securities available for sale. In addition, we may purchase securities to provide additional FHLB-qualifying collateral. At December 31, 2007, we had unused short-term lines of credit totaling $40.0 million with correspondent banks. We began providing cash management services to community banks in 2003. As part of this service, we manage a pool of overnight federal funds. Most of this pool is invested with upstream correspondent banks and we use up
to 25% as a funding source. At December 31, 2007, the pool of federal funds totaled $235.8 million of which we used $16.9 million as a funding source compared with $247.9 million and $35.0 million at December 31, 2006.
The following table presents additional information about our contractual obligations as of December 31, 2007, which by their terms have contractual maturity and termination dates subsequent to December 31, 2007 (dollars in thousands):
Table 18
In March of 2008, the Bank entered into a contract to purchase a building for our headquarters in Birmingham, AL for $8.7 million.
Our management believes that we have adequate liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.
Off-Balance Sheet Arrangements
At December 31, 2007, we had outstanding standby letters of credit of $15.4 million and unfunded loan commitments outstanding of $215.9 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, we have the ability to liquidate federal funds sold or securities available-for-sale, or on a short-term basis to borrow and purchase federal funds from correspondent banks. At December 31, 2007, we had accommodations with upstream correspondent banks for unsecured short-term advances. These accommodations have various covenants related to their term and availability, and in most cases must be repaid within a month.
The following table presents additional information about our unfunded commitments as of December 31, 2007, which by their terms have contractual maturity dates subsequent to December 31, 2007 (dollars in thousands):
Table 19
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
See “Market Risk and Asset/Liability Management” and “Liquidity Risk Management” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 2, Restrictions on Cash and Due from Bank Accounts, and Note 17, Disclosures about Fair Value of Financial Instruments, from our 2007 Consolidated Financial Statements for quantitative and qualitative disclosures about market risk, which information is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
MANAGEMENT’S STATEMENT OF FINANCIAL RESPONSIBILITY
Management of Nexity Financial Corporation (the “Corporation”) and subsidiaries is committed to quality customer service, enhanced shareholder value, financial stability, and integrity in all dealings. Management has prepared the accompanying consolidated financial statements in conformity with U.S. generally accepted accounting principles. The statements include amounts that are based on management’s best estimates and judgments. Other financial information in this report is consistent with the consolidated financial statements. Both the Chief Executive Officer and the Chief Financial Officer have certified that the Corporation’s 2007 Annual Report of Form 10-K fully complies with the applicable sections of the Securities Exchange Act of 1934 and that the information reported therein fairly represents, in all material respects, the financial position and results of operations of the Corporation.
In meeting its responsibility, management relies on its internal control structure that is supplemented by a program of internal audits. The internal control structure is designed to provide reasonable assurance that financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against unauthorized use or disposition. See “Management’s Report of Internal Control over Financial Reporting” in Item 9A for additional discussion. Mauldin & Jenkins LLC’s report on internal control in accordance with the Sarbanes-Oxley Act of 2002 is also included in Item 9A of this Annual Report on Form 10-K.
Mauldin & Jenkins LLC, independent registered public accounting firm, audited the Corporations’ consolidated financial statements in accordance with standards of the Public Company Accounting Oversight Board (United States). Mauldin & Jenkins LLC reviews the results of its audit with both management and the Audit Committee of the Board of Directors of the Corporation. The consolidated financial statements have not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.
The Audit Committee, composed entirely of independent directors, meets periodically with management, the Corporation’s internal auditors and Mauldin & Jenkins LLC (separately and jointly) to discuss audit, financial reporting and related matters. Mauldin & Jenkins LLC and the internal auditors have direct access to the Audit Committee.
Greg L. Lee
Chairman and
Chief Executive Officer
John J. Moran
Executive Vice President and
Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Nexity Financial Corporation
Birmingham, Alabama
We have audited the consolidated balance sheets of Nexity Financial Corporation and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated statements of income, changes in stockholders’ equity and comprehensive income and cash flows of Nexity Financial Corporation and Subsidiaries for the year ended December 31, 2005 were audited by other auditors, whose report dated March 16, 2006 expressed an unqualified opinion on those statements.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nexity Financial Corporation and Subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Nexity Financial Corporation and Subsidiaries’ 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) and our report dated March 12, 2008 expressed an unqualified opinion on the effectiveness of Nexity Financial Corporation and Subsidiaries’ internal control over financial reporting.
/s/ Mauldin & Jenkins, LLC
Birmingham, Alabama
March 12, 2008
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Nexity Financial Corporation
We have audited the accompanying consolidated statements of income, changes in stockholders’ equity, and cash flows of Nexity Financial Corporation and subsidiaries (the Company) as of December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the Company’s consolidated results of their operations and their cash flows for the year ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Birmingham, Alabama
March 16, 2006
Nexity Financial Corporation and Subsidiaries
Consolidated Balance Sheets
The accompanying notes to the consolidated financial statements
are an integral part of these financial statements.
Nexity Financial Corporation & Subsidiaries
Consolidated Statements of Income
The accompanying notes to the consolidated financial statements
are an integral part of these financial statements.
Nexity Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
The accompanying notes to the consolidated financial statements
are an integral part of these financial statements.
Nexity Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
The accompanying notes to the consolidated financial statements
are an integral part of these financial statements.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation: Nexity Financial Corporation (the “Corporation”) is a registered financial holding company incorporated on March 12, 1999 under the laws of the State of Delaware. The Corporation was formed to enter the commercial banking business and to invest in other bank-related businesses. The Corporation provides its customers with banking services through its subsidiary, Nexity Bank (the “Bank”), and owns 100% of its issued and outstanding capital stock. Nexity Capital Trust II, a statutory trust and wholly owned subsidiary, was established by the Corporation on May 20, 2004. Nexity Capital Trust II is a special interest nonbank subsidiary that issues trust preferred securities, whereby the proceeds from the issuance are loaned to the Corporation.
Consolidation: The consolidated financial statements include the accounts of the Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain amounts in prior year financial statements have been reclassified to conform to the current year presentation. In accordance with the revised Financial Accounting Standards Board Interpretation No. 46, (“FIN 46”), “Consolidation of Variable Interest Entities,” which addresses consolidation by business enterprises of variable interest entities, the Corporation deconsolidated one trust subsidiary, which had been formed to raise capital by issuing preferred securities to institutional investors.
Use of Estimates: The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Investment Securities: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” management determines at the time of purchase the classification of investment securities as either held-to-maturity, available-for-sale or trading. In determining such classification, debt securities that the Corporation has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost. All other investment securities are classified as available-for-sale and carried at estimated fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis as accumulated other comprehensive income. Realized gains and losses are recognized on the specific identification method. Premiums and discounts are included in the basis of investment securities and are recognized in income using the effective interest method.
Securities carried in trading accounts are carried at estimated fair value with unrealized gains and losses recorded in earnings.
Brokerage and Investment Services: Fee income is derived from providing brokerage and investment services to correspondent banks. Fee income is recognized on a trade date basis.
Loans and Allowance for Loan Losses: Loans are reported at their face amount less payments collected. Unearned income on discounted loans is reported as a reduction of the loan balances and is recognized as income using the straight line method, a method approximating the effective interest method. Interest on loans is principally recognized over the term of the loan based on the loan balance outstanding.
Net nonrefundable fees and direct costs of loan originations are deferred and amortized over the lives of the underlying loans as an adjustment to interest income in accordance with SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.”
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
In many lending transactions, collateral is obtained to provide an additional measure of security. Generally, the cash flow and earnings power of the borrower represent the primary source of repayment and collateral is considered as an additional safeguard to further reduce credit risk. The need for collateral is determined on a case-by-case basis after considering the current and prospective creditworthiness of the borrower, terms of the lending transaction, and economic conditions. When a loan becomes 90 days past due as to interest or principal or serious doubt exists as to collectibility, the accrual of income is discontinued unless the loan is well secured and in process of collection. Previously accrued interest is reversed against current earnings and any subsequent interest is recognized on the cash basis.
Generally, all loans that are past due 90 days or more as to principal or interest, or where reasonable doubt exists as to timely collection, including loans which are individually identified as being impaired, are classified as nonaccrual loans unless well secured and in the process of collection. Interest collections on nonaccrual loans for which ultimate collectibility of principal is uncertain are applied as principal reductions. Otherwise, such collections are credited to income when received.
In accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” the Corporation measures loans for impairment when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. It is the Corporation’s policy to apply the provisions of SFAS No. 114 to all impaired loans on a loan-by-loan basis.
The allowance for loan losses is maintained at a level considered adequate by management to provide for potential losses inherent in the loan portfolio. Management’s evaluation of the adequacy of the allowance is based on a review of individual loans, recent loss experience, current economic conditions, risk characteristics of the various classifications of loans, underlying collateral values, and other relevant factors.
A formal review of the allowance for loan losses is prepared quarterly to assess the risk in the portfolio and to determine the adequacy of the allowance for loan losses. For purposes of this review, the portfolio is segregated between commercial and consumer loans. Every commercial loan is assigned a risk rating based on a numerical scale of one to eight by loan officers using established credit policy guidelines. These risk ratings are reviewed periodically and adjusted as warranted and are subject to review by loan review personnel and bank regulators.
Each risk rating is assigned a risk factor that, when multiplied times the sum of the historical loss factor plus the qualitative factor, results in the amount of the allowance for loan losses allocated to those loans. The qualitative factor takes into consideration current economic conditions, recent trends in the portfolio and trends in the industry. Any adversely classified commercial loans greater than $50,000 are individually evaluated and a specific allowance allocated for any impairment losses identified. The consumer loan portfolio is separated by loan type into homogeneous pools and an allocation is made for each pool based on the sum of the historical loss factors plus a qualitative factor multiplied by the risk factor.
Losses on loans are charged to and recoveries are credited to the allowance at the time the loss or recovery occurs. It is possible that a change in the relevant factors used in management’s evaluation may occur in the future.
Foreclosed Properties: Assets are classified as foreclosed properties upon actual foreclosure or when physical possession of the collateral is taken regardless of whether foreclosure proceedings have taken place.
Foreclosed properties are carried at the lower of the recorded amount of the loan for which the property previously served as collateral, or the fair value of the property less estimated costs to sell.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Prior to foreclosure, the recorded amount of the loan is reduced, if necessary, to the fair value, less estimated costs to sell. Subsequent to foreclosure, gains and losses on the sale of and losses on the periodic revaluation of foreclosed properties are credited or charged to expense. Net costs of maintaining foreclosed properties are expensed as incurred.
Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the asset’s estimated useful life (5 to 40 years for buildings and improvements; 3 to 7 years for furniture and equipment). Gains or losses on routine dispositions are charged to operating expenses, and improvements and betterments are capitalized. Interest costs incurred related to the construction of banking premises is included in the cost of the related asset.
Intangible Assets: At December 31, 2007 and 2006, we had no unamortized goodwill. We had $910,655 in unamortized other intangible assets at December 31, 2007 and 2006. The other intangible asset is the bank charter, which upon adoption of SFAS No. 142, we no longer amortize. In accordance with SFAS No. 142, our bank charter is reviewed at least annually to ensure that there have been no events or circumstances resulting in an impairment of the recorded amount of the intangible asset. Adverse changes in the economic environment, operations of the business unit, or other factors could result in a decline in the implied fair value. If the implied fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to fair value.
Treasury Stock: In March of 2006, April of 2007, and July of 2007, we announced stock repurchase plans authorizing the Corporation to repurchase up to 400,000, 250,000 and 800,000 shares of common stock, respectively, for an aggregate total of 1,450,000 shares. In connection with stock repurchases, we have repurchased shares of our common stock in private transactions and open-market purchases, as authorized by our Board of Directors. At December 31, 2007, we had repurchased 971,286 shares or 67.0% of shares authorized for repurchase at an average price of $10.10 per share. Treasury shares are recorded at cost.
Segment Information: SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” requires that public business enterprises report certain information about operating segments in their annual financial statements. It also requires that enterprises disclose information about products and services provided by significant segments, geographic areas, major customers, differences between the measurement used in reporting segment information and those used in the enterprise’s general-purpose financial statements, and changes in measurement of segment amounts from period to period.
Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. During 2007 and 2006, we did not have any reportable segments.
Income Taxes: We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities.
The Corporation and its subsidiaries file a consolidated federal income tax return. The consolidated financial statements (including the provision for income taxes) are prepared on the accrual basis. The Corporation accounts for income taxes using the liability method pursuant to SFAS No. 109, “Accounting for Income Taxes.” Under this method, the Corporation’s deferred tax assets and liabilities are determined by applying federal and state tax rates currently in effect to its cumulative temporary book/tax differences. Temporary differences are differences between financial statement carrying amounts and the corresponding tax bases of assets and liabilities. Deferred taxes are provided as a result of such temporary differences.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Earnings Per Share: Earnings per share computations are based upon the weighted average number of shares outstanding during the periods. Diluted earnings per share computations are based upon the weighed average number of shares outstanding during the periods plus the dilutive effect of outstanding stock options.
Stock Based Compensation: At December 31, 2007, we had a stock option plan, which is described more fully in Note 16 to the Consolidated Financial Statements in this annual report. Effective January 1, 2006, we adopted SFAS No. 123 (revised), “Share-Based Payment” (“SFAS 123R”) utilizing the modified prospective approach. Prior to the adoption of SFAS 123R we accounted for stock option grants in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (the intrinsic value method), and accordingly recognized no compensation expense for stock option grants.
Under the modified prospective approach, SFAS 123R applies to new awards granted after the effective date and for all unvested awards granted prior to the effective date and requires compensation cost to be recognized based upon the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Prior periods were not restated to reflect the impact of adopting the new standard.
Grant-date fair value is measured on the date of grant using an option-pricing model with market assumptions. The grant-date fair value is amortized into expense on a straight-line basis over the vesting period. We used the minimum value option pricing method until we began trading as a public company on NASDAQ on September 21, 2005. After this date we applied the Black-Scholes option-pricing model. Option pricing models require the use of highly subjective assumptions, including but not limited to, expected stock price volatility, forfeiture rates, and interest rates, which if changed can materially affect fair value estimates. Accordingly the model does not necessarily provide a reliable single measure of the fair value of our stock options.
As a result of adopting SFAS 123R on January 1, 2006, our income before taxes and net income for the years ended December 31, 2007 and 2006, were $151,141 and $99,753, and $62,476 and $41,234, respectively lower than if we had continued to account for stock-based compensation under APB opinion No. 25 for our stock option grants. The effect of adopting this standard on our earnings per share was not significant.
The following table provides pro forma net income and earnings per share information, adjusted for the one-for-four reverse stock split effected on September 1, 2005, as if we had applied the fair value recognitions provisions of SFAS No. 123R to stock-based employee compensation option plans for the year ended December 31, 2005:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Prior to the adoption of Statement 123R, we would have presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the statement of cash flows. Statement 123R requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.
Statement of Cash Flows: For purposes of the Consolidated Statement of Cash Flows, we defined cash on hand, amounts due from banks, and federal funds sold as cash and cash equivalents. Generally, federal funds are purchased and sold for one-day periods.
Comprehensive Income: SFAS No. 130, “Reporting Comprehensive Income” establishes standards for reporting and displaying comprehensive income and its components in general-purpose financial statements. The statement requires additional reporting of items that are recorded directly to stockholders’ equity, but not reported in net income, such as unrealized gains and losses on available-for-sale securities. We elected to present the required disclosures in the Consolidated Statements of Changes in Stockholders’ Equity.
Recent Accounting Standards
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. The Statement provides guidance for using fair value to measure assets and liabilities. It defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurement. Under the Statement, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. It clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the Statement establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the Statement, fair value measurements would be separately disclosed by level within the fair value hierarchy. Statement No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and is not expected to have a material impact on our financial condition or results of operations.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115. The Statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument (with a few exceptions), is irrevocable (unless a new election date occurs) and is applied only to entire instruments and not to portions of instruments. Most of the provisions in Statement 159 are elective; however, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. Statement No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007 and is not expected to have a material impact on our financial condition or results of operations.
In December 2007, the FASB issued Statement No. 141 (Revised 2007), Business Combinations. The Statement will significantly change the accounting for business combinations, as an acquiring entity will be required to recognize all the assets and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. The Statement changes the accounting treatment for several specific items, such as acquisition costs, noncontrolling interests (formerly referred to as minority interests), contingent liabilities, restructuring costs and changes in deferred tax asset valuation allowances. The Statement also includes a substantial number of new disclosure requirements. Statement No. 141R applies prospectively to business
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. We are currently evaluating the impact the adoption of this statement will have on the accounting for future acquisitions and business combinations.
In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51. The Statement establishes new accounting and reporting standards for the noncontrolling interest (formerly referred to as minority interests) in a subsidiary and for the deconsolidation of a subsidiary. Statement No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on our after December 15, 2008 and early adoption is prohibited. We currently do not have any noncontrolling interests and is evaluating the impact the adoption of this statement will have on the accounting for future business combinations and ventures.
NOTE 2-RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The Bank is required by regulation to maintain average cash reserve balances based on a percentage of deposits. The required cash reserve balances for the periods ended December 31, 2007 and 2006 were $4.1 million and $4.9 million, respectively.
NOTE 3-INVESTMENT SECURITIES
The amortized cost and fair value of investment securities available-for-sale at December 31 are presented below:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The amortized cost and fair value of debt securities available-for-sale at December 31, 2007, based on contractual maturities, are shown below. Actual maturities may differ from contractual maturities or maturities shown below because borrowers have the right to prepay obligations with or without prepayment penalties.
Investment securities with a fair value of $137,184,805 and $117,715,769 at December 31, 2007 and 2006, respectively, were pledged as collateral for borrowed funds and for other purposes as required or permitted by law.
Proceeds from sales of investment securities available-for-sale were $35,951,716, $15,768,262, and $4,560,304 in 2007, 2006, and 2005, respectively.
Gains of $292,051, $722,506, and $468,351 were realized on these sales during 2007,2006, and 2005, respectively. Losses of $481,553 were realized on these sales during 2006. There were no realized losses in 2007 and 2005.
The reclassification of unrealized holding gains to net gains realized in net income is presented below for each year ended December 31:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The fair value and unrealized losses on investment securities with unrealized losses at December 31, 2007 are presented below. The fair value and unrealized losses are presented for those securities that have had unrealized losses for less than 12 months and those that have been in an unrealized loss position for 12 consecutive months or longer.
The fair value and unrealized losses on investment securities with unrealized losses at December 31, 2006 are presented below. The fair value and unrealized losses are presented for those securities that have had unrealized losses for less than 12 months and those that have been in an unrealized loss position for 12 consecutive months or longer.
The above securities are considered temporarily impaired and no loss has been recognized. We have the ability and intent to hold these securities until such time as the value recovers or the securities mature. We believe, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 4-LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans at December 31 are comprised of the following:
Included in gross loans at December 31, 2007 and 2006 were ($11,449) and $113,905, respectively of net deferred loan costs (fees).
The following table presents selected loan maturities and interest rate sensitivity at December 31, 2007:
Our directors and executive officers are loan and deposit customers and have other transactions with us in the ordinary course of business. Total loans to these persons were $5,888,926 and $485,000 at December 31, 2007 and 2006, respectively. Total commitments to these persons were $6,673,890 and $1,009,000 at December 31, 2007 and 2006, respectively. These loans were made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and involve no unusual risk or collectibility.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Activity in the allowance for loan losses is summarized as follows:
Our nonperforming assets (including cash basis loans) at December 31, are summarized below:
Impaired loans, which include nonaccrual loans and loans past due 90 days or more, are loans for which it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. At December 31, 2007 we had 17 loans totaling $38,495,576 considered impaired compared to 1 loan for $513,920 at December 21, 2006. Impaired loans had a related specific allowance for loan losses of $2,110,388 and $0 at December 31, 2007 and 2006, respectively. There were no material commitments to lend additional funds to customers whose loans were classified as impaired at December 31, 2007 and 2006. The average investment in impaired loans for 2007, 2006, and 2005 was $10,573,500, $803,250, and $713,750, respectively.
None of our impaired loans have had terms modified in troubled-debt restructurings.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 5-PREMISES AND EQUIPMENT
Premises and equipment at December 31, consist of the following:
Provision for depreciation included in noninterest expense in 2007, 2006, and 2005 was $ 512,816, $508,300, and $451,227, respectively. We have entered into various noncancellable operating leases for buildings and equipment used in its operations. Certain leases have various renewal options, which include increased rentals under cost of living escalation clauses. Rental expenses charged to occupancy and equipment expense in 2007, 2006, and 2005 were $754,783, $582,332, and $518,338, respectively.
At December 31, 2007, future minimum rental commitments under noncancellable operating leases that have a remaining life in excess of one year are summarized as follows:
NOTE 6-INTANGIBLE ASSETS
Upon the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets” on January 1, 2002, the Corporation ceased amortizing other intangible assets. The Corporation has had no changes in the carrying amount of intangible assets during the years ended December 31, 2007 and 2006.
NOTE 7-OTHER ASSETS AND OTHER LIABILITIES
Accrued interest receivable and other assets at December 31 are comprised of the following:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Accrued expenses and other liabilities at December 31 are comprised of the following:
NOTE 8-DEPOSITS
The aggregate amount of time deposits at December 31, 2007 was $427,645,180, which included brokered deposits of $15,201,000.
At December 31, 2007, the aggregate maturities of time deposits are summarized as follows:
NOTE 9-INCOME TAXES
The components of consolidated income tax expense for the years ended December 31, 2007, 2006, and 2005 are as follows:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The significant components of the Corporation’s deferred tax liabilities and assets recorded pursuant to SFAS No. 109 and included in the Consolidated Balance Sheets at December 31, 2007 and 2006 are as follows:
The realization of deferred tax assets will be based on future taxable income.
The state net operating loss carryforwards available to us as of December 31, 2007 in the various states in which we operate totaled $5.2 million and expire in various years through 2027.
Total income tax expense differs from the amount of income tax determined by applying the U.S. statutory federal income tax rate (34%) to pretax income as a result of the following differences for the years ended December 31, 2007, 2006 and 2005:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The Company adopted Financial Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises’ financial statements in accordance with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The following table reconciles the changes to our unrecognized tax benefit for the year ended December 31, 2007 recognized in accordance with FIN 48:
The total amount of unrecognized tax benefit that, if recognized, would affect the effective tax rate was $140,000 at December 31, 2007. The total amount of interest and penalties included in the consolidated balance sheet as of December 31, 2007 was $10,000.
We file a federal U.S. tax return and various state income and franchise tax returns. We are subject to examination for our federal U.S. returns for calendar years 2004 through 2007. In general, we are subject to state income tax examinations for calendar years 2004 through 2007.
NOTE 10-SHORT-TERM BORROWINGS
Short-term borrowings at December 31 include the following:
We have unsecured federal funds lines of credit with correspondent banks totaling $40.0 million. We are a member of the FHLB and may borrow short-term and long-term funds up to thirty percent of the Bank’s total assets. Pursuant to collateral agreements with the FHLB, advances are secured by Federal Home loan Bank stock (carried at cost of $7.5 million) and U.S. Treasury, Government sponsored agency securities, and mortgage-backed securities.
We provide clearing and cash management services to community banks. As part of this program we may retain a portion of these funds as unsecured federal funds purchased up to the limit established by the community bank. We typically sell a significant portion of these funds to upstream correspondent banks. At December 31, 2007 and 2006, our total federal funds purchased through this program were $16,930,082 and $35,000,000, respectively.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 11-LONG-TERM DEBT
Advances from the FHLB with an initial maturity of more than one year totaled $120,000,000 and $110,000,000 at December 31, 2007 and 2006, respectively. These advances are collateralized by the same collateral agreements as short-term funds from the FHLB (See Note 10). Fixed interest rates on these advances ranged from 2.99% to 4.80%, payable monthly or quarterly, with principal due at various maturities ranging from 2010 to 2017.
The FHLB has the option to convert $70,000,000 in advances to three month LIBOR-based floating rate advances in 2008, $15,000,000 in 2009, $25,000,000 in 2010, and $5,000,000 in 2011.
We have a revolving line of credit with LaSalle Bank of $15,000,000 of which $1,400,000 was outstanding at December 31, 2007. Under the terms of the Loan Agreement, the loan is secured by 100% of the common stock in the Bank. This advance matures on November 18, 2008, and has a floating rate equal to three month LIBOR, appearing in the Wall Street Journal, plus 150 basis points (1.50%), which was 6.3575% at December 31, 2007. Interest is payable quarterly and principal is due at maturity
Principal maturities on long-term debt are summarized below:
NOTE 12-JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED SUBSIDIARY TRUSTS
We formed Nexity Capital Trust II, a Delaware statutory trust, of which 100% of the common equity is owned by the Corporation. The trust was formed for the purpose of issuing Corporation-obligated mandatory redeemable trust preferred securities to third-party investors and investing the proceeds from the sale of such trust preferred securities solely in junior subordinated debt securities of the Corporation (the debentures). The debentures held by the trust are the sole assets of the trust. Distributions on the trust preferred securities issued by the trust are payable quarterly at a rate per annum equal to three-month LIBOR plus 280 basis points.
We have fully and unconditionally guaranteed all obligations of Nexity Capital Trust II on a subordinated basis with respect to the trust preferred securities. The trust preferred securities and subordinated debentures have 30-year lives with a call option on July 23, 2009 and each interest date thereafter, subject to regulatory approval, or earlier, depending upon certain changes in tax or investment company laws, or regulatory capital requirements.
Subject to certain limitations, the trust preferred securities qualify as Tier 1 capital for the Corporation under Federal Reserve Board guidelines.
As a result of applying the provisions of FIN 46, governing when an equity interest should be consolidated, we were required to deconsolidate the subsidiary trust from its financial statements in 2006 and 2007. The deconsolidation of the net assets and results of operations of the trust had virtually no impact on our financial statements or liquidity position, since we continue to be obligated to repay the debentures held by the trust and guarantees repayment of the trust preferred securities issued by the trust.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Our consolidated debt obligations related to subsidiary trust holding solely debentures of the Corporation follows:
NOTE 13-OTHER OPERATING EXPENSE
Other operating expense for the years ended December 31, includes the following:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 14-PER SHARE INFORMATION
SFAS No. 128, “Earnings Per Share,” requires dual presentation of basic and diluted EPS on the face of the Consolidated Statement of Income and requires a reconciliation of the numerator and denominator of the diluted EPS calculation.
Net income per share-basic is computed by dividing net income by the weighted average number of common shares outstanding. Net income per share-diluted is computed by dividing net income by the weighted average number of common shares outstanding and dilutive common share equivalents using the treasury stock method. Dilutive common share equivalents include common shares issuable upon exercise of outstanding stock options.
In accordance with SFAS No. 128, the calculation of net income per share-basic and net income per share-diluted for the years ended December 31 are presented below:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 15-EMPLOYEE BENEFIT PLANS
We adopted a pre-tax savings plan (“401(k) Plan”), which covers substantially all employees of the Corporation effective January 1, 2000. The 401(k) Plan allows for employer matching contributions and discretionary profit sharing contributions. The Board of Directors approved a discretionary employer matching contribution and a profit sharing contribution to the 401(k) Plan in 2007, 2006 and 2005. Total expenses of the 401(k) Plan, including amounts contributed, which are included in employee benefits expense for the years ended December 31, 2007, 2006, and 2005 were $373,041, $293,979, and $261,229, respectively.
In 2004, we began maintaining Supplementary Executive Retirement Plans (“SERPs”) for certain officers. These plans provide salary continuation benefits after the participant reaches normal retirement age and continue for 15 years. The SERPs also provide limited benefits in the event of early termination, death, or disability while employed by the Corporation. The officers vest in the benefits over a ten-year period as defined by the SERPs. In the event of a change of control of the Corporation as defined in the SERPs, the officers become 100% vested in the total benefit. We have purchased life insurance policies on these officers, the earnings from which offset the expense of the SERP’s. For the years ended December 31, 2007, 2006, and 2005, $85,978, $69,481, and $61,644, respectively, were charged to operations related to these SERPs.
NOTE 16-STOCK OPTION PLAN
During 1999, we adopted a stock option plan covering certain officers, employees and directors. The maximum number of shares issuable under the plan is 2,250,000, adjusted for the one-for-four reverse stock split effected on September 1, 2005. Options granted under the plan become exercisable generally over a three-year period and have a ten year life. Some of the options granted under the plan became exercisable immediately while other options granted under the plan expire in periods of five to ten years from the date of grant.
Activity under the plan is summarized below and is adjusted for the one-for-four reverse stock split effected on September 1, 2005:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The following table presents information on nonvested stock options for the year ended December 31, 2007:
The following table presents information on stock options outstanding as of December 31, 2007:
* The aggregate intrinsic value of stock options with an exercise price less than $6.64, the closing price of the Company’s common stock on December 31, 2007, was $3,485,117.
At December 31, 2007, 1,729,708 optioned shares were exercisable at prices between $4.00 and $20.00 per share. When options are exercised, par value of the shares issued is recorded as an addition to common stock, and the remainder of the proceeds (including any tax benefit, if applicable) is credited to capital surplus. The following table summarizes information about stock options outstanding at December 31, 2007.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The compensation cost related to our stock option plan charged against income for the years ended December 31, 2007, 2006 and 2005 were $151,141, $62,476, and $0 respectively. Income tax benefits recognized for the respective years were $51,388, $21,242, and $0.
There were no options exercised during the year ended December 31, 2007. Cash received from the exercise of options was $124,020 and $104,508 for the years ended December 31, 2006 and 2005, respectively. The tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $96,551 and $39,871 for the years ended December 31, 2006 and 2005, respectively.
As of December 31, 2007, there was $215,453 of total unrecognized compensation cost related to the nonvested share based compensation arrangements granted under the option plan. That cost is expected to be recognized over a weighted-average period of 1.9 years.
Grant-date fair value is measured on the date of grant using an option-pricing model with market assumptions. The grant-date fair value is amortized into expense on a straight-line basis over the vesting period. We used the minimum value option pricing method until we began trading as a public company on NASDAQ on September 21, 2005. After this date we applied the Black-Scholes-Merton option-pricing model. Our option pricing models require the use of highly subjective assumptions, including but not limited to, expected stock price volatility, term, dividend rates, forfeiture rates, and risk-free interest rates, which if changed can materially affect fair value estimates. Accordingly the model does not necessarily provide a reliable single measure of the fair value of our stock options.
The following is a summary of the Corporation’s weighted average assumptions used to estimate the weighted-average per share fair value of options granted on the date of grant using the Black-Scholes-Merton option pricing model since September 21, 2005 and the minimum value option-pricing model the remainder of 2005:
NOTE 17-DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, “Disclosure About Fair Value of Financial Instruments,” requires entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized (See Note 18).
Many of our financial instruments lack an available trading market as characterized by a willing buyer and a willing seller engaging in an exchange transaction. Further, our general practice is to hold our financial instruments to maturity and not to engage in trading activities. Therefore, we used significant estimates and present value calculations for the purpose of this disclosure. Such estimates involve judgments as to economic conditions, risk characteristics, and future expected loss experience of various financial instruments and other factors that cannot be determined with precision. The fair value estimates presented herein are based on information available to management as of December 31, 2007 and 2006.
The following is a description of the methods and assumptions used to estimate the fair value of each class of the Corporation’s financial instruments:
Cash and short-term investments: The carrying amount is a reasonable estimate of fair value.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Investment securities: For securities available-for-sale, fair value equals the carrying amount which is generally the quoted market price. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans: For certain categories of loans, such as variable rate loans and other lines of credit, the carrying amount, adjusted for credit risk, is a reasonable estimate of fair value because there is no contractual maturity and/or we have the ability to reprice the loan as interest rate shifts occur. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. As the discount rates are based on current loan rates as well as management estimates, the fair values presented may not necessarily be indicative of the value negotiated in an actual sale.
Other financial assets: Include bank-owned life insurance for which the carrying value is a reasonable estimate of fair value and is included in accrued interest receivable and other assets on the Consolidated Balance Sheets.
Deposit liabilities: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
Short-term borrowings: The carrying amount is a reasonable estimate of fair value.
Long-term borrowings and subordinated debentures: The fair value of long-term borrowings and subordinated debentures is estimated using discounted cash flow analyses, based on the Corporation’s estimated borrowing rates for similar types of borrowing arrangements.
Standby letters of credit: The fair value of standby letters of credit are generally based upon fees charged to enter into similar agreements taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Commitments to extend credit: For certain categories of commitments, and variable rate lines of credit, a reasonable estimate of fair value would be nominal because we have the ability to reprice the commitment as interest rate shifts occur. The fair value of other types of commitments to extend credit is estimated by discounting the potential future cash flows using the current rate at which similar commitments would be made to borrowers with similar credit ratings. As the discount rates are based on current loan rates as well as management estimates, the fair values presented may not necessarily be indicative of the value negotiated in an actual sale.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The estimated fair values (in thousands) of the Corporation’s financial instruments at December 31 are as follows:
NOTE 18-COMMITMENTS, CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
We have various claims, commitments, and contingent liabilities arising from the normal conduct of our business which are not reflected in the accompanying consolidated financial statements and are not expected to have any material adverse effect on our financial position or results of operations.
We are defendants in litigation and claims arising from the normal course of business. Based on consultation with legal counsel, management is of the opinion that the outcome of pending and threatened litigation will not have a material impact on our consolidated financial statements.
We are party to financial instruments with off-balance sheet risk (See Note 17) in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and stand-by letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. The notional value of those instruments reflect the extent of involvement we have in each class of financial instruments.
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 payment of a fee. Generally, we do not charge a fee to customers to extend a commitment. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Standby letters of credit are conditional commitments issued by the us to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit to customers. The amount of collateral obtained if deemed necessary by use upon extension of credit is based on management’s credit evaluation of the counterparty.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the notional value of those instruments. We use the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. We require collateral or other security to support certain financial instruments with credit risk. The notional and estimated fair value of these financial instruments at December 31, 2007 and 2006 are presented in Note 17.
NOTE 19-REGULATORY MATTERS
The Corporation 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 possibly additional discretionary actions by regulators that if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of the Corporation’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. Bank holding companies are not subject to prompt corrective action provisions.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets as defined in the regulations. Management believes, as of December 31, 2007, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2007 and 2006, the Bank was well capitalized under this regulatory framework. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since December 31, 2007 that management believes have changed either the Corporation’s or the Bank’s capital classifications.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The Corporation’s and the Bank’s actual capital amounts and ratios are also presented in the table.
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
NOTE 20-NEXITY FINANCIAL CORPORATION (PARENT COMPANY ONLY)
The Parent’s principal assets are its investments in the Bank, and the principal source of income for the Parent will be dividends from the Bank. Certain regulatory and legal requirements restrict payment of dividends and lending of funds between the Bank and the Parent.
The Parent’s condensed balance sheets at December 31, 2007 and 2006, and condensed statements of income and of cash flows for the years ended December 31 are presented below:
Nexity Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The Parent paid interest of $1,035,848, $969,222, and $768,943 in 2007, 2006, and 2005, respectively. The Parent paid taxes or received (benefits) of ($392,275), $35,251, and ($320,100) in 2007, 2006, and 2005, respectively.
NOTE 21-QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
NOTE 22-SUBSEQUENT EVENT
In March of 2008, the Bank entered into a contract to purchase a building for our headquarters in Birmingham, AL for $8,606,250.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no disagreements or reportable events with accountants on accounting and financial disclosure.
Item 9A.
Item 9A. Controls and Procedures
(a) Management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness, as of December 31, 2007, of our “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures, as of December 31, 2007, were effective to provide reasonable assurance that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Management’s Report on Internal Control Over Financial Reporting
The management of Nexity Financial Corporation and Subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15 and 15d-15. This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The management of Nexity Financial Corporation and Subsidiaries has assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2007. To make this assessment, we used the criteria for effective internal control over financial reporting described in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment and based on such criteria, we believe that, as of December 31, 2007, the Company’s internal control over financial reporting was effective.
Mauldin & Jenkins, LLC, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued a report on the Company’s internal control over financial reporting as of December 31, 2007. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, is included in this Item under the heading “Report of Independent Registered Public Accounting Firm.”
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Nexity Financial Corporation
Birmingham, Alabama
We have audited Nexity Financial Corporation and Subsidiaries’ 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). Nexity Financial Corporation and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Nexity Financial Corporation and Subsidiaries 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 the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Nexity Financial Corporation and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income and cash flows for the years then ended and our report dated March 12, 2008 expressed an unqualified opinion.
/s/ Mauldin & Jenkins LLC
Birmingham, Alabama
March 12, 2008
(c) Changes in internal control over financial reporting. We continually assess the adequacy of our internal control over financial reporting and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. No control enhancements during the quarter ended December 31, 2007 or through the date of this Annual Report on Form 10-K have materially affected, or are reasonably likely to materially 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
See Executive Compensation Plan in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
See Election of Directors, Description of the Board Committees, Section 16(a) Beneficial Ownership Reporting Compliance, Certain Relationships and Related Transactions, Executive Officers, and Corporate Governance in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
Information about director and executive compensation is incorporated by reference from the discussion under the headings Executive Compensation, Description of the Board Committees, Compensation Committee Report, and Total Shareholder Return in our 2008 Proxy Statement, which information is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
See Security Ownership of Directors and Management in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
See Equity Compensation Plan Information in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
See Certain Relationships and Related Transactions in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
See Audit Fees, Other Audit Committee Matters, and Selection of Independent Public Accountants in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders filed with the Securities and Exchange Commission, which information is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements filed as part of this report:
The following management’s statement on responsibility for financial reporting, report of independent registered public accounting firm and consolidated financial statements for the year ending December 31, 2007 are included in Item 8 hereof:
Management’s Statement on Responsibility for Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2007 and 2006
Consolidated Statements of Income for the years ended December 31, 2007, 2006, and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006, and 2005
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
Notes to Consolidated Financial Statements
57-82
(a)(2) Financial Statement Schedules
All schedules to the consolidated financial statements required by Article 9 of Regulation S-X and all other schedules to the financial statements required by Article 5 of Regulation S-X are not required under the related instructions or are inapplicable and, therefore, have been omitted, or the required information in contained in the Consolidated Financial Statements or the notes thereto, which are included in Item 8 hereof.
(a)(3) Listing of Exhibits
* Indicates filed herewith.
+ Indicates management contract or compensatory plan.
Copies of exhibits are available upon written request to John J. Moran, Executive Vice President and Chief Financial Officer of Nexity Financial Corporation and online at the SEC’s website, www.sec.gov.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this to be signed on its behalf by the undersigned, thereunto duly authorized.
NEXITY FINANCIAL CORPORATION
(Registrant)
Exhibit Index
+ Indicates management contract or compensatory plan