FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2012
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 0-13358
(Exact name of registrant as specified in its charter)
Florida
59-2273542
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
217 North Monroe Street, Tallahassee, Florida
32301
(Address of principal executive office)
(Zip Code)
(850) 402-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes oNo x
At October 31, 2012, 17,228,761 shares of the Registrant’s Common Stock, $.01 par value, were outstanding.
CAPITAL CITY BANK GROUP, INC.QUARTERLY REPORT ON FORM 10-QFOR THE PERIOD ENDED SEPTEMBER 30, 2012TABLE OF CONTENTS
Page
PART I – Financial Information
Item 1.
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Financial Condition – September 30, 2012 and December 31, 2011
4
Consolidated Statements of Operations and Comprehensive Income – Three and Nine Months Ended September 30, 2012 and 2011
5
Consolidated Statement of Changes in Shareowners’ Equity – Nine Months Ended September 30, 2012 and 2011
6
Consolidated Statements of Cash Flow – Nine Months Ended September 30, 2012 and 2011
7
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
42
Item 4.
Controls and Procedures
PART II – Other Information
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
43
Signatures
44
2
INTRODUCTORY NOTECaution Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements.
Our ability to achieve our financial objectives could be adversely affected by the factors discussed in detail in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q, the following sections of our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”): (a) “Introductory Note” in Part I, Item 1. “Business”; (b) “Risk Factors” in Part I, Item 1A., as updated in our subsequent quarterly reports filed on Form 10-Q, and (c) “Introduction” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II, Item 7 as well as:
▪
our need and our ability to incur additional debt or equity financing;
the accuracy of our financial statement estimates and assumptions, including the estimates used for our loan loss provision and deferred tax asset valuation allowance;
continued depression of the market value of the Company that could result in an impairment of goodwill;
the frequency and magnitude of foreclosure of our loans;
the effects of our lack of a diversified loan portfolio, including the risks of geographic and industry concentrations;
our ability to successfully manage interest rate risk, liquidity risk, and other risks inherent to our industry;
legislative or regulatory changes, including the Dodd-Frank Act and Basel III;
the strength of the United States economy in general and the strength of the local economies in which we conduct operations;
restrictions on our operations, including the inability to pay dividends without our regulators’ consent;
the effects of the health and soundness of other financial institutions, including the FDIC’s need to increase Deposit Insurance Fund assessments;
our ability to declare and pay dividends;
changes in the securities and real estate markets;
changes in monetary and fiscal policies of the U.S. Government;
inflation, interest rate, market and monetary fluctuations;
the effects of harsh weather conditions, including hurricanes, and man-made disasters;
our ability to comply with the extensive laws and regulations to which we are subject;
our ability to comply with the laws of each jurisdiction where we operate;
the willingness of clients to accept third-party products and services rather than our products and services and vice versa;
increased competition and its effect on pricing;
technological changes;
negative publicity and the impact on our reputation;
the effects of security breaches and computer viruses that may affect our computer systems;
changes in consumer spending and saving habits;
growth and profitability of our noninterest income;
changes in accounting principles, policies, practices or guidelines;
the limited trading activity of our common stock;
the concentration of ownership of our common stock;
anti-takeover provisions under federal and state law as well as our Articles of Incorporation and our Bylaws;
other risks described from time to time in our filings with the Securities and Exchange Commission; and
our ability to manage the risks involved in the foregoing.
However, other factors besides those referenced also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
3
PART I. FINANCIAL INFORMATIONItem 1. CONSOLIDATED FINANCIAL STATEMENTS
CAPITAL CITY BANK GROUP, INC.CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands, Except Share Data)
Unaudited September 30, 2012
December 31, 2011
ASSETS
Cash and Due From Banks
$
53,076
54,953
Federal Funds Sold and Interest Bearing Deposits
314,318
330,361
Total Cash and Cash Equivalents
367,394
385,314
Investment Securities, Available-for-Sale
288,166
307,149
Loans Held For Sale
16,527
21,225
Loans, Net of Unearned Income
1,516,768
1,607,458
Allowance for Loan Losses
(30,222
)
(31,035
Loans, Net
1,486,546
1,576,423
Premises and Equipment, Net
109,003
110,991
Goodwill
84,811
Other Intangible Assets
350
673
Other Real Estate Owned
53,172
62,600
Other Assets
87,815
92,126
Total Assets
2,493,784
2,641,312
LIABILITIES
Deposits:
Noninterest Bearing Deposits
596,660
618,317
Interest Bearing Deposits
1,423,934
1,554,202
Total Deposits
2,020,594
2,172,519
Short-Term Borrowings
42,388
43,372
Subordinated Notes Payable
62,887
Other Long-Term Borrowings
38,126
44,606
Other Liabilities
79,427
65,986
Total Liabilities
2,243,422
2,389,370
SHAREOWNERS’ EQUITY
Preferred Stock, $.01 par value, 3,000,000 shares authorized; no shares outstanding
—
Common Stock, $.01 par value, 90,000,000 shares authorized; 17,223,157 and 17,160,274 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
172
Additional Paid-In Capital
38,493
37,838
Retained Earnings
235,694
237,461
Accumulated Other Comprehensive Loss, Net of Tax
(23,997
(23,529
Total Shareowners’ Equity
250,362
251,942
Total Liabilities and Shareowners’ Equity
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
CAPITAL CITY BANK GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME(Unaudited)
Three Months EndedSeptember 30,
Nine Months EndedSeptember 30,
(Dollars in Thousands, Except Per Share Data)
2012
2011
INTEREST INCOME
Interest and Fees on Loans
21,274
23,777
64,638
72,029
Taxable Securities
692
828
2,216
2,504
Tax Exempt Securities
106
150
316
562
Federal Funds Sold
254
136
723
452
Total Interest Income
22,326
24,891
67,893
75,547
INTEREST EXPENSE
Deposits
480
907
1,679
3,248
71
78
127
299
372
339
1,126
1,022
467
1,204
1,453
Total Interest Expense
1,295
1,791
4,136
6,022
NET INTEREST INCOME
21,031
23,100
63,757
69,525
Provision for Loan Losses
2,864
3,718
13,400
11,396
Net Interest Income After Provision For Loan Losses
18,167
19,382
50,357
58,129
NONINTEREST INCOME
Service Charges on Deposit Accounts
6,406
6,629
19,028
18,921
Data Processing
687
749
2,042
2,487
Asset Management Fees
1,020
1,080
3,055
3,240
Retail Brokerage Fees
666
807
2,308
2,475
Mortgage Banking Fees
978
645
2,690
1,830
Bank Card Fees
2,616
2,590
8,171
7,644
Other
1,202
1,693
3,773
8,378
Total Noninterest Income
13,575
14,193
41,067
44,975
NONINTEREST EXPENSE
Salaries and Associate Benefits
15,510
15,805
48,470
48,382
Occupancy, Net
2,332
2,495
6,874
7,338
Furniture and Equipment
2,245
2,118
6,691
6,461
Intangible Amortization
108
323
568
Other Real Estate
2,542
9,589
9,252
7,390
7,579
23,144
Total Noninterest Expense
30,201
30,647
95,091
95,145
INCOME (LOSS) BEFORE INCOME TAXES
1,541
2,928
(3,667
7,959
Income Tax Expense (Benefit)
420
951
(1,900
2,527
NET INCOME (LOSS)
1,121
1,977
(1,767
5,432
Other Comprehensive Income:
Change in Net Unrealized Gain On Available-For-Sale Securities (net of tax)
(14
(230
(468
461
Total Comprehensive Income (Loss)
1,107
1,747
(2,235
5,893
BASIC NET INCOME (LOSS) PER SHARE
0.07
0.12
(0.10
0.32
DILUTED NET INCOME (LOSS) PER SHARE
Average Basic Shares Outstanding
17,215
17,152
17,196
17,134
Average Diluted Shares Outstanding
17,228
17,167
17,143
CAPITAL CITY BANK GROUP, INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY(Unaudited)
Shares Outstanding
Common Stock
AdditionalPaid-In Capital
AccumulatedOther Comprehensive Loss, Net of Taxes
Total
Balance, January 1, 2012
17,160,274
Comprehensive Income:
Net Loss
Change in Net Unrealized Gain on Available-for-Sale Securities (net of tax benefit of $286)
Total Comprehensive Loss
Stock Performance Plan Compensation
131
Issuance of Common Stock
62,883
524
Balance, September 30, 2012
17,223,157
SharesOutstanding
Accumulated Other Comprehensive Loss, Net ofTaxes
Balance, January 1, 2011
17,100,081
171
36,920
237,679
(15,751
259,019
Net Income
Change in Net Unrealized Gain on Available-for-Sale Securities (net of tax expense of $287)
Total Comprehensive Income
Cash Dividends ($0.30 per share)
(5,142
430
56,490
1
724
725
Balance, September 30, 2011
17,156,571
38,074
237,969
(15,290
260,925
CAPITAL CITY BANK GROUP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)
Nine Months Ended September 30,
(Dollars in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net (Loss) Income
Adjustments to Reconcile Net (Loss) Income to Cash Provided by Operating Activities:
Depreciation
5,087
5,127
Amortization of Premiums, Discounts, and Fees (net)
2,441
2,789
Amortization of Intangible Assets
Net Decrease (Increase) in Loans Held-for-Sale
4,698
(3,889
Stock-Based Compensation
Deferred Income Taxes
(920
(586
Loss on Sales and Write-Downs of Other Real Estate Owned
5,504
4,368
Net Decrease in Other Assets
5,516
8,520
Net Increase in Other Liabilities
13,441
10,322
Net Cash Provided By Operating Activities
47,854
44,477
CASH FLOWS FROM INVESTING ACTIVITIES
Securities Available-for-Sale:
Purchases
(105,774
(60,672
Sales
805
Payments, Maturities, and Calls
120,614
62,257
Net Decrease in Loans
62,582
56,467
Proceeds From Sales of Other Real Estate Owned
17,963
23,660
Purchases of Premises and Equipment
(3,099
(1,242
Net Cash Provided By Investing Activities
93,091
80,470
CASH FLOWS FROM FINANCING ACTIVITIES
Net Decrease in Deposits
(151,925
(60,178
Net Decrease in Short-Term Borrowings
(8,168
(45,419
Increase in Other Long-Term Borrowings
3,070
789
Repayment of Other Long-Term Borrowings
(2,366
(5,501
Dividends Paid
Net Cash Used In Financing Activities
(158,865
(114,726
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(17,920
10,221
Cash and Cash Equivalents at Beginning of Period
236,193
Cash and Cash Equivalents at End of Period
246,414
Supplemental Disclosure:
Loans Transferred to Other Real Estate Owned
14,039
31,287
Transfer of Current Portion of Long-Term Borrowings
7,184
CAPITAL CITY BANK GROUP, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Capital City Bank Group, Inc. (“CCBG” or the “Company”) provides a full range of banking and banking-related services to individual and corporate clients through its subsidiary, Capital City Bank, with banking offices located in Florida, Georgia, and Alabama. The Company is subject to competition from other financial institutions, is subject to regulation by certain government agencies and undergoes periodic examinations by those regulatory authorities.
Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of CCBG, and its wholly-owned subsidiary, Capital City Bank (“CCB” or the “Bank” and together with the Company). All material inter-company transactions and accounts have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.
The consolidated statement of financial condition at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011.
NOTE 2 - INVESTMENT SECURITIES
Investment Portfolio Composition. The amortized cost and related market value of investment securities available-for-sale were as follows:
September 30, 2012
AmortizedCost
UnrealizedGains
UnrealizedLosses
MarketValue
U.S. Treasury
108,028
690
108,718
U.S. Government Agency
41,664
153
15
41,802
States and Political Subdivisions
70,438
165
70,561
Mortgage-Backed Securities
55,644
677
69
56,252
Other Securities(1)
11,433
600
10,833
Total Investment Securities
287,207
1,685
726
168,001
1,463
169,464
14,758
27
48
14,737
58,946
186
38
59,094
51,775
809
87
52,497
11,957
11,357
305,437
2,485
773
(1)
Includes Federal Home Loan Bank and Federal Reserve Bank stock recorded at cost of $6.0 million and $4.8 million, respectively, at September 30, 2012 and $6.5 million and $4.8 million, respectively, at December 31, 2011.
Securities with an amortized cost of $136.3 million and $102.1 million at September 30, 2012 and December 31, 2011, respectively, were pledged to secure public deposits and for other purposes.
The Bank, as a member of the Federal Home Loan Bank of Atlanta (“FHLB”), is required to own capital stock in the FHLB based generally upon the balances of residential and commercial real estate loans, and FHLB advances. FHLB stock which is included in other securities is pledged to secure FHLB advances. No ready market exists for this stock, and it has no quoted market value. However, redemption of this stock has historically been at par value.
Maturity Distribution. As of September 30, 2012, the Company’s investment securities had the following maturity distribution based on contractual maturities:
Amortized Cost
Market Value
Due in one year or less
99,462
99,800
Due after one through five years
175,495
176,636
Due after five through ten years
817
897
Due over ten years
No Maturity
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Other Than Temporarily Impaired Securities. The following table summarizes the investment securities with unrealized losses aggregated by major security type and length of time in a continuous unrealized loss position.
Less Than12 Months
Greater Than12 Months
7,273
14
1,228
8,501
17,022
36
4,051
21,073
4,111
22
6,347
47
10,458
Other Securities
28,406
72
12,226
654
40,632
9,698
14,597
11,612
37
11,649
35,907
173
637
36,544
Management evaluates securities for other than temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: 1) the length of time and the extent to which the fair value has been less than amortized cost, 2) the financial condition and near-term prospects of the issuer, and 3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by rating agencies have occurred, regulatory issues, and analysts’ reports.
At September 30, 2012, the Company had securities of $288.2 million with net pre-tax unrealized gains of $1.0 million on these securities, of which $40.6 million have unrealized losses totaling $0.7 million. Approximately $28.4 million of these securities, with an unrealized loss of $0.1 million, have been in a loss position for less than 12 months. Approximately $11.6 million of these securities, with an unrealized loss of approximately $54,000 have been in a loss position for greater than 12 months. These securities are primarily in a loss position because they were acquired when the general level of interest rates was lower than that on September 30, 2012. The Company believes that the losses in these securities are temporary in nature and that the full principal will be collected as anticipated. Because the declines in the market value of these investments are attributable to changes in interest rates and not credit
9
quality and because the Company has the present ability and intent to hold these investments until there is a recovery in fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2012. One preferred bank stock issue for $0.6 million has also been in a loss position for greater than 12 months. The Company continues to closely monitor the fair value of this security as the subject bank continues to experience negative operating trends.
NOTE 3 – LOANS, NET
Loan Portfolio Composition. The composition of the loan portfolio was as follows:
Commercial, Financial and Agricultural
135,939
130,879
Real Estate - Construction
39,537
18,892
Real Estate - Commercial Mortgage
609,671
639,140
Real Estate - Residential(1)
335,149
385,621
Real Estate - Home Equity
239,446
244,263
Consumer
157,026
188,663
Loans, Net of Unearned Income(2)
Includes loans in process with outstanding balances of $8.1 million and $12.5 million for September 30, 2012 and December 31, 2011, respectively.
(2)
Loans held for sale are presented separately on the balance sheet and not included in the table above.
Net deferred fees included in loans were $1.6 million at September 30, 2012 and December 31, 2011, respectively.
Loan Portfolio Aging. A loan is defined as a past due loan when one full payment is past due or a contractual maturity is over 30 days past due (“DPD”).
The following table presents the aging of the recorded investment in past due loans by class of loans:
30-59DPD
60-89DPD
Over 90DPD
TotalPast Due
TotalCurrent
TotalLoans
120
459
133,961
155
37,569
43,278
3,390
295
3,685
565,674
Real Estate - Residential
3,408
1,447
4,855
314,681
341,044
1,370
346
1,716
233,170
1,768
285
2,053
161,242
163,917
Total Past Due Loans
10,430
2,493
12,923
1,446,297
1,533,295
307
49
46
402
129,722
26,034
26,367
646
3,716
592,604
7,983
3,031
58
11,072
350,133
386,877
1,139
500
95
1,734
238,246
2,355
345
2,725
197,272
201,157
14,854
4,571
224
19,649
1,534,011
1,628,683
10
Nonaccrual Loans. Loans are generally placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be doubtful. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current or when future payments are reasonably assured.
The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days and still on accrual by class of loans:
Nonaccrual
Over 90 Days
1,521
755
5,554
334
40,312
42,820
21,508
25,671
4,559
4,283
621
1,160
Total Nonaccrual Loans
74,075
75,023
Impaired Loans. Loans are deemed to be impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due (principal and interest payments), according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
The following table presents loans individually evaluated for impairment by class of loans:
UnpaidPrincipalBalance
RecordedInvestmentWith NoAllowance
RecordedInvestmentWithAllowance
RelatedAllowance
2,379
910
1,469
453
5,716
797
4,919
701
73,859
28,956
44,903
5,566
28,429
3,905
24,524
3,604
3,380
753
2,627
858
112
98
17
113,875
35,335
78,540
11,199
1,653
671
982
311
511
68
65,624
19,987
45,637
5,828
36,324
6,897
29,427
4,702
3,527
2,882
239
143
90
53
26
107,782
28,290
79,492
11,174
11
The following table summarizes the average recorded investment and interest income recognized by class of impaired loans:
Three Months Ended September 30,
AverageRecordedInvestment
TotalInterestIncome
1,969
1,582
2,016
1,520
52
6,138
21
2,000
3,114
91
2,197
116
68,202
1,051
43,721
69,741
2,221
45,733
1,436
28,850
332
27,946
215
32,377
29,209
650
3,474
67
3,453
133
2,482
102
39
128
33
41
108,724
1,532
77,341
1,219
110,829
3,396
81,213
2,397
Troubled Debt Restructurings (“TDRs”). TDRs are loans in which the borrower is experiencing financial difficulty and the Company has granted an economic concession to the borrower that it would not otherwise consider. In these instances, as part of a work-out alternative, the Company will defer cash payments required as part of the loan agreement through either a principal moratorium or extension of the loan term. The impact of the TDR modifications and defaults are factored into the allowance for loan losses on a loan-by-loan basis as all TDRs are, by definition, impaired loans. Thus, specific reserves are established based upon the results of either a discounted cash flow analysis or the underlying collateral value, if the loan is deemed to be collateral dependent. In the limited circumstances that a loan is removed from TDR classification it is the Company’s policy to also remove it from the impaired loan category, but to continue to individually evaluate loan impairment based on the contractual terms specified by the loan agreement.
The following table presents loans classified as TDRs:
Accruing
Nonaccruing
1,044
694
163
713
178
29,407
9,815
20,062
12,029
13,228
2,660
15,553
947
1,482
1,161
649
Total TDRs
45,973
13,188
37,675
12,976
Loans classified as TDRs during the three and nine months ended September 30, 2012 and 2011 are presented in the table below. The modifications made during the reporting period involved either an extension of the loan term or a principal moratorium and the financial impact of these modifications was not material.
NumberofContracts
Pre-ModifiedRecordedInvestment
Post-ModifiedRecordedInvestment
871
875
162
969
976
18
5,255
5,360
45
13,799
14,104
34
2,950
2,860
54
5,445
5,418
16
611
610
57
591
59
586
635
9,761
9,798
185
22,281
22,618
12
Number ofContracts
338
318
547
1,176
1,175
1,352
1,330
5,093
5,347
13,658
13,768
5,355
5,325
70
10,540
10,824
462
472
639
660
24
23
12,424
12,637
130
26,781
27,152
Loans modified as TDRs within the previous 12 months that have subsequently defaulted during the three and nine months ended September 30, 2012 and 2011 are presented in the table below.
Number of Contracts
282
1,721
751
1,710
1,033
3,431
161
851
2,323
988
1,967
1,839
4,451
13
Credit Risk Management. The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures designed to maximize loan income within an acceptable level of risk. Management and the Board of Directors review and approve these policies and procedures on a regular basis (at least annually).
Reporting systems have been implemented to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans. Management and the Credit Risk Oversight Committee periodically review our lines of business to monitor asset quality trends and the appropriateness of credit policies. In addition, total borrower exposure limits are established and concentration risk is monitored. As part of this process, the overall composition of the portfolio is reviewed to gauge diversification of risk, client concentrations, industry group, loan type, geographic area, or other relevant classifications of loans. Specific segments of the loan portfolio are monitored and reported to the Board on a quarterly basis and have strategic plans in place to supplement Board approved credit policies governing exposure limits and underwriting standards. Detailed below are the categories of loans within the Company’s loan portfolio and risk characteristics unique to each.
Commercial, Financial, and Agricultural – Loans in this category are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral and personal or other guarantees. Lending policy establishes debt service coverage ratio limits that require a borrower’s cash flow to be sufficient to cover principal and interest payments on all new and existing debt. The majority of these loans are secured by the assets being financed or other business assets such as accounts receivable, inventory, or equipment. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines.
Real Estate Construction – Loans in this category consist of short-term construction loans, revolving and non-revolving credit lines and construction/permanent loans made to individuals and investors to finance the acquisition, development, construction or rehabilitation of real property. These loans are primarily made based on identified cash flows of the borrower or project and generally secured by the property being financed, including 1-4 family residential properties and commercial properties that are either owner-occupied or investment in nature. These properties may include either vacant or improved property. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines.
Real Estate Commercial Mortgage – Loans in this category consists of commercial mortgage loans secured by property that is either owner-occupied or investment in nature. These loans are primarily made based on identified cash flows of the borrower or project with consideration given to underlying real estate collateral and personal guarantees. Lending policy establishes debt service coverage ratios and loan to value ratios specific to the property type. Collateral values are determined based upon third party appraisals and evaluations.
Real Estate Residential – Residential mortgage loans held in the Company’s loan portfolio are made to borrowers that demonstrate the ability to make scheduled payments with full consideration to underwriting factors such as current income, employment status, current assets, and other financial resources, credit history, and the value of the collateral. Collateral consists of mortgage liens on 1-4 family residential properties. Collateral values are determined based upon third party appraisals and evaluations. The Company does not originate sub-prime loans.
Real Estate Home Equity – Home equity loans and lines are made to qualified individuals for legitimate purposes generally secured by senior or junior mortgage liens on owner-occupied 1-4 family homes or vacation homes. Borrower qualifications include favorable credit history combined with supportive income and debt ratio requirements and combined loan to value ratios within established policy guidelines. Collateral values are determined based upon third party appraisals and evaluations.
Consumer Loans – This loan portfolio includes personal installment loans, direct and indirect automobile financing, and overdraft lines of credit. The majority of the consumer loan portfolio consists of indirect and direct automobile loans. Lending policy establishes maximum debt to income ratios, minimum credit scores, and includes guidelines for verification of applicants’ income and receipt of credit reports.
Credit Quality Indicators. As part of the ongoing monitoring of the Company’s loan portfolio quality, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment performance, credit documentation, and current economic/market trends, among other factors. Risk ratings are assigned to each loan and revised as needed through established monitoring procedures for individual loan relationships over a predetermined amount and review of smaller balance homogenous loan pools. The Company uses the definitions noted below for categorizing and managing its criticized loans. Loans categorized as “Pass” do not meet the criteria set forth for the Special Mention, Substandard, or Doubtful categories and are not considered criticized.
Special Mention – Loans in this category are presently protected from loss, but weaknesses are apparent which, if not corrected, could cause future problems. Loans in this category may not meet required underwriting criteria and have no mitigating factors. More than the ordinary amount of attention is warranted for these loans.
Substandard – Loans in this category exhibit well-defined weaknesses that would typically bring normal repayment into jeopardy. These loans are no longer adequately protected due to well-defined weaknesses that affect the repayment capacity of the borrower. The possibility of loss is much more evident and above average supervision is required for these loans.
Doubtful – Loans in this category have all the weaknesses inherent in a loan categorized as Substandard, with the characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
The following table presents the risk category of loans by segment:
Commercial,Financial,Agriculture
Real Estate
Special Mention
5,363
48,974
54,375
Substandard
11,026
199,854
1,218
212,098
Doubtful
160
1,879
2,039
Total Criticized Loans
16,549
250,707
1,256
268,512
4,883
43,787
79
48,749
9,804
202,734
1,699
214,237
111
7,763
7,874
14,798
254,284
1,778
270,860
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses within the existing portfolio of loans. Loans are charged-off to the allowance when losses are deemed to be probable and reasonably quantifiable.
The following table details the activity in the allowance for loan losses by portfolio class for the three and nine months ended September 30, 2012 and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
Commercial, Financial, Agricultural
Real Estate Construction
Real Estate Commercial Mortgage
Real Estate Residential
Real EstateHomeEquity
Unallocated
Three Months Ended September 30, 2012
Beginning Balance
1,320
2,703
8,550
12,085
2,830
1,441
1,000
29,929
572
329
1,788
(792
1,130
(130
(33
Charge-Offs
(331
(127
(512
(981
(834
(355
(3,140
Recoveries
76
382
569
Net Charge-Offs
(278
(118
(478
(905
(819
(2,571
Ending Balance
1,614
2,914
9,860
10,388
3,141
1,338
967
30,222
Nine Months Ended September 30, 2012
1,534
1,133
10,660
12,518
2,392
1,887
911
31,035
534
2,147
4,548
3,505
2,752
(142
56
(657
(402
(5,562
(6,843
(2,152
(1,635
(17,251
203
214
1,208
149
3,038
(454
(366
(5,348
(5,635
(2,003
(407
(14,213
Three Months Ended September 30, 2011
1,784
1,745
8,561
13,947
2,248
1,795
31,080
(17
(530
3,187
557
356
(186
(75
(1,031
(3,287
(580
(832
(5,991
271
(153
(994
(3,016
(472
(430
(5,140
1,140
10,754
11,488
2,132
1,530
29,658
Nine Months Ended September 30, 2011
1,544
2,060
8,645
17,046
2,522
2,612
1,007
35,436
(845
6,215
3,113
1,922
(135
(7
(1,208
(90
(4,270
(9,115
(2,513
(2,055
(19,251
145
164
444
201
1,108
2,077
(1,063
(4,106
(8,671
(2,312
(947
(17,174
The following table details the amount of the allowance for loan losses by portfolio class disaggregated on the basis of the Company’s impairment methodology
Real Estate Home Equity
Period-end amount allocated to:
Loans Individually Evaluated for Impairment
700
Loans Collectively Evaluated for Impairment
2,214
4,294
6,784
2,283
19,023
September 30, 2011
419
484
5,931
4,062
103
10,999
1,195
656
4,823
7,426
2,029
18,659
The Company’s recorded investment in loans related to each balance in the allowance for loan losses by portfolio class and disaggregated on the basis of the Company’s impairment methodology was as follows:
Allowance Allocated to:
Individually Evaluated for Impairment
75,707
28,592
115,886
Collectively Evaluated for Impairment
133,560
37,562
533,964
312,452
236,066
163,805
1,417,409
Total Loans:
1,435
44,911
26,063
1,756
76,855
141,076
29,301
599,217
376,343
243,682
191,225
1,580,844
142,511
31,991
644,128
402,406
245,438
1,657,699
NOTE 4 - INTANGIBLE ASSETS
The Company had net intangible assets of $85.2 million and $85.5 million at September 30, 2012 and December 31, 2011, respectively. Intangible assets were as follows:
GrossAmount
AccumulatedAmortization
Core Deposit Intangibles
47,176
47,097
46,918
Customer Relationship Intangible
1,867
1,596
1,452
Total Intangible Assets
133,854
48,693
48,370
Net Core Deposit Intangibles: As of September 30, 2012 and December 31, 2011, the Company had net core deposit intangibles of $0.1 million and $0.3 million, respectively. Amortization expense for the first nine months of 2012 and 2011 was approximately $0.3 million and $0.4 million, respectively. Estimated annual amortization expense for 2012 is $0.2 million. All of our core deposit intangibles will be fully amortized in January 2013.
Goodwill: As of September 30, 2012 and December 31, 2011, the Company had goodwill of $84.8 million.
Goodwill is tested for impairment on an annual basis, or more often if impairment indicators exist. A goodwill impairment test consists of two steps. Step one compares the estimated fair value of the reporting unit to its carrying amount. If the carrying amount exceeds the estimated fair value, Step two is performed by comparing the fair value of the reporting unit’s implied goodwill to the carrying value of goodwill. If the carrying value of the reporting unit’s goodwill exceeds the estimated fair value, an impairment charge is recorded equal to the excess.
As of September 30, 2012, the book value of the Company’s equity exceeded its market capitalization, and as such the Company performed goodwill impairment testing. The Step one test indicated that the carrying amount (including goodwill) of the Company’s reporting unit exceeded its estimated fair value. The Step two test indicated the estimated fair value of our reporting unit’s implied goodwill exceeded its carrying amount. Based on the results of the Step two analysis, the Company concluded that goodwill was not impaired as of September 30, 2012. The Company will continue to evaluate goodwill for impairment as defined by ASC Topic 350.
Other: As of September 30, 2012 and December 31, 2011, the Company had a customer relationship intangible asset, net of accumulated amortization, of $0.3 million and $0.4 million, respectively. This intangible asset was recorded as a result of the March 2004 acquisition of trust customer relationships. Amortization expense for the first nine months of 2012 and 2011 was approximately $144,000. Estimated annual amortization expense is approximately $0.2 million based on use of a 10-year useful life.
NOTE 5 - DEPOSITS
The composition of the Company’s interest bearing deposits were as follows:
NOW Accounts
703,327
828,990
Money Market Accounts
285,084
276,910
Savings Deposits
181,523
158,462
Other Time Deposits
254,000
289,840
Total Interest Bearing Deposits
NOTE 6 - EMPLOYEE BENEFIT PLANS
The Company has a defined benefit pension plan covering substantially all full-time and eligible part-time associates and a Supplemental Executive Retirement Plan (“SERP”) covering its executive officers.
The components of the net periodic benefit costs for the Company’s qualified benefit pension plan were as follows:
Service Cost
1,599
1,507
4,797
4,521
Interest Cost
1,397
1,311
4,190
3,932
Expected Return on Plan Assets
(1,698
(1,639
(5,095
(4,917
Prior Service Cost Amortization
270
347
Net Loss Amortization
847
555
2,543
1,667
Net Periodic Cost
2,235
1,850
6,705
5,550
Discount Rate
5.00
%
5.55
Long-Term Rate of Return on Assets
8.00
The components of the net periodic benefit costs for the Company’s SERP were as follows:
35
105
142
134
Net Gain Amortization
(92
(104
(277
(310
Net Periodic (Benefit)
(10
(22
(30
(65
NOTE 7 - COMMITMENTS AND CONTINGENCIES
Lending Commitments. The Company is a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of its clients. These financial instruments consist of commitments to extend credit and standby letters of credit.
The Company’s maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance sheet instruments. The amounts associated with the Company’s off-balance sheet obligations were as follows:
Fixed
Variable
Commitments to Extend Credit(1)
47,292
261,087
308,379
38,432
257,081
295,513
Standby Letters of Credit
12,140
10,920
59,432
320,519
49,352
306,433
Commitments include unfunded loans, revolving lines of credit, and other unused commitments.
Commitments to extend credit are agreements to lend to a client so 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities. In general, management does not anticipate any material losses as a result of participating in these types of transactions. However, any potential losses arising from such transactions are reserved for in the same manner as management reserves for its other credit facilities.
19
For both on- and off-balance sheet financial instruments, the Company requires collateral to support such instruments when it is deemed necessary. The Company evaluates each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include deposits held in financial institutions; U.S. Treasury securities; other marketable securities; real estate; accounts receivable; property, plant and equipment; and inventory.
Contingencies. The Company is a party to lawsuits and claims arising out of the normal course of business. In management’s opinion, there are no known pending claims or litigation, the outcome of which would, individually or in the aggregate, have a material effect on the consolidated results of operations, financial position, or cash flows of the Company.
Indemnification Obligation. The Company is a member of the Visa U.S.A. network. Visa U.S.A believes that its member banks are required to indemnify it for potential future settlement of certain litigation (the “Covered Litigation”) that relates to several antitrust lawsuits challenging the practices of Visa and MasterCard International. In 2008, the Company, as a member of the Visa U.S.A. network, obtained Class B shares of Visa, Inc. upon its initial public offering. Since its initial public offering, Visa, Inc. has funded a litigation reserve for the Covered Litigation resulting in a reduction in the Class B shares held by the Company. During the first quarter of 2011, the Company sold its remaining Class B shares resulting in a $3.2 million pre-tax gain. Associated with this sale, the Company entered into a swap contract with the purchaser of the shares that requires a payment to the counterparty in the event that Visa, Inc. makes subsequent revisions to the conversion ratio for its Class B shares.
In July 2012, Visa and MasterCard International entered into a memorandum of understanding to enter into a settlement agreement to resolve the aforementioned Covered Litigation matter. Visa’s share of the claim is to be paid from the litigation reserve account. Subsequent to the memorandum of understanding, Visa increased the litigation reserve by $150 million and revised the conversion ratio for the Class B shares resulting in a $56,000 payment by the Company under the swap contract. The Company does not expect to make any additional payments to the counterparty other than certain fixed charges included in the liability, which are payable quarterly in the amount of approximately $25,000 until the settlement is finalized. Conversion ratio payments and ongoing fixed quarterly charges are reflected in earnings in the period incurred.
NOTE 8 – FAIR VALUE MEASUREMENTS
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from, or corroborated, by market data by correlation or other means.
Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Securities Available for Sale. U.S. Treasury securities and certain U.S. Government Agency securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the bond’s terms and conditions, among other things.
The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness to ensure such prices are aligned with traditional pricing matrices. In general, the Company does not purchase securities that have a complicated structure. The Company’s entire portfolio consists of traditional investments, nearly all of which are U.S. Treasury obligations, federal agency bullet or mortgage pass-through securities, or general obligation or revenue based municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. From time to time, the Company will validate,
20
on a sample basis, prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.
Fair Value Swap. The Company entered into a stand-alone derivative contract with the purchaser of its Visa Class B shares. The valuation represents an internally developed estimate of the exposure based upon probability-weighted potential Visa litigation losses and related carrying cost obligations required under the contract.
A summary of fair values for assets and liabilities recorded at fair value consisted of the following:
Level 1 Inputs
Level 2 Inputs
Level 3Inputs
Total Fair Value
ASSETS:
Securities available for sale:
33,291
8,511
LIABILITIES:
Fair Value Swap
Assets Measured at Fair Value on a Non-Recurring Basis
Certain assets are measured at fair value on a non-recurring basis (i.e., the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances). An example would be assets exhibiting evidence of impairment). The following is a description of valuation methodologies used for assets measured on a non-recurring basis.
Impaired Loans. Loans deemed to be impaired are valued based upon the lower of cost or the fair value of the underlying collateral or discounted cash flow analysis. The fair value of collateral is determined by an independent valuation or professional appraisal in conformance with banking regulations. Collateral values are estimated using Level 3 inputs due to the volatility in the real estate market, and the judgment and estimation involved in the real estate appraisal process. The inputs used in performing discounted cash flow analyses are not observable and therefore is considered a Level 3 input. Impaired loans had a carrying value of $113.9 million with a valuation allowance of $11.0 million at September 30, 2012 and $107.8 million and $11.2 million, respectively, at December 31, 2011.
Loans Held for Sale. Loans held for sale were $16.5 million and $21.2 million as of September 30, 2012 and December 31, 2011, respectively. These loans are carried at the lower of cost or fair value and are adjusted to fair value on a non-recurring basis. Fair value is based on observable markets rates for comparable loan products, which is considered a Level 2 fair value measurement.
Other Real Estate Owned. During the first nine months of 2012, certain foreclosed assets, upon initial recognition, were measured and reported at fair value through a charge-off to the allowance for loan losses based on the fair value of the foreclosed asset less estimated cost to sell. The fair value of the foreclosed asset is determined by an independent valuation or professional appraisal in conformance with banking regulations. On an ongoing basis, we will obtain updated appraisals on foreclosed assets and realize valuation adjustments as necessary. The fair value of foreclosed assets is estimated using Level 3 inputs due to the volatility of the real estate market, and judgment and estimation involved in the real estate valuation process. Foreclosed assets measured at fair value upon initial recognition totaled $14.0 million during the nine months ended September 30, 2012. The Company disposed of $20.1 million in foreclosed assets, recognized subsequent write-downs totaling $3.0 million for properties that were re-valued, and realized miscellaneous adjustments totaling $0.3 million during the nine months ended September 30, 2012. The carrying value of foreclosed assets was $53.2 million at September 30, 2012 and $62.6 million at December 31, 2011.
Assets and Liabilities Disclosed at Fair Value
The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities, for which it is practical to estimate fair value and the following is a description of valuation methodologies used for those assets and liabilities.
Cash and Short-Term Investments – The carrying amount of cash and short-term investments is used to approximate fair value, given the short time frame to maturity and as such assets do not present unanticipated credit concerns.
Loans - The loan portfolio is segregated into categories and the fair value of each loan category is calculated using present value techniques based upon projected cash flows and estimated discount rates that reflect the credit and interest rate risks inherent in each loan category. The calculated present values are then reduced by an allocation of the allowance for loan losses against each respective loan category.
Deposits - The fair value of Noninterest Bearing Deposits, NOW Accounts, Money Market Accounts and Savings Accounts are the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using present value techniques and rates currently offered for deposits of similar remaining maturities.
Subordinated Notes Payable - The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar obligations.
Short-Term and Long-Term Borrowings - The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar debt.
A summary of estimated fair values of significant financial instruments consisted of the following:
CarryingValue
Level 3 Inputs
Cash
Short-Term Investments
Investment Securities
142,009
146,157
Loans Held for Sale
Loans, Net of Allowance for Loan Losses
1,357,305
2,021,069
41,678
62,912
Long-Term Borrowings
41,406
184,201
122,948
1,464,588
2,173,331
42,021
62,858
47,770
All non-financial instruments were excluded from the above table. The disclosures also do not include certain intangible assets such as client relationships, deposit base intangibles and goodwill. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
NOTE 9 – ACCOUNTING STANDARDS UPDATES
ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.”ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-03 became effective for the Company on January 1, 2012, however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” as further discussed below. In connection with the application of ASU 2011-05, the Company’s financial statements now include one continuous statement of comprehensive income.
ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” ASU 2011-08 amends Topic 350, “Intangibles – Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 became effective for the Company on January 1, 2012, and did not have a significant impact on the Company’s financial statements.
ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.”ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to re-deliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 became effective for the Company on January 1, 2012, and did not have a significant impact on the Company’s financial statements.
QUARTERLY FINANCIAL DATA (UNAUDITED)
2010
(Dollars and Shares in Thousands)
Third
Second
First(1)
Fourth
First
Summary of Operations:
Interest Income
22,437
23,130
23,912
25,467
25,189
26,831
Interest Expense
1,372
1,515
2,208
2,203
2,473
Net Interest Income
21,065
21,661
22,397
23,439
22,986
24,358
5,743
4,793
7,600
3,545
4,133
3,783
Net Interest Income After Provision for Loan Losses
15,322
16,868
14,797
19,894
18,853
20,575
Noninterest Income
13,906
13,586
13,873
14,448
16,334
14,735
Noninterest Expense
32,293
32,597
31,103
31,167
33,331
33,540
Income (Loss) Before Income Taxes
(3,065
(2,143
(2,433
3,175
1,856
1,770
(1,339
(1,898
1,030
546
(148
Net Income (Loss)
(1,726
(1,162
(535
2,145
1,310
1,918
Net Interest Income (FTE)
21,179
21,219
21,833
22,560
23,326
23,704
23,257
24,654
Per Common Share:
Net Income (Loss) Basic
(0.07
(0.03
0.08
Net Income (Loss) Diluted
Dividends Declared
0.00
0.10
Diluted Book Value
14.54
14.48
14.60
14.68
15.20
15.13
15.15
Market Price:
High
10.96
8.73
9.91
11.11
11.18
13.12
13.80
14.19
Low
7.00
6.35
7.32
9.43
9.81
9.94
11.87
11.56
Close
10.64
7.37
7.45
9.55
10.38
10.26
12.68
12.60
Selected Average Balances:
1,541,262
1,570,827
1,596,480
1,646,715
1,667,720
1,704,348
1,730,330
1,782,916
Earning Assets
2,209,166
2,262,847
2,268,307
2,146,463
2,202,927
2,258,931
2,278,602
2,218,049
2,566,239
2,624,417
2,636,907
2,509,915
2,563,251
2,618,287
2,643,017
2,576,793
2,075,482
2,135,653
2,161,388
2,032,975
2,061,913
2,107,301
2,125,379
2,115,867
Shareowners’ Equity
251,746
252,644
254,447
264,276
263,902
262,371
261,603
262,622
Common Equivalent Average Shares:
Basic
17,192
17,181
17,160
17,127
17,122
17,095
Diluted
17,161
17,139
17,130
17,096
Performance Ratios:
Return on Average Assets
0.17
(0.26
)%
(0.18
(0.08
0.31
0.33
0.20
0.30
Return on Average Equity
1.77
(2.75
(1.84
(0.80
2.97
3.28
2.03
2.90
Net Interest Margin (FTE)
3.82
3.77
3.87
4.17
4.20
4.21
4.14
4.41
Noninterest Income as % of Operating Revenue
39.31
39.88
38.64
38.34
38.14
38.13
41.54
37.69
Efficiency Ratio
87.68
90.88
91.73
85.08
81.40
81.41
83.30
83.75
Asset Quality:
31,217
33,873
Allowance for Loan Losses to Loans
1.97
1.93
1.98
1.91
1.79
1.84
2.01
Nonperforming Assets (“NPA’s”)
127,247
132,829
136,826
137,623
114,592
122,092
129,318
123,637
NPA’s to Total Assets
5.10
5.02
5.14
5.21
4.54
4.70
4.86
4.72
NPA’s to Loans + OREO
8.02
8.23
8.36
8.14
6.67
6.98
7.31
6.81
Allowance to Non-Performing Loans
40.80
40.03
39.65
41.37
55.54
50.89
45.80
53.94
Net Charge-Offs to Average Loans
0.66
1.80
1.16
1.50
1.22
1.49
1.33
1.35
Capital Ratios:
Tier 1 Capital Ratio
14.43
14.17
13.96
14.05
13.83
13.46
13.24
Total Capital Ratio
15.80
15.54
15.32
15.41
15.19
14.82
14.59
Leverage Ratio
9.83
9.60
9.71
10.20
9.95
9.74
10.10
Tangible Capital Ratio
6.86
6.40
6.42
6.51
7.19
6.96
6.73
6.82
Includes a $2.6 million (net) pre-tax gain from sale of Visa shares – $3.2 million gain less $0.6 million related swap liability.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes. The MD&A is divided into subsections entitled “Business Overview,” “Financial Overview,” “Results of Operations,” “Financial Condition,” “Market Risk and Interest Rate Sensitivity,” “Liquidity and Capital Resources,” “Off-Balance Sheet Arrangements,” and “Critical Accounting Policies.” The following information should provide a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2012 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and subsidiaries, collectively, are referred to as “CCBG,” “Company,” “we,” “us,” or “our.”
In this MD&A, we present an operating efficiency ratio which is not calculated based on accounting principles generally accepted in the United States (“GAAP”), but that we believe provides important information regarding our results of operations. Our calculation of the operating efficiency ratio is computed by dividing noninterest expense less intangible amortization, by the sum of tax equivalent net interest income and noninterest income. Management uses this non-GAAP measure as part of its assessment of its performance in managing noninterest expenses. We believe that excluding intangible amortization and merger expenses in our calculations better reflect our periodic expenses and is more reflective of normalized operations.
Although we believe the above-mentioned non-GAAP financial measure enhances investors’ understanding of our business and performance this non-GAAP financial measure should not be considered an alternative to GAAP. In addition, there are material limitations associated with the use of this non-GAAP financial measure such as the risks that readers of our financial statements may disagree as to the appropriateness of items included or excluded in this measure and that our measure may not be directly comparable to other companies that calculate this measure differently. Our management compensates for this limitation by providing a detailed reconciliation between GAAP information and the non-GAAP financial measure as detailed below.
Reconciliation of operating efficiency ratio to efficiency ratio:
Three Months Ended
Nine Months Ended
Sept 30,2012
June 30, 2012
Sept 30,2011
Sept 30, 2012
Efficiency ratio
87.99
91.18
81.68
90.42
82.55
Effect of intangible amortization expense
(0.31
(0.30
(0.28
(0.48
Operating efficiency ratio
90.12
82.07
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including this MD&A section, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A. Risk Factors of our 2011 Report on Form 10-K, as updated in our subsequent quarterly reports filed on Form 10-Q, and in our other filings made from time to time with the SEC after the date of this report.
However, other factors besides those listed in our Quarterly Report or in our Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
BUSINESS OVERVIEW
Our Business
We are a bank holding company headquartered in Tallahassee, Florida, and we are the parent of our wholly-owned subsidiary, Capital City Bank (the “Bank” or “CCB”). The Bank offers a broad array of products and services through a total of 66 full-service offices located in Florida, Georgia, and Alabama. The Bank offers commercial and retail banking services, as well as trust and asset management, retail securities brokerage and data processing services.
Our profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest received on earning assets, such as loans and securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by the provision for loan losses, operating expenses such as salaries and employee benefits, occupancy and other operating expenses including income taxes, and noninterest income such as service charges on deposit accounts, asset management and trust fees, retail securities brokerage fees, mortgage banking fees, bank card fees, and data processing fees.
A detailed discussion regarding the economic conditions in our markets and our long-term strategic objectives is included as part of the MD&A section of our 2011 Form 10-K.
FINANCIAL OVERVIEW
A summary overview of our financial performance is provided below.
Results of Operations
Net income of $1.1 million, or $0.07 per diluted share for the third quarter of 2012 compared to a net loss of $1.7 million, or $0.10 per diluted share in the second quarter of 2012, and net income of $2.0 million, or $0.12 per diluted share for the third quarter of 2011. For the first nine months of 2012, we realized a net loss of $1.8 million, or $0.10 per diluted share, compared to net income of $5.4 million, or $0.32 per diluted share, for the comparable period of 2011. Performance in 2011 reflects the sale of our Visa stock which resulted in a net pre-tax gain of $2.6 million.
Tax equivalent net interest income for the third quarter of 2012 was $21.2 million, which is comparable to the second quarter of 2012 and was $23.3 million for the third quarter of 2011. For the nine months of 2012, tax equivalent net interest income totaled $64.2 million compared to $70.3 million in 2011. The reduction from both periods in 2011 was due to a reduction in loan income primarily attributable to declining loan balances and unfavorable asset repricing, partially offset by a reduction in interest expense and a lower level of foregone interest on loans
Total credit costs (loan loss provision plus other real estate owned (“OREO”) costs) were $5.5 million, $9.2 million, and $6.3 million for the quarters ended September 30, 2012, June 30, 2012, and September 30, 2011, respectively. Total credit costs for the first nine months of 2012 were $23.0 million compared to $20.6 million for the same period of 2011.
Noninterest income for the third quarter of 2012 totaled $13.6 million, a decrease of $0.3 million from the second quarter of 2012 and a decrease of $0.6 million from the third quarter of 2011. The decrease compared to second quarter of 2012 was due to lower wealth management and bank card fees and the decline from the third quarter of 2011 reflects lower deposit fees and gains from the sale of OREO properties. For the first nine months of 2012, noninterest income totaled $41.1 million, a decrease of $3.9 million from the same period of 2011 primarily attributable to a $3.2 million gain from the sale of our Visa stock realized in 2011 and a lower level of gains from the sale of OREO properties.
Noninterest expense for the third quarter of 2012 totaled $30.2 million, a decrease of $2.1 million, or 6.5%, from the second quarter of 2012 and $0.4 million, or 1.5%, from the third quarter of 2011. The decrease from the second quarter of 2012 was primarily attributable to lower compensation expense, advertising expense, and OREO expense. Lower compensation expense and occupancy costs drove the decrease compared to the same period in 2011. For the first nine months of 2012, noninterest expense totaled $95.1 million, a decrease of $0.1 million from the same period of 2011 driven by lower occupancy costs.
Financial Condition
Average earning assets were $2.209 billion for the third quarter of 2012, an increase of $62.7 million, or 2.9%, over the fourth quarter of 2011 reflective of a higher level of overnight funds driven by higher deposit balances, primarily public funds.
Nonperforming assets totaled $127.2 million at September 30, 2012, a decrease of $10.4 million from December 31, 2011 driven by a reduction in our OREO balance, reflecting continued progress in disposing of properties. Nonperforming assets represented 5.10% of total assets at September 30, 2012 compared to 5.21% at December 31, 2011.
As of September 30, 2012, we are well-capitalized with a risk based capital ratio of 15.80% and a tangible common equity ratio of 6.86% compared to 15.32% and 6.51%, respectively, at December 31, 2011.
RESULTS OF OPERATIONS
For the third quarter of 2012, we realized net income of $1.1 million, or $0.07 per diluted share, compared to a net loss of $1.7 million, or $0.10 per diluted share for the second quarter of 2012, and net income of $2.0 million, or $0.12 per diluted share, for the third quarter of 2011. For the first nine months of 2012, we realized a net loss of $1.8 million, or $0.10 per diluted share, compared to net income of $5.4 million, or $0.32 per diluted share, for the same period in 2011.
Compared to the second quarter of 2012, the increase in earnings reflects a lower loan loss provision of $2.9 million, and a $2.1 million decline in noninterest expense, partially offset by lower operating revenues (net interest income plus noninterest income) of $0.4 million and higher income taxes of $1.8 million.
Compared to the third quarter of 2011, the reduction in earnings was due to lower operating revenues of $2.7 million partially offset by a $0.9 million decrease in the loan loss provision, a $0.4 million reduction in noninterest expense, and lower income taxes of $0.5 million.
The decrease in earnings for the nine month period ended September 30, 2012 is attributable to lower operating revenues of $9.7 million, and a higher loan loss provision of $2.0 million, partially offset by lower noninterest expense of $0.1 million and income taxes of $4.4 million. Earnings in 2011 reflect the sale of our Visa Class B shares of stock which resulted in a net pre-tax gain of $2.6 million ($3.2 million pre-tax gain included in noninterest income and recognition of a $0.6 million swap liability included in noninterest expense).
A condensed earnings summary of each major component of our financial performance is provided below:
(Dollars in Thousands, except per share data)
Sept 30, 2011
Taxable equivalent Adjustments
148
154
226
474
762
Total Interest Income (FTE)
22,474
22,591
25,117
68,367
76,309
64,231
70,287
Taxable Equivalent Adjustments
Net Interest Income After provision for Loan Losses
Basic Net Income (Loss) Per Share
Diluted Net Income (Loss) Per Share
(0.93
2.77
(0.09
0.28
28
Net interest income represents our single largest source of earnings and is equal to interest income and fees generated by earning assets less interest expense paid on interest bearing liabilities. This information is provided on a “taxable equivalent” basis to reflect the tax-exempt status of income earned on certain loans and investments, the majority of which are state and local government debt obligations. We provide an analysis of our net interest income including average yields and rates in Table I on page 41.
Tax equivalent net interest income for the third quarter of 2012 was $21.2 million, which is comparable to the second quarter of 2012, and down from $23.3 million for the third quarter of 2011. For the nine months ended September 30, 2012, tax equivalent net interest income totaled $64.2 million compared to $70.3 million for the same period of 2011. Factors affecting net interest income relative to the second quarter of 2012 include a reduction in loan income primarily attributable to declining loan balances, primarily offset by one additional calendar day and interest recoveries. When compared to the three and nine months periods of 2011, the decrease was primarily driven by declines in loan income attributable to lower portfolio balances, which was partially offset by a reduction in interest expense. The lower interest expense is primarily attributable to certificates of deposit and reflects both lower balances and favorable repricing.
Tax equivalent interest income for the third quarter of 2012 was $22.5 million compared to $22.6 million for the second quarter of 2012 and $25.1 million for the third quarter of 2011. The decrease when compared to all periods is specifically attributable to both the shift in earning asset mix and lower yields. The declining loan portfolio has resulted in the higher yielding earning assets being replaced with lower yielding federal funds or investment securities. Additionally, lower yields on new loan and investment production and loan portfolio repricing continue to unfavorably affect net interest income.
Interest expense for the third quarter of 2012 was $1.3 million compared to $1.4 million for the second quarter of 2012 and $1.8 million for the third quarter in 2011. The lower cost of funds when compared to both periods was a result of continued rate reductions on all deposit products except savings accounts. The rate reductions on deposits reflect our response to a historically low interest rate environment and desire to continue our focus on core banking relationships.
The decline in the loan portfolio, coupled with the low rate environment continues to put downward pressure on our net interest income. The loan portfolio yield has been declining because the average rate on new loans is lower than the loans being paid off and the existing adjustable rate loans reprice lower. Lowering our cost of funds, to the extent we can, and continuing to shift the mix of our deposits will help to partially mitigate the unfavorable impact of weak loan demand and repricing, although the impact is expected to be minimal.
The net interest margin for the third quarter of 2012 was 3.82%, an increase of five basis points from the second quarter of 2012 and a decline of 38 basis points from the third quarter of 2011. Year-to-date net interest margin of 3.81% declined 37 basis points from the comparable period in 2011. The increase in margin compared to the second quarter of 2012 reflects a lower level of earning assets and an increase in interest recoveries. The decrease in the net interest margin compared to the third quarter of 2011 and year-to-date is attributable to the shift in our earning asset mix and unfavorable asset repricing, partially offset by a lower average cost of funds.
Historically low interest rates, foregone interest, lower loan fees, unfavorable asset repricing without the flexibility to significantly adjust deposit rates, and core deposit growth (which has strengthened our liquidity position, but contributed to an unfavorable shift in our earning asset mix), have all placed pressure on our net interest margin. Our current strategy, as well as our historic strategy, is to not accept greater interest rate risk by reaching further out on the curve for yield, particularly given the fact that short term rates are at historical lows. We continue to maintain short duration portfolios on both sides of the balance sheet and believe we are well positioned to quickly respond to changing market conditions. Although this strategy has unfavorably impacted our net interest margin in the current environment, over time this strategy has consistently resulted in our net interest margins significantly exceeding those in our peer group. Given the unfavorable asset repricing and low rate environment, we anticipate continued downward pressure on the net interest margin for the remainder of 2012 and into 2013.
The provision for loan losses for the third quarter of 2012 was $2.9 million compared to $5.7 million in the second quarter of 2012 and $3.7 million for the third quarter of 2011. The decrease from both periods was driven by slower problem loan migration and lower net charge-offs resulting in a favorable impact on our general reserve allocation. For the first nine months of 2012, the loan loss provision totaled $13.4 million compared to $11.4 million for the same period in 2011 with the increase primarily attributable to an increase in impaired loans. Net charge-offs for the third quarter of 2012 totaled $2.6 million, or 0.66%, of average loans (annualized) compared to $7.0 million, or 1.80%, for the second quarter of 2012 and $5.1 million, or 1.22%, in the third quarter of 2011. For the first nine months of 2012, net charge-offs totaled $14.2 million, or 1.21%, of average loans (annualized) compared to $17.2 million, or 1.35%, for the same period of 2011. At quarter-end, the allowance for loan losses of $30.2 million was 1.97% of outstanding loans (net of overdrafts) and provided coverage of 41% of nonperforming loans compared to 1.93% and 40%, respectively, at June 30, 2012, and 1.91% and 41%, respectively, at December 31, 2011.
29
Charge-off activity for the respective periods is set forth below:
CHARGE-OFFS
331
657
275
75
512
3,519
1,031
5,562
4,270
981
3,894
3,287
6,843
9,115
834
425
580
2,152
2,513
355
550
832
1,635
2,055
Total Charge-offs
3,140
8,720
5,991
17,251
19,251
RECOVERIES
83
Total Recoveries
1,689
Net Charge-offs
2,571
7,031
5,140
14,213
17,174
Net Charge-offs (Annualized)as a percent of Average Loans Outstanding, Net ofUnearned Income
1.21
Noninterest income for the third quarter of 2012 totaled $13.6 million, a decrease of $0.3 million, or 2.4%, from the second quarter of 2012 and a decrease of $0.6 million, or 4.4%, from the third quarter of 2011. The decrease from the second quarter of 2012 was driven primarily by lower wealth management fees (i.e., trust fees and retail brokerage fees) of $0.2 million and bank card fees of $0.2 million, partially offset by higher mortgage banking fees of $0.1 million. Compared to the third quarter of 2011, the decrease primarily reflects a reduction in deposit fees of $0.2 million, wealth management fees of $0.2 million, data processing fees of $0.1 million, and other income of $0.5 million, partially offset by higher mortgage banking fees of $0.3 million.
For the first nine months of 2012, noninterest income totaled $41.1 million, a decrease of $3.9 million from the same period of 2011 attributable to the Visa shares gain realized in the first quarter of 2011. Lower data processing fees of $0.4 million, wealth management fees of $0.4 million, and other income of $1.4 million (i.e., primarily lower gains from the sale of OREO properties), partially offset by higher mortgage banking fees of $0.9 million and bank card fees of $0.5 million, also contributed to the variance.
Noninterest income represented 39.31% of operating revenues (net interest income plus noninterest income) in the third quarter of 2012 compared to 39.88% in the second quarter of 2012 and 38.14% in the third quarter of 2011. For the first nine months of 2012, noninterest income represented 39.3% of operating revenues compared to 39.4% for the same period of 2011.
30
The table below reflects the major components of noninterest income.
June 30,2012
Noninterest Income:
6,313
Data Processing Fees
680
Asset Management Fees(1)
Retail Brokerage Fees(1)
884
864
Interchange Fees (2)
1,619
1,580
1,420
4,725
4,223
ATM/Debit Card Fees (2)
997
1,170
3,446
3,421
Gain on Visa Stock
3,172
1,361
5,206
Together referred to as “Wealth Management Fees”
Together referred to as “Bank Card Fees”
Significant components of noninterest income are discussed in more detail below.
Service Charges on Deposit Accounts. Deposit service charge fees for the third quarter of 2012 totaled $6.4 million, a $93,000, or 1.5%, increase over the second quarter of 2012 and a decrease of $223,000, or 3.4%, from the third quarter of 2011. For the first nine months of 2012, deposit service charge fees totaled $19.0 million, an increase of $107,000, or 0.6%, over the comparable period in 2011. The increase compared to the second quarter of 2012 was due to an increase in overdraft fees. A reduction in overdraft fees drove the variance compared to the third quarter of 2011 while a lower level of overdraft charge-offs was the primary reason for the increase over the corresponding nine month period of 2011.
Data Processing Fees. Fees from data processing services for the third quarter of 2012 totaled $687,000, comparable to the second quarter of 2012. Fees decreased by $62,000, or 8.3%, compared to the third quarter of 2011, attributable to lower processing volume. For the first nine months of 2012, fees totaled $2.0 million, a decrease of $445,000, or 17.9%, primarily due to a reduction in the number of banks that we provide processing services to as two of our user banks were acquired and discontinued service in mid 2011.
Asset Management Fees. Fees from asset management activities totaled $1.0 million for the third quarter of 2012, which is comparable to the second quarter of 2012, and a decrease of $60,000, or 5.6%, from the third quarter of 2011. For the first nine months of 2012, fees totaled $3.1 million, which is a decrease of $185,000, or 5.7%, from the same period of 2011. The decrease from the third quarter of 2011 reflects fluctuation in asset values for accounts under discretionary management for which fees are based on the account value at quarter-end. The decline in fees for the nine month period was driven by both lower asset values for managed accounts as well as a decline in estate management fees. At September 30, 2012, assets under management totaled $690.9 million compared to $660.6 million at December 31, 2011 and $677.1 million at September 30, 2011.
Retail Brokerage Fees. Fees from the sale of retail investment and insurance products totaled $666,000 for the third quarter of 2012, a decrease of $218,000, or 24.7%, from the second quarter of 2012 and a decrease of $141,000, or 17.5%, from the third quarter of 2011. For the first nine months of 2012, fees totaled $2.3 million, a $167,000, or 6.7%, decrease from the comparable period of 2011. The change for each period reflects fluctuation in trading activity by our clients.
Mortgage Banking Fees. Mortgage banking fees totaled $978,000 for the third quarter of 2012, an increase of $114,000, or 13.2%, over the second quarter of 2012 and $333,000, or 51.6%, over the third quarter of 2011. For the first nine months of 2012, mortgage banking fees totaled $2.7 million, an increase of $860,000, or 47.0%, over the same period of 2011. The increase for all respective periods is attributable to increased home purchase activity in our markets and an increase in refinancing activity due to the lower rate environment. The mix of refinance and home purchase new loan production for the first nine months of 2012 was 38% and 62%, respectively, compared to 30% and 70%, respectively, for the same period of 2011.
Bank Card Fees. Bank Card Fees (including interchange fees and ATM/debit card fees) totaled $2.6 million for the third quarter of 2012, a decrease of $168,000, or 6.0%, from the second quarter of 2012, and an increase of $26,000, or 1.0%, over the third quarter of 2011. For the first nine months of 2012, fees totaled $8.2 million, which represents an increase of $527,000, or 6.9%, over the same period of 2011. The decrease from the second quarter was due to a lower level of ATM transactions. The increase over both periods in 2011 reflects higher card utilization as well as growth in active cards due to an increase in the number of deposit accounts.
31
Other. Other income totaled $1.2 million for the third quarter of 2012, a decrease of $159,000, or 11.7%, from the second quarter of 2012, and a decrease of $491,000, or 29.0%, from the third quarter of 2011. For the first nine months of 2012, other income totaled $3.8 million, a decrease of $1.4 million from the same period of 2011. The changes during the third quarter of 2012 compared to all prior periods are partially attributable to lower gains from the sale of OREO properties.
Noninterest expense for the third quarter of 2012 totaled $30.2 million, a decrease of $2.1 million, or 6.5%, from the second quarter of 2012 and $0.4 million, or 1.5%, from the third quarter of 2011. The decrease compared to the second quarter of 2012 reflects a reduction in compensation expense of $0.6 million and other expense of $1.5 million. The decrease in compensation expense was due to lower associate salary expense reflective of lower headcount, pension plan expense, and associate insurance expense. The decline in the other expense category was primarily due to lower OREO expense and advertising expense. A decline in miscellaneous expense reflecting one-time severance costs recorded in the second quarter of 2012 also contributed to the variance. Compared to the third quarter of 2011, the decrease was driven by lower compensation and occupancy expense.
For the first nine months of 2012, noninterest expense totaled $95.1 million, a decrease of $0.1 million from the same period of 2011 attributable to lower occupancy expense of $0.2 million primarily reflecting lower expense for building maintenance and utilities. This favorable variance was partially offset by slightly higher compensation expense and other expense. Compensation expense increased due to higher pension plan expense that was partially offset by lower expense for associate salaries and performance compensation. The increase in other expense primarily reflects higher professional fees and OREO costs, partially offset by lower intangible amortization expense, advertising costs, and FDIC insurance fees.
The table below reflects the major components of noninterest expense.
Noninterest Expense:
Salaries
12,102
12,296
12,609
37,139
38,054
Associate Benefits
3,821
3,196
11,331
10,328
Total Compensation
16,117
Premises
2,276
Equipment
Total Occupancy
4,577
4,613
13,565
Legal Fees
1,090
1,093
983
3,286
3,138
Professional Fees
1,070
1,184
952
3,574
2,707
Processing Services
1,016
886
2,930
2,775
Advertising
609
1,424
1,702
Travel and Entertainment
220
222
625
Printing and Supplies
926
970
Telephone
455
503
1,407
1,442
Postage
471
1,245
1,332
Insurance - Other
1,018
1,049
3,072
107
3,460
Miscellaneous
1,434
1,765
1,703
4,655
4,948
Total Other
10,114
11,655
10,229
33,056
32,964
Significant components of noninterest expense are discussed in more detail below.
Compensation. Compensation expense totaled $15.5 million for the third quarter of 2012, a decrease of $607,000, or 3.8%, from the second quarter of 2012 and $295,000, or 1.9%, from the third quarter of 2011. The decrease compared to the second quarter of 2012 reflects lower salaries of $194,000 and associate benefits of $413,000. The decrease in the salary expense category was primarily due to lower associate base salaries due to reduced headcount. Associate benefit expense decreased due to lower pension plan expense and associate insurance expense. Compared to the third quarter of 2011, the decrease was attributable to both a decline in associate base salaries due to reduced headcount and lower performance compensation.
32
For the first nine months of 2012, compensation expense totaled $48.5 million, an increase of $88,000, or 0.2%, over the same period of 2011 driven by higher expense for associate benefits partially offset by lower associate salary expense. The increase in associate benefit expense reflects higher expense for our pension plans attributable to the utilization of a lower discount rate in 2012 due to lower long-term bond rates. The decrease in salaries was due to lower expense for associate base salaries reflecting lower headcount, and performance compensation.
Occupancy. Occupancy expense (including premises and equipment) totaled $4.6 million for the third quarter of 2012, a $56,000, or 1.2%, increase over the second quarter of 2012 and a $36,000, or 0.8%, decrease from the third quarter of 2011. For the first nine months of 2012, occupancy expense totaled $13.6 million, a $234,000, or 1.7%, decrease from the same period in 2011, attributable to lower building maintenance costs and utility expense.
Other. Other noninterest expense totaled $10.1 million for the third quarter of 2012 compared to $11.7 million for the second quarter of 2012 and $10.2 million for the third quarter of 2011. The $1.5 million, or 13.2%, decrease from the second quarter of 2012 was due to lower OREO costs of $844,000, advertising costs of $189,000, professional fees of $114,000, and miscellaneous expense of $331,000. A decline in valuation adjustments drove the decrease in OREO expense. A lower level of promotional activities drove the decrease in advertising costs. The decline in professional fees was due to lower costs for the engagement of third party professional services. The decrease in miscellaneous expense reflects one-time severance costs recorded in the second quarter of 2012 due to office closings and the outsourcing of our item processing function. The $115,000, or 1.1%, decrease from the third quarter of 2011 was primarily due to lower postage expense reflective of our effort to convert from sending our clients paper statements to e-statements.
For the first nine months of 2012, other noninterest expense totaled $33.1 million, an increase of $92,000, or 0.3%, over the same period of 2011 primarily attributable to higher professional fees of $867,000 and OREO expense of $337,000, partially offset by lower advertising expense of $278,000, FDIC insurance fees of $433,000, and intangible amortization expense of $245,000. Professional fees increased due to higher audit fees and consulting fees. OREO expense increased due to higher carrying costs. Advertising expense declined due to improved cost controls over advertising for our free checking account products and a lower level of promotional activity. FDIC insurance fees declined due to a lower premium rate reflective of the revised rate structure implemented in mid-2011. The reduction in intangible amortization expense reflects the full amortization of certain core deposit intangibles from past acquisitions.
Our operating efficiency ratio (expressed as noninterest expense, excluding intangible amortization expense, as a percent of the sum of taxable-equivalent net interest income plus noninterest income) was 87.68% for the third quarter of 2012 compared to 90.88% for the second quarter of 2012 and 81.40% for the third quarter of 2011. For the first nine months of 2012, this ratio was 90.12% compared to 82.07% for the comparable period of 2011. Lower noninterest expense drove the decrease in this ratio compared to the second quarter of 2012. The increase in this ratio over both prior periods in 2011 reflects a declining level of net interest income contribution to operating revenues as well as higher noninterest expense. The increase when compared to the first nine months of 2011 also reflects the gain on sale of Visa stock realized in 2011. During 2012, we have continued to realize an elevated level of costs related to the management and resolution of nonperforming assets. We continue to review and evaluate opportunities to optimize our operations and reduce operating costs as well as better manage our discretionary expenses.
Income Taxes
We realized an income tax expense of $0.4 million in the third quarter of 2012 compared to a benefit of $1.3 million for the second quarter of 2012 and income tax expense of $1.0 million for the third quarter of 2011. For the first nine months of 2012, we realized an income tax benefit of $1.9 million compared to income tax expense of $2.5 million for the same period in 2011. A higher level of book taxable income drove the variance compared to the second quarter of 2012 and lower book taxable income drove the variance compared to the periods in 2011.
FINANCIAL CONDITION
Average assets totaled approximately $2.566 billion for the third quarter of 2012, a decrease of $58.2 million, or 2.2%, from the second quarter of 2012, and an increase of $56.3 million, or 2.2%, over the fourth quarter of 2011. Average earning assets were $2.209 billion for the third quarter of 2012, a decrease of $53.7 million, or 2.4%, from the second quarter of 2012, and an increase of $62.7 million, or 2.9%, over the fourth quarter of 2011. We discuss these variances in more detail below.
In the third quarter of 2012, our average investment portfolio increased $1.2 million, or 0.4%, from the second quarter of 2012 and decreased $26.0 million, or 8.4%, from the fourth quarter of 2011. As a percentage of average earning assets, the investment portfolio represented 12.8% in the third quarter of 2012, compared to 12.4% in the prior quarter and 14.3% in the fourth quarter of 2011. The increase in the average balance of the investment portfolio compared to the second quarter of 2012 was primarily attributable to
increases in mortgage backed securities, U.S. Government agencies, and municipal bonds that were partially offset by declines in U.S. Treasuries. The decrease in the average balance compared to the fourth quarter of 2011 was due to declines in U.S. Treasury and mortgage-backed securities, partially offset by increases to municipal bonds and U.S. Government Agencies. Deposits which require collateralization declined during the comparable periods which allowed for maturing U.S. Treasuries not to be replaced. When appropriate, we will continue to look to deploy a portion of the overnight funds position in the investment portfolio during the remainder of 2012.
The investment portfolio is a significant component of our operations and, as such, it functions as a key element of liquidity and asset/liability management. As of September 30, 2012, all securities are classified as available-for-sale, which offers management full flexibility in managing our liquidity and interest rate sensitivity without adversely impacting our regulatory capital levels. It is neither management’s intent nor practice to participate in the trading of investment securities for the purpose of recognizing gains and therefore we do not maintain a trading portfolio. Securities in the available-for-sale portfolio are recorded at fair value with unrealized gains and losses associated with these securities recorded net of tax, in the accumulated other comprehensive income (loss) component of shareowners’ equity.
At September 30, 2012, the investment portfolio maintained a net pre-tax unrealized gain of $1.0 million compared to $1.0 million and $1.7 million at June 30, 2012 and December 31, 2011, respectively. The decrease in the unrealized gains compared to the fourth quarter of 2011 resulted from declines in U.S. Treasuries. Yields increased slightly on the short-end of the Treasury curve during that period, resulting in lower prices.
At quarter end, there were 92 positions with unrealized losses totaling approximately $0.1 million. The positions consisted of Ginnie Mae (“GNMA”) mortgage-backed securities, Small Business Administration (“SBA”) securities, a Federal Farm Credit Bank bond (“FFCB”), and municipal bonds. Both the GNMA and SBA securities carry the full faith and credit guarantee of the U.S. Government and float to the prime rate. The FFCB bond remains “AAA” rated by Moody’s, and the municipal bonds are either pre-refunded with U.S. Government securities or carry a minimum rating of “AA-”. All debt securities with unrealized losses are not considered impaired, and are expected to mature at par. We also maintain a $0.6 million unrealized loss on a preferred stock investment that maintained a zero book value as of September 30, 2012, June 30, 2012, and December 31, 2011. No additional impairment has been recorded in 2012, but we continue to closely monitor the fair value of this security as the issuer of this security continues to experience negative operating trends. This unrealized loss is reflected in the unrealized gains previously discussed.
The average maturity of the total portfolio at September 30, 2012 was 1.66 years compared to 1.53 years and 1.39 years at June 30, 2012 and December 31, 2011, respectively. The average life of the total portfolio in the third quarter of 2012 increased slightly compared to both periods as U.S. Treasuries and municipal bonds with maturities out to three years were purchased.
Loans
When compared to the second quarter of 2012 and the fourth quarter of 2011, average loans declined by $29.6 million and $105.5 million, respectively. Most loan categories have experienced declines with the reduction primarily in the commercial real estate and residential categories. Our core loan portfolio continues to be impacted by normal amortization and a higher level of payoffs that have outpaced our new loan production. New loan production continues to be impacted by weak loan demand attributable to the trend toward consumers and businesses deleveraging, the lack of consumer confidence, and a persistently sluggish economy.
The resolution of problem loans, which has the effect of lowering the loan portfolio as loans are either charged off or transferred to OREO, also contributed to the overall decline. During the third quarter of 2012, loan charge-offs and loans transferred to OREO accounted for $6.0 million, or 26%, of the net reduction in total loans of $22.9 million from the second quarter of 2012. Compared to the fourth quarter of 2011, loan resolution accounted for $31.3 million, or 33%, of the net reduction in loans of $95.4 million. The problem loan resolutions and reductions in portfolio balances noted in this paragraph are based on “as of” balances, not averages.
Efforts to stimulate new loan growth remain ongoing and while we strive to identify opportunities to increase loans outstanding and enhance our loan portfolio’s overall contribution to earnings, we will only do so by adhering to sound lending principles applied in a prudent and consistent manner. Thus, we will not relax our underwriting standards in order to achieve designated growth goals and, where appropriate, have adjusted our standards to reflect risks inherent in the current economic environment.
Nonperforming Assets
Nonperforming assets (nonaccrual loans and OREO) totaled $127.2 million at the end of the third quarter of 2012 compared to $132.8 million at the end of the second quarter of 2012 and $137.6 million at the end of the fourth quarter of 2011. Nonaccrual loans totaled $74.1 million, a decrease of $0.7 million from the second quarter of 2012 and $0.9 million from the fourth quarter of 2011, reflective of loan charge-offs and the migration of loans to OREO, which outpaced gross additions. Gross additions to nonaccrual status were up slightly during the third quarter, but have slowed noticeably during 2012. The balance of OREO totaled $53.2 million at the end of the third quarter, a $4.9 million decrease from the second quarter of 2012 and $9.4 million from the fourth quarter of 2011. We continue to experience progress in our efforts to dispose of OREO by selling properties totaling $20.1 million during the first nine months of
2012. Nonperforming assets represented 5.10% of total assets at September 30, 2012 compared to 5.02% at June 30, 2012 and 5.21% at December 31, 2011.
Nonperforming assets are summarized in the table below.
Nonaccruing Loans:
815
6,382
39,701
22,805
4,192
Total Nonperforming Loans (“NPLs”)(1)
74,770
58,059
Total Nonperforming Assets (“NPAs”)
Past Due Loans 30 – 89 Days
16,695
19,425
Past Due Loans 90 Days or More (accruing)
Performing TDR’s
38,734
Nonperforming TDR’s(1)
13,570
Nonperforming Loans/Loans
4.83
4.80
4.61
Nonperforming Assets/Total Assets
Nonperforming Assets/Loans Plus OREO
Nonperforming Assets/Capital(2)
45.35
47.62
48.63
Allowance/Nonperforming Loans
Nonperforming TDR’s are included in the Nonaccrual/NPL totals
For computation of this percentage, “Capital” refers to shareowners’ equity plus the allowance for loan losses.
Activity within our nonperforming asset portfolio is provided in the table below.
Three Months Ended Sept 30,
Nine Months Ended Sept 30,
NPA Beginning Balance:
122,091
Change in Nonaccrual Loans:
61,076
65,700
Additions
15,578
14,895
48,532
60,009
(2,871
(5,186
(14,852
(17,788
Transferred to OREO
(2,830
(8,074
(11,578
(29,895
Paid Off/Payments
(5,806
(3,214
(11,734
(8,113
Restored to Accrual
(4,766
(6,101
(11,316
(16,517
53,396
Change in OREO:
61,016
57,937
8,361
Valuation Write-downs
(714
(703
(2,954
(2,828
(7,002
(7,238
(20,082
(24,864
(1
(240
(431
(336
61,196
NPA Net Change
(5,582
(7,499
(10,376
(9,045
NPA Ending Balance
We maintain an allowance for loan losses at a level sufficient to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Credit losses arise from borrowers’ inability or unwillingness to repay, and from other risks inherent in the lending process, including collateral risk, operations risk, concentration risk and economic risk. All related risks of lending are considered when assessing the adequacy of the loan loss reserve. The allowance for loan losses is established through a provision charged to expense. Loans are charged against the allowance when management believes collection of the principal is unlikely. The allowance for loan losses is based on management’s judgment of overall loan quality. This is a significant estimate based on a detailed analysis of the loan portfolio. The balance can and will change based on changes in the assessment of the loan portfolio’s overall credit quality. We evaluate the adequacy of the allowance for loan losses on a quarterly basis.
The allowance for loan losses was $30.2 million at September 30, 2012 compared to $29.9 million at June 30, 2012 and $31.0 million at December 31, 2011. The allowance for loan losses was 1.97% of outstanding loans and provided coverage of 41% of nonperforming loans at September 30, 2012 compared to 1.93% and 40%, respectively, at June 30, 2012 and 1.91% and 41%, respectively, at December 31, 2011. It is management’s opinion that the allowance at September 30, 2012 is adequate to absorb losses inherent in the loan portfolio at quarter-end.
Average total deposits were $2.075 billion for the third quarter of 2012, a decrease of $60.2 million, or 2.8%, from the second quarter of 2012 and higher by $42.5 million, or 2.1%, from the fourth quarter of 2011. The decrease in deposits when compared to the second quarter of 2012 resulted from lower public funds and certificates of deposit, partially offset by growth in noninterest bearing accounts, regular savings, and money market accounts. Compared to the fourth quarter of 2011, the increase was driven primarily by higher public fund balances, savings and noninterest bearing deposits. This was partially offset by a reduction of certificates of deposit. The seasonal low in public fund balances generally occurs in the fourth quarter, and these balances are anticipated to increase through the first quarter of 2013.
Our mix of deposits continues to improve as higher cost certificates of deposit are replaced with lower rate non-maturity deposits and noninterest bearing demand accounts. Prudent pricing discipline will continue to be the key to managing our mix of deposits. Therefore, we do not attempt to compete with higher rate paying competitors for deposits.
During the fourth quarter of 2012, we may realize some attrition in noninterest bearing deposit balances due to the unlimited government guarantee on noninterest bearing accounts, which if not extended, is set to expire at year-end. Our average noninterest bearing deposits represented 29.2% of our total deposits during the third quarter of 2012.
MARKET RISK AND INTEREST RATE SENSITIVITY
Market Risk and Interest Rate Sensitivity
Overview. Market risk management arises from changes in interest rates, exchange rates, commodity prices, and equity prices. We have risk management policies to monitor and limit exposure to market risk and do not participate in activities that give rise to significant market risk involving exchange rates, commodity prices, or equity prices. In asset and liability management activities, our policies are designed to minimize structural interest rate risk.
Interest Rate Risk Management. Our net income is largely dependent on net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or re-price on a different basis than interest-earning assets. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income. Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds, such as noninterest-bearing deposits and shareowners’ equity.
We have established a comprehensive interest rate risk management policy, which is administered by management’s Asset/Liability Management Committee (“ALCO”). The policy establishes limits of risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity (“EVE”) at risk) resulting from a hypothetical change in interest rates for maturities from one day to 30 years. We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology used by us. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals
of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan clients’ ability to service their debts, or the impact of rate changes on demand for loan, and deposit products.
We prepare a current base case and four alternative interest rate simulations (Down 100, Up 100, Up 200 and Up 300) basis points, at least once per quarter, and report the analysis to the Board of Directors. In addition, more frequent simulations may be produced when interest rates are particularly uncertain or when other business conditions so dictate.
Our interest rate risk management goal is to avoid unacceptable variations in net interest income and capital levels due to fluctuations in market rates. Management attempts to achieve this goal by balancing, within policy limits, the volume of floating-rate liabilities with a similar volume of floating-rate assets, by keeping the average maturity of fixed-rate asset and liability contracts reasonably matched, by maintaining our core deposits as a significant component of our total funding sources, and by adjusting pricing rates to market conditions on a continuing basis.
The balance sheet is subject to testing for interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by plus or minus 100, 200, and 300 basis points (“bp”), although we may elect not to use particular scenarios that we determined are impractical in a current rate environment. It is management’s goal to structure the balance sheet so that net interest earnings at risk over a 12-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.
We augment our interest rate shock analysis with alternative external interest rate scenarios on a quarterly basis. These alternative interest rate scenarios may include non-parallel rate ramps.
Analysis. Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
ESTIMATED CHANGES IN NET INTEREST INCOME (1)
Changes in Interest Rates
+300 bp
+200 bp
+100 bp
-100 bp
Policy Limit (±)
10.0
7.5
5.0
-1.6
0.6
1.3
-1.0
0.3
2.1
2.2
-0.8
The net interest income at risk position declined for the third quarter of 2012, when compared to the second quarter of 2012, for all rate scenarios. Our largest exposure in the rising rate scenarios is at the up 300 bp level, with a measure of -1.6%, which is still within our policy limit of +/-10.0%. This is unfavorable over the prior quarter reflecting lower levels of repricing assets, primarily overnight funds, partially offset with lower levels of interest bearing non-maturity deposits and repurchase agreements. All measures of net interest income at risk are within our prescribed policy limits.
The measures of equity value at risk indicate our ongoing economic value by considering the effects of changes in interest rates on all of our cash flows, and discounting the cash flows to estimate the present value of assets and liabilities. The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of our net assets.
ESTIMATED CHANGES IN ECONOMIC VALUE OF EQUITY(1)
12.5
3.5
6.9
6.5
-5.1
7.9
7.0
-4.4
Our risk profile, as measured by EVE, declined for the third quarter of 2012 when compared to the second quarter of 2012, in all rate scenarios. In the rising rate scenarios, our largest exposure is at the up 300 bp scenario, with a measure of 3.5%, which is still within our policy limit of +/-12.5%. The variances from the prior quarter were attributable to decreases in both Treasury and FHLB curves, reflecting declines in the market value of loans, more than offsetting the increase in the market value of deposits and borrowings. All measures of economic value of equity are within our prescribed policy limits.
Down 200 and 300 bp scenarios have been excluded due to the current historically low interest rate environment as a result of the Federal Reserve’s near-zero interest rate policy.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies that are formulated and monitored by our ALCO and senior management, and which take into account the marketability of assets, the sources and stability of funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. Our principal source of funding has been our client deposits, supplemented by our short-term and long-term borrowings, primarily from securities sold under repurchase agreements, federal funds purchased and FHLB borrowings. We believe that the cash generated from operations, our borrowing capacity and our access to capital resources are sufficient to meet our future operating capital and funding requirements.
As of September 30, 2012, we had the ability to generate $729.8 million in additional liquidity through all of our available resources. In addition to the primary borrowing outlets mentioned above, we also have the ability to generate liquidity by borrowing from the Federal Reserve Discount Window and through brokered deposits. We recognize the importance of maintaining liquidity and have developed a Contingency Liquidity Plan, which addresses various liquidity stress levels and our response and action based on the level of severity. We periodically test our credit facilities for access to the funds, but also understand that as the severity of the liquidity level increases that certain credit facilities may no longer be available. The liquidity available to us at this time is considered sufficient to meet our ongoing needs.
We view our investment portfolio as a source of liquidity and have the option to pledge the portfolio as collateral for borrowings or deposits, and/or sell selected securities. The portfolio consists of debt issued by the U.S. Treasury, U.S. governmental and federal agencies, and municipal governments. The weighted average life of the portfolio is approximately 1.66 years and as of quarter-end had a net unrealized pre-tax gain of $1.0 million.
Our average liquidity (defined as funds sold plus interest bearing deposits with other banks less funds purchased) was $386.0 million during the third quarter of 2012 compared to an average net overnight funds sold position of $411.3 million in the second quarter of 2012 and an average overnight funds sold position of $191.8 million in the fourth quarter of 2011. The lower balance when compared to the second quarter of 2012 reflects lower levels of public funds deposits partially offset by a decrease in the loan portfolio. The higher balances when compared to the fourth quarter of 2011 reflect higher levels of public funds and savings accounts, in addition to liquidity generated through the loan and investment portfolios as these portfolios have declined period over period.
Capital expenditures are expected to approximate $3.0 million over the next 12 months, which consist primarily of office remodeling, office equipment and furniture, and technology purchases. We believe that these capital expenditures will be funded with existing resources without impairing our ability to meet our on-going obligations.
Borrowings
At September 30, 2012, advances from the FHLB consisted of $45.0 million in outstanding debt consisting of 47 notes, which are used to match-fund specific loans. During the first nine months of 2012, the Bank made FHLB principal advance payments totaling approximately $2.5 million, paid off two advances totaling approximately $0.2 million and obtained two new FHLB advances totaling $3.1 million. The FHLB notes are collateralized by a blanket floating lien on all of our 1-4 family residential mortgage loans, commercial real estate mortgage loans and home equity mortgage loans.
We have issued two junior subordinated deferrable interest notes to our wholly-owned Delaware statutory trusts. The first note for $30.9 million was issued to CCBG Capital Trust I in November 2004. The second note for $32.0 million was issued to CCBG Capital Trust II in May 2005. The interest payment for the CCBG Capital Trust I borrowing is due quarterly and adjusts quarterly to a variable rate of LIBOR plus a margin of 1.90%. This note matures on December 31, 2034. The interest payment for the CCBG Capital Trust II borrowing is due quarterly and adjusts annually to a variable rate of LIBOR plus a margin of 1.80%. This note matures on June 15, 2035. The proceeds of these borrowings were used to partially fund acquisitions. Under the terms of each trust preferred securities note, in the event of default or if we elect to defer interest on the note, we may not, with certain exceptions, declare or pay dividends or make distributions on our capital stock or purchase or acquire any of our capital stock. As of February 2012, in consultation with the Federal Reserve, we elected to defer the interest payments on the notes. We will, however, continue the accrual of the interest on the notes in accordance with our contractual obligations.
In accordance with a regulatory agreement (discussed in further detail in our 2011 Form 10-K “Holding Company Resolution”), CCBG must receive approval from the Federal Reserve prior to incurring new debt, refinancing existing debt, or making interest payments on its trust preferred securities.
Capital
Equity capital was $250.4 million as of September 30, 2012, compared to $249.0 million as of June 30, 2012 and $251.9 million as of December 31, 2011. For the same periods, our leverage ratio was 9.83%, 9.60%, and 10.26%, respectively, and our tangible capital ratio was 6.86%, 6.40%, and 6.51%, respectively. Our risk-adjusted capital ratio of 15.80% at September 30, 2012, exceeded the 10% threshold to be designated as “well-capitalized” under the risk-based regulatory guidelines.
During the first nine months of 2012, shareowners’ equity decreased by approximately $1.5 million, or 2.4%, on an annualized basis. During this same period, shareowners’ equity was negatively impacted by a net loss of $1.7 million and a $0.4 million decline in the net unrealized gain on securities. Shareowners’ equity was positively impacted by the issuance of stock totaling $0.5 million and stock compensation of $0.1 million.
At September 30, 2012, our common stock had a book value of $14.54 per diluted share compared to $14.48 at June 30, 2012 and $14.68 at December 31, 2011. Book value is impacted by changes in the amount of our net unrealized gain or loss on investment securities available-for-sale and changes to the amount of our unfunded pension liability both of which are recorded through other comprehensive income. At September 30, 2012, the net unrealized gain on investment securities available for sale was $0.6 million and the amount of our unfunded pension liability was $24.6 million.
State and federal regulations place certain restrictions on the payment of dividends by both CCBG and the Bank. Florida law and Federal regulations limit the amount of dividends that the Bank can pay annually to us. Pursuant to a regulatory agreement (discussed in further detail within our 2011 Form 10-K “Federal Reserve Resolutions”), without prior approval, CCBG is prohibited from paying dividends to shareowners and CCB is prohibited from paying dividends to CCBG.
OFF-BALANCE SHEET ARRANGEMENTS
We do not currently engage in the use of derivative instruments to hedge interest rate risks. However, we are a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of our clients.
At September 30, 2012, we had $308.4 million in commitments to extend credit and $12.1 million in standby letters of credit. Commitments to extend credit are agreements to lend to a client so 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a client to a third party. We use the same credit policies in establishing commitments and issuing letters of credit as we do for on-balance sheet instruments.
If commitments arising from these financial instruments continue to require funding at historical levels, management does not anticipate that such funding will adversely impact its ability to meet on-going obligations. In the event these commitments require funding in excess of historical levels, management believes current liquidity, advances available from the FHLB and the Federal Reserve, and investment security maturities provide a sufficient source of funds to meet these commitments.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in our 2011 Form 10-K. The preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (“GAAP”) and reporting practices applicable to the banking industry requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates.
We have identified accounting for (i) the allowance for loan losses, (ii) valuation of goodwill and other intangible assets, and (iii) pension plans as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require our subjective and complex judgment as a result of the need to make estimates about the effects of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2011 Form 10-K.
Goodwill. Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets. We perform an impairment review on an annual basis during the fourth quarter or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. Impairment testing requires management to make significant judgments and estimates relating to the fair value of its reporting unit. Significant changes to our estimates, when and if they occur, could result in a non-cash impairment charge and thus have a material impact on our operating results for any particular reporting period. A goodwill impairment charge would not adversely affect the calculation of our risk based and tangible capital ratios.
Because the book value of our equity exceeded our market capitalization as of September 30, 2012, we considered the guidelines set forth in ASC Topic 350 to discern whether further testing for potential impairment was needed. Based on this assessment, we performed an interim impairment test which consists of two steps. Step one compares the estimated fair value of the reporting unit to its carrying amount. If the carrying amount exceeds the estimated fair value, Step two is performed by comparing the fair value of the reporting unit’s implied goodwill to the carrying value of goodwill. If the carrying value of the reporting unit’s goodwill exceeds the estimated fair value, an impairment charge is recorded equal to the excess. A more detailed discussion of the methodology and key assumptions utilized in this step process is included in Part II, Item 7, Critical Accounting Policies of our 2011 Form 10-K.
The Step one test we performed indicated that the carrying amount (including goodwill) of our reporting unit exceeded its estimated fair value. The Step two test indicated the estimated fair value of our reporting unit’s implied goodwill exceeded its carrying amount by approximately 69%, therefore, we concluded that goodwill was not impaired as of September 30, 2012. Future circumstances and/or conditions may result in an impairment of our goodwill, which could have a material adverse affect on our results of operations in a future period. Such circumstances and/or conditions could include, but are not limited to a decline in our stock price, revision to our internal financial forecasts, adverse changes in the fair value of our assets and liabilities, and/or market information indicating a decline in the fair value of comparable financial institutions used to estimate the fair value of the Company. We will continue to evaluate goodwill as defined by ASC Topic 350.
40
TABLE IAVERAGE BALANCES & INTEREST RATES
Average
Balances
Interest
Rate
Assets:
Loans(1)(2)
21,366
5.51
23,922
5.69
1,569,420
64,943
5.53
1,700,570
72,488
5.70
Taxable Securities(2)
214,431
691
1.28
248,138
1.32
224,584
2,215
241,321
1.40
Tax-Exempt Securities
67,446
0.97
55,388
231
1.67
62,509
486
1.04
63,457
865
1.82
Funds Sold
386,027
0.26
231,681
0.23
390,122
0.25
241,195
Total Earning Assets
4.05
4.52
2,246,635
4.06
2,246,543
Cash & Due From Banks
47,207
47,252
48,112
48,539
Allowance For Loan Losses
(30,260
(30,969
(31,077
(32,914
340,126
344,041
345,361
345,725
TOTAL ASSETS
2,609,031
2,607,893
Liabilities:
740,178
144
726,652
790,733
765,209
742
0.13
287,250
60
282,378
281,746
198
0.09
281,798
362
Savings Accounts
179,445
0.05
153,748
173,346
64
150,357
263,007
253
0.38
324,951
571
0.70
273,839
914
0.45
341,286
2,091
0.82
1,469,880
1,487,729
0.24
1,519,663
0.15
1,538,650
59,184
0.48
64,160
54,289
75,976
0.53
Subordinated Note Payable
2.31
2.11
2.35
2.14
38,494
3.85
46,435
3.99
41,123
3.91
48,795
3.98
Total Interest Bearing Liabilities
1,630,445
1,661,211
0.43
1,677,962
1,726,308
0.47
605,602
574,184
604,333
559,316
78,446
63,954
73,795
59,635
TOTAL LIABILITIES
2,314,493
2,299,349
2,356,090
2,345,259
TOTAL SHAREOWNERS’ EQUITY
252,941
262,634
TOTAL LIABILITIES AND SHAREOWNERS’ EQUITY
Interest Rate Spread
3.73
4.09
4.07
Net Interest Margin(3)
3.81
4.18
Average balances include nonaccrual loans. Interest income includes fees on loans of $378,000 and $1.2 million for the three and nine months ended September 30, 2012 versus $345,000 and $1.1 million for the comparable periods ended September 30, 2011.
Interest income includes the effects of taxable equivalent adjustments using a 35% tax rate.
(3)
Taxable equivalent net interest income divided by average earning assets.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Market Risk and Interest Rate Sensitivity” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, above, which is incorporated herein by reference. Management has determined that no additional disclosures are necessary to assess changes in information about market risk that have occurred since December 31, 2011.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of September 30, 2012, the end of the period covered by this Form 10-Q, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer each concluded that as of September 30, 2012, the end of the period covered by this Form 10-Q, we maintained effective disclosure controls and procedures.
Changes in Internal Control over Financial Reporting
Our management, including the Chief Executive Officer and Chief Financial Officer, has reviewed our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). There have been no significant changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II.
OTHER INFORMATION
We are party to lawsuits arising out of the normal course of business. In management’s opinion, there is no known pending litigation, the outcome of which would, individually or in the aggregate, have a material effect on our consolidated results of operations, financial position, or cash flows.
In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our 2011 Form 10-K, as updated in our subsequent quarterly reports. The risks described in our 2011 Form 10-K, as updated, are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
None.
(A) Exhibits
31.1
Certification of William G. Smith, Jr., Chairman, President and Chief Executive Officer of Capital City Bank Group, Inc., Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2
Certification of J. Kimbrough Davis, Executive Vice President and Chief Financial Officer of Capital City Bank Group, Inc., Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1
Certification of William G. Smith, Jr., Chairman, President and Chief Executive Officer of Capital City Bank Group, Inc., Pursuant to 18 U.S.C. Section 1350.
32.2
Certification of J. Kimbrough Davis, Executive Vice President and Chief Financial Officer of Capital City Bank Group, Inc., Pursuant to 18 U.S.C. Section 1350.
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned Chief Financial Officer hereunto duly authorized.
CAPITAL CITY BANK GROUP, INC. (Registrant)
/s/ J. Kimbrough Davis
J. Kimbrough Davis
Executive Vice President and Chief Financial Officer
(Mr. Davis is the Principal Financial Officer and has been duly authorized to sign on behalf of the Registrant)
Date: November 9, 2012
Exhibit Index
Exhibit
Description